(Mark One)
For the quarterly period ended September 30, 2003
OR
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 October 31, 2003: 38,143,590.
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements.
See accompanying notes to financial statements.
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TREDEGAR CORPORATIONNOTES TO THE CONSOLIDATED INTERIM FINANCIAL STATEMENTS(Unaudited)
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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 ended 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
Third Quarter 2003 Compared with Third Quarter 2002
Net income from continuing operations was $6.4 million (17 cents per share) in the third quarter of 2003 compared with $11.9 million (30 cents per share) in 2002.
Discontinued operations in 2002 include an after-tax loss of $12.7 million related to venture capital investment activities and an after-tax loss of $975,000 related to Molecumetics. There were no discontinued operations in the third quarter of 2003. See Note 2 on page 5 for more information on discontinued operations.
Overall, sales in 2003 decreased less than 1% compared with 2002. Net sales (sales less freight) and volume declined in Film Products and increased in Aluminum Extrusions. For more information on net sales and volume, see the business segment review beginning on page 16.
Gross profit (sales minus cost of goods sold and freight) as a percentage of sales decreased to 15.9% in 2003 from 19.5% in 2002. At Film Products, an overall lower gross profit margin was driven primarily by the loss of certain domestic backsheet business (lower overall contribution to cover fixed costs), higher raw material prices and higher manufacturing costs on certain new products. At Aluminum Extrusions, the gross profit margin declined primarily due to higher energy costs, higher insurance costs and the impact of the Canadian Dollar appreciating against the U.S. Dollar.
As a percentage of sales, selling, general and administrative (“SG&A”) expenses increased to 7.1% compared with 6.2% in 2002, primarily due to appreciation of the Canadian Dollar and Euro against the U.S. Dollar, higher employee-related costs and expenses associated with commencing the implementation of a new information system in Film Products.
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Research and development (“R&D”) expenses declined to $4.3 million in the third quarter of 2003 from $5 million in 2002. R&D spending at Therics declined to $2.5 million in 2003 from $3.1 million in 2002 due to cost reduction efforts. R&D spending at Film Products was $1.8 million in 2003, down $100,000 from last year.
Gains on the sale of corporate assets in the third quarter of 2003 include pretax gains of $942,000 on the sale of public securities and $1.3 million on the sale of corporate real estate (included in “Other income (expense), net” in the Consolidated Statements of Income).
Losses associated with plant shutdowns, asset impairments and restructurings in the third quarter of 2003 include:
Losses associated with plant shutdowns, asset impairments and restructurings in the third quarter of 2002 of $178,000 relate to the shutdown of the films plant in Carbondale, Pennsylvania.
For more information on costs and expenses, see the business segment review beginning on page 16.
Interest income, which is included in “Other income (expense), net” in the Consolidated Statements of Income, was $253,000 in 2003 and $448,000 in 2002. Interest income was down primarily due to a lower average tax equivalent yield earned on cash equivalents (about 1% in 2003 and 1.8% 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.
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Interest expense was $1.2 million in 2003 compared with $2.4 million in 2002. Average debt outstanding and interest rates were as follows:
The effective tax rate from continuing operations was 35.6% in the third quarters of 2003 and 2002.
Nine Months 2003 Compared with Nine Months 2002
The net loss for the first nine months of 2003 was $35.7 million (92 cents per share) compared with a net loss of $4.5 million (12 cents per share) in 2002. Net income from continuing operations was $13 million (34 cents per share) in 2003 compared with $36.3 million (93 cents per share) in 2002.
Discontinued operations for the first nine 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 $32.1 million related to venture capital investment activities and an after-tax loss of $8.7 million related to Molecumetics. See Note 2 on page 5 for more information on discontinued operations.
Overall, sales for the first nine months of 2003 decreased 2.8% compared with 2002. Net sales (sales less freight) for 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 16.
Gross profit (sales less cost of goods sold and freight) as a percentage of sales decreased to 15.5% in the first nine months of 2003 from 20.4% in 2002. This decrease is primarily attributable to the reasons that resulted in the third quarter decline as described on page 11.
