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MOD-PAC CORP. 10-Q 2011 UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Commission File Number: 0-50063
MOD-PAC CORP.
(Exact Name of Registrant as Specified in its Charter)
(716) 873-0640
(Registrant's telephone number, including area code)
______________________________________________________________
(Former name, former address and former fiscal year, if changed since last report)
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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [ X ] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [ X ]
The number of shares outstanding of each class of common stock as of October 1, 2011 was:
Common Stock, $0.01 par value 2,571,207 shares
Class B Common Stock, $0.01 par value 599,073 shares
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MOD-PAC CORP.
QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
MOD-PAC CORP.
CONSOLIDATED BALANCE SHEETS
See accompanying notes to financial statements 3
MOD-PAC CORP.
CONSOLIDATED STATEMENTS OF INCOME
See accompanying notes to financial statements
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MOD-PAC CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to financial statements
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MOD-PAC CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED OCTOBER 1, 2011
(unaudited)
1) Basis of Presentation
The Registrant, MOD-PAC CORP., is referred to in this Quarterly Report on Form 10-Q as “MOD-PAC” or "the Company" or in the nominative “we” or the possessive “our.”
The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included and are of a normal recurring nature. The results of operations for any interim period are not necessarily indicative of results for the full year. Operating results for the nine-month period ended October 1, 2011 are not necessarily
indicative of the results that may be expected for the year ending December 31, 2011.
The balance sheet at December 31, 2010 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by generally accepted U.S. accounting principles for complete financial statements.
For further information, refer to the financial statements and footnotes thereto included in the Company's 2010 annual report on Form 10-K.
Revenue is recognized when title, ownership, and risk of loss pass to the customer, all of which occurs upon shipment or delivery of the product and is based on the applicable shipping terms.
2) Product Line Net Sales
Product line net sales are as follows:
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3) Income Per Share
The following table sets forth the computation of income per share:
For the nine months ended October 1, 2011 and October 2, 2010, approximately 325 thousand and 396 thousand of common shares potentially issuable from the exercise of stock options were excluded from the calculation of diluted earnings per share because the exercise price was greater than the average market price of common stock for the respective period.
4) Inventories
Inventories are stated at the lower of cost or market, cost being determined in accordance with the first-in, first-out method.
Inventories are as follows:
5) Income Taxes
The Company’s effective tax rate for the third quarter and first nine months of 2011 was 36.9% and 34.0%, respectively. The Company’s effective tax rate for the third quarter and first nine months of 2010 was 0.4% and 1.8%, respectively. The effective tax rate for the first nine months and third quarter of 2010 was recorded at a rate lower than customary mainly due to the utilization of available net operating loss carry-forward credits for which a full valuation allowance was previously recorded.
The Company's continuing practice is not to recognize interest and/or penalties related to income tax matters in income tax expense. As of October 1, 2011, the Company had no amounts accrued related to uncertain tax positions. The tax years 2007, 2008, 2009 and 2010 remain open to examination by the major taxing jurisdictions to which the Company is subject.
6) Stock-Based Compensation
MOD-PAC CORP. established a Stock Option Plan that authorized the issuance of 800,000 shares of Common Stock for the purpose of attracting and retaining executive officers and key employees, and to align management’s interests with those of the shareholders of MOD-PAC CORP. The options must be exercised no more than ten years from the grant date and vest over up to a five-year period. The exercise price for the options is equal to the fair market value of the common stock at the date of grant.
MOD-PAC CORP. established the Director’s Stock Option Plan that authorized the issuance of 200,000 shares of Common Stock for the purpose of attracting and retaining the services of experienced and knowledgeable outside directors, and to align their interest with those of its shareholders. The options must be exercised no more than ten years from the grant date and vest after six months. The exercise price for the options is equal to the fair market value at the date of grant.
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The Company uses a straight-line method of attributing the value of stock-based compensation expense, subject to minimum levels of expense, based on vesting. Stock compensation expense recognized during the period is based on the value of the portion of shared-based payment awards that is ultimately expected to vest during the period.
The fair value of stock options granted was estimated on the date of grant using the Black-Scholes option-pricing model. The weighted average fair value of the options was $3.20 and $4.12 for options granted during the nine months ended October 1, 2011 and October 2, 2010, respectively. The following table provides the range of assumptions used to value stock options granted during the nine months ended October 1, 2011 and October 2, 2010.
To determine expected volatility, the Company uses historical volatility based on weekly closing prices of its Common Stock since the Company’s spin-off from Astronics Corporation in March 2003. The risk-free rate is based on the United States Treasury yield curve at the time of grant for the appropriate term of the options granted. Expected dividends are based on the Company’s history and expectation of dividend payouts. The expected term of stock options is based on vesting schedules, expected exercise patterns and contractual terms.
