UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

☒QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2016

 

☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                  to                  

 

Commission File Number: 001-33494

 

KapStone Paper and Packaging Corporation

(Exact Name of Registrant as Specified in its Charter)

 

 

KapStone Paper and Packaging Corporation

1101 Skokie Blvd., Suite 300

Northbrook, IL 60062

(Address of Principal Executive Offices including zip code)

 

Registrant’s Telephone Number, including area code (847) 239-8800

 

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 ☒  No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒  No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes   No ☒

 

There were 96,571,405 shares of the Registrant’s Common Stock, $0.0001 par value, outstanding at July 20, 2016.

 

 

 

 

KAPSTONE PAPER AND PACKAGING CORPORATION

Index to Form 10-Q

TABLE OF CONTENTS

 

 

 

 

 

PART  1. FINANCIAL INFORMATION

ITEM 1. - FINANCIAL STATEMENTS

KAPSTONE PAPER AND PACKAGING CORPORATION

Consolidated Balance Sheets

(In thousands, except share and per share amounts)

 

 

See notes to consolidated financial statements.

KAPSTONE PAPER AND PACKAGING CORPORATION

Consolidated Statements of Comprehensive Income

(In thousands, except share and per share amounts)

(unaudited)

 

 

See notes to consolidated financial statements.

KAPSTONE PAPER AND PACKAGING CORPORATION

Consolidated Statements of Cash Flows

(In thousands)

(unaudited)

 

 

See notes to consolidated financial statements.

KAPSTONE PAPER AND PACKAGING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except share and per share amounts)

 

(unaudited)

 

1.           Financial Statements

 

The accompanying unaudited consolidated financial statements of KapStone Paper and Packaging Corporation (the “Company,” “we,” “us,” “our” or “KapStone”) have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information, the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of a normal recurring nature) considered necessary for a fair presentation have been included. Operating results for the six months ended June 30, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016. For further information, refer to the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2015.

 

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 was established June 1, 2015 concurrent with the acquisition of Victory Packaging, L.P. and its subsidiaries (“Victory”). For more information about our segments, see Note 11, Segment Information.

 

In these consolidated financial statements, certain amounts in prior periods’ consolidated financial statements have been reclassified to conform with the current period presentation.  Amortization of intangible assets and the fair value of the contingent consideration liability are now separately identified in the Statement of Cash Flows and 2015 was recast to conform to the current year presentation.  These reclassifications did not affect our results of operations, financial position, or cash flows.

 

2.           Recent Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards 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 periods therein. Additionally the FASB approved the option to early adopt up to the original effective date (fiscal years beginning after December 15, 2016). We are currently evaluating the impact that the adoption of ASU 2014-09 will have on our financial position, results of operations and disclosures.

 

In April 2015, the FASB issued ASU 2015-03, “Simplifying the Presentation of Debt Issuance Costs”, which changes the presentation of debt issuance costs in financial statements. ASU 2015-03 requires an entity to present such costs in the balance sheet as a direct deduction from the related debt liability rather than as an asset. Amortization of the costs will continue to be reported as interest expense. ASU 2015-03 was adopted and it had no material impact on our financial statements.

 

In July 2015, the FASB issued ASU 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.  Early adoption is permitted.  The Company does not expect the adoption of this standard to have a material impact on its consolidated balance sheets.

 

In February 2016, the FASB issued ASU 2016-02, “Leases”. This guidance revises existing practice related to accounting for leases under Accounting Standards Codification Topic 840 Leases (ASC 840) 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, the new standard 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. We are currently evaluating the impact that the adoption of ASU 2016-02 will have on our financial position, results of operations and disclosures.

 

In March 2016, the FASB issued ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting”, which will require all income tax effects of awards to be recognized in the income statement when the awards vest or are settled. It also will allow an employer to repurchase more of an employee’s shares than it can today 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. Early adoption is permitted.  We are currently evaluating the impact that the adoption of ASU 2016-9 will have on our financial position, results of operations and disclosures.

 

3.           Planned Maintenance Outages

 

Planned maintenance outage costs for the three months ended June 30, 2016 and 2015 totaled $19.0 million and $11.1 million, respectively, and are included in cost of sales.  Outage costs for the three months ended June 30, 2016 and 2015 included an annual planned maintenance outage at the Company’s paper mill in Roanoke Rapids, North Carolina.  In 2016, the outage lasted approximately 9 days with a cost of approximately $8.4 million and resulted in an 11,700 reduction in tons produced. In 2015, the outage lasted approximately 8 days with a cost of approximately $8.0 million and resulted in a 10,400 reduction in tons produced.  In addition, the Longview, Washington paper mill incurred $6.2 million of outage costs for the quarter ended June 30, 2016 compared to $0.2 million for the quarter ended June 30, 2015 primarily due to timing. 

 

Planned maintenance outage costs for the six months ended June 30, 2016 and 2015 totaled $25.6 million and $19.7 million, respectively, and are included in cost of sales. 

 

4.           Inventories

 

Inventories consist of the following at June 30, 2016 and December 31, 2015, respectively:

 

 

 

5.           Short-term Borrowings and Long-term Debt

 

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 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).

