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Four M Corp · 10-K · For 12/31/97

Filed On 4/1/98   ·   SEC File 333-08043   ·   Accession Number 1005477-98-1081

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  As Of               Filer                 Filing     On/For/As Docs:Pgs              Issuer               Agent

 3/31/98  Four M Corp                       10-K       12/31/97    3:69                                     1005477

Annual Report   ·   Form 10-K
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 10-K        Annual Report                                         67    312K 
 2: EX-12.1     Ratio of Earnings to Fixed Charges                     1      5K 
 3: EX-27.1     Financial Data Schedule                                1      7K 


10-K   ·   Annual Report
Document Table of Contents

Page (sequential) | (alphabetic) Top
 
11st Page
3Item 1. Business
4Ft. Madison Mill
"St. Joe Mill
5Box USA of Florida, L.P
7Environmental Matters
9Item 2. Properties
10Item 3. Legal Proceedings
"Item 4. Submission of Matters to a Vote of Security Holders
11Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
"Item 6. Selected Financial Data
14Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
18Item 8. Financial Statements and Supplementary Data
"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
19Item 10. Directors and Executive Officers of the Registrant
21Item 11. Executive Compensation
22Item 12. Security Ownership of Certain Beneficial Owners and Management
"Item 13. Certain Relationships and Related Party Transactions
23Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
44Fibre Marketing
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SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------------------ FORM 10-K FOR ANNUAL AND TRANSITIONAL REPORTS PURSUANT TO SECTIONS 13 AND 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 1997 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number: 333-8043 Four M Corporation (Exact name of Registrant as Specified in Its Charter) Maryland 52-0822639 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 115 Stevens Avenue 10595 Valhalla, New York 10595 (Zip Code) (Address of Principal Executive Offices) Registrant's telephone number, including area code: (914) 749-3200 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: None ----------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. |_| As of December 31, 1997, there were no shares of voting stock of the registrant held by non-affiliates. As of December 31, 1997, registrant had 6,815,867 shares of Common Stock outstanding.
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FOUR M CORPORATION TRANSITION REPORT ON FORM 10-K TABLE OF CONTENTS PART I Item 1. Business ......................................................... 1 Item 2. Properties ....................................................... 7 Item 3. Legal Proceedings ................................................ 8 Item 4. Submission of Matters to a Vote of Security Holders .............. 8 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters ............................................. 9 Item 6. Selected Financial Data .......................................... 9 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations ....................................... 12 Item 8. Financial Statements and Supplementary Data ...................... 16 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ........................................ 16 PART III Item 10. Directors and Executive Officers of the Registrant ............... 17 Item 11. Executive Compensation ........................................... 19 Item 12. Security Ownership of Certain Beneficial Owners and Management ...................................................... 20 Item 13. Certain Relationships and Related Party Transactions ............. 20 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K ..................................................... 21 Signatures
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PART I Item 1. BUSINESS General Four M Corporation (the "Company" or "Four M"), which operates under the trade name Box USA, believes that it is one of the largest independent full-service converters of corrugated packaging materials in North America. The Company, through its subsidiaries, operates 23 strategically located converting facilities, which sold 11.7 billion square feet of finished corrugated containers, partitions and sheets during the fiscal year ended December 31, 1997 ("Fiscal 1997"). The Company also owns a paper mill at Ft. Madison, Iowa (the "Ft. Madison Mill") which sold 62,880 tons of corrugating medium during Fiscal 1997, most of which was sold to third parties. The Company was founded in 1966 as a manufacturer of corrugated partitions. From a single partition plant, the Company expanded initially through internal growth and later through 12 separate acquisitions involving 23 manufacturing facilities. The Company has historically targeted assets to which the Company could significantly improve profitability. These strategic acquisitions have allowed the Company to (i) supply its partition plants with lower-cost corrugated sheets for conversion into interior packaging components, (ii) capture a portion of its partition customers' corrugated container business and (iii) diversify its customer base to include a broader variety of users of corrugated packaging materials. On May 30, 1996, the Company acquired (i) substantially all of the assets of St. Joe Container Company ("St. Joe Container"), which consisted primarily of 16 converting facilities and related working capital (the "St. Joe Acquisition") and (ii) a 50% interest in Florida Coast Paper Company, L.L.C. ("Florida Coast"), a limited liability company which owns a linerboard mill located in Port St. Joe, Florida (the "St. Joe Mill") and Stone Container Corporation ("Stone Container", together with the Company, the "Joint Venture Partners") acquired the remaining 50% interest in Florida Coast. The St. Joe Acquisition more than doubled the size of the Company to 28 converting facilities and enabled the Company to increase its geographic coverage from nine to 17 states and serves the Midwest, Mid-Atlantic and the faster growing Southeast markets. While corrugated packaging plants typically serve customers within a 150-mile radius, the Company is generally able to extend its service area to a radius of approximately 250 miles. The Company believes that improved operating efficiencies enable it to overcome any incremental costs associated with its larger trading areas. The markets for corrugated packaging materials produced by the Company are generally subject to changes in industry capacity and cyclical changes in the economy, both of which can significantly impact the Company's profitability. The ability of the Company to sustain profitability during cyclical fluctuations in corrugating packaging material markets is dependent upon the Company's ability to maintain value-added margins (net sales less the cost of raw materials). For corrugating packaging material manufacturers, raw materials typically represent approximately 70% of the total cost of goods sold. The ability of the Company to maintain value-added margins is primarily a function of the speed with which the Company can pass along raw material cost increases to its customers or conversely, absorb reductions in raw materials prices. Historically, the Company has been able to sustain consistent value-added margins on a unit basis. Although prices for corrugated packaging products have declined due to an industry-wide excess of capacity, the Company has experienced growth in volume for such products. One of the Company's competitive advantages is its long-term relationships with many customers, some of which have been maintained for over 25 years. A second feature which distinguishes the Company from its competitors is the significant relationships it has established with its containerboard suppliers. The Company believes that it is the largest customer of its four primary raw material suppliers. As one of the largest purchasers of linerboard and corrugating medium in the industry, the Company believes that it has been able to purchase raw materials from certain of its outside suppliers at prices below those reported in Pulp & Paper Week, an industry trade publication. Four M has no independent business operations other than its ownership interest in its subsidiaries. Operations The Company operates three types of converting facilities: (i) corrugator plants which convert linerboard and corrugating medium into corrugated sheets and then convert the sheets into corrugated containers, (ii) sheet or specialty container plants which receive corrugated sheets from the Company's corrugator plants or external suppliers and then manufacture corrugated containers and displays and (iii) partition plants which receive corrugated sheets from the Company's corrugator plants or external suppliers and manufacture corrugated interior packaging components. The Company also operates the Ft. Madison Mill, which produces corrugating medium primarily for sale to third parties. 1
