Bemis Company 10-K 2007
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2006
Commission File Number 1-5277
BEMIS COMPANY, INC.
(Exact name of Registrant as specified in its charter)
Registrants telephone number, including area code:
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to section 12(g) of the Act: None
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No o
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x
Indicate by check mark whether the Registrant 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 and has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrants 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. x
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.
Large Accelerated Filer x Accelerated Filer o Non-Accelerated Filer o
Indicate by check mark whether the Registrant is a shell company. Yeso No x
The aggregate market value of the voting stock held by nonaffiliates of the Registrant on June 30, 2006, based on a closing price of $30.62 per share as reported on the New York Stock Exchange, was $3,210,079,000.
As of February 28, 2007, the Registrant had 104,591,366 shares of Common Stock issued and outstanding.
Documents Incorporated by Reference
Portions of the Proxy Statement - Annual Meeting of Stockholders May 3, 2007 - Part III
BEMIS COMPANY, INC. AND SUBSIDIARIES
ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Bemis Company, Inc., a Missouri corporation (the Registrant or Company), continues a business formed in 1858. The Company was incorporated in 1885 as Bemis Bro. Bag Company with the name changed to Bemis Company, Inc. in 1965. The Company is a principal manufacturer of flexible packaging products and pressure sensitive materials, selling to customers throughout the United States, Canada, South America, and Europe with a growing presence in Asia Pacific and Mexico. In 2006, approximately 82 percent of the Companys sales were derived from the Flexible Packaging segment and approximately 18 percent were derived from the Pressure Sensitive Materials segment.
The Companys products are sold to customers primarily in the food industry. Other customers include companies in the following types of businesses: chemical, agribusiness, medical, pharmaceutical, personal care, electronics, automotive, construction, graphic industries, and other consumer goods. Further information about the Companys operations in its business segments is available at Note 12 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
As of December 31, 2006, the Company had approximately 15,700 employees, about 10,400 of whom were classified as production employees. Many of the North American production employees are covered by collective bargaining contracts involving three different international unions, one independent union, and 15 individual contracts with terms ranging from one to six years. During 2006, two contracts covering approximately 300 employees at two different locations in the United States were successfully negotiated. Four domestic labor agreements covering approximately 300 employees are scheduled to expire in 2007. Many of the non-North American production employees as well as some of the non-North American salaried workforce are covered by collective bargaining contracts involving nine different unions with terms ranging from one to two years.
Working capital elements fluctuate throughout the year in relation to the level of customer volume and other marketplace conditions. Inventory levels reflect a reasonable balance between raw material pricing and availability, and the Companys commitment to promptly fill customer orders. Manufacturing backlogs are not a significant factor in the industries in which the Company operates. The business of each of the segments is not seasonal to any significant extent.
The Company is the owner or licensee of a number of United States and foreign patents and patent applications that relate to certain of its products, manufacturing processes, and equipment. The Company also has a number of trademarks and trademark registrations in the United States and in foreign countries. The Companys patents, licenses, and trademarks collectively provide a competitive advantage. However, the loss of any single patent or license alone would not have a material adverse effect on the Companys results as a whole or those of either of its segments.
The Companys business activities are organized around its two business segments, Flexible Packaging and Pressure Sensitive Materials. Both internal and external reporting conform to this organizational structure. A summary of the Companys business activities reported by its two business segments follows.
Flexible Packaging Segment
The flexible packaging segment manufactures a broad range of consumer and industrial packaging. Multilayer flexible polymer film structures and laminates are sold for food, medical, and personal care products as well as non-food applications utilizing vacuum or modified atmosphere packaging. Additional products include blown and cast stretchfilm products, carton sealing tapes and application equipment, custom thermoformed plastic packaging, multiwall and single-ply paper bags, printed paper roll stock, and bag closing materials. Markets for our products include processed and fresh meat, liquids, frozen foods, cereals, snacks, cheese, coffee, condiments, candy, pet food, bakery, seed, lawn and garden, tissue, fresh produce, personal care and hygiene, disposable diapers, printed shrink overwrap for the food and beverage industry, agribusiness, pharmaceutical, minerals, and medical device packaging.
Pressure Sensitive Materials Segment
The pressure sensitive materials segment manufactures pressure sensitive materials that are sold into label markets, graphic markets, and technical markets.
Products for label markets include narrow-web rolls of pressure sensitive paper, film, and metalized film printing stocks used in high-speed printing and die-cutting of primary package labeling, secondary or promotional decoration, and for high-speed, high-volume data processing (EDP) stocks, bar code labels, and numerous laser printing applications. Primary markets include food and consumer goods, inventory control labeling, shipping labels, postage stamps, and laser/ink jet printed labels.
Products for graphic markets include pressure sensitive papers and films used for decorative signage through computer-aided plotters, digital and screen printers, and photographic overlaminate and mounting materials including optically clear films with built-in UV inhibitors. Offset printers, sign makers, and photo labs use these products on short-run and/or digital printing technology to create signs or vehicle graphics. Primary markets are indoor and outdoor signage, photograph and digital print overlaminates, and vehicle graphics.
Products for technical markets are pressure sensitive materials that are technically engineered for performance in varied industrial applications. They include micro-thin film adhesives used in delicate electronic parts assembly and pressure sensitives utilizing foam and tape based stocks to perform fastening and mounting functions. Tapes sold to medical markets feature medical-grade adhesives suitable for direct skin contact. Primary markets are electronics, automotive, construction, medical, and pharmaceuticals.
Marketing, Distribution, and Competition
While the Companys sales are made through a variety of distribution methods, more than 90 percent of each segments sales are made by the Companys direct sales force. Sales offices and plants are located throughout the United States, Canada, United Kingdom, Continental Europe, Scandinavia, Asia Pacific, South America, and Mexico to provide prompt and economical service to more than 30,000 customers. The Companys technically trained sales force is supported by product development engineers, design technicians, and a customer service organization.
No single customer accounts for ten percent or more of the Companys total sales. Furthermore, the loss of one or a few major customers would not have a material adverse effect on the Companys operating results. Nevertheless, business arrangements with large customers require a large portion of the manufacturing capacity at a few individual manufacturing sites. Any change in the business arrangement would typically occur over a period of time, which would allow for an orderly transition for both the Companys manufacturing site and the customer.
The major markets in which the Company sells its products are highly competitive. Areas of competition include service, innovation, quality, and price. This competition is significant as to both the size and the number of competing firms. Major competitors in the Flexible Packaging segment include Alcan Packaging, Amcor Limited, Exopack Company, Hood Packaging Corporation, Intertape Polymer Group Inc., Pliant Corporation, Printpack, Inc., Sealed Air Corporation, Smurfit-Stone Container Corporation, Sonoco Products Company, and Wihuri OY. In the Pressure Sensitive Materials segment major competitors include 3M, Acucote, Inc., Avery Dennison Corporation, Flexcon Co., Inc., Green Bay Packaging Inc., Ricoh Company, Ltd., Ritrama Inc., Spinnaker Industries, Inc., Technicote Inc., UPM-Kymmene Corporation, and Wausau Coated Products Inc.
The Company considers itself to be a significant factor in the market niches it serves; however, due to the diversity of the Flexible Packaging and Pressure Sensitive Materials segments, the Companys precise competitive position in these markets is not reasonably determinable. Advertising is limited primarily to business and trade publications emphasizing the Companys product features and related technical capabilities and the individual problem-solving approach to customer problems.
Plastic resins and films, paper, inks, adhesives, and chemicals constitute the basic major raw materials. These are purchased from a variety of industry sources and the Company is not dependent on any one supplier for its raw materials. While temporary industry-wide shortages of raw materials may occur, the Company expects to continue to successfully manage raw material supplies without significant supply interruptions, as demonstrated during the 2005 hurricane season. Currently, raw materials are readily available.
Research and Development Expense
Research and development expenditures were as follows:
Compliance with federal, state, and local provisions which have been enacted or adopted regulating discharges of materials into the environment or otherwise relating to the protection of the environment, is not expected to have a material effect upon the capital expenditures, earnings, or competitive position of the Company and its subsidiaries.
