(Mark One)
Commission file number 1-10258
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 o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
The number of shares of Common Stock, no par value, outstanding as of October 31, 2005: 38,654,418.
PART I - FINANCIAL INFORMATION
2
3
4
5
TREDEGAR CORPORATIONNOTES TO THE CONSOLIDATED INTERIM FINANCIAL STATEMENTS(Unaudited)
6
7
8
9
10
11
12
13
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Executive Summary
Third-quarter 2005 net income was $7.6 million (20 cents per share) compared with $15.3 million (40 cents per share) in the third quarter of 2004. Net income was $15.3 million (40 cents per share) for the first nine months of 2005 compared with $22.9 million (60 cents per share) for the first nine months of 2004. Gains on the sale of assets and other items and losses related to plant shutdowns, assets impairments and restructurings are described in Note 2 on page 6. The business segment review begins on page 20.
Third-quarter profits in Film Products improved over last year due primarily to growth in higher value-added products including surface protection, elastic and apertured materials. Given the intense upward pressure on resin costs, and the timing between these rising costs and corresponding price increases, we expect a significant decline in fourth-quarter profits from year-ago levels. The films business has resin index-based pass-through or cost-sharing agreements for the majority of its sales. However, under certain agreements, changes in resin costs are not passed through for an average period of 90 days. For non-indexed customers, Film Products has announced price increases, which it hopes will further mitigate the impact of rising resin costs.
In Aluminum Extrusions, operating profit from ongoing operations in the third quarter declined to $4.4 million compared with $7.4 million last year. The profit decline was due to a $2.3 million increase in energy costs and a negative impact of $900,000 caused by appreciation of the Canadian Dollar. Third quarter volume was flat versus last year at 63.9 million pounds as relatively strong performance in U.S. operations was offset by softer demand across all Canadian markets.
On June 30, 2005, substantially all of the assets of AFBS, Inc., a wholly-owned subsidiary of Tredegar (formerly known as Therics, Inc.), were sold or assigned to a newly-created limited liability company, Therics, LLC, controlled and managed by an individual not affiliated with Tredegar. AFBS received a 17.5% equity interest in Therics, LLC, valued at $170,000 and a 3.5% interest in Theken Spine, LLC, valued at $800,000, along with potential future payments based on the sale of certain products by Therics, LLC. AFBS retained substantially all of its liabilities in the transaction, which included customary indemnification provisions for pre-transaction liabilities. Tredegar has no obligation or intent to fund any future losses that may occur at Therics, LLC or Theken Spine, LLC. The ownership interest in Therics, LLC is accounted for under the equity method of accounting with losses limited to its initial carrying value of $170,000. The ownership interest in Theken Spine, LLC is accounted for under the cost method, with an impairment loss recognized and a new cost basis established for any write-down to estimated fair value, if necessary. The potential future payments due from Therics, LLC based on the sale of certain products will be recognized as income when earned.
Net capitalization and other credit measures are provided in the liquidity and capital resources section beginning on page 22.
Critical Accounting Policies and Recently Issued Accounting Standards
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, 2004, 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, pension benefits and income taxes. These policies require management to exercise judgments that are often difficult, subjective and complex due to the necessity of estimating the
14
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. See Note 2 on page 6 for losses related to plant shutdowns, assets impairments and restructurings occurring during 2005 and the comparable period in 2004.
Recently issued accounting standards are summarized in Note 9 on page 13.
Results of Operations
Third quarter 2005 Compared with Third quarter 2004
Overall, sales in the third quarter of 2005 increased 8.2% compared with 2004. Net sales (sales less freight) increased 11.3% in Film Products primarily due to growth in higher value-added products, including surface protection, elastic and apertured materials, and higher selling prices, which were driven by the pass-through of higher raw material costs. Net sales increased 5.4% in Aluminum Extrusions due to higher selling prices, which were driven primarily by higher metal costs. For more information on net sales and volume, see the business segment review beginning on page 20.
Gross profit (sales minus cost of goods sold and freight) as a percentage of sales decreased to 13.5% in the third quarter of 2005 from 14.2% in 2004. At Film Products, an overall higher gross profit margin was driven primarily by growth in higher value-added products, including surface protection, elastic and apertured materials. At Aluminum Extrusions, the gross profit margin declined primarily due to higher energy costs and appreciation of the Canadian Dollar.
As a percentage of sales, selling, general and administrative (“SG&A”) expenses decreased to 6.5% in the third quarter of 2005 compared with 6.7% in 2004 due to higher sales and the divestiture of substantially all of our interest in AFBS at the end of the second quarter of 2005.
