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PACKAGING CORP OF AMERICA - Quarter Report: 2009 September (Form 10-Q)

e10vq
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
 
Form 10-Q
 
     
(Mark One)    
þ
  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the Quarterly Period Ended September 30, 2009
or
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the transition period from          to          
 
Commission file number 1-15399
 
PACKAGING CORPORATION OF AMERICA
(Exact Name of Registrant as Specified in its Charter)
 
     
Delaware   36-4277050
(State or other Jurisdiction of
Incorporation or Organization)
  (IRS Employer Identification No.)
     
1900 West Field Court
Lake Forest, Illinois
  60045
(Zip Code)
(Address of Principal Executive Offices)    
 
(847) 482-3000
(Registrant’s telephone number, including area code)
 
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
 
 
 
 
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 þ     No o
 
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for shorter period that the Registrant was required to submit and post such files).  Yes o     No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer þ Accelerated filer o Non-accelerated filer o Smaller reporting company o
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ
 
As of November 2, 2009, the Registrant had outstanding 102,983,542 shares of common stock, par value $0.01 per share.
 


 

 
TABLE OF CONTENTS
 
             
        Page
 
PART I
Item 1.   Financial Statements     3  
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations     18  
Item 3.   Quantitative and Qualitative Disclosures About Market Risk     25  
Item 4.   Controls and Procedures     25  
 
PART II
Item 1.   Legal Proceedings     26  
Item 1A.   Risk Factors     26  
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds     26  
Item 3.   Defaults Upon Senior Securities     26  
Item 4.   Submission of Matters to a Vote of Security Holders     26  
Item 5.   Other Information     26  
Item 6.   Exhibits     26  
SIGNATURES     27  
EX-31.1            
EX-31.2            
EX-32.1            
EX-32.2            


2


 

 
PART I
 
FINANCIAL INFORMATION
 
Item 1.   Financial Statements.
 
Packaging Corporation of America
 
Condensed Consolidated Balance Sheets
(Unaudited)
 
                 
    September 30,
    December 31,
 
    2009     2008  
(In thousands, except share and per share amounts)         (Audited)  
 
ASSETS
Current assets:
               
Cash and cash equivalents
  $ 224,287     $ 149,397  
Accounts receivable, net of allowance for doubtful accounts and customer deductions of $6,575 and $6,862 as of September 30, 2009 and December 31, 2008, respectively
    274,026       254,898  
Inventories
    208,736       206,954  
Alternative fuel mixture tax credits receivable
    106,381        
Prepaid expenses and other current assets
    13,965       6,684  
Deferred income taxes
    20,108       15,240  
                 
Total current assets
    847,503       633,173  
Property, plant and equipment, net
    1,177,593       1,221,019  
Goodwill
    38,854       37,163  
Other intangible assets, net
    11,994       12,669  
Other long-term assets
    35,557       35,717  
                 
Total assets
  $ 2,111,501     $ 1,939,741  
                 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
               
Short-term debt and current maturities of long-term debt
  $ 109,000     $ 109,000  
Capital lease obligations
    615       606  
Accounts payable
    116,734       101,064  
Dividends payable
    15,442       30,719  
Accrued interest
    4,457       12,723  
Accrued federal and state income taxes
    9,884       1,282  
Accrued liabilities
    112,175       106,588  
                 
Total current liabilities
    368,307       361,982  
Long-term liabilities:
               
Long-term debt
    548,662       548,400  
Capital lease obligations
    22,663       23,129  
Deferred income taxes
    210,707       208,879  
Pension and postretirement benefit plans
    79,489       85,964  
Other long-term liabilities
    29,357       27,438  
                 
Total long-term liabilities
    890,878       893,810  
Stockholders’ equity:
               
Common stock, par value $.01 per share, 300,000,000 shares authorized, 102,972,727 shares and 102,397,952 shares issued as of September 30, 2009 and December 31, 2008, respectively
    1,030       1,024  
Additional paid in capital
    385,353       379,104  
Retained earnings
    503,118       342,072  
Accumulated other comprehensive income (loss):
               
Unrealized gain on treasury lock, net
    4,973       6,358  
Unfunded employee benefit obligations, net
    (42,158 )     (44,609 )
                 
Total accumulated other comprehensive loss
    (37,185 )     (38,251 )
                 
Total stockholders’ equity
    852,316       683,949  
                 
Total liabilities and stockholders’ equity
  $ 2,111,501     $ 1,939,741  
                 
 
See notes to condensed consolidated financial statements.


3


 

Packaging Corporation of America
 
Condensed Consolidated Statements of Income
(Unaudited)
 
                 
    Three Months Ended September 30,  
    2009     2008  
(In thousands, except per share amounts)            
 
Net sales
  $ 553,573     $ 620,785  
Cost of sales
    (443,041 )     (488,734 )
                 
Gross profit
    110,532       132,051  
Selling and administrative expenses
    (44,258 )     (44,792 )
Corporate overhead
    (13,188 )     (16,085 )
Alternative fuel mixture tax credits
    47,137        
Other expense, net
    (3,892 )     (2,469 )
                 
Income from operations
    96,331       68,705  
Interest expense, net
    (8,961 )     (8,071 )
                 
Income before taxes
    87,370       60,634  
Provision for income taxes
    (14,715 )     (22,532 )
                 
Net income
  $ 72,655     $ 38,102  
                 
Weighted average common shares outstanding:
               
Basic
    101,713       102,562  
Diluted
    102,536       103,590  
Net income per common share:
               
Basic
  $ 0.71     $ 0.37  
                 
Diluted
  $ 0.71     $ 0.37  
                 
Dividends declared per common share
  $ 0.15     $ 0.30  
                 
 
See notes to condensed consolidated financial statements.


4


 

Packaging Corporation of America
 
Condensed Consolidated Statements of Income
(Unaudited)
 
                 
    Nine Months Ended September 30,  
    2009     2008  
(In thousands, except per share amounts)            
 
Net sales
  $ 1,615,332     $ 1,814,442  
Cost of sales
    (1,276,293 )     (1,437,034 )
                 
Gross profit
    339,039       377,408  
Selling and administrative expenses
    (130,325 )     (131,913 )
Corporate overhead
    (42,076 )     (44,460 )
Alternative fuel mixture tax credits
    126,832        
Other expense, net
    (11,815 )     (11,011 )
                 
Income from operations
    281,655       190,024  
Interest expense, net
    (26,529 )     (22,571 )
                 
Income before taxes
    255,126       167,453  
Provision for income taxes
    (47,914 )     (62,086 )
                 
Net income
  $ 207,212     $ 105,367  
                 
Weighted average common shares outstanding:
               
Basic
    101,516       103,147  
Diluted
    102,275       104,048  
Net income per common share:
               
Basic
  $ 2.04     $ 1.02  
                 
Diluted
  $ 2.03     $ 1.01  
                 
Dividends declared per common share
  $ 0.45     $ 0.90  
                 
 
See notes to condensed consolidated financial statements.


