Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended September 30, 2016March 31, 2017

 

oTRANSITION 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)

 

Delaware

 

20-2699372

(State or Other Jurisdiction of

 

(I.R.S. Employer

Incorporation or Organization)

 

Identification No.)

 

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 x  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 such shorter period that the registrant was required to submit and post such files).

 

Yes x  No o

 

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

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

Emerging growth company filer o

(Do not check if a smaller reporting company)

 

 

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 x

 

There were 96,627,34196,792,424 shares of the Registrant’s Common Stock, $0.0001 par value, outstanding at OctoberApril 19, 2016.2017.

 

 

 



Table of Contents

 

KAPSTONE PAPER AND PACKAGING CORPORATION

Index to Form 10-Q

TABLE OF CONTENTS

 

PART I. — FINANCIAL INFORMATION

 

 

 

Item 1. — Consolidated Financial Statements (Unaudited) and Notes to Consolidated Financial Statements

1

 

 

Item 2. — Management’s Discussion and Analysis of Financial Condition and Results of Operations

1314

 

 

Item 3. — Quantitative and Qualitative Disclosures about Market Risk

2019

 

 

Item 4. — Controls and Procedures

2019

 

 

PART II. — OTHER INFORMATION

 

 

 

Item 1. — Legal Proceedings

2120

 

 

Item 1A. — Risk Factors

2120

 

 

Item 2. — Unregistered Sales of Equity Securities and Use of Proceeds

2120

 

 

Item 3. — Defaults Upon Senior Securities

2120

 

 

Item 4. — Mine Safety Disclosures

2120

 

 

Item 5. — Other Information

2120

 

 

Item 6. — Exhibits

2221

 

 

SIGNATURE

2322

 

i



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)

 

 

September 30,

 

December 31,

 

 

March 31,

 

December 31,

 

 

2016

 

2015

 

 

2017

 

2016

 

 

(unaudited)

 

 

 

 

(unaudited)

 

 

 

Assets

 

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

9,449

 

$

6,821

 

 

$

7,915

 

$

29,385

 

Trade accounts receivable (Includes $356,945 at September 30, 2016, and $345,372 at December 31, 2015, associated with the receivables credit facility)

 

388,520

 

363,869

 

Trade accounts receivable (Includes $383,209 at March 31, 2017, and $368,922 at December 31, 2016, associated with the receivables credit facility)

 

416,591

 

392,962

 

Other receivables

 

16,398

 

18,732

 

 

14,177

 

13,562

 

Inventories

 

347,450

 

335,903

 

 

341,403

 

322,664

 

Prepaid expenses and other current assets

 

12,911

 

28,932

 

 

22,824

 

10,247

 

Total current assets

 

774,728

 

754,257

 

 

802,910

 

768,820

 

Plant, property and equipment, net

 

1,419,035

 

1,406,146

 

 

1,452,636

 

1,441,557

 

Other assets

 

22,765

 

12,532

 

 

25,887

 

25,468

 

Intangible assets, net

 

321,923

 

344,583

 

 

320,913

 

314,413

 

Goodwill

 

705,617

 

704,592

 

 

720,473

 

705,617

 

Total assets

 

$

3,244,068

 

$

3,222,110

 

 

$

3,322,819

 

$

3,255,875

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

 

Short-term borrowings

 

$

11,500

 

$

6,400

 

 

$

25,988

 

$

 

Other current borrowings

 

6,214

 

 

Dividend payable

 

9,987

 

9,862

 

 

10,043

 

10,052

 

Accounts payable

 

210,987

 

196,491

 

 

232,429

 

189,350

 

Accrued expenses

 

66,501

 

73,138

 

 

94,023

 

76,480

 

Accrued compensation costs

 

48,680

 

64,149

 

 

45,797

 

48,840

 

Accrued income taxes

 

8,052

 

15

 

 

225

 

15,971

 

Total current liabilities

 

355,707

 

350,055

 

 

414,719

 

340,693

 

Other liabilities:

 

 

 

 

 

 

 

 

 

 

Long-term debt (Includes $269,503 at September 30, 2016, and $265,614 at December 31, 2015, associated with the receivables credit facility)

 

1,484,373

 

1,543,748

 

Long-term debt (Includes $264,683 at March 31, 2017, and $269,273 at December 31, 2016, associated with the receivables credit facility)

 

1,481,912

 

1,485,323

 

Pension and postretirement benefits

 

36,443

 

40,510

 

 

32,805

 

34,207

 

Deferred income taxes

 

420,669

 

418,479

 

 

407,393

 

405,561

 

Other liabilities

 

53,336

 

24,038

 

 

79,212

 

85,761

 

Total other liabilities

 

1,994,821

 

2,026,775

 

 

2,001,322

 

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; 96,624,550 shares issued and outstanding (excluding 40,000 treasury shares) at September 30, 2016 and 96,327,506 shares issued and outstanding (excluding 40,000 treasury shares) at December 31, 2015

 

10

 

10

 

Common stock — $0.0001 par value; 175,000,000 shares authorized; 96,787,331 shares issued and outstanding (excluding 40,000 treasury shares) at March 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

 

274,176

 

266,220

 

 

281,317

 

275,970

 

Retained earnings

 

681,061

 

642,306

 

 

685,891

 

689,668

 

Accumulated other comprehensive loss

 

(61,707

)

(63,256

)

 

(60,440

)

(61,318

)

Total stockholders’ equity

 

893,540

 

845,280

 

 

906,778

 

904,330

 

Total liabilities and stockholders’ equity

 

$

3,244,068

 

$

3,222,110

 

 

$

3,322,819

 

$

3,255,875

 

 

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)

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

Three Months Ended March 31,

 

 

2016

 

2015

 

2016

 

2015

 

 

2017

 

2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

776,636

 

$

807,563

 

$

2,299,762

 

$

2,025,107

 

 

$

765,843

 

$

738,215

 

Cost of sales, excluding depreciation and amortization

 

548,811

 

569,267

 

1,650,919

 

1,421,943

 

 

560,898

 

533,277

 

Depreciation and amortization

 

44,954

 

42,500

 

135,528

 

114,617

 

 

45,348

 

44,539

 

Freight and distribution expenses

 

71,750

 

70,623

 

207,787

 

167,941

 

 

72,988

 

65,059

 

Selling, general, and administrative expenses

 

56,113

 

63,577

 

172,407

 

150,252

 

 

66,485

 

60,740

 

Operating income

 

55,008

 

61,596

 

133,121

 

170,354

 

 

20,124

 

34,600

 

Foreign exchange loss

 

543

 

766

 

1,518

 

1,704

 

Loss on debt extinguishment

 

679

 

628

 

679

 

628

 

Foreign exchange (gain) / loss

 

(82

)

103

 

Equity method investments income

 

(677

)

 

Interest expense, net

 

10,148

 

9,528

 

29,965

 

24,456

 

 

10,730

 

9,811

 

Income before provision for income taxes

 

43,638

 

50,674

 

100,959

 

143,566

 

 

10,153

 

24,686

 

Provision for income taxes

 

12,620

 

16,468

 

33,045

 

49,004

 

 

4,161

 

8,512

 

Net income

 

$

31,018

 

$

34,206

 

$

67,914

 

$

94,562

 

 

$

5,992

 

$

16,174

 

Other comprehensive income, net of tax

 

 

 

 

 

 

 

 

 

Pension and postretirement plan reclassification adjustments:

 

 

 

 

 

 

 

 

 

Amortization (accretion) of prior service costs

 

(104

)

12

 

(312

)

36

 

Other comprehensive income

 

 

 

 

 

Foreign currency translation adjustment

 

359

 

 

Pension and postretirement plan reclassification adjustments, net of tax:

 

 

 

 

 

Accretion of prior service costs

 

(117

)

(104

)

Amortization of net loss

 

620

 

192

 

1,861

 

574

 

 

636

 

621

 

Other comprehensive income, net of tax

 

516

 

204

 

1,549

 

610

 

 

878

 

517

 

Total comprehensive income

 

$

31,534

 

$

34,410

 

$

69,463

 

$

95,172

 

 

$

6,870

 

$

16,691

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

96,581,703

 

96,310,998

 

96,499,771

 

96,235,404

 

 

96,698,637

 

96,399,351

 

Diluted

 

97,888,469

 

97,629,641

 

97,639,370

 

97,631,247

 

 

98,463,667

 

97,509,528

 

Net income per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.32

 

$

0.36

 

$

0.70

 

$

0.98

 

 

$

0.06

 

$

0.17

 

Diluted

 

$

0.32

 

$

0.35

 

$

0.70

 

$

0.97

 

 

$

0.06

 

$

0.17

 

Dividends declared per common share

 

$

0.10

 

$

0.10

 

$

0.30

 

$

0.30

 

 

$

0.10

 

$

0.10

 

 

See notes to consolidated financial statements.

