PKG 09.30.2014 10Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________________________________________
FORM 10-Q
_______________________________________________
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2014
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 1-15399
_______________________________________________

(Exact Name of Registrant as Specified in its Charter)
Delaware
 
36-4277050
(State or Other Jurisdiction of
 Incorporation or Organization)
 
(I.R.S. Employer Identification No.)
 
 
 
1955 West Field Court, Lake Forest, Illinois
 
60045
(Address of Prinicpal Executive Offices)
 
(Zip Code)
Registrant's telephone number, including area code
(847) 482-3000
_____________________________________

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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
x
Accelerated filer
¨
Non-accelerated filer
¨ (Do not check if a 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

As of October 31, 2014, the Registrant had outstanding 98,383,452 shares of common stock, par value $0.01 per share.




Table of Contents
 
PART I
 
 
 
 
Item 1.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
PART II
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
Item 6.
 
 
 

All reports we file with the Securities and Exchange Commission (SEC) are available free of charge via the Electronic Data Gathering Analysis and Retrieval (EDGAR) System on the SEC website at www.sec.gov. We also provide copies of our SEC filings at no charge upon request and make electronic copies of our reports available through our website at www.packagingcorp.com as soon as reasonably practicable after filing such material with the SEC.


i


PART I
FINANCIAL INFORMATION

Item 1.
FINANCIAL STATEMENTS

Packaging Corporation of America
Consolidated Statements of Income and Comprehensive Income
(unaudited, dollars in thousands, except per-share data)

 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
2014
 
2013
 
2014
 
2013
Statements of Income:
 
 
 
 
 
 
 
Net sales
$
1,518,940

 
$
845,440

 
$
4,418,653

 
$
2,400,877

Cost of sales
(1,198,607
)
 
(617,841
)
 
(3,486,108
)
 
(1,792,782
)
Gross profit
320,333

 
227,599

 
932,545

 
608,095

Selling, general, and administrative expenses
(119,645
)
 
(77,096
)
 
(359,007
)
 
(226,606
)
Other expense, net
(12,310
)
 
(7,721
)
 
(44,004
)
 
(22,510
)
Income from operations
188,378

 
142,782

 
529,534

 
358,979

Interest expense, net
(23,111
)
 
(11,850
)
 
(65,311
)
 
(30,333
)
Income before taxes
165,267

 
130,932

 
464,223

 
328,646

Income tax provision
(60,822
)
 
(46,250
)
 
(170,135
)
 
(115,418
)
Net income
$
104,445

 
$
84,682

 
$
294,088

 
$
213,228

 
 
 
 
 
 
 
 
Net income per common share:
 
 
 
 
 
 
 
Basic
$
1.06

 
$
0.88

 
$
2.99

 
$
2.21

Diluted
$
1.06

 
$
0.87

 
$
2.99

 
$
2.19

Dividends declared per common share
$
0.40

 
$
0.40

 
$
1.20

 
$
1.11

 
 
 
 
 
 
 
 
Statements of Comprehensive Income:
 
 
 
 
 
 
 
Net income
$
104,445

 
$
84,682

 
$
294,088

 
$
213,228

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustment, net of tax of ($106), $0, ($76), and $0, respectively
(1,564
)
 

 
(1,656
)
 

Reclassification adjustments to cash flow hedges included in net income, net of tax of $553, $552, $1,668, and $1,658, respectively
870

 
870

 
2,599

 
2,609

Amortization of pension and postretirement plans actuarial loss and prior service cost, net of tax of $685, $2,153, $2,157, and $7,574, respectively
1,080

 
3,387

 
3,137

 
11,921

Changes in unfunded employee benefit obligation, net of tax of $0, $3,152, $0, and $8,522, respectively

 
4,963

 

 
13,418

Other comprehensive income
386

 
9,220

 
4,080

 
27,948

Comprehensive income
$
104,831

 
$
93,902

 
$
298,168

 
$
241,176


See accompanying condensed notes to unaudited quarterly consolidated financial statements.


1


Packaging Corporation of America
Consolidated Balance Sheets
(unaudited, dollars and shares in thousands, except per-share data)
 
September 30,
2014
 
December 31,
2013
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
154,323

 
$
190,960

Accounts receivable, net of allowance for doubtful accounts and customer deductions of $12,118 and $10,567 as of September 30, 2014, and December 31, 2013, respectively
717,947

 
643,083

Inventories
616,962

 
594,291

Prepaid expenses and other current assets
76,195

 
32,101

Federal and state income taxes receivable

 
22,958

Deferred income taxes
32,280

 
47,616

Total current assets
1,597,707

 
1,531,009

Property, plant, and equipment, net
2,818,133

 
2,805,704

Goodwill
541,911

 
526,789

Intangible assets, net
299,096

 
310,539

Other long-term assets
73,902

 
69,738

Total assets
$
5,330,749

 
$
5,243,779

LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
Current liabilities:
 
 
 
Current maturities of long-term debt
$
6,500

 
$
39,000

Capital lease obligations
1,082

 
1,030

Accounts payable
387,854

 
357,432

Dividends payable
39,393

 
39,297

Federal and state income taxes payable
7,176

 

Accrued liabilities
228,758

 
214,058

Accrued interest
19,272

 
9,722

Total current liabilities
690,035

 
660,539

Long-term liabilities:
 
 
 
Long-term debt
2,350,484

 
2,508,845

Capital lease obligations
23,055

 
23,874

Deferred income taxes
426,086

 
434,835

Pension and postretirement benefit plans
204,286

 
193,548

Other long-term liabilities
84,764

 
65,318

Total long-term liabilities
3,088,675

 
3,226,420

Commitments and contingent liabilities


 


Stockholders' equity:
 
 
 
Common stock, par value $0.01 per share, 300,000 shares authorized, 98,383 and 98,172 shares issued as of September 30, 2014, and December 31, 2013, respectively
984

 
982

Additional paid in capital
427,844

 
401,761

Retained earnings
1,184,155

 
1,019,101

Accumulated other comprehensive loss
(60,944
)
 
(65,024
)
Total stockholders' equity
1,552,039

 
1,356,820

Total liabilities and stockholders' equity
$
5,330,749

 
$
5,243,779


See accompanying condensed notes to unaudited quarterly consolidated financial statements.

2


Packaging Corporation of America
Consolidated Statements of Cash Flows
(unaudited, dollars in thousands)
 
Nine Months Ended
September 30
 
2014
 
2013
Cash Flows from Operating Activities:
 
 
 
Net income
$
294,088

 
$
213,228

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation, depletion, and amortization of intangibles and deferred financing costs
296,486

 
137,412

Share-based compensation expense
11,648

 
9,956

Deferred income tax provision
17,427

 
6,137

Alternative energy tax credits

 
76,280

Pension and postretirement benefits expense, net of contributions
19,230

 
10,600

Other, net
4,187

 
4,651

Changes in operating assets and liabilities, net of acquisitions:
 
 
 
Increase in assets —
 
 
 
Accounts receivable
(74,970
)
 
(57,583
)
Inventories
(22,520
)
 
(4,628
)
Prepaid expenses and other current assets
(27,882
)
 
(9,196
)
Increase (decrease) in liabilities —
 
 
 
Accounts payable
(12,957
)
 
46,418

Accrued liabilities
21,810

 
7,109

Federal and state income taxes payable / receivable
30,173

 
(20,216
)
Net cash provided by operating activities
556,720

 
420,168

Cash Flows from Investing Activities:
 
 
 
Additions to property, plant, and equipment
(254,865
)
 
(130,410
)
Acquisition of business, net of cash acquired
(20,290
)
 

Additions to other long term assets
(11,617
)
 
(2,459
)
Other
3,188

 
350

Net cash used for investing activities
(283,584
)
 
(132,519
)
Cash Flows from Financing Activities:
 
 
 
Repayments of debt and capital lease obligations
(590,641
)
 
(11,967
)
Proceeds from issuance of debt
398,864

 

Financing costs paid
(3,209
)
 
(8,220
)
Common stock dividends paid
(118,004
)
 
(69,883
)
Repurchases of common stock

 
(7,799
)
Proceeds from exercise of stock options
3,739

 
2,756

Excess tax benefits from stock-based awards
11,796

 
7,539

Shares withheld to cover employee restricted stock taxes
(12,051
)
 
(10,873
)
Other
(267
)
 

Net cash used for financing activities
(309,773
)
 
(98,447
)
Net (decrease) increase in cash and cash equivalents
(36,637
)
 
189,202

Cash and cash equivalents, beginning of period
190,960

 
207,393

Cash and cash equivalents, end of period
$
154,323

 
$
396,595


See accompanying condensed notes to unaudited quarterly consolidated financial statements.

3


Condensed Notes to Unaudited Quarterly Consolidated Financial Statements

1.     Nature of Operations and Basis of Presentation

Packaging Corporation of America ("we," "us," "our," PCA," or the "Company") was incorporated on January 25, 1999. In April 1999, PCA acquired the containerboard and corrugated packaging products business of Pactiv Corporation ("Pactiv"), formerly known as Tenneco Packaging, Inc., a wholly owned subsidiary of Tenneco Inc. On October 25, 2013, PCA acquired Boise Inc. ("Boise"). For more information, see Note 3, Acquisitions.

After the acquisition of Boise, we began reporting our business in three reportable segments: Packaging, Paper, and Corporate and Other. Our Packaging segment produces a wide variety of corrugated packaging products. The Paper segment manufactures and sells a range of papers, including communication-based papers and pressure sensitive papers (collectively, white papers) and market pulp. Corporate and Other includes support staff services and related assets and liabilities, transportation assets, and activity related to other ancillary support operations. For more information about our segments, see Note 16, Segment Information.

