UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
| x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE |
| ACT OF 1934 |
For the fiscal year ended September 30, 2009
OR
| ¨ | 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 1-12613
ROCK-TENN COMPANY
(Exact Name of Registrant as Specified in Its Charter)
| Georgia | 62-0342590 | |
| (State or Other Jurisdiction of Incorporation or Organization) |
(I.R.S. Employer Identification No.) | |
| 504 Thrasher Street, Norcross, Georgia | 30071 | |
| (Address of Principal Executive Offices) | (Zip Code) | |
Registrant’s Telephone Number, Including Area Code: (770) 448-2193
Securities registered pursuant to Section 12(b) of the Act:
| Title of Each Class | Name of Exchange on Which Registered | |
| Class A Common Stock, par value $0.01 per share | New York Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
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 definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer x | Accelerated filer ¨ | |
| Non-accelerated filer ¨ (Do not check if smaller reporting company) | 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 ¨ No x
The aggregate market value of the common equity held by non-affiliates of the registrant as of March 31, 2009, the last day of the registrant’s most recently completed second fiscal quarter (based on the last reported closing price of $27.05 per share of Class A Common Stock as reported on the New York Stock Exchange on such date), was approximately $962 million.
As of November 6, 2009, the registrant had 38,748,787 shares of Class A Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the Annual Meeting of Shareholders to be held on January 29, 2010, are incorporated by reference in Parts II and III.
INDEX TO FORM 10-K
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PART I
| Item 1. | BUSINESS |
Unless the context otherwise requires, “we”, “us”, “our”, “RockTenn” and “the Company” refer to the business of Rock-Tenn Company, its wholly-owned subsidiaries and its partially-owned consolidated subsidiaries, including RTS Packaging, LLC (“RTS”), GraphCorr LLC, Schiffenhaus Canada, Inc. and Schiffenhaus California, LLC. See “Note 1. Description of Business and Summary of Significant Accounting Policies” of the Notes to Consolidated Financial Statements.
General
We are primarily a manufacturer of packaging products, recycled paperboard, containerboard, bleached paperboard and merchandising displays. We operate a total of 100 facilities located in 27 states, Canada, Mexico, Chile and Argentina.
Products
We report our results of operations in four segments: (1) Consumer Packaging, (2) Corrugated Packaging, (3) Merchandising Displays, and (4) Specialty Paperboard Products. For segment financial information, see Item 8, “Financial Statements and Supplementary Data.” For non-U.S. operations financial information and other segment information, see “Note 21. Segment Information” of the Notes to Consolidated Financial Statements.
Consumer Packaging Segment
We operate an integrated system of five coated recycled mills and a bleached paperboard mill that produce paperboard for our folding carton operations and third parties. We believe we are one of the largest manufacturers of folding cartons in North America measured by net sales. Customers use our folding cartons to package dry, frozen and perishable foods for the retail sale and quick-serve markets; beverages; paper goods; automotive products; hardware; health care and nutritional food supplement products; household goods; health and beauty aids; recreational products; apparel; take out food products; and other products. We also manufacture express mail envelopes for the overnight courier industry. Folding cartons typically protect customers’ products during shipment and distribution and employ graphics to promote them at retail. We manufacture folding cartons from recycled and virgin paperboard, laminated paperboard and various substrates with specialty characteristics such as grease masking and microwaveability. We print, coat, die-cut and glue the paperboard to customer specifications. We ship finished cartons to customers for assembling, filling and sealing. We employ a broad range of offset, flexographic, gravure, backside printing, and double coating technologies. We support our customers with new product development, graphic design and packaging systems services.
We believe we operate the lowest cost coated recycled paperboard mill system in the U.S. and are one of the largest U.S. manufacturers of 100% recycled paperboard measured by tons produced. We manufacture bleached paperboard and market pulp. We believe our bleached paperboard and market pulp mill is one of the lowest cost solid bleached sulphate paperboard mills in North America because of cost advantages achieved through original design, process flow, relative age of its recovery boiler and hardwood pulp line replaced in the early 1990s and access to hardwood and softwood fiber. We sell our coated recycled and bleached paperboard to manufacturers of folding cartons, and other paperboard products. Sales of consumer packaging products to external customers accounted for 52.6%, 54.0%, and 62.4% of our net sales in fiscal 2009, 2008, and 2007, respectively.
Corrugated Packaging Segment
We operate an integrated system that manufactures linerboard and corrugated medium (“containerboard”), corrugated sheets, corrugated packaging and preprinted linerboard for sale to industrial and consumer products manufacturers and corrugated box manufacturers. To make corrugated sheet stock, we feed linerboard and
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corrugated medium into a corrugator that flutes the medium to specified sizes, glues the linerboard and fluted medium together and slits and cuts the resulting corrugated paperboard into sheets to customer specifications. We also convert corrugated sheets into corrugated products ranging from one-color protective cartons to graphically brilliant point-of-purchase containers and displays. We provide structural design and engineering services. Sales of corrugated packaging products to external customers accounted for 25.4%, 20.3%, and 9.2% of our net sales in fiscal 2009, 2008, and 2007, respectively. The increase in fiscal 2008 was the result of our March 5, 2008 acquisition of Southern Container Corp. (“Southern Container” and the “Southern Container Acquisition”).
Merchandising Displays Segment
We manufacture temporary and permanent point-of-purchase displays. We believe that we are one of the largest manufacturers of temporary promotional point-of-purchase displays in North America measured by net sales. We design, manufacture and, in most cases, pack temporary displays for sale to consumer products companies. These displays are used as marketing tools to support new product introductions and specific product promotions in mass merchandising stores, supermarkets, convenience stores, home improvement stores and other retail locations. We also design, manufacture and, in some cases, pre-assemble permanent displays for the same categories of customers. We make temporary displays primarily from corrugated paperboard. Unlike temporary displays, permanent displays are restocked and, therefore, are constructed primarily from metal, plastic, wood and other durable materials. We provide contract packing services such as multi-product promotional packing and product manipulation such as multipacks and onpacks. We manufacture lithographic laminated packaging for sale to our customers that require packaging with high quality graphics and strength characteristics. Sales of our merchandising display products to external customers accounted for 11.4%, 12.3%, and 13.2% of our net sales in fiscal 2009, 2008, and 2007, respectively.
Specialty Paperboard Products Segment
We operate an integrated system of five specialty recycled paperboard mills (including our Seven Hills Paperboard LLC (“Seven Hills”) joint venture) which produce paperboard for our converting operations (including our solid fiber interior packaging locations) and third parties, and we buy and sell recycled fiber. We sell our specialty recycled paperboard to manufacturers of solid fiber interior packaging, tubes and cores, and other paperboard products. Through our Seven Hills joint venture we manufacture gypsum paperboard liner for sale to our joint venture partner. We also convert specialty paperboard into book cover and laminated paperboard products for use in furniture, automotive components, storage, and other industrial products. Our 65% owned subsidiary, RTS, designs and manufactures fiber partitions and die-cut paperboard components. We believe we are the largest manufacturer of solid fiber partitions in North America measured by net sales. We sell our solid fiber partitions principally to glass container manufacturers and producers of beer, food, wine, spirits, cosmetics and pharmaceuticals. We also manufacture specialty agricultural packaging for specific fruit and vegetable markets and sheeted separation products. We manufacture solid fiber interior packaging primarily from recycled paperboard. Our solid fiber interior packaging is made from varying thicknesses of single ply and laminated paperboard to meet different structural requirements, including those required for high speed-casing, de-casing and filling lines. We employ primarily proprietary manufacturing equipment developed by our engineering services group. This equipment delivers high-speed production and rapid turnaround on large jobs and specialized capabilities for short-run, custom applications. RTS operates in the United States, Canada, Mexico, Chile, and Argentina. Our paper recovery facilities collect primarily waste paper from factories, warehouses, commercial printers, office complexes, retail stores, document storage facilities, and paper converters, and from other wastepaper collectors. We handle a wide variety of grades of recovered paper, including old corrugated containers, office paper, box clippings, newspaper and print shop scraps. After sorting and baling, we transfer collected paper to our paperboard mills for processing, or sell it, principally to U.S. manufacturers of paperboard, tissue, newsprint, roofing products and insulation. We also operate a fiber marketing and brokerage group that serves large regional and national accounts as well as our coated and specialty recycled paperboard mills and sells scrap materials for our converting businesses and paperboard mills. Sales of specialty paperboard products to external customers accounted for 10.6%, 13.4%, and 15.2% of our net sales in fiscal 2009, 2008, and 2007, respectively.
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Raw Materials
The primary raw materials that our paperboard operations use are recycled fiber at our recycled paperboard and containerboard mills and virgin fibers from hardwoods and softwoods at our bleached paperboard mill. The average cost per ton of recycled fiber that our recycled paperboard and containerboard mills used during fiscal 2009, 2008, and 2007 was $81, $145, and $115, respectively. Recycled fiber prices can fluctuate significantly. While virgin fiber prices have generally been more stable than recycled fiber prices, they also fluctuate, particularly during prolonged periods of heavy rain or during housing slowdowns. The average cost per ton of virgin fiber that our bleached paperboard mill used during fiscal 2009, 2008, and 2007 was $149, $134, and $116, respectively. Pursuant to a five year agreement entered into in June 2005, Gulf States Paper Corporation (“Gulf States”, currently known as the Westervelt Company) has essentially agreed to continue to sell to our bleached paperboard mill the supply of softwood chips that it made available to the mill before our acquisition of substantially all of the assets of Gulf States’ Paperboard and Packaging operations (“GSPP”) and the assumption of certain of Gulf States’ related liabilities in June 2005 (the “GSPP Acquisition”). This supply represents approximately 75% to 80% of the mill’s historical softwood chip supply requirements and approximately 23% of the mill’s total wood fiber supply requirement. We are in the process of evaluating extending the contract.
Recycled and virgin paperboard are the primary raw materials that our paperboard converting operations use. One of the two primary grades of virgin paperboard, coated unbleached kraft, used by our folding carton operations, has only two domestic suppliers. While we believe that we would be able to obtain adequate replacement supplies in the market should either of our current vendors discontinue supplying us coated unbleached kraft, the failure to obtain these supplies or the failure to obtain these supplies at reasonable market prices could have an adverse effect on our results of operations. We supply substantially all of our needs for recycled paperboard from our own mills and consume approximately half of our bleached paperboard production, although we have the capacity to consume substantially all of our bleached paperboard by displacing outside purchases. Because there are other suppliers that produce the necessary grades of recycled and bleached paperboard used in our converting operations, we believe that we would be able to obtain adequate replacement supplies in the market should we be unable to meet our requirements for recycled or bleached paperboard through internal production.
Energy
Energy is one of the most significant manufacturing costs of our mill operations. We use natural gas, electricity, fuel oil and coal to operate our mills and to generate steam to make paper. We use primarily electricity for our converting equipment. We generally purchase these products from suppliers at market rates. Occasionally, we enter into agreements to purchase natural gas at fixed prices. In recent years, the costs of natural gas, oil, coal and electricity have fluctuated significantly. The average cost of energy used by our recycled paperboard and containerboard mills, excluding our Solvay mill, to produce a ton of paperboard during fiscal 2009 was $64 per ton, compared to $90 per ton during fiscal 2008 and $78 per ton in fiscal 2007. Our bleached paperboard mill uses wood by-products and pulp process wastes to supply a substantial portion of the mill’s energy needs. Our Solvay mill purchases its process steam under a long-term contract with an adjacent coal fired power plant — with steam pricing based primarily on coal prices. The mill’s electric energy supply is low priced due to the availability of hydro-based electric power.
Transportation
Inbound and outbound freight is a significant expenditure for us. Factors that influence our freight expense are distance between our shipping and delivery locations, distance from customers and suppliers, mode of transportation (rail, truck, intermodal) and freight rates, which are influenced by supply and demand and fuel costs.
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Sales and Marketing
Our top 10 external customers represented approximately 24% of consolidated net sales in fiscal 2009, none of which individually accounted for more than 10% of our consolidated net sales. We generally manufacture our products pursuant to customers’ orders. The loss of any of our larger customers could have a material adverse effect on the income attributable to the applicable segment and, depending on the significance of the product line, our results of operations. We believe that we have good relationships with our customers.
In fiscal 2009, we sold:
| • | consumer packaging products to approximately 1,100 customers, the top 10 of which represented approximately 30% of the external sales of our Consumer Packaging segment; |
| • | corrugated packaging products to approximately 1,300 customers, the top 10 of which represented approximately 31% of the external sales of our Corrugated Packaging segment; |
| • | merchandising display products to approximately 200 customers, the top 10 of which represented approximately 88% of the external sales of our Merchandising Displays segment; and |
| • | specialty paperboard products to approximately 1,400 customers, the top 10 of which represented approximately 43% of the external sales of our Specialty Paperboard Products segment. |
During fiscal 2009, we sold approximately 48% of our coated recycled paperboard mills’ production and 49% of our bleached paperboard production to internal customers, primarily to manufacture folding cartons. Approximately 72% of our containerboard production was sold to internal customers, primarily to manufacture corrugated products. Excluding our gypsum paperboard liner production, which our Seven Hills joint venture sells as discussed below, we sold approximately 50% of our specialty mills’ production to internal customers, primarily to manufacture interior partitions. Our mills’ sales volumes may therefore be directly impacted by changes in demand for our packaging products. Under the terms of our Seven Hills joint venture arrangement, our joint venture partner is required to purchase all of the qualifying gypsum paperboard liner produced by Seven Hills.
We market our products primarily through our own sales force. We also market a number of our products through either independent sales representatives or independent distributors, or both. We generally pay our sales personnel a base salary plus commissions. We pay our independent sales representatives on a commission basis.
Competition
The packaging products, paperboard and containerboard industries are highly competitive, and no single company dominates either industry. Our competitors include large, vertically integrated packaging products companies that manufacture paperboard or containerboard and numerous smaller non-integrated companies. In the folding carton and corrugated packaging markets, we compete with a significant number of national, regional and local packaging suppliers in North America. In the solid fiber interior packaging, promotional point-of-purchase display, and converted paperboard products markets, we compete with a smaller number of national, regional and local companies offering highly specialized products. Our paperboard operations compete with integrated and non-integrated national and regional companies operating in North America that manufacture various grades of paperboard and containerboard and, to a limited extent, manufacturers outside of North America.
Because all of our businesses operate in highly competitive industry segments, we regularly bid for sales opportunities to customers for new business or for renewal of existing business. The loss of business or the award of new business from our larger customers may have a significant impact on our results of operations.
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The primary competitive factors in the packaging products and paperboard and containerboard industries are price, design, product innovation, quality and service, with varying emphasis on these factors depending on the product line and customer preferences. We believe that we compete effectively with respect to each of these factors and we evaluate our performance with annual customer service surveys. However, to the extent that any of our competitors becomes more successful with respect to any key competitive factor, our business could be materially adversely affected.
Our ability to pass through cost increases can be limited based on competitive market conditions for our products and by the actions of our competitors. In addition, we sell a significant portion of our paperboard and paperboard-based converted products pursuant to contracts that provide that prices are either fixed for specified terms or provide for price adjustments based on negotiated terms, including changes in specified paperboard index prices. The effect of these contractual provisions generally is to either limit the amount of the increase or delay our ability to recover announced price increases for our paperboard and paperboard-based converted products.
The packaging products, recycled paperboard and containerboard industries have undergone significant consolidation in recent years. Within the packaging products industry, larger corporate customers with an expanded geographic presence have tended in recent years to seek suppliers who can, because of their broad geographic presence, efficiently and economically supply all or a range of their customers’ packaging needs. In addition, during recent years, purchasers of paperboard, containerboard and packaging products have demanded higher quality products meeting stricter quality control requirements. These market trends could adversely affect our results of operations or, alternatively, favor our products depending on our competitive position in specific product lines.
Our paperboard packaging products compete with plastic and corrugated packaging and packaging made from other materials. Customer shifts away from paperboard packaging to packaging from other materials could adversely affect our results of operations.
Governmental Regulation
Health and Safety Regulations
Our operations are subject to federal, state, local and foreign laws and regulations relating to workplace safety and worker health including the Occupational Safety and Health Act (“OSHA”) and related regulations. OSHA, among other things, establishes asbestos and noise standards and regulates the use of hazardous chemicals in the workplace. Although we do not use asbestos in manufacturing our products, some of our facilities contain asbestos. For those facilities where asbestos is present, we believe we have properly contained the asbestos and/or we have conducted training of our employees in an effort to ensure that no federal, state or local rules or regulations are violated in the maintenance of our facilities. We do not believe that future compliance with health and safety laws and regulations will have a material adverse effect on our results of operations, financial condition or cash flows.
Environmental Regulation
We are subject to various federal, state, local and foreign environmental laws and regulations, including, among others, the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”), the Clean Air Act (as amended in 1990), the Clean Water Act, the Resource Conservation and Recovery Act and the Toxic Substances Control Act. These environmental regulatory programs are primarily administered by the U.S. Environmental Protection Agency. In addition, some states in which we operate have adopted equivalent or more stringent environmental laws and regulations or have enacted their own parallel environmental programs, which are enforced through various state administrative agencies.
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We believe that future compliance with these environmental laws and regulations currently in effect will not have a material adverse effect on our results of operations, financial condition or cash flows. We cannot currently assess with certainty the impact that the future emissions standards and enforcement practices associated with changes to regulations promulgated under the Clean Air Act, or other environmental laws and regulations, will have on our operations or capital expenditure requirements. However, our compliance and remediation costs could increase materially.
We estimate that we will spend approximately $5 to $6 million for capital expenditures during fiscal 2010 in connection with matters relating to safety and environmental compliance.
For additional information concerning environmental regulation, see “Note 20. Commitments and Contingencies” of the Notes to Consolidated Financial Statements.
Patents and Other Intellectual Property
We hold a substantial number of patents and pending patent applications in the United States and certain foreign countries. Our patent portfolio consists primarily of utility and design patents relating to our products and manufacturing operations. Certain of our products and services are also protected by trademarks such as CartonMate®, DuraFrame®, DuraFreeze®, MillMask®, AngelCote®, BlueCuda®, MAXPDQ®, EcoMAX®, AdvantaEdge®, Clik Top®, Formations®, Bio-Pak®, Bio-Plus®, Fold-Pak®, CaseMate®, CitruSaver®, WineGuard®, and Pop-N-Shop™. Our patents and other intellectual property, particularly our patents relating to our interior packaging, retail displays and folding carton operations, are important to our operations as a whole.
Employees
At September 30, 2009, we employed approximately 10,300 employees. Of these employees, approximately 7,700 were hourly and approximately 2,600 were salaried. Approximately 3,400 of our hourly employees are covered by union collective bargaining agreements, which generally have three-year terms. Approximately 300 of our employees are working under an expired contract and approximately 1,400 of our employees are covered under collective bargaining agreements that expire within one year. We have not experienced any work stoppages in the past 10 years other than a three-week work stoppage at our Aurora, Illinois, specialty recycled paperboard facility during fiscal 2004. Management believes that our relations with our employees are good.
Available Information
Our Internet address is www.rocktenn.com. Our Internet address is included herein as an inactive textual reference only. The information contained on our website is not incorporated by reference herein and should not be considered part of this report. We file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (“SEC”) and we make available free of charge most of our SEC filings through our Internet website as soon as reasonably practicable after filing with the SEC. You may access these SEC filings via the hyperlink that we provide on our website to a third-party SEC filings website. We also make available on our website the charters of our audit committee, our compensation committee, and our nominating and corporate governance committee, as well as the corporate governance guidelines adopted by our board of directors, our Code of Business Conduct for employees, our Code of Business Conduct and Ethics for directors and our Code of Ethical Conduct for CEO and senior financial officers. We will also provide copies of these documents, without charge, at the written request of any shareholder of record. Requests for copies should be mailed to: Rock-Tenn Company, 504 Thrasher Street, Norcross, Georgia 30071, Attention: Corporate Secretary.
Forward-Looking Information
We, or our executive officers and directors on our behalf, may from time to time make “forward-looking statements” within the meaning of the federal securities laws. Forward-looking statements include statements
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preceded by, followed by or that include the words “believes,” “expects,” “anticipates,” “plans,” “estimates,” or similar expressions. These statements may be contained in reports and other documents that we file with the SEC or may be oral statements made by our executive officers and directors to the press, potential investors, securities analysts and others. These forward-looking statements could involve, among other things, statements regarding any of the following: our results of operations, financial condition, cash flows, liquidity or capital resources, including expectations regarding sales growth, income tax rates, our production capacities, our ability to achieve operating efficiencies, and our ability to fund our capital expenditures, interest payments, estimated tax payments, stock repurchases, dividends, working capital needs, and repayments of debt; the consummation of acquisitions and financial transactions, the effect of these transactions on our business and the valuation of assets acquired in these transactions; the timing and impact of alternative fuel tax credits; our competitive position and competitive conditions; our ability to obtain adequate replacement supplies of raw materials or energy; our relationships with our customers; our relationships with our employees; our plans and objectives for future operations and expansion; amounts and timing of capital expenditures and the impact of such capital expenditures on our results of operations, financial condition, or cash flows; our compliance obligations with respect to health and safety laws and environmental laws, the cost of compliance, the timing of these costs, or the impact of any liability under such laws on our results of operations, financial condition or cash flows, and our right to indemnification with respect to any such cost or liability; the impact of any gain or loss of a customer’s business; the impact of announced price increases; the scope, costs, timing and impact of any restructuring of our operations and corporate and tax structure; the scope and timing of any litigation or other dispute resolutions and the impact of any such litigation or other dispute resolutions on our results of operations, financial condition or cash flows; factors considered in connection with any impairment analysis, the outcome of any such analysis and the anticipated impact of any such analysis on our results of operations, financial condition or cash flows; pension and retirement plan obligations, contributions, the factors used to evaluate and estimate such obligations and expenses, the impact of amendments to our pension and retirement plans, the impact of governmental regulations on our results of operations, financial condition or cash flows; pension and retirement plan asset investment strategies; the financial condition of our insurers and the impact on our results of operations, financial condition or cash flows in the event of an insurer’s default on their obligations; potential liability for outstanding guarantees and indemnities and the potential impact of such liabilities; the impact of any market risks, such as interest rate risk, pension plan risk, foreign currency risk, commodity price risks, energy price risk, rates of return, the risk of investments in derivative instruments, and the risk of counterparty nonperformance, and factors affecting those risks; the amount of contractual obligations based on variable price provisions and variable timing and the effect of contractual obligations on liquidity and cash flow in future periods; the implementation of accounting standards and the impact of these standards once implemented; factors used to calculate the fair value of financial instruments and other assets and liabilities; factors used to calculate the fair value of options, including expected term and stock price volatility; our assumptions and expectations regarding critical accounting policies and estimates; the adequacy of our system of internal controls over financial reporting; and the effectiveness of any actions we may take with respect to our system of internal controls over financial reporting.
Any forward-looking statements are based on our current expectations and beliefs at the time of the statements and are subject to risks and uncertainties that could cause actual results of operations, financial condition, acquisitions, financing transactions, operations, expansion and other events to differ materially from those expressed or implied in these forward-looking statements. With respect to these statements, we make a number of assumptions regarding, among other things, expected economic, competitive and market conditions generally; expected volumes and price levels of purchases by customers; competitive conditions in our businesses; possible adverse actions of our customers, our competitors and suppliers; labor costs; the amount and timing of expected capital expenditures, including installation costs, project development and implementation costs, severance and other shutdown costs; restructuring costs; the expected utilization of real property that is subject to the restructurings due to realizable values from the sale of that property; anticipated earnings that will be available for offset against net operating loss carry-forwards; expected credit availability; raw material and energy costs; replacement energy supply alternatives and related capital expenditures; and expected year-end inventory levels and costs. These assumptions also could be affected by changes in management’s plans, such as
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delays or changes in anticipated capital expenditures or changes in our operations. We believe that our assumptions are reasonable; however, undue reliance should not be placed on these assumptions, which are based on current expectations. These forward-looking statements are subject to certain risks including, among others, that our assumptions will prove to be inaccurate. There are many factors that impact these forward-looking statements that we cannot predict accurately. Actual results may vary materially from current expectations, in part because we manufacture most of our products against customer orders with short lead times and small backlogs, while our earnings are dependent on volume due to price levels and our generally high fixed operating costs. Forward-looking statements speak only as of the date they are made, and we, and our executive officers and directors, have no duty under the federal securities laws and undertake no obligation to update any such information as future events unfold.
