UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________________________
Form 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2014 |
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
_____________________________________
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class | Name of Each Exchange On Which Registered | |
Common Stock, $0.01 par value | 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 (§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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) 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. x
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
At June 30, 2014, the last day of the Registrant's most recently completed second fiscal quarter, the aggregate market value of Registrant's common equity held by non-affiliates was approximately $6,937,544,233 based upon the closing sale price as reported on the New York Stock Exchange. This calculation of market value has been made for the purposes of this report only and should not be considered as an admission or conclusion by the Registrant that any person is in fact an affiliate of the Registrant.
On January 30, 2015, there were 98,368,249 shares of Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Specified portions of the Proxy Statement for the Registrant's 2015 Annual Meeting of Stockholders are incorporated by reference to the extent indicated in Part III of this Form 10-K.
Table of Contents
PART I | ||
Item 1. | ||
Item 1A. | ||
Item 1B. | ||
Item 2. | ||
Item 3. | ||
Item 4. | ||
PART II | ||
Item 5. | ||
Item 6. | ||
Item 7. | ||
Item 7A. | ||
Item 8. | ||
Item 9. | ||
Item 9A. | ||
Item 9B. | ||
PART III | ||
Item 10. | ||
Item 11. | ||
Item 12. | ||
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PART I
Item 1. | BUSINESS |
Packaging Corporation of America ("we," "us," "our," "PCA," or the "Company") is the fourth largest producer of containerboard and the third largest producer of white papers in North America, based on production capacity. We operate eight mills and 99 corrugated products manufacturing plants. We are headquartered in Lake Forest, Illinois, and have approximately 14,000 employees. Our operations are primarily in the United States and we have some converting operations in Europe, Mexico, and Canada.
On October 25, 2013, PCA acquired Boise Inc. (Boise) for $2.1 billion, including the fair value of assumed debt. After the acquisition, we began reporting in three reportable segments: Packaging, Paper, and Corporate and Other. We present information pertaining to each of our segments and the geographic areas in which they operate in Note 18, Segment Information, of the Notes to Consolidated Financial Statements in "Part II, Item 8. Financial Statements and Supplementary Data" of this Form 10-K. For more information about our acquisition of Boise, see Note 3, Acquisitions, of the Notes to Consolidated Financial Statements.
Production and Shipments
The following table summarizes the Packaging segment's containerboard production and corrugated products shipments and the Paper segment's production, including Boise Inc. Boise's historical data for periods prior to the acquisition on October 25, 2013, are included for comparative purposes only, and are not included in PCA's historical results.
First Quarter | Second Quarter | Third Quarter | Fourth Quarter (a) | Full Year | ||||||||||||
Containerboard Production | PCA | 2014 | 821 | 846 | 858 | 927 | 3,452 | |||||||||
(thousand tons) | 2013 | 646 | 629 | 671 | 803 | 2,749 | ||||||||||
2012 | 640 | 638 | 670 | 652 | 2,600 | |||||||||||
Boise | 2013 | 171 | 188 | 196 | 50 | 605 | ||||||||||
2012 | 186 | 180 | 189 | 193 | 748 | |||||||||||
Corrugated Shipments (BSF) | PCA | 2014 | 11.6 | 12.1 | 12.4 | 12.1 | 48.2 | |||||||||
2013 | 8.8 | 9.4 | 9.3 | 10.9 | 38.4 | |||||||||||
2012 | 8.5 | 8.8 | 8.6 | 8.8 | 34.7 | |||||||||||
Boise | 2013 | 2.4 | 2.5 | 2.4 | 0.7 | 8.0 | ||||||||||
2012 | 2.3 | 2.4 | 2.5 | 2.4 | 9.6 | |||||||||||
Newsprint Production | PCA | 2014 | 56 | 56 | 50 | — | 162 | |||||||||
(thousand tons) | 2013 | — | — | — | 44 | 44 | ||||||||||
Boise | 2013 | 53 | 58 | 60 | 15 | 186 | ||||||||||
2012 | 55 | 58 | 60 | 60 | 233 | |||||||||||
White Paper (UFS) Production | PCA | 2014 | 286 | 275 | 296 | 287 | 1,144 | |||||||||
(thousand tons) | 2013 | — | — | — | 208 | 208 | ||||||||||
Boise | 2013 | 303 | 301 | 323 | 76 | 1,003 | ||||||||||
2012 | 320 | 313 | 323 | 293 | 1,249 | |||||||||||
Market Pulp Production | PCA | 2014 | 26 | 23 | 26 | 25 | 100 | |||||||||
(thousand tons) | 2013 | — | — | — | 20 | 20 | ||||||||||
Boise | 2013 | 24 | 24 | 29 | 5 | 82 | ||||||||||
2012 | 39 | 30 | 26 | 25 | 120 | |||||||||||
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(a) | Production and shipments activity prior to the acquisition of Boise on October 25, 2013, is included in the "Boise" fourth quarter 2013 production and shipments. Activity subsequent to the acquisition of Boise is included in the "PCA" fourth quarter 2013 production and shipments. |
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Below is a map of our locations:
Packaging
Packaging Products
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. In addition, we are a large producer of packaging for meat, fresh fruit and vegetables, processed food, beverages, and other industrial and consumer products.
During the year ended December 31, 2014, our Packaging segment produced 3.5 million tons of containerboard at our mills. Our corrugated products manufacturing plants sold about 48.2 billion square feet (BSF) of corrugated products. Our net sales to third parties totaled $4.5 billion in 2014.
On October 17, 2014, we completed the No. 3 newsprint machine conversion at the DeRidder, Louisiana, mill to produce containerboard. After startup, the converted machine produced 58,000 tons of containerboard during the fourth quarter. We stopped producing newsprint in September 2014.
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Facilities
We manufacture our Packaging products at five containerboard mills, one containerboard machine (at our Wallula, Washington, white paper mill), corrugated manufacturing operations, and protective packaging operations. The following provides more details of our operations:
Counce. Our Counce, Tennessee, mill produces kraft linerboard. Its year-end 2014 annual estimated production capacity, as reported to the American Forest and Paper Association (AF&PA), was 1,070,000 tons. In 2014, the mill produced 1,079,000 tons of kraft linerboard on two paper machines. The mill can produce basis weights from 26 lb. to 90 lb. The mill also produces a variety of performance and specialty grades of linerboard.
DeRidder. Our DeRidder, Louisiana, mill, acquired as part of the Boise acquisition, produces kraft linerboard on its No. 1 machine and linerboard and medium on its newly-converted No. 3 machine. The year-end 2014 estimated capacity reported to the AF&PA, on the two machines, was 935,000 tons. The No. 1 machine produced 601,000 tons of kraft linerboard during 2014. The No. 3 machine, which was converted from a newsprint machine and began operation as a containerboard machine on October 17, 2014, produced 46,000 tons of medium and 12,000 tons of linerboard after conversion. The mill can produce linerboard in basis weights of 26 lb. to 69 lb. and medium in basis weights of 23 lb. to 33 lb.
Valdosta. Our Valdosta, Georgia, mill produces kraft linerboard. Its year-end 2014 annual estimated production capacity, as reported to the AF&PA, was 570,000 tons. In 2014, our single paper machine at Valdosta produced 573,000 tons of kraft linerboard. The mill can produce basis weights from 35 lb. to 96 lb.
Tomahawk. Our Tomahawk, Wisconsin, mill produces semi-chemical corrugating medium. Its year-end 2014 annual estimated production capacity, as reported to the AF&PA, was 555,000 tons. In 2014, the mill produced 555,000 tons of semi-chemical corrugating medium on two paper machines. The Tomahawk mill can produce basis weights from 23 lb. to 47 lb. and a variety of performance and specialty grades of corrugating medium.
Filer City. Our Filer City, Michigan, mill produces semi-chemical corrugating medium. Its year-end 2014 annual estimated production capacity, as reported to the AF&PA, was 440,000 tons. In 2014, the mill produced 444,000 tons on three paper machines. Filer City can produce corrugating medium in basis weight from 20 lb. to 47 lb.
Wallula. Our Wallula, Washington, mill, acquired as part of the Boise acquisition, primarily produces white paper, but also produces corrugating medium on one of its paper machines. Its year-end 2014 annual estimated production capacity of medium, as reported to the AF&PA, was 145,000 tons. In 2014, the mill produced 142,000 tons of corrugating medium. Wallula can produce corrugating medium in basis weights from 23 lb. to 45 lb.
We operate 99 corrugated manufacturing operations, a technical and development center, eight regional design centers, a rotogravure printing operation, and a complement of packaging supplies and distribution centers. Of the 99 manufacturing facilities, 65 operate as combining operations, commonly called corrugated plants, which manufacture corrugated sheets and finished corrugated containers, 33 are sheet plants which procure combined sheets and manufacture finished corrugated containers, and one is a corrugated sheet-only manufacturer.
We have corrugated manufacturing operations in 32 states in the U.S. We also have Hexacomb converting operations outside of the continental U.S., including three facilities in Europe, two in Mexico, and one in Canada.
Corrugated products plants tend to be located in close proximity to customers to minimize freight costs. Each of our plants serve a market radius of around 150 miles. Our sheet plants are generally located in close proximity to our larger corrugated plants, which enables us to offer additional services and converting capabilities such as small volume and quick turnaround items.
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Major Raw Materials Used
Fiber supply. Fiber is the single largest raw material cost to manufacture containerboard. We consume both wood fiber and recycled fiber in our containerboard mills. We have no 100% recycled mills, or mills whose fiber consumption consists solely of recycled fiber. To reduce our fiber costs, we have invested in processes and equipment to ensure a high degree of fiber flexibility. Our mill system has the capability to shift a portion of its fiber consumption between softwood, hardwood, and recycled sources. All of our mills, other than the Valdosta mill, can utilize some recycled fiber in their containerboard production. Our ability to use various types of virgin and recycled fiber helps mitigate the impact of changes in the prices of various fibers. Our corrugated manufacturing operations generate recycled fiber as a by-product from the manufacturing process, which is sold to our mills directly or through trade agreements. In 2014, we were a net recycled fiber buyer of less than 13% of our packaging mills' fiber requirements.
We procure wood fiber through leases of cutting rights, long-term supply agreements, and market purchases. We currently lease the cutting rights to approximately 88,000 acres of timberland located near our Counce, Tennessee, and Valdosta, Georgia, mills. Virtually all of the acres under cutting rights agreements are located within 100 miles of these two mills which results in lower wood transportation costs and provides a secure source of wood fiber. These leased cutting rights agreements have terms with about 14 years remaining, on average.
We participate in the Sustainable Forestry Initiative® (SFI) and we are certified under the SFI sourcing standards. These standards are aimed at ensuring the long-term health and conservation of forestry resources. We are committed to sourcing wood fiber through environmentally, socially, and economically sustainable practices and promoting resource and conservation stewardship ethics.
Energy supply. Energy at our packaging mills is obtained through purchased or self-generated fuels and electricity. Fuel sources include natural gas, by-products of the containerboard manufacturing and pulping process (including black liquor and wood waste), purchased wood waste, coal, and oil. Each of our mills self-generates process steam requirements from by-products (black liquor and wood waste), as well as from the various purchased fuels. The process steam is used throughout the production process and also to generate electricity.
In 2014, our packaging mills consumed about 59 million MMBTU’s of fuel to produce both steam and electricity. Of the 59 million MMBTU’s consumed, about 59% was from mill generated by-products, and 41% was from purchased fuels. Of the 41% in purchased fuels, 41% was from natural gas, 38% was from purchased wood waste, and 14% was from coal.
Sales, Marketing, and Distribution
Our corrugated products are sold through a direct sales and marketing organization, independent brokers, and distribution partners. We have sales representatives and a sales manager at most of our corrugated manufacturing operations and also have corporate account managers who serve customer accounts with a national presence. Additionally, our design centers maintain an on-site dedicated graphics sales force. In addition to direct sales and marketing personnel, we utilize new product development engineers and product graphics and design specialists. These individuals are located at both the corrugated plants and the design centers. General marketing support is located at our corporate headquarters.
Our containerboard sales group is responsible for the coordination of linerboard and corrugating medium sales to our corrugated plants, to other domestic customers, and to export customers. This group handles order processing for all shipments of containerboard from our mills to our corrugated plants. These personnel also coordinate and execute all containerboard trade agreements with other containerboard manufacturers.
Containerboard produced in our mills is shipped by rail or truck. Rail shipments typically represent approximately 65% of the tons shipped and the remaining 35% is comprised of truck shipments. Our corrugated products are delivered by truck due to our large number of customers and their demand for timely service. Our corrugated manufacturing operations typically serve customers within a 150 mile radius. We use third-party warehouses for short-term storage of corrugated products.
Customers
We sell corrugated products to approximately19,000 customers in over 30,000 locations. About three-quarters of our corrugated products sales are to regional and local accounts, which are broadly diversified across industries and geographic
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locations. The remaining one-quarter of our customer base consists primarily of national accounts that have multiple locations and are served by a number of PCA plants. No single customer exceeds 10% of segment sales.
The primary end-use markets in the United States for corrugated products are shown below as reported in the 2013 Fibre Box Association annual report:
Food, beverages, and agricultural products | 40 | % |
Retail and wholesale trade | 21 | % |
Paper and other products | 20 | % |
Miscellaneous manufacturing | 9 | % |
Chemical, plastic, and rubber products | 7 | % |
Furniture and related products | 3 | % |
Competition
As of December 31, 2014, we are the fourth largest producer of containerboard and corrugated products in the United States, according to industry sources and our own estimates. According to industry sources, corrugated products are produced by about 535 U.S. companies operating approximately 1,200 plants. The primary basis for competition for most of our packaging products includes quality, service, price, product design, and innovation. Most corrugated products are manufactured to the customer’s specifications. Corrugated producers generally sell within a 150-mile radius of their plants and compete with other corrugated producers in their local region. Competition in our corrugated product operations tends to be regional, although we also face competition from large competitors with significant national account presence, and competition varies based on each type of corrugated container we sell.
On a national level our primary competitors are International Paper Company, Rock-Tenn Company, Georgia-Pacific LLC, and KapStone Paper and Packaging Corporation. However, with our strategic focus on regional and local accounts, we also compete with the smaller, independent converters.
Paper
Our Paper segment operating under the trade name Boise Paper, was acquired with the acquisition of Boise Inc. on October 25, 2013. We are the third largest manufacturer of white papers in North America, according to industry sources and our own estimates. We 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. White papers consist of communication papers (cut-size office papers and printing and converting papers) and pressure sensitive papers, including release liners, which our customers use to produce labels for use in consumer and commercially-packaged products. The Paper segment also produces market pulp on one paper machine at our Wallula, Washington, mill, which is sold to outside customers to produce paper products.