A summary of the Company’s stock option activity and related information for the nine months ended October 1, 2011 is as follows:
The aggregate intrinsic value in the preceding table represents the total pretax option holder’s intrinsic value, based on the Company’s closing stock price of Common Stock of $5.67 as of October 1, 2011, which would have been received by the option holders had all option holders with an exercise price less than the market price been exercised as of that date. The Company’s current policy is to issue additional new shares upon exercise of stock options.
The fair value of options vested since December 31, 2010 is $235 thousand. At October 1, 2011, total compensation costs related to non-vested awards not yet recognized was $183 thousand which will be recognized over a weighted average period of 2.0 years.
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The following is a summary of weighted average exercise prices and contractual lives for outstanding and exercisable stock options as of October 1, 2011:
7) Capital Structure
The Company's Class B stock is fully convertible into Common stock on a one-for-one basis at no cost. During the first nine months of 2011, 17,399 shares of Class B stock were converted to Common stock.
8) Information Regarding Industry Segments
The Company operates as one reporting segment. The Company’s customer base is comprised of companies and individuals throughout the United States and North America and is diverse in both geographic and demographic terms. The format of the information used by the Company’s President and CEO is consistent with the reporting format used in the Company’s 2010 Form 10-K and other external information.
9) Financial Instruments
The Company’s financial instruments consist primarily of cash and cash equivalents, accounts receivable, accounts payable and long-term debt. The carrying value of the Company’s accounts receivable and accounts payable approximate fair value due to the short-term nature of the instruments. The recorded amounts for long-term debt approximate fair value based on current market rates of similar instruments.
10) Long-Term Debt
Long-term debt includes the following:
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11) Assets Under Capital Leases Included in Property, Plant and Equipment
Assets under capital leases included in property, plant and equipment are summarized as follows:
12) Long-Lived Assets
Long-lived assets, including acquired identifiable intangible assets, are tested for impairment whenever events or changes in circumstances indicate that the carrying amount of those assets may not be recoverable. An impairment loss is recognized if the carrying amount of a long-lived asset or asset group is not recoverable and exceeds its fair value. The carrying amount of a long-lived asset or asset group is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset or asset group. That assessment is based on the carrying amount of the asset or asset group at the date tested. An impairment loss
is measured as the amount by which the carrying amount of a long-lived asset or asset group exceeds its fair value which is based upon estimated future discounted cash flows.
Based on this testing, no asset impairment charges were recognized in the first nine months of 2011 or 2010.
13) Line of Credit
The Company has access to a $3.0 million secured line of credit with a commercial bank which expires June 9, 2013. Interest on the line of credit is based on LIBOR plus 2.75%, with an interest floor of 3.35%. At October 1, 2011, $0.2 million was in use through a standby letter of credit and there was no balance drawn on the line. The Company was in compliance with all applicable covenants at October 1, 2011. The amount of the line of credit that was unused and available to the Company at October 1, 2011 was $2.8 million.
14) Legal Proceedings
The Company was a third party defendant in an action filed in Supreme Court, Erie County, New York (David George, Plaintiff v. Speedways Conveyors, Incorporated and H.M. Cross & Sons, Inc., Defendants and Speedways Conveyors, Incorporated, Third-Party Plaintiff v. Mod-Pac Corporation, Third-Party Defendant. (Erie Co. Index No. 2003-8579 and 2003-8579 TP-1) by one of its employees for injuries he suffered during the course of his employment. The action has been settled without any monetary contribution from the Company.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
OVERVIEW
In the third quarter of 2011, we continued to focus our resources on our growing custom folding carton line. We believe that we are beginning to gain some traction in our sales and marketing efforts in this product line with the more concentrated approach we have applied since rationalizing our product lines and exiting the commercial print market in the second quarter of 2009. As a result of that rationalization, we also have realized a significant improvement in our operating performance. Over the last two years, we lowered our cost structure, improved our operating efficiency and implemented sustainable improvements in every area of our business resulting in more than
two full years of profitability.
Our custom folding carton customers are generally in the healthcare, confectionary, food and food service, and automotive industries, including private label manufacturers. Our expertise in this market is our ability to run, on-demand, the specific quantities required by our customers as opposed to doing long runs and creating inventory and obsolescence challenges. As a result, we do not require minimum print orders and are more flexible than most printers in addressing our customers’ needs. This capability has served our private label customers, who may have several of the same carton requirements with varying print requirements for their customers, extremely
well.
We also plan to continue developing our stock packaging and personalized print product lines. Our stock packaging line, which serves primarily private confectionaries, is seasonal in nature and driven by the economy. Nonetheless, we believe that we are a leader in this market with more than 3,000 customers that we serve primarily in the United States.