 

On February 9, 2016, the Company entered into the First Amendment (“First Amendment”) to the Credit Agreement. The First Amendment modified, among other things, 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 or prior to June 30, 2018, and it modified certain defined terms used in the calculation of the financial covenants in a manner favorable to the Company. The First Amendment also modified the pricing grid applicable to interest rates and the unused commitment fee under the Credit Agreement in order to provide for an additional pricing level based on the total leverage ratio of the Company.

 

The Company paid approximately $2.3 million of loan amendment fees associated with the First Amendment, which are being amortized over the term of the Credit Agreement using the effective interest method.

 

Short-term Borrowings

 

As of June 30, 2016, the Company had $16.0 million of short-term borrowings outstanding under the Revolver which bear interest at 4.25 percent.

 

As of June 30, 2016, the Company has available borrowings of $466.9 million under the Revolver.

 

Receivables Credit Facility

 

On June 8, 2016, the Company entered into Amendment No. 2 to the Receivables Purchase Agreement (the “Amendment to Receivables Purchase Agreement”) amending its Receivables Purchase Agreement dated as of September 26, 2014 (as previously amended, the “Receivables Purchase Agreement”).  In addition, the Company, KapStone Receivables, LLC (“KAR”), KapStone Kraft Paper Corporation, KapStone Container Corporation, KapStone Charleston Kraft LLC, Longview Fibre Paper and Packaging, Inc. and Victory Packaging, L.P. (collectively, the “Originators”), entered into Amendment No. 2 to the Receivables Sales Agreement (the “Amendment to Receivables

Sales Agreement” and, together with the Amendment to Receivables Purchase Agreement, the “Amendment”).  The Amendment establish the primary terms and conditions of an accounts receivable securitization program (the “Securitization Program”).  The Amendment extended the “Facility Termination Date” (as defined in the Receivable Purchase Agreement) from June 8, 2016 to June 6, 2017.

 

Under our Securitization Program, the Originators sell, on an ongoing basis without recourse, certain trade receivables to 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 June 30, 2016, $382.0 million of our trade accounts receivables were sold to KAR.  KAR in turn assigns a collateral interest in these receivables to a financial institution under a one-year $275 million facility (the “Receivables Credit Facility”) for proceeds of $259.5 million. The assets of KAR are not available to us until all obligations of KAR are satisfied in the event of bankruptcy or insolvency proceedings.

 

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 June 30, 2016, the Company was in compliance with all applicable covenants in the Credit Agreement.

 

Fair Value of Debt

 

As of June 30, 2016, the fair value of the Company’s debt approximates the carrying value of $1.6 billion as the variable interest rates re-price frequently at current market rates. Our weighted-average cost of borrowings was 2.1 percent and 1.8 percent for the six months ended June 30, 2016 and June 30, 2015, respectively.

 

6.           Income Taxes

 

The Company’s effective income tax rate for the three and six months ended June 30, 2016 was 36.5 percent and 35.6 percent, respectively, compared to 35.2 percent and 35.0 percent for the three and six months ended June 30, 2015. Our tax rate is affected by recurring items such as state income taxes, as well as discrete items that may occur in any given period but are not consistent from period to period. In addition to state income taxes, the domestic manufacturing deduction had the most significant impact on the difference between our statutory U.S. federal income tax rate of 35 percent and our effective income tax rate for both periods. The higher effective income tax rate in the three and six months ended June 30, 2016 includes a provision for an unfavorable state examination adjustment.

 

In the normal course of business, the Company is subject to examination by taxing authorities. The Company's open federal tax years are 2013 and 2014. The Company has open tax years for state income tax filings generally starting in 2012.

 

7.           Net Income per Share

 

The Company’s basic and diluted net income per share is calculated as follows:

 

 

Approximately 1,798,000 and 800,000 of unexercised stock options were outstanding at June 30, 2016 and 2015, respectively, but were not included in the computation of diluted earnings per share because the options were anti-dilutive.

 

8.           Pension Plan and Post-Retirement Benefits

 

Defined Benefit Plan

 

Net pension cost (benefit) recognized for the three and six months ended June 30, 2016 and 2015 for the Company’s defined benefit plan (the “Pension Plan”) is as follows:

 

 

The Company currently does not anticipate making any Pension Plan contributions in 2016. This estimate is based on current tax laws, plan asset performance, and liability assumptions, which are subject to change.

 

The Company provides postretirement health care insurance benefits through an indemnity plan for certain salary and non-salary Longview employees and their dependents.  The Company anticipates making contributions to its postretirement plans in 2016 as claims are submitted.

 

Defined Contribution Plan

 

The Company offers 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.  For the three months ended June 30, 2016 and 2015, the Company recognized expense of $2.4 million and $5.0 million, respectively, for the Company contributions to the Contribution Plan.  For the six months ended June 30, 2016 and 2015, the Company recognized expense of $6.0 million and $10.0 million, respectively, for the Company contributions to the Contribution Plans.