Further, our business is subject to a number of general risks that would affect any forward-looking statements, including the risks discussed under Item 1A. “Risk Factors.”
| Item 1A. | RISK FACTORS |
| • | We May Face Increased Costs and Reduced Supply of Raw Materials |
Historically, the costs of recovered paper and virgin paperboard, our principal externally sourced raw materials, have fluctuated significantly due to market and industry conditions. Increasing demand for products packaged in 100% recycled paper and the shift by manufacturers of virgin paperboard, tissue, newsprint and corrugated packaging to the production of products with some recycled paper content have and may continue to increase demand for recovered paper. Furthermore, there has been a substantial increase in demand for U.S. sourced recovered paper by Asian countries. These increasing demands may result in cost increases. In recent years, the cost of natural gas, which we use in many of our manufacturing operations, including most of our paperboard mills, and other energy costs (including energy generated by burning natural gas and coal) have fluctuated significantly. There can be no assurance that we will be able to recoup any past or future increases in the cost of recovered paper or other raw materials or of natural gas, coal or other energy through price increases for our products. Further, a reduction in availability of recovered paper, virgin paperboard or other raw materials due to increased demand or other factors could have an adverse effect on our results of operations and financial condition.
| • | We May Experience Pricing Variability |
The paperboard, containerboard and converted products industries historically have experienced significant fluctuations in selling prices. If we are unable to maintain the selling prices of products within these industries, that inability may have a material adverse effect on our results of operations and financial condition. We are not able to predict with certainty market conditions or the selling prices for our products.
| • | Our Earnings are Highly Dependent on Volumes |
Our operations generally have high fixed operating cost components and therefore our earnings are highly dependent on volumes, which tend to fluctuate. These fluctuations make it difficult to predict our results with any degree of certainty.
| • | We Face Intense Competition |
Our businesses are in industries that are highly competitive, and no single company dominates an industry. Our competitors include large, vertically integrated packaging products, paperboard and containerboard companies and numerous non-integrated smaller companies. We generally compete with companies operating in North America. Competition from foreign manufacturers in the future could negatively impact our sales volumes and pricing. Because all of our businesses operate in highly competitive industry segments, we regularly bid for
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sales opportunities to customers for new business or for renewal of existing business. The loss of business from our larger customers may have a significant impact on our results of operations. Further, competitive conditions may prevent us from fully recovering increased costs and may continue to inhibit our ability to pass on cost increases to our customers. Our mills’ sales volumes may be directly impacted by changes in demand for our packaging products. See Item 1. “Business — Competition” and “Business — Sales and Marketing.”
| • | We Have Been Dependent on Certain Customers |
Each of our segments has certain large customers, the loss of which could have a material adverse effect on the segment’s sales and, depending on the significance of the loss, our results of operations, financial condition or cash flows.
| • | We May Incur Business Disruptions |
We take measures to minimize the risks of disruption at our facilities. The occurrence of a natural disaster, such as a hurricane, tropical storm, earthquake, tornado, flood, fire, or other unanticipated problems such as labor difficulties, equipment failure or unscheduled maintenance could cause operational disruptions or short term rises in raw material or energy costs that could materially adversely affect our earnings to varying degrees dependent upon the facility and the duration of the disruption. Any losses due to these events may not be covered by our existing insurance policies or may be subject to certain deductibles.
| • | We May be Adversely Affected by Current Economic and Financial Market Conditions |
Our businesses may be affected by a number of factors that are beyond our control such as general economic and business conditions, and conditions in the financial services markets including counterparty risk, insurance carrier risk and rising interest rates. The current macro-economic challenges, including current conditions in financial and capital markets and relatively high levels of unemployment, may continue to put pressure on the economy. As a result, customers, vendors or counterparties may experience significant cash flow problems. If customers are not successful in generating sufficient revenue or cash flows or are precluded from securing financing, they may not be able to pay or may delay payment of accounts receivable that are owed to us or we may experience lower sales volumes. We are not able to predict with certainty market conditions, and our business could be materially and adversely affected by these market conditions.
| • | We May be Unable to Complete and Finance Acquisitions |
We have completed several acquisitions in recent years and may seek additional acquisition opportunities. There can be no assurance that we will successfully be able to identify suitable acquisition candidates, complete and finance acquisitions, integrate acquired operations into our existing operations or expand into new markets. There can also be no assurance that future acquisitions will not have an adverse effect upon our operating results. Acquired operations may not achieve levels of revenues, profitability or productivity comparable with those our existing operations achieve, or otherwise perform as expected. In addition, it is possible that, in connection with acquisitions, our capital expenditures could be higher than we anticipated and that we may not realize the expected benefits of such capital expenditures.
| • | We are Subject to Extensive Environmental and Other Governmental Regulation |
We are subject to various federal, state, local and foreign environmental laws and regulations, including those regulating the discharge, storage, handling and disposal of a variety of substances, as well as other financial and non-financial regulations.
We regularly make capital expenditures to maintain compliance with applicable environmental laws and regulations. However, environmental laws and regulations are becoming increasingly stringent. Consequently, our compliance and remediation costs could increase materially. In addition, we cannot currently assess the
11
impact that the future emissions standards, climate control initiatives and enforcement practices will have on our operations or capital expenditure requirements. Further, we have been identified as a potentially responsible party at various “superfund” sites pursuant to CERCLA or comparable state statutes. See “Note 20. Commitments and Contingencies” of the Notes to Consolidated Financial Statements. There can be no assurance that any liability we may incur in connection with these superfund sites or other governmental regulation will not be material to our results of operations, financial condition or cash flows.
| • | We May Incur Additional Restructuring Costs |
We have restructured portions of our operations from time to time in recent years and it is possible that we may engage in additional restructuring opportunities. Because we are not able to predict with certainty market conditions, the loss of large customers, or the selling prices for our products, we also may not be able to predict with certainty when it will be appropriate to undertake restructurings. It is also possible, in connection with these restructuring efforts, that our costs could be higher than we anticipate and that we may not realize the expected benefits.
| • | We May Incur Increased Transportation Costs |
We distribute our products primarily by truck and rail. Reduced availability of truck or rail carriers could negatively impact our ability to ship our products in a timely manner. There can be no assurance that we will be able to recoup any past or future increases in transportation rates or fuel surcharges through price increases for our products.
| • | We May Incur Increased Employee Benefit Costs |
Our pension and health care benefits are dependent upon multiple factors resulting from actual plan experience and assumptions of future experience. Our pension plan assets are primarily made up of equity and fixed income investments. Fluctuations in market performance and changes in interest rates may result in increased or decreased pension costs in future periods. Changes in assumptions regarding expected long-term rate of return on plan assets, changes in our discount rate or expected compensation levels could also increase or decrease pension costs. Future pension funding requirements, and the timing of funding payments, may also be subject to changes in legislation. During 2006, Congress passed the Pension Protection Act of 2006 (the “Pension Act”) with the stated purpose of improving the funding of U.S. private pension plans. The Pension Act imposes stricter funding requirements, introduces benefit limitations for certain under-funded plans and requires underfunded pension plans to improve their funding ratios within prescribed intervals based on the level of their underfunding. The Pension Act applies to pension plan years beginning after December 31, 2007. We have made contributions to our pension plans and expect to continue to make contributions in the coming years in order to ensure that our funding levels remain adequate in light of projected liabilities and to meet the requirements of the Pension Act and other regulations. There can be no assurance that such changes, including the current turmoil in financial and capital markets, will not be material to our results of operations, financial condition or cash flows.
| Item 1B. | UNRESOLVED STAFF COMMENTS |
Not applicable — there are no unresolved SEC staff comments.
| Item 2. | PROPERTIES |
We operate at a total of 100 locations. These facilities are located in 27 states (mainly in the Eastern and Midwestern United States), Canada, Mexico, Chile and Argentina. We own our principal executive offices in Norcross, Georgia. There are 33 owned facilities used by operations in our Consumer Packaging segment, 14 owned and five leased facilities used by operations in our Corrugated Packaging segment, one owned and 16 leased facilities used by operations in our Merchandising Displays segment, and 19 owned and 11 leased
12
facilities used by operations in our Specialty Paperboard Products segment. We believe that our existing production capacity is adequate to serve existing demand for our products. We consider our plants and equipment to be in good condition.
The following table shows information about our mills. We own all of our mills.
| Location of Mill |
Production Capacity (in tons @ 9/30/2009) |
Paperboard and Containerboard Produced | |||
| Solvay, NY |
770,000 | Recycled containerboard | |||
| St. Paul, MN |
200,000 | Recycled corrugated medium | |||
| Total Recycled Containerboard Capacity |
970,000 | ||||
| Demopolis, AL |
340,000 | Bleached paperboard | |||
| 100,000 | Market pulp | ||||
| Total Bleached and Market Pulp Capacity |
440,000 | ||||
| Battle Creek, MI |
160,000 | Coated recycled paperboard | |||
| St. Paul, MN |
160,000 | Coated recycled paperboard | |||
| Sheldon Springs, VT (Missisquoi Mill) |
110,000 | Coated recycled paperboard | |||
| Dallas, TX |
110,000 | Coated recycled paperboard | |||
| Stroudsburg, PA |
78,000 | Coated recycled paperboard | |||
| Total Coated Recycled Capacity |
618,000 | ||||
| Chattanooga, TN |
132,000 | Specialty recycled paperboard | |||
| Lynchburg, VA |
103,000 | (1) | Specialty recycled paperboard | ||
| Eaton, IN |
60,000 | Specialty recycled paperboard | |||
| Cincinnati, OH |
53,000 | Specialty recycled paperboard | |||
| Aurora, IL |
32,000 | Specialty recycled paperboard | |||
| Total Specialty Recycled Capacity |
380,000 | ||||
| Total Mill Capacity |
2,408,000 | ||||
| (1) | Reflects the production capacity of a paperboard machine that manufactures gypsum paperboard liner and is owned by our Seven Hills joint venture. |
The following is a list of our significant facilities other than our mills:
| Type of Facility |
Locations | |
| Merchandising Display Operations |
Winston-Salem, NC (sales, design, manufacturing and contract packing) | |
| Headquarters |
Norcross, GA |
| Item 3. | LEGAL PROCEEDINGS |
We are a party to litigation incidental to our business from time to time. We are not currently a party to any litigation that management believes, if determined adversely to us, would have a material adverse effect on our results of operations, financial condition or cash flows. For additional information regarding litigation to which we are a party, see “Note 20. Commitments and Contingencies” of the Notes to Consolidated Financial Statements, which is incorporated by reference into this item.
| Item 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
Not applicable — there were no matters submitted to a vote of security holders in our fourth fiscal quarter ended September 30, 2009.
13
PART II
| Item 5. | MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
Common Stock
Our Class A common stock, par value $0.01 per share (“Common Stock”), trades on the New York Stock Exchange under the symbol RKT. As of October 30, 2009, there were approximately 292 shareholders of record of our Common Stock. The number of shareholders of record only includes a single shareholder, Cede & Co., for all of the shares held by our shareholders in individual brokerage accounts maintained at banks, brokers and institutions.
Price Range of Common Stock
| Fiscal 2009 | Fiscal 2008 | |||||||||||
| High | Low | High | Low | |||||||||
| First Quarter |
$ | 40.44 | $ | 23.87 | $ | 30.47 | $ | 23.63 | ||||
| Second Quarter |
$ | 36.89 | $ | 22.84 | $ | 32.00 | $ | 21.77 | ||||
| Third Quarter |
$ | 42.08 | $ | 25.95 | $ | 37.61 | $ | 29.77 | ||||
| Fourth Quarter |
$ | 52.58 | $ | 36.22 | $ | 46.37 | $ | 28.76 | ||||
Dividends
During fiscal 2009 and 2008, we paid a quarterly dividend on our Common Stock of $0.10 per share ($0.40 per share annually). In October 2009, our board of directors approved a resolution to increase our quarterly dividend to $0.15 per share, indicating an annualized dividend of $0.60 per share on our Common Stock.
For additional dividend information, please see Item 6. “Selected Financial Data.”
Securities Authorized for Issuance Under Equity Compensation Plans
The section under the heading “Executive Compensation Tables” entitled “Equity Compensation Plan Information” in the Proxy Statement for the Annual Meeting of Shareholders to be held on January 29, 2010, which will be filed with the SEC on or before December 31, 2009, is incorporated herein by reference.
For additional information concerning our capitalization, see “Note 17. Shareholders’ Equity” of the Notes to Consolidated Financial Statements.
Our board of directors has approved a stock repurchase plan that allows for the repurchase from time to time of shares of Common Stock over an indefinite period of time. In August 2007, the board of directors amended our stock repurchase plan to allow for the repurchase of an additional 2.0 million shares bringing the cumulative total authorized to 6.0 million shares of Common Stock. Pursuant to our repurchase plan, during fiscal 2007, we repurchased approximately 2.1 million shares for an aggregate cost of $58.7 million. In fiscal 2009 and 2008, we did not repurchase any shares of Common Stock. As of September 30, 2009, we had approximately 1.9 million shares of Common Stock available for repurchase under the amended repurchase plan.
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| Item 6. | SELECTED FINANCIAL DATA |
The following selected consolidated financial data should be read in conjunction with our Consolidated Financial Statements and Notes thereto and Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included herein. We derived the consolidated statements of income and consolidated statements of cash flows data for the years ended September 30, 2009, 2008, and 2007, and the consolidated balance sheet data as of September 30, 2009 and 2008, from the Consolidated Financial Statements included herein. We derived the consolidated statements of income and consolidated statements of cash flows data for the years ended September 30, 2006 and 2005, and the consolidated balance sheet data as of September 30, 2007, 2006, and 2005, from audited Consolidated Financial Statements not included in this report. The table that follows is consistent with those presentations.
On March 5, 2008, we acquired the stock of Southern Container. The Southern Container Acquisition was the primary reason for the changes in the selected financial data beginning in fiscal 2008. On June 6, 2005, we acquired from Gulf States substantially all of the GSPP assets. The GSPP Acquisition was the primary reason for the changes in the selected financial data beginning in fiscal 2005. Our results of operations shown below may not be indicative of future results.
| Year Ended September 30, | ||||||||||||||||
| 2009 | 2008 | 2007 | 2006 | 2005 | ||||||||||||
| (In millions, except per share amounts) | ||||||||||||||||
| Net sales |
$ | 2,812.3 | $ | 2,838.9 | $ | 2,315.8 | $ | 2,138.1 | $ | 1,733.5 | ||||||
| Alternative fuel tax credit, net of expenses (a) |
54.1 | — | — | — | — | |||||||||||
| Restructuring and other costs, net |
13.4 | 15.6 | 4.7 | 7.8 | 7.5 | |||||||||||
| Net income |
222.3 | 81.8 | 81.7 | 28.7 | 17.6 | |||||||||||
| Diluted earnings per common share |
5.75 | 2.14 | 2.07 | 0.77 | 0.49 | |||||||||||
| Dividends paid per common share |
0.40 | 0.40 | 0.39 | 0.36 | 0.36 | |||||||||||
| Book value per common share |
20.07 | 16.75 | 15.51 | 13.49 | 12.57 | |||||||||||
| Total assets |
2,884.4 | 3,013.1 | 1,800.7 | 1,784.0 | 1,798.4 | |||||||||||
| Current portion of debt |
56.3 | 245.1 | 46.0 | 40.8 | 7.1 | |||||||||||
| Total long-term debt |
1,293.1 | 1,453.8 | 676.3 | 765.3 | 908.0 | |||||||||||
| Total debt (b) |
1,349.4 | 1,698.9 | 722.3 | 806.1 | 915.1 | |||||||||||
| Shareholders’ equity |
776.8 | 640.5 | 589.0 | 508.6 | 456.2 | |||||||||||
| Net cash provided by operating activities |
389.7 | 240.9 | 238.3 | 153.5 | 153.3 | |||||||||||
| Capital expenditures |
75.9 | 84.2 | 78.0 | 64.6 | 54.3 | |||||||||||
| Cash paid for investment in unconsolidated entities |
1.0 | 0.3 | 9.6 | 0.2 | 0.1 | |||||||||||
| Cash paid for purchase of businesses, including amounts (received from) paid into escrow, net of cash received |
(4.0 | ) | 817.9 | 32.1 | 7.8 | 552.3 | ||||||||||
| Cash paid for the purchase of a leased facility |
8.1 | — | — | — | — | |||||||||||
Notes (in millions):
| (a) | The alternative fuel tax credit, net of expenses represents a reduction of cost of goods sold in our Consumer Packaging segment. This credit, which is not taxable for federal or state income tax purposes, is discussed in “Note 5. Alternative Fuel Tax Credit” of the Notes to Consolidated Financial Statements. |
| (b) | Total debt includes the aggregate of fair value hedge adjustments resulting from terminated and/or existing fair value interest rate derivatives or swaps of $3.8, $6.6, $8.5, $10.4, and $12.3 during fiscal 2009, 2008, 2007, 2006, and 2005, respectively. |
15
| Item 7. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Segment and Market Information
We report our results in four segments: (1) Consumer Packaging, (2) Corrugated Packaging, (3) Merchandising Displays, and (4) Specialty Paperboard Products. See “Note 21. Segment Information” of the Notes to Consolidated Financial Statements.
The following table shows certain operating data for our four segments. We do not allocate certain of our income and expenses to our segments and, thus, the information that management uses to make operating decisions and assess operating performance does not reflect such amounts. We report these items as non-allocated expenses or in other line items in the table below after Total segment income.
| Year Ended September 30, | ||||||||||||
| 2009 | 2008 | 2007 | ||||||||||
| (In millions) | ||||||||||||
| Net sales (aggregate): |
||||||||||||
| Consumer Packaging |
$ | 1,503.1 | $ | 1,551.4 | $ | 1,459.6 | ||||||
| Corrugated Packaging |
752.9 | 607.5 | 236.7 | |||||||||
| Merchandising Displays |
320.6 | 350.8 | 305.8 | |||||||||
| Specialty Paperboard Products |
306.9 | 392.9 | 361.7 | |||||||||
| Total |
$ | 2,883.5 | $ | 2,902.6 | $ | 2,363.8 | ||||||
| Less net sales (intersegment): |
||||||||||||
| Consumer Packaging |
$ | 25.1 | $ | 18.1 | $ | 15.0 | ||||||
| Corrugated Packaging |
37.3 | 31.1 | 22.7 | |||||||||
| Merchandising Displays |
0.4 | 0.4 | — | |||||||||
| Specialty Paperboard Products |
8.4 | 14.1 | 10.3 | |||||||||
| Total |
$ | 71.2 | $ | 63.7 | $ | 48.0 | ||||||
| Net sales (unaffiliated customers): |
||||||||||||
| Consumer Packaging |
$ | 1,478.0 | $ | 1,533.3 | $ | 1,444.6 | ||||||
| Corrugated Packaging |
715.6 | 576.4 | 214.0 | |||||||||
| Merchandising Displays |
320.2 | 350.4 | 305.8 | |||||||||
| Specialty Paperboard Products |
298.5 | 378.8 | 351.4 | |||||||||
| Total |
$ | 2,812.3 | $ | 2,838.9 | $ | 2,315.8 | ||||||
| Segment income: |
||||||||||||
| Consumer Packaging |
$ | 228.3 | $ | 119.8 | $ | 125.2 | ||||||
| Corrugated Packaging |
178.9 | 71.3 | 18.9 | |||||||||
| Merchandising Displays |
31.9 | 41.9 | 38.8 | |||||||||
| Specialty Paperboard Products |
26.5 | 30.3 | 28.8 | |||||||||
| Total segment income |
465.6 | 263.3 | 211.7 | |||||||||
| Restructuring and other costs, net |
(13.4 | ) | (15.6 | ) | (4.7 | ) | ||||||
| Non-allocated expenses |
(33.6 | ) | (29.3 | ) | (24.1 | ) | ||||||
| Interest expense |
(96.7 | ) | (86.7 | ) | (49.8 | ) | ||||||
| Loss on extinguishment of debt and related items |
(4.4 | ) | (1.9 | ) | — | |||||||
| Interest income and other income (expense), net |
— | 1.6 | (1.3 | ) | ||||||||
| Minority interest in income of consolidated subsidiaries |
(3.6 | ) | (5.3 | ) | (4.8 | ) | ||||||
| Income before income taxes |
313.9 | 126.1 | 127.0 | |||||||||
| Income tax expense |
(91.6 | ) | (44.3 | ) | (45.3 | ) | ||||||
| Net income |
$ | 222.3 | $ | 81.8 | $ | 81.7 | ||||||
16
Overview
On March 5, 2008, we acquired Southern Container, which owned the Solvay containerboard mill, eight integrated corrugated box plants, two sheet plants and four high impact graphics facilities. With the acquisition, RockTenn became one of the largest manufacturers of containerboard in North America, and continues as one of America’s leading manufacturers of bleached and recycled paperboard with annual mill capacity of approximately 2.4 million tons. The acquisition added highly integrated low operating cost assets to our Corrugated Packaging segment. We have included the results of Southern Container’s operations in our Corrugated Packaging segment in our financial statements since the March 2, 2008 effective date of the acquisition. We financed the acquisition with $1.2 billion of new senior secured credit facilities and $200 million of 9.25% senior notes due March 2016. See “Note 7. Acquisitions” and “Note 11. Debt”, respectively, of the Notes to Consolidated Financial Statements section of the Financial Statements included herein.
Segment income for fiscal 2009 increased $202.3 million to $465.6 million compared to fiscal 2008 primarily due to increased earnings in our Corrugated Packaging segment as the Southern Container Acquisition contributed twelve months of earnings in fiscal 2009, compared to seven months of earnings in fiscal 2008, alternative fuel tax credits recorded in fiscal 2009 and comparatively lower recycled fiber and energy costs in fiscal 2009, which were partially offset by generally lower sales volumes. Our Consumer Packaging segment benefited from $54.1 million of alternative fuel tax credits, net of related expenses, for the period from January 22, 2009 to September 30, 2009. The tax credit is scheduled to expire on December 31, 2009; therefore, we expect to record an additional tax credit of approximately $21 million in the first quarter of fiscal 2010. See “Note 5. Alternative Fuel Tax Credit” of the Notes to Consolidated Financial Statements section of the Financial Statements included herein.
We incurred specific pre-tax charges related to the Southern Container Acquisition aggregating approximately $9 million and $27 million in fiscal 2009 and fiscal 2008, respectively. The specific pre-tax charges in fiscal 2009 consisted of a loss on extinguishment of debt and related items of $2.4 million related to amounts paid in excess of carrying value to redeem certain debt assumed in the acquisition, $3.3 million of integration costs and $3.5 million of deferred compensation expense funded into escrow through a purchase price reduction from Southern Container’s stockholders. The pre-tax charges in fiscal 2008 consisted of $12.7 million of acquisition inventory step up expense, $3.0 million for an acquisition bridge financing fee, $1.9 million of loss on extinguishment of debt and related items associated with the acquisition, $4.6 million of integration costs and $5.0 million of deferred compensation expense funded into escrow through a purchase price reduction from Southern Container’s stockholders. Net income increased $140.5 million to $222.3 million in fiscal 2009 largely due to the items discussed above.
Results of Operations
We provide below quarterly information to reflect trends in our results of operations. For additional discussion of quarterly information, see our quarterly reports on Form 10-Q filed with the SEC and “Note 22. Financial Results by Quarter (Unaudited)” of the Notes to Consolidated Financial Statements.
Net Sales (Unaffiliated Customers)
Net sales for fiscal 2009 were $2,812.3 million compared to $2,838.9 million in fiscal 2008. The decrease in net sales was primarily due to reduced sales volumes and lower recycled fiber selling prices which were largely offset by the Southern Container Acquisition, which contributed net sales of $569.4 million for twelve months of operations in fiscal 2009, compared to net sales of $375.9 million for seven months of operations in fiscal 2008, and increased selling prices in some of our segments.
Net sales for fiscal 2008 increased 22.6% to $2,838.9 million compared to $2,315.8 million in fiscal 2007 primarily due to the Southern Container Acquisition which contributed net sales of $375.9 million and increased volume and pricing across our segments.
17
Net Sales (Aggregate) — Consumer Packaging Segment
| First Quarter | Second Quarter | Third Quarter | Fourth Quarter | Fiscal Year | |||||||||||
| (In millions) | |||||||||||||||
| 2007 |
$ | 346.8 | $ | 363.7 | $ | 373.0 | $ | 376.1 | $ | 1,459.6 | |||||
| 2008 |
374.7 | 394.8 | 388.9 | 393.0 | 1,551.4 | ||||||||||
| 2009 |
368.8 | 362.9 | 377.2 | 394.2 | 1,503.1 | ||||||||||
The 3.1% decrease in net sales before intersegment eliminations for the Consumer Packaging segment in fiscal 2009 compared to fiscal 2008 was primarily due to lower sales volumes, partially offset by higher selling prices. Coated recycled paperboard, bleached paperboard and market pulp tons shipped decreased 3.2%, 2.5% and 4.3%, respectively.
The 6.3% increase in net sales before intersegment eliminations for the Consumer Packaging segment in fiscal 2008 compared to fiscal 2007 was primarily due to higher sales of folding cartons due to increases in volume and prices and higher pricing across all coated paperboard grades. Coated recycled paperboard and bleached paperboard tons shipped increased 1.5% and 1.9%, respectively, and market pulp tons decreased 0.9%.
Net Sales (Aggregate) — Corrugated Packaging Segment
| First Quarter | Second Quarter | Third Quarter | Fourth Quarter | Fiscal Year | |||||||||||
| (In millions) | |||||||||||||||
| 2007 |
$ | 56.2 | $ | 59.3 | $ | 60.2 | $ | 61.0 | $ | 236.7 | |||||
| 2008 |
61.4 | 112.0 | 208.9 | 225.2 | 607.5 | ||||||||||
| 2009 |
203.2 | 176.5 | 186.5 | 186.7 | 752.9 | ||||||||||
The 23.9% increase in Corrugated Packaging segment net sales before intersegment eliminations for fiscal 2009 compared to fiscal 2008 was primarily due to the Southern Container Acquisition, which contributed net sales of $569.4 million in fiscal 2009 compared with a contribution of $375.9 million in net sales in fiscal 2008. These increases were partially offset by reduced sales volumes.
The 156.7% increase in Corrugated Packaging segment net sales before intersegment eliminations for fiscal 2008 compared to fiscal 2007 was primarily due to the Southern Container Acquisition, which contributed net sales of $375.9 million, and increased sales prices in our legacy corrugated business. These net sales increases were partially offset by an increase in the number of tons that we shipped to a counterparty from which we buy inventory, which are not recorded as sales under generally accepted accounting principles in the United States (“GAAP”) but are accounted for as an inventory swap transaction.
Net Sales (Aggregate) — Merchandising Displays Segment
| First Quarter | Second Quarter | Third Quarter | Fourth Quarter | Fiscal Year | |||||||||||
| (In millions) | |||||||||||||||
| 2007 |
$ | 60.9 | $ | 82.6 | $ | 76.8 | $ | 85.5 | $ | 305.8 | |||||
| 2008 |
82.0 | 94.3 | 86.1 | 88.4 | 350.8 | ||||||||||
| 2009 |
74.8 | 82.9 | 79.7 | 83.2 | 320.6 | ||||||||||
Net sales for the Merchandising Displays segment decreased 8.6% in fiscal 2009 compared to fiscal 2008 primarily due to decreased demand for promotional displays.
The 14.7% increase in Merchandising Displays segment net sales before intersegment eliminations for fiscal 2008 compared to fiscal 2007 was primarily due to higher sales volumes on strong demand for promotional displays.