R&D expenses declined to $1.9 million in the third quarter of 2005 from $3.8 million in 2004 primarily due to the divestiture of substantially all of our interest in AFBS.
Plant shutdowns, asset impairments and restructurings in the third quarter of 2005 shown in the segment operating profit table on page 20 include:
Plant shutdowns, asset impairments and restructurings in the third quarter of 2004 shown in the segment operating profit table on page 20 include:
15
Recent restructurings associated with the R&D function in Film Products and the shutdown of the aluminum plant in Aurora, Ontario are substantially complete and no significant future charges are anticipated.
Income taxes in 2004 include a third-quarter tax benefit of $4 million related to the reversal of income tax contingency accruals upon favorable conclusion of IRS and state examinations through 2000.
16
The effective tax rate was 36.8% in the third quarter of 2005, up from 12.7% in 2004. The increase is due primarily to a tax benefit in 2004 of $4 million related to the reversal of income tax contingency accruals upon favorable conclusion of IRS and state examinations through 2000.
First Nine months of 2005 Compared with First Nine months of 2004
Overall, sales in the first nine months of 2005 increased 13.0% compared with 2004. Net sales (sales less freight) increased 14.0% in Film Products primarily due to growth of higher value-added new products (primarily surface protection, elastic and apertured materials). Net sales also benefited from higher selling prices driven by the pass-through of higher raw material costs and foreign exchange rate changes. Net sales increased 11.9% in Aluminum Extrusions due to higher selling prices, which were driven primarily by higher metal costs. For more information on net sales and volume, see the business segment review beginning on page 20.
Gross profit (sales minus cost of goods sold and freight) as a percentage of sales decreased to 13.1% in the first nine months of 2005 from 14.5% in 2004. At Film Products, an overall lower gross profit margin was driven primarily by higher resin costs. At Aluminum Extrusions, the gross profit margin declined primarily due to higher energy costs and appreciation of the Canadian Dollar.
As a percentage of sales, SG&A expenses increased to 6.9% in the first nine months of 2005 compared with 6.8% in 2004 due to the classification of certain costs at AFBS as operating versus R&D consistent with the commercialization of the company’s bone void filler products last year, partially offset by higher sales and the divestiture of substantially all of our interest in AFBS at the end of the second quarter of 2005.
R&D expenses declined to $7.2 million in the first nine months of 2005 from $11.9 million in 2004. R&D spending at AFBS declined to $2.4 million in the first nine months of 2005 from $6 million in 2004 due to cost reduction efforts and the classification of certain costs as operating versus R&D consistent with the commercialization of the company’s bone void filler products last year, and the divestiture of substantially all of our interest in AFBS at the end of the second quarter of 2005. R&D spending at Film Products dropped to $4.8 million in the first nine months of 2005 compared with $5.9 million in 2004 due to restructuring.
Plant shutdowns, asset impairments and restructurings in the first nine months of 2005 shown in the segment operating profit table on page 20 include:
17
Plant shutdowns, asset impairments and restructurings in the first nine months of 2004 shown in the segment operating profit table on page 20 include:
Gain on sale of corporate assets for the nine months ended September 30, 2005 includes a pretax gain of $61,000 related to the sale of corporate real estate. Gain on sale of corporate assets in 2004 includes a second-quarter pretax gain on the sale of corporate real estate of $413,000 and a first-quarter pretax gain on the sale of public equity securities of $6.1 million. These gains are included in “Other income (expense), net” in the consolidated statements of income and separately shown in the operating profit by segment table on page 20.
During the first quarter of 2005, we recognized a pretax gain for interest receivable on tax refund claims of $508,000 (included in “Other income (expense), net” in the consolidated statements of income and “Corporate expenses, net” in the operating profit by segment table on page 20). Income taxes in 2004 include a third-quarter tax benefit of $4 million related to the reversal of income tax contingency accruals upon favorable conclusion of IRS and state examinations through 2000.
The other pretax gain in 2004 of $7.3 million included in the Aluminum Extrusions section of the operating profit by segment table on page 20 is comprised of the present value of an insurance settlement of $8.4 million (future value of $8.5 million) associated with environmental costs related to prior years, partially offset by accruals for expected future environmental costs of $1 million. The company received
18
$5.2 million of the $8.5 million insurance settlement in September of 2004 and recognized receivables at present value for future amounts due ($1.5 million received in February of 2005 and $1.8 million due in February 2006). The gain from the insurance settlement is included in “Other income (expense), net” in the condensed consolidated statements of income, while the accruals for expected future environmental costs are included in “Cost of goods sold.”
For more information on costs and expenses, see the business segment review beginning on page 20.