5


 

Packaging Corporation of America
 
Condensed Consolidated Statements of Cash Flows
(Unaudited)
 
                 
    Nine Months Ended
 
    September 30,  
    2009     2008  
(In thousands)            
 
Cash Flows from Operating Activities:
               
Net income
  $ 207,212     $ 105,367  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation, depletion and amortization
    111,900       109,965  
Amortization of financing costs
    580       489  
Amortization of net gain on treasury lock
    (1,385 )     (1,945 )
Share-based compensation expense
    6,021       7,441  
Deferred income tax provision
    (4,340 )     (8,903 )
Loss on disposals of property, plant and equipment
    4,590       5,586  
Alternative fuel mixture tax credits receivable
    (106,381 )      
Changes in operating assets and liabilities:
               
Increase in assets —
               
Accounts receivable
    (16,946 )     (29,973 )
Inventories
    (838 )     (4,798 )
Prepaid expenses and other current assets
    (7,290 )     (7,133 )
Increase (decrease) in liabilities —
               
Accounts payable
    12,396       6,118  
Accrued liabilities
    13,792       1,773  
Other, net
    (10,018 )     (1,812 )
                 
Net cash provided by operating activities
    209,293       182,175  
                 
Cash Flows from Investing Activities:
               
Additions to property, plant and equipment
    (68,600 )     (98,268 )
Additions to other long term assets
    (1,941 )     (3,072 )
Acquisition of business, net of cash acquired
    (3,136 )      
Proceeds from disposals of property, plant and equipment
    28       952  
                 
Net cash used for investing activities
    (73,649 )     (100,388 )
                 
Cash Flows from Financing Activities:
               
Payments on long-term debt
    (457 )     (170,148 )
Proceeds from long-term debt issued
          149,939  
Financing costs paid
          (1,075 )
Settlement of treasury lock
          (4,386 )
Common stock dividends paid
    (61,456 )     (93,960 )
Repurchases of common stock
          (45,334 )
Proceeds from exercise of stock options
    249       2,391  
Excess tax benefits from share-based awards
    910       610  
                 
Net cash used for financing activities
    (60,754 )     (161,963 )
                 
Net increase (decrease) in cash and cash equivalents
    74,890       (80,176 )
Cash and cash equivalents, beginning of period
    149,397       228,143  
                 
Cash and cash equivalents, end of period
  $ 224,287     $ 147,967  
                 
 
See notes to condensed consolidated financial statements.


6


 

 
Packaging Corporation of America

Notes to Condensed Consolidated Financial Statements
(Unaudited)
September 30, 2009
 
1.   Basis of Presentation
 
The condensed consolidated financial statements as of September 30, 2009 and 2008 of Packaging Corporation of America (“PCA” or the “Company”) and for the three- and nine-month periods then ended are unaudited but include all adjustments (consisting only of normal recurring adjustments) that management considers necessary for a fair presentation of such financial statements. These financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with Article 10 of SEC Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete audited financial statements. Operating results for the period ended September 30, 2009 are not necessarily indicative of the results that may be expected for the year ending December 31, 2009. These condensed consolidated financial statements should be read in conjunction with PCA’s Annual Report on Form 10-K for the year ended December 31, 2008.
 
2.   Summary of Accounting Policies
 
Basis of Consolidation
 
The accompanying condensed consolidated financial statements of PCA include all majority-owned subsidiaries. All intercompany transactions have been eliminated. The Company has one joint venture that is accounted for under the equity method.
 
Use of Estimates
 
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts in the financial statements and the accompanying notes. Actual results could differ from those estimates.
 
Revenue Recognition
 
The Company recognizes revenue as title to the products is transferred to customers. Shipping and handling billings to a customer are included in net sales. Shipping and handling costs are included in cost of sales. In addition, the Company offers volume rebates to certain of its customers. The total cost of these programs is estimated and accrued as a reduction to net sales at the time of the respective sale.
 
Segment Information
 
PCA is engaged in one line of business: the integrated manufacture and sale of packaging materials, boxes and containers for industrial and consumer markets. No single customer accounts for more than 10% of total net sales.
 
Comprehensive Income
 
Comprehensive income is as follows:
 
                 
    Three Months Ended September 30,  
    2009     2008  
(In thousands)            
 
Net income
  $ 72,655     $ 38,102  
Other comprehensive income, net of tax:
               
Amortization of unfunded employee benefit obligations
    858       491  
Amortization of net gain on treasury lock
    (462 )     (507 )
                 
Comprehensive income
  $ 73,051     $ 38,086  
                 
 


7


 

 
Packaging Corporation of America

Notes to Condensed Consolidated Financial Statements
(Unaudited)
September 30, 2009
 
2.   Summary of Accounting Policies (Continued)
 
                 
    Nine Months Ended
 
    September 30,  
    2009     2008  
(In thousands)            
 
Net income
  $ 207,212     $ 105,367  
Other comprehensive income, net of tax:
               
Amortization of unfunded employee benefit obligations
    2,576       1,472  
Amortization of net gain on treasury lock
    (1,385 )     (1,945 )
Settlement of treasury lock
          (4,386 )
Other
    (125 )     3  
                 
Comprehensive income
  $ 208,278     $ 100,511  
                 
 
On June 12, 2003, in connection with a contemplated issuance of five-year and ten-year debt securities, PCA entered into interest rate protection agreements with a counterparty to protect against increases in the five-year and ten-year U.S. Treasury Note rates. On January 17, 2008, in connection with a contemplated issuance of ten-year debt securities, PCA entered into an interest rate protection agreement with a counterparty to protect against increases in the ten-year U.S. Treasury Note rate. These treasury rates served as references in determining the interest rates applicable to the debt securities the Company issued in July 2003 and March 2008. As a result of changes in the interest rates on those treasury securities between the time PCA entered into the agreements and the time PCA priced and issued the debt securities, the Company: (1) received a payment of $27.0 million from the counterparty upon settlement of the 2003 interest rate protection agreements on July 21, 2003; and (2) made a payment of $4.4 million to the counterparty upon settlement of the 2008 interest rate protection agreement on March 25, 2008. The Company recorded the settlements in accumulated other comprehensive income (loss) and is amortizing the $27.0 million gain and the $4.4 million loss to interest expense over the lives of the respective notes.
 
Recent Accounting Pronouncements
 
In August 2009, the Financial Accounting Standards Board (“FASB”) updated its guidance in the Fair Value Measurements and Disclosures Topic of the Codification related to fair value measurement of liabilities. This update provides clarification that in circumstances in which a quoted price in an active market for an identical liability is not available, a reporting entity is required to measure fair value using one or more valuation techniques. This guidance is effective for the first reporting period beginning after issuance. The Company does not expect the adoption of this guidance to have any impact on its financial position, cash flows or results of operations.
 
In June 2009, the FASB issued guidance in the Generally Accepted Accounting Principles Topic of the Codification. This guidance established a new hierarchy of GAAP sources for non-governmental entities under the FASB Accounting Standards Codification. The Codification is the sole source for authoritative U.S. GAAP and supersedes all accounting standards in U.S. GAAP, except for those issued by the SEC. The guidance was effective for financial statements issued for reporting periods ending after September 15, 2009. The Company adopted this guidance effective July 1, 2009. The adoption had no impact on the Company’s financial position, cash flows or results of operations.
 