18
Net Sales (Aggregate) — Specialty Paperboard Products Segment
| First Quarter | Second Quarter | Third Quarter | Fourth Quarter | Fiscal Year | |||||||||||
| (In millions) | |||||||||||||||
| 2007 |
$ | 79.5 | $ | 91.9 | $ | 94.0 | $ | 96.3 | $ | 361.7 | |||||
| 2008 |
91.8 | 99.8 | 102.1 | 99.2 | 392.9 | ||||||||||
| 2009 |
75.3 | 70.2 | 77.2 | 84.2 | 306.9 | ||||||||||
The 21.9% decrease in Specialty Paperboard Products segment net sales before intersegment eliminations in fiscal 2009 compared to fiscal 2008 was primarily due to reduced recycled fiber selling prices and lower sales volumes. Specialty recycled paperboard tons shipped decreased 10.9%.
The 8.6% increase in Specialty Paperboard Products segment net sales before intersegment eliminations in fiscal 2008 compared to fiscal 2007 was primarily due to higher sales volumes and pricing for recycled fiber, interior packaging products and specialty paperboard. Specialty recycled paperboard tons shipped increased 4.6%.
Cost of Goods Sold
Cost of goods sold decreased to $2,049.6 million in fiscal 2009 compared to $2,296.8 million in fiscal 2008. Cost of goods sold as a percentage of net sales decreased in fiscal 2009 compared to fiscal 2008 primarily related to a net alternative fuel tax credit of $54.1 million for the period from January 22, 2009 to September 30, 2009 and reduced recycled fiber and energy costs and the impact of an additional five months of higher margin Southern Container sales. Excluding the impact of Southern Container, recycled fiber and energy costs decreased $62 per ton and $26 per ton, respectively, and virgin fiber costs increased approximately $17 per ton, over the prior year. Additionally, excluding the impact of the Southern Container Acquisition, decreased freight expense due to cost reduction programs and lower sales volumes decreased cost of goods sold by $19.2 million. Partially offsetting these amounts, we experienced increased pension expense of $6.3 million and increased group insurance expense of $2.6 million, excluding the impact of the Southern Container Acquisition. Additionally, in fiscal 2008, acquisition accounting required us to step up the value of inventory acquired in the Southern Container Acquisition, which effectively eliminated the manufacturing profit that we would have realized upon sale of that inventory. This write up reduced our pre-tax income in fiscal 2008 by approximately $12.7 million as the acquired inventory was sold and charged to cost of sales.
Cost of goods sold increased to $2,296.8 million in fiscal 2008 compared to $1,870.2 million in fiscal 2007 primarily due to the incremental sales associated with the Southern Container Acquisition. Cost of goods sold as a percentage of sales was essentially flat in fiscal 2008 compared to fiscal 2007, 80.9% in fiscal 2008 and 80.8% in fiscal 2007, as rising input costs and the impact of the acquisition inventory step up expense offset higher pricing and the higher margin Southern Container sales included since the acquisition. Recycled fiber costs, excluding the Solvay mill, and virgin fiber costs increased approximately $23 per ton and $18 per ton, respectively, over the prior fiscal year. Energy and chemical costs at our recycled paperboard mills increased $12 per ton and $5 per ton, respectively, over the prior fiscal year. Excluding the impact of the Southern Container Acquisition, in fiscal 2008 we experienced increased energy costs of approximately $22.0 million, increased freight expense of $8.5 million, increased workers’ compensation expense of $3.0 million and increased group insurance expense of $1.4 million across our operations. We also experienced higher costs associated with our Dallas mill due to a dryer section failure and rebuild in December 2007. Partially offsetting these amounts, in fiscal 2008, we received approximately $1.7 million in recovery of previously expensed environmental remediation costs and incurred reduced pension expense of $4.7 million. We have foreign currency transaction risk primarily due to our operations in Canada. See “Quantitative and Qualitative Disclosures About Market Risk — Foreign Currency” below. The impact of foreign currency transactions in fiscal 2008 compared to fiscal 2007 decreased costs of goods sold by $1.6 million.
19
We value the majority of our U.S. inventories at the lower of cost or market with cost determined on the last-in first-out (“LIFO”) inventory valuation method, which we believe generally results in a better matching of current costs and revenues than under the first-in first-out (“FIFO”) inventory valuation method. In periods of increasing costs, the LIFO method generally results in higher cost of goods sold than under the FIFO method. In periods of decreasing costs, the results are generally the opposite.
The following table illustrates the comparative effect of LIFO and FIFO accounting on our results of operations. This supplemental FIFO earnings information reflects the after-tax effect of eliminating the LIFO adjustment each year.
| Fiscal 2009 | Fiscal 2008 | Fiscal 2007 | ||||||||||||||||
| LIFO | FIFO | LIFO | FIFO | LIFO | FIFO | |||||||||||||
| (In millions) | ||||||||||||||||||
| Cost of goods sold |
$ | 2,049.6 | $ | 2,057.8 | $ | 2,296.8 | $ | 2,287.0 | $ | 1,870.2 | $ | 1,863.4 | ||||||
| Net income |
222.3 | 217.2 | 81.8 | 88.0 | 81.7 | 86.0 | ||||||||||||
Net income in fiscal 2009 is higher under the LIFO method because we experienced a period of declining costs, and net income in fiscal 2008 and 2007 is lower under the LIFO method because we experienced periods of rising costs.
Selling, General and Administrative Expenses
Selling, general and administrative (“SG&A”) expenses increased $20.3 million to $330.8 million in fiscal 2009 compared to $310.5 million in fiscal 2008 due primarily to the additional five months of SG&A expense associated with the Southern Container Acquisition in fiscal 2009. SG&A increased as a percentage of net sales due largely to lower fiscal 2009 net sales associated with lower sales volumes and reduced recycled fiber selling prices, which more than offset the additional five months of net sales associated with the Southern Container Acquisition. Excluding the impact of the Southern Container Acquisition, SG&A expenses in fiscal 2009 were $9.6 million lower than fiscal 2008. We experienced increased aggregate pension expense of $4.3 million, increased stock based compensation expense of $2.2 million, and increased group insurance expense of $1.0 million, excluding the impact of the Southern Container Acquisition. Partially offsetting these amounts, we incurred reduced consulting and outside services for various projects of $4.3 million, commissions expense of $1.7 million due to lower sales volumes, decreased travel and entertainment expense of $1.2 million and reduced bonus expense of $1.1 million, excluding the impact of the Southern Container Acquisition.
SG&A expenses increased $51.4 million to $310.5 million in fiscal 2008 compared to $259.1 million in fiscal 2007 primarily due to SG&A expenses associated with the Southern Container Acquisition. SG&A expenses as a percentage of net sales decreased to 10.9% in fiscal 2008 from 11.2% in fiscal 2007 primarily due to increased net sales from higher sales volumes and prices. Excluding the impact of the Southern Container Acquisition, SG&A labor costs increased $5.7 million, commissions expense increased $2.7 million on increased sales, stock based compensation expense increased $1.9 million, and bad debt expense increased $1.5 million. These increases were partially offset by reduced bonus expense of $2.4 million and reduced pension expense of $1.2 million.
Acquisitions
On March 5, 2008, we acquired the stock of Southern Container for $1,059.9 million, net of cash received of $54.0 million, including expenses. RockTenn and Southern Container made an election under section 338(h)(10) of the Internal Revenue Code of 1986, as amended (the “Code”) that increased RockTenn’s tax basis in the acquired assets and is expected to result in a net present value benefit of approximately $135 million, net of an agreed upon payment included in the purchase price for the election to the sellers of approximately $68.6 million paid to Southern Container’s former stockholders in November 2008. In fiscal 2008, we incurred $26.8 million of
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debt issuance costs in connection with the transaction. We recorded fair values for acquired assets and liabilities including $374.3 million of goodwill and $108.7 million of intangibles. See “Note 7. Acquisitions” and “Note 11. Debt”, respectively, of the Notes to Consolidated Financial Statements section of the Financial Statements included herein.
On January 24, 2007, we acquired, for $32.0 million, the remaining 40% minority interest in Fold-Pak, LLC (“Fold-Pak”, formerly known as GSD Packaging, LLC), giving us sole ownership. These operations are included in the results of our Consumer Packaging segment. We acquired our initial 60% interest in Fold-Pak in connection with the GSPP Acquisition in June 2005. Fold-Pak makes paperboard-based food containers serving a very broad customer base and is a consumer of board from our bleached paperboard mill.
For additional information, including the opening balance sheet and pro forma information reflecting the Southern Container Acquisition, see “Note 7. Acquisitions” of the Notes to Consolidated Financial Statements.
Restructuring and Other Costs, Net
We recorded pre-tax restructuring and other costs, net of $13.4 million, $15.6 million, and $4.7 million for fiscal 2009, 2008, and 2007, respectively. These amounts are not comparable since the timing and scope of the individual actions associated with a restructuring can vary. In most instances when we close a facility we transfer a substantial portion of the facility’s assets and production to other facilities. We recognize, if necessary, an impairment charge, primarily to reduce the carrying value of equipment or other property to their estimated fair value or fair value less cost to sell, and record charges for severance and other employee related costs. Any subsequent change in fair value, less cost to sell prior to disposition, is recognized as identified; however, no gain is recognized in excess of the cumulative loss previously recorded. At the time of each announced closure, we generally expect to record future charges for equipment relocation, facility carrying costs, costs to terminate a lease or contract before the end of its term and other employee related costs. We generally expect the integration of the closed facility’s assets and production to enable the receiving facilities to better leverage their fixed costs while eliminating fixed costs from the closed facility. For additional information, see “Note 8. Restructuring and Other Costs, Net” of the Notes to Consolidated Financial Statements.
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Paperboard Tons Shipped and Average Price (in thousands, except Average Price Per Ton)
The table below includes coated recycled paperboard, bleached paperboard and market pulp tons shipped in our Consumer Packaging segment, containerboard tons shipped from our two containerboard mills in our Corrugated Packaging segment, as well as the tons shipped from our specialty recycled mills in our Specialty Paperboard Products segment and the average price per ton of the aggregated group. The decrease in average price per ton in the second quarter of fiscal 2008 is due to the higher percentage of lower priced containerboard included in the average subsequent to the Southern Container Acquisition.
| Coated and Specialty Recycled Paperboard Tons Shipped (a) |
Bleached Paperboard Tons Shipped |
Market Pulp Tons Shipped |
Containerboard Tons Shipped (b) |
Average Price (Per Ton) (a)(c) | |||||||
| (In thousands, except Average Price Per Ton) | |||||||||||
| First Quarter |
221.5 | 74.0 | 20.9 | 44.6 | $ | 558 | |||||
| Second Quarter |
223.0 | 82.2 | 24.6 | 46.2 | 571 | ||||||
| Third Quarter |
225.1 | 90.1 | 25.6 | 45.3 | 588 | ||||||
| Fourth Quarter |
223.5 | 88.7 | 24.8 | 46.8 | 596 | ||||||
| Fiscal 2007 |
893.1 | 335.0 | 95.9 | 182.9 | $ | 578 | |||||
| First Quarter |
217.1 | 79.6 | 21.2 | 44.7 | $ | 599 | |||||
| Second Quarter |
229.0 | 84.9 | 27.8 | 102.1 | 587 | ||||||
| Third Quarter |
235.9 | 86.3 | 24.5 | 218.5 | 566 | ||||||
| Fourth Quarter |
234.2 | 90.7 | 21.5 | 244.1 | 585 | ||||||
| Fiscal 2008 |
916.2 | 341.5 | 95.0 | 609.4 | $ | 583 | |||||
| First Quarter |
204.9 | 86.3 | 20.7 | 221.9 | $ | 596 | |||||
| Second Quarter |
212.0 | 78.3 | 19.5 | 188.6 | 586 | ||||||
| Third Quarter |
219.8 | 79.4 | 24.2 | 203.0 | 564 | ||||||
| Fourth Quarter |
224.3 | 88.9 | 26.5 | 235.2 | 557 | ||||||
| Fiscal 2009 |
861.0 | 332.9 | 90.9 | 848.7 | $ | 575 | |||||
| (a) | Recycled Paperboard Tons Shipped and Average Price Per Ton include gypsum paperboard liner tons shipped by Seven Hills. |
| (b) | Containerboard Tons Shipped includes corrugated medium and linerboard, which include the Solvay mill tons beginning in March 2008. |
| (c) | Beginning in the second quarter of fiscal 2008, Average Price Per Ton includes coated and specialty recycled paperboard, containerboard, bleached paperboard and market pulp. |
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Segment Income
Segment Income — Consumer Packaging Segment
| Net Sales (Aggregate) |
Segment Income |
Return on Sales |
|||||||
| (In millions, except percentages) | |||||||||
| First Quarter |
$ | 346.8 | $ | 24.3 | 7.0 | % | |||
| Second Quarter |
363.7 | 29.7 | 8.2 | ||||||
| Third Quarter |
373.0 | 36.9 | 9.9 | ||||||
| Fourth Quarter |
376.1 | 34.3 | 9.1 | ||||||
| Fiscal 2007 |
$ | 1,459.6 | $ | 125.2 | 8.6 | % | |||
| First Quarter |
$ | 374.7 | $ | 28.7 | 7.7 | % | |||
| Second Quarter |
394.8 | 32.5 | 8.2 | ||||||
| Third Quarter |
388.9 | 27.9 | 7.2 | ||||||
| Fourth Quarter |
393.0 | 30.7 | 7.8 | ||||||
| Fiscal 2008 |
$ | 1,551.4 | $ | 119.8 | 7.7 | % | |||
| First Quarter |
$ | 368.8 | $ | 31.5 | 8.5 | % | |||
| Second Quarter |
362.9 | 39.2 | 10.8 | ||||||
| Third Quarter |
377.2 | 83.0 | 22.0 | ||||||
| Fourth Quarter |
394.2 | 74.6 | 18.9 | ||||||
| Fiscal 2009 |
$ | 1,503.1 | $ | 228.3 | 15.2 | % | |||
Segment income of the Consumer Packaging segment for fiscal 2009 increased $108.5 million primarily due to the recognition of the $54.1 million of alternative fuel tax credits, net, and, as previously discussed, decreased recycled fiber, energy and freight costs, increased selling prices and continued operational improvements, which were partially offset by lower sales volumes and increased virgin fiber and chemical costs. Recycled fiber and energy costs decreased approximately $33.0 million, or $59 per ton, and approximately $19.0 million, or $19 per ton, respectively, over the prior year. Freight expense declined $14.8 million due to cost reduction programs and lower sales volumes. Virgin fiber and chemical costs increased approximately $7.2 million and $3.4 million, respectively, and pension and group insurance expense increased $5.1 million and $1.5 million, respectively. Partially offsetting these increases in expense was reduced bonus expense of $2.2 million and reduced salaries expense of $2.1 million.
Consumer Packaging segment income decreased to $119.8 million in fiscal 2008 from $125.2 million in fiscal 2007 as productivity improvements, operating efficiencies and sales price increases were more than offset by higher energy, chemicals, and fiber costs in our mills. At our coated mills, recycled fiber costs increased $14.4 million, virgin fiber costs increased $7.0 million, energy costs increased $13.5 million, chemical costs increased $11.5 million and shipping costs increased approximately $3.4 million, over the prior year. During the first quarter of fiscal 2008 we received approximately $1.7 million in recovery of previously expensed environmental remediation costs, which was largely offset by the impact of a dryer section failure and rebuild in our Dallas mill in December 2007. Workers’ compensation expense increased $2.0 million, commissions expense increased $1.7 million, group insurance expense increased $1.4 million, and bad debt expense increased $1.1 million. These higher costs were only partially offset by increases in selling prices over the prior year, an increase in coated tons shipped, decreased pension expense of $3.7 million, decreased expense of $1.4 million related to foreign currency transactions, and decreased bonus expense of $2.5 million.
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Segment Income — Corrugated Packaging Segment
| Net Sales (Aggregate) |
Segment Income |
Return on Sales |
|||||||
| (In millions, except percentages) | |||||||||
| First Quarter |
$ | 56.2 | $ | 6.0 | 10.7 | % | |||
| Second Quarter |
59.3 | 5.8 | 9.8 | ||||||
| Third Quarter |
60.2 | 4.0 | 6.6 | ||||||
| Fourth Quarter |
61.0 | 3.1 | 5.1 | ||||||
| Fiscal 2007 |
$ | 236.7 | $ | 18.9 | 8.0 | % | |||
| First Quarter |
$ | 61.4 | $ | 4.3 | 7.0 | % | |||
| Second Quarter |
112.0 | 4.4 | 3.9 | ||||||
| Third Quarter |
208.9 | 23.2 | 11.1 | ||||||
| Fourth Quarter |
225.2 | 39.4 | 17.5 | ||||||
| Fiscal 2008 |
$ | 607.5 | $ | 71.3 | 11.7 | % | |||
| First Quarter |
$ | 203.2 | $ | 50.6 | 24.9 | % | |||
| Second Quarter |
176.5 | 41.6 | 23.6 | ||||||
| Third Quarter |
186.5 | 49.6 | 26.6 | ||||||
| Fourth Quarter |
186.7 | 37.1 | 19.9 | ||||||
| Fiscal 2009 |
$ | 752.9 | $ | 178.9 | 23.8 | % | |||
Segment income attributable to the Corrugated Packaging segment for fiscal 2009 increased $107.6 million compared to fiscal 2008 primarily due to increased segment income from the Southern Container Acquisition due largely to an additional five months of ownership in fiscal 2009, decreased recycled fiber, energy and chemical costs and continued operational improvements, which were partially offset by lower sales volumes and lower selling prices. At our containerboard mills, recycled fiber, energy and chemical costs decreased approximately $60.9 million, or $72 per ton, approximately $7.4 million, or $9 per ton, and approximately $2.8 million, or $3 per ton, respectively, over the prior year. Freight expense declined $1.1 million due to cost reduction programs and lower sales volumes. Our segment income for fiscal 2008 was reduced by $12.7 million of acquisition inventory charges and $3.8 million due to an upgrade and capacity expansion at our Solvay mill.
Corrugated Packaging segment income in fiscal 2008 increased to $71.3 million from $18.9 million in fiscal 2007 primarily due to the Southern Container Acquisition and increased income at our legacy corrugated plants, which were partially offset by lower income at our legacy recycled corrugated medium mill due to higher fiber and energy costs. Acquisition accounting requires us to step up the value of the inventory acquired which effectively eliminates a portion of the profit that we otherwise would realize upon the sale of that inventory. This write up associated with the Southern Container Acquisition reduced our pre-tax income in the year by approximately $12.7 million as the acquired inventory was sold and charged to cost of goods sold. Our fiscal 2008 segment income was reduced by approximately $3.8 million primarily because of lost production during an upgrade and capacity expansion at our Solvay mill. The annual capacity of the Solvay mill is now 770,000 tons per year, 50,000 tons more than when we closed the acquisition in March 2008.
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Segment Income — Merchandising Displays Segment
| Net Sales (Aggregate) |
Segment Income |
Return on Sales |
|||||||
| (In millions, except percentages) | |||||||||
| First Quarter |
$ | 60.9 | $ | 5.2 | 8.5 | % | |||
| Second Quarter |
82.6 | 12.1 | 14.6 | ||||||
| Third Quarter |
76.8 | 10.9 | 14.2 | ||||||
| Fourth Quarter |
85.5 | 10.6 | 12.4 | ||||||
| Fiscal 2007 |
$ | 305.8 | $ | 38.8 | 12.7 | % | |||
| First Quarter |
$ | 82.0 | $ | 8.0 | 9.8 | % | |||
| Second Quarter |
94.3 | 13.8 | 14.6 | ||||||
| Third Quarter |
86.1 | 8.4 | 9.8 | ||||||
| Fourth Quarter |
88.4 | 11.7 | 13.2 | ||||||
| Fiscal 2008 |
$ | 350.8 | $ | 41.9 | 11.9 | % | |||
| First Quarter |
$ | 74.8 | $ | 5.1 | 6.8 | % | |||
| Second Quarter |
82.9 | 9.7 | 11.7 | ||||||
| Third Quarter |
79.7 | 8.0 | 10.0 | ||||||
| Fourth Quarter |
83.2 | 9.1 | 10.9 | ||||||
| Fiscal 2009 |
$ | 320.6 | $ | 31.9 | 10.0 | % | |||
Segment income attributable to the Merchandising Displays segment for fiscal 2009 decreased $10.0 million, compared to fiscal 2008 primarily due to lower sales volumes.
Merchandising Displays segment income in fiscal 2008 increased $3.1 million, compared to fiscal 2007 due to an increase in display sales which were partially offset by higher input costs and increased salary expense of $1.7 million to support our increased sales levels.
Segment Income — Specialty Paperboard Products Segment
| Net Sales (Aggregate) |
Segment Income |
Return On Sales |
|||||||
| (In millions, except percentages) | |||||||||
| First Quarter |
$ | 79.5 | $ | 7.3 | 9.2 | % | |||
| Second Quarter |
91.9 | 7.2 | 7.8 | ||||||
| Third Quarter |
94.0 | 7.8 | 8.3 | ||||||
| Fourth Quarter |
96.3 | 6.5 | 6.7 | ||||||
| Fiscal 2007 |
$ | 361.7 | $ | 28.8 | 8.0 | % | |||
| First Quarter |
$ | 91.8 | $ | 7.4 | 8.1 | % | |||
| Second Quarter |
99.8 | 6.6 | 6.6 | ||||||
| Third Quarter |
102.1 | 7.8 | 7.6 | ||||||
| Fourth Quarter |
99.2 | 8.5 | 8.6 | ||||||
| Fiscal 2008 |
$ | 392.9 | $ | 30.3 | 7.7 | % | |||
| First Quarter |
$ | 75.3 | $ | 2.8 | 3.7 | % | |||
| Second Quarter |
70.2 | 6.2 | 8.8 | ||||||
| Third Quarter |
77.2 | 9.4 | 12.2 | ||||||
| Fourth Quarter |
84.2 | 8.1 | 9.6 | ||||||
| Fiscal 2009 |
$ | 306.9 | $ | 26.5 | 8.6 | % | |||
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Segment income attributable to the Specialty Paperboard Products segment for fiscal 2009 decreased $3.8 million compared to fiscal 2008. The impact of reduced recycled fiber and specialty recycled paperboard selling prices and lower sales volumes were partially offset by a decrease in fiber costs at our specialty mills of approximately $12.9 million, or $61 per ton, and decreased energy costs of approximately $2.9 million, or $13 per ton over the prior year. In fiscal 2008 we received approximately $1.7 million in recovery of previously expensed environmental remediation costs. Partially offsetting fiscal 2009 decreases in fiber and energy costs was increased pension and group insurance expense of $1.3 million and $1.2 million over the prior year, respectively. Freight expense declined $2.7 million due to cost reduction programs and lower sales volumes.
Specialty Paperboard Products segment income for fiscal 2008 increased to $30.3 million compared to $28.8 million in fiscal 2007 primarily due to higher sales as a result of increases in volume and prices, which were partially offset by increased recycled fiber costs in our specialty mills of approximately $4.9 million, or $23 per ton, over the prior year period. Across the segment, energy costs increased approximately $3.8 million.
Equity in Income of Unconsolidated Entities
Equity in income of unconsolidated entities included in segment income in fiscal 2009 was $0.1 million compared to $2.4 million in fiscal 2008. The decrease in income was primarily due to a decline in performance of our Seven Hills and DSA investments. Equity in income of unconsolidated entities included in segment income in fiscal 2008 was $2.4 million compared to $1.1 million in fiscal 2007. Fiscal 2008 includes our share of our Seven Hills, Display Source Alliance (“DSA”) and Quality Packaging Specialists International, LLC (“QPSI”) investments as well as our Pohlig Brothers, LLC (“Pohlig”) and Greenpine Road, LLC (“Greenpine”) investments acquired in the Southern Container Acquisition. Fiscal 2007 includes our share of our Seven Hills as well as our share of our QPSI and DSA investments that we entered into during the first quarter and third quarter of fiscal 2007, respectively.
Interest Expense
Interest expense for fiscal 2009 increased to $96.7 million from $86.7 million due to the impact of twelve months of expense in fiscal 2009 associated with the additional debt required to fund the Southern Container Acquisition, compared to approximately seven months of related expense in the prior year. Deferred financing cost amortization increased $3.1 million and the increase in our average outstanding borrowings increased interest expense by approximately $12.4 million and lower interest rates, net of interest rate swaps, decreased interest expense by approximately $2.5 million. Included in fiscal 2008 was a $3.0 million bridge financing fee.
Interest expense for fiscal 2008 increased to $86.7 million from $49.8 million for fiscal 2007 as a result of the additional debt required to fund the Southern Container Acquisition. Fiscal 2008 interest expense included a $3.0 million bridge financing fee associated with the acquisition. The increase in our average outstanding borrowings increased interest expense by approximately $34.3 million and lower interest rates, net of interest rate swaps, decreased interest expense by approximately $3.1 million. Increased deferred financing cost amortization accounted for $2.7 million.
Loss on Extinguishment of Debt and Related Items
Loss on extinguishment of debt and related items for fiscal 2009 was $4.4 million and primarily included $1.9 million of expense recognized in connection with the tender offer for up to $100 million of our August 2011 Notes (as hereinafter defined) and $2.4 million of expense incurred to retire at 102% of par the Solvay industrial development revenue bonds (the “Solvay IDBs”), which we assumed as part of the Southern Container Acquisition. The $2.4 million was funded by the former Southern Container stockholders. Loss on extinguishment of debt and related items for fiscal 2008, previously included in interest expense, was $1.9 million and was associated with the Southern Container Acquisition.
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Interest Income and Other Income (Expense), net
Interest income and other income (expense), net for fiscal 2008 was income of $1.6 million primarily due to interest income. Interest income and other income (expense), net was expense of $1.3 million in fiscal 2007 primarily due to a charge for an other than temporary decline in the fair value of a cost method investment.
Minority Interest in Income of Consolidated Subsidiaries
Minority interest in income of our consolidated subsidiaries for fiscal 2009 decreased to $3.6 million from $5.3 million in fiscal 2008 due primarily to lower earnings at our consolidated solid fiber interior packaging subsidiary and the impairment of certain assets at one of our consolidated corrugated graphics subsidiaries. Minority interest in income of our consolidated subsidiaries for fiscal 2008 increased to $5.3 million from $4.8 million in fiscal 2007 primarily as a result of the addition of partially-owned businesses acquired in the Southern Container Acquisition, which together with increased earnings at our RTS subsidiary offset the effect in fiscal 2008 of acquiring the outstanding minority interest in Fold-Pak.
