UNITED STATESSECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
|X|
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
OR
|_|
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission file number 1-10258
Tredegar Corporation
(Exact Name of Registrant as Specified in Its Charter)
Registrant’s Telephone Number, Including Area Code: (804) 330-1000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes |X| No |_|
The number of shares of Common Stock, no par value, outstanding as of July 31, 2003: 38,081,140.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
Tredegar CorporationConsolidated Balance Sheets(In Thousands)(Unaudited)
June 30, 2003
Dec. 31, 2002
Assets
Current assets:
Cash and cash equivalents
$
113,074
109,928
Accounts and notes receivable
90,365
92,892
Income taxes recoverable
60,179
12,863
Inventories
46,260
43,969
Deferred income taxes
9,294
20,976
Prepaid expenses and other
4,174
3,962
Total current assets
323,346
284,590
Property, plant and equipment, at cost
546,122
505,093
Less accumulated depreciation
274,190
254,490
Net property, plant and equipment
271,932
250,603
Net non-current assets of Therics held for sale
—
10,406
Venture capital investments
93,765
Other assets and deferred charges
74,529
66,316
Goodwill and other intangibles
139,845
132,282
Total assets
809,652
837,962
Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable
43,848
35,861
Accrued expenses
46,307
42,409
Current portion of long-term debt
62,500
55,000
Total current liabilities
152,655
133,270
Long-term debt
167,592
204,280
54,856
27,443
Other noncurrent liabilities
10,368
10,037
Total liabilities
385,471
375,030
Shareholders’ equity:
Common stock, no par value
104,153
108,389
Common stock held in trust for savings restoration plan
(1,212
)
Unrealized gain on available-for-sale securities
1,069
586
Foreign currency translation adjustment
4,731
(4,422
Loss on derivative financial instruments
142
(842
Minimum pension liability
(3,310
Retained earnings
318,608
363,743
Total shareholders’ equity
424,181
462,932
Total liabilities and shareholders’ equity
See accompanying notes to financial statements.
2
Tredegar CorporationConsolidated Statements of Income(In Thousands, except per share amounts)(Unaudited)
Second Quarter Ended June 30
Six Months Ended June 30
2003
2002
Revenues:
Sales
181,574
200,554
363,619
378,006
Other income (expense), net
428
366
1,151
416
182,002
200,920
364,770
378,422
Costs and expenses:
Cost of goods sold
149,836
153,968
299,337
291,368
Freight
4,532
4,051
8,720
7,794
Selling, general and administrative
12,313
13,104
25,201
24,981
Research and development
5,076
5,058
10,379
10,674
Amortization of intangibles
67
11
134
78
Interest expense
1,683
2,310
3,786
4,498
Plant shutdowns, asset impairments and restructurings
5,882
268
5,967
1,264
Unusual items
1,067
179,389
178,770
354,591
340,657
Income before income taxes
2,613
22,150
10,179
37,765
Income taxes
932
7,879
3,639
13,435
Income from continuing operations
1,681
14,271
6,540
24,330
Discontinued operations:
Loss from venture capital investment activities (including an after-tax loss on the sale of the venture capital investment portfolio of $49,216 in 2003)
(12,160
(49,516
(19,329
Income (loss) from operations of Molecumetics (including an after-tax gain on the sale of intellectual property of $891 in 2003 and an expected loss on disposal of $3,900 in 2002)
891
(5,446
(7,753
Income (loss) from discontinued operations
(17,606
(48,625
(27,082
Net income (loss)
2,572
(3,335
(42,085
(2,752
Earnings (loss) per share:
Basic:
Continuing operations
.04
.37
.17
.64
Discontinued operations
.02
(.46
(1.28
(.71
.06
(.09
(1.11
(.07
Diluted:
.36
.63
(.45
(1.26
(.70
(1.09
Shares used to compute earnings (loss) per share:
Basic
38,047
38,270
38,113
38,219
Diluted
38,418
39,111
38,498
38,990
Dividends per share
.08
3
Tredegar CorporationConsolidated Statements of Cash Flows(In Thousands)(Unaudited)
Cash flows from operating activities:
Adjustments for noncash items:
Noncash loss from discontinued operations
6,000
Depreciation
15,669
16,459
33,365
1,748
Accrued pension income and postretirement benefits
(2,664
(4,862
Loss on venture capital investments
70,256
27,388
Loss on asset impairments
2,023
Changes in assets and liabilities:
6,352
(18,965
(175
4,345
(47,148
3,316
25
(185
6,129
(1,838
4,388
(1,455
Other, net
1,164
(1,450
Net cash provided by operating activities
47,433
27,827
Cash flows from investing activities:
Capital expenditures
(26,083
(13,851
(2,807
(11,137
Proceeds from the sale of venture capital investments
21,504
6,408
(116
(2,361
Net cash used in investing activities
(7,502
(20,941
Cash flows from financing activities:
Dividends paid
(3,050
(3,064
Net decrease in borrowings
(29,188
(5,097
Repurchases of Tredegar common stock
(5,170
Proceeds from exercise of stock options
623
1,009
Net cash used in financing activities
(36,785
(7,152
Increase (decrease) in cash and cash equivalents
3,146
(266
Cash and cash equivalents at beginning of period
96,810
Cash and cash equivalents at end of period
96,544
4
TREDEGAR CORPORATIONNOTES TO THE CONSOLIDATED INTERIM FINANCIAL STATEMENTS(Unaudited)
1.