In May 2009, the FASB issued guidance in the Subsequent Events Topic of the Codification, which sets forth: (1) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, (2) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements and (3) the disclosures that an entity should make about events or transactions that occurred after the

8


 

 
Packaging Corporation of America

Notes to Condensed Consolidated Financial Statements
(Unaudited)
September 30, 2009
 
2.   Summary of Accounting Policies (Continued)
 
balance sheet date. The guidance was effective on a prospective basis for interim or annual financial periods ending after June 15, 2009. The Company adopted this guidance on June 30, 2009. See Note 15 for additional information.
 
In April 2009, the FASB updated its guidance in the Fair Value Measurements and Disclosures Topic of the Codification related to estimating fair value when the volume and level of activity for an asset or liability have significantly decreased and identifying circumstances that indicate a transaction is not orderly. The guidance was effective for interim and annual reporting periods ending after June 15, 2009 with early adoption permitted for periods ending after March 15, 2009. The adoption of this guidance on June 30, 2009 did not have any impact on the Company’s results of operations.
 
Also in April 2009, the FASB updated its guidance in the Financial Instruments Topic of the Codification, which requires disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. This guidance also requires those disclosures in summarized financial information at interim reporting periods. The guidance was effective for interim reporting periods ending after June 15, 2009 with early adoption permitted for periods ending after March 15, 2009. The Company adopted this guidance on June 30, 2009. For additional information, see Note 9.
 
The FASB updated its guidance in the Business Combinations Topic of the Codification in April 2009, which addresses application issues on initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination. This guidance was effective for business combinations occurring on or after the beginning of the first annual period on or after December 15, 2008. The Company applied the guidance to its accounting for the sheet plant that was acquired on July 2, 2009. See Note 14 for additional information regarding this acquisition.
 
In December 2008, the FASB updated its guidance in the Compensation — Retirement Benefits Topic of the Codification, which requires detailed disclosures about employers’ plan assets, including employers’ investment strategies, major categories of plan assets, concentrations of risk within plan assets, and valuation techniques used to measure the fair value of plan assets. The disclosures required by this guidance must be provided in financial statements for fiscal years ending after December 15, 2009. Earlier application of the provisions of this guidance is permitted. The Company will comply with the additional disclosures required by this guidance upon its adoption in December 2009.
 
In June 2008, the FASB updated its guidance in the Earnings Per Share Topic of the Codification. This guidance clarified that all unvested share-based payment awards with a right to receive nonforfeitable dividends are participating securities and provides guidance on how to allocate earnings to participating securities and compute basic earnings per share using the two-class method. This guidance was effective for fiscal years beginning after December 15, 2008. The Company adopted this guidance on January 1, 2009. The adoption did not have a material impact on the Company’s earnings per share calculations.
 
In March 2008, the FASB issued guidance in the Derivatives and Hedging Topic of the Codification, which changes the disclosure requirements for derivative instruments and hedging activities. Entities will be required to provide enhanced disclosures about how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for, and how derivative instruments and related items affect an entity’s financial position, operations and cash flows. This guidance was effective as of the beginning of an entity’s fiscal year that begins after November 15, 2008. To the extent that PCA is a party to any derivative instruments after December 31, 2008, this guidance will impact PCA’s disclosures related to derivative instruments and hedging activities.
 
In December 2007, the FASB issued guidance in the Business Combinations Topic of the Codification. This guidance significantly changes the accounting for and reporting of business combination transactions in consolidated financial statements. These significant changes include: (1) recognition of 100% of the fair value of assets


9


 

 
Packaging Corporation of America

Notes to Condensed Consolidated Financial Statements
(Unaudited)
September 30, 2009
 
2.   Summary of Accounting Policies (Continued)
 
acquired, liabilities assumed and noncontrolling interests of acquired businesses, even if 100% of the business has not been acquired; (2) recognition of contingent consideration arrangements and preacquisition gain and loss contingencies at their acquisition-date fair values; (3) capitalization of research and development assets acquired at acquisition-date fair value; (4) recognition of acquisition-related transaction costs as expense when incurred; and (5) recognition of acquisition-related restructuring cost accruals only if the criteria in the Exit or Disposal Cost Obligations Topic of the Codification are met as of the acquisition date. This guidance was effective for fiscal years beginning after December 15, 2008. The Company applied the guidance to its accounting for the sheet plant that was acquired on July 2, 2009. See Note 14 for additional information regarding this acquisition.
 
3.   Earnings Per Share
 
The following table sets forth the computation of basic and diluted income per common share for the periods presented.
 
                 
    Three Months Ended September 30,  
    2009     2008  
(In thousands, except per share data)            
 
Numerator:
               
Net income
  $ 72,655     $ 38,102  
Denominator:
               
Basic common shares outstanding
    101,713       102,562  
Effect of dilutive securities:
               
Stock options
    119       438  
Unvested restricted stock
    704       590  
                 
Dilutive common shares outstanding
    102,536       103,590  
                 
Basic income per common share
  $ 0.71     $ 0.37  
Diluted income per common share
  $ 0.71     $ 0.37  
 
                 
    Nine Months Ended September 30,  
    2009     2008  
(In thousands, except per share data)            
 
Numerator:
               
Net income
  $ 207,212     $ 105,367  
Denominator:
               
Basic common shares outstanding
    101,516       103,147  
Effect of dilutive securities:
               
Stock options
    69       414  
Unvested restricted stock
    690       487  
                 
Dilutive common shares outstanding
    102,275       104,048  
                 
Basic income per common share
  $ 2.04     $ 1.02  
Diluted income per common share
  $ 2.03     $ 1.01  
 
Options to purchase 1.5 million shares and 1.9 million shares for the three- and nine-month periods ended September 30, 2009, respectively, and 0.2 million shares for both the three- and nine-month periods ended


10


 

 
Packaging Corporation of America

Notes to Condensed Consolidated Financial Statements
(Unaudited)
September 30, 2009
 
3.   Earnings Per Share (Continued)
 
September 30, 2008 were not included in the computation of diluted common shares outstanding as their exercise price exceeded the average market price of the Company’s common stock for each respective reporting period.
 
4.   Stock-Based Compensation
 
In October 1999, the Company adopted a long-term equity incentive plan, which provides for grants of stock options, stock appreciation rights, restricted stock and performance awards to directors, officers and employees of PCA, as well as others who engage in services for PCA. Option awards granted to directors, officers and employees have contractual lives of seven or ten years. Options granted to officers and employees vest ratably over a three-year period, and options granted to directors vest immediately. Restricted stock awards granted to employees vest at the end of a four-year period, and restricted stock awards granted to directors vest at the end of a six-month period. The plan, which was scheduled to terminate on October 19, 2009, was amended on May 27, 2009. The amendment extended the plan’s term by five years to October 19, 2014 and increased the number of shares that may be granted under the plan by 2,000,000 shares, to a total issuance of up to 8,550,000 shares of common stock over the life of the plan (including prior awards). As of September 30, 2009, options and restricted stock of 6,546,494 shares have been granted, net of forfeitures. Forfeitures are added back to the pool of shares of common stock available to be granted at a future date.
 
