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TABLE OF CONTENTS
INDEX TO FINANCIAL STATEMENTS
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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For the fiscal year ended December 31, 2017 |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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For the transition period from to , |
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Commission File No.: 001-33494
KapStone Paper and Packaging Corporation
(Exact name of registrant as specified in its charter)
| Delaware (State or other jurisdiction of incorporation or organization) |
20-2699372 (I.R.S. Employer Identification No.) |
KapStone Paper and Packaging Corporation
1101 Skokie Blvd. Suite 300
Northbrook, IL 60062
(Address of principal executive offices) (ZIP Code)
Registrant's telephone number, including area code: (847) 239-8800
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
| Title of Each Class | Name of Exchange On Which Registered | |
|---|---|---|
| Common Stock (Par Value $0.0001) | 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 ý No o
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 o No ý
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 ý No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for shorter period that the registrant was required to submit and post such files). Yes ý No o
Indicate by check mark if disclosure of delinquent filers pursuant to item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the 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. ý
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
| Large Accelerated Filer ý | Accelerated Filer o | Non-Accelerated Filer o (Do not check if a smaller reporting company) |
Smaller Reporting Company o Emerging Growth Company o |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý
The aggregate market value of the 86,198,428 shares of Common Stock held by non-affiliates of the registrant on June 30, 2017, was $1,778,273,562. This calculation was made using a price per share of Common Stock of $20.63; the closing price of the Common Stock on the New York Stock Exchange on June 30, 2017, the last day of the registrant's most recently completed second fiscal quarter of 2017. Solely for purposes of this calculation, all shares held by directors and executive officers of the registrant have been excluded. This exclusion should not be deemed an admission that these individuals are affiliates of the registrant.
On February 13, 2018, there were 97,380,941 shares of Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
The registrant's Definitive Proxy Statement for its 2018 Annual Meeting of Stockholders will be filed with the Securities and Exchange Commission no later than 120 days after the end of the fiscal year covered by this Form 10-K pursuant to General Instruction G(3) of the Form 10-K. Information from such Definitive Proxy Statement will be incorporated by reference into Part III.
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KapStone History
KapStone Paper and Packaging Corporation was formed in Delaware as a special purpose acquisition corporation on April 15, 2005 for the purpose of effecting a merger, capital stock exchange, asset acquisition or other similar business combination with an unidentified operating business in the paper, packaging, forest products, and related industries. Unless the context otherwise requires, references to "KapStone," the "Company," "we," "us" and "our" refer to KapStone Paper and Packaging Corporation and its subsidiaries.
Merger Agreement
On January 28, 2018, KapStone Paper and Packaging Corporation, WestRock Company, a Delaware corporation ("WestRock"), Whiskey Holdco, Inc., a Delaware corporation and a newly formed wholly-owned subsidiary of WestRock ("Holdco"), Kola Merger Sub, Inc., a Delaware corporation and a newly formed wholly-owned subsidiary of Holdco ("Company Merger Sub"), and Whiskey Merger Sub, Inc., a Delaware corporation and a newly formed wholly-owned subsidiary of Holdco ("Holdco Merger Sub"), entered into an Agreement and Plan of Merger (the "Merger Agreement"). Pursuant to the Merger Agreement, and subject to the terms and conditions thereof, WestRock will acquire all of the outstanding shares of KapStone through a transaction in which: (i) WestRock will merge with and into Holdco Merger Sub, with WestRock surviving such merger (the "WestRock Merger") as a wholly-owned subsidiary of Holdco, and Holdco shall, effective at the effective time of the WestRock Merger and the Merger (as defined below) (the "Effective Time"), change its name to "WestRock Company," and (ii) KapStone will merge with and into Company Merger Sub, with KapStone surviving such merger as a wholly-owned subsidiary of Holdco (the "Merger").
Subject to the terms and conditions set forth in the Merger Agreement, at the Effective Time: (i) each share of common stock, par value $0.0001 per share, of KapStone (the "KapStone Common Stock") issued and outstanding immediately prior to the Effective Time (excluding any shares of KapStone Common Stock that are held (a) in treasury or (b) by any KapStone stockholder who is entitled to exercise, and properly exercises, appraisal rights with respect to such shares of KapStone Common Stock) will be converted into the right to receive, at the election of the stockholder (subject to proration as described below): (a) $35.00 in cash, without interest (the "Cash Consideration"), or (b) 0.4981 shares of common stock (the "Holdco Common Stock"), par value $0.01 per share, of Holdco (the "Stock Consideration" and, together with the Cash Consideration, the "Merger Consideration"); and (ii) each share of common stock, par value $0.01 per share, of WestRock issued and outstanding immediately prior to the Effective Time will convert into one share of Holdco Common Stock.
KapStone stockholders will be permitted to make an election to receive the Stock Consideration by submitting an election form no later than 5:00 p.m., Eastern time, on the business day immediately prior to the stockholder meeting of KapStone that will be held to adopt the Merger Agreement (the "KapStone Stockholders Meeting"). Any KapStone stockholder not making an election to receive the Stock Consideration will receive the Cash Consideration. Elections by KapStone stockholders for the Stock Consideration will be subject to proration procedures set forth in the Merger Agreement that will limit the total amount of the Stock Consideration to be issued to KapStone stockholders such that the Stock Consideration will be received in respect of no more than 25 percent of the outstanding shares of KapStone Common Stock immediately prior to the Effective Time.
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The completion of the Merger is subject to customary conditions, including, without limitation: the adoption of the Merger Agreement by KapStone stockholders at the KapStone Stockholders Meeting; the expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended; the receipt of other required antitrust approvals, including in Austria, Germany, and Mexico; the receipt of certain tax opinions; and the effectiveness of a registration statement on Form S-4 in connection with the potential issuance of shares of Holdco Common Stock in the Merger. The Merger is expected to close during the quarter ending September 30, 2018.
Acquisition History
On January 2, 2007, we acquired from International Paper Company substantially all of the assets and assumed certain liabilities of the Kraft Papers Business ("KPB") for $155.0 million, less $7.8 million of working capital adjustments. The KPB assets consisted of an unbleached kraft paper manufacturing facility in Roanoke Rapids, North Carolina, Ride Rite® Converting, an inflatable dunnage bag manufacturer located in Fordyce, Arkansas, trade accounts receivable and inventories. We subsequently paid an aggregate of $53.7 million additional purchase price pursuant to contingent earn-out payments based upon achieving certain EBITDA targets.
On July 1, 2008, we acquired from MeadWestvaco Corporation substantially all of the assets and assumed certain liabilities of the Charleston Kraft Division ("CKD") for $485.0 million (net of cash acquired of $10.6 million), less $8.9 million of working capital adjustments. The CKD assets consisted of an unbleached kraft paper manufacturing facility in North Charleston, South Carolina (including a cogeneration facility), chip mills located in Elgin, Hampton, Andrews and Kinards, South Carolina, a lumber mill located in Summerville, South Carolina, trade accounts receivable and inventories.
On March 31, 2009, we completed the sale of our inflatable dunnage bag business to Illinois Tool Works Inc. for $36.0 million, less $1.1 million of working capital adjustments. The Company considered the sale an opportunity to reduce its debt and focus on its core Paper and Packaging business.
On October 31, 2011, we acquired U.S. Corrugated Acquisition Inc. ("USC") pursuant to a merger for $330.0 million in cash plus $1.9 million of working capital adjustments. USC owned, at the time of the merger, a recycled containerboard paper mill in Cowpens, South Carolina and fourteen corrugated packaging plants across the Eastern and Midwestern United States.
On July 18, 2013, we acquired 100 percent of the capital stock of Longview Fibre Paper and Packaging, Inc., ("Longview") for $1.025 billion plus $41.5 million of working capital adjustments. Longview is a leading manufacturer of high quality containerboard, kraft papers and corrugated products. Longview's operations include a paper mill located in Longview, Washington equipped with five paper machines which have the capacity to produce approximately 1.3 million tons of containerboard and kraft paper annually. Longview also owns seven converting facilities located in the Pacific Northwest.
On June 1, 2015, we acquired 100 percent of the partnership interests in Victory Packaging, L.P. and its subsidiaries ("Victory") for $615.0 million in cash and $2.0 million of working capital adjustments. Victory, headquartered in Houston, TX, provides its customers comprehensive packaging solutions and services and is one of the largest North American distributors of packaging materials. Victory's operations include approximately 60 distribution and fulfillment facilities in the United States, Mexico and Canada. See Note 4 "Victory Acquisition" for further detail.
On April 8, 2016, the Company's board of directors approved the plan to expand its geographical footprint into Southern California with a new sheet plant with a total estimated cost of approximately $14.0 million. In conjunction with this, the Company signed a 10-year lease agreement with a total commitment of approximately $9.8 million. The new sheet plant started manufacturing boxes in
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February 2017 and is intended to primarily supply the Company's Victory distribution operations in Southern California as well as other KapStone customers. See Note 3 "Strategic Investments" for further detail.
On July 1, 2016, the Company acquired 100 percent of the common stock of Central Florida Box Corporation ("CFB"), a corrugated products manufacturer located near Orlando, Florida, for $15.4 million, net of cash acquired. See Note 3 "Strategic Investments" for further detail.
On September 1, 2016, the Company made a $10.6 million investment for a 49 percent equity interest in a sheet feeder operation located in Florida. In April of 2016, the Company made a $1.25 million investment for a 20 percent equity interest in a sheet feeder operation located in California. These investments are expected to increase the Company's vertical integration by over 60,000 tons per year and will ramp up to that level over eighteen months. See Note 3 "Strategic Investments" for further detail.
On February 1, 2017, the Company acquired the assets of Associated Packaging, Inc. and Fast Pak, LLC (together, "API") with operations located in Greer, South Carolina for $33.5 million. API provides corrugated packaging and digital production needs serving a diverse customer base, including an emphasis on fulfillment and kitting for the automotive and consumer products industries. See Note 3 "Strategic Investments" for further detail.
We report our operating results in two reportable segments: Paper and Packaging and Distribution. Our Paper and Packaging segment manufactures and sells a wide variety of containerboard, corrugated products and specialty paper for industrial and consumer markets. The Distribution segment, through Victory, a North American distributor of packaging materials, with approximately 60 distribution centers located in the United States, Mexico and Canada, provides packaging materials and related products to a wide variety of customers. For more information about our segments, see Note 18 "Segment Information".
General
Our Paper and Packaging segment produces containerboard, corrugated products and specialty paper. In 2017, we produced 2.8 million tons, nearly 86 percent of which was sold to third party converters or shipped to our corrugated products manufacturing plants based in the United States, and 14 percent of which was sold to foreign based customers. In 2017, our corrugated products manufacturing plants sold about 912 thousand tons or 14.4 billion square feet ("BSF") of corrugated products in the U.S. Our Paper and Packaging net sales in 2017 totaled $2.4 billion, which was primarily comprised of $1.6 billion of containerboard and corrugated products and $0.7 billion of specialty paper.
Our Distribution segment, which operates under the Victory trade name, provides its customers comprehensive packaging solutions and services and distributes corrugated packaging materials and other specialty packaging products, which include stretch film, void fill, carton sealing tape and other specialty tapes. In 2017, our Distribution segment's net sales totaled $1.0 billion, 5 percent of which was sold to customers in Mexico and Canada.
The Company's business is affected by cyclical industry conditions and general economic conditions in North America and in other parts of the world where we export containerboard and specialty paper and distribute packaging materials. These conditions affect the prices that we are able to charge for our products and services. Our foreign and export sales may also be affected by fluctuations in foreign exchange rates and trade policies and relations.
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Industry Overviews
Our Paper and Packaging segment competes in the containerboard, corrugated products and specialty paper markets. We view the specialty paper market as including kraft paper, saturating kraft and unbleached folding carton board.
Our Distribution segment competes in the distribution and fulfillment services market, serving customers across a range of industries. These customers include governmental entities, as well as customers in the moving and storage, automotive, retail and other industries.
Paper and Packaging Segment
Containerboard
Containerboard, consisting of linerboard and corrugated medium, is primarily used to manufacture corrugated containers for packaging products. U.S. demand for corrugated containers and containerboard tends to be driven by industrial production of processed foods, nondurable goods and certain durable goods.
The American Forest and Paper Association's ("AF&PA") estimate of the size of the U.S. containerboard market is as follows:
| (In millions) |
2017 | 2016 | 2015 | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
Total U.S. sales |
33.5 tons | 32.4 tons | 32.2 tons | |||||||
U.S. production |
37.4 tons | 36.3 tons | 35.8 tons | |||||||
Imports |
1.4 tons | 1.2 tons | 1.1 tons | |||||||
Exports |
5.3 tons | 5.1 tons | 4.8 tons | |||||||
U.S. operating rates |
98 | % | 95 | % | 94 | % | ||||
The primary markets for our containerboard are our corrugated products manufacturing plants, independent corrugated and laminated products customers who focus on specialty niche packaging and Victory.
Corrugated Products
According to the Fibre Box Association's most recent annual report dated April 2017, the value of 2016 industry shipments of corrugated products was $30.8 billion, an increase of $0.3 billion, or 1.0 percent compared to 2015.
The primary end-use markets for corrugated products are shown below (as reported in the most recent Fibre Box Association annual report dated April 2017):
Food, beverages and agricultural products |
45 | % | ||
General retail and wholesale trade |
18 | % | ||
Petroleum, plastic, synthetic, and rubber products |
10 | % | ||
Miscellaneous manufacturing |
9 | % | ||
Paper products |
9 | % | ||
Appliances, vehicles, and metal products |
5 | % | ||
E-Commerce |
4 | % | ||
| | | | | |
|
100 | % | ||
| | | | | |
| | | | | |
| | | | | |
Corrugated products manufacturing plants tend to be located in close proximity to customers to minimize freight costs and shipping times. The Fibre Box Association estimates that the U.S. corrugated products industry consists of approximately 500 companies and over 1,100 plants.
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Specialty Paper
Kraft Paper
We produce three general categories of kraft paper:
- •
- Multiwall paper is used to produce bags for agricultural products, pet food, baking products,
cement and chemicals. We are the only U.S. manufacturer of extensible, high performance multiwall kraft paper. Our FibreShield® and TEA-Kraft® lines of products offer
durability, savings, efficiency and are supported by our exceptional customer and technical service. We also manufacture durable flat multiwall sack paper for a variety of end-use applications.
- •
- Specialty products have a large variety of uses within coating and laminating applications that
requires a smooth surface. Specialty paper is also used to produce shingle wrap, end caps, roll wrap and dunnage bags. Our specialty paper products are designed to meet the unique needs of a variety
of customers and end uses. We modify a range of specialty paper products for our specialty paper grades, such as sizing, smoothness, porosity, wet strength, pH and others. Our specialty paper products
are manufactured for a variety of converters, including laminators, coaters, insulation manufacturers, agricultural product processors and food product packaging producers.
- •
- Lightweight paper is used in a variety of flexible packaging applications that range from 100 percent recycled content for quick-service restaurant carry out bags to 100 percent virgin content for direct contact food packaging. Our lightweight virgin furnished papers are produced from specifically blended wood chip recipes. These wood chip and pulp recipes are specifically designed to develop paper properties important for a variety of specialty packaging end uses and coating base paper applications. Our recycled content light weight papers are made in a wide variety of basis weights and percentages of recycled fiber content, and are valued for their cleanliness, strength, sustainability and end-use possibilities. The most recently developed product line, FibreGreen®, is composed of old corrugated containers ("OCC") processed in our state-of-the-art OCC facility and is available in a wide range of basis weights. FibreGreen® meets the U.S. Food and Drug Administration's requirements for direct food contact and is certified by the Sustainable Forestry Initiative®.
The AF&PA's estimate of the size of the U.S. kraft paper market is as follows:
| (In millions) |
2017 | 2016 | 2015 | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
Total U.S. sales |
1.81 tons | 1.80 tons | 1.58 tons | |||||||
U.S. operating rates |
89 | % | 93 | % | 90 | % | ||||
Saturating Kraft
Saturating kraft is used in multiple industries around the world, including construction, electronics manufacturing and furniture manufacturing. The major end-use is thin high pressure laminates ("HPL"), used to create decorative surfaces such as kitchen and bath countertops, home and office furniture and flooring. Within the HPL market there is a growing and distinct HPL segment manufacturing and selling a much thicker product called compact laminates used as surfacing products such as exterior cladding, partitions and doors. In Asia, there is significant use of saturating kraft product for the manufacturing of printed circuit boards and copper clad laminates and there is also a growing use for thin HPL in decorative surfaces. We are not aware of any published data reporting the size of the saturating kraft market. Barriers to entry for producing high quality saturating kraft are high as it is a technically difficult grade of paper to produce.
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Unbleached Folding Carton Board
Unbleached folding carton board is a low density virgin fiber board. Applications are widely spread throughout end uses in the general folding carton segment of the paperboard packaging market. This product can replace the use of more expensive coated recycled board, coated natural kraft board and solid bleached sulfate board, which are currently much larger markets. There is no published data we are aware of reporting the size of the unbleached, uncoated folding carton market.
Distribution Segment
The Distribution segment, through Victory's operations, works with customers to improve and facilitate the various aspects of packaging and distribution, including packaging design, creation, storage, delivery and management. Based in Houston, TX, Victory has approximately 60 warehouses and distribution facilities, with the majority in the United States, 3 in Canada and 15 in Mexico. Nationwide, Victory is one of the largest distributors specializing in packaging solutions for its customers on a national scale. Victory also oversees local packaging and distribution for regional customers. The Distribution segment's national network includes approximately 6.4 million square feet of warehouse space and approximately 230 delivery vehicles.
Victory distributes corrugated and other specialty packaging products, which include stretch film, void fill, carton sealing tape and other specialty tapes.
Manufacturing
We operate four paper mills, three in the Southeastern region and one in the Pacific Northwest region of the United States. In 2017, we produced 2.8 million tons of containerboard and specialty paper at our mills in North Charleston, South Carolina; Roanoke Rapids, North Carolina; Cowpens, South Carolina; and Longview, Washington. Our mills generally operate 24 hours a day, seven days a week. Fiber used to make containerboard and specialty paper is produced from a combination of locally sourced roundwood and woodchips. After the wood is debarked and chipped, the chips are loaded into digesters for cooking. Woodchips, chemicals and steam are mixed in the digester to produce softwood pulp. Hardwood pulp is produced in a similar fashion at North Charleston primarily for the production of DuraSorb® saturating kraft and Kraftpak® and at Longview primarily for the production of corrugated medium. The pulp is screened and washed through a series of washers and then stored prior to the paper making process. OCC is used to make recycled containerboard at our Cowpens mill and is a component of certain grades of kraft paper and containerboard at our Longview mill. The Company processes pulp using eleven paper machines at our facilities. Management monitors productivity on a real-time basis with on-line reporting tools that track production values versus targets. Overall equipment efficiency is also monitored daily through production reporting systems.
As of December 31, 2017, we operated 23 corrugated products manufacturing plants, comprised of 12 box plants, nine sheet plants and two sheet feeder plants. Box plants operate as combining operations that manufacture corrugated sheets and finished corrugated products. Sheet feeder plants have a corrugator machine and manufacture corrugated sheets, which are shipped to sheet or box plants. Sheet plants have various machines that convert corrugated sheets, purchased either from our operations or third parties, into finished corrugated products. Plants with a corrugating machine have total capacity of approximately 19 BSF.
Our corrugated products manufacturing plants operate in 15 states in the U.S., with no manufacturing facilities outside of the continental U.S. Each plant, for the most part, serves a market radius that typically averages 200 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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We produce a wide variety of products ranging from basic corrugated shipping containers to specialized packaging. We also have multi-color printing capabilities to make high-impact graphics boxes and displays that offer customers such as consumer products companies more attractive packaging.
We execute containerboard buy/sell arrangements with other containerboard manufacturers.
Supply Chain
Containerboard and specialty paper produced in our paper mills is shipped by rail or truck to customers in the U.S. and is shipped by truck to nearby ports and then by ocean vessel to our export customers. Domestic rail shipments represent about 48 percent of the tons shipped and the remaining 52 percent is shipped by truck.
Our corrugated products are delivered by truck due to our customers demand for timely service. We use a combination of a dedicated third-party fleet and our own trucks.
The majority of Victory's products in the U.S. and Canada are delivered directly from Victory's network of distribution and fulfillment facilities using its fleet of approximately 230 delivery vehicles. In Mexico, delivery is outsourced to third party logistics companies. Our distribution and fulfillment facilities offer a range of delivery options depending on the customer's needs and preferences. The strategic placement of the distribution and fulfillment facilities also allows for delivery of special or "rush" orders to many customers.
Sales and Marketing
Our containerboard and specialty paper marketing strategy is to sell our products to third-party converters and manufacturers of industrial and consumer packaging products. We seek to meet the quality and service needs of the customers of our corrugated operations at the most efficient cost, while balancing those needs against the demands of our containerboard customers.
We sell our products directly to end users and converters, as well as through sales agents. Our sales groups are responsible for the sale of these products to third party converters in the U.S. Sales to export markets are managed by personnel who are based in Europe and Asia.
Our corrugated and packaging products and services are sold through an internal sales and marketing organization. We have sales representatives and sales managers who serve local and regional accounts. We also have corporate account managers who serve large national accounts at multiple customer locations. Our corrugated operations focus on supplying both high-volume commodity products and specialized packaging with high-value graphics.
Customers and Products
Our Paper and Packaging segment has over 3,000 U.S.-based and over 200 export customers, and our Distribution segment has approximately 6,300 active customers.
Containerboard is sold to domestic and foreign converters in the corrugated packaging industry and to other converters for a variety of uses including laminated tier sheets and wrapping material, among others. Historically, our focus is on independent converters who do not have their own mill systems or converters who otherwise commonly purchase containerboard in the open market.
Corrugated products are sold primarily to regional and local accounts, which are broadly diversified across industries and geographic locations. We have a select number of national accounts, or those customers with a national presence. These national customers typically purchase corrugated products from several of our box plants throughout the United States.
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Specialty paper is sold to both domestic and export converters who produce multiwall bags for food grade agricultural products, pet food, cement and chemicals, grocery bags and specialty conversion products, such as wrapping paper products, dunnage bags and roll wrap.
Our saturating kraft paper, sold under the trade name Durasorb®, has a customer base split among three geographic regions: the Americas; Europe; and Asia. Approximately 88 percent of our Durasorb® sales are exports to customers in Europe, Latin America and Asia where growth opportunities are favorable. KapStone, or its predecessor, has done business with many of these customers for well over 40 years. Some customers have consolidated to form a greater presence in their end-use markets. Customer consolidation is particularly evident in North America and is in the early phase in Europe. In Asia, there are numerous players and it is a highly fragmented market making entry difficult for some companies that do not have a presence in the region. KapStone has acquired a leadership position with our Durasorb® product through knowledge of our markets and understanding the technical needs of our customers' manufacturing processes and the demanding requirements of their products.
Our unbleached folding carton board sold under the Kraftpak® trade name has a customer base consisting primarily of integrated and independent converters in the folding carton industry. Our unbleached folding carton board product is a unique, low-density virgin fiber board. KapStone believes that the best growth opportunities for Kraftpak are in consumer brands that are changing their images to promote environmental friendliness and sustainability. Kraftpak and similar products replace the use of coated recycled board, coated natural kraft board and solid bleached sulfate board, which are currently much larger markets.
Victory's customer base includes local, regional and national accounts across a wide range of industries and size and through a variety of means ranging from multi-year supply agreements to transactional sales. Besides offering material-neutral design capabilities and high levels of distribution services, Victory also specializes in fulfillment, kitting and contract packaging services.
Victory has valuable, multi-year, long-term supply agreements with many of its largest customers that set forth the terms and conditions of sale, including product pricing. Generally, customers are not required to purchase any minimum amount of products under these agreements and can place orders on an individual purchase order basis. However, Victory enters into negotiated supply agreements with certain customers, which include commitments to inventory held in its distribution facilities. Victory's working capital needs generally reflect the need to carry significant amounts of inventory in its distribution and fulfillment facilities to meet delivery requirements of its distribution and fulfillment customers, as well as significant accounts receivable balances. As is typical in this industry, Victory's customers often do not pay upon receipt, but are offered terms which are heavily dependent on the specific circumstances of the sale.
No customer accounts for more than 10 percent of consolidated net sales. Our business is not dependent upon a single customer or upon a small number of major customers.
Seasonality and Backlog
In our Paper and Packaging segment, demand for our major product lines is relatively constant throughout the year, and seasonal fluctuations in marketing, production, shipments and inventories are not significant. Seasonal fluctuations are largely driven by the agricultural market within the western United States. Backlogs are a factor in the industry, as they allow paper mills to run more efficiently. However, most orders are placed for delivery within 30 days.
In our Distribution segment, operating results are subject to some seasonal influences that are not material to the consolidated results of the Company. Historically, our highest shipments occur during the second and third quarters, while our lowest shipments occur during the first quarter. Within the
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Distribution segment, shipments for the first quarter are typically less than shipments for the fourth quarter of the preceding year.
Suppliers and Major Raw Materials Used
Fiber
Fiber is the single largest cost in the manufacture of containerboard and specialty paper. KapStone consumes both wood fiber and recycled fiber in its paper mills. Our paper mills in North Charleston and Roanoke Rapids use 100 percent virgin fiber. The fiber needs in 2017 of our Longview, Washington mill were supplied by approximately 70 percent of virgin fiber. Fiber used to make containerboard and specialty paper is produced from a combination of locally sourced roundwood and woodchips. We rely on supply agreements and open-market purchases to supply these mills with roundwood and wood chips. Fiber resources are generally available within proximity to these mills and we have not experienced any significant difficulty in obtaining our mill fiber needs.
In 2017, the Company began operating two wood chipping facilities managed by a third party for use at the North Charleston and Roanoke Rapids paper mills.
Recycled Fiber
The fiber consumption in our mill in Cowpens, South Carolina consists 100 percent of recycled fiber or OCC. We obtain OCC pursuant to certain supply agreements and in open market purchases from suppliers within proximity to the Cowpens Mill. OCC has historically exhibited significant price volatility. The Cowpens mill has not experienced any significant difficulty in obtaining OCC. Approximately 30 percent of the fiber needs at our Longview, WA mill are recycled.
Containerboard
Our corrugated manufacturing plants consume containerboard produced at our mills or from third parties and through buy/sell arrangements. We also use third-party mills which are closer to our corrugated manufacturing plants to realize freight savings. Containerboard, which includes both linerboard and corrugating medium, is the principal raw material used to manufacture corrugated products. Linerboard is used as the inner and outer facings, or liners, of corrugated products. Corrugating medium is fluted and laminated to linerboard in corrugated plants to produce corrugated sheets. The sheets are subsequently printed, cut, folded and glued to produce corrugated products.
Distributed Products
Victory purchases products from a number of suppliers, mainly in the U.S. Victory's suppliers consist of large paper and packaging corporations, regional corrugated and sheet plants and non-corrugated corporations. Upon being acquired by KapStone, Victory increased its purchases from KapStone's corrugated products manufacturing plants. Suppliers are selected based on customer demand for the product and a supplier's total service, cost and product quality offering.
The product sourcing is designed to ensure that Victory is able to offer consistent but varied product selections and market competitive pricing across the enterprise while maintaining the ability to service localized market requirements. Our procurement program is also focused on replenishment, which includes purchase order placement and managing the total cost of inventory by improving the number of days inventory is on hand, negotiating favorable payment terms and maintaining vendor-owned and vendor-managed programs. As a large purchaser of packaging material, we can qualify for volume allowances with some suppliers and can realize significant economies of scale. We in turn enter into incentive agreements with certain of our largest customers, which are generally based on sales to these customers.
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Energy
Energy at the paper mills is obtained through purchased electricity or through various fuels, which are converted to steam or electricity on-site. Fuel sources include coal, purchased biomass fuel, natural gas, oil, bark, sawdust and by-products of the manufacturing and pulping process, including black liquor. These fuels are burned in boilers to produce steam. Steam turbine generators are used to produce electricity. To reduce our mill energy cost, we have invested in processes and equipment to ensure a high level of purchased fuel flexibility. In recent history, fuel oil has exhibited higher costs per thermal unit and more price volatility than natural gas and coal. KapStone took advantage of declining coal prices plus additional short-term opportunities in declining natural gas prices to balance the utilization of both gas and coal in 2017 with other fuels at our Charleston and Roanoke Rapids mills. A substantial portion of our Longview mill electricity requirements are satisfied by hydroelectric power, which has relatively stable pricing.
In 2017, we purchased coal under one contract. Contracts for the purchase of natural gas at fixed prices have been layered in for various terms and quantities, with the shortest terms ending in 2019 and the longest terms ending in 2022.
KapStone's corrugated products manufacturing plants primarily use boilers that produce steam which is used in the product manufacturing process. The majority of these boilers burn natural gas, although some also have the ability to burn fuel oil. Sheet plants use electricity for their main source of power.
Volatile fuel prices have a direct impact on our Distribution segment, as it affects the prices paid by us for products as well as the costs incurred to deliver products to our distribution and fulfillment customers. Victory purchases diesel fuel under contracts tied to market prices for diesel and does not engage in any material forward or hedging fuel contracts.
Competition
The markets in which we sell our products are highly competitive and comprised of many participants. We face significant competitors, including large, vertically integrated companies and numerous smaller companies.
Our principal competitors with respect to sales of our containerboard and specialty paper are a number of large, diversified paper and packaging corporations, including International Paper Company, Georgia-Pacific (owned by Koch Industries, Inc.), WestRock Company and Packaging Corporation of America, all of which have greater financial resources than we do. We also compete with other regional manufacturers of these products. Our specialty paper products (other than our Durasorb® and Kraftpak® products) are each generally considered a commodity-type product that can be purchased from numerous suppliers and competition is based primarily on price, product specification, service and quality.
Corrugated products businesses seek to differentiate themselves through innovation, quality, service and product design. We compete for both local and national account business, and we compete against producers of other types of packaging products. On a national level, our primary competitors include International Paper Company, Georgia-Pacific (owned by Koch Industries, Inc.), WestRock Company and Packaging Corporation of America. However, with our strategic focus on local and regional accounts, we also compete with the smaller, independent converters.
The packaging distribution industry is highly competitive, with numerous regional and local competitors, and is a mature industry characterized by slowing growth. Victory's principal competitors include regional and local distributors, national and regional manufacturers and independent brokers. Most of these competitors generally offer a wide range of products at prices comparable to those Victory offers, though at varying service levels. On a national level, our primary competitors include
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International Paper Company, Georgia-Pacific (owned by Koch Industries, Inc.), WestRock Company, Veritiv and Packaging Corporation of America. However, with our strategic focus on local and regional accounts, we also compete with the smaller, independent distribution companies. Additionally, new competition could arise from non-traditional sources, group purchasing organizations, e-commerce, discount wholesalers or consolidation among competitors. We believe that Victory offers the full range of services required to effectively compete, but if new competitive sources appear it may result in margin erosion or make it more difficult to attract and retain customers.