In these consolidated financial statements, certain amounts in prior periods' consolidated financial statements have been reclassified to conform with the current period presentation. In accordance with Accounting Standards Codification (“ASC”) 280, "Segment Reporting," we recast segment information for the three and nine months ended September 30, 2013, to conform with the current period presentation. In addition, we reclassified amounts previously disclosed in "Corporate overhead" in the Consolidated Statements of Income for the three and nine months ended September 30, 2013, into "Selling, general, and administrative expenses" given that Corporate and Other is now a separately disclosed segment. With the exception of the change in accounting principle relating to our inventories described below in Note 2, Change in Accounting Principle: Inventories, none of the reclassifications affected our results of operations, financial position, or cash flows.

The consolidated financial statements of PCA as of September 30, 2014, and for the three and nine months ended September 30, 2014 and 2013, are unaudited but include all adjustments (consisting only of normal recurring adjustments) that management considers necessary for a fair presentation of such financial statements. The preparation of the consolidated financial statements involves the use of estimates and accruals. Actual results may vary from those estimates. These financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with Article 10 of SEC Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete audited financial statements. Operating results for the period ended September 30, 2014, are not necessarily indicative of the results that may be expected for the year ending December 31, 2014. These consolidated financial statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2013, and the updated consolidated financial statements included in our Current Report on Form 8-K filed on May 9, 2014 (referred to as "updated 2013 Financial Statements" throughout this document).

The consolidated financial statements include the accounts of PCA and its majority-owned subsidiaries after elimination of intercompany balances and transactions. Boise's results are included in our results for periods after October 25, 2013.

2.     Change in Accounting Principle: Inventories

Effective January 1, 2014, the Company elected to change its method of accounting for certain inventories from lower of cost, as determined by the LIFO method, or market, to lower of cost, as determined by the average cost method, or market. Had the Company not made this change in accounting method, "Net income" for the three and nine months ended September 30, 2014, would have been $1.7 million and $1.5 million, respectively, higher than reported in the Consolidated Statements of Income and "Inventories" at September 30, 2014, would have been $69.3 million lower than reported in the Consolidated Balance Sheets.

4


We applied this change in method of inventory costing retrospectively to all prior periods presented in accordance with U.S. generally accepted accounting principles relating to accounting changes. As a result of the retrospective change in accounting principle, opening retained earnings as of January 1, 2013, increased $38.8 million. Certain components of our financial statements affected by the change in valuation methodology as originally reported under the LIFO method and as adjusted for the change to the average cost method were as follows (in thousands, except per share data):
 
 
Three Months Ended 
 September 30, 2013
 
Nine Months Ended 
 September 30, 2013
Consolidated Statements of Income and Comprehensive Income
 
As Previously Reported (a)
 
Effect of Change
 
As Adjusted
 
As Previously Reported (a)
 
Effect of Change
 
As Adjusted
Cost of sales
 
$
(618,663
)
 
$
822

 
$
(617,841
)
 
$
(1,799,285
)
 
$
6,503

 
$
(1,792,782
)
Gross profit
 
226,777

 
822

 
227,599

 
601,592

 
6,503

 
608,095

Income from operations
 
141,960

 
822

 
142,782

 
352,476

 
6,503

 
358,979

Income before taxes
 
130,110

 
822

 
130,932

 
322,143

 
6,503

 
328,646

Provision for income taxes
 
(45,930
)
 
(320
)
 
(46,250
)
 
(112,885
)
 
(2,533
)
 
(115,418
)
Net income
 
84,180

 
502

 
84,682

 
209,258

 
3,970

 
213,228

Comprehensive income
 
93,400

 
502

 
93,902

 
237,206

 
3,970

 
241,176

Net income per common share:
 
 
 
 
 
 
 
 
 
 
 
 
Basic
 
0.87

 
0.01

 
0.88

 
2.17

 
0.04

 
2.21

Diluted
 
0.86

 
0.01

 
0.87

 
2.15

 
0.04

 
2.19

___________
(a)
Certain amounts in prior periods' consolidated financial statements have been reclassified to conform with the current period presentation.
 
 
December 31, 2013
Consolidated Balance Sheet
 
As Previously Reported
 
Effect of Change
 
As Adjusted
Inventories
 
$
522,523

 
$
71,768

 
$
594,291

Deferred income tax assets
 
75,579

 
(27,963
)
 
47,616

Retained earnings
 
975,296

 
43,805

 
1,019,101


 
 
Nine Months Ended 
 September 30, 2013
Consolidated Statement of Cash Flows
 
As Previously Reported
 
Effect of Change
 
As Adjusted
Net income
 
$
209,258

 
$
3,970

 
$
213,228

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
 
 
Deferred income tax provision
 
3,604

 
2,533

 
6,137

Change in inventories
 
1,875

 
(6,503
)
 
(4,628
)

The components of inventories were as follows (dollars in thousands):
 
September 30,
2014
 
December 31,
2013
Raw materials
$
239,673

 
$
212,027

Work in process
12,739

 
13,898

Finished goods
195,538

 
209,972

Supplies and materials
169,012

 
158,394

Inventories
$
616,962

 
$
594,291



5


3.     Acquisitions

Crockett Packaging Acquisition

On April 28, 2014, we acquired the assets of Crockett Packaging, a corrugated products manufacturer, for $21.2 million, before $0.9 million of working capital adjustments. The assets included a corrugated plant and a sheet plant in Southern California. Sales and total assets of the acquired company are not material to our overall sales and total assets. Operating results of the acquired assets subsequent to April 28, 2014, are included in our Packaging segment's 2014 operating results. We have estimated the allocation of the purchase price to the assets acquired and liabilities assumed based on estimates of the fair value at the date of the acquisition, of which $10.7 million has been allocated to goodwill (which is deductible for tax purposes) and $5.5 million to intangible assets (to be amortized over a weighted average life of approximately ten years), primarily customer relationships, in the Packaging segment. The purchase price allocation continues to be preliminary, as estimates and assumptions are subject to change as more information becomes available.

Boise Acquisition

On October 25, 2013, we acquired 100% of the outstanding stock and voting equity interests of Boise for $2.1 billion including the assumption of debt. In connection with the acquisition, we allocated the purchase price to the assets acquired and liabilities assumed based on estimates of the fair value at the date of the acquisition. See Note 3, Acquisitions, of the Notes to Consolidated Financial Statements in "Part II, Item 8. Financial Statements and Supplementary Data" of our updated 2013 Financial Statements. During the nine months ended September 30, 2014, we recorded approximately $4.3 million of purchase price adjustments that increased goodwill. These adjustments related primarily to a true-up to the valuation of fixed assets and the associated impact to income tax liabilities. As of September 30, 2014, the purchase price allocation continues to be preliminary. The primary areas of the purchase price allocation that are not yet finalized relate to valuation of fixed assets, income taxes, and residual goodwill.

Pro Forma Financial Information

The following pro forma financial information presents the combined results of operations as if Boise had been combined with us on January 1, 2013. The pro forma results are intended for informational purposes only and do not purport to represent what the combined companies' results of operations would actually have been had the transactions in fact occurred on January 1, 2013. They also do not reflect any cost savings, operating synergies, or revenue enhancements that we may achieve or the costs necessary to achieve those cost savings, operating synergies, or revenue enhancements, or costs relating to integration efforts (dollars in millions, except per-share amounts).
 
Pro Forma (a)
 
Nine Months Ended 
 September 30, 2013
Net sales
$
4,256

Net income (b)
$
248

Net income per share—diluted (b)
$
2.54

____________
(a)
The pro forma financial information presented in the table above has been adjusted to give effect to adjustments that are directly related to the acquisition, factually supportable, and expected to have a continuing impact. These adjustments include, but are not limited to, the application of our accounting policies (including the deferral method of accounting for planned major maintenance activities, which increased pro forma net income $12.5 million for the nine months ended September 30, 2013); elimination of intercompany transactions; depreciation and amortization related to fair value adjustments to property, plant, and equipment and intangible assets; interest expense on acquisition-related debt; and $7.5 million of pre-tax acquisition-related costs which primarily consist of advisory, legal, accounting, financing, and other professional or consulting fees.
(b)
Included in pro forma net income for the nine months ended September 30, 2013, are $16.2 million of pre-tax costs, related primarily to the restructuring of Boise's white paper mill in International Falls, Minnesota, and $15.2 million of incremental depreciation expense related to shortening the estimated useful lives of certain assets, primarily at the white paper mill in International Falls, Minnesota.


6


4.     Other Expense, Net

The components of other (income) expense were as follows (in thousands):
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
2014
 
2013
 
2014
 
2013
DeRidder restructuring (a)
$
4,270

 
$

 
$
5,690

 
$

Integration-related and other costs (b)
3,040

 

 
11,999

 

Class action lawsuit settlement (c)

 

 
17,600

 

Pension curtailment charges (d)

 
3,132

 

 
10,908

Acquisition-related costs (e)

 
1,479

 

 
1,479

Asset disposals and write-offs
2,854

 
3,486

 
6,912

 
9,508

Other
2,146

 
(376
)
 
1,803

 
615

Total
$
12,310

 
$
7,721

 
$
44,004

 
$
22,510

___________
(a)
Costs relate primarily to the conversion of the Number 3 newsprint machine at our DeRidder, Louisiana, mill to produce lightweight linerboard and corrugating medium, and our exit from the newsprint business in September 2014.
(b)
The three and nine months ended September 30, 2014, include Boise acquisition integration-related and other costs.
(c)
The nine months ended September 30, 2014, includes $17.6 million of costs for the settlement of the Kleen Products LLC v Packaging Corp. of America et al class action lawsuit. See Note 18, Commitments, Guarantees, Indemnifications and Legal Proceedings, for more information.
(d)
The three and nine months ended September 30, 2013, include $3.1 million and $10.9 million, respectively, of non-cash pension curtailment charges related to pension plan changes in which certain hourly corrugated plant and containerboard mill employees will transition from a defined benefit pension plan to a defined contribution (401k) plan.
(e)
The three and nine months ended September 30, 2013, both include $1.5 million of acquisition-related costs, primarily for professional fees related to transaction-advisory services and expenses related to financing the acquisition of Boise.