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Corrugators The Company supplies corrugated containers to national, regional and local accounts, which include companies in the food, household products, cosmetics, personal care, beverage, pharmaceutical, electrical and other machinery, and high-tech industries. The Company's corrugator plants are value-added container manufacturers, as well as suppliers of corrugated sheets to the Company's and third-parties' sheet and partition plants. The Company's corrugators convert mottled white linerboard, unbleached kraft linerboard and corrugating medium into corrugated sheets and containers. Mottled white containers are generally sold at a premium over unbleached kraft containers; however, the premium tends to cover the higher cost of mottled white linerboard without increasing operating margins at the container facilities. Approximately 94.6% of the corrugated materials produced in these facilities in Fiscal 1997 required unbleached kraft linerboard and the remaining 5.4% required mottled white linerboard. Sheet Plants The Company's sheet plants convert corrugated sheets into specialty containers and point-of-sale displays. The Company operates one sheet plant in Ohio, one in Alabama, two in California and one in Florida. During Fiscal 1997, the Company's sheet plants accounted for approximately 11.0% of the Company's net sales. The Company operates the sheet plants for smaller production runs and specialized containers. The customers for these plants are primarily local and regional accounts. By serving different market segments, sheet plants allow the Company to operate in trading areas which overlap those of the corrugator plants without competing with the larger, integrated facilities. Partition Plants The Company believes that it is the largest producer of corrugated interior packaging components in the United States. The Company operates four free-standing partition plants in the Midwest and Southeast and supplies interior packaging components to major food, household products, and glass and plastic container producers. The Company also has partition manufacturing capability at two of its sheet plants. The Company maintains a leading position in the partition segment of the corrugated market by supplying national account, high-volume users. Ft. Madison Mill The Company's Ft. Madison Mill is currently capable of producing up to 80,000 tons per year of corrugating medium. The Ft. Madison Mill sells its output primarily to smaller, independent corrugated container manufacturers in the Midwest. In Fiscal 1997, the Ft. Madison Mill generated net sales of $13.2 million of corrugating medium to third parties. In Fiscal 1997, prices for corrugating medium declined as a result of increased capacity in the industry and decreased demand for such products. In response to such market conditions, the Company shut down the Ft. Madison Mill on March 31, 1997 and resumed limited production on August 18, 1997. Full production commenced on September 1, 1997. The Ft. Madison Mill has the capability to process both wood fiber and recycled fiber. Recycled fiber utilized at the Ft. Madison Mill consists of double-lined kraft clippings. This flexibility in raw materials processing has enabled the Company to reduce the impact of fluctuations in raw material prices. Recycled fibers represented approximately 39% of the raw materials used by the Ft. Madison Mill in Fiscal 1997. St. Joe Mill On May 30, 1996, Florida Coast, a joint venture (the "Mill Joint Venture") of the Company and Stone Container acquired the St. Joe Mill for its strategic location and to fulfill a portion of the linerboard requirements of the corrugated container facilities of the Joint Venture Partners. The St. Joe Mill has two paper machines which are capable of producing an aggregate of approximately 500,000 tons of linerboard annually in a variety of grades and basis weights. The St. Joe Mill's production presently is approximately 18% mottled white linerboard, a premium priced product, and 82% unbleached kraft linerboard. Under the Output Purchase Agreement, each of the Joint Venture Partners has agreed to purchase one-half of the St. Joe Mill's entire annual linerboard production, representing approximately one-third of the Company's total requirements, at a price that is $25 per ton below the price published in Pulp & Paper Week, under the section entitled "Price Watch: Paper and Paperboard," subject to a minimum purchase price, intended to generate sufficient funds to cover cash operating costs, cash interest expense and maintenance capital expenditures. 2
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Management determined that it was probable that the Company would be required to pay additional amounts above market price for linerboard pursuant to the Output Purchase Agreement and established a reserve (the "Reserve") in the amount of $20.2 million for such purchases. During Fiscal 1997, pursuant to the Output Purchase Agreement, the Company was required to pay a purchase price adjustment in the amount of $17.5 million. In addition, the Company increased the Reserve by $6.0 million in Fiscal 1997. The Company advanced loans of $1.6 million under the Subordinated Credit Facility (the "Subordinated Credit Facility"), pursuant to which the Company provides, if needed, Florida Coast with up to $10.0 million of subordinated indebtedness on a revolving credit basis. The loans under the Subordinated Credit Facility are fully reserved. The St. Joe Mill is expected to generate net earnings and operating cash flow in Fiscal 1998 and additional reserve requirements are not anticipated. In addition, in April 1997 the Joint Venture Partners shut down the St. Joe Mill due to a decline in prices for linerboard as a result of increased capacity in the industry. The St. Joe Mill resumed limited production in early September 1997 and full production commenced in October 1997. During the period of the St. Joe Mill shut down, the Company remained subject to the terms of the Output Purchase Agreement. Fibre Marketing Group During Fiscal 1996, the Company acquired a 50% interest in Fibre Marketing Group, LLC ("Fibre Marketing"), which procures and markets waste paper. Fibre Marketing acts as a broker for the sale and transportation of waste material from companies which generate waste, such as printers, paper converters and recycling processors, to paper mills. Fibre Marketing currently provides brokerage services to all of the Company's converting facilities. Fibre Marketing also owns and operates Fibre Processing Corporation, a waste paper processing company located in Edgemere, Maryland, which services sources of recyclable waste paper which are too small to utilize brokerage services. Fibre Marketing discontinued operations at this facility as of December 31, 1997. Box USA of New Jersey, Inc. During Fiscal 1996, the Company acquired 49% of the outstanding shares of common stock of Box USA of New Jersey, Inc. ("Box USA of New Jersey"), formerly known as MannKraft Corporation, from Stone Container (the "New Jersey Acquisition"), increasing its ownership interest to 50%. Box USA of New Jersey is a manufacturer of corrugated paper products, such as cartons and displays, which it sells primarily in New Jersey, southern New York, southeastern Connecticut