Intellectual Property
The Company owns patents, licenses, trademarks and trade names on products. However, we do not believe that our intellectual property is material to our business and the loss of any or our intellectual property rights would not have a material adverse effect on our operations or financial condition.
Employees
As of December 31, 2017, we had approximately 6,400 employees. Of these, approximately 2,000 employees are salaried and 4,400 are hourly. Approximately 2,400 of our hourly employees are represented by unions. The majority of our unionized employees are represented by either the United Steel Workers or the Association of Western Pulp and Paper Workers.
Currently, there is a collective bargaining agreement in effect with respect to approximately 630 employees at the Longview paper mill through May 2024, approximately 560 employees at the North Charleston paper mill through June 2025 and approximately 310 employees at the Roanoke Rapids paper mill through August 2020.
Environmental Matters
Compliance with environmental requirements is a significant factor in our business operations. We commit substantial resources to maintaining environmental compliance and managing environmental risk. We are subject to, and must comply with, a variety of foreign, federal, state and local environmental laws, particularly those relating to air and water quality, waste disposal, and cleanup of contaminated soil, groundwater or rivers. The most significant of these U.S. laws affecting us are:
- 1.
- Resource
Conservation and Recovery Act;
- 2.
- Clean
Water Act;
- 3.
- Clean
Air Act;
- 4.
- The
Emergency Planning and Community Right-to-Know-Act;
- 5.
- Toxic
Substance Control Act; and
- 6.
- Safe Drinking Water Act.
We believe that we are currently in material compliance with these and all applicable environmental rules and regulations. Because environmental regulations are constantly evolving, we have incurred, and will continue to incur, costs to maintain compliance with these and other environmental laws and regulations. We work diligently to anticipate and budget for the impact of applicable environmental regulations and do not currently expect that future environmental compliance obligations will materially affect our business or financial condition.
We do not believe that any ongoing remedial projects are material in nature.
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The Company's subsidiary, Longview is a potentially responsible party under the Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA") with respect to the Lower Duwamish Waterway Superfund Site in the State of Washington (the "Site"). The U.S. Environmental Protection Agency ("EPA") asserts that the Site is contaminated as a result of discharges from various businesses and government entities located along the Lower Duwamish Waterway, including a corrugated converting plant owned and operated by Longview. In November 2014, the EPA issued a Record of Decision ("ROD") for the Site. The ROD includes a selected remedy for the Site. In the ROD, EPA states that the total estimated net present value costs (discounted at 2.3 percent) for the selected remedy are $342 million, although many uncertainties remain that could result in increased remedial costs. This estimate does not include actual costs already incurred to date for remedial investigation and feasibility studies or potential natural resource damage claims by parties allegedly affected by the contamination at the Site. The Company has received notice from the Elliot Bay Trustee Council regarding the Company's potential liability for natural resource damages arising from the Site. Neither the Company nor Longview has received a specific monetary demand regarding its potential liability for the Site. In addition, Longview is a participant with approximately 45 other potentially responsible parties in a non-judicial allocation process with respect to the Site. Pursuant to the non-judicial allocation process, Longview and other participating parties will seek to allocate certain costs, including but not limited to the costs necessary to perform the work under the ROD. The non-judicial allocation process is not scheduled to be completed until 2020. Based upon the information available to the Company at this time, the Company cannot reasonably estimate its potential liability for this Site, including any liability for the current or any future third-party claims associated with the Site.
We could also incur environmental liabilities as a result of claims by third parties for civil damages, including liability for personal injury or property damage, arising from releases of hazardous substances or contamination. Except as described above, we are not aware of any material claims of this type currently pending against us.
While legislation regarding the regulation of greenhouse gas emissions has been proposed from time to time over the past several years at the federal level, there is no indication of any near term action. In the absence of broad legislation, the EPA has moved forward with an increasing array of regulations governing greenhouse gas emissions in certain industrial sectors under existing Clean Air Act programs. The result of a broader regulation of greenhouse gas emissions could be an increase in our future environmental compliance costs, or additional capital expenditures to modify facilities, which may be material. However, climate change regulations, possible future legislation and the resulting future energy policy could also provide us with opportunities if the use of renewable energy continues to be encouraged. We currently generate a significant portion of our power requirements for our mills using bark, black liquor and other 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 or regulation will be and how our business and industry will be affected.
In 2004, EPA published the Boiler MACT regulations, establishing air emissions standards and certain other requirements for industrial boilers. These regulations have been subject to a series of legal challenges and have been promulgated and / or amended by EPA several times since the initial rules were published. A final reconsidered regulation was issued in January 2013 but legal challenges were filed. In July 2016, the U.S. Court of Appeals for the District of Columbia Circuit ruled on consolidated cases challenging the Boiler MACT regulations. The court vacated emission limits for certain subcategories of solid fuel boilers, and remanded other issues to the EPA for further explanation. In December 2016, in response to a request by EPA, the court changed its remedy for the vacated standards and remanded them to EPA instead. The U.S. Supreme Court declined to review the matter in June 2017, but legal proceedings continue. We cannot currently predict with certainty how
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these recent decisions will impact our existing Boiler MACT compliance or whether our operating costs will increase in order to comply with any revised Boiler MACT regulations. All of our mills currently subject to federal Boiler MACT regulations have demonstrated compliance with the current standards and requirements.
In addition to Boiler MACT and greenhouse gas standards, the EPA has recently finalized a number of other environmental rules, which may impact the pulp and paper industry. The EPA also is revising existing environmental standards and developing several new rules that may apply to the industry in the future. We cannot currently predict with certainty how any future changes in environmental laws and regulations (or their interpretation) and/or enforcement practices will affect our business; however, it is possible that our compliance, capital expenditure requirements and operating costs could increase materially.
In January 2017, the Company received a letter from the state of Washington Department of Ecology ("WDOE") contending that the Company is, along with several other companies, responsible for investigation and cleanup of an allegedly contaminated site where the named companies, including Longview, may store or have stored petroleum products. The letter concerns the possible release of petroleum products into the environment. In 1998, Longview (before it was acquired by the Company) and certain other companies who owned or operated underground storage tanks and pipes entered into an agreement for investigating and remediating the area independently of (but in consultation with) the WDOE. Upon expiration of the 1998 agreement, groundwater monitoring continued. In June 2017, the WDOE further notified the Company that WDOE determined Longview is a potentially liable party related to the release or threatened release of petroleum at the site. The Company has responded to the notices and has been engaged in discussions with the WDOE and other potentially liable parties. Based upon the information available to the Company at this time, the Company cannot reasonably estimate its potential liability for this matter.
Available Information
We make available free of charge our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished as required by Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, through our Internet Website (www.kapstonepaper.com) as soon as is reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. Information contained in or incorporated into our Internet Website is not incorporated by reference herein.
Financial Information About Segments and Geographic Areas
We operate as two segments with 86 percent of our revenues sold in the United States and 14 percent sold to foreign based customers. See "Segment Information" of Note 2 "Summary of Significant Accounting Policies" and Note 18 "Segment Information" contained in the Notes to Consolidated Financial Statements.
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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 operating and performance results, earnings, expenditures and financial condition and liquidity. 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, as well as various factors related to the Merger, including but not limited to: the ability of KapStone and WestRock to receive the required regulatory approvals for the proposed transaction (and the risk that such approvals may result in the imposition of conditions that could adversely affect the combined company or the expected benefits of the transaction), to receive approval of KapStone's stockholders and to satisfy the other conditions to the closing of the transaction on a timely basis or at all; the occurrence of events that may give rise to a right of one or both of the parties to terminate the Merger Agreement; negative effects of the announcement or the consummation of the transaction on the market price of WestRock's or KapStone's common stock and/or on their respective businesses, financial conditions, results of operations and financial performance; risks relating to the value of the Holdco Common Stock that may be issued in the transaction, significant transaction costs and/or unknown liabilities; the possibility that the anticipated benefits from the proposed transaction cannot be realized in full or at all or may take longer to realize than expected; risks associated with third party contracts containing consent and/or other provisions that may be triggered by the proposed transaction; risks associated with transaction-related litigation; the possibility that costs or difficulties related to the integration of KapStone's operations with those of WestRock will be greater than expected; the outcome of legally required consultation with employees, their works councils or other employee representatives; and the ability of KapStone and the combined company to retain and hire key personnel. There can be no assurance that the proposed transaction or any other transaction described above will in fact be consummated in the manner described or at all.
We face additional risks and uncertainties not presently known to us or that we currently believe to be immaterial. Should any known or unknown risks and uncertainties develop into actual events, these developments could have a material adverse effect on our business, results of operations, financial condition or liquidity.
Our actual results, performance, financial condition, liquidity, prospects and opportunities could differ materially from those expressed in, or implied by, these forward-looking statements, and accordingly, we can give no assurances that any of the events anticipated by the forward-looking statements will transpire or occur, or if any of them do so, what impact they will have on our business, results of operations, financial condition or liquidity. 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, except as required by law or regulation.
Risks associated with our business
We are dependent upon key management executives and other key employees, the loss of whom may adversely impact our business.
We depend on the expertise, experience and continued services of corporate, mill and distribution services management, and other key employees. The loss of such management, or an inability to attract
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or retain other key individuals, could materially adversely affect our business. There can be no assurance that our salaries and incentive compensation plans will allow us to retain the services of such management and other key employees or hire new key employees. We compete with other businesses for management and other key employees and invest significant resources in training and motivating them. There is no assurance that we will be able to attract or retain highly qualified employees. The inability to retain or hire qualified personnel at economically reasonable compensation levels would impair our ability to improve our business and result in lower operating results and profitability. In addition, our ability to retain all our employees in order to continue to conduct our business in the ordinary course could be affected due to the proposed merger with WestRock.
We may incur business disruptions.
We take measures to reduce the risks of disruptions at our manufacturing and distribution facilities. However, the occurrence of a natural disaster, such as a hurricane, tropical storm, earthquake, tornado, flood, fire or other unanticipated problems, such as labor difficulties (including work stoppages or strikes), equipment failure or unscheduled maintenance, could cause operational disruptions and could materially adversely affect our business, earnings and cash flows. Any losses due to these events may not be covered by our existing insurance policies or may be subject to certain deductibles.
Our significant indebtedness may adversely affect our financial health.
As of December 31, 2017, we had approximately $1.4 billion of outstanding debt. As a result of the indebtedness, our ability to obtain additional financing for working capital, capital expenditures, acquisitions or other general corporate purposes may be impaired in the future. The debt could make us vulnerable to economic downturns and may hinder our ability to adjust to rapidly changing market conditions.
A significant portion of our cash flow from operations will be needed to meet the payment of principal and interest on our indebtedness. The business may not generate sufficient cash flow from operations to enable it to repay our indebtedness and to fund other liquidity needs, including capital expenditure requirements, or to pay dividends on our common stock. The indebtedness incurred by us under our senior credit facility (the "Credit Facility") under our Second Amended and Restated Credit Agreement (as amended, the "Credit Agreement") bears interest at variable rates, and therefore if interest rates increase, our debt service requirements would increase. In such case, we may need to refinance or restructure all or a portion of our indebtedness on or before maturity. We may not be able to refinance any of our indebtedness, including the Credit Facility, on commercially reasonable terms, or at all. If we cannot service or refinance our indebtedness, we may have to take actions such as suspending the payment of, or reducing the amount of, dividends, selling assets, seeking additional equity or reducing or delaying capital expenditures, any of which could have a material adverse effect on the price of our common stock, our operations, business and financial condition.
Our Credit Facility contains restrictive covenants that limit our liquidity and corporate activities, including our ability to pursue additional acquisitions. Our Credit Facility imposes operating and financial restrictions that limit our ability to:
- •
- incur additional indebtedness;
- •
- create additional liens on our assets;
- •
- make investments;
- •
- engage in mergers or acquisitions;
- •
- pay dividends; and
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- •
- sell all or any substantial part of our assets.
In addition, our Credit Facility also imposes other restrictions on us. Therefore, we would need to seek permission from the lenders in order to engage in certain corporate actions. The lenders' interests may be different from ours, and no assurance can be given that we will be able to obtain the lenders' permission when needed. This may prevent us from taking actions that we believe are in the best interest of the Company and its stockholders.
Our Credit Facility requires us to maintain certain financial ratios. The failure to maintain the specified ratios could result in an event of default (and prohibit us from borrowing under our revolver under our Credit Facility) if not cured or waived.
In the event of a default under our Credit Agreement, the lenders generally would be able to declare all outstanding indebtedness, together with accrued interest, to be due and payable. In addition, borrowings under the Credit Facility are secured by a first priority lien on substantially all of our assets (other than real estate) and, upon the occurrence and continuation of any event of a default under that facility, the lenders generally would be entitled to seize the collateral. An event of default under any debt instrument, unless cured or waived, would likely have a material adverse effect on our business, liquidity and financial condition.
We sell some of our products internationally, and, accordingly, our business, results of operations, cash flows and financial condition could be adversely affected by the political and economic conditions of the countries in which we conduct business, by fluctuations in exchange rates and other factors related to our international operations.
Approximately 14 percent of our revenues in 2017 and 2016 were derived from foreign and export sales. Our international operations and activities face increasing exposure to the risks of selling to customers in foreign countries. These factors include:
- •
- Changes in foreign currency exchange rates or controls which could adversely affect selling prices for our products and therefore our
competitive position in a particular market.
- •
- Trade protection measures in favor of local producers of competing products, including government subsidies, tax benefits, trade actions (such
as anti-dumping proceedings) and other measures giving local producers a competitive advantage over us.
- •
- Changes generally in political, regulatory, social or economic conditions in the countries in which we sell our products.
A stronger U.S. dollar adversely affects our pricing with respect to exports, increases foreign imports of containerboard at relatively lower prices, impacts our U.S. sales, and adversely affects our business and results of operations. These risks could affect the cost of selling our products, our pricing, sales volume and ultimately our financial performance. The likelihood of such occurrences and their potential effect on the Company vary from country to country and are unpredictable.
If we fail to extend or renegotiate the collective bargaining agreements as they expire from time to time, or if our unionized employees were to engage in a strike or other work stoppage, our business, operating results and financial condition could be materially harmed.
Most of our hourly paid employees are represented by trade unions. From time to time, we may be party to collective bargaining contracts which apply to approximately 900 employees at various corrugating manufacturing plants, 630 employees at the Longview mill, 560 employees at the North Charleston mill and 310 employees at the Roanoke Rapids mill. No assurance can be given that we will be able to successfully extend or renegotiate the collective bargaining agreements as they expire from
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time to time. Currently, there is a collective bargaining agreement in effect at the Longview through May 2024, North Charleston through June 2025 and Roanoke Rapids through August 2020.
If we are unable to extend or negotiate new agreements without work stoppages, it could negatively impact our ability to manufacture our products and adversely affect our business results of operations and financial condition. In addition, we can give no assurances that prior work stoppages are indicative of the duration and impact on our business or results of operations of any future work stoppage. Furthermore, if a significant number of our remaining employees were to unionize, including in the wake of any future legislation or administrative regulation that makes it easier for employees to unionize, our business, results of operations and financial condition could be adversely affected. Any inability to negotiate acceptable new contracts under these collective bargaining arrangements could cause strikes or other work stoppages, and new contracts could result in increased operating costs. If any such strikes or other work stoppages occur, or if additional employees become represented by a union, a disruption of our operations and higher labor costs could result. Labor relations matters affecting our suppliers of products and services could also adversely affect our business from time to time.
We may be required to record a charge to our earnings if our goodwill becomes impaired.
We test for impairment of goodwill annually in accordance with generally accepted accounting principles. When events or changes in circumstances indicate that the carrying value for such assets may not be recoverable, we review goodwill for impairment on an interim basis. Factors that may be considered a change in circumstances requiring interim testing include a decline in stock price as compared to our book value per share, future cash flows and slower growth rates. In connection with future annual or interim tests, we may be required to record a non-cash charge to earnings during the period in which any impairment of goodwill is determined, which would adversely impact our results of operations.
See Note 2 "Significant Accounting Policies—Goodwill and Intangible Assets" in the Notes to the Consolidated Financial Statements for additional information related to testing for impairment of goodwill.
Our operations are dependent upon certain supply arrangements for fiber.
We rely on certain supply arrangements to provide us roundwood and woodchips. If one of our suppliers failed to deliver quality roundwood or woodchips in the quantities we require, KapStone's supply may not be adequate to cover customer needs, which could have an adverse effect on our business, results of operations, cash flows and financial condition.
We rely on key customers and a loss of one or more of our key customers could adversely affect our business, results of operations, cash flows and financial condition.
During the year ended December 31, 2017, no customer accounted for more than 10 percent of consolidated net sales. However, each of our business segments has large customers, the loss of one or more of which could adversely affect the segment's sales and, depending on the significance of the loss, our overall business, results of operations, cash flows and financial condition. In particular, because all of our businesses operate in highly competitive industry segments, we regularly bid for new business or for the renewal of existing business and the renewal of business on less favorable terms, may adversely impact our overall business, results of operations, cash flows and financial condition.
Our business depends on effective information management systems.
We rely on our enterprise resource planning systems to support such critical business operations as processing sales orders and invoicing, inventory control, purchasing and supply chain management,
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payroll and human resources and financial reporting. We periodically implement upgrades to such systems or migrate one or more of our affiliates, facilities or operations, including acquired businesses and assets, from one system to another. If we are unable to adequately maintain such systems to support our developing business requirements or effectively manage any upgrade or migration, we could encounter difficulties that could have a material adverse impact on our business, internal controls over financial reporting, financial results or our ability to timely and accurately report such results.
We are subject to cyber-security risks related to certain customer, employee, vendor or other company data.
We use information technologies to securely manage operations and various business functions. We rely upon various technologies to process, store and report on our business and interact with customers, vendors and employees. Despite our security design and controls, and those of our third-party providers, we could become subject to cyber-attacks which could result in operational disruptions or the misappropriation of sensitive data. Our ability to plan our operations, source materials, manufacture and ship product, account for orders and interface generally with our customers and vendors could be denied or misused. Likewise, our internal financial reporting system could be compromised. In addition, theft of intellectual property, trade secrets or confidential information about us or our employees, vendors or customers could result from a cyber incident. There can be no assurance that any such disruptions or misappropriations and the resulting repercussions would not be material to our results of operations, financial condition or cash flows.
Environmental regulations and potential environmental liabilities could materially adversely affect our results of operations and financial condition and require us to make unexpected capital expenditures.
We are subject to environmental regulation by federal, state and local authorities in the United States and by authorities in Mexico with respect to our Distribution segment operations located in Northern Mexico, including requirements that regulate discharge into the environment, waste management, hazardous substance reporting, remediation of environmental contamination, forestry operations and endangered species habitats. We cannot predict the impact of future environmental laws and regulations (or changes in interpretations of existing environmental laws and regulations), particularly in the areas of emissions, climate control initiatives, Boiler MACT, NAAQSs or enforcement practices, will have on our operations and capital expenditure requirements. Environmental liabilities or new or changed compliance obligations could result in civil or criminal fines or penalties, enforcement actions, or other additional significant costs, which could adversely impact our results of operations, cash flows and financial condition.
Due to past history of industrial operations at the Roanoke Rapids mill, North Charleston mill, Longview mill and some of our corrugating manufacturing plants, the possibility of on-site and off-site environmental impact to the soil and groundwater may present a heightened risk of contamination. If we are required to make significant expenditures for remediation, the costs of such efforts may have a significant negative impact on our results of operations, cash flows and financial condition.
Risks related to compliance and changes with U.S., international and tax laws, rules and regulations could adversely impact our business and results of operations.
Our operations are subject to U.S., foreign and international laws, rules and regulations, including those concerning transportation and safety, the import and export of goods, customs regulations, respect in the work force, payments to government officials, bribery, fraud, anti-kickback and false claims rules, competition, money laundering, and data privacy laws. While we strive to maintain high standards, we cannot provide assurance that our internal controls and compliance systems will always protect us from acts committed by our employees, agents, or business partners that would violate such laws, rules or regulations. We could incur substantial costs in order to comply with such laws, rules and regulations, or incur substantial fines or sanctions, enforcement actions (including orders limiting our
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operations or requiring corrective measures), and third-party claims for property damage and personal injury or sustain harm to our reputation with customers, suppliers or investors as a result of violations of, or liabilities under, laws, regulations, codes and common law.
Risks related to changes in U.S. and global economic and financial market conditions and social and political change could adversely impact our business and results of operations.
Our businesses may be affected by a number of factors that are beyond our control, including general economic and business conditions in the U.S., countries in which we have operation or sell our products or globally, changes in tax laws or tax rates and conditions in the financial services markets, including counterparty risk, insurance carrier risk, rising interest rates, inflation, deflation, fluctuations in the value of local currency versus the U.S. dollar, the impact of a stronger U.S. dollar or U.S social and political change impacting matters such as environmental regulations, non-U.S. trade policies, or other factors, each of which may adversely impact our ability to compete and our business. Macro-economic challenges, including conditions in U.S. and global financial and capital markets, levels of unemployment and the ability of the U.S. and other countries to address their rising debt levels may continue to put pressure on the their respective economies or lead to changes in tax laws or tax rates. Changes in tax laws or tax rates may have a material impact on our future cash taxes, effective tax rate or deferred tax assets and liabilities. Adverse developments in the U.S. and global economy could adversely affect the demand for our products, our manufacturing costs and results of operations. In an inflationary environment, we may not be able to pass along some or all of our increased costs to our customers through increased product pricing, which could adversely impact our business, cash flows and profitability. We are not able to predict with certainty future economic and financial market conditions, and our business, results of operations, cash flows and financial condition could be adversely affected by adverse market conditions.
Our pension costs are subject to a variety of factors and assumptions that could cause these costs to change.
We have a defined benefit pension plan that covers 32 percent of our U.S. employees. Our pension costs are dependent upon a variety of factors and assumptions. Fluctuations in market returns, interest rates, mortality rates, the number of retirees and longer life-expectancy may result in increased pension costs. Similarly, changes in assumptions regarding current discount rates and expected rates of return on plan assets could also change pension costs. Material adverse changes in these factors could have a negative impact on our results of operations, cash flows and financial condition.
We may not be able to fully compensate for increases in fuel costs.
Volatile fuel prices have a direct impact on our business. The cost of fuel affects the price paid by us for products and raw materials, as well as the costs incurred to produce and deliver products to our customers. Although we have been able to pass along a portion of increased fuel costs to our customers in the past, there is no guarantee that we can continue to do so, which may have a negative impact on our business and our profitability.
Risks associated with KapStone's common stock
The market price for our common stock may be highly volatile.
The market price of our common stock may be volatile due to certain factors, including, but not limited to: quarterly fluctuations in our financial and operating results; general conditions in the paper and packaging industries; or changes in earnings estimates.
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Our executive officers and directors control approximately 11 percent of our common stock and thus may influence certain actions requiring a stockholder vote.
At December 31, 2017, our executive officers and directors owned 10.5 million shares of our common stock, or approximately 11 percent of our total outstanding common stock. Accordingly, our named executive officers and directors may have some influence over the outcome of all matters requiring approval by our stockholders, including certain mergers, acquisitions, dispositions, equity issuances and the election of directors. In addition, our board of directors is divided into three classes, each of which will generally serve for a term of three years with only one class of directors being elected in each year. At the annual meeting, as a consequence of our "staggered" board of directors, only a minority of the board of directors will be considered for election and our officers and directors, because of their ownership position, will have some influence regarding the outcome of the election.
Risks associated with the paper, packaging, forest products and related industries
The paper, packaging, forest products and related industries are highly cyclical. Fluctuations in the prices and cost of production of, and the demand for products could result in smaller profit margins and lower sales volumes.
Historically, economic and market shifts, fluctuations in capacity and changes in foreign currency exchange rates have created cyclical changes in prices, sales volume and margins for products in the paper, packaging, forest products and related industries. The length and magnitude of industry cycles have varied over time and by product, but generally reflect changes in macroeconomic conditions and levels of industry capacity. Most paper products and many wood products used in the packaging industry are commodities that are widely available from many producers. Because commodity products have few distinguishing qualities from producer to producer, competition for these products is based primarily on price, which is determined by supply relative to demand. The overall levels of demand for these commodity products reflect fluctuations in levels of end-user demand, which depend in large part on general macroeconomic conditions in North America and regional economic conditions in our markets (including Europe, Asia, and Central and South America), as well as foreign currency exchange rates. In addition, if we fail or delay to make investments in cost-reducing machinery and equipment, our costs of production could be higher as compared to our competitors. The foregoing factors could materially and adversely impact our sales, cash flows, profitability and results of operations.
An increase in the cost or a reduction in the availability of wood fiber, other raw materials, energy and transportation may have an adverse effect on our profitability and results of operations.
Wood fiber, including OCC, is the principal raw material in many parts of the paper and packaging industry. Wood fiber is a commodity, and prices historically have been cyclical and have varied on a regional basis. Environmental litigation and regulatory developments have caused, and may cause in the future, significant reductions in the amount of timber available for commercial harvest in the United States. In addition, future domestic or foreign legislation and litigation concerning the use of timberlands, the protection of endangered species, the promotion of forest health and the response to and prevention of catastrophic wildfires could also affect timber supplies. Availability of harvested timber may further be limited by fire, insect infestation, disease, ice storms, wind storms, flooding and other causes, thereby reducing supply and increasing prices. Increasing demand for products packaged in containers with greater (or 100 percent) recycled paper content have and may continue to increase the demand for OCC. In addition, demand for OCC, especially from China, could result in shortages or spikes in the cost of OCC.
Industry supply of commodity paper and wood products is also subject to fluctuation, as changing industry conditions can influence producers to idle or permanently close individual machines or entire
22
mills. In addition, to avoid substantial cash costs in connection with idling or closing a mill, some producers will choose to continue to operate at a loss, sometimes even a cash loss, which could prolong weak pricing environments due to oversupply. Oversupply in these markets can also result from producers introducing new capacity in response to favorable short-term pricing trends. Industry supply of commodity papers and wood products is also influenced by overseas production capacity, which has grown in recent years and is expected to continue to grow. Wood fiber pricing is subject to regional market influences, and the cost of wood fiber may increase in particular regions due to market shifts in those regions. In addition, the ability to obtain wood fiber from foreign countries may be impacted by economic, legal and political conditions in those countries as well as transportation difficulties.
Energy is a significant input cost for the paper and packaging industry. Increases in energy prices can be expected to adversely impact businesses. Energy prices, particularly for electricity, coal and fuel oil, have been volatile in recent years. These fluctuations have historically impacted manufacturing costs of companies in the industry, often contributing to reduced margins and increased earnings volatility. Current or future environmental laws, rules and regulations (or their interpretation or changes in their interpretation) that adversely and materially impact electric utilities, including those restricting or limiting "greenhouse gas" emissions, are likely to result in increased electric costs and could adversely affect our results of operations, profitability and financial condition. We could be materially adversely impacted by energy supply disruptions or the inability to pass on cost increases to our customers.
Disruptions in transportation could adversely affect our supply or raw materials and/or our ability to distribute our products and could have an adverse effect on our results, profitability and liquidity.
Since we distribute our products by truck, rail, and ship, the reduced availability of those modes of transportation could limit our ability to promptly deliver products to our customers. Reduced availability of transportation could also affect our ability to receive adequate supplies of raw materials in a timely manner. In addition, the increased costs of transportation may reduce our profitability if we are not able to recover those costs through price increases for our products.
Our business in the past has been and in the future could be adversely affected by strikes and labor renegotiations affecting seaports, labor disputes between railroads or trucking companies and their union employees, or by a work stoppage at one or more seaports, railroads or local trucking companies servicing the areas in which we operate or with whom we do business. The impact of any transportation disruption on our business and operations is unpredictable and will be affected by, among other things, the duration of the disruption, alternative modes of transportation available to us, if any, and the additional costs associated with any alternative transportation method, which costs we may not be able to pass on to our customers.
Certain paper and wood products are vulnerable to long-term declines in demand due to competing technologies or materials.
Companies in the paper and packaging industry are subject to possible declines in demand for their products as the use of alternative materials and technologies grows and the prices of such alternatives become more competitive. Any substantial shift in demand from wood and paper products to competing technologies or materials could result in a material decrease in sales of our products and could adversely affect our results of operations, cash flows and financial condition. We cannot ensure that any efforts we might undertake to adapt our product offerings to such changes would be successful or not adversely impact our business, results of operations or financial condition.
23
Paper and packaging companies are subject to significant environmental regulation and environmental compliance expenditures, as well as other potential environmental liabilities.
Companies in the paper and packaging industry are subject to a wide range of general and industry specific environmental laws and regulations, particularly with respect to air emissions, wastewater discharges, solid and hazardous waste management, hazardous substance reporting, hazardous substance release notification, site remediation, forestry operations and endangered species habitats. We may incur substantial expenditures to maintain compliance with applicable environmental laws and regulations (or new interpretations thereof), which could adversely affect our results of operations. Failure to comply with applicable environmental laws and regulations could expose us to civil or criminal fines or penalties or enforcement actions, including orders limiting operations or requiring corrective measures, installation of pollution control equipment or other remedial actions.
Related to the Proposed Merger with WestRock
The announcement and pendency of the proposed Merger may adversely affect our business, financial condition and results of operations.
Uncertainty about the effect of the proposed Merger on our employees, customers, suppliers and other parties may have an adverse effect on our business, financial condition and results of operations regardless of whether the Merger is completed. These risks to our business include the following, all of which could be exacerbated by a delay in the completion of the proposed Merger:
- •
- the impairment of our ability to attract, retain and motivate our employees, including key personnel;
- •
- the diversion of significant management time and resources;
- •
- difficulties maintaining relationships with customers, suppliers and other business partners;
- •
- delays or deferments of certain business decisions by our customers, suppliers and other business partners;
- •
- the inability to pursue alternative business opportunities or make appropriate changes to our business because of requirements in the Merger
Agreement that we use our reasonable best efforts to conduct our business in the ordinary course of business consistent with past practice and not engage in certain activities prior to the completion
of the proposed Merger;
- •
- litigation relating to the proposed Merger and the costs related thereto; and
- •
- the incurrence of significant costs, expenses, and fees for professional services and other transaction costs in connection with the proposed Merger.
Failure to consummate the proposed Merger within the expected timeframe or at all could have a material adverse impact on our business, financial condition and results of operations.