5.     Earnings Per Share

The following table sets forth the computation of basic and diluted income per common share for the periods presented (dollars and shares in thousands, except per share data).
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
2014
 
2013
 
2014
 
2013
Numerator:
 
 
 
 
 
 
 
Net income
$
104,445

 
$
84,682

 
$
294,088

 
$
213,228

Less: distributed and undistributed earnings allocated to participating securities
(1,451
)
 

 
(4,381
)
 

Net income attributable to common shareholders
$
102,994

 
$
84,682

 
$
289,707

 
$
213,228

Denominator:
 
 
 
 
 
 
 
Weighted average basic common shares outstanding
97,165

 
96,758

 
96,954

 
96,536

Effect of dilutive securities
57

 
839

 
53

 
976

Diluted common shares outstanding
97,222

 
97,597

 
97,007

 
97,512

Basic income per common share
$
1.06

 
$
0.88

 
$
2.99

 
$
2.21

Diluted income per common share
$
1.06

 
$
0.87

 
$
2.99

 
$
2.19


During the nine months ended September 30, 2014 and 2013, all outstanding options to purchase shares were included in the computation of diluted common shares outstanding. On June 29, 2014, all remaining options to purchase shares expired.


7


6.     Income Taxes

For the three and nine months ended September 30, 2014, we recorded $60.9 million and $170.1 million of income tax expense and had an effective tax rate of 36.8% and 36.6%, respectively. For the three and nine months ended September 30, 2013, we recorded $46.2 million and $115.4 million of income tax expense and had an effective tax rate of 35.3% and 35.1%, respectively. During the three and nine months ended September 30, 2014 and 2013, the primary reasons for the difference from the federal statutory income tax rate of 35.0% were the effect of state and local income taxes and the domestic manufacturers’ deduction.

During the three and nine months ended September 30, 2014, there were no significant changes to our uncertain tax positions. For more information, see Note 5, Income Taxes, of the Notes to Consolidated Financial Statements in "Part II, Item 8. Financial Statements and Supplementary Data" of our updated 2013 Financial Statements.

During the nine months ended September 30, 2014 and 2013, cash paid for taxes, net of refunds received, was $110.8 million and $45.7 million, respectively.

7.    Property, Plant, and Equipment

Property, plant, and equipment consist of the following (dollars in thousands):
 
September 30,
2014
 
December 31,
2013
Land and land improvements
$
138,486

 
$
140,592

Buildings
645,173

 
628,948

Machinery and equipment
4,374,819

 
4,246,294

Construction in progress
253,150

 
168,808

Other
53,177

 
48,058

Property, plant, and equipment, at cost
5,464,805

 
5,232,700

Less accumulated depreciation
(2,646,672
)
 
(2,426,996
)
Property, plant, and equipment, net
$
2,818,133

 
$
2,805,704


Depreciation expense for the three months ended September 30, 2014 and 2013, was $95.1 million and $42.4 million, respectively. During the nine months ended September 30, 2014 and 2013, depreciation expense was $264.1 million and $125.2 million, respectively. The increase in depreciation expense relates primarily to the acquisition of Boise in fourth quarter 2013, as well as accelerated depreciation related to shortening the useful lives of our newsprint-related assets at the DeRidder, Louisiana, mill. During the three and nine months ended September 30, 2014, we recognized $18.2 million and $35.4 million, respectively, of incremental depreciation expense related to shortening the useful lives of our newsprint-related assets at the DeRidder, Louisiana, mill.

At September 30, 2014, purchases of property, plant, and equipment included in accounts payable was $49.6 million.

8.     Goodwill and Intangible Assets

Goodwill

Goodwill represents the excess of the cost of an acquired business over the fair value of the identifiable tangible and intangible assets acquired and liabilities assumed in a business combination. At September 30, 2014, and December 31, 2013, we had $487.9 million and $472.9 million of goodwill recorded in our Packaging segment, respectively, and $54.0 million and $53.9 million of goodwill recorded in our Paper segment, respectively, on our Consolidated Balance Sheets.


8


Changes in the carrying amount of our goodwill were as follows (dollars in thousands):
 
Goodwill
Balance at December 31, 2013
$
526,789

Acquisitions (a)
10,734

Adjustments related to purchase accounting (b)
4,388

Balance at September 30, 2014
$
541,911

___________
(a)
In April 2014, we acquired the assets of Crockett Packaging, a corrugated products manufacturer, for $21.2 million, before $0.9 million of working capital adjustments, and recorded $10.7 million of goodwill in our Packaging segment.
(b)
Adjustments relate primarily to the Boise acquisition, see Note 3, Acquisitions, for more information.

We have historically performed our annual goodwill impairment testing as of December 31. During the third quarter of 2014, we changed the annual goodwill impairment testing date from December 31 to October 1. We believe this change in measurement date, which represents a change in method of applying an accounting principle, is preferable. While remaining in the fourth quarter, the measurement date will lessen resource constraints in connection with the year-end close and financial reporting process by allowing us additional time to complete our annual impairment testing in advance of our year-end reporting. The change in accounting principle does not delay, accelerate, or avoid an impairment charge. We have determined that it is not practical to objectively determine projected cash flows and related valuation estimates that would have been used as of October 1 for periods prior to October 1, 2014, without the use of hindsight. As such, we prospectively applied the change in our annual goodwill impairment test date as of the first day of the fourth quarter of 2014.

Intangible Assets

Intangible assets are primarily comprised of customer relationships and trademarks and trade names.

The weighted average remaining useful life, gross carrying amount, and accumulated amortization of our intangible assets were as follows (dollars in thousands):
 
September 30, 2014
 
December 31, 2013
 
Weighted Average Remaining Useful Life (in Years)
 
Gross 
Carrying
Amount
 
Accumulated
Amortization
 
Weighted Average Remaining Useful Life (in Years)
 
Gross 
Carrying
Amount
 
Accumulated
Amortization
Customer relationships
14.5
 
$
311,461

 
$
31,759

 
15.4
 
$
306,361

 
$
16,509

Trademarks and trade names
13.6
 
21,770

 
2,455

 
14.7
 
21,370

 
794

Other
2.4
 
220

 
141

 
3.0
 
220

 
109

Total intangible assets (excluding goodwill)
14.4
 
$
333,451

 
$
34,355

 
15.4
 
$
327,951

 
$
17,412


Amortization expense for the three months ended September 30, 2014 and 2013, was $5.7 million and $0.8 million, respectively. During the nine months ended September 30, 2014 and 2013, amortization expense was $16.9 million and $2.5 million, respectively. The increase in amortization expense relates primarily to the acquisition of Boise in fourth quarter 2013.


9


9.    Accrued Liabilities

The components of accrued liabilities were as follows (in thousands):
 
September 30,
2014
 
December 31,
2013
Compensation and benefits
$
136,996

 
$
130,455

Franchise, property, sales and use taxes
27,942

 
20,232

Medical insurance and workers’ compensation
26,185

 
26,399

Customer volume discounts and rebates
12,695

 
11,436

Environmental liabilities and asset retirement obligations
6,829

 
7,812

Severance
2,052

 
8,172

Legal contingencies
1,283

 
1,000

Other
14,776

 
8,552

Total
$
228,758

 
$
214,058


10.    Debt

Our long-term debt and interest rates on that debt were as follows (dollars in thousands):
 
September 30, 2014
 
December 31, 2013
 
Amount
 
Interest Rate
 
Amount
 
Interest Rate
Revolving Credit Facility, due October 2018
$

 
%
 
$

 
%
Five-Year Term Loan, due October 2018
65,000

 
1.53

 
650,000

 
1.54

Seven-Year Term Loan, due October 2020
645,125

 
1.78

 
650,000

 
1.79

6.50% Senior Notes, net of discounts of $22 and $26 as of September 30, 2014 and December 31, 2013, respectively, due March 2018
149,978

 
6.50

 
149,974

 
6.50

3.90% Senior Notes, net of discounts of $275 and $302 as of September 30, 2014 and December 31, 2013, respectively, due June 2022
399,725

 
3.90

 
399,698

 
3.90

4.50% Senior Notes, net of discount of $1,714 and $1,827 as of September 30, 2014 and December 31, 2013, respectively, due November 2023
698,286

 
4.50

 
698,173

 
4.50

3.65% Senior Notes, net of discount of $1,130 as of September 30, 2014, due September 2024
398,870

 
3.65

 

 

Total
2,356,984

 
3.56

 
2,547,845

 
3.08

Less current portion
6,500

 
1.78

 
39,000

 
1.59

Total long-term debt
$
2,350,484

 
3.56
%
 
$
2,508,845

 
3.10
%

On September 5, 2014, we issued $400.0 million of 3.65% fixed-rate senior notes due September 15, 2024, through a registered public offering. We used the proceeds of this offering and other cash from operations to repay $589.9 million of debt during the nine months ended September 30, 2014. In connection with the $400.0 million debt issuance, we paid $3.2 million of deferred financing costs, which will be amortized to interest expense using the effective interest method over the term of the debt.

For the nine months ended September 30, 2014 and 2013, cash payments for interest were $50.0 million and $21.0 million, respectively.

Annual principal maturities for debt, excluding unamortized debt discount, as of September 30, 2014 were: $1.6 million for the remainder of 2014, $6.5 million for 2015, 2016, and 2017; $221.5 million for 2018; $6.5 million for 2019; and $2.1 billion for 2020 and thereafter.