The Company is a large accelerated filer (as defined in Exchange Act Rule 12b-2) and is also an electronic filer. Electronically filed reports (Forms 4, 8-K, 10-K, 10-Q, S-3, S-8, etc.) can be accessed at the Securities and Exchange Commission (SEC) website (http://www.sec.gov) or by visiting the SECs Public Reference Room located at 100 F St., N.E., Washington, DC 20549 (call 1-202-551-8090 or 1-800-732-0330 for hours of operation). Electronically filed reports can also be accessed through the Companys own website (http://www.bemis.com), under Investor Relations/SEC Filings or by writing for free information, including SEC filings, to Investor Relations, Bemis Company, Inc., One Neenah Center, 4th Floor, P.O. Box 669, Neenah, Wisconsin 54957-0669, or calling (920) 727-4100. In addition, the Companys Board Committee charters, Principles of Corporate Governance, and the Companys code of business conduct and ethics can be electronically accessed at the Companys website under Company Overview or, free of charge, by writing directly to the Company, Attention: Corporate Secretary. The Company has adopted a Financial Code of Ethics which is filed as an exhibit to this Annual Report on Form 10-K, and is also posted on the Companys website. The Company intends to post any amendment to, or waiver from, a provision of the Financial Code of Ethics that applies to our principal executive officer, principal financial officer, principal accounting officer, controller and other persons performing similar functions on the Investor Relations section of its website (www.bemis.com) promptly following the date of such amendment or waiver.
Explanation of Terms Describing the Companys Products
Barrier laminate A multilayer plastic film made by laminating two or more films together with the use of glue or a molten plastic to achieve a barrier for the planned package contents.
Barrier products Products that provide protection and extend the shelf life of the contents of the package. These products provide this protection by combining different types of plastics and chemicals into a multilayered plastic package. These products protect the contents from such things as moisture, sunlight, odor, or other elements.
Blown film A plastic film that is extruded through a round die in the form of a tube and then expanded by a column of air in the manufacturing process.
Cast film A plastic film that is extruded through a straight slot die as a flat sheet during its manufacturing process.
Coextruded film A multiple layer extruded plastic film.
Controlled atmosphere packaging A package which limits the flow of elements, such as oxygen or moisture, into or out of the package.
Decorative products Pressure sensitive materials used for decorative signage, promotional items, and displays and advertisements.
Flexible polymer film A non-rigid plastic film.
Flexographic printing The most common flexible packaging printing process in North America using a raised rubber or alternative material image mounted on a printing cylinder.
In-line overlaminating capability The ability to add a protective coating to a printed material during the printing process.
Label products Pressure sensitive materials made up and sold in roll form.
Labelstock Base material for pressure sensitive labels.
Modified atmosphere packaging A package in which the atmosphere inside the package has been modified by a gas such as nitrogen.
Monolayer film A single layer extruded plastic film.
Multiwall paper bag A package made from two or more layers of paper.
Polyolefin shrink film A packaging film consisting of polyethylene and/or polypropylene resins extruded via the blown process. The film can be irradiated in a second process to cross link the molecules for added strength, durability, and toughness. The product is characterized by thin gauge, high gloss, sparkle, transparency, and good sealing properties.
Pressure sensitive material A material with adhesive such that upon contact with another material it will stick.
Rotogravure printing A high quality, long run printing process utilizing a metal cylinder.
Sheet products Pressure sensitive materials cut into sheets and sold in sheet form.
Stretch film A plastic film used to wrap pallets in the shipping process, which has significant ability to stretch.
Technical products Technically engineered pressure sensitive materials used primarily for fastening and mounting functions.
Thermoformed plastic packaging A package formed by applying heat to a film to shape it into a tray or cavity and then placing a flat film on top of the package after it has been filled.
UV inhibitors Chemicals which protect against ultraviolet rays.
Funded status of pension plansRecognition of pension liabilities may cause a significant reduction in stockholders equity.
Statement of Financial Accounting Standards (FAS) No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans, requires balance sheet recognition of the funded status of our defined benefit pension and postretirement benefit plans. If the fair value of our pension plans assets at a future reporting date decreases or if the discount rate used to calculate the projected benefit obligation (PBO) as of that date decreases, we will be required to record the incremental change in the excess of PBO over the fair value of the assets as a reduction of stockholders equity. The resulting non-cash after-tax charge would not reduce reported earnings. It would be recorded directly as a decrease in the Accumulated Other Comprehensive Income component of stockholders equity. While we cannot estimate the future funded status of our pension liability with any certainty at this time, we believe that if the market value of assets or the discount rate used to calculate our pension liability decreases, the adjustment could significantly reduce our stockholders equity. A significant reduction in stockholders equity may impact our compliance with debt covenants or could cause a downgrade in our credit ratings that could also adversely impact our future cost and speed of borrowing and have an adverse affect on our financial condition, results of operations and liquidity. We have identified pension assumptions as critical accounting estimates. See Managements Discussion and Analysis of Financial Condition and Results of OperationsCritical Accounting Estimates and JudgmentsAccounting for annual pension costs and Pension assumptions sensitivity analysis included in Item 7 of this Annual Report on Form 10-K.
Goodwill and other intangible assetsA significant write down of goodwill and/or other intangible assets would have a material adverse effect on our reported results of operations and net worth.
On January 1, 2002, we adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (FAS No. 142). We no longer amortize goodwill, but we review our goodwill balance for impairment at least once a year using the business valuation methods required by FAS No. 142. These methods include the use of a weighted-average cost of capital to calculate the present value of the expected future cash flows of our reporting units. Future changes in the cost of capital, expected cash flows, or other factors may cause our goodwill and/or other intangible assets to be impaired, resulting in a non-cash charge against results of operations to write down these assets for the amount of the impairment. If a significant write down is required, the charge would have a material adverse effect on our reported results of operations and net worth. We have identified the valuation of intangibles as a critical accounting estimate. See Managements Discussion and Analysis of Financial Condition and Results of OperationsCritical Accounting Estimates and JudgmentsIntangible assets and goodwill included in Item 7 of this Annual Report on Form 10-K.
Foreign operationsConditions in foreign countries and changes in foreign exchange rates may reduce our reported results of operations.
We have operations in North America, South America, Europe, and Asia. In 2006, approximately 34 percent of our sales were generated by entities operating outside of the United States. Fluctuations in currencies can cause transaction and translation losses. In addition, our revenues and net income may be adversely affected by economic conditions, political situations, and changing laws and regulations in foreign countries, as to which we have no control.
Interest ratesAn increase in interest rates could reduce our reported results of operations.
At December 31, 2006, our variable rate borrowings approximated $467.0 million. Fluctuations in interest rates can increase borrowing costs and have an adverse impact on results of operations. In September 2001, we entered into interest rate swap agreements with three U.S. banks, which increased our exposure to variable rates. Accordingly, increases in short-term interest rates will directly
impact the amount of interest we pay. For each one percent increase in variable interest rates, our annual interest expense on $789.8 million of total debt ($467.0 million of which is variable) outstanding as of December 31, 2006 would increase by $4.7 million.
Credit Rating A downgrade in our credit rating could increase our borrowing costs and negatively affect our financial condition and results of operations.
In addition to using cash provided by operations, we regularly issue commercial paper to meet our short-term liquidity needs. Our credit ratings are important to our ability to issue commercial paper at favorable rates of interest. A downgrade in our credit rating could increase the cost of borrowing by increasing the spread over prevailing market rates that we pay for our commercial paper or the fees associated with our bank credit facility. In addition, our bank credit facility has covenants that include limits on the sale of businesses, minimum net worth calculations, and a maximum ratio of debt to total capitalization. If for any reason our existing credit arrangements were no longer available to us we would be required to seek alternative sources of financing. We would expect to meet our financial liquidity needs by accessing the bank market, which would further increase our borrowing costs.
Raw materialsRaw material cost increases or shortages could adversely affect our results of operations.
