ITEM 1. BUSINESS
INTRODUCTION
We were founded as a Delaware corporation in 1967 to acquire the General Felt Products division of Standard Packaging Corporation. At that time, we were located in Brooklyn, NY, where we produced laminated closure (cap) liners primarily for the pharmaceutical and food industries. Over the years, we have built a reputation for solving difficult packaging problems and providing customers with high quality, advanced packaging materials. In 1970, we built an additional manufacturing facility in Somerville, New Jersey, diversifying into the business of producing polystyrene foam trays for the poultry processing industry.
In March 1994, Tekni-Plex was acquired by Dr. F. Patrick Smith and other investors. Dr. Smith was elected Chief Executive Officer. At that time, the principal product lines consisted of clear, high-barrier laminations for pharmaceutical blister packaging (which we refer to as clear blister packaging); closure liners, primarily for pharmaceutical end-uses; and foam processor trays primarily for the poultry industry.
In December 1995, Tekni-Plex acquired the Flemington, NJ, plant and business of Hargro Flexible Packaging Corporation. The Flemington plant utilized lamination and coating technology to produce packaging materials primarily for pharmaceutical products such as transdermal patches, sutures, iodine and alcohol swabs, aspirin and other physician samples. We relocated the Brooklyn equipment and business into the Flemington facility during 1996. The synergistic result of having complementary technologies in one location created a combined operation with considerably higher efficiencies and lower costs than the sum of the stand-alone operations.
In February 1996, we expanded our food packaging business by completing our acquisition of Dolco Packaging Corp., a publicly-traded $81 million foam products company that was nearly twice the size of Tekni-Plex. Dolco had been in the business of producing foam packaging products since the 1960s and had attained the leading share of foam egg carton sales in the United States. The Dolco acquisition also solidified our position as a leading supplier of foam processor trays. In August 1997, Dolco, which had been a wholly owned subsidiary of Tekni-Plex, was merged into Tekni-Plex.
In July 1997, we acquired the business and operating facility of PurePlast Inc. of Cambridge, Ontario, Canada. PurePlast produced calendered polyvinyl chloride (vinyl) sheet primarily for food and electronics packaging applications. Following the acquisition, we diversified the end markets served by this location by developing proprietary formulations of vinyl sheet for vertical integration into our clear blister packaging business and for sale directly to our global pharmaceutical customers.
In March 1998, Tekni-Plex acquired PureTec Corporation, a publicly-traded company with annual sales of $315 million. PureTec was a leading manufacturer of plastic packaging, products, and materials primarily for the healthcare and consumer markets. PureTec enjoyed leading market positions in its core products, including garden and irrigation hose, precision tubing and gaskets primarily for the aerosol packaging industry, vinyl medical tubing, and vinyl compounds for the production of medical devices. PureTec is a wholly-owned subsidiary of Tekni-Plex.
In January 1999, we acquired substantially all the assets of Tri-Seal International, Inc., a leader in sophisticated extruded and co-extruded capliners and seals. The Tri-Seal operations have been integrated with and into our closure liner business.
In April 1999, we acquired substantially all the assets of Natvar, a producer of disposable medical tubing and electrical sheathing. As with Tri-Seal, the Natvar acquisition was intended to strengthen our existing core business and expand product offerings. The Natvar operation has been integrated into our medical tubing and industrial extrusions businesses.
In June 2000, we completed a recapitalization of Tekni-Plex. As part of the recapitalization, existing investors other than management sold most of their interests, and a group of new investors contributed an aggregate of $167 million in new equity and agreed to contribute up to $103 million in additional equity over the next five years, all of which has been funded. All members of management maintained 100% of their interests in the Company. Also, Tekni-Plex entered into a new credit agreement, issued $275 million in new senior subordinated notes, and repaid the debt that existed prior to the recapitalization.
In October 2000, we acquired substantially all the assets of the Super Plastics division of RCR International Inc. Super Plastics is primarily a manufacturer of garden hose and has a manufacturing facility in Mississauga, Ontario, Canada. The Super Plastics operations have been integrated with and into our garden hose business.
In October 2001, we acquired substantially all of the assets of the garden hose business of Mark IV Industries, Inc. which operates under the name Swan Hose. Swan, which has one manufacturing facility located in Bucyrus, Ohio, enhanced Tekni-Plex's geographic coverage of the North American garden hose market. The Swan operations have been integrated with and into our garden hose business.
In July 2002, we acquired substantially all of the assets of Elm Packaging Company. Elm produces polystyrene foam plates, bowls, and meat and bakery trays. The Elm acquisition significantly increases our capacity to produce foamed polystyrene products primarily for customers in the food packaging and food service markets.
In July 2004, we acquired the egg carton business of Genpak and we have integrated this business into our packaging operations.
DESCRIPTION OF SEGMENTS
See footnote 14 of our June 30, 2006 audited consolidated financial statements.
DESCRIPTION OF BUSINESS
We are a global, diversified manufacturer of packaging, packaging products and materials as well as tubing products. We primarily serve the food, healthcare and consumer markets. We have built leadership positions in our core markets, and focus on vertically integrated production of highly specialized products. We have operations in the United States, Europe, Argentina and Canada. We believe that our end market and product line diversity has the effect of reducing overall risk related to any single product or customer. Our operations are aligned under two business segments: Packaging and Tubing Products. Products that do not fit in either of these two segments, including recycled PET, vinyl compounds and specialty resins have been reflected in Other. Representative product lines in each of our business segments are listed below:
BUSINESS SEGMENT
COMPETITIVE STRENGTHS
We believe that our competitive strengths include:
- Strong market positions in core businesses. We have a strong market presence in the United States in our core product lines. The following table shows what we believe to be our market position in the U.S. in our primary product lines:
PRODUCT MARKET POSITION
- Significant barriers to entry. We believe there are significant barriers to entry to our packaging and tubing products businesses. In our pharmaceutical packaging business, we believe that pharmaceutical companies are generally reluctant to change or substitute packaging once a new drug offering has gained FDA approval. In our food packaging businesses, we believe that high capital costs and high technical competence required for manufacturing processes create barriers to entry. In
our medical tubing and garden hose businesses, we utilize proprietary formulations and are a low cost market leader with technologically advanced processes that cannot be readily replicated.
- Non-cyclical end markets. A majority of our packaging products and materials are sold into markets which are traditionally stable through economic cycles, including food and beverages, personal care products, pharmaceuticals, and medical tubing. We also believe that our garden hose business, while highly seasonal, is resistant to economic cyclicality.
- Strong customer relationships. We have long-standing relationships with many of our customers. We attribute our long-term customer relationships to our ability to consistently manufacture high quality products and provide a superior level of customer service. We routinely win customer awards for our superior products and customer service.
- Cost efficient producer. We continually focus on improving underlying operations and reducing costs. Our acquisitions since 1995 have provided significant opportunities to realize cost savings and synergies in the combined businesses through the sharing of complementary technologies and manufacturing techniques, as well as economies of scale, including the purchase of raw materials. For example, we applied technologies that we utilize in the manufacturing of our aerosol packaging components to our garden hose business which significantly increased manufacturing throughput and product functionality while reducing material cost.
- Producer of high quality, technically sophisticated products. We believe, based upon our knowledge and experience in the industry, we have a long-standing reputation as a manufacturer of high quality, high performance products, materials and primary packaging (where the packaging material comes into direct contact with the end product). Our emphasis on quality is evidenced by our product lines which address the more technically sophisticated areas of their respective markets.
- Experienced management team. Our Senior management team has an average of 25 years of experience in the industry. Since 1994, management has successfully integrated the acquisition of the operations and assets of 10 businesses. Management has substantially improved the competitive position of each of the acquired businesses by integrating the acquisitions, effecting turnarounds, providing strategic direction and leadership, increasing sales and market share, improving manufacturing efficiencies and productivity, and developing new technologies to enhance their competitive strengths. Current management owns more than 20% of the fully diluted common stock of the Company.
EMPLOYEES
We have approximately 3,100 employees. Approximately one-third of our employees are represented by labor unions; we believe our labor relations with those unions are satisfactory.
BUSINESS STRATEGY
We seek to maximize our profitability and growth and take advantage of our competitive strengths by pursuing the following business strategy:
- Ongoing cost reduction through technical process improvement. We have an ongoing program to improve manufacturing and other processes in order to drive down costs. Examples of cost improvement programs include:
- material and energy conservation through enhanced process controls and advanced product design;
- reduction in machine set-up time through the use of proprietary technology;
- continual product line rationalization; and
- development of backward and forward integration opportunities.
- Growth through product line extension and improvement. We continually seek to improve and extend our product lines and leverage our existing technological capabilities in order to increase market share in existing markets, effectively penetrate new markets and improve profitability. Our strategy is to emphasize our expertise in providing packaging, products and materials with specific high performance characteristics through the development of various unique proprietary materials and proprietary manufacturing process techniques.
- Growth through international expansion. We believe that there is significant opportunity to expand our international sales, which currently represent approximately 13.6% of our total revenues. At present, we have manufacturing operations with attached sales offices in Europe, China, Canada and Argentina. We have a regional sales office in Asia and sales representatives in the Middle East. We believe that our growing international presence, which is a combination of our own regional manufacturing and sales forces and independent sales representatives, will continue to generate opportunities to increase our sales.
PACKAGING SEGMENT
The Packaging segment of our business had revenues of $374.1 million (50.4% of total revenues) for the year ended June 30, 2006 and $348.7 million (50.1% of total revenues) for the year ended July 1, 2005. Further details of the major markets served by this segment are given below:
FOAM EGG CARTONS
We believe that we are the leading manufacturer of egg cartons in the United States. Thermoformed foam polystyrene packaging has been the material of choice for food packaging cartons for many years. In terms of economic and functional characteristics, foamed polystyrene products offer a combination of high strength, minimum material content and superior moisture barrier performance. Foamed polystyrene products also offer greater dimensional consistency that enhances the high speed mechanical feeding of cartons into automated package filling operations. We sell these products through our direct sales force.
In the egg packaging market, our primary competitor manufactures pulp-based egg cartons. We believe that we compete effectively based on product quality, performance and prompt delivery. Our customer base includes most of the domestic egg packagers (including those owned by egg retailers).
PHARMACEUTICAL BLISTER FILMS
We believe that we are a market leader for clear, high-barrier laminations for pharmaceutical blister packaging. These packaging materials are used for fast-acting pharmaceuticals that are generally highly reactive to moisture. Transparent, high-barrier blister packaging is primarily used to protect drugs from moisture vapor infiltration or desiccation. Blister packaging is the preferred packaging form when dispenser handling can affect shelf life or drug efficacy, or when unit dose packaging is needed. Unit dose packaging is being used to improve patient compliance with regard to dosage regimen, and has been identified as the packaging form of choice in addressing child safety aspects of drug packaging. The advantages of transparent blisters, as opposed to opaque foil-based materials manufactured by various competitors, include the ability to visually inspect the contents of the blister and to present the product with maximum confidence.
We believe the flexible and semi-rigid packaging segment of the pharmaceutical packaging industry is growing at a faster rate than the non-plastics segments because of the generally lower package cost and broader range of functional characteristics of plastic packaging. As a result, the technologies used to manufacture plastic packaging materials continue to develop at a faster pace than those used in the more mature paper, glass, and metal products.