Provision for Income Taxes
For fiscal 2009, we recorded a provision for income taxes of $91.6 million, at an effective rate of 29.2% of pre-tax income, as compared to a provision of $44.3 million for fiscal 2008, at an effective rate of 35.1% of pre-tax income. The effective tax rate for fiscal 2009 was primarily impacted by the exclusion of the alternative fuel tax credit from taxable income, a $1.7 million tax benefit related to research tax credits, and a $3.7 million tax benefit related to other federal and state tax credits. For fiscal 2008, we recorded a provision for income taxes of $44.3 million, at an effective rate of 35.1% of pre-tax income, as compared to a provision of $45.3 million for fiscal 2007, at an effective rate of 35.7% of pre-tax income. We estimate that the annual domestic marginal effective income tax rate for fiscal 2009 was approximately 37%. We discuss the alternative fuel tax credit and the provision for income taxes in more detail in “Note 5. Alternative Fuel Tax Credit” and “Note 15. Income Taxes” of the Notes to the Consolidated Financial Statements included herein.
In fiscal 2008, we recorded a deferred tax benefit of $1.4 million related to a tax rate reduction in Canada. We adjusted the rate at which our deferred taxes are computed for state income tax purposes on our domestic operations from approximately 3.4% to approximately 3.7%, resulting in additional tax expense of $0.7 million. We also recorded a benefit of $2.3 million and $0.3 million for research and development and other tax credits, net of valuation allowances, in the United States and Canada, respectively. We also recorded $0.5 million of additional expense to increase our liability for unrecognized tax benefits. Other differences from the statutory federal tax rate are more fully described in “Note 15. Income Taxes” of the Notes to the Consolidated Financial Statements included herein.
In fiscal 2007, we adjusted the rate at which our deferred taxes are computed for state income tax purposes on our domestic operations from approximately 3% to approximately 3.4%, resulting in additional tax expense of $1.2 million. We also recorded a benefit of $4.0 million for research and development and other tax credits, net of valuation allowances. We also recorded $0.6 million of additional expense to increase our tax contingency reserves.
During the first quarter of fiscal 2006, we repatriated $33.3 million from certain of our foreign subsidiaries as allowed under the American Jobs Creation Act of 2004. This Act created a temporary incentive for United States corporations to repatriate accumulated income earned abroad by allowing a deduction from U.S. taxable income of an amount equal to 85% of certain dividends received from controlled foreign corporations. As a result of this repatriation, in fiscal 2007 we paid $0.8 million in United States taxes.
Selected Balance Sheet Changes
Accrued Pension and Other Long-Term Benefits increased to $161.5 million at September 30, 2009 from $70.8 million at September 30, 2008 and Accumulated Other Comprehensive Loss increased to $108.4 million
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from $20.4 million during fiscal 2009 primarily as a result of recording the increase in our pension unfunded status. The increase in our unfunded status was primarily due to the 197 basis point decrease in our discount rate in our five defined benefit pension plans’ (“U.S. Qualified Plans”). More information on our pension benefit obligation, the fair value of our pension assets and our accumulated other comprehensive loss is available in “Note 16. Retirement Plans” and “Note 3. Other Comprehensive (Loss) Income” of the Notes to the Consolidated Financial Statements included herein.
Liquidity and Capital Resources
We fund our working capital requirements, capital expenditures and acquisitions from net cash provided by operating activities, borrowings under term notes, our receivables-backed financing facility and bank credit facilities, and proceeds received in connection with the issuance of industrial development revenue bonds as well as other debt and equity securities.
The sum of cash and cash equivalents and restricted cash and marketable debt securities was $11.8 million at September 30, 2009, and $72.0 million at September 30, 2008. The decrease was primarily due to funds used for debt repayment in the first quarter of fiscal 2009. Our debt balance at September 30, 2009 was $1,349.4 million compared to $1,698.9 million at September 30, 2008. During fiscal 2009, we paid down $349.5 million of debt. We are exposed to changes in interest rates as a result of our debt. We use interest rate swap instruments from time to time to manage our exposure to changes in interest rates on portions of our outstanding debt. At the inception of the swaps, we usually designate such swaps as either cash flow hedges or fair value hedges of the interest rate exposure on an equivalent amount of our floating rate or fixed rate debt, respectively. At September 30, 2009, we had certain pay-fixed, receive-floating interest rate swaps that terminate in April 2012 and cover debt with an aggregate notional amount of $452 million, declining at periodic intervals through April 2012 to an aggregate notional amount of $132 million. These swaps are based on the one-month LIBOR rate, and the fixed rates average 4.00%.
On March 5, 2008, we entered into an Amended and Restated Credit Agreement (the “Credit Facility”) with an original maximum principal amount of $1.2 billion and issued $200.0 million aggregate principal amount of 9.25% senior notes due March 2016 (“March 2016 Notes”). The Credit Facility includes revolving credit, swing, term loan, and letters of credit consisting of a $450 million revolving credit facility, a $550 million term loan A facility and a $200 million term loan B facility. The Credit Facility is pre-payable at any time. Scheduled term loan payments or other term loan payments reduce the facility size. The revolving credit facility and term loan A facility are scheduled to mature on the earlier to occur of (a) March 5, 2013 or (b) if our $100 million March 2013 Notes (as defined in “Note 11. Debt” of the Notes to the Consolidated Financial Statements) have not been paid in full or refinanced by September 15, 2012, then September 15, 2012; the term loan B facility is scheduled to mature on the earlier to occur of (a) March 5, 2014 or (b) if the March 2013 Notes have not been paid in full or refinanced by September 15, 2012, then September 15, 2012. Certain restrictive covenants govern our maximum availability under this facility, including Minimum Consolidated Interest Ratio Coverage; Maximum Leverage Ratio; and Minimum Consolidated Net Worth; as those terms are defined by the Credit Facility. We test and report our compliance with these covenants each quarter. We are in compliance with all of our covenants. Our available borrowings under the revolving credit portion of the Credit Facility, reduced by outstanding letters of credit not drawn upon of approximately $32.2 million, were $398.7 million at September 30, 2009. The March 2016 Notes are guaranteed by the guarantors listed therein (comprising most of our subsidiaries which are guarantors under the Credit Facility). The senior note indenture contains financial and restrictive covenants, including limitations on restricted payments, dividend and other payments affecting restricted subsidiaries, incurrence of debt, asset sales, transactions with affiliates, liens, sale and leaseback transactions and the creation of unrestricted subsidiaries. On May 29, 2009, we consummated a tender offer for $93.3 million of August 2011 Notes and financed this tender offer with a $100 million add-on to our March 2016 Notes. The purchase price of the $93.3 million of tendered bonds was at a price of 103% of par. Subsequent to September 30, 2009, we repurchased $19.5 million of our March 2013 Notes at an average price of approximately 98% of par and recorded an aggregate gain on extinguishment of debt of approximately $0.5 million.
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In fiscal 2008, in connection with the Southern Container Acquisition we assumed Solvay IDBs totaling $132.3 million and recorded $110.7 million of debt for cash payable to the sellers for cash held to comply with the Solvay IDBs, net of a 2% redemption fee of approximately $2.4 million to terminate the Solvay IDBs, and an agreed upon payment to the sellers related to the Code section 338(h)(10) election. On November 3, 2008, the first call date of the Solvay IDBs, we repaid the Solvay IDBs and recorded a loss on extinguishment of debt and related items of $2.4 million due to amounts paid in excess of carrying value. The loss was funded by the former Southern Container stockholders. We repaid the Solvay IDBs using cash and cash equivalents, restricted cash and marketable debt securities aggregating approximately $70 million and proceeds from the revolving portion of our Credit Facility. On November 14, 2008, we paid the former Southern Container stockholders for the cash payable to sellers primarily with funds from the revolving credit portion of our Credit Facility.
On September 2, 2008, we amended our 364-day receivables-backed financing facility (the “Receivables Facility”) and increased its size from $110.0 million to $175.0 million. On July 14, 2009 we amended our existing Receivables Facility to, among other things, extend the maturity to set it to expire on July 13, 2012 and reduce the size of the facility to $100.0 million. On August 14, 2009 we amended the facility to increase the facility size to $135.0 million. At September 30, 2009 we had $100.0 million outstanding under the Receivables Facility. Borrowing availability under this facility is based on the eligible underlying receivables and certain covenants. We test and report our compliance with these covenants monthly. We are in compliance with all of our covenants. One of our covenants is based on the percentage of receivables 31 to 60 days past due, and another is based on the percentage of receivables greater than 61 days past due. Given current economic conditions it is possible that the age of qualifying receivables could exceed the limit in the covenant. If this event were to occur, we would either amend the facility or terminate the facility utilizing available capacity under the revolving credit portion of our existing Credit Facility. Available borrowings, reduced by outstanding letters of credit not drawn upon, were $398.7 million under the revolving credit portion of the Credit Facility. For additional information regarding our outstanding debt, our credit facilities and their securitization, the repayment of the Solvay IDBs and cash payable to sellers, our interest rate swaps and our July 2009 Credit Facility amendment, see “Note 11. Debt” of the Notes to Consolidated Financial Statements.
Net cash provided by operating activities during fiscal 2009 and fiscal 2008 was $389.7 million and $240.9 million, respectively. The increase was primarily due to increased earnings, an increase in deferred income tax benefit due to increases in temporary differences and a net decrease in operating assets and liabilities including reduced cash tax payments as a result of utilizing alternative fuel tax credits. Alternative fuel tax credits reduced our cash tax payments by approximately $30 million in fiscal 2009. We expect to collect in excess of an additional $25 million when we file our 2009 tax return for amounts recorded in fiscal 2009 and reduce fiscal 2010 cash tax payments in excess of $21 million for amounts expected to be earned in the first quarter of fiscal 2010. Net cash provided by operating activities during fiscal 2008 and 2007 was $240.9 million and $238.3 million, respectively. We had a net use of working capital of $1.0 million as our increased accounts receivable balance was impacted primarily by higher sales prices and volumes offset by our increased accounts payable balance which was impacted by higher input costs and both were impacted by our ongoing working capital improvement initiatives. Fiscal 2008 included net proceeds from termination of cash flow interest rate hedges of $6.9 million. Fiscal 2007 was impacted by a greater source of funds for working capital due to our ongoing working capital improvement initiatives.
Net cash used for investing activities was $75.4 million during fiscal 2009 compared to $895.2 million in fiscal 2008. Net cash used for investing activities in fiscal 2009 consisted primarily of $75.9 million of capital expenditures and $8.1 million for the purchase of a leased facility. Net cash used for investing activities was $895.2 million during fiscal 2008 compared to $109.1 million in fiscal 2007. Net cash used for investing activities in fiscal 2008 consisted primarily of $816.8 million related to the Southern Container Acquisition and $84.2 million of capital expenditures. Net cash used for investing activities in fiscal 2007 consisted primarily of $78.0 million of capital expenditures, $32.0 million paid to acquire the remaining 40% interest in Fold-Pak, and $9.6 million of investment in unconsolidated entities, primarily for our interest in QPSI in our Merchandising Displays segment. Partially offsetting these amounts in fiscal 2007 was a return of capital of $6.5 million primarily from our Seven Hills investment.
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Net cash used for financing activities was $356.7 million during fiscal 2009 compared to net cash provided by $696.5 million in fiscal 2008. Fiscal 2009 primarily included net repayments of debt aggregating $346.3 million and cash dividends paid to shareholders of $15.3 million, which was partially offset by the reduction in restricted cash and investments of $19.2 million. In fiscal 2008, net cash provided by financing activities consisted primarily of net additions to debt and proceeds from issuance of notes aggregating $737.7 million. Partially offsetting these amounts were $27.1 million of debt issuance costs and cash dividends paid to shareholders of $15.2 million. Net cash used for financing activities in fiscal 2007 was $124.9 million and consisted primarily of net repayments of debt of $86.8 million, purchases of Common Stock of $58.7 million, cash dividends paid to shareholders of $15.4 million, repayments of advances from an unconsolidated entity of $5.4 million, and distributions paid to minority interest partners of $4.2 million. These items were partially offset by $31.5 million in issuances of Common Stock and $14.1 million for tax benefits from share-based compensation. In fiscal 2007, cash from the issuance of Common Stock increased due to the exercise of stock options for approximately 2.3 million shares.
In fiscal 2007, we received $1.6 million of insurance proceeds primarily for property damage claims for a flood that occurred at one of our mills during fiscal 2006. The proceeds have been used primarily to repair certain property and equipment. Net cash used for investing activities in fiscal 2007 included $1.3 million for capital equipment purchased and the balance was classified in cash provided by operating activities.
Our capital expenditures aggregated $75.9 million in fiscal 2009. We used these expenditures primarily for the purchase and upgrading of machinery and equipment. We were obligated to purchase approximately $10 million of fixed assets at September 30, 2009. We estimate that our capital expenditures will aggregate approximately $90 to $95 million in fiscal 2010. Included in our capital expenditures estimate is approximately $5 to $6 million for capital expenditures that we expect to spend during fiscal 2010 in connection with matters relating to environmental compliance.
Based on current facts and assumptions, we expect our cash tax payments to be less than income tax expense in each of fiscal 2010, 2011 and 2012.
In connection with prior dispositions of assets and/or subsidiaries, we have made certain guarantees to third parties as of September 30, 2009. Our specified maximum aggregate potential liability (on an undiscounted basis) is approximately $7.1 million, other than with respect to certain specified liabilities, including liabilities relating to title, taxes, and certain environmental matters, with respect to which there may be no limitation. We estimate the fair value of our aggregate liability for outstanding indemnities, including the indemnities described above with respect to which there are no limitations, to be a de minimis amount. We have also made guarantees, primarily for certain debt, related to three equity investees in an amount less than $7 million. We have no material off balance sheet arrangements. For additional information regarding our guarantees, see “Note 20. Commitments and Contingencies” of the Notes to Consolidated Financial Statements.
During fiscal 2009 and 2008, we made contributions of $40.9 and $15.9 million, respectively, to our pension and supplemental retirement plans. The under funded status of our plans at September 30, 2009 was $161.6 million. Based on current facts and assumptions, we anticipate contributing approximately $26 million to our U.S. Qualified Plans in fiscal 2010. Future contributions are subject to changes in our under funded status based on factors such as discount rates and return on plan assets. It is possible that our assumptions may change, actual market performance may vary or we may decide to contribute a different amount. Other than any potential financial impacts resulting from the uncertainty associated with the current turmoil in the financial and capital markets, we do not expect complying with the Pension Act will have a material adverse effect on our results of operations, financial condition or cash flows. However, the current turmoil in the financial and capital markets may require us to materially increase our funding.
During fiscal 2009, we recorded a charge to other comprehensive income of $2.1 million for foreign currency translation adjustments, primarily due to the change in the Canadian/U.S. dollar exchange rates; and we
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recorded deferred losses, net of reclassification adjustments included in earnings, to other comprehensive income of $11.5 million, net of tax, related primarily to our interest rate derivative cash flow hedges; we recorded deferred losses and costs, net of amortization adjustments, to other comprehensive income of $74.4 million, net of tax, related to pension obligation adjustments.
In October 2009, our board of directors approved a resolution to pay our quarterly dividend of $0.15 per share indicating an annualized dividend of $0.60 per share on our Common Stock.
We anticipate that we will be able to fund our capital expenditures, interest payments, stock repurchases, dividends, pension payments, working capital needs, bond repurchases, and repayments of current portion of long-term debt for the foreseeable future from cash generated from operations, borrowings under our Credit Facility and Receivables Facility, proceeds from the issuance of debt or equity securities or other additional long-term debt financing, including new or amended facilities to finance acquisitions.
Contractual Obligations
We summarize our enforceable and legally binding contractual obligations at September 30, 2009, and the effect these obligations are expected to have on our liquidity and cash flow in future periods in the following table. We based some of the amounts in this table on management’s estimates and assumptions about these obligations, including their duration, the possibility of renewal, anticipated actions by third parties, and other factors. Because these estimates and assumptions are subjective, the enforceable and legally binding obligations we actually pay in future periods may vary from those we have summarized in the table.
| Payments Due by Period | |||||||||||||||
| Contractual Obligations |
Total | Fiscal 2010 |
Fiscal 2011 & 2012 |
Fiscal 2013 & 2014 |
Thereafter | ||||||||||
| (In millions) | |||||||||||||||
| Long-term debt, including current portion (a)(e) |
$ | 1,348.2 | $ | 56.3 | $ | 528.8 | $ | 441.3 | $ | 321.8 | |||||
| Operating lease obligations (b) |
34.0 | 10.9 | 12.6 | 6.7 | 3.8 | ||||||||||
| Purchase obligations and other (c)(d)(f)(g) |
284.3 | 204.1 | 68.6 | 9.4 | 2.2 | ||||||||||
| Total |
$ | 1,666.5 | $ | 271.3 | $ | 610.0 | $ | 457.4 | $ | 327.8 | |||||
| (a) | We have included in the long-term debt line item above amounts owed on our note agreements, industrial development revenue bonds, and Credit Facility. For purposes of this table, we assume that all of our long-term debt will be held to maturity, except for our March 2013 Notes, which we expect will be paid in full or refinanced by September 15, 2012 as discussed in footnote (d) of “Note 11. Debt” referenced below. Also included in the “Fiscal 2011 & 2012” column in the table above is our August 2011 Notes (as defined in “Note 11. Debt” of the Notes to the Consolidated Financial Statements). We have not included in these amounts interest payable on our long-term debt. We have excluded aggregate fair value hedge adjustments resulting from terminated interest rate derivatives of $3.8 million and excluded unamortized discounts of $2.6 million from the table to arrive at actual debt obligations. For information on the interest rates applicable to our various debt instruments, see “Note 11. Debt” of the Notes to Consolidated Financial Statements. |
| (b) | For more information, see “Note 14. Leases” of the Notes to Consolidated Financial Statements. |
| (c) | Purchase obligations include agreements to purchase goods or services that are enforceable and legally binding and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provision; and the approximate timing of the transaction. Purchase obligations exclude agreements that are cancelable without penalty. |
| (d) | Seven Hills commenced operations on March 29, 2001. Our partner has the option to require us to purchase its interest in Seven Hills, at a formula price, effective on the anniversary of the commencement date by providing us notice two years prior to any such anniversary. No notification has been received to date, |
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| therefore, the earliest date on which we could be required to purchase our partner’s interest is March 29, 2012. We currently project this contingent obligation to purchase our partner’s interest (based on the formula) to be approximately $14 million, which would result in a purchase price of approximately 60% of our partner’s share of the net equity reflected on Seven Hills’ September 30, 2009 balance sheet. We have not included the $14 million in the table above. |
| (e) | We have not included in the table above an item labeled “other long-term liabilities” reflected on our consolidated balance sheet because none of our other long-term liabilities has a definite pay-out scheme. As discussed in “Note 16. Retirement Plans” of the Notes to Consolidated Financial Statements, we have long-term liabilities for deferred employee compensation, including pension, supplemental retirement plans, and deferred compensation. We have not included in the table the payments related to the supplemental retirement plans and deferred compensation because these amounts are dependent upon, among other things, when the employee retires or leaves our Company, and whether the employee elects lump-sum or installment payments. In addition, we have not included in the table pension funding requirements because such amounts are not available for all periods presented. We estimate that we will contribute approximately $26 million to our pension plans in fiscal 2010. However, it is possible that our assumptions may change, actual market performance may vary or we may decide to contribute a different amount. During fiscal 2009, we contributed approximately $41 million to our pension and supplemental retirement plans. |
| (f) | The Solvay mill steam supply contract expires in December 2018. We may cancel the contract subject to certain penalties. Included for fiscal 2010 in the table above is $5.9 million for the non-cancellable portion of the steam supply contract. |
| (g) | Included in the line item “Purchase obligations and other” is an aggregate $13.3 million of certain provisions of ASC 740 (as hereinafter defined) liabilities based on our estimate of cash settlement with the respective taxing authorities. |
In addition to the enforceable and legally binding obligations quantified in the table above, we have other obligations for goods and services and raw materials entered into in the normal course of business. These contracts, however, are subject to change based on our business decisions.
For information concerning certain related party transactions, see “Note 19. Related Party Transactions” of the Notes to Consolidated Financial Statements.
Stock Repurchase Program
Our board of directors has approved a stock repurchase plan that allows for the repurchase from time to time of shares of Common Stock over an indefinite period of time. In August 2007 our board of directors amended our stock repurchase plan to allow for the repurchase of an additional 2.0 million shares bringing the cumulative total authorized to 6.0 million shares of Common Stock. Pursuant to our repurchase plan, during fiscal 2007, we repurchased 2.1 million shares for an aggregate cost of $58.7 million. In fiscal 2009 and 2008, we did not repurchase any shares of Common Stock. At September 30, 2009, we had approximately 1.9 million shares of Common Stock available for repurchase under the amended repurchase plan.
Expenditures for Environmental Compliance
For a discussion of our expenditures for environmental compliance, see Item 1. “Business — Governmental Regulation — Environmental Regulation.”
Critical Accounting Policies and Estimates
We have prepared our accompanying consolidated financial statements in conformity with GAAP, which require management to make estimates that affect the amounts of revenues, expenses, assets and liabilities
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reported. The following are critical accounting matters that are both important to the portrayal of our financial condition and results and that require some of management’s most subjective and complex judgments. The accounting for these matters involves the making of estimates based on current facts, circumstances and assumptions that, in management’s judgment, could change in a manner that would materially affect management’s future estimates with respect to such matters and, accordingly, could cause our future reported financial condition and results to differ materially from those that we are currently reporting based on management’s current estimates. For additional information, see “Note 1. Description of Business and Summary of Significant Accounting Policies” of the Notes to Consolidated Financial Statements. See also Item 7A. “Quantitative and Qualitative Disclosures About Market Risk.”
Accounts Receivable and Allowances
We have an allowance for doubtful accounts, credits, returns and allowances, and cash discounts that serve to reduce the value of our gross accounts receivable to the amount we estimate we will ultimately collect. The allowances contain uncertainties because the calculation requires management to make assumptions and apply judgment regarding the customer’s credit worthiness and the credits, returns and allowances and cash discounts that may be taken by our customers. We perform ongoing evaluations of our customers’ financial condition and adjust credit limits based upon payment history and the customer’s current credit worthiness, as determined by our review of their current financial information. We continuously monitor collections from our customers and maintain a provision for estimated credit losses based upon our customers’ financial condition, our collection experience and any other relevant customer specific information. Our assessment of this and other information forms the basis of our allowances. We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to estimate the allowances. However, while these credit losses have historically been within our expectations and the provisions we established, it is possible that our credit loss rates could be higher or lower in the future depending on changes in business conditions. At September 30, 2009, our accounts receivable net of allowances of $8.8 million was $305.5 million; a 1% additional loss on accounts receivable would be $3.1 million and a 5% change in our allowance assumptions would change our allowance by approximately $0.4 million.
Inventory
We carry our inventories at the lower of cost or market. Cost includes materials, labor and overhead. Market, with respect to all inventories, is replacement cost or net realizable value, depending on the inventory. Management frequently reviews inventory to determine the necessity to markdown excess, obsolete or unsaleable inventory. Judgment and uncertainty exists with respect to this estimate because it requires management to assess customer and market demand. These estimates may prove to be inaccurate, in which case we may have overstated or understated the markdown required for excess, obsolete or unsaleable inventory. We have not made any material changes in the accounting methodology used to markdown inventory during the past three fiscal years. We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to calculate inventory markdowns. While these markdowns have historically been within our expectations and the markdowns we established, it is possible that our reserves could be higher or lower in the future if our estimates are inaccurate. At September 30, 2009, our inventory reserves were $3.1 million; a 5% change in our inventory allowance assumptions would change our reserve by approximately $0.2 million.
Prior to the application of the LIFO method, our U.S. operating divisions use a variety of methods to estimate the FIFO cost of their finished goods inventories. Such methods include a standard cost system, average costs computed by dividing the actual cost of goods manufactured by the tons produced and multiplying this amount by the tons of inventory on hand. Lastly, certain operations calculate a ratio, on a plant by plant basis, the numerator of which is the cost of goods sold and the denominator is net sales. This ratio is applied to the estimated sales value of the finished goods inventory. Variances and other unusual items are analyzed to determine whether it is appropriate to include those items in the value of inventory. Examples of variances and
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unusual items that are considered to be current period charges include, but are not limited to, abnormal production levels, freight, handling costs, and wasted materials (spoilage). Cost includes raw materials and supplies, direct labor, indirect labor related to the manufacturing process and depreciation and other factory overheads.
Goodwill and Long-Lived Assets
We review the recorded value of our goodwill annually during the fourth quarter of each fiscal year, or sooner if events or changes in circumstances indicate that the carrying amount may exceed fair value as set forth in the Financial Accounting Standards Board’s Accounting Standards Codification (“ASC”) 350, “Intangibles — Goodwill and Other”. We test goodwill for impairment at the reporting unit level, which is an operating segment or one level below an operating segment, which is referred to as a component. A component of an operating segment is a reporting unit if the component constitutes a business for which discrete financial information is available and segment management regularly reviews the operating results of that component. However, two or more components of an operating segment are aggregated and deemed a single reporting unit if the components have similar economic characteristics. The amount of goodwill acquired in a business combination that is assigned to one or more reporting units as of the acquisition date is the excess of the purchase price of the acquired businesses (or portion thereof) included in the reporting unit, over the fair value assigned to the individual assets acquired or liabilities assumed. Goodwill is assigned to the reporting unit(s) expected to benefit from the synergies of the combination even though other assets or liabilities of the acquired entity may not be assigned to that reporting unit.