As a manufacturer, our sales and profitability are dependent upon the availability and cost of raw materials, which are subject to price fluctuations. Inflationary and other increases in the costs of raw materials have occurred in the past and are expected to recur, and our performance depends in part on our ability to reflect changes in costs in selling prices for our products. For example, operating profit during the first quarter of 2005 was negatively impacted as our selling prices did not keep pace with the rapidly increasing cost of polymer resins, adhesives, and coatings that occurred during the latter part of the fourth quarter of 2004 and the early part of the first quarter of 2005. In the past, we have been generally successful in managing increased raw material costs and increasing selling prices when necessary. Past performance may or may not be replicable in the future. Natural disasters such as hurricanes, in addition to terrorist activity and government regulation of environmental emissions, may negatively impact the production or delivery capacity of our raw material suppliers in the chemical and paper industries. This could result in increased raw material costs or supply shortages, which may have a negative impact on our profitability if we are unable to pass along the increased costs in our selling prices or, in the case of a shortage, secure raw materials from alternative sources.
Patents and proprietary technologyOur success is dependent on our ability to develop and successfully introduce new products and to acquire and retain intellectual property rights.
Our ability to develop and successfully market new products and to develop, acquire, and retain necessary intellectual property rights is essential to our continued success, which ability cannot be assured.
Industry investigationsSeveral lawsuits have been filed against us related to alleged unlawful competitive activities in the industry in connection with now-concluded investigations of the labelstock industry by the U.S. Department of Justice and of the paper and forest products sector by the European Commission.
In April 2003, we were notified by the U.S. Department of Justices Antitrust Division that it expected to initiate a criminal investigation into competitive practices in the labelstock industry, and in August 2003, the U.S. Department of Justice issued a subpoena to us in connection with the investigation. In May 2004, the European Commission, seeking evidence of unlawful anticompetitive activities, initiated inspections and obtained documents from our pressure sensitive materials facility in Belgium. We cooperated fully with these investigations, and both investigations were closed by each agency without further action. We and one of our subsidiaries are named defendants in lawsuits in the United States seeking treble damages and other relief for alleged unlawful competitive practices, which were filed after the announcement of the U.S. Department of Justice investigation. We are unable to predict the outcome of these matters although the effect could be material to the results of operations and/or cash flows of the period in which the matter is resolved.
AcquisitionsWe may not be able to successfully integrate the businesses that we acquire.
We have made numerous acquisitions in the past and are actively seeking new acquisitions that we believe will provide meaningful opportunities to grow our business and improve profitability. Since the beginning of 2003, we have completed three acquisitions to enhance the breadth of our product offerings and expand the market and geographic participation of our business segments, which included our acquisition on January 5, 2005 of majority ownership of Dixie Toga S.A., one of the largest packaging companies in South America. Acquired businesses may not achieve the levels of revenue, profit, productivity, or otherwise perform as we expect. Acquisitions involve special risks, including, without limitation, the potential assumption of unanticipated liabilities and contingencies as well as difficulties in integrating acquired businesses. While we believe that our acquisitions will improve our competitiveness and profitability, we can give no assurance that acquisitions will be successful or accretive to earnings.
Information technologyA failure in our information technology infrastructure or applications could negatively affect our business.
We depend on information technology to record and process customers orders, manufacture and ship products in a timely manner, and maintain the financial accuracy of our business records. We are in the process of developing a global Enterprise Resource Planning (ERP) system that will redesign and deploy new processes and a common information system across our plants over a period of several years. The first plant is scheduled to implement the new system during the fourth quarter of 2007, with the majority of our United States manufacturing operations expected to be using the new system by the end of 2009. There can be no certainty that this system will deliver the expected benefits. The failure to achieve our goals may impact our ability to (1) process transactions accurately and efficiently and (2) remain in step with the changing needs of the trade, which could result in the loss of customers. In addition, the failure to either deliver the application on time, or anticipate the necessary readiness and training needs, could lead to business disruption and loss of customers and revenue.
Our information systems could also be penetrated by outside parties intent on extracting information, corrupting information or disrupting business processes. Such unauthorized access could disrupt our business and could result in the loss of assets.
Numerous other factors over which we may have limited or no control may affect our performance and profitability.
Other factors that may influence our earnings include: legal and administrative cases and proceedings (whether civil, such as environmental and product related, or criminal), settlements, judgments, and investigations; developments or assertions by or against us relating to intellectual property rights and intellectual property licenses; adoption of new, or change in, accounting policies or practices and the application of such policies and practices; changes in business mix; customer and supplier business reorganizations or combinations; increase in cost of debt; ability to retain adequate levels of insurance coverage at acceptable rates; fluctuations in pension and employee benefit costs; loss of significant contract(s); risks and uncertainties relating to investment in development activities and new facilities; timely development and successful market acceptance of new products; pricing of competitive products; disruptions in transportation networks; increased participation in potentially less stable emerging markets; reliability of utility services; impact of computer viruses; general or specific economic conditions and the ability and willingness of purchasers to substitute other products for the products that we manufacture; financial condition and inventory strategies of customers and suppliers; credit risks; changes in customer order patterns; employee work stoppages at plants; increased competition; changes in government regulations and the impact of changes in the world political environment, including the ability to estimate the impact of foreign currency exchange rates on financial results; the impact of epidemiological events on the economy and on our customers and suppliers; and acts of war, terrorism, weather, and other natural disasters.
Properties utilized by the Company at December 31, 2006, were as follows:
Flexible Packaging Segment
This segment has 48 manufacturing plants located in 13 states and nine non-USA countries, of which 43 are owned directly by the Company or its subsidiaries and five are leased from outside parties. Initial lease terms generally provide for minimum terms of five to 25 years and have one or more renewal options. The initial term of leases in effect at December 31, 2006, expire between 2008 and 2014. In addition a flexible packaging operating location leased adjacent vacant land in 1999 for an initial lease term of 42 years.
Pressure Sensitive Materials Segment
This segment has seven manufacturing plants located in three states and two non-USA countries, all of which are owned directly by the Company or its subsidiaries.
Corporate and General
The Company considers its plants and other physical properties to be suitable, adequate, and of sufficient productive capacity to meet the requirements of its business. The manufacturing plants operate at varying levels of utilization depending on the type of operation and market conditions. The executive offices of the Company, which are leased, are located in Neenah, Wisconsin.
The Company is involved in a number of lawsuits incidental to its business, including environmental related litigation. Although it is difficult to predict the ultimate outcome of these cases, management believes, except as discussed below, that any ultimate liability would not have a material adverse effect upon the Companys financial condition or results of operations.
The Company is a potentially responsible party (PRP) in twelve superfund sites around the United States. The Company expects its future liability relative to these sites to be insignificant, individually and in the aggregate. The Company has reserved an amount that it believes to be adequate to cover its exposure.
Dixie Toga S.A., acquired by the Company on January 5, 2005, is involved in a tax dispute with the City of São Paulo, Brazil. The City imposes a tax on the rendering of printing services. The City has assessed this city services tax on the production and sale of printed labels and packaging products. Dixie Toga, along with a number of other packaging companies, disagree and contend that the city services tax is not applicable to its products and that the products are subject only to the state value added tax (VAT). Under Brazilian law, state VAT and city services tax are mutually exclusive and the same transaction can be subject to only one of those taxes. Based on a ruling from the State of São Paulo, advice from legal counsel, and long standing business practice, Dixie Toga appealed the city services tax and instead continued to collect and pay only the state VAT.
The City of São Paulo disagreed and assessed Dixie Toga the city services tax for the years 1991-1995. The assessments for those years are estimated to be approximately $51.3 million at the date the Company acquired Dixie Toga, translated to U.S. dollars at the 2006 year end exchange rate. Dixie Toga challenged the assessments and ultimately litigated the issue. A lower court decision in 2002 cancelled all of the assessments for 1991-1995. The City of São Paulo, the State of São Paulo, and Dixie Toga have each appealed parts of the lower court decision. The City continues to assert the applicability of the city services tax and has issued assessments for the subsequent years 1996-2001. The assessments for those years for tax and penalties (exclusive of interest) are estimated to be approximately $32.6 million at the date of acquisition, translated to U.S. dollars at the 2006 year end exchange rate. In the event of an adverse resolution, these estimated amounts for all assessments could be substantially increased for interest, monetary adjustments, and corrections.