Our high-barrier blister packaging is sold to major pharmaceutical companies (or their designated contract packagers). We market our full pharmaceutical product line directly on a worldwide basis, and have assembled a global network of sales and marketing personnel on six continents.
In the clear blister packaging market, we have one principal competitor worldwide with resources equal to or greater than ours. However, we believe that this competitor does not have the breadth of product offering to match ours, and that this differentiation is significant as viewed by the pharmaceutical industry. Also, the high manufacturing and compliance standards imposed by the pharmaceutical companies on their suppliers provide a significant barrier to the entry of new competitors. Entry barriers also arise due to the lengthy and stringent approval process required by pharmaceutical companies. Since approval requires that the drug be tested while packaged in the same packaging materials intended for commercial use, changing materials after approval risks renewed scrutiny by the FDA. The packaging materials for pharmaceutical applications also require special documentation of material sources and uses within the manufacturing process as well as heightened quality assurance measures.
POULTRY AND MEAT PROCESSOR TRAYS
Our processor tray operations produce thermoformed foam polystyrene poultry and meat processor trays. We are a leading supplier of processor trays to the poultry industry.
As with egg cartons, thermoformed foam polystyrene has been the material of choice for processor trays for the same reasons noted above.
Within the polystyrene foam processor tray market, we compete principally with one large competitor, who has significantly greater financial resources than ours and who controls the largest share of this market.
CLOSURE LINERS
Tekni-Plex is also a leading producer of sophisticated extruded, co-extruded and laminated cap-liners and seals, known as closure liners, for glass and plastic bottles. Closure liners perfect the seal between a container and its closure, for example, between a bottle and its cap. The liner material has become an integral part of the container/closure package. Without the gasketing effect of the liner, most container/closure packages would not be secure enough to protect the contents from contamination or loss of product efficacy.
We sell these products through our direct sales force primarily to packagers of pharmaceutical, healthcare and food products. We have two principal competitors in North America but also compete with several smaller companies having substantially smaller market shares. However, as a result of the Tri-Seal acquisition, we believe that we offer the widest range of liner materials in the industry. We remain competitive by focusing on product quality, performance and prompt delivery.
AEROSOL AND PUMP PACKAGING COMPONENTS
Our Aerosol and Pump Packaging Components business produces dip tubes, which transmit the contents of the container to the nozzle, and specialized, molded or punched rubber-based valve gaskets that serve to control the release of the product from the container. The group also produces writing instrument products, including pen barrels and ink tubing as well as ink reservoirs for felt-tip pens.
Sales are primarily to manufacturers of aerosol valves, dispenser pumps, and writing instruments. These products are sold throughout the United States and Europe, as well as selected worldwide markets. Sales are made through our direct sales force. We believe that we are the leading supplier of aerosol valve and dispenser pump gaskets and dip tubes in the world.
Our dip tubes and pen barrels are manufactured at extremely high speeds while holding to precise tolerances. The process enhancements that allow simultaneous high speed and precision are proprietary to us. The precision rubber gasket products, which we have manufactured for over fifty years, are produced using proprietary formulations. These formulations are designed to provide consistent functional performance throughout the entire shelf life of the product by incorporating chemical resistance characteristics appropriate to the fluid being packaged. For example, we have developed unique formulations that virtually eliminate contamination of the products packaged in spray dispensers. This has greatly expanded the use of these dispensers for personal hygiene products, foods, and fragrances. The Company has also developed proprietary methods for achieving extremely accurate thickness control, superior surface finish, and the elimination of internal imperfections prevalent in other processing methods.
We are the single-source supplier to much of the industry. The principal competitive pressure in this product line, particularly the dip tube portion, is the possibility of customers switching to internal production, or vertical integration. To counteract this possibility, the Company focuses on product quality, cost reduction, prompt delivery, technical service and innovation.
FOAM PLATES
Our foam plate operations produce thermoformed foam polystyrene disposable plates, bowls, and hinged-lid containers as well as agricultural packaging products. Our sales are primarily to the consumer, agricultural and foodservice industries. We compete with numerous participants who use a variety of materials including foam polystyrene, pulp-based products and various plastic materials.
TUBING SEGMENT
The Tubing Products segment of our business had revenues of $215.8 million (29.1% of total revenues) for the year ended June 30, 2006 and $213.1 million (30.6% of total revenues) for the year ended July 1, 2005. Further details of the major markets served by this segment are given below:
GARDEN AND IRRIGATION HOSE PRODUCTS
We believe that we are the leading producer of garden hose in North America. We have produced garden hose products for over fifty years, and produce its primary components internally, including proprietary material formulations and brass couplings. Innovations have included the patented Colorite(R) Evenflow(R) design and ultra high quality product lines that utilize medical-grade plastics. We also manufacture specialty hose products such as air hose and irrigator ("soaker") hose.
We sell these products primarily through our direct sales force and also through independent representatives. Both private label and brand-name products are sold to the retail market, primarily to home centers, hardware cooperatives, food, automotive, drug and mass merchandising chains and catalog companies throughout the United States and Canada. Our customers include some of the fastest growing and the most widely respected retail chains in North America. Our market strategy is to provide a complete line of innovative, high-quality products along with superior customer service.
The garden hose business is highly seasonal with approximately 75% of sales occurring in the spring and early summer months. This seasonality tends to have an impact on the Company's financial results from quarter to quarter.
MEDICAL TUBING
We believe we are the leading non-captive supplier of vinyl medical tubing in North America and Europe. We manufacture medical tubing using proprietary plastic extrusion processes. The primary raw materials are proprietary compounds, which we produce. We specialize in high-quality; close tolerance tubing for various surgical procedures and related medical applications. These applications include intravenous ("IV") therapy, hemodialysis therapy, cardio-vascular procedures such as coronary bypass surgery, suction and aspiration products, and urinary drainage and catheter products. New medical tubing products we have developed include microbore tubing and silicone substitute formulations. Microbore tubing can be used to regulate the delivery of critical intravenous fluids without the need for more expensive drip control devices. Medical professionals can precisely control the drug delivery speed simply by selecting the proper (color-coded) diameter tube, thereby improving accuracy and reducing cost. More importantly, as home healthcare trends continue, the use of microbore tubing will help eliminate critical dosage errors on the part of the non-professional caregiver or the patient.
Medical tubing is sold primarily to manufacturers of medical devices that are packaged specifically for such procedures and applications. These products are sold through our direct sales force. We remain competitive by focusing on product quality, performance and prompt delivery.
ITEM 1A.
ITEM 1A. RISK FACTORS
OUR PROFITS WILL LIKELY DECLINE AS A RESULT OF PRICE VOLATILITY AND AVAILABILITY OF RAW MATERIALS IF WE ARE UNABLE TO PASS PRICE INCREASES ON TO CUSTOMERS OR TO OBTAIN NECESSARY RAW MATERIALS.
Our profitability will likely decline if raw material prices increase and we are unable to pass these price increases on to our customers, employ successful hedging strategies, enter into supply contracts at favorable prices or buy on the spot market at favorable prices. Our products are manufactured from commodity petrochemicals that are readily available in bulk quantities from numerous large, vertically integrated chemical companies. Except for PCTFE film, a raw material used in the manufacturing of our clear, laminated blister packaging materials, we currently purchase each principal raw material from several of the top suppliers. Prices for our raw materials have fluctuated in the past and likely will continue to do so in the future. Historically, we have been able to pass on substantially all of the price increases in raw materials to our customers on a timely basis, although in the case of most of our garden hose products we are usually not able to do so until the following season because prices are typically set annually. While we have not guaranteed prices for our garden hose product, for the 2006 selling season, we cannot assure you that we will be able to pass on price increases in the future.
WE OPERATE IN DISCRETE MARKET SEGMENTS OF OUR INDUSTRY, SOME OF WHICH ARE HIGHLY COMPETITIVE AND INCLUDE PARTICIPANTS WITH GREATER RESOURCES THAN OURS. WE MAY NOT BE ABLE TO COMPETE SUCCESSFULLY AGAINST THESE PARTICIPANTS.
We compete with a wide variety of manufacturers because we operate in discrete market segments. Some of our competitors are larger, have greater financial resources and are less leveraged than we are. As a result, these competitors may be better able to withstand a change in market conditions within the industry and throughout the economy as a whole. These competitors may also be able to maintain significantly greater operating and financial flexibility than we can. Additionally, a number of our niche product applications are customized or sold for highly specialized uses. Competitors with greater financial, technological, manufacturing and marketing resources than ours and that do not currently market similar applications for these uses could choose to do so in the future. If we are faced with increased competition, our business, financial condition or results of operations could suffer as a result of loss of customers and declining profits.
THE GARDEN AND IRRIGATION HOSE PRODUCTS BUSINESS IS HIGHLY SEASONAL AND IS IMPACTED BY WEATHER CONDITIONS, WHICH RESULTS IN SIGNIFICANT FLUCTUATION OF OUR FINANCIAL RESULTS OVER THE COURSE OF THE FISCAL YEAR.
The market for our garden and irrigation hose products is highly seasonal, with a majority of our sales occurring in spring and early summer. As a result of the need to build up inventories in anticipation of such sales, our working capital requirements peak in the spring. In addition, this seasonality has a significant impact on our net income from quarter to quarter. To the extent such sales peak later in any fiscal year compared to other fiscal years, as a result of weather or other factors, cash flows may not be comparable on an interim period basis. In addition, the market for our garden and irrigation hose products is impacted by adverse weather conditions.
OUR FOREIGN INVESTMENT AND OPERATIONS SUBJECT OUR BUSINESS TO ONGOING FOREIGN REGULATION AND OTHER RISKS ASSOCIATED WITH CONDUCTING BUSINESS IN FOREIGN COUNTRIES. IF WE FAIL TO COMPLY WITH SUCH REGULATION OR ADAPT TO SUCH RISKS, WE MAY BE UNABLE TO SELL OUR PRODUCTS.
We have operations and other investments in a number of countries outside of the United States. Our foreign operations and investments are subject to the risks normally associated with conducting business in foreign countries, including:
- - limitations on ownership and on repatriation of earnings;
- - import and export restrictions and tariffs;
- - additional expenses relating to the difficulties and costs of staffing and managing international operations;
- - labor disputes and uncertain political and economic environments, including risks of war and civil disturbances and the impact of foreign business cycles;
- - change in laws or policies of a foreign country;
- - delays in obtaining or the inability to obtain necessary governmental permits;
- - potentially adverse consequences resulting from the applicability of foreign tax laws;
- - cultural differences; and
- - increased expenses due to inflation.
Our foreign operations and investments may be limited, and our ability to sell our products may be disrupted by, laws and policies of the United States and the other countries in which we operate affecting foreign trade, investment and taxation.
WE ARE DEPENDENT ON CERTAIN KEY PERSONNEL AND THE LOSS OF THEIR SERVICES OR THE FAILURE TO ATTRACT ADDITIONAL QUALIFIED PERSONNEL COULD HARM OUR BUSINESS.