10


Included in interest expense, net, are amortization of treasury lock settlements and amortization of financing costs. For both the three months ended September 30, 2014 and 2013, amortization of treasury lock settlements was $1.4 million, and for both the nine months ended September 30, 2014 and 2013, amortization of treasury lock settlements was $4.2 million. During the three months ended September 30, 2014 and 2013, amortization of financing costs was $2.0 million and $2.9 million, respectively, and during the nine months ended September 30, 2014 and 2013, amortization of financing costs was $2.9 million and $3.3 million, respectively. In connection with our debt repayments during the three months ended September 30, 2014, we expensed $1.5 million of deferred financing costs.

At September 30, 2014, we have $1,646.9 million of fixed-rate senior notes and $710.1 million of variable-rate term loans outstanding. At September 30, 2014, the fair value of our fixed-rate debt was estimated to be $1,713.1 million. The difference between the book value and fair value is due to the difference between the period-end market interest rate and the stated rate of our fixed-rate debt. We estimated the fair value of our fixed-rate debt using quoted market prices (Level 2 inputs) within the fair value hierarchy, which is further defined in Note 2, Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements in "Part II, Item 8. Financial Statements and Supplementary Data" of our updated 2013 Financial Statements.

11.     Employee Benefit Plans and Other Postretirement Benefits

The components of net periodic benefit cost for our pension plans were as follows (dollars in thousands):
 
Pension Plans
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
2014
 
2013
 
2014
 
2013
Service cost
$
5,828

 
$
5,825

 
$
17,428

 
$
18,322

Interest cost
11,507

 
4,269

 
34,400

 
12,250

Expected return on plan assets
(12,657
)
 
(3,796
)
 
(38,008
)
 
(11,297
)
Net amortization of unrecognized amounts
 
 
 
 
 
 
 
Prior service cost
1,641

 
163

 
4,922

 
3,284

Actuarial loss
155

 
2,217

 
465

 
5,221

Curtailment loss (a)

 
3,132

 

 
10,908

Net periodic benefit cost
$
6,474

 
$
11,810

 
$
19,207

 
$
38,688

___________
(a)
In June 2013, the United Steelworkers (“USW”) ratified a master labor agreement with PCA under which we froze certain USW-represented corrugated plant employees pension accruals under PCA’s hourly pension plan. Additionally, in September 2013, the USW ratified a master labor agreement with PCA under which we froze certain USW-represented containerboard mill employees pension accruals under PCA’s hourly pension plan. Following the pension freezes, affected USW-represented employees will transition to a defined contribution 401k plan. We recorded a $3.1 million and $10.9 million pre-tax pension curtailment charge related to the unrecognized prior service costs of employees impacted by the pension freezes during the three and nine months ended September 30, 2013, respectively. We also remeasured the hourly pension plan benefit obligation using current fair values of plan assets and current assumptions, resulting in a decrease in the benefit obligation of $21.9 million with a corresponding decrease in accumulated other comprehensive income (loss) of $13.4 million and deferred taxes of $8.5 million.

PCA makes pension plan contributions that are sufficient to fund its actuarially determined costs, generally equal to the minimum amounts required by the Employee Retirement Income Security Act (ERISA). During the nine months ended September 30, 2014, we contributed $0.4 million to our pension plans, which exceeds our 2014 minimum required contributions, calculated under the pension provisions of the Highway and Transportation Funding Act passed in August 2014. We do not expect to make any additional contributions during the fourth quarter of 2014.


11


The components of net periodic benefit cost for our postretirement plans were as follows (dollars in thousands):
 
Postretirement Plans
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
2014
 
2013
 
2014
 
2013
Service cost
$
392

 
$
515

 
$
1,177

 
$
1,545

Interest cost
311

 
311

 
933

 
934

Net amortization of unrecognized amounts
 
 
 
 
 
 
 
Prior service benefit
(57
)
 
(106
)
 
(170
)
 
(319
)
Actuarial loss
26

 
134

 
77

 
401

Net periodic benefit cost
$
672

 
$
854

 
$
2,017

 
$
2,561


12.     Share-based Compensation

The Company has a long-term equity incentive plan, which allows for grants of stock options, stock appreciation rights, restricted stock, and performance awards to directors, officers, and employees, as well as others who engage in services for PCA. The plan, as amended, terminates May 1, 2023, and authorizes 10.6 million shares of common stock for grant over the life of the plan. As of September 30, 2014, 1.9 million shares were available for future issuance under the plan. Forfeitures are added back to the pool of shares of common stock available to be granted at a future date.

The following table presents restricted stock and performance unit award activity for the nine months ended September 30, 2014:
 
Restricted Stock
 
Performance Units
 
Shares
 
Weighted Average Grant- Date Fair Value
 
Shares
 
Weighted Average Grant- Date Fair Value
Outstanding at December 31, 2013
1,463,694

 
$
31.48

 
70,600

 
$
47.83

Granted
229,489

 
70.24

 
56,889

 
71.19

Vested
(475,050
)
 
23.86

 

 

Forfeitures
(1,165
)
 
62.74

 

 

Outstanding at September 30, 2014
1,216,968

 
$
41.73

 
127,489

 
$
58.25


Compensation Expense

Our share-based compensation expense is recorded in "Selling, general, and administrative expenses". Compensation expense for share-based awards recognized in the Consolidated Statements of Income, net of forfeitures was as follows (dollars in thousands):
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
2014
 
2013
 
2014
 
2013
Restricted stock
$
(3,453
)
 
$
(2,933
)
 
$
(10,501
)
 
$
(9,691
)
Performance units
(594
)
 
(249
)
 
(1,147
)
 
(265
)
Impact on income before income taxes
(4,047
)
 
(3,182
)
 
(11,648
)
 
(9,956
)
Income tax benefit
1,572

 
1,237

 
4,530

 
3,868

Impact on net income
$
(2,475
)
 
$
(1,945
)
 
$
(7,118
)
 
$
(6,088
)

The fair value of restricted stock and performance units is determined based on the closing price of the Company’s common stock on the grant date. As PCA’s Board of Directors has the ability to accelerate vesting of share-based awards upon an employee’s retirement, the Company accelerates the recognition of compensation expense for certain employees approaching normal retirement age.


12


The unrecognized compensation expense for all share-based awards at September 30, 2014, was as follows (dollars in thousands):
 
September 30, 2014
 
Unrecognized Compensation Expense
 
Remaining Weighted Average Recognition Period (in years)
Restricted stock
$
30,543

 
2.7
Performance units
6,025

 
3.4
Total unrecognized share-based compensation expense
$
36,568

 
2.8

13.     Stockholders' Equity

Dividends

During the nine months ended September 30, 2014, we paid $118.0 million of dividends to shareholders. On August 28, 2014, PCA's Board of Directors approved a regular quarterly cash dividend $0.40 per share, which was paid on October 15, 2014, to shareholders of record as of September 15, 2014. The dividend payment was $39.4 million.

Accumulated Other Comprehensive Income (Loss)

Changes in accumulated other comprehensive income (loss) (“AOCI”) by component follows (dollars in thousands). Amounts in parentheses indicate losses.
 
Foreign Currency Translation Adjustments
 
Unrealized Loss On Treasury Locks, Net
 
Unrealized Loss on Foreign Exchange Contracts
 
Unfunded Employee Benefit Obligations
 
Total
Balance at December 31, 2013
$
(136
)
 
$
(28,191
)
 
$
(371
)
 
$
(36,326
)
 
$
(65,024
)
Other comprehensive income (loss) before reclassifications, net of tax
(1,656
)
 

 

 

 
(1,656
)
Amounts reclassified from AOCI, net of tax

 
2,584

(a)
15

(b)
3,137

(c)
5,736

Net current-period other comprehensive income (loss)
(1,656
)
 
2,584

 
15

 
3,137

 
4,080

Balance at September 30, 2014
$
(1,792
)
 
$
(25,607
)
 
$
(356
)
 
$
(33,189
)
 
$
(60,944
)


13


The following table presents information about reclassifications out of AOCI (dollars in thousands). Amounts in parentheses indicate expenses in the Consolidated Statements of Income.
 
 
Amounts Reclassified from AOCI
 
 
 
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
Affected Line Item in the Statement Where Net Income is Presented
Details about AOCI Components
 
2014
 
2013
 
2014
 
2013
 
Unrealized loss on treasury locks, net
 
$
(1,414
)
 
$
(1,414
)
 
$
(4,242
)
 
$
(4,242
)
 
See (a) below
 
 
549

 
549

 
1,658

 
1,648

 
Tax benefit
 
 
$
(865
)
 
$
(865
)
 
$
(2,584
)
 
$
(2,594
)
 
Net of tax
 
 
 
 
 
 
 
 
 
 
 
Unrealized loss on foreign exchange contracts
 
$
(9
)
 
$
(8
)
 
$
(25
)
 
$
(25
)
 
See (b) below
 
 
4

 
3

 
10

 
10

 
Tax benefit
 
 
$
(5
)
 
$
(5
)
 
$
(15
)
 
$
(15
)
 
Net of tax
 
 
 
 
 
 
 
 
 
 
 
Unfunded employee benefit obligations
 
 
 
 
 
 
 
 
 
 
Amortization of prior service costs
 
$
(1,584
)
 
$
(57
)
 
$
(4,752
)
 
$
(2,965
)
 
See (c) below
Amortization of actuarial losses
 
(181
)
 
(2,351
)
 
(542
)
 
(5,622
)
 
See (c) below
Curtailment loss
 

 
(3,132
)
 

 
(10,908
)
 
See (c) below
 
 
(1,765
)
 
(5,540
)
 
(5,294
)
 
(19,495
)
 
Total before tax
 
 
685

 
2,153

 
2,157

 
7,574

 
Tax benefit
 
 
$
(1,080
)
 
$
(3,387
)
 
$
(3,137
)
 
$
(11,921
)
 
Net of tax
____________
(a)
This AOCI component is included in interest expense, net. Amount relates to the amortization of the effective portion of treasury lock derivative instruments recorded in AOCI. The net amount of settlement gains or losses on derivative instruments included in AOCI to be amortized over the next 12 months is a net loss of $5.7 million ($3.5 million after tax). For a discussion of treasury lock derivative instrument activity, see Note 11, Derivative Instruments and Hedging Activities, of the Notes to Consolidated Financial Statements in "Part II, Item 8. Financial Statements and Supplementary Data" of our updated 2013 Financial Statements.
(b)
This AOCI component is included in cost of sales.
(c)
These AOCI components are included in the computation of net pension and postretirement benefit costs. See Note 11, Employee Benefit Plans and Other Postretirement Benefits, for additional information.