and eastern Pennsylvania. Box USA of Florida, L.P. During Fiscal 1996, Four M Manufacturing Group of Georgia, Inc. acquired a 51% interest in Box USA of Florida, L.P. ("Box USA of Florida, L.P."). Box USA of Florida, L.P. operates a sheet plant in Jacksonville, Florida. Recent Developments In January 1998, the Company sold its Dallas and Houston corrugating operations for $19.8 million in cash, subject to working capital adjustments, which approximated net book value. Approximately $11.2 million of the net proceeds is held in trust pursuant to the terms of the Indenture governing the Senior Notes and the remainder has been used for working capital purposes. Sales, Marketing and Customers Sales and Marketing The Company's products are primarily sold on a direct basis and, to a lesser degree, through the use of brokers. Currently, the Company generates approximately 90% of its business through direct sales and the balance through brokers. The Company seeks to be a leader in customer service for the markets it serves by capitalizing on its marketing experience, technical expertise and manufacturing flexibility. The Company's corrugated packaging materials are typically manufactured to customer order. The Company believes that the strong integration between manufacturing, marketing and sales provides it with a competitive advantage by allowing it to respond favorably and quickly to changing customer demands. The Company prides itself on its sales oriented culture and its long-standing relationships with customers. The Company's senior executive officers personally handle a number of the larger accounts. Each of the Company's sales representatives receives training in product specifications and manufacturing techniques in order to satisfy customer requirements and maintain existing national and local account relationships. The Company emphasizes achieving sales efficiency by 3
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preserving existing relationships, having a thorough knowledge of customer requirements and being flexible and responsive to changing customer needs. The Company has focused on capturing market share by targeting a diverse customer base and offering a full product line within a given geographical area. The Company believes that the St. Joe Acquisition has provided access to markets previously outside the Company's geographic service areas, as well as allowed it to expand relationships with existing customers which have packaging requirements within geographic areas serviced by the St. Joe Container facilities. The Company's sales and marketing system is supported by a centralized computer network. All sales are invoiced and entered into the computer network at the plant level. Sales information and data are accessible on a real-time basis from computer terminals at each plant and at the Company's executive offices. The Company's sales and marketing organization provides the Company with accurate and timely information on projected product demand, competitive activity in the marketplace and potential markets for new products and services. Customers In Fiscal 1997, the Company's largest customer accounted for approximately 2.6% of net sales. The top 10 customers accounted for approximately 9.5% of net sales during Fiscal 1997. The Company typically has one-year, and in some cases multi-year, contracts with its national accounts. These contracts have provisions which provide for price adjustments based on changes in the Company's raw material prices. Sales to national accounts accounted for approximately 15% of net sales in Fiscal 1997. Competition The markets in which the Company sells its products are highly competitive. Competitors of the Company's corrugators include large, integrated manufacturers with operations throughout the United States as well as small, independent converters with a regional or local focus. The Company competes by offering its customers high-quality products produced to the customers' specifications, rapid order turnaround, competitive pricing and high levels of customer service. The Company's sheet plants generally compete with independent regional and local sheet plants. Competitive factors include product quality, price, delivery time and customer service. The Company believes that its ready access to raw materials from its corrugator plants provides it with a competitive advantage over its non-integrated competitors. The market for corrugated partitions is mature. The primary competitors in the partition business are producers of solid fiber partitions. Solid fiber partitions have a price advantage over corrugated partitions due to lower raw material costs but are not as effective as corrugated partitions for protection of fragile products during shipment and storage. The Company competes with the solid fiber manufacturers by tailoring timing, manufacturing specifications and delivery requirements to individual customer needs. As consolidation among users of corrugated partitions has increased, the Company has continued to focus on aligning its manufacturing capabilities with individual customer needs to maintain its market share in the partition segment. In addition, the Company has utilized its relationships with its partition customers to increase sales of corrugated containers. Distribution Corrugated packaging materials generally are delivered by truck due to the large number of customers and demand for timely service. The dispersion of customers and the high bulk and low density and value of corrugated packaging materials make shipping costs a relatively high percentage of total costs. As a result, corrugated packaging material plants tend to be located close to customers to minimize freight costs. Generally, corrugated packaging material plants service an area within a 150-mile radius of the plant locations. Each of the Company's plants typically services a market within a 250-mile radius of the plant. The Company believes that improved operating efficiencies have enabled it to overcome any incremental freight costs associated with its larger trading areas. Raw Materials The Company's primary raw materials are linerboard and corrugating medium. Historically, over two-thirds of the Company's raw materials have been provided by Stone Container, Inland Container Corporation and Tenneco Packaging Inc. pursuant to long-term supply contracts. The Company has recently negotiated renewals of these contracts; two of them expire in March and July 2000, and the third contract expires in December 2002. The Company has also entered into an additional long-term supply contract with Georgia-Pacific Corporation which expires in January 2001. The contracts specify certain monthly and annual discounts to negotiated market prices, which are based on volumes purchased. The Company believes that alternate sources of raw materials are available. 4
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In Fiscal 1997, the Company bought only 109,958 tons of its linerboard requirements from the St. Joe Mill under the Output Purchase Agreement as the mill was shut down for six months. The Company expects to purchase approximately 210,000 tons of linerboard from the St. Joe Mill in Fiscal 1998. The Ft. Madison Mill purchases its virgin fiber and its recycled fiber from several suppliers, including some suppliers of recycled fiber who are also customers of the Ft. Madison Mill. The Ft. Madison Mill does not typically enter into long-term supply contracts. Environmental Matters The Company's operations are subject to environmental regulation by federal, state and local authorities in the United States. The Company believes that it is in substantial compliance with current federal, state and local environmental regulation. Unreimbursed liabilities arising from environmental claims, if significant, could have a material adverse effect on the Company's results of operations and financial condition. Furthermore, actions by federal, state and local governments concerning environmental matters could result in laws or regulations that could increase the cost of compliance with environmental laws and regulations. The operations of the St. Joe Mill are subject to extensive and changing environmental regulation by federal, state and local