Facilities
We have three white paper mills located in the United States. The following paragraphs describe our white paper mills:
Jackson. Our Jackson, Alabama, mill produces both commodity and specialty papers. Its year-end 2014 annual estimated production capacity of white papers on two paper machines, as reported to the AF&PA, was 490,000 tons. In 2014, the mill produced 494,000 tons of white papers. On a converted basis, from rollstock to cut-size white papers, the mill produced 416,000 tons in 2014.
International Falls. Our International Falls, Minnesota, mill produces both commodity and specialty papers. Its year-end 2014 annual estimated production capacity of white papers on two paper machines, as reported to the AF&PA, was 455,000 tons. In 2014, the mill produced 457,000 tons of white papers. On a converted basis, from rollstock to cut-size white papers, the mill produced 335,000 tons in 2014.
Wallula. Our Wallula, Washington, mill has the ability, on one machine, to switch production between pressure sensitive papers and a variety of white paper grades. The mill also produces corrugating medium and market pulp. Its year-end 2014 annual estimated production capacity of white paper grades and market pulp, as reported to the AF&PA, was 190,000 tons
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and 100,000 tons, respectively. The corrugating medium produced at Wallula is included in our Packaging segment as discussed above. In 2014, the mill produced 193,000 tons of white papers and 100,000 tons of market pulp.
Major Raw Materials Used
Fiber supply. Fiber is our principal raw material in this segment, including wood fiber, recycled fiber, and purchased pulp. We purchase both whole logs and wood chips, which are a byproduct of lumber and plywood production. At our mill in Jackson, Alabama, we also purchase recycled fiber to produce our line of recycled office papers. Our Jackson and International Falls paper mills also purchase pulp from third parties pursuant to contractual arrangements. We negotiate these arrangements periodically, and terms can fluctuate based on prevailing pulp market conditions, including pricing and supply dynamics.
We purchase wood fiber through contracts and open-market purchases. Our contracts are generally with suppliers located in close proximity to the specific facility they supply, and they commonly contain price adjustment mechanisms to account for market price and expense volatility.
We participate in the Sustainable Forestry Initiative® (SFI) and the Forest Stewardship Council® (FSC) and are certified under the SFI sourcing standards. We procure all wood fiber for our white paper mills through our certified systems that are managed in accordance with the SFI and FSC standards. These standards are aimed at ensuring the long-term health and conservation of forestry resources.
Energy supply. We obtain energy through purchased or self-generated fuels and electricity. Fuel sources include natural gas, electricity, by-products of the manufacturing and pulping process (including black liquor and wood waste), and purchased wood waste. Each of the paper mills self-generates process steam requirements from by-products (black liquor and wood waste), as well as from the various purchased fuels. The process steam is used throughout the production process and also to generate electricity.
In 2014, our white paper mills consumed about 29 million MMBTU’s of fuel to produce both steam and electricity. Of the 29 million MMBTU’s consumed, about 64% was from mill generated by-products, and 36% was from purchased fuels. Of the 36% in purchased fuels, 71% was from natural gas, and 29% from purchased wood waste.
Chemical supply. We consume a significant amount of chemicals in the production of white papers and pulp, including starch, precipitated calcium carbonate, caustic soda, sodium chlorate, dyestuffs, and optical brighteners. Most of our chemicals are purchased under contracts, which may contain price adjustment mechanisms or fixed prices designed to provide greater pricing stability than open-market purchases. These contracts are bid or negotiated periodically.
Sales, Marketing, and Distribution
Our white papers are sold primarily by our own sales personnel. We ship to customers both directly from our mills and through distribution centers and a network of outside warehouses by rail or truck. This allows us to respond quickly to customer requirements. Rail shipments typically represent approximately 70% of the tons shipped and the remaining 30% is comprised of truck shipments.
Customers
We have over 200 customers in approximately 500 locations. These customers include paper merchants, commercial and financial printers, envelope converters, and customers who use our pressure sensitive paper for specialty applications such as consumer and commercial product labels. We have established long-term relationships with many of our customers. OfficeMax Incorporated (OfficeMax), a wholly-owned subsidiary of Office Depot, Inc., is our largest customer in the Paper segment. We have an agreement with OfficeMax in which we will supply at least 80% of OfficeMax's requirements for commodity office papers through December 2017; however, there are circumstances that could cause the agreement to terminate before 2017. If this were to occur, OfficeMax's purchase obligations under the agreement would phase out over two years. OfficeMax was acquired by Office Depot, Inc. late in 2013. In 2014, our sales revenue to Office Depot (including OfficeMax) represented 44% of our Paper segment sales revenue.
Competition
The markets in which our Paper segment competes are large and highly competitive. Commodity grades of white paper are globally traded, with numerous worldwide manufacturers, and as a result, these products compete primarily on the basis of price. All of our paper manufacturing facilities are located in the United States, and although we compete primarily in
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the domestic market, we do face competition from foreign producers, and have experienced increased foreign competition in recent years. The level of this competition varies depending on domestic and foreign demand and foreign currency exchange rates. In general, paper production does not rely on proprietary processes or formulas, except in highly specialized or custom grades.
In January 2015, we, along with the United Steel Workers (USW) and other domestic paper producers, filed a petition before the United States International Trade Commission and the United States Department of Commerce, alleging that paper producers in China, Indonesia, Australia, Brazil, and Portugal are selling products in the United States and/or receiving government subsidies in violation of international trade rules. The agencies will investigate the claims over the next 12 to 15 months. If the investigations determine that trade rules were violated, then antidumping and/or countervailing duties will be imposed on imports from the countries found in violation. We cannot provide any assurance as to the ultimate outcome of these investigations.
Our largest competitors include Domtar Corporation, International Paper Company, and Georgia-Pacific LLC. Although price is the primary basis for competition in most of our paper grades, quality, and service are important competitive determinants. Our white papers compete with electronic data transmission, e-readers, electronic document storage alternatives, and paper grades we do not produce. Increasing shifts to these alternatives have had, and are likely to continue to have, an adverse effect on traditional print media and paper usage.
Corporate and Other
Our Corporate and Other segment includes corporate support staff services and related assets and liabilities, and foreign exchange gains and losses. This segment also includes transportation assets, such as rail cars and trucks, which we use to transport our products from our manufacturing sites and assets related to a 50% owned variable interest entity, Louisiana Timber Procurement Company, L.L.C. (LTP). For segment financial information see Note 18, Segment Information, of the Notes to Consolidated Financial Statements in "Part II, Item 8. Financial Statements and Supplementary Data" of this Form 10-K.
Employees
As of December 31, 2014, we had approximately 14,000 employees, including 4,300 salaried employees and 9,700 hourly employees. Approximately 75% of our hourly employees are represented by unions. The majority of our unionized employees are represented by the USW, the International Brotherhood of Teamsters (IBT), the International Association of Machinists (IAM), and the Association of Western Pulp and Paper Workers (AWPPW). We are currently in negotiations to renew or extend any union contracts that have recently expired or are expiring in the near future, including the agreements at our Jackson, Alabama, paper mill, which expired August 31, 2014, and DeRidder, Tomahawk, and a portion of International Falls mill, which all expire in 2015. During 2014, we experienced no work stoppages and we believe we have satisfactory labor relations with our employees.
Environmental Matters
Our discussion of the financial impact of our compliance with environmental laws is presented under the caption "Environmental Matters" in "Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" of this Form 10-K.
Executive Officers of the Registrant
Brief statements setting forth the age at February 27, 2015, the principal occupation, employment during the past five years, the year in which such person first became an officer of PCA, and other information concerning each of our executive officers appears below.
Mark W. Kowlzan, 59, Chief Executive Officer and Director - Mr. Kowlzan has served as Chief Executive Officer and a director of PCA since July 2010. From 1998 through June 2010, Mr. Kowlzan led the company’s containerboard mill system, first as Vice President and General Manager and then as Senior Vice President - Containerboard. From 1996 through 1998, Mr. Kowlzan served in various senior mill-related operating positions with PCA and Tenneco Packaging, including as manager of the Counce linerboard mill. Prior to joining Tenneco Packaging, Mr. Kowlzan spent 15 years at International Paper Company, where he held a series of operational and managerial positions within its mill organization. Mr. Kowlzan is a member of the board of American Forest and Paper Association.
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Thomas A. Hassfurther, 59, Executive Vice President - Corrugated Products - Mr. Hassfurther has served as Executive Vice President - Corrugated Products of PCA since September 2009. From February 2005 to September 2009, Mr. Hassfurther served as Senior Vice President - Sales and Marketing, Corrugated Products. Prior to this he held various senior-level management and sales positions at PCA and Tenneco Packaging. Mr. Hassfurther joined the company in 1977.
Richard B. West, 62, Senior Vice President and Chief Financial Officer - Mr. West has served as Chief Financial Officer of PCA since March 1999 and as Senior Vice President since March 2002. From April 1999 to June 2007, Mr. West also served as Corporate Secretary. From 1995 through April 1999, Mr. West served in various senior financial positions with PCA and Tenneco Packaging. Prior to joining Tenneco Packaging, Mr. West spent 20 years with International Paper Company in various financial positions.
Judith M. Lassa, 56, Senior Vice President - Paper - Ms. Lassa has served as Senior Vice President - Paper since October 2013. Prior to PCA’s acquisition of Boise Inc., she served as Executive Vice President and Chief Operating Officer of Boise from January 2013 to October 2013. Ms. Lassa served as Senior Vice President of Boise's paper and specialty products operations from November 2010 to December 2012. Prior to November 2010, she served in a number of capacities with Boise Cascade Corporation, Boise Cascade, L.L.C. and Boise Inc.
Thomas W.H. Walton, 55, Senior Vice President - Sales and Marketing, Corrugated Products - Mr. Walton has served as Senior Vice President - Sales and Marketing, Corrugated Products since October 2009. Prior to this, he served as a Vice President and Area General Manager within the Corrugated Products Group since 1998. Mr. Walton joined the company in 1981 and has also held positions in production, sales, and general management.
Kent A. Pflederer, 44, Senior Vice President, General Counsel and Secretary - Mr. Pflederer has served as General Counsel and Corporate Secretary since June 2007 and Senior Vice President since January 2013. Prior to joining PCA, Mr. Pflederer served as Senior Counsel, Corporate and Securities, at Hospira, Inc. from 2004 to 2007 and served in the corporate and securities practice at Mayer Brown, LLP from 1996 to 2004.
Charles J. Carter, 55, Senior Vice President - Containerboard Mill Operations - Mr. Carter has served as Senior Vice President - Containerboard Mill Operations since July 2013. Prior to this, he served as Vice President – Containerboard Mill Operations since January 2011. From March 2010 to January 2011, Mr. Carter served as PCA’s Director of Papermaking Technology. Prior to joining PCA in 2010, Mr. Carter spent 28 years with various pulp and paper companies in managerial and technical positions of increasing responsibility, most recently as Vice President and General Manager of the Calhoun, Tennessee, mill of Abitibi Bowater from 2007 to 2010 and as manager of SP Newsprint’s Dublin, Georgia, mill from 1999 to 2007.
Available Information
PCA’s internet website address is www.packagingcorp.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 are available free of charge through our website as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission. In addition, our Code of Ethics may be accessed in the Investor Relations section of PCA’s website. PCA’s website and the information contained or incorporated therein are not intended to be incorporated into this report.
Item 1A. | RISK FACTORS |
Some of the statements in this report and, in particular, statements found in Management’s Discussion and Analysis of Financial Condition and Results of Operations, that are not historical in nature are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include statements about our expectations regarding our future liquidity, earnings, expenditures, and financial condition. These statements are often identified by the words "will," "should," "anticipate," "believe," "expect," "intend," "estimate," "hope," or similar expressions. These statements reflect management’s current views with respect to future events and are subject to risks and uncertainties. There are important factors that could cause actual results to differ materially from those in forward-looking statements, many of which are beyond our control. These factors, risks and uncertainties include, but are not limited to, the factors described below.
Our actual results, performance, or achievement could differ materially from those expressed in, or implied by, these forward-looking statements, and accordingly, we can give no assurances that any of the events anticipated by the forward-
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looking statements will transpire or occur, or if any of them do so, what impact they will have on our results of operations or financial condition. In view of these uncertainties, investors are cautioned not to place undue reliance on these forward-looking statements. We expressly disclaim any obligation to publicly revise any forward-looking statements that have been made to reflect the occurrence of events after the date hereof.
In addition to the risks and uncertainties we discuss elsewhere in this Form 10-K (particularly in "Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations") or in our other filings with the Securities and Exchange Commission (SEC), the following are important factors that could cause our actual results to differ materially from those we project in any forward-looking statement.
Industry Risks
Industry Cyclicality - Changes in the prices of our products could materially affect our financial condition, results of operations, and liquidity. Macroeconomic conditions and fluctuations in industry capacity can create changes in prices, sales volumes, and margins for most of our products, particularly commodity grades of packaging and paper products. Prices for all of our products are driven by many factors, including general economic conditions, demand for our products, and competitive conditions in our industry, and we have little influence over the timing and extent of price changes, which are often volatile. If supply exceeds demand, prices for our products could decline, resulting in decreased earnings and cash generated from operations. Additionally, market conditions beyond our control can affect the prices for our commodity products. If the prices for our products decline or if we are unable to control our costs, it could have a material adverse effect on our operating cash flows, profitability, and liquidity.
Competition - The intensity of competition in the industries in which we operate could result in downward pressure on pricing and volume, which could lower earnings and cash generated from operations. Our industries are highly competitive, with no single containerboard, corrugated packaging, or white paper producer having a dominant position. Containerboard and commodity white paper products cannot generally be differentiated by producer, which tends to intensify price competition. The corrugated packaging industry is also sensitive to changes in economic conditions, as well as other factors including innovation, design, quality, and service. To the extent that one or more competitors are more successful than we are with respect to any key competitive factor, our business could be adversely affected. Our packaging products also compete, to some extent, with various other packaging materials, including products made of paper, plastics, wood, and various types of metal. Our white paper products compete with electronic data transmission and document storage alternatives. Increasing shifts to electronic alternatives have had and will continue to have an adverse effect on usage of these products. The intensity of competition could lead to a reduction in our market share as well as lower sales prices for our products, both of which could reduce our earnings and cash flow.