Compensation expense for both stock options and restricted stock recognized in the condensed consolidated statements of income for the three- and nine-month periods ended September 30, 2009 and 2008 was as follows:
 
                                 
    Three Months Ended
    Nine Months Ended
 
    September 30,     September 30,  
    2009     2008     2009     2008  
(In thousands)                        
 
Stock options
  $ 210     $ 185     $ 576     $ 1,273  
Restricted stock
    1,300       3,445       5,445       6,168  
                                 
Impact on income before income taxes
    1,510       3,630       6,021       7,441  
Income tax benefit
    (588 )     (1,409 )     (2,340 )     (2,888 )
                                 
Impact on net income
  $ 922     $ 2,221     $ 3,681     $ 4,553  
                                 
 
The Company uses the Black-Scholes-Merton option-pricing model to estimate the fair value of each option grant as of the date of grant. Expected volatilities are based on historical volatility of the Company’s common stock. The expected life of the option is estimated using historical data pertaining to option exercises and employee terminations. Separate groups of employees that have similar historical exercise behavior are considered separately for estimating the expected life. The risk-free interest rate is based on U.S. Treasury yields in effect at the time of grant. The fair value of restricted stock is determined based on the closing price of the Company’s common stock on the grant date. There were no option grants during the first, second, or third quarters of 2009.


11


 

 
Packaging Corporation of America

Notes to Condensed Consolidated Financial Statements
(Unaudited)
September 30, 2009
 
4.   Stock-Based Compensation (Continued)
 
A summary of the Company’s stock option activity and related information follows:
 
                                 
                Weighted-
       
          Weighted-
    Average
       
          Average
    Remaining
    Aggregate
 
          Exercise
    Contractual
    Intrinsic
 
    Options     Price     Term (years)     Value  
                      (In thousands)  
 
Outstanding at December 31, 2008
    2,227,032     $ 19.85                  
Exercised
    (138,345 )     6.58                  
Forfeited
    (62,444 )     18.83                  
                                 
Outstanding at September 30, 2009
    2,026,243     $ 20.79       3.5     $ 2,272  
                                 
Outstanding — vested or expected to vest at September 30, 2009
    2,025,927     $ 20.79       3.5     $ 2,272  
                                 
Exercisable at September 30, 2009
    1,957,853     $ 20.61       3.4     $ 2,272  
                                 
 
The total intrinsic value of options exercised during the three months ended September 30, 2009 and 2008 was $0.1 million and $0.6 million, respectively, and during the nine months ended September 30, 2009 and 2008 the intrinsic value was both $1.4 million. As of September 30, 2009, there was $0.2 million of total unrecognized compensation cost related to non-vested stock option awards granted under the Company’s equity incentive plan. The Company expects to recognize the cost of these stock option awards over a weighted-average period of 0.75 year.
 
A summary of the Company’s restricted stock activity follows:
 
                                 
    2009     2008  
          Fair Market
          Fair Market
 
          Value at
          Value at
 
          Date of
          Date of
 
(Dollars in thousands)   Shares     Grant     Shares     Grant  
 
Restricted stock at January 1
    1,038,270     $ 23,023       764,705     $ 17,490  
Granted
    444,985       6,995       374,455       7,947  
Vested
    (234,930 )     (5,025 )     (91,995 )     (2,209 )
Cancellations
    (12,210 )     (261 )     (4,895 )     (110 )
                                 
Restricted stock at September 30
    1,236,115     $ 24,732       1,042,270     $ 23,118  
                                 
 
The Company generally recognizes compensation expense associated with restricted stock awards ratably over their vesting periods. As PCA’s Board of Directors has the ability to accelerate vesting of restricted stock upon an employee’s retirement, the Company accelerates the recognition of compensation expense for certain employees approaching normal retirement age. As of September 30, 2009, there was $10.7 million of total unrecognized compensation costs related to the above restricted stock awards. The Company expects to recognize the cost of these stock awards over a weighted-average period of 2.9 years.


12


 

 
Packaging Corporation of America

Notes to Condensed Consolidated Financial Statements
(Unaudited)
September 30, 2009
 
 
5.   Inventories
 
The components of inventories are as follows:
 
                 
    September 30,
    December 31,
 
    2009     2008  
(In thousands)         (Audited)  
 
Raw materials
  $ 93,587     $ 106,165  
Work in process
    7,371       6,560  
Finished goods
    65,345       65,213  
Supplies and materials
    100,098       94,849  
                 
Inventories at FIFO or average cost
    266,401       272,787  
Excess of FIFO or average cost over LIFO cost
    (57,665 )     (65,833 )
                 
Inventories, net
  $ 208,736     $ 206,954  
                 
 
An actual valuation of inventory under the LIFO method is made only at the end of each year based on the inventory levels and costs at that time. Accordingly, interim LIFO calculations must necessarily be based on management’s estimates of expected year-end inventory levels and costs. Because these are subject to many factors beyond management’s control, interim results are subject to the final year-end LIFO inventory valuation.
 
6.   Goodwill and Other Intangible Assets
 
Goodwill
 
Changes in the carrying amount of goodwill for the period ended September 30, 2009 are as follows:
 
         
(In thousands)      
 
Balance as of December 31, 2008
  $ 37,163  
Acquisition
    1,691  
         
Balance at September 30, 2009
  $ 38,854  
         
 
Other Intangible Assets
 
The components of other intangible assets are as follows:
 
                                     
        As of September 30, 2009     As of December 31, 2008  
    Weighted
  Gross
          Gross
       
    Average
  Carrying
    Accumulated
    Carrying
    Accumulated
 
    Remaining Life   Amount     Amortization     Amount     Amortization  
(In thousands)                   (Audited)  
 
Customer lists and relations
  31.3 years   $ 17,441     $ 5,447     $ 17,441     $ 4,836  
Covenants not to compete
      2,292       2,292       2,292       2,228  
                                     
Total other intangible assets
      $ 19,733     $ 7,739     $ 19,733     $ 7,064  
                                     


13


 

 
Packaging Corporation of America

Notes to Condensed Consolidated Financial Statements
(Unaudited)
September 30, 2009
 
 
7.   Employee Benefit Plans and Other Postretirement Benefits
 
For the three- and nine-months ended September 30, 2009 and 2008, net pension costs were comprised of the following:
 
                                 
    Three Months
    Nine Months
 
    Ended
    Ended
 
    September 30,     September 30,  
    2009     2008     2009     2008  
(In thousands)                        
 
Components of Net Pension Costs
                               
Service cost for benefits earned during the year
  $ 4,489     $ 4,445     $ 13,466     $ 13,335  
Interest cost on accumulated benefit obligation
    2,524       1,957       7,685       5,871  
Expected return on assets
    (2,143 )     (2,145 )     (6,429 )     (6,435 )
Net amortization of unrecognized amounts
    1,426       868       4,279       2,604  
Settlement gain
                (126 )      
                                 
Net pension costs
  $ 6,296     $ 5,125     $ 18,875     $ 15,375  
                                 
 
The Company makes pension plan contributions that are sufficient to fund its actuarially determined costs, generally equal to the minimum amounts required by the Employee Retirement Income Security Act (ERISA). However, from time to time the Company may make discretionary contributions in excess of the required minimum amounts. The Company expects to contribute $35.2 million to the pension plans in 2009, of which $30.9 million has been contributed through September 30, 2009.
 