We are dependent on the management experience and continued services of our executive officers, including Dr. F. Patrick Smith, who may be difficult to replace if we lose his services. The loss of the services of these officers could have a material adverse effect on our business. In addition, our continued growth depends on our ability to attract and retain experienced key employees. We maintain a key person life insurance policy on Dr. Smith, and we have an employment agreement with Dr. Smith.
IF WE WERE REQUIRED TO WRITE DOWN ALL OR PART OF OUR GOODWILL, OUR NET INCOME AND NET WORTH COULD DECREASE.
Historically, we have amortized goodwill on a straight-line basis. Effective June 29, 2002, we no longer amortize goodwill. Instead, we are required to periodically determine if our goodwill has become impaired, in which case we would write down the impaired portion of our goodwill. If we were required to write down all or part of our goodwill, our net income and net worth could decrease. In fiscal 2006 we decreased our goodwill by $35.1 million due to impairment at our Swan garden hose operation resulting from lost market share.
COMPLIANCE WITH ENVIRONMENTAL AND HEALTH AND SAFETY LAWS AND REGULATIONS COULD IMPOSE SUBSTANTIAL COSTS UPON US.
Our facilities, operations, and properties are subject to foreign, federal, provincial, state and local environmental and health and safety laws and regulations. These laws and regulations are complex, change frequently and they and the enforcement of them against our industry have tended to become more stringent over time. We are involved from time to time in administrative or legal proceedings relating to environmental and health and safety matters and have in the past and will continue to incur capital costs and other expenditures relating to these matters. While we have budgeted for future capital and operating expenditures to maintain compliance with environmental and health and safety laws and regulations, these laws and regulations may change or become more stringent in the future. Failures to comply with these laws and regulations or more stringent enforcement of them could result in fines, other sanctions or could require changes in our product formulation or labeling.
We could incur significant fines, penalties, capital costs or other liabilities or obligations associated with any noncompliance, contamination or natural resource damage or toxic tort liability at or related to any of our current or former operations, facilities or properties. Changes in laws or the interpretation thereof, the development of new facts or the failure of third parties to address contamination at current or former facilities or properties could also cause us to incur additional costs. Any of these foregoing fines, penalties, capital costs, liabilities or obligations could impose substantial costs on us and could, in turn, harm our businesses, financial condition or results of operations.
Current and prior owners and operators of property or businesses may be subject to joint and several liability for investigation and remediation costs at contaminated sites under environmental laws without regard to fault or to knowledge about the condition or action causing the liability and may have liability for related damages to natural resources. We are currently, and may in the future be, required to incur costs relating to the investigation or remediation of property, including property where we dispose of our waste, under the requirements of New Jersey's Industrial Site Recovery Act or other laws, and environmental conditions could lead to other claims for damages to natural resources, personal injury or property damage.
Certain properties that we now or previously owned or leased are undergoing investigation or remediation by us or by third parties or may in the future require such action as a result of historical operations. We cannot assure you that any costs ultimately borne by us in connection with any of these remediation projects would not be material.
A SIGNIFICANT PORTION OF OUR WORKFORCE IS UNIONIZED AND UNSATISFACTORY RELATIONS WITH OUR WORKFORCE, INCLUDING WORK STOPPAGES, COULD DISRUPT OUR PRODUCTION AND HARM OUR BUSINESS.
As of June 30, 2006, we had approximately 3,100 employees, of whom approximately one third were represented by labor unions under various collective bargaining agreements. We have had one labor strike in the United States in our history, which occurred at our Ridgefield, NJ plant in August 2003. Although we consider our current relations with these unions to be generally good, if we do not maintain these good relations, if we cannot negotiate the collective bargaining agreements on favorable terms or if a major work disruption event were to occur, it could harm our business.
OUR DISCLOSURE CONTROLS AND PROCEDURES ARE NOT EFFECTIVE.
In connection with the completion of its audit of and the issuance of an unqualified report on the Company's consolidated financial statements for the fiscal year ended June 30, 2006, the Company's independent registered public accounting firm, BDO Seidman, LLP ("BDO"), communicated to the Company's Audit Committee that the following matters involving the Company's internal controls and operations were considered to be "significant deficiencies", as defined under standards established by the Public Company Accounting Oversight Board:
- - Lack of quantity of staff in order to ensure the timeliness and completeness of financial reporting.
We agree with this assessment.
Significant deficiencies are matters coming to the attention of the independent auditors that in their judgment, relate to material weaknesses in the design or operation of internal controls that could adversely affect the Company's ability to record, process, summarize and report financial data consistent with the assertions of management in the financial statements. In addition, BDO has advised the Company that they consider these matters, which are listed above, to be a "material weakness" that, by itself, may increase the possibility that a material misstatement in our financial statements might not be prevented or detected by our employees in the normal course of performing their assigned functions.
ITEM 2.
ITEM 2. FACILITIES
The Company believes that its facilities are suitable for their purposes and have sufficient productive capacity for its current and foreseeable operational and administrative needs. Set forth below is a list and brief description of all of the Company's offices and facilities, all of which are owned unless otherwise indicated.
(Years relate to calendar years)
(1) Leased on a month-to-month basis.
(2) Lease expires in 2006.
(3) Lease expires in 2007.
(4) Lease expires in 2008.
(5) Lease expires in 2009.
(6) Lease expires in 2011.
(7) Lease expires in 2012.
(8) Lease expires in 2013.
(9) Lease expires in 2014.
(10) Lease expires in 2015.
(11) Lease expires in 2030.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS AND ENVIRONMENTAL MATTERS
The Company is a party to various legal proceedings arising in the normal conduct of business. Management believes that the final outcome of these proceedings will not have a material adverse effect on the Company's financial position.
We previously reported, in January 1993 and 1994, our Belgian subsidiary received income tax assessments aggregating approximately 74.9 million Belgian Francs for the disallowance of certain foreign tax credits and investment losses claimed for the years ended July 31, 1990 and 1991. Additionally, in January 1995, the subsidiary received an income tax assessment of approximately 32.8 million Belgian francs for the year ended July 31, 1992. By Belgium law, these assessments are capped at the values above, increased by late payment interest for a period of 18 months only (approximately 15.5 million Belgian francs) and do not continue to accrue additional penalties or interest as long as the Tax Director has not rendered a decision in connection with the tax complaints that have been filed against these tax assessments. To date, the Tax Director has not rendered a decision. These liabilities, which total approximately EUR 3,054,000 or $3.8 million at current exchange rates, have been fully accrued for in fiscal 2006.
We are subject to environmental laws requiring the investigation and cleanup of environmental contamination. In addition to remediation being undertaken by third parties at a limited number of our locations, we are currently remediating contamination resulting from past industrial activity at three of our New Jersey facilities which we acquired from PureTec in 1998. This remediation is being conducted pursuant to the requirements of New Jersey's Industrial Site Recovery Act which were triggered by the 1998 PureTec transaction. If any other events were to occur in the future that would be deemed to have effected a "change of control" of any of our New Jersey facilities as defined under New Jersey's Industrial Site Recovery Act, we would be required to take additional actions to comply with such statute, including possibly additional investigations and remediation. We also are conducting remediation at a formerly-owned New Jersey facility under a voluntary cleanup agreement with the state.
We recently voluntarily self-disclosed to regulators certain non-compliances with the air permit for our Troy, OH facility. While discussions with the Ohio Regional Air Pollution Control Agency are ongoing, we expect that we will be required to install additional pollution controls at this facility in 2006; the capital investment of which we estimate should not exceed $1 million, based on current information. We may also be required to pay a fine, but based on the preliminary stage of discussions, we cannot predict whether such a fine will be imposed, or if so, in what amount.
In 2004, the National Enforcement Investigation Center (NEIC), on behalf of the United States Environmental Protection Agency (EPA), conducted an environmental review of our Burlington, NJ site concerning federal Clean Air Act requirements. The EPA subsequently issued a request for further information regarding these air issues under Section 114 of the federal Clean Air Act. In February and March, 2006 the New Jersey Department of Environmental Protection (NJDEP) issued administrative orders alleging violations of certain state air regulations at the Burlington facility. In March, 2006, the United States Department of Justice (DOJ) contacted Colorite on behalf of the EPA. The DOJ indicated that certain violations under several federal environmental statutes had been identified as a result of the EPA's inspection. They discussed the alleged violations and attempted to negotiate a settlement. Since that date, representatives of Colorite have met with representatives of EPA, DOJ and NJDEP on several occasions to discuss the alleged federal and state violations. Tekni-Plex continues to evaluate the alleged violations and its defenses to them, and anticipates negotiating with the government agencies to attempt to resolve these matters.
In 2004, we also received a similar request for information from the EPA concerning air emissions at our Wenatchee, Washington plant which we do not expect to result in significant costs or fines or penalties.
In fiscal 2006 we established an incremental $900,000 reserve in our financial statements to reflect our best estimate of the aggregate expenses associated with these environmental matters. This reserve is in addition to existing environmental reserves which total $522,500 and the reserves described in Note 7 related to our Elm and Swan acquisitions.
Although we believe that, based on historical experience, the costs of achieving and maintaining compliance with environmental laws and regulations are unlikely to have a material adverse effect on our business, we could incur significant fines, penalties, capital costs or other liabilities associated with any confirmed noncompliance or remediation of contamination or natural resource damage liability at or related to any of our current or former facilities, the precise nature of which we cannot now predict. Furthermore, we cannot assure you that future environmental laws or regulations will not require substantial expenditures by us or significant modifications of our operations.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS
Not Applicable.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected historical consolidated financial information of the Company, and has been derived from and should be read in conjunction with the Company's audited consolidated financial statements, including the notes thereto, which appear elsewhere herein and previously filed. Acquisitions the Company made in certain years result in years not being comparable.
As previously disclosed on Form 8-K as filed September 21, 2005, Tekni-Plex has identified certain overstated inventory at its American Gasket & Rubber Division which resulted in a $6.8 million overstatement of inventory. This inventory overstatement has required a non-cash charge to results of operations as follows:
- ---------- (a) Interest expense included a $1,400 reduction in deferred financing costs and a $5,000 reduction in deferred financing costs in fiscal 2005 and fiscal 2004 respectively.
(b) Income tax provision contains an increase in the valuation allowance of deferred tax assets of $23.1 million and $7.0 million in 2005 and 2004, respectively.
(c) In September 2005, we concluded our annual garden hose contract negotiations. While we were largely successful in securing our target price increases, we lost meaningful market share. With this information in mind, in the second quarter of fiscal 2006 we deemed it appropriate to retest the goodwill in our Tubing segment in greater detail, evaluating each line of business within this segment separately. Accordingly, we recorded a $35.1 million impairment charge against the goodwill associated with our Swan operations as we anticipate reducing the capacity of this operation, eliminating much of its fixed costs, to reflect our reduced market position. As a result of impairment tests being performed at the end of fiscal 2006 and 2005, the Company did not record an impairment charge. In fiscal 2004, an impairment charge of $10.0 million associated with its specialty resins operations was recorded.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
You should read the following discussion and analysis in conjunction with the "Selected Historical Financial Information" and the Financial Statements included elsewhere in this Annual Report. Restated financial statements can be found elsewhere in this filing. The table below sets forth, for the periods indicated, selected operating data as a percentage of net sales.