Several of our competitors are larger than we are and may have greater financial and other resources, greater manufacturing economies of scale, greater energy self sufficiency, or lower operating costs, compared with our company. We may be unable to compete with these companies particularly during economic downturns. Some of the factors that may adversely affect our ability to compete in the markets in which we participate include the entry of new competitors (including overseas producers, who have increased imports of white paper to the United States in recent years and some of whom we believe may be violating international trade rules) into the markets we serve, our competitors' pricing strategies, our inability to anticipate and respond to changing customer preferences, and our inability to maintain the cost-efficiency of our facilities.
Company Risks
Inflation and Other General Cost Increases - We are subject to both contractual, inflation, and other general cost increases. If we are unable to offset these cost increases by price increases, growth, and/or cost reductions in our operations, these inflation and other general cost increases could have a material adverse effect of our operating cash flows, profitability, and liquidity.
In 2014, our total company costs including cost of sales (COS) and selling, general, and administrative expenses (SG&A) was $5.1 billion, and excluding non-cash costs (depreciation, pension, and share-based compensation expense) was $4.7 billion. A 1% increase in COS and SG&A costs would increase costs by $51 million and cash costs by $47 million.
Certain items of product input costs have historically been subject to more cost volatility including fiber, purchased energy, and chemicals.
Cost of Fiber - An increase in the cost of fiber could increase our manufacturing costs and lower our earnings. The market price of wood fiber varies based upon availability, source, and the costs of fuels used in the harvesting and
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transportation of wood fiber. The cost and availability of wood fiber can also be impacted by weather, general logging conditions, and geography.
The availability and cost of recycled fiber depends heavily on recycling rates and the domestic and global demand for recycled products. We purchase recycled fiber for use at seven of our eight mills. In 2014, we purchased approximately 493,000 tons of recycled fiber, net of the recycled fiber generated by our corrugated box plants. The amount of recycled fiber purchased each year varies based upon production and the prices of both recycled fiber and wood fiber.
Periods of supply and demand imbalance have tended to create significant price volatility. Periods of higher recycled fiber costs and unusual price volatility have occurred in the past and may occur again in the future, which could result in lower or volatile earnings.
Cost of Purchased Energy and Chemicals - An increase in the cost of purchased energy and chemicals could lead to higher manufacturing costs, resulting in reduced earnings. We have the ability to use various types of purchased fuels in our manufacturing operations, including coal, bark, natural gas, and oil. Energy prices, in particular prices for oil and natural gas, have fluctuated dramatically in the past. New and more stringent environmental regulations may discourage, or make more expensive, the use of certain fuels. In addition, costs for key chemicals used in our manufacturing also fluctuate. These fluctuations impact our manufacturing costs and result in earnings volatility. If energy and chemical prices rise, our production costs and transportation costs will increase and cause higher manufacturing costs and reduced earnings.
Material Disruption of Manufacturing - A material disruption at one of our manufacturing facilities could prevent us from meeting customer demand, reduce our sales, and/or negatively affect our results of operations and financial condition. Our business depends on continuous operation of our facilities, particularly at our mills. Any of our manufacturing facilities, or any of our machines within such facilities, could cease operations unexpectedly for a significant period of time due to a number of events, including:
• | Unscheduled maintenance outages. |
• | Prolonged power failures. |
• | Equipment failure. |
• | Explosion of a boiler. |
• | Disruption in the supply of raw materials, such as wood fiber, energy, or chemicals. |
• | A chemical spill or release. |
• | Closure related to environmental concerns. |
• | Labor difficulties. |
• | Disruptions in the transportation infrastructure, including roads, bridges, railroad tracks, and tunnels. |
• | Fires, floods, earthquakes, hurricanes, or other catastrophes. |
• | Terrorism or threats of terrorism. |
• | Other operational problems. |
These events could harm our ability to serve our customers and lead to higher costs and reduced earnings.
Environmental Matters - PCA may incur significant environmental liabilities with respect to both past and future operations. We are subject to, and must comply with, a variety of federal, state and local environmental laws, particularly those relating to air and water quality, waste disposal and the cleanup of contaminated soil and groundwater. Because environmental regulations are constantly evolving, we have incurred, and will continue to incur, costs to maintain compliance with those laws. See Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations - Environmental Matters" for estimates of expenditures we expect to make for environmental compliance in the next few years. New and more stringent environmental regulations, including new U.S. Environmental Protection Agency rules relating to industrial boiler emissions known as the Boiler MACT rules, are expected to require us to incur significant additional capital expenditures to modify or replace certain of our boilers. In addition, environmental regulations may increase the cost of our raw materials and purchased energy. Although we have established reserves to provide for known environmental liabilities, these reserves may change over time due to the enactment of new environmental laws or regulations or changes in existing laws or regulations, which might require additional significant environmental expenditures.
Customer Concentration - OfficeMax represents a significant portion of PCA’s paper business. We have a supply agreement with OfficeMax, our largest customer in the paper segment. The agreement requires OfficeMax to buy, and us to supply, at least 80% of OfficeMax’s requirements for office papers through December 2017; however, there are circumstances that could cause the agreement to terminate before 2017. If this were to occur, OfficeMax's purchase obligations under the agreement would phase out over two years. OfficeMax was acquired by Office Depot, Inc. late in 2013. Office Depot has since
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agreed to be acquired by Staples, Inc. on February 4, 2015. The pending acquisition by Staples is subject to the satisfaction of certain conditions. If the acquisition of Office Depot by Staples is consummated, the risks described below may be intensified.
Our agreement with OfficeMax will continue to remain in effect after a merger or acquisition as to the office paper requirements of the legacy OfficeMax business. However, we cannot predict how any merger or acquisition will affect the financial condition of the ultimate entity, the paper requirements of the legacy Office Max business, the purchasing decisions of the ultimate entity or the effects on pricing or competition for office papers. In 2014, sales to Office Depot (including Office Max) represented 44% of our Paper segment sales. If these sales are reduced, whether as a result of the pending integration of Office Max into Office Depot, the future acquisition of Office Depot by Staples or otherwise, we would need to find new customers, which could harm our profitability if our prices are lower or costs are higher. Any significant deterioration in the financial condition of the ultimate entity affecting its ability to pay or any other change that results in its willingness to purchase our products will harm our business and results of operations.
Acquisition Integration - The acquired businesses may underperform relative to our expectations, and we may not be able to successfully integrate the businesses. The acquired businesses may underperform relative to our expectations, which may cause our financial results to differ from our own or the investment community’s expectations. If the acquired businesses underperform relative to our expectations, or if we fail to successfully integrate the businesses, our business, financial condition, and results of operations may be materially and adversely affected.
Cyber Security - Risks related to security breaches of company, customer, employee, and vendor information, as well as the technology that manages our operations and other business processes, could adversely affect our business. We rely on various information technology systems to capture, process, store, and report data and interact with customers, vendors, and employees. Despite careful security and controls design, implementation, updating, and internal and independent third-party assessments, our information technology systems, and those of our third party providers, could become subject to cyber attacks or security breaches. Network, system, and data breaches could result in misappropriation of sensitive data or operational disruptions including interruption to systems availability and denial of access to and misuse of applications required by our customers to conduct business with us. Misuse of internal applications; theft of intellectual property, trade secrets, or other corporate assets; and inappropriate disclosure of confidential information could stem from such incidents. Delayed sales, slowed production, or other repercussions resulting from these disruptions could result in lost sales, business delays, and negative publicity and could have a material adverse effect on our operations, financial condition, or cash flows.
Risks Related to Economic, Financial, and Investment Risk
Increased leverage may reduce our operating flexibility. At December 31, 2014, we had $2.3 billion of long-term debt outstanding and a $350.0 million undrawn revolving credit facility. We and our subsidiaries may incur additional indebtedness in the future. Our current borrowings, plus any future borrowings, may affect our future operations, including, without limitation:
• | Result in additional cash requirements to make interest and maturity payments on our outstanding indebtedness; |
• | Increase our vulnerability to adverse changes in our business or industry conditions; |
• | Limit our ability to obtain additional financing for working capital, capital expenditures, general corporate, and other purposes; |
• | Limit our flexibility in planning for, or reacting to, changes in our business and our industry; and |
• | Limit our flexibility to make acquisitions. |
Further, if we cannot service our indebtedness, we may have to take actions to secure additional cash by selling assets, seeking additional equity or reducing investments.
Market Price of our Common Stock - The market price of our common stock may be volatile, which could cause the value of the stock to decline. Securities markets worldwide periodically experience significant price declines and volume fluctuations. This market volatility, as well as general economic, market, or political conditions, could reduce the market price of our common stock in spite of our operating performance. In addition, our operating results could be below the expectations of public market analysts and investors, and in response, the market price of our common stock could decrease significantly.
General Economic Conditions - Adverse business and global economic conditions may have a material adverse effect on our business, results of operations, liquidity, and financial position. General global economic conditions adversely affect the demand and production of consumer goods, employment levels, the availability and cost of credit, and ultimately, the profitability of our business. High unemployment rates, lower family income, lower corporate earnings, lower business
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investment, and lower consumer spending typically result in decreased demand for our products. These conditions are beyond our control and may have a significant impact on our business, results of operations, liquidity, and financial position.
Item 1B. | UNRESOLVED STAFF COMMENTS |
None.
Item 2. | PROPERTIES |
We own and lease properties in our business. All of our leases are noncancelable and are primarily accounted for as operating leases. These leases are not subject to early termination except for standard nonperformance clauses.
Information concerning capacity and utilization of our principal operating facilities, the segments that use those facilities, and a map of geographical locations is presented in "Part I, Item 1. Business" of this Form 10-K. We assess the condition and capacity of our manufacturing, distribution, and other facilities needed to meet our operating requirements. Our properties have been generally well maintained and are in good operating condition. In general, our facilities have sufficient capacity and are adequate for our production and distribution requirements.
We currently own buildings and land for five containerboard mills and three white paper mills. Additionally, we have 99 corrugated manufacturing operations, of which the buildings and land for 53 are owned, including 45 combining operations, or corrugated plants, one corrugated sheet-only manufacturer, and seven sheet plants. For 20 corrugated plants and 26 sheet plants the buildings and land are leased. We own one warehouse and miscellaneous other properties, including sales offices and woodlands management offices. We lease space for regional design centers and numerous other distribution centers, warehouses, and facilities. The equipment in these leased facilities is, in virtually all cases, owned by us, except for forklifts and other rolling stock which are generally leased.
We lease the cutting rights to approximately 88,000 acres of timberland located near our Valdosta mill (77,000 acres) and our Counce mill (11,000 acres). On average, these cutting rights agreements have terms with approximately 14 years remaining. Additionally, we lease approximately 9,000 acres of land for a fiber farm, located near our Wallula mill, where we plant, grow, and harvest fiber.
Our corporate headquarters is located in Lake Forest, Illinois. The headquarter facilities are leased for the next seven years with provisions for two additional five year lease extensions. We also lease an administrative office in Boise, Idaho, which is leased through March 2018.
Item 3. | LEGAL PROCEEDINGS |
Information concerning legal proceedings can be found in 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 this Form 10-K.
Item 4. | MINE SAFETY DISCLOSURE |
Not applicable.
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PART II
Item 5. | MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES |
Market Information
PCA’s common stock is listed on the New York Stock Exchange (NYSE) under the symbol "PKG". The following table sets forth the high and low sales prices as reported by the NYSE and the cash dividends declared per common share during the last two years.
2014 | 2013 | ||||||||||||||||||||||
Sales Price | Dividends Declared | Sales Price | Dividends Declared | ||||||||||||||||||||
Quarter Ended | High | Low | High | Low | |||||||||||||||||||
March 31 | $ | 75.10 | $ | 61.35 | $ | 0.40 | $ | 44.93 | $ | 37.86 | $ | 0.31 | |||||||||||
June 30 | 72.74 | 65.00 | 0.40 | 50.78 | 42.36 | 0.40 | |||||||||||||||||
September 30 | 72.82 | 63.11 | 0.40 | 61.32 | 48.45 | 0.40 | |||||||||||||||||
December 31 | 80.14 | 57.06 | 0.40 | 64.39 | 55.66 | 0.40 | |||||||||||||||||
Stockholders
On January 30, 2015, there were 73 holders of record of our common stock.
Dividend Policy
PCA expects to continue to pay regular cash dividends, although there is no assurance as to the timing or level of future dividend payments because these depend on future earnings, capital requirements, and financial condition. The timing and amount of future dividends are subject to the determination of PCA’s Board of Directors.
On February 26, 2015, PCA announced an increase of its quarterly cash dividend on its common stock from an annual payout of $1.60 per share to an annual payout of $2.20 per share. The first quarterly dividend of $0.55 per share will be paid on April 15, 2015 to shareholders of record as of March 13, 2015.
Purchases of Equity Securities
Stock Repurchase Program
On December 14, 2011, PCA announced that its Board of Directors had authorized the repurchase of an additional $150.0 million of its common stock. In 2014, the Company did not repurchase any shares of common stock. In 2013, the Company repurchased 171,263 shares of common stock for $7.8 million, or an average price of $45.54 per share. All shares repurchased under this authorization were retired prior to the end of 2013. As of December 31, 2014, $98.1 million of the $150.0 million authorization remained available for repurchase of the Company’s common stock. All shares repurchased under this authorization have been retired.
The Company withholds shares from vesting employee equity awards to cover employee tax liabilities. Total shares withheld in 2014 were 183,170 at an average price of $71.94, or $13.2 million. Total shares withheld in 2013 were 223,995 at an average price of $48.91, or $11.0 million.
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The following table presents information related to our repurchases of common stock made under our plan announced on December 14, 2011, and shares withheld to cover taxes on vesting of equity awards, during the three months ended December 31, 2014:
Issuer Purchases of Equity Securities | ||||||||||||||
Period | Total Number of Shares Purchased (a) | Average Price Paid Per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs | ||||||||||
October 1-31, 2014 | — | $ | — | — | $ | 98,086 | ||||||||
November 1-30, 2014 | — | — | — | 98,086 | ||||||||||
December 1-31, 2014 | 14,706 | 76.55 | — | 98,086 | ||||||||||
Total | 14,706 | (a) | $ | 76.55 | — | $ | 98,086 | |||||||
____________
(a) | 14,706 shares were withheld from employees to cover income and payroll taxes on equity awards that vested during the period. |
Performance Graph
The graph below compares PCA’s cumulative 5-year total shareholder return on common stock with the cumulative total returns of the S&P 500 index; the S&P Midcap 400 index; and a Peer Group that includes three publicly-traded companies, which are International Paper Company, Kapstone Paper and Packaging Corporation, and Rock-Tenn Company. The graph tracks the performance of a $100 investment (including the reinvestment of all dividends) in our common stock, in each index, and in the peer groups' common stock from December 31, 2009, through December 31, 2014. The stock price performance included in this graph is not necessarily indicative of future stock price performance.