KAPSTONE PAPER AND PACKAGING CORPORATION

Consolidated Statements of Cash Flows

(In thousands)

(unaudited)

 

 

Nine Months Ended September 30,

 

 

Three Months Ended March 31,

 

 

2016

 

2015

 

 

2017

 

2016

 

Operating activities

 

 

 

 

 

 

 

 

 

 

Net income

 

$

67,914

 

$

94,562

 

 

$

5,992

 

$

16,174

 

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

 

 

 

 

 

 

 

 

 

 

Depreciation of plant and equipment

 

110,143

 

98,010

 

 

37,758

 

35,603

 

Amortization of intangible assets

 

25,385

 

16,607

 

 

7,590

 

8,936

 

Stock-based compensation expense

 

7,188

 

8,122

 

 

5,265

 

3,421

 

Pension and postretirement

 

(1,588

)

(8,379

)

 

(572

)

(448

)

Excess tax (deficiency) / benefit from stock-based compensation

 

150

 

(1,518

)

Excess tax benefit from stock-based compensation

 

 

140

 

Amortization of debt issuance costs

 

3,625

 

4,364

 

 

1,179

 

1,124

 

Loss on debt extinguishment

 

679

 

628

 

Loss on disposal of fixed assets

 

3,156

 

5

 

Loss (gain) on disposal of fixed assets

 

526

 

(62

)

Deferred income taxes

 

220

 

6,441

 

 

1,521

 

1,064

 

Change in fair value of contingent consideration liability

 

4,579

 

2,053

 

 

2,516

 

1,526

 

Equity method investments income

 

(167

)

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

 

 

 

Trade accounts receivable, net

 

(23,010

)

(27,022

)

 

(21,145

)

(8,169

)

Other receivables

 

1,949

 

2,744

 

 

(659

)

1,789

 

Inventories

 

(11,086

)

(5,639

)

 

(17,870

)

847

 

Prepaid expenses and other current assets

 

14,399

 

(2,595

)

 

(12,549

)

8,007

 

Other assets

 

(995

)

(153

)

 

(208

)

 

Accounts payable

 

16,926

 

(11,005

)

 

41,413

 

7,936

 

Accrued expenses and other liabilities

 

(650

)

6,345

 

 

964

 

(6,303

)

Accrued compensation costs

 

(15,524

)

912

 

 

(3,139

)

(15,320

)

Accrued income taxes

 

8,927

 

(7,834

)

 

(15,746

)

2,340

 

Net cash provided by operating activities

 

212,387

 

176,648

 

 

32,669

 

58,605

 

 

 

 

 

 

 

 

 

 

 

Investing activities

 

 

 

 

 

 

 

 

 

 

Equity method investments

 

(11,750

)

 

Capital expenditures

 

(38,669

)

(36,163

)

Purchase of intangible assets

 

(2,025

)

 

 

 

(500

)

Acquisitions, net of cash acquired

 

(15,438

)

(617,046

)

 

(33,500

)

 

Capital expenditures

 

(99,246

)

(94,895

)

Proceeds from the sale of assets

 

4,881

 

 

 

 

4,856

 

Net cash used in investing activities

 

(123,578

)

(711,941

)

 

(72,169

)

(31,807

)

 

 

 

 

 

 

 

 

 

 

Financing activities

 

 

 

 

 

 

 

 

 

 

Proceeds from revolving credit facility

 

353,200

 

268,200

 

 

122,988

 

134,600

 

Repayments on revolving credit facility

 

(348,100

)

(266,200

)

 

(97,000

)

(131,000

)

Proceeds from receivables credit facility

 

36,556

 

112,961

 

 

17,031

 

6,670

 

Repayments on receivables credit facility

 

(32,667

)

(18,449

)

 

(21,621

)

(24,700

)

Proceeds from long-term debt

 

 

519,763

 

Repayments on long-term debt

 

(64,687

)

(64,688

)

Payment of loan amendment fees and debt issuance costs

 

(2,250

)

(10,790

)

Payment of loan amendment fees

 

 

(2,250

)

Proceeds from other current borrowings

 

 

6,615

 

 

6,214

 

 

Repayment on other current borrowings

 

 

(4,401

)

Cash dividends paid

 

(29,001

)

(29,098

)

 

(9,664

)

(9,696

)

Payment of withholding taxes on vested stock awards

 

(841

)

(2,460

)

 

(856

)

(692

)

Proceeds from exercises of stock options

 

788

 

778

 

 

451

 

209

 

Proceeds from shares issued to ESPP

 

971

 

844

 

 

487

 

464

 

Excess tax (deficiency) / benefit from stock-based compensation

 

(150

)

1,518

 

Excess tax (deficiency) from stock-based compensation

 

 

(140

)

Net cash (used in) provided by financing activities

 

(86,181

)

514,593

 

 

18,030

 

(26,535

)

 

 

 

 

 

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

 

2,628

 

(20,700

)

 

(21,470

)

263

 

Cash and cash equivalents-beginning of period

 

6,821

 

28,467

 

 

29,385

 

6,821

 

Cash and cash equivalents-end of period

 

$

9,449

 

$

7,767

 

 

$

7,915

 

$

7,084

 

 

 

 

 

 

 

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 ninethree months ended September 30, 2016March 31, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016.2017. 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, 2015.2016.

 

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 concurrentthrough Victory, a North American distributor of packaging materials, with more than 60 distribution centers located in the acquisitionUnited States, Mexico and Canada, provides packaging materials and related products to a wide variety of Victory Packaging, L.P. and its subsidiaries (“Victory”).customers.  For more information about our segments, see Note 12, Segment Information.

In 2016, the Company entered into two joint venture agreements that are accounted for using the equity method.

In these consolidated financial statements, certain amounts in prior periods’ consolidated financial statements have been reclassified to conform to 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 the presentation of Cash Flows for 2015 has been 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 StandardsStandard’s Board (“FASB’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 currentlyin the diagnostic phase of evaluating the overall impact that the adoption of ASU 2014-092014-09. The Company has determined that it will have on our financial position, results of operations and disclosures.

In April 2015,adopt this standard utilizing the FASB issued ASU 2015-03, “Simplifying the Presentation of Debt Issuance Costs”,modified retrospective method, which changes the presentation of debt issuance costs in financial statements. ASU 2015-03 requires an entity to present such costswill result in the balance sheet as a direct deduction fromrecognition of the related debt liability rather thancumulative effect of initially applying the standard (if any) as an asset. Amortization ofadjustment to opening retained earnings for the costsfiscal year beginning January 1, 2018. During 2016, the Company reported its progress to management and the Audit Committee on a periodic basis. The Company will continue to be reportedprovide additional disclosure as interest expense. ASU 2015-03 was adoptedthe implementation plan progresses during the interim period ended March 31, 2016, and it had no material impact on our financial statements.2017.

 

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 expectASU 2015-11 was adopted during the adoption of this standard to have ainterim period ended March 31, 2017, and it had no material impact on itsthe Company’s consolidated balance sheets.financial statements.

 

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 evaluatingThe Company does have a significant number of leases for both property and equipment. As such, the impactCompany expects that the adoption of ASU 2016-02there will havebe a material impact on our financial position, results of operations and disclosures.disclosures upon the adoption of ASU 2016-02. The Company will provide additional disclosure as the implementation plan progresses.

 

In March 2016, the FASB issued ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting”, which will requirerequires all income tax effects of awards to be recognized in the income statement when the awards vest or are settled. It also will allowallows 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 iswas 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 2016-09 will have on our financial position, resultswas adopted prospectively during the interim period ended March 31, 2017, and it increased the Company’s provision for incomes taxes by $0.5 million. The Company elected to continue to recognize estimated forfeitures over the term of operations and disclosures.the awards.

 

In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230): 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. We are 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 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. We currently do not expect that the adoption of these provisions will have a material effect on our consolidated financial statements and related disclosures.

In January 2017, the FASB issued ASU 2017-01, “Clarifying the Definition of a Business”, which amends the guidance in ASC 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 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. We currently do 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.

 

3.                                      API Acquisition and Equity Method Investments

Acquisition

 

On JulyFebruary 1, 2016,2017, 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.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 $500 million 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. Operating results of the acquisition since JulyFebruary 1, 20162017 are included in the Company’s Paper and Packaging segment operating results.segment. The Company has allocated the purchase price to the assets acquired and liabilities assumed, of which $10.5$14.1 million has been allocated to customer relationship intangible assets, $2.8 million to plant, property and equipment, $1.7$1.8 million to net working capital $1.0and $14.8 million to goodwill (which is deductible for tax purposes) and $2.2 million to customer relationships (to be amortized over a life of 10 years).  The purchase price allocation is preliminary pending further review by management of the fair value assigned to long-livedfor intangible assets.

 

Transaction fees and expenses for the CFBAPI acquisition related to due diligence, advisory and legal services have been expensed as incurred.  These expenses were $0.6 million and $0.8$0.4 million for the three and nine month periodsperiod ended September 30, 2016, respectively,March 31, 2017, and were recorded as selling, general and administrative expenses in the Consolidated Statements of Comprehensive Income.

 

Equity Method InvestmentsThis acquisition further strengthens the Company’s goal of increasing mill integration.

 

In September of 2016,conjunction with the Company made a $10.5 million investment for a 49 percent equity interest in a sheet feeder operation located in Florida.  In April of 2016,API acquisition, 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.

New Plant Start-up

In May of 2016, the Company began building a new sheet plant in Ontario, California with a total estimated cost of approximately $14.0 million.  The Company signed a 10 year25-year lease agreement with a total commitment of approximately $9.0$14.7 million.  The new sheet plant is expected to be manufacturing boxes by January 2017 and is intended to primarily supply the Company’s Victory Packaging operations in Southern California as well as other KapStone customers.

 

4.                                      Planned Maintenance Outages

 

Planned maintenance outage costs for the three months ended September 30,March 31, 2017 and 2016 and 2015 totaled $3.8$6.2 million and $4.4$6.6 million, respectively, and are included in cost of sales.

Planned maintenance outage costs for the nine months ended September 30, 2016 and 2015 totaled $29.4 million and $24.1 million, respectively, and are included in cost of sales. Included in the outage costs for the nine months ended September 30, 2016 and 2015 was the 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 $11.9 million of outage costs for the nine months ended September 30, 2016 compared to $9.8 million for the nine months ended September 30, 2015.

 

5.                                      Inventories

 

Inventories consist of the following at September 30, 2016March 31, 2017 and December 31, 2015,2016, respectively:

 

 

(unaudited)

 

 

 

 

(unaudited)

 

 

 

 

September 30,

 

December 31,

 

 

March 31,

 

December 31,

 

 

2016

 

2015

 

 

2017

 

2016

 

Raw materials

 

$

100,048

 

$

101,250

 

 

$

93,672

 

$

79,377

 

Work in process

 

7,022

 

6,165

 

 

4,557

 

6,371

 

Finished goods

 

155,545

 

149,774

 

 

156,229

 

151,497

 

Replacement parts and supplies

 

84,815

 

79,717

 

 

87,383

 

85,857

 

Inventory at FIFO costs

 

347,430

 

336,906

 

 

341,841

 

323,102

 

LIFO inventory reserves

 

20

 

(1,003

)

 

(438

)

(438

)

Inventories

 

$

347,450

 

$

335,903

 

 

$

341,403

 

$

322,664

 

 

6.                                      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”).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,March 27, 2017, the Company entered into the FirstSecond 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 itwhich 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.