SELECTED FINANCIAL INFORMATION (PERCENTAGE OF NET SALES)
Net sales increased to $742.7 million in fiscal 2006 from $695.5 million the same period last year, representing a 6.8% increase. Net sales in our Packaging Segment grew 7.3% to $374.1 million in the most recent period from $348.7 million in fiscal 2005 primarily due to higher selling prices. Net sales in our Tubing Products Segment increased 1.3% to $215.8 million in fiscal 2006 from $213.1 million in fiscal 2005 due to significant price increases, in excess of 10% on average, that went into effect midway through our fiscal year for our garden hose products. These price increases were largely offset by lower sales volumes due to lost market share, in excess of 10 percentage points, at our garden hose operations. Other net sales grew 14.2% to $152.8 million in fiscal 2006 compared to $133.8 million in the previous year due to higher selling prices which rose 16.8% on average, offset by lower volumes which declined by approximately 2.4%.
Rebates, discounts and sales allowances totaled to $57.3 million or 7.7% of net sales in fiscal 2006 compared to $43.0 million or 6.2% of net sales in fiscal 2005. The increase was due to changes in our sales programs as well as changes in the volumes purchased by each of our customers during the relevant years.
Cost of goods sold increased to $622.0 million in fiscal 2006 from $600.2 million in fiscal 2005 due to higher energy, labor and freight costs. Despite generally higher prices for our raw materials, our material cost decreased a modest 0.3% in fiscal 2006 compared to fiscal 2005. Lower material costs resulted from both lower garden hose volumes due to lost market share and improved material utilization rates. Expressed as a percentage of net sales, cost of goods sold decreased to 83.7% in the current period compared to 86.3% in the prior period
Tekni-Plex's primary raw materials are Polyvinyl Chloride (PVC), Polystyrene, Vinyl Chloride Monomer (VCM) and various plasticizers, all of which are petrochemical based. Generally higher oil and natural gas prices, coupled with strong global demand for commodity chemicals and tight supplies, have resulted in generally higher costs for all of our key raw materials. We expect this trend to continue for the foreseeable future. In most of our businesses we have been able to pass on higher material costs to our customers in a relatively short time period. However, like most seasonal retail products, we traditionally have sold garden hose under annual agreements, where prices are generally set in the fall and generally remain in effect for the calendar year. In general, the increase in raw material costs at our garden hose operations during a 12-month time period reduces our profitability. In fiscal 2006, the two primary raw materials for our garden hose business, PVC and plasticizers, rose an average of 12.4% and 18.3% respectively. Price increases on our garden hose products that generally went into effect in January 2006 coupled with cost reduction initiatives and product mix improvements more than offset this increase in raw material costs. To further mitigate the potential impact of continued increases in the cost of our raw materials and in contrast to previous years, we did not guarantee garden hose pricing for the 2006 selling season, nor do we anticipate doing so in fiscal 2007.
Our cost of goods sold includes a $2.8 million inventory write-down (0.4% of net sales) in fiscal 2005 to reflect inventory restatements at our American Gasket and Rubber Division.
Gross profit, as a result of the above, increased to $120.7 million in the current period compared to $95.4 million in the prior period. Expressed as a percentage of net sales, gross profit increased to 16.3% in fiscal 2006 from 13.7% last year.
Our Packaging Segment gross profit increased 12.7% to $93.7 million in fiscal 2006 from $83.1 million in fiscal 2005 due to higher selling prices. Expressed as a percentage of net sales, Packaging Segment gross profit increased to 25.1% in the current period from 23.8% in the previous period.
Our Tubing Products Segment gross profit increased 136.6% to $16.8 million in fiscal 2006 from $7.1 million in fiscal 2005 as significantly higher selling prices more than offset both higher raw material costs and reduced volumes. Expressed as a percentage of net sales, our Tubing Products Segment gross profit more than doubled to 7.8% in the current period from 3.3% in the previous period.
Other gross profit increased to $10.1 million in fiscal 2006 from $5.2 million in fiscal 2005 primarily due to higher pricing. Expressed as a percentage of net sales, other gross profit improved to 6.6% in fiscal 2006 from 3.8% a year earlier.
Selling, general and administrative expenses increased to $96.5 million in the most recent fiscal year from $60.7 million last year largely due to the inclusion of a $35.1 million non-cash charge in our second fiscal quarter to write off goodwill associated with our garden hose operations. In recent years our garden hose operations have not been profitable. While the price increases we secured for the 2006 selling season has returned these operations to profitability, we have lost significant market share. In the near term, we expect to reduce our production capacity at our Swan operations to reflect our reduced market share and accordingly we have deemed it appropriate to write-off the goodwill associated with these operations. Measured as a percentage of net sales, selling, general and administrative expenses increased to 13.0% in the current period from 8.7% in the previous period.
Integration expenses decreased to $5.3 million or 0.7% of net sales in fiscal 2006 from $10.5 million or 1.5% of net sales in fiscal 2005. The decrease was largely related to the fact that we completed the closing of our Rockaway facility early in fiscal 2006 and we incurred lower costs associated with the integration of our Elm facilities. Our integration expenses are typically cash expenses and relate to reconfiguring and realignment of acquired facilities to conform to the Company's current production and product standards as well as the costs associated with consolidating facilities. These costs are comprised of the following measured in millions:
We expect the closing of our Rockaway facility to result in approximately $1.0 million of annual cost savings. We also expect the reconfiguring and realignment of our Elm facilities to result in significant cost reductions as well as enable us to produce higher value added products; however, we cannot currently quantify these benefits.
Operating profit, as a result of the above, decreased to $19.0 million in fiscal 2006 from $24.2 million in fiscal 2005. Expressed as a percentage of net sales, operating profit decreased to 2.6% in the most recent period from 3.5% in the comparable period of last year.
Our Packaging Segment operating profit increased 29.9% to $63.6 million (17.0% of net sales) in the current period compared to $49.0 million (14.0% of net sales) in the previous period. Our Tubing Products Segment reported an operating loss of ($30.5) million in fiscal 2006 compared to an operating loss of ($6.5) million in fiscal 2005. Measured as a percent of net sales, our Tubing Segment operating loss decreased to (14.2%) of net sales in the current period compared to (3.0%) of net sales in the previous year. The 2006 period included a $35.1 million non-cash charge to write-off goodwill associated with our garden hose operations. Our Tubing Segment reported $4.6 million of operating profit before goodwill impaiment in fiscal 2006. Our Other segment reported a $3.0 million or 2.0% of net sales operating profit in fiscal 2006 compared to a loss of ($1.2) million or (0.9%) of net sales in the comparable period of 2005.
Interest expense increased to $104.8 million (14.1% of net sales) in fiscal 2006 from $89.9 million (12.9% of net sales) in fiscal 2005 due to the inclusion of a $15.2 million, non-cash interest expense associated with our Series A Redeemable preferred stock reflecting its accretion to its mandatory redemption amount.
Unrealized gain on derivative transactions was $3.8 million or 0.5% of net sales in fiscal 2006 compared to $8.3 million or 1.2% of net sales in the previous year due to the various movements of the interest rates embedded in our derivative contracts. See the Liquidity and Capital Resources discussion below for a detailed description of our derivative transactions.
Loss before income taxes, as a result, was a loss of ($79.3) million or (10.7%) of net sales for fiscal 2006 compared to a loss of ($55.2) million or (7.9%) of net sales for fiscal 2005.
Income tax expense was $5.0 million for fiscal 2006 compared to $26.2 million for fiscal 2005 primarily reflecting foreign taxes as we continued to fully reserve against our deferred tax asset. Our fiscal 2005 tax provision include a $23.1 million charge to increase our deferred tax assets' valuation allowance.
Net loss, as a result, was a loss of ($84.3) million for fiscal 2006 or (11.4%) of net sales compared with a loss of ($81.5) million for fiscal 2005 or (11.7%) of net sales.
YEAR ENDED JULY 1, 2005 COMPARED TO THE YEAR ENDED JULY 2, 2004
Net sales increased to $695.5 million in fiscal 2005 from $635.6 million in fiscal 2004, representing a 9.4% gain. Net sales in our Packaging Segment grew 13.9% to $348.7 million in the most recent period from $306.1 million in the comparable period of 2004 due to both higher selling prices and sales volumes. Net sales in our Tubing Products Segment increased 1.3% to $213.1 million in fiscal 2005 from $210.2 million in fiscal 2004 primarily due to a 3 to 6 percent increase in our garden hose prices that generally went into effect in January 2005. Higher garden hose prices were partially offset by lower, weather-related, garden hose sales volumes during fiscal 2005 compared to the previous year. Other net sales grew 12.2% to $133.8 million in fiscal 2005 compared to $119.3 million in the previous year due to both higher selling prices and higher volumes.
Our accruals for rebates, discounts and sales allowances decreased to $43.0 million or 6.2% of net sales in fiscal 2005 compared to $49.1 million or 7.7% of net sales in fiscal 2004. The decrease was due to changes in our sales programs as well as changes in the volumes purchased by each of our customers during the year.
Cost of goods sold increased to $600.2 million in fiscal 2005 from $530.4 million in fiscal 2004. Expressed as a percentage of net sales, cost of goods sold increased to 86.3% in the current period compared to 83.4% in the prior period, primarily due to higher raw material costs. Tekni-Plex's primary raw materials are Polyvinyl Chloride (PVC), Polystyrene, Vinyl Chloride Monomer (VCM) and various plasticizers, all of which are petrochemical based. Generally higher oil and natural gas prices, coupled with strong global demand for commodity chemicals and tight supplies, have resulted in generally higher costs for all of our key raw materials. We expect this trend to continue for the foreseeable future. In most of our businesses we have been able to pass on higher material costs to our customers in a relatively short time period. However, like most seasonal retail products, we traditionally have sold garden hose under annual agreements, where prices are generally set in the fall and generally remain in effect for the calendar year. Consequently, in recent fiscal years, the increase in raw material costs at our garden hose operations during a 12-month time period has reduced our profitability. In fiscal 2005, the two primary raw materials for our garden hose business, PVC and plasticizers, rose an average of 12% and 38% respectively. To mitigate the impact of expected increases in the cost of our raw materials and in contrast to previous years, we have not guaranteed garden hose pricing for the 2006 selling season.
Our cost of goods sold reflects a $2.8 million inventory write-down (0.5% of net sales) in fiscal 2005 and a $2.7 million inventory write-down (0.4% of net sales) in fiscal 2004 to correct inventory restatements at our American Gasket and Rubber Division.
Gross profit, as a result of the above, decreased to $95.4 million in the current period compared to $105.3 million in the prior period. Expressed as a percentage of net sales, gross profit declined to 13.7% in fiscal 2005 from 16.6% in comparable period of last year.
Our Packaging Segment gross profit increased to $83.1 million in fiscal 2005 from $80.1 million for fiscal 2004 as we were largely able to pass on higher raw material costs to our Packaging Segment customers during the year. Expressed as a percentage of net sales, Packaging Segment gross profit decreased to 23.8% in the current period from 26.2% in the previous period.