We determine recoverability by comparing the estimated fair value of the reporting unit to which the goodwill applies to the carrying value, including goodwill, of that reporting unit using a discounted cash flow model. Estimating the fair value of the reporting unit involves uncertainties, because it requires management to develop numerous assumptions, including assumptions about the future growth and potential volatility in revenues and costs, capital expenditures, industry economic factors and future business strategy. The variability of the factors that management uses to perform the goodwill impairment test depends on a number of conditions, including uncertainty about future events and cash flows. All such factors are interdependent and, therefore, do not change in isolation. Accordingly, our accounting estimates may materially change from period to period due to changing market factors. If we had used other assumptions and estimates or if different conditions occur in future periods, future operating results could be materially impacted. However, as of our most recent review during the fourth quarter of fiscal 2009, if forecasted net operating profit before tax was decreased by 10%, the estimated fair value of each of our reporting units would have continued to exceed their respective carrying values. Also, based on the same information, if we had concluded that it was appropriate to increase by 100 basis points the discount rate we used to estimate the fair value of each reporting unit, the fair value for each of our reporting units would have continued to exceed its carrying value. Therefore, based on current estimates and beliefs we do not believe there is a reasonable likelihood that there will be a change in future assumptions or estimates which would put any of our reporting units with a material amount of goodwill at risk of failing the step one goodwill impairment test. No events have occurred since the latest annual goodwill impairment assessment that would necessitate an interim goodwill impairment assessment.
We follow the provisions included in ASC 360, “Property, Plant and Equipment”, in determining whether the carrying value of any of our long-lived assets is impaired. Our judgments regarding the existence of impairment indicators are based on legal factors, market conditions and operational performance. Future events could cause us to conclude that impairment indicators exist and that assets associated with a particular operation are impaired. Evaluating the impairment also requires us to estimate future operating results and cash flows, which also require judgment by management. Any resulting impairment loss could have a material adverse impact on our financial condition and results of operations.
Included in our long-lived assets are certain intangible assets. These intangible assets are amortized based on the approximate pattern in which the economic benefits are consumed over their estimated useful lives
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ranging from 5 to 40 years and have a weighted average life of approximately 20.4 years. We identify the weighted average lives of our intangible assets by category in “Note 9. Other Intangible Assets” of the Notes to Consolidated Financial Statements.
We have not made any material changes to our impairment loss assessment methodology during the past three fiscal years. We do not believe there is a reasonable likelihood that there will be a material change in future assumptions or estimates we use to calculate impairment losses. However, if actual results are not consistent with our assumptions and estimates, we may be exposed to additional impairment losses that could be material.
Purchase Price Allocations
From time to time, we may enter into material business combinations. The purchase price is allocated to the various assets acquired and liabilities assumed at their estimated fair value. Fair values of assets acquired and liabilities assumed are based upon available information and may involve us engaging an independent third party to perform an appraisal of certain tangible and intangible assets. Estimating fair values can be complex and subject to significant business judgment and most commonly impacts property, plant and equipment and intangible assets, including those with indefinite lives. Generally, we have, if necessary, up to one year from the date of acquisition to obtain all of the information that we have arranged to obtain and that is known to be obtainable to finalize the purchase price allocation. Until such time, the purchase price allocation may remain subject to change based on final valuations of assets acquired and liabilities assumed and may be subject to material revision.
Fair Value of Financial Instruments
Financial instruments not recognized at fair value on a recurring or nonrecurring basis include cash and cash equivalents, accounts receivables, certain other current assets, short-term debt, accounts payable, certain other current liabilities and long-term debt. With the exception of long-term debt, the carrying amounts of these financial instruments approximate their fair values due to their short maturities. The fair values of our long-term debt are estimated using quoted market prices or are based on the discounted value of future cash flows. Financial instruments recognized at fair value include mutual fund investments and derivative contracts. We measure the fair value of our mutual fund investments based on quoted prices in active markets. We measure the fair value of our derivative contracts based on the discounted value of future cash flows. At September 30, 2009, a hypothetical increase or decrease of up to 100 basis points in the LIBOR forward curve would increase or decrease the aggregate fair value of our interest rate swap derivatives by $7.5 million or $5.9 million, respectively. We discuss fair values in more detail in “Note 13. Fair Value” of the Notes to Consolidated Financial Statements.
Accounting for Income Taxes
As part of the process of preparing our Consolidated Financial Statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. We estimate our actual current tax exposure and assess temporary differences resulting from differing treatment of items for tax and financial accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. Certain judgments, assumptions and estimates may affect the carrying value of any deferred tax assets and their associated valuation allowances, if any, and deferred tax liabilities in our Consolidated Financial Statements. We periodically review our estimates and assumptions of our tax assets and obligations using historical experience for the particular jurisdiction and our expectations regarding the future outcome of the related matters. In addition, we maintain reserves for certain tax contingencies based upon our expectations of the outcome of tax audits in the jurisdictions where we operate. While we believe that our assumptions are appropriate, significant differences in our actual experience or significant changes in our assumptions may materially affect our income tax expense and liabilities. We recognize interest and penalties related to unrecognized tax benefits in income tax expense in the consolidated statements of income. A 1%
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increase in our effective tax rate would increase tax expense by approximately $3.1 million for fiscal 2009. A 1% increase in our estimated tax rate used to compute deferred tax liabilities and assets, as recorded on the September 30, 2009 consolidated balance sheet, would increase tax expense by approximately $5.1 million for fiscal 2009.
Pension Plans
We have five defined benefit pension plans, with approximately 42% of our employees in the United States currently accruing benefits. In addition, under several labor contracts, we make payments based on hours worked into multi-employer pension plan trusts established for the benefit of certain collective bargaining employees in facilities both inside and outside the United States. We also have a Supplemental Executive Retirement Plan (“SERP”) that provides unfunded supplemental retirement benefits to certain of our executives. The determination of our obligation and expense for these plans is dependent on our selection of certain assumptions used by actuaries in calculating such amounts. We describe these assumptions in “Note 16. Retirement Plans” of the Notes to Consolidated Financial Statements, which include, among others, the discount rate, expected long-term rate of return on plan assets and expected rates of increase in compensation levels. Although there is authoritative guidance on how to select most of these assumptions, management must exercise some degree of judgment when selecting these assumptions.
The amounts necessary to fund future payouts under these plans are subject to numerous assumptions and variables. Certain significant variables require us to make assumptions such as a discount rate, expected rate of return on plan assets and future compensation levels. We evaluate these assumptions with our actuarial advisors on an annual basis, and we believe they are within accepted industry ranges, although an increase or decrease in the assumptions or economic events outside our control could have a direct impact on reported net earnings.
Our discount rate used for determining future net periodic benefit cost for each plan is based on the Citigroup Pension Discount Curve. We project benefit cash flows from our defined benefit plans against discount rates published in the September 30, 2009 Citigroup Pension Discount Curve matched to fit our expected liability payment pattern. The benefits paid in each future year were discounted to the present at the published rate of the Citigroup Pension Discount Curve for that year. These present values were added up and a discount rate for each plan was determined that would develop the same present value as the sum of the individual years. To set the discount rate for our U.S. Qualified Plans, the weighted average of the discount rate for these plans was used. The expected liability payment pattern in the SERP differs materially from that of the U.S. Qualified Plans so the discount rate for the SERP was determined separately. We believe these discount rates applied to the future defined benefit payment streams for our plans results in an appropriate measure of our obligations. For measuring benefit obligations of our U.S. Qualified Plans as of September 30, 2009 and September 30, 2008 we employed a discount rate of 5.53% and 7.50%, respectively. The 197 basis point decrease in our U.S. Qualified Plans discount rate compared to the prior measurement date and the negative return on plan assets experienced in fiscal 2009 was partially offset by our $40.9 million of employer contributions to our pension and supplemental retirement plans in fiscal 2009, resulting in a $91.2 million decrease in funded status compared to the prior fiscal year. For measuring benefit obligations of our SERP as of September 30, 2009 and September 30, 2008 we employed a discount rate of 4.21% and 7.375%, respectively.
In determining the long-term rate of return for a plan, we consider the historical rates of return, the nature of the plan’s investments and an expectation for the plan’s investment strategies. As of September 30, 2009 and 2008, we used an expected return on plan assets of 8.65%. The plan assets are divided among various investment classes. As of September 30, 2009, approximately 55% of plan assets were invested with equity managers, approximately 35% of plan assets were invested with fixed income managers, and approximately 10% of plan assets were held in cash. The difference between actual and expected returns on plan assets is accumulated and amortized over future periods and, therefore, affects our recognized expenses in such future periods. For fiscal 2009, our pension plans had actual losses on plan assets of $4.1 million, including administrative fees, as
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compared with expected returns on plan assets of $22.4 million, which resulted in a net deferred loss of $26.5 million. At September 30, 2009, we had an unrecognized actuarial loss of $211.4 million. In fiscal 2010, we expect to charge to net periodic pension cost approximately $17.8 million of this unrecognized loss. The amount of this unrecognized loss charged to pension cost in future years is dependent upon future interest rates and pension investment results. A 25 basis point change in the discount rate, the expected increase in compensation levels or the expected long-term rate of return on plan assets would have had the following effect on fiscal 2009 pension expense (amounts in the table in parentheses reflect additional income, in millions):
| 25 Basis Point Increase |
25 Basis Point Decrease |
|||||||
| Discount rate |
$ | (1.1 | ) | $ | 1.1 | |||
| Compensation level |
$ | 0.1 | $ | (0.1 | ) | |||
| Expected long-term rate of return on plan assets |
$ | (0.6 | ) | $ | 0.6 | |||
Several factors influence our annual funding requirements. For the U.S. Qualified Plans, our funding policy consists of annual contributions at a rate that provides for future plan benefits and maintains appropriate funded percentages. These contributions are not less than the minimum required by the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), and subsequent pension legislation and is not more than the maximum amount deductible for income tax purposes. Amounts necessary to fund future obligations under these plans could vary depending on estimated assumptions. The effect on operating results in the future of pension plan funding will depend in part on investment performance, funding decisions and employee demographics.
In fiscal 2009, we made cash contributions to the U.S. Qualified Plans aggregating $40.1 million which exceeded the $10.4 million contribution required by ERISA. In fiscal 2008, we made cash contributions to the U.S. Qualified Plans aggregating $15.7 million which exceeded the $15.1 million contribution required by ERISA. Based on current assumptions, our projected funding to the U.S. Qualified Plans will be approximately $26 million in fiscal 2010. However, it is possible that our assumptions may change, actual market performance may vary or we may decide to contribute a different amount.
New Accounting Standards
See “Note 1. Description of Business and Summary of Significant Accounting Policies” of the Notes to Consolidated Financial Statements for a full description of recent accounting pronouncements including the respective expected dates of adoption and expected effects on results of operations and financial condition.
| Item 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
We are exposed to market risk from changes in interest rates, foreign exchange rates and commodity prices. Our objective is to identify and understand these risks and then implement strategies to manage them. When evaluating these strategies, we evaluate the fundamentals of each market, our sensitivity to movements in pricing, and underlying accounting and business implications. To implement these strategies, we periodically enter into various hedging transactions. The sensitivity analyses we present below do not consider the effect of possible adverse changes in the general economy, nor do they consider additional actions we may take to mitigate our exposure to such changes. There can be no assurance that we will manage or continue to manage any risks in the future or that our efforts will be successful.
Derivative Instruments
We enter into a variety of derivative transactions. We use interest rate swap agreements to manage the interest rate characteristics on a portion of our outstanding debt. We evaluate market conditions and our leverage ratio in order to determine our tolerance for potential increases in interest expense that could result from floating interest rates. From time to time we use forward contracts to limit our exposure to fluctuations in non-functional
37
foreign currency rates with respect to our operating units’ receivables. We also use commodity swap agreements to limit our exposure to falling sales prices and rising raw material costs. See “Note 1. Description of Business and Summary of Significant Accounting Policies” and “Note 12. Derivatives” of the Notes to Consolidated Financial Statements.
Interest Rates
We are exposed to changes in interest rates, primarily as a result of our short-term and long-term debt. We use interest rate swap agreements to manage the interest rate characteristics of a portion of our outstanding debt. Based on the amounts and mix of our fixed and floating rate debt at September 30, 2009 and September 30, 2008, if market interest rates increase an average of 100 basis points, after considering the effects of our interest rate swaps in effect, our interest expense would have increased by $2.1 million and $4.0 million, respectively. We determined these amounts by considering the impact of the hypothetical interest rates on our borrowing costs and interest rate swap agreements. These analyses do not consider the effects of changes in the level of overall economic activity that could exist in such an environment.
Market Risks Impacting Pension Plans
Our pension plans are influenced by trends in the financial markets and the regulatory environment. Adverse general stock market trends and falling interest rates increase plan costs and liabilities. During fiscal 2009 and 2008, the effect of a 0.25% change in the discount rate would have impacted income from continuing operations before income taxes by approximately $1.1 million in fiscal 2009 and $1.3 million in fiscal 2008.
Foreign Currency
We are exposed to changes in foreign currency rates with respect to our foreign currency denominated operating revenues and expenses. Our principal foreign exchange exposure is the Canadian dollar. The Canadian dollar is the functional currency of our Canadian operations.
We have transaction gains or losses that result from changes in our operating units’ non-functional currency. For example, we have non-functional currency exposure at our Canadian operations because they have purchases and sales denominated in U.S. dollars. We record these gains or losses in foreign exchange gains and losses in the income statement. From time to time, we enter into currency forward or option contracts to mitigate a portion of our foreign currency transaction exposure. To mitigate potential foreign currency transaction losses, we may use offsetting internal exposures or forward contracts.
We also have translation gains or losses that result from translation of the results of operations of an operating unit’s foreign functional currency into U.S. dollars for consolidated financial statement purposes. Translated earnings were $2.8 million lower in fiscal 2009 than if we had translated the same earnings using fiscal 2008 exchange rates. Translated earnings were $1.2 million higher in fiscal 2008 than if we had translated the same earnings using fiscal 2007 exchange rates.
During fiscal 2009 and 2008, the effect of a 1% change in exchange rates would have impacted accumulated other comprehensive income by approximately $1.8 million and $1.7 million, respectively.
Commodities
Recycled Fiber
The principal raw material we use in the production of recycled paperboard and containerboard is recycled fiber. Our purchases of old corrugated containers (“OCC”) and double-lined kraft clippings account for our largest fiber costs and approximately 74% of our fiscal 2009 fiber purchases. The remaining 26% of our fiber purchases consists of a number of other grades of recycled paper.
38
Including purchases made by our Solvay mill for the seven months we owned it in fiscal 2008, a hypothetical 10% increase in total fiber prices, would have increased our costs by $13 million and $20 million in fiscal 2009 and 2008, respectively. In times of higher fiber prices, we may have the ability to pass a portion of the increased costs on to our customers in the form of higher finished product pricing; however, there can be no assurance that we will be able to do so.
Virgin Fiber
The principal raw material we use in the production of bleached paperboard and market pulp is virgin fiber. A hypothetical 10% increase in virgin fiber prices, would have increased our costs by $6 million in each of fiscal 2009 and 2008, respectively. In times of higher virgin fiber prices, we may have the ability to pass a portion of the increased costs on to our customers in the form of higher finished product pricing; however, there can be no assurance that we will be able to do so.
Solid Bleached Sulphate
We purchase solid bleached sulphate (“SBS”) from external sources to use in our folding carton converting business. A hypothetical 10% increase in SBS prices throughout each year would have increased our costs by approximately $11 million during fiscal 2009 and by approximately $13 million during fiscal 2008. In times of higher SBS prices, we may have the ability to pass a portion of our increased costs on to our customers in the form of higher finished product pricing; however, there can be no assurance that we will be able to do so.
Coated Unbleached Kraft
We purchase Coated Unbleached Kraft (“CUK”) from external sources to use in our folding carton converting business. A hypothetical 10% increase in CUK prices throughout each year would have increased our costs by approximately $9 million during fiscal 2009 and by approximately $10 million during fiscal 2008. In times of higher CUK prices, we may have the ability to pass a portion of our increased costs on to our customers in the form of higher finished product pricing; however, there can be no assurance that we will be able to do so.
Linerboard/Corrugated Medium
In fiscal 2009, we converted approximately 700,000 tons of corrugated medium and linerboard in our corrugated box converting operations into corrugated sheet stock. A hypothetical 10% increase in linerboard and corrugated medium costs throughout each year, including purchases made by the operations acquired in the Southern Container Acquisition for the seven months we owned them in fiscal 2008, would have resulted in increased costs of approximately $39 million and $29 million during fiscal 2009 and 2008, respectively. We may have the ability to pass a portion of our increased costs on to our customers in the form of higher finished product pricing; however, there can be no assurance that we will be able to do so.
Energy
Energy is one of the most significant manufacturing costs of our mill operations. We use natural gas, electricity, fuel oil and coal to generate steam used in the paper making process and to operate our recycled paperboard machines and we use primarily electricity for our converting equipment. Our bleached paperboard mill uses wood by-products for most of its energy. We generally purchase these products from suppliers at market rates. Occasionally, we enter into long-term agreements to purchase natural gas.
We spent approximately $147 million on all energy sources in fiscal 2009. Natural gas and fuel oil accounted for approximately 34% (8.5 million MMBtu, which is lower than fiscal 2008 due primarily to decreased mill volumes) of our total energy purchases in fiscal 2009. Our Solvay mill purchases its process steam
39
under a long-term contract with an adjacent coal fired power plant — with steam pricing based primarily on coal prices. The mill’s electric energy supply is low priced due to the availability of hydro-based electric power. A hypothetical 10% increase in the price of energy throughout the year would have increased our cost of energy by $15 million.
We spent approximately $172 million on all energy sources in fiscal 2008. Natural gas and fuel oil accounted for approximately 48% (9.0 million MMBtu) of our total energy purchases in fiscal 2008. Excluding fixed price natural gas forward contracts, a hypothetical 10% increase in the price of energy throughout the year would have increased our cost of energy by $17 million.
We may have the ability to pass a portion of our increased costs on to our customers in the form of higher finished product pricing; however, there can be no assurance that we will be able to do so.
40
| Item 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
Index to Financial Statements
| Description |
||
| Page 42 | ||
| Page 43 | ||
| Page 44 | ||
| Page 45 | ||
| Page 47 | ||
| Page 101 | ||
| Report of Independent Registered Public Accounting Firm On Internal Control over Financial Reporting |
Page 102 | |
| Management’s Annual Report on Internal Control Over Financial Reporting |
Page 103 |
For supplemental quarterly financial information, please see “Note 22. Financial Results by Quarter (Unaudited)” of the Notes to Consolidated Financial Statements.
41
CONSOLIDATED STATEMENTS OF INCOME
| Year Ended September 30, | ||||||||||||
| 2009 | 2008 | 2007 | ||||||||||
| (In millions, except per share data) | ||||||||||||
| Net sales |
$ | 2,812.3 | $ | 2,838.9 | $ | 2,315.8 | ||||||
| Cost of goods sold (net of alternative fuel tax credit of $54.1, $0 and $0) |
2,049.6 | 2,296.8 | 1,870.2 | |||||||||
| Gross profit |
762.7 | 542.1 | 445.6 | |||||||||
| Selling, general and administrative expenses |
330.8 | 310.5 | 259.1 | |||||||||
| Restructuring and other costs, net |
13.4 | 15.6 | 4.7 | |||||||||
| Operating profit |
418.5 | 216.0 | 181.8 | |||||||||
| Interest expense |
(96.7 | ) | (86.7 | ) | (49.8 | ) | ||||||
| Loss on extinguishment of debt and related items |
(4.4 | ) | (1.9 | ) | — | |||||||
| Interest income and other income (expense), net |
— | 1.6 | (1.3 | ) | ||||||||
| Equity in income of unconsolidated entities |
0.1 | 2.4 | 1.1 | |||||||||
| Minority interest in income of consolidated subsidiaries |
(3.6 | ) | (5.3 | ) | (4.8 | ) | ||||||
| Income before income taxes |
313.9 | 126.1 | 127.0 | |||||||||
| Income tax expense |
(91.6 | ) | (44.3 | ) | (45.3 | ) | ||||||
| Net income |
$ | 222.3 | $ | 81.8 | $ | 81.7 | ||||||
| Basic earnings per share |
$ | 5.87 | $ | 2.19 | $ | 2.12 | ||||||
| Diluted earnings per share |
$ | 5.75 | $ | 2.14 | $ | 2.07 | ||||||
See accompanying notes.
42
CONSOLIDATED BALANCE SHEETS
| September 30, | ||||||||
| 2009 | 2008 | |||||||
| (In millions, except share and per share data) |
||||||||
| ASSETS |
||||||||
| Current assets: |
||||||||
| Cash and cash equivalents |
$ | 11.8 | $ | 52.8 | ||||
| Restricted cash and marketable debt securities |
— | 19.2 | ||||||
| Accounts receivable (net of allowances of $8.8 and $9.0) |
305.5 | 304.3 | ||||||
| Inventories |
275.1 | 283.0 | ||||||
| Other current assets |
65.0 | 49.2 | ||||||
| Assets held for sale |
0.9 | 0.7 | ||||||
| Total current assets |
658.3 | 709.2 | ||||||
| Property, plant and equipment at cost: |
||||||||
| Land and buildings |
413.8 | 398.3 | ||||||
| Machinery and equipment |
1,857.1 | 1,826.2 | ||||||
| Transportation equipment |
13.5 | 15.2 | ||||||
| Leasehold improvements |
5.4 | 7.6 | ||||||
| 2,289.8 | 2,247.3 | |||||||
| Less accumulated depreciation and amortization |
(1,013.7 | ) | (914.2 | ) | ||||
| Net property, plant and equipment |
1,276.1 | 1,333.1 | ||||||
| Goodwill |
736.4 | 727.0 | ||||||
| Intangibles, net |
151.3 | 176.9 | ||||||
| Investment in unconsolidated entities |
23.8 | 29.4 | ||||||
| Other assets |
38.5 | 37.5 | ||||||
| $ | 2,884.4 | $ | 3,013.1 | |||||
| LIABILITIES AND SHAREHOLDERS’ EQUITY |
||||||||
| Current liabilities: |
||||||||
| Current portion of debt |
$ | 56.3 | $ | 245.1 | ||||
| Accounts payable |
233.9 | 241.5 | ||||||
| Accrued compensation and benefits |
88.0 | 95.2 | ||||||
| Other current liabilities |
71.1 | 65.9 | ||||||
| Total current liabilities |
449.3 | 647.7 | ||||||
| Long-term debt due after one year |
1,289.3 | 1,447.2 | ||||||
| Hedge adjustments resulting from terminated fair value interest rate derivatives or swaps |
3.8 | 6.6 | ||||||
| Total long-term debt |
1,293.1 | 1,453.8 | ||||||
| Accrued pension and other long-term benefits |
161.5 | 70.8 | ||||||
| Deferred income taxes |
149.2 | 153.3 | ||||||
| Other long-term liabilities |
36.7 | 29.4 | ||||||
| Commitments and contingencies (Notes 14 and 20) |
||||||||
| Minority interest |
17.8 | 17.6 | ||||||
| Shareholders’ equity: |
||||||||
| Preferred stock, $0.01 par value; 50,000,000 shares authorized; no shares outstanding |
— | — | ||||||
| Class A common stock, $0.01 par value; 175,000,000 shares authorized; 38,707,695 and 38,228,523 shares outstanding at September 30, 2009 and September 30, 2008, respectively |
0.4 | 0.4 | ||||||
| Capital in excess of par value |
264.5 | 238.8 | ||||||
| Retained earnings |
620.3 | 421.7 | ||||||
| Accumulated other comprehensive loss |
(108.4 | ) | (20.4 | ) | ||||
| Total shareholders’ equity |
776.8 | 640.5 | ||||||
| $ | 2,884.4 | $ | 3,013.1 | |||||
See accompanying notes.
43
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
| Year Ended September 30, | ||||||||||||
| 2009 | 2008 | 2007 | ||||||||||
| (In millions, except share and per share data) | ||||||||||||
| Number of Class A Common Shares Outstanding: |
||||||||||||
| Balance at beginning of year |
38,228,523 | 37,988,779 | 37,688,522 | |||||||||
| Shares granted under restricted stock plan |
194,885 | 25,000 | 165,497 | |||||||||
| Restricted stock grants forfeited |
(26,499 | ) | (59,499 | ) | — | |||||||
| Issuance of Class A common stock, net of stock received for minimum tax withholdings |
310,786 | 274,243 | 2,278,460 | |||||||||
| Purchases of Class A common stock |
— | — | (2,143,700 | ) | ||||||||
| Balance at end of year |
38,707,695 | 38,228,523 | 37,988,779 | |||||||||
| Class A Common Stock: |
||||||||||||
| Balance at beginning of year |
$ | 0.4 | $ | 0.4 | $ | 0.4 | ||||||
| Balance at end of year |
0.4 | 0.4 | 0.4 | |||||||||
| Capital in Excess of Par Value: |
||||||||||||
| Balance at beginning of year |
238.8 | 222.6 | 179.6 | |||||||||
| Income tax benefit from share-based plans |
5.5 | 1.8 | 14.1 | |||||||||
| Compensation expense under share-based plans |
11.9 | 9.2 | 7.3 | |||||||||
| Issuance of Class A common stock, net of stock received for minimum tax withholdings |
8.3 | 5.2 | 33.6 | |||||||||
| Purchases of Class A common stock |
— | — | (12.0 | ) | ||||||||
| Balance at end of year |
264.5 | 238.8 | 222.6 | |||||||||
| Retained Earnings: |
||||||||||||
| Balance at beginning of year |
421.7 | 357.8 | 341.2 | |||||||||
| Net income |
222.3 | 81.8 | 81.7 | |||||||||
| Impact of adopting certain provisions of ASC 740 (as hereinafter defined) |
— | (1.8 | ) | — | ||||||||
| Cash dividends (per share — $0.40, $0.40 and $0.39) |
(15.3 | ) | (15.2 | ) | (15.4 | ) | ||||||
| Issuance of Class A common stock, net of stock received for minimum tax withholdings |
(8.4 | ) | (0.9 | ) | (3.0 | ) | ||||||
| Purchases of Class A common stock |
— | — | (46.7 | ) | ||||||||
| Balance at end of year |
620.3 | 421.7 | 357.8 | |||||||||
| Accumulated Other Comprehensive (Loss) Income: |
||||||||||||
| Balance at beginning of year |
(20.4 | ) | 8.2 | (12.6 | ) | |||||||
| Foreign currency translation (loss) gain |
(2.1 | ) | (12.0 | ) | 14.0 | |||||||
| Net deferred (loss) gain on cash flow hedge derivatives |
(16.7 | ) | 1.9 | (0.4 | ) | |||||||
| Reclassification adjustment of net loss (gain) on cash flow hedge derivatives included in earnings |
5.2 | 0.6 | (2.5 | ) | ||||||||
| Pension liability adjustments, prior to adoption of certain provisions of ASC 715 (as hereinafter defined) |
— | — | 24.0 | |||||||||
| Net actuarial loss arising during period |
(78.6 | ) | (21.2 | ) | — | |||||||
| Amortization of net actuarial loss |
4.5 | 2.0 | — | |||||||||
| Prior service cost arising during period |
(1.0 | ) | (0.1 | ) | — | |||||||
| Amortization of prior service cost |
0.7 | 0.2 | — | |||||||||
| Net other comprehensive (loss) income adjustments, net of tax |
(88.0 | ) | (28.6 | ) | 35.1 | |||||||
| Impact of adopting certain provisions of ASC 715 (as hereinafter defined) |
— | — | (14.3 | ) | ||||||||
| Balance at end of year |
(108.4 | ) | (20.4 | ) | 8.2 | |||||||
| Total Shareholders’ Equity |
$ | 776.8 | $ | 640.5 | $ | 589.0 | ||||||
| Comprehensive Income: |
||||||||||||
| Net income |
$ | 222.3 | $ | 81.8 | $ | 81.7 | ||||||
| Net other comprehensive (loss) income adjustments, net of tax |
(88.0 | ) | (28.6 | ) | 35.1 | |||||||
| Total comprehensive income |
$ | 134.3 | $ | 53.2 | $ | 116.8 | ||||||
See accompanying notes.