In September of 2016, the Company made a voluntary prepayment on its term loans under the Credit Facility of $64.7 million and as a result, $0.7 million of unamortized debt issuance costs were written-off as a loss on debt extinguishment.

 

Short-term Borrowings

 

As of September 30, 2016,March 31, 2017, the Company had $11.5$26.0 million of short-term borrowings outstanding under the Revolver, which bearwith a weighted average interest at 4.25of 3.42 percent.

 

As of September 30, 2016,March 31, 2017, the Company has available borrowing capacity of $471.3$457.4 million under the Revolver.

 

Receivables Credit Facility

 

On June 8, 2016,February 21, 2017, the Company entered into Amendment No. 23 to the Receivables PurchaseSale Agreement (the “Amendment to Receivables Purchase Agreement”)  amending its Receivables Purchase Agreement dated as of September 26, 2014 (as previously amended,amend 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 (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 Receivables Purchase Agreement and Receivables Sales Agreement, as amended by the Amendment, establishes the primary terms and conditions of an accounts receivable securitization program (the “Securitization Program”).  The Amendment extended of the “Facility Termination Date” (as defined inCompany and certain of its subsidiaries. All accounts receivable purchased from API and Fast Pak, LLC (the “Sellers”) and all accounts receivable generated from facilities acquired from the Receivable Purchase Agreement) from June 8, 2016Sellers that are not paid to June 6, 2017.an eligible bank account are designated as “Excluded Receivables”.

 

Under our Securitization Program, the OriginatorsCompany and its subsidiaries that participate in the Securitization Program (the “Originators”) sell, on an ongoing basis without recourse, certain trade receivables to KAR,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 September 30, 2016, $356.9March 31, 2017, $383.2 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 $269.5$264.7 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.

Other Borrowing

In January 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 agreement requires the Company to pay three quarterly payments through the term of the financing agreement ending on December 1, 2017.  As of March 31, 2017, there was $6.2 million outstanding under the current agreement.

 

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 September 30, 2016,March 31, 2017, the Company was in compliance with all applicable covenants in the Credit Agreement.

Fair Value of Debt

 

As of September 30, 2016,March 31, 2017, the fair value of the Company’s debt approximates the carrying value of $1.5 billion as the variable interest rates re-price frequently at current market rates. Our weighted-average cost of borrowings was 2.152.61 percent and 1.822.08 percent for the ninethree months ended September 30,March 31, 2017 and March 31, 2016, and September 30, 2015, respectively.

 

7.                                      Income Taxes

 

The Company’s effective income tax rate for the three and nine months ended September 30, 2016March 31, 2017 was 28.941.0 percent and 32.7 percent, respectively, compared to 32.5 percent and 34.134.5 percent for the three and nine months ended September 30, 2015.March 31, 2016.  The lowerhigher effective income tax rate in the three months ended September 

30, 2016 is driven by a favorable $1.4March 31, 2017 reflects $0.5 million return-to-provision adjustmentin tax expense from the Company’s recently filed 2015 federaladoption of ASU 2016-09 which requires the tax impact of elements of stock compensation to be recorded in the provision for income taxes.

Cash taxes paid in the quarter ending March 31, 2017 were $21.1 million compared to net cash tax return.refunds of $11.5 million for the quarter ended March 31, 2016.

 

In the normal course of business, the Company is subject to examination by taxing authorities. The Company’s open federal tax years are 2013, 2014 and 2014.2015. The Company has open tax years for state and foreign income tax filings generally starting in 2012.

 

8.                                      Net Income per Share

 

The Company’s basic and diluted net income per share for the three and nine months ended September 30,March 31, 2017 and 2016 and 2015 is calculated as follows:

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

Three Months Ended March 31,

 

 

2016

 

2015

 

2016

 

2015

 

 

2017

 

2016

 

Net income

 

$

31,018

 

$

34,206

 

$

67,914

 

$

94,562

 

 

$

5,992

 

$

16,174

 

Weighted-average number of common shares for basic net income per share

 

96,581,703

 

96,310,998

 

96,499,771

 

96,235,404

 

 

96,698,637

 

96,399,351

 

Incremental effect of dilutive common stock equivalents:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unexercised stock options

 

942,090

 

1,030,234

 

840,281

 

1,112,767

 

 

1,319,602

 

806,311

 

Unvested restricted stock awards

 

364,676

 

288,409

 

299,318

 

283,076

 

 

445,428

 

303,866

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-average number of shares for diluted net income per share

 

97,888,469

 

97,629,641

 

97,639,370

 

97,631,247

 

 

98,463,667

 

97,509,528

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income per share - basic

 

$

0.32

 

$

0.36

 

$

0.70

 

$

0.98

 

 

$

0.06

 

$

0.17

 

Net income per share - diluted

 

$

0.32

 

$

0.35

 

$

0.70

 

$

0.97

 

 

$

0.06

 

$

0.17

 

 

Approximately 1,100,000A total of 1,189,244 and 1,462,796 weighted average unexercised stock options were outstanding for both of the three month periods ended September 30,at March 31, 2017 and 2016, and 2015, respectively, but were not included in the computation of diluted earningsnet income per share because the options were anti-dilutive.

Approximately 1,809,000 and 900,000 of unexercised stock options were outstanding for the nine month periods ended September 30, 2016 and 2015, respectively, but were not included in the computation of diluted earnings per share because the optionsawards were anti-dilutive.

 

9.                                      Pension Plan and Post-Retirement Benefits

 

Defined Benefit Plan

 

Net pension cost (benefit) recognized for the three and nine months ended September 30,March 31, 2017 and 2016 and 2015 for the Company’s defined benefit plan (the “Pension Plan”) is as follows:

 

 

Three Months Ended March 31,

 

 

 

2017

 

2016

 

Service cost for benefits earned during the quarter

 

$

1,077

 

$

1,125

 

Interest cost on projected benefit obligations

 

6,567

 

7,079

 

Expected return on plan assets

 

(9,031

)

(9,340

)

Amortization of net loss

 

1,197

 

1,157

 

Amortization of prior service cost

 

4

 

24

 

Net pension cost (benefit)

 

$

(186

)

$

45

 

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2016

 

2015

 

2016

 

2015

 

Service cost for benefits earned during the quarter

 

$

1,125

 

$

1,215

 

$

3,374

 

$

3,645

 

Interest cost on projected benefit obligations

 

7,079

 

6,900

 

21,236

 

20,701

 

Expected return on plan assets

 

(9,340

)

(10,236

)

(28,020

)

(30,708

)

Amortization of net loss

 

1,157

 

533

 

3,471

 

1,601

 

Amortization of prior service cost

 

24

 

69

 

72

 

207

 

Net pension cost (benefit)

 

$

45

 

$

(1,519

)

$

133

 

$

(4,554

)

The Company currently does not anticipate making any Pension Plan contributions in 2016.2017. 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 of its subsidiary Longview Fibre Paper and Packaging, Inc. (“Longview”) employees and their dependents.  The Company anticipates making contributions to its’its postretirement plans in 20162017 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 September 30,March 31, 2017 and 2016, and 2015, the Company recognized expense of $2.5$6.2 million and $5.5 million, respectively, for matching contributions.  For the nine months ended September 30, 2016 and 2015, the Company recognized expense of $8.5 million and $15.5$3.6 million, respectively, for matching contributions.

 

In March 2016,2017, the Company suspendedrestored matching contributions to its Contribution Plans for certain employees.employees that were previously suspended during 2016.  As a result, contributions were $3.2$2.6 million lowerhigher in the quarter ended September 30, 2016, and $8.5 million lower for the nine months ended September 30, 2016,March 31, 2017 compared to the same period in 2015.  This was partially offset by an increase attributable2016.

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 approximately 300 hourly employees at four corrugated products manufacturing plants.  On October 31, 2016, the Company provided formal notification to the inclusionplan trustee of Victory underits withdrawal from the Contribution Plansplan and cessation of $0.2plan contributions effective December 31, 2016.  Accordingly, the Company recorded an estimated withdrawal liability of approximately $6.4 million, forbased 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 quarter ended September 30, 2016, and $1.5 million forfacts available to management; however, the nine months ended September 30, 2016 compared to 2015.withdrawal liability will ultimately be determined by the plan trustee.

 

10.                               Stock-Based Compensation

In the quarter ended March 31, 2017, the compensation committee of the board of directors approved stock-based awards to executive officers, certain employees and directors.  The 2017 award consisted of the grant of 957,270 stock options, and 342,264 restricted stock units with a combined cost of $15.1 million.

 

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 nine months ended September 30,March 31, 2017 and 2016 and 2015 is as follows:

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

Three Months Ended March 31,

 

 

2016

 

2015

 

2016

 

2015

 

 

2017

 

2016

 

Stock option compensation expense

 

$

928

 

$

826

 

$

3,669

 

$

4,048

 

 

$

2,616

 

$

1,789

 

Restricted stock unit compensation expense

 

898

 

759

 

3,519

 

4,074

 

 

2,649

 

1,632

 

Total stock-based compensation expense

 

$

1,826

 

$

1,585

 

$

7,188

 

$

8,122

 

 

$

5,265

 

$

3,421

 

 

Total unrecognized stock-based compensation cost related to the stock options and restricted stock units as of September 30, 2016March 31, 2017 and December 31, 20152016 is as follows:

 

 

September 30,

 

December 31,

 

 

March 31,

 

December 31,

 

 

2016

 

2015

 

 

2017

 

2016

 

Unrecognized stock option compensation expense

 

$

4,791

 

$

4,217

 

 

$

8,563

 

$

3,849

 

Unrecognized restricted stock unit compensation expense

 

5,819

 

5,094

 

 

9,703

 

4,899

 

Total unrecognized stock-based compensation expense

 

$

10,610

 

$

9,311

 

 

$

18,266

 

$

8,748

 

 

As of September 30, 2016,March 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 2.12.5 years and 2.02.4 years, respectively.