14.     Concentrations of Risk

Our Paper segment has had a long-standing commercial and contractual relationship with OfficeMax Incorporated (OfficeMax), and OfficeMax is our largest customer in the Paper segment. Following a merger in late 2013, OfficeMax is now a wholly-owned subsidiary of Office Depot, Inc. This relationship exposes us to a significant concentration of business and financial risk. Our sales to Office Depot (including OfficeMax) represented 9% of our total company sales revenue, for both the three and nine months ended September 30, 2014, and 44% of our Paper segment sales revenue for both those periods, respectively. At September 30, 2014, and December 31, 2013, we had $64.6 million and $39.2 million of accounts receivable due from Office Depot (including OfficeMax), which represents 9% and 6% of our total company receivables, respectively.

We cannot predict how the merger between OfficeMax and Office Depot will affect our business. Significant increases in paper purchases would intensify the concentration of risk. Significant reductions in paper purchases would cause our paper business to expand its customer base and could potentially decrease its profitability if new customer sales required either a decrease in pricing and/or an increase in cost of sales. Any significant deterioration in the financial condition of the post-merger entity affecting the ability to pay or causing a significant change in the willingness to continue to purchase our products could harm our business and results of operations.

Labor

At September 30, 2014, we had approximately 14,000 employees and approximately 50% of these employees worked pursuant to collective bargaining agreements. Approximately 75% of our hourly employees are represented by unions. The majority of our unionized employees are represented by the United Steel Workers (USW), the International Brotherhood of

14


Teamsters (IBT), the International Association of Machinists (IAM), and the Association of Western Pulp and Paper Workers (AWPPW). Approximately 22% of our employees work pursuant to collective bargaining agreements that will expire within the next twelve months.

15.     Transactions With Related Parties

Louisiana Timber Procurement Company, L.L.C. (LTP) is a variable-interest entity that is 50% owned by PCA and 50% owned by Boise Cascade Company (Boise Cascade). LTP procures sawtimber, pulpwood, residual chips, and other residual wood fiber to meet the wood and fiber requirements of PCA and Boise Cascade in Louisiana. PCA is the primary beneficiary of LTP, and has the power to direct the activities that most significantly affect the economic performance of LTP. Therefore, we consolidate 100% of LTP in our financial statements in our Corporate and Other segment. The carrying amounts of LTP's assets and liabilities (which relate primarily to noninventory working capital items) on our Consolidated Balance Sheets were both $6.4 million at September 30, 2014, and $5.0 million at December 31, 2013. During the three and nine months ended September 30, 2014, we recorded $21.9 million and $56.9 million, respectively, of LTP sales to Boise Cascade in "Net Sales" in the Consolidated Statements of Income and approximately the same amount of expenses in "Cost of Sales". The sales were at prices designed to approximate market prices.

During the three and nine months ended September 30, 2014, fiber purchases from related parties were $7.0 million and $21.3 million, respectively. Most of these purchases related to chip and log purchases by LTP from Boise Cascade's wood products business. These purchases are recorded in "Cost of Sales" in the Consolidated Statements of Income.

16.     Segment Information

Prior to the acquisition of Boise on October 25, 2013, we manufactured and sold packaging products and reported our results in one reportable segment. In connection with the acquisition, we expanded our packaging business and entered the paper business as the third largest producer of white papers in North America in terms of production capacity. As a result, we began managing our business in three reportable segments: Packaging, Paper, and Corporate and Other. These segments represent distinct businesses that are managed separately because of differing products and services. Each of these businesses requires distinct operating and marketing strategies. There are no differences in our basis of segmentation or in our basis of measurement of segment profit or loss from those disclosed in Note 19, Segment Information, of the Notes to Consolidated Financial Statements in "Part II, Item 8. Financial Statements and Supplementary Data" of our updated 2013 Financial Statements.

Each segment's profits and losses are measured on operating profits before interest expense and interest income. After the acquisition of Boise, expenses that were historically included in "Corporate overhead" on our Consolidated Statements of Income, were reclassified to "Selling, general, and administrative expenses" to conform with the current year presentation. In addition, after increasing our product offerings to include both packaging and paper products after the Boise acquisition, we began allocating the amounts associated with running those businesses, previously included in "Corporate overhead", to our segments. For many of these allocated expenses, the related assets and liabilities remain in the Corporate and Other segment.

Effective January 1, 2014, the Company elected to change its method of accounting for certain inventories from lower of cost, as determined by the LIFO method, or market, to lower of cost, as determined by the average cost method, or market. The Company has applied this change in method of inventory costing retrospectively to all prior periods presented herein in accordance with U.S. generally accepted accounting principles relating to accounting changes. See Note 2, Change in Accounting Principle: Inventories, for additional information.


15


An analysis of operations by reportable segment were as follows (dollars in millions):
 
 
Sales, net
 
Operating Income (Loss)
 
Three Months Ended September 30, 2014 (a)
 
Trade
 
Inter-
segment
 
Total
 
 
Packaging
 
$
1,174.2

 
$
1.5

 
$
1,175.7

 
$
164.7

(b)
Paper
 
312.5

 

 
312.5

 
43.0

(c)
Corporate and Other
 
32.2

 
37.0

 
69.2

 
(19.3
)
(d)
Intersegment eliminations
 

 
(38.5
)
 
(38.5
)
 

 
 
 
$
1,518.9

 
$

 
$
1,518.9

 
188.4

 
Interest expense, net
 
 
 
 
 
 
 
(23.1
)
(e)
Income before taxes
 
 
 
 
 
 
 
$
165.3

 
 
 
Sales, net
 
Operating Income (Loss)
 
Three Months Ended September 30, 2013
 
Trade
 
Inter-
segment
 
Total
 
 
Packaging
 
$
845.4

 
$

 
$
845.4

 
$
154.9

(f)
Corporate and Other
 

 

 

 
(12.1
)
(g)
 
 
$
845.4

 
$

 
$
845.4

 
142.8

 
Interest expense, net
 
 
 
 
 
 
 
(11.9
)
(h)
Income before taxes
 
 
 
 
 
 
 
$
130.9

 
 
 
Sales, net
 
Operating Income (Loss)
 
Nine Months Ended September 30, 2014 (a)
 
Trade
 
Inter-
segment
 
Total
 
 
Packaging
 
$
3,413.8

 
$
4.5

 
$
3,418.3

 
$
501.8

(b)
Paper
 
917.0

 

 
917.0

 
104.3

(c)
Corporate and Other
 
87.9

 
112.8

 
200.7

 
(76.6
)
(d)
Intersegment eliminations
 

 
(117.3
)
 
(117.3
)
 

 
 
 
$
4,418.7

 
$

 
$
4,418.7

 
529.5

 
Interest expense, net
 
 
 
 
 
 
 
(65.3
)
(e)
Income before taxes
 
 
 
 
 
 
 
$
464.2

 
 
 
Sales, net
 
Operating Income (Loss)
 
Nine Months Ended September 30, 2013
 
Trade
 
Inter-
segment
 
Total
 
 
Packaging
 
$
2,400.9

 
$

 
$
2,400.9

 
$
395.1

(f)
Corporate and Other
 

 

 

 
(36.1
)
(g)
 
 
$
2,400.9

 
$

 
$
2,400.9

 
359.0

 
Interest expense, net
 
 
 
 
 
 
 
(30.4
)
(h)
Income before taxes
 
 
 
 
 
 
 
$
328.6

 
____________
(a)
On October 25, 2013, we acquired Boise. The 2014 results include Boise for the full period.
(b)
Includes costs related primarily to the conversion of the Number 3 newsprint machine at our DeRidder, Louisiana, mill to produce lightweight linerboard and corrugating medium, and our exit from the newsprint business in September 2014. The three and nine months ended September 30, 2014, include $26.0 million and $47.8 million, respectively, of restructuring charges, primarily accelerated depreciation. The three and nine months ended September 30, 2014, includes $1.0 million and $5.4 million of Boise acquisition integration-related and other costs recorded in "Other expense, net".
(c)
Includes $0.4 million of income, net of expenses, for the nine months ended September 30, 2014, of integration related and other costs recorded in "Other expense, net".



16


(d)
Includes $2.0 million and $7.0 million, for the three and nine months ended September 30, 2014, of Boise acquisition integration-related and other costs recorded in "Other expense, net".
The nine months ended September 30, 2014, includes $17.6 million of costs for the settlement of the Kleen Products LLC v Packaging Corp. of America et al class action lawsuit. See Note 18, Commitments, Guarantees, Indemnifications and Legal Proceedings, for more information. These costs are recorded in "Other expense, net".
(e)
Includes $1.5 million of expense related to the write-off of deferred financing costs in connection with the debt refinancing discussed in Note 10, Debt.
(f)
Includes $3.1 million and $10.9 million, for the three and nine months ended September 30, 2013, respectively, of non-cash pension curtailment charges related to pension plan changes in which certain hourly corrugated plant and containerboard mill employees will transition from a defined benefit pension plan to a defined contribution (401k) plan.
(g)
Includes $1.5 million of Boise acquisition-related costs primarily for professional fees related to transaction-advisory services.
(h)
Includes $2.7 million of acquisition-related costs primarily related to financing the acquisition of Boise.