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As a percentage of sales, SG&A expenses increased to 7.0% compared with 6.5% in 2002, primarily due to lower sales, the appreciation of the Canadian Dollar and Euro against the U.S. Dollar, higher employee-related costs and expenses associated with commencing the implementation of a new information system in Film Products.
R&D expenses for the first nine months declined to $14.7 million in 2003 ($8.8 million for Therics and $5.9 million for Film Products) from $15.7 million in 2002 ($9.7 million for Therics and $6.0 million for Film Products). The decline was primarily due to cost reduction efforts at Therics.
Gains on the sale of corporate assets in 2003 include pretax gains of $942,000 on the sale of public securities and $1.3 million on the sale of corporate real estate (included in “Other income (expense), net” in the Consolidated Statements of Income).
Losses associated with plant shutdowns, asset impairments and restructurings in the first nine months of 2003 include:
Losses associated with plant shutdowns, asset impairments and restructurings in the first nine months of 2002 include:
Unusual items in the first nine 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 nine months of 2002.
Interest income, which is included in “Other income (expense), net” in the Consolidated Statements of Income, was $1.1 million in the first nine months of 2003 and $1.5 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 (1.1% in 2003 and 2% in 2002).
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Interest expense for the first nine months was $5 million in the 2003 compared with $6.9 million in 2002. Average debt outstanding and interest rates for the first nine months of 2003 and 2002 were as follows:
The effective tax rate from continuing operations was 35.7% in the first nine months of 2003 and 35.6% in 2002.
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Business Segment Review
The following tables present Tredegar’s net sales and operating profit by segment for the third quarters and nine months ended September 30, 2003 and 2002:
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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 2.4% and 35%, respectively, in the third quarter, and 2.4% and 35%, respectively, for the first nine months. Volume for the quarter was 68 million pounds, down 8% from 74 million pounds in 2002. Year-to-date volume decreased 11% to 207 million pounds from 232 million pounds. Net sales, operating profit and volume in the second quarter of 2003, the first full quarter reflecting the loss of certain discontinued domestic backsheet business with The Procter & Gamble Company (“P&G”), were $88.4 million, $10.1 million and 66 million pounds, respectively. On a sequential basis (third quarter 2003 compared to second quarter of 2003) net sales, operating profit and volume were up 4.2%, 7% and 3.3%, respectively.
Film Products’ strategy is based on expanding sales of apertured, elastic and specialty products. Sales of these and other products that are unrelated to certain discontinued domestic backsheet business continue to grow and now comprise approximately 90% of Film Products’ revenue. Expectations for near-term profit improvement are tempered by higher costs related to recent resin price increases, new product introductions and capacity additions in Europe, China and the U.S. Cost reduction activities are continuing, including the qualification of new lower cost resins, manufacturing efficiency efforts and the closure of the plant in New Bern, North Carolina. Operating profit from ongoing operations is expected to remain near third-quarter levels in the fourth quarter and gradually improve in 2004.
Third-quarter net sales in Aluminum Extrusions were flat at $96 million while operating profit from ongoing operations declined to $6.5 million, down 20% from $8.1 million in 2002. Volume was 63 million pounds for the quarter, up 1% from 62 million pounds in 2002. Profits continue to be affected by 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 22). On a sequential basis, net sales were up 8% while operating profit improved by $1.6 million or 35% over second-quarter results. Volume was up 9% compared to the second quarter.
Year-to-date net sales were $269.1 million, down 4% from $279.6 million in 2002. Operating profit from ongoing operations for the nine-month period was $12.6 million, down 47% from $23.7 million in 2002. Year-to-date volume decreased 4% to 174 million pounds, down from 181 million pounds in 2002. Lower year-to-date operating profits are due primarily to the decline in volume and the other factors noted above in describing third quarter results.
Customer orders in Aluminum Extrusions have declined to levels similar to 2002 after showing improvement early in the third quarter, and the business is now entering the seasonally weak winter months. Given these factors, fourth-quarter aluminum profits are not likely to show improvement over year-ago levels.