For the three- and nine-months ended September 30, 2009 and 2008, net postretirement costs were comprised of the following:
 
                                 
    Three Months
    Nine Months
 
    Ended
    Ended
 
    September 30,     September 30,  
    2009     2008     2009     2008  
(In thousands)                        
 
Components of Net Postretirement Costs
                               
Service cost for benefits earned during the year
  $ 335     $ 267     $ 1,005     $ 801  
Interest cost on accumulated benefit obligation
    256       197       768       591  
Net amortization of unrecognized amounts
    (22 )     (60 )     (66 )     (180 )
                                 
Net postretirement costs
  $ 569     $ 404     $ 1,707     $ 1,212  
                                 
 
8.   Transfers of Financial Assets
 
PCA has an on-balance sheet securitization program for its trade accounts receivable that is accounted for as a secured borrowing under the Transfers and Servicing Topic of the Codification. To effectuate this program, the Company formed a wholly owned limited purpose subsidiary, Packaging Credit Company, LLC (“PCC”), which in turn formed a wholly owned, bankruptcy-remote, special-purpose subsidiary, Packaging Receivables Company, LLC (“PRC”), for the purpose of acquiring receivables from PCC. Both of these entities are included in the consolidated financial statements of the Company. Under this program, PCC purchases on an ongoing basis substantially all of the receivables of the Company and sells such receivables to PRC. PRC and lenders established a $150.0 million receivables-backed revolving credit facility (“Receivables Credit Facility”) through which PRC obtains funds to purchase receivables from PCC. The receivables purchased by PRC are solely the property of PRC. In the event of liquidation of PRC, the creditors of PRC would be entitled to satisfy their claims from PRC’s assets prior to any distribution to PCC or the Company. Credit available under the receivables credit facility is on a


14


 

 
Packaging Corporation of America

Notes to Condensed Consolidated Financial Statements
(Unaudited)
September 30, 2009
 
8.   Transfers of Financial Assets (Continued)
 
borrowing-base formula. As a result, the full amount of the facility may not be available at all times. At September 30, 2009, $109.0 million was outstanding and included in “Short-term debt and current maturities of long-term debt” on the condensed consolidated balance sheet. Approximately $253.2 million of accounts receivable at September 30, 2009 have been sold to PRC and are included in “Accounts receivable, net of allowance for doubtful accounts and customer deductions” on the condensed consolidated balance sheet.
 
9.   Financial Instruments
 
The carrying and estimated fair values of PCA’s financial instruments at September 30, 2009 and December 31, 2008 were as follows:
 
                                 
    September 30, 2009     December 31, 2008  
    Carrying
          Carrying
       
    Amount     Fair Value     Amount     Fair Value  
(In thousands)               (Audited)  
 
Cash and cash equivalents
  $ 224,287     $ 224,287     $ 149,397     $ 149,397  
Accounts receivable, net
    274,026       274,026       254,898       254,898  
Accounts and dividends payable
    (132,176 )     (132,176 )     (131,783 )     (131,783 )
Long-term debt —
                               
5.75% senior notes
    (398,714 )     (415,000 )     (398,457 )     (367,000 )
6.50% senior notes
    (149,948 )     (155,625 )     (149,943 )     (133,500 )
Receivables credit facility
    (109,000 )     (109,000 )     (109,000 )     (109,000 )
Capital lease obligations
    (23,278 )     (23,278 )     (23,735 )     (23,735 )
 
The fair value of cash and cash equivalents, accounts receivable, net and accounts and dividends payable approximate their carrying amounts due to the short-term nature of these financial instruments.
 
The fair value of the receivables credit facility approximates its carrying amount due to the variable interest-rate feature of the instrument. The fair values of the senior notes are based on quoted market prices. The fair value of the capital lease obligations was estimated to not be materially different from the carrying amount.
 
10.   Fair Value Measurements
 
PCA adopted the guidance in the Fair Value Measurements and Disclosures Topic of the Codification on January 1, 2008. The guidance defines fair value, establishes a consistent framework for measuring fair value and expands disclosure for each major asset and liability category measured at fair value on either a recurring or nonrecurring basis. The guidance clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, the guidance establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:
 
Level 1 — observable inputs such as quoted prices in active markets
 
Level 2 — inputs, other than quoted prices in active markets, that are observable either directly or indirectly
 
Level 3 — unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions


15


 

 
Packaging Corporation of America

Notes to Condensed Consolidated Financial Statements
(Unaudited)
September 30, 2009
 
10.   Fair Value Measurements (Continued)
 
Assets and liabilities measured at fair value are based on one or more of three valuation techniques noted in the guidance. The valuation techniques are as follows:
 
(a) Market approach — prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities
 
(b) Cost approach — amount that would be required to replace the service capacity of an asset (replacement cost)
 
(c) Income approach — techniques to convert future amounts to a single present amount based on market expectations (including present value techniques, option-pricing and excess earnings models)
 
Assets and liabilities measured at fair value on a recurring basis are as follows:
 
                         
          Quoted Prices in
       
          Active Markets for
       
    September 30,
    Identical Assets
    Valuation
 
    2009     (Level 1)     Technique  
(In thousands)                  
 
Money Market Funds
  $ 223,791     $ 223,791       (a )
 
The money market funds PCA invests in include funds comprised of U.S. Treasury obligations or backed by U.S. Treasury obligations.
 
There were no changes in the Company’s valuation techniques used to measure fair values on a recurring basis as a result of adopting this guidance. PCA had no assets or liabilities that were measured on a nonrecurring basis.
 
11.   Environmental Liabilities
 
The potential costs for various environmental matters are uncertain due to such factors as the unknown magnitude of possible cleanup costs, the complexity and evolving nature of governmental laws and regulations and their interpretations, and the timing, varying costs and effectiveness of alternative cleanup technologies. From 1994 through September 30, 2009, remediation costs at the PCA’s mills and corrugated plants totaled approximately $3.2 million. As of September 30, 2009, the Company maintained an environmental reserve of $8.9 million relating to on-site landfills and surface impoundments as well as ongoing and anticipated remedial projects. Liabilities recorded for environmental contingencies are estimates of the probable costs based upon available information and assumptions. Because of these uncertainties, PCA’s estimates may change. As of the date of this filing, the Company believes that it is not reasonably possible that future environmental expenditures and asset retirement obligations above the $8.9 million accrued as of September 30, 2009, will have a material impact on our financial condition, results of operations, or cash flows.
 
