# Packaging Corp of America: Form 10-Q for the period ended Mar 31, 2010

- Company: [Packaging Corp of America](/companies/pkg.md) (CIK 75677)
- Form: 10-Q
- Filed: 2010-05-05
- Accepted by EDGAR: May 5, 2010, 20:24 ET
- Period: 2010-03-31
- Accession: 0000950123-10-044527
- Inline XBRL: no
- Main document: https://www.sec.gov/Archives/edgar/data/75677/000095012310044527/c57749e10vq.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/75677/000095012310044527/

## Management's discussion and analysis

As filed, 24,059 characters.

### Overview

Packaging Corporation of America, or PCA, is the fifth largest producer of containerboard and corrugated products in the United States, based on production capacity. We produce a wide variety of corrugated products ranging from basic corrugated shipping containers to specialized packaging, such as wax-coated boxes for the agriculture industry. We also have multi-color printing capabilities to make high-impact graphics boxes and displays that offer our customers more attractive packaging. Our operating facilities and customers are located primarily in the United States.

In analyzing our operating performance, we focus on the following factors that affect our business and are important to consider when reviewing our financial and operating results:

- containerboard and corrugated products demand;
- corrugated products and containerboard pricing and mix;
- cost trends and volatility for our major costs, including wood and recycled fiber, purchased fuels, electricity, labor and fringe benefits, and transportation costs; and
- cash flow from operations and capital expenditures.

The cost to manufacture containerboard is dependent, in large part, on the costs of wood fiber, recycled fiber, purchased fuels, electricity and labor and fringe benefits. Excluding the cost of containerboard, labor and benefits costs make up the largest component of corrugated products’ manufactured costs.

The market for containerboard is generally subject to changes in the U.S. economy. Historically, supply and demand, as well as industry-wide inventory levels, have influenced prices of containerboard and corrugated products. In addition to U.S. shipments, approximately 10% of domestically produced containerboard has been exported annually for use in other countries.

### Industry Conditions

The market for containerboard and corrugated products continued to improve for both the industry and PCA in the first quarter of 2010. Industry-wide shipments of corrugated products increased 3.7% for the three months ended March 31, 2010 compared to the same period in 2009, and first quarter 2010 industry containerboard production increased 13.2% from the first quarter of 2009. Industry containerboard export shipments increased 42.2% over the same time period in 2009. Industry published prices for containerboard increased $50 per ton in January and increased an additional $60 per ton in April. Reported industry containerboard inventories at the end of March 2010 were at their lowest level in nearly 30 years, approximately 344,000 tons below March 2009.

### PCA Operations Summary

During the first quarter of 2010, we produced approximately 569,000 tons of containerboard at our mills, of which about 83% was consumed in our corrugated products manufacturing plants, 9% was sold to domestic customers and 8% was sold in the export market. In the first quarter, our production was reduced by a total of 35,000 tons due to 20,000 tons of downtime from our Counce, Tennessee annual mill maintenance outage, an additional 8,000 tons from our Valdosta, Georgia outage required to complete preliminary tie-in work related to our major energy project (which will be completed in the fourth quarter of 2011), and 7,000 tons of downtime at our Counce, Tennessee mill from wood shortages.

Our corrugated products manufacturing plants sold about 7.6 billion square feet (“bsf”) of corrugated products during the first quarter of 2010. Corrugated products shipments were up 14.2% compared to the first quarter of 2009 and essentially equaled our corrugated volume in the first quarter of 2008. Containerboard volume sold to domestic and export customers increased 48.0% for the three months ended March 31, 2010 compared to the same period in 2009. Sales prices of corrugated products were lower than the first quarter of 2009 as a result of containerboard and corrugated products price decreases that occurred throughout 2009. During the first quarter, recycled fiber prices rose significantly and for the quarter were nearly $100 per ton above first quarter 2009 levels. In addition, poor weather conditions in the U.S. South made access to wood fiber very difficult, which resulted in the previously mentioned downtime at our Counce, Tennessee linerboard mill and higher wood costs. Purchased energy costs were lower than last year’s first quarter with prices paid for fuels decreasing by more than 20%.

Our earnings for the first quarter of 2010 benefitted from income related to alternative fuel tax mixture credits generated in 2009 ($9.2 million), which is fully described in Note 13 to the condensed consolidated financial statements.