The third-quarter operating loss from ongoing operations at Therics was $2.6 million compared to a loss of $3.3 million in 2002. On a similar basis, the year-to-date loss was $9.2 million compared to $10.1 million in 2002. On October 21, 2003, we announced the completion of a strategic assessment of Therics, which resulted in a decision to support the 2004 rollout of a new line of orthopaedic products. This decision is based on our belief that Therics’ technology has value. It also reflects our confidence in the new management team at Therics, which is highly focused on bringing the first product line to market and controlling expenses. Therics’ management expects the company to begin generating revenue in the first half of 2004. We will monitor Therics’ near-term progress against milestones that are clearly defined and measurable.
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Therics has developed an initial family of products that is expected to be launched in the first half of 2004. These products will be introduced into the orthobiologics sector of orthopaedic and neurosurgical medicine, specifically the growing market for bone graft substitutes. Orthobiologic products use biology and biochemistry to repair, replace or regenerate musculoskeletal structures.
We expect near-term operating losses at Therics to remain around $3 million per quarter. Operating losses should decline assuming sales begin to ramp up in the second half of 2004.
Liquidity and Capital Resources
Tredegar’s total assets decreased to $809.5 million at September 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, positive foreign currency translation adjustments associated with Canadian and European operations and appreciation of $4.6 million of shares held in Vascular Solutions, Inc. (NASDAQ: VASC) and Illumina, Inc. (NASDAQ: ILMN).
The net deferred income tax liability (deferred income tax liabilities minus deferred income tax assets) increased to $45.5 million at September 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 $57.4 million in the first nine months of 2003 compared with $45.8 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 $21.5 million in the first nine months of 2003 compared with cash used in investing activities of $31 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 $7.9 million in 2002. This was partially offset by higher capital expenditures, an increase of $22.6 million.
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Capital expenditures in the first nine months of 2003 reflect the normal replacement of machinery and equipment and:
Cash used in financing activities was $51 million in the first nine months of 2003 versus $8 million in 2002. This change is attributable to repayments of debt in the total amount of $42.2 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). There were no purchases during the third quarter of 2003.
Debt outstanding of $217.1 million at September 30, 2003, consisted of a $212.5 million term loan and other debt of $4.6 million. On October 17, 2003, we refinanced our debt with a new $250 million credit agreement consisting of a $175 million three-year revolving credit facility and a $75 million three-year term loan. The amount available under the revolving credit facility is reduced by $50 million on the earlier of the receipt of the $54.4 million income tax recoveries related to the sale of the venture capital portfolio (see Note 2 on page 5) or September 15, 2004. Term loan installments are due as follows:
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Pro forma capitalization as if the Credit Agreement were in place as of September 30, 2003, is provided below:
Excluded from the pro forma analysis above are income tax recoveries of $54.4 million expected in mid-2004 related to the sale of the venture capital portfolio. See Note 2 on page 5 for more information.
The credit spread over LIBOR and commitment fees charged on the unused amount under the Credit Agreement at various indebtedness-to-adjusted EBITDA levels are as follows:
The computations of adjusted EBITDA, adjusted EBIT, the leverage ratio and interest coverage ratio as defined in the Credit Agreement are presented below along with the related most restrictive covenants. Adjusted EBITDA and adjusted EBIT as defined in the Credit Agreement are not intended to represent cash flow from operations as defined by GAAP and should not be considered as either an alternative to net income or to cash flow.
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Noncompliance with any one or more of the debt covenants may have an adverse effect on financial condition or liquidity in the event such noncompliance is incapable of being cured or should we be unable to obtain a waiver from the lenders. Renegotiation of the covenant through an amendment to the Credit Agreement may effectively cure the noncompliance, but may have an effect on financial condition or liquidity depending upon how the covenant is renegotiated.
We believe that existing borrowing availability, our current cash balances and our cash flow from operations will be sufficient to satisfy our working capital, capital expenditure and dividend requirements for the foreseeable future.
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.
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 nine months of 2003 and 2002 are presented below:
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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
Film Products
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Aluminum Extrusions
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Therics
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
See discussion under “Quantitative and Qualitative Disclosures About Market Risk” beginning on page 22.
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, ourprincipal 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 September 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
Item 6. Exhibits and Reports on Form 8-K.
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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.
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