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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
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 26, 2007: 37,505,455.
PART I - FINANCIAL INFORMATION
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Forward-looking and Cautionary Statements
Some of the information contained in this quarterly report on Form 10-Q may constitute “forward-looking statements” within the meaning of the “safe-harbor” provisions of the Private Securities Litigation Reform Act of 1995. When we use words such as “believe,” “estimate,” “anticipate,” “expect,” “project,” “likely,” “may” and similar expressions, we do so to identify forward-looking statements. 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. Risk factors that may cause such a difference are summarized on pages 29-31 and are incorporated herein.
Executive Summary
Third-quarter 2007 net loss was $18.4 million (47 cents per share) compared with net income of $9.7 million (25 cents per share) in the third quarter of 2006. Our overall loss for the quarter was due to an after-tax asset impairment charge of $22.7 million or 58 cents per share relating to our aluminum extrusions operations in Canada, which had an operating loss of $7 million or 12 cents per share after taxes in the first nine months of 2007. Excluding this item, earnings declined by 14 cents per share or 56% in the third quarter of 2007 versus last year due to lower operating profits in Aluminum Extrusions, a writedown of an investment and other special items (a loss of 9 cents per share on a combined basis in the third quarter of 2007 versus a loss of 1 cent per share last year) and a higher effective tax rate, partially offset by higher profits in Film Products and lower pension and interest costs. Special items are described in Note 2 on page 6. The following tables present Tredegar’s net sales and operating profit by segment for the three and nine months ended September 30, 2007 and 2006:
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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 for purposes of assessing performance.
Film Products. Third-quarter net sales in Film Products were $134.1 million, down slightly from $135.0 million in the third quarter of 2006, while operating profit from ongoing operations increased to $15.9 million in the third quarter of 2007 from $13.8 million in 2006. Volume was 60.0 million pounds in the third quarter of 2007 compared with 64.4 million pounds in the third quarter of last year. Results in films continue to fluctuate significantly from quarter-to-quarter.
Volume was down in the third quarter of 2007 compared with the third quarter of 2006 primarily due to a decrease in sales of lower margin packaging and barrier films, partially offset by an increase in sales of high-value materials used primarily for the hygiene market. Net sales declined for the same reasons but were partially offset by appreciation of currencies for operations outside of the U.S.
Operating profit from ongoing operations increased in the third quarter of 2007 compared with the third quarter of 2006 due primarily to appreciation of currencies for operations outside of the U.S. (a benefit of approximately $900,000) and increases in sales of the high-value materials noted above, partially offset by lower volume and margins for packaging and barrier films. We estimate that the impact of the lag in the pass-through of changes in average resin costs had a negative impact on operating profit of approximately $1 million in the third quarter of 2007 compared with an estimated negative impact on operating profit of $1.5 million in the third quarter of 2006. Film Products has index-based pass-through raw material cost agreements for the majority of its business. However, under certain agreements, changes in resin prices are not passed through for an average period of 90 days.
Net sales in Film Products were $400.4 million in the first nine months of 2007, up 4.6% versus $382.7 million in the first nine months of 2006. Operating profit from ongoing operations was $46.5 million in the first nine months of 2007, up 9.2% compared with $42.6 million in the first nine months of 2006. Volume decreased to 185.7 million pounds in the first nine months of 2007 from 190.8 million pounds in the first nine months of 2006. The growth in sales and operating profit during the first nine months of 2007 versus 2006 were primarily due to increases in sales of high-value surface protection and hygiene materials and appreciation of currencies for operations outside of the U.S. (currency appreciation resulted in an improvement in operating profit of approximately $2.1 million), partially offset by lower volume and margins for packaging and barrier films. Volume declined primarily due to lower sales of certain commodity barrier films that were dropped in conjunction with the shutdown in the second quarter of 2006 of the plant in LaGrange, Georgia.
Capital expenditures were $11.7 million in the first nine months of 2007 and are projected to be approximately $20 million for the year. Depreciation expense was $25 million in the first nine months of 2007 and is projected to be $33 million for the year.
Aluminum Extrusions. Third-quarter net sales in Aluminum Extrusions were $135.2 million, down 12.2% from $154.0 million in the third quarter of 2006. Operating profit from ongoing operations decreased to $1.1 million in the third quarter of 2007, down 80% from $5.4 million in the third quarter of 2006. Volume decreased to 55.9 million pounds in the third quarter of 2007, down 18.3% from 68.4 million pounds in the third quarter of 2006.
Net sales in Aluminum Extrusions were $417.4 million in the first nine months of 2007, down 5.8% from $443.0 million in the first nine months of 2006. Operating profit from ongoing operations decreased to $7.9 million in the first nine months of 2007, down 50.3% from $15.9 million in the first nine months of 2006. Volume decreased to 170.6 million pounds in the first nine months of 2007, down 15.3% from 201.5 million pounds in the first nine months of 2006.