Stock Options

Stock option awards to employees generally vest as follows: 50% after two years and the remaining 50% after three years or upon a grantee of such stock options attaining the age 65. The stock options awarded in 2017 have a contractual term of ten years and are subject to forfeiture should the recipient terminate his or her employment with the Company for certain reasons prior to vesting in his or her 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 ($22.20 for the 2017 awards described above) and compensation expense is recorded on an accelerated basis over the awards’ vesting periods.

The weighted average fair value of the stock options granted in March 2017 and 2016 was $7.79 and $3.79, 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 term 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 our 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. The expected dividend yield is calculated as the annual dividend per share amount divided by the average market price of the common stock on the date of the grant.

The assumptions utilized for calculating the fair value of stock options during the period are as follows:

 

 

Three Months Ended March 31,

 

 

 

2017

 

2016

 

KapStone Stock Options Black-Scholes assumptions (weighted average):

 

 

 

 

 

Expected volatility

 

43.40

%

43.61

%

Expected life (years)

 

5.26

 

5.07

 

Risk-free interest rate

 

2.06

%

1.35

%

Expected dividend yield

 

1.73

%

3.14

%

 

The following table summarizes stock options amounts and activity:

 

 

 

 

Weighted

 

Weighted

 

Intrinsic

 

 

 

 

 

Average

 

Average

 

Value

 

 

 

 

 

Exercise

 

Remaining

 

(dollars in

 

 

 

Options

 

Price

 

Life (Years)

 

thousands)

 

Outstanding at January 1, 2016

 

3,265,900

 

$

15.45

 

 

 

 

 

Granted

 

1,263,078

 

12.77

 

 

 

 

 

Exercised

 

(107,194

)

9.77

 

 

 

 

 

Lapsed (forfeited or cancelled)

 

(95,897

)

22.80

 

 

 

 

 

Outstanding at September 30, 2016

 

4,325,887

 

$

14.64

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Exercisable at September 30, 2016

 

2,321,008

 

$

10.20

 

4.7

 

$

23,002

 

 

 

 

 

Weighted

 

Weighted

 

Intrinsic

 

 

 

 

 

Average

 

Average

 

Value

 

 

 

 

 

Exercise

 

Remaining

 

(dollars in

 

 

 

Options

 

Price

 

Life (Years)

 

thousands)

 

Outstanding at January 1, 2017

 

4,293,081

 

$

14.61

 

 

 

 

 

Granted

 

957,270

 

22.20

 

 

 

 

 

Exercised

 

(38,763

)

13.49

 

 

 

 

 

Lapsed (forfeited or cancelled)

 

(23,172

)

21.76

 

 

 

 

 

Outstanding at March 31, 2017

 

5,188,416

 

$

15.99

 

 

 

 

 

Exercisable at March 31, 2017

 

2,692,270

 

$

13.47

 

4.8

 

$

31,087

 

 

For the three and nine months ended September 30,March 31, 2017 and 2016, cash proceeds from the exercise of stock options totaled $0.4$0.5 million and $0.8$0.2 million, respectively.  No options were exercised in the three months ended September 30, 2015.  For the nine months ended September 30, 2015, cash proceeds from the exercise of stock options totaled $0.8 million.

 

Restricted Stock

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 unvested restricted stock units amounts and activity:

 

 

 

 

Weighted

 

 

 

 

Weighted

 

 

 

 

Average

 

 

 

 

Average

 

 

 

 

Grant

 

 

 

 

Grant

 

 

Units

 

Price

 

 

Units

 

Price

 

Outstanding at January 1, 2016

 

550,009

 

$

24.60

 

Outstanding at January 1, 2017

 

691,720

 

$

20.93

 

Granted

 

392,696

 

12.68

 

 

342,264

 

22.20

 

Vested

 

(210,988

)

14.87

 

 

(127,251

)

30.42

 

Forfeited

 

(31,006

)

23.49

 

 

(6,639

)

21.40

 

Outstanding at September 30, 2016

 

700,711

 

$

20.89

 

Outstanding at March 31, 2017

 

900,094

 

$

20.07

 

 

11.                               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 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 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.

 

In October 2016, the Company’s subsidiary KapStone Charleston Kraft LLC (“KCK”) received a Notice of Alleged Violation from the South Carolina Department of Health and Environmental Control (“DHEC”) in which DHEC made several allegations related to air regulatory requirements. Several of the allegations related to recordkeeping/reporting, monitoring or paperwork requirements which did not implicate actual emissions (and which have been corrected); however, three of the allegations related to periodic compliance monitoring of particulates from operating equipment sources that are considered to be serious under DHEC guidelines. No emissions from the monitoring resulted in any impact to the environment or human health, and no annual limits were exceeded because this allegation involved spare equipment that is operated only a limited number of days each year. Discussions with DHEC regarding the alleged violations are ongoing, and the resolution of the matters raised in this notice is uncertain at this time (and therefore the Company cannot reasonably estimate its potential liability for this enforcement matter). However, no capital expenditure is required and all repairs and corrective actions have been performed resulting in full compliance as of March 31, 2017; thus the Company currently does not expect that the result of those discussions will be material to the our results of operations, cash flows or financial condition.

In January 2017, the Company received a letter from the state of Washington Department of Ecology contending that the Company may, along with several other companies, be 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 Washington Department of Ecology. Upon expiration of the 1998 agreement, groundwater monitoring continued. The Company plans to respond to the notice and further investigate the allegations in the letter. Based upon the information available to the Company at this time, the Company cannot reasonably estimate its potential liability, if any, for this site.

There have been no material changes in any of our legal proceedings for the ninethree months ended September 30, 2016.March 31, 2017.

 

Contingent Consideration

 

The Company’s contingent consideration obligation relates to the acquisition of Victory acquisition that was consummatedPackaging, L.P. (“Victory”) on June 1, 2015 and is considered a Level 3 liability. The fair value of the obligation as of September 30, 2016March 31, 2017 and December 31, 20152016 was $17.9$17.4 million and $13.3$14.9 million, respectively. The fair value of the contingent consideration is driven byestimated based on the probability of reaching the performance measures through December 1, 2017 required by the purchase agreement and the associated discount rate.November 30, 2017. 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.  The Company expects to payout this obligation in the first quarter of 2018.

 

12.                               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 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 income from equity investments, foreign exchange gains / (losses), loss on debt extinguishment, net interest expense and income taxes.

 

 

Net Sales

 

Operating
Income

 

Depreciation
and

 

Capital

 

 

 

Three Months Ended September 30, 2016

 

Trade

 

Intersegment

 

Total

 

(Loss)

 

Amortization

 

Expenditures

 

Assets

 

Paper and Packaging:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Containerboard / Corrugated products

 

$

342,386

 

$

18,674

 

$

361,060

 

 

 

 

 

 

 

 

 

Specialty paper

 

169,331

 

 

169,331

 

 

 

 

 

 

 

 

 

Other

 

21,845

 

 

21,845

 

 

 

 

 

 

 

 

 

Paper and Packaging

 

$

533,562

 

$

18,674

 

$

552,236

 

$

57,731

 

$

37,491

 

$

24,900

 

$

2,526,342

 

Distribution*

 

243,074

 

 

243,074

 

8,230

 

5,795

 

936

 

676,350

 

Corporate

 

 

 

 

(10,953

)

1,668

 

1,037

 

41,376

 

Intersegment eliminations

 

 

(18,674

)

(18,674

)

 

 

 

 

 

 

$

776,636

 

$

 

$

776,636

 

$

55,008

 

$

44,954

 

$

26,873

 

$

3,244,068

 

 

 

Net Sales

 

Operating
Income

 

Depreciation
and

 

Capital

 

 

 

 

Net Sales

 

Operating

 

Depreciation

 

 

 

 

 

Three Months Ended September 30, 2015

 

Trade

 

Intersegment

 

Total

 

(Loss)

 

Amortization

 

Expenditures

 

Assets

 

Three Months Ended March 31, 2017

 

Trade

 

Inter-
segment

 

Total

 

Income
(Loss)

 

and
Amortization

 

Capital
Expenditures

 

Assets

 

Paper and Packaging:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Containerboard / Corrugated products

 

$

358,216

 

$

7,628

 

$

365,844

 

 

 

 

 

 

 

 

 

 

$

345,342

 

$

21,197

 

$

366,539

 

 

 

 

 

 

 

 

 

Specialty paper

 

179,451

 

 

179,451

 

 

 

 

 

 

 

 

 

 

180,348

 

 

180,348

 

 

 

 

 

 

 

 

 

Other

 

21,768

 

 

21,768

 

 

 

 

 

 

 

 

 

 

21,954

 

 

21,954

 

 

 

 

 

 

 

 

 

Paper and Packaging

 

$

559,435

 

$

7,628

 

$

567,063

 

$

60,185

 

$

36,059

 

$

25,448

 

$

2,524,562

 

 

$

547,644

 

$

21,197

 

$

568,841

 

$

34,315

 

$

37,406

 

$

36,490

 

$

2,591,747

 

Distribution *

 

248,128

 

 

248,128

 

11,139

 

5,522

 

1,283

 

683,555

 

Distribution

 

218,199

 

 

218,199

 

2,597

 

5,978

 

679

 

687,854

 

Corporate

 

 

 

 

(9,728

)

919

 

4,453

 

41,818

 

 

 

 

 

(16,788

)

1,964

 

1,500

 

43,218

 

Intersegment eliminations

 

 

(7,628

)

(7,628

)