In the opinion of management, the accompanying consolidated financial statements of Tredegar Corporation and Subsidiaries (“Tredegar”) contain all adjustments necessary to present fairly, in all material respects, Tredegar’s consolidated financial position as of June 30, 2003, the consolidated results of operations for the three and six months ended June 30, 2003 and 2002, and the consolidated cash flows for the six months ended June 30, 2003 and 2002. All such adjustments are deemed to be of a normal, recurring nature. These financial statements should be read in conjunction with the consolidated financial statements and related notes included in Tredegar’s Annual Report on Form 10-K for the year ended December 31, 2002. The results of operations for the six months ended June 30, 2003, are not necessarily indicative of the results to be expected for the full year.
2.
See pages 11 and 13 for information on unusual items and losses associated with plant shutdowns, asset impairments and restructurings. During the second quarter of 2003 Tredegar began reporting losses associated with plant shutdowns, asset impairments and restructurings as a separate line in the Consolidated Statements of Income and Operating Profit by Segment table. These amounts were previously classified as unusual items. Prior periods have been reclassified to conform to the new presentation.
On March 7, 2003, Tredegar Investments, Inc. (“Tredegar Investments”) reached definitive agreements to sell substantially all of its portfolio of private equity partnership interests to GS Vintage Funds II, which are investment partnerships managed by Goldman Sachs Asset Management’s Private Equity Group. On the same date and in a separate transaction, Tredegar Investments also agreed to sell to W Capital Partners, an independent private equity manager, the subsidiary funds that hold substantially all of Tredegar Investments’ direct venture capital investments. The sale of these fund interests included the assumption by the buyer of Tredegar Investments’ obligations to make additional capital contributions to those funds in the future.
The sale to W Capital Partners of the subsidiary funds that hold the direct investments occurred on March 7, 2003. The sale of the private equity fund interests occurred in a series of closings.
Net proceeds from the sales totaled $21.5 million. An additional $54.4 million of proceeds, in the form of income tax recoveries, are expected in mid-2004 from the carry-back of 2003 capital losses generated by these sales against gains realized in 2000 by Tredegar Investments.
The agreements governing these transactions contain customary contingent indemnification provisions that Tredegar believes will not have a material effect on its financial position or results of operations.
The operating results from venture capital investment activities have been reported as discontinued operations and results for prior periods have been restated. Cash flows from venture capital investment activities have not been separately disclosed in the accompanying Consolidated Statements of Cash Flows. Discontinued operations for the six months ended June 30, 2003, also includes an after-tax loss on the sale of $49.2 million.
5
Tredegar Investments still holds 860,642 shares of Vascular Solutions, Inc. (NASDAQ: VASC) and 813,455 shares of Illumina, Inc. (NASDAQ: ILMN). These securities relate to Tredegar Investments’ earlier venture capital investment activities and are classified as available-for-sale securities. These holdings, which are included in the Consolidated Balance Sheets in “Other assets and deferred charges” at June 30, 2003 ($4.2 million market value), and “Venture capital investments” at December 31, 2002 ($3.6 million market value), are stated at market value with unrealized gains shown directly in equity net of related deferred income taxes.
On March 22, 2002, Tredegar announced its intent to divest its biotech operations. Operations were ceased at Molecumetics on July 2, 2002. The operating results of Molecumetics have been reported as discontinued operations.
Discontinued operations are shown net of income taxes. Income taxes related to discontinued venture capital investment activities include income tax benefits of $6.8 million, $20.7 million and $10.9 million for the second quarter ended June 30, 2002 and the six months ended June 30, 2003 and 2002, respectively. Income taxes related to discontinued operations of Molecumetics include income tax expense of $480,000 for the second quarter and six months ended June 30, 2003, and income tax benefits of $2.9 million and $4.2 million for the second quarter and six months ended June 30, 2002, respectively.
During the first quarter, we suspended efforts to sell Therics, Inc. (“Therics”), our biotech subsidiary, pending a reassessment of strategic options. As a result, the long-lived assets of Therics are no longer classified as held for sale and an adjustment of $1.1 million to catch up depreciation was recorded during the first quarter as an unusual item.
3.
The components of other comprehensive income or loss are as follows:
Three Months Ended June 30
(In Thousands)
Other comprehensive income (loss):
Available-for-sale securities adjustment, net of reclassification adjustment
(1,828
483
(5,954
6,102
2,838
9,153
720
Derivative financial instrument adjustment
588
(98
984
1,140
Minimum pension liability adjustment
Comprehensive income (loss)
10,331
(2,423
(31,465
(6,846
6
4.