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The decreases in net sales and operating profit in the third quarter and first nine months were mainly due to lower volume partially offset by higher selling prices. Appreciation of the Canadian Dollar also had an estimated adverse impact on profits of $600,000 in the third quarter of 2007 versus 2006 and $1.3 million in the first nine months of 2007 versus 2006. Shipments declined in most markets, especially extrusions used in hurricane protection products and residential construction. Overall backlog at the end of the quarter was 14.9 million pounds, down from 25.4 million pounds at September 30, 2006.
Capital expenditures were $4.2 million in the first nine months of 2007 and are projected to be approximately $6 million for the year. Depreciation expense was $9.4 million in the first nine months of 2007 and is projected to be $13 million for the year.
During the third quarter of 2007, as a result of deteriorating business conditions and financial results relating to aluminum extrusions operations in Canada, we recognized an asset impairment charge of $27.6 million ($22.7 million or 58 cents per share after taxes). See Note 2 on page 6 for more information.
Other Items. Net pension income was $536,000 in the third quarter of 2007 and $1.7 million in the first nine months of 2007, a favorable change of $1.1 million (2 cents per share after taxes) and $3.6 million (6 cents per share after taxes) from amounts recognized in the third quarter and first nine months of 2006, respectively. Most of the favorable changes relate to a pension plan that is reflected in “Corporate expenses, net” in the operating profit by segment table on page 15. The company contributed $1.1 million to its pension plans in 2006 and expects to contribute the same amount in 2007.
Interest expense was $628,000 in the third quarter of 2007 and $2.0 million in first nine months of 2007, a decline of $703,000 (1 cent per share after taxes) and $2.2 million (4 cents per share after taxes) versus the third quarter and first nine months of last year, respectively, due to lower average debt outstanding.
See Note 9 on page 12 regarding significant differences in our effective tax rate between periods.
During the first quarter of 2007, we adopted new accounting standards for maintenance costs and uncertain income tax positions, neither of which had a material impact on Tredegar’s results of operations or financial condition. In addition, Tredegar adopted new accounting standards on fair value measurements and the fair value option for financial assets and liabilities, neither of which had an impact on historical results at the date of adoption.
On April 2, 2007, we invested $10 million in Harbinger Capital Partners Special Situations Fund, L.P. (“Harbinger”), a fund that seeks to achieve superior absolute returns by participating primarily in medium to long-term investments involving distressed/high yield debt securities, special situation equities and private loans and notes. The fund is a highly speculative investment subject to a two-year lock-up and additional limitations on withdrawal. There is no secondary market for interests in the fund. Our investment in Harbinger, which represents less than 2% of Harbinger’s total partnership capital, is accounted for under the cost method. At September 30, 2007, Harbinger reported our capital account value at $17.8 million reflecting $7.8 million of unrealized appreciation ($5.1 million or 13 cents per share after taxes) versus the carrying value in our balance sheet of $10 million (included in “Other assets and deferred charges”).
On August 31, 2007, we invested $6.5 million in a privately held drug delivery company representing ownership on a fully diluted basis of approximately 23%. The company is developing and commercializing state of the art drug delivery systems designed to improve patient compliance and outcomes. See Note 6 on page 9 for more information. During the first nine months of 2007, we invested $5.7 million in real estate. At September 30, 2007, the carrying value in our balance sheet (“Other assets and deferred charges”) of our recent investments in this real estate and the drug delivery company equaled the respective amounts invested.
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During the third quarter of 2007, we used a portion of a standing authorization from our Board of Directors to repurchase approximately 1.7 million shares of our stock at an average price of $17.14 per share. As of September 30, 2007, we had approximately 3.3 million shares that can be repurchased in the future under this authorization. More information on net capitalization and other credit measures are provided in the liquidity and capital resources section beginning on page 21.
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, 2006, 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 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 have been no changes in these policies that have had a significant impact on results of operations or financial position. See Note 2 on page 6 for losses related to plant shutdowns, asset impairments and restructurings occurring during 2007 and the comparable period in 2006.
Results of Operations
Third Quarter 2007 Compared with Third Quarter 2006
Overall, sales in the third quarter of 2007 decreased by 6.9% compared with 2006. For more information on sales and volume, see the executive summary beginning on page 15.
Consolidated gross profit (sales minus cost of goods sold and freight) as a percentage of sales increased to 12.7% in the third quarter of 2007 from 12.2% in 2006. The gross profit margin increased in Film Products but decreased in Aluminum Extrusions primarily because of the changes in sales. In addition, higher costs from appreciation of the Canadian Dollar relative to the U.S. Dollar had an adverse impact in Aluminum Extrusions.
As a percentage of sales, selling, general and administrative and R&D expenses were 7.3% in the third quarter of 2007, up from 6.8% in the third quarter of last year. The increase is primarily due to higher costs in Film Products, including costs associated with a new information system and a reorganization that resulted in the hiring of additional personnel.
Plant shutdowns, asset impairments and restructurings and other special items in the third quarter of 2007 and third quarter of 2006 are described in Note 2 beginning on page 6.
For more information on overall operating results by business segment, see the executive summary beginning on page 15.
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The effective tax rate for the quarter was significantly affected by the tax accrual associated with charges for asset impairments and writedowns. See Note 6 on page 9 for more information.