There can be no assurance that the proposed Merger will occur. Consummation of the Merger is subject to specified conditions, including:
- •
- the affirmative vote in favor of the adoption of the Merger Agreement by the holders of a majority of the outstanding shares of our common
stock entitled to vote thereon;
- •
- expiration or termination of the applicable waiting period (or extensions thereof) under the Hart-Scott-Rodino Antitrust Improvements Act of
1976 ("HSR Act");
- •
- receipt of required antitrust approvals in Austria, Germany and Mexico;
24
- •
- the effectiveness of a registration statement on Form S-4 to be filed by Holdco (as the new parent company of WestRock) registering the
issuance of the Holdco common stock that may be issued as consideration in the Merger;
- •
- the absence of any material law or any order prohibiting the consummation of the Merger;
- •
- subject to certain materiality exceptions, the accuracy of the representations and warranties of each of the parties to the Merger Agreement,
as well as the performance of each party's obligations under the Merger Agreement in all material respects;
- •
- each of WestRock and KapStone receiving an opinion from their respective counsel to the effect that the WestRock Merger or the Merger,
respectively, should qualify for the applicable intended tax treatment; and
- •
- the absence of any order by any governmental entity rendering the Merger illegal, or prohibiting or preventing the Merger; and
- •
- other customary closing conditions.
We cannot provide any assurances that these conditions will be satisfied in a timely manner or at all or that the proposed Merger will occur.
In addition, the Merger Agreement contains certain termination rights, including (i) for KapStone and WestRock in the event the Merger is not consummated on or before October 29, 2018 (which deadline may be extended under certain circumstances to April 29, 2019), (ii) for KapStone and WestRock in the event the approval of our stockholders is not obtained or (iii) for KapStone to terminate the Merger Agreement to enter into a definitive written agreement providing for a superior alternative transaction. The conditions to the closing of the Merger may not be satisfied and the Merger Agreement could be terminated. In certain specified circumstances upon termination of the Merger Agreement, we would be required to pay WestRock a termination fee of approximately $105.6 million or reimburse WestRock for its expenses incurred in connection with the Merger in an amount up to $17.6 million. If we are required to make these payments, doing so may materially adversely affect our business, financial conditions and liquidity. In addition, satisfying the conditions to the Merger may take longer, and could cost more, than we and WestRock expect. The occurrence of any of these events individually or in combination may adversely affect the benefits WestRock's stockholders expect to achieve from the Merger and the trading price of WestRock's common stock. In addition, if the Merger does not close, the attention of our management will have been diverted to the Merger, rather than our operations and pursuit of other opportunities.
There can be no assurance that a remedy will be available to us in the event of a breach of the Merger Agreement by WestRock. Further, any disruptions to our business resulting from the announcement and pendency of the Merger, including any adverse changes in our relationships with our customers, suppliers and employees, could continue or accelerate in the event the transaction is not completed. In addition, if the Merger is not completed, and there are no other parties willing and able to acquire the Company at a price of $35.00 per share or higher, on terms acceptable to us, the share price of our common stock will likely decline to the extent that the current market price of our common stock reflects an assumption that the Merger will be completed. Also, we have incurred, and will continue to incur, significant costs, expenses and fees for professional services and other transaction costs in connection with the proposed Merger, for which we will have received little or no benefit if the Merger is not completed. Many of these fees and costs will be payable by us even if the Merger is not completed and may relate to activities that we would not have undertaken other than to complete the Merger.
25
The number of shares of Holdco Common Stock that will be received per share of our common stock by KapStone stockholders receiving Stock Consideration in the Merger is fixed and will not be adjusted in the event of any change in either our or WestRock's stock prices.
The exchange ratio is fixed in the Merger Agreement and will not be adjusted for changes in the market price of either our common stock or WestRock's common stock, which changes may result from a variety of factors (many of which are beyond our control), including:
- •
- changes in our and WestRock's respective businesses, operations, assets, liabilities and prospects;
- •
- changes in market assessments of the business, operations, financial position and prospects of either company or the combined company;
- •
- market assessments of the likelihood that the Merger will be completed;
- •
- interest rates, general market and economic conditions and other factors generally affecting the price of our or WestRock's common stock;
- •
- federal, state and local legislation, governmental regulation and legal developments in the businesses in which we and WestRock operate; and
- •
- other factors beyond our control, including those described in this "Risk Factors" section.
The Merger Agreement contains provisions that may discourage other companies from trying to acquire us.
The Merger Agreement contains provisions that apply both during the pendency of the Merger transaction with WestRock as well as afterward should the Merger Agreement be terminated that may discourage a third party from submitting a business combination proposal to us that might result in greater value to our stockholders than the Merger. These Merger Agreement provisions include a general prohibition on us from soliciting, or, subject to certain exceptions, entering into discussions with any third party regarding any acquisition proposal or offers for competing transactions. In addition, we would be required to pay WestRock a termination fee of approximately $105.6 million or reimburse WestRock for its expenses incurred in connection with the Merger in an amount up to $17.6 million in certain circumstances.
Item 1B. Unresolved Staff Comments
None.
26
The table below provides a summary of our paper mills, the principal products produced and each mill's annual practical maximum capacity based upon all of our paper machines' production capabilities, as reported to the AF&PA:
Location
|
Products | Capacity (tons) | ||||
|---|---|---|---|---|---|---|
Longview, WA |
Containerboard / Specialty Paper | 1,300,000 | ||||
North Charleston, SC |
Containerboard / Specialty Paper | 975,000 | ||||
Roanoke Rapids, NC |
Containerboard / Specialty Paper | 480,000 | ||||
Cowpens, SC |
Recycled containerboard | 255,000 | ||||
| | | | | | | |
Total |
3,010,000 | |||||
| | | | | | | |
| | | | | | | |
| | | | | | | |
Our corrugated products manufacturing plants include:
Location
|
Approx. Sq. Ft. | Property Leased / Owned |
Year of Lease Expiration |
||||||
|---|---|---|---|---|---|---|---|---|---|
Full-Line Box Plants |
|||||||||
Amsterdam, NY |
227,000 | Leased | 2032 | ||||||
Aurora, IL |
323,000 | Leased | 2028 | ||||||
Bowling Green, KY |
306,000 | Leased | 2032 | ||||||
Cedar Rapids, IA |
386,000 | Leased | 2032 | ||||||
College Park, GA |
183,000 | Owned | — | ||||||
Longview, WA |
241,000 | Owned | — | ||||||
Mesquite, TX |
275,000 | Leased | 2024 | ||||||
Minneapolis, MN |
275,000 | Leased | 2032 | ||||||
Seattle, WA |
132,000 | Owned | — | ||||||
Spanish Fork, UT |
519,000 | Owned | — | ||||||
Twin Falls, ID |
446,000 | Owned | — | ||||||
Yakima,WA |
420,000 | Owned | — | ||||||
Sheet Plants |
|||||||||
Atlanta, GA |
113,000 | Leased | 2020 | ||||||
Cedar City, UT |
143,000 | Owned | — | ||||||
Greer, SC |
225,000 | Leased | 2042 | ||||||
Lake Mary, FL |
190,000 | Owned | — | ||||||
Ontario, CA |
158,000 | Leased | 2026 | ||||||
Seward, NE |
85,000 | Leased | 2032 | ||||||
Somerset, KY |
87,000 | Leased | 2018 | ||||||
Springfield, MA |
235,000 | Owned | — | ||||||
San Antonio, TX |
51,000 | Leased | 2026 | ||||||
Sheet Feeders |
|||||||||
Atlanta, GA |
133,000 | Leased | 2023 | ||||||
Fort Worth, TX |
100,000 | Owned | — | ||||||
As of December 31, 2017, our Distribution segment had a network of approximately 60 distribution centers all of which are leased with initial terms generally ranging from 3 to 10 years. These leased locations comprise approximately 5.3 million square feet located in the U.S. and approximately 1.1 million square feet located in Mexico and are strategically located in order to efficiently serve our customer base while also facilitating expedited delivery services for special orders. We continually evaluate location, size and attributes to maximize efficiency, deliver top quality customer service and achieve economies of scale.
27
We currently lease space for our corporate headquarters located in Northbrook, Illinois, under leases that expire in 2027.
We currently believe that our owned and leased space for facilities and properties are sufficient to meet our operating requirements for the foreseeable future.
We are from time to time subject to various administrative and legal investigations, claims and proceedings incidental to our business, including environmental and safety matters, labor and employments matters, personal injury claims, contractual, commercial and other disputes and taxes. We establish reserves for claims and proceedings when it is probable that liabilities exist and where reasonable estimates can be made. We also maintain insurance that may limit our financial exposure for defense costs, as well as liability, if any, for claims covered by the insurance (subject also to deductibles and self-insurance amounts). While any investigation, claim or proceeding has an element of uncertainty, and we cannot predict or assure the outcome of any claim or proceeding involving the Company, we believe the outcome of any pending or threatened claim or proceeding (other than those that cannot be assessed due to their preliminary nature), will not have a material adverse effect on our results of operations, cash flows or financial condition. See Note 16 "Commitment and Contingencies" for more information.
Item 4. Mine Safety Disclosure
Not applicable.
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock, par value $0.0001 per share, trades on the New York Stock Exchange ("NYSE") under the symbol "KS". As of December 31, 2017, there were 10 shareholders of record of our common stock. The number of shareholders of record includes one single shareholder, Cede & Co., for all of the shares held by our shareholders in individual brokerage accounts maintained at banks, brokers and institutions.
The following table sets forth the high and low sales price information for the Company's common stock from January 1, 2016 through December 31, 2017, as reported by the NYSE and the cash dividends declared per common share during the last two years.
| |
2017 | |
2016 | |
|||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Dividends Declared |
Dividends Declared |
|||||||||||||||||
Quarter Ended
|
Low | High | Low | High | |||||||||||||||
March 31 |
$ | 21.85 | $ | 24.80 | $ | 0.10 | $ | 9.05 | $ | 22.14 | $ | 0.10 | |||||||
June 30 |
$ | 19.93 | $ | 24.26 | $ | 0.10 | $ | 12.64 | $ | 16.92 | $ | 0.10 | |||||||
September 30 |
$ | 20.90 | $ | 23.34 | $ | 0.10 | $ | 12.42 | $ | 19.87 | $ | 0.10 | |||||||
December 31 |
$ | 20.72 | $ | 23.12 | $ | 0.10 | $ | 17.66 | $ | 22.73 | $ | 0.10 | |||||||
At December 29, 2017, the closing share price on the NYSE was $22.69.
The timing and amount of future dividends are subject to the determination of the Company's board of directors.
28
Stock Performance Graph
The performance graph shall not be deemed to be "soliciting material" or to be "filed" with the Securities and Exchange Commission or subject to Regulation 14A or 14C, or to the liabilities of Section 18, of the Securities Exchange Act of 1934 as amended.
The following graph compares a $100 investment in our common stock on December 31, 2012 with a $100 investment in each of the S&P 500 and the S&P Paper and Packaging Index (the Company's peer group) also made on December 31, 2012. The graph portrays total return, 2012-2017, assuming reinvestment of dividends.
Item 6. Selected Financial Data
The following table sets forth KapStone's selected financial information derived from its audited consolidated financial statements as of, and for the years ended, December 31, 2017, 2016, 2015, 2014 and 2013.
The selected financial data presented below summarizes certain financial data which has been derived from and should be read in conjunction with Item 7. "Management's Discussion and Analysis
29
of Financial Condition and Results of Operations" and KapStone's audited consolidated financial statements included in Item 8.
| |
Years Ended December 31, | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
In thousands, except per share amounts
|
2017(2) | 2016(3) | 2015(1)(4) | 2014 | 2013(1)(5) | |||||||||||
Statement of Income Data: |
||||||||||||||||
Net sales |
$ | 3,315,660 | $ | 3,077,257 | $ | 2,789,345 | $ | 2,300,920 | $ | 1,748,162 | ||||||
Operating income |
$ | 199,125 | $ | 170,646 | $ | 199,167 | $ | 299,931 | $ | 219,888 | ||||||
Net income |
$ | 243,503 | $ | 86,252 | $ | 106,386 | $ | 171,915 | $ | 127,338 | ||||||
Basic net income per share(6) |
$ | 2.51 | $ | 0.89 | $ | 1.11 | $ | 1.79 | $ | 1.34 | ||||||
Diluted net income per share(6) |
$ | 2.47 | $ | 0.88 | $ | 1.09 | $ | 1.76 | $ | 1.32 | ||||||
Cash dividends declared per common share |
$ | 0.40 | $ | 0.40 | $ | 0.40 | $ | 0.10 | $ | — | ||||||
Balance Sheet Data: |
||||||||||||||||
Cash and cash equivalents |
$ | 28,065 | $ | 29,385 | $ | 6,821 | $ | 28,467 | $ | 12,967 | ||||||
Total assets |
$ | 3,323,985 | $ | 3,255,875 | $ | 3,222,110 | $ | 2,556,274 | $ | 2,651,862 | ||||||
Long-term liabilities |
$ | 1,764,441 | $ | 2,010,852 | $ | 2,026,775 | $ | 1,501,328 | $ | 1,715,504 | ||||||
Total stockholders' equity |
$ | 1,137,014 | $ | 904,330 | $ | 845,280 | $ | 778,127 | $ | 666,080 | ||||||
- (1)
- Results
for 2015 and later reflect the Victory acquisition on June 1, 2015. Results for 2013 and later reflect the Longview acquisition on July 18,
2013.
- (2)
- 2017 net income includes a $144.4 million provisional benefit due to the passage of the Tax Cuts and Jobs Act (the "Tax Act") on December 22, 2017. Operating income in 2017 includes the following:
- •
- $10.2 million for the Oakland, California plant closure costs;
- •
- $5.9 million for union contract ratification costs;
- •
- $5.8 million related to the Victory acquisition contingent consideration expense; and
- •
- $4.4 million for Ontario, California plant operating expenses.
- (3)
- 2016
operating income includes the following:
- •
- $6.4 million of multiemployer pension plan expense due to the Company's formal notification to withdraw from its GCIU multiemployer
pension plan; and
- •
- $6.4 million of costs due to Hurricane Matthew.
- (4)
- 2015
operating income includes the following:
- •
- $15.1 million due to the 2015 Longview mill work stoppage costs; and
- •
- $5.8 million of inventory step-up expense related to the Victory acquisition.
- (5)
- 2013
net income includes a $5.0 million benefit from the reversal of the tax reserves for alternative fuel mixture credits.
- (6)
- Earnings per share for all periods have been restated for the stock split declared in December 2013.
See Note 4 "Victory Acquisition" in the Notes to Consolidated Financial Statements for a discussion of the Victory acquisition.
30
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Overview
KapStone is the fifth largest producer of containerboard and the largest producer of kraft paper in North America, based on production capacity. We operate four containerboard mills and 23 corrugated products manufacturing plants. Our paper mills produce a combination of containerboard, which we ship to our corrugated products manufacturing plants and to third party converters, as well as specialty papers consisting of kraft paper, saturating kraft paper sold under the trade name Durasorb® and uncoated paper stock board sold under the trade name Kraftpak®. Our corrugated products manufacturing plants produce a wide variety of corrugated packaging products, including conventional shipping containers used to protect and transport manufactured goods and multi-color boxes and displays with strong visual appeal that help to merchandise the packaged product in retail locations. In addition, we produce packaging for fresh fruit and vegetables, processed food, beverages, and other industrial and consumer products. We also operate a network of approximately 60 distribution centers across the United States, Mexico and Canada which distribute packaging materials to a wide variety of customers and industry segments. Substantially all of our operations are located in the United States, but we ship approximately 14 percent of containerboard and specialty products to customers in Europe, Asia and Latin America.
Executive Summary
Industry and Business Conditions
Trade publications reported industry-wide corrugated products total shipments increased 2.5 percent for the year ended December 31, 2017, compared to 2016. Reported industry mill containerboard production increased 3.1 percent compared to 2016, and reported industry containerboard inventories as of December 31, 2017, were approximately 2.4 million tons, up 3.3 percent compared to the same period in 2016. Reported containerboard export shipments increased 4.1 percent compared to 2016.
Results of Operations for the Year Ended December 31, 2017
In 2017, consolidated net income was $243.5 million, or $2.47 per diluted share, compared with $86.3 million, or $0.88 per diluted share, for 2016.
Paper and Packaging segment operating income for the year ended December 31, 2017 increased $46.2 million to $227.4 million, primarily due to higher prices and a more favorable product mix, partially offset by higher production costs due to inflation, management incentives and benefits, Oakland, California plant closure costs, Ontario, California plant operating expenses and unplanned boiler downtime.
Distribution Segment operating income for the year ended December 31, 2017 increased $0.9 million to $30.2 million, primarily due to margin improvement from higher prices and lower incentive compensation and benefits, partially offset by a bad debt charge due to a customer bankruptcy, a loss on asset disposal, and inflation on rent, fuel and labor costs.
Corporate operating expenses increased by $18.7 million to $58.5 million for the year ended December 31, 2017 compared to 2016, primarily due to $7.3 million of higher management incentives and benefits, a $6.0 million increase in stock compensation expense, a $4.2 million increase in expense for the Victory contingent consideration liability based on the expected payout of $20.7 million to be paid in early 2018, $1.0 million of higher professional fees and $0.4 million for API acquisition expenses.
31
Other Operating Highlights for 2017
In February 2017, the Company acquired the assets of API with operations located in Greer, South Carolina for $33.5 million. API provides corrugated packaging and digital production needs serving a diverse customer base, including an emphasis on fulfillment and kitting for the automotive and consumer products industries. This acquisition further strengthens the Company's goal of increasing mill integration.
In February 2017, the new sheet plant located in Ontario, California began manufacturing boxes.
In March 2017, the labor unions at the Company's paper mill in North Charleston ratified a new 8-year collective bargaining agreement covering approximately 560 employees.
In July 2017, the labor unions at the Roanoke Rapids paper mill ratified a new 4-year collective bargaining agreement covering 310 employees.
On August 1, 2017, the Company approved and announced the closing of one of its Paper and Packaging segment box plants located in Oakland, California. All operating activities ceased at this location as of October 1, 2017. Plant closure costs were $10.2 million for the year ended December 31, 2017. The real estate was sold in February 2018 for $14.7 million after fees, taxes and commissions, resulting in a gain of $7.5 million.
In September 2017, the Company announced a $50 per ton price increase for Kraft paper grades and $50 per ton for Saturating Kraft paper shipments beginning October 1, 2017.
In January 2018, Victory announced that all distribution segment locations across North America received ISO 9001:2015 certification for the design, sales, distribution processing and value added services associated with the supply of packaging materials and related products. International Organization of Standardization (ISO) 9001:2015 focuses on quality management systems and performance and is the most updated standard of its kind.
In January 2018, the Company announced a $50 per ton price increase for North American containerboard shipments beginning March 1, 2018.
On January 29, 2018, the Company signed a definitive agreement to be acquired by WestRock for $35.00 per share plus the assumption of long-term debt for a total purchase price of approximately $4.9 billion. The sale is subject to customary closing conditions and approval of the Company's stockholders. The sale is expected to close during the quarter ending September 30, 2018.
32
Results of Operations for the Years Ended December 31, 2017, 2016 and 2015
The following table compares results of operations for the years ended December 31, 2017 and 2016:
| |
Years Ended December 31, | |
% of Net Sales | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Increase/ (Decrease) |
|||||||||||||||
| |
2017 | 2016 | 2017 | 2016 | ||||||||||||
Paper and packaging |
$ | 2,421,623 | $ | 2,199,309 | $ | 222,314 | 73.0 | % | 71.5 | % | ||||||
Distribution |
980,546 | 950,037 | 30,509 | 29.6 | % | 30.8 | % | |||||||||
Intersegment Eliminations |
(86,509 | ) | (72,089 | ) | (14,420 | ) | (2.6 | )% | (2.3 | )% | ||||||
| | | | | | | | | | | | | | | | | |
Net sales |
$ | 3,315,660 | $ | 3,077,257 | $ | 238,403 | 100.0 | % | 100.0 | % | ||||||
| | | | | | | | | | | | | | | | | |
Cost of sales, excluding depreciation and amortization |
2,364,731 | 2,214,872 | 149,859 | 71.3 | % | 72.0 | % | |||||||||
Depreciation and amortization |
186,801 | 182,213 | 4,588 | 5.6 | % | 5.9 | % | |||||||||
Freight and distribution expenses |
299,872 | 279,023 | 20,849 | 9.0 | % | 9.1 | % | |||||||||
Selling, general, and administrative expenses |
265,131 | 224,127 | 41,004 | 8.0 | % | 7.3 | % | |||||||||
Multiemployer pension plan withdrawal expense |
— | 6,376 | (6,376 | ) | 0.0 | % | 0.2 | % | ||||||||
| | | | | | | | | | | | | | | | | |
Operating income |
$ | 199,125 | $ | 170,646 | $ | 28,479 | 6.0 | % | 5.5 | % | ||||||
| | | | | | | | | | | | | | | | | |
Foreign exchange (gain) / loss |
(993 | ) | 2,255 | (3,248 | ) | 0.0 | % | 0.0 | % | |||||||
Equity method investments income |
(1,752 | ) | (548 | ) | (1,204 | ) | (0.1 | )% | 0.0 | % | ||||||
Loss on debt extinguishment |
1,305 | 679 | 626 | 0.0 | % | 0.0 | % | |||||||||
Interest expense, net |
52,282 | 40,078 | 12,204 | 1.6 | % | 1.3 | % | |||||||||
| | | | | | | | | | | | | | | | | |
Income before provision (benefit) for income taxes |
148,283 | 128,182 | 20,101 | 4.6 | % | 4.2 | % | |||||||||
Provision (benefit) for income taxes |
(95,220 | ) | 41,930 | (137,150 | ) | (2.9 | )% | 1.4 | % | |||||||
| | | | | | | | | | | | | | | | | |
Net income |
$ | 243,503 | $ | 86,252 | $ | 157,251 | 7.3 | % | 2.8 | % | ||||||
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
Paper and Packaging segment net sales increased by $222.3 million to $2,421.6 million for the year ended December 31, 2017 due to $154.7 million of higher prices and a more favorable product mix, $50.3 million of higher sales volume and $14.4 million of increased intersegment sales to the Distribution segment. Average mill selling price per ton for the year ended December 31, 2017 was $677 compared to $623 for 2016, reflecting higher containerboard prices and a more favorable product mix.
The following price increases contributed to the year-over-year revenue growth for the Paper and Packaging segment:
- •
- In the third quarter of 2016, the Company implemented a $40 per ton price increase for North American containerboard effective for shipments
beginning October 1, 2016 and an 8 to 10 percent increase for corrugated products effective for shipments beginning November 1, 2016.
- •
- In the first quarter of 2017, the Company announced a $50 per ton price increase for all North America containerboard products effective for
shipments beginning March 13, 2017 and a 10 to 12 percent price increase for all corrugated products.
- •
- In September 2017, the Company announced a $50 per ton price increase for Kraft paper grades and $50 per ton for Saturating Kraft paper for shipments beginning October 1, 2017.
Distribution segment net sales increased $30.5 million to $980.5 million for the year ended December 31, 2017 compared to 2016, due to higher prices related to the pass thru of higher containerboard costs, partially offset by lower sales volume.
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Paper and Packaging segment sales to customers by product line were as follows:
| |
Years Ended December 31, | ||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Net Sales (in thousands) | |
|
Tons Sold | |
|
|||||||||||||||||||
| |
Increase/ (Decrease) |
|
Increase/ (Decrease) |
|
|||||||||||||||||||||
Product Line Revenue:
|
2017 | 2016 | % | 2017 | 2016 | % | |||||||||||||||||||
Containerboard / Corrugated products |
$ | 1,614,936 | $ | 1,420,339 | $ | 194,597 | 13.7 | % | 1,858,251 | 1,796,491 | 61,760 | 3.4 | % | ||||||||||||
Specialty paper |
718,532 | 692,043 | 26,489 | 3.8 | % | 1,005,678 | 1,023,559 | (17,881 | ) | (1.7 | %) | ||||||||||||||
Other |
88,155 | 86,927 | 1,228 | 1.4 | % | — | — | — | — | ||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | |
Product sold |
$ | 2,421,623 | $ | 2,199,309 | $ | 222,314 | 10.1 | % | 2,863,929 | 2,820,050 | 43,879 | 1.6 | % | ||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
Tons of product sold in 2017 was 2,863,929 tons compared to 2,820,050 tons in 2016, an increase of 43,879 tons, or 1.6 percent, as follows:
- •
- Containerboard / Corrugated products sales increased by 61,760 tons to 1,858,251 tons, primarily due to higher domestic containerboard
shipments of 83,950 tons and an increase in corrugated products sales of 27,006 tons, partially offset by lower export containerboard shipments of 49,196 tons.
- •
- Specialty paper sales volume decreased by 17,881 tons to 1,005,678 tons, primarily due to a decrease in pulp shipments of 28,365 tons, kraft paper shipments of 26,100 tons and Kraftpak® shipments of 9,484 tons, partially offset by higher DuraSorb® shipments of 46,066 tons.
Cost of sales, excluding depreciation and amortization expense, for the year ended December 31, 2017 was $2,364.7 million compared to $2,214.9 million for the year ended December 31, 2016, an increase of $149.8 million, or 6.8 percent. The increase in cost of sales was mainly due to $50.9 million of higher manufacturing costs, $33.8 million of higher OCC costs, $24.2 million due to higher sales volume, $14.2 million of higher planned maintenance outage costs, $11.9 million of higher management incentives and benefits, $10.2 million for the closure of the Oakland, California box plant, $8.1 million for the Company's Charleston and Longview paper mills unplanned downtime, $5.9 million for union contract ratification costs, and $2.0 million for a Longview paper mill hazardous piping inspection settlement. These costs were partially offset by $11.4 million of favorable productivity. Planned maintenance outage costs of approximately $46.8 million and $32.6 million are included in cost of sales for the years ended December 31, 2017 and 2016, respectively.
Depreciation and amortization expense for the year ended December 31, 2017 totaled $186.8 million compared to $182.2 million in 2016. The increase of $4.6 million was primarily due to $6.6 million of higher depreciation expense, partially offset by $2.0 million of lower amortization expense.
Freight and distribution expenses for the year ended December 31, 2017 totaled $299.9 million compared to $279.0 million in 2016. The increase of $20.9 million was primarily due to a higher percentage of domestic container board shipments and higher operating costs.
Selling, general and administrative expenses for the year ended December 31, 2017 totaled $265.1 million compared to $224.1 million in 2016. The increase of $41.0 million, or 18.3 percent, was primarily due to $23.0 million of higher management incentives and benefits, a $6.0 million increase in stock compensation expense, $5.1 million related to strategic investments, $4.2 million increase in expense related to the Victory contingent consideration liability and $1.2 million of higher Distribution segment operating costs. For the year ended December 31, 2017, selling, general and administrative expenses as a percentage of net sales increased to 8.0 percent from 7.3 percent in 2016.
In October 2016, the Company provided formal notification to withdraw from its GCIU multiemployer pension plan. Accordingly, the Company recorded an estimated withdrawal liability of approximately $6.4 million during the year ended December 31, 2016. There was not a similar charge in 2017.
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Foreign exchange (gain) / loss for the year ended December 31, 2017 totaled $(1.0) million compared to $2.3 million in 2016 primarily due to the weakening of the U.S. dollar to euro.
Equity method investments income for year ended December 31, 2017 totaled $1.8 million compared to $0.5 million in 2016 due to the full year benefit of the Company's 2016 strategic investments.
Loss on debt extinguishment for the years ended December 31, 2017 and 2016 totaled $1.3 million and $0.7 million, respectively, due to voluntary prepayments on the term loans under the Credit Facility.
Net interest expense for the year ended December 31, 2017 and 2016 was $52.3 million and $40.1 million, respectively. Interest expense was $12.2 million higher in 2017, due to $8.9 million related to higher interest rates and $3.3 million of implicit interest on the long-term financing obligation. As of December 31, 2017 and 2016 our weighted-average cost of borrowings was 3.13 percent and 2.40 percent, respectively.
Provision (benefit) for income taxes for the year ended December 31, 2017 and 2016 was a ($95.2) million tax benefit and a $41.9 million tax expense, respectively, reflecting an effective income tax rate of (64.2) percent for 2017, compared to 32.7 percent for 2016. The lower provision (benefit) for income taxes in 2017 primarily reflects a $144.4 million provisional tax benefit from the Tax Act from re-measuring the Company's deferred tax liabilities from 35 percent to the new 21 percent rate, less a transition tax accrual. Absent the Tax Act, the Company's 2017 effective income tax rate would have been 33.2 percent.
The following table compares results of operations for the years ended December 31, 2016 and 2015:
| |
Years Ended December 31, | |
% of Net Sales | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Increase/ (Decrease) |
|||||||||||||||
| |
2016 | 2015 | 2016 | 2015 | ||||||||||||
Paper and packaging |
$ | 2,199,309 | $ | 2,228,676 | $ | (29,367 | ) | 71.5 | % | 79.9 | % | |||||
Distribution |
950,037 | 582,949 | 367,088 | 30.8 | % | 20.9 | % | |||||||||
Intersegment Eliminations |
(72,089 | ) | (22,280 | ) | (49,809 | ) | (2.3 | )% | (0.8 | )% | ||||||
| | | | | | | | | | | | | | | | | |
Net sales |
$ | 3,077,257 | $ | 2,789,345 | $ | 287,912 | 100.0 | % | 100.0 | % | ||||||
| | | | | | | | | | | | | | | | | |
Cost of sales, excluding depreciation and amortization |
2,214,872 | 1,982,686 | 232,186 | 72.0 | % | 71.1 | % | |||||||||
Depreciation and amortization |
182,213 | 162,179 | 20,034 | 5.9 | % | 5.8 | % | |||||||||
Freight and distribution expenses |
279,023 | 234,469 | 44,554 | 9.1 | % | 8.4 | % | |||||||||
Selling, general, and administrative expenses |
224,127 | 210,844 | 13,283 | 7.3 | % | 7.6 | % | |||||||||
Multiemployer pension plan withdrawal expense |
6,376 | — | 6,376 | 0.2 | % | 0.0 | % | |||||||||
| | | | | | | | | | | | | | | | | |
Operating income |
$ | 170,646 | $ | 199,167 | $ | (28,521 | ) | 5.5 | % | 7.1 | % | |||||
| | | | | | | | | | | | | | | | | |
Foreign exchange loss |
2,255 | 2,556 | (301 | ) | 0.0 | % | 0.1 | % | ||||||||
Equity method investments income |
(548 | ) | — | (548 | ) | 0.0 | % | 0.0 | % | |||||||
Loss on debt extinguishment |
679 | 1,218 | (539 | ) | 0.0 | % | 0.0 | % | ||||||||
Interest expense, net |
40,078 | 33,759 | 6,319 | 1.3 | % | 1.2 | % | |||||||||
| | | | | | | | | | | | | | | | | |
Income before provision for income taxes |
128,182 | 161,634 | (33,452 | ) | 4.2 | % | 5.8 | % | ||||||||
Provision for income taxes |
41,930 | 55,248 | (13,318 | ) | 1.4 | % | 2.0 | % | ||||||||
| | | | | | | | | | | | | | | | | |
Net income |
$ | 86,252 | $ | 106,386 | $ | (20,134 | ) | 2.8 | % | 3.8 | % | |||||
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
Consolidated net sales for the year ended December 31, 2016 were $3,077.3 million compared to $2,789.3 million for the year ended December 31, 2015, an increase of $288.0 million, or 10.3 percent.