The Company strongly disagrees with the Citys position and intends to vigorously challenge any assessments by the City of São Paulo. The Company is unable at this time to predict the ultimate outcome of the controversy and as such has not recorded any liability
related to this matter. An adverse resolution could be material to the results of operations and/or cash flows of the period in which the matter is resolved.
The Company first disclosed in a Form 8-K filed with the Securities and Exchange Commission on April 23, 2003, that the Department of Justice expected to initiate a criminal investigation into competitive practices in the labelstock industry and the Company further discussed the investigation and disclosed that it expected to receive a subpoena in its Form 10-Q filed for the quarter ended June 30, 2003. In a Form 8-K filed with the Securities and Exchange Commission on August 15, 2003, the Company disclosed that it had received a subpoena from the U.S. Department of Justice in connection with the Departments criminal investigation into competitive practices in the labelstock industry. The Company responded to the subpoena and cooperated fully with the requests of the U.S. Department of Justice. On October 20, 2006, the Department of Justice informed the Company that it was closing the investigation without any further action.
The Company and its wholly-owned subsidiary, Morgan Adhesives Company, have been named as defendants in fifteen civil lawsuits. Five of these lawsuits purport to represent a nationwide class of labelstock purchasers, and each alleges a conspiracy to fix prices within the self-adhesive labelstock industry. On November 5, 2003, the Judicial Panel on MultiDistrict Litigation issued a decision consolidating all of the federal class actions for pretrial purposes in the United States District Court for the Middle District of Pennsylvania, before the Honorable Chief Judge Vanaskie. Judge Vanaskie entered an order which called for discovery to be taken on the issues relating to class certification and briefing on plaintiffs motion for class certification to be completed by March 1, 2007. At this time, a discovery cut-off and a trial date have not been set. The Company has also been named in four lawsuits filed in the California Superior Court in San Francisco. Three of these lawsuits seek to represent a class of all California indirect purchasers of labelstock and each alleged a conspiracy to fix prices within the self-adhesive labelstock industry. These three lawsuits have been consolidated. The fourth lawsuit seeks to represent a class of California direct purchasers of labelstock and alleges a conspiracy to fix prices within the self-adhesive labelstock industry. Finally, the Company has been named in one lawsuit in Vermont, seeking to represent a class of all Vermont indirect purchasers of labelstock, one lawsuit in Ohio, seeking to represent a class of all Ohio indirect purchasers of labelstock, one lawsuit in Nebraska seeking to represent a class of all Nebraska indirect purchasers of labelstock, one lawsuit in Kansas seeking to represent a class of all Kansas indirect purchasers of labelstock, one lawsuit in Tennessee, seeking to represent a class of purchasers of labelstock in various jurisdictions, and one lawsuit in Arizona seeking to represent a class of Arizona indirect purchasers of labelstock, all alleging a conspiracy to fix prices within the self-adhesive labelstock industry. The Company intends to vigorously defend these lawsuits.
In a Form 8-K filed with the Securities and Exchange Commission on May 25, 2004, the Company disclosed that representatives from the European Commission had commenced a search of business records and interviews of certain Company personnel at its self-adhesive labelstock operation in Soignies, Belgium to investigate possible violations of European competition law in connection with an investigation of potential anticompetitive activities in the European paper and forestry products sector. The Company cooperated fully with the requests of the European Commission. On November 16, 2006, the European Commission informed the Company that it was closing the investigation without any further action.
Given the ongoing status of the class-action civil lawsuits, the Company is unable to predict the outcome of these matters although the effect could be material to the results of operations and/or cash flows of the period in which the matter is resolved. The Company is currently not otherwise subject to any pending litigation other than routine litigation arising in the ordinary course of business, none of which is expected to have a material adverse effect on the business, results of operations, financial position, or liquidity of the Company.
No matters were submitted to a vote of security holders during the fourth quarter of 2006.
The Companys common stock is traded on the New York Stock Exchange under the symbol BMS. On December 31, 2006, there were 4,192 registered holders of record of our common stock. Dividends paid and the high and low common stock prices per share were as follows:
FIVE-YEAR CONSOLIDATED REVIEW
(dollars in millions, except per share amounts)
Managements Discussion and Analysis
Three Years Ended December 31, 2006
Managements Discussion and Analysis should be read in conjunction with the Consolidated Financial Statements and related Notes included in Item 8 of this Annual Report on Form 10-K.
Bemis Company, Inc. is a leading global manufacturer of flexible packaging and pressure sensitive materials supplying a variety of markets. Generally about 60 percent of our total company net sales are to customers in the food industry. Sales of our flexible packaging products are widely diversified among food categories and can be found in nearly every aisle of the grocery store. Other markets into which we sell our flexible packaging products include medical devices, personal care, and lawn and garden. Our emphasis on supplying packaging to the food industry provides a more stable market environment for our flexible packaging business segment, which accounts for about 82 percent of our net sales. The remaining 18 percent of our net sales is from the pressure sensitive materials business segment which, while diversified in end use products, is less focused on food industry applications and more exposed to economically sensitive end markets.
The markets into which our products are sold are highly competitive. Our leading flexible packaging market positions in North and South America reflect our focus on value-added, proprietary products that are not available from most of our competitors. During 2006, many of our large customers announced sales growth strategies that were supported by new product introductions. This provides opportunities for future growth at Bemis since new customer products often require innovative new packaging. In Europe and Asia, where our market position is smaller, we continue to introduce our proprietary products to the market, and we are encouraged by the strengthening economies in those regions. The stronger European economy has also benefited our pressure sensitive graphic product line which is predominately sold in Europe. The primary raw materials for our business segments are polymer resins and adhesives. The cost of raw materials moderated during 2006 after experiencing a period of significant volatility during late 2004 and 2005. Raw material costs have been impacted in recent years by higher energy prices in addition to production disruptions related to the 2005 Gulf Coast hurricanes.
Restructuring and Related Charges
On January 25, 2006, we announced a facility consolidation project intended to reduce fixed costs and shift production to lower cost facilities. These cost reduction efforts included the closure of five flexible packaging facilities and one pressure sensitive materials facility during 2006 and was substantially complete as of December 31, 2006. Restructuring and related charges incurred in 2006 totaled $31.2 million, of which $12.3 million primarily reflected accelerated depreciation and was recorded as a component of cost of products sold. The remaining $18.9 million primarily reflects employee-related costs and was recorded as a component of other costs (income).
During 2003, we initiated a restructuring program in which five facilities were closed. While most of the restructuring activities were completed as of December 31, 2003, gains and losses related to the sale of these closed facilities resulted in a net charge of $2.4 million in 2004 and a net gain of $0.9 million in 2005.
On January 5, 2005, we acquired majority ownership of Dixie Toga S.A., one of the largest packaging companies in South America with 2004 annual revenues totaling about $325 million. The acquisition included the outstanding voting common stock of Dixie Toga in addition to 43 percent of the outstanding nonvoting preferred stock. The initial cash purchase price, paid in 2005, was approximately $235 million increased by $4.2 million in 2006 related to post close adjustments. This acquisition significantly increased our exposure to the growing South American packaging market and provides a strong platform from which to introduce our propriety film products to a new region. Subsequently, our South American subsidiary has repurchased additional shares of its outstanding preferred stock in the open market, reducing the total minority interest in our subsidiary to 14 percent as of December 31, 2006. In April 2006, we also acquired the remaining shares of our three majority-owned joint ventures in Mexico for $6.8 million.
2006 versus 2005
For the year ended December 31, 2006, net sales increased 4.8 percent. Currency translation was a benefit to net sales growth of 1.8 percent. The remaining 3.0 percent increase in net sales reflects increased sales of higher priced, value-added products in each of the two business segments.