12.   Stock Repurchase Program
 
On October 17, 2007, PCA announced that its Board of Directors authorized a $150.0 million common stock repurchase program. There is no expiration date for the common stock repurchase program. Through December 31, 2008, the Company repurchased 3,818,729 shares of common stock. All repurchased shares were retired prior to December 31, 2008. No shares were repurchased during the first nine months of 2009. As of September 30, 2009, $65.0 million of the $150.0 million authorization remained available for repurchase of the Company’s common stock.
 
13.   Alternative Fuel Mixture Tax Credits
 
The Company generates “black liquor” as a by-product of its pulp manufacturing process and uses it in a mixture with diesel fuel to produce energy at its Counce, Tennessee, Valdosta, Georgia, and Tomahawk, Wisconsin mills. The U.S. Internal Revenue Code provides a $0.50 per gallon refundable tax credit for taxpayers who use


16


 

 
Packaging Corporation of America

Notes to Condensed Consolidated Financial Statements
(Unaudited)
September 30, 2009
 
13.   Alternative Fuel Mixture Tax Credits (Continued)
 
alternative fuels in their trade or business. The Company filed applications with the Internal Revenue Service (the “IRS”) in December 2008 to be registered as an alternative fuel mixer and received approval in April 2009. As a registered alternative fuel mixer, the Company believes the use of black liquor as an alternative fuel qualifies for this tax credit. The laws governing this credit, as well as the taxability of benefits received from this credit, are complex. The alternative fuel mixture tax credit is scheduled to expire on December 31, 2009, unless proposed legislation to eliminate the credit goes into effect prior to that date. During the three- and nine-month periods ended September 30, 2009, PCA recorded $47.1 million and $126.8 million, respectively, of these credits after net operating expenses of $0.5 million and $2.0 million, respectively. The Company applied $18.7 million of these credits against its second quarter 2009 federal cash tax payment and $3.7 million against its third quarter 2009 federal cash tax payment, resulting in a receivable of $106.4 million for the remaining balance of the alternative fuel mixture tax credits earned through September 30, 2009 that is included on the Company’s balance sheet at September 30, 2009.
 
14.   Acquisition
 
On July 2, 2009, the Company acquired a specialty sheet business located in Chicago, Illinois, for approximately $3.1 million, net of cash acquired. The purchase method of accounting was used to account for the acquisition. Goodwill of $1.7 million (which is deductible for income tax purposes) was recorded in connection with the acquisition. Sales and total assets of the acquisition were not material to the Company’s overall sales and total assets prior to the acquisition. Operating results of the plant subsequent to the date of the acquisition are included in the Company’s operating results.
 
15.   Subsequent Event
 
The Company has evaluated subsequent events through November 4, 2009, the filing date of this Form 10-Q, and determined there were no events to disclose.


17


 

Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
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:
 
  •  corrugated products demand;
 
  •  corrugated products and containerboard pricing;
 
  •  containerboard inventories; and
 
  •  cost trends and volatility for our major costs, including wood and recycled fiber, purchased energy, labor and fringe benefits, and transportation costs.
 
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. In addition to U.S. shipments, approximately 10% of all domestically produced containerboard has been exported annually for use in other countries.
 
Industry Conditions
 
The U.S. economy experienced a severe downturn in the fourth quarter of 2008 which continued through the first quarter of 2009 with some improvement seen in the second and third quarter. Industry-wide shipments of corrugated products decreased 8.0% for the three months ended September 30, 2009 compared to the same period in 2008, but were up 1.5% compared to the second quarter of 2009. Reported third quarter 2009 industry containerboard production decreased 7.4% from the third quarter of 2008. However, export shipments of containerboard decreased only 1.7% over the same time period. Industry published prices for containerboard stabilized during June, July and August, but fell $10 per ton in September. Third quarter average published transaction prices for linerboard were $73 per ton lower than third quarter 2008. Reported industry containerboard inventories at the end of September 2009 were approximately 200,000 tons below September 2008, the lowest September-ending level in nearly 30 years.
 
PCA Operations Summary
 
During the third quarter of 2009, we produced approximately 588,000 tons of containerboard at our mills, of which about 80% was consumed in our corrugated products manufacturing plants, 12% was sold to domestic customers and 8% was sold in the export market. Production in the third quarter was down about 33,000 tons compared to the third quarter of 2008, primarily due to market-related downtime.
 
Our corrugated products manufacturing plants sold about 7.5 billion square feet (“bsf”) of corrugated products during the third quarter of 2009. Corrugated products shipments were up 1.5% compared to the second quarter of 2009, but were 4.8% below third quarter 2008. Sales prices of containerboard and corrugated products prices were lower than the third quarter 2008 primarily due to the published price decreases during the first half of 2009. In addition, recycled fiber, transportation and energy costs were lower than last year’s third quarter. However, the improvement from decreased costs was more than offset by the impact of lower sales prices due to the weaker economy.
 
Looking ahead to the fourth quarter, our earnings are expected to be impacted by lower volume due to three less shipping days than the third quarter along with normal seasonality that typically results in lower fourth quarter


18


 

volume. Prices are expected to be lower as a result of previously published containerboard price changes. We also expect wood costs and energy usage to increase with colder and wetter weather. Considering these items, and excluding any income from alternative fuel mixture tax credits, described in Note 13 to the financial statements included elsewhere in this report, we expect our fourth quarter 2009 earnings to be lower than our earnings in the third quarter of 2009.
 
Results of Operations
 
Three Months Ended September 30, 2009 Compared to Three Months Ended September 30, 2008
 
The historical results of operations of PCA for the three months ended September 30, 2009 and 2008 are set forth below:
 
                         
    Three Months Ended September 30,        
    2009     2008     Change  
(In thousands)                  
 
Net sales
  $ 553,573     $ 620,785     $ (67,212 )
                         
Income from operations
  $ 96,331     $ 68,705     $ 27,626  
Interest expense, net
    (8,961 )     (8,071 )     (890 )
                         
Income before taxes
    87,370       60,634       26,736  
Provision for income taxes
    (14,715 )     (22,532 )     7,817  
                         
Net income
  $ 72,655     $ 38,102     $ 34,553  
                         
 
Net Sales
 
Net sales decreased by $67.2 million, or 10.8%, for the three months ended September 30, 2009 from the comparable period in 2008, primarily as a result of the impact of decreased sales volume of corrugated products and containerboard to third parties ($35.0 million) and decreased sales prices ($32.2 million). Sales prices decreased as a result of monthly published industry containerboard price decreases from December 2008 through May 2009 and also in September 2009, which reduced linerboard and corrugating medium transaction prices by a total $80 per ton (or 13.1%) and $90 per ton (or 15.3%), respectively, compared to November 2008 published price levels.
 
Corrugated products shipments on a total and per-workday basis for the third quarter decreased 4.8% compared to the third quarter of 2008. The number of workdays were the same in the third quarters of 2008 and 2009. Containerboard volume sold to domestic and export customers was 6.0% lower for the three months ended September 30, 2009 compared to the three months ended September 30, 2008. Containerboard mill production for the three months ended September 30, 2009 was 588,000 tons compared to 621,000 tons during the same period in 2008, down 33,000 tons as a result of the market-related downtime taken during the third quarter.
 