authorities. In November 1997, the US Environmental Protection Agency (the "EPA") issued its final rules, informally known as the "cluster rules", which are more stringent than the existing requirements for discharge of wastewaters under the Clean Water Act and impose new requirements on air emissions under the Clean Air Act for the pulp and paper industry. Although the final rules are less stringent, in some respects than as initially proposed, the Company currently believes that the St. Joe Mill will be required to make capital expenditures of approximately $30 million during the period of 1998 through 2005 in order to meet the requirements of the new regulations. See "Management Discussion and Analysis of Financial Condition and Results of Operations - Environmental Matters". St. Joe Container, St. Joe Paper and St. Joe Forest (collectively, the "Paper Indemnitors") agreed to indemnify the Company for certain "On-Site Environmental Liabilities" (as defined in the Asset Purchase Agreement dated as of November 1, 1995 covering the St. Joe Acquisition (the "St. Joe Acquisition Agreement")) arising from conditions existing on the date of the closing of the St. Joe Acquisition (the "Closing Date") and relating either to the St. Joe Mill or the St. Joe Container facilities. Pursuant to these provisions, (1) 100.0% of the first $2.5 million of such liability will be paid by the Company or Florida Coast, (2) 100.0% of the next $2.5 million by the Paper Indemnitors, (3) 100.0% of the next $2.5 million of such liability will be paid by the Company or Florida Coast, (4) 100.0% of the next $2.5 million of such liability will be paid by the Paper Indemnitors, (5) 100.0% of the next $2.5 million of such liability will be paid by the Company or Florida Coast and (6) 100.0% of the next $5.0 million of such liability will be paid by the Paper Indemnitors; provided that the conditions that give rise to such On-Site Environmental Liabilities are discovered and the Paper Indemnitors are notified not later than three years after the Closing Date and, subject to certain exceptions, remediation expenses are incurred within five years after the Closing Date. The Paper Indemnitors will have no responsibility to indemnify the Company or Florida Coast for expenses relating to On-Site Environmental Liabilities in excess of the foregoing or for any On-Site Environmental Liabilities discovered after the third anniversary of the Closing Date. The Company is solely responsible for On-Site Environmental Liabilities that arise from the acts or omissions of the Company after the Closing Date. In the event that On-Site Environmental Liabilities arise from acts or omissions which occurred both before and after the Closing Date, such liabilities will be allocated between the Paper Indemnitors, on the one hand, and the Company or Florida Coast, on the other hand, based on the relative contribution of the acts and omissions occurring in each time period to such On-Site Environmental Liabilities. St. Joe Paper and its affiliates, including St. Joe Container, have retained responsibility for "Off-Site Environmental Liabilities" (as defined in the St. Joe Acquisition Agreement) that arise from conditions existing on the Closing Date. In the event Off-Site Environmental Liabilities arise from acts or omissions that occurred both before and after the Closing, such Liabilities will be allocated between the Paper Indemnitors, on the one hand, and the Company and Florida Coast, on the other hand, based on the relative contribution of the acts and omissions occurring in each time period to such Off-Site Environmental Liabilities. Should a condition exist that requires remediation costs to be incurred both within and without the boundaries of the real property, the costs for work within the boundaries will be deemed On-Site Environmental Liabilities, and the work outside such boundaries will be deemed Off-Site Environmental Liabilities. Subject to certain exceptions, On-Site Environmental Liabilities do not include liabilities that arise due to a change in any law or regulation becoming effective after November 1, 1995. Pursuant to the Indemnification Reimbursement Agreement between Florida Coast and the Company, the benefit of indemnification from the Paper Indemnitors with respect to such environmental liabilities will be allocated 80.0% to Florida Coast and 20.0% to the Company, with Florida Coast or the Company being obligated, under certain circumstances, to reimburse the other in the event either recovers more than its allocated share and the other recovers less. The obligations of the Paper Indemnitors with respect to On-Site Environmental Liabilities will terminate in the event that either the Company or Florida Coast undergoes a "change of control" (as defined in the St. Joe Acquisition Agreement). Change of Control is defined to mean (i) a transaction in which any Person or Group (as defined in Rule 13d-5 of the Exchange Act) other than the "Principals" (as defined in the St. Joe Acquisition Agreement) or the "Lenders" (as defined in the St. Joe Acquisition Agreement) acquires more than 50.0% of the total 5
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voting power of all classes of voting stock of the Company or Florida Coast, as the case may be, (ii) a transaction in which any Person or Group (as defined in Rule 13d-5 of the Exchange Act) other than the Principals or the Lenders has a sufficient number of nominees elected to constitute a majority of the Board of Directors of the Company or of the Board of Managers of Florida Coast, as the case may be, (iii) the sale of all or substantially all of the capital stock of the Company or Florida Coast, as the case may be, as an entirety or substantially as an entirety to any Person or Group (as defined in Rule 13d-5 of the Exchange Act) other than the Principals or the Lenders and (iv) the sale or transfer of all or substantially all of the assets of the Company or Florida Coast, as the case may be, as an entirety or substantially as an entirety to any Person other than the Principals or the Lenders. For purposes of the definition of Change of Control, "Principals" is defined as (1) Dennis Mehiel in the case of the Company, (2) the Company and Stone Container, in the case of Florida Coast, and (3) any subsidiary of Dennis Mehiel, the Company or Stone Container; and "Lenders" is defined as one or more institutional lenders which provide debt financing to the Company or Florida Coast as of the Closing. Pursuant to the St. Joe Acquisition Agreement, St. Joe Container has completed, at its sole cost, remedial actions required for a former land application area at the container facility located in Laurens, South Carolina and remedial actions associated with two underground storage tanks at the container facility located in Chicago, Illinois. St. Joe Container has also agreed to reimburse the Company for up to $1.4 million of expenses incurred by the Company after the Closing Date to undertake certain identified environmental projects at several of the acquired container facilities. To date, the Company has spent approximately $100,000 in connection with these projects and expects that it will be reimbursed for these amounts from St. Joe Container. The indemnification provisions in the St. Joe Acquisition Agreement are generally intended to be the exclusive remedies of the parties with respect to such agreements. Personnel As of December 31, 1997, the Company had 2,328 employees, of whom 1,702 were hourly employees and 626 were salaried employees. Of such employees, 519 were engaged in management and administrative functions, 107 were engaged in sales and marketing and 1,702 were engaged in manufacturing. There were 1,314 hourly employees at 20 Company facilities who are members of unions under 19 separate contracts. Six of these contracts will expire in the second half of 1998, six expire in 1999, three expire in 2000, one expires in 2001 and one expires in 2002. Management believes that its employee relations are good. A contract was recently finalized in February 1998. 6