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Cumulative Total Return | |||||||||||||||||||||||
December 31 | |||||||||||||||||||||||
2009 | 2010 | 2011 | 2012 | 2013 | 2014 | ||||||||||||||||||
Packaging Corporation of America | $ | 100.00 | $ | 115.11 | $ | 115.88 | $ | 182.34 | $ | 308.86 | $ | 389.45 | |||||||||||
S&P 500 | 100.00 | 115.06 | 117.49 | 136.30 | 180.44 | 205.14 | |||||||||||||||||
S&P Midcap 400 | 100.00 | 126.64 | 124.45 | 146.69 | 195.84 | 214.97 | |||||||||||||||||
Peer Group | 100.00 | 105.80 | 117.87 | 160.44 | 220.35 | 251.79 | |||||||||||||||||
The information in the graph and table above is not deemed "filed" with the Securities and Exchange Commission and is not to be incorporated by reference in any of PCA’s filings under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date of this Annual Report on Form 10-K, except to the extent that PCA specifically incorporates such information by reference.
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Item 6. | SELECTED FINANCIAL DATA |
The following table sets forth selected historical financial data of PCA (dollars and shares in millions, except per share data). The information contained in the table should be read in conjunction with the disclosures in "Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Part II, Item 8. Financial Statements and Supplementary Data" of this Form 10-K.
Year Ended December 31 | |||||||||||||||||||
2014 (a) | 2013 (a) | 2012 | 2011 | 2010 | |||||||||||||||
Statement of Income Data (b): | |||||||||||||||||||
Net Sales | $ | 5,852.6 | $ | 3,665.3 | $ | 2,843.9 | $ | 2,620.1 | $ | 2,435.6 | |||||||||
Net Income | 392.6 | 441.3 | 160.2 | 158.8 | 210.0 | ||||||||||||||
Net income per common share: | |||||||||||||||||||
— basic | 3.99 | 4.57 | 1.66 | 1.60 | 2.07 | ||||||||||||||
— diluted | 3.99 | 4.52 | 1.64 | 1.58 | 2.05 | ||||||||||||||
Weighted average common shares outstanding: | |||||||||||||||||||
— basic | 97.0 | 96.6 | 96.4 | 99.3 | 101.7 | ||||||||||||||
— diluted | 97.1 | 97.5 | 97.5 | 100.4 | 102.6 | ||||||||||||||
Earnings, before interest, taxes, depreciation, and amortization (EBITDA) (c) | $ | 1,083.7 | $ | 683.7 | $ | 608.4 | $ | 437.6 | $ | 349.2 | |||||||||
Cash dividends declared per common share | 1.60 | 1.51 | 1.00 | 0.80 | 0.60 | ||||||||||||||
Balance Sheet Data (b): | |||||||||||||||||||
Total assets | $ | 5,348.5 | $ | 5,243.8 | $ | 2,494.9 | $ | 2,454.8 | $ | 2,267.5 | |||||||||
Total debt obligations | 2,379.3 | 2,572.7 | 819.5 | 830.3 | 680.6 | ||||||||||||||
Stockholders' equity | 1,521.4 | 1,356.8 | 1,008.2 | 971.2 | 1,050.6 | ||||||||||||||
____________
(a) | On October 25, 2013, we acquired Boise Inc. (Boise). Our financial results include Boise subsequent to acquisition. |
(b) | Effective January 1, 2014, the Company changed its method of accounting for 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 applied the change retrospectively to all prior periods presented herein in accordance with US generally accepted accounting principles (GAAP) relating to accounting changes. For more information, see 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 this Form 10-K. |
(c) | EBITDA represents income before interest (interest expense and interest income), income tax provision (benefit), and depreciation, amortization, and depletion. We present EBITDA because it provides a means to evaluate our performance on an ongoing basis using the same measure that is used by our management and because it is frequently used by investors and other interested parties in the evaluation of companies. EBITDA, however, is not a measure of our liquidity or financial performance under generally accepted accounting principles (GAAP) and should not be considered as an alternative to net income, income from operations, or any other performance measure derived in accordance with GAAP or as an alternative to cash flow from operating activities as a measure of our liquidity. 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. See "Reconciliations of Non-GAAP Financial Measures to Reported Amounts" included in "Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" of this Form 10-K for a reconciliation of non-GAAP measures to the most comparable GAAP measure. |
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Item 7. | MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The following discussion and analysis of historical results of operations and financial condition should be read in conjunction with the audited financial statements and the notes thereto which appear elsewhere in this Form 10-K. This discussion 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 "Part I, Item 1A. Risk Factors" of this 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 statements. Our actual results may differ materially from those contained in or implied by any of the forward-looking statements in this Form 10-K.
Overview
PCA is the fourth largest producer of containerboard and the third largest producer of white papers in North America, based on production capacity. We operate five containerboard mills, three paper mills, and 99 corrugated products manufacturing plants. 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.
Executive Summary
In 2014, sales grew 59.7% to a record $5,852.6 million. We reported $392.6 million of net income, or $3.99 per diluted share in 2014, compared with $441.3 million, or $4.52 per share in 2013. Excluding the special items discussed below, we recorded $458.6 million of net income, or a record $4.66 per diluted share in 2014, compared with $325.2 million and $3.33 per diluted share in 2013. Packaging segment income was $663.2 million, compared with $554.2 million in 2013, and earnings before interest, taxes, depreciation, amortization, and depletion (EBITDA) excluding special items was $1,015.0 million, compared with $774.7 million in 2013. Paper segment income was $135.4 million, compared with $13.5 million in 2013, and EBITDA excluding special items was $186.0 million, compared with $24.2 million for the two months and five days after the Boise acquisition in 2013.
Compared with 2013, the improvement in our 2014 financial results excluding special items, was primarily due to the Boise acquisition in October 2013. The acquisition was significantly 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.
On October 17, 2014, we completed the No. 3 newsprint machine conversion at the DeRidder, Louisiana, mill to produce containerboard, which will provide our containerboard mill system with needed capacity and reduce our outside purchases of containerboard. After startup, the machine produced 58,000 tons during the fourth quarter.
In 2014, our results included $103.3 million ($47.7 million non-cash and $55.6 million cash) of pre-tax expense from special items, compared with $87.3 million of income from special items in 2013. The 2014 special items included $65.8 million ($46.1 million non-cash and $19.7 million cash) of expenses related to the DeRidder mill restructuring, $19.9 million ($1.7 million non-cash and $18.2 million cash) of Boise acquisition integration-related, debt-refinancing, and other costs, and $17.6 million of cash expense related to the settlement of a class action lawsuit. Special items in 2013 included $166.0 million of income from the reversal of previously established tax reserves, partially offset by $67.8 million of pretax costs primarily related to the acquisition of Boise and $10.9 million of pension plan curtailment charges.
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Earnings per diluted share, excluding special items, in 2014 and 2013 were as follows:
Year Ended December 31 | |||||||
2014 | 2013 | ||||||
Earnings per diluted share | $ | 3.99 | $ | 4.52 | |||
Special items: | |||||||
DeRidder restructuring (a) | 0.43 | — | |||||
Integration-related and other costs (b) | 0.13 | 0.11 | |||||
Class action lawsuit settlement (c) | 0.11 | — | |||||
Alternative energy tax credits (d) | — | (1.70 | ) | ||||
Acquisition inventory step-up (e) | — | 0.14 | |||||
Acquisition-related costs (f) | — | 0.11 | |||||
Acquisition-related financing costs (f) | — | 0.08 | |||||
Pension curtailment charges (g) | — | 0.07 | |||||
Total special items | 0.67 | (1.19 | ) | ||||
Earnings per diluted share, excluding special items | $ | 4.66 | $ | 3.33 | |||
____________
(a) | Includes $65.8 million of costs related primarily to the conversion of the No. 3 newsprint machine at our DeRidder, Louisiana, mill and related start-up costs, and our exit from the newsprint business in September 2014 ($42.1 million after-tax or $0.43 per diluted share). |
(b) | 2014 includes $19.9 million ($12.7 million after-tax or $0.13 per diluted share) and 2013 includes $17.4 million ($11.0 million after-tax or $0.11 per diluted share) of Boise acquisition integration-related and other costs, primarily for severance, retention, travel, and professional fees. |
(c) | Includes $17.6 million of costs accrued for the settlement of the Kleen Products LLC v Packaging Corp. of America et al class action lawsuit ($11.2 million after-tax or $0.11 per diluted share). |
(d) | 2013 includes $1.70 of income per diluted share for the reversal of $166.0 million of tax reserves related to alternative energy tax credits. Approximately $103.9 million of the reversal is due to the completion of an IRS audit of PCA's Filer City mill's cellulosic biofuel tax credits and $62.1 million is from the reversal of reserves for the taxability of the alternative energy tax credits acquired in the acquisition of Boise. |
(e) | Generally accepted accounting principles (GAAP) required us to value the inventory from the acquisition of Boise at fair value, which increased the value of the inventory by $21.5 million. This reduced the profit on the sale of the acquired inventory to that portion attributable to the selling effort. This step-up in value increased expenses by $21.5 million as the acquired inventory was sold and charged to cost of sales ($13.6 million after-tax or $0.14 per diluted share). |
(f) | Includes $28.9 million of acquisition-related costs, primarily for professional fees related to transaction-advisory services and expenses related to financing the acquisition of Boise ($18.3 million after-tax or $0.19 per diluted share). |
(g) | Includes $10.9 million of non-cash pension curtailment charges related to pension plan changes in which certain hourly corrugated and containerboard mill employees will transition from a defined benefit pension plan to a defined contribution 401k plan ($7.0 million after-tax or $0.07 per diluted share). |
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. 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 later in Item 7 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 1.2% during 2014, compared with 2013. In 2014, our corrugated products shipments, including Boise, increased 25.5% over last year and 25.0% per workday with one more workday in 2014. Excluding Boise shipments, corrugated products shipments increased 4.7% in total, or 4.3% per workday. The acquisition of Crockett Packaging in April 2014 contributed about 1.0% to the increase in shipments. Reported industry containerboard production was 1.8% higher than 2013, with export shipments up 6.3%. PCA containerboard
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mill production in 2014 was 3,452,000 total tons, including 801,000 tons from Boise, compared with 2,749,000 total tons in 2013, which included 141,000 tons from Boise. With strong internal containerboard demand needed to supply our box plants, we reduced our outside sales of containerboard, both domestic and export, by 46,000 tons compared with last year and we purchased 182,000 tons of containerboard from the outside market in 2014. Our domestic containerboard pricing remained steady throughout 2014, while our export pricing decreased slightly, due, in part, to a stronger U.S. dollar.
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 2.1% or 16,000 tons in 2014, compared with Boise's shipments last year. Our printing and converting papers and pressure sensitive papers shipments were down about 18.5% or 81,000 tons compared with 2013, as a result of closing two paper machines at the International Falls, Minnesota, mill in fourth quarter 2013. In 2014, our white paper mills produced 1,144,000 tons. In 2014, our average price for all products produced in our paper segment was $996 per ton compared with the 2013 average price of $984 per ton.
Outlook
In the first quarter of 2015, we expect lost containerboard production of about 60,000 tons and higher operating costs from annual maintenance outages at Counce and DeRidder, our two largest containerboard mills, and two less production days compared with the fourth quarter of 2014. Corrugated products shipments are expected to be seasonally lower, and white paper prices are expected to be lower from the impact of published price decreases in November and December 2014 and changes in mix. Seasonally colder weather will increase wood, energy, and chemical costs. In addition, labor and benefit costs will be higher with annual wage increases and timing-related fringe benefit increases. These items will be partially offset by higher production on the DeRidder No. 3 paper machine. As a result, we expect first quarter earnings, excluding special items, to be lower than fourth quarter 2014.
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Results of Operations
Year Ended December 31, 2014, Compared with Year Ended December 31, 2013
The historical results of operations of PCA for the years ended December 31, 2014 and 2013 are set forth below (dollars in millions):
Year Ended December 31 | |||||||||||
2014 (a) | 2013 (a) | Change | |||||||||
Packaging | $ | 4,540.3 | $ | 3,431.7 | $ | 1,108.6 | |||||
Paper | 1,201.4 | 216.9 | 984.5 | ||||||||
Corporate and other and eliminations | 110.9 | 16.7 | 94.2 | ||||||||
Net sales | $ | 5,852.6 | $ | 3,665.3 | $ | 2,187.3 | |||||
Packaging | $ | 663.2 | $ | 554.2 | $ | 109.0 | |||||
Paper | 135.4 | 13.5 | 121.9 | ||||||||
Corporate and other and eliminations | (95.9 | ) | (85.8 | ) | (10.1 | ) | |||||
Income from operations | $ | 702.7 | $ | 481.9 | $ | 220.8 | |||||
Interest expense, net | (88.4 | ) | (58.3 | ) | (30.1 | ) | |||||
Income before taxes | 614.3 | 423.6 | 190.7 | ||||||||
Income tax (expense) benefit | (221.7 | ) | 17.7 | (239.4 | ) | ||||||
Net income | $ | 392.6 | $ | 441.3 | $ | (48.7 | ) | ||||
Net income excluding special items (b) | $ | 458.6 | $ | 325.2 | $ | 133.4 | |||||
EBITDA (b) | $ | 1,083.7 | $ | 683.7 | $ | 400.0 | |||||
EBITDA excluding special items (b) | $ | 1,143.6 | $ | 750.7 | $ | 392.9 | |||||
____________
(a) | On October 25, 2013, we acquired Boise Inc. (Boise). Our financial results include Boise subsequent to acquisition. |
(b) | See "Reconciliations of Non-GAAP Financial Measures to Reported Amounts" included in this Item 7 for a reconciliation of non-GAAP measures to the most comparable GAAP measure. |
Net Sales
Net sales increased $2,187.3 million, or 59.7%, to a record $5,852.6 million in 2014, compared with $3,665.3 million in 2013. The increase in 2014 related to a full year of Boise operations, compared with only two months and five days in 2013 ($1,962.8 million) and increased sales in PCA's historical operations ($224.5), which resulted from higher sales volumes and higher sales prices and mix.