Interest income, which is included in “Other income (expense), net” in the consolidated statements of income, was $386,000 in 2005 and $232,000 in 2004.
Interest expense increased to $3.3 million in the first nine months of 2005 compared with $2.2 million in 2004. Average debt outstanding and interest rates were as follows:
The effective tax rate was 38.4% in the first nine months of 2005, up from 22.2% in 2004. The increase is due primarily to a tax benefit in 2004 of $4 million related to the reversal of income tax contingency accruals upon favorable conclusion of IRS and state examinations through 2000 and a 35% tax benefit accrued on operating losses, asset impairments and restructuring charges at AFBS versus a higher tax rate accrued on income-generating operations.
19
Business Segment Review
The following tables present Tredegar’s net sales and operating profit by segment for the three and nine months ended September 30, 2005 and 2004:
20
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.
Film Products
Net sales (sales less freight) in Film Products increased 11.3% in the third quarter of 2005 compared with last year primarily due to growth in higher value-added products, including surface protection, elastic and apertured materials, and higher selling prices, which were driven by the pass-through of higher raw material costs. Growth in sales of higher value-added products was also the primary driver for improvement in ongoing operating profit in the third quarter of 2005.
Resin costs have been steadily increasing since 2002. Hurricane-related supply shortages have contributed to particularly significant increases during the late third quarter of 2005 into the fourth quarter. As of October 31, enacted or announced increases in North America for polyethylene resin indicates that the average cost of this material purchased in the fourth quarter will be about 25 cents per pound greater than the third quarter of 2005. Similar trends are expected in Europe. To mitigate the impact of resin cost fluctuations, the films business has resin index-based pass-through or cost-sharing agreements for the majority of its sales. However, under certain agreements, changes in resin costs are not passed through for an average period of 90 days. For non-indexed customers, Film Products has announced price increases, which it hopes will further mitigate the impact of rising resin costs. Given the intense upward pressure on resin costs, and the timing between these rising costs and corresponding selling price increases for our products, we expect a significant decline in fourth-quarter profits from year-ago levels.
While resin supply tightness is expected to continue into the first quarter of 2006, we do not believe this situation will negatively affect our ability to satisfy our customers’ orders in the fourth quarter of 2005. We expect to source resin from existing inventories and purchases, including resin purchased from sources located outside of hurricane-damaged areas.
Net sales and operating profit in Film Products increased in the first nine months of 2005 compared with 2004 primarily due to the same reasons discussed above for the third quarter.
Aggregate capital expenditures in 2003 and 2004 totaled $102 million, and we expect to spend approximately $55 million in 2005 (we spent $39 million in the first nine months of 2005), including expansion of capacity for apertured and elastic materials and surface protection films and a new global information system. Approximately one-third of our capital expenditures during 2003 and 2004 and capital expenditures during 2005 (already spent or proposed to be spent) relate to customer-specific opportunities that are covered by capital indemnification, take-or-pay or similar arrangements. Excluding these opportunities and possible additional expansion needed to meet growing demand for surface protection films, we estimate that our ongoing capital expenditure requirement in Film Products is about $35 million annually. Long-term growth will depend on our ability to provide innovative materials at or below existing material costs. This includes lowering equipment and other capital costs.
Aluminum Extrusions
Third-quarter and year-to-date 2005 net sales in Aluminum Extrusions were up 5.4% and 11.9%, respectively, due to higher selling prices, which were primarily driven by higher metal costs. Volume was flat for the quarter at 63.9 million pounds, and year-to-date volume increased slightly to 185.7 million pounds from 183.8 million pounds in 2004. A relatively strong performance in U.S. operations was offset by softer demand across all Canadian markets. The decline in ongoing operating profit for the quarter and year-to-date was primarily due to higher energy costs (adverse impact of $2.3 million for the quarter and about $4 million year-to-date) and appreciation of the Canadian Dollar (adverse impact of $900,000 for the quarter and about $3 million year-to-date). For every $1 mmBtu change in the price of natural gas, we
21
estimate a corresponding operating profit impact of approximately $150,000 per month. Aluminum Extrusions has increased selling prices in an effort to buffer the negative impact of rising energy costs.
Capital expenditures for the first nine months of 2005 were $10.1 million and are expected to be approximately $15 million for the year. Capital expenditures related to ongoing support and continuity are about $10 million annually, or approximately the same level as depreciation ($10.9 million in 2004). Capital expenditures expected in 2005 in excess of ongoing support and continuity are primarily due to the consolidation of some of our Canadian operations, including closing the plant in Aurora, Ontario. We moved the Aurora plant’s largest press to the plant in Pickering, Ontario, and invested $8 million to upgrade the press and enlarge the facility. This consolidation is substantially complete and expected to reduce annual operating costs by approximately $2 million.