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Item 2. PROPERTIES The Company owns or leases manufacturing properties having an aggregate floor space of approximately 4.1 million square feet. The table below provides summary information regarding the principal properties owned or leased by the Company. Approximate Leased Location Square Footage Type or Owned -------- -------------- ---- -------- Birmingham, AL(1) 167,000 Corrugator Owned Compton, CA(8) 135,000 Corrugator Leased Port St. Joe, FL(1)(2)(6) 142,000 Corrugator Leased Lake Wales, FL(1) 275,000 Corrugator Owned Stockbridge, GA(3) 160,000 Corrugator Leased Chicago, IL(1) 185,000 Corrugator Owned Hartford City,IN(1) 277,150 Corrugator Owned Louisville, KY(1) 240,000 Corrugator Owned Baltimore, MD(1) 220,000 Corrugator Owned Newark, NJ 180,000 Corrugator Owned Charlotte, NC(6) 170,000 Corrugator Owned Newark, OH 107,000 Corrugator Owned Eighty Four, PA 133,000 Corrugator Owned Pittsburgh, PA(1) 225,000 Corrugator Owned Laurens, SC(1) 180,000 Corrugator Owned Memphis, TN(1) 216,000 Corrugator Owned Chesapeake, VA(1) 148,000 Corrugator Owned Dothan, AL(1) 31,000 Sheet Owned Montebello, CA(8) 90,000 Sheet Leased San Leandro, CA 110,000 Sheet(4) Leased Jacksonville, FL 72,700 Sheet Leased Byesville, OH 60,000 Sheet Owned Jacksonville, FL(3) 69,000 Partition Leased Litchfield, IL 42,000 Partition Leased Portland, IN(3) 40,500 Partition Leased Bethesda, OH(3) 44,100 Partition Leased Ft. Madison, IA 138,570 Mill Owned Valhalla, NY 16,000 Executive Offices Leased New York City, NY 3,500 Executive Offices Leased College Park, GA(1)(7) 167,000 Corrugator Owned Vernon, CA(5) 200,000 Corrugator/Sheet(4) Owned North Brunswick, NJ(6) 107,220 Sheet Leased In January 1998, the Company sold its Dallas and Houston corrugating operations for $19.8 million in cash, subject to working capital adjustments, which approximated net book value. Approximately $11.2 million of the net proceeds is held in trust pursuant to the terms of the Indenture governing the Senior Notes and the remainder has been used for working capital purposes. ---------- (1) Properties acquired in the St. Joe Acquisition. (2) Property net leased from Florida Coast for a nominal rental payment. (3) Properties owned, directly or indirectly, by Dennis Mehiel. See "Certain Relationships and Related Party Transactions." (4) Sheet plants which have the capability to produce partitions. (5) Acquired on June 4, 1996 by Box USA Group, Inc., a wholly-owned subsidiary of the Company, for approximately $4.5 million. The Company has spent approximately $1.2 million for capital expenditures on this property. Full operations commenced during Fiscal 1997. (6) Inactive facilities. (7) Machinery and equipment sold in January 1997 and the property net leased to the purchaser. (8) Lease terminated. 7
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Item 3. LEGAL PROCEEDINGS From time to time, the Company is subject to legal proceedings and other claims arising in the ordinary course of its business. The Company maintains insurance coverage against claims in an amount which it believes to be adequate. The Company believes that it is not presently a party to any litigation, the outcome of which could reasonably be expected to have a material adverse effect on its financial condition or results of operations. On July 19, 1996, a civil action was filed in the Superior Court of Fulton County, Georgia (the "Suit") by Sid Dunken, individually and on behalf of D&M Partnership, a purported Georgia partnership, against Four M, Box USA Group, Inc., Four M Manufacturing Group of Georgia, Inc. and Dennis Mehiel. The complaint alleges that Dunken is entitled to an equity interest in Four M or in the alternative, $150,000,000 in compensatory damages, as well as punitive damages and attorneys' fees. On September 23, 1996, the Company filed an answer in response to the Complaint. The Company believes that the Suit is without merit. The Company intends to defend against the Suit vigorously and believes that it has adequate defenses. However, the Suit is in a very preliminary stage, and there can be no assurance that the outcome of the Suit will not be adverse to Four M. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS During the fourth quarter of the fiscal year covered by this report, no matter was submitted to a vote of security holders of the Company. 8
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PART II Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS There is no established public trading market for the Company's Common Stock. Dennis Mehiel, the Chairman of the Board of Directors and the Chief Executive Officer of the Company, is the sole beneficial shareholder of the Company's outstanding Common Stock. Item 6. SELECTED FINANCIAL DATA The following historical data have been derived from consolidated financial statements of the Company. The data as of and for the year ended December 31, 1997, the five months ended December 31, 1996, and the fiscal years ended July 31, 1996, 1995 and 1994 are derived from the consolidated financial statements of the Company audited by BDO Seidman, LLP, independent certified public accountants, whose report thereon is included elsewhere in this report or are incorporated by reference. The data as of and for the fiscal year ended July 31, 1993 is derived from the Company's consolidated financial statements audited by KPMG Peat Marwick LLP, independent certified public accountants, whose report is not included herein. The data as of and for the five months ended December 31, 1995 are unaudited, but in the opinion of management, include all adjustments (consisting only of normal recurring adjustments and accruals) which the Company considers necessary for a fair presentation of the operating results for that period. The following data should be read in conjunction with the Company's consolidated financial statements, and related notes, "Management's Discussions and Analysis of Financial Condition and Results of Operations" and the other financial information included elsewhere herein. 9
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· Enlarge/Download Table Year ended December Five Months Ended 31, December 31, Fiscal Year Ended July 31, --- ------------ ----------------------------------------------- 1997 1996 1995 1996 1995 1994 1993 --------- --------- --------- --------- --------- --------- --------- (In thousands) Statement of Operation Data: Net sales ............................... $ 468,867 $ 196,787 $ 95,614 $ 257,817 $ 271,994 $ 228,563 $ 214,936 Cost of goods sold ...................... 403,160 171,304 81,119 222,105 232,154 205,025 192,208 --------- --------- --------- --------- --------- --------- --------- Gross profit ............................ 65,707 25,483 14,495 35,712 39,840 23,538 22,728 Selling, general and administrative expenses ................................ 47,503 17,499 6,320 19,217 19,703 22,018 21,813 Plant shutdown expenses ................. 2,800 -- -- -- -- -- -- --------- --------- --------- --------- --------- --------- --------- Income from operations .................. 15,404 7,984 8,175 16,495 20,137 1,520 915 Loss on joint venture contract .......... 7,408 1,668 -- -- -- -- -- Other income ............................ 529 425 2 -- 1,927 126 3,651 Interest expense ........................ 26,917 10,314 1,589 7,565 5,607 5,448 4,948 --------- --------- --------- --------- --------- --------- --------- Income (loss) before provision (benefit) for income taxes, minority interest, cumulative effect of change in method of accounting and extraordinary gain on early retirement of debt ............. (18,392) (3,573) 6,588 8,930 16,457 (3,802) (382) Minority interest ....................... (26) (87) -- -- (146) (180) -- Cumulative effect in change in method of accounting for taxes on income ....... -- -- -- -- -- 381 -- Provision (benefit) for income taxes .... (12,895) (1,486) 2,966 3,817 5,483 (325) 453 Extraordinary gain on early retirement of debt ................................. -- -- -- -- 2,219 -- -- --------- --------- --------- --------- --------- --------- --------- Net income (loss) ....................... $ (5,523) $ (2,174) $ 3,622 $ 5,113 $ 13,047 $ (3,276) $ (835) ========= ========= ========= ========= ========= ========= ========= Other Financial Data: Ratio of earnings to fixed charges(1) ... 