 

 

 

 

 

 

(21,197

)

(21,197

)

 

 

 

 

 

$

807,563

 

$

 

$

807,563

 

$

61,596

 

$

42,500

 

$

31,184

 

$

3,249,935

 

 

$

765,843

 

$

 

$

765,843

 

$

20,124

 

$

45,348

 

$

38,669

 

$

3,322,819

 

 

 

 

 

 

 

 

 

Operating

 

Depreciation

 

 

 

 

 

 

Net Sales

 

Operating

 

Depreciation

 

 

 

 

 

 

Net Sales

 

Income

 

and

 

Capital

 

 

 

Nine Months Ended September 30, 2016

 

Trade

 

Intersegment

 

Total

 

(Loss)

 

Amortization

 

Expenditures

 

 

 

Three Months Ended March 31, 2016

 

Trade

 

Inter-
segment

 

Total

 

Income
(Loss)

 

and
Amortization

 

Capital
Expenditures

 

Assets

 

Paper and Packaging:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Containerboard / Corrugated products

 

$

1,002,995

 

$

55,667

 

$

1,058,662

 

 

 

 

 

 

 

 

 

 

$

324,290

 

$

16,469

 

$

340,759

 

 

 

 

 

 

 

 

 

Specialty paper

 

517,977

 

 

517,977

 

 

 

 

 

 

 

 

 

 

174,438

 

 

174,438

 

 

 

 

 

 

 

 

 

Other

 

65,201

 

 

65,201

 

 

 

 

 

 

 

 

 

 

21,312

 

 

21,312

 

 

 

 

 

 

 

 

 

Paper and Packaging

 

$

1,586,173

 

$

55,667

 

$

1,641,840

 

$

145,054

 

$

112,790

 

$

91,520

 

 

 

 

$

520,040

 

$

16,469

 

$

536,509

 

$

46,241

 

$

37,136

 

$

32,355

 

$

2,501,605

 

Distribution *

 

713,589

 

 

713,589

 

21,947

 

17,158

 

3,934

 

 

 

Distribution

 

218,175

 

 

218,175

 

1,381

 

5,661

 

2,066

 

665,458

 

Corporate

 

 

 

 

(33,880

)

5,580

 

3,792

 

 

 

 

 

 

 

(13,022

)

1,742

 

1,742

 

45,603

 

Intersegment eliminations

 

 

(55,667

)

(55,667

)

 

 

 

 

 

 

 

(16,469

)

(16,469

)

 

 

 

 

 

$

2,299,762

 

$

 

$

2,299,762

 

$

133,121

 

$

135,528

 

$

99,246

 

 

 

 

$

738,215

 

$

 

$

738,215

 

$

34,600

 

$

44,539

 

$

36,163

 

$

3,212,666

 

 

 

 

Net Sales

 

Operating
Income

 

Depreciation
and

 

Capital

 

 

 

Nine Months Ended September 30, 2015

 

Trade

 

Intersegment

 

Total

 

(Loss)

 

Amortization

 

Expenditures

 

 

 

Paper and Packaging:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Containerboard / Corrugated products

 

$

1,068,315

 

$

8,416

 

$

1,076,731

 

 

 

 

 

 

 

 

 

Specialty paper

 

548,157

 

 

548,157

 

 

 

 

 

 

 

 

 

Other

 

67,109

 

 

67,109

 

 

 

 

 

 

 

 

 

Paper and Packaging

 

$

1,683,581

 

$

8,416

 

$

1,691,997

 

$

190,321

 

$

104,723

 

$

81,954

 

 

 

Distribution *

 

341,526

 

 

341,526

 

12,859

 

7,467

 

1,526

 

 

 

Corporate

 

 

 

 

(32,826

)

2,427

 

11,415

 

 

 

Intersegment eliminations

 

 

(8,416

)

(8,416

)

 

 

 

 

 

 

 

$

2,025,107

 

$

 

$

2,025,107

 

$

170,354

 

$

114,617

 

$

94,895

 

 

 


* Reflects acquisition of Victory Packaging on June 1, 2015.

13.Subsequent Event

On Thursday October 6th, the Company began to prepare for Hurricane Matthew at the       North Charleston, South Carolina Paper Mill Union Contract

On March 3, 2017, the labor unions at the Company’s paper mill with an orderly shutdownin North Charleston, South Carolina ratified a new 8 year collective bargaining agreement covering approximately 600 employees. The agreement puts in place a high deductible health care plan beginning January 1, 2018. It allows for more efficient use of operating and maintenance employees and changes the defined pension benefit plan to a defined contribution plan. For the quarter ended March 31, 2017, the costs incurred were $5.0 million to ratify this agreement and are included in cost of sales in the period.

14.Subsequent Events

On April 2, 2017, the compensation committee of the board of directors granted 126,976 restricted stock units to certain Company employees for retention purposes.  The total value of the award was $2.9 million.  These restricted stock units to certain executive officers vest within one year of the grant date while the non-executive officers’ units vest within 90 days of the grant date.  In addition to the restricted stock units, a retention award of $0.5 million was paid in cash to other employees.

On April 9, 2017, the Company’s paper machines with only essential positions on staff at the mill.mill in Roanoke Rapids, North Carolina completed its annual planned maintenance outage. The storm made landfall on Saturday, October 8th.  The mill began starting the machines back up on Sunday, Octoberoutage lasted approximately 9th and was in full operation by Tuesday, October 11th.  In total, the mill was idle for a total of 4 days with a production loss of approximately 10,000 tons with an estimated overall unfavorablecost of $8.9 million, primarily for annual maintenance and inspections, and the fixed cost impact to operating incomeassociated with lost paper production of approximately $5.0 million.11,600 tons.

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, 20152016 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.

 

Executive Summary

 

Consolidated net sales for the quarter ended September 30, 2016March 31, 2017 were $776.6$765.8 million compared to $807.6$738.2 million for the thirdfirst quarter of 2015, a decrease2016, an increase of $31.0$27.6 million, or 3.83.7 percent, primarily due to index-driven lower domestic containerboard prices, lower export containerboard and kraft paper$15.6 million of higher prices and a lessmore favorable product mix.mix and $11.5 million of higher sales volumes.

 

Consolidated net income for the quarter ended September 30, 2016March 31, 2017 was $31.0$6.0 million, or $0.32$0.06 per diluted share, compared with $34.2$16.2 million, or $.035$0.17 per diluted share, for the same period in 2015.  Earnings per share for the current quarter included a charge of $0.01 per diluted share for market downtime.2016.

 

Paper and Packaging segment operating income resultsfor the quarter ended March 31, 2017 decreased $11.9 million to $34.3 million, primarily due to $10.5 million of higher old corrugated containers (“OCC”) costs, $6.3 million of higher freight costs primarily due to higher percentage of domestic shipments, $5.0 million for Charleston’s union contract ratification costs and $2.6 million due to the restoration of certain employee benefits.  These decreases in operating income were partially offset by $14.6 million of higher prices and more favorable product mix and $2.3 million of lower severance charges.

Distribution Segment operating income for the current quarter decreased $2.5increased $1.2 million to $2.6 million, primarily due to $31.0lower operating expenses.

Corporate operating expenses increased by $3.8 million to $16.8 million for the quarter ended March 31, 2017 compared to 2016, primarily due a $1.8 million increase in stock compensation expense, a $1.0 million increase in expense associated with the fair value of lower prices and less favorable product mix, and $1.9 million of market downtime.  These decreases were partially offset by $14.1the contingent consideration liability, $0.6 million due to the Longview mill work stoppage in 2015, $3.6 million of savings due to the suspensionrestoration of certain employee benefits $2.9 million of lower management incentives due to lower earnings, $6.1 million of productivity gains, $1.5 million of lower severance expenses and $0.6 million of lower planned outage costs.

Distribution operating income results for the current quarter decreased $2.9 million, primarily due to a $3.1 million decrease in supplier rebate income due to timing and $1.3 million lower sales volume, partially offset by the 2015 purchase accounting inventory step-up adjustment of $1.9 million.

During the first nine months of 2016, consolidated net sales were $2,299.8 million compared to $2,025.1$0.4 million for the nine months of 2015, an increase of $274.7 million, or 13.6 percent.  The increase in net sales was driven by the Victory acquisition.  Victory accounted for approximately $377.1 million of the netAPI acquisition expenses.

sales increase, which was partially offset by the Paper and Packaging segment’s decrease in net sales for the period.

During the first nine months of 2016, consolidated net income was $67.9 million, or $0.70 per diluted share, compared with $94.6 million, or $0.97 per diluted share, for the same period of 2015.

Paper and Packaging operating income results for the nine months ended September 30, 2016, decreased $45.3 million, primarily due to $83.3 million of lower prices and less favorable product mix and $5.3 million of higher planned maintenance outage costs, partially offset by $10.3 million of savings due to the suspension of certain employee benefits, $9.2 million of lower management incentives due to lower earnings, and $14.1 million due to the Longview mill work stoppage in 2015.

Distribution operating income results for the nine months ended September 30, 2016, increased $9.1 million.  The increase in operating income was primarily driven by the benefit of owning Victory for nine months in 2016 as compared to four months in 2015.  This benefit accounted for $5.7 million of the increase as well as the 2015 purchase accounting inventory step-up adjustment of $5.8 million.