17.     New and Recently Adopted Accounting Standards

In August 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-15, Presentation of Financial Statements (Topic 205): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. This ASU provides guidance that will explicitly require management to assess an entity’s ability to continue as a going concern, and to provide related footnote disclosures in certain circumstances. The guidance is effective for the annual period ending after December 15, 2016, and for annual and interim periods thereafter. Early adoption is permitted. We do not believe the adoption of this update will affect our financial position and results of operations.

In May 2014, the FASB issued ASU 2014-09: Revenue from Contracts with Customers (Topic 606). ASU 2014-09 amends the guidance for revenue recognition to replace numerous, industry-specific requirements and converges areas under this topic with those of the International Financial Reporting Standards. The ASU implements a five-step process for customer contract revenue recognition that focuses on transfer of control, as opposed to transfer of risk and rewards. The amendment also requires enhanced disclosures regarding the nature, amount, timing, and uncertainty of revenues and cash flows from contracts with customers. The amendments in this ASU are effective for reporting periods beginning after December 15, 2016, and early adoption is prohibited. Entities can transition to the standard either retrospectively or as a cumulative-effect adjustment as of the date of adoption. We are currently assessing the impact the adoption of ASU 2014-09 may have on our financial position and results of operations.

In April 2014, the FASB issued ASU 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. This ASU defines a discontinued operation as a disposal of a component or group of components that is disposed of or is classified as held for sale and represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results. The standard also requires additional disclosures about discontinued operations. We adopted the provisions of this guidance in third quarter 2014, and it did not have a material effect on our financial position and results of operations.

In February 2013, the FASB issued ASU 2013-04, Liabilities (Topic 405): Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation is Fixed at the Reporting Date. This ASU requires an entity to measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this guidance is fixed at the reporting date, as the sum of (a) the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors and (b) any additional amount the reporting entity expects to pay on behalf of its co-obligors. This ASU also requires an entity to disclose the nature and amount of the obligation as well as other information about those obligations. We adopted the provisions of this guidance January 1, 2014, and it did not have a material effect on our financial position and results of operations.

In July 2013, the FASB issued ASU 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. This ASU requires that liabilities related to unrecognized tax benefits offset deferred tax assets for net operating loss carryforwards, a similar tax loss, or a tax credit carryforward if such settlement is required or expected in the event the uncertain tax position is disallowed. In situations in which carryforwards cannot be used or the deferred tax asset is not intended to be used for such purpose, the unrecognized tax benefit should be recorded as a liability and should not offset deferred tax assets. We adopted the provisions of this guidance on December 31, 2013, and it did not have a significant effect on our financial position or results of operations.


17


There were no other accounting standards recently issued that had or are expected to have a material impact on our financial position or results of operations.

18.     Commitments, Guarantees, Indemnifications and Legal Proceedings

We have financial commitments and obligations that arise in the ordinary course of our business. These include long-term debt, capital commitments, lease obligations, and purchase commitments for goods and services, which are discussed in Note 8, Debt, and Note 20, Commitments, Guarantees, Indemnifications, and Legal Proceedings, of the Notes to Consolidated Financial Statements in "Part II, Item 8. Financial Statements and Supplementary Data" of our updated 2013 Financial Statements. Except as disclosed in Note 10, Debt, and in Legal Proceedings below, at September 30, 2014, there have been no other significant changes to commitments outside the normal course of business.

Guarantees and Indemnifications

We provide guarantees, indemnifications, and other assurances to third parties in the normal course of our business. These include tort indemnifications, environmental assurances, and representations and warranties in commercial agreements. At September 30, 2014, we are not aware of any material liabilities arising from any guarantee, indemnification, or financial assurance we have provided. If we determined such a liability was probable and subject to reasonable determination, we would accrue for it at that time.

Legal proceedings

During 2010, PCA and eight other U.S. and Canadian containerboard producers were named as defendants in five purported class action lawsuits filed in the United States District Court for the Northern District of Illinois, alleging violations of the Sherman Act. The lawsuits were consolidated in a single complaint under the caption Kleen Products LLC v Packaging Corp. of America et al. The consolidated complaint alleges that the defendants conspired to limit the supply of containerboard, and that the purpose and effect of the alleged conspiracy was to artificially increase prices of containerboard products during the period of August 2005 to October 2010 (the time of filing of the complaint). The complaint was filed as a class action suit on behalf of all purchasers of containerboard products during such period. On April 4, 2014, we reached an agreement with the representatives of the class to settle this lawsuit for $17.6 million. These costs were recorded in "Other expense, net" in our Consolidated Income Statement for the nine months ended September 30, 2014. On May 6, 2014, the court preliminarily approved the settlement. Notice of the proposed settlement was mailed to potential class members and $17.6 million was paid to the settlement fund escrow account in June 2014. The court granted final approval to the settlement on September 4, 2014.

We are also a party to other legal actions arising in the ordinary course of our business. These legal actions include commercial liability claims, premises liability claims, and employment-related claims, among others. As of the date of this filing, we believe it is not reasonably possible that any of the legal actions against us will, either individually or in the aggregate, have a material adverse effect on our financial condition, results of operations, or cash flows.


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Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This management's discussion and analysis includes statements regarding our expectations with respect to our future performance, liquidity, and capital resources. Such statements, along with any other nonhistorical statements in the discussion, are forward-looking. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described in our 2013 Annual Report on Form 10-K, as well as those factors listed in other documents we file with the Securities and Exchange Commission (SEC). We do not assume any obligation to update any forward-looking statement. Our actual results may differ materially from those contained in or implied by any of the forward-looking statements in this Form 10-Q.

Overview

PCA is the fourth largest producer of containerboard in the United States and the third largest producer of white papers in North America, based on production capacity. We operate eight mills and 100 corrugated products manufacturing plants. Our mills are comprised of five containerboard mills and three paper mills. Our corrugated products manufacturing plants produce a wide variety of corrugated packaging products, including conventional shipping containers used to protect and transport manufactured goods, multi-color boxes and displays with strong visual appeal that help to merchandise the packaged product in retail locations, and honeycomb protective packaging. In addition, we are a large producer of packaging for meat, fresh fruit and vegetables, processed food, beverages, and other industrial and consumer products. We also manufacture and sell white papers, including both commodity and specialty papers, which may have custom or specialized features such as colors, coatings, high brightness, and recycled content. We operate primarily in the United States and have some converting operations in Europe, Mexico, and Canada.

This Item 2 is intended to supplement, and should be read in conjunction with, “Management’s Discussion and Analysis of Financial Condition and Results of Operations" included with the updated 2013 Financial Statements.

Executive Summary

In third quarter 2014, sales grew 80% to $1,518.9 million, compared with $845.4 million in third quarter 2013. We reported $104.4 million of net income, or $1.06 per diluted share during third quarter 2014, compared with $84.7 million, or $0.87 per diluted share during the same period in 2013. Excluding the special items discussed below, we recorded $123.9 million of net income, or $1.26 per diluted share during third quarter 2014, compared with $89.4 million, or $0.92 per share in 2013. Sales grew 84% in the first three quarters of 2014 to $4,418.7 million, and we reported $294.1 million of net income, or $2.99 per diluted share, compared with $213.2 million of net income, or $2.19 per diluted share in the first nine months of 2013. Excluding special items, we recorded $344.2 million of net income, or $3.50 per diluted share during the first three quarters of 2014, compared with $222.9 million, or $2.29 per diluted share in the first nine months of 2013.

During the three and nine months ended September 30, 2014, our packaging segment generated $164.7 million and $501.8 million of operating income, respectively, and $262.3 million and $765.3 million of earnings before interest, taxes, depreciation, amortization and depletion (EBITDA) excluding special items, respectively. Our paper segment, during the three and nine months ended September 30, 2014, generated $43.0 million and $104.3 million of operating income, respectively, and $55.9 million and $141.1 million of EBITDA excluding special items, respectively.

Compared with the three and nine months ended September 30, 2013, our results were positively affected by the Boise acquisition, which closed in October 2013. The acquisition was meaningfully accretive to our earnings before special items due to earnings generated by Boise as well as the synergies generated from the integration of its packaging business and operational improvements in the white papers business, which have resulted in lower costs and higher margins.

On October 17, 2014, we completed the No. 3 newsprint machine conversion at the DeRidder, Louisiana, mill to produce containerboard. In addition to providing our containerboard mill system with needed capacity, we expect to benefit from grade optimization and freight savings with the operation of the D3 machine. 

The three and nine months ended September 30, 2014, included $30.5 million ($21.6 million non-cash and $8.9 million cash) and $78.9 million ($43.6 million non-cash and $35.3 million cash) of pre-tax special items, respectively. The three months ended September 30, 2014, included $26.0 million of expenses related to the DeRidder mill restructuring and $4.5 million of Boise acquisition integration-related, debt-refinancing, and other costs. The nine months ended September 30, 2014,

19


included $47.8 million of expenses related to the DeRidder mill restructuring, $17.6 million of expenses related to the settlement of a class action lawsuit, and $13.5 million of integration-related and other costs.

Earnings per diluted share, excluding special items, during the three and nine months ended September 30, 2014 and 2013, were as follows.
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
2014 (a)
 
2013
 
2014 (a)
 
2013
Earnings per diluted share, as reported
$
1.06

 
$
0.87

 
$
2.99

 
$
2.19

Special items (b):
 
 
 
 
 
 
 
DeRidder restructuring
0.17

 

 
0.31

 

Integration-related and other costs
0.03

 

 
0.09

 

Class action lawsuit settlement

 

 
0.11

 

Pension curtailment charges

 
0.02

 

 
0.07

Acquisition-related financing costs

 
0.02

 

 
0.02

Acquisition-related costs

 
0.01

 

 
0.01

Total special items
0.20

 
0.05

 
0.51

 
0.10

Earnings per diluted share, excluding special items
$
1.26

 
$
0.92

 
$
3.50

 
$
2.29

____________
(a)
On October 25, 2013, we acquired Boise Inc. (Boise). The 2014 consolidated results include Boise for the full period.
(b)
See "Reconciliations of Non-GAAP Financial Measures to Reported Amounts" in this Management's Discussion and Analysis of Financial Condition and Results of Operations for more information on the special items.