Packaging. Sales increased $1,108.6 million, or 32.3%, to $4,540.3 million, compared with $3,431.7 million in 2013. A full year of Boise operations contributed $878.7 million of the increase and the remaining increase related to higher sales volumes ($160.5 million) and higher sales prices and mix ($69.4 million) in PCA's historical operations. Total corrugated products volume sold in 2014, including Boise, increased 25.5% over 2013 and shipments per workday increased 25.0%. The year ended December 31, 2014, included 251 workdays, those days not falling on a weekend or holiday, compared with 250 workdays in 2013. Excluding Boise shipments, corrugated products shipments increased 4.7% in total, or 4.3% per workday in 2014, compared with 2013. The acquisition of Crockett Packaging in April 2014, contributed about 1.0% to the increase in shipments, with the rest of the increase coming from organic growth. We reduced our outside sales of containerboard, both domestic and export, by 46,000 tons compared with last year and we purchased 182,000 tons of containerboard from the outside market in 2014. Containerboard mill production in 2014 was 3,452,000 total tons, including 801,000 tons from Boise, compared with 2,749,000 total tons in 2013, which included 141,000 tons from Boise.
Paper. Our paper segment sales include the sales for the white paper mills we acquired from Boise. Sales for 2014 were $1,201.4 million. In 2013, sales during the two months and five days we owned Boise were $216.9 million. In 2014, sales volumes of white paper were 1,114,000 tons, compared with 210,000 tons in 2013, for the period we owned Boise.
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Gross Profit
Gross profit increased $362.0 million, or 41.7%, in 2014, compared with 2013. In 2014, gross profit included $58.1 million of expense from special items, most of which related to restructuring charges at our DeRidder, Louisiana mill, including 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. In 2013, gross profit included $21.5 million of expense from special items related to the step-up in value of inventory acquired in the Boise acquisition. Excluding special items, gross profit increased $398.6 million. Approximately 90% of the increase was due to a full year of Boise operations, including realized synergies, and the remaining increase was from higher gross profit in PCA's historical packaging operations due to higher sales prices, volume, and mix, partially offset by increases in costs for labor, depreciation, freight, wood fiber, and chemical expenses. Gross profit as a percentage of net sales decreased to 21.0% of net sales in 2014 compared with 23.7% in 2013 due primarily to a full year impact of the white papers business whose products generally have lower margins than the products sold in the packaging business and the DeRidder restructuring charges described above.
Selling, General, and Administrative Expenses
Selling, general, and administrative expenses increased $142.9 million, or 43.8%, in 2014 compared with 2013. Approximately 90% of the increase relates to the acquired Boise businesses. The remaining increase in our historical PCA business is due primarily to a $12.0 million increase in salary and fringe benefit expenses and other increases, which were individually insignificant.
Other Expense, Net
Other expense, net, in 2014 was $57.3 million, which included Boise acquisition integration-related and other costs, which primarily relate to severance, retention, travel, and professional fees ($20.0 million), costs for the settlement of the Kleen Products LLC v Packaging Corp. of America et al class action lawsuit ($17.6 million), DeRidder mill restructuring costs primarily related to the conversion of the No. 3 newsprint machine to produce lightweight linerboard and corrugating medium and related start-up costs, and our exit from the newsprint business in September 2014 ($7.3 million), and asset disposals and write-offs charges ($10.1 million). In 2013, "Other expense, net" was $59.0 million, which primarily included acquisition-related costs ($17.2 million), Boise acquisition integration-related and other costs ($17.4 million), pension plan curtailment charges ($10.9 million), and asset disposals and write-offs charges ($13.2 million).
Income from Operations
Income from operations increased $220.8 million, or 45.8%, for the year ended December 31, 2014, compared with 2013. Our 2014 income from operations included $101.8 million of expense from special items, compared with $67.0 million of expense from special items in 2013. See "Reconciliations of Non-GAAP Financial Measures to Reported Amounts" in this Item 7 for more information on special items. Excluding special items, income from operations increased $255.6 million in 2014, compared with 2013. Approximately 90% of the increase was due to a full year of Boise operations, including realized synergies, and the remaining 10% was due to improvement in PCA's historical earnings.
Packaging. Segment income from operations increased $109.0 million, or 19.7%, to $663.2 million, compared with $554.2 million in 2013. Excluding $70.7 million of special items in 2014 and $30.3 million in 2013, segment income increased $149.4 million to $733.9 million, compared with $584.5 million. The increase primarily related to a full year of Boise operations in 2014 (approximately 90% of the change, including realized synergies, and excluding special items) and increased income in PCA's historical packaging business, which related to higher sales price and improved mix ($69.4 million), higher sales volume ($12.8 million), partially offset by increased costs for labor and benefits ($28.4 million), depreciation ($16.6 million), transportation ($10.9 million), energy ($10.2 million), wood fiber ($5.0 million), chemicals ($2.8 million), and repairs ($2.8 million).
Paper. Segment income from operations was $135.4 million in 2014, compared with $13.5 million for the two months and five days after the Boise acquisition in 2013. Segment income in 2013 included $3.5 million of acquisition inventory step-up costs included in cost of sales, partially offset by $1.9 million of income for an insurance settlement related to Boise's former St. Helens, Oregon, mill, net of other expenses. Excluding these special items, segment income in 2013 for the white papers business was $15.1 million.
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Interest Expense, Net, and Income Taxes
Interest expense, net, was $88.4 million in 2014, compared with $58.3 million in 2013. The increase in interest expense primarily related to higher average outstanding borrowings following the acquisition of Boise in October of 2013. Interest expense in 2014 and 2013 included $1.5 million and $1.1 million of expense, respectively, related to the write-off of deferred financing costs in connection with the repayment of debt. Also, 2013 included $10.5 million of expenses related to financing the acquisition of Boise.
In 2013, we recorded a $17.7 million income tax benefit, which included $166.0 million of income tax benefits from the reversal of the reserve for unrecognized tax benefits from alternative energy tax credits. The IRS completed its audit of PCA’s 2008 and 2009 Federal income tax returns and all claimed alternative energy tax credits were allowed. In November 2013, PCA received a confirmation letter from the Joint Committee on Taxation that their review was complete. As a result, a $103.9 million ($102.0 million of tax plus $1.9 million of accrued interest) reserve for unrecognized tax benefits for the Filer City mill’s cellulosic biofuel tax credit was fully reversed as a benefit to income taxes in 2013. Excluding the alternative energy tax credits, the 2013 effective tax rate was 35.0%, compared with 36.1% in 2014. The credits are described in Note 7, Alternative Energy Tax Credits, of the Notes to Consolidated Financial Statements in "Part II, Item 8. Financial Statements and Supplementary Data" of this Form 10-K. The effective tax rate in 2014 varies from the U.S. federal statutory tax rate of 35.0% principally due to the impact of state and local income taxes and the domestic manufacturers’ deduction.
Year Ended December 31, 2013, Compared with Year Ended December 31, 2012
The historical results of operations of PCA for the years ended December 31, 2013 and 2012 are set forth below (dollars in millions):
Year Ended December 31 | |||||||||||
2013 (a) | 2012 | Change | |||||||||
Packaging | $ | 3,431.7 | $ | 2,843.9 | $ | 587.8 | |||||
Paper | 216.9 | — | 216.9 | ||||||||
Corporate and other and eliminations | 16.7 | — | 16.7 | ||||||||
Net sales | $ | 3,665.3 | $ | 2,843.9 | $ | 821.4 | |||||
Packaging | $ | 554.2 | $ | 383.9 | $ | 170.3 | |||||
Paper | 13.5 | — | 13.5 | ||||||||
Corporate and other and eliminations | (85.8 | ) | 53.7 | (139.5 | ) | ||||||
Income from operations | $ | 481.9 | $ | 437.6 | $ | 44.3 | |||||
Interest expense, net | (58.3 | ) | (62.9 | ) | 4.6 | ||||||
Income before taxes | 423.6 | 374.7 | 48.9 | ||||||||
Provision for income taxes | 17.7 | (214.5 | ) | 232.2 | |||||||
Net income | $ | 441.3 | $ | 160.2 | $ | 281.1 | |||||
Net income excluding special items (b) | $ | 325.2 | $ | 197.2 | $ | 128.0 | |||||
EBITDA (b) | $ | 683.7 | $ | 608.4 | $ | 75.3 | |||||
EBITDA excluding special items (b) | $ | 750.7 | $ | 514.9 | $ | 235.8 | |||||
____________
(a) | On October 25, 2013, we acquired Boise. Our financial results include Boise subsequent to acquisition. |
(b) | See "Reconciliations of Non-GAAP Financial Measures to Reported Amounts" included in this Item 7 for a reconciliation of non-GAAP measures to the most comparable GAAP measure. |
Net Sales
Net sales increased $821.4 million, or 28.9%, to a record $3,665.3 million in 2013, compared with $2,843.9 million in 2012. The increase in 2013 related to higher sales price and mix ($205.5 million), higher sales volumes ($176.8 million), and two months and five days of Boise operations ($439.1 million).
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Packaging. Sales increased $587.8 million, or 20.7%, to $3,431.7 million, compared with $2,843.9 million in 2012. As discussed above, higher sales price and mix, higher sales volumes, and two months and five days of Boise operations increased sales in our Packaging segment. Corrugated products shipments per workday increased 11.1% in 2013, compared with the same period in 2012, on a shipments-per-workday basis. Excluding Boise's shipments, 2013 shipments increased 5.7% in total, and were up 6.1% per workday compared with 2012, all of which came from organic growth. Total corrugated products volume sold in 2013, including Boise, increased 10.7% over the same period last year. The year ended December 31, 2013, included 250 workdays, those days not falling on a weekend or holiday, compared with 251 workdays in 2012. Containerboard volume sold to outside domestic and export customers was essentially unchanged in 2013, compared with 2012, as the additional Boise outside containerboard sales in the partial fourth quarter were offset by decreased export sales. Containerboard mill production in 2013 was 2,749,000 tons, which included 141,000 tons from the acquired Boise mills, compared with 2,600,000 tons in 2012.
Paper. Our paper segment sales include the sales for the white paper mills we acquired from Boise. Sales for the two months and five days we owned Boise were $216.9 million. During this period, sales volumes of white paper were 210,000 tons.
Gross Profit
Gross profit increased $232.8 million, or 36.7%, in 2013, compared with 2012 due primarily to the sales price and volume increases described above. Gross profit as a percentage of net sales increased to 23.7% of net sales in 2013 compared with 22.3% in the same period in 2012. Reported 2013 gross profit was negatively affected by $21.5 million of expense for the acquisition inventory step-up related to the acquisition of Boise, of which $18.0 million was recorded in the Packaging segment and $3.5 million was recorded in the Paper segment. Excluding the step-up expense, gross profit was 24.3% of 2013 net sales.
Selling, General, and Administrative Expenses
Selling, general, and administrative expenses increased $45.8 million, or 16.3%, in 2013 compared with 2012. Excluding selling, general, and administrative expenses associated with the acquired Boise businesses of approximately $25.2 million, selling, general, and administrative expenses increased $20.6 million, primarily due to to higher costs for salaries ($6.9 million), incentive compensation ($4.8 million), fringe benefits ($1.8 million), legal expenses ($3.0 million), travel and meeting costs ($1.7 million), and broker commissions ($1.5 million).
Other Expense, Net
Other expense, net, in 2013 was $59.0 million, which primarily included acquisition-related costs ($17.2 million), Boise acquisition integration-related and other costs ($17.4 million), pension plan curtailment charges ($10.9 million), and asset disposals and write-offs charges ($13.2 million). In 2012, "Other expense, net" was $11.8 million, which related primarily to asset disposal and write-offs charges ($10.8 million).
Income from Operations
Income from operations increased $44.3 million, or 10.1%, for the year ended December 31, 2013, compared with 2012. Our 2013 income from operations included $67.1 million of expense from special items, consisting of $56.1 million of costs primarily related to the acquisition of Boise on October 25, 2013, and $10.9 million of pension plan curtailment charges. Income from operations in 2012 included $95.5 million of income related to alternative energy tax credits, offset partially by $2.0 million of plant closure charges. Excluding special items, income from operations increased $204.9 million in 2013, compared with 2012. The increase was primarily due to increased sales price, improved mix, higher sales volume, and a partial quarter of Boise operations, partially offset by increased costs.
Packaging. Segment income from operations increased $170.3 million, or 44.4%, to $554.2 million, compared with $383.9 million in 2012. Excluding $30.3 million of special items in 2013 related to acquisition inventory step-up, integration-related and other costs, and pension curtailment charges, segment income increased $198.6 million to $584.5 million, compared with $385.9 million, excluding $2.0 million of special items in 2012. The increase primarily related to increased sales price and improved mix ($219.6 million), higher sales volume ($25.2 million), and income from Boise's operations for two months and five days in the fourth quarter of 2013. These improvements were partially offset by increased costs for labor ($16.8 million), energy ($10.4 million), transportation ($6.9 million), incentive compensation ($5.5 million), wood fiber ($5.8 million), and repairs ($4.1 million).
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Paper. Segment income from operations was $13.5 million in 2013, which included $3.5 million of acquisition inventory step-up included in cost of sales, partially offset by $1.9 million of income for an insurance settlement related to Boise's St. Helens, Oregon, mill, net of other expenses. Excluding these special items, segment income for the white papers business was $15.1 million.
Interest Expense, Net, and Income Taxes
Interest expense, net, was $58.3 million in 2013, compared with $62.9 million in 2012. Excluding $10.5 million of expenses related to financing the acquisition of Boise in the fourth quarter of 2013, and $1.1 million of expense for the write-off of deferred financing costs in connection with repaying the term loan due 2016 and the receivables credit facility due 2014, interest expense was $46.7 million, compared with $38.1 million in 2012, excluding $24.8 million of debt refinancing charges. The 2013 increase in interest expense, excluding special items, primarily related to two months of increased interest expense on the higher average outstanding borrowings used to fund the acquisition of Boise.