Results of Operations

 

Comparison of Results of Operations for the Three Months Ended September 30,March 31, 2017 and 2016 and 2015

(In thousands)

 

 

Three Months Ended September 30,

 

Increase/

 

% of Net Sales

 

 

Three Months Ended March 31,

 

Increase/

 

% of Net Sales

 

 

2016

 

2015

 

(Decrease)

 

2016

 

2015

 

 

2017

 

2016

 

(Decrease)

 

2017

 

2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Paper and packaging

 

$

552,236

 

$

567,063

 

$

(14,827

)

71.1

%

70.2

%

 

$

568,841

 

$

536,509

 

$

32,332

 

74.3

%

72.7

%

Distribution

 

243,074

 

248,128

 

(5,054

)

31.2

%

30.7

%

 

218,199

 

218,175

 

24

 

28.5

%

29.6

%

Intersegment Eliminations

 

(18,674

)

(7,628

)

(11,046

)

(2.4

)%

(0.9

)%

 

(21,197

)

(16,469

)

(4,728

)

(2.8

)%

(2.2

)%

Net sales

 

$

776,636

 

$

807,563

 

$

(30,927

)

100.0

%

100.0

%

 

$

765,843

 

$

738,215

 

$

27,628

 

100.0

%

100.0

%

Cost of sales, excluding depreciation and amortization

 

548,811

 

569,267

 

(20,456

)

70.7

%

70.5

%

 

560,898

 

533,277

 

27,621

 

73.2

%

72.2

%

Depreciation and amortization

 

44,954

 

42,500

 

2,454

 

5.8

%

5.3

%

 

45,348

 

44,539

 

809

 

5.9

%

6.0

%

Freight and distribution expenses

 

71,750

 

70,623

 

1,127

 

9.2

%

8.7

%

 

72,988

 

65,059

 

7,929

 

9.5

%

8.8

%

Selling, general, and administrative expenses

 

56,113

 

63,577

 

(7,464

)

7.2

%

7.9

%

 

66,485

 

60,740

 

5,745

 

8.7

%

8.2

%

Operating income

 

$

55,008

 

$

61,596

 

$

(6,588

)

7.1

%

7.6

%

 

$

20,124

 

$

34,600

 

$

(14,476

)

2.6

%

4.7

%

Foreign exchange loss

 

543

 

766

 

(223

)

0.1

%

0.1

%

Loss on debt extinguishment

 

679

 

628

 

51

 

0.1

%

0.1

%

Foreign exchange (gain) / loss

 

(82

)

103

 

(185

)

0.0

%

0.0

%

Equity method investments income

 

(677

)

 

(677

)

-0.1

%

0.0

%

Interest expense, net

 

10,148

 

9,528

 

620

 

1.3

%

1.2

%

 

10,730

 

9,811

 

919

 

1.4

%

1.3

%

Income before provision for income taxes

 

43,638

 

50,674

 

(7,036

)

5.6

%

6.3

%

 

10,153

 

24,686

 

(15,210

)

1.3

%

3.3

%

Provision for income taxes

 

12,620

 

16,468

 

(3,848

)

1.6

%

2.0

%

 

4,161

 

8,512

 

(4,351

)

0.5

%

1.2

%

Net income

 

$

31,018

 

$

34,206

 

$

(3,188

)

4.0

%

4.2

%

 

$

5,992

 

$

16,174

 

$

(10,859

)

0.8

%

2.2

%

 

Paper and Packaging segment net sales decreasedincreased by $14.8$32.3 million to $552.2$568.8 million for the quarter ended September 30, 2016March 31, 2017 due to $31.0$14.6 million of lowerhigher prices and lessmore favorable product mix, partially offset by $11.0$12.4 million of higher sales volume primarily due to the recent acquisitions and $4.7 million of increased intersegment sales to Victory and $5.4 million of higher volume, primarily containerboard.the Distribution segment.  Average mill selling price per ton for the quarter ended September 30, 2016March 31, 2017 was $626$648 compared to $671$625 for the prior year’s quarter, reflecting index driven lower domestichigher containerboard prices and lower prices for export containerbard and export kraft paper prices and a lessmore favorable product mix.

 

Distribution segment net sales decreased by $5.1 million to $243.1 million for the quarter ended September 30, 2016, as a result of lower volume.

In the third quarter of 2016, the Company announcedimplemented a $50$40 per ton price increase for North American containerboard effective for shipments beginning October 1, 2016 and aan 8 to 10 percent increase for corrugated products effective for shipments beginning November 1, 2016.

 

Distribution segment net sales were flat for the quarter ended March 31, 2017 compared to 2016, due to higher prices, related to the pass thru of higher containerboard cost, offset by lower sales volume.

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.

Paper and Packaging segment sales by product line for the quarter ended September 30,March 31, 2017 and 2016 and 2015 were as follows:

 

 

Net Sales (in thousands)

 

Increase/

 

 

 

Tons Sold

 

Increase/

 

 

 

 

Net Sales (in thousands)

 

Increase/

 

 

 

Tons Sold

 

Increase/

 

 

 

Product Line Tons:

 

2016

 

2015

 

(Decrease)

 

%

 

2016

 

2015

 

(Decrease)

 

%

 

 

2017

 

2016

 

(Decrease)

 

%

 

2017

 

2016

 

(Decrease)

 

%

 

Containerboard / Corrugated products

 

$

361,060

 

$

365,844

 

$

(4,784

)

(1.3

)%

450,924

 

434,192

 

16,732

 

3.9

%

 

$

366,539

 

$

340,759

 

$

25,780

 

7.6

%

434,380

 

434,001

 

379

 

0.1

%

Specialty paper

 

169,331

 

179,451

 

(10,120

)

(5.6

)%

248,862

 

253,051

 

(4,189

)

(1.7

)%

 

180,348

 

174,438

 

5,910

 

3.4

%

264,386

 

258,479

 

5,907

 

2.3

%

Other

 

21,845

 

21,768

 

77

 

0.4

%

 

 

 

 

 

 

21,954

 

21,312

 

642

 

3.0

%

 

 

 

 

 

Product sold

 

$

552,236

 

$

567,063

 

$

(14,827

)

(2.6

)%

699,786

 

687,243

 

12,543

 

1.8

%

 

$

568,841

 

$

536,509

 

$

32,332

 

6.0

%

698,766

 

692,480

 

6,286

 

0.9

%

 

Tons of product sold for the Paper and Packaging segment for the quarter ended September 30, 2016March 31, 2017 was 699,786698,766 tons compared to 687,243692,480 tons for the quarter ended September 30, 2015,March 31, 2016, an increase of 12,5436,286 tons, or 1.80.9 percent, as follows:

 

·                  Shipments of Containerboard / Corrugated products for the quarter increased 16,732 tons primarilywere flat quarter-over-quarter due to an increase inhigher domestic and export containerboard shipments of 12,11320,482 tons and 7,201corrugated shipments of 12,799 tons, respectively. This was partially offset by a decrease in corrugated product shipments of 2,582 tons.  Total tons includes shipments to the distribution segment of 22,101 tons in the current quarter.lower export containerboard volume.

 

·                  Specialty paper decreaseincrease in tons sold for the quarter was primarily due to a decrease inhigher DuraSorb shipments of 18,351 tons partially offset by an increase in kraft paper shipments of 7,499 tons and higher pulp shipments of 7,285.6,105 tons.

 

Cost of sales, excluding depreciation and amortization expense, for the quarter ended September 30, 2016March 31, 2017 was $548.8$560.9 million compared to $569.3$533.3 million for the thirdfirst quarter of 2015, a decrease2016, an increase of $20.5$27.6 million, or 3.65.2 percent.  The decreaseincrease in cost of sales was mainly due to $14.1$11.2 million of 2015 Longview mill work stoppagehigher manufacturing costs, not incurred in 2016, $4.2$10.5 million of productivity gains, $1.4higher OCC costs, $5.0 million of savingsfor the Charleston mill’s union ratification costs, and $0.8 million due to the suspensionrestoration of certain employee benefits, $0.6 million of lower management incentives due to lower earnings and $0.6 million lower planned outage costs.  These cost decreases were partially offset by $1.9 million of market downtime.benefits.  Planned maintenance outage costs of approximately $3.8$6.2 million and $4.4$6.6 million are included in cost of sales for the quarters ended September 30,March 31, 2017 and 2016, and 2015, respectively.

 

Depreciation and amortization expense for the quarter ended September 30, 2016March 31, 2017 totaled $45.0$45.3 million compared to $42.5$44.5 million for the quarter ended September 30, 2015.March 31, 2016. The increase of $2.5$0.8 million was primarily due to $2.2 million higher capital spending.depreciation expense due to higher captial spending, partially offset by $1.4 million of lower amortization expense.

 

Freight and distribution expenses for the quarter ended September 30, 2016March 31, 2017 totaled $71.8$73.0 million compared to $70.6$65.1 million for the quarter ended September 30, 2015.March 31, 2016. The increase of $1.2$7.9 million was primarily due to $4.0 million related to a higher sales volume, partially offset by lower fuel costspercentage of domestic shipments and customer mix.higher operating costs.

 

Selling, general and administrative expenses for the quarter ended September 30, 2016March 31, 2017 totaled $56.1$66.5 million compared to $63.6$60.7 million for the quarter ended September 30, 2015.March 31, 2016. The decreaseincrease of $7.5$5.8 million, or 11.89.6 percent, was primarily due to $3.0 million of lower management incentives due to lower earnings and $2.4 million due to the suspensionrestoration of certain employee benefits.  These decreasesbenefits, a $1.8 million increase in stock compensation expense, a $1.0 million increase in expense were partially offset by a $1.2 million increase for the long-term incentive plan related to the Victory acquisitionfair value of a contingent consideration liability and $0.6$0.4 million of CFBAPI acquisition related expenses.  For the quarter ended September 30, 2016,March 31, 2017, selling, general and administrative expenses as a percentage of net sales decreasedincreased to 7.28.7 percent from 7.98.2 percent in the quarter ended September 30, 2015.

Loss on debt extinguishment for the quarters ended September 30, 2016 and 2015 totaled $0.7 million and $0.6 million, respectively, due to repayments on the term loans under the Credit Facility.March 31, 2016.

 

Net interest expense for the quarters ended September 30,March 31, 2017 and 2016 and 2015 was $10.1$10.7 million and $9.5$9.8 million, respectively. Interest expense reflects interest on the outstanding borrowings under the Credit Facility

and the Receivables Credit Facility and amortization of debt issuance costs.  Interest expense was $0.6$0.9 million higher in the quarter ended September 30, 2016,March 31, 2017, primarily due to higher interest rates.