Our Tubing Products Segment gross profit decreased to $7.1 million in fiscal 2005 from $20.6 million in fiscal 2004. Expressed as a percentage of net sales, our Tubing Products Segment gross profit decreased to 3.3% in the current period from 9.8% in the previous period as significantly higher raw material cost, particularly for plasticizers, more than offset the 3 to 6 percent price increases that went into effect in January at our garden hose unit.
Other gross profit increased to $5.2 million in fiscal 2005 from $4.5 million in fiscal 2004. Expressed as a percentage of net sales, other gross profit remained flat at 3.8%.
Selling, general and administrative expenses decreased to $60.7 million in the most recent fiscal year from $69.2 million last year, primarily due to the inclusion of a $10 million reduction in goodwill in fiscal 2004. Measured as a percentage of net sales, selling, general and administrative expenses decreased to 8.7% in the current period from 10.9% in the previous period.
Integration expenses increased to $10.5 million or 1.5% of net sales in fiscal 2005 from $7.8 million or 1.2% of net sales in fiscal 2004. The increase was largely related to the closing of our Rockaway, New Jersey facility and consolidating its operations at our Clinton, Illinois and Clayton, North Carolina facilities. Our integration expenses are typically cash expenses and relate to reconfiguring and realignment of acquired facilities to conform to the Company's current production and product standards as well as the costs associated with consolidating facilities. These costs are comprised of the following:
We expect the closing of our Rockaway facility to result in approximately $1 million of annual cost savings. We also expect the reconfiguring and realignment of our Elm facilities to result in significant cost reductions as well as enable us to produce higher value added products; however, we cannot currently quantify these benefits.
Operating profit, as a result of the above, decreased to $24.2 million in fiscal 2005 from $28.3 million in fiscal 2004. Expressed as a percentage of net sales, operating profit decreased to 3.5% in the most recent period from 4.5% in the comparable period of last year.
Our Packaging Segment operating profit decreased to $49.0 million (14.0% of net sales) in the current period compared to $51.3 million (16.8% of net sales) in the previous period. Our Tubing Products Segment reported an operating loss of ($6.5) million or (3.0%) of net sales in the current period compared to profit of $6.5 million or 3.1% of net sales in the previous year. Other operating profit improved to a ($1.2) million loss or (0.9%) of net sales in the current period compared to a ($11.8) million loss or (9.9%) of net sales in the previous period.
Interest expense increased to $89.9 million (12.9% of net sales) in fiscal 2005 from $84.5 million (13.3% of net sales) in fiscal 2004 due to an increase of $11.7 of debt as well as higher average interest rates. Interest expense also included a reduction in deferred financing costs of $1.4 million in fiscal 2005 and $5.0 million in fiscal 2004 resulting from repaying certain outstanding debt obligations through the issuance of new senior secured notes (see Note 7 of the audited consolidated financial statements).
Unrealized gain on derivative transactions was $8.3 million or 1.2% of net sales in fiscal 2005 compared to $10.7 million or 1.7% of net sales in the previous year due to the various movements of the interest rates embedded in our derivative contracts.
Income (loss) before income taxes, as a result, was a loss of ($55.2) million or (7.9%) of net sales for fiscal 2005 compared to a loss of ($46.1) million or (7.2%) of net sales for fiscal 2004.
Income tax expense was $26.2 million for fiscal 2005 compared to $11.1 million for fiscal 2004 as we increased our valuation allowance of our deferred tax asset by $23.1 million in fiscal 2005 and $15.0 million in fiscal 2004. Given our continued pre-tax losses in recent years, we decided to reserve fully against our deferred tax assets at the end of fiscal 2005.
Net income (loss), as a result, was a loss of ($81.5) million for fiscal 2005 or (11.7%) of net sales compared with a loss of ($57.2) million for fiscal 2004 or (9.0%) of net sales.
LIQUIDITY AND CAPITAL RESOURCES
For the year ended July 1, 2006, net cash used in operating activities was $11.2 million compared to $24.5 million of cash used in operating activities in the prior year. The $13.3 million improvement was due primarily to improved earnings before non-cash charges (such as goodwill impairment and interest accretion) as our garden hose operations returned to profitability in the second half of our fiscal year. Beginning with the 2006 selling season, we have discontinued the practice of guaranteeing garden hose prices for the entire season. While we believe raw material costs may continue to rise in fiscal 2007, we also believe the prices we have secured to date for our garden hose products has helped restore our profitability. Furthermore, we believe that, subject to prevailing competitive pressures, we will generally be able to pass on future increases in raw material costs to primarily all of our customers, including our garden hose customers, albeit with a lag of one to three months. However, we can give you no assurance to that effect.
Despite improved earnings before non cash charges, increases in our accounts receivable and inventories as well as a reduction in our trade accounts payable contributed to our use of cash from operations in fiscal 2006. Other various year-over-year changes in operating assets, accrued expenses, and liabilities are generally due to offsetting timing differences.
As of September 22, 2006, we had an outstanding balance of $15.0 million under our $75.0 million asset backed credit facility. Also as of September 22, 2006 availability under this facility was reduced by $7.0 million of letters of credit related to our workmen's compensation insurance programs.
Working capital at June 30, 2006 was $215.4 million compared to $200.8 million at July 1, 2005. The increase was primarily caused by an increase in net borrowings under our asset backed credit facility reduced by operating losses.
Our principal uses of cash will be debt service, capital expenditures and working capital requirements. Our capital expenditures for the years ended June 30, 2006, July 1, 2005, and July 2, 2004 were $19.1 million and $18.2 million and $29.5 million, respectively. Management believes that we will be able to pass along expected higher raw material costs to our garden hose customers during fiscal 2007 and consequently, cash generated from operations plus funds available in the Company's asset backed facility will be sufficient to meet its needs and to provide it with the flexibility to make capital expenditures and other investments which management believes are prudent. However, we cannot assure you that sufficient funds will be available from operations or borrowings under our credit facility to meet all of our future cash needs.
In June 2000, Tekni-Plex entered into a series of interest rate derivative transactions designed to protect us from rising interest rates on our senior term debt facilities while enabling us to partially benefit from falling interest rates. At that time, Tekni-Plex had $344.0 million of term loans outstanding with variable rates of interest tied to US$ LIBOR. These loans, which originally had maturity dates ranging from June 2006 through June 2008, have been repaid. Concurrent with incurring this debt, Tekni-Plex entered into a series of interest swap contracts to pay variable rates of interest based on a basket of LIBOR benchmarks and receive variable rates of interest based on 3 month dollar LIBOR on an aggregate of $344.0 million amount of indebtedness. The swaps amortized on the same schedule as the original term loans. As of July 1, 2006 the notional amount of the swaps is $230.0 million.
Portfolio theory and empirical evidence suggested that the change in value of a basket of LIBOR benchmarks would be less volatile than the change in value of a single benchmark. Since 2000, this has generally been our experience.
In conjunction with its swap contracts Tekni-Plex also purchased an interest rate cap. Tekni-Plex believes the reduced volatility created by the interest rate swaps made the interest rate cap less expensive.
We recorded an unrealized gain from derivative transactions of $3.8 million and $8.3 million in fiscal years 2006 and 2005,
respectively.
Our Senior debt and our Senior Subordinated Notes include various covenants, the most restrictive of which limit our incremental debt and capital expenditures. The availability of borrowings under our new asset based facility is subject to a borrowing base limitations equal to the lesser of the borrowing base as defined in the asset backed agreement and the then effective commitments under the new asset based facility minus such availability reserves as the administrative agent, in its sole discretion, deems appropriate.
At June 30, 2006, the Company's contractual obligations are as follows:
- ---------- (1) Interest expense includes obligations under our interest rate swap agreement.
(2) May be paid in kind
(3) Non-cash increase in preferred stock.
(4) Includes initial preferred stock value $54.8 million
CRITICAL ACCOUNTING POLICIES
The Company prepares its financial statements in accordance with accounting principles generally accepted in the United States. Preparing financial statements in accordance with generally accepted accounting principles requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The following paragraphs include a discussion of some critical areas where estimates are required. You should also review Note 1 to the financial statements for further discussion of significant accounting policies.
The Company records revenue when products are shipped. Legal title and risk of loss with respect to the products pass to customers at the point of shipment. The Company provides an allowance for returned product and volume sales rebates on an estimated basis based on written agreements and past experience.
The Company makes estimates of sales rebates and allowances related to current period product revenue. Management analyzes historical trends, current economic conditions, and compliance with written agreements when evaluating the adequacy of the reserve for sales rebates and allowances. Management judgments and estimates must be made and used in connection with establishing the sales rebates and allowances in any accounting period.
The Company evaluates its long-lived assets for impairment based on the undiscounted future cash flows of such assets. If a long-lived asset is identified as impaired, the value of the asset will be reduced to its fair value.
The Company records inventories at the lower of cost (weighted average) or market. We record inventory reserves to reduce the carrying value of inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and estimated market value based on assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory reserves may be required.
The Company extends credit based upon evaluations of a customer's financial condition and provide for any anticipated credit losses in our financial statements based upon management's estimates and ongoing reviews of recorded allowances. If the financial conditions of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional reserves may be required. Conversely, reserves are deducted to reflect credit and collection improvements.
The Company has intangible assets related to acquired intangibles. The determination of related estimated useful lives and whether or not these assets are impaired involves management judgments. Changes in strategy and/or market conditions could significantly impact these judgments and require adjustments to recorded asset balances. We adopted SFAS 142, which requires us to cease
amortization of goodwill, but instead be tested for impairment at least annually or earlier if there are impairment indicators. The Company performs a two-step process for impairment testing of goodwill as required by SFAS No. 142. The first step of this test, used to identify potential impairment, compares the fair value of a reporting unit with its carrying amount. The second step (if necessary) measures the amount of the impairment. We have traditionally conducted these tests at the segment level of our businesses. In September 2005, we concluded our annual garden hose contract negotiations. While we were largely successful in securing our target price increases, we lost meaningful market share. With this information in mind, in the second quarter of fiscal 2006 we deemed it appropriate to retest the goodwill in our Tubing segment. Accordingly, we recorded a $35.1 million impairment charge against the goodwill associated with our Swan operations as we anticipate reducing the capacity of this operation, eliminating much of its fixed costs, to reflect our reduced market position. As a result of impairment tests being performed at the end of fiscal 2006 and 2005, the Company did not record an impairment charge. In fiscal 2004, an impairment charge of $10.0 million associated with its specialty resins operations was recorded.
In performing the above noted goodwill impairment testing, the Company uses a measure of fair value based on an evaluation of future discounted cash flows. This evaluation utilized what management believes to be the best information available in the circumstances, including what management believes to be reasonable and supportable assumptions and projections. Such assumptions are consistent with those utilized in the Company's annual planning process and appropriately take into account managements' initiatives to improve operational efficiencies. If these turnaround initiatives do not achieve their earning objectives, the assumptions and estimates underlying this goodwill impairment evaluation could be modified in the future leading to further impairment in the recorded value of goodwill.
The Company records a valuation allowance to reduce the amount of our deferred tax assets to the amount that is more likely than not to be realized. While we have considered future taxable income and ongoing tax planning strategies in assessing the need for the valuation allowance, in the event that we determined that we would be able to realize our deferred tax assets in the future in excess of the net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. Likewise, if it were determined that we would not be able to realize all or part of the net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made. Based on our recent financial performance, in fiscal 2006 we continued to fully reserve against our deferred tax asset.