44
CONSOLIDATED STATEMENTS OF CASH FLOWS
| Year Ended September 30, | ||||||||||||
| 2009 | 2008 | 2007 | ||||||||||
| (In millions) | ||||||||||||
| Operating activities: |
||||||||||||
| Net income |
$ | 222.3 | $ | 81.8 | $ | 81.7 | ||||||
| Adjustments to reconcile net income to net cash provided by operating activities: |
||||||||||||
| Depreciation and amortization |
150.0 | 133.4 | 103.7 | |||||||||
| Deferred income tax expense |
46.0 | 22.8 | 22.2 | |||||||||
| Share-based compensation expense |
11.9 | 9.2 | 7.3 | |||||||||
| Loss on extinguishment of debt and related items |
4.4 | 1.9 | — | |||||||||
| (Gain) loss on disposal of plant and equipment and other, net |
2.8 | (0.4 | ) | 0.9 | ||||||||
| Minority interest in income of consolidated subsidiaries |
3.6 | 5.3 | 4.8 | |||||||||
| Equity in income of unconsolidated entities |
(0.1 | ) | (2.4 | ) | (1.1 | ) | ||||||
| Proceeds from (payment on) termination of cash flow interest rate hedges |
— | 6.9 | (0.7 | ) | ||||||||
| Pension funding more than expense |
(23.1 | ) | (7.1 | ) | (7.5 | ) | ||||||
| Alternative fuel tax credit benefit |
(55.4 | ) | — | — | ||||||||
| Impairment adjustments and other non-cash items |
3.1 | 2.8 | 2.0 | |||||||||
| Change in operating assets and liabilities, net of acquisitions: |
||||||||||||
| Accounts receivable |
(0.3 | ) | (25.3 | ) | 3.4 | |||||||
| Inventories |
8.0 | 2.2 | (2.6 | ) | ||||||||
| Other assets |
(12.1 | ) | 1.1 | 3.0 | ||||||||
| Accounts payable |
(6.4 | ) | 32.8 | 18.7 | ||||||||
| Income taxes |
45.4 | (12.5 | ) | (4.3 | ) | |||||||
| Accrued liabilities and other |
(10.4 | ) | (11.6 | ) | 6.8 | |||||||
| Net cash provided by operating activities |
389.7 | 240.9 | 238.3 | |||||||||
| Investing activities: |
||||||||||||
| Capital expenditures |
(75.9 | ) | (84.2 | ) | (78.0 | ) | ||||||
| Cash paid for the purchase of a leased facility |
(8.1 | ) | — | — | ||||||||
| Cash paid for purchase of businesses, including amounts received from (paid into) escrow, net of cash received |
4.0 | (817.9 | ) | (32.1 | ) | |||||||
| Investment in unconsolidated entities |
(1.0 | ) | (0.3 | ) | (9.6 | ) | ||||||
| Return of capital from unconsolidated entities |
4.1 | 0.8 | 6.5 | |||||||||
| Proceeds from sale of property, plant and equipment |
1.4 | 6.4 | 2.8 | |||||||||
| Proceeds from property, plant and equipment insurance settlement |
0.1 | — | 1.3 | |||||||||
| Net cash used for investing activities |
(75.4 | ) | (895.2 | ) | (109.1 | ) | ||||||
| Financing activities: |
||||||||||||
| Proceeds from issuance of notes |
100.0 | 198.6 | — | |||||||||
| Additions to revolving credit facilities |
230.8 | 206.0 | 68.1 | |||||||||
| Repayments of revolving credit facilities |
(244.6 | ) | (238.7 | ) | (91.9 | ) | ||||||
| Additions to debt |
119.6 | 764.0 | 22.1 | |||||||||
| Repayments of debt |
(552.1 | ) | (192.2 | ) | (85.1 | ) | ||||||
| Debt issuance costs |
(4.4 | ) | (27.1 | ) | — | |||||||
| Cash paid for debt extinguishment costs |
(5.2 | ) | — | — | ||||||||
| Restricted cash and investments |
19.2 | (0.4 | ) | — | ||||||||
| Issuances of common stock, net of related minimum tax withholdings |
(0.1 | ) | 4.3 | 31.5 | ||||||||
| Purchases of common stock |
— | — | (58.7 | ) | ||||||||
| Excess tax benefits from share-based compensation |
5.5 | 1.8 | 14.1 | |||||||||
| Capital contributed to consolidated subsidiary from minority interest |
1.7 | — | — | |||||||||
| (Repayments to) advances from unconsolidated entity |
(7.0 | ) | 0.7 | (5.4 | ) | |||||||
| Cash dividends paid to shareholders |
(15.3 | ) | (15.2 | ) | (15.4 | ) | ||||||
| Cash distributions paid to minority interest |
(4.8 | ) | (5.3 | ) | (4.2 | ) | ||||||
| Net cash (used for) provided by financing activities |
(356.7 | ) | 696.5 | (124.9 | ) | |||||||
| Effect of exchange rate changes on cash and cash equivalents |
1.4 | (0.3 | ) | (0.3 | ) | |||||||
| (Decrease) increase in cash and cash equivalents |
(41.0 | ) | 41.9 | 4.0 | ||||||||
| Cash and cash equivalents at beginning of year |
52.8 | 10.9 | 6.9 | |||||||||
| Cash and cash equivalents at end of year |
$ | 11.8 | $ | 52.8 | $ | 10.9 | ||||||
45
ROCK-TENN COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS — (Continued)
Supplemental disclosure of cash flow information:
| Year Ended September 30, | ||||||||||
| 2009 | 2008 | 2007 | ||||||||
| (In millions) | ||||||||||
| Cash paid during the period for: |
||||||||||
| Income taxes, net of refunds |
$ | (3.9 | ) | $ | 31.4 | $ | 13.1 | |||
| Interest, net of amounts capitalized |
104.9 | 82.5 | 54.4 | |||||||
Supplemental schedule of non-cash investing and financing activities:
The fiscal 2007 line item “Issuance of Class A common stock net of stock received for minimum tax withholdings” in our consolidated statements of shareholders’ equity differs from the fiscal 2007 line item “Issuances of common stock, net of related minimum tax withholdings” in our consolidated statements of cash flows due to $0.9 million of receivables from the sale of stock being outstanding from employees at September 30, 2006. These receivables were collected in fiscal 2007.
Liabilities assumed in the table below primarily reflect the March 5, 2008 acquisition of Southern Container Corp. (“Southern Container” and “Southern Container Acquisition”) and reflects the final purchase price allocation completed during fiscal 2009. In conjunction with the Southern Container Acquisition, we also assumed debt.
| Year Ended September 30, | |||
| 2008 | |||
| (In millions) | |||
| Fair value of assets acquired, including goodwill |
$ | 1,188.2 | |
| Cash paid, net of cash received |
817.9 | ||
| Liabilities assumed |
$ | 370.3 | |
| Included in liabilities assumed are the following items: |
|||
| Debt assumed in acquisition |
$ | 132.4 | |
| Cash payable to sellers in connection with the acquisition |
110.7 | ||
| Total debt assumed |
$ | 243.1 | |
For additional information on the Southern Container Acquisition and financing see “Note 7. Acquisitions” and “Note 11. Debt”.
In fiscal 2007, we contributed $3.9 million of assets to our unconsolidated Display Source Alliance, LLC joint venture. The assets consisted primarily of equipment and inventory.
See accompanying notes.
46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Description of Business and Summary of Significant Accounting Policies
Description of Business
Unless the context otherwise requires, “we”, “us”, “our”, “RockTenn” and “the Company” refer to the business of Rock-Tenn Company, its wholly-owned subsidiaries and its partially-owned consolidated subsidiaries, including RTS Packaging, LLC (“RTS”), GraphCorr LLC, Schiffenhaus Canada, Inc. and Schiffenhaus California, LLC. We own 65% of RTS and conduct our interior packaging products business through RTS. Following the Southern Container Acquisition in March 2008, we own 68% of GraphCorr LLC, 66.67% of Schiffenhaus Canada, Inc. and 50% of Schiffenhaus California, LLC, through which we conduct some of our graphics corrugated manufacturing operations. Our references to the business of Rock-Tenn Company do not include the following entities that we do not consolidate but account for on the equity method of accounting: Seven Hills Paperboard, LLC (“Seven Hills”), Quality Packaging Specialists International, LLC (“QPSI”), Display Source Alliance, LLC (“DSA”), Pohlig Brothers, LLC (“Pohlig”) and Greenpine Road, LLC (“Greenpine”). Pohlig and Greenpine were acquired in the Southern Container Acquisition. We own 49% of Seven Hills, a manufacturer of gypsum paperboard liner, 23.96% of QPSI, a business providing merchandising displays, contract packing, logistics and distribution solutions, 45% of DSA, a business providing primarily permanent merchandising displays, 50% of Pohlig, a small folding carton manufacturer, and 50% of Greenpine, which owns the real property from which Pohlig operates.
We are primarily a manufacturer of packaging products, recycled paperboard, containerboard, bleached paperboard and merchandising displays.
Consolidation
The consolidated financial statements include our accounts and the accounts of our partially-owned consolidated subsidiaries. Equity investments in which we exercise significant influence but do not control and are not the primary beneficiary are accounted for using the equity method. Investments in which we are not able to exercise significant influence over the investee are accounted for under the cost method. We have eliminated all significant intercompany accounts and transactions.
We have determined that Seven Hills, DSA, Pohlig and Greenpine are variable interest entities as defined in the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”) 810, “Consolidation.” We are not, however, the primary beneficiary of each of these entities. Accordingly, we use the equity method to account for our investment in Seven Hills, DSA, Pohlig and Greenpine. We have accounted for our investment in QPSI under the equity method.
Use of Estimates
Preparing consolidated financial statements in conformity with generally accepted accounting principles in the United States (“GAAP”) requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates, and the differences could be material.
The most significant accounting estimates inherent in the preparation of our consolidated financial statements include estimates to evaluate the recoverability of goodwill, intangibles and property, plant and equipment, to determine the useful lives of assets that are amortized or depreciated, and to measure income taxes, self-insured obligations, restructuring activities and allocate the purchase price of acquired business to the fair
47
ROCK-TENN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
value of acquired assets and liabilities. In addition, significant estimates form the basis for our reserves with respect to collectibility of accounts receivable, inventory valuations, pension benefits, and certain benefits provided to current employees. Various assumptions and other factors underlie the determination of these significant estimates. The process of determining significant estimates is fact specific and takes into account factors such as historical experience, current and expected economic conditions, product mix, and in some cases, actuarial techniques. We regularly re-evaluate these significant factors and make adjustments where facts and circumstances dictate.
Revenue Recognition
We recognize revenue when there is persuasive evidence that an arrangement exists, delivery has occurred or services have been rendered, our price to the buyer is fixed or determinable and collectibility is reasonably assured. Delivery is not considered to have occurred until the customer takes title and assumes the risks and rewards of ownership. The timing of revenue recognition is dependent on the location of title transfer which is normally either on the exit from our plants (i.e., shipping point) or on arrival at customers’ plants (i.e., destination point). We do not recognize revenue from transactions where we bill customers but retain custody and title to these products until the date of custody and title transfer.
We net, against our gross sales, provisions for discounts, returns, allowances, customer rebates and other adjustments. We account for such provisions during the same period in which we record the related revenues. We include in net sales any amounts related to shipping and handling that are billed to a customer.
Shipping and Handling Costs
We classify shipping and handling costs as a component of cost of goods sold.
Derivatives
We are exposed to interest rate risk, commodity price risk, and foreign currency exchange risk. To manage these risks, from time-to-time and to varying degrees, we enter into a variety of financial derivative transactions and certain physical commodity transactions that are determined to be derivatives. Interest rate swaps may be entered into in order to manage the interest rate risk associated with a portion of our outstanding debt. Interest rate swaps are either designated as cash flow hedges of floating rate debt or fair value hedges of fixed rate debt, or we may elect not to treat them as accounting hedges. Forward contracts on certain commodities may be entered into to manage the price risk associated with forecasted purchases of those commodities. In addition, certain commodity derivative contracts and physical commodity contracts that are determined to be derivatives are not designated as accounting hedges because either they do not meet the criteria for treatment as accounting hedges under ASC 815, “Derivatives and Hedging”, or we elect not to treat them as hedges under ASC 815. We may also enter into forward contracts to manage our exposure to fluctuations in Canadian foreign currency rates with respect to our receivables denominated in Canadian dollars.
Outstanding financial derivative instruments expose us to credit loss in the event of nonperformance by the counterparties to the agreements. However, we do not expect any of the counterparties to fail to meet their obligations. Our credit exposure related to these financial instruments is represented by the fair value of contracts reported as assets. We manage our exposure to counterparty credit risk through minimum credit standards, diversification of counterparties and procedures to monitor concentrations of credit risk.
For derivative instruments that are designated as a cash flow hedge, the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income and reclassified into
48
ROCK-TENN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
earnings in the same line item associated with the forecasted hedged transaction, and in the same period or periods during which the forecasted hedged transaction affects earnings. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings.
For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative instrument as well as the offsetting loss or gain on the hedged item attributable to the hedged risk are recognized in the same line item associated with the hedged item in current earnings. We amortize the adjustment to the carrying value of our fixed rate debt instruments that arose from previously terminated fair value hedges to interest expense using the effective interest method over the remaining life of the related debt.
For derivative instruments not designated as accounting hedges, the gain or loss is recognized in current earnings.
Cash Equivalents
We consider all highly liquid investments that mature three months or less from the date of purchase to be cash equivalents. The carrying amounts we report in the consolidated balance sheets for cash and cash equivalents approximate fair market values. We place our cash and cash equivalents with large credit worthy banks, which limits the amount of our credit exposure.
Restricted Cash and Marketable Debt Securities
As part of the Southern Container Acquisition we received restricted cash and marketable debt securities. At September 30, 2008, restricted cash and marketable debt securities were classified in the balance sheet in current assets because they were to be used within a year for payment of existing or maturing obligations. We classified these marketable debt securities as available-for-sale. We carried these securities at fair market value based on current market quotes. There was no significant unrealized gain or loss in fiscal 2009 or 2008. The restricted cash and securities were liquidated in November 2008 at amounts that approximated carrying value as of September 30, 2008.
Accounts Receivable and Allowances
We perform periodic evaluations of our customers’ financial condition and generally do not require collateral. Receivables generally are due within 30 to 45 days. We serve a diverse customer base primarily in North America and, therefore, have limited exposure from credit loss to any particular customer or industry segment.
We state accounts receivable at the amount owed by the customer, net of an allowance for estimated uncollectible accounts, returns and allowances, cash discounts and other adjustments. We do not discount accounts receivable because we generally collect accounts receivable over a relatively short time. We account for sales and other taxes that are imposed on and concurrent with individual revenue-producing transactions between a customer and us on a net basis which excludes the taxes from our net sales. We estimate our allowance for doubtful accounts based on our historical experience, current economic conditions and the credit worthiness of our customers. We charge off receivables when they are determined to be no longer collectible. In fiscal 2009, 2008, and 2007, we recorded bad debt expense of $2.6 million, $3.1 million, and $1.0 million, respectively.
49
ROCK-TENN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The following table represents a summary of the changes in the reserve for allowance for doubtful accounts, returns and allowances and cash discounts for fiscal 2009, 2008, and 2007 (in millions):
| 2009 | 2008 | 2007 | ||||||||||
| Balance at the beginning of period |
$ | 9.0 | $ | 5.4 | $ | 5.2 | ||||||
| Reduction in sales and charges to costs and expenses |
39.2 | 35.9 | 22.6 | |||||||||
| Southern Container opening balance |
— | 4.7 | — | |||||||||
| Deductions |
(39.4 | ) | (37.0 | ) | (22.4 | ) | ||||||
| Balance at the end of period |
$ | 8.8 | $ | 9.0 | $ | 5.4 | ||||||
Inventories
We value substantially all U.S. inventories at the lower of cost or market, with cost determined on the last-in, first-out (“LIFO”) basis. We value all other inventories at lower of cost or market, with cost determined using methods that approximate cost computed on a first-in, first-out (“FIFO”) basis. These other inventories represent primarily foreign inventories and spare parts inventories and aggregate approximately 24.7% and 23.3% of FIFO cost of all inventory at September 30, 2009 and 2008, respectively.
Prior to the application of the LIFO method, our U.S. operating divisions use a variety of methods to estimate the FIFO cost of their finished goods inventories. Such methods include a standard cost system, or average costs computed by dividing the actual cost of goods manufactured by the tons produced and multiplying this amount by the tons of inventory on hand. Lastly, certain operations calculate a ratio, on a plant by plant basis, the numerator of which is the cost of goods sold and the denominator is net sales. This ratio is applied to the estimated sales value of the finished goods inventory. Variances and other unusual items are analyzed to determine whether it is appropriate to include those items in the value of inventory. Examples of variances and unusual items that are considered to be current period charges include, but are not limited to, abnormal production levels, freight, handling costs, and wasted materials (spoilage). Cost includes raw materials and supplies, direct labor, indirect labor related to the manufacturing process and depreciation and other factory overheads.
Property, Plant and Equipment
We state property, plant and equipment at cost. Cost includes major expenditures for improvements and replacements that extend useful lives, increase capacity, increase revenues or reduce costs. During fiscal 2009, 2008, and 2007, we capitalized interest of approximately $0.5 million, $0.8 million, and $0.8 million, respectively. For financial reporting purposes, we provide depreciation and amortization primarily on a straight-line method over the estimated useful lives of the assets as follows:
| Buildings and building improvements |
15-40 years | |
| Machinery and equipment |
3-44 years | |
| Transportation equipment |
3-8 years |
Generally our machinery and equipment have estimated useful lives between 3 and 20 years; however, select portions of machinery and equipment at our mills have estimated useful lives up to 44 years. Leasehold improvements are depreciated over the shorter of the asset life or the lease term, generally between 3 and 10 years. Depreciation expense for fiscal 2009, 2008, and 2007 was approximately $130.6 million, $118.9 million, and $96.6 million, respectively.
50
ROCK-TENN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Goodwill and Long-Lived Assets
We review the recorded value of our goodwill annually at the beginning of the fourth quarter of each fiscal year, or more often if events or changes in circumstances indicate that the carrying amount may exceed fair value as set forth in ASC 350, “Intangibles — Goodwill and Other”. We test goodwill for impairment at the reporting unit level, which is an operating segment or one level below an operating segment, which is referred to as a component. A component of an operating segment is a reporting unit if the component constitutes a business for which discrete financial information is available and segment management regularly reviews the operating results of that component. However, two or more components of an operating segment are aggregated and deemed a single reporting unit if the components have similar economic characteristics. The amount of goodwill acquired in a business combination that is assigned to one or more reporting units as of the acquisition date is the excess of the purchase price of the acquired businesses (or portion thereof) included in the reporting unit, over the fair value assigned to the individual assets acquired or liabilities assumed. Goodwill is assigned to the reporting unit(s) expected to benefit from the synergies of the combination even though other assets or liabilities of the acquired entity may not be assigned to that reporting unit. We determine recoverability by comparing the estimated fair value of the reporting unit to which the goodwill applies to the carrying value, including goodwill, of that reporting unit using a discounted cash flow model.
The goodwill impairment model is a two-step process. In step one, we utilize the present value of expected net cash flows to determine the estimated fair value of our reporting units. This present value model requires management to estimate future net cash flows, the timing of these cash flows, and a discount rate (based on a weighted average cost of capital), which represents the time value of money and the inherent risk and uncertainty of the future cash flows. Factors that management must estimate when performing this step in the process include, among other items, sales volume, prices, inflation, discount rates, exchange rates, tax rates and capital spending. The assumptions we use to estimate future cash flows are consistent with the assumptions that the reporting units use for internal planning purposes, updated to reflect current expectations. If we determine that the estimated fair value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is not impaired. If we determine that the carrying amount of the reporting unit exceeds its estimated fair value, we must complete step two of the impairment analysis. Step two involves determining the implied fair value of the reporting unit’s goodwill and comparing it to the carrying amount of that goodwill. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, we recognize an impairment loss in an amount equal to that excess. We completed the annual test of the goodwill associated with each of our reporting units during fiscal 2009 and concluded the fair values were in excess of the carrying values of each of the reporting units. No events have occurred since the latest annual goodwill impairment assessment that would necessitate an interim goodwill impairment assessment.
We follow provisions included in ASC 360, “Property, Plant and Equipment” in determining whether the carrying value of any of our long-lived assets, including amortizing intangibles other than goodwill, is impaired. The ASC 360 test is a three-step test for assets that are “held and used” as that term is defined by ASC 360. First, we determine whether indicators of impairment are present. ASC 360 requires us to review long-lived assets for impairment only when events or changes in circumstances indicate that the carrying amount of the long-lived asset might not be recoverable. Accordingly, while we do routinely assess whether impairment indicators are present, we do not routinely perform tests of recoverability. Second, if we determine that indicators of impairment are present, we determine whether the estimated undiscounted cash flows for the potentially impaired assets are less than the carrying value. This requires management to estimate future net cash flows through operations over the remaining useful life of the asset and its ultimate disposition. The assumptions we use to estimate future cash flows are consistent with the assumptions we use for internal planning purposes, updated to reflect current expectations. Third, if such estimated undiscounted cash flows do not exceed the carrying value,
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ROCK-TENN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
we estimate the fair value of the asset and record an impairment charge if the carrying value is greater than the fair value of the asset. We estimate fair value using discounted cash flows, prices for similar assets, or other valuation techniques. We record assets classified as “held for sale” at the lower of their carrying value or estimated fair value less anticipated cost to sell.
Included in our long-lived assets are certain identifiable intangible assets. These intangible assets are amortized based on the estimated pattern in which the economic benefits are realized over their estimated useful lives ranging generally from 5 to 40 years and have a weighted average life of approximately 20.4 years.
Our judgments regarding the existence of impairment indicators are based on legal factors, market conditions and operational performance. Future events could cause us to conclude that impairment indicators exist and that assets associated with a particular operation are impaired. Evaluating impairment also requires us to estimate future operating results and cash flows, which also require judgment by management. Any resulting impairment loss could have a material adverse impact on our financial condition and results of operations.
Purchase Price Allocations
From time to time, we may enter into material business combinations. In accordance with ASC 805, “Business Combinations”, the purchase price is allocated to the various assets acquired and liabilities assumed at their estimated fair value. Fair values of assets acquired and liabilities assumed are based upon available information and may involve us engaging an independent third party to perform an appraisal of certain tangible and intangible assets. Estimating fair values can be complex and subject to significant business judgment and most commonly impacts property, plant and equipment and intangible assets, including those with indefinite lives. Generally, we have, if necessary, up to one year from the date of acquisition to obtain all of the information that we have arranged to obtain and that is known to be obtainable to finalize the purchase price allocation. Until such time, the purchase price allocation may remain subject to change based on final valuations of assets acquired and liabilities assumed and may be subject to material revision.
Fair Value of Financial Instruments
Financial instruments not recognized at fair value on a recurring or nonrecurring basis include cash and cash equivalents, accounts receivables, certain other current assets, short-term debt, accounts payable, certain other current liabilities and long-term debt. With the exception of long-term debt, the carrying amounts of these financial instruments approximate their fair values due to their short maturities. The fair values of our long-term debt are estimated using quoted market prices or are based on the discounted value of future cash flows. Financial instruments recognized at fair value include mutual fund investments and derivative contracts. We measure the fair value of our mutual fund investments based on quoted prices in active markets. We measure the fair value of our derivative contracts based on the discounted value of future cash flows. We discuss fair values in more detail in “Note 13. Fair Value”.
Health Insurance
We are self-insured for the majority of our group health insurance costs, subject to specific retention levels. We calculate our group health insurance reserve on an undiscounted basis based on estimated reserve rates. We utilize claims lag data provided by our claims administrators to compute the required estimated reserve rate. We calculate our average monthly claims paid using the actual monthly payments during the trailing 12-month period. At that time, we also calculate our required reserve using the reserve rates discussed above. While we believe that our assumptions are appropriate, significant differences in our actual experience or significant changes in our assumptions may materially affect our group health insurance costs.
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ROCK-TENN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Workers’ Compensation
We purchase large risk deductible workers’ compensation policies for the majority of our workers’ compensation liabilities that are subject to various deductibles to limit our exposure. We calculate our workers’ compensation reserves on an undiscounted basis based on estimated actuarially calculated development factors.
Income Taxes
We account for income taxes under the liability method which requires that we recognize deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases. We record a valuation allowance against deferred tax assets when the weight of available evidence indicates it is more likely than not that the deferred tax asset will not be realized at its initially recorded value. See “Note 15. Income Taxes”.