Management excludes special items and uses non-GAAP measures to focus on PCA’s on-going operations and assess its operating performance and believes that it is useful to investors because it enables them to perform meaningful comparisons of past and present operating results. A reconciliation of diluted EPS to diluted EPS excluding special items is included above and the reconciliations of other non-GAAP measures used in this Management's Discussion and Analysis of Financial Condition and Results of Operations, to the most comparable measure reported in accordance with GAAP, are included in Item 2 under “Reconciliations of Non-GAAP Financial Measures to Reported Amounts.” Any analysis of non-GAAP financial measures should be done in conjunction with results presented in accordance with GAAP. The non-GAAP measures are not intended to be substitutes for GAAP financial measures and should not be used as such.

Industry and Business Conditions

Trade publications reported that industry-wide corrugated products shipments increased 1.7% during third quarter 2014, compared with the same quarter in 2013. Reported industry containerboard production was 0.9% higher than third quarter 2013, with containerboard export shipments up 13.4%. In third quarter 2014, our containerboard production was 858,000 tons, up 12,000 tons compared with the second quarter, due in part to an additional production day. In third quarter 2014, our corrugated products shipments, including Boise, increased 33% over third quarter of last year and 31% per workday with one more workday in third quarter 2014. Excluding Boise shipments, corrugated products shipments increased 6.2% in total, or 4.5% per workday. The acquisition of Crockett Packaging in April 2014, contributed about 1.5% to the increase in shipments. With strong internal containerboard demand needed to supply our box plants, we reduced our outside sales of containerboard, both domestic and export, by 19,000 tons compared with last year's third quarter and we purchased 47,000 tons of containerboard from the outside market in third quarter 2014. Our domestic containerboard pricing remained steady throughout the quarter, while our export pricing decreased slightly.

The market for communication papers competes heavily with electronic data transmission and document storage alternatives. Increasing shifts to these alternatives have reduced usage of traditional print media and communication papers. In 2014, we elected to exit some business which lowered our office paper shipments. Our office paper shipments decreased 5% or 11,000 tons in third quarter 2014, compared with Boise's shipments in third quarter of last year. Our printing and converting papers and pressure sensitive papers shipments were down about 22,000 tons compared with third quarter 2013, as a result of closing two paper machines at our International Falls, Minnesota, mill in fourth quarter 2013. In third quarter 2014, our white paper mills ran well, producing 296,000 tons. Our paper inventories were up about 6,000 tons compared with the end of second quarter 2014. Our white paper prices increased in third quarter 2014 compared with third quarter 2013 due to previously

20


announced price increases for office papers, printing and converting paper, and pressure-sensitive papers and were flat with the second quarter.

Outlook

Looking ahead to the fourth quarter, with the completed machine conversion in DeRidder, Lousiana, we expect higher containerboard mill production, which will allow us to reduce our outside purchases of containerboard. Corrugated products shipments are expected to be lower than in the third quarter with three less shipping days and some seasonal slowdown in demand that usually occurs during the holiday season. We also expect seasonally lower white paper shipments. Amortization of annual outage repair costs will be higher than the third quarter, and we expect seasonal increases in fuel and transportation costs. Considering these items, we expect fourth quarter 2014 earnings, excluding special items, to be lower than our third quarter earnings, excluding special items.

Results of Operations

Three Months Ended September 30, 2014, compared with Three Months Ended September 30, 2013

The historical results of operations of PCA for the three months ended September 30, 2014 and 2013, are set forth below (dollars in millions):
 
Three Months Ended
September 30
 
 
 
2014 (a)
 
2013
 
Change
Packaging
$
1,175.7

 
$
845.4

 
$
330.3

Paper
312.5

 

 
312.5

Corporate and other and eliminations
30.7

 

 
30.7

Net sales
$
1,518.9

 
$
845.4

 
$
673.5

 
 
 
 
 
 
Packaging
$
164.7

 
$
154.9

 
$
9.8

Paper
43.0

 

 
43.0

Corporate and other and eliminations
(19.3
)
 
(12.1
)
 
(7.2
)
Income from operations
$
188.4

 
$
142.8

 
$
45.6

 
 
 
 
 
 
Interest expense, net
(23.1
)
 
(11.9
)
 
(11.2
)
Income before taxes
165.3

 
130.9

 
34.4

Income tax provision
(60.9
)
 
(46.2
)
 
(14.7
)
Net income
$
104.4

 
$
84.7

 
$
19.7

Net income excluding special items (b)
$
123.9

 
$
89.4

 
$
34.5

Earnings, before interest, taxes, depreciation, and amortization (EBITDA)
$
292.2

 
$
186.9

 
$
105.3

EBITDA excluding special items (b)
$
303.0

 
$
191.5

 
$
111.5

____________
(a)
On October 25, 2013, we acquired Boise Inc. (Boise). The 2014 consolidated results include Boise for the full period.
(b)
See "Reconciliations of Non-GAAP Financial Measures to Reported Amounts" included in this Item 2 for a reconciliation of non-GAAP measures to the most comparable GAAP measure.


21


Net Sales

Net sales increased $673.5 million, or 79.7%, to $1,518.9 million during the three months ended September 30, 2014, compared with $845.4 million during the same period in 2013. The increase in third quarter 2014 related to a full quarter of Boise operations ($628.9 million) and increased sales in PCA's historical operations ($44.6 million).

Packaging. Sales increased $330.3 million, or 39.1%, to $1,175.7 million, compared with $845.4 million in third quarter 2013. A full quarter of Boise operations contributed $285.7 million of sales and the remaining $44.6 million increase related to higher sales volumes ($36.0 million) and higher sales price and mix ($8.6 million). In third quarter 2014, our corrugated products shipments increased 33.4% over the third quarter last year, or 31.4% per workday with one additional workday in third quarter 2014. Excluding Boise shipments, corrugated products shipments were up 6.2% compared with last year's third quarter, and increased 4.5% per workday. Our containerboard mills produced 858,000 tons, compared with 671,000 tons in third quarter 2013, prior to the acquisition of Boise.

Paper. Our paper segment sales include the sales for the white paper mills we acquired from Boise. Sales during the three months ended September 30, 2014, were $312.5 million. During this period, sales volumes of white paper were 287,000 tons.

Gross Profit

Gross profit increased $92.7 million, or 40.7%, during the three months ended September 30, 2014, compared with the same period in 2013. In third quarter 2014, gross profit included $21.8 million of special items, most of which related to incremental depreciation expense related to changing the estimated useful lives of newsprint-related assets in connection with our exit from the newsprint business in September 2014. Excluding special items, gross profit increased $114.5 million primarily related to a full quarter of Boise operations ($119.8 million). Gross profit from PCA's historical packaging operations decreased $5.4 million due to increased labor and fringe benefits, depreciation, freight, energy, and wood fiber, partially offset by higher sales price, volume, and mix. During the three months ended September 30, 2014, our gross profit as a percentage of net sales decreased to 21.1% of net sales, compared with 26.9% in the same period in 2013, due primarily to the addition of the white papers business whose products generally have lower margins than the products sold in the packaging business and also due to the DeRidder restructuring charges described above.

Selling, General, and Administrative Expenses

Selling, general, and administrative expenses increased $42.5 million, or 55.2%, during the three months ended September 30, 2014, compared with the same period in 2013. Excluding selling, general, and administrative expenses associated with the acquired Boise businesses of $39.9 million, selling, general, and administrative expenses increased $2.6 million, primarily due to increased salary and related fringe benefits expense ($2.5 million).

Other Expense, Net

Other expense, net, during the three months ended September 30, 2014, was $12.3 million, compared with $7.7 million during the three months ended September 30, 2013. Third quarter 2014 included DeRidder restructuring charges ($4.3 million) and integration-related and other costs ($3.0 million), while third quarter 2013 included a $3.1 million pension curtailment charge and $1.5 million of Boise acquisition-related costs. We discuss these items in more detail in Note 4, Other Expense, Net of the Condensed Notes to Unaudited Quarterly Consolidated Financial Statements in "Part I, Item1. Financial Statements" of this Form 10-Q.

Income from Operations

Income from operations increased $45.6 million, or 31.9%, during the three months ended September 30, 2014, compared with the same period in 2013. Third quarter 2014 included $29.0 million of expense from special items, including cash charges of $8.9 million and non-cash charges of $20.1 million. Third quarter 2014 special items included $26.0 million of charges related to restructuring the DeRidder mill we acquired from Boise and $3.0 million of integration-related and other costs. Third quarter 2013 income from operations included a $3.1 million pension curtailment charge and $1.5 million of Boise acquisition-related costs. Excluding these special items, income from operations increased $70.0 million during the three months ended September 30, 2014, compared with the same period in 2013. The increase in earnings, excluding special items, was driven by a full quarter of Boise operations, which contributed $77.8 million, and a $7.8 million decrease in PCA's historical earnings.

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Packaging. Segment income from operations increased $9.8 million, or 6.3%, to $164.7 million, compared with $154.9 million during the three months ended September 30, 2013. Excluding special items, which included $26.0 million of DeRidder restructuring charges and $1.0 million of integration-related and other costs in third quarter 2014 and $3.1 million of pension curtailment charges in third quarter 2013, segment income increased $33.7 million to $191.7 million from $158.0 million the previous year. The increase in third quarter 2014 related to a full quarter of Boise operations ($39.1 million) and slightly lower income in PCA's pre-acquisition operations, which related to increased costs for labor and fringe benefits ($9.0 million), depreciation ($4.0 million), freight ($3.0 million), energy ($2.6 million), and wood fiber ($1.4 million), partially offset by higher sales price and mix ($8.6 million), and increased sales volumes ($6.0 million).