Diluted earnings per share were $1.65 for 2006, including $0.18 per share of restructuring and related charges. For 2005, diluted earnings per share totaled $1.51, including approximately $0.06 per share of tax charges related to the repatriation of international subsidiary earnings under The American Jobs Creation Act of 2004. The improvement in 2006 resulted from a more profitable sales mix, a moderating raw material cost environment, and successful cost management efforts.
2005 versus 2004
For the year ended December 31, 2005, net sales increased 22.6 percent. The 2005 Dixie Toga acquisition accounted for 16.5 percent of the increase in sales while currency translation was insignificant to net sales growth in 2005. The remaining 6.1 percent increase in net sales reflects the impact of increased price and mix in all market categories. Price increases during 2005 were driven by increased raw material costs. Unit volume was flat compared to 2004.
Diluted earnings per share were $1.51 for 2005, including $0.06 per share of tax charges related to the repatriation of international subsidiary earnings under The American Jobs Creation Act of 2004. For 2004, diluted earnings per share totaled $1.67, including a net gain of $0.02 per share on the sale of certain plant assets. Results for 2005 were negatively impacted by significant increases in raw material costs during the year.
Flexible Packaging Business Segment
Our flexible packaging business segment provides packaging to a variety of end markets, including meat and cheese, confectionery and snack, frozen foods, lawn and garden, health and hygiene, beverages, medical devices, bakery, and dry foods. These markets are generally less affected by economic cycles and grow through product innovation and geographical expansion.
The most significant raw materials used in this business segment are polymer resins, which we use to develop and manufacture single layer and multilayer film products. During periods of unusual raw material cost volatility, selling price changes may lag behind changes in our raw material costs. During both 2004 and 2005, resin costs dramatically increased resulting in double-digit percentage increases for each year. These raw material costs were reflected in increased selling prices throughout each year; however the magnitude and frequency of the cost increases negatively impacted operating profit. The impact of raw material cost changes in 2006 was more moderate.
In January of 2006, we announced a restructuring plan to close five flexible packaging plants in order to consolidate production capacity and improve overall cost structure and efficiency throughout this business segment. These efforts were substantially completed by December 31, 2006. Restructuring and related charges for the flexible packaging business segment totaled $29.0 million in 2006. The disposal of facilities closed during the 2003 restructuring program resulted in a charge of $0.6 million in 2005 and a gain of $0.7 million in 2004.
2006 versus 2005
Our flexible packaging business segment recorded a 5.1 percent increase in net sales in 2006. Currency translation was a benefit of 2.1 percent. The remaining 3.0 percent increase is attributable to increased net sales for packaging in markets such as meat and cheese, health and hygiene, coffee, unitizing films for cans and bottles, and medical devices. This was partially offset by lower net sales for markets such as confectionery, snack and frozen foods.
Operating profit as a percentage of net sales decreased to 11.2 percent in 2006 from 11.7 percent in 2005. During 2006, restructuring and related charges totaling $29.0 million were recorded as a reduction of operating profit. Operating profit in 2006 benefited from stronger sales of value-added flexible packaging products. During 2005, operating profit includes the impact of restructuring and related charges totaling $0.6 million.
2005 versus 2004
Our flexible packaging business segment recorded a 27.0 percent increase in net sales in 2005. The acquisition of Dixie Toga increased 2005 sales by 20.8 percent. The remaining 6.2 percent increase is attributable to price and mix across all market categories. Increases in demand for packaging in markets such as meat and cheese, health and hygiene, cereal and other dry foods, coffee, unitizing films for cans and bottles, and medical devices were offset by lower unit sales for markets such as confectionery and snack, frozen foods, bakery, and pet products.
Operating profit as a percentage of net sales decreased in 2005. During the fourth quarter of 2004, we recorded a gain of $5.6 million from the sale of a manufacturing facility in Florence, Kentucky. During 2005, raw material cost increases outpaced increases in selling prices, negatively impacting operating profit.
Pressure Sensitive Materials Business Segment
The pressure sensitive materials business segment offers adhesive products to three markets: prime and variable information labels, which include roll label stock used in a wide variety of label markets; graphic design, used to create signage and decorations; and technical components, which represent pressure sensitive components for industries such as the electronics, automotive, construction and medical industries.
Paper and adhesive are the primary raw materials used in our pressure sensitive materials business segment. For the last several years, general economic conditions have had a greater influence on selling prices and operating performance than raw material costs.
In January of 2006, we announced a restructuring plan which included the closure of one pressure sensitive materials plant in order to consolidate production capacity and improve overall cost structure and efficiency. This effort was completed by December 31, 2006. Restructuring and related charges incurred and related to the pressure sensitive materials business segment totaled $1.0 million in 2006. These costs were primarily employee-related costs and were recorded as a component of other costs (income), net.
In 2003, we announced the restructuring of our label products capacity, closing two facilities to reduce fixed costs and improve capacity utilization. During 2004, restructuring and related charges totaling $3.1 million related primarily to the cost of closing a label products plant in Nevada. Of this total, $1.8 million represented equipment relocation and was recorded as other costs (income), net, with the remaining costs associated with accelerated depreciation charged to costs of products sold. During 2005, a net gain of $1.5 million was recorded for the sale of previously closed facilities and property.
During 2005, we changed the year-end of our pressure sensitive materials European subsidiary from November 30 to December 31. This resulted in a 13-month reporting period in 2005 for this subsidiary, increasing 2005 net sales by $17.2 million. The impact on operating profit was insignificant.
2006 versus 2005
Our pressure sensitive materials business segment reported a net sales increase of 3.4 percent in 2006. Net sales in 2005 include the impact of the thirteenth month of net sales from the European subsidiary. The increase in net sales in 2006 was driven by unit sales volume growth in each of the pressure sensitive materials product lines during the year. Currency benefits provided less than one percent net sales growth in 2006.
Operating profit as a percent of sales improved in 2006 compared to 2005, reflecting increased sales of value-added graphic and technical products. In addition, the profitability of the label product line increased with continued improvements in cost management and production efficiency. Currency translation did not impact operating profit in 2006.
2005 versus 2004
Our pressure sensitive materials business segment reported a net sales increase of 5.7 percent in 2005. The thirteenth month of net sales from the European subsidiary accounted for about 3.0 percent sales growth compared to 2004. The remaining 2.7 percent increase was driven by unit sales volume growth in label products during the year, partially offset by unit sales volume decreases in the other product categories. Price increases were offset by increased unit sales of lower priced label products in 2005, and currency had no impact on net sales for the year.
Improved profit levels in 2005 reflect improved profit from label products and focused cost control measures. Currency translation did not impact operating profit in 2005 and contributed $2.2 million in 2004.
Consolidated Gross Margin
Restructuring and related charges reduced gross margins by $12.9 million in 2006 and $1.1 million in 2004. The time lag between the implementation of selling price increases and increases in raw material costs reduced gross margins as a percent of net sales in each of the years presented. This reduction in gross margin as a percentage of net sales was partially offset by ongoing improvements in production efficiency, sales mix and cost management during the same timeframe.
Consolidated Selling, General and Administrative Expenses
In 2006, the lower ratio of expenses to net sales reflects the benefits of cost management programs, and the impact of higher selling prices on consolidated net sales. In 2005, the lower ratio compared to 2004 reflects lower costs associated with the South American operations purchased in January 2005, and the impact of higher selling prices on consolidated net sales.
Research and Development
Our efforts to introduce new products continue at a steady pace and are an integral part of our daily plant operations. Our research and development engineers work directly on commercial production equipment, bringing new products to market without the use
of pilot equipment. We believe this approach significantly improves the efficiency, effectiveness and relevance of our research and developments activities and results in earlier commercialization of new products. Expenditures that are not distinctly identifiable as research and development costs are included in costs of products sold.