NEW ACCOUNTING PRONOUNCEMENTS
In February 2006, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 155, Accounting for Certain Hybrid Financial Instruments--an amendment of FASB Statements No. 133 and 140 ("SFAS 155"). SFAS 155 amends FASB Statements No. 133, Accounting for Derivative Instruments and Hedging Activities and FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. SFAS 155 resolves issues addressed in Statement 133 Implementation Issue No. D1, Application of Statement 133 to Beneficial Interests in Securitized Financial Assets. More specifically, SFAS 155:
1. Permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation.
2. Clarifies which interest-only strips and principal-only strips are not subject to the requirements of Statement 133.
3. Establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation.
4. Clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives.
5. Amends Statement 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument.
SFAS 155 is effective for all financial instruments acquired or issued after the beginning of an entity's first fiscal year that begins after September 15, 2006. The Company has not determined the effect, if any, that the adoption of SFAS 155 will have on the Company's consolidated financial position or results of operations.
In July 2006, FASB issued interpretation No. 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109 ("FIN 48"). This interpretation clarifies the accounting for uncertainty in income taxes recognized in financial statements in accordance that FASB Statement No. 109, Accounting for Income Taxes. FIN 48 will require companies to determine whether it is more-likely-than-not that a tax position taken or expected to be taken in a tax return will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. If a tax position meets the more-likely-than-not recognition threshold, it is measured to determine the amount of benefit to recognize in the financial statements based on guidance in the interpretation. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company has not determined the effect, if any, that the adoption of FIN 48 will have on the Company's consolidated financial position or results of operations.
INFLATION
During fiscal 2006 and fiscal 2005, we contended with significant and rapidly rising raw material prices. Over the long term, we believe we have generally been able to offset the effects thereof through continuing improvements in operating efficiencies and by increasing prices to our customers to the extent permitted by competitive factors. However, we cannot assure you that such cost increases can be passed through to our customers in the future or that the effects can be offset by further improvements in operating efficiencies.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The market risk inherent in the Company's financial instruments and positions represents the potential loss arising from adverse changes in interest rates. At June 30, 2006 and July 1, 2005 the principal amount of the Company's aggregate outstanding variable rate indebtedness was $39.0 million and $12.0 million respectively. A hypothetical 1% adverse change in interest rates would have had an annualized unfavorable impact of approximately $0.4 million and $0.1 million respectively, on the Company's earnings and cash flows based upon these year-end debt levels.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS
The financial statements commence on Page.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
ITEM 9a.
ITEM 9a. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES.
The Company maintains disclosure controls and procedures designed to ensure that information required to be disclosed in its Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to the Company's management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
In connection with the completion of its audit of and the issuance of an unqualified report on the Company's consolidated financial statements for the fiscal year ended June 30, 2006, the Company's independent registered public accounting firm, BDO Seidman, LLP ("BDO"), communicated to the Company's Audit Committee that the following matters involving the Company's internal controls and operations were considered to be "significant deficiencies", as defined under standards established by the Public Company Accounting Oversight Board:
- - Lack of quantity of staff in order to ensure timeliness and completeness of financial reporting.
Management agrees with this assessment.
Significant deficiencies are matters coming to the attention of the independent auditors that in their judgment, relate to material weaknesses in the design or operation of internal controls that could adversely affect the Company's ability to record, process, summarize and report financial data consistent with the assertions of management in the financial statements. In addition, BDO has advised the Company that they consider this matter, which is listed above, to be a "material weakness" that, by itself, may increase the possibility that a material misstatement in our financial statements might not be prevented or detected by our employees in the normal course of performing their assigned functions.
Over the last 12 months we have made a number of significant changes to our internal controls. They include:
(1) creating of an internal audit department;
(2) adding additional staff to the accounting and finance functional group
(3) centralizing the reporting of financial managers to 4 group controllers who will provide increased oversight and improved training;
(4) during annual performance reviews of accounting and bookkeeping personnel; requiring all reviewing personnel to inquire whether the reviewed employee has had or observed any problems in the use of approved accounting systems or in the accounting function generally;
(5) improving its internal financial reporting systems and related controls across all of its divisions to, among other things, increase both the frequency by which inventory and rebates discounts and allowances are monitored as well as increasing the number of managers responsible for monitoring these functions;
(6) instituting a policy of performing routine credit and background checks on all financial staff and key managers; and
(7) beginning the process of centralizing our cash management function and significantly improving our controls over cash disbursements.
As required by SEC Rule 13a-15(b), the Company carried out an evaluation under the supervision and with the participation of its management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operations of the Company's disclosure controls and procedures and internal controls over financial reporting as of September 26, 2006 as well as of June 30, 2006. Given the material weakness noted above, the Company's Chief Executive Officer and Chief Financial Officer determined that its controls are not effective as of those dates. However, the Chief Executive Officer and Chief Financial Officer noted that significant improvement in its controls have been made and they expect its controls can be improved further. Consequently, the Company will continue to improve and refine its internal controls over the next 12 months.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Our current directors and executive officers are listed below. Each director is elected at the annual meeting of the stockholders of Tekni-Plex to serve a one year term until the next annual meeting or until a successor is elected and qualified, or until his earlier resignation. Each executive officer holds his office until a successor is chosen and qualified or until his earlier resignation or removal.
Pursuant to our by-laws, we indemnify our officers and directors to the fullest extent permitted by the General Corporation Law of the State of Delaware and our certificate of incorporation.
Dr. F. Patrick Smith has been Chairman of the Board and Chief Executive Officer of Tekni-Plex since March 1994. He received his doctorate degree in chemical engineering from Texas A&M University in 1975. He served as Senior Chemical Engineer to Texas Eastman Company, a wholly owned chemical and plastics subsidiary of Eastman Kodak, where he developed new grades of polyolefin resins and hot melt and pressure sensitive adhesives. In 1979, he became Technical Manager of the Petrochemicals and Plastics Division of Cities Service Company, and a Member of the Business Steering Committee of that division. From 1982 to 1984, Dr. Smith was Vice President of R&D and Marketing for Guardian Packaging Corporation, a diversified flexible packaging company. Thereafter, he joined Lily-Tulip, Inc. and managed their research and marketing functions before becoming Senior Vice President of Manufacturing and Technology. Following the acquisition of Lily-Tulip by Fort Howard Corporation in 1986, he became the Corporate Vice President of Fort Howard, responsible for the manufacturing and technical functions of the combined Sweetheart Products and Lily-Tulip operations. From 1987 to 1990, Dr. Smith was Chairman and Chief Executive Officer of WFP Corporation. Since 1990, Dr. Smith has been a principal of Brazos Financial Group, a business consulting firm. Since 2000, Dr. Smith has been a general partner of Eastport Operating Partners L.P.
James E. Condon is a Senior Vice President, Secretary and Chief Financial Officer of Tekni-Plex, Inc. He joined Tekni-Plex in 2001 and became a Director in 2004. Prior to joining Tekni-Plex Mr. Condon was a Vice President at J.P. Morgan Securities Inc.
Edward Goldberg is a Senior Vice President of the Company, and manages six of its divisions. He has been with the company since June, 2001, and as of March, 2005 was appointed to serve on the Board of Directors. He received his BS and MS degrees in Chemical Engineering from Rensselaer Polytechnic Institute in 1971. He worked for P&G and The Scott Paper Company for a total of 25 years, in diverse roles including Vice President of: Supply Systems; Business Development; and Strategic Planning. Prior to leaving Scott Paper he was the company's U.S. V.P. - Consumer Supply System. He subsequently worked for the Nice Pak and the Lander corporations in senior management positions. His most specific field of emphasis has been General Management for turn around situations.
John S. Geer has served as a director of Tekni-Plex since June 2000. He also serves on the Executive Council of Century Park Capital Partners and on the Board of the Robb Report. He is a former Partner of Mellon Ventures, Inc. and former Senior Vice President of Security Pacific Capital Corp. He has served on 20 boards of directors of emerging growth and middle market companies.
J. Andrew McWethy has served as a director of Tekni-Plex since March 1994. He co-founded and managed MST Partners L.P., a private equity investment fund, from 1989 to 2000. In 2000, Mr. McWethy co-founded Eastport Operating Partners, L.P., a private equity investment fund that he continues to manage. Prior to 1989, Mr. McWethy was employed by Irving Trust Company for 12 years.
Michael F. Cronin has served as a director of Tekni-Plex since March 1994. He has invested in emerging growth companies and various industrial and service businesses since 1978. Since June 1991, Mr. Cronin has been a general partner of Weston Presidio Capital.
COMPENSATION OF DIRECTORS
Tekni-Plex reimburses directors for any reasonable out-of-pocket expenses incurred by them in connection with services provided in such capacity. In addition, each outside director is paid an annual fee of $50,000.
COMPENSATION OF EXECUTIVE OFFICERS
The following table sets forth the remuneration paid by Tekni-Plex to the Chief Executive Officer and other highly compensated executive officers of Tekni-Plex.
SUMMARY COMPENSATION TABLE
- ---------- (a) Includes amounts reimbursed during the fiscal year for payment of auto expense, membership fees, etc.
(b) In fiscal 2006, Mr. Goldberg and Mr. Condon each received options to purchase 4 shares of Tekni-Plex stock with a strike price of $43,681 per share. These options have nominal, if any, value today.
OPTION/SAR GRANTS IN LAST FISCAL YEAR
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES
EMPLOYMENT AGREEMENTS
In May 2005, Dr. Smith entered into amended and restated employment agreement. The two year agreement provides for a $4,000,000 annual salary.
The employment agreement provides that the executive may be terminated for cause or upon death or disability. Dr. Smith is entitled to severance benefits if he is terminated. The employment agreement also contain certain non-compete provisions.
COMPENSATION COMMITTEE
The board of directors maintains a two-member compensation committee comprised of Dr. Smith, and Mr. Cronin. The compensation committee's duties include the annual review and approval of the compensation for our Chief Executive Officer, as well as the administration of our stock incentive plan. No member of the compensation committee is allowed to vote on issues pertaining to that member's compensation (including option grants). The board may also delegate additional duties to the compensation committee in the future.
Changes in Mr. Condon's compensation are subject to approval by Mr. Cronin. Compensation levels and bonus awards for all other employees are controlled by Dr. Smith.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Tekni-Plex Partners LLC holds approximately 96.3% and MST/TP Partners LLC holds approximately 3.7% of Tekni-Plex's outstanding common stock.
Tekni-Plex Management LLC, controlled by Dr. Smith, is the sole managing member of both Tekni-Plex Partners LLC and MST/TP Partners LLC.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
CONSULTING ARRANGEMENTS
Our policy is not to enter into any significant transaction with one of our affiliates unless a majority of the disinterested directors of the board of directors determines that the terms of the transaction are at least as favorable as those we could obtain in a comparable transaction made on an arm's-length basis with unaffiliated parties. This determination is made in the board's sole discretion.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
In accordance with the requirements of the Sarbanes-Oxley Act of 2002 and the Audit Committee's charter, all audit and audit-related work and all non-audit work performed by our independent accountants, BDO Seidman LLP, is approved in advance by the Audit Committee, including the proposed fees for such work. The Audit Committee is informed of each service actually rendered.