In 2013, we recorded a $17.7 million income tax benefit, which included $166.0 million of income tax benefits from the reversal of the reserve for unrecognized tax benefits from alternative energy tax credits. The IRS completed its audit of PCA’s 2008 and 2009 Federal income tax returns and all claimed alternative energy tax credits were allowed. In November 2013, PCA received a confirmation letter from the Joint Committee on Taxation that their review was complete. As a result, a $103.9 million ($102.0 million of tax plus $1.9 million of accrued interest) reserve for unrecognized tax benefits for the Filer City mill’s cellulosic biofuel tax credit was fully reversed as a benefit to income taxes in the fourth quarter of 2013. Excluding the alternative energy tax credits, the 2013 effective tax rate was 35.0%, compared with 57.2% in 2012, as reported, or 34.4%, excluding the impact from amending our 2009 tax return in 2012 related to alternative energy tax credits. The credits are described in Note 7, Alternative Energy Tax Credits, of the Notes to Consolidated Financial Statements in "Part II, Item 8. Financial Statements and Supplementary Data" of this Form 10-K. The effective tax rate varies from the U.S. federal statutory tax rate of 35.0% principally due to the impact of the alternative energy tax credits, state and local income taxes and the domestic manufacturers’ deduction.
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. We ended the year with $124.9 million of cash and $325.1 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. 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.
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):
Year Ended December 31 | |||||||||||
2014 | 2013 | 2012 | |||||||||
Net cash provided by (used for): | |||||||||||
Operating activities | $ | 736.1 | $ | 608.2 | $ | 404.2 | |||||
Investing activities | (451.1 | ) | (1,411.4 | ) | (107.5 | ) | |||||
Financing activities | (351.1 | ) | 786.8 | (245.6 | ) | ||||||
Net (decrease) increase in cash and cash equivalents | $ | (66.1 | ) | $ | (16.4 | ) | $ | 51.1 | |||
Our foreign operations are not material to our financial position or results of operations. At December 31, 2014, we had $10.4 million of cash and short-term investments held in operations outside of the United States. We indefinitely reinvest our earnings in operations outside the United States; however, if foreign earnings were repatriated at a future date, we would need to accrue and pay taxes. It is not practicable to determine the amount of unrecognized deferred tax liability on these
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undistributed earnings because the actual tax liability, if any, is dependent on circumstances existing when the repatriation occurs.
Operating Activities
2014
The major components of cash provided by operations are earnings from continuing operations adjusted for non-cash income and expense items and changes in working capital. Earnings from continuing operations, adjusted for non-cash income and expense items, increased $216.0 million due to record earnings in 2014, which was driven by the acquisition of Boise in fourth quarter 2013. Cash used for operating assets and liabilities, excluding acquisitions, totaled $97.0 million in 2014, compared with $8.7 million in 2013. The higher requirements for operating assets and liabilities, excluding acquisitions, in 2014 were driven primarily by higher containerboard and office papers inventory levels built in advance of four of our five containerboard mills and two of our three white papers mills taking maintenance outages in the first half of 2015 and lower accounts payable levels due to the timing of payments, partially offset by a decrease in federal and state income taxes receivable at December 31, 2014, compared with December 31, 2013. Cash requirements for operating activities are subject to PCA’s operating needs and the timing of collection of receivables and payments of payables and expenses.
2013
In 2013, net cash provided by operating activities was $608.2 million, compared with $404.2 million in 2012, an increase of $204.0 million. Approximately 67.5%, or $137.7 million of the increase in cash provided by operating activities before changes in operating assets and liabilities, relate to the increase in income from our operations in 2013, which we discuss above under "Operating Results," and two months and five days of income included in 2013 from the newly acquired Boise operations. In addition, we used an additional $7.2 million of alternative energy tax credits to reduce federal income tax payments during 2013, compared with 2012. Cash used for operating assets and liabilities, excluding acquisitions, totaled $8.7 million in 2013, compared with $74.9 million in 2012. The lower requirements for operating assets and liabilities, excluding acquisitions, in 2013, were driven primarily by higher accounts payable and lower inventory levels, partially offset by lower accrued liabilities at December 31, 2013, compared with December 31, 2012.
Investing Activities
2014
We used $451.1 million for investing activities in 2014, compared with $1,411.4 million in 2013. In 2014, we spent $420.2 million for capital investments, compared with $234.4 million in 2013. The increase in capital spending was due primarily to having a full year of Boise capital investments, including $104.2 million for the the conversion of the No. 3 newsprint machine at our DeRidder, Louisiana, mill to produce containerboard. In 2014, we spent $20.5 million for the acquisition of Crockett Packaging, a corrugated products manufacturer. In 2013 we spent $1,174.5 million on the acquisition of Boise, net of $121.7 million of cash acquired.
The details of capital expenditures for property and equipment, excluding acquisitions, by segment for the years ended December 31, 2014, 2013, and 2012, are included in the table below (dollars in millions).
Year Ended December 31 | ||||||||||||
2014 | 2013 | 2012 | ||||||||||
Packaging | $ | 362.1 | $ | 222.2 | $ | 127.8 | ||||||
Paper | 51.7 | 10.0 | — | |||||||||
Corporate and Other | 6.4 | 2.2 | 0.7 | |||||||||
$ | 420.2 | $ | 234.4 | $ | 128.5 | |||||||
We expect capital investments in 2015 to be between $275.0 million and $300.0 million, including capital required for synergies and Boiler MACT spending, but excluding any acquisitions. These expenditures could increase or decrease as a result of a number of factors, including our financial results, future economic conditions, and our regulatory compliance requirements. We currently estimate capital expenditures to comply with Boiler MACT regulations (as discussed below under "Environmental Matters") in 2015 of up to $16.0 million and we expect other environmental capital expenditures of about $5.0 million in 2015.
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Our estimated environmental expenditures could vary significantly depending upon the enactment of new environmental laws and regulations, including those related to greenhouse gas emissions and industrial boilers. For additional information, see "Environmental Matters" in this Management's Discussion and Analysis of Financial Condition and Results of Operations.
At December 31, 2014, PCA had commitments for capital expenditures of $94.7 million. PCA believes that cash-on-hand combined with cash flow from operations will be sufficient to fund these commitments.
2013
Net cash used for investing activities in 2013 increased $1,303.9 million, to $1,411.4 million, compared with $107.5 million in 2012. In 2013, we paid $1,174.5 million for the acquisition of Boise, net of $121.7 million of cash acquired, while in 2012 we spent $35.4 million on the acquisition of our Cheswick, Pennsylvania, corrugated products plant. We spent $234.4 million for capital investments in 2013, compared with $128.5 million in 2012. In 2012, we received $57.4 million in grant proceeds from the U.S. Treasury.
Financing Activities
2014
In 2014, we used $351.1 million for financing activities, while financing activities provided $786.8 million in 2013. In 2014, we made $592.5 million of principal payments on long-term debt and capital leases and received $398.9 million of proceeds (net of debt discount) from long-term debt issuances, for a net reduction in debt of $193.6 million. To reduce exposure to variable interest rates, in September 2014, we issued $400 million of ten-year notes with a fixed interest rate of 3.65% and used the proceeds to pay down a portion of our five-year, variable-rate term loan. In October 2013, we entered into $2.35 billion of new credit facilities, including a $350.0 million revolver which remains undrawn. We used the proceeds from borrowings under these facilities and cash on hand to finance the acquisition of Boise, repay $953.6 million of indebtedness, which included $829.8 million of acquired Boise debt, and for general corporate purposes. In addition, in 2013, we repaid $12.2 million of outstanding debt prior to the acquisition of Boise and repaid $109.0 million under our receivables credit facility that we terminated in December 2013. In 2014, we also paid $3.4 million of financing costs, compared with $19.4 million in 2013. We paid $157.4 million of dividends in 2014, compared with $109.1 million of dividends and $7.8 million of common stock repurchases in 2013. The lower dividends paid in 2013 resulted from accelerating the dividends that would have been paid in January 2013 to December 2012. During 2014, we withheld 183,170 shares from vesting equity awards to cover employee tax liabilities of $13.2 million, compared with $11.0 million in 2013. Proceeds from the exercise of stock options and tax benefits from share-based awards contributed $15.9 million in 2014, compared with $10.7 million in 2013.
For more information about our debt, commitments, and treasury lock derivative instruments, see Note 10, Debt, Note 20, Commitments, Guarantees, Indemnifications, and Legal Proceedings, and Note 13, Derivative Instruments and Hedging Activities, respectively, of the Notes to Consolidated Financial Statements in "Part II, Item 8. Financial Statements and Supplementary Data" of this Form 10-K.
On February 26, 2015, PCA announced an increase of its quarterly cash dividend on its common stock from an annual payout of $1.60 per share to an annual payout of $2.20 per share. The first quarterly dividend of $0.55 per share will be paid on April 15, 2015 to shareholders of record as of March 13, 2015.
2013
In 2013, financing activities provided $786.8 million, while we used $245.6 million for financing activities in 2012. The change was due primarily to activities related to financing the acquisition of Boise, as described above. We paid $109.1 million of dividends and we repurchased $7.8 million of common stock in 2013, compared with $117.8 million of dividends paid and $45.2 million of common stock repurchases in 2012. The higher dividends paid in 2012 resulted from accelerating the dividends that would have been paid in January 2013 to December 2012, offset partially by increases in dividends during 2013. Beginning in 2013, we began withholding shares from vesting equity awards to cover employee tax liabilities, which amounted to $11.0 million. In 2012, we also paid $65.5 million to settle treasury locks.
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Commitments
Contractual Obligations
The table below sets forth our enforceable and legally binding obligations as of December 31, 2014, for the categories described below. Some of the amounts included in the table are based 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 necessarily subjective, our actual payments may vary from those reflected in the table. Purchase orders made in the ordinary course of business are excluded from the table below. Any amounts for which we are liable under purchase orders are reflected on the Consolidated Balance Sheets as accounts payable and accrued liabilities (dollars in millions):
Payments Due by Period | |||||||||||||||||||
Total | Less Than 1 Year | 1-3 Years | 3-5 Years | More Than 5 Years | |||||||||||||||
Term loan, due October 2018 | $ | 65.0 | $ | — | $ | — | $ | 65.0 | $ | — | |||||||||
Term loan, due October 2020 | 643.5 | 6.5 | 13.0 | 13.0 | 611.0 | ||||||||||||||
6.50% Senior Notes, due March 2018 | 150.0 | — | — | 150.0 | — | ||||||||||||||
3.90% Senior Notes, due June 2022 | 400.0 | — | — | — | 400.0 | ||||||||||||||
4.50% Senior notes, due November 2023 | 700.0 | — | — | — | 700.0 | ||||||||||||||
3.65% Senior notes, due September 2024 | 400.0 | — | — | — | 400.0 | ||||||||||||||
Total short-term and long-term debt (a) | 2,358.5 | 6.5 | 13.0 | 228.0 | 2,111.0 | ||||||||||||||
Interest on long-term debt (b) | 638.8 | 84.6 | 168.8 | 148.9 | 236.5 | ||||||||||||||
Capital lease obligations, including interest | 36.5 | 2.7 | 5.4 | 5.4 | 23.0 | ||||||||||||||
Operating leases (c) | 274.3 | 58.9 | 86.7 | 49.8 | 78.9 | ||||||||||||||
Capital commitments | 94.7 | 94.7 | — | — | — | ||||||||||||||
Purchase commitments: | |||||||||||||||||||
Raw materials (d) | 94.9 | 47.3 | 22.2 | 16.0 | 9.4 | ||||||||||||||
Energy related (e) | 47.3 | 39.5 | 7.8 | — | — | ||||||||||||||
Other long-term liabilities reflected on our Consolidated Balance Sheet (f): | |||||||||||||||||||
Compensation and benefits (g) | 368.0 | 6.3 | 48.0 | 58.2 | 255.5 | ||||||||||||||
Other (h) (i) | 70.8 | 3.2 | 10.0 | 7.6 | 50.0 | ||||||||||||||
$ | 3,983.8 | $ | 343.7 | $ | 361.9 | $ | 513.9 | $ | 2,764.3 | ||||||||||
____________
(a) | The table assumes our long-term debt is held to maturity and includes the current portion of long-term debt. See Note 10, Debt, of the Notes to Consolidated Financial Statements in "Part II, Item 8. Financial Statements and Supplementary Data" of this Form 10-K. Amounts are reported gross and do not include unamortized debt discounts of $3.1 million at December 31, 2014. |
(b) | Amounts represent estimated future interest payments as of December 31, 2014, assuming our long-term debt is held to maturity and using interest rates in effect at December 31, 2014. See "Item 7A. Quantitative and Qualitative Disclosures About Market Risk” for the impact of changes in interest rates on PCA’s future cash flows. |
(c) | We enter into operating leases in the normal course of business. We lease some of our operating facilities, as well as other property and equipment, under operating leases. Some lease agreements provide us with the option to renew the lease or purchase the leased property. Our operating lease obligations would change if we exercised these renewal options and/or if we entered into additional operating lease agreements. |
(d) | Included among our raw materials purchase obligations are contracts to purchase approximately $84.4 million of wood fiber. Purchase prices under most of these agreements are set quarterly or semiannually based on regional market prices, and the estimate is based on contract terms or first quarter 2015 pricing. Except for deposits required pursuant to wood supply contracts, these obligations are not recorded in our consolidated financial statements until contract payment terms take effect. Under most of these log, fiber, and wood chip supply agreements, we have the right to cancel or reduce our commitments in the event of a mill curtailment or shutdown. Our log, fiber, and wood chip obligations are subject to change based on, among other things, the effect of governmental laws and regulations, our manufacturing operations not operating in the normal course of business, log and fiber availability, and the status of environmental appeals. |
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(e) | We enter into utility contracts for the purchase of electricity and natural gas. We also purchase these services under utility tariffs. The contractual and tariff arrangements include multiple-year commitments and minimum annual purchase requirements. Our payment obligations were based upon prices in effect on December 31, 2014, or contract language, if available. |
(f) | Long-term deferred income taxes of $409.9 million and unrecognized tax benefits of $4.8 million, including interest and penalties, are excluded from this table, because the timing of their future cash outflows are uncertain. |
(g) | Amounts primarily consist of pension and postretirement obligations, including current portion of $6.3 million. We have no required minimum qualified pension contributions in 2015. Actuarially determined liabilities related to pension benefits are recorded based on estimates and assumptions. Key factors used in developing estimates of these liabilities include assumptions related to discount rates, retirement and mortality rates, expected contributions, and other factors. Changes in estimates and assumptions related to the measurement of funded status could have a material impact on the amount reported. In the table above, we allocated our pension obligations by year based on the future required minimum pension contributions, as determined by our actuaries. See Note 11, Employee Benefit Plans and Other Postretirement Benefits, of the Notes to Consolidated Financial Statements in "Part II, Item 8. Financial Statements and Supplementary Data" of this Form 10-K, for additional information. |
(h) | Includes current liabilities of $2.9 million related primarily to the current portion of workers' compensation liability. |
(i) | We have excluded $0.4 million of noncurrent deferred lease costs and unfavorable lease liabilities from the other long-term liabilities in the table above. These amounts have been excluded because deferred lease costs relate to operating leases which are already reflected in the operating lease category in the table, and unfavorable lease liabilities do not represent a contractual obligation which will be settled in cash. |
Off-Balance-Sheet Arrangements
The Company does not have any off-balance sheet arrangements as of December 31, 2014.