The increase in interest expense in 2006 reflects higher interest rates in 2006 compared to 2005 and 2004. In addition, debt levels increased in 2005 as a result of the January 2005 acquisition of Dixie Toga. Prior to 2005, substantially all of our outstanding debt was subject to variable interest rates. In 2005, we issued $300 million of fixed rate public bonds at a 4.875 percent interest rate. This effectively reduced our percentage of variable rate debt to about 59 percent in 2006 and 62 percent in 2005. The effective interest rate was 5.9 percent in 2006, 4.9 percent in 2005, and 2.7 percent in 2004.
Other Costs (Income), Net
In 2006, other costs (income) included $18.3 million of restructuring and related charges, which were more than offset by financial income of $18.0 million and a $4.5 million favorable resolution of a litigated foreign excise tax liability. About half of the financial income relates to interest income on cash held at non-U.S. locations. The remainder of the financial income is generated from fiscal incentives for certain locations and is considered as a part of flexible packaging operating profit. In 2005, net other expenses primarily reflect interest income offset by currency exchange losses. Net other income in 2004 includes a $5.6 million gain on the sale of a rotogravure facility partially offset by restructuring and related charges of $1.2 million. Equity income from our Brazilian joint venture was $11.7 million in 2004. Since the January 2005 acquisition of Dixie Toga, the Brazilian joint venture has been accounted for on a consolidated basis and the related operating results are included with the flexible packaging segment. The remainder of other income in 2004 is primarily interest income.
Minority Interest in Net Income
In connection with the January 2005 acquisition of Dixie Toga, we acquired approximately 80 percent of the total outstanding shares of Dixie Toga. As of December 31, 2006, our ownership had increased to approximately 86 percent of the total outstanding shares. The increase in minority interest in net income in 2005 is primarily due to the accounting for the shares of Dixie Toga that were not acquired. In April 2006, we acquired the remaining minority interest in our three Mexican joint ventures which reduced minority interest in net income.
The difference between our overall tax rate and the U. S. statutory tax rate of 35 percent in each of the three years presented principally relates to state and local income taxes net of federal income tax benefits. During 2005, an additional $6.0 million of tax expense was recorded as a result of the repatriation of international subsidiary earnings under The American Jobs Creation Act of 2004 (The Jobs Act), increasing the effective tax rate for 2005 from 39.0 percent to 41.2 percent. For the total year 2006, the effective tax rate was 38.3 percent, reflecting the final determination of the benefits provided under The Jobs Act.
Liquidity and Capital Resources
Debt to Total Capitalization
Debt to total capitalization (which includes total debt, long-term deferred tax liabilities and equity) was 33.0 percent at December 31, 2006, compared to 35.7 percent at December 31, 2005 and 26.7 percent at December 31, 2004. Total debt was $789.8 million, $844.1 million, and $539.6 million at year-end 2006, 2005 and 2004, respectively. The increase in 2005 primarily reflects the impact of the Dixie Toga acquisition in January 2005.
Our capital structure and financial practices have earned Bemis Company long-term credit ratings of A from Standard & Poors and Baa1 from Moodys Investors Service, and a credit rating of A-1 and Prime-2 for our commercial paper program from Standard & Poors and Moodys Investor Service, respectively. Our strong financial positions and credit ratings are important to our ability to issue commercial paper at favorable rates of interest.
Sources of Liquidity
Cash provided by operations was $349.0 million for the year ended December 31, 2006, compared to $280.4 million in 2005 and $271.5 million in 2004. Cash provided by operations in each of the years ended December 31, 2006, 2005 and 2004 was reduced by voluntary pension contributions to our U.S. pension plans of $24.0 million, $35.0 million, and $50.0 million, respectively. While no contributions are required for our U.S. pension plans in 2007, we continue to monitor the funded status of all pension plans and will evaluate the benefits of future voluntary contributions subject to available liquidity. Increasing raw material costs during the three-year period resulted in increased levels of working capital, which had a negative impact on cash provided by operations during each of the three years presented.
In addition to using cash provided by operations, we issue commercial paper to meet our short-term liquidity needs. At year-end, our commercial paper debt outstanding was $80.7 million. Based upon our current credit rating, we enjoy ready access to the commercial paper markets. While not anticipated, if these markets were to become illiquid or if a credit rating downgrade limited our ability to issue commercial paper, we would draw upon our existing back-up credit facility. In September 2004, we renegotiated our back-up credit facility to extend the term to September 2009. This credit facility provides $500 million of available financing supported by a group of major U.S. and international banks. Covenants imposed by this bank credit facility include limits on the sale of businesses, minimum net worth calculations, and a maximum ratio of debt to total capitalization. In addition to funds available under this credit facility, we also have the capability of issuing up to approximately $100 million of Extendable Commercial Notes (ECNs), which are short-term instruments whose maturity can be extended to 390 days from the date of issuance. If these credit facilities and ECNs were no
longer available to us, we would expect to meet our financial liquidity needs by accessing the bank market, which would increase our borrowing costs.
The $500 million credit facility includes a $100 million multicurrency limit to support the financing needs of our international subsidiaries. As of December 31, 2006, outstanding multicurrency borrowings under the credit facility totaled $59.7 million. Borrowings from the credit agreement mature in September 2009 and are subject to a variable interest rate.
As of December 31, 2006, available capacity on the credit agreement which matures in September 2009 was $351.6 million.
Commercial paper outstanding at December 31, 2006, has been classified as long-term debt in accordance with our intention and ability to refinance such obligations on a long-term basis. The related back-up credit agreement expires in 2009.
Uses of Liquidity
Capital expenditures were $158.8 million during 2006, compared to $187.0 million in 2005, and $134.5 million in 2004. Higher levels of expenditures in 2005 funded additional capacity for our South American operations to meet strong demand for our shrink bag products and new capacity in our high growth North American production plants. Capital expenditures for 2007 are estimated to be in the $175 million to $185 million range, which includes about $20 million of costs related to the design of a new enterprise resource planning system. After 2007, capital expenditures are expected to return to levels approximately equivalent to total annual depreciation and amortization expenses.
We increased our quarterly cash dividend by 5.6 percent during the first quarter of 2006 to 19 cents per share from 18 cents per share. This follows increases of 12.5 percent in 2005 and 14.3 percent in 2004. In February 2007, the Board of Directors approved the 24th consecutive annual increase in the quarterly cash dividend on common stock to 21 cents per share, a 10.5 percent increase.
During 2006, we purchased 600,000 shares of common stock in the open market. During 2005, we purchased 1.9 million shares of common stock in the open market. We did not make any share repurchases during 2004. As of December 31, 2006, we were authorized to purchase up to 2.2 million shares of additional common stock for the treasury. In February 2007, the Board of Directors authorized an additional 3 million shares for repurchase.
The following table provides a summary of contractual obligations including our debt payment obligations, capital lease obligations, operating lease obligations and certain other purchase obligations as of December 31, 2006.
(1) These amounts are included in our Consolidated Balance Sheet. A portion of this debt is commercial paper backed by a bank credit facility that expires on September 2, 2009.
(2) A portion of the interest expense disclosed is subject to variable interest rates. The amounts disclosed above assume that variable interest rates are equal to rates at December 31, 2006.
(3) Amount noted also includes estimated interest costs. The present value of these obligations, excluding interest, is included on our Consolidated Balance Sheet. See Note 11 to the Consolidated Financial Statements for additional information about our capital lease obligations.
(4) We enter into operating leases in the normal course of business. Substantially all lease agreements have fixed payments terms based on the passage of time. Some lease agreements provide us with the options to renew the lease. Our future operating lease obligations would change if we exercised these renewal options and if we entered into additional operating lease agreements.
(5) Purchase obligations represent contracts or commitments for the purchase of raw materials, utilities, capital equipment and various other goods and services.
(6) Postretirement obligations represent contracts or commitments for postretirement healthcare benefits and benefit payments for the unfunded Bemis Supplemental Retirement Plan.