Audit and audit-related fees billed or expected to be billed to us by BDO Seidman, LLP for the audit of the financial statements included in our Annual Report on Form 10-K and reviews of the financial statements included in our Quarterly Reports on Form 10-Q, for the fiscal years ended June 30, 2006 and July 1, 2005 totaled approximately $895,000 and $110,000 and $882,000 and $110,000, respectively. Audit related fees include reviews of offerings, SEC comment letters, and employee benefit plan audits.
Tax preparation, review, and advisory services billed or expected to be billed to us by BDO for the fiscal years ended June 30, 2006 and July 1, 2005 totaled approximately $336,000 and $477,000, respectively.
No other services were provided to us by BDO Seidman, LLP during fiscal 2006 and 2005.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) (1) Financial Statements and Schedules
The financial statements listed in the Index to Financial Statements under Part II, Item 8 and the financial statement schedules listed under Exhibit 27 are filed as part of this annual report.
(a) (2) Financial Statement Schedule--Schedule II--Valuation and Qualifying Accounts
(a) (3) Exhibits
The exhibits listed on the Index to Exhibits following the Signature Page herein are filed as part of this annual report or by incorporation by reference from the documents there listed.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
TEKNI-PLEX, INC.
By: /s/ F. PATRICK SMITH ------------------------------------ F. Patrick Smith Chairman of the Board and Chief Executive Officer
Dated: September 28, 2006
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
By: /s/ JAMES E. CONDON ------------------------------------ James E. Condon Chief Financial Officer
Dated: September 28, 2006
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of Registrant and in the capacities indicated, on September 28, 2006.
EXHIBIT INDEX
- ---------- * Filed previously as an Exhibit to our Registration Statement on Form S-4 (File No. 333-43800) filed on August 15, 2000.
** Filed previously as an Exhibit to our Registration Statement on Form S-4 (File No. 333-98561) filed on August 22, 2002.
*** Filed previously as an Exhibit to our Registration Statement on Form S-4 (File No. 333-111778) filed on January 8, 2004.
**** Filed previously as an Exhibit to our Form 8-K filed on May 19, 2005.
***** Filed previously as an Exhibit to our Form 8-K filed on June 16, 2005.
****** Filed previously as an Exhibit to our Registration Statement on Form S-4/A (File No. 333-111778) filed on July 13, 2005.
******* Filed previously as an Exhibit to our Registration Statement on Form S-4 (File No. 333-127404) filed on August 10, 2005.
******** Filed herewith.
TEKNI-PLEX, INC. CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED JUNE 30, 2006, JULY 1, 2005, JUNE 2, 2004
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors Tekni-Plex, Inc. Somerville, New Jersey
We have audited the accompanying consolidated balance sheets of Tekni-Plex, Inc. and its subsidiaries (the "Company") as of June 30, 2006 and July 1, 2005, and the related consolidated statements of operations, stockholders' deficit and cash flows for each of the three years in the period ended June 30, 2006. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Tekni-Plex, Inc. and its subsidiaries as of June 30, 2006 and July 1, 2005, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 2006, in conformity with accounting principles generally accepted in the United States of America.
/s/ BDO Seidman, LLP Woodbridge, New Jersey
September 8, 2006
TEKNI-PLEX, INC.
CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
See accompanying notes to consolidated financial statements.
TEKNI-PLEX, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLARS IN THOUSANDS)
See accompanying notes to consolidated financial statements.
TEKNI-PLEX, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT (DOLLARS IN THOUSANDS)
See accompanying notes to consolidated financial statements.
TEKNI - PLEX, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)
See accompanying notes to consolidated financial statements.
TEKNI-PLEX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS, EXCEPT PERCENTAGES AND SHARE AMOUNTS)
(b) In July 2002, the Company acquired substantially all the net assets of Elm Packaging Company ("ELM") for $16,762. Elm produces polystyrene foam plates, bowls, and meat and bakery trays. The financial results of Elm are included in the Packaging segment. The acquisition was recorded under the purchase method. In connection with the acquisition, the Company incurred an integration reserve of $4.5 million. The components of the Integration reserve and activity through June 30, 2006 was as follows:
The remaining legal and environmental costs are expected to extend over the next four years. TEKNI-PLEX, INC.
(c) In October 2001, the Company purchased certain assets and assumed certain liabilities of Swan for approximately $63,600. Swan is a manufacturer of garden hose. The financial results of Swan are included in the tubing segment. The acquisition was recorded under the purchase method, whereby Swan's net assets were recorded at estimated fair value and its operations have been reflected in the statement of operations since that date.
In connection with the acquisition, the Company incurred an integration reserve of $10 million. The components of the Integration reserve and activity through June 30, 2006 was as follows:
(A) SENIOR DEBT
In June 2005, we entered into a new asset based facility with Citicorp USA, Inc., as administrative agent, and the other agents and lenders named therein. Our asset based facility consists of a four-year, asset-based revolving credit facility in the maximum amount of $75,000. Availability under the asset based facility equals (i) the lesser of (A) the borrowing base (as defined in the new asset based facility) and (B) the then effective commitments under the new asset based facility minus (ii) such availability reserves as the administrative agent, in its sole discretion, deems appropriate.
The asset based facility includes a $25,000 letter of credit sub facility. We currently have $6,990 of letters of credit outstanding related to workmen's compensation insurance. Amounts borrowed under our new asset based facility will be used for general corporate and working capital purposes. The commitments under our asset based facility will terminate on the fourth anniversary of the closing date, at which time all loans outstanding under the new asset based facility will become due and payable.
Loans under the asset based facility are guaranteed by each of our domestic subsidiaries. Loans under the asset based facility are secured on a first priority basis by all of our domestic subsidiaries' assets.
Loans under our asset based facility bear interest by reference to a base rate or a reserve adjusted Eurodollar rate, at our option, in each case, plus an applicable margin, as each such term is defined in the asset based facility.
In addition, the asset based facility includes a provision permitting, at our option, an increase in the aggregate amount of the asset based facility by up to an additional $60,000, subject to certain conditions. In fiscal 2006 we used $10,000 of this capacity to upsize our asset backed revolver from $65,000 to $75,000.
The asset based facility imposes certain restrictions on us and our subsidiaries. As part of these covenants, we are restricted or limited in our ability to, among other things:
- incur and voluntarily prepay certain of our and our subsidiaries' debt;
- grant liens on our and our subsidiaries' assets;
- undertake certain mergers, consolidations and sales / purchases of assets;
- pay certain dividends or distributions and redeem, purchase, retire or make other acquisitions of our equity interests;
- make certain investments and acquisitions;
- transact with our affiliates; and
- make capital expenditures.
The asset based facility provides that certain events will constitute events of default under the new asset based facility. These events include, among other things;
- our failure to pay when due amounts owed under the asset based facility;
- our or our subsidiaries' failure to observe or perform the covenants set forth in the asset based facility;
- the inaccuracy of the representations and warranties set forth in the asset based facility;
- the imposition of certain judgments against us or our subsidiaries;
- our or our subsidiaries' failure to pay certain other of our or our subsidiaries' debt;
- the acceleration of the maturity of material debt;
- the occurrence of certain bankruptcy or insolvency proceedings or events;
- the invalidity or unenforceability of any lien or guarantee securing our obligations under the asset based facility; and
- the occurrence of a change of control.
(B) SENIOR SUBORDINATED NOTES
In June 2000 and May 2002, we respectively issued $275.0 million and $40.0 million aggregate principal amount of the 12 3/4 % senior subordinated notes due June 15, 2010. These notes are our senior subordinated unsecured obligations and are guaranteed by each of our existing and future domestic restricted subsidiaries with assets or stockholders' equity in excess $25,000. The senior subordinated notes bear interest at an annual rate of 12 3/4 %, payable semiannually on each June 15 and December 15.
The senior subordinated notes are subject to redemption, in whole or in part, at our option, at any time on or after June 15, 2005 at the redemption prices described below if redeemed during the twelve month period commencing June 15 in the years set forth below:
Holders of the senior subordinated notes have the option of requiring us to repurchase their notes in cash upon a change of control at a repurchase price equal to 101% of the principal amount of the notes plus accrued interest, if any, to the date of the repurchase.
The indenture governing the senior subordinated notes restricts our ability and the ability of our restricted subsidiaries to:
- incur additional indebtedness and issue preferred stock;
- pay dividends or make other distributions;
- create liens;
- incur restrictions on the ability of our restricted subsidiaries to pay dividends or other payments to us;
- sell assets;
- merge or consolidate with other entities;
- enter into transactions with affiliates;
- issue capital stock of restricted subsidiaries; and
- effect acquisitions.
However, these limitations are subject to a variety of exceptions and qualifications.
The senior subordinated notes include customary events of default, including failure to pay principal and interest on the notes, a failure to comply with covenants, a failure by us or our subsidiaries to pay material judgments or indebtedness and bankruptcy and insolvency events with respect to us and our material subsidiaries.
In April, 2005, we received the consents required to amend certain covenants in the indenture governing our senior subordinated notes including our debt incurrence covenant. The amendments allow us, among other things, to incur incremental debt, not to exceed $90.0 million at any one time outstanding, in ratio of 1.5:1.0 for every dollar of equity received after April 1, 2005. Since that date, we have raised $37.2 million of additional equity through the issuance of our Series A redeemable preferred stock.
(C) SENIOR SECURED NOTES DUE 2013
We issued $275,000 senior secured notes on November 21, 2003. Interest on those senior secured notes accrues at the rate of 8 3/4 % per annum and are payable semi-annually in arrears on May 15 and November 15 of each year, beginning May 15, 2004. The 2013 Notes will mature on November 15, 2013.
We may redeem all or part of those senior secured notes on or after November 15, 2008. Prior to November 15, 2006, we may redeem up to 35% of the aggregate principal amount of the senior secured notes at a premium of 8.75% with the proceeds of certain equity offerings.
The senior secured notes are secured by second priority liens on the collateral securing our existing credit facility. The collateral includes, but is not limited to, the following property of us and the guarantors party to the indenture:
- all of the stock and equity interests of certain of our domestic subsidiaries and 65% of the capital stock and equity interests of certain of the our foreign subsidiaries;
- all accounts, inventory, general intangibles, equipment and insurance policies;
- all documents of title covering, evidencing or representing goods;
- all instruments and chattel paper;
- commercial tort claims;
- certain Company-owned real property;
- rights under certain railcar leases;
- patents, trademarks, copyrights and other intellectual property;
- all letter of credit rights;
- all supporting obligations;
- certain deposit accounts; and
- all proceeds of, and all other profits, products, rents or receipts, arising from the collection, sale, lease, exchange, assignment, licensing or other disposition or realization upon the collateral described in (1) through (11) above.
Pursuant to a registration rights agreement that we and our subsidiary guarantors entered into in connection with our existing senior secured notes, we and our subsidiary guarantors agreed to file a registration agreement with the SEC relating to an offer to exchange or register the senior secured notes and guarantees for publicly tradable notes and guarantees having substantially identical terms. We and the guarantors also agreed to use all commercially reasonable efforts to cause the registration statement to
be declared effective by the SEC on or prior to the date specified in the registration rights agreement. We have not been able to cause the registration statement to be declared effective by the SEC on or prior to the date specified in the registration rights agreement, as a result, we have been paying liquidated damages in an amount equal to 1.0% of the principal amount of the senior secured notes per annum to holders of the existing senior secured notes as required by the registration rights agreement.