 

Provision for income taxes for the quarters ended September 30,March 31, 2017 and 2016 and 2015 was $12.6$4.2 million and $16.5$8.5 million, respectively, reflecting an effective income tax rate of 28.941.0 percent for the quarter ended September 30, 2016,March 31, 2017, compared to 32.534.5 percent for the similar period in 2015.2016. The lower provision for income taxes in 20162017 primarily reflects lower pre-tax income of $7.0 million and a $1.4 million favorable return to provision adjustment in the current quarter.

Comparison of Results of Operations for the Nine Months Ended September 30, 2016 and 2015

(In thousands)

 

 

Nine Months Ended September 30,

 

Increase/

 

% of Net Sales

 

 

 

2016

 

2015

 

(Decrease)

 

2016

 

2015

 

Paper and packaging

 

$

1,641,840

 

$

1,691,997

 

$

(50,157

)

71.4

%

83.6

%

Distribution

 

713,589

 

341,526

 

372,063

 

31.0

%

16.9

%

Intersegment Eliminations

 

(55,667

)

(8,416

)

(47,251

)

(2.4

)%

(0.4

)%

Net sales

 

$

2,299,762

 

$

2,025,107

 

$

274,655

 

100.0

%

100.0

%

Cost of sales, excluding depreciation and amortization

 

1,650,919

 

1,421,943

 

228,976

 

71.8

%

70.2

%

Depreciation and amortization

 

135,528

 

114,617

 

20,911

 

5.9

%

5.7

%

Freight and distribution expenses

 

207,787

 

167,941

 

39,846

 

9.0

%

8.3

%

Selling, general, and administrative expenses

 

172,407

 

150,252

 

22,155

 

7.5

%

7.4

%

Operating income

 

$

133,121

 

$

170,354

 

$

(37,233

)

5.8

%

8.4

%

Foreign exchange loss

 

1,518

 

1,704

 

(186

)

0.1

%

0.1

%

Loss on debt extinguishment

 

679

 

628

 

51

 

0.0

%

0.0

%

Interest expense, net

 

29,965

 

24,456

 

5,509

 

1.3

%

1.2

%

Income before provision for income taxes

 

100,959

 

143,566

 

(42,607

)

4.4

%

7.1

%

Provision for income taxes

 

33,045

 

49,004

 

(15,959

)

1.4

%

2.4

%

Net income

 

$

67,914

 

$

94,562

 

$

(26,648

)

3.0

%

4.7

%

Paper and Packaging segment net sales for the nine months ended September 30, 2016 decreased by $50.2 million to $1,641.8 million due to $83.3 million of lower prices and a less favorable product mix and $13.0 million of lower domestic sales volumes, partially offset by $47.3 million of increased intersegment sales to Victory and higher export volumes.  Average mill selling price per ton for the nine months ended September 30, 2016 was $625 compared to $673 for the prior year’s period, reflecting index driven lower containerboard prices and export kraft paper prices and a less favorable product mix.

Distribution segment net sales for the nine months ended September 30, 2016 increased by $372.1 million to $713.6$14.5 million.  The increase in net sales was primarily driven by the benefit of owning Victory for the nine months in 2016 as compared to four months in 2015.  This benefit accounted for approximately $377.1 million of the increase.  This increase was partially offset by $5.1 million of lower volume.

Paper and Packaging segment sales to customers by product line were as follows:

 

 

Net Sales (in thousands)

 

Increase/

 

 

 

Tons Sold

 

Increase/

 

 

 

Product Line Tons:

 

2016

 

2015

 

(Decrease)

 

%

 

2016

 

2015

 

(Decrease)

 

%

 

Containerboard / Corrugated products

 

$

1,058,662

 

$

1,076,731

 

$

(18,069

)

(1.7

)%

1,331,613

 

1,290,921

 

40,692

 

3.2

%

Specialty paper

 

517,977

 

548,157

 

(30,180

)

(5.5

)%

764,099

 

767,688

 

(3,589

)

(0.5

)%

Other

 

65,201

 

67,109

 

(1,908

)

(2.8

)%

 

 

 

 

 

Product sold

 

$

1,641,840

 

$

1,691,997

 

$

(50,157

)

(3.0

)%

2,095,712

 

2,058,609

 

37,103

 

1.8

%

Tons of product sold for the Paper and Packaging segment for the nine months ended September 30, 2016 was 2,095,712 tons compared to 2,058,609 tons for the nine months ended September 30, 2015, an increase of 37,103 tons, or 1.8 percent, as follows:

·                  Containerboard sales increased by 40,692 tons to 1,331,613 tons, primarily due to an increase in export containerboard shipments of 40,604 tons and an increase in corrugated products sales of 5,014 tons.  This was partially offset by a decrease in domestic containerboard shipments of 4,926 tons.  This includes shipments to the distribution segment of 65,996 tons for the nine months ended September 30, 2016.

·                  Specialty paper sales volume decreased by 3,589 tons to 764,099 tons, primarily due to lower DuraSorb® shipments of 42,394 tons.  This was partially offset by an increase in kraft paper shipments of 21,365 tons, pulp shipments of 15,478 tons and Kraftpak® shipments of 1,962 tons.

Cost of sales, excluding depreciation and amortization expense, for the nine months ended September 30, 2016 was $1,650.9 million compared to $1,421.9 million for the nine months of 2015, an increase of $229.0 million, or 16.1 percent.  The increase in cost of sales was mainly due to the $270.1 million impact of the Victory acquisition.  Excluding the Victory acquisition, cost of sales decreased by $41.1 million, or 2.9 percent, due to $14.1 million of the 2015 Longview mill work stoppage costs not incurred in 2016, $11.0 million of productivity gains, $11.4 million of lower sales volume, $4.0 million due to the suspension of certain employee benefits, $1.3 million of lower management incentives due to lower earnings and $2.6 million of deflation on material costs.  These cost decreases were partially offset by $5.3 million of higher planned maintenance outage costs.  Planned maintenance outage costs of approximately $29.4 million and $24.1 million are included in cost of sales for the nine months ended September 30, 2016 and 2015, respectively.

Depreciation and amortization expense for the nine months ended September 30, 2016 totaled $135.5 million compared to $114.6 million for the nine months ended September 30, 2015.  The increase of $20.9 million was primarily due to $11.5 million from higher capital spending and $9.4 million from the Victory acquisition, including $7.9 million of amortization expense for acquired intangible assets.

Freight and distribution expenses for the nine months ended September 30, 2016 totaled $207.8 million compared to $167.9 million for the nine months ended September 30, 2015. The increase of $39.9 million was primarily due to $39.0 million attributable to the Victory acquisition.

Selling, general and administrative expenses for the nine months ended September 30, 2016 totaled $172.4 million compared to $150.3 million for the nine months ended September 30, 2015. The increase of $22.1 million, or 14.7 percent, was primarily due to Victory’s direct selling and administrative expenses of $46.0 million.  Excluding the impact of the Victory acquisition, selling, general and administrative expenses decreased by $23.9 million, or 15.9 percent.  The decrease in selling, general and administrative expenses was primarily due to $9.7 million of lower management incentives due to lower earnings, $6.8 million of savings due to the suspension of certain employee benefits, $2.7 million of Victory acquisition related expenses not incurred in 2016, $0.9 million of lower stock compensation expense and $1.8 million of lower integration expenses relating to Longview.  These decreases in expense were partially offset by $2.8 million for the change in fair value of the contingent consideration liability related to the Victory acquisition, $1.9 million of severance expense, $1.2 million for the long-term incentive plan related to the Victory acquisition and $0.8 million of CFB acquisition related expenses.  For the nine months ended September 30, 2016, selling, general and administrative expenses as a percentage of net sales increased to 7.5 percent from 7.4 percent in the nine months ended September 30, 2015.

Loss on debt extinguishment for the nine months ended September 30, 2016 and 2015 totaled $0.7 million and $0.6 million, respectively, due to repayments on the term loans under the Credit Facility.

Net interest expense for the nine months ended September 30, 2016 and 2015 was $30.0 million and $24.5 million, respectively. Interest expense reflects interest on the outstanding borrowings under the Credit Facility and the Receivables Credit Facility and amortization of debt issuance costs.  Interest expense was $5.5 million higher in the nine months ended September 30, 2016, primarily due to higher term loan balances associated with the Victory acquisition and higher interest rates.

Provision for income taxes for the nine months ended September 30, 2016 and 2015 was $33.0 million and $49.0 million, respectively, reflecting an effective income tax rate in the three months ended March 31, 2017 reflects $0.5 million in tax expense from the Company’s adoption of 32.7 percent forASU 2016-09 which requires the nine months

ended September 30, 2016, comparedtax impact of elements of stock compensation to 34.1 percent forbe recorded in the similar period in 2015. The lower provision for income taxes in 2016 primarily reflects lower pre-tax income of $42.6 million and a $1.4 million favorable return to provision adjustment partially offset by an unfavorable state tax adjustment.taxes.

Liquidity and Capital Resources

 

Credit Facility

 

The Company had $471.3$457.4 million available to borrow under the Revolver at September 30, 2016.March 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).

 

Receivables Credit Facility

 

On June 8, 2016,February 21, 2017, the Company entered into Amendment No. 23 to the Receivables PurchaseSale Agreement (the “Amendment to Receivables Purchase Agreement”)  amending its Receivables Purchase Agreement dated as of September 26, 2014 (as previously amended,amend 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 (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 Receivables Purchase Agreement and Receivables Sales Agreement, as amended by the Amendment, establishes the primary terms and conditions of anSecuritization Program. All accounts receivable securitization programpurchased from API and Fast Pak, LLC (the “Securitization Program”“Sellers”).  The Amendment extended and all accounts receivable generated from facilities acquired from the “Facility Termination Date” (as defined in the Receivable Purchase Agreement) from June 8, 2016Sellers that are not paid to June 6, 2017.an eligible bank account are designated as “Excluded Receivables”.