The components of inventories are as follows:
Finished goods
8,933
7,841
Work-in-process
4,248
3,905
Raw materials
22,466
21,076
Stores, supplies and other
10,613
11,147
Total
5.
Basic earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding. Diluted earnings per share is computed by dividing net income by the weighted average common and potentially dilutive common equivalent shares outstanding, determined as follows:
Weighted average shares outstanding used to compute basic earnings per share
Incremental shares issuable upon the assumed exercise of stock options
371
841
385
771
Shares used to compute diluted earnings per share
Incremental shares issuable upon the assumed exercise of outstanding stock options are computed using the average market price during the related period. At June 30, 2003, 2,447,225 options were excluded from the calculation of incremental shares issuable upon the assumed exercise of stock options due to their anti-dilutive effect on earnings per share for the period.
6.
Pursuant to our stock option plans, 594,500 stock options were granted during the first quarter of 2002. None were granted during the second quarter of 2002, the first quarter of 2003 or the second quarter of 2003. The 2002 stock options were granted to officers, management and other employees.
We account for the fair value of stock options granted to employees and directors in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” Accordingly, no compensation expense has been recognized since the exercise price of the options was equal to the fair value of the underlying common stock on the date of grant. Had compensation cost for our stock-based compensation plans been determined based on the fair value of the options at the grant dates consistent with the method of accounting under Statement of Financial Accounting Standards No. 123, “Accounting for Stock Based Compensation,” our income and diluted earnings per share from continuing operations would have been reduced to the pro forma amounts indicated below:
7
(In Thousands, except per share data)
Income from continuing operations:
As reported
Stock-based compensation cost, net of tax, based on the fair value method
(545
(567
(1,090
(1,134
Pro forma income from continuing operations
1,136
13,704
5,450
23,196
Diluted earnings per share from continuing operations:
Pro forma
.03
.35
.14
.59
For the purposes of the above presentation, the fair value of each option was estimated as of the grant date using the Black-Scholes option-pricing model. The weighted-average assumptions used in this model are provided below:
Dividend yield
.9
%
Weighted average market price at date of grant:
Volatility percentage
45.0
Officers and management
18.71
Weighted average risk-free interest rate
4.7
Other employees
18.90
Holding period (years):
Officers
7.0
Estimated weighted average fair value of options per share at date of grant:
Management
5.0
9.14
3.0
8.02
6.20
7.
The effective tax rate from continuing operations was 35.7% for the three months ended June 30, 2003, and 35.8% for the six months ended June 30, 2003. The effective tax rate from continuing operations was 35.6% for the three months ended June 30, 2002, and 35.6% for the six months ended June 30, 2002.
8.
On April 16, 2003, we extended our $100 million 364-day credit facility for one year. There are no amounts currently borrowed under this facility. Effective August 1, 2003, the fully borrowed spread over LIBOR charged at various debt-to-total capitalization levels is as follows:
Fully-Borrowed Spread Over LIBOR Under Credit Agreements (Basis Points)
Debt-to-Total Capitalization Ratio
364-Day Credit Facility (None Borrowed at 6/30/03)
Term Loan ($225 Million Outstanding at 6/30/03)
> 55% and <= 60%
100.0
> 50% and <= 55%
87.5
> 40% and <= 50%
162.5
75.0
> 35% and <= 40%
150.0
62.5
> 30% and <= 35%
<= 30%
125.0
50.0
8
9.
Information by business segment is reported below. There are no accounting transactions between segments and no allocations to segments. There have been no significant changes to identifiable assets by segment other than for Tredegar Investments due to the sale of substantially all of our venture capital investment portfolio (see Note 2). Net sales (sales less freight) and operating profit from ongoing operations are the measures of sales and operating profit used by the chief operating decision maker of each segment for purposes of assessing performance. See Note 2 regarding the reclassification of unusual items and losses associated with plant shutdowns, asset impairments and restructurings.
Tredegar CorporationNet Sales and Operating Profit by Segment(In Thousands)(Unaudited)
Net Sales
Film Products
88,410
97,285
181,794
186,194
Aluminum Extrusions
88,632
99,124
173,105
183,830
Therics
94
188
Total net sales
177,042
196,503
354,899
370,212
Add back freight
Sales as shown in the Consolidated Statements of Income
Operating Profit
Film Products:
Ongoing operations
10,104
18,705
24,032
36,797
(2,609
(295
(2,694
(1,095
7,495
18,410
21,338
35,702
Aluminum Extrusions:
4,855
10,277
6,066
15,630
(388
27
(169
4,467
10,304
5,678
15,461
Therics:
(3,306
(3,134
(6,603
(6,827
Restructurings
(1,704
(1,067
(5,010
(9,374
Total operating profit
6,952
25,580
17,642
44,336
Interest income
409
496
833
1,050
Corporate expenses, net
3,065
1,616
4,510
3,123
9
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Critical Accounting Policies
In the ordinary course of business, we make a number of estimates and assumptions relating to the reporting of results of operations and financial position in the preparation of financial statements in conformity with generally accepted accounting principles. We believe the estimates, assumptions and judgments described in the section “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies” of our Annual Report on Form 10-K for the year ending December 31, 2002, have the greatest potential impact on our financial statements, so we consider these to be our critical accounting policies. These policies include our accounting for impairment of long-lived assets and goodwill, investments, deferred tax assets and pension benefits. These policies require management to exercise judgments that are often difficult, subjective and complex due to the necessity of estimating the effect of matters that are inherently uncertain. Actual results could differ significantly from those estimates under different assumptions and conditions. We believe the consistent application of these policies enables us to provide readers of our financial statements with useful and reliable information about our operating results and financial condition. There has been no significant change in these policies, or the estimates used in the application of these policies since our 2002 fiscal year-end.
