Glatfelter Corp - Quarter Report: 2013 March (Form 10-Q)

1.	ORGANIZATION

P. H. Glatfelter Company and subsidiaries (“Glatfelter”) is a manufacturer of specialty papers and fiber-based engineered materials. Headquartered in York, Pennsylvania, our manufacturing facilities are located in Spring Grove, Pennsylvania; Chillicothe and Freemont, Ohio; Gatineau, Quebec, Canada; Lydney, England; Caerphilly, Wales; Gernsbach and Falkenhagen, Germany; Scaër, France; and the Philippines. Our products are marketed worldwide, either through wholesale paper merchants, brokers and agents, or directly to customers.

 

2.	ACCOUNTING POLICIES

Basis of Presentation The unaudited condensed consolidated financial statements (“financial statements”) include the accounts of Glatfelter and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated.

We prepared these financial statements in accordance with accounting principles generally accepted in the United States of America (“generally accepted accounting principles” or “GAAP”). In our opinion, the financial statements reflect all normal, recurring adjustments needed to present fairly our results for the interim periods. When preparing these financial statements, we have assumed that you have read the audited consolidated financial statements included in our 2012 Annual Report on Form 10-K (“2012 Form 10-K”).

Accounting Estimates The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingencies as of the balance sheet date and the reported amounts of revenues and expenses during the reporting period. Management believes the estimates and assumptions used in the preparation of these financial statements are reasonable, based upon currently available facts and known circumstances, but recognizes that actual results may differ from those estimates and assumptions.

Recently Issued Accounting Pronouncements In February 2013, the FASB issued ASU 2013-02 – “Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income” which requires new disclosures about items reclassified out of accumulated other

comprehensive income. We adopted the requirements of this standard in the first quarter of 2013.

 

3.	GAINS ON DISPOSITIONS OF PLANT, EQUIPMENT AND TIMBERLANDS, NET

During the first quarters of 2013 and 2012, we completed sales of assets as summarized in the following table:

 

Dollars in thousands		Acres				Proceeds				Gain
2013
Other			n/a			$	73			$	73
Total						$	73			$	73
2012
Other			n/a			$	49			$	37
Total						$	49			$	37

 

4.	EARNINGS PER SHARE

The following table sets forth the details of basic and diluted earnings per share (EPS):

 

		Three months ended March 31
In thousands, except per share		2013				2012
Net income		$	15,629			$	18,878
Weighted average common shares outstanding used in basic EPS			42,966				42,751
Common shares issuable upon exercise of dilutive stock options and PSAs / RSUs			955				716
Weighted average common shares outstanding and common share equivalents used in diluted EPS			43,921				43,467
Earnings per share
Basic		$	0.36			$	0.44
Diluted			0.36				0.43

The following table sets forth potential common shares outstanding for stock options and restricted stock units that were not included in the computation of diluted EPS for the period indicated, because their effect would be anti-dilutive:

 

		March 31
In thousands		2013				2012
Potential common shares			—				589

 

6.	INCOME TAXES

Income taxes are recognized for the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in our consolidated financial statements or tax returns. The effects of income taxes are measured based on enacted tax laws and rates.

As of March 31, 2013 and December 31, 2012, we had $26.5 million and $30.4 million of gross unrecognized tax benefits. As of March 31, 2013, if such benefits were to be recognized, approximately $26.5 million would be recorded as a component of income tax expense, thereby affecting our effective tax rate.

We, or one of our subsidiaries, file income tax returns with the United States Internal Revenue Service, as well as various state and foreign authorities.

The following table summarizes, by major jurisdiction, tax years that remain subject to examination:

 

		Open Tax Years
Jurisdiction		Examinations not yet initiated				Examination in progress
United States
Federal			2009 - 2012			N/A
State			2008 - 2012			2009
Canada (1)			2010 - 2012			2007 - 2011
Germany (1)			2007, 2010 - 2012			2008 - 2011
France			2010 - 2012			N/A
United Kingdom			2009 - 2012			N/A
Philippines			2011 - 2012			2010

 

(1)	– includes provincial or similar local jurisdictions, as applicable

The amount of income taxes we pay is subject to ongoing audits by federal, state and foreign tax authorities, which often result in proposed assessments. Management performs a comprehensive review of its global tax positions on a quarterly basis and accrues