Our personalized print product line is focused on store, catalog and web sales. Because we provide products such as personalized dinner and cocktail napkins, small boxes for sundries at events, and other celebration-type items for both the retail and corporate markets, this product line is heavily impacted by economic downturns. We compete in personalized print with much larger companies, yet we have developed a strong brand as Krepe-Kraft among event planners and wedding coordinators. Our website, www.partybasics.com, has had some success,
and we also provide our products to third-party web stores as well.
REVENUE
For the third quarter of 2011, total revenue was $14.4 million compared with $12.4 million in 2010, an increase of 16.0%. The custom folding carton product line sales were $11.2 million compared with $9.3 million in the third quarter of 2010. The 21.1% increase was mainly due to increased business from several large existing customers, business from two new customers and increased waste sales due to improved market conditions, offset partially by decreased business with several existing customers. Sales of the Company’s stock packaging product line were $2.3 million in the third quarter of 2011, up 2.7% from the third quarter of 2010, primarily due to improved market
conditions. Personalized print sales for the second quarter of 2011 were $0.7 million compared with $0.8 million in 2010, a decrease of 4.2%, mainly due to continued weakness in this market.
For the first nine months of 2011, total revenue was $41.7 million, compared with $35.9 million in 2010, an increase of 16.0%. The custom folding cartons product line sales were $32.5 million compared with $27.0 million in 2010. The increase of 20.6% was mainly due to increased business from several large existing customers, business from three new customers and increased waste sales due to improved market conditions, offset partially by decreased business from several large customers. Sales of the Company’s stock packaging product line were $6.6 million, compared with $6.3 million in the prior year, an increase of 5.3% mainly due to improved general business
conditions. Personalized print sales for the first nine months of 2011 were $2.2 million, a decrease of 4.2% compared to the in the same period of 2010, primarily due to continued weakness in the market.
EXPENSES AND MARGINS
Gross margin was 19.7% for the third quarter of 2011, compared with 22.1% in the third quarter of 2010. Gross margin in 2011 was negatively affected by increased paperboard, repairs, supplies costs and sales mix, offset, partially, by decreased rental expense and operational leverage generated by increased product sales.
Selling, general, and administrative (“SG&A”) costs were $1.8 million in the third quarter of 2011, an increase of 5.0% from the same period in the prior year. This increase was driven primarily by higher selling commissions.
Gross margin was 18.7% for the first nine months of 2011, compared to 18.1% for the same period of 2010. Operational leverage generated by increased product sales had a positive impact on gross margin. Gross margin was also positively affected by decreased rental expense, offset partially by increased repairs, supplies and paperboard costs, depreciation expense and sales mix.
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SG&A costs increased 3.7% to $5.6 million in the first nine months of 2011 from $5.4 million during the same period in the prior year. This increase was primarily the result of increased employee related costs and selling commissions offset partially by decreased professional services costs.
TAXES
The Company’s effective tax rate for the third quarter and first nine months of 2011 was 36.9% and 34.0%, respectively. The Company’s effective tax rate for the third quarter and first nine months of 2010 was 0.4% and 1.8%, respectively. The effective tax rate for the first nine months and third quarter of 2010 was recorded at a rate lower than customary mainly due to the utilization of available net operating loss carry-forward credits for which a full valuation allowance was previously recorded.
NET INCOME AND INCOME PER SHARE
The net income for the third quarter of 2011 was $625 thousand, compared with net income of $1.0 million in the third quarter of 2010. The net income was due to the fluctuations discussed above. Diluted income per share was $0.18 in the third quarter of 2011 and $0.28 in the third quarter of 2010.
The net income for the first nine months of 2011 was $1.5 million or $0.42 per diluted share, compared with $1.1 million, or $0.30 per diluted share, in the first nine months of 2010. This net income was due to the fluctuations discussed above.
LIQUIDITY
Cash and cash equivalents at October 1, 2011 was $2.2 million, which was down from the $3.4 million balance at December 31, 2010 for the reasons set forth below.
Accounts payable increased $0.9 million during the first nine months of 2011, primarily due to the timing of purchases and payments.
Accounts receivable increased by $1.0 million during the first nine months of 2011, primarily due to increased sales and the timing of payments from customers.
Inventory increased by $2.4 million mainly due to build-up of raw material and finished goods to satisfy customer needs.
Capital expenditures, driven primarily by productivity improvement and capacity investments, for the first nine months of 2011 and 2010 were $1.9 million and $1.2 million, respectively. Depreciation and amortization for the first nine months of 2011 and 2010 was $2.2 million and $2.1 million, respectively.
The Company made estimated tax payments of $0.6 million during the first nine months of 2011. This is less than the 2011 year to date tax expense of $0.8 million due to the utilization of available net operating loss carry-forwards for which a valuation allowance was previously recorded.