AFBS
See the Executive Summary on page 14 regarding the sale or assignment of substantially all of the assets of AFBS.
Liquidity and Capital Resources
Tredegar’s total assets increased to $789.6 million at September 30, 2005, from $769.5 million at December 31, 2004, due primarily to the net effects of:
If inventories in Film Products are not replenished by year-end, a decrement may occur for inventories carried on the last-in first-out basis (“LIFO”) resulting in product costs charged to income at substantially lower costs than current replacement costs. Any significant income created by LIFO decrements will be separately disclosed.
22
Capital expenditures in the first nine months of 2005 include the normal replacement of machinery and equipment and primarily:
Capital expenditures for all of 2005 are expected to be approximately $55 million in Film Products and about $15 million in Aluminum Extrusions. See the business segment review beginning on page 20 for more information.
23
At September 30, 2005, the interest rate on debt under the Credit Agreement was priced at one-month LIBOR plus the applicable credit spread of 125 basis points.
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.
24
We believe that as of September 30, 2005, and currently we are in compliance with all of our debt covenants. 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 cannot be 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.
Tredegar expects to refinance its debt by the end of 2005 with a new multi-year revolving credit facility. Under the current credit agreement, $3.8 million is due for each of the next three quarters with the remainder due on September 30, 2006. We believe that the borrowing availability under our expected new credit facility, 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. See the section on liquidity and capital resources beginning on page 22 regarding Credit Agreement and interest rate exposures.
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 energy costs. There is no assurance of our ability to pass through higher raw material and energy costs to our customers.
Resin prices in Europe and Asia have exhibited similar trends. The price of resin is driven by several factors including supply and demand and the price of oil, ethylene and natural gas. To address fluctuating resin prices, we have indexed pass-through or cost-sharing agreements covering about 65% of our sales, but many have a 90-day lag. Most new customer contracts contain resin pass-through arrangements. As of October 31, 2005, enacted or announced increases in North America for polyethylene
25
resin indicates that the average cost of this material purchased in the fourth quarter will be about 25 cents per pound greater than the third quarter of 2005. Similar trends are expected in Europe. For non-indexed customers, Film Products has announced price increases, which it hopes will further mitigate the impact of rising resin costs.
In Aluminum Extrusions, we hedge from time-to-time a portion of our exposure to natural gas price volatility (see the chart below) by entering into fixed-price forward purchase contracts with our natural gas suppliers. As of September 30, 2005, the Company had fixed prices through its natural gas suppliers for approximately 10% of its usage through March 2006. We estimate that, in an unhedged situation, every $1 per mmBtu per month change in the market price of natural gas has a $150,000 impact on the monthly operating profit of Aluminum Extrusions.
26
We sell to customers in foreign markets through our foreign operations and through exports from U.S. plants. The percentage of sales from manufacturing operations related to foreign markets for the first nine months of 2005 and 2004 are as follows:
We attempt to match the pricing and cost of our products in the same currency (except in Canada where about 75% of our sales of aluminum extrusions are U.S. Dollar-based) 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 and the Hungarian Forint.
The relatively high percentage of U.S. Dollar-priced sales in Canada is partly due to the shifting of a large portion of the customers previously served by the aluminum extrusions plant in El Campo, Texas, in 2001. The resulting mismatch between the currency denomination of sales and costs causes lower U.S. Dollar translated profits when the Canadian Dollar appreciates since our costs are higher in U.S. Dollar equivalent terms while sales are mostly unaffected (the opposite effect occurs when the Canadian Dollar depreciates in value relative to the U.S. Dollar). We estimate that the appreciation of the Canadian Dollar relative to the U.S. Dollar had an adverse impact on the first nine months of 2005 compared with the first nine months of 2004 of about $3 million. In Film Products, where we have been able to better match the currency of our sales and costs, we estimate that the appreciation of the Euro and Hungarian Forint relative to the U.S. Dollar had a positive impact on results for the first nine months of about $1 million compared with the first nine months of 2004.
27
We are continuing to review the loading of our aluminum extrusions plants in North America to optimize production mix and minimize cost in light of the increase in the U.S. Dollar equivalent cost structure of our plants in Canada.
Forward-looking and Cautionary Statements
From time to time, we may make statements (such as using the words “believe,” “hope,” “expect,” “are likely,” and similar expressions) 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
28
29
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
See discussion under “Quantitative and Qualitative Disclosures About Market Risk” beginning on page 25.
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 to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act, is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
There has been no change in our internal control over financial reporting during the quarter ended September 30, 2005, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
30
31
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.
32