0.4x 0.7x 3.9x 2.0x 3.3x 0.5x 1.0x EBITDA(2) ............................... $ 30,171 $ 13,271 $ 9,607 $ 21,677 $ 25,382 $ 6,796 $ 6,209 Net cash provided by (used for) operating activities(3) ........................... (5,132) (3,930) 1,127 26,621 (2,217) 4,794 8,860 Net cash provided by (used for) investing activities .............................. (22,591) (4,707) (221) (166,203) (1,975) (9,126) (4,135) Net cash provided by (used for) financing activities .............................. 27,433 10,257 (1,032) 139,167 3,518 5,182 (3,841) Depreciation and amortization ........... 14,767 5,287 1,432 5,182 5,245 5,276 5,294 Capital expenditures .................... 29,072 6,721 1,405 8,612 3,690 3,916 3,935 Adjusted net sales(4) ................... 468,867 196,787 89,252 246,140 212,562 155,869 153,857 Adjusted EBITDA(4) ...................... 30,171 13,271 11,057 24,831 24,210 3,926 2,196 Year ended December Five Months Ended 31, December 31, Fiscal Year Ended July 31, --- ------------ -------------------------- 1997 1996 1995 1996 1995 1994 1993 -------- -------- -------- -------- -------- -------- -------- (In thousands) Balance Sheet Data: Working capital .................. $ 53,196 $ 38,537 $ 16,108 $ 37,590 $ 14,504 $ 8,903 $ 10,413 Property, plant and equipment, net 181,549 173,333 33,736 157,973 27,044 36,536 36,052 Total assets ..................... 322,774 296,333 76,322 263,809 73,137 93,933 79,716 Total long-term debt ............. 237,323 210,691 36,113 187,092 30,998 44,105 40,993 Stockholder's equity ............. 6,665 12,188 12,131 14,362 8,649 1,278 4,554 The accompanying footnotes, which are an integral part of this financial data, appear on the following page. 10
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(1) For purpose of calculating the ratio of earnings to fixed charges, earnings consist of earnings (loss) before provision (benefit) for income taxes, minority interest and extraordinary gain on early retirement of debt plus fixed charges, and fixed charges consist of interest expense plus that portion of rental payments on operating leases deemed representative on the interest factor. (2) EBITDA represents income from operations before interest expense, provision (benefit) for income taxes and depreciation and amortization. EBITDA provides information regarding a company's ability to service and/or incur debt. EBITDA should not be considered in isolation or as a substitute for net income, cash flows from operations or other consolidated income or cash flow data prepared in accordance with generally accepted accounting principles or as a measure of a company's profitability or liquidity. EBITDA is not intended to disclose excess funds available for reinvestments because other commitments and obligations exist, including, but not limited to, principal repayment obligations and lease commitments, that are not considered in the calculation of EBITDA. See Notes 12, 13 and 16 through 19 to the Company's financial statements. (3) Material differences between EBITDA and net cash provided by or used in operating activities may occur because of the inherent differences in each such calculation including (a) the change in operating assets and liabilities between the beginning and end of each period, as well as certain non-cash items which are considered when presenting net cash provided by or used in operating activities but are not used when calculating EBITDA and (b) interest expense, provision for income taxes and other income or expenses, which are included when presenting net cash provided by or used in operating activities but are not included in the calculation of EBITDA. EBITDA is a measure used as part of the covenants of the Credit Facility. (4) Adjusted to exclude the results of The Fonda Group, Inc. ("Fonda"), which was a subsidiary of the Company until March 1995, and the Flint, Michigan facility (the "Flint Facility") which was owned by Box USA Group, Inc. ("Box USA Group"), a wholly-owned subsidiary of the Company. On August 16, 1996, Box USA Group discontinued its operations at the Flint Facility and disposed of substantially all of the machinery and equipment, finished goods and work-in-progress inventory and certain related assets utilized at such facility. 11
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Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS General The following discussion and analysis should be read in conjunction with the financial statements of the Company and the notes thereto included elsewhere in this report. In December 1996, the Company changed its fiscal year end from July 31 to December 31. To facilitate comparisons of the operating results, the data as of and for the year ended December 31, 1996 and for the five months ended December 31, 1995 are unaudited, but in the opinion of management include all adjustments (consisting only of normal recurring adjustments and accruals) which the Company considers necessary for a fair presentation of the operating results for that period. The table presented below is in millions of dollars, except for percentage amounts. The Company manufactures corrugated paper, rolled paper and other paper products such as cartons and displays. The markets for corrugated packing materials produced by the Company are generally subject to changes in industry capacity and cyclical changes in the economy, both of which can significantly impact the Company's profitability. The ability of the Company to sustain profitability during cyclical fluctuations in corrugating packaging material markets is dependent upon the Company's ability to maintain value-added margins (net sales less the cost of raw materials). For corrugated packaging material manufacturers, raw materials typically represent approximately 70% of the total cost of goods sold. The ability of the Company to maintain value-added margins is primarily a function of the speed with which the Company can pass on raw material cost increases to its customers or conversely, absorb reductions in raw materials prices. Historically, the Company has been able to sustain consistent value-added margins on a unit basis. In addition, the Company also believes it has been able to mitigate raw material price increases at its converting facilities by entering into several long-term supply contracts. In April 1997, the Joint Venture Partners shut down the St. Joe Mill due to a decline in prices for linerboard as a result of increased capacity in the industry. The mill resumed full production in October 1997. During the period of the St. Joe Mill shutdown, the Company remained subject to the terms of the Output Purchase Agreement and pursuant thereto, paid a purchase price adjustment in the amount of $17.5 million. In addition, the Company increased the Reserve by $6.0 million in 1997. In Fiscal 1997, the Company advanced loans of $1.6 million under the Subordinated Credit Facility. The loans under the Subordinated Credit Facility are fully reserved. In Fiscal 1997, prices for corrugating medium declined as a result of increased capacity in the industry and decreased demand for such products. In response to such market conditions, the Company shut down the Ft. Madison Mill on March 31, 1997 and resumed limited production on August 18, 1997. Full production commenced on September 1, 1997. · Enlarge/Download Table Year Ended December 31, Five Months Ended December 31, ------------------------------------- ------------------------------------ 1997 1996 1996 1995 ---------------- ---------------- ---------------- --------------- Percent Percent Percent Percent of Net of Net of Net of Net Amount Sales Amount Sales Amount Sales Amount Sales ------ ------ ------ ------ ------ ------ ------ ------ Net sales ...................... $468.9 100.0% $360.5 100.0% $196.8 100.0% $ 95.6 100.0% Cost of goods sold ............. 403.2 86.0 315.8 87.6 171.3 87.0 81.1 84.8 Gross profit ................... 65.7 14.0 44.7 12.4 25.5 13.0 14.5 15.2 Selling, general and ........... administrative expenses ... 47.5 10.1 30.5 8.5 17.5 8.9 6.3 6.6 Plant shutdown expenses ........ 2.8 .6 -- -- -- -- -- -- Income from operations ......... 15.4 3.3 14.2 3.9 8.0 4.1 8.2 8.6 Loss on joint venture contract . 7.4 1.6 -- -- 1.7 0.9 -- -- Other income ................... .5 .1 .6 .2 0.4 0.2 -- -- Interest expense ............... 