Results of Operations
Second Quarter 2003 Compared with Second Quarter 2002
Net income for the second quarter of 2003 was $2.6 million (6 cents per share) compared with a net loss of $3.3 million (9 cents per share) in 2002. Net income from continuing operations was $1.7 million (4 cents per share) in 2003 compared with $14.3 million (36 cents per share) in 2002.
Discontinued operations in 2003 include an after-tax gain of $891,000 on the sale of intellectual property related to Molecumetics. Discontinued operations in 2002 include an after-tax loss of $5.4 million related to Molecumetics and an after-tax loss of $12.2 million related to venture capital investment activities. See Note 2 on page 5 for more information on discontinued operations.
Overall, sales in 2003 decreased 9.5% compared with 2002. Net sales (sales less freight) at both Film Products and Aluminum Extrusions declined primarily due to lower sales volume. For more information on net sales, see the business segment review beginning on page 15.
Gross profit (sales minus cost of goods sold and freight) as a percentage of sales decreased to 15% in 2003 from 21.2% in 2002. At Film Products, an overall lower gross profit margin was driven by the loss of certain domestic backsheet business (lower overall contribution to cover fixed costs), higher raw material prices, lower volume from a seasonal domestic customer due to the unusual amount of rain during the spring months and higher manufacturing costs on certain new products. At Aluminum Extrusions, the gross profit margin declined primarily due to lower volume, higher energy costs, higher insurance costs and the impact of the Canadian Dollar appreciating against the U.S. Dollar.
10
As a percentage of sales, selling, general and administrative (“SG&A”) expenses increased to 6.8% compared with 6.5% in 2002, due primarily to lower sales.
Research and development (“R&D”) expenses were $5.1 million in 2003 and 2002. R&D spending in 2003 at Therics ($3.1 million) and Film Products ($2 million) were about the same as last year.
Losses associated with plant shutdowns, asset impairments and restructurings in the second quarter of 2003 include:
•
Charges for severance costs in connection with restructurings in Film Products ($1.6 million), Therics ($1.2 million) and at corporate headquarters ($1.2 million; included in “Corporate expenses, net” in the Operating Profit by Segment tables on pages 9 and 15);
A pretax charge of $956,000 for asset impairments in Film Products;
A pretax charge of $388,000 related to an early retirement program in Aluminum Extrusions;
A pretax charge of $549,000 related to the estimated loss on the sublease of a portion of the Therics facility in Princeton, New Jersey; and
A pretax charge of $53,000 for additional costs incurred related to previously announced plant shutdowns in Film Products.
Losses associated with plant shutdowns, asset impairments and restructurings in the second quarter of 2002 of $268,000 primarily related to the shutdown of the films plant in Tacoma, Washington.
For more information on costs and expenses, see the business segment review beginning on page 15.
Interest income, which is included in “Other income (expense), net” in the Consolidated Statements of Income, was $409,000 in 2003 and $496,000 in 2002. Despite a higher average cash and cash equivalents balance, interest income was down due to lower average tax equivalent yield earned on cash equivalents (1.15% in 2003 and 2% in 2002). Our policy permits investment of excess cash in marketable securities that have the highest credit ratings and maturities of less than one year. The primary objectives of our policy are safety of principal and liquidity.
Interest expense was $1.7 million in 2003 compared with $2.3 million in 2002. Average debt outstanding and interest rates were as follows:
(In Millions)
Floating-rate debt with interest charged on a rollover basis at one-month LIBOR:
Average outstanding debt balance
186.5
175.0
Average interest rate
2.0
2.6
Floating-rate debt fixed via interest rate swaps in the second quarter of 2001 and maturing in the second quarter of 2003:
40.4
5.4
Fixed-rate and other debt:
9.3
13.4
7.2
Total debt:
236.2
263.4
2.8
3.6
The effective tax rate from continuing operations was 35.7% in the second quarter of 2003 and 35.6% in 2002.
Six Months 2003 Compared with Six Months 2002
The net loss for the first six months of 2003 was $42.1 million ($1.09 per share) compared with a net loss of $2.8 million (7 cents per share) in 2002. Net income from continuing operations was $6.5 million (17 cents per share) in 2003 compared with $24.3 million (63 cents per share) in 2002.