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Paper and Packaging segment net sales of $2,199.3 million decreased by $29.4 million from the prior year due to $100.0 million of lower prices and a less favorable product mix, partially offset by $19.8 million of higher domestic sales volumes and $49.8 million of increased intersegment sales. Average mill selling price per ton for 2016 was $623 compared to $667 for 2015, reflecting lower containerboard prices and export kraft paper prices and a less favorable product mix.
Distribution segment net sales of $950.0 million increased by $367.1 million from the prior year, primarily driven by the benefit of owning Victory for the full year of 2016, as compared to seven months in 2015.
Paper and Packaging segment sales to customers by product line were as follows:
| |
Years Ended December 31, | ||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Net Sales (in thousands) | |
|
Tons Sold | |
|
|||||||||||||||||||
| |
Increase/ (Decrease) |
|
Increase/ (Decrease) |
|
|||||||||||||||||||||
Product Line Revenue:
|
2016 | 2015 | % | 2016 | 2015 | % | |||||||||||||||||||
Containerboard / Corrugated products |
$ | 1,420,339 | $ | 1,421,802 | $ | (1,463 | ) | (0.1 | )% | 1,796,491 | 1,714,476 | 82,015 | 4.8 | % | |||||||||||
Specialty paper |
692,043 | 720,588 | (28,545 | ) | (4.0 | )% | 1,023,559 | 1,017,905 | 5,654 | 0.6 | % | ||||||||||||||
Other |
86,927 | 86,286 | 641 | 0.7 | % | — | — | — | — | ||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | |
Product sold |
$ | 2,199,309 | $ | 2,228,676 | $ | (29,367 | ) | (1.3 | )% | 2,820,050 | 2,732,381 | 87,669 | 3.2 | % | |||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
Tons of product sold in 2016 was 2,820,050 tons compared to 2,732,381 tons in 2015, an increase of 87,669 tons, or 3.2 percent, as follows:
- •
- Containerboard / Corrugated products sales increased by 82,015 tons to 1,796,491 tons, primarily due to an increase in containerboard shipments
of 72,039 tons and an increase in corrugated products sales of 9,976 tons.
- •
- Specialty paper sales volume increased by 5,654 tons to 1,023,559 tons, primarily due to an increase in kraft paper shipments of 38,313 tons, pulp shipments of 14,318 tons and Kraftpak® shipments of 6,749 tons, partially offset by lower DuraSorb® shipments of 53,726 tons.
Cost of sales, excluding depreciation and amortization expense, for the year ended December 31, 2016 was $2,214.9 million compared to $1,982.7 million for the year ended December 31, 2015, an increase of $232.2 million, or 11.7 percent. The increase in cost of sales was mainly due to the $264.0 million impact of the Victory acquisition. Excluding the Victory acquisition, cost of sales decreased by $31.8 million, or 1.6 percent, due to $15.1 million of the 2015 Longview mill work stoppage costs not incurred in 2016, $9.2 million of deflation on material costs, $5.4 million due to the suspension of certain employee benefits, $1.6 million of lower management incentives due to lower earnings, and $4.8 million of lower planned maintenance outage costs. These cost decreases were partially offset by $6.4 million of costs due to Hurricane Matthew. Planned maintenance outage costs during 2016 and 2015 totaled $32.6 million and $37.4 million, respectively, and were included in cost of sales for those years.
Depreciation and amortization expense for the year ended December 31, 2016 totaled $182.2 million compared to $162.2 million for 2015. The increase of $20.0 million was primarily due to $10.1 million from higher capital spending and $9.9 million from the Victory acquisition, including $8.2 million of amortization expense for acquired intangible assets.
Freight and distribution expenses for the year ended December 31, 2016 totaled $279.0 million compared to $234.5 million in 2015. The increase of $44.5 million was primarily due to $40.6 million attributable to the Victory acquisition and higher sales volume.
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Selling, general and administrative expenses for the year ended December 31, 2016 totaled $224.1 million compared to $210.8 million in 2015. The increase of $13.3 million, or 6.3 percent, was primarily due to Victory's direct selling and administrative expenses of $44.0 million. Excluding the impact of the Victory acquisition, selling, general and administrative expenses decreased by $30.7 million, or 14.6 percent. The decrease in selling, general and administrative expenses was primarily due to $9.8 million of lower management incentives due to lower earnings, $8.7 million of savings due to the suspension of certain employee benefits, $2.9 million of Victory acquisition related expenses not incurred in 2016, $2.1 million of lower expense due to the change in fair value of the contingent consideration liability related to the Victory acquisition, $2.6 million of lower integration expenses and $0.9 million of lower stock compensation expense. These decreases in expense were partially offset by $1.1 million of CFB acquisition related expenses. As a percentage of net sales, selling, general and administrative expenses decreased to 7.3 percent from 7.6 percent in 2015.
In October 2016, the Company provided formal notification to withdraw from its GCIU multiemployer pension plan. Accordingly, the Company recorded an estimated withdrawal liability of approximately $6.4 million during the year ended December 31, 2016.
Loss on debt extinguishment for the years ended December 31, 2016 and 2015 totaled $0.7 million and $1.2 million, respectively. The decrease is due to lower repayments on the term loans under the Credit Facility in 2016.
Net interest expense for the years ended December 31, 2016 and 2015 was $40.1 million and $33.8 million, respectively. Interest expense reflects interest on the outstanding borrowings under the Credit Facility and the receivables credit facility in connection with our trade receivables securitization program (the "Receivables Credit Facility") and amortization of debt issuance costs. Interest expense was $6.3 million higher for the year ended 2016, primarily due to higher term loan balances associated with the Victory acquisition and higher interest rates. The weighted-average cost of borrowing was 2.40 percent as of December 31, 2016 compared to 2.05 percent as of December 31, 2015.
Provision for income taxes for the years ended December 31, 2016 and 2015 was $41.9 million and $55.2 million, respectively, reflecting an effective income tax rate of 32.7 percent for 2016, compared to 34.2 percent for 2015. The lower provision for income taxes in 2016 primarily reflects lower pre-tax income of $33.5 million.
Liquidity and Capital Resources
The Company's primary sources of liquidity are net cash provided by operating activities and available borrowing capacity under our revolving credit facility.
Credit Facility
The Company had $485.9 million available to borrow under the $500 million revolving credit facility ("Revolver") portion of our Credit Facility at December 31, 2017. In addition, the Credit Facility also includes an uncommitted accordion feature that allows the Company, subject to certain significant conditions, to request additional commitments from our existing or new lenders under the Credit Facility without further approvals of any existing lenders thereunder. The aggregate amount of such increases in potential commitments (and potential borrowings) is limited to $600 million, unless the Company would maintain a pro forma total leverage ratio of 2.5 to 1.0 or less after giving effect to the increase in potential commitments (and potential borrowings). For a description of our Credit Facility, see Note 10 "Short-term Borrowings and Long-term Debt".
37
Receivables Credit Facility
Effective as of June 1, 2017, the Company entered into Amendment No. 3 to the Receivables Purchase Agreement (the "Amendment") amending its Receivables Purchase Agreement dated as of September 26, 2014 (as amended from time to time, the "Receivables Purchase Agreement"), which is part of an accounts receivable securitization program (the "Securitization Program") of the Company and certain of its subsidiaries. The Amendment included the following changes to the Receivables Purchase Agreement:
- •
- the aggregate commitment of the Purchasers (as defined in the Receivables Purchase Agreement) under the Receivables Purchase Agreement was
increased from $275.0 million to $325.0 million;
- •
- the "Facility Termination Date" (as defined in the Receivables Purchase Agreement) was extended from June 6, 2017 to June 1,
2018; and
- •
- certain definitions used to determine the maximum amount that may be outstanding under the Securitization Program were added or modified, as applicable, in a manner favorable to the Company.
On February 21, 2017, the Company entered into Amendment No. 3 to the Receivables Sale Agreement amending its Receivables Sale Agreement dated as of September 26, 2014, which is part of the Securitization Program. All accounts receivable purchased from API and all accounts receivable generated from facilities acquired from API that are not paid to an eligible bank account are designated as "Excluded Receivables".
For a description of our Securitization Program, see Note 10 "Short-term Borrowings and Long-term Debt—Receivables Credit Facility".
As of December 31, 2017, the Company had $308.8 million of outstanding borrowings under its $325.0 million Receivables Credit Facility with an interest rate of 2.31 percent.
Voluntary and Mandatory Prepayments
For the years ended December 31, 2017 and 2016, the Company made $155.0 million and $64.7 million, respectively, of voluntary prepayments on its term loans under its Credit Facility using cash generated from operations.
For the years ended December 31, 2017 and 2016, the Company made $50.3 million and $39.3 million, respectively, of mandatory payments throughout the year on the Receivable Credit Facility based on certain trade receivable balances as defined by the Amendment No. 3 to the Receivables Sales Agreement.
Other Borrowing
In 2017, the Company entered into a $6.2 million financing agreement at an annual interest rate of approximately 2.4 percent for its annual property insurance premiums. The Company repaid this obligation as of December 31, 2017.
In 2016, the Company paid its annual property insurance premiums with cash on hand.
Debt Covenants
The Company must comply on a quarterly basis with the financial covenants of its Credit Agreement, including a maximum permitted leverage ratio. The leverage ratio is calculated by dividing the Company's debt net of available cash by its rolling twelve month total earnings before interest expense, taxes, depreciation and amortization and allowable adjustments. The maximum permitted
38
leverage ratio declines over the life of the Credit Agreement. On December 31, 2017, the Company was in compliance with a leverage ratio of 3.20 to 1.00 compared to a maximum permitted leverage ratio of 4.50 to 1.00.
The Credit Agreement also includes a financial covenant requiring a minimum interest coverage ratio. This ratio is calculated by dividing the Company's trailing twelve month total earnings before interest expense, taxes, depreciation and amortization and allowable adjustments by the sum of our net cash interest payments during the twelve month period. On December 31, 2017, the Company was in compliance with the Credit Agreement with an interest coverage ratio of 8.98 to 1.00 compared to a minimum required ratio of 3.00 to 1.00.
As of December 31, 2017, the Company was also in compliance with all other covenants in the Credit Agreement.
Income Taxes
Income taxes paid, net of refunds, were $45.8 million, $23.8 million and $65.5 million in 2017, 2016 and 2015, respectively. The increase in 2017 was primarily due to higher pre-tax income and the election to defer certain payments from 2016 to 2017. The Company expects its 2018 cash tax rate to be approximately 24 percent.
Sources and Uses of Cash
Years ended December 31 ($ in thousands)
|
2017 | 2016 | 2015 | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
Operating activities |
$ | 325,468 | $ | 281,920 | $ | 262,457 | ||||
Investing activities |
(171,386 | ) | (151,754 | ) | (743,802 | ) | ||||
Financing activities |
(155,402 | ) | (107,602 | ) | 459,699 | |||||
| | | | | | | | | | | |
Total change in cash and cash equivalents |
$ | (1,320 | ) | $ | 22,564 | $ | (21,646 | ) | ||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
2017
Cash and cash equivalents decreased by $1.3 million from December 31, 2016, reflecting $325.5 million provided by operating activities, $171.4 million used in investing activities and $155.4 million used in financing activities.
Net cash provided by operating activities was $325.5 million, comprised of net income of $243.5 million, non-cash charges of $68.4 million and improved working capital of $13.6 million. Net cash provided by operating activities increased by $43.5 million during the year ended December 31, 2017, compared to 2016, mainly due to $157.3 million of higher net income, $7.6 million decrease in cash used for working capital, partially offset by lower non-cash charges of $121.3 million. The decrease in cash used for working capital is primarily due to higher accrued compensation and accounts payable, partially offset by higher trade receivables reflecting a 14.8 percent increase in net sales.
Net cash used in investing activities was $171.4 million and includes $138.4 million for capital expenditures and $33.5 million for the API acquisition. Net cash used in investing activities increased by $19.6 million for the year ended December 31, 2017, compared to 2016, primarily due to the API acquisition and higher capital spending in 2017, partially offset by the strategic investment activity in 2016.
Net cash used in financing activities was $155.4 million and reflects a $155.0 million prepayment of the term loans under the Credit Facility, $38.7 million of quarterly dividend payments, partially offset by $39.6 million of net borrowings under the Receivable Credit Facility. Net cash used in financing activities increased by $47.8 million for the year ended December 31, 2017, compared to 2016, primarily
39
due to higher prepayment of the term loans under the Credit Facility in 2017, partially offset by higher borrowings under the receivables credit facility.
2016
Cash and cash equivalents increased by $22.6 million from December 31, 2015, reflecting $281.9 million of net cash provided by operating activities, $151.8 million of net cash used in investing activities and $107.6 million of net cash used in financing activities.
Net cash provided by operating activities was $281.9 million, comprised primarily of net income of $86.3 million, non-cash charges of $189.7 million and improved working capital of $5.9 million. Net cash provided by operating activities increased by $19.5 million during the year ended December 31, 2016, compared to 2015, mainly due to a $37.3 million decrease in cash used for working capital and $2.3 million of higher non-cash charges, partially offset by $20.1 million of lower net income. The decrease in cash used for working capital mainly reflects lower raw material inventories and prepaid expenses offset by higher trade accounts receivable.
Net cash used in investing activities includes $126.9 million for capital expenditures, $15.4 million for the CFB acquisition and $11.8 million of equity method investments, partially offset by $4.9 million of proceeds from asset sales. Net cash used by investing activities decreased by $592.0 million for the year ended December 31, 2016, compared to 2015, primarily due to the Victory acquisition in 2015.
Net cash used in financing activities was $107.6 million and reflects a $64.7 million prepayment of the term loans under the Credit Facility, $38.7 million of quarterly cash dividend payments, $6.4 million of net short-term borrowings under the Revolver and $2.3 million of loan amendment fees, partially offset by $3.7 million of net borrowings under the Receivables Credit Facility. Net cash provided by financing activities decreased by $567.3 million for the year ended December 31, 2016, compared to 2015, primarily due to higher net borrowings in 2015 to fund the Victory acquisition.
Future Cash Needs
We expect that cash on hand at December 31, 2017 and cash generated from operating activities in 2018 will be sufficient to meet anticipated cash needs, which primarily consists of approximately $169.0 million of expected capital expenditures, approximately $45.0 million of interest expense, $39.0 million of cash dividends to stockholders and any additional working capital needs.
Should the need arise, we have the ability to draw from our $500.0 million Revolver. In addition, if available and subject to specified significant conditions, we may have the ability to request additional commitments from our existing or new lenders and borrow up to $600.0 million under the accordion provision of our Credit Facility without further approvals of any existing lenders thereunder. As of December 31, 2017, the Company had no borrowings under the Revolver and $485.9 million of remaining Revolver availability, net of outstanding letters of credit.
On a long term basis, we expect that cash generated from operating activities and, if needed, the ability to draw from our Revolver and accordion provision, if available, will be sufficient to meet long term obligations. Our long term obligations primarily consist of $1.4 billion of debt service and interest (which includes a $657.6 million final payment on our term loan A-1 and $308.8 million on our Receivable Credit Facility in June 2020 and a final payment on our term loan A-2 in June 2022 of $421.2 million), capital expenditures of approximately $140.0 million to $170.0 million annually, cash dividends to stockholders and working capital needs.
Off-Balance Sheet Arrangements
We have not entered into any off-balance sheet financing arrangements. The Company established a special purpose entity in connection with the Receivables Credit Facility, which is consolidated as part
40
of our financial statements. We have not guaranteed any debt or commitments of other entities or entered into any options on non-financial assets.
Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of expenses during the reporting period. Actual results could differ from those estimates. We believe our critical accounting policies are those described below. The Company's audit committee has reviewed the policies listed below. For a detailed discussion of these and other accounting policies, see Note 2 "Significant Accounting Policies" of the Notes to the Consolidated Financial Statements.
Revenue Recognition
The Company recognizes revenue in accordance with Accounting Standards Codification ("ASC") 605, Revenue Recognition. Revenue is recognized when the customer takes title and assumes the risks and rewards of ownership, when the price is fixed and determinable and when collectability is reasonably assured. Sales with terms designated f.o.b. (free on board) shipping point are recognized at the time of shipment. For sales transactions with terms f.o.b. destination, revenue is recorded when the product is delivered to the customer's site and when title and risk of loss are transferred. Sales on consignment are recognized in revenue at the earlier of the month that the goods are consumed or after a period of time subsequent to receipt by the customer as specified by contract terms. Incentive rebates are typically paid in cash and are netted against revenue on an accrual basis as qualifying purchases are made by the customer to earn and thereby retain the rebate.
The Company recognizes revenue from the sale of shaft horsepower, generated by its cogeneration facility, and energy sales on a gross basis and is included in net sales.
Freight charged to customers is recognized in net sales.
Goodwill and Intangibles
Certain business acquisitions have resulted in the recording of goodwill. Upon acquisition, the purchase price is first allocated to identifiable assets and liabilities based on estimated fair value, with any remaining purchase price recorded as goodwill. Goodwill is considered an indefinite lived intangible asset and as such is not amortized. At December 31, 2017, we have goodwill of $720.6 million. In conjunction with the API acquisition in February 2017 the Company's goodwill increased by $15.0 million. See Note 3 "Strategic Investments" of the Notes to Consolidated Financial Statements.
Goodwill Valuations
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, 2017, we had $720.6 million of goodwill, of which we recorded $170.7 million in connection with the Victory acquisition in 2015, $1.0 million in connection with the CFB acquisition in 2016 and $15.0 million in connection with the API acquisition in 2017. At December 31, 2017, we had $549.9 million and $170.7 million of goodwill allocated to our Paper and Packaging and Distribution segments, respectively.
We test 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. The test is performed at the reporting unit level. A reporting unit is an operating segment or one level below an operating segment (referred to as a "component"). A component is considered a reporting unit for purposes of
41
goodwill testing if the component constitutes a business for which discrete financial information is available and segment management regularly reviews the operating results of that component. We maintain three reporting units for purposes of our goodwill testing, Western Paper and Packaging Operations, Eastern Paper and Packaging Operations and Distribution. Regional paper and packaging reporting units make up our Paper and Packaging segment and the Distribution reporting unit is the same as the Distribution segment. Segment information is discussed further in Note 18 "Segment Information" of the Notes to Consolidated Financial Statements.
In 2017, the Company performed a quantitative assessment. In conducting our quantitative goodwill impairment analysis, we use a two-step process. First, we compare the book value of a reporting unit, including goodwill, with its fair value. The fair value is estimated based on a combined market approach and a discounted cash flow analysis, also known as the income approach, and is reconciled back to the current market capitalization for the Company to ensure that the implied control premium is reasonable. If the book value of a reporting unit exceeds its fair value, we perform the second step to estimate an implied fair value of the reporting unit's goodwill by allocating the fair value for the reporting unit to all of the assets and liabilities other than goodwill (including any unrecognized intangible assets). The difference between the total fair value of the reporting unit and the fair value of all the assets and liabilities other than goodwill is the implied fair value of that goodwill. The amount of impairment loss is equal to the excess of the book value of the goodwill over the implied fair value of that goodwill. The initial step of our impairment test indicated no impairment for any of the years presented.
The following assumptions are used in calculating the fair value of reporting units:
- •
- Company 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 assumptions for sales volume growth, price and mix changes, synergy
benefits from acquisitions, inflation on costs and expenses, income taxes, and capital expenditures. Our forecasts take into consideration recent sales data for existing products, planned integration
of recent strategic investments, planned timing of capital projects, and economic indicators to estimate future production volumes, selling prices, and key input costs for our manufactured products.
Our pricing assumptions include 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. The terminal growth rate assumption in our discounted
cash flow analysis was 3 percent for all reporting units.
- •
- 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. We used discount rates ranging from 9.5 percent to 11.5 percent in determining the discounted cash flows for each of our reporting
units.
- •
- 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 to corroborate the value calculated in our discounted cash flow analysis.
42
As of October 1, 2017, we determined that the fair values of all our reporting units were 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.
The estimates and assumptions we use are consistent with the business plans and estimates we use to manage operations and to make acquisition and divestiture decisions. The use of different assumptions could impact whether an impairment charge is required and, if so, the amount of such impairment. Future outcomes may also differ. If we fail to achieve estimated volume and pricing targets, experience unfavorable market conditions or achieve results that differ from our estimates, then revenue and cost forecasts may not be achieved, and we may be required to recognize impairment charges, 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.
Intangible assets acquired in a business combination or asset purchase are initially valued at the fair market value using generally accepted valuation methods appropriate for the type of the intangible asset. Definite-lived intangible assets are amortized over their estimated useful lives and are reviewed for impairment if indicators of impairment arise. The evaluation of the impairment is based upon a comparison of the carrying amount of the intangible asset to the estimated future undiscounted cash flows expected to be generated by the asset. If the estimated undiscounted future cash flows are less than the carrying amount of the assets, the asset is considered to be impaired. If impaired, the intangible asset is written down to estimated fair market value.
Pension and Postretirement Benefits
The Company provides pension and postretirement benefits to certain employees and accounts for these benefits in accordance with ASC 715, Compensation—Retirement Benefits. For financial reporting purposes, long-term assumptions are developed through consultations with actuaries. Such assumptions include the expected long-term rate of return on plan assets, discount rates, health care trend rates and mortality rates. The discount rate for the current year is based on long-term high quality bond rates. We describe these assumptions in Note 12, "Pension and Postretirement Benefits", of the Notes to Consolidated Financial Statements, which include, among others, the discount rate, expected long-term rate of return on plan assets and expected rates of increase in compensation levels. Although there is authoritative guidance on how to select most of these assumptions, management must exercise judgment when selecting these assumptions. We evaluate these assumptions with our actuarial advisors on an annual basis and we believe they are within accepted industry ranges, although an increase or decrease in the assumptions or economic events outside our control could have a direct impact on recorded obligations and reported net earnings.
A summary of key assumptions for 2017, 2016 and 2015 is as follows:
| |
Pension Benefits Actuarial Assumptions |
|||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| |
2017 | 2016 | 2015 | |||||||
Weighted-average discount rate assumption used to determine PBO at December 31, |
4.10 | % | 4.50 | % | 4.66 | % | ||||
Weighted-average actuarial assumptions for net expense: |
||||||||||
Discount rate |
4.50 | % | 4.66 | % | 4.24 | % | ||||
Long-term rate of return on plan assets |
6.50 | % | 6.50 | % | 6.50 | % | ||||
The measurement date for our plan is year-end as of December 31. Accordingly, at the end of each year, we determine the discount rate to be used to discount pension liabilities to its present value.
43
This rate is adjusted to match the duration of the liabilities associated with the pension plan. The discount rate reflects the current rate at which the pension liabilities could be effectively settled at the end of the year. The Company's estimate of its projected benefit obligation ("PBO") is highly dependent on changes in market interest rates. In estimating this rate at the end of 2017, we reviewed rates of return on relevant market indices and concluded that the Fidelity Bond Modeler is consistent with observable market conditions and industry standards for developing spot rate curves. The impact of the change in market interest rates during 2017 resulted in a $26.3 million increase to our PBO as of December 31, 2017. These changes were recorded through "Accumulated other comprehensive loss," a component of "Stockholders' Equity" in the Consolidated Balance Sheets.
A significant element in determining our net periodic benefit income is the expected return on plan assets. For 2017, our expected long-term rate of return on plan assets was 6.50 percent, or $36.1 million. This expected return on plan assets is included in the net periodic benefit income for the year ended December 31, 2017.
Actual return on plan assets was $78.5 million in 2017, an increase of $42.4 million compared to the expected return. The difference between the expected return and the actual return on plan assets is reflected on the Consolidated Balance Sheets through charges (credits) to "Accumulated other comprehensive loss." As of December 31, 2017 and 2016, the fair value of plan assets is $613.1 million and $574.4 million, respectively.
In addition to the discount rate change, we adopted updated U.S. mortality tables in 2017 for purposes of determining our mortality assumption used in the defined benefit plan's liability calculation. The new assumptions were based on the Society of Actuaries recent mortality experience study and reflect future mortality improvement. Based on our experience and in consultation with our actuaries, we utilized a base RP-2014 with MP-2017 projection scale and appropriate collar adjustments. In 2016, we utilized the RP-2014 mortality tables with MP-2016 projection scale. The updated mortality assumption resulted in a decrease to the PBO of $4.7 million as of the end of 2017 and was recorded through "Accumulated other comprehensive loss."
The decrease in the discount rate, the change to the updated mortality and other assumptions and overall plan experience has increased the PBO by $19.5 million to $621.9 million as of December 31, 2017 from $602.4 million as of December 31, 2016. As of December 31, 2017 and 2016, the plan's unfunded status was $8.8 million and $28.1 million, respectively.
We recognized net periodic pension income of $0.4 million in 2017, compared to $0.1 million in 2016. For the year ended December 31, 2018, we estimate net periodic pension income to approximate $8.1 million, reflecting a discount rate of 4.10 percent, an expected return on plan assets of 6.5 percent and amortization of actuarial losses of $2.1 million.
On October 31, 2016, the Company provided formal notification to withdraw from its GCIU multiemployer pension plan. Accordingly, the Company recorded an estimated withdrawal liability of approximately $6.4 million, based on annual payments of approximately $0.4 million over 20 years, discounted at a credit adjusted risk-free rate return of approximately 3.6 percent. This liability is based on an analysis of the facts available to management; however, the withdrawal liability will ultimately be determined by the plan trustee.
Income Taxes
The Company accounts for income taxes under the liability method in accordance with ASC 740, Income Taxes. Accordingly, deferred income taxes are provided for the future tax consequences attributable to differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes. Deferred tax assets and liabilities are measured using tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. A valuation
44
allowance is established when necessary to reduce deferred tax assets to the amount that is more likely than not to be realized. The Company recognizes the benefit of tax positions when it is more likely than not to be sustained on its technical merits. The Company records interest and penalties on unrecognized tax benefits in the provision for income taxes. As of December 31, 2017, the Company has $0.8 million in valuation allowances.
As of December 31, 2017, the Company re-measured its deferred income tax liabilities based on the enactment of the Tax Act signed into law on December 22, 2017. The new law reduces the federal statutory tax rate from 35 percent to 21 percent. Accordingly, the Company provisionally reduced its deferred income tax liability by approximately $144 million. Due to this new law, the Company expects its effective income tax and cash tax rates to approximate 24 percent in 2018.
Recent Accounting Pronouncements
See Note 2 "Significant Accounting Policies" in the Notes to Consolidated Financial Statements for a discussion of recent accounting pronouncements.
Contractual Obligations
The following table summarizes our contractual obligations as of December 31, 2017 ($000's):
| |
Payments Due by Period | |||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Contractual Obligations
|
Total | 2018 | 2019 | 2020 | 2021 | 2022 | Thereafter | |||||||||||||||
Long-term debt(1) |
$ | 1,078,875 | $ | — | $ | — | $ | 657,637 | $ | — | $ | 421,238 | $ | — | ||||||||
Receivable credit facility(1) |
308,849 | — | — | 308,849 | — | — | — | |||||||||||||||
Interest on long-term debt(2) |
140,559 | 45,953 | 45,936 | 27,796 | 14,789 | 6,085 | — | |||||||||||||||
Operating lease obligations(3) |
273,866 | 45,812 | 40,777 | 35,349 | 29,616 | 24,510 | 97,802 | |||||||||||||||
Capital lease obligation |
14,230 | 561 | 561 | 561 | 561 | 574 | 11,412 | |||||||||||||||
Purchase obligations(4)(5) |
360,247 | 35,686 | 32,703 | 31,938 | 31,174 | 30,792 | 197,954 | |||||||||||||||
Victory contingent consideration(6) |
20,694 | 20,694 | — | — | — | — | — | |||||||||||||||
Multiemployer pension plan(7) |
8,880 | 444 | 444 | 444 | 444 | 444 | 6,660 | |||||||||||||||
API long-term incentive plan(8) |
5,000 | 5,000 | — | — | — | — | — | |||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
Total |
$ | 2,211,200 | $ | 154,150 | $ | 120,421 | $ | 1,062,574 | $ | 76,584 | $ | 483,643 | $ | 313,828 | ||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
- (1)
- These
obligations are reflected on our Consolidated Balance Sheets at December 31, 2017, in long-term debt, net of current portion, as appropriate. See
Note 10 "Short-term Borrowings and Long-term Debt" in the Notes to Consolidated Financial Statements.
- (2)
- Assumes
debt is carried to full term. Debt bears interest at variable rates and the amounts above assume future interest will be incurred at the rates in effect on
December 31, 2017. These obligations are not reflected on our Consolidated Balance Sheets at December 31, 2017.
- (3)
- These
obligations are not reflected on our Consolidated Balance Sheets at December 31, 2017. See Note 16 "Commitments and Contingencies" in the Notes
to Consolidated Financial Statements.
- (4)
- Purchase obligations are agreements to purchase goods that are enforceable and legally binding on us and that specify all significant terms, including fixed or minimum quantities to be purchased. These obligations are not reflected on our Consolidated Balance Sheets at December 31, 2017. See Note 16 "Commitments and Contingencies" in the Notes to Consolidated Financial Statements regarding the Company's purchase obligation relating to the Long Term Fiber Supply Agreement and the purchase of a contracted volume of natural gas.
45
- (5)
- In
September, 2015, the Company signed a non-cancellable contract with a third party to produce wood chips for use at the Company's North Charleston and Roanoke
Rapids paper mills for twenty years, with an annual purchase obligation of approximately $13.4 million.
- (6)
- As
of December 31, 2017, the Company is obligated to pay $20.7 million of contingent consideration to the former owners of Victory based on achieving
certain financial performance criteria for the thirty month period following the closing.
- (7)
- On
October 31, 2016, the Company provided formal notification to withdraw from its GCIU multiemployer pension plan. Accordingly, the Company recorded an
estimated withdrawal liability of approximately $6.4 million. The withdrawal liability is calculated based on annual payments of approximately $0.4 million over 20 years,
discounted at a credit adjusted risk-free rate return of approximately 3.6 percent. This liability is based on an analysis of the facts available to management; however, the withdrawal
liability will ultimately be determined by the plan trustee.