We have elected to treat earnings from certain foreign subsidiaries, from the date we acquired those subsidiaries, as subject to repatriation, and we provide for taxes accordingly. However, we consider all earnings of our other foreign subsidiaries indefinitely reinvested in those respective operations. We have not provided for any incremental United States taxes that would be due upon repatriation of those earnings into the United States. However, in the event of a distribution of those earnings in the form of dividends or otherwise, we may be subject to both United States income taxes, subject to an adjustment for foreign tax credits, and withholding taxes payable to the various foreign countries. Determination of the amount of unrecognized deferred United States income tax liability is not practicable because of the complexities associated with its hypothetical calculation.
Pension and Other Post-Retirement Benefits
We account for pensions in accordance with ASC 715, “Compensation — Retirement Benefits”. Accordingly, we recognize the funded status of our pension plans as assets or liabilities in our consolidated balance sheets. The funded status is the difference between our projected benefit obligations and fair value of plan assets. The determination of our obligation and expense for pension and other post-retirement benefits is dependent on our selection of certain assumptions used by actuaries in calculating such amounts. We describe these assumptions in “Note 16. Retirement Plans,” which include, among others, the discount rate, expected long-term rate of return on plan assets and rates of increase in compensation levels. As provided under ASC 715, we defer actual results that differ from our assumptions and amortize the difference over future periods. Therefore, these differences generally affect our recognized expense and funding requirements in future periods. While we believe that our assumptions are appropriate, significant differences in our actual experience or significant changes in our assumptions may materially affect our pension and other post-retirement benefit obligations and our future expense.
Stock Based Compensation
We account for stock based compensation in accordance with ASC 718, “Compensation — Stock Compensation”. Pursuant to our 2004 Incentive Stock Plan, we can award shares of restricted Common Stock to employees and our board of directors. The grants generally vest over a period of 3 to 5 years depending on the nature of the award, except for non-employee director grants which vest over one year. Our restricted stock grants generally contain market or performance conditions that must be met in conjunction with a service requirement for the shares to vest. We charge compensation under the plan to earnings over each increment’s individual restriction period. See “Note 17. Shareholders’ Equity” for additional information.
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ROCK-TENN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Asset Retirement Obligations
The Company accounts for asset retirement obligations in accordance with ASC 410, “Asset Retirement and Environmental Obligations”. A liability and an asset are recorded equal to the present value of the estimated costs associated with the retirement of long-lived assets where a legal or contractual obligation exists and the liability can be reasonably estimated. The liability is accreted over time and the asset is depreciated over the remaining life of the related asset. Upon settlement of the liability, we will recognize a gain for any difference between the settlement amount and the liability recorded. Asset retirement obligations with indeterminate settlement dates are not recorded until such time that a reasonable estimate may be made. Asset retirement obligations consist primarily of wastewater lagoon and landfill closure costs at certain of our paperboard mills. The amount accrued is not significant.
Repair and Maintenance Costs
We expense routine repair and maintenance costs as we incur them. We defer expenses we incur during planned major maintenance activities and recognize the expenses ratably over the shorter of the life provided or until replaced by the next major maintenance activity. Our bleached paperboard mill is the only facility that currently conducts planned major maintenance activities. This maintenance is generally performed every twelve to eighteen months and has a significant impact on our results of operations in the period performed.
Foreign Currency
We translate the assets and liabilities of our foreign operations from their functional currency into U.S. dollars at the rate of exchange in effect as of the balance sheet date. We reflect the resulting translation adjustments in shareholders’ equity. We translate the revenues and expenses of our foreign operations at a daily average rate prevailing for each month during the fiscal year. We include gains or losses from foreign currency transactions, such as those resulting from the settlement of foreign receivables or payables, in the consolidated statements of income. We recorded a gain of $0.6 million in fiscal 2009 and 2008 and recorded a loss of $0.9 million in fiscal 2007 from foreign currency transactions.
Environmental Remediation Costs
We accrue for losses associated with our environmental remediation obligations when it is probable that we have incurred a liability and the amount of the loss can be reasonably estimated. We generally recognize accruals for estimated losses from our environmental remediation obligations no later than completion of the remedial feasibility study and adjust such accruals as further information develops or circumstances change. We recognize recoveries of our environmental remediation costs from other parties as assets when we deem their receipt probable.
New Accounting Standards — Recently Adopted
In June 2009, the FASB issued FASB Statement No. 168, “Generally Accepted Accounting Principles” (“SFAS 168”). SFAS 168 establishes the FASB Accounting Standards Codification as the source of authoritative accounting principles recognized by the FASB to be applied by non-governmental entities in the preparation of financial statements in conformity with GAAP in the United States. SFAS 168 is effective for financial statements issued for interim and annual periods ending after September 15, 2009. We have updated our GAAP references accordingly. SFAS 168 was codified in ASC 105, “Generally Accepted Accounting Principles”.
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ROCK-TENN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
In April 2009, the FASB issued certain provisions included in ASC 825, “Financial Instruments”, to require disclosures about fair value of financial instruments in interim financial statements as well as in annual financial statements. These provisions were effective for interim and annual periods ending after June 15, 2009, with early adoption permitted. We began providing the related disclosures starting with our interim financial statements as of June 30, 2009.
In May 2009, the FASB issued ASC 855, “Subsequent Events”. ASC 855 establishes general standards of accounting for and disclosures of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. ASC 855 requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date. ASC 855 is effective for interim and annual periods ending after June 15, 2009. We adopted ASC 855 as of June 30, 2009, and it did not have an impact on our consolidated financial position, results of operations, and cash flows.
In September 2006, the FASB issued ASC 820, “Fair Value Measurements and Disclosures”. ASC 820 defines fair value, establishes a framework for measuring fair value in accordance with GAAP, and expands disclosures about fair value measurements. ASC 820 emphasizes that fair value is a market-based measurement, not an entity-specific measurement. Therefore, a fair value measurement would be determined based on the assumptions that market participants would use in pricing the asset or liability. ASC 820, as issued, was effective for fiscal years beginning after November 15, 2007 (October 1, 2008 for us). In February 2008, the FASB amended certain provisions of ASC 820 to defer for one year the effective date of ASC 820 for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (that is, at least annually). We adopted ASC 820, as amended, as of October 1, 2008, the beginning of our current fiscal year. See “Note 13. Fair Value” to our Consolidated Financial Statements.
In March 2008, the FASB issued certain provisions of ASC 815, “Derivatives and Hedging”. These provisions require entities to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under ASC 815, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. The provisions are effective for fiscal years and interim periods beginning after November 15, 2008. We adopted these provisions on January 1, 2009, and have included the additional disclosures in “Note 12. Derivatives” to our Consolidated Financial Statements. The provisions apply only to financial statement disclosures and, accordingly, had no impact on our consolidated financial position, results of operations, and cash flows.
New Accounting Standards — Recently Issued
In June 2009, the FASB issued SFAS No. 166 “Accounting for Transfers of Financial Assets — an amendment of FASB Statement No. 140” (“SFAS 166”). SFAS 166 requires additional disclosures about the transfer and derecognition of financial assets and eliminates the concept of qualifying special-purpose entities under ASC 860 “Transfers and Servicing”. SFAS 166 is effective for fiscal years beginning after November 15, 2009 (October 1, 2010 for us). We are currently evaluating the effect of adopting SFAS 166 on our consolidated financial statements.
In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretations No. 46(R)” (“SFAS 167”). SFAS 167 revises the approach to determining the primary beneficiary of a variable interest entity (“VIE”) to be more qualitative in nature and requires companies to more frequently reassess whether they must consolidate a VIE. SFAS No. 167 is effective for fiscal years beginning after November 15, 2009 (October 1,
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ROCK-TENN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
2010 for us), for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. We are currently evaluating the effect of adopting SFAS 167 on our consolidated financial statements.
In June 2008, the FASB issued certain provisions of ASC 260, “Earnings Per Share”, which state that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and are to be included in the computation of earnings per share under the two-class method as described in ASC 260. These provisions are effective for fiscal years beginning after December 15, 2008 (October 1, 2009 for us) with early adoption prohibited. These provisions require all presented prior-period earnings per share data to be adjusted. We are currently evaluating the effect the implementation of these new provisions will have on our consolidated financial statements, and we believe the adoption will not materially change the previously reported computed earnings per share.
In December 2007, the FASB issued ASC 805, “Business Combinations”. ASC 805 expands the definition of a business combination and requires the fair value of the purchase price of an acquisition, including the issuance of equity securities, to be determined on the acquisition date. ASC 805 also requires that all assets, liabilities, contingent considerations, and, under certain circumstances, contingencies of an acquired business be recorded at fair value at the acquisition date. In addition, ASC 805 requires that acquisition costs generally be expensed as incurred, restructuring costs generally be expensed in periods subsequent to the acquisition date, and changes in deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period impact income tax expense. ASC 805 is effective for fiscal years beginning after December 15, 2008 (October 1, 2009 for us) with early adoption prohibited. The effect the implementation of ASC 805 will have on our consolidated financial statements will depend upon the facts and circumstances of future acquisitions.
In December 2007, the FASB issued certain provisions of ASC 810, “Consolidation”, which change the accounting and reporting for minority interests such that minority interests generally will be recharacterized as noncontrolling interests and will be required to be reported as a component of equity, requires that purchases or sales of subsidiaries’ equity interests that do not result in a change in control be accounted for as equity transactions and, upon a loss of control, requires the interest sold, as well as any interest retained, to be recorded at fair value with any gain or loss recognized in earnings. These provisions are effective for fiscal years beginning on or after December 15, 2008 (October 1, 2009 for us) with early adoption prohibited. We are currently evaluating the effect the implementation of these provisions will have on our consolidated financial statements.
In February 2008, the FASB amended certain provisions of ASC 820, “Fair Value Measurements and Disclosures” that deferred the effective date of ASC 820 for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (that is, at least annually), until fiscal years beginning after November 15, 2008 (October 1, 2009 for us). We are currently evaluating the effect these provisions will have on our consolidated financial statements.
Reclassifications
We have made certain reclassifications to prior year amounts to conform to the current year presentation.
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ROCK-TENN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 2. Basic and Diluted Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per share (in millions, except for earnings per share information):
| Year Ended September 30, | |||||||||
| 2009 | 2008 | 2007 | |||||||
| Numerator: |
|||||||||
| Net income |
$ | 222.3 | $ | 81.8 | $ | 81.7 | |||
| Denominator: |
|||||||||
| Denominator for basic earnings per share — weighted average shares |
37.9 | 37.4 | 38.5 | ||||||
| Effect of dilutive stock options and restricted stock awards |
0.8 | 0.8 | 1.0 | ||||||
| Denominator for diluted earnings per share — weighted average shares and assumed conversions |
38.7 | 38.2 | 39.5 | ||||||
| Basic earnings per share: |
|||||||||
| Net income per share — basic |
$ | 5.87 | $ | 2.19 | $ | 2.12 | |||
| Diluted earnings per share: |
|||||||||
| Net income per share — diluted |
$ | 5.75 | $ | 2.14 | $ | 2.07 | |||
Options to purchase 0.4 million, 0.4 million and 0.1 million shares of Common Stock in fiscal 2009, 2008, and 2007, respectively, were not included in the computation of diluted earnings per share because the effect of including the options in the computation would have been antidilutive. The dilutive impact of the remaining options outstanding in each year was included in the effect of dilutive securities.
Note 3. Other Comprehensive (Loss) Income
Accumulated other comprehensive loss is comprised of the following, net of taxes (in millions):
| September 30, | ||||||||
| 2009 | 2008 | |||||||
| Foreign currency translation gain |
$ | 35.4 | $ | 37.5 | ||||
| Net deferred (loss) gain on cash flow hedge derivatives |
(7.8 | ) | 3.7 | |||||
| Unrecognized pension net loss |
(133.5 | ) | (59.4 | ) | ||||
| Unrecognized pension prior service cost |
(2.5 | ) | (2.2 | ) | ||||
| Total accumulated other comprehensive loss |
$ | (108.4 | ) | $ | (20.4 | ) | ||
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ROCK-TENN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
A summary of the components of other comprehensive (loss) income for the years ended September 30, 2009, 2008 and 2007, is as follows (in millions):
| Pre-Tax Amount |
Tax | Net of Tax Amount |
||||||||||
| Fiscal 2009 |
||||||||||||
| Foreign currency translation loss |
$ | (2.1 | ) | $ | — | $ | (2.1 | ) | ||||
| Net deferred loss on cash flow hedge derivatives |
(27.3 | ) | 10.6 | (16.7 | ) | |||||||
| Reclassification adjustment of net loss on cash flow hedge |
8.4 | (3.2 | ) | 5.2 | ||||||||
| Net actuarial loss arising during period |
(121.3 | ) | 42.7 | (78.6 | ) | |||||||
| Amortization of net actuarial loss |
7.4 | (2.9 | ) | 4.5 | ||||||||
| Prior service cost arising during period |
(1.5 | ) | 0.5 | (1.0 | ) | |||||||
| Amortization of prior service cost |
1.2 | (0.5 | ) | 0.7 | ||||||||
| Other comprehensive loss |
$ | (135.2 | ) | $ | 47.2 | $ | (88.0 | ) | ||||
| Pre-Tax Amount |
Tax | Net of Tax Amount |
||||||||||
| Fiscal 2008 |
||||||||||||
| Foreign currency translation loss |
$ | (12.0 | ) | $ | — | $ | (12.0 | ) | ||||
| Net deferred gain on cash flow hedge derivatives |
3.2 | (1.3 | ) | 1.9 | ||||||||
| Reclassification adjustment of net loss on cash flow hedge |
1.0 | (0.4 | ) | 0.6 | ||||||||
| Net actuarial loss arising during period |
(35.3 | ) | 14.1 | (21.2 | ) | |||||||
| Amortization of net actuarial loss |
3.2 | (1.2 | ) | 2.0 | ||||||||
| Prior service cost arising during period |
(0.2 | ) | 0.1 | (0.1 | ) | |||||||
| Amortization of prior service cost |
0.4 | (0.2 | ) | 0.2 | ||||||||
| Other comprehensive loss |
$ | (39.7 | ) | $ | 11.1 | $ | (28.6 | ) | ||||
| Pre-Tax Amount |
Tax | Net of Tax Amount |
||||||||||
| Fiscal 2007 |
||||||||||||
| Foreign currency translation gain |
$ | 14.0 | $ | — | $ | 14.0 | ||||||
| Net deferred loss on cash flow hedge derivatives |
(0.7 | ) | 0.3 | (0.4 | ) | |||||||
| Reclassification adjustment of net gain on cash flow hedge derivatives included in earnings |
(4.0 | ) | 1.5 | (2.5 | ) | |||||||
| Pension liability adjustments, prior to adoption of certain provisions of ASC 715 |
39.1 | (15.1 | ) | 24.0 | ||||||||
| Other comprehensive income |
$ | 48.4 | $ | (13.3 | ) | $ | 35.1 | |||||
58
ROCK-TENN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 4. Inventories
Inventories are as follows (in millions):
| September 30, | ||||||||
| 2009 | 2008 | |||||||
| Finished goods and work in process |
$ | 154.2 | $ | 163.3 | ||||
| Raw materials |
107.4 | 113.4 | ||||||
| Supplies and spare parts |
49.0 | 49.9 | ||||||
| Inventories at FIFO cost |
310.6 | 326.6 | ||||||
| LIFO reserve |
(35.5 | ) | (43.6 | ) | ||||
| Net inventories |
$ | 275.1 | $ | 283.0 | ||||
It is impracticable to segregate the LIFO reserve between raw materials, finished goods and work in process. In fiscal 2009, 2008, and 2007, we reduced inventory quantities in some of our LIFO pools. This reduction generally results in a liquidation of LIFO inventory quantities typically carried at lower costs prevailing in prior years as compared with the cost of the purchases in the respective fiscal years, the effect of which typically decreases cost of goods sold. The impact of the liquidations in fiscal 2009, 2008, and 2007 was not significant.
Note 5. Alternative Fuel Tax Credit
In April 2009, we received notification from the Internal Revenue Service that our registration as an alternative fuel mixer had been approved. As a result, we are eligible for a tax credit equal to $0.50 per gallon of alternative fuel used at our Demopolis, Alabama bleached paperboard mill from January 22, 2009 through the expiration of the tax credit, which is currently set at December 31, 2009. The alternative fuel eligible for the tax credit is liquid fuel derived from biomass. We recognized approximately $55.4 million of an alternative fuel tax credit, which is not taxable for federal or state income tax purposes, and reduced cost of goods sold in our Consumer Packaging segment by $54.1 million, net of expenses, in fiscal 2009.
Note 6. Assets Held for Sale
The assets we recorded as held for sale consisted of property, plant and equipment from a variety of plant closures and are as follows (in millions):
| September 30, | ||||||
| 2009 | 2008 | |||||
| Property, plant and equipment |
$ | 0.9 | $ | 0.7 | ||
Note 7. Acquisitions
Southern Container Acquisition
On March 5, 2008, we acquired the stock of Southern Container. We have included the results of Southern Container’s operations in our financial statements in our Corrugated Packaging segment since the March 2, 2008 effective date. We made the acquisition in order to expand our corrugated packaging business with the Southern Container operations that we believe have the lowest system costs and the highest EBITDA margins of any major integrated corrugated company in North America.
59
ROCK-TENN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The purchase price for the acquisition was $1,059.9 million, net of cash received of $54.0 million, including debt assumed and transaction costs. RockTenn and Southern Container made an election under section 338(h)(10) of the Internal Revenue Code of 1986, as amended (the “Code”) that increased RockTenn’s tax basis in the acquired assets and is expected to result in a net present value benefit of approximately $135 million (unaudited), net of an agreed upon payment included in the purchase price for the election to the sellers of approximately $68.6 million paid to Southern Container’s former stockholders in November 2008. In fiscal 2008, we incurred $26.8 million of debt issuance costs in connection with the transaction. See “Note 11. Debt”.
Our allocation of purchase price as of March 2, 2008, follows (in millions):
| Current assets, net of cash received |
$ | 135.0 | |
| Property, plant, and equipment |
546.5 | ||
| Goodwill |
374.3 | ||
| Intangible assets |
108.7 | ||
| Other long-term assets |
22.6 | ||
| Total assets acquired |
1,187.1 | ||
| Current portion of debt |
116.8 | ||
| Current liabilities |
83.7 | ||
| Long-term debt due after one year |
126.3 | ||
| Minority interest and other long-term liabilities |
43.5 | ||
| Total liabilities assumed |
370.3 | ||
| Net assets acquired |
$ | 816.8 | |
We recorded estimated fair values for acquired assets and liabilities including goodwill and intangibles. The intangibles are being amortized over estimated useful lives ranging generally from 11 to 40 years on a straight-line basis over a weighted average life of approximately 18 years, and 15 years for tax purposes. We recorded $72.3 million of customer relationship intangibles with a weighted average life of approximately 15 years, $18.1 million of trade names and trademarks with a weighted average life of approximately 39 years and $18.3 million for a steam supply contract with a life of approximately 11 years. None of the intangibles has significant residual value. Approximately $320 million of the goodwill is deductible for income tax purposes as a result of the Code section 338(h)(10) election.
The following unaudited pro forma information reflects our consolidated results of operations as if the Southern Container Acquisition had taken place as of the beginning of each of the periods presented. The unaudited pro forma information includes adjustments primarily for depreciation and amortization based on the preliminary fair value of the acquired property, plant and equipment, acquired intangibles and interest expense on the acquisition financing debt. We have added back the minority interest in the earnings of the Solvay mill subsidiary, since such interests were acquired by Southern Container prior to our acquisition; we have eliminated certain expenses that Southern Container historically incurred that the combined company does not expect to incur due to changes in employment and other contractual arrangements. In addition, for fiscal 2008, we eliminated certain non-recurring pre-tax expenses directly associated with the acquisition including $12.7 million of inventory step up expense, $5.0 million of deferred compensation expense funded into escrow through a purchase price reduction from Southern Container’s stockholders, $3.0 million for an acquisition bridge financing fee and $1.9 million of loss on extinguishment of debt and related items associated with the acquisition (included in interest expense in fiscal 2008). Pre-tax integration costs of $4.6 million are included in the unaudited pro forma net income below for the year ended September 30, 2008. The unaudited pro forma
60
ROCK-TENN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
information is not necessarily indicative of the results of operations that we would have reported had the transaction actually occurred at the beginning of these periods nor is it necessarily indicative of future results.
| Year Ended September 30, | ||||||
| (Unaudited) | ||||||
| (In millions, except per share data) | 2008 | 2007 | ||||
| Net sales |
$ | 3,128.1 | $ | 2,853.7 | ||
| Net income |
$ | 110.2 | $ | 97.4 | ||
| Diluted earnings per common share |
$ | 2.88 | $ | 2.47 | ||
Prior to the acquisition, Southern Container used a 52/53 week fiscal year and reported its results of operations in three 12-week periods and one 16-week period, with the 16-week period being the fourth period and ending on the last Saturday of the calendar year. The unaudited pro forma information above for the fiscal years ended September 30, 2008 and 2007 uses the consolidated statements of income for RockTenn for the fiscal years ended September 30, 2008 and 2007 and the condensed consolidated statements of operations of Southern Container for the 25 weeks preceding the March 2, 2008 effective date and the 52 weeks ended September 8, 2007.
Consumer Packaging
On January 24, 2007, we acquired for $32.0 million the remaining 40% minority interest in Fold-Pak, giving us sole ownership. We acquired our initial 60% interest in Fold-Pak in connection with the GSPP Acquisition in June 2005. Fold-Pak makes paperboard-based food containers serving a very broad customer base and is a consumer of board from our bleached paperboard mill. We have included the results of these operations in our consolidated financial statements in our Consumer Packaging segment. The acquisition included $18.7 million of intangibles, primarily for customer relationships, and $3.5 million of goodwill. The goodwill is deductible for income tax purposes. We are amortizing the non-goodwill intangibles on a straight-line basis over a weighted average life of 19 years.
61
ROCK-TENN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 8. Restructuring and Other Costs, Net
We recorded pre-tax restructuring and other costs, net of $13.4 million, $15.6 million, and $4.7 million for fiscal 2009, 2008, and 2007, respectively. Of these costs, $3.3 million, $2.3 million and $1.1 million were non-cash for fiscal 2009, 2008, and 2007, respectively. These amounts are not comparable since the timing and scope of the individual actions associated with a restructuring can vary. We discuss these charges in more detail below.