(D) SENIOR SECURED NOTES DUE 2012
We issued $150,000 senior secured notes on June 7, 2005. Interest on those senior secured notes accrues at the rate of 10 7/8% per annum and is payable semi-annually in arrears on August 15 and February 15 of each year, beginning February 15, 2006. The 2013 Notes will mature on August 15, 2012. The proceeds were used primarily to refinance existing bank debt.
We may redeem all or part of those senior secured notes on or after August 15, 2009. Prior to August 15, 2008, we may redeem up to 35% of the aggregate principal amount of the senior secured notes with the proceeds of certain equity offerings.
The senior secured notes are secured by second priority liens on the collateral securing our existing credit facility. The collateral includes, but is not limited to, the following property of us and the guarantors party to the indenture:
- all of the stock and equity interests of certain of our domestic subsidiaries and 65% of the capital stock and equity interests of certain of the our foreign subsidiaries;
- all accounts, inventory, general intangibles, equipment and insurance policies;
- all documents of title covering, evidencing or representing goods;
- all instruments and chattel paper;
- commercial tort claims;
- certain Company-owned real property;
- rights under certain railcar leases;
- patents, trademarks, copyrights and other intellectual property;
- all letter of credit rights;
- all supporting obligations;
- certain deposit accounts; and
- all proceeds of, and all other profits, products, rents or receipts, arising from the collection, sale, lease, exchange, assignment, licensing or other disposition or realization upon the collateral described in (1) through (11) above.
(E) SERIES A REDEEMABLE PREFERRED STOCK
On May 13, 2005 we issued 31,800 shares of Series A redeemable Preferred Stock for $1,000 per share. In July 2005 we issued an additional 5,423 shares at $1,000 per share. In addition, we issued 22,500 shares to certain investors in consideration for capital contributions made in 2004. In accordance with SFAS 150, the Series A redeemable preferred stock is being characterized as a liability. Dividends and accretion to maturity are classified as interest expense.
The following summary of certain provisions of our Series A Redeemable Preferred Stock does not purport to be complete and is subject to, and qualified in its entirety by, our Amended and Restated Certificate of Incorporation.
Liquidation Event. Upon the occurrence of a sale of the Company or its subsidiaries, whether by merger, asset sale or change in equity control, or a liquidation of the Company, the Series A Preferred Stock shall be redeemed at an amount per share equal to (i) 115% of the purchase price of the Series A Preferred Stock prior to October 31, 2005, and (ii) three times the purchase price thereafter (such amount determined in (i) or (ii) hereinafter referred to as the "Liquidation Value").
Mandatory Redemption. Upon the earlier of (i) February 15, 2014 or (ii) to the extent such redemption is permitted under the Company's new asset based facility, the payment in full of the Company's senior subordinated notes and existing senior secured notes, the Series A Redeemable Preferred Stock shall be redeemed in full in cash at the price equal to 115% of the purchase price of the Series A Preferred Stock prior to October 31, 2005 and three times the purchase price thereafter.
Dividends. From and after Trigger Event, the Series A Preferred Stock shall be entitled to receive out of any assets legally available cumulative dividends at a rate of 12% per annum, compounded quarterly, on the original purchase price. The dividends shall begin to accrue on the Trigger Event and shall be paid quarterly in arrears. However, if the Company is prevented from paying such dividends in cash for certain reasons, the dividend will accumulate at the rate of 12% per annum, compounded quarterly.
Trigger Event. A Trigger Event shall mean:
(i) the failure of the Company to redeem any shares of the Series A Preferred Stock in cash when required to do so;
(ii) the failure by the Company or Dr. Smith, the Company's CEO, to perform or observe any other covenant in the Series A Preferred Stock Purchase Agreement or any ancillary documents that is continued for more than sixty (60) days and that reasonably expected to have a material adverse effect on the Company or the holders of the Series A Preferred Stock;
(iii) any false or misleading representations or warranty by the Company in the Series A Preferred Stock Purchase Agreement that is reasonably expected to have a material adverse effect on the Company or the holders of the Series A Preferred Stock;
(iv) the failure by the Company or any Significant Subsidiary (as defined in Rule 1-02(w) of Regulation S-X) to make payments when due (which failure is continued beyond the cure period contained in the documents governing such payments or which has not been waived by the Lender): (A) of the principal amount of any indebtedness or other security (whether at maturity, upon a scheduled amortization date or any other mandatory prepayment date) having an aggregate principal amount in Excess of $10 million; or (B) which failure results in the acceleration of indebtedness which aggregates in excess of $10 million;
(v) the Company or any Significant Subsidiary pursuant to or within the meaning of Title 11 of the United States Code or any other Federal, state or foreign bankruptcy, insolvency or similar law ("Bankruptcy Law") (A) commences a voluntary case or proceeding, (B) consents to the entry of an order for relief against it in an involuntary case or proceeding, (C) consents to the appointment of a custodian of it or for all or substantially all of its property, (D) makes a general assignment for the benefit of its creditors, or (E) generally is not paying its debts as they become due;
(v) a court of competent jurisdiction enters an order or decree under any Bankruptcy Law that (A) is for relief against the Company or any of its Significant Subsidiaries in an involuntary case, appoints a custodian of the Company or any of its Significant Subsidiaries or for all or substantially all of the property of the Company or any of its Significant Subsidiaries, or (C) orders the liquidation of the Company or any of its Significant Subsidiaries, and in each case, the order or decree remains unstayed and in effect for sixty (60) consecutive days;
(vii) an unsatisfied judgment against the Company or any of its Significant Subsidiaries in excess of $10,000 which remains undischarged or unstayed (including stays pending appeal) for a period of 60 days;
(viii) the failure of Dr. Smith to serve as Chief Executive Officer as a result of his death or disability or for any other reason except voluntary resignation if a replacement, acceptable to the holders of a majority of the Series A Preferred Stock in their sole and absolute discretion, is not found within six months after such death or disability;
(ix) the failure of Dr. Smith to serve as Chief Executive Officer as a result of a voluntary resignation of employment;
(x) April 30, 2007; or
(xi) closing of an underwritten registered initial offering of the Company's equity any Liquidation Event or any repayment in full of the Notes, in each case upon which the Company does not redeem the Series A Preferred Stock in full in cash in an amount equal to the Liquidation Value.
Voting Rights. Holders of shares of Series A Preferred Stock will have no voting rights except as described below. In such case, each such holder shall be entitled to one vote for each share held.
The board of directors of the Company consists of six directors, one of whom shall be elected by the holders of the Series A Preferred Stock. After the occurrence of certain Trigger Events (as defined in the Company's Amended and Restated Certificate of Incorporation) the Series A Preferred Stockholders shall have the right to increase the vote of the director elected by Series A Preferred Stockholders from one vote to six votes for all matters considered by the Company's board of directors.
Protective Provisions. As long as shares of Series A Preferred Stock are issued and outstanding, without first obtaining the approval of the Series A Preferred Stockholders, the Company Shall not, and shall not permit its subsidiaries to, either directly or indirectly, through a merger, consolidation or otherwise:
- Create, authorize or issue any securities of the Company or any significant subsidiary other than common stock or options to purchase common stock not to exceed 45.75206 shares of common stock and (ii) certain refinancing securities as defined in the Amended and Restated
Certificate of Incorporation;
- Amend the Amended and Restated Certificate of Incorporation or the by-laws of the Company;
- Except where the proceeds are used to redeem the Series A Preferred Stock, consummate any sale of the Company or any significant subsidiary or sale of substantially all of the assets of the Company or any significant subsidiary;
- Liquidate or dissolve the Company or any significant subsidiary;
- Declare or pay any dividend or other distribution of the Company or its significant subsidiaries' securities or redeem or repurchase any securities of the Company or any significant subsidiaries other than Series A Preferred Stock;
- Increase or decrease the authorized number of directors of the Company;
- Enter into any related party transactions in excess of $1,000 in the aggregate;
- Incur any indebtedness other than indebtedness the terms of which do not prohibit the Redemption of the Series A Preferred Stock in full in cash on February 15, 2014;
- Amend the Company's agreements relating to indebtedness that would prohibit the redemption of the Series A Preferred Stock in full in cash on February 15, 2014;
- Hire or terminate the Chief Executive Officer, the Chief Financial Officer or the Chief Operating Officer or making any modifications to their compensation arrangements; or
- Report a distribution on the Series A Preferred Stock for tax purposes except to the extent such Distribution is paid in cash or to the extent that the Company has received consent from the Representative chosen by a majority of the Series A Preferred Stockholder, which consent shall not be unreasonably withheld.
Scheduled principal payments on debt over the next five years and thereafter are as follows:
Condensed Consolidating Statement of Operations - For the year ended June 30,
Condensed Consolidating Balance Sheet - at June 30, 2006
Condensed Consolidating Cash Flows - For the year ended June 30, 2006
Condensed Consolidating Statement of Operations - For the year ended July 1,
Condensed Consolidating Balance Sheet - at July 1, 2005
Condensed Consolidating Cash Flows - For the year ended July 1, 2005
Condensed Consolidating Statement of Operations - For the year ended July 2,
Condensed Consolidating Balance Sheet - at July 2, 2004
Condensed Consolidating Cash Flows - For the year ended July 2, 2004
16. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
1. In the fourth quarter of fiscal 2005, the Company identified certain overstated inventory at its American Gasket and Rubber Division which resulted in a non-cash charge to operations of $2.8 million in fiscal 2005. The first three quarters of fiscal 2005 were restated to reflect this charge.
2. In September 2005, we concluded our annual garden hose contract negotiations. While we were largely successful in securing our target price increases, we lost meaningful market share. With this information in mind, in the second quarter of fiscal 2006 we deemed it appropriate to retest the goodwill in our Tubing segment. Accordingly, we recorded a $35.1 million impairment charge against the goodwill associated with our Swan operations as we anticipate reducing the capacity of this operation, eliminating much of its fixed costs, to reflect our reduced market position.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON SUPPLEMENTAL SCHEDULE
Board of Directors Tekni-Plex, Inc. Somerville, New Jersey
The audits referred to in our report dated September 8, 2006 relating to the consolidated financial statements of Tekni-Plex, Inc. and its subsidiaries (the "Company"), included the audits of the financial statement schedule for the years ended June 30, 2006, July 1, 2005 and July 2, 2004 listed in the accompanying index. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statement schedule based upon our audits.
In our opinion, such financial statement schedule presents fairly, in all material respects, the information set forth therein.
/s/ BDO Seidman, LLP Woodbridge, New Jersey September 8, 2006
TEKNI-PLEX, INC.
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (DOLLARS IN THOUSANDS)
- ---------- (1) To increase accounts receivable allowance.
(2) Uncollectible accounts written off, net of recoveries.
(3) Amounts do not include certain accounts receivable reserves that are disclosed as "allowances" on the Consolidated Balance Sheets since they are not valuation reserves.