- (8)
- In February 2017, the Company acquired API. As part of the acquisition, the Company signed a four-year long-term incentive agreement with the sellers contingent on the achievement of certain financial targets. This agreement contains an acceleration clause that would trigger upon the sale of the Company prior to the fourth anniversary of the API acquisition. Contingent upon the closing of the KapStone acquisition by WestRock Company announced January 29, 2018, the Company will be required to make a $5.0 million payment to the sellers. As of December 31, 2017, no accrual has been recorded related to this contingent obligation.
At this time, the Company does not expect to have any required contributions to its defined benefit plan in 2018. The timing and amount of future contributions, which could be material, will depend on a number of factors, including the actual earnings and changes in values of plan assets, changes in interest rates and changes in mortality tables.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Market risk is the sensitivity of income to changes in interest rates, commodity prices and foreign currency changes. The Company is exposed to the following types of market risk: interest rates, commodity prices and foreign currency.
Interest Rates
Under our Credit Agreement, at December 31, 2017, our Credit Facility consisted of two term loans totaling approximately $1.1 billion outstanding and the Revolver that provides for borrowing of up to $500 million. Depending on the type of borrowing, the applicable interest rate under the Credit Facility is calculated at a per annum rate equal to (a) LIBOR plus an applicable margin or (b) the base rate that is calculated as (i) the greatest of (x) the prime rate, (y) the federal funds effective rate plus 0.50% or (z) a daily rate equal to one month LIBOR plus 1% plus (ii) an applicable margin. The unused portion of the Revolver is also subject to an unused fee that is calculated at a per annum rate (the "Unused Fee Rate").
The applicable margin for borrowings under the Credit Facility and the Unused Fee Rate is determined by reference to the pricing grid based on the Company's total leverage ratio. Under such pricing grid, the applicable margins for Term Loan A-1 and Revolver ranges from 1.00% to 2.00% for Eurodollar loans and from 0.0% to 1.00% for base rate loans and the Unused Fee Rate ranges from 0.20% to 0.325%. The applicable margins for Term Loan A-2 ranges from 1.125% to 2.125% for Eurodollar loans and from 0.125% to 1.125% for base rate loans. At December 31, 2017 the weighted average interest rate of the term loans was 3.4 percent.
Under our Receivables Credit Facility, at December 31, 2017, we had $308.8 million of outstanding borrowings. The outstanding capital of each investment in the receivable interests accrues yield for each
46
day at a rate per annum equal to the sum of (a) for any day, the one-month Eurodollar rate for U.S. dollar deposits plus (b) the applicable margin. At December 31, 2017 the interest rate on outstanding amounts under the Receivables Credit Facility was 2.31 percent.
Changes in market rates may impact the base or LIBOR rate under all borrowings. For instance, if the LIBOR rate was to increase or decrease by one percentage point (1.0%), our annual interest expense would change by approximately $14.1 million based upon our expected future monthly term loan balances per our existing repayment schedule and the Receivables Credit Facility.
Commodity Prices
We are exposed to price fluctuations of certain commodities used in production and distribution. Key materials and energy used in the production process include roundwood and woodchips, recycled fiber (OCC), containerboard, electricity, coal, natural gas and caustic soda. Diesel fuel prices have a direct impact on our Distribution segment. We generally purchase these commodities in each of our segments at market prices and do not use forward contracts or other financial instruments to hedge our exposure to price risk related to these commodities.
A hypothetical 10% increase in virgin fiber prices in our mills for a year would increase our costs by approximately $37.0 million. A hypothetical 10% increase in the price of energy throughout the year would increase our cost of energy by approximately $19.0 million.
We have one contract to purchase coal at fixed prices through December 31, 2018. Contracts for the purchase of natural gas at fixed prices have been layered in for various terms and quantities, with the shortest terms ending in 2019 and the longest terms ending in 2022.
We are exposed to price fluctuations in the price of our finished goods. The prices we charge for our products are primarily based on market conditions.
Foreign Currency
We are exposed to currency fluctuations as we invoice certain European customers in Euros and Mexican customers in Pesos. As of December 31, 2017 and 2016, the Company did not have any foreign currency forward contracts and foreign exchange forward contracts outstanding.
As of December 31, 2017, trade accounts receivable denominated in Euros and Mexican Pesos totaled $9.9 million and $3.1 million, respectively.
Item 8. Financial Statements and Supplementary Data
Financial statements are attached hereto beginning on Page F-1.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
Disclosure Controls and Procedures.
An evaluation of the effectiveness of our disclosure controls and procedures as of December 31, 2017 was made by our Chief Executive Officer and Chief Financial Officer. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.
47
Internal Control over Financial Reporting.
Management Annual Report on Internal Control over Financial Reporting. Our management's report on internal control over financial reporting is set forth on page F-2 of this report.
Changes in Internal Control over Financial Reporting. There were no changes in our internal control over financial reporting during the most recent fiscal quarter that have materially affected, or are reasonably likely to affect, our internal control over financial reporting.
None.
Item 10. Directors, Executive Officers and Corporate Governance
The information required by this item is incorporated by reference from our definitive proxy statement to be filed with the Securities and Exchange Commission ("SEC") no later than 120 days after the end of the fiscal year covered by this Form 10-K.
Additional information required by this Item (i) with respect to members of our Board of Directors will be contained in the Company's Proxy Statement to be filed with the SEC under the caption "Proposal 1—Election of Directors", (ii) with respect to our executive officers will be contained in the Company's Proxy Statement under the caption "Executive Officers", (iii) with respect to our audit committee will be contained in the Company's Proxy Statement under the caption "Governance Structure—What Committees has the Board Established?", (iv) with respect to compliance under Section 16(a) of the Securities Exchange Act of 1934 will be contained in Company's Proxy Statement under the caption "Section 16(a) Beneficial Ownership Reporting Compliance", and (v) with respect to our code of ethics will be contained in the Company's Proxy Statement under the caption "Code of Ethics" and is incorporated herein by this reference.
KapStone adopted a code of ethics that applies to its CEO and CFO, as well as all other officers and employees of the Company and its affiliates. This code of ethics, entitled "Code of Conduct and Ethics," is posted on the Company's website at under "Governance." The Code of Conduct and Ethics is administered by the Chief Compliance Officer of the Company. Any amendment to, or waiver of, a provision of the Code of Conduct and Ethics that applies to the CEO, CFO, or persons performing similar functions will be disclosed on the Company's website under "Governance." We will also provide a copy of the Code of Conduct and Ethics without charge at the written request of any shareholder of record. Requests for copies may be directed to the Chief Compliance Office at our corporate headquarters.
Item 11. Executive Compensation
The information required by this Item will be contained in the Company's Proxy Statement to be filed with the SEC under the captions "Executive Compensation," "Oversight of Compensation Risk," "Summary Compensation Table," "2017 Grants of Plan-Based Awards," "Outstanding Equity Awards at 2017 Fiscal Year End," "Option Exercises and Stock Vested in 2017," "Pension Benefits in 2017," "Potential Payments upon Change-in-Control or Termination," and "Governance Structure—2017 Director Compensation," and is incorporated herein by this reference.
48
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this Item will be contained in the Company's Proxy Statement to be filed with the SEC under the captions "Stock Ownership—Securities Authorized for Issuance Under Equity Compensation Plans", "Stock Ownership—Security Ownership of Management" and "Stock Ownership—Security Ownership of Certain Beneficial Stockholders" and is incorporated herein by this reference.
Item 13. Certain Relationships and Related Persons Transactions and Director Independence
The information required by this Item will be contained in the Company's Proxy Statement to be filed with the SEC under the captions "Certain Relationships and Related Person Transactions," and "Governance Structure" is incorporated herein by this reference.
Item 14. Principal Accountant Fees and Services
The information required by this Item will be contained in the Company's Proxy Statement to be filed with the SEC under the caption "Independent Registered Public Accounting Firm" and is incorporated herein by this reference.
Item 15. Exhibits and Financial Statement Schedules
- (a)
- (1) Financial Statements
An index to Consolidated Financial Statements appears on page F-1.
- (a)
- (2) Financial Statement Schedules
Certain financial statement schedules have been omitted because they are not applicable or the required information is shown in the financial statements or the notes thereto.
- (b)
- Exhibits.
The following Exhibits are filed as part of this report:
49
50
51
- *
- Management compensatory plan or arrangement.
52
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant had duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| KAPSTONE PAPER AND PACKAGING CORPORATION | ||||
February 23, 2018 |
By: |
/s/ MATTHEW KAPLAN Matthew Kaplan, President, Chief Executive Officer and Director |
||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
| February 23, 2018 | By: | /s/ MATTHEW KAPLAN Matthew Kaplan, President, Chief Executive Officer and Director |
||
February 23, 2018 |
By: |
/s/ ANDREA K. TARBOX Andrea K. Tarbox, Executive Vice President and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) |
||
February 23, 2018 |
By: |
/s/ ROGER W. STONE Roger W. Stone, Executive Chairman of the Board |
||
February 23, 2018 |
By: |
/s/ MARK NIEHUS Mark A. Niehus, Vice President and Corporate Controller |
||
February 23, 2018 |
By: |
/s/ ROBERT J. BAHASH Robert J. Bahash, Director |
||
February 23, 2018 |
By: |
/s/ JOHN M. CHAPMAN John M. Chapman, Director |
53
| February 23, 2018 | /s/ PAULA H.J. CHOLMONDELEY Paula H.J. Cholmondeley |
|||
February 23, 2018 |
By: |
/s/ JONATHAN R. FURER Jonathan R. Furer, Director |
||
February 23, 2018 |
By: |
/s/ DAVID G. GABRIEL David G. Gabriel, Director |
||
February 23, 2018 |
By: |
/s/ BRIAN R. GAMACHE Brian R. Gamache, Director |
||
February 23, 2018 |
By: |
/s/ RONALD J. GIDWITZ Ronald J. Gidwitz, Director |
||
February 23, 2018 |
By: |
/s/ MATTHEW H. PAULL Matthew H. Paull, Director |
||
February 23, 2018 |
By: |
/s/ MAURICE S. REZNIK Maurice S. Reznik, Director |
||
February 23, 2018 |
By: |
/s/ DAVID P. STORCH David P. Storch, Director |
54
KapStone Paper and Packaging Corporation
(INDEX TO FINANCIAL STATEMENTS)
F-1
MANAGEMENT'S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 3a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements and can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2017. Management based this assessment on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in "Internal Control—Integrated Framework (2013 Framework)."
Based on this assessment, management concluded that, as of December 31, 2017, our internal control over financial reporting is effective.
Ernst & Young LLP, an independent registered public accounting firm, has audited the consolidated financial statements of the Company and the Company's internal control over financial reporting and has included their reports herein.
F-2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and the Board of Directors of KapStone Paper and Packaging Corporation
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of KapStone Paper and Packaging Corporation (the Company) as of December 31, 2017 and 2016, and the related consolidated statements of comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2017, and the related notes (collectively referred to as the "consolidated financial statements"). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2017, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 23, 2018 expressed an unqualified opinion thereon.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ Ernst & Young LLP
We have served as the Company's auditor since 2006.
Chicago,
Illinois
February 23, 2018
F-3
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and the Board of Directors of KapStone Paper and Packaging Corporation
Opinion on Internal Control over Financial Reporting
We have audited KapStone Paper and Packaging Corporation's internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, KapStone Paper and Packaging Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the 2017 consolidated financial statements of the Company and our report dated February 23, 2018 expressed an unqualified opinion thereon.
Basis for Opinion
The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.
Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/
Ernst & Young LLP
Chicago, Illinois
February 23, 2018
F-4
KapStone Paper and Packaging Corporation
Consolidated Balance Sheets
(In thousands, except share and per share amounts)
| |
December 31, | ||||||
|---|---|---|---|---|---|---|---|
| |
2017 | 2016 | |||||
Assets |
|||||||
Current assets: |
|||||||
Cash and cash equivalents |
$ | 28,065 | $ | 29,385 | |||
Trade accounts receivable (Includes $425,216 at December 31, 2017, and $368,922 at December 31, 2016, associated with the securitization facility) |
443,462 | 392,962 | |||||
Other receivables |
23,289 | 13,562 | |||||
Inventories |
315,575 | 322,664 | |||||
Prepaid expenses and other current assets |
17,470 | 10,247 | |||||
| | | | | | | | |
Total current assets |
827,861 | 768,820 | |||||
| | | | | | | | |
Plant, property and equipment, net |
1,453,607 | 1,441,557 | |||||
Other assets |
24,431 | 25,468 | |||||
Intangible assets, net |
297,475 | 314,413 | |||||
Goodwill |
720,611 | 705,617 | |||||
| | | | | | | | |
Total assets |
$ | 3,323,985 | $ | 3,255,875 | |||
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
Liabilities and Stockholders' Equity |
|||||||
Current liabilities: |
|||||||
Capital lease obligation |
30 | — | |||||
Dividend payable |
10,302 | 10,052 | |||||
Accounts payable |
199,574 | 189,350 | |||||
Accrued expenses |
105,951 | 76,480 | |||||
Accrued compensation costs |
75,215 | 48,840 | |||||
Accrued income taxes |
31,458 | 15,971 | |||||
| | | | | | | | |
Total current liabilities |
422,530 | 340,693 | |||||
| | | | | | | | |
Other liabilities: |
|||||||
Long-term debt (Includes $308,849 at December 31, 2017, and $269,273 at December 31, 2016, associated with the securitization facility) |
1,374,502 | 1,485,323 | |||||
Long-term financing obligation |
82,199 | — | |||||
Capital lease obligation |
4,595 | — | |||||
Pension and postretirement benefits |
14,196 | 34,207 | |||||
Deferred income taxes |
252,101 | 405,561 | |||||
Other liabilities |
36,848 | 85,761 | |||||
| | | | | | | | |
Total other liabilities |
1,764,441 | 2,010,852 | |||||
| | | | | | | | |
Stockholders' equity: |
|||||||
Preferred stock $0.0001 par value; 1,000,000 shares authorized; no shares issued and outstanding |
— | — | |||||
Common stock—$0.0001 par value; 175,000,000 shares authorized; 97,043,750 shares issued and outstanding (excluding 40,000 treasury shares) at December 31, 2017 and 96,639,920 shares issued and outstanding (excluding 40,000 treasury shares) at December 31, 2016 |
10 | 10 | |||||
Additional paid-in-capital |
291,629 | 275,970 | |||||
Retained earnings |
894,061 | 689,668 | |||||
Accumulated other comprehensive loss |
(48,686 | ) | (61,318 | ) | |||
| | | | | | | | |
Total stockholders' equity |
1,137,014 | 904,330 | |||||
| | | | | | | | |
Total liabilities and stockholders' equity |
$ | 3,323,985 | $ | 3,255,875 | |||
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
See notes to consolidated financial statements.
F-5
KapStone Paper and Packaging Corporation
Consolidated Statements of Comprehensive Income
(In thousands, except share and per share amounts)
| |
Years Ended December 31, | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| |
2017 | 2016 | 2015 | |||||||
Net sales |
$ | 3,315,660 | $ | 3,077,257 | $ | 2,789,345 | ||||
Cost of sales, excluding depreciation and amortization |
2,364,731 | 2,214,872 | 1,982,686 | |||||||
Depreciation and amortization |
186,801 | 182,213 | 162,179 | |||||||
Freight and distribution expenses |
299,872 | 279,023 | 234,469 | |||||||
Selling, general, and administrative expenses |
265,131 | 224,127 | 210,844 | |||||||
Multiemployer pension plan withdrawal expense |
— | 6,376 | — | |||||||
| | | | | | | | | | | |
Operating income |
199,125 | 170,646 | 199,167 | |||||||
Foreign exchange (gain) / loss |
(993 | ) | 2,255 | 2,556 | ||||||
Equity method investments income |
(1,752 | ) | (548 | ) | — | |||||
Loss on debt extinguishment |
1,305 | 679 | 1,218 | |||||||
Interest expense, net |
52,282 | 40,078 | 33,759 | |||||||
| | | | | | | | | | | |
Income before provision (benefit) for income taxes |
148,283 | 128,182 | 161,634 | |||||||
Provision (benefit) for income taxes |
(95,220 | ) | 41,930 | 55,248 | ||||||
| | | | | | | | | | | |
Net income |
$ | 243,503 | $ | 86,252 | $ | 106,386 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
Other comprehensive income / (loss), net of tax |
||||||||||
Foreign currency translation adjustment |
373 | (551 | ) | — | ||||||
Defined pension and post-retirement plans: |
||||||||||
Net actuarial gain/(loss) |
12,178 | 502 | (13,182 | ) | ||||||
Prior service cost |
(2,063 | ) | — | — | ||||||
Pension and postretirement plan reclassification adjustments: |
||||||||||
Amortization (accretion) of prior service costs |
(282 | ) | (416 | ) | 1,413 | |||||
Amortization of net loss |
2,426 | 2,403 | 502 | |||||||
| | | | | | | | | | | |
Other comprehensive income/(loss), net of tax |
12,632 | 1,938 | (11,267 | ) | ||||||
| | | | | | | | | | | |
Total comprehensive income |
$ | 256,135 | $ | 88,190 | $ | 95,119 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
Weighted average number of shares outstanding: |
||||||||||
Basic |
96,859,516 | 96,533,368 | 96,257,749 | |||||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
Diluted |
98,615,101 | 97,777,066 | 97,635,539 | |||||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
Net income per share: |
||||||||||
Basic |
$ | 2.51 | $ | 0.89 | $ | 1.11 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
Diluted |
$ | 2.47 | $ | 0.88 | $ | 1.09 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
Dividends declared per common share |
$ | 0.40 | $ | 0.40 | $ | 0.40 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
See notes to consolidated financial statements.
F-6
KapStone Paper and Packaging Corporation
Consolidated Statements of Changes in Stockholders' Equity
(In thousands, except share amounts)
| |
Common Stock, net of Treasury Stock |
|
|
|
|
||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
|
|
Accumulated Other Comprehensive Loss |
|
|||||||||||||||
| |
Additional Paid-In Capital |
Retained Earnings |
Total Stockholders' Equity |
||||||||||||||||
| |
Shares | Amount | |||||||||||||||||
Balance—December 31, 2014 |
96,046,554 | $ | 10 | $ | 255,505 | $ | 574,601 | $ | (51,989 | ) | $ | 778,127 | |||||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
Stock-based compensation expense |
— | — | 9,835 | — | — | 9,835 | |||||||||||||
Payment of withholding taxes on vested restricted stock awards and options exercised |
155,283 | (2,508 | ) | — | — | (2,508 | ) | ||||||||||||
Exercise of stock options |
91,256 | — | 896 | — | — | 896 | |||||||||||||
Excess tax benefit from stock-based compensation |
— | — | 1,649 | — | — | 1,649 | |||||||||||||
Employee Stock Purchase Plan |
34,413 | — | 843 | — | — | 843 | |||||||||||||
Dividends declared |
— | — | — | (38,681 | ) | — | (38,681 | ) | |||||||||||
Net income |
— | — | — | 106,386 | — | 106,386 | |||||||||||||
Pension and postretirement plan adjustments, net of tax of $6,852 |
— | — | — | — | (11,267 | ) | (11,267 | ) | |||||||||||
| | | | | | | | | | | | | | | | | | | | |
Balance—December 31, 2015 |
96,327,506 | $ | 10 | $ | 266,220 | $ | 642,306 | $ | (63,256 | ) | $ | 845,280 | |||||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
Stock-based compensation expense |
— | — | 8,938 | — | — | 8,938 | |||||||||||||
Payment of withholding taxes on vested restricted stock awards and options exercised |
149,411 | — | (810 | ) | — | — | (810 | ) | |||||||||||
Exercise of stock options |
100,367 | — | 858 | — | — | 858 | |||||||||||||
Excess tax deficiency from stock-based compensation |
— | — | (207 | ) | — | — | (207 | ) | |||||||||||
Employee Stock Purchase Plan |
62,636 | — | 971 | — | — | 971 | |||||||||||||
Dividends declared |
— | — | — | (38,890 | ) | — | (38,890 | ) | |||||||||||
Net income |
— | — | — | 86,252 | — | 86,252 | |||||||||||||
Pension and postretirement plan adjustments, net of tax of $1,493 |
— | — | — | — | 2,489 | 2,489 | |||||||||||||
Foreign currency translation adjustment |
— | — | — | — | (551 | ) | (551 | ) | |||||||||||
| | | | | | | | | | | | | | | | | | | | |
Balance—December 31, 2016 |
96,639,920 | $ | 10 | $ | 275,970 | $ | 689,668 | $ | (61,318 | ) | $ | 904,330 | |||||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
Stock-based compensation expense |
— | — | 14,910 | — | — | 14,910 | |||||||||||||
Payment of withholding taxes on vested restricted stock awards and options exercised |
176,444 | — | (1,884 | ) | — | — | (1,884 | ) | |||||||||||
Exercise of stock options |
180,643 | — | 1,686 | — | — | 1,686 | |||||||||||||
Employee Stock Purchase Plan |
46,743 | — | 947 | — | — | 947 | |||||||||||||
Dividends declared |
— | — | — | (39,110 | ) | — | (39,110 | ) | |||||||||||
Net income |
— | — | — | 243,503 | — | 243,503 | |||||||||||||
Pension and postretirement plan adjustments, net of tax of $4,459 |
— | — | — | — | 12,259 | 12,259 | |||||||||||||
Foreign currency translation adjustment |
— | — | — | — | 373 | 373 | |||||||||||||
| | | | | | | | | | | | | | | | | | | | |
Balance—December 31, 2017 |
97,043,750 | $ | 10 | $ | 291,629 | $ | 894,061 | $ | (48,686 | ) | $ | 1,137,014 | |||||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
See notes to consolidated financial statements.
F-7
KapStone Paper and Packaging Corporation
Consolidated Statements of Cash Flows
(In thousands)
| |
Years Ended December 31, | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| |
2017 | 2016 | 2015 | |||||||
Operating activities |
||||||||||
Net income |
$ | 243,503 | $ | 86,252 | $ | 106,386 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: |
||||||||||
Depreciation of plant and equipment |
155,903 | 149,318 | 136,886 | |||||||
Amortization of intangible assets |
30,898 | 32,895 | 25,293 | |||||||
Stock-based compensation expense |
14,910 | 8,938 | 9,835 | |||||||
Pension and postretirement |
(3,292 | ) | (3,694 | ) | (11,182 | ) | ||||
Multiemployer pension plan withdrawal expense |
— | 6,376 | — | |||||||
Excess tax deficiency / (benefit) from stock-based compensation |
— | 207 | (1,649 | ) | ||||||
Amortization of debt issuance costs |
4,787 | 4,804 | 5,546 | |||||||
Loss on debt extinguishment |
1,305 | 679 | 1,218 | |||||||
Loss on disposal of fixed assets |
5,372 | 3,599 | 951 | |||||||
Deferred income taxes |
(157,918 | ) | (14,440 | ) | 11,042 | |||||
Inventory step-up expense |
— | — | 5,800 | |||||||
Change in fair value of contingent consideration liability |
5,794 | 1,600 | 3,700 | |||||||
Equity method investments income, net of cash received |
98 | (548 | ) | — | ||||||
Plant closure costs |
7,522 | — | — | |||||||
Provision for bad debt expense |
3,024 | — | — | |||||||
Changes in assets and liabilities: |
||||||||||
Trade accounts receivable, net |
(51,040 | ) | (27,452 | ) | 8,960 | |||||
Other receivables |
(7,945 | ) | 2,685 | (1,596 | ) | |||||
Inventories |
6,904 | 13,700 | (13,086 | ) | ||||||
Prepaid expenses and other current assets |
296 | 17,063 | (13,375 | ) | ||||||
Other assets |
(843 | ) | (993 | ) | 478 | |||||
Accounts payable |
9,676 | (12,782 | ) | (13,352 | ) | |||||
Accrued expenses and other liabilities |
10,952 | 11,806 | 16,155 | |||||||
Accrued compensation costs |
30,075 | (15,364 | ) | (7,120 | ) | |||||
Accrued income taxes |
15,487 | 17,271 | (8,433 | ) | ||||||
| | | | | | | | | | | |
Net cash provided by operating activities |
325,468 | 281,920 | 262,457 | |||||||
| | | | | | | | | | | |
Investing activities |
||||||||||
Equity method investments |
— | (11,807 | ) | — | ||||||
Purchase of intangible assets |
— | (2,525 | ) | — | ||||||
Acquisitions, net of cash acquired |
(33,500 | ) | (15,438 | ) | (617,046 | ) | ||||
Proceeds from the sale of assets |
472 | 4,881 | — | |||||||
Capital expenditures |
(138,358 | ) | (126,865 | ) | (126,756 | ) | ||||
| | | | | | | | | | | |
Net cash used in investing activities |
(171,386 | ) | (151,754 | ) | (743,802 | ) | ||||
| | | | | | | | | | | |
Financing activities |
||||||||||
Proceeds from revolving credit facility |
422,000 | 451,000 | 350,000 | |||||||
Repayments on revolving credit facility |
(422,000 | ) | (457,400 | ) | (343,600 | ) | ||||
Proceeds from receivables credit facility |
89,914 | 43,001 | 134,701 | |||||||
Repayments on receivables credit facility |
(50,338 | ) | (39,342 | ) | (36,088 | ) | ||||
Proceeds from long-term debt |
— | — | 519,763 | |||||||
Repayments on long-term debt |
(155,000 | ) | (64,687 | ) | (116,438 | ) | ||||
Repayments on long-term financing obligations |
(495 | ) | — | — | ||||||
Repayments on capital lease |
(22 | ) | — | — | ||||||
Cash dividends paid |
(38,722 | ) | (38,736 | ) | (38,729 | ) | ||||
Payment of loan amendment and debt issuance costs |
(1,488 | ) | (2,250 | ) | (10,790 | ) | ||||
Proceeds from other current borrowings |
6,214 | — | 6,615 | |||||||
Repayments on other current borrowings |
(6,214 | ) | — | (6,615 | ) | |||||
Payment of withholding taxes on stock awards |
(1,884 | ) | (810 | ) | (2,508 | ) | ||||
Proceeds from exercises of stock options |
1,686 | 858 | 896 | |||||||
Proceeds from shares issued to ESPP |
947 | 971 | 843 | |||||||
Excess tax (deficiency) / benefit from stock-based compensation |
— | (207 | ) | 1,649 | ||||||
| | | | | | | | | | | |
Net cash (used in) provided by financing activities |
(155,402 | ) | (107,602 | ) | 459,699 | |||||
| | | | | | | | | | | |
Net increase (decrease) in cash and cash equivalents |
(1,320 | ) | 22,564 | (21,646 | ) | |||||
Cash and cash equivalents-beginning of period |
29,385 | 6,821 | 28,467 | |||||||
| | | | | | | | | | | |
Cash and cash equivalents-end of period |
$ | 28,065 | $ | 29,385 | $ | 6,821 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
See notes to consolidated financial statements.
F-8
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
($ in thousands, except share and per share amounts)
1. Description of Business and Basis of Presentation
KapStone Paper and Packaging Corporation, or the "Company," produces and sells a variety of containerboard, corrugated products and specialty paper products in the United States and globally. The Company was incorporated on April 15, 2005 in Delaware.
On June 1, 2015, the Company acquired 100 percent of the partnership interests in Victory Packaging, L.P. and its subsidiaries ("Victory"). As a result of the Victory acquisition, the accompanying consolidated financial statements are not comparative. The accompanying consolidated financial statements include the results of Victory since the date of its acquisition, see Note 4 "Victory Acquisition".
Principles of Consolidation—The consolidated financial statements have been prepared on the accrual basis of accounting in conformity with accounting principles generally accepted in the United States of America ("U.S. GAAP"). The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated.
Use of Estimates—The preparation of financial statements and related disclosures requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Although these estimates are based on management's best knowledge of current events and actions that the Company may undertake in the future, actual results may be different from the estimates.
Recently Adopted Accounting Standards—In July 2015, the Financial Accounting Standard's Board ("FASB") issued Accounting Standards Update ("ASU") No. 2015-11, "Simplifying the Measurement of Inventory", which is intended to simplify the subsequent measurement of inventories by replacing the current lower of cost or market test with a lower of cost and net realizable value test. The guidance applies only to inventories for which cost is determined by methods other than last-in first-out and the retail inventory method. Application of the standard, which should be applied prospectively, is required for the annual and interim periods beginning after December 15, 2016. We adopted ASU 2015-11 during the interim period ended March 31, 2017, and it had no material impact on the Company's consolidated financial statements.
In March 2016, the FASB issued ASU 2016-09, "Improvements to Employee Share-Based Payment Accounting", which requires all income tax effects of awards to be recognized in the income statement when the awards vest or are settled. It also allows an employer to repurchase more of an employee's shares than previously allowed for tax withholding purposes without triggering liability accounting and to make a policy election to account for forfeitures as they occur. The guidance is effective for public business entities for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. We adopted ASU 2016-09 prospectively during the interim period ended March 31, 2017. The adoption of this ASU increased the Company's provision for income taxes by $0.1 million for the year ended December 31, 2017. The Company has elected to continue recognizing estimated forfeitures over the vesting term of the awards.
F-9
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
2. Significant Accounting Policies
Revenue Recognition—Revenue is recognized when the customer takes title and assumes the risks and rewards of ownership, when the price is fixed and determinable and when collectability is reasonably assured. Sales with terms f.o.b. (free on board) shipping point are recognized at the time of shipment. For sales transactions with terms f.o.b. destination, revenue is recorded when the product is delivered to the customer's site and when title and risk of loss are transferred. Sales on consignment are recognized in revenue at the earlier of the month that the goods are consumed or after a period of time subsequent to receipt by the customer as specified by contract terms, provided all other revenue recognition criteria is met. Incentive rebates are typically paid in cash and are netted against revenue on an accrual basis as qualifying purchases are made by the customer to earn and thereby retain the rebate. During 2017, 2016, and 2015, customer rebates totaled $35.4 million, $34.3 million and $32.7 million, respectively.
Freight charged to customers is recognized in net sales.
Cost of Sales—Cost of sales includes material, labor and overhead costs, but excludes depreciation of plant and equipment and amortization. Proceeds received from the sale of by-products generated from the paper and packaging manufacturing process are reflected as a reduction to cost of sales. Income from sales of by-products is derived primarily from the sale of tall oil, hardwood, turpentine and waste bales to third parties. During 2017, 2016 and 2015 cost of sales was reduced by $40.9 million, $32.6 million and $36.1 million, respectively, for these by-product sales.
Freight and Distribution Expenses—Freight and distribution includes shipping and handling costs for product sold to customers and is excluded from cost of sales.
Planned Maintenance Outage Costs—The Company recognizes the cost of maintenance activities in the period in which they occur under the direct expense method in accordance with ASC 360, Property, Plant and Equipment. The Company performs planned maintenance outages at its paper mills. Costs of approximately $46.8 million, $32.6 million and $37.4 million related to planned maintenance outages are included in cost of sales for the years ended December 31, 2017, 2016 and 2015, respectively.