Interest Rate Swaps
Our long-term unsecured notes include $250 million due in August 2008. In September 2001, we entered into interest rate swap agreements with two U.S. banks, which increased our exposure to variable rates. We generally prefer variable rate debt since it has been our experience that borrowing at variable rates is less expensive than borrowing at fixed rates over the long term. These interest rate swap agreements, which expire in 2008, reduced the interest cost of the $250 million of long-term debt from 6.5 percent to about 6.0 percent in 2006. Since these variable rates are based upon six-month London Interbank Offered Rates (LIBOR), calculated in arrears, at the semiannual interest payment dates of the corresponding notes, increases in short-term interest rates will directly impact the amount of interest we pay.
Accounting principles generally accepted in the United States of America require that the fair value of these swaps, which have been designated as hedges of our fixed rate unsecured notes outstanding, be recorded as an asset or liability of the Company. The fair value of these swaps was recorded as an asset of $2.5 million at December 31, 2006, and an asset of $5.0 million at December 31, 2005. For each period, an offsetting increase is recorded in the fair value of the related long-term notes outstanding. These fair value adjustments do not impact the actual balance of outstanding principal on the notes, nor do they impact the income statement or related cash flows. Credit loss from counterparty nonperformance is not anticipated.
In connection with the issue of seven-year, $300 million notes in March 2005, we entered into a forward starting swap on February 3, 2005, in order to lock in an interest rate in advance of the pricing date for the notes. On March 14, 2005, in connection with the pricing of the notes, we terminated the swap and recorded the resulting gain of $6.1 million (pre-tax) on the balance sheet as a component of other comprehensive income. This gain is being amortized as a component of interest expense over the term of the notes.
Market Risks and Foreign Currency Exposures
We enter into contractual arrangements (derivatives) in the ordinary course of business to manage foreign currency exposure and interest rate risks. We do not enter into derivative transactions for trading purposes. Our use of derivative instruments is subject to internal policies that provide guidelines for control, counterparty risk, and ongoing reporting. These derivative instruments are designed to reduce the income statement volatility associated with movement in foreign exchange rates, establish rates for future issuance of public bonds, and to achieve greater exposure to variable interest rates.
Interest expense calculated on our outstanding debt is substantially subject to short-term interest rates. As such, increases in short-term interest rates will directly impact the amount of interest we pay. For each one percent increase in variable interest rates, the annual interest expense on $789.8 million of total debt outstanding would increase by $4.7 million.
Our international operations enter into forward foreign currency exchange contracts to manage foreign currency exchange rate exposures associated with certain foreign currency denominated receivables and payables. At December 31, 2006 and 2005, we had outstanding forward exchange contracts with notional amounts aggregating $3.5 million and $4.4 million, respectively. Forward exchange contracts generally have maturities of less than nine months. Counterparties to the forward exchange contracts are major financial institutions. Credit loss from counterparty nonperformance is not anticipated. We have not designated these derivative instruments as hedging instruments. The net settlement amount (fair value) related to the active forward foreign currency exchange contacts is insignificant and recorded on the balance sheet within current liabilities and as an element of other costs (income), net, which offsets the related transactions gains and losses on the related foreign denominated asset or liability.
The operating results of our international operations are recorded in local currency and translated into U.S. dollars for consolidation purposes. The impact of foreign currency translation on net sales was an increase of $63.3 million in 2006 and $5.4 million in 2005. Operating profit improved by approximately $7.0 million in 2006 and $0.6 million in 2005 as a result of the positive effect of foreign currency translation.
Our practice of awarding long-term compensation has relied primarily on restricted stock unit programs that are valued at the time of the award and expensed over the vesting period. Beginning in 2004, we discontinued the awarding of stock options. Stock options granted prior to 2004 were granted at prices equal to the fair market value on the date of grant and exercisable, upon vesting, over varying periods up to ten years from the date of grant. Stock options for Directors vested immediately, while options for Company employees generally become vested over three years (one-third per year). Beginning January 1, 2006, accounting rules require us to follow a fair value based method of recognizing expense for stock options. The impact to diluted earnings per share for stock options expense in 2006 was insignificant. If we had followed this fair value method prior to 2006, the impact on diluted earnings per share would have been one cent for each year ended 2005 and 2004.
Critical Accounting Estimates and Judgments
Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of expenses during the reporting period. On an ongoing basis, management evaluates its estimates and judgments, including those related to retirement benefits, intangible assets, goodwill, and expected future performance of operations. Our estimates and judgments are based upon historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.
We believe the following are critical accounting estimates used in the preparation of our consolidated financial statements.
· The calculation of annual pension costs and related assets and liabilities; and
· The valuation and useful lives of intangible assets and goodwill.
Accounting for annual pension costs
We account for our defined benefit pension plans in accordance with FAS No. 87, Employers Accounting for Pensions, as amended by FAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans, which requires that amounts recognized in financial statements be determined on an actuarial basis. FAS No. 158 requires us to recognize the overfunded or underfunded status of the pension plans on our balance sheet. A substantial portion of our pension amounts relate to our defined benefit plans in the United States.
Pension expense recorded in 2006 was $16.1 million, compared to pension expense of $27.7 million in 2005 and $22.6 million in 2004. Effective January 1, 2006, our U.S. defined benefit pension plans were amended for approximately two-thirds of the participant population. For those employees impacted, future pension benefits were replaced with a defined contribution plan which is subject to achievement of certain financial performance goals of the Company.
One element used in determining annual pension income and expense in accordance with accounting rules is the expected return on plan assets. As of January 1, 2007, for our U.S. defined benefit pension plans, we have assumed that the expected long-term rate of return on plan assets will be 8.75 percent. This is consistent with the rate assumed for 2006 and 2005.
To develop the expected long-term rate of return on assets assumption, we considered compound historical returns and future expectations based upon our target asset allocation. Using historical long-term investment periods of 10, 15 and 20 years, our pension plan assets have earned rates of return of 7.8 percent, 8.7 percent and 9.4 percent, respectively. Considering these long-term results, we selected an 8.75 percent long-term rate of return on assets assumption as of January 1, 2007. Using our target asset allocation of plan assets of 80 percent equity securities and 20 percent fixed income securities, our outside actuaries have used their independent economic model to calculate a range of expected long-term rates of return and have determined our assumptions to be reasonable.
This assumed long-term rate of return on assets is applied to a calculated value of plan assets, which recognizes changes in the fair value of plan assets in a systematic manner over approximately three years. This process calculates the expected return on plan assets that is included in pension income or expense. The difference between this expected return and the actual return on plan assets is generally deferred and recognized over subsequent periods. The net deferral of asset gains and losses affects the calculated value of pension plan assets and, ultimately, future pension income and expense.
At the end of each year, we determine the discount rate to be used to calculate the present value of pension plan liabilities. This discount rate is an estimate of the current interest rate at which the pension liabilities could be effectively settled at the end of the year. In estimating this rate, we look to changes in rates of return on high quality, fixed income investments that receive one of the two highest ratings given by a recognized ratings agency. At December 31, 2006, for our U.S. defined benefit pension plans we determined this rate to be 5.75 percent, an increase of one quarter of one percent from the 5.50 percent rate used at December 31, 2005.
Pension assumptions sensitivity analysis
Based upon current assumptions of 5.75 percent for the discount rate and 8.75 percent for the expected rate of return on pension plan assets, we expect pension expense before the effect of income taxes for 2007 to be in a range of $15 million to $20 million. The following charts depict the sensitivity of estimated 2007 pension expense to incremental changes in the discount rate and the expected long-term rate of return on assets.
In accordance with FAS No. 158, the amount by which the fair value of plan assets differs from the projected benefit obligation of a pension plan must be recorded on the Consolidated Balance Sheet as an asset, in the case of an overfunded plan, or as a liability, in the case of an underfunded plan. The gains or losses and prior service costs or credits that arise but are not recognized as components of pension cost are recorded as a component of other comprehensive income. The following chart depicts the sensitivity of the total pension adjustment to other comprehensive income to changes in the assumed discount rate.