Paper. Segment income from operations was $43.0 million during the three months ended September 30, 2014.

Interest Expense, Net, and Income Taxes

Interest expense, net, was $23.1 million during the three months ended September 30, 2014, compared with $11.9 million during the three months ended September 30, 2013. The increase in interest expense primarily related to higher average outstanding borrowings following the acquisition of Boise. In addition, in connection with our debt repayments during the three months ended September 30, 2014, we expensed $1.5 million of deferred financing costs.

During the three months ended September 30, 2014, we recorded $60.9 million of income tax expense, compared with $46.2 million of expense during the three months ended September 30, 2013. The effective tax rate for the three months ended September 30, 2014 and 2013, was 36.8% and 35.3%, respectively.

Nine Months Ended September 30, 2014, compared with Nine Months Ended September 30, 2013

The historical results of operations of PCA for the nine months ended September 30, 2014 and 2013, are set forth below (dollars in millions):
 
Nine Months Ended
September 30
 
 
 
2014 (a)
 
2013
 
Change
Packaging
$
3,418.3

 
$
2,400.9

 
$
1,017.4

Paper
917.0

 

 
917.0

Corporate and other and eliminations
83.4

 

 
83.4

Net sales
$
4,418.7

 
$
2,400.9

 
$
2,017.8

 
 
 
 
 
 
Packaging
$
501.8

 
$
395.1

 
$
106.7

Paper
104.3

 

 
104.3

Corporate and other and eliminations
(76.6
)
 
(36.1
)
 
(40.5
)
Income from operations
$
529.5

 
$
359.0

 
$
170.5

 
 
 
 
 
 
Interest expense, net
(65.3
)
 
(30.4
)
 
(34.9
)
Income before taxes
464.2

 
328.6

 
135.6

Income tax provision
(170.1
)
 
(115.4
)
 
(54.7
)
Net income
$
294.1

 
$
213.2

 
$
80.9

Net income excluding special items (b)
$
344.2

 
$
222.9

 
$
121.3

Earnings, before interest, taxes, depreciation, and amortization (EBITDA)
$
818.3

 
$
488.8

 
$
329.5

EBITDA excluding special items (b)
$
860.3

 
$
501.2

 
$
359.1

____________
(a)
On October 25, 2013, we acquired Boise Inc. (Boise). The 2014 consolidated results include Boise for the full period.
(b)
See "Reconciliations of Non-GAAP Financial Measures to Reported Amounts" included in this Item 2 for a reconciliation of non-GAAP measures to the most comparable GAAP measure.


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Net Sales

Net sales increased $2,017.8 million, or 84.0%, to $4,418.7 million during the nine months ended September 30, 2014, compared with $2,400.9 million during the same period in 2013. The increase in the first three quarters of 2014 related to a full period of Boise operations ($1,839.5 million) and increased sales in PCA's historical operations ($178.3 million), which resulted from higher sales volumes and higher sales price and mix.

Packaging. Sales increased $1,017.4 million, or 42.4%, to $3,418.3 million, compared with $2,400.9 million in the first three quarters of 2013. A full period of Boise operations contributed $839.1 million of sales and the remaining increase related to higher sales volumes ($108.1 million) and higher sales price and mix ($70.2 million) in PCA's historical operations. In the first three quarters of 2014, our corrugated products shipments increased 31.2% over the first three quarters of last year. Excluding Boise shipments, corrugated products shipments for the nine months ended September 30, 2014, were up 4.5% over the comparable period last year. Our containerboard mills produced 2,525,000 tons, or 1,967,000 tons excluding Boise, compared with 1,945,000 tons in 2013.

Paper. Our paper segment sales include the sales for the white paper mills we acquired from Boise. Sales during the nine months ended September 30, 2014, were $917.0 million. During this period, sales volumes of white paper were 847,000 tons.

Gross Profit

Gross profit increased $324.5 million, or 53.4%, during the nine months ended September 30, 2014, compared with the same period in 2013. In the first nine months of 2014, gross profit included $42.1 million of special items, most of which related to incremental depreciation related to changing the estimated useful lives of newsprint-related assets in connection with our exit from the newsprint business in September 2014. Excluding special items, gross profit increased $366.6 million, due primarily to a full nine months of Boise operations ($335.4 million). Gross profit from PCA's historical packaging operations increased $31.2 million due to higher sales price, volume, and mix, partially offset by increases in labor, depreciation, energy, freight, wood fiber, and chemicals. During the nine months ended September 30, 2014, our gross profit as a percentage of net sales decreased to 21.1% of net sales, compared with 25.3% in the same period in 2013, due primarily to the addition of the white papers business whose products generally have lower margins than the products sold in the packaging business and also due to the DeRidder restructuring charges described above.

Selling, General, and Administrative Expenses

Selling, general, and administrative expenses increased $132.4 million, or 58.4%, during the nine months ended September 30, 2014, compared with the same period in 2013. Excluding selling, general, and administrative expenses associated with the acquired Boise businesses of $120.8 million, selling, general, and administrative expenses increased $11.6 million, primarily due to increased salary and related fringe benefit expense ($9.7 million) and other increases, which were individually insignificant.

Other Expense, Net

Other expense, net, during the nine months ended September 30, 2014, was $44.0 million, compared with $22.5 million during the nine months ended September 30, 2013. During the first nine months of 2014 we recorded costs for the settlement of the Kleen Products LLC v Packaging Corp. of America et al class action lawsuit ($17.6 million), integration-related and other costs ($12.0 million), and DeRidder restructuring charges ($5.7 million). During the nine months ended September 30, 2013, we recorded a $10.9 million pension curtailment charge and $1.5 million of Boise acquisition-related costs. We discuss these items in more detail in Note 4, Other Expense, Net, and Note 18, Commitments, Guarantees, Indemnifications and Legal Proceedings of the Condensed Notes to Unaudited Quarterly Consolidated Financial Statements in "Part I, Item1. Financial Statements" of this Form 10-Q.

Income from Operations

Income from operations increased $170.5 million, or 47.5%, during the nine months ended September 30, 2014, compared with the same period in 2013. The first three quarters of 2014 included $77.4 million of expense from special items, including cash charges of $35.3 million and non-cash charges of $42.1 million. During the first nine months of 2014, special items included $47.8 million of charges related to restructuring the DeRidder mill we acquired from Boise, $17.6 million of costs incurred for the settlement of the Kleen Products LLC v Packaging Corp. of America et al class action lawsuit, and $12.0

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million of integration-related costs. The first nine months of 2013 included $12.4 million of expense related to special items. Excluding special items, income from operations increased $235.5 million during the nine months ended September 30, 2014, compared with the same period in 2013. The increase in earnings, excluding special items, was driven by a full nine months of Boise operations, which contributed $213.0 million, and a $22.5 million improvement in PCA's historical earnings.

Packaging. Segment income from operations increased $106.7 million, or 27.0%, to $501.8 million, compared with $395.1 million during the nine months ended September 30, 2013. Excluding $47.8 million of special items related to the DeRidder restructuring and $5.4 million of integration-related and other costs during the first nine months of 2014, and a $10.9 million pension curtailment charge in the first nine months of 2013, segment income increased $149.0 million. The increase in the the first three quarters of 2014 related to a full period of Boise operations ($122.4 million, excluding the special items discuss above) and increased income in PCA's pre-acquisition operations, which related to higher sales price and mix ($70.2 million), higher sales volumes ($12.8 million), partially offset by increased costs for depreciation ($12.1 million), labor ($12.1 million), energy ($8.7 million), freight ($7.9 million), wood fiber ($5.1 million), chemicals ($4.4 million), repairs ($2.8 million), and incentives ($2.4 million).

Paper. Segment income from operations was $104.3 million during the nine months ended September 30, 2014. During this period, sales volumes of white paper were 847,000 tons.

Interest Expense, Net, and Income Taxes

Interest expense, net, was $65.3 million during the nine months ended September 30, 2014, compared with $30.4 million during the nine months ended September 30, 2013. The increase in interest expense primarily related to higher average outstanding borrowings following the acquisition of Boise. In addition, in connection with our debt repayments during the nine months ended September 30, 2014, we expensed $1.5 million of deferred financing costs.

During the nine months ended September 30, 2014, we recorded $170.1 million of income tax expense, compared with $115.4 million of expense during the nine months ended September 30, 2013. The effective tax rate for the nine months ended September 30, 2014 and 2013, was 36.6% and 35.1%, respectively.

Liquidity and Capital Resources

Sources and Uses of Cash

Our primary sources of liquidity are net cash provided by operating activities and available borrowing capacity under our revolving credit facility. At September 30, 2014, we had $154.3 million of cash and $325.0 million of unused borrowing capacity under the revolving credit facility, net of letters of credit. Currently, our primary uses of cash are for operations, capital expenditures, debt service (including voluntary payments of debt), and declared common stock dividends, which we expect to be able to fund from these sources. 

We believe that net cash generated from operating activities, cash on hand, available borrowings under our revolving credit facility, and available capital through access to capital markets will be adequate to meet our liquidity and capital requirements, including payments of any declared common stock dividends, for the foreseeable future. As our debt or credit facilities become due, we will need to repay, extend, or replace such facilities. Our ability to do so will be subject to future economic conditions and financial, business, and other factors, many of which are beyond our control.


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Below is a summary table of our cash flows, followed by a discussion of our sources and uses of cash through operating activities, investing activities, and financing activities (dollars in millions):