First Nine Months of 2007 Compared with First Nine Months of 2006
Overall, sales in the first nine months of 2007 decreased by 1.2% compared with 2006, primarily due to a decline in sales in Aluminum Extrusions. For more information on sales and volume, see the executive summary beginning on page 15.
Consolidated gross profit (sales minus cost of goods sold and freight) as a percentage of sales were 12.6% in the first nine months of 2007 and 2006. The gross profit margin increased in Film Products but decreased in Aluminum Extrusions primarily because of the changes in sales. In addition, higher costs from appreciation of the Canadian Dollar relative to the U.S. Dollar had an adverse impact in Aluminum Extrusions.
As a percentage of sales, selling, general and administrative and R&D expenses were 7.0% in the first nine months of 2007, up from 6.7% in the first nine months of last year. The increase is primarily due to higher costs in Film Products, including costs associated with a new information system and a reorganization that resulted in the hiring of additional personnel.
Plant shutdowns, asset impairments and restructurings and other special items in the first nine months of 2007 and first nine months of 2006 are described in Note 2 beginning on page 6.
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The effective tax rate for the first nine months of 2007 was significantly affected by the tax accrual associated with charges for asset impairments and writedowns. See Note 6 on page 9 for more information.
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Liquidity and Capital Resources
Changes in operating assets and liabilities from December 31, 2006 to September 30, 2007 are summarized below:
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Capital expenditures in the first nine months of 2007 primarily included the normal replacement of machinery and equipment and continued expansion of capacity for surface protection films and elastic materials. Capital expenditures for all of 2007 are expected to be approximately $20 million in Film Products and approximately $6 million in Aluminum Extrusions.
Net cash flow used in financing activities was $43.3 million in the first nine months of 2007, and related to repurchases of our common stock of $26.7 million (net of settlement payable of $2.3 million), repayments on our revolving credit facility with excess cash flow of $18.4 million and the payment of first, second and third quarter regular dividends aggregating $4.7 million (4 cents per share per quarter), partially offset by proceeds received from the exercise of stock options of $6.5 million. See Note 10 on page 13 for more information on repurchases of our common stock.
Further information on cash flows for the first nine months of 2007 and 2006 is provided in the consolidated statements of cash flows on page 4.
At September 30, 2007, the interest rate on debt under the revolving credit agreement was priced at one-month LIBOR plus the applicable credit spread of 75 basis points.
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The computations of adjusted EBITDA, adjusted EBIT, the leverage ratio and interest coverage ratio as defined in the revolving credit agreement are presented below along with the related most restrictive covenants. Adjusted EBITDA and adjusted EBIT as defined in the revolving 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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We believe that as of September 30, 2007, we were, 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 a covenant through an amendment to the revolving credit agreement may effectively cure the noncompliance, but may have an effect on financial condition or liquidity depending upon how the covenant is renegotiated. In addition, we would incur additional expenses associated with obtaining any required waiver or amendment.
We believe that the borrowing availability under our revolving credit agreement, 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.
Item 3. 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 21 regarding the revolving 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. With the exception of certain contractual arrangements, there is no assurance of our ability to pass through higher raw material and energy costs to our customers.
Average quarterly prices of low density polyethylene resin (a primary raw material for Film Products) are shown in the chart below.
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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. In order to hedge our exposure to aluminum price volatility (see the chart below) 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 or hedge aluminum, based on the scheduled deliveries.
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We attempt to match the pricing and cost of our products in the same currency (except in Canada where about 80% of our sales of aluminum extrusions are U.S. Dollar-based) and generally view the volatility of foreign currencies (see trends for the Euro, Canadian Dollar and Chinese Yuan in the chart on page 28) 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 relates to the Canadian Dollar, the Euro, the Chinese Yuan, the Hungarian Forint and the Brazilian Real.
The relatively high percentage of U.S. Dollar-priced sales in Canada causes a mismatch between the currency denomination of sales and costs resulting in 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 changes in the value of the Canadian Dollar relative to the U.S. Dollar had an adverse impact on operating profit in the first nine months of 2007 of $1.3 million compared with the first nine months of 2006. In Film Products, where we have been able to better match the currency of our sales and costs, we estimate that the appreciation of foreign currencies (primarily the Euro and Hungarian Forint and to a lesser extent the Chinese Yuan and Brazilian Real) relative to the U.S. Dollar had a positive impact on operating profit of about $2.1 million in the first nine months of 2007 compared with 2006.
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We continue 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. In addition, we have partially hedged our exposure to the Canadian Dollar and Euro as shown in the following tables (accounted for as cash flow hedges):
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Trends for the Euro, Canadian Dollar and Chinese Yuan are shown in the chart below:
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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, 2007, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
Item 1A. Risk Factors.
There are a number of risks and uncertainties that can have a material effect on the operating results of our businesses and our financial condition. These risk factors include, but are not limited to, the following:
General
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Film Products
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Aluminum Extrusions
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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Item 6. Exhibits.
Exhibit Nos.
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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.
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