Discontinued operations for the first six months of 2003 include a loss of $49.5 million related to venture capital investment activities (including an after-tax loss on the sale of the venture capital investment portfolio of $49.2 million) and an after-tax gain of $891,000 on the sale of intellectual property related to Molecumetics. Discontinued operations in 2002 include an after-tax loss of $19.3 million related to venture capital investment activities and an after-tax loss of $7.8 million related to Molecumetics. See Note 2 on page 5 for more information on discontinued operations.
Overall, sales for the first six months of 2003 decreased 3.8% compared with 2002. Net sales (sales less freight) at both Film Products and Aluminum Extrusions declined primarily due to lower sales volume. For more information on net sales, see the business segment review beginning on page 15.
Gross profit (sales less cost of goods sold and freight) as a percentage of sales decreased to 15.3% in the first six months of 2003 from 20.9% in 2002, and was primarily due to the reasons described in the second quarter decline (see page 10).
12
As a percentage of sales, SG&A expenses increased to 6.9% compared with 6.6% in 2002, primarily due to lower sales.
R&D expenses for the first six months declined to $10.4 million in 2003 ($6.4 million for Therics and $4 million for Film Products) from $10.7 million in 2002 ($6.6 million for Therics and $4.1 million for Film Products). The decline was primarily due to cost reduction efforts at Therics.
Losses associated with plant shutdowns, asset impairments and restructurings in the first six months of 2003 include:
Second-quarter pretax charges for severance costs in connection with restructurings in Film Products ($1.6 million), Therics ($1.2 million) and at corporate headquarters ($1.2 million; included in “Corporate expenses, net” in the Operating Profit by Segment tables on pages 9 and 15);
A second-quarter pretax charge of $956,000 for asset impairments in Film Products;
A second-quarter pretax charge of $388,000 related to an early retirement program in Aluminum Extrusions;
A second-quarter pretax charge of $549,000 related to the estimated loss on the sublease of a portion of the Therics facility in Princeton, New Jersey; and
Pretax charges of $53,000 in the second quarter and $85,000 in the first quarter for additional costs incurred related to previously announced plant shutdowns in Film Products.
Losses associated with plant shutdowns, asset impairments and restructurings in the first six months of 2002 include:
Second-quarter pretax net charges of $268,000, primarily related to the shutdown of the films plant in Tacoma, Washington;
A first-quarter pretax charge of $800,000 related to the shutdown of the films plant in Carbondale, Pennsylvania; and
A first-quarter pretax charge of $196,000 for the shutdown of the aluminum extrusions plant in El Campo, Texas.
Unusual items in the first six months of 2003 include a first-quarter pretax charge of $1.1 million related to an adjustment for depreciation at Therics based on Tredegar’s decision to suspend divestiture efforts. There were no unusual items during the first six months of 2002.
Interest income, which is included in “Other income (expense), net” in the Consolidated Statements of Income, was $833,000 in the first six months of 2003 and $1.1 million in 2002. Despite a higher average cash and cash equivalents balance, interest income was down due to lower average tax equivalent yield earned on cash equivalents (1.3% in 2003 and 2% in 2002).
13
Interest expense for the first six months was $3.8 million in the 2003 compared with $4.5 million in 2002. Average debt outstanding and interest rates for the first six months of 2003 and 2002 were as follows:
175.6
57.5
9.7
14.1
242.8
264.1
The effective tax rate from continuing operations was 35.8% in the first six months of 2003 and 35.6% in 2002.
14
Business Segment Review
The following tables present Tredegar’s net sales and operating profit by segment for the second quarters and six months ended June 30, 2003 and 2002:
15
Net sales (sales less freight) and operating profit from ongoing operations are the measures of sales and operating profit used by the chief operating decision maker of each segment for purposes of assessing performance. See Note 2 on page 5 regarding the reclassification of unusual items and losses associated with plant shutdowns, asset impairments and restructurings.
Net sales and operating profit from ongoing operations in Film Products were down 9.1% and 46%, respectively, in the second quarter, and 2.4% and 35%, respectively, for the first six months. Volume for the quarter was 66 million pounds, down 19% from 81 million pounds in 2002. Year-to-date volume decreased 12% to 139 million pounds from 158 million pounds. Results for 2002 and the first quarter of 2003 include revenues and profits related to certain discontinued domestic backsheet business with The Procter & Gamble Company (“P&G”).
On June 16, we announced that we would not achieve the $12 million ongoing operating profit level in Film Products that had been expected in the second quarter due to higher costs associated with raw materials, lower than expected volumes from a seasonal customer and higher manufacturing costs on certain new products. We were unable to recover the full cost of resin price increases, and costs related to certain new product start-ups were higher than expected. Our strategy in Film Products is based on expanding sales of apertured, elastic and breathable film products. We are commercializing several new products, including a new feminine pad topsheet for P&G for European markets. We continue to expect growth in 2004 from sales and operating profit from ongoing operations.