Net Income per Common Share—Basic net income per share is based on the weighted average number of common shares outstanding during the period. Diluted income per share reflects the potential dilution assuming common shares were issued for the exercise of outstanding in-the-money stock options and unvested restricted stock awards and assuming the proceeds thereof were used to purchase common shares at the average market price during the period such awards were outstanding and inclusion of such shares is dilutive to net income per share.
Concentrations of Risk—Financial instruments that potentially expose the Company to concentrations of credit and market risk consist primarily of cash and cash equivalents and trade accounts receivable from sales of product to third parties. When excess cash and cash equivalents are invested they are placed in investment grade commercial paper.
No customer accounted for more than 10 percent of consolidated net sales in 2017, 2016 or 2015. In order to mitigate credit risk, the Company obtains letters of credit for certain export customers. For the years ended December 31, 2017, 2016 and 2015, net sales to U.S. based customers were 86 percent, 83 percent and 82 percent, respectively, of consolidated net sales. Net sales to foreign based customers
F-10
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
2. Significant Accounting Policies (Continued)
during 2017, 2016 and 2015 were 14 percent, 17 percent and 18 percent, respectively, of consolidated net sales. See Note 18 "Segment Information".
The Company establishes its allowance for doubtful accounts based upon factors mainly surrounding the credit risks of specific customers and other related information. Once an account is deemed uncollectible, it is written off. At December 31, 2017, 2016 and 2015 changes to the allowance for doubtful accounts are summarized as follows ($000's):
Year ended:
|
Balance at beginning of year |
Acquisition | Charged to Expense |
Write-offs | Balance at end of year |
|||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
December 31, 2017 |
$ | 1,353 | — | $ | 3,024 | $ | (3,723 | ) | $ | 654 | ||||||
December 31, 2016 |
$ | 1,084 | $ | — | $ | 881 | $ | (612 | ) | $ | 1,353 | |||||
December 31, 2015 |
$ | 285 | $ | 742 | $ | 368 | $ | (311 | ) | $ | 1,084 | |||||
Foreign Currency Transactions—The Company invoices certain European customers in Euros and Mexican customers in Pesos. Outstanding amounts for such transactions are remeasured into U.S. dollars at the year-end rate of exchange and statements of comprehensive income items are remeasured at the weighted average exchange rates for the period. Gains and losses arising from these transactions are included in foreign exchange gains / (losses) within the Consolidated Statements of Comprehensive Income.
Cash and Cash Equivalents—Cash equivalents include all highly liquid investments with maturities of three months or less when purchased.
Fair value of Financial Instruments—The Company's cash and cash equivalents, trade accounts receivables, pension assets, contingent consideration liability and accounts payables are financial assets and liabilities with carrying values that approximate fair value. The Company's variable rate term loans are financial liabilities with fair values that approximate their carrying value of $1.4 billion. See Note 10 "Short-term Borrowings and Long-term debt".
Inventories—Inventories are valued at the lower of cost or market; whereby cost includes all direct and indirect materials, labor and manufacturing overhead, less by-product recoveries. Costs of raw materials, work-in-process, and finished goods are determined using the first-in, first-out method for KapStone locations with the exception of the Longview Paper mill and the seven western corrugated products manufacturing plants, which are on the last-in, first-out method. In total, these locations represent 18 percent and 22 percent of consolidated inventories as of December 31, 2017 and 2016, respectively. Replacement parts and other supplies are stated using the average cost method. Purchases and sales of inventory with the same counterparty that are entered into in contemplation of one another are combined and recorded as exchanges of inventory measured at the book value of the item exchanged.
In conjunction with the Victory acquisition, KapStone acquired inventories which were recorded at fair value as of the acquisition date. The cost for the Victory inventories is stated at the lower cost or market and is determined under the first-in, first-out method.
F-11
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
2. Significant Accounting Policies (Continued)
Plant, Property, and Equipment, net—Plant, property, and equipment are stated at cost less accumulated depreciation. Property, plant, and equipment acquired in acquisitions were recorded at fair value on the date of acquisition. Depreciation is computed using the straight-line method over the assets' estimated useful lives. Assets under capital leases are depreciated on a straight-line method over the term of the lease or the useful life, if shorter. The range of estimated useful lives is as follows:
| |
Years | |
|---|---|---|
| Land improvements | 3 - 25 | |
| Buildings | 11 - 40 | |
| Machinery and equipment | 3 - 30 | |
| Furniture and office equipment | 5 - 10 | |
| Computer hardware and software | 3 - 5 |
The Company accounts for costs incurred for the development of software for internal use in accordance with ASC 350 Intangibles—Goodwill and Other. This standard requires the capitalization of certain costs incurred in connection with developing or obtaining internal use software.
Leases—The Company assesses lease classification as either capital or operating at lease inception or upon modification. We lease 13 of our corrugated products manufacturing plants and most distribution centers, as well as other property and equipment, under operating leases. For purposes of determining straight-line rent expense, the lease term is calculated from the date of possession of the facility, including any periods of free rent and any renewal option periods that are reasonably assured of being exercised.
Goodwill and Intangible Assets—Goodwill is the excess of purchase price over the fair value of the net assets of businesses acquired. On an annual basis and in accordance with ASC 350, Intangibles—Goodwill and Other, the Company evaluates goodwill using a quantitative or qualitative assessment to determine whether it is more likely than not that fair value of any reporting unit is less than it carrying amount. If the Company determines that the fair value of the reporting unit may be less than its carrying amount, the Company evaluates goodwill using a two-step impairment test. Otherwise, the Company concludes that no impairment is indicated and does not perform the two-step impairment test.
If the qualitative assessment concludes that the two-step impairment test is necessary, the first step is to compare the book value of the reporting unit, including goodwill, with its fair value. A reporting unit is an operating segment or one level below an operating segment (referred to as a "component"). A component is considered a reporting unit for purposes of goodwill testing if the component constitutes a business for which discrete financial information is available and segment management regularly reviews the operating results of that component. The Company has identified three reporting units; Western Paper and Packaging Operations, Eastern Paper and Packaging Operations and Distribution. The fair value is estimated based on a market approach and a discounted cash flow analysis, also known as the income approach, and is reconciled to the current market capitalization for the Company to ensure that the implied control premium is reasonable. A discounted cash flow analysis requires the Company to make various judgmental assumptions, including assumptions about future cash flows, growth rates and discount rates. The assumptions about future cash flows and growth
F-12
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
2. Significant Accounting Policies (Continued)
rates are based on the forecast and long-term business plans of each reporting unit. Discount rate assumptions are considered Level 3 inputs in the fair value hierarchy defined in ASC 820, Fair Value Measurements and Discounts. Management also considers market-multiple information to corroborate the fair value conclusions reached using the discounted cash flow analysis. If necessary, the second step of the goodwill impairment test compares the implied fair value of the reporting unit's goodwill with the carrying amount of that goodwill. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. The Company's goodwill impairment analysis is performed annually at the beginning of the fourth quarter. The Company performed a quantitative assessment and it did not result in an impairment charge for any periods presented.
Intangible assets acquired in a business combination or asset purchase are initially valued at the fair market value using generally accepted valuation methods appropriate for the type of the intangible asset. Definite-lived intangible assets are amortized over their estimated useful lives and are reviewed for impairment if indicators of impairment arise. The evaluation of the impairment is based upon a comparison of the carrying amount of the intangible asset to the estimated future undiscounted cash flows expected to be generated by the asset. If the estimated undiscounted future cash flows are less than the carrying amount of the assets, the asset is considered to be impaired. If impaired, the intangible asset is written down to estimated fair market value.
Pension and Postretirement Benefits—The Company provides pension and postretirement benefits to certain employees and accounts for these benefits in accordance with ASC 715, Compensation—Retirement Benefits. For financial reporting purposes, long-term assumptions are developed through consultations with actuaries. Such assumptions include the expected long-term rate of return on plan assets, discount rates, health care trend rates and mortality rates. The discount rate for the current year is based on interest rates for long-term high quality bonds.
The amount of unrecognized actuarial gains and losses recognized in the current year's operations is based on amortizing the unrecognized gains or losses for each plan that exceeds the larger of 10 percent of the projected benefit obligation or the fair value of plan assets, also known as the corridor. The amount of unrecognized gain or loss that exceeds the corridor is amortized over the average future service of the plan participants. While we believe that our assumptions are appropriate, significant differences in our actual experience or significant changes in our assumptions may materially affect our pension and other postretirement benefit obligations and our future expense.
Income Taxes—The Company accounts for income taxes under the liability method in accordance with ASC 740, Income Taxes. Accordingly, deferred income taxes are provided for the future tax consequences attributable to differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes. Deferred tax assets and liabilities are measured using tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. A valuation allowance is established when necessary to reduce deferred tax assets to the amount that is more likely than not to be realized. The Company recognizes the benefit of tax positions when it is more likely than not to be sustained on its technical merits. The Company records interest and penalties on unrecognized tax benefits in the provision for income taxes.
F-13
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
2. Significant Accounting Policies (Continued)
Amortization of Debt Issuance Costs—The Company capitalizes costs incurred in connection with borrowings or establishment of credit facilities. These costs are amortized over the life of the borrowing or life of the credit facility using the effective interest method. For the years ended December 31, 2017, 2016 and 2015, $4.8 million, $4.8 million and $5.5 million, respectively, of debt issuance costs have been amortized and recognized within interest expense, net.
In 2017, 2016 and 2015, the Company recorded losses on debt extinguishment of $1.3 million, $0.7 million and $1.2 million, respectively, due to voluntary prepayments totaling $155.0 million, $64.7 million and $103.5 million, respectively, on the term loans under the Company's senior secured credit facility.
Stock Based Compensation Expense—The Company accounts for employee stock and stock-based compensation in accordance with ASC 718, Compensation—Stock Compensation. Accordingly, compensation expense for the fair value of stock options, as determined on the date of grant, is recorded on an accelerated basis over the awards' vesting periods. The compensation expense for the fair value of restricted stock units, as determined on the date of grant, is recorded on a straight-line basis over the awards' vesting periods. Forfeitures are estimated on the date of grant and revised if actual or expected forfeiture activity differs materially from the original estimate.
Segment Information—The Company reports results in two reportable segments: Paper and Packaging and Distribution. These segments represent distinct businesses that are managed separately because of differing products and services. Each of these businesses requires distinct operating and marketing strategies.
The Paper and Packaging segment produces containerboard, corrugated products and specialty paper which are sold to customers who convert our products into end-market finished products or internally to corrugated products manufacturing plants that produce a wide variety of products ranging from basic corrugated shipping containers to specialized packaging.
The Distribution segment, which operates under the Victory trade name, provides its customers comprehensive packaging solutions and services and distributes corrugated packaging materials and other specialty packaging products, which include stretch film, void fill, carton sealing tape and other specialty tapes.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standard's Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, "Revenue from Contracts with Customers". The guidance in this update affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards (for example, insurance contracts or lease contracts). The guidance in this update supersedes the revenue recognition requirements in Accounting Standards Codification ("ASC") Topic 605, "Revenue Recognition", and most industry-specific guidance throughout the Industry Topics of the Codification. Additionally, this update supersedes some cost guidance included in Subtopic 605-35, "Revenue Recognition—Construction-Type and Production-Type Contracts". The standard will be effective for public entities for annual reporting periods beginning after December 15, 2017 and interim
F-14
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
2. Significant Accounting Policies (Continued)
periods therein. Additionally the FASB approved the option to early adopt up to the original effective date (fiscal years beginning after December 15, 2016). The Company did not elect to early adopt this standard.
The Company has determined that it will adopt this standard utilizing the modified retrospective method, which will result in the recognition of the cumulative effect of initially applying the standard (if any) as an adjustment to opening retained earnings for the fiscal year beginning January 1, 2018.
Our implementation team, consisting of senior leadership from finance, legal, sales and operations, reported its progress to management and to the audit committee of our board of directors on a periodic basis. We have completed the significant contract review phase of the assessment and have made all necessary updates to our systems and control environment to support additional disclosures under the new standard. We have also made necessary changes to policies and procedures.
During our assessment, the Company considered whether the adoption would require a transition from point-in-time revenue recognition to an over-time approach for products produced by the Company without an alternative use, which would result in acceleration of revenue. The Company has determined that based on its enforceable rights included in its contracts or prevailing terms and conditions, an enforceable right of payment that includes a reasonable profit throughout the duration of the contract does not exist. Therefore, the Company will remain at a point-in-time approach and record revenue at the point control transfers to the customer.
We do not expect to recognize a cumulative adjustment to opening retained earnings under the modified retrospective approach and do not expect that the adoption of this standard to have a material effect on the Company's financial position or results of operations. We anticipate the primary impact to be the additional required disclosures around revenue recognition in the notes to the consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, "Leases". This guidance revises existing practice related to accounting for leases under ASC Topic 840 Leases for both lessees and lessors. The new guidance in ASU 2016-02 requires lessees to recognize a right-of-use asset and a lease liability for virtually all of their leases (other than leases that meet the definition of a short-term lease). The lease liability will be equal to the present value of lease payments and the right-of-use asset will be based on the lease liability, subject to adjustment such as for initial direct costs. For income statement purposes, the new standard retains a dual model similar to ASC 840, requiring leases to be classified as either operating or finance. For lessees, operating leases will result in straight-line expense (similar to current accounting by lessees for operating leases under ASC 840), while finance leases will result in a front-loaded expense pattern (similar to current accounting by lessees for capital leases under ASC 840).
While the new standard maintains similar accounting for lessors as under ASC 840, it reflects updates to, among other things, align with certain changes to the lessee model. The guidance is effective for public entities for fiscal years beginning after December 15, 2018, including interim periods within those years. Early adoption is permitted for all entities.
The Company does have a significant number of leases for both property and equipment. As such, the Company expects that there will be a material impact on our financial position and disclosures upon the adoption of ASU 2016-02. Our implementation team, consisting of senior leadership from
F-15
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
2. Significant Accounting Policies (Continued)
finance, legal, IT and operations, reports its progress to management and to the audit committee of our board of directors on a periodic basis. We are in the process of abstracting data from existing leases and are assessing the need for new or updated systems to support additional disclosures under the new standard. The Company will provide additional disclosure as the implementation progresses.
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326) Measurement of Credit Losses on Financial Instruments. This standard replaces the incurred loss methodology previously employed to measure credit losses for most financial assets and requires the use of a forward-looking expected loss model. Current accounting delays the recognition of credit losses until it is probable a loss has been incurred, while the update will require financial assets to be measured at amortized costs less a reserve and equal to the net amount expected to be collected. This standard will be effective for annual periods beginning after December 15, 2019, including interim periods within that reporting period, and early application is permitted. The Company is currently evaluating the new guidance to determine the impact it will have on its consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15, "Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments", which clarifies the treatment of several cash flow categories. In addition, ASU 2016-15 clarifies that when cash receipts and cash payments have aspects of more than one class of cash flows and cannot be separated, classification will depend on the predominant source or use. This update is effective for annual periods beginning after December 15, 2017, and interim periods within those fiscal years, with early adoption permitted, including adoption in an interim period. The Company is currently evaluating the impact that the adoption of ASU 2016-15 will have on our cash flows and related disclosures.
In January 2017, the FASB issued ASU 2017-04, "Simplifying the Test for Goodwill Impairment", which amends the guidance in ASC Topic 350, "Intangibles-Goodwill and Other". The ASU eliminates the requirement to calculate the implied fair value of goodwill to measure a goodwill impairment charge. Instead, entities will record an impairment charge based on the excess of a reporting unit's carrying amount over its fair value. The ASU is effective for annual and interim impairment tests performed in periods beginning after December 15, 2019. Early adoption is permitted for annual and interim goodwill impairment testing dates after January 1, 2017. The ASU will be applied prospectively. The Company currently does not expect that the adoption of these provisions will have a material effect on our consolidated financial statements and related disclosures, but will simplify the measurement of any impairment loss should goodwill be impaired in the future.
In January 2017, the FASB issued ASU 2017-01, "Clarifying the Definition of a Business", which amends the guidance in ASC Topic 805, "Business Combinations". The ASU changes the definition of a business to assist entities with evaluating when a set of transferred assets and activities is a business. Under the new guidance, an entity first determines whether substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets. If this threshold is met, the set is not a business. If it is not met, the entity then evaluates whether the set meets the requirements that a business include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create outputs. The ASU defines an output as "the result of inputs and processes applied to those inputs that provide goods or services to customers, investment income (such as dividends or interest), or other revenues." The ASU
F-16
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
2. Significant Accounting Policies (Continued)
is effective for annual reporting periods beginning after December 15, 2017, including interim periods within those annual periods, and early adoption is permitted. The ASU will be applied prospectively to any transactions occurring within the period of adoption. The Company currently does not expect that the adoption of these provisions will have a material effect on our consolidated financial statements.
In March, 2017, the FASB issued ASU No. 2017-07, "Compensation—Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost." This ASU applies to all employers that offer to their employees defined benefit pension plans, other postretirement benefit plans, or other types of benefits accounted for under Topic 715, Compensation—Retirement Benefits. The ASU requires that an employer report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit cost are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations, if one is presented. If a separate line item or items are used to present the other components of net benefit cost, that line item or items must be appropriately described. If a separate line item or items are not used, the line item or items used in the income statement to present the other components of net benefit cost must be disclosed. The ASU also allows only the service cost component to be eligible for capitalization when applicable (e.g., as a cost of internally manufactured inventory or a self-constructed asset). This ASU is effective for annual reporting periods beginning after December 15, 2017, including interim periods within those annual periods. Early adoption is permitted as of the beginning of an annual period for which financial statements (interim or annual) have not been issued or made available for issuance. The Company is currently evaluating the effect that ASU No. 2017-07 will have on its consolidated financial statements and related disclosures.
In May 2017, the FASB issued ASU 2017-09 Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting, to clarify which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. This ASU is effective for annual periods beginning after December 15, 2017. This ASU will be applied prospectively when changes to the terms or conditions of a share-based payment award occur. The Company is currently evaluating the effect that ASU No. 2017-07 will have on its consolidated financial statements and related disclosures.
In February 2018, the FASB issued ASU No. 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (ASU 2018-02). Under existing U.S. GAAP, the effects of changes in tax rates and laws on deferred tax balances are recorded as a component of income tax expense in the period in which the law was enacted. When deferred tax balances related to items originally recorded in accumulated other comprehensive income are adjusted, certain tax effects become stranded in accumulated other comprehensive income. The amendments in ASU 2018-02 allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the 2017 Tax Cuts and Jobs Act. The amendments in this ASU also require certain disclosures about stranded tax effects. The guidance is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption in any period is permitted. The Company's provisional adjustments recorded in 2017 to account for the impact of the
F-17
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
2. Significant Accounting Policies (Continued)
2017 Tax Cuts and Jobs Act resulted in stranded tax effects. The Company is currently evaluating the timing and impact of adopting ASU 2018-02.
3. Strategic Investments
API Acquisition
On February 1, 2017, the Company acquired the assets of Associated Packaging, Inc. and Fast Pak, LLC (together, "API") with operations located in Greer, South Carolina for $33.5 million. The acquisition was funded from borrowings on the Company's revolving credit facility ("Revolver"). API provides corrugated packaging and digital production needs serving a diverse customer base, including an emphasis on fulfillment and kitting for the automotive and consumer products industries. The Company has allocated the purchase price to the assets acquired and liabilities assumed, of which $14.0 million has been allocated to intangible assets (to be amortized over a life of 10 years), $2.8 million to plant, property and equipment, $1.7 million to net working capital and $15.0 million to goodwill (which is deductible for tax purposes). The purchase price allocation is final.
Transaction fees and expenses for the API acquisition related to due diligence, advisory and legal services have been expensed as incurred. These expenses were $0.4 million for the year ended December 31, 2017, and were recorded as selling, general and administrative expenses in the Consolidated Statements of Comprehensive Income.
This acquisition further strengthens the Company's goal of increasing mill integration.
As part of the acquisition, the Company signed a four-year long-term incentive agreement with the sellers contingent on the achievement of certain financial targets. This agreement contains an acceleration clause that would trigger upon the sale of the Company prior to the fourth anniversary of the API acquisition. Contingent upon the closing of the KapStone acquisition by WestRock Company announced January 29, 2018, the Company will be required to make a $5.0 million payment to the sellers. As of December 31, 2017, no accrual has been recorded related to this contingent obligation.
Operating results of the acquisition since February 1, 2017 are included in the Company's Paper and Packaging segment. The Company's consolidated statement of comprehensive income for the year ended December 31, 2017 includes $22.8 million of net sales and $1.0 million of operating income from this acquired business.
In conjunction with the API acquisition, the Company signed a 25-year lease agreement with a total commitment of approximately $14.7 million. The Company estimated the fair value of the lease to be $4.7 million based on an assessment of the market values of comparable properties. The lease was capitalized as a long-term building asset and capital lease obligation as the present value of the payments is more than 90 percent of the fair value of the property. Amortization of the asset under this capital lease obligation is included in depreciation expense.
CFB Acquisition
On July 1, 2016, the Company acquired 100 percent of the common stock of Central Florida Box Corporation ("CFB"), a corrugated products manufacturer located near Orlando, Florida, for $15.4 million, net of cash acquired. Sales and total assets of CFB are not material to KapStone.
F-18
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
3. Strategic Investments (Continued)
Operating results of the acquisition since July 1, 2016 are included in the Company's Paper and Packaging segment operating results. The Company has allocated the purchase price to the fair value of assets acquired and liabilities assumed, of which $10.5 million has been allocated to plant, property and equipment, $1.7 million to net working capital, $1.0 million to goodwill (which is deductible for tax purposes) and $2.2 million to customer relationship intangible assets (to be amortized over a life of 10 years). The purchase price allocation is final.
Equity Method Investments
In September of 2016, the Company made a $10.6 million investment for a 49 percent equity interest in a sheet feeder operation located in Florida. In April of 2016, the Company made a $1.25 million investment for a 20 percent equity interest in a sheet feeder operation located in California. These investments are expected to increase the Company's vertical integration by over 60,000 tons per year and will ramp up to that level over eighteen months. Both investments are included in other assets on the Company's Consolidated Balance Sheets.
For the years ended December 31, 2017 and 2016, the Company recognized $1.8 million and $0.5 million, respectively, of income from these equity method investments.
New Plant Start-up
In April of 2016, the Company approved a plan to expand its geographical footprint into Southern California with a new sheet plant. As of December 31, 2017, approximately $15.2 million has been invested. In addition, the Company signed a 10-year facility lease agreement with a total commitment of approximately $9.8 million. The new sheet plant started manufacturing boxes in February 2017 and is intended to primarily supply the Company's Victory distribution center in Southern California, as well as other KapStone customers. For the year ended December 31, 2017, $4.4 million of operating expenses were incurred.
4. Victory Acquisition
On June 1, 2015, the Company purchased 100 percent of the partnership interests in Victory for $615.0 million in cash and $2.0 million for working capital adjustments. Victory, headquartered in Houston, TX, is a North American distributor of packaging materials.
As of December 31, 2017, the Company is obligated to pay up an additional $20.7 million of contingent consideration to the former owners of Victory based on achieving certain financial performance criteria for the thirty month period following the closing.
The excess of the purchase price paid at the time of the acquisition over the aggregate estimated fair value of net assets acquired was allocated to goodwill. The purchase price allocation is final.
There has been no change to the fair value of the assets acquired and liabilities assumed since December 31, 2016.
F-19
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
4. Victory Acquisition (Continued)
The following unaudited pro forma consolidated results of operations assume that the acquisition of Victory occurred as of January 1, 2015. The unaudited pro forma consolidated results include the accounting effects of the business combination, including the application of the Company's accounting policies, amortization of intangible assets and depreciation of equipment related to fair value adjustments, interest expense on acquisition related debt, elimination of intercompany sales and income tax effects of the adjustments. The pro forma adjustments are directly attributable to the Victory acquisition, factually supportable and are expected to have a continuing impact on the Company's combined results. Unaudited pro forma data is based on historical information and does not necessarily reflect the actual results that would have occurred, nor is it indicative of future results of operations.
| |
Year Ended December 31, (unaudited) 2015 |
|||
|---|---|---|---|---|
Net sales |
$ | 3,166,725 | ||
Net income |
$ | 105,466 | ||
Net income per share—diluted |
$ | 1.08 | ||
5. Plant Closure and Assets Held for Sale
In August 2017, the Company approved and announced the closing of its Paper and Packaging segment box plant located in Oakland, California. All operating activities ceased at this location in October 2017. For the year ended December 31, 2017, the Company recorded charges of $10.2 million, which includes $6.0 million write-off of impaired property, plant and equipment, $1.5 million of severance and other employee costs, $1.7 million of facility carrying costs and $1.0 million write-off of impaired inventory.
As of December 31, 2017, the Company's Consolidated Balance Sheets includes $7.2 million of land and building held for sale and is included in prepaid expenses and other current assets.
6. Inventories
Inventories consist of the following at December 31, 2017 and 2016, respectively:
| |
December 31, | ||||||
|---|---|---|---|---|---|---|---|
| |
2017 | 2016 | |||||
Raw materials |
$ | 75,616 | $ | 79,377 | |||
Work in process |
4,144 | 6,371 | |||||
Finished goods |
145,652 | 151,497 | |||||
Replacement parts and supplies |
93,043 | 85,857 | |||||
| | | | | | | | |
Inventory at FIFO costs |
318,455 | 323,102 | |||||
LIFO inventory reserves |
(2,880 | ) | (438 | ) | |||
| | | | | | | | |
Inventories |
$ | 315,575 | $ | 322,664 | |||
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
At December 31, 2017 and 2016, finished goods inventory included inventory consigned to third parties totaling $6.2 million and $9.6 million, respectively.
F-20
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
7. Plant, Property and Equipment, net
Plant, property and equipment, net consist of the following at December 31, 2017 and 2016, respectively:
| |
December 31, | ||||||
|---|---|---|---|---|---|---|---|
| |
2017 | 2016 | |||||
Land and land improvements |
$ | 72,963 | $ | 76,704 | |||
Buildings and leasehold improvements |
187,521 | 177,705 | |||||
Machinery and equipment |
1,913,020 | 1,741,552 | |||||
Construction-in-process |
54,863 | 99,172 | |||||
| | | | | | | | |
|
2,228,367 | 2,095,133 | |||||
Less accumulated depreciation and amortization |
774,760 | 653,576 | |||||
| | | | | | | | |
Plant, property, and equipment, net |
$ | 1,453,607 | $ | 1,441,557 | |||
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
Depreciation expense for the years ended December 31, 2017, 2016 and 2015, was $155.9 million, $149.3 million and $136.9 million, respectively.
8. Goodwill and Other Intangible Assets
The following table shows changes in goodwill for the years 2017 and 2016:
| |
Paper and Packaging |
Distribution | Total Goodwill |
|||||||
|---|---|---|---|---|---|---|---|---|---|---|
Balances at December 31, 2015 |
$ | 533,851 | $ | 170,741 | $ | 704,592 | ||||
CFB acquisition |
1,025 | — | 1,025 | |||||||
| | | | | | | | | | | |
Balances at December 31, 2016 |
$ | 534,876 | $ | 170,741 | $ | 705,617 | ||||
API acquisition |
14,994 | — | 14,994 | |||||||
| | | | | | | | | | | |
Balances at December 31, 2017 |
$ | 549,870 | $ | 170,741 | $ | 720,611 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
The following table shows changes in other intangible assets for the years 2017 and 2016:
| |
Intangible Assets, Net |
|||
|---|---|---|---|---|
Balances at December 31, 2015 |
$ | 344,583 | ||
CFB acquisition |
2,200 | |||
Other |
525 | |||
Amortization expense |
(32,895 | ) | ||
| | | | | |
Balances at December 31, 2016 |
$ | 314,413 | ||
API acquisition |
13,960 | |||
Amortization expense |
(30,898 | ) | ||
| | | | | |
Balances at December 31, 2017 |
$ | 297,475 | ||
| | | | | |
| | | | | |
| | | | | |
F-21
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
8. Goodwill and Other Intangible Assets (Continued)
Intangible assets other than goodwill include the following:
| |
December 31, 2017 | December 31, 2016 | |||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Gross Carrying Amount |
Accumulated Amortization |
Net Carrying Amount |
Gross Carrying Amount |
Accumulated Amortization |
Net Carrying Amount |
|||||||||||||
Definite-lived trademarks |
$ | 70,185 | $ | (34,614 | ) | $ | 35,571 | $ | 69,325 | $ | (32,060 | ) | $ | 37,265 | |||||
Customer lists and relationships |
346,504 | (92,758 | ) | 253,746 | 333,404 | (67,260 | ) | 266,144 | |||||||||||
Lease, contracts and other |
30,243 | (22,085 | ) | 8,158 | 30,243 | (19,239 | ) | 11,004 | |||||||||||
| | | | | | | | | | | | | | | | | | | | |
Total |
$ | 446,932 | $ | (149,457 | ) | $ | 297,475 | $ | 432,972 | $ | (118,559 | ) | $ | 314,413 | |||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
Amortization expense for the years ended December 31, 2017, 2016 and 2015, was $30.9 million, $32.9 million and $25.3 million, respectively. The increase in amortization expense for the year ended December 31, 2016 was primarily due to the Victory acquisition.
Estimated amortization expense for the next five years, beginning with 2018, is as follows: $30.8 million, $30.4 million, $29.8 million, $26.7 million, and $22.8 million. At December 31, 2017, the weighted average remaining useful life for trademarks is 20.5 years; customer relationships is 10.8 years; other contractual agreements is 5.6 years; and for intangible assets in total is 11.8 years.
9. Accrued Expenses
Accrued expenses consist of the following at December 31, 2017 and 2016, respectively:
| |
December 31, | ||||||
|---|---|---|---|---|---|---|---|
| |
2017 | 2016 | |||||
Real and property taxes |
$ | 14,748 | $ | 13,090 | |||
Energy costs |
12,911 | 12,527 | |||||
Capital spending |
9,915 | 7,883 | |||||
Customer rebates |
8,940 | 9,998 | |||||
Worker's compensation |
6,416 | 8,249 | |||||
Current postretirement obligation |
1,106 | 1,378 | |||||
Freight |
3,881 | 2,354 | |||||
Contingent consideration |
20,694 | — | |||||
Other accruals |
27,340 | 21,001 | |||||
| | | | | | | | |
Accrued expenses |
$ | 105,951 | $ | 76,480 | |||
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
10. Short-term Borrowings and Long-term Debt
Short-term Borrowings
As of December 31, 2017, the Company had no amounts outstanding under its revolving credit facility and had borrowing availability of $485.9 million.