 

amounts for uncertain tax positions. Based on these reviews and the result of discussions and resolutions of matters with certain tax authorities and the closure of tax years subject to tax audit, reserves are adjusted as necessary. However, future results may include favorable or unfavorable adjustments to our estimated tax liabilities in the period the assessments are determined or resolved or as such statutes are closed. Due to potential for resolution of federal, state and foreign examinations, and the expiration of various statutes of limitation, it is reasonably possible our gross unrecognized tax benefits balance may decrease within the next twelve months by a range of zero to $14.0 million. Substantially all of this range relates to tax positions taken in the U.S., the U.K. and Germany

We recognize interest and penalties related to uncertain tax positions as income tax expense. During the first quarter of 2013, we recorded a $0.2 million benefit from a reduction in the amount of interest payable. For the first quarter of 2012, we recognized $0.1 million of interest expense. As of March 31, 2013 and December 31, 2012, we had recognized a liability for interest of $1.2 million and $1.4 million, respectively. We did not record any penalties associated with uncertain tax positions during the first quarters of 2013 or 2012.

 

7.	STOCK-BASED COMPENSATION

The P. H. Glatfelter Amended and Restated Long Term Incentive Plan (the “LTIP”) provides for the issuance of up to 5,500,000 shares of Glatfelter common stock to eligible participants in the form of restricted stock units, restricted stock awards, non-qualified stock options, performance shares, incentive stock options and performance units.

Since the approval of the LTIP, we have issued to eligible participants restricted stock units, performance share awards and stock only stock appreciation rights (“SOSARs”).

Restricted Stock Units (“RSU”) and Performance Share Awards (“PSAs”) Awards of RSUs and PSAs are made under our LTIP. The vesting of RSUs is based solely on the passage of time, generally on a graded scale over a three, four, and five-year period. PSAs are issued annually and cliff vest on December 31 of the third year following the grant assuming the achievement of predetermined, three-year cumulative performance targets. The performance measures include a minimum, target and maximum performance level providing the grantees an opportunity to receive more or less shares than targeted depending on actual financial performance. For both RSUs and PSAs, the grant date fair value of the awards, which is equal to the closing price per common share on the date of the award, is used to determine the amount of expense to be recognized over the applicable service period. Settlement of RSUs and PSAs will be made in shares of our common stock currently held in treasury.

The following table summarizes RSU and PSA activity during the first three months of 2013 and 2012:

 

Units		2013				2012
Balance January 1,			847,679				788,088
Granted			153,265				162,217
Forfeited			(9,313	)			(17,100	)
Shares delivered			(97,681	)			(72,080	)
Balance March 31,			893,950				861,125

The amount granted in 2013 and 2012 includes PSAs of 151,955 and 161,083, respectively, exclusive of reinvested dividends. The following table sets forth aggregate RSU and PSA compensation expense for the periods indicated:

 

		Three months ended March 31
Dollars in thousands		2013				2012
Compensation expense		$	720			$	576

Stock Only Stock Appreciation Rights (SOSARs) Under terms of the SOSAR, a recipient receives the right to a payment in the form of shares of common stock equal to the difference, if any, in the fair market value of one share of common stock at the time of exercising the SOSAR and the exercise price. The SOSARs vest ratably over a three year period and have a term of ten years.

 

The following table sets forth information related to outstanding SOSARS.

 

		2013								2012
SOSARS		Shares				Wtd Avg Exercise Price				Shares				Wtd Avg Exercise Price
Outstanding at January 1,			2,121,454			$	12.93				2,298,288			$	12.35
Granted			361,923				18.36				371,812				15.61
Exercised			(40,986	)			13.90				(65,637	)			(10.57	)
Canceled / forfeited			(23,920	)			15.61				(10,000	)			(14.96	)
Outstanding at March 31,			2,418,471			$	13.70				2,594,463			$	12.85
SOSAR Grants
Weighted average grant date fair value per share		$	5.64							$	4.98
Aggregate grant date fair value (in thousands)		$	2,042							$	1,850
Black-Scholes assumptions
Dividend yield			2.18	%							2.31	%
Risk free rate of return			0.99	%							1.05	%
Volatility			39.62	%							41.51	%
Expected life			6 yrs								6 yrs

The following table sets forth SOSAR compensation expense for the periods indicated:

 

		March 31
In thousands		2013				2012
Three months ended		$	385			$	354

8.	RETIREMENT PLANS AND OTHER POST-RETIREMENT BENEFITS

The following table provides information with respect to the net periodic costs of our pension and post retirement medical benefit plans.