Net sales and operating profit from ongoing operations in Aluminum Extrusions were down 10.6% and 53%, respectively, in the second quarter, and 5.8% and 61%, respectively, for the first six months. Volume for the quarter was 58 million pounds, down 8% from 63 million pounds in 2002. Year-to-date volume decreased 6% to 112 million pounds from 119 million pounds.
The decline in ongoing operating profit in Aluminum Extrusions is primarily due to lower volume and higher energy and insurance costs. Appreciation of the Canadian Dollar against the U.S. Dollar also had an adverse impact (see “Quantitative and Qualitative Disclosures About Market Risk” on page 17). Recent orders reflect a pick-up in overall industry demand; however, we cannot forecast a significant profit upturn until we see more evidence of a sustainable increase in order rates at appropriate margins.
The second-quarter operating loss from ongoing operations at Therics was $3.3 million compared to a loss of $3.1 million in 2002. On a similar basis, the year-to-date loss was $6.6 million compared to $6.8 million in 2002. In April, we announced that we had suspended efforts to sell Therics pending a reassessment of strategic alternatives. We will provide an update on the status of this strategic review when we report third-quarter earnings.
Liquidity and Capital Resources
Tredegar’s total assets decreased to $809.7 million at June 30, 2003, from $838 million at December 31, 2002, due primarily to the impact of the sale of substantially all of the venture capital investment portfolio, partially offset by capital expenditures in excess of depreciation and positive foreign currency translation adjustments associated with Canadian and European operations.
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The net deferred income tax liability (deferred income tax liabilities minus deferred income tax assets) increased to $45.6 million at June 30, 2003, from $6.5 million at December 31, 2002, due to the reversal of deferred tax assets totaling approximately $35 million related to the sale of the venture capital portfolio. Pretax proceeds from the sale totaled $21.5 million. An additional $54.4 million of proceeds, in the form of income tax recoveries, are expected in mid-2004 from the carry-back of 2003 capital losses generated by these sales against gains realized in 2000 by Tredegar Investments. See Note 2 on page 5 for more information.
Cash provided by operating activities was $47.4 million in the first six months of 2003 compared with $27.8 million in 2002. The increase is due primarily to a decrease in the level of primary working capital (accounts receivable, inventories and accounts payable).
Cash used in investing activities was $7.5 million in the first six months of 2003 compared with cash used in investing activities of $20.9 million in 2002. The change is primarily attributable to proceeds from the sale of venture capital investments, net of investments made, of $18.7 million in 2003 versus a net investment of $4.7 million in 2002. This was partially offset by higher capital expenditures, an increase of $12.2 million.
Capital expenditures in the first six months of 2003 reflect the normal replacement of machinery and equipment and:
Machinery and equipment purchased to upgrade lines and expand capacity at our films plant in Kerkrade, The Netherlands;
Expansion of capacity at our films plant in Shanghai, China; and
Machinery and equipment purchased to upgrade our wastewater treatment system at our aluminum extrusions plant in Newnan, Georgia.
Cash used in financing activities was $36.8 million in the first six months of 2003 versus $7.2 million in 2002. This change is attributable to repayments of debt in the total amount of $29.2 million in 2003. In addition, we repurchased 406,400 shares of our common stock during the first six months of 2003 for a total of $5.2 million (an average price of $12.72 per share).
Debt outstanding of $230.1 million at June 30, 2003, consisted of a $225 million term loan and other debt of $5.1 million. On April 16, 2003, we extended our $100 million 364-day credit facility for one year. This short-term facility is an interim step to longer-term financing that we hope to complete by September 30, 2003. There are no amounts currently borrowed under this facility.
Quantitative and Qualitative Disclosures About Market Risk
Tredegar has exposure to the volatility of interest rates, polyethylene and polypropylene resin prices, aluminum ingot and scrap prices, energy prices, foreign currencies and emerging markets.
Changes in resin prices, and the timing of those changes, could have a significant impact on profit margins in Film Products. Profit margins in Aluminum Extrusions are sensitive to fluctuations in aluminum ingot and scrap prices as well as natural gas prices. There is no assurance of our ability to pass through higher raw material and energy costs to our customers.
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In the normal course of business, we enter into fixed-price forward sales contracts with certain customers for the sale of fixed quantities of aluminum extrusions at scheduled intervals. To hedge our exposure to aluminum price volatility under these fixed-price arrangements, which generally have a duration of not more than 12 months, we enter into a combination of forward purchase commitments and futures contracts to acquire aluminum, based on scheduled deliveries.
In Aluminum Extrusions, we hedge from time-to-time a portion of our exposure to natural gas price volatility by entering into fixed-price forward purchase contracts with our natural gas suppliers.
We sell to customers in foreign markets through our foreign operations and through exports from U.S. plants. The percentage of consolidated net sales from manufacturing operations related to foreign markets for the first six months of 2003 and 2002 are presented below:
Percentage of Net Sales from ManufacturingOperations Related to Foreign Markets*
Exports From U.S.