Income from Operations
 
Income from operations increased by $27.6 million, or 40.2%, for the three months ended September 30, 2009 compared to the three months ended September 30, 2008, primarily due to an alternative fuel mixture tax credit ($47.1 million). Please see Note 13 to the financial statements included in this report for a description of the alternative fuel mixture tax credit. Excluding the alternative fuel mixture tax credit, income from operations was $19.5 million below the previous year’s third quarter primarily as a result of the impact of decreased sales prices of corrugated products and containerboard ($32.2 million) and lower sales volume ($10.2 million). These items were partially offset by decreased costs of transportation ($8.8 million) energy ($7.8 million), recycled fiber ($3.2 million) and chemicals ($2.7 million).
 
Gross profit decreased $21.5 million, or 16.3%, for the three months ended September 30, 2009 from the comparable period in 2008. Gross profit as a percentage of net sales decreased from 21.3% of net sales in the three months ended September 30, 2008 to 20.0% of net sales in the current quarter due primarily to the decreased prices described above.


19


 

Selling and administrative expenses decreased $0.5 million, or 1.2%, for the three months ended September 30, 2009 compared to the same period in 2008, as a result of reduced salary and fringe benefit expenses ($0.7 million) partially offset by other items which were individually insignificant.
 
Corporate overhead decreased $2.9 million, or 18.0%, for the three months ended September 30, 2009 compared to the same period in 2008, primarily attributable to a decrease in salary expense due to the timing of both share-based compensation and incentive compensation ($2.4 million) and lower fees for professional services related to tax, audit and human resource matters ($0.3 million).
 
Other expense for the three months ended September 30, 2009 increased $1.4 million or 57.6% compared to the third quarter of 2008, primarily due to increased fixed asset disposals in the third quarter of 2009 ($1.4 million).
 
Interest Expense, Net and Income Taxes
 
Net interest expense increased $0.9 million, or 11.0%, for the three months ended September 30, 2009 from the three months ended September 30, 2008, primarily as a result of lower interest income ($1.0 million) earned on PCA’s cash equivalents. The $1.0 million decrease in interest income was primarily due to lower interest income rates during the three months ended September 30, 2009 compared to the same period in 2008.
 
PCA’s effective tax rate was 16.8% for the three months ended September 30, 2009 and 37.2% for the comparable period in 2008. The effective tax rate 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.
 
Nine Months Ended September 30, 2009 Compared to Nine Months Ended September 30, 2008
 
The historical results of operations of PCA for the nine months ended September 30, 2009 and 2008 are set forth below:
 
                         
    For the Nine Months Ended September 30,        
    2009     2008     Change  
(In thousands)                  
 
Net sales
  $ 1,615,332     $ 1,814,442     $ (199,110 )
                         
Income from operations
  $ 281,655     $ 190,024     $ 91,631  
Interest expense, net
    (26,529 )     (22,571 )     (3,958 )
                         
Income before taxes
    255,126       167,453       87,673  
Provision for income taxes
    (47,914 )     (62,086 )     14,172  
                         
Net income
  $ 207,212     $ 105,367     $ 101,845  
                         
 
Net Sales
 
Net sales decreased by $199.1 million, or 11.0%, for the nine months ended September 30, 2009 from the comparable period in 2008 primarily as a result of decreased sales volume of corrugated products and containerboard to third parties ($185.6 million) and lower average prices for the first nine months of 2009 ($13.5 million) compared to the first nine months of 2008. Sales prices decreased as a result of published price reductions since December 2008 described earlier.
 
Corrugated products shipments per workday for the nine months ended September 30, 2009 decreased 7.4% compared to the same period in 2008 and were 8.3% lower on a total shipments basis due to the fact that the first nine months of 2009 contained two fewer workdays than the same period in 2008. Containerboard volume sold to domestic and export customers was 19.9% lower for the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008. Containerboard mill production for the first nine months of 2009 was approximately 1,658,000 tons compared to 1,820,000 tons produced in the first nine months of 2008, a decrease of 162,000 tons as a result of market-related downtime, planned annual maintenance outages and machine slowbacks.


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Income from Operations
 
Income from operations increased by $91.6 million, or 48.2%, for the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008, primarily attributable to the alternative fuel mixture tax credit of $126.8 million described previously. Excluding the alternative fuel mixture tax credit, income from operations decreased $35.2 million for the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008 primarily attributable to lower sales volume ($66.4 million), decreased sales prices of corrugated products and containerboard ($13.5 million) and increased labor and fringe benefit costs ($7.7 million). These items were partially offset by decreased costs of recycled fiber ($19.7 million), transportation ($18.6 million), energy ($11.8 million) and starch and wax ($1.9 million).
 
Gross profit decreased $38.4 million, or 10.2%, for the nine months ended September 30, 2009 from the comparable period in 2008. Gross profit as a percentage of net sales increased from 20.8% of net sales in the nine months ended September 30, 2008 to 21.0% of net sales in the nine months ended September 30, 2009 due primarily to the cost decreases described above.
 
Selling and administrative expenses decreased $1.6 million, or 1.2%, for the nine months ended September 30, 2009 compared to the same period in 2008, primarily as a result of lower expenses related to travel and entertainment ($1.0 million), warehousing costs ($0.4 million) and salary and fringe benefits ($0.3 million).
 
Corporate overhead for the nine months ended September 30, 2009 decreased $2.4 million or 5.4% compared to the same period in 2008, primarily due to decreased salary and incentive compensation expense ($1.7 million), reduced fees paid for professional services related to tax, audit and human resource matters ($0.4 million) and other items which were individually insignificant.
 
Other expense for the nine months ended September 30, 2009 increased $0.8 million or 7.3% compared to the same period in 2008, primarily due to increased fixed asset disposals ($1.0 million).
 
Interest Expense, Net and Income Taxes
 
Net interest expense increased $4.0 million, or 17.5%, for the nine months ended September 30, 2009 from the nine months ended September 30, 2008, primarily as a result of lower interest income ($4.9 million) earned on PCA’s cash equivalents, partially offset by lower interest expense ($0.9 million) related to PCA’s outstanding debt balances. The $4.9 million decrease in interest income was primarily due to lower interest income rates during the nine months ended September 30, 2009 compared to the same period in 2008. The $0.9 million decrease in interest expense was primarily due to a decrease in interest expense related to the Company’s receivables credit facility due to lower interest rates.
 
PCA’s effective tax rate was 18.8% for the nine months ended September 30, 2009 and 37.1% for the comparable period in 2008. The effective tax rate 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 impacting FIN No. 48 during the first nine months of 2009.
 