Looking ahead to the second quarter our earnings are expected to be significantly higher than the first quarter from the full realization of the first quarter containerboard and corrugated products price increases. In addition, our April containerboard price increase and May corrugated products price increases will increase earnings; however, the majority of the impact from these increases will not be fully realized until the third quarter. Planned mill outages will reduce production by approximately 35,000 tons and increase operating costs, which will be partially offset by lower energy costs with warmer weather and lower wood costs. Outside shipments of containerboard are expected to be lower due to our low containerboard inventory. Considering these items, we expect our second quarter 2010 earnings to be significantly higher than our first quarter earnings of $12.5 million, which excludes income of $9.2 million related to the alternative fuel mixture tax credits generated in 2009 and a $2.5 million after tax charge from asset disposals related to the energy optimization projects and the announced closure of the Ackerman, Mississippi facility.

### Results of Operations

### Three Months Ended March 31, 2010 Compared to Three Months Ended March 31, 2009

The historical results of operations of PCA for the three months ended March 31, 2010 and 2009 are set forth below:

*(In thousands)*

|  | Three Months Ended March 31, 2010 | 2009 | Change |
| --- | ---: | ---: | ---: |
| Net sales | $550,732 | $512,378 | $38,354 |
| Income from operations | $33,616 | $49,607 | $(15,991) |
| Interest expense, net | (8,723) | (8,738) | 15 |
| Income before taxes | 24,893 | 40,869 | (15,976) |
| Provision for income taxes | (5,699) | (15,193) | 9,494 |
| Net income | $19,194 | $25,676 | $(6,482) |

### Net Sales

Net sales increased by $38.4 million, or 7.5%, for the three months ended March 31, 2010 from the comparable period in 2009, primarily as a result of the impact of increased sales volume of corrugated products and containerboard to third parties ($81.0 million), partially offset by decreased sales prices ($42.6 million). Sales prices decreased as a result of published industry containerboard price decreases and corrugated products price decreases throughout 2009.

Corrugated products shipments were up 14.2% compared to the first quarter of 2009 and on per-workday basis increased 12.4%. The percentage increase, on a shipments-per-workday basis, was lower due to one more workday in the first quarter of 2010 (63 days), those days not falling on a weekend or holiday, than the first quarter of 2009 (62 days). Containerboard volume sold to domestic and export customers was 48.0% higher for the three months ended March 31, 2010 compared to the three months ended March 31, 2009. Containerboard mill production for the three months ended March 31, 2010 was 569,000 tons compared to 515,000 tons during the same period in 2009, up 54,000 tons due to the market-related downtime taken during the first quarter of 2009, partially offset by planned maintenance and wood fiber shortage outages taken in first quarter 2010.

### Income from Operations

Income from operations decreased by $16.0 million, or 32.2%, for the three months ended March 31, 2010 compared to the three months ended March 31, 2009, primarily due to lower sales prices ($42.6 million), increased fiber costs ($15.7 million), charges related to the closure of the Ackerman, Mississippi wood products facility ($2.0 million) and asset disposals required for our major energy project at our Counce, Tennessee and Valdosta, Georgia linerboard mills ($2.0 million). Partially offsetting these items was increased containerboard and corrugated products sales volume ($26.1 million), decreased energy ($6.7 million) and chemical costs ($3.0 million) in addition to income related to alternative fuel tax mixture credits generated in 2009 ($9.2 million), which is fully described in Note 13 to the condensed consolidated financial statements.

Excluding the alternative fuel mixture tax credit, the charges related to the announced Ackerman, Mississippi wood products facility sawmill closure and the asset disposals related to the major mill energy project, income from operations decreased $21.3 million, or 42.9% primarily attributable to the items described above.

Gross profit decreased $23.2 million, or 21.1%, for the three months ended March 31, 2010 from the comparable period in 2009. Gross profit as a percentage of net sales decreased from 21.5% of net sales in the three months ended March 31, 2009 to 15.8% of net sales in the current quarter due primarily to decreased prices.

Selling and administrative expenses increased $1.0 million, or 2.2%, for the three months ended March 31, 2010 compared to the same period in 2009, as a result of increased public warehousing costs ($0.5 million) related to increased customer requirements and increased costs for travel ($0.2 million) and relocation ($0.2 million).