 

		Three months ended March 31
In thousands		2013				2012
Pension Benefits
Service cost		$	3,211			$	2,931
Interest cost			5,520				5,772
Expected return on plan assets			(10,903	)			(10,563	)
Amortization of prior service cost			774				613
Amortization of unrecognized loss			5,289				4,323
Subtotal		$	3,891			$	3,076
Other Benefits
Service cost		$	789			$	710
Interest cost			545				609
Expected return on plan assets			—				(113	)
Amortization of prior service cost			(125	)			(234	)
Amortization of unrecognized loss			202				179
Net periodic benefit cost		$	1,411			$	1,151

 

9.	INVENTORIES

Inventories, net of reserves, were as follows:

 

In thousands		March 31 2013				December 31 2012
Raw materials		$	57,689			$	61,084
In-process and finished			103,605				102,331
Supplies			59,814				58,951
Total		$	221,108			$	222,366

 

10.	LONG-TERM DEBT

Long-term debt is summarized as follows:

 

In thousands		March 31 2013				December 31 2012
Revolving credit facility, due Nov. 2016		$	—			$	—
5.375% Notes, due Oct. 2020			250,000				250,000
Total long-term debt			250,000				250,000
Less current portion			—				—
Long-term debt, net of current portion		$	250,000			$	250,000

On November 21, 2011, we entered into an amendment to our revolving credit agreement with a consortium of banks (the “Revolving Credit Facility”) which increased the amount available for borrowing to $350 million, extended the maturity of the facility to November 21, 2016, and instituted a lower interest rate pricing grid.

For all U.S. dollar denominated borrowings under the Revolving Credit Facility, the borrowing rate is, at our option, (a) the bank’s base rate which is equal to the greater of i) the prime rate; ii) the federal funds rate plus 50 basis points plus an applicable spread ranging from 25 basis points to 125 basis points based on our corporate credit ratings determined by Standard & Poor’s Rating Services and Moody’s Investor Service, Inc. (the “Corporate Credit Rating”); or iii) the daily Euro-rate plus 100 basis points; or (b) the daily Euro-rate plus an applicable margin ranging from 125 basis points to 225 basis points based on the Corporate Credit Rating. For non-US dollar denominated borrowings, interest is based on (b) above.

The Revolving Credit Facility contains a number of customary covenants for financings of this type that, among other things, restrict our ability to dispose of or create liens on assets, incur additional indebtedness, repay other indebtedness, limit certain intercompany financing arrangements, make acquisitions and engage in mergers or consolidations. We are also required to comply with specified financial tests and ratios including: i) maximum net debt to earnings before interest, taxes, depreciation and amortization (“EBITDA”) ratio; ii) a consolidated EBITDA to interest expense ratio; and iii) beginning December 31, 2015, a minimum liquidity ratio. A breach of these requirements would give rise to certain remedies under the Revolving Credit Facility, among which are the termination of the agreement and accelerated repayment of the outstanding borrowings plus accrued and unpaid interest under the credit facility.

On October 3, 2012, we completed a private placement offering of $250.0 million aggregate principal amount of 5.375% Senior Notes due 2020 (the “5.375% Notes”). The 5.375% Notes are fully and unconditionally

guaranteed, jointly and severally, by PHG Tea Leaves, Inc., Mollanvick, Inc., The Glatfelter Pulp Wood Company, and Glatfelter Holdings, LLC (the “Guarantors”).

Unamortized deferred debt issuance costs related to the offering of the 5.375% Notes totaled $4.7 million and $4.8 million as of March 31, 2013 and December 31, 2012, respectively, and are reported under the caption “Other assets” in the accompanying condensed consolidated balance sheets. The deferred costs are being amortized on a straight line basis over the life of the 5.375% Notes.

Interest on the 5.375% Notes is payable semiannually in arrears on April 15 and October 15.

The 5.375% Notes are redeemable, in whole or in part, at anytime on or after October 15, 2016 at the redemption prices specified in the applicable Indenture. Prior to October 15, 2016, we may redeem some or all of the Notes at a “make-whole” premium as specified in the Indenture. These Notes and the guarantees of the notes are senior obligations of the Company and the Guarantors, respectively, rank equally in right of payment with future senior indebtedness of the Company and the Guarantors and will mature on October 15, 2020.

The 5.375% Notes contain cross default provisions that could result in all such notes becoming due and payable in the event of a failure to repay debt outstanding under the Revolving Credit Agreement at maturity or a default under the Revolving Credit Agreement that accelerates the debt outstanding thereunder. As of March 31, 2013, we met all of the requirements of our debt covenants.