Foreign Operations
Canada
18
Europe
Latin America
Asia
34
30
*
Based on consolidated net sales from manufacturing operations.
We attempt to match the pricing and cost of our products in the same currency and generally view the volatility of foreign currencies and emerging markets, and the corresponding impact on earnings and cash flow, as part of the overall risk of operating in a global environment. Exports from the U.S. are generally denominated in U.S. Dollars. Our foreign currency exposure on income from foreign operations in Europe primarily relates to the Euro. In Canada, the U.S. Dollar-based spread (the difference between selling prices and aluminum costs) generated from Canadian casting operations and exports from Canada to the U.S. are currently in excess of our Canadian Dollar-based operating profit. Consequently, at current sales levels our Canadian aluminum extrusion operations will generally be negatively affected by appreciation of the Canadian Dollar relative to the U.S. Dollar, and positively affected by depreciation of the Canadian Dollar relative to the U.S. Dollar.
Forward-Looking and Cautionary Statements
From time to time, we may make statements that may constitute “forward-looking statements” within the meaning of the “safe-harbor” provisions of the Private Securities Litigation Reform Act of 1995. Such statements are based on our then current expectations and are subject to a number of risks and uncertainties that could cause actual results to differ materially from those addressed in the forward-looking statements. Factors that may cause such a difference include, but are not limited to the following:
General
Our future performance is influenced by costs incurred by Film Products and Aluminum Extrusions including, for example, the cost of energy and raw materials. There is no assurance that we will be able to offset fully the effects of higher raw material costs through price increases. Further, there is no assurance that cost control efforts will positively impact results or that such efforts could be increased to a level that offsets any additional future declines in revenue or increases in energy or raw material costs.
Film Products is highly dependent on sales associated with one customer, P&G. P&G comprised 33% of our net sales in 2002, 31% in 2001 and 28% in 2000. The loss or significant reduction of sales associated with P&G would have a material adverse effect on our business, as would delays in P&G rolling out products utilizing new technologies developed by Tredegar. While we have undertaken efforts to expand our customer base, there can be no assurance that such efforts will be successful, or that they will offset any delay or loss of sales and profits associated with P&G. See the business segment review beginning on page 16 for a discussion regarding the loss of P&G’s domestic diaper backsheet business.
Growth of Film Products depends on our ability to develop and deliver new products, especially in the personal care market, which comprised over 75% of Film Products’ net sales in each of the last three years. Personal care products are now being made with a variety of new materials, replacing traditional backsheet and other components. While we have substantial technical resources, there can be no assurance that our new products can be brought to market successfully, or if brought to market successfully, at the same level of profitability and market share of replaced films. A shift in customer preferences away from our technologies, our inability to develop and deliver new profitable products, or delayed acceptance of our new products in domestic or foreign markets, could have a material adverse effect on our business.
Film Products operates in a field where our significant customers and competitors have substantial intellectual property portfolios. The continued success of this business depends on our ability not only to protect our own technologies and trade secrets, but also to develop and sell new products that do not infringe upon existing patents. Although we are not currently involved in any patent litigation, the outcome of any such action could have a significant adverse impact on Film Products.
As Film Products expands its personal care business, we have greater credit risk that is inherent in broadening our customer base.
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Sales volume and profitability of Aluminum Extrusions is cyclical and highly dependent on economic conditions of end-use markets in the United States and Canada, particularly in the construction, distribution and transportation industries. Our market segments are also subject to seasonal slowdowns during the winter months. From 1992 to the second quarter of 2000, profits in Aluminum Extrusions grew as a result of positive economic conditions in the markets we serve and manufacturing efficiencies. However, a slowdown in these markets in the second half of 2000 resulted in a 13% decline in sales volume and 28% decline in ongoing operating profit compared with the second half of 1999. The aluminum extrusions industry continued to be affected by poor economic conditions in 2001 and 2002. Our sales volume declined 23% and operating profit declined 49% in 2002 compared with 2000. In 2001, our sales volume declined 20% and operating profit declined 52% compared with 2000. The decline in ongoing operating profit during these periods at approximately two to three times the rate of the decline in sales volume illustrates the operating leverage inherent in our operations (fixed operating costs). Any benefits associated with cost reductions and productivity improvements may not be sufficient to offset the adverse effects on profitability from pricing and margin pressure and higher bad debts that usually accompany a downturn.
The markets for our products are highly competitive with product quality, service and price being the principal competitive factors. As competitors increase capacity or reduce prices to increase business, there could be pressure to reduce prices to our customers. Aluminum Extrusions is under increasing domestic and foreign competitive pressures, including a growing presence of Chinese imports in a number of markets. This competition could result in loss of market share due to a competitor’s ability to produce at lower costs and sell at lower prices. There can be no assurance that we will be able to maintain current margins and profitability. Our continued success and prospects depend on our ability to retain existing customers and participate in overall industry cross-cycle growth.