Corporate overhead decreased $0.8 million, or 6.0%, for the three months ended March 31, 2010 compared to the same period in 2009, primarily attributable to a decrease in salary expense due to the timing of incentive compensation ($1.1 million).

Other expense for the three months ended March 31, 2010 increased $1.9 million or 50.7% compared to the first quarter of 2009, primarily due to the charge related to the Ackerman, Mississippi sawmill closure ($2.0 million).

### Interest Expense, Net and Income Taxes

Net interest expense decreased by 0.2% for the three months ended March 31, 2010 from the three months ended March 31, 2009.

PCA’s effective tax rate was 22.9% for the three months ended March 31, 2010 and 37.2% for the comparable period in 2009. The effective tax rate in 2010 varies from the U.S. federal statutory tax rate of 35% principally due to the impact of the alternative fuel mixture tax credit, state and local income taxes, and the domestic manufacturers’ deduction. The Company had no material changes to its uncertain tax positions under ASC 740, “Income Taxes,” during the first three months of 2010.

### Liquidity and Capital Resources

The following table presents a summary of our cash flows for the periods presented:

*(In thousands)*

| Net cash provided by (used for): | Three Months Ended March 31, 2010 | 2009 | Change |
| --- | ---: | ---: | ---: |
| Operating activities | $14,504 | $50,679 | $(36,175) |
| Investing activities | (64,262) | (29,310) | (34,952) |
| Financing activities | (13,368) | (30,743) | 17,375 |
| Net decrease in cash and cash equivalents | $(63,126) | $(9,374) | $(53,752) |

18

### Operating Activities

Net cash provided by operating activities for the three months ended March 31, 2010 was $14.5 million compared to $50.7 million for the three months ended March 31, 2009, a decrease of $36.2 million, or 71.4%. Net income, excluding the income from the alternative fuel mixture tax credits of $9.2 million (described in Note 13 to the financial statements included in this report) and the $2.5 million charge from asset disposals related to the mill energy projects and the announced closure of Ackerman, was $12.5 million for the first three months of 2010 compared to $25.7 million for the comparable period in 2009, a decrease of $13.2 million that reduced net cash provided by operating activities. This was partially offset by a higher deferred tax provision in 2010 of $11.5 million. Additionally, requirements for operating assets and liabilities were higher by $34.1 million in 2010 compared to 2009. This was primarily due to higher accounts receivable levels of $32.4 million as a result of the higher sales volumes in 2010 previously described. Cash requirements for operating activities are subject to PCA’s operating needs, the timing of collection of receivables and payments of payables and expenses, and seasonal fluctuations in the Company’s operations.

### Investing Activities

Net cash used for investing activities for the three months ended March 31, 2010 increased $35.0 million, or 119.2%, to $64.3 million, compared to the three months ended March 31, 2009. The increase was primarily related to higher additions to property, plant and equipment of $35.2 million, which included $39.7 million for the major energy optimization projects, during the three months ended March 31, 2010 compared to the same period in 2009.

### Financing Activities

Net cash used for financing activities totaled $13.4 million for the three months ended March 31, 2010, a decrease of $17.4 million, or 56.5%, compared to the same period in 2009. The difference was primarily attributable to lower common stock dividends paid of $15.3 million during the first three months of 2010 compared to the same period in 2009.

PCA’s primary sources of liquidity are net cash provided by operating activities, borrowings under PCA’s revolving credit facility, and additional borrowings under PCA’s receivables credit facility. As of March 31, 2010, PCA had $172.2 million in unused borrowing capacity under its existing credit agreements, net of the impact on this borrowing capacity of $18.8 million of outstanding letters of credit. Currently, PCA’s primary uses of cash are for operations, capital expenditures, debt service and declared common stock dividends, which it expects to be able to fund from these sources.