F-22
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
10. Short-term Borrowings and Long-term Debt (Continued)
Other Borrowing
In 2017, the Company entered into a short-term financing agreement of $6.2 million at an annual interest rate of 2.4 percent for its annual property insurance premiums. The Company repaid this obligation as of December 31, 2017.
Long-term Debt
Long-term debt consists of the following at December 31, 2017 and 2016, respectively:
| |
December 31, | ||||||
|---|---|---|---|---|---|---|---|
| |
2017 | 2016 | |||||
Term loan A-1 under Credit Agreement with interest payable monthly at LIBOR of 1.57% plus 1.75% at December 31, 2017 |
$ | 657,637 | $ | 775,500 | |||
Term loan A-2 under Credit Agreement with interest payable monthly at LIBOR of 1.57% plus 1.875% at December 31, 2017 |
421,238 | 458,375 | |||||
Receivable Credit Facility with interest payable monthly at LIBOR of 1.56% plus 0.75% at December 31, 2017 |
308,849 | 269,273 | |||||
| | | | | | | | |
Total long-term debt |
1,387,724 | 1,503,148 | |||||
Less unamortized debt issuance costs |
(13,222 | ) | (17,825 | ) | |||
| | | | | | | | |
Long-term debt, net of debt issuance costs |
$ | 1,374,502 | $ | 1,485,323 | |||
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
Interest paid for the years ended December 31, 2017, 2016 and 2015, was $44.7 million, $32.9 million and $28.1 million, respectively. Interest paid was $11.8 million higher for the year ended 2017, primarily due to higher interest rates, partially offset by lower term loan balances due to $155.0 million of prepayments made in 2017.
The principal portion of the total long-term debt at December 31, 2017 becomes due as follows:
2018 |
$ | — | ||
2019 |
— | |||
2020 |
966,486 | |||
2021 |
— | |||
2022 |
421,238 | |||
| | | | | |
Total |
$ | 1,387,724 | ||
| | | | | |
| | | | | |
| | | | | |
KapStone and certain of our subsidiaries are parties to a Second Amended and Restated Credit Agreement dated June 1, 2015 (as amended from time to time, the "Credit Agreement"), which provides for a senior secured credit facility (the "Credit Facility") of $1.915 billion, consisting of a Term Loan A-1 in the aggregate amount of $940 million and a Term Loan A-2 in the aggregate amount of $475 million and a $500 million revolving credit facility (the "Revolver"). In addition, the Credit Facility also includes an uncommitted accordion feature that allows the Company, subject to certain
F-23
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
10. Short-term Borrowings and Long-term Debt (Continued)
significant conditions, to request additional commitments from our existing or new lenders under the Credit Facility without further approvals of any existing lenders thereunder. The aggregate amount of such increases in potential commitments (and potential borrowings) is limited to $600 million, unless the Company would maintain a pro forma total leverage ratio of 2.5 to 1.0 or less after giving effect to the increase in potential commitments (and potential borrowings).
In July 2017, the Company entered into the Third Amendment ("Third Amendment") to the Credit Agreement. The Third Amendment modified the financial covenant in the Credit Agreement related to maintenance of a maximum total leverage ratio by increasing the permitted total leverage ratio for fiscal quarters ending on September 30, 2017, December 31, 2017 and March 31, 2018, and modified certain defined terms used in the calculation of the financial covenants in a manner favorable to the Company. The Company paid approximately $1.3 million of loan amendment fees associated with the Third Amendment, which are being amortized over the remaining term of the Credit Agreement using the effective interest method.
During 2017, the Company made two voluntary prepayments totaling $155.0 million on its term loans under the credit facility and as a result, $1.3 million of unamortized debt issuance costs were written-off as loss on debt extinguishment.
Receivables Credit Facility
Effective as of June 1, 2017, the Company entered into Amendment No. 3 to the Receivables Purchase Agreement (the "Amendment") amending its Receivables Purchase Agreement dated as of September 26, 2014 (as amended from time to time, the "Receivables Purchase Agreement"), which is part of an accounts receivable securitization program (the "Securitization Program") of the Company and certain of its subsidiaries. The Amendment included the following changes to the Receivables Purchase Agreement:
- •
- the aggregate commitment of the Purchasers (as defined in the Receivables Purchase Agreement) under the Receivables Purchase Agreement was
increased from $275.0 million to $325.0 million;
- •
- the "Facility Termination Date" (as defined in the Receivables Purchase Agreement) was extended from June 6, 2017 to June 1,
2018; and
- •
- certain definitions used to determine the maximum amount that may be outstanding under the Securitization Program were added or modified, as applicable, in a manner favorable to the Company.
The Company paid approximately $0.2 million of loan amendment fees associated with this Amendment, which are being amortized over the remaining term using the effective interest method.
On February 21, 2017, the Company entered into Amendment No. 3 to the Receivables Sale Agreement amending its Receivables Sale Agreement dated as of September 26, 2014, which is part of the Securitization Program. All accounts receivable purchased from API and all accounts receivable generated from facilities acquired from API that are not paid to an eligible bank account are designated as "Excluded Receivables".
F-24
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
10. Short-term Borrowings and Long-term Debt (Continued)
Under our Securitization Program, the Company and its subsidiaries that participate in the Securitization Program (the "Originators") sell, on an ongoing basis without recourse, certain trade receivables to KapStone Receivables, LLC ("KAR"), which is considered a wholly-owned, bankruptcy-remote variable interest entity ("VIE"). The Company has the authority to direct the activities of the VIE and, as a result, we have concluded that we maintain control of the VIE, are the primary beneficiary (as defined by accounting guidance) and, therefore, consolidate the account balances of KAR. As of December 31, 2017, $425.2 million of our trade accounts receivables were sold to KAR. KAR in turn assigns a collateral interest in these receivables to a group of financial institutions under a one-year $325 million facility (the "Receivables Credit Facility") for proceeds of $308.8 million. The assets of KAR are not available to the Company until all obligations of KAR are satisfied in the event of bankruptcy or insolvency proceedings.
The Company included the Receivables Credit Facility in Long-term debt on the Consolidated Balance Sheets based on management's intent to continue to refinance this agreement until the maturity of the Term loan A-l which is June 1, 2020. The Company also has the ability to refinance this short-term obligation on a long-term basis using its Revolver. There are no additional requirements as to when borrowings under the Revolver would need to be repaid other than the maturity date of June 1, 2020.
Debt Covenants
Our Credit Agreement governing our Credit Facility contains, among other provisions, covenants with which we must comply. The covenants limit our ability to, among other things, incur indebtedness, create additional liens on our assets, make investments, engage in mergers and acquisitions and sell any assets outside the normal course of business.
As of December 31, 2017, the Company was in compliance with all applicable covenants in the Credit Agreement.
Fair Value of Debt
As of December 31, 2017, the fair value of the Company's debt approximates the carrying value of $1.4 billion as the variable interest rates re-price frequently at current market rates. As of December 31, 2017 and 2016 our weighted-average cost of borrowings was 3.13 percent and 2.40 percent, respectively.
11. Long-term Financing Obligations
In 2015, the Company signed non-cancellable contracts with a third party to construct facilities to produce wood chips for the use at the Company's North Charleston and Roanoke Rapids paper mills for twenty years, with an annual purchase obligation of approximately $13.4 million. The Company has evaluated these agreements and concluded that they represent in-substance leases under ASC 840, Leases. In accordance with the special provisions discussed in ASC 840-40-55-15, language within the contracts result in the Company assuming a certain level of construction risk, and as such, the Company is considered the accounting owner of the assets during the construction period, even though these facilities are being constructed and financed entirely by the third party. Accordingly, as the third-
F-25
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
11. Long-term Financing Obligations (Continued)
party incurred the construction project costs, the assets and corresponding financial obligation were recorded in plant, property and equipment, net and other liabilities in the Company's consolidated balance sheets. As of December 31, 2017 and 2016, $88.2 million and $46.6 million, respectively, for these facilities is included in property, plant and equipment, net.
Upon completion of each project, the Company evaluated if the in-substance leases met certain 'sale-leaseback' criteria under ASC 840. The contract did not meet such requirements, which is the expectation for each of these contracts, and $82.2 million is recorded as a financing liability as of December 31, 2017. Payments under these contracts are allocated between a reduction of the financing obligation and interest expense, utilizing an imputed interest rate in accordance with ASC 840.
The Company incurred $3.3 million of implicit interest expense on these long-term financing obligations for the year ended December 31, 2017.
12. Pension and Postretirement Benefits
The Company and its subsidiaries has a defined benefit retirement plan ("Plan") for certain eligible employees. The Plan provides benefits based on years of credited service and stated dollar level multipliers for each year of service.
The Company also provides postretirement health care insurance benefits through an indemnity plan and a health maintenance organization plan for certain salary and hourly employees and their dependents. Individual benefits generally continue until age 65. The Company does not pre-fund these benefits, and, accordingly, there are no postretirement plan assets. The postretirement plan also includes a retiree contribution requirement for certain salaried and certain hourly employees. The retiree contribution amount is adjusted annually.
The liabilities for the benefit obligation for the eligible union groups are based on the collective bargaining agreements currently in effect. Current and future negotiations on collective bargaining agreements could have an effect on these liabilities.
F-26
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
12. Pension and Postretirement Benefits (Continued)
The changes in benefit obligations and Plan assets at December 31, 2017 and 2016 were:
| |
Pension Benefits | Other Benefits | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
2017 | 2016 | 2017 | 2016 | |||||||||
Change in Benefit Obligation |
|||||||||||||
Benefit obligation at beginning of year |
$ | 602,426 | $ | 626,056 | $ | 7,515 | $ | 9,418 | |||||
Service cost |
3,582 | 4,215 | 12 | 28 | |||||||||
Interest cost |
26,626 | 28,237 | 262 | 332 | |||||||||
Actuarial loss (gain) |
26,310 | (2,583 | ) | (110 | ) | (818 | ) | ||||||
Participant contributions |
— | — | 363 | 526 | |||||||||
Benefits paid |
(39,758 | ) | (53,499 | ) | (1,599 | ) | (1,971 | ) | |||||
Plan amendment |
2,740 | — | — | — | |||||||||
| | | | | | | | | | | | | | |
Benefit obligation at end of year |
$ | 621,926 | $ | 602,426 | $ | 6,443 | $ | 7,515 | |||||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
Change in Plan Assets |
|||||||||||||
Fair value of plan assets at beginning of year |
$ | 574,356 | $ | 593,125 | $ | — | $ | — | |||||
Actual return on plan assets |
78,469 | 34,730 | — | — | |||||||||
Employer contributions |
— | — | 1,236 | 1,445 | |||||||||
Participant contributions |
— | — | 363 | 526 | |||||||||
Benefits paid |
(39,758 | ) | (53,499 | ) | (1,599 | ) | (1,971 | ) | |||||
| | | | | | | | | | | | | | |
Fair value of plan assets at end of year |
$ | 613,067 | $ | 574,356 | $ | — | $ | — | |||||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
The funded status and amounts recognized in our consolidated balance sheets at December 31, 2017 and 2016 were:
| |
Pension Benefits | Other Benefits | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
2017 | 2016 | 2017 | 2016 | |||||||||
Funded Status at End of Year |
$ | (8,859 | ) | $ | (28,070 | ) | $ | (6,443 | ) | $ | (7,515 | ) | |
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
Amounts Recognized in Consolidated Balance Sheets: |
|||||||||||||
Accrued expenses |
$ | — | $ | — | $ | (1,106 | ) | $ | (1,378 | ) | |||
Pension and postretirement benefits |
(8,859 | ) | (28,070 | ) | (5,337 | ) | (6,137 | ) | |||||
| | | | | | | | | | | | | | |
Net amount recognized |
$ | (8,859 | ) | $ | (28,070 | ) | $ | (6,443 | ) | $ | (7,515 | ) | |
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
Amounts Recognized in Accumulated Other Comprehensive Income / (Loss)—(Pre-tax) |
|||||||||||||
Total net actuarial (gain) loss |
$ | 79,908 | $ | 101,193 | $ | (1,851 | ) | $ | (3,208 | ) | |||
Prior service cost |
2,469 | 21 | (1,317 | ) | (2,079 | ) | |||||||
| | | | | | | | | | | | | | |
Total |
$ | 82,377 | $ | 101,214 | $ | (3,168 | ) | $ | (5,287 | ) | |||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
Weighted-Average Discount Rate Assumption used to Determine Projected Benefit Obligations at December 31, 2017 and 2016 |
4.10 | % | 4.50 | % | 3.91 | % | 4.20 | % | |||||
F-27
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
12. Pension and Postretirement Benefits (Continued)
The accumulated benefit obligation for the defined Plan was $621.9 million and $602.4 million at December 31, 2017 and 2016, respectively.
The change in our Plan's funded status in 2017 is primarily due to higher earnings in plan assets and changes in mortality and other assumptions, partially offset by a lower discount rate applied to the pension obligation. In 2017, we used the new mortality tables from the Society of Actuaries and evaluated our mortality experience to establish mortality assumptions. Based on our experience and in consultation with our actuaries, we utilized a base RP-2014 with MP-2017 projection scale. In 2016, we utilized the RP-2014 mortality tables with MP-2016 projection scale.
The plan amendment cost of $2.7 million represents the respective negotiated increases in pension benefits for various union participants during 2017 for all applicable past service measured at the contract's effective date.
Components of pension benefit and other postretirement benefit income was:
| |
Pension Benefits | Other Benefits | |||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
2017 | 2016 | 2015 | 2017 | 2016 | 2015 | |||||||||||||
Service cost |
$ | 3,582 | $ | 4,215 | $ | 4,723 | $ | 12 | $ | 28 | $ | 33 | |||||||
Interest cost |
26,626 | 28,237 | 27,610 | 261 | 332 | 428 | |||||||||||||
Expected return on plan assets |
(36,082 | ) | (37,327 | ) | (41,082 | ) | — | — | — | ||||||||||
Amortization of prior service cost (benefit) |
292 | 95 | 275 | (762 | ) | (762 | ) | (242 | ) | ||||||||||
Amortization of net loss (gain) |
5,208 | 4,657 | 1,934 | (1,467 | ) | (812 | ) | (1,126 | ) | ||||||||||
| | | | | | | | | | | | | | | | | | | | |
Benefit income |
$ | (374 | ) | $ | (123 | ) | $ | (6,540 | ) | $ | (1,956 | ) | $ | (1,214 | ) | $ | (907 | ) | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
Weighted-Average actuarial assumptions used to determine benefit costs were:
| |
Pension Benefits | Other Benefits | |||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
2017 | 2016 | 2015 | 2017 | 2016 | 2015 | |||||||||||||
Discount rate |
4.50 | % | 4.66 | % | 4.24 | % | 4.20 | % | 4.12 | % | 3.78 | % | |||||||
Long-term rate of return on plan assets |
6.50 | % | 6.50 | % | 6.50 | % | — | — | — | ||||||||||
The Company assumed health care cost trend rates for its postretirement benefits plans as follows:
Plans
|
2018 | |||
|---|---|---|---|---|
Health care cost trend rate assumed for next year |
7.25 | % | ||
Rate to which the cost trend rate is assumed to decline (the ultimate rate) |
4.50 | % | ||
Year the rate reaches the ultimate trend rate |
2029 | |||
F-28
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
12. Pension and Postretirement Benefits (Continued)
The effect of a one percentage point increase or decrease in the assumed health care cost trend rates at December 31, 2017 is summarized below:
Change in Health Care
|
Minus 1% | Plus 1% | |||||
|---|---|---|---|---|---|---|---|
Service and interest cost |
$ | (6 | ) | $ | 6 | ||
Accumulated benefit obligation |
$ | (132 | ) | $ | 138 | ||
Other changes in Plan assets and benefit obligations recognized in accumulated other comprehensive loss were:
| |
Pension Benefits | Other Benefits | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
2017 | 2016 | 2017 | 2016 | |||||||||
Net actuarial (gain) loss |
$ | (16,077 | ) | $ | 15 | $ | (110 | ) | $ | (818 | ) | ||
Prior service cost / (credit) |
2,740 | — | — | — | |||||||||
Amortization of prior service (cost) benefit |
(292 | ) | (95 | ) | 762 | 762 | |||||||
Amortization of net gain (loss) |
(5,208 | ) | (4,657 | ) | 1,467 | 812 | |||||||
| | | | | | | | | | | | | | |
Net amount recognized before tax |
$ | (18,837 | ) | $ | (4,737 | ) | $ | 2,119 | $ | 756 | |||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
The amounts in accumulated other comprehensive loss expected to be recognized as components of net pension expense during 2018 are as follows:
| |
Pension Benefits |
Other Benefits |
|||||
|---|---|---|---|---|---|---|---|
Prior service cost (benefit) |
$ | 509 | $ | (761 | ) | ||
Net actuarial loss / (gain) |
$ | 2,109 | $ | (561 | ) | ||
For the pension plan, accumulated actuarial gains and losses in excess of 10 percent of the accumulated benefit obligation are amortized over the average future service period of approximately 8.4 years.
As of December 31, 2017 and 2016, $(48.5) million and $(60.8) million, respectively, were included net of tax in accumulated other comprehensive loss.
F-29
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
12. Pension and Postretirement Benefits (Continued)
Plan Assets
The fair value of Plan assets, summarized by level within the fair value hierarchy as of December 31, 2017 was as follows:
| |
Level 1 | Level 2 | Level 3 | Total | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Cash and cash equivalents |
$ | 7,698 | $ | — | $ | — | $ | 7,698 | |||||
Equity securities: |
|||||||||||||
Common stock |
97 | — | — | 97 | |||||||||
Domestic equity mutual funds |
12,560 | — | — | 12,560 | |||||||||
International equity mutual funds |
52,101 | — | — | 52,101 | |||||||||
U.S. large cap collective funds |
— | 112,411 | — | 112,411 | |||||||||
Fixed income: |
|||||||||||||
Corporate bonds and notes |
— | 229,275 | 229,275 | ||||||||||
U.S. Government securities |
— | 76,659 | 76,659 | ||||||||||
Limited partnership investments |
— | — | 11,180 | 11,180 | |||||||||
| | | | | | | | | | | | | | |
|
$ | 72,456 | $ | 418,345 | $ | 11,180 | $ | 501,981 | |||||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
Assets measured at Net Asset Value |
|||||||||||||
Hedge funds: |
|||||||||||||
Fixed income funds |
37,976 | ||||||||||||
Equity funds |
73,110 | ||||||||||||
| | | | | | | | | | | | | | |
Total assets at fair value |
$ | 613,067 | |||||||||||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
F-30
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
12. Pension and Postretirement Benefits (Continued)
The table below resents a summary of changes in the fair value of the Plans' level three assets as of December 31, 2017:
Year ended December 31, 2017
|
Limited Partnership Investments |
Total | |||||
|---|---|---|---|---|---|---|---|
Balance, beginning of year |
$ | 13,343 | $ | 13,343 | |||
Transfers into Level 3 |
— | — | |||||
Transfers out of Level 3 |
— | — | |||||
Total gains or (losses): |
|||||||
Included in changes in net assets |
1,007 | 1,007 | |||||
Included in other comprehensive income |
— | — | |||||
Purchases, issuances, sales, and settlements: |
|||||||
Purchases |
263 | 263 | |||||
Issuances |
— | — | |||||
Sales |
(3,433 | ) | (3,433 | ) | |||
Settlements |
— | — | |||||
| | | | | | | | |
Balance, end of year |
$ | 11,180 | $ | 11,180 | |||
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
The amount of total gains or losses for the year included in changes in net assets attributed to the change in unrealized gains or losses relating to assets still held at the reporting date |
$ | 219 | $ | 219 | |||
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
F-31
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
12. Pension and Postretirement Benefits (Continued)
The fair value of Plan assets, summarized by level within the fair value hierarchy as of December 31, 2016 was as follows:
| |
Level 1 | Level 2 | Level 3 | Total | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Cash and cash equivalents |
$ | 16,973 | $ | — | $ | — | $ | 16,973 | |||||
Equity securities: |
|||||||||||||
Common stock |
12,869 | — | — | 12,869 | |||||||||
Domestic equity mutual funds |
9,556 | — | — | 9,556 | |||||||||
International equity mutual funds |
48,539 | — | — | 48,539 | |||||||||
U.S. large cap collective funds |
— | 96,518 | — | 96,518 | |||||||||
Fixed income: |
|||||||||||||
Corporate bonds and notes |
201,241 | 201,241 | |||||||||||
U.S. Government securities |
78,163 | 78,163 | |||||||||||
Limited partnership investments |
— | — | 13,343 | 13,343 | |||||||||
| | | | | | | | | | | | | | |
|
$ | 87,937 | $ | 375,922 | $ | 13,343 | $ | 477,202 | |||||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
Assets measured at Net Asset Value |
|||||||||||||
Hedge funds: |
|||||||||||||
Fixed income funds |
34,897 | ||||||||||||
Equity funds |
62,257 | ||||||||||||
| | | | | | | | | | | | | | |
Total assets at fair value |
$ | 574,356 | |||||||||||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
Level 1 assets are valued based on quoted prices in active markets for identical securities.
Level 2 assets are valued based on other significant observable inputs including quoted prices for similar securities, yield curves, indices, etc. Level 2 assets listed above consist primarily of commingled equity investments where values are based on the net asset value of the underlying investments held, individual fixed income securities where values are based on quoted prices of similar securities and observable market data, and commingled fixed income investments where values are based on the net asset value of the underlying investments held.
Level 3 assets are valued based on unobservable inputs. Quoted market prices are not available for certain investments, including real estate and limited partnership investments. These investments are recorded at their estimated fair market value; therefore, the reported value may differ from the value that would have been used had a quoted market price existed. Investments of this nature are valued by the Company based on the nature of each investment and the information available to management at the valuation date.
Limited Partnership investments generally have limited liquidity and are made through long-term partnerships or joint ventures that invest in pools of capital invested in primarily non-publicly traded entities. Underlying investments include venture capital, buyout, and special situations investing. Private equity management firms typically acquire and then reorganize private companies to create increased long-term value. Valuation is based on statements received from the investment managers, transaction data, analysis of and judgments about underlying investments and other third-party information deemed reliable for the purposes of developing an estimate of fair market value.
F-32
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
12. Pension and Postretirement Benefits (Continued)
Hedge funds are privately owned institutional investment funds that generally have moderate liquidity. Hedge funds seek specified levels of return, regardless of market conditions, and generally have a low correlation to public equity and debt markets. Hedge funds often invest substantially in financial market instruments (stocks, bonds, commodities, currencies, derivatives, etc.) using a broad range of trading activities to manage portfolio risks. Plan holdings in hedge funds are valued using the net asset value ("NAV") provided by the administrator of the fund and reviewed by the Company. The NAV is based on the value of the underlying assets owned by the fund, minus liabilities and divided by the number of shares or units outstanding. These assets are reported at NAV as a practical expedient. For the year ended December 31, 2017, the Plan held investments in hedge funds with restrictions on redemption for the first year after funds are invested, and funds restricting investment redemption to a 25 percent gate in any given quarter.
The Company believes that the reported amounts for these investments are a reasonable estimate of their fair value at December 31, 2017. However, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value at the reporting date.
To develop the expected long-term rate of return on plan assets assumption for the Plan, the Company considers the current asset allocation strategy, the historical investment performance, and the expectations for future returns of each asset class.
The Company's Plan weighted-average asset allocations and target asset allocations at December 31, 2017 and 2016, by asset category were as follows:
| |
2017 | 2016 | Target Allocation |
|||||||
|---|---|---|---|---|---|---|---|---|---|---|
Fixed income |
56 | % | 55 | % | 53 | % | ||||
Equity securities |
41 | % | 40 | % | 47 | % | ||||
Cash |
1 | % | 3 | % | — | % | ||||
Other |
2 | % | 2 | % | — | % | ||||
| | | | | | | | | | | |
Total |
100 | % | 100 | % | 100 | % | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
The Company's investment strategy is to invest in a prudent manner to maintain the security of funds while maximizing returns within the Company's Investment Policy guidelines. The strategy is implemented utilizing assets from the categories listed.
The investment goals are to provide a total return that, over the long term, increases the ratio of Plan assets to liabilities subject to an acceptable level of risk. This is accomplished through diversification of assets in accordance with the Investment Policy guidelines. Investment risk is mitigated by periodic rebalancing between asset classes as necessitated by changes in market conditions within the Investment Policy guidelines.
The Company currently does not anticipate making any contributions to the Plan in 2018. This estimate is based on current tax laws, Plan asset performance, and liability assumptions, which are subject to change. The Company anticipates making contributions to the postretirement plans in 2018 as claims are submitted.
F-33
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
12. Pension and Postretirement Benefits (Continued)
The following table presents estimated future gross benefit payments for the Company's plans:
| |
Pension Benefits |
Other Benefits |
|||||
|---|---|---|---|---|---|---|---|
2018 |
$ | 39,271 | $ | 1,127 | |||
2019 |
39,482 | 969 | |||||
2020 |
39,670 | 849 | |||||
2021 |
40,310 | 580 | |||||
2022 |
40,681 | 501 | |||||
Succeeding 5 years |
201,294 | 1,532 | |||||
Multiemployer Pension Plan
In conjunction with each of the Longview and U.S. Corrugated acquisitions, the Company assumed participation in the GCIU-Employer Retirement Fund for a total of approximately 300 hourly employees at four corrugated products manufacturing plants. For the plan year ended December 31, 2015, the most recent date for which information was available, the contributions made by the Company were less than 5.3 percent of the total employers' contributions to the multiemployer plan.
On October 31, 2016, the Company provided formal notification to the plan trustee of its withdrawal from the plan and cessation of plan contributions effective December 31, 2016. Management has updated its analysis of the estimated withdrawal liability recorded as of December 31, 2017. The estimated withdrawal liability of approximately $6.4 million did not change. It is based on annual payments of approximately $0.4 million over 20 years, discounted at a credit adjusted risk-free rate return of approximately 3.6 percent. This liability is based on an analysis of the facts currently available to management; however, the withdrawal liability will ultimately be determined by the plan trustee.
Defined Contribution Plans
We offer a 401(k) Defined Contribution Plans ("Contribution Plans") to eligible employees. The Company's monthly contributions are based on the matching of certain employee contributions or based on a union negotiated formula. The expense related to this plan was $23.0 million, $9.2 million and $22.3 million for the years ended December 31, 2017, 2016 and 2015, respectively, for matching contributions.
In 2017, the Company restored matching contributions to its Contribution Plans for certain employees that were previously suspended during 2016. As a result, contributions were $13.8 million higher for the year ended December 31, 2017, compared to 2016.
13. Income taxes
The Company's U.S. federal statutory income tax rates were 35.0 percent for each of 2017, 2016 and 2015. The Company's effective income tax rates for the years ended December 31, 2017, 2016 and 2015 were (64.2) percent, 32.7 percent and 34.2 percent, respectively.
F-34
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
13. Income taxes (Continued)
The Company's provision for income taxes for the years ended December 31, 2017, 2016 and 2015 consists of the following:
| |
Years Ended December 31, | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| |
2017 | 2016 | 2015 | |||||||
Income before provision (benefit) for income taxes: |
||||||||||
United States |
$ | 144,585 | $ | 125,540 | $ | 159,790 | ||||
Foreign |
3,698 | 2,642 | 1,844 | |||||||
| | | | | | | | | | | |
Total |
$ | 148,283 | $ | 128,182 | $ | 161,634 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
Provision (benefit) for income taxes: |
||||||||||
Current: |
||||||||||
US federal |
$ | 54,808 | $ | 49,131 | $ | 40,324 | ||||
State and local |
6,451 | 6,002 | 3,116 | |||||||
Foreign |
1,439 | 1,237 | 766 | |||||||
| | | | | | | | | | | |
Total current |
62,698 | 56,370 | 44,206 | |||||||
| | | | | | | | | | | |
Deferred: |
||||||||||
US federal |
(156,655 | ) | (14,841 | ) | 10,990 | |||||
State and local |
(1,280 | ) | 401 | 52 | ||||||
Foreign |
17 | — | — | |||||||
| | | | | | | | | | | |
Total deferred |
(157,918 | ) | (14,440 | ) | 11,042 | |||||
| | | | | | | | | | | |
Total United States |
(96,676 | ) | 40,693 | 54,482 | ||||||
Foreign |
1,456 | 1,237 | 766 | |||||||
| | | | | | | | | | | |
Total provision (benefit) for income taxes |
$ | (95,220 | ) | $ | 41,930 | $ | 55,248 | |||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
For the years ended December 31, 2017, 2016 and 2015, substantially all income was earned in the United States. Foreign earnings primarily include results from Victory's operations in Mexico, which were acquired June 1, 2015.
Income taxes paid, net of refunds, were $45.8 million, $23.8 million and $65.5 million in 2017, 2016 and 2015, respectively.
F-35
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
13. Income taxes (Continued)
The Company's effective income tax rate differs from the statutory federal income tax rate as follows:
| |
Years Ended December 31, | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| |
2017 | 2016 | 2015 | |||||||
Statutory income tax rate |
35.0 | % | 35.0 | % | 35.0 | % | ||||
State income taxes, net of federal income tax benefit |
1.9 | % | 2.0 | % | 2.3 | % | ||||
Domestic manufacturing deduction |
(3.6 | )% | (3.6 | )% | (2.9 | )% | ||||
Tax Cuts and Jobs Act |
(97.4 | )% | — | % | — | % | ||||
Other |
(0.1 | )% | (0.7 | )% | (0.2 | )% | ||||
| | | | | | | | | | | |
Effective income tax rate |
(64.2 | )% | 32.7 | % | 34.2 | % | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
The Tax Cuts and Jobs Act (the "Tax Act") enacted on December 22, 2017 resulted in a provisional net tax benefit of $144.4 million, comprised of a $144.7 tax benefit from re-measuring federal deferred tax liabilities from 35 percent to 21 percent, partially offset by a $0.3 million transition tax expense. Absent the Tax Act, the Company's 2017 effective income tax rate would have been 33.2 percent.
While the Company's analysis of the final impact from the Tax Act has not been completed, reasonable estimates can be made and therefore these provisional estimates are reflected in our consolidated financial statements. Adjustments will be made during the measurement period under SEC Staff Bulletin No. 118.
At this time, we do not expect any material impact to the Company from other aspects of the Tax Act; however, due to the complexity of the new tax rules we are continuing to evaluate the Tax Act and the application of ASC 740. Therefore the recorded tax effects in the 2017 financial results are provisional estimates that will be adjusted and disclosed, as necessary, in future reporting periods as new information becomes available. The new information that could cause us to adjust in future periods the tax effects already recorded as of December 31, 2017, include changes to deferred tax assets and liabilities pending the final determination of 2017 taxable income when the 2017 tax return is prepared; transition tax computational adjustments from E&P calculations, foreign taxes paid and foreign tax credit limitations; and from new information from the Internal Revenue Service, the SEC and the FASB as further guidance is issued.