The following table represents a summary of restructuring and other charges related to our active restructuring initiatives that we incurred during the fiscal year, the cumulative recorded amount since we announced the initiative, and the total we expect to incur (in millions):
Summary of Restructuring and Other Costs (Income), Net
| Segment |
Period | Net Property, Plant and Equipment (1) |
Severance and Other Employee Related Costs |
Equipment and Inventory Relocation |
Facility Carrying Costs |
Other Costs |
Total | ||||||||||||||||
| Consumer Packaging (a) |
Fiscal 2009 | $ | 0.2 | $ | (0.1 | ) | $ | 0.5 | $ | — | $ | 1.3 | $ | 1.9 | |||||||||
| Fiscal 2008 | 0.9 | 2.0 | 0.6 | 0.5 | 0.1 | 4.1 | |||||||||||||||||
| Fiscal 2007 | 1.1 | 1.0 | 0.6 | 0.3 | 1.7 | 4.7 | |||||||||||||||||
|
Cumulative |
4.1 | 4.1 | 2.5 | 1.0 | 5.6 | 17.3 | |||||||||||||||||
| Expected Total | 4.1 | 4.1 | 2.5 | 1.0 | 5.6 | 17.3 | |||||||||||||||||
| Corrugated Packaging (b) |
Fiscal 2009 | 1.6 | (0.1 | ) | 0.4 | 0.1 | 1.1 | 3.1 | |||||||||||||||
| Fiscal 2008 | 1.6 | 0.3 | — | — | 0.3 | 2.2 | |||||||||||||||||
| Fiscal 2007 | — | — | — | — | — | — | |||||||||||||||||
| Cumulative | 3.2 | 0.2 | 0.4 | 0.1 | 1.4 | 5.3 | |||||||||||||||||
| Expected Total | 3.2 | 0.2 | 0.4 | 0.1 | 1.4 | 5.3 | |||||||||||||||||
| Specialty Paperboard Products (c) |
Fiscal 2009 | 0.5 | 0.5 | 0.1 | 0.2 | 0.2 | 1.5 | ||||||||||||||||
| Fiscal 2008 | (0.3 | ) | — | — | — | — | (0.3 | ) | |||||||||||||||
| Fiscal 2007 | — | — | — | — | — | — | |||||||||||||||||
|
Cumulative |
0.2 | 0.7 | 0.2 | 0.5 | 0.2 | 1.8 | |||||||||||||||||
| Expected Total | 0.2 | 0.8 | 0.2 | 0.7 | 0.2 | 2.1 | |||||||||||||||||
| Other (d) |
Fiscal 2009 | — | 0.1 | — | — | 6.8 | 6.9 | ||||||||||||||||
| Fiscal 2008 | — | — | — | — | 9.6 | 9.6 | |||||||||||||||||
| Fiscal 2007 | — | — | — | — | — | — | |||||||||||||||||
| Cumulative | — | 0.1 | — | — | 16.4 | 16.5 | |||||||||||||||||
| Expected Total | — | 0.1 | — | — | 16.5 | 16.6 | |||||||||||||||||
| Total |
Fiscal 2009 | $ | 2.3 | $ | 0.4 | $ | 1.0 | $ | 0.3 | $ | 9.4 | $ | 13.4 | ||||||||||
| Fiscal 2008 | $ | 2.2 | $ | 2.3 | $ | 0.6 | $ | 0.5 | $ | 10.0 | $ | 15.6 | |||||||||||
| Fiscal 2007 | $ | 1.1 | $ | 1.0 | $ | 0.6 | $ | 0.3 | $ | 1.7 | $ | 4.7 | |||||||||||
|
Cumulative |
$ | 7.5 | $ | 5.1 | $ | 3.1 | $ | 1.6 | $ | 23.6 | $ | 40.9 | |||||||||||
| Expected Total | $ | 7.5 | $ | 5.2 | $ | 3.1 | $ | 1.8 | $ | 23.7 | $ | 41.3 | |||||||||||
62
ROCK-TENN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
| (1) | For this Note 8, we have defined “Net property, plant and equipment” as: property, plant and equipment impairment losses, subsequent adjustments to fair value for assets classified as held for sale, and subsequent (gains) or losses on sales of property, plant and equipment and related parts and supplies. |
When we close a facility, if necessary, we recognize an impairment charge primarily to reduce the carrying value of equipment or other property to their estimated fair value less cost to sell, and record charges for severance and other employee related costs. Any subsequent change in fair value, less cost to sell, prior to disposition is recognized as identified; however, no gain is recognized in excess of the cumulative loss previously recorded. At the time of each announced closure, we generally expect to record future charges for equipment relocation, facility carrying costs, costs to terminate a lease or contract before the end of its term and other employee related costs. Expected future charges are reflected in the table above in the “Expected Total” lines until incurred.
| (a) | The Consumer Packaging segment charges primarily reflect the following folding carton plant closures recorded: Baltimore, Maryland (announced in fiscal 2008 and closed in fiscal 2009), Chicopee, Massachusetts (announced and closed in fiscal 2008), Stone Mountain, Georgia (announced and closed in fiscal 2007), and Kerman, California (announced and closed in fiscal 2006) and Waco, Texas (announced and closed in fiscal 2005). Although specific circumstances vary, our strategy has generally been to consolidate our business into large well-equipped plants that operate at high utilization rates and take advantage of available capacity created by operational excellence initiatives. Therefore, we transferred a substantial portion of each plant’s assets and production to our other folding carton plants. Included in the “Other Costs” column are charges of $1.4 million in fiscal 2007 related to the estimated fair value of the liability for future lease payments when we ceased operations at the Stone Mountain plant. We believe these actions have allowed us to more effectively manage our business. |
| (b) | The Corrugated Packaging segment charges primarily reflect the closure of our Greenville, South Carolina sheet plant (announced in fiscal 2008 and closed in fiscal 2009) and the fiscal 2009 impairment of certain assets at one of our consolidated corrugated graphics subsidiaries, including a $1.0 million charge included in the “Other Costs” column for a customer relationship intangible. We have transferred a substantial portion of Greenville’s production to our other corrugated plants. |
| (c) | The Specialty Paperboard Products segment charges primarily reflect the closure of our Litchfield, Illinois interior packaging plant (announced and closed in fiscal 2009). The income in fiscal 2008 primarily reflects the gain on sale of real estate relating to a previously closed facility. |
| (d) | The expenses in the “Other Costs” column reflect Southern Container integration expenses and deferred compensation expense for key Southern Container employees. The deferred compensation and retention bonus expense was funded through a purchase price reduction from Southern Container’s stockholders. Nearly all of these funds were escrowed and were disbursed in March 2009 following the one year anniversary of the acquisition. The pre-tax charges are summarized below (in millions): |
| Integration Expenses |
Deferred Compensation Expense |
Total | |||||||
| Fiscal 2009 |
$ | 3.3 | $ | 3.5 | $ | 6.8 | |||
| Fiscal 2008 |
4.6 | 5.0 | 9.6 | ||||||
63
ROCK-TENN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The following table represents a summary of the restructuring accrual, which is primarily composed of accrued severance and other employee costs, and a reconciliation of the restructuring accrual to the line item “Restructuring and other costs, net” on our consolidated statements of income for fiscal 2009, 2008, and 2007 (in millions):
| 2009 | 2008 | 2007 | ||||||||||
| Accrual at beginning of fiscal year |
$ | 3.4 | $ | 2.4 | $ | 2.1 | ||||||
| Additional accruals |
1.8 | 3.3 | 2.6 | |||||||||
| Payments |
(4.0 | ) | (1.8 | ) | (2.0 | ) | ||||||
| Adjustment to accruals |
(0.1 | ) | (0.5 | ) | (0.3 | ) | ||||||
| Accrual at September 30, |
$ | 1.1 | $ | 3.4 | $ | 2.4 | ||||||
| Reconciliation of accruals and charges to restructuring and other costs, net: |
|
|||||||||||
| Additional accruals and adjustment to accruals (see table above) |
$ | 1.7 | $ | 2.8 | $ | 2.3 | ||||||
| Deferred compensation expense |
3.5 | 5.0 | — | |||||||||
| Integration expenses (not in accruals) |
2.7 | 4.1 | — | |||||||||
| Net property, plant and equipment |
2.3 | 2.2 | 1.1 | |||||||||
| Severance and other employee costs |
0.4 | 0.3 | 0.2 | |||||||||
| Equipment relocation |
1.0 | 0.6 | 0.6 | |||||||||
| Facility carrying costs |
0.3 | 0.5 | 0.3 | |||||||||
| Intangible asset impairments and other |
1.5 | 0.1 | 0.2 | |||||||||
| Total restructuring and other costs, net |
$ | 13.4 | $ | 15.6 | $ | 4.7 | ||||||
Note 9. Other Intangible Assets
The gross carrying amount and accumulated amortization relating to intangible assets, excluding goodwill, is as follows (in millions):
| September 30, | ||||||||||||||||
| 2009 | 2008 | |||||||||||||||
| Weighted Avg. Life |
Gross Carrying Amount |
Accumulated Amortization |
Gross Carrying Amount |
Accumulated Amortization |
||||||||||||
| Customer relationships |
18.7 | $ | 148.2 | $ | (32.5 | ) | $ | 150.5 | $ | (23.7 | ) | |||||
| Non-compete agreements |
5.0 | 2.1 | (1.2 | ) | 8.3 | (7.0 | ) | |||||||||
| Patents |
8.9 | 1.2 | (0.3 | ) | 1.4 | (0.2 | ) | |||||||||
| Trademarks and tradenames |
40.0 | 19.8 | (0.9 | ) | 21.3 | (1.5 | ) | |||||||||
| Contracts |
11.0 | 18.3 | (3.4 | ) | 29.4 | (1.6 | ) | |||||||||
| License Costs |
— | — | — | 0.3 | (0.3 | ) | ||||||||||
| Total |
20.4 | $ | 189.6 | $ | (38.3 | ) | $ | 211.2 | $ | (34.3 | ) | |||||
During fiscal 2009, our net intangible asset balance decreased $25.6 million primarily due to amortization of intangible assets, an $11.1 million purchase price allocation adjustment to reduce the estimated fair value of a contract-based intangible asset acquired in the Southern Container Acquisition and a $1.0 million customer relationship impairment at one of our majority-owned corrugated graphics subsidiaries. During fiscal 2008, our
64
ROCK-TENN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
net intangible asset balance increased $109.3 million primarily due to $120.7 million of intangibles acquired in the Southern Container Acquisition, which was partially offset by amortization of intangible assets.
During fiscal 2009, 2008, and 2007, intangible asset amortization expense was $12.5 million, $10.7 million, and $5.9 million, respectively. Estimated intangible asset amortization expense for the succeeding five fiscal years is as follows (in millions):
| 2010 |
$ | 11.6 | |
| 2011 |
11.4 | ||
| 2012 |
10.5 | ||
| 2013 |
10.3 | ||
| 2014 |
9.9 |
Note 10. Unconsolidated Entities
Seven Hills commenced operations on March 29, 2001. Our partner has the option to require us to purchase its interest in Seven Hills, at a formula price, effective on the anniversary of the commencement date by providing us notice two years prior to any such anniversary. No notification has been received to date, therefore, the earliest date on which we could be required to purchase our partner’s interest is March 29, 2012. We have not recorded any liability for this unexercised option. We currently project this contingent obligation to purchase our partner’s interest (based on the formula) to be approximately $14 million at September 30, 2009, which would result in a purchase price of approximately 60% of our partner’s net equity reflected on Seven Hills’ September 30, 2009 balance sheet. The partners of the joint venture have guaranteed funding of any net losses of Seven Hills in relation to their proportionate share of ownership. Seven Hills has no third party debt. Our investment in Seven Hills at September 30, 2009, net of capital returns and cumulative losses, was $12.5 million. Our investment is reflected in the assets of our Specialty Paperboard Products segment. Our share of cumulative pre-tax losses by Seven Hills that we have recognized as of September 30, 2009 and 2008 were $1.9 million and $1.1 million, respectively. During fiscal 2009, 2008, and 2007, our share of operating results at Seven Hills amounted to losses of $0.8 million, earnings of $0.2 million, and earnings of $0.4 million, respectively.
Under the terms of the Seven Hills joint venture arrangement, our partner is required to purchase all of the saleable gypsum paperboard liner produced by Seven Hills, for which we receive fees for tons of gypsum paperboard liner calculated using formulas in the joint venture agreement. We also provide other services related to the operation of Seven Hills, for which the joint venture reimburses our expenses, and we lease to Seven Hills the land and building occupied by the joint venture. Our pre-tax income from the Seven Hills joint venture, including the fees we charge the venture and our share of the joint venture’s net income, was $2.5 million, $3.9 million and $3.0 million, for fiscal 2009, 2008, and 2007, respectively. We contributed cash of $0.1 million, $0.1 million, and $0.4 million for fiscal 2009, 2008, and 2007, respectively. Our contributions for each of those years were for capital expenditures.
65
ROCK-TENN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
We collect the receivables and disburse the payables for our Seven Hills joint venture. Therefore, at each balance sheet date we have either a liability due to the joint venture or a receivable from the joint venture. Interest income or expense is recorded between the two parties on the average outstanding balance. At September 30, 2009 and 2008 we had a current receivable of $0.7 million and a current liability of $6.3 million, respectively, on our consolidated balance sheets. The change in the liability is reflected in the financing activities section of our consolidated statements of cash flows on the line item (Repayments to) advances from unconsolidated entity.
As a result of the fiscal 2008 Southern Container Acquisition, we own 50% of Pohlig, a small folding carton manufacturer, and 50% of Greenpine, which owns the real property from which Pohlig operates. We account for our investment in both Pohlig and Greenpine under the equity method. Our initial investments in these ventures aggregate to $0.6 million and are included in our Consumer Packaging segment.
In fiscal 2007, we entered into two business ventures accounted for under the equity method. We acquired 23.96% of QPSI, a business providing merchandising displays, contract packing, logistics and distribution solutions, and we acquired 45% of DSA, a business providing primarily permanent merchandising displays. Our investment exceeds the underlying equity in net assets of each of the two investees. The difference is attributed to our proportional interest in specific assets of the ventures and is amortized over the useful lives of the respective assets. The difference at September 30, 2009 is $4.3 million for QPSI and $0.5 million for DSA and is being amortized over a weighted average life of 20.3 years and 7.0 years, respectively, primarily for the write-up of customer intangibles, fixed assets, and trade names and trademarks.
66
ROCK-TENN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 11. Debt
The following were individual components of debt (in millions):
| September 30, 2009 |
September 30, 2008 | |||||
| Face value of 8.20% notes due August 2011, net of unamortized discount of $0.1 and $0.2 (a) |
$ | 154.6 | $ | 249.8 | ||
| Hedge adjustments resulting from terminated interest rate derivatives or swaps |
2.6 | 5.1 | ||||
| 157.2 | 254.9 | |||||
| Face value of 5.625% notes due March 2013, net of unamortized discount of $0.1 and $0.1 (b) |
99.9 | 99.9 | ||||
| Hedge adjustments resulting from terminated interest rate derivatives or swaps |
1.2 | 1.5 | ||||
| 101.1 | 101.4 | |||||
| Face value of 9.25% notes due March 2016, net of unamortized discount of $1.1 and $1.3 (c) |
298.9 | 198.7 | ||||
| Term loan facilities, net of unamortized discount of $1.3 and $1.7 (d) |
643.8 | 747.3 | ||||
| Revolving credit and swing facilities (d) |
19.1 | 33.5 | ||||
| Receivables-backed financing facility (e) |
100.0 | 92.0 | ||||
| Cash payable to sellers (f) |
— | 110.7 | ||||
| Industrial development revenue bonds bearing interest at: variable rates — $16.9 million at 2.70% at September 30, 2009, and $29.0 million at 10.06% at September 30, 2008; fixed rates — $120.9 million at 6.97% at September 30, 2008; due at various dates through July 2035 (g) |
16.9 | 149.9 | ||||
| Other notes |
12.4 | 10.5 | ||||
| Total Debt |
1,349.4 | 1,698.9 | ||||
| Less current portion of debt |
56.3 | 245.1 | ||||
| Long-term debt due after one year |
$ | 1,293.1 | $ | 1,453.8 | ||
| The following were the aggregate components of debt (in millions): | ||||||
| Face value of debt instruments, net of unamortized discounts |
$ | 1,345.6 | $ | 1,692.3 | ||
| Hedge adjustments resulting from terminated interest rate derivatives or swaps |
3.8 | 6.6 | ||||
| Total Debt |
$ | 1,349.4 | $ | 1,698.9 | ||
A portion of the debt classified as long-term, which includes the revolving and swing facilities, may be paid down earlier than scheduled at our discretion without penalty. During fiscal 2009, 2008, and 2007, amortization of debt issuance costs charged to interest expense was $6.9 million, $3.8 million, and $1.2 million, respectively.
| (a) | In August 2001, we sold $250.0 million in aggregate principal amount of our 8.20% notes due August 15, 2011 (“August 2011 Notes”). Interest on the August 2011 Notes is payable in arrears each February and August. The August 2011 Notes are redeemable prior to maturity, subject to certain rules and restrictions, and are not subject to any sinking fund requirements. The August 2011 Notes are senior, secured obligations and rank equally with all other secured debt as they share generally, on a pro-rata basis, in the same Principal Property (as defined in the Amended and Restated Credit Agreement) that was granted to the banks as part of the Amended and Restated Credit Agreement. The indenture related to the August 2011 Notes restricts us and our subsidiaries from incurring certain liens and entering into certain sale and leaseback transactions, subject to a number of exceptions. The |
67
ROCK-TENN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
| August 2011 Notes were originally issued at a discount of $0.7 million and incurred debt issuance costs of $2.1 million. Accordingly, unamortized original issue discount and debt issuance costs are being amortized through the maturity date of the August 2011 Notes. On May 29, 2009, we consummated a tender offer for up to $100 million aggregate principal amount of the August 2011 Notes and financed this tender offer with the net cash proceeds of an unregistered offering of $100 million aggregate principal amount of our 9.25% senior notes due March 2016, as described in footnote (c) below. We purchased $93.3 million of tendered August 2011 Notes at a price of 103% of par. In connection with our purchase of $93.3 million of tendered August 2011 Notes, we reclassified the proportionate amount of original issue discount and debt issuance costs associated with the extinguished debt to earnings as a component of net loss on extinguishment of debt and related items. We recorded a net loss on extinguishment of debt and related items of $1.9 million associated with the two transactions. Giving effect to the amortization of the original issue discount, the terminated fair value hedge adjustments and the debt issuance costs, the effective interest rate of the August 2011 Notes is approximately 7.45%. |
| (b) | In March 2003, we sold $100.0 million in aggregate principal amount of our 5.625% notes due March 15, 2013 (“March 2013 Notes”). Interest on the March 2013 Notes is payable in arrears each September and March. The March 2013 Notes are redeemable prior to maturity, subject to certain rules and restrictions, and are not subject to any sinking fund requirements. The March 2013 Notes are senior, secured obligations and rank equally with all other secured debt as they share generally, on a pro-rata basis, in the same Principal Property that was granted to the banks as part of the Amended and Restated Credit Agreement. The indenture related to the March 2013 Notes restricts us and our subsidiaries from incurring certain liens and entering into certain sale and leaseback transactions, subject to a number of exceptions. We are amortizing debt issuance costs of approximately $0.8 million over the term of the March 2013 Notes. Giving effect to the amortization of the original issue discount, the terminated fair value hedge adjustments and the debt issuance costs, the effective interest rate on the March 2013 Notes is approximately 5.39%. Subsequent to September 30, 2009, we repurchased $19.5 million of our March 2013 Notes at an average price of approximately 98% of par and recorded an aggregate gain on extinguishment of debt of approximately $0.5 million (unaudited). |
| (c) | On March 5, 2008, we issued $200.0 million aggregate principal amount of 9.25% senior notes due March 2016 (“March 2016 Notes”). Interest on our March 2016 Notes is payable in arrears each March and September. The March 2016 Notes are redeemable prior to maturity, subject to certain rules and restrictions, and are not subject to any sinking fund requirements. The indenture related to the March 2016 Notes contains incurrence based financial and restrictive covenants applicable to the notes, including limitations on: restricted payments, dividend and other payments affecting restricted subsidiaries (as defined therein), incurrence of debt, asset sales, transactions with affiliates, liens, sale and leaseback transactions and the creation of unrestricted subsidiaries. The March 2016 Notes were originally issued at a discount of $1.4 million and incurred debt issuance costs of $4.7 million. On May 29, 2009, we issued an additional $100 million aggregate principal amount of March 2016 Notes (the “Additional Notes”) and as a result incurred debt issuance costs of approximately $2.7 million related to the Additional Notes; these debt issuance costs, together with the original issue debt discount and debt issuance costs, are being amortized through the maturity date of the March 2016 Notes. Giving effect to the amortization of the original issue discount and the debt issuance costs, the effective interest rate of the March 2016 Notes and the Additional Notes is approximately 9.64%. |
| (d) | On March 5, 2008 we entered into an Amended and Restated Credit Agreement (the “Credit Facility”) with an original maximum principal amount of $1.2 billion. The Credit Facility includes revolving credit, swing, term loan, and letters of credit components, consisting of a $450 million revolving credit |
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
| facility, a $550 million term loan A facility and a $200 million term loan B facility. The Credit Facility is pre-payable at any time. Scheduled term loan payments or other term loan prepayments reduce the facility size. As of September 30, 2009, the term loan A and term loan B facilities had been reduced to $524.7 million and $120.4 million, respectively. The revolving credit facility and term loan A facility are scheduled to mature on the earlier to occur of (a) March 5, 2013 or (b) if our $100 million March 2013 Notes have not been paid in full or refinanced by September 15, 2012, then September 15, 2012; the term loan B facility is scheduled to mature on the earlier to occur of (a) March 5, 2014 or (b) if the March 2013 Notes have not been paid in full or refinanced by September 15, 2012, then September 15, 2012. We expect the March 2013 Notes will be paid in full or refinanced by September 15, 2012. The Credit Facility provides for up to $100.0 million in Canadian or U.S. Dollar loans to a Canadian subsidiary. In November 2008, the amount committed under the Credit Facility for loans to a Canadian subsidiary was reduced from $100.0 million to $45.0 million, and $55.0 million was reallocated to the U.S. revolving credit facility, increasing its maximum availability to $405.0 million. At September 30, 2009, there was $19.1 million borrowed under the revolving credit facility; $6.7 million in borrowings by the Canadian subsidiary, predominantly denominated in Canadian dollars and $12.4 million under the U.S. revolver consisting primarily of U.S. dollar Swing/Base Loans (as defined below). At September 30, 2009, available borrowings under the revolving credit portion of the Credit Facility, reduced by outstanding letters of credit not drawn upon of approximately $32.2 million, were approximately $398.7 million. |
At our option, borrowings under the Credit Facility (other than swingline and Canadian dollar loans) bear interest at either (1) LIBOR plus an applicable margin (“LIBOR Loans”) or (2) the base rate, which will be the higher of the prime commercial lending rate of the U.S. Administrative Agent plus an applicable margin or the Federal Funds Rate for Federal Reserve System overnight borrowing transactions plus an applicable margin (“Base Rate Loans”). The following table summarizes the applicable margins and percentages related to the revolving credit facility and term loan A of the Credit Facility:
| Range | September 30, 2009 | |||
| Applicable margin/percentage for determining: |
||||
| Base Rate Loans interest rate (1) |
0.25%-1.50% | 0.50% | ||
| Banker’s Acceptance and LIBOR Loans interest rate (1) |
1.25%-2.50% | 1.50% | ||
| Facility commitment fee (2) |
0.175%-0.40% | 0.20% |
| (1) | The rates vary based on the ratio of our total funded debt to EBITDA as defined in the credit agreement (“Leverage Ratio”). |
| (2) | Applied to the aggregate borrowing availability based on the Leverage Ratio. |
The applicable margin for determining the interest rate of the term loan B is fixed at 1.75% per annum in the case of Base Rate Loans and 2.75% for LIBOR Loans. If we select LIBOR Loans for the term B facility, we have agreed to pay term loan B lenders a minimum LIBOR rate of 3.00% plus the applicable margin then in effect. The variable rate on our term loan A and term loan B facilities, before the effect of interest rate swaps, was 1.77% and 5.75%, respectively, at September 30, 2009, and 4.74% and 5.76%, respectively, at September 30, 2008. We had interest rates on our revolving credit facility for borrowings both in the U.S. and Canada, ranging from 1.76% to 3.75% at September 30, 2009 and from 6.00% to 6.25% at September 30, 2008.
Our obligations under the Credit Facility and under certain related hedging agreements are guaranteed by substantially all of our U.S. subsidiaries, and partially by our Canadian subsidiaries. Future
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
subsidiaries will be required to guarantee the obligations under the Credit Facility unless we designate them as “unrestricted subsidiaries”. Obligations under the Credit Facility are secured by a first priority security interest in a substantial portion of our assets, including the capital stock or other equity interests and indebtedness of certain of our U.S. subsidiaries, certain of the stock of our first tier Canadian subsidiary and certain of our and our subsidiaries’ real and personal property.
The Credit Facility includes usual and customary affirmative and negative covenants, including maintenance of financial ratios and restrictions on the creation of additional long-term and short-term debt, the creation or existence of certain liens, the occurrence of certain mergers, acquisitions or disposals of assets and certain leasing arrangements, the occurrence of certain fundamental changes in the primary nature of our consolidated business, the nature of certain investments, and other matters. Financial covenants include maintenance of a maximum Leverage Ratio, which as of September 30, 2009 was 4.25 to 1.00 (which decreases to 3.50 to 1.00 over the term of the loans), a minimum Consolidated Interest Coverage Ratio of 3.00 to 1.00 (which increases to 3.50 to 1.00 over the term of the loans), and a minimum Consolidated Net Worth of not less than the sum of $525.0 million plus 50% of cumulative Consolidated Net Income (in each case as defined in the Credit Facility documentation). We are permitted under our Credit Facility to repurchase our capital stock and pay cash dividends. If on a pro forma basis our Leverage Ratio does not exceed 3.00 to 1.00, no default or event of default exists under the Credit Facility and we are able to incur an additional $1.00 of funded debt under the covenants in the Credit Facility documentation, we are permitted to make stock repurchases and dividend declarations in the aggregate amount up to 50% of cumulative Consolidated Net Income from April 1, 2008 through the last day of the most recent fiscal quarter end for which financial statements have been delivered. If on a pro forma basis our Leverage Ratio is greater than 3.00 to 1.00, no default or event of default exists under the Credit Facility and we are able to incur an additional $1.00 of funded debt under the debt and financial covenants in the Credit Facility documentation, the aggregate amount of stock repurchases and dividend declarations shall not exceed $30.0 million per year. We test and report our compliance with these covenants each quarter. We are in compliance with all of our covenants.
On July 21, 2009, we amended our Credit Facility to, among other things, allow us to refinance the March 2016 Notes and to redeem, repurchase, defease, purchase prior to maturity or prepay the August 2011 Notes and/or the March 2013 Notes in an aggregate amount not to exceed (i) an annual limit of $85 million in any fiscal year plus, at the beginning of the fiscal year ended September 30, 2011, $85 million plus the unused amount available under the annual limit for the immediately preceding fiscal year and (ii) $170 million for all such redemptions, repurchases, defeasances, purchases or prepayments (collectively, the “repurchases”), subject in each case to certain conditions. Such repurchases are available to us as long as no default or event of default has occurred or would be directly or indirectly caused as a result thereof, subject to availability under the Aggregate Revolving Committed Amount of at least $300 million. In addition, when the Leverage Ratio does not exceed 3.00 to 1.00 after giving effect to all such repurchases on a Pro Forma Basis, as such terms are defined in the Credit Facility, as amended, we may repurchase an additional $100 million of the August 2011 Notes and/or March 2013 Notes.
| (e) | On September 2, 2008, we amended our 364-day receivables-backed financing facility (the “Receivables Facility”) to increase its size from $110.0 million to $175.0 million and to set it to expire on September 1, 2009. Accordingly, such borrowings were classified as current at September 30, 2008. On July 14, 2009 we amended our existing Receivables Facility to, among other things, extend the maturity to set it to expire on July 13, 2012 and reduce the size to a $100.0 million facility limit. On August 14, 2009 we amended the facility to increase the facility size to $135.0 million. Accordingly, |
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
| such borrowings are classified as long-term at September 30, 2009. The borrowing rate, which consists of the market rate for asset-backed commercial paper plus a utilization fee, was 2.53% and 5.15% as of September 30, 2009 and September 30, 2008, respectively. Borrowing availability under this facility is based on the eligible underlying accounts receivable and certain covenants. The agreement governing the Receivables Facility contains restrictions, including, among others, creation of certain liens on the underlying collateral. We test and report our compliance with these covenants monthly. We are in compliance with all of our covenants. One of our covenants is based on the percentage of receivables 31 to 60 days past due, and another is based on the percentage of receivables greater than 61 days past due. Given current economic conditions it is possible that the age of qualifying receivables could exceed the limit in the covenant. If this event were to occur, we would either amend the facility or terminate the facility utilizing available capacity under the revolving credit portion of our existing Credit Facility. At September 30, 2009 and September 30, 2008, maximum available borrowings under this facility were approximately $114.6 million and $166.3 million, respectively. The carrying amount of accounts receivable collateralizing the maximum available borrowings at September 30, 2009 was approximately $215 million. |
| (f) | Cash payable to sellers was the liability associated with cash held by us to support certain indebtedness of our Solvay Paperboard subsidiary, and an agreed upon payment to the sellers related to the Code section 338(h)(10) election. These items were paid in November 2008. Of these amounts, approximately $69 million was refinanced using proceeds from the revolving credit portion of our Credit Facility and, accordingly, was recorded in long-term debt at September 30, 2008 since it was refinanced on a long-term basis. |