 

As of September 30, 2016,March 31, 2017, the Company had $269.5$264.7 million of outstanding borrowings under its $275.0 million Receivables Credit Facility with an interest rate of 1.31.7 percent.

 

Debt Covenants

 

As of September 30, 2016,March 31, 2017, under the financial covenants of the Credit Agreement, the Company must comply on a quarterly basis with a maximum permitted leverage ratio as of the end of each quarter. The leverage ratio is calculated by dividing the Company’s debt net of available cash up to $150 million by its rolling twelve month total earnings before interest expense, taxes, depreciation and amortization after accounting for allowable adjustments. The maximum permitted leverage ratio declines over the life of the Credit Agreement. On September 30, 2016,March 31, 2017, the maximum permitted leverage ratio was 4.50 to 1.00. On September 30, 2016,March 31, 2017, the Company was in compliance with a leverage ratio of 3.983.99 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 after accounting for allowable adjustments by the sum of our net cash interest payments during the twelve month period. For the quarter ended September 30, 2016,March 31, 2017, the interest coverage ratio was required to be at least 3.00 to 1.00. On September 30, 2016,March 31, 2017, the Company was in compliance with the Credit Agreement with an interest coverage ratio of 11.0910.63 to 1.00.

 

As of September 30, 2016,March 31, 2017, KapStone was also in compliance with all other covenants in the Credit Agreement.

 

Income taxes

 

The Company’s effective income tax rate, excluding discrete items for 2016,2017, is projected to be 33.534.3 percent.  The Company’s cash tax rate for 20162017 is projected to be less than the book rate due to timing and extent of estimated tax payments.40.0 percent.

Sources and Uses of Cash

 

Nine months ended September 30 ($ in thousands)

 

2016

 

2015

 

Incr / (Dcr)

 

Operating activities

 

$

212,387

 

$

176,648

 

$

35,739

 

Investing activities

 

(123,578

)

(711,941

)

588,363

 

Financing activities

 

(86,181

)

514,593

 

(600,774

)

Total change in cash and cash equivalents

 

$

2,628

 

$

(20,700

)

$

23,328

 

Three months ended March 31 ($ in thousands)

 

2017

 

2016

 

Incr / (Dcr)

 

Operating activities

 

$

32,669

 

$

58,605

 

$

(25,936

)

Investing activities

 

(72,169

)

(31,807

)

(40,362

)

Financing activities

 

18,030

 

(26,535

)

44,565

 

Total change in cash and cash equivalents

 

$

(21,470

)

$

263

 

$

(21,733

)

Cash and cash equivalents increaseddecreased by $2.6$21.5 million from December 31, 2015,2016, reflecting $212.4$32.7 million of net cash provided by operating activities, $123.6$72.2 million of net cash used in investing activities and $86.2$18.0 million of net cash used inprovided by financing activities in the first ninethree months of 2016.2017.

 

Net cash provided by operating activities was $212.4$32.7 million, comprised primarily of net income for the first ninethree months of $67.9$6.0 million and non-cash charges of $153.6$55.6 million.  Changes in operating assets and liabilities used $9.1$28.9 million of cash. Net cash provided by operating activities increaseddecreased by $35.7$25.9 million in the ninethree months ended September 30, 2016,March 31, 2017, compared to the ninethree months ended September 30, 2015,March 31, 2016, mainly due to a $35.1an $20.0 million decreaseincrease in cash used for working capital and $10.2 million of lower net income, partially offset by higher non-cash charges of $27.3 million, partially offset by $26.7 million of lower net income.$4.3 million.  The decreaseincrease in cash used for working capital in the ninethree months ended September 30, 2016March 31, 2017 compared to 20152016 is primarily due to lowerhigher trade receivables, inventory levels and timing of income tax payments, partially offset by accounts payable.

 

Net cash used in investing activities was $72.2 million and includes $99.2$38.7 million for capital expenditures $15.4and $33.5 million for the CFB acquisition and $11.8 million of equity method investments, partially offset by $4.9 million of proceeds from asset sales.API acquisition.  Net cash used byin investing activities decreasedincreased by $588.4$40.4 million in the ninethree months ended September 30, 2016,March 31, 2017, compared to the ninethree months ended September 30, 2015,March 31, 2016, primarily due to the API acquisition of Victory in 2015, partially offset byand higher capital spending in 2016 and the strategic investment activities.2017.

 

Net cash used inprovided by financing activities was $86.2$18.0 million and reflects a $64.7 million prepayment of the term loans under the Credit Facility, $29.0 million of quarterly dividend payments and $2.3 million of loan amendment fees, partially offset by $5.1$26.0 million of net short-term borrowings under the Revolver and $3.9$6.2 million of other current borrowings.  These borrowings were partially offset by a $9.7 million quarterly dividend payment and $4.6 million of net borrowingsrepayments under the Receivables Credit Facility.  Net cash provided by financing activities decreasedincreased by $600.8$44.6 million in the ninethree months ended September 30, 2016,March 31, 2017, compared to the ninethree months ended September 30, 2015,March 31, 2016, primarily due to higher net borrowings in 2015 to fund the Victory acquisition.2017.

 

Future Cash Needs

 

The Company expects that cash generated from operating activities will be sufficient to meet its remaining 20162017 cash needs.  The cash needs consist of approximately $9.7$30.0 million for the cash dividend payment on October 13, 2016,dividends subject to board approval and any additional working capital needs.  In addition, capital expenditures for the full year are estimated to be $130.0$136.0 million.

 

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 September 30, 2016,March 31, 2017, the Company had $11.5$26.0 million of borrowings under the Revolver and $471.3$457.4 million of remaining Revolver availability, net of outstanding letters of credit.

 

Off-Balance Sheet Arrangements

 

We have not entered into any off-balance sheet financing arrangements.  The Company established KAR,maintains a special purpose entity, in connection with the Receivables Credit Facility, which is consolidated as part of our financial statements. We have not guaranteed any debt or commitments of other entities or entered into any options on non-financial assets.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Market risk is the sensitivity of income to changes in interest rates, commodity prices, equity prices and other market-driven rates or prices.

 

Under our Credit Agreement, at September 30, 2016 we have aMarch 31, 2017, our Credit Facility consistingconsisted of two term loans totaling approximately $1.2 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 September 30, 2016March 31, 2017 the weighted average interest rate of the term loans was 2.32.8 percent.

 

Under our Receivables Credit Facility, at September 30, 2016March 31, 2017, we have $269.5had $264.7 million of outstanding borrowings. The outstanding capital of each investment in the receivable interests accrues yield for each 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 September 30, 2016March 31, 2017 the interest rate on outstanding amounts under the Receivables Credit Facility was 1.31.7 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 $15.1$15.2 million based upon our expected future monthly term loan balances per our existing repayment schedule and the Receivables Credit Facility.

 

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. We have one contract to purchase coal at fixed prices through December 31, 20162017 and contracts to purchase natural gas at fixed prices through December 2020.

 

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.

 

We are exposed to currency fluctuations as we invoice certain European customers in Euros and Mexican customers in Pesos. The Company did not use forward contracts to reduce the impact of currency fluctuations during the quarter ended September 30, 2016.March 31, 2017. No such contracts were outstanding at September 30, 2016.March 31, 2017.

 

ITEM 4.

CONTROLS AND PROCEDURES

As of the end of the period covered by this report, our Chief Executive Officer and our Chief Financial Officer carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as required by Rule 13a-15(b) under the Securities Exchange Act of 1934. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of September 30, 2016.March 31, 2017.

 

There were no changes in our internal control over financial reporting during the three months ended September 30, 2016March 31, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. — OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS

 

There have been no material changes in the legal proceedings described in our Form 10-K for the year ended December 31, 2015.2016.

 

ITEM 1A.

RISK FACTORS

 

There have been no material changes from the Risk Factors described in our Form 10-K for the year ended December 31, 2015.2016.

 

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

None.

 

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4.

MINE SAFETY DISCLOSURES

 

None.

 

ITEM 5.

OTHER INFORMATION

 

None.

ITEM 6.

EXHIBITS

 

The following Exhibits are filed as part of this report.

 

Exhibit


No.

 

Description

2.410.20

 

Second Amendment to Equity Purchasethe Second Amended and Restated Credit Agreement dated as of October 25, 2016,March 27, 2017, by and among KapStone Paper and Packaging Corporation, KapStone Kraft Paper Corporation, KapStone Charleston Kraft LLC, VP Holdco, Inc.as Borrower, the subsidiaries of Borrower named therein, as Guarantors, the lenders named therein, Bank of America, N.A., as Administrative Agent, Swing Line Lender and Victory Packaging Management, LLC.

3.2

AmendedL/C Issuer, and Restated Bylaws of KapStone PaperBarclays Bank PLC and Packaging Corporation. Incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on August 12, 2016.Wells Fargo Bank, National Association, as co-Syndication Agents.

 

 

 

31.1

 

Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

31.2

 

Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

32.1

 

Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

 

32.2

 

Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

 

101.INS

 

XBRL Instance Document.

 

 

 

101.SCH

 

XBRL Taxonomy Extension Schema.

 

 

 

101.CAL

 

XBRL Taxonomy Extension Calculation Linkbase.

 

 

 

101.DEF

 

XBRL Taxonomy Extension Definition Linkbase.

 

 

 

101.LAB

 

XBRL Taxonomy Extension Label Linkbase.

 

 

 

101.PRE

 

XBRL Extension Presentation Linkbase.

SIGNATURE

 

In accordance withPursuant to the requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

KAPSTONE PAPER AND PACKAGING CORPORATION

 

 

 

 

 

 

November 1, 2016April 26, 2017

By:

/s/ Andrea K. Tarbox

 

 

Andrea K. Tarbox

 

 

Executive Vice President and Chief Financial Officer

(duly authorized officer and principal financial

officer)

 

2322