The following table provides the outstanding balances and the weighted average interest rates as of March 31, 2010 for PCA’s revolving credit facility, the receivables credit facility, and the senior notes:

*(In thousands)*

| Borrowing Arrangement | Balance at March 31, 2010 | Weighted Average Interest Rate | Projected Annual Cash Interest Payments |
| --- | ---: | ---: | ---: |
| Revolving Credit Facility | $— | N/A | N/A |
| Receivables Credit Facility | 109,000 | 1.96% | $2,133 |
| 53/4% Senior Notes (due August 1, 2013) | 400,000 | 5.75 | 23,000 |
| 61/2% Senior Notes (due March 15, 2018) | 150,000 | 6.50 | 9,750 |
| Total | $659,000 | 5.29% | $34,883 |

The above table excludes unamortized debt discount of $1.2 million at March 31, 2010. It also excludes from the projected annual cash interest payments, the non-cash income from the annual amortization of the $22.8 million received in July 2003 and the non-cash expense from the annual amortization of the $4.4 million paid in March 2008 to settle the treasury locks related to the 53/4% senior notes due 2013 and 61/2% senior notes due 2018. The amortization is being recognized over the terms of the 53/4% senior notes due 2013 and 61/2% senior notes due 2018 and is included in interest expense, net.

On April 14, 2010, PCA extended its $150.0 million receivables-backed credit facility through March 1, 2011.

The instruments governing PCA’s indebtedness contain financial and other covenants that limit, among other things, the ability of PCA and its subsidiaries to:

- enter into sale and leaseback transactions,
- incur liens,
- incur indebtedness at the subsidiary level,
- enter into certain transactions with affiliates, or
- merge or consolidate with any other person or sell or otherwise dispose of all or substantially all of the assets of PCA.

These limitations could limit corporate and operating activities.

In addition, PCA must maintain minimum net worth and maximum debt to total capitalization and minimum interest coverage ratios under the revolving credit facility. A failure to comply with the restrictions contained in the revolving credit facility could lead to an event of default, which could result in an acceleration of any outstanding indebtedness and/or prohibit PCA from drawing on the revolving credit facility. Such an acceleration may also constitute an event of default under the senior notes indentures and the receivables credit facility. As of March 31, 2010, PCA was in compliance with these covenants.

PCA currently expects to incur capital expenditures of about $300.0 million in 2010, including up to $176.0 million for major energy optimization projects at its Counce and Valdosta mills. The remaining $124.0 million in expenditures will be used primarily for maintenance capital, cost reduction, business growth and environmental compliance. As of March 31, 2010, PCA spent $63.1 million for capital expenditures and had committed to spend an additional $275.0 million in the remainder of 2010 and beyond.

PCA believes that net cash generated from operating activities, available cash reserves and alternative fuel mixture tax credit receivable, and available borrowings under its committed credit facilities and available capital through access to capital markets will be adequate to meet its liquidity and capital requirements, including payments of any declared common stock dividends, for the foreseeable future. As its debt or credit facilities become due, PCA will need to repay, extend or replace such facilities, which will be subject to future economic conditions and financial, business and other factors, many of which are beyond PCA’s control.

### Market Risk and Risk Management Policies

PCA is exposed to the impact of interest rate changes and changes in the market value of its financial instruments. PCA periodically enters into derivatives in order to minimize these risks, but not for trading purposes. For a discussion of derivatives and hedging activities, see Note 9 to PCA’s condensed consolidated financial statement included elsewhere in this report.

The interest rates on approximately 84% of PCA’s debt are fixed. A one percent increase in interest rates related to variable rate debt would have resulted in an increase in interest expense and a corresponding decrease in income before taxes of $1.1 million annually. In the event of a change in interest rates, management could take actions to mitigate its exposure to the change. However, due to the uncertainty of the specific actions that would be taken and their possible effects, the sensitivity analysis assumes no changes in PCA’s financial structure.

### Environmental Matters

PCA is subject to, and must comply with, a variety of federal, state and local environmental laws, particularly those relating to air and water quality, waste disposal and the cleanup of contaminated soil and groundwater. The most significant of these laws affecting the Company are:

- Resource Conservation and Recovery Act (RCRA);
- Clean Water Act (CWA);

20

- Clean Air Act (CAA);
- The Emergency Planning and Community Right-to-Know-Act (EPCRA);
- Toxic Substance Control Act (TSCA); and
- Safe Drinking Water Act (SDWA).