Intangible assets and goodwill
The purchase price of each new acquisition is allocated to tangible assets, identifiable intangible assets, liabilities assumed, and goodwill. Determining the portion of the purchase price allocated to identifiable intangible assets and goodwill requires us to make significant estimates. The amount of the purchase price allocated to intangible assets is generally determined by estimating the future cash flows of each asset and discounting the net cash flows back to their present values. The discount rate used is determined at the time of the acquisition in accordance with accepted valuation methods.
Goodwill represents the excess of the aggregate purchase price over the fair value of net assets acquired, including intangible assets. We review our goodwill for impairment annually and assess whether significant events or changes in the business circumstances indicate that the carrying value of the goodwill may not be recoverable. The test for impairment requires us to make estimates about fair value, most of which are based on projected future cash flows. Our estimates associated with the goodwill impairment tests are considered critical due to the amount of goodwill recorded on our consolidated balance sheet and the judgment required in determining fair value amounts, including projected future cash flows. Goodwill was $603.7 million as of December 31, 2006.
Intangible assets consist primarily of purchased technology, customer relationships, patents, trademarks, and tradenames and are amortized using the straight-line method over their estimated useful lives, which range from one to 30 years, when purchased. We review these intangible assets for impairment as changes in circumstances or the occurrence of events suggest that the remaining value is not recoverable. The test for impairment requires us to make estimates about fair value, most of which are based on projected future cash flows. These estimates and projections require judgments as to future events, condition and amounts of future cash flows.
New Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (FAS) No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. FAS No. 157 will apply whenever another standard requires (or permits) assets or liabilities to be measured at fair value. The standard does not expand the use of fair value to any new circumstances, and is effective beginning after December 31, 2007. We are currently evaluating the impact of adopting FAS No. 157 on our financial position and results of operations.
In June 2006, the FASB issued FASB Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109 (FIN 48). FIN 48 clarifies the accounting for uncertain tax positions in accordance with FAS No. 109, Accounting for Income Taxes. We will be required to recognize, in our financial statements, the largest tax benefit of a tax position that is more-likely-than-not to be sustained on audit based solely on the technical merits of the position as of the reporting date. In addition, FIN 48 provides guidance on new disclosure requirements, reporting and accrual of interest and penalties, accounting in interim periods, and transition. FIN 48 is effective beginning January 1, 2007, with the cumulative effect of initially applying FIN 48 recognized as a change in accounting principle recorded as an adjustment to opening retained earnings. We are currently evaluating the impact of adopting this standard and upon implementation do not expect a material impact to the financial statements.
This Annual Report contains certain estimates, predictions, and other forward-looking statements (as defined in the Private Securities Litigation Reform Act of 1995, and within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended). Forward-looking statements are generally identified with the words believe, expect, anticipate, intend, estimate, target, may, will, plan, project, should, continue, or the negative thereof or other similar expressions, or discussion of future goals or aspirations, which are predictions of or indicate future events and trends and which do not relate to historical matters. Such statements are based on information available to management as of the time of such statements and relate to, among other things, expectations of the business environment in which we operate, projections of future performance (financial and otherwise), including those of acquired companies, perceived opportunities in the market and statements regarding our mission and vision. Forward-looking statements involve known and unknown risks, uncertainties and other factors, which may cause actual results, performance or achievements to differ materially from anticipated future results, performance or achievements expressed or implied by such forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events, or otherwise.
Factors that could cause actual results to differ from those expected include, but are not limited to, general economic conditions caused by inflation, interest rates, consumer confidence, rates of unemployment and foreign currency exchange rates; investment performance of assets in our pension plans; operating results and cash flows from acquisitions may differ from what we anticipate; competitive conditions within our markets, including the acceptance of our new and existing products; threats or challenges to our patented or proprietary technologies; raw material costs, availability, and terms, particularly for polymer resins and adhesives; price changes for raw materials and our ability to pass these price changes on to our customers or otherwise manage commodity price fluctuation risks; the presence of adequate cash available for investment in our business in order to maintain desired debt levels; unexpected costs or manufacturing issues related to the implementation of a new enterprise resource system; changes in governmental regulation, especially in the areas of environmental, health and safety matters, and foreign investment; unexpected outcomes in our current and future litigation proceedings and any related proceedings or civil lawsuits; unexpected outcomes in our current and future domestic and international tax proceedings; changes in our labor relations; and the impact of changes in the world political environment including threatened or actual armed conflict. These and other risks, uncertainties, and assumptions identified from time to time in our filings with
the Securities and Exchange Commission, including without limitation, those described under Item 1A Risk Factors of this Annual Report on Form 10-K and our quarterly reports on Form 10-Q, could cause actual future results to differ materially from those projected in the forward-looking statements. In addition, actual future results could differ materially from those projected in the forward-looking statement as a result of changes in the assumptions used in making such forward-looking statement.
The information required is included in Note 14 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K, and under the caption Market Risks and Foreign Currency Exposures which is part of Managements Discussion and Analysis included in Item 7 of this Annual Report on Form 10-K. Based on a sensitivity analysis (assuming a 10 percent adverse change in market rates) of our foreign exchange and interest rate derivatives and other financial instruments, changes in exchange rates or interest rates would not materially affect our financial position and liquidity. The effect on our results of operations would be substantially offset by the impact of the hedged items.
The management of Bemis Company, Inc. is responsible for the integrity, objectivity, and accuracy of the financial statements of the Company. The financial statements are prepared by the Company in accordance with accounting principles generally accepted in the United States of America, and using managements best estimates and judgments, where appropriate. The financial information presented throughout this Annual Report on Form 10-K is consistent with that in the financial statements.
The management of Bemis Company, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the direction, supervision, and participation of the Chief Executive Officer and the Chief Financial Officer, the Companys management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO-Framework). Based on the results of this evaluation management has concluded that internal control over financial reporting was effective as of December 31, 2006.
Item 9A of this Annual Report on Form 10-K contains managements favorable assessment of internal controls over financial reporting based on their review and evaluation utilizing the COSO-Framework criteria. Managements assessment of the effectiveness of internal control over financial reporting as of December 31, 2006, has been audited by PricewaterhouseCoopers LLP, the Companys independent registered public accounting firm, as stated in their report which is included in Item 8 of this Form 10-K.
The Audit Committee of the Board of Directors, which is composed solely of outside directors, meets quarterly with management, the Internal Audit Director, the Director of Global Financial Compliance, and independent accountants to review the work of each and to satisfy itself that the respective parties are properly discharging their responsibilities. PricewaterhouseCoopers LLP, the Director of Global Financial Compliance, and the Internal Audit Director have had and continue to have unrestricted access to the Audit Committee, without the presence of Company management.
To the Stockholders and Board of Directors of Bemis Company:
We have completed integrated audits of Bemis Company, Inc.s consolidated financial statements and of its internal control over financial reporting as of December 31, 2006 in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.
Consolidated financial statements and financial statement schedule
In our opinion, the accompanying balance sheets and the related consolidated statements of income, of stockholders equity and of cash flows present fairly, in all material respects, the financial position of Bemis Company, Inc. and its subsidiaries at December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the 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 financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As described in Note 6, effective December 31, 2006, the Company adopted the provisions of Financial Accounting Standards Board Statement No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans.
Internal control over financial reporting
Also, in our opinion, managements assessment, included in the Managements Report on Internal Control Over Financial Reporting appearing under Item 9A, that the Company maintained effective internal control over financial reporting as of December 31, 2006 based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on Internal Control - Integrated Framework issued by the COSO. The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on managements assessment and on the effectiveness of the Companys internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the 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 effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating managements assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
BEMIS COMPANY, INC. AND SUBSIDIARIES
(in thousands, except per share amounts)
See accompanying notes to consolidated financial statements.
BEMIS COMPANY, INC. AND SUBSIDIARIES
(dollars in thousands, except per share amounts)
See accompanying notes to consolidated financial statements.
BEMIS COMPANY, INC. AND SUBSIDIARIES
See accompanying notes to consolidated financial statements
BEMIS COMPANY, INC. AND SUBSIDIARIES
(dollars in thousands, except per share amounts)