As of March 31, 2013 and December 31, 2012, we had $5.2 million of letters of credit issued to us by certain financial institutions. The letters of credit, which reduce amounts available under our revolving credit facility, primarily provide financial assurances for the benefit of certain state workers compensation insurance agencies in conjunction with our self-insurance program. We bear the credit risk on this amount to the extent that we do not comply with the provisions of certain agreements. No amounts are outstanding under the letters of credit.

 

11.	ASSET RETIREMENT OBLIGATION

During 2008, we recorded $11.5 million, net present value, of asset retirement obligations related to the legal requirement to close several lagoons at the Spring Grove, PA facility. Historically, lagoons were used to dispose of residual waste material. Closure of the lagoons, which is expected to be completed in 2016, will be accomplished by filling the lagoons, installing a non-permeable liner

 

which will be covered with soil to construct the required cap over the lagoons. The amount referred to above, in addition to upward revisions, were accrued with a corresponding increase in the carrying value of the property, equipment and timberlands caption on the consolidated balance sheet. The amount capitalized is being amortized as a charge to operations on the straight-line basis in relation to the expected closure period. Following is a summary of activity recorded during the first quarters of 2013 and 2012:

 

In thousands		2013				2012
Balance at January 1,		$	8,882			$	9,679
Accretion			82				122
Payments			(662	)			(207	)
Balance at March 31,		$	8,302			$	9,594

At March 31, 2013 and December 31, 2012, $3.0 million and $3.6 million, respectively, is recorded in the accompanying condensed consolidated balance sheets under the caption “Other current liabilities” and the balance is recorded under the caption “Other long-term liabilities.”

 

12.	FAIR VALUE OF FINANCIAL INSTRUMENTS

The amounts reported on the condensed consolidated balance sheets for cash and cash equivalents and accounts receivable approximate fair value. The following table sets forth carrying value and fair value of long-term debt:

 

		March 31, 2013								December 31, 2012
In thousands		Carrying Value				Fair Value				Carrying Value				Fair Value
Fixed-rate bonds		$	250,000			$	263,750			$	250,000			$	260,340
Variable rate debt			—				—				—				—
Total		$	250,000			$	263,750			$	250,000			$	260,340

As of March 31, 2013, and December 31, 2012, we had $250.0 million of 5.375% fixed rate debt. These bonds are publicly registered, but thinly traded. Accordingly, the values set forth above are based on debt instruments with similar characteristics (Level 2). The fair value of financial derivatives is set forth below in Note 13.

 

13.	FINANCIAL DERIVATIVES AND HEDGING ACTIVITIES

As part of our overall risk management practices, we enter into financial derivatives primarily designed to either i) hedge foreign currency risks associated with forecasted transactions – “cash flow hedges” or ii) mitigate the impact that changes in currency exchange rates have on intercompany financing transactions and

foreign currency denominated receivables and payables – “foreign currency hedges.”

Derivatives Designated as Hedging Instruments – Cash Flow Hedges We use currency forward contracts as cash flow hedges to manage our exposure to fluctuations in the currency exchange rates on certain forecasted production costs expected to be incurred over a maximum of twelve months. Currency forward contracts involve fixing the EUR-USD exchange rate or USD-CAD for delivery of a specified amount of foreign currency on a specified date.

We designate certain currency forward contracts as cash flow hedges of forecasted raw material purchases or certain production costs with exposure to changes in foreign currency exchange rates. The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges of foreign exchange risk is deferred as a component of accumulated other comprehensive income in the accompanying condensed consolidated balance sheets and is subsequently reclassified into costs of products sold in the period that inventory produced using the hedged transaction affects earnings. The ineffective portion of the change in fair value of the derivative is recognized directly to earnings and reflected in the accompanying condensed consolidated statements of income as non-operating income (expense) under the caption “Other-net.”

We had the following outstanding derivatives that were used to hedge foreign exchange risks associated with forecasted transactions and designated as hedging instruments:

 

In thousands		March 31 2013				December 31 2012
Derivative		Buy Notional
Sell / Buy
Euro / U.S. dollar			25,929				27,003
U.S. dollar / Canadian dollar			12,528				12,369

These contracts have maturities of twelve months or less.

Derivatives Not Designated as Hedging Instruments – Foreign Currency Hedges We also enter into forward foreign exchange contracts to mitigate the impact changes in currency exchange rates have on balance sheet monetary assets and liabilities. None of these contracts are designated as hedges for financial accounting purposes and, accordingly, changes in value of the foreign exchange forward contracts and in the offsetting underlying on-balance-sheet transactions are reflected in the accompanying condensed consolidated statements of income under the caption “Other – net.”