PCA believes that it is currently in material compliance with these and all applicable environmental rules and regulations. Because environmental regulations are constantly evolving, the Company has incurred, and will continue to incur, costs to maintain compliance with these and other environmental laws. PCA works diligently to anticipate and budget for the impact of applicable environmental regulations, and does not currently expect that future environmental compliance obligations will materially affect its business or financial condition.

### Impact of Inflation

PCA does not believe that inflation has had a material impact on its financial position or results of operations during the three-month periods ending March 31, 2010 and 2009.

### Off-Balance Sheet Arrangements

PCA does not have any off-balance sheet arrangements as of March 31, 2010 that would require disclosure under SEC FR-67, “Disclosure in Management’s Discussion and Analysis About Off-Balance Sheet Arrangements and Aggregate Contractual Obligations.”

### Critical Accounting Policies and Estimates

Management’s discussion and analysis of PCA’s financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an ongoing basis, PCA evaluates its estimates, including those related to bad debts, inventories, intangible assets, pensions and other postretirement benefits, income taxes, contingencies and litigation. PCA bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

PCA has included in its Annual Report on Form 10-K for the year ended December 31, 2009, a discussion of its critical accounting policies which it believes affect its more significant judgments and estimates used in the preparation of its consolidated financial statements. PCA has not made any changes in any of these critical accounting policies during the first three months of 2010.

### Forward-Looking Statements

Some of the statements in this Quarterly Report on Form 10-Q, and in particular, statements found in Management’s Discussion and Analysis of Financial Condition and Results of Operations, that are not historical in nature are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are often identified by the words “will,” “should,” “anticipate,” “believe,” “expect,” “intend,” “estimate,” “hope,” or similar expressions. These statements reflect management’s current views with respect to future events and are subject to risks and uncertainties. There are important factors that could cause actual results to differ materially from those in forward-looking statements, many of which are beyond our control. These factors, risks and uncertainties include the following:

- the impact of general economic conditions;
- containerboard and corrugated products general industry conditions, including competition, product demand and product pricing;

21

- fluctuations in wood fiber and recycled fiber costs;
- fluctuations in purchased energy costs;
- the possibility of unplanned outages or interruptions at our principal facilities; and
- legislative or regulatory actions or requirements, particularly concerning environmental or tax matters.

Our actual results, performance or achievement could differ materially from those expressed in, or implied by, these forward-looking statements, and accordingly, we can give no assurances that any of the events anticipated by the forward-looking statements will transpire or occur, or if any of them do occur, what impact they will have on our results of operations or financial condition. In view of these uncertainties, investors are cautioned not to place undue reliance on these forward-looking statements. We expressly disclaim any obligation to publicly revise any forward-looking statements that have been made to reflect the occurrence of events after the date hereof. For a discussion of other factors, risks and uncertainties that may affect our business, see Item 1A. Risk Factors included in our Annual Report on Form 10-K for the year ended December 31, 2009.

## Market risk

As filed, 238 characters.

For a discussion of market risks related to PCA, see Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Market Risk and Risk Management Policies” in this Quarterly Report on Form 10-Q.

## Controls and procedures

As filed, 1,621 characters.

PCA maintains disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934) that are designed to provide reasonable assurance that information required to be disclosed in PCA’s filings under the Securities Exchange Act is recorded, processed, summarized and reported within the periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to PCA’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Prior to filing this report, PCA completed an evaluation under the supervision and with the participation of PCA’s management, including PCA’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of PCA’s disclosure controls and procedures as of March 31, 2010. The evaluation of PCA’s disclosure controls and procedures included a review of the controls’ objectives and design, PCA’s implementation of the controls and the effect of the controls on the information generated for use in this report. Based on this evaluation, PCA’s Chief Executive Officer and Chief Financial Officer concluded that PCA’s disclosure controls and procedures were effective at the reasonable assurance level as of March 31, 2010.

During the quarter ended March 31, 2010, there were no changes in internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, PCA’s internal control over financial reporting.

### PART II

### OTHER INFORMATION

## Risk factors

As filed, 162 characters.

There have been no material changes to the risk factors disclosed in Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2009.

Filed May 5, 2010.
Source: SEC EDGAR, the filing index for accession 0000950123-10-044527. Last ingested by Listed: Oct 24, 2026, 14:53 ET. No prices; not investment advice.