There were 182,539 shares repurchased by the Company during the first nine months of 2011. The Company has authorization to repurchase 200,000 shares at October 1, 2011. The closing price of the Company’s stock at October 1, 2011 was $5.67. At this price, the repurchase of 200,000 shares would require $1.1 million.
The Company has access to a $3.0 million secured line of credit with a commercial bank which expires June 9, 2013. Interest on the line of credit is based on LIBOR plus 2.75%, with an interest floor of 3.35%. At October 1, 2011, $0.2 million was in use through a standby letter of credit and there was no balance drawn on the line. The Company was in compliance with all applicable covenants at October 1, 2011. The amount of the line of credit that was unused and available to the Company at October 1, 2011 was $2.8 million.
The Company believes that cash and cash equivalents, which totaled $2.2 million at October 1, 2011, in combination with cash expected to be generated from operations, will be adequate for the Company to meet its obligations, other working capital requirements and capital expenditure needs for the foreseeable future.
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COMMITMENTS
The Company has commitments for items that it purchases in the normal on-going affairs of the business. The Company is not aware of any obligations in excess of normal market conditions, or of any long-term commitments that would have a material adverse effect on its financial condition.
MARKET RISK
There has been no significant change in market risks since December 31, 2010.
As a result of short cycle times, the Company does not have any long-term commitments to purchase production raw materials or sell products that would present significant risks due to price fluctuations. Raw paper stock is available to us from multiple domestic sources; as a result, we believe the risk of supply interruptions due to such things as strikes at the source of supply or to failures in logistics systems are limited.
Risks due to fluctuation in interest rates are not material to the Company at October 1, 2011 because of our limited exposure to floating rate debt.
Over 90% of the Company's power needs are met through natural gas. The Company has investigated supply contracts of various lengths and currently it has supply arrangements for fixed prices on approximately 80% of its estimated usage through October 2011 and 100% of its usage from November 2011 to October 2012. Historically, the price of natural gas has fluctuated widely. The Company monitors the availability of natural gas, considering such factors as amount in storage, gas production data and transportation data, so that it can take appropriate action if concerns about availability occur. The Company has investigated and tested a back-up power source in the form
of a rented transportable diesel-powered generator.
We have no foreign operations, nor do we transact any business in foreign currencies. Accordingly, we have no foreign currency market risks.
The market risk that the Company was exposed to at December 31, 2010 was generally the same as described above.
CRITICAL ACCOUNTING POLICIES
There have been no changes in critical accounting policies in the current year from those disclosed in our 2010 Form 10-K.
FORWARD-LOOKING STATEMENTS
Certain statements contained in this report are "forward-looking statements" within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. All forward-looking statements involve risks and uncertainties. All statements contained herein that are not clearly historical in nature are forward-looking, and the word "anticipate," "believe," "expect," "estimate," "project," and similar expressions are generally intended to identify forward-looking statements. Any forward looking statement contained herein, in press releases, written statements or other documents filed with the Securities and Exchange Commission, or in MOD-PAC's communications and discussions with investors and analysts
in the normal course of business through meetings, webcasts, phone calls and conference calls, regarding expectations with respect to sales, earnings, cash flows, operating efficiencies, product and market channel expansions, capacity utilization and expansion, and repurchase of capital stock, are subject to known and unknown risks, uncertainties and contingencies. Many of these risks, uncertainties, and contingencies are beyond our control, and may cause actual results, performance or achievements to differ materially from anticipated results, performance or achievements. Factors that might affect such forward-looking statements include, among other things:
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
See Market Risk in Item 2, above.
Item 4. Controls and Procedures
(a.) Evaluation of Disclosure Controls and Procedures:
The Company’s management, with the participation of the Company’s President and Chief Executive Officer, and Chief Operating Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures as defined in Rules 13a - 15(e) and 15(d) - 15(e) of the Securities Exchange Act of 1934, as of October 1, 2011. Based on that evaluation, the Company’s President and Chief Executive Officer, and Chief Operating Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of October 1, 2011.
(b.) Changes in Internal Control over Financial Reporting:
There were no changes in the Company’s internal control over financial reporting during the first nine months of 2011 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
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PART II - OTHER INFORMATION
Item 1. Legal Proceedings
We were a third party defendant in an action filed in Supreme Court, Erie County, New York (David George, Plaintiff v. Speedways Conveyors, Incorporated and H.M. Cross & Sons, Inc., Defendants and Speedways Conveyors, Incorporated, Third-Party Plaintiff v. Mod-Pac Corporation, Third-Party Defendant. (Erie Co. Index No. 2003-8579 and 2003-8579 TP-1) by an employee for injuries he suffered during the course of his employment with us. The action has been settled without any monetary contribution from the Company.
Item 1A. Risk Factors>
There has been no significant change to the risk factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2010.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. (Removed and Reserved)
Item 5. Other Information
Not applicable.
Item 6. Exhibits
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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