26.9 5.7 16.4 4.5 10.3 5.2 1.6 1.7 ------ ------ ------ ------ ------ ------ ------ ------ Income (loss) before provision (benefit) for income taxes, minority interest and extraordinary gain on early retirement of debt ...................... (18.4) (3.9) (1.6) (.4) (3.6) (1.8) 6.6 6.9 Provision (benefit) for income taxes .............. (12.9) (3.2) (.5) (.1) (1.5) (0.1) 3.0 3.1 ------ ------ ------ ------ ------ ------ ------ ------ Net income (loss) before minority interest and extraordinary gain on early retirement of debt ........ $ (5.5) (.7)% $ (1.1) (.3)% $ (2.1) (1.1)% $ 3.6 3.8% ====== ====== ====== ====== ====== ====== ====== ====== Fiscal Year Ended July 31, 1996 1995 --------------- --------------- Percent Percent of Net of Net Amount Sales Amount Sales ------ ------ ------ ------ Net sales ...................... $257.8 100.0% $272.0 100.0% Cost of goods sold ............. 222.1 86.2 232.2 85.4 Gross profit ................... 35.7 13.8 39.8 14.6 Selling, general and ........... administrative expenses ... 19.2 7.4 19.7 7.2 Plant shutdown expenses ........ -- -- -- -- Income from operations ......... 16.5 6.4 20.1 7.4 Loss on joint venture contract . -- -- -- -- Other income ................... -- -- 2.0 0.7 Interest expense ............... 7.6 2.9 5.6 2.1 ------ ------ ------ ------ Income (loss) before provision (benefit) for income taxes, minority interest and extraordinary gain on early retirement of debt ...................... 8.9 3.5 16.5 6.1 Provision (benefit) for income taxes .............. 3.8 1.5 5.5 2.0 ------ ------ ------ ------ Net income (loss) before minority interest and extraordinary gain on early retirement of debt ........ $ 5.1 2.0% $ 11.0 4.1% ====== ====== ====== ====== 12
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Year Ended December 31, 1997 Compared to the Year Ended December 31, 1996 (Unaudited) Net sales for the fiscal year ended December 31, 1997 were $468.9 million compared to $360.5 million in the comparable 1996 period, an increase of 30%. The net sales increase was due to increased unit volume primarily as a result of the St. Joe Acquisition and the New Jersey Acquisition. On a proforma basis, unit volume for the Company's corrugating operations increased 8.4% while average selling prices declined 15.0% in Fiscal 1997 compared to Fiscal 1996, assuming a full year of operations for the acquisitions consummated in Fiscal 1996. Net sales at the Ft. Madison Mill were $13.2 million compared to $17.3 million in the comparable 1996 period due to a decrease in average selling prices and unit volumes as a result of the Ft. Madison Mill shutdown. Gross profit increased $21.0 million, or 46.9%, to $65.7 million in Fiscal 1997. The gross profit increase was due to increased unit volume primarily as a result of the St. Joe Acquisition and the New Jersey Acquisition, which was partially offset by losses arising from the temporary shutdown at the Ft. Madison Mill. Margins as a percentage of net sales, however, decreased due to the decline in average selling prices, which were substantially offset by lower raw material costs and losses at the Fort Madison Mill. Selling, general and administrative expenses increased $17.0 million, or 56%, to $47.5 million in Fiscal 1997. This increase is primarily attributable to the St. Joe Acquisition and the New Jersey Acquisition. As a percentage of net sales, the selling, general and administrative expenses increased to 10.1% in Fiscal 1997 compared to 8.5% in the comparable 1996 period primarily as a result of lower average selling prices. As a result of the foregoing factors, income from operations increased $1.2 million, or 8.5%, to $15.4 million in Fiscal 1997 from $14.2 million in the comparable 1996 period. Interest expense increased $10.5 million, or 64%, to $26.9 million in Fiscal 1997 from $16.4 million in the comparable 1996 period, primarily as a result of the Company's 12% Senior Secured Notes due 2006 issued in connection with the St. Joe Acquisition. An income tax benefit of $12.9 million was recorded during Fiscal 1997. The increased benefit arose from the reversal of the valuation allowance in 1997. 1996 Transition Period Compared to the Five Month Period Ended December 31, 1995 Net sales were $196.8 million in the five month period from August 1, 1996 to December 31, 1996 (the "1996 Transition Period") compared to $95.6 million in the comparable 1995 period, an increase of 105.9%. The sales increase was due to increased unit volume primarily as a result of the St. Joe Acquisition and the New Jersey Acquisition which was partially offset by a decrease in average selling prices during the 1996 Transition Period. Net sales at the Ft. Madison Mill were $6.1 million in the 1996 Transition Period compared to $15.3 million in the comparable 1995 period primarily due to a 54.1% decrease in sales price to $262 per ton. Gross profit increased $11.0 million, or 75.9%, to $25.5 million in the 1996 Transition Period from $14.5 million in the 1995 Period. The gross profit increase was due to increased unit volume primarily as a result of the St. Joe Acquisition and the New Jersey Acquisition which was partially offset by losses arising from the temporary shutdown of the Ft. Madison Mill during the 1996 Transition Period. Margins as a percentage of net sales, however, decreased due to the decline in average selling prices, which was partially offset by lower raw material costs of linerboard and losses at the Fort Madison Mill. Selling, general and administrative expenses increased $11.3 million, or 181.0%, to $17.6 million in the 1996 Transition Period from $6.3 million in the comparable 1995 period, primarily as a result of the St. Joe Acquisition and the New Jersey Acquisition. Selling, general and administrative expenses as a percent of net sales increased to 9.0% in the 1996 Transition Period from 6.6% in the comparable 1995 period. This increase is primarily a result of lower average selling prices. Loss on joint venture contract was $1.7 million in the 1996 Transition Period. Operating income decreased $0.4 million, or 4.9%, to $7.8 million in the 1996 Transition Period from $8.2 million in the comparable 1995 period, operating income decreased $.4 million, or $4.9%, to $7.8 million in the 1996 Transition Period from $8.2 million in the comparable 1995 period, primarily a result of a decrease in selling price per ton. Interest expense was $10.1 million in the 1996 Transition Period compared to $1.6 million in the comparable 1995 period. This increase is primarily a result of the issuance of the Company's 12% Senior Secured Notes due 2006 in connection with the St. Joe Acquisition. An income tax benefit of $1.5 million was recorded in the 1996 Transition Period as compared to a provision of $3.0 million in the comparable 1995 period. This change is related to the decrease in income before taxes. The effective tax rate in the 1996 Transition 13
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Period was 41.6% compared to 45.5% in the comparable 1995 period. This decrease was primarily due to a gain on the sale of one of the Company's subsidiaries in the comparable 1995 period. Fiscal 1996 Compared to Fiscal 1995 The Company's net sales decreased $14.2 million, or 5.2%, to $257.8 million in Fiscal 1996 compared to $272.0 million in the twelve month period ended July 31, 1995 ("Fiscal 1995"). Net sales for the Company's converting operations increased $39.9 million, or 20.4%, to $235.9 million in Fiscal 1996 compared to $196.0 million in Fiscal 1995 primarily as a result of the St. Joe Acquisition, which increased sales by $44.8 million, or 22.8%. This increase was partially offset by the effect of the sale in August 1995 by the Company of its equity interest in Timberline Packaging, Inc. ("Timberline"), a converting facility which accounted for $1.2 million, or 0.5%, of net sales for Fiscal 1996 compared to $13.6 million, or 5.0%, for Fiscal 1995. Net sales at the Ft. Madison Mill decreased $11.7 million, or 34.8%, to $21.9 million in Fiscal 1996 compared to $33.6 million in Fiscal 1995 due to a 16.1% decrease in price per ton to $371.47 in Fiscal 1996 from $442.67 in Fiscal 1995. The Company's net sales decreased by $42.4 million, or 15.6%, in Fiscal 1996 due to