Liquidity and Capital Resources
 
The following table presents a summary of our cash flows for the periods presented:
 
                         
    Nine Months Ended
       
    September 30,        
    2009     2008     Change  
(In thousands)                  
 
Net cash provided by (used for):
                       
Operating activities
  $ 209,293     $ 182,175     $ 27,118  
Investing activities
    (73,649 )     (100,388 )     26,739  
Financing activities
    (60,754 )     (161,963 )     101,209  
                         
Net increase (decrease) in cash and cash equivalents
  $ 74,890     $ (80,176 )   $ 155,066  
                         


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Operating Activities
 
Net cash provided by operating activities for the nine months ended September 30, 2009 was $209.3 million compared to $182.2 million for the nine months ended September 30, 2008, an increase of $27.1 million, or 14.9%. Net income, excluding the impact of the alternative fuel mixture tax credits described in Note 13 to the financial statements included in this report, was $79.7 million for the first nine months of 2009 compared to $105.4 million for the comparable period in 2008, a decrease of $25.7 million that reduced net cash provided by operating activities. This decrease was more than offset by reduced cash requirements, including a $22.4 million reduction in federal tax payments in the second and third quarters of 2009 as a result of the alternative fuel mixture tax credits. Cash requirements for operating activities are subject to PCA’s operating needs, which were impacted by the weakened business conditions during the first nine months of 2009, 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 nine months ended September 30, 2009 decreased $26.7 million, or 26.6%, to $73.6 million, compared to the nine months ended September 30, 2008. The decrease was primarily related to lower additions to property, plant and equipment of $29.7 million during the nine months ended September 30, 2009 compared to the same period in 2008, partially offset by a $3.1 million acquisition completed during the third quarter of 2009.
 
In October 2009, the Company announced that its Board of Directors had approved a major energy optimization project at its Counce and Valdosta mills. The total capital is expected to be about $295 million to be spent over the next two years. The project is expected to be funded with existing cash and cash generated from operating activities and is expected to be completed in the fourth quarter of 2011.
 
Financing Activities
 
Net cash used for financing activities totaled $60.8 million for the nine months ended September 30, 2009, a decrease of $101.2 million, or 62.5%, compared to the same period in 2008. The difference was primarily attributable to lower debt payments of $169.7 million in 2009, $45.3 million in repurchases of PCA common stock during the first nine months of 2008 and lower common stock dividends paid of $32.5 million during the first nine months of 2009 compared to the same period in 2008, partially offset by $145.2 million in net proceeds received from PCA’s notes offering in 2008 described below.
 
In connection with the senior notes offering in March of 2008, PCA received proceeds, net of discount, of $149.9 million and paid $4.4 million for settlement of a treasury lock that it entered into to protect it against increases in the ten-year U.S. Treasury rate, which served as a reference in determining the interest rate applicable to the notes. PCA also incurred financing costs in the amount of $0.3 million in connection with the senior notes offering. PCA later used the proceeds of this offering, together with cash on hand, to repay all of the $150.0 million of outstanding 43/8% senior notes due 2008 on August 1, 2008.
 
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 September 30, 2009, 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 capital expenditures, debt service and declared common stock dividends, which it expects to be able to fund from these sources.


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The following table provides the outstanding balances, excluding unamortized debt discount of $1.3 million, and the weighted average interest rates as of September 30, 2009 for PCA’s revolving credit facility, the receivables credit facility, and the senior notes:
 
                         
                Projected
 
    Balance at
    Weighted
    Annual
 
    September 30,
    Average
    Cash Interest
 
Borrowing Arrangement
  2009     Interest Rate     Payments  
(In thousands)                  
 
Revolving Credit Facility
  $       N/A       N/A  
Receivables Credit Facility
    109,000       2.05 %   $ 2,236  
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       5.31 %   $ 34,986  
                         
 
The above table 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 15, 2009, PCA extended its $150.0 million receivables-backed credit facility through April 14, 2010.
 
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 September 30, 2009, PCA was in compliance with these covenants.
 
PCA currently expects to incur capital expenditures of about $120.0 million in 2009, including $20.0 million for major energy projects at its Counce and Valdosta mills. These expenditures will be used primarily for maintenance capital, cost reduction, business growth and environmental compliance. As of September 30, 2009, PCA spent $68.6 million for capital expenditures and had committed to spend an additional $37.3 million in the remainder of 2009 and beyond.
 
On February 26, 2009, PCA announced that it had reduced its quarterly common stock dividend from $0.30 per share to $0.15 per share effective for the dividend payable April 15, 2009 to shareholders of record as of March 13, 2009.
 
PCA believes that net cash generated from operating activities, available cash reserves 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.


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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. As of September 30, 2009, PCA was not a party to any derivative instruments.
 
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);
 
  •  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- and nine-month periods ending September 30, 2009 and 2008.
 
Off-Balance Sheet Arrangements
 
PCA does not have any off-balance sheet arrangements as of September 30, 2009 that would require disclosure under SEC FR-67, “Disclosure in Management’s Discussion and Analysis About Off-Balance Sheet Arrangement 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, 2008, 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 nine months of 2009.


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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;
 
  •  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, 2008.
 
Item 3.   Quantitative and Qualitative Disclosures About Market Risk.
 
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.
 
Item 4.   Controls and Procedures.
 
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 September 30, 2009. 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 September 30, 2009.
 
During the quarter ended September 30, 2009, 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.


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PART II
 
OTHER INFORMATION
 
Item 1.   Legal Proceedings.
 
PCA is a party to various legal actions arising in the ordinary course of our business. These legal actions cover a broad variety of claims spanning our entire business. As of the date of this filing, we believe it is not reasonably possible that the resolution of these legal actions will, individually or in the aggregate, have a material adverse effect on our financial condition, results of operations or cash flows.
 
Item 1A.   Risk Factors
 
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, 2008.
 
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds.
 
As summarized in the following table, the Company did not repurchase any of its stock in the third quarter of 2009:
 
                                 
                      Approximate
 
                Total Number
    Dollar Value
 
                of Shares
    of Shares that
 
                Purchased as
    may yet be
 
    Total Number
    Average
    Part of Publicly
    Purchased Under
 
    of Shares
    Price Paid
    Announced
    the Plan or
 
Period
  Purchased     per Share     Plans or Programs     Program  
                      (In thousands)  
 
July 1, 2009 to July 31, 2009
        $           $ 64,974  
August 1, 2009 to August 31, 2009
                      64,974  
September 1, 2009 to September 30, 2009
                      64,974  
                                 
Total
        $           $ 64,974  
                                 
 
Item 3.   Defaults Upon Senior Securities.
 
None.
 
Item 4.   Submission of Matters to a Vote of Security Holders.
 
None.
 
Item 5.   Other Information.
 
None.
 
Item 6.   Exhibits.
 
         
  31 .1   Certification of Chief Executive Officer, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
  31 .2   Certification of Chief Financial Officer, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
  32 .1   Certification of Chief Executive Officer Pursuant to 18 U.S.C. §1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
  32 .2   Certification of Chief Financial Officer Pursuant to 18 U.S.C. §1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002


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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.
 
Packaging Corporation of America
(Registrant)
 
  By: 
/s/  Paul T. Stecko
Chairman and Chief Executive Officer
 
  By: 
/s/  Richard B. West
Senior Vice President and Chief Financial Officer
 
Date: November 4, 2009


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