Efforts to sell Therics have been suspended pending a reassessment of our strategic options. We will continue to incur losses as we support Therics’ operations during the reassessment process. There is no assurance we will realize any return on our continuing investment in Therics.
Therics has incurred losses since inception, and we are unsure when, or if, it will become profitable. We have not brought any products to commercialization. There can be no assurance that any new products can be brought to market successfully. In addition, there can be no assurance that the FDA and other regulatory authorities will clear our products in a timely manner.
Our ability to develop and commercialize products will depend on our ability to internally develop preclinical, clinical, regulatory and sales and marketing capabilities, or enter into arrangements with third parties to provide those functions. We may not be successful in developing these capabilities or entering into agreements with third parties on favorable terms. Further, our reliance upon third parties for these capabilities could reduce our control over such activities and could make us dependent upon these parties. Our inability to develop or contract for these capabilities would significantly impair our ability to develop and commercialize products.
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We are highly dependent on several principal members of our management and scientific staff. The loss of key personnel could have a material adverse effect on Therics’ business and results of operations, and could inhibit product development and commercialization efforts. In addition, recruiting and retaining qualified scientific personnel to perform future R&D work is critical to our success. Competition for experienced scientists is intense. Failure to recruit and retain executive management and scientific personnel on acceptable terms could prevent us from achieving our business objectives.
The patent positions of biotechnology firms generally are highly uncertain and involve complex legal and factual questions that can determine who has the right to develop a particular product. No clear policy has emerged regarding the breadth of claims covered by biotechnology patents in the United States. The biotechnology patent situation outside the United States is even more uncertain and is currently undergoing review and revision in many countries. Changes in, or different interpretations of, patent laws in the United States and other countries might allow others to use our discoveries or to develop and commercialize our products without any compensation to us.
Item 3.
See discussion under “Quantitative and Qualitative Disclosures About Market Risk” beginning on page 17.
Item 4.
Controls and Procedures.
Pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, we carried out an evaluation, with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of our disclosure controls and procedures (as defined under Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based upon that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to Tredegar required to be included in our periodic SEC filings.
There has been no change in our internal control over financial reporting during the quarter ended June 30, 2003, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II - OTHER INFORMATION
Submission of Matters to a Vote of Security Holders.
Tredegar’s Annual Meeting of Shareholders was held on April 24, 2003. The following sets forth the vote results with respect to each of the matters voted upon at the meeting:
(a)
Election of Directors
Nominee
No. of Votes “For”
No. of Votes “Withheld”
Austin Brockenbrough, III
34,885,846
297,729
Donald T. Cowles
34,907,781
275,794
William M. Gottwald
34,834,891
348,684
Richard L. Morrill
34,890,618
292,957
Norman A. Scher
34,873,397
310,178
R. Gregory Williams
34,893,593
289,982
There were no broker non-votes with respect to the election of directors.
The term of office for the following directors continued after the annual meeting and such directors were not up for election at the annual meeting:
Phyllis CothranRichard W. GoodrumFloyd D. Gottwald, Jr.John D. GottwaldThomas G. Slater, Jr.
(b)
Approval of Auditors
Approval of the designation of PricewaterhouseCoopers LLP as the auditors for Tredegar for the fiscal year ending December 31, 2003:
No. of Votes “Against”
No. of Abstentions
34,788,883
355,114
39,578
There were no broker non-votes with respect to the approval of auditors.
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Item 6.
Exhibits and Reports on Form 8-K.
Exhibit Nos.
Amended By-Laws
First amendment to Credit Agreement, dated as of April 29, 2003, by and among Tredegar Corporation, as borrower, and the lenders (SunTrust Bank, as syndication agent, Bank of America, N.A., as documentation agent, and Wachovia Bank, National Association, as administrative agent for the lenders)
31.1
Certification of Norman A. Scher, President and Chief Executive Officer of Tredegar Corporation, pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of D. Andrew Edwards, Vice President, Finance and Treasurer (Principal Financial Officer) of Tredegar Corporation, pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
Certification of Norman A. Scher, President and Chief Executive Officer of Tredegar Corporation, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2
Certification of D. Andrew Edwards, Vice President, Finance and Treasurer (Principal Financial Officer) of Tredegar Corporation, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Reports on Form 8-K.
On July 21, 2003, we furnished a Form 8-K with respect to our second quarter 2003 earnings press release dated July 21, 2003. On June 16, 2003, we furnished a Form 8-K with respect to our press release announcing the scheduled closing of our films plant in New Bern, North Carolina. The press release also provided an update to certain forward-looking statements relative to 2003, including the second quarter of 2003, and provided information on other cost reduction efforts. On April 21, 2003, we furnished a Form 8-K with respect to our first quarter 2003 earnings press release dated April 21, 2003.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Tredegar Corporation (Registrant)
Date:
August 13, 2003
/s/ D. Andrew Edwards
D. Andrew Edwards Vice President, Finance and Treasurer (Principal Financial and Accounting Officer)
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