the spinoff of Fonda in March 1995. Gross profit decreased $4.1 million, or 10.3%, to $35.7 million in Fiscal 1996 compared to $39.8 million in Fiscal 1995. As a percentage of net sales, gross profit decreased to 13.8% in Fiscal 1996 compared to 14.6% in Fiscal 1995. Gross profit as a percentage of net sales for the Company's converting operations decreased to 12.0% in Fiscal 1996 compared to 12.4% in Fiscal 1995 as a result of a shift in product mix in Fiscal 1996. Gross profit as a percentage of net sales for the Ft. Madison Mill decreased to 25.7% in Fiscal 1996 compared to 26.8% in Fiscal 1995 primarily as a result of a decrease in selling prices per ton. Selling, general and administrative expenses decreased $0.5 million, or 2.5%, to $19.2 million in Fiscal 1996 from $19.7 million in Fiscal 1995. The decrease is primarily a result of the elimination of Fonda's expenses after March 1995, partially offset by the addition of St. Joe expenses for June and July 1996. Selling, general and administrative expenses as a percent of net sales remained flat in Fiscal 1996 and Fiscal 1995. Operating income decreased $3.6 million, or 31.9%, to $16.5 million in Fiscal 1996 from $20.1 million in Fiscal 1995, primarily as a result of the spin-off of Fonda, the sale of the Company's interest in Timberline and a decrease in selling price per ton. Income taxes decreased $1.7 million to $3.8 million in Fiscal 1996 compared to $5.5 million in Fiscal 1995. This decrease in the provision for income taxes is related to the decrease in income before taxes. Liquidity and Capital Resources Historically, the Company has relied on cash flows from operations and bank borrowing to finance its working capital requirements and capital expenditures. Net cash used for investing activities was $22.6 million in Fiscal 1997 compared to $171.4 million ($159.5 million of which included the St. Joe Acquisition and the New Jersey Acquisition) in the comparable 1996 period. Gross capital expenditures were $29.1 million in Fiscal 1997 as compared to $15.0 million in Fiscal 1996. This increase in capital expenditures was primarily due to upgrade and maintenance capital expenditures at the converting facilities acquired by the Company in the St. Joe Acquisition and includes outfitting the Company's new facility in Vernon, California with machinery and equipment. A portion of the funding for the 1997 capital expenditures was derived from the net proceeds of the sale of other fixed assets. The Company's 1998 capital expenditure budget is $12.7 million and will be financed through a trust account pursuant to the terms of the Indenture governing the Senior Notes. Net cash provided by financing activities was $27.4 million in Fiscal 1997 compared to $166.8 million in the comparable 1996 period. This difference is primarily attributable to the issuance of the 12% Senior Secured Notes in Fiscal 1996 and higher net borrowings under the revolving credit agreement in Fiscal 1997. On May 30, 1996, the Company established a Credit Facility which matures in 2001. The Credit Facility provides total borrowing of up to $80.0 million on a revolving basis, subject to borrowing base limitations, to finance the Company's working capital needs. Unused borrowing base availability must be at least $5.0 million. Effective December 5, 1997 the Credit Facility was modified, so as to among other things, (i) reduce, per the Company's request, the borrowing capacity from $80.0 million to $65.0 million; (ii) modify the base borrowing interest rate from the lender's prime rate plus .5% to a sliding scale rate, based on performance, of the lender's prime rate plus .5% to 1.0%; and (iii) reduce the minimum unused borrowing base availability to $1.0 million increasing on December 31, 1998 to $5.0 million. On December 31, 1997, the Company had unused borrowing capacity of approximately $6.2 million under the Credit Facility. 14
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In addition, pursuant to the Subordinated Credit Facility, the Company will provide, if needed, Florida Coast with up to $10.0 million of subordinated indebtedness on a revolving credit basis. During Fiscal 1997, the Company advanced loans of $1.6 million to Florida Coast under the Subordinated Credit Facility which are fully reserved. Florida Coast currently has availability of $8.4 million from each Joint Venture Partner under the Subordinated Credit Facility. Pursuant to the Output Purchase Agreement, the Company paid Florida Coast approximately $44.0 million for its share of the linerboard produced by the St. Joe Mill during Fiscal 1997. During the period of the St. Joe Mill shutdown, the Company remained subject to the terms of the Output Purchase Agreement and pursuant thereto, paid a purchase price adjustment in the amount of $17.5 million. In addition, the Company increased the Reserve by $6.0 million in 1997. The St. Joe Mill is expected to generate net earnings and operating cash flow in 1998 and additional reserve requirements are not anticipated. Although there can be no assurance, the Company believes that cash generated by operations together with amounts available under the Credit Facility, will be sufficient to meet its debt service requirements and working capital needs for the next twelve months. Impact of Inflation A period of rising prices will affect the Company's cost of production and, in particular, the Company's raw material costs. Since the Company's business is a margin business, the impact of increased costs on the Company will depend upon the Company's ability to pass on such costs to its customers. The Company is typically able to pass on a significant portion of its increased raw material costs in a timely fashion. From time to time, however, there is a lag in passing on price adjustments which creates a temporary margin contraction in a rising price environment. Historically, the Company has been able to recover fully from the impact of rising prices over a short period of time. Environmental Matters The Company's operations are subject to environmental regulation by federal, state and local authorities in the United States. The Company believes that it is in substantial compliance with current federal, state and local environmental regulation. Unreimbursed liabilities arising from environmental claims, if significant, could have a material adverse effect on the Company's results of operations and financial condition. Furthermore, actions by federal, state and local governments concerning environmental matters could result in laws or regulations that could increase the cost of compliance with environmental laws and regulations. The operations of the St. Joe Mill are subject to extensive and changing environmental regulation by federal, state and local authorities. Significant capital expenditures have been made in the past to comply with water, air and solid and hazardous waste regulations at the St. Joe Mill. The St. Joe Mill expects to make significant expenditures in the future. Capital expenditures by the St. Joe Mill for environmental control equipment was approximately $0.2 million in Fiscal 1997 and is budgeted to be approximately $1.0 million in Fiscal 1998. In November 1997, the EPA issued its final rules, informally known as the "cluster rules", which are more stringent than the existing requirements for discharge of wastewaters under the Clean Water Act and impose new requirements on air emissions under the Clean Air Act for the pulp and paper industry. Although the final rules are less stringent, in some respect, than as initially proposed, the Company currently believes that the St. Joe Mill will be required to make capital expenditures of approximately $30 million during the period of 1998 through 2005 in order to meet the requirements of the new regulations . The Joint Venture Partners may determine that, under the final regulations, the costs associated with the production of mottled white linerboard are prohibitive and could therefore discontinue its production. If the Joint Venture Partners determine to discontinue the production of mottled white linerboard, the Company estimates the capital spending that would be required to comply with the regulations would be approximately $9 million. Because of the current