Inflation and Other General Cost Increases
We are subject to both contractual, inflation, and other general cost increases. If we are unable to offset these cost increases by price increases, growth, and/or cost reductions in our operations, these inflation and other general cost increases could have a material adverse effect of our operating cash flows, profitability, and liquidity.
In 2014, our total company costs including cost of sales (COS) and selling, general, and administrative expenses (SG&A) was $5.1 billion, and excluding non-cash costs (depreciation, pension, and share-based compensation expense) was $4.7 billion. A 1% increase in COS and SG&A costs would increase costs by $51 million and cash costs by $47 million.
Certain items of product input costs have historically been subject to more cost volatility including fiber, purchased energy, and chemicals.
Energy
In 2014, our mills, including both packaging and paper mills, consumed about 88 million MMBTU’s of fuel, including internally generated and externally purchased, to produce both steam and electricity. The following table for 2014 provides the total MMBTU's purchased externally by fuel type each quarter and the average cost per MMBTU by fuel type for the year. Our mills represent about 90% of our total purchased fuel costs. The cost per MMBTU includes the cost of the fuel plus our transportation and delivery costs.
2014 Fuel Purchased (millions of MMBTU's) | 2014 Avg. | ||||||||||||||||||
Fuel Type | First Quarter | Second Quarter | Third Quarter | Fourth Quarter | Full Year | Cost / MMBTU | |||||||||||||
Natural gas | 4.86 | 3.85 | 4.08 | 4.44 | 17.23 | $ | 5.17 | ||||||||||||
Purchased bark | 2.93 | 3.06 | 2.78 | 3.34 | 12.11 | $ | 2.75 | ||||||||||||
Coal | 1.01 | 0.85 | 0.65 | 0.83 | 3.34 | $ | 4.01 | ||||||||||||
Other fuels | 0.46 | 0.48 | 0.44 | 0.56 | 1.94 | $ | 3.17 | ||||||||||||
Total mills | 9.26 | 8.24 | 7.95 | 9.17 | 34.62 | $ | 4.10 | ||||||||||||
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In addition, the mills purchased 24.83 million CkWh (hundred kilowatt hours) of purchased electricity in 2014. The purchases by quarter and the average cost per CkWh were as follows:
2014 Purchased Electricity (millions of CkWh) | 2014 Avg. | ||||||||||||||||||
First Quarter | Second Quarter | Third Quarter | Fourth Quarter | Full Year | Cost / CkWh | ||||||||||||||
Purchased electricity | 6.33 | 6.34 | 6.69 | 5.47 | 24.83 | $ | 5.58 | ||||||||||||
Environmental Matters
Environmental compliance requirements are a significant factor affecting our business. We employ processes in the manufacture of containerboard, paper, and pulp which result in various discharges, emissions and waste disposal. These processes are subject to numerous federal, state, local and foreign environmental laws and regulations. We operate and expect to continue to operate, under environmental permits and similar authorizations from various governmental authorities that regulate such discharges, emissions, and waste disposal. The most significant of these laws affecting the Company are:
• | Resource Conservation and Recovery Act (RCRA); |
• | Clean Water Act (CWA); |
• | Clean Air Act (CAA); |
• | The Emergency Planning and Community Right-to-Know-Act (EPCRA); |
• | Toxic Substance Control Act (TSCA); and |
• | Safe Drinking Water Act (SDWA). |
We believe that we are currently in material compliance with these and all applicable environmental rules and regulations. Because environmental regulations are constantly evolving, the Company has incurred, and will continue to incur, costs to maintain compliance with these and other environmental laws. The Company works diligently to anticipate and budget for the impact of applicable environmental regulations, and does not currently expect that future environmental compliance obligations will materially affect its business or financial condition. For the years ended December 31, 2014, 2013, and 2012, we spent $43.9 million, $41.1 million, and $25.8 million, respectively, to comply with the requirements of these and other environmental laws.
As is the case with any industrial operation, PCA has, in the past, incurred costs associated with the remediation of soil or groundwater contamination, as required by the federal Comprehensive Environmental Response, Compensation and Liability Act, commonly known as the federal "Superfund" law, and analogous state laws. Cleanup requirements arise with respect to properties the Company currently owns or operates, former facilities and off-site facilities where the Company has disposed of hazardous substances. As part of the sale to PCA of the containerboard and corrugated products business of Pactiv Corporation in April 1999, Pactiv agreed to retain all liability for all former facilities and all sites associated with pre-closing off-site waste disposal. Pactiv also retained environmentally impaired real property in Filer City, Michigan unrelated to current mill operations. In addition, OfficeMax (now an indirect, wholly owned subsidiary of Office Depot) retains responsibility for certain environmental liabilities related to some of the businesses, facilities, and assets we acquired from Boise. Generally, this responsibility relates to hazardous substance releases and other environmental incidents that arose before 2004. Some of these liabilities could be significant; however, OfficeMax may not have sufficient funds to satisfy its indemnification obligations, and in some cases, we may not be entitled to such indemnification.
In January 2013, the U.S. Environmental Protection Agency (the "EPA") established a three year deadline for compliance with the Boiler MACT regulations, establishing air emissions standards and certain other requirements for industrial boilers. States are authorized to extend the deadline an additional year if they so elect. PCA is currently assessing the impact of these regulations, which are expected to require modifications to or replacement of certain of PCA’s boilers. PCA currently estimates that compliance with the final rule will require capital expenditures of up to $16 million in 2015. Due to the complexity of these regulations, and the potential for additional future regulatory or judicial modification to these regulations, this estimate is subject to further revisions. We currently expect other environmental capital expenditures of about $5.0 million in 2015. Total capital expenditures for environmental matters were $29.0 million in 2014, $6.2 million in 2013, and $1.8 million for 2012.
Because liability for remediation costs under environmental laws is strict, meaning that liability is imposed without fault, joint and several, meaning that liability is imposed on each party without regard to contribution, and retroactive, PCA
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could receive notifications of cleanup liability in the future and this liability could be material. From 1994 through 2014, remediation costs at PCA’s mills and corrugated plants totaled approximately $3.2 million and the acquired Boise locations have not incurred any significant remediation costs since Boise Inc.'s inception in 2008. As of December 31, 2014, we maintained an environmental reserve of $35.4 million relating to on-site landfills and surface impoundments as well as ongoing and anticipated remedial projects. The Company believes that it is not reasonably possible that future environmental expenses above the $35.4 million accrued at December 31, 2014, will have a material impact on its financial condition, results of operations, and cash flows.
While legislation regarding the regulation of greenhouse gas emissions has been proposed at the federal level, it is uncertain whether such legislation will be passed and, if so, what the breadth and scope of such legislation will be. The result of the regulation of greenhouse gas emissions could be an increase in our future environmental compliance costs, through caps, taxes or additional capital expenditures to modify facilities, which may be material. However, climate change legislation and the resulting future energy policy could also provide us with opportunities if the use of renewable energy is encouraged. We currently self-generate a significant portion of our power requirements at our mills using bark, black liquor and biomass as fuel, which are derived from renewable resources. While we believe we are well-positioned to take advantage of any renewable energy incentives, it is uncertain what the ultimate costs and opportunities of any climate change legislation will be and how our business and industry will be affected.
Critical Accounting Policies and Estimates
Management’s discussion and analysis of financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an ongoing basis, PCA evaluates its estimates, including those related to business combinations, goodwill and intangible assets, pensions and other postretirement benefits, environmental liabilities, income taxes, and long-lived asset impairment, among others. PCA bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Critical accounting estimates are those that are most important to the portrayal of our financial condition and results. These estimates require management's most difficult, subjective, or complex judgments. We review the development, selection, and disclosure of our critical accounting estimates with the Audit Committee of our board of directors. The Company believes that of its significant accounting policies, the following involve a higher degree of judgment and/or complexity:
Pensions
The Company accounts for defined benefit pension plans in accordance with Accounting Standards Codification (ASC) 715, "Compensation - Retirement Benefits." The calculation of pension expense and pension liabilities requires decisions about a number of key assumptions that can significantly affect expense and liability amounts, including discount rates, expected return on plan assets, expected rate of compensation increases, longevity and service lives of participants, expected contributions, and other factors. The pension assumptions used to measure pension expense and liabilities are discussed in Note 11, Employee Benefit Plans and Other Postretirement Benefits.
We recognize the funded status of our pension plans on our Consolidated Balance Sheet and recognize the actuarial and experience gains and losses and the prior service costs and credits as a component of "Accumulated Other Comprehensive Loss" in our Consolidated Statement of Changes in Stockholders' Equity. Actual results that differ from assumptions are accumulated and amortized over future periods and, therefore, generally affect recognized expense in future periods. At December 31, 2014, we had approximately $126.1 million of actuarial losses recorded in "Accumulated other comprehensive loss, net of tax" on our Consolidated Balance Sheet. Accumulated losses in excess of 10% of the greater of the projected benefit obligation or the market-related value of assets will be recognized on a straight-line basis over the average remaining service period of active employees, which is between seven to ten years, to the extent that losses are not offset by gains in subsequent years. While we believe that the assumptions used to measure our pension obligations are reasonable, differences in actual experience or changes in assumptions may materially affect our pension obligations and future expense.
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We believe that the accounting estimate related to pensions is a critical accounting estimate because it is highly susceptible to change from period to period. As discussed above, the future effects of pension plans on our financial position and results of operations will depend on economic conditions, employee demographics, mortality rates, retirement rates, investment performance, and funding decisions, among other factors. The following table presents selected assumptions used and expected to be used in the measurement of pension expense in the following periods (dollars in millions):
Year Ending December 31, 2015 | Year Ended December 31 | ||||||||||
2014 | 2013 | ||||||||||
Pension expense | $ | 30.5 | $ | 25.3 | $ | 46.4 | |||||
Assumptions | |||||||||||
Discount rate | 4.14 | % | 5.00 | % | 4.57 | % | |||||
Expected rate of return on plan assets | 6.73 | % | 6.69 | % | 6.53 | % | |||||
A change of 0.25% in either direction to the discount rate or the expected rate of return on plan assets would have had the following effect on 2014 and 2015 pension expense (dollars in millions):
Base Expense | Increase (Decrease) in Pension Expense (a) | ||||||||||
0.25% Increase | 0.25% Decrease | ||||||||||
2014 Expense | |||||||||||
Discount rate | $ | 25.3 | $ | (0.8 | ) | $ | 1.9 | ||||
Expected rate of return on plan assets | 25.3 | (1.9 | ) | 1.9 | |||||||
2015 Expense | |||||||||||
Discount rate | $ | 30.5 | $ | (2.9 | ) | $ | 3.7 | ||||
Expected rate of return on plan assets | 30.5 | (2.0 | ) | 2.0 | |||||||
____________
(a) | The sensitivities shown above are specific to 2014 and 2015. The sensitivities may not be additive, so the impact of changing multiple factors simultaneously cannot be calculated by combining the individual sensitivities shown. |
For more information related to our pensions benefit plans, see Note 11, Employee Benefit Plans and Other Postretirement Benefits, of the Notes to Consolidated Financial Statements in "Part II, Item 8. Financial Statements and Supplementary Data" of this Form 10-K.
Goodwill and Intangible Asset Impairment
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 December 31, 2014, we had $546.8 million of goodwill, of which we recorded $458.6 million in connection with the acquisition of Boise in fourth quarter 2013. At December 31, 2014, we had $491.6 million and $55.2 million of goodwill recorded in our Packaging and Paper segments, respectively. All of our intangible assets are amortized over their estimated useful lives.
We maintain two reporting units for purposes of our goodwill and intangible asset impairment testing, Packaging and Paper, which are the same as our operating segments discussed in Note 18, Segment Information, of the Notes to Consolidated Financial Statements in "Part II, Item 8. Financial Statements and Supplementary Data" of this Form 10-K. We test goodwill for impairment annually in the fourth quarter or sooner if events or changes in circumstances indicate that the carrying value of the asset may exceed fair value.
In conducting our goodwill impairment analysis, we utilize the income approach, based on a discounted cash flow model (Level 3 measurement). The fair value was also calculated using the market approach based primarily on comparable company EBITDA multiples (Level 2 measurement) and was compared to and supported the fair value based upon the discounted cash flow approach. We believe that the discounted cash flow model captures our estimates regarding the results of our future prospects; however, we also considered the market's expectations based on observable market information. The
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discounted cash flow model estimates the projected future cash flows to be generated by our reporting units, discounted to present value using a discount rate for a potential market participant. The market approach estimates fair value based on multiples of EBITDA. The following assumptions are key to our estimates of fair value:
Business Projections. The discounted cash flow model utilizes business projections that are developed internally by management for use in managing the business. These projections include significant assumptions such as estimates of future revenues, profits, income taxes, and capital expenditures. Our forecasts take into consideration recent sales data for existing products, planned timing of capital projects, and key economic indicators to estimate future production volumes, selling prices, and key input costs for our manufactured products. Our pricing assumptions are estimated based upon an assessment of industry supply and demand dynamics for our major products.
Growth Rates. A growth rate is used to calculate the terminal value in the discounted cash flow model. The growth rate is the expected rate at which earnings or revenue is projected to grow beyond the forecast period.
Discount Rates. Future cash flows are discounted at a rate that is consistent with a weighted average cost of capital for a potential market participant. The weighted average cost of capital is an estimate of the overall after-tax rate of return required by equity and debt holders of a business enterprise. The discount rates selected are based on existing conditions within our industry and reflect adjustments for potential risk premiums in those markets as well as weighting of the market cost of equity versus debt.
EBITDA Multiples. The market approach requires the use of a valuation multiple to calculate the estimated fair value of a reporting unit. We use an EBITDA multiple based on a selection of comparable companies and recent acquisition transactions within our industries.
Based on the results of the first step of the goodwill impairment test, we determined that the fair value of our Packaging and Paper reporting units were substantially in excess of the carrying amount, and therefore, no goodwill impairment existed. As a result, the second step of the goodwill impairment test was not required to be completed.