F-36
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
13. Income taxes (Continued)
The tax effects of the temporary differences that give rise to significant portions of the deferred tax assets and liabilities at December 31, 2017 and 2016, are as follows:
| |
December 31, | ||||||
|---|---|---|---|---|---|---|---|
| |
2017 | 2016 | |||||
Deferred tax assets resulting from: |
|||||||
Accrued compensation costs |
$ | 5,091 | $ | 8,200 | |||
Pension and postretirement benefits |
5,267 | 16,010 | |||||
Stock based compensation |
8,200 | 10,433 | |||||
State tax credit and net operating loss carry-forwards |
4,090 | 2,819 | |||||
Other |
5,286 | 5,519 | |||||
| | | | | | | | |
Total deferred tax assets |
$ | 27,934 | $ | 42,981 | |||
| | | | | | | | |
Valuation allowance |
(822 | ) | — | ||||
| | | | | | | | |
Net deferred tax assets |
$ | 27,112 | $ | 42,981 | |||
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
Deferred tax liabilities resulting from: |
|||||||
Depreciable assets |
(246,518 | ) | (398,921 | ) | |||
Goodwill and intangible assets |
(28,359 | ) | (40,810 | ) | |||
Other |
(4,336 | ) | (8,811 | ) | |||
| | | | | | | | |
Total deferred tax liabilities |
$ | (279,213 | ) | $ | (448,542 | ) | |
| | | | | | | | |
Net deferred tax liabilities |
$ | (252,101 | ) | $ | (405,561 | ) | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
The Company has $21.4 million of state tax net operating loss carry-forwards, which are available to reduce future taxable income in various state jurisdictions and expire between 2029 and 2037. The Company has $3.8 million of state tax credit carry-forwards, which expire between 2018 and 2026. The Company believes that it is not more likely than not that the benefit from state tax credit carryforwards and other state deferred tax assets in certain states will be realized. In recognition of this risk the Company has provided a partial valuation allowance of $1.0 million on those deferred tax assets ($0.8 million net of federal benefit).
The Company accounts for income taxes in accordance with ASC 740, Income Taxes, which provides that an entity shall initially recognize the financial statement effects of a tax position when it is more likely than not, based on the technical merits, that the position will be sustained upon examination. The term more likely than not means a likelihood of more than 50 percent. When measuring the tax benefit to be recorded, in concluding a tax position meets the more-likely-than-not recognition threshold we consider the amounts and probabilities of the possible outcomes that could be realized upon settlement using the facts, circumstances and information available at the reporting date. If these cumulative probabilities exceed 50 percent the tax benefit is recognized.
Total unrecognized tax benefits as of December 31, 2017 and December 31, 2016 are $0.7 million and $0.5 million, respectively. Unrecognized tax benefits and related accrued interest and penalties are included in other liabilities in the accompanying Consolidated Balance Sheets. The Company does not expect a material change in its unrecognized tax benefits within the next twelve months.
F-37
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
13. Income taxes (Continued)
In the normal course of business, the Company is subject to examination by taxing authorities. The Company's open federal tax years are 2014, 2015 and 2016. The Company has open tax years for state and foreign income tax filings generally starting in 2013.
14. Stockholder's equity
Employee Stock Purchase Plan
In December 2009, the Company established the KapStone Paper and Packaging Corporation Employee Stock Purchase Plan ("ESPP"), effective January 1, 2010. The ESPP allows for employees to purchase shares of Company stock at a five percent discount from market price. A total of 1,000,000 shares were reserved for future purchases under the ESPP (amount reflects the stock split announced in December 2013). A total of 46,743 shares and 62,636 shares were issued under the ESPP for the years ended December 31, 2017 and 2016, respectively.
Common Stock Reserved for Issuance
At December 31, 2017, approximately 6.3 million shares of common stock were reserved for issuance, including 5.6 million shares for stock awards and 0.7 million shares for the ESPP.
Cash Dividends
For the years ended December 31, 2017 and 2016, we paid $38.7 million of dividends to stockholders. On December 15, 2017, the board of directors approved a quarterly cash dividend $0.10 per share, which was paid on January 12, 2018, to stockholders of record as of December 29, 2017.
15. Stock-Based Compensation
Share-Based Plan
On May 11, 2016, stockholders of the Company approved the 2016 Incentive Plan ("2016 Plan").
Under the 2016 Plan, awards may be granted to employees, officers and directors of, and consultants and advisors to, the Company. The maximum number of shares was increased to 9.1 million shares of our common stock which will initially be available for all awards, subject to adjustment in the event of certain corporate transactions described in the 2016 Plan.
As of December 31, 2017, approximately 5.6 million shares were reserved for granting additional stock options, restricted stock awards or stock appreciation rights. If any award is forfeited or expires without being exercised, or if restricted stock is repurchased by the Company, the common shares subject to the award shall be available for additional grants under the 2016 Plan. The number of shares available under the 2016 Plan is subject to adjustment in the event of any stock split, stock dividend, recapitalization, spin-off or other similar action. Options intended to qualify, under the standards set forth in certain federal tax rules as incentive stock options ("ISOs"), may be granted only to employees while actually employed by the Company. Non-employee directors, consultants and advisors are not entitled to receive ISOs. Option awards granted under the 2016 Plan are exercisable for a period fixed by the administrator, but no longer than 10 years from the date of grant, at an exercise price which is not less than the fair market value of the shares on the date of the grant.
F-38
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
15. Stock-Based Compensation (Continued)
The compensation committee of the board of directors has authority over the granting of all stock awards, but may delegate that authority to the full board of directors or, subject to certain exceptions, the Chief Executive Officer or another executive officer of the Company. The Company accounts for stock awards in accordance with ASC 718, Compensation—Stock Compensation, which requires that the cost resulting from all share-based payment transactions be recognized as compensation cost over the vesting period based on the fair value of the instrument on the date of grant.
Total non-cash stock-based compensation expense related to stock options and restricted stock for the years ended December 31, 2017, 2016 and 2015 is as follows:
| |
Years Ended December 31, | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| |
2017 | 2016 | 2015 | |||||||
Stock option compensation expense |
$ | 6,096 | $ | 4,564 | $ | 4,938 | ||||
Restricted stock unit compensation expense |
8,814 | 4,374 | 4,897 | |||||||
| | | | | | | | | | | |
Total stock-based compensation expense |
$ | 14,910 | $ | 8,938 | $ | 9,835 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
Total unrecognized stock-based compensation cost related to the stock options and restricted stock as of December 31, 2017 and 2016 is as follows:
| |
December 31, | ||||||
|---|---|---|---|---|---|---|---|
| |
2017 | 2016 | |||||
Unrecognized stock option compensation expense |
$ | 4,709 | $ | 3,849 | |||
Unrecognized restricted stock unit compensation expense |
5,891 | 4,899 | |||||
| | | | | | | | |
Total unrecognized stock-based compensation expense |
$ | 10,600 | $ | 8,748 | |||
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
As of December 31, 2017, total unrecognized compensation cost related to non-vested stock options and restricted stock units is expected to be recognized over a weighted average period of 2.0 years and 1.9 years, respectively.
Stock Options
In 2017, 2016 and 2015 the Company granted stock options for 975,873, 1,265,046 and 668,362 common shares, respectively, to executive officers, directors and employees as compensation for service. The Company's outstanding stock options awarded to employees generally vest as follows: 50 percent after two years and the remaining 50 percent after three years. Stock options granted in 2017, 2016, and 2015 have a contractual term of ten years. The stock options are subject to forfeiture should these employees terminate their employment with the Company for certain reasons prior to vesting in their awards, or the occurrence of certain other events such as termination with cause. The exercise price of these stock options is based on the average market price of our common stock on the date of grant. Compensation expense is recorded on an accelerated basis over the awards' vesting periods.
F-39
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
15. Stock-Based Compensation (Continued)
A summary of information related to stock options is as follows:
| |
Options | Weighted Average Exercise Price |
Weighted Average Remaining Life (Years) |
Intrinsic Value (dollars in thousands) |
|||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Outstanding at December 31, 2014 |
2,759,306 | $ | 11.81 | ||||||||||
Granted |
668,362 | 30.24 | |||||||||||
Exercised |
(108,952 | ) | 10.35 | ||||||||||
Lapsed (forfeited or cancelled) |
(52,816 | ) | 23.03 | ||||||||||
| | | | | | | | | | | | | | |
Outstanding at December 31, 2015 |
3,265,900 | 15.45 | |||||||||||
Granted |
1,265,046 | 12.78 | |||||||||||
Exercised |
(121,146 | ) | 10.06 | ||||||||||
Lapsed (forfeited or cancelled) |
(116,719 | ) | 22.70 | ||||||||||
| | | | | | | | | | | | | | |
Outstanding at December 31, 2016 |
4,293,081 | 14.61 | |||||||||||
Granted |
975,873 | 22.20 | |||||||||||
Exercised |
(192,260 | ) | 10.14 | ||||||||||
Lapsed (forfeited or cancelled) |
(148,113 | ) | 22.34 | ||||||||||
| | | | | | | | | | | | | | |
Outstanding at December 31, 2017 |
4,928,581 | $ | 16.07 | 6.1 | $ | 40,027 | |||||||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
Exercisable at December 31, 2017 |
2,605,778 | $ | 13.75 | 4.0 | $ | 28,515 | |||||||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
The total intrinsic value of options exercised during 2017, 2016 and 2015 was $2.3 million, $0.8 million and $2.0 million, respectively.
The weighted average fair value of the Company stock options granted in 2017, 2016 and 2015 was $7.78, $3.82 and $9.45, respectively. The fair value of awards granted in 2017, 2016 and 2015 was $7.6 million, $4.8 million and $6.3 million, respectively. The fair value was calculated using the Black-Scholes option-pricing model based on the market price at the grant date and the weighted average assumptions specific to the underlying options. The expected life used by the Company is based on the historical average life of stock option awards. The expected volatility assumption is based on the volatility of the Company's common stock from the same time period as the expected term of the stock options. The risk-free interest rate was selected based upon yields of U.S. Treasury issues with a term similar to the expected life of the stock options.
Cash proceeds from the exercise of stock options for the years ended December 31, 2017, 2016, and 2015 was $1.7 million, $0.9 million and $0.9 million, respectively.
F-40
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
15. Stock-Based Compensation (Continued)
The assumptions utilized for determining the fair value of stock options awarded during the years 2017, 2016 and 2015 are as follows:
| |
December 31, | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| |
2017 | 2016 | 2015 | |||||||
KapStone Stock Options Black-Scholes assumptions (weighted average): |
||||||||||
Expected volatility |
43.40 | % | 43.63 | % | 38.73 | % | ||||
Expected life (years) |
5.25 | 5.07 | 4.92 | |||||||
Risk-free interest rate |
2.05 | % | 1.35 | % | 1.36 | % | ||||
Expected dividend yield |
1.76 | % | 1.81 | % | 1.55 | % | ||||
Restricted Stock
In 2017, 2016 and 2015, the Company granted restricted stock units of 475,446, 393,389 and 214,051 to executive officers, directors, and employees as compensation for service. Restricted stock units for executive officers and certain employees are restricted as to transferability until they generally vest three years from the grant date or upon a grantee of such restricted stock units attaining the age 65. Restricted stock units for directors are restricted as to transferability until they generally vest one year from the grant date or upon a grantee of such restricted stock units attaining the age of 65. These restricted stock units are subject to forfeiture should applicable employees terminate their employment with the Company for certain reasons prior to vesting in their awards, or the occurrence of certain other events. The value of these restricted stock units is based on the average market price of our common stock on the date of grant and compensation expense is recorded on a straight-line basis over the awards' vesting periods.
The following table summarizes non-vested restricted stock amounts and activity:
| |
Units | Weighted Average Grant Price |
|||||
|---|---|---|---|---|---|---|---|
Outstanding at December 31, 2014 |
588,067 | $ | 16.98 | ||||
Granted |
214,051 | 30.41 | |||||
Vested |
(228,825 | ) | 10.94 | ||||
Forfeited |
(23,284 | ) | 20.43 | ||||
| | | | | | | | |
Outstanding at December 31, 2015 |
550,009 | $ | 24.60 | ||||
Granted |
393,389 | 12.79 | |||||
Vested |
(215,243 | ) | 15.00 | ||||
Forfeited |
(36,435 | ) | 23.16 | ||||
| | | | | | | | |
Outstanding at December 31, 2016 |
691,720 | $ | 20.93 | ||||
Granted |
475,446 | 22.42 | |||||
Vested |
(261,718 | ) | 26.51 | ||||
Forfeited |
(42,522 | ) | 20.49 | ||||
| | | | | | | | |
Outstanding at December 31, 2017 |
862,926 | $ | 20.11 | ||||
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
F-41
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
15. Stock-Based Compensation (Continued)
The fair value of awards granted in 2017, 2016 and 2015 was $10.7 million, $5.0 million and $6.5 million, respectively. The fair value of awards vested in 2017, 2016 and 2015 was $6.9 million, $3.2 million and $2.5 million, respectively.
16. Commitments and Contingencies
Commercial Commitments
The Company's commercial commitments as of December 31, 2017 represent commitments not recorded on the balance sheet, but potentially triggered by future events, and primarily consist of letters of credit to provide security for certain transactions and operating leases as requested by third parties. The Company had $14.1 million and $16.6 million of these commitments as of December 31, 2017 and 2016, respectively, with all expiring in 2018 if not renewed. No amounts have been drawn under these letters of credit.
Operating Leases
The Company leases space for 13 of its corrugated products manufacturing plants and approximately 60 of its distribution warehouses. Most of these leases include escalation clauses.
Future minimum rentals under non-cancellable leases
The following represents the Company's future minimum rental payments due under non-cancellable operating leases that have initial or remaining lease terms in excess of one year as of the following years
Years Ended December 31,
|
|
|||
|---|---|---|---|---|
2018 |
$ | 45,812 | ||
2019 |
40,777 | |||
2020 |
35,349 | |||
2021 |
29,616 | |||
2022 |
24,510 | |||
Thereafter |
97,802 | |||
| | | | | |
Total |
$ | 273,866 | ||
| | | | | |
| | | | | |
| | | | | |
The Company's rental expense under operating leases amounted to $51.0 million, $49.1 million and $36.0 million for the years ended December 31, 2017, 2016 and 2015, respectively. The increase in rental expense for the year ended December 31, 2016 reflects the full year impact of the inclusion of approximately 60 distribution centers assumed with the Victory acquisition on June 1, 2015.
Purchase Obligations
In conjunction with the 2008 Charleston Kraft Division acquisition, the Company entered into a 15-year fiber supply agreement. Pursuant to the agreement, expiring in 2023, the Company's North Charleston mill will purchase approximately 25 percent of its pine pulpwood and 60 percent of its saw timber requirements. The purchases are based on market prices and are accounted for as raw
F-42
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
16. Commitments and Contingencies (Continued)
materials. The Company's North Charleston mill purchased approximately $29.8 million, $35.2 million and $39.1 million of materials in accordance with the agreement for years ended December 31, 2017, 2016 and 2015, respectively.
The Company has contracted with a third party to produce wood chips for use at the Company's North Charleston and Roanoke Rapids paper mills for twenty years, with an annual purchase obligation of approximately $13.4 million.
The Company has committed to purchase $27.5 million of natural gas through 2022.
Union Contract Status
At December 31, 2017, we had approximately 6,400 employees. Of these, approximately 2,400, or 38 percent, are represented by trade unions under collective bargaining agreements. The majority of our unionized employees are represented by the United Steel Workers union.
Currently, there is a collective bargaining agreement in effect with respect to approximately 630 employees at the Longview paper mill through May 2024, approximately 560 employees at the North Charleston paper mill through June 2025 and approximately 310 employees at the Roanoke Rapids paper mill through August 2020.
Contingent Consideration
The Company's contingent consideration obligation relates to the Victory acquisition that was consummated on June 1, 2015. As of December 31, 2017, the Company is obligated to pay an additional $20.7 million of contingent consideration to the former owners of Victory based on achieving certain financial performance criteria for the thirty month period following the closing.
Legal claims
The Company and its subsidiaries are from time to time subject to various administrative and legal investigations, claims and proceedings incidental to our business, including environmental and occupational, health and safety matters, labor and employment matters, personal injury and property damage claims, contractual, commercial and other disputes and taxes. We establish reserves for investigations, claims and proceedings when it is probable that liabilities exist and we can reasonably estimate the amount of such liabilities (including any losses, costs and expenses). We also maintain insurance that may limit our financial exposure for defense costs, as well as liability, if any, for claims covered by the insurance (subject also to deductibles and self-insurance amounts). Any investigation, claim or proceeding has an element of uncertainty, and we cannot predict or assure the outcome of any investigation, claim or proceeding involving the Company or any of its subsidiaries, particularly those described below that cannot be assessed due to their preliminary nature. It is possible that any of the investigations, claims and proceedings against the Company or its subsidiaries, including those described below, could be decided unfavorably against the Company or any of its subsidiaries involved in such matters and could also result in losses, costs or expenses in excess of any reserve we have established. Accordingly, it is possible that an adverse outcome from any investigation, claim or proceeding (including associated penalties, costs and expenses) could exceed any reserve we may have accrued in
F-43
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
16. Commitments and Contingencies (Continued)
an amount that could have a material adverse effect on our consolidated results of operations, cash flows and financial condition.
The Company's subsidiary, Longview is a potentially responsible party under the Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA") with respect to the Lower Duwamish Waterway Superfund Site in the State of Washington (the "Site"). The U.S. Environmental Protection Agency ("EPA") asserts that the Site is contaminated as a result of discharges from various businesses and government entities located along the Lower Duwamish Waterway, including a corrugated converting plant owned and operated by Longview. In November 2014, the EPA issued a Record of Decision ("ROD") for the Site. The ROD includes a selected remedy for the Site. In the ROD, EPA states that the total estimated net present value costs (discounted at 2.3 percent) for the selected remedy are $342 million, although many uncertainties remain that could result in increased remedial costs. This estimate does not include actual costs already incurred to date for remedial investigation and feasibility studies or potential natural resource damage claims by parties allegedly affected by the contamination at the Site. The Company has received notice from the Elliot Bay Trustee Council regarding the Company's potential liability for natural resource damages arising from the Site. Neither the Company nor Longview has received a specific monetary demand regarding its potential liability for the Site. In addition, Longview is a participant with approximately 45 other potentially responsible parties in a non-judicial allocation process with respect to the Site. Pursuant to the non-judicial allocation process, Longview and other participating parties will seek to allocate certain costs, including but not limited to the costs necessary to perform the work under the ROD. The non-judicial allocation process is not scheduled to be completed until 2020. Based upon the information available to the Company at this time, the Company cannot reasonably estimate its potential liability for this Site, including any liability for the current or any future third-party claims associated with the Site.
In January 2017, the Company received a letter from the state of Washington Department of Ecology ("WDOE") contending that the Company is, along with several other companies, responsible for investigation and cleanup of an allegedly contaminated site where the named companies, including Longview, may store or have stored petroleum products. The letter concerns the possible release of petroleum products into the environment. In 1998, Longview (before it was acquired by the Company) and certain other companies who owned or operated underground storage tanks and pipes entered into an agreement for investigating and remediating the area independently of (but in consultation with) the WDOE. Upon expiration of the 1998 agreement, groundwater monitoring continued. In June 2017, the WDOE further notified the Company that WDOE determined Longview is a potentially liable party related to the release or threatened release of petroleum at the site. The Company has responded to the notices and has been engaged in discussions with the WDOE and other potentially liable parties. Based upon the information available to the Company at this time, the Company cannot reasonably estimate its potential liability for this matter.
F-44
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
17. Net income per share
The Company's basic and diluted net income per share is calculated as follows:
| |
Years Ended December 31, | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| |
2017 | 2016 | 2015 | |||||||
Net income |
$ | 243,503 | $ | 86,252 | $ | 106,386 | ||||
Weighted-average number of common shares for basic net income per share |
96,859,516 | 96,533,368 | 96,257,749 | |||||||
Incremental effect of dilutive common stock equivalents: |
||||||||||
Unexercised stock options |
1,285,701 | 915,488 | 1,096,085 | |||||||
Unvested restricted stock awards |
469,884 | 328,210 | 281,705 | |||||||
| | | | | | | | | | | |
Weighted-average number of shares for diluted net income per share |
98,615,101 | 97,777,066 | 97,635,539 | |||||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
Net income per share—basic |
$ | 2.51 | $ | 0.89 | $ | 1.11 | ||||
Net income per share—diluted |
$ | 2.47 | $ | 0.88 | $ | 1.09 | ||||
A total of 1,670,288 and 1,107,999 weighted average unexercised stock options were outstanding at December 31, 2017 and 2016, respectively, but were not included in the computation of diluted net income per share because the awards were anti-dilutive.
18. Segment Information
Paper and Packaging: This segment manufactures and sells a wide variety of container board, corrugated products, and specialty paper for industrial and consumer markets.
Distribution: Through Victory, a North American distributor of packaging materials, with approximately 60 distribution centers located in the United States, Mexico and Canada, the Company provides packaging materials and related products to a wide variety of customers.
Each segment's operating income is measured on operating profits before foreign exchange losses, equity method investments income and interest expense, net.
F-45
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
18. Segment Information (Continued)
An analysis of operations by segment is as follows:
| |
Net Sales | |
|
|
|
|||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Year Ended December 31, 2017
|
Trade | Inter- segment |
Total | Operating Income (Loss) |
Depreciation and Amortization |
Capital Expenditures |
Total Assets |
|||||||||||||||
Paper and Packaging(a): |
||||||||||||||||||||||
Containerboard / Corrugated products |
$ | 1,528,427 | $ | 86,509 | $ | 1,614,936 | ||||||||||||||||
Specialty paper |
718,532 | — | 718,532 | |||||||||||||||||||
Other |
88,155 | — | 88,155 | |||||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
Total Paper and Packaging |
$ | 2,335,114 | $ | 86,509 | $ | 2,421,623 | $ | 227,388 | $ | 155,605 | $ | 129,360 | $ | 2,620,391 | ||||||||
Distribution |
980,546 | — | 980,546 | 30,204 | 23,667 | 2,258 | 652,544 | |||||||||||||||
Corporate |
— | — | — | (58,467 | ) | 7,529 | 6,740 | 51,050 | ||||||||||||||
Intersegment eliminations |
— | (86,509 | ) | (86,509 | ) | |||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
|
$ | 3,315,660 | $ | — | $ | 3,315,660 | $ | 199,125 | $ | 186,801 | $ | 138,358 | $ | 3,323,985 | ||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
| |
Net Sales | |
|
|
|
|||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Year Ended December 31, 2016
|
Trade | Inter- segment |
Total | Operating Income (Loss) |
Depreciation and Amortization |
Capital Expenditures |
Total Assets |
|||||||||||||||
Paper and Packaging(a): |
||||||||||||||||||||||
Containerboard / Corrugated products |
$ | 1,348,250 | $ | 72,089 | $ | 1,420,339 | ||||||||||||||||
Specialty paper |
692,043 | — | 692,043 | |||||||||||||||||||
Other |
86,927 | — | 86,927 | |||||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
Total Paper and Packaging |
$ | 2,127,220 | $ | 72,089 | $ | 2,199,309 | $ | 181,157 | $ | 151,506 | $ | 116,022 | $ | 2,541,634 | ||||||||
Distribution |
950,037 | — | 950,037 | 29,296 | 23,027 | 4,349 | 658,208 | |||||||||||||||
Corporate |
— | — | — | (39,807 | ) | 7,680 | 6,494 | 56,033 | ||||||||||||||
Intersegment eliminations |
— | (72,089 | ) | (72,089 | ) | — | — | — | — | |||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
|
$ | 3,077,257 | $ | — | $ | 3,077,257 | $ | 170,646 | $ | 182,213 | $ | 126,865 | $ | 3,255,875 | ||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
F-46
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
18. Segment Information (Continued)
| |
Net Sales | |
|
|
|
|||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Year Ended December 31, 2015
|
Trade | Inter- segment |
Total | Operating Income (Loss) |
Depreciation and Amortization |
Capital Expenditures |
Total Assets |
|||||||||||||||
Paper and Packaging: |
||||||||||||||||||||||
Containerboard / Corrugated products |
$ | 1,399,522 | $ | 22,280 | $ | 1,421,802 | ||||||||||||||||
Specialty paper |
720,588 | — | 720,588 | |||||||||||||||||||
Other |
86,286 | — | 86,286 | |||||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
Total Paper and Packaging |
$ | 2,206,396 | $ | 22,280 | $ | 2,228,676 | $ | 224,012 | $ | 145,363 | $ | 108,599 | $ | 2,489,683 | ||||||||
Distribution(b) |
582,949 | — | 582,949 | 20,719 | 13,108 | 3,190 | 675,204 | |||||||||||||||
Corporate |
— | — | — | (45,564 | ) | 3,708 | 14,967 | 57,223 | ||||||||||||||
Intersegment eliminations |
— | (22,280 | ) | (22,280 | ) | — | — | — | — | |||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
|
$ | 2,789,345 | $ | — | $ | 2,789,345 | $ | 199,167 | $ | 162,179 | $ | 126,756 | $ | 3,222,110 | ||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
- (a)
- The
Paper and Packaging segment income excludes $1.8 million and $0.5 million of income from equity method investments for the years ended
December 31, 2017 and 2016, respectively.
- (b)
- Results for the year ended December 31, 2015 includes Victory for the period June 1 through December 31, 2015 and represents the entire Distribution segment.
| |
Years Ended December 31, | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
Net sales by location:
|
2017 | 2016 | 2015 | |||||||
To customers located in the United States |
$ | 2,849,995 | $ | 2,540,592 | $ | 2,300,806 | ||||
Foreign and export sales to foreign based customers |
465,665 | 536,665 | 488,539 | |||||||
| | | | | | | | | | | |
Total |
$ | 3,315,660 | $ | 3,077,257 | $ | 2,789,345 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
No foreign country accounted for more than 10 percent of consolidated net sales in 2017, 2016, or 2015.
Substantially all long-lived assets are located within the United States.
19. Quarterly Financial Information (Unaudited)
The following tables set forth the historical unaudited quarterly financial data for 2017 and 2016. The information for each of these periods has been prepared on the same basis as the audited consolidated financial statements and, in our opinion, reflects all adjustments consisting only of normal
F-47
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
19. Quarterly Financial Information (Unaudited) (Continued)
recurring adjustments necessary to present fairly our financial results. Operating results for previous periods do not necessarily indicate results that may be achieved in any future period.
| |
Quarters Ended | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
March 31, 2017 |
June 30, 2017 |
September 30, 2017 |
December 31, 2017 |
|||||||||
Fiscal 2017: |
|||||||||||||
Net sales |
$ | 765,843 | $ | 822,717 | $ | 868,418 | $ | 858,682 | |||||
Gross profit(1) |
$ | 86,609 | $ | 108,508 | $ | 122,512 | $ | 146,627 | |||||
Operating income(2) |
$ | 20,124 | $ | 41,195 | $ | 59,745 | $ | 78,061 | |||||
Net income(3) |
$ | 5,992 | $ | 19,776 | $ | 30,026 | $ | 187,709 | |||||
Net income per share: |
|||||||||||||
Basic |
$ | 0.06 | $ | 0.20 | $ | 0.31 | $ | 1.94 | |||||
Diluted |
$ | 0.06 | $ | 0.20 | $ | 0.30 | $ | 1.90 | |||||
- (1)
- Gross
profit is defined as net sales less cost of sales, depreciation and amortization, freight, and distribution expenses. Gross profit includes the
following:
- •
- planned maintenance outage costs of $6.2 million, $17.6 million, $13.0 million and $10.0 million in the quarters
ended March 31, June 30, September 30 and December 31, 2017, respectively;
- •
- California plant closure costs of $8.9 million and $1.3 million in the quarters ended September 30 and December 31,
2017, respectively;
- •
- union contract ratification costs of $5.0 million and $0.9 million in the quarters ended March 31 and September 30,
2017, respectively; and
- •
- Ontario, California plant operating expenses of $1.3 million, $1.0 million, $1.0 million and $1.1 million in the
quarters ended March 31, June 30, September 30, and December 31, 2017, respectively.
- (2)
- Operating income includes Victory contingent consideration expense (income) of $2.5 million, $1.1 million, $(3.9) million and $6.1 million in the quarters ended March 31, June 30, September 30 and December 31, 2017, respectively.
F-48
KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
($ in thousands, except share and per share amounts)
19. Quarterly Financial Information (Unaudited) (Continued)
- (3)
- For the quarter ended December 31, 2017, net income includes a $144.4 million provisional income tax benefit due to the passage of the Tax Act on December 22, 2017.
| |
Quarters Ended | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
March 31, 2016 |
June 30, 2016 |
September 30, 2016 |
December 31, 2016 |
|||||||||
Fiscal 2016: |
|||||||||||||
Net sales(1) |
$ | 738,215 | $ | 784,911 | $ | 776,636 | $ | 777,495 | |||||
Gross profit(2) |
$ | 95,340 | $ | 99,067 | $ | 111,121 | $ | 95,621 | |||||
Operating income |
$ | 34,600 | $ | 43,513 | $ | 55,008 | $ | 37,525 | |||||
Net income |
$ | 16,174 | $ | 20,722 | $ | 31,018 | $ | 18,338 | |||||
Net income per share: |
|||||||||||||
Basic |
$ | 0.17 | $ | 0.21 | $ | 0.32 | $ | 0.19 | |||||
Diluted |
$ | 0.17 | $ | 0.21 | $ | 0.32 | $ | 0.19 | |||||
- (1)
- Gross
profit is defined as net sales less cost of sales, depreciation and amortization, freight, and distribution expenses. Gross profit includes planned maintenance
outage costs of $6.6 million, $19.0 million, $3.8 million and $3.2 million in the quarters ended March 31, June 30, September 30 and
December 31, 2016, respectively and $6.4 million of costs due to Hurricane Matthew in the quarter ended December 31, 2016.
- (2)
- Operating
income in the quarter ended December 31, 2016, includes a $6.4 million charge for withdrawing from a GCIU multiemployer pension plan.
Note: The sum of the quarters may not equal the total of the respective years' earnings per share on either a basic or diluted basis due to changes in the weighted average shares outstanding throughout the year.
20. Subsequent Events
On January 29, 2018, the Company signed a definitive agreement to be acquired by WestRock for $35.00 per share plus the assumption of long-term debt for a total purchase price of approximately $4.9 billion. The sale is subject to customary closing conditions and approval of the Company's stockholders. If approved, the sale is expected to close during the quarter ending September 30, 2018.
On February 1, 2018, the Company signed a contract to sell land and building in Oakland, California for $14.7 million after fees, taxes and commissions. In conjunction with this sale, the Company will record a gain of $7.5 million in the first quarter of 2018.
F-49