 

In March 2016, the Company suspended matching contributions to its Contribution Plans for certain employees.  As a result, contributions were $3.1 million lower in the quarter ended June 30, 2016, and $5.3 million lower for the six months ended June 30, 2016.  This was partially offset by an increase attributable to the inclusion of Victory under the Contributions Plans of $0.5 million for the quarter ended June 30, 2016, and $1.3 million for the six months ended June 30, 2016.

 

9.         Stock-Based Compensation

 

The Company accounts for stock-based 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 stock-based compensation expense related to the stock option and restricted stock unit grants for the three and six months ended June 30, 2016 and 2015 is as follows:

 

 

Total unrecognized stock-based compensation cost related to the stock options and restricted stock units as of June 30, 2016 and December 31, 2015 is as follows:

 

 

 

As of June 30, 2016, 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 2.3 years and 2.2 years, respectively.

 

Stock Options

 

The following table summarizes stock options amounts and activity:

 

 

For the three and six months ended June 30, 2016, cash proceeds from the exercise of stock options totaled $0.2 million and $0.4 million, respectively.  For the three and six months ended June 30, 2015, cash proceeds from the exercise of stock options totaled $0.3 million and $0.8 million, respectively.

 

 

Restricted Stock

 

The following table summarizes unvested restricted stock units amounts and activity:

 

 

 

10.        Commitments and Contingencies

 

Legal Claims

 

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 employment matters, personal injury claims, contractual 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), or all of them combined, will not have a material adverse effect on our results of operations, cash flows or financial condition.

 

The Company's subsidiary, Longview Fibre Paper and Packaging, Inc. (“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%) for the selected remedy are $342 million. Neither the Company nor Longview has received a specific monetary demand regarding its potential liability for the Site. In addition, Longview is a participant 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 2019. Based upon the information available to the Company at this time, the Company cannot reasonably estimate its potential liability for this Site.

 

There have been no material changes in any of our legal proceedings for the six months ended June 30, 2016.

 

Contingent Consideration

 

The Company's contingent consideration obligation relates to the Victory acquisition that was consummated on June 1, 2015 and is considered a Level 3 liability. The fair value of the obligation as of June 30, 2016 and December 31, 2015 was $16.4 million and $13.3 million, respectively.  The fair value of the contingent consideration is driven by the probability of reaching the performance measures through December 1, 2017 required by the purchase agreement and the associated discount rate.  The probability is estimated by reviewing financial forecasts and assessing the likelihood of reaching the required performance measures based on factors specific to the acquisition.  The discount rate is determined by applying a risk premium to a risk-free interest rate.  The total potential payout under this obligation is $25.0 million.

 

 

11.         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 its more than 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 profits and losses are measured on operating profits before foreign exchange gains / (losses), net interest expense and income taxes.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

12.         Subsequent Event

 

On July 1, 2016, the Company acquired Central Florida Box Corporation (“CFB”) with operations located in Lake Mary, Florida for approximately $15.4 million, net of cash acquired. The acquisition was funded from borrowings on the Company’s Revolver. CFB operates a 191,000 square foot facility, accommodating office, warehouse and manufacturing space. CFB provides design, graphics, manufacturing, assembly, fulfillment, warehousing and distribution services to over 400 customers ranging from small, family-owned companies to large, national corporations.

 

This acquisition further strengthens the goal of increasing mill integration by up to 20,000 tons.  Acquisition expenses incurred in the second quarter of 2016 totaled approximately $0.2 million.

 

The purchase price allocation has not been completed due to the timing of the close of the acquisition.

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

 

This Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We have based these forward-looking statements on our current expectations and projections about future events. These forward-looking statements are subject to known and unknown risks, uncertainties and assumptions about us that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may,” “should,” “could,” “would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “continue,” or the negative of such terms or other similar expressions. Factors that might cause or contribute to such a discrepancy include, but are not limited to, those described in Part I Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2015 and in our other Securities and Exchange Commission filings. The information contained in this Form 10-Q represents our best judgment at the date of this report based on information currently available. In providing forward-looking statements, KapStone does not intend, and does not undertake any duty or obligation, to update its statements as a result of new information, future events or otherwise.

 

The following discussion should be read in conjunction with our Consolidated Financial Statements and related Notes thereto included elsewhere in this report.

 

Comparison of Results of Operations for the Three Months Ended June 30, 2016 and 2015

(In thousands)

 

 

Consolidated net sales for the quarter ended June 30, 2016 were $784.9 million compared to $671.3 million for the second quarter of 2015, an increase of $113.6 million, or 16.9 percent.  The increase in net sales was driven by the benefit of a full quarter of owning Victory in 2016 as compared to a partial quarter in 2015.  Victory accounted for approximately $158.9 million of the net sales increase which was partially offset by the Paper and Packaging segment’s decrease in net sales for the quarter ended June 30, 2016.

 

Paper and Packaging segment net sales decreased by $25.6 million to $553.1 million for the quarter ended June 30, 2016, due to $24.0 million of lower prices and less favorable product mix and $21.0 million of lower domestic volume, partially offset by $19.7 million of increased intersegment sales to Victory and higher export volumes.  Average mill selling price per ton for the quarter ended June 30, 2016 was $624 compared to $667 for the prior year’s quarter, reflecting lower containerboard and kraft paper prices and a less favorable product mix.