If management's estimates of future operating results materially change or if there are changes to other assumptions, the estimated fair value of our identifiable intangible assets and goodwill could change significantly. Such change could result in impairment charges in future periods, which could have a significant noncash impact on our operating results and financial condition. We cannot predict the occurrence of future events that might adversely affect the reported value of our goodwill and intangible assets. As additional information becomes known, we may change our estimates.
Long-Lived Asset Impairment
An impairment of a long-lived asset exists when the carrying value of an asset is not recoverable through future undiscounted cash flows from operations and when the carrying value of the asset exceeds its fair value. Long-lived asset impairment is a critical accounting estimate, as it is susceptible to change from period to period.
We review the carrying value of long-lived assets for impairment when events or changes in circumstances indicate that the carrying amount of assets may not be recoverable. For purposes of testing for impairment, we group our long-lived assets at the lowest level for which identifiable cash flows are largely independent of the cash flows from other assets and liabilities. Our asset groupings vary based on the related business in which the long-lived asset is employed and the interrelationship between those long-lived assets in producing net cash flows. Asset groupings could change in the future if changes in the operations of the business or business environment affect the way particular long-lived assets are employed or the interrelationships between assets. To estimate whether the carrying value of an asset or asset group is impaired, we estimate the undiscounted cash flows that could be generated under a range of possible outcomes. To measure future cash flows, we are required to make assumptions about future production volumes, future product pricing, and future expenses to be incurred. In addition, estimates of future cash flows may change based on the availability of fiber, environmental requirements, capital spending, and other strategic management decisions. We estimate the fair value of an asset or asset group based on quoted market prices for similar assets and liabilities or inputs that are observable either directly (Level 1 measurement) or indirectly (the amount for which the asset(s) could be bought or sold in a current transaction with a third party) when available (Level 2 measurement). When quoted market prices are not available, we use a discounted cash flow model to estimate fair value (Level 3 measurement).
We periodically assess the estimated useful lives of our assets. Changes in circumstances, such as changes to our operational or capital strategy, changes in regulation, or technological advances, may result in the actual useful lives differing
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from our estimates. Revisions to the estimated useful lives of assets requires judgment and constitutes a change in accounting estimate, which is accounted for prospectively by adjusting or accelerating depreciation and amortization rates. During the year ended December 31, 2014, we recognized $42.0 million of accelerated depreciation expense related to shortening the useful lives of assets at the DeRidder, Louisiana, mill, which primarily related to the newsprint business we exited in 2014.
Income Taxes
We account for income taxes and separately recognize deferred tax assets and deferred tax liabilities. We are subject to income taxes in both the U.S. and foreign jurisdictions. Significant judgments and estimates are required in determining the consolidated income tax expense and our tax basis in assets and liabilities.
PCA’s annual tax rate is determined based on income, statutory tax rates and the tax impacts of items treated differently for tax purposes than for financial reporting purposes. Tax law requires some items to be included in the tax return at different times than the items reflected in the financial statements. As a result, the annual tax rate in the financial statements is different than the rate reported on PCA’s tax return. Some of these differences are permanent, such as expenses that are not deductible in the tax return, and some differences are temporary, reversing over time, such as depreciation expense. These temporary differences create deferred tax assets and liabilities. We also recognize only the impact of tax positions that, based on their technical merits, are more likely than not to be sustained upon an audit by the taxing authority.
Inherent in determining the annual tax rate are judgments regarding business plans, planning opportunities, and expectations about future outcomes. Significant management judgments are required for the following items:
• | Management reviews PCA’s deferred tax assets for realizability. Valuation allowances are established when management believes that it is more likely than not that some portion of the deferred tax assets will not be realized. Changes in valuation allowances from period to period are included in the tax provision. |
• | PCA establishes accruals for unrecognized tax benefits when, despite the belief that PCA’s tax return positions are fully supported, PCA believes that an uncertain tax position does not meet the recognition threshold of ASC 740, "Income Taxes." The tax contingency accruals are adjusted in light of changing facts and circumstances, such as the progress of tax audits, the expiration of the statute of limitations for the relevant taxing authority to examine a tax return, case law and emerging legislation. While it is difficult to predict the final outcome or timing of resolution for any particular tax matter, PCA believes that the accruals for unrecognized tax benefits at December 31, 2014, reflect the likely outcome of known tax contingencies as of such date in accordance with accounting for uncertainty in income taxes under ASC 740. |
The calculation of our tax liabilities involves dealing with uncertainties in the application of complex U.S. and foreign tax regulations, exposures from not filing in some jurisdictions, and transfer pricing exposures from allocation of income between jurisdictions. It is inherently difficult and subjective to estimate uncertain tax positions, because we have to determine the probability of various possible outcomes. We evaluate these uncertain tax positions on a quarterly basis. This evaluation is based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, effectively settled issues under audit, and new audit activity. Such a change in recognition or measurement would result in the recognition of a tax benefit or an additional charge to the tax provision.
New and Recently Adopted Accounting Standards
For a listing of our new and recently adopted accounting standards, see 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 this Form 10-K.
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Reconciliations of Non-GAAP Financial Measures to Reported Amounts
Income from operations and net income excluding special items are non-GAAP financial measures. 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. 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. Reconciliations of the non-GAAP measures to the most comparable measure reported in accordance with GAAP for the years ended December 31, 2014, 2013, and 2012, follow (in millions, except per share amounts):
Year Ended December 31 | |||||||||||||||||||||||
2014 (a) | 2013 (a) | 2012 | |||||||||||||||||||||
Income from Operations | Net Income | Income from Operations | Net Income | Income from Operations | Net Income | ||||||||||||||||||
As reported in accordance with GAAP | $ | 702.7 | $ | 392.6 | $ | 481.9 | $ | 441.3 | $ | 437.6 | $ | 160.2 | |||||||||||
Special items: | |||||||||||||||||||||||
DeRidder restructuring (b) | 65.8 | 42.1 | — | — | — | — | |||||||||||||||||
Integration-related and other costs (c) | 18.4 | 12.7 | 17.4 | 11.0 | — | — | |||||||||||||||||
Class action lawsuit settlement (d) | 17.6 | 11.2 | — | — | — | — | |||||||||||||||||
Alternative energy tax credits (e) | — | — | — | (166.0 | ) | (95.5 | ) | 23.0 | |||||||||||||||
Acquisition inventory step-up (f) | — | — | 21.5 | 13.6 | — | — | |||||||||||||||||
Acquisition-related costs (g) | — | — | 17.2 | 10.9 | — | — | |||||||||||||||||
Acquisition-related financing costs (g) | — | — | — | 7.4 | — | — | |||||||||||||||||
Pension curtailment charges (h) | — | — | 10.9 | 7.0 | — | — | |||||||||||||||||
Debt financing charges (i) | — | — | — | — | — | 16.0 | |||||||||||||||||
State income tax adjustments | — | — | — | — | — | (3.4 | ) | ||||||||||||||||
Plant closure charges | — | — | — | — | 2.0 | 1.4 | |||||||||||||||||
Total special items | 101.8 | 66.0 | 67.0 | (116.1 | ) | (93.5 | ) | 37.0 | |||||||||||||||
Excluding special items | $ | 804.5 | $ | 458.6 | $ | 548.9 | $ | 325.2 | $ | 344.1 | $ | 197.2 | |||||||||||
_________
(a) | On October 25, 2013, we acquired Boise Inc. (Boise). Our financial results include Boise subsequent to acquisition. |
(b) | Includes $65.8 million of costs related primarily to the conversion of the No. 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. |
(c) | 2014 and 2013 include $18.4 million and $17.4 million, respectively, of Boise acquisition integration-related and other costs, primarily for severance, retention, travel, and professional fees. 2014 includes $1.5 million of expense related to the write-off of deferred financing costs in connection with the debt refinancing recorded in "Interest expense, net". |
(d) | Includes $17.6 million of costs for the settlement of the Kleen Products LLC v Packaging Corp. of America et al class action lawsuit recorded in "Other expense, net". See Note 20, Commitments, Guarantees, Indemnifications, and Legal Proceedings, for more information. |
(e) | 2013 includes the reversal of $166.0 million of tax reserves related to alternative energy tax credits. Approximately $103.9 million of the reversal is due to the completion of the IRS audit of PCA's Filer City mill's cellulosic biofuel tax credits and $62.1 million is from the reversal of a reserve for the taxability of the alternative energy tax credits acquired in the acquisition of Boise. |
In first quarter 2012, PCA amended its 2009 tax return to reduce the gallons claimed as cellulosic biofuel producer credits previously recorded as a tax benefit, and increase the gallons claimed for alternative energy tax credits previously recorded as income. The increase in gallons claimed as alternative energy tax credits resulted in income of $95.5 million, and the decrease in gallons claimed as cellulosic biofuel producer credits resulted in a decrease in tax benefits of $118.5 million, or a net charge of $23.0 million.
(f) | Generally accepted accounting principles required us to value the inventory from the acquisition of Boise at fair value, which increased the value of the inventory by $21.5 million. This reduced the profit on the sale of the acquired inventory to that portion attributable to the selling effort. This step-up in value increased expenses by $21.5 million as the acquired inventory was sold and charged to cost of sales. |
(g) | Includes acquisition-related costs, primarily for professional fees related to transaction-advisory services and expenses related to financing the acquisition of Boise. |
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(h) | Includes $10.9 million of non-cash pension curtailment charges related to pension plan changes in which certain hourly corrugated and containerboard mill employees will transition from a defined benefit pension plan to a defined contribution 401k plan. |
(i) | Consists of charges related to the Company’s refinancing of debt completed in 2012, including the redemption premium, the charge to settle the treasury lock prior to its maturity, and other items. |
The following table reconciles net income (loss) to EBITDA for the periods indicated (dollars in millions):
Year Ended December 31 | |||||||||||||||||||
2014 | 2013 | 2012 | 2011 | 2010 | |||||||||||||||
Net income (loss) | $ | 392.6 | $ | 441.3 | $ | 160.2 | $ | 158.8 | $ | 210.0 | |||||||||
Interest expense, net | 88.4 | 58.3 | 62.9 | 29.2 | 32.3 | ||||||||||||||
Provision (benefit) for income taxes | 221.7 | (17.7 | ) | 214.5 | 86.0 | (49.4 | ) | ||||||||||||
Depreciation, amortization, and depletion | 381.0 | 201.8 | 170.8 | 163.6 | 156.3 | ||||||||||||||
EBITDA (a) | $ | 1,083.7 | $ | 683.7 | $ | 608.4 | $ | 437.6 | $ | 349.2 | |||||||||
Special items: | |||||||||||||||||||
DeRidder restructuring | $ | 23.9 | $ | — | $ | — | $ | — | $ | — | |||||||||
Integration-related and other costs | 18.4 | 17.4 | — | — | — | ||||||||||||||
Class action lawsuit settlement | 17.6 | — | — | — | — | ||||||||||||||
Acquisition inventory step-up | — | 21.5 | — | — | — | ||||||||||||||
Acquisition-related costs | — | 17.2 | — | — | — | ||||||||||||||
Pension curtailment charges | — | 10.9 | — | — | — | ||||||||||||||
Plant closure charges | — | — | 2.0 | 7.4 | 13.2 | ||||||||||||||
Alternative energy tax credits | — | — | (95.5 | ) | — | 86.8 | |||||||||||||
Medical benefits reserve adjustment | — | — | — | (1.6 | ) | — | |||||||||||||
EBITDA excluding special items (a) | $ | 1,143.6 | $ | 750.7 | $ | 514.9 | $ | 443.4 | $ | 449.2 | |||||||||
____________
(a) | EBITDA and EBITDA, excluding special items, are non-GAAP financial measures. We present these measures because they provide a means to evaluate the performance of our segments and our company on an ongoing basis using the same measures that are used by our management and because these measures are frequently used by investors and other interested parties in the evaluation of companies and the performance of their segments. For each non-GAAP financial measure, we provide a reconciliation to the most directly comparable financial measure presented in accordance with GAAP. These measures may differ from similarly captioned measures of other companies. 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. |
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The following table reconciles segment income (loss) to EBITDA and EBITDA excluding special items:
Year Ended December 31 | |||||||||||
2014 | 2013 | 2012 | |||||||||
Packaging | |||||||||||
Segment income | $ | 663.2 | $ | 554.2 | $ | 383.9 | |||||
Depreciation, amortization, and depletion | 323.0 | 190.2 | 169.4 | ||||||||
EBITDA | 986.2 | 744.4 | 553.3 | ||||||||
DeRidder restructuring | 23.9 | — | — | ||||||||
Integration-related and other costs | 4.9 | 1.4 | — | ||||||||
Acquisition inventory step-up | — | 18.0 | — | ||||||||
Pension curtailment charges | — | 10.9 | — | ||||||||
Plant closure charges | — | — | 2.0 | ||||||||
EBITDA excluding special items | $ | 1,015.0 | $ | 774.7 | $ | 555.3 | |||||
Paper | |||||||||||
Segment income | $ | 135.4 | $ | 13.5 | $ | — | |||||
Depreciation, amortization, and depletion | 50.6 | 9.1 | — | ||||||||
EBITDA | 186.0 | 22.6 | — | ||||||||
Integration-related and other costs | — | (1.9 | ) | — | |||||||
Acquisition inventory step-up | — | 3.5 | — | ||||||||
EBITDA excluding special items | $ | 186.0 | $ | 24.2 | $ | — | |||||
Corporate and Other | |||||||||||
Segment income (loss) | $ | (95.9 | ) | $ | (85.8 | ) | $ | 53.7 | |||
Depreciation, amortization, and depletion | 7.4 | 2.5 | 1.4 | ||||||||
EBITDA | (88.5 | ) | (83.3 | ) | 55.1 | ||||||
Integration-related and other costs | 13.5 | 17.9 | — | ||||||||
Class action lawsuit settlement | 17.6 | — | — | ||||||||
Acquisition-related costs | — | 17.2 | — | ||||||||
Alternative energy tax credits | — | — | (95.5 | ) | |||||||
EBITDA excluding special items | $ | (57.4 | ) | $ | (48.2 | ) | $ | (40.4 | ) | ||
EBITDA | $ | 1,083.7 | $ | 683.7 | $ | 608.4 | |||||
EBITDA excluding special items | $ | 1,143.6 | $ | 750.7 | $ | 514.9 | |||||
Item 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
PCA is exposed to the impact of interest rate changes and changes in the market value of its financial instruments. PCA periodically enters into derivatives in order to minimize these risks, but not for trading purposes. For a discussion of derivatives and hedging activities, see Note 13, Derivative Instruments and Hedging Activities, of the Notes to Consolidated Financial Statements in "Part II, It