Tredegar Corporation 10-Q 09-30-2006


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________

FORM 10-Q
(Mark One)

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

For the quarterly period ended September 30, 2006

OR

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

For the transition period from
 
to
 

Commission file number 1-10258

Tredegar Corporation
(Exact Name of Registrant as Specified in Its Charter)

Virginia
 
54-1497771
(State or Other Jurisdiction of Incorporation or Organization)
 
(I.R.S. Employer Identification No.)

1100 Boulders Parkway
   
Richmond, Virginia
 
23225
(Address of Principal Executive Offices)
 
(Zip Code)

Registrant's Telephone Number, Including Area Code: (804) 330-1000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x   No  o

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

Large accelerated filer o
Accelerated filer x
Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o   No  x

The number of shares of Common Stock, no par value, outstanding as of October 30, 2006: 38,822,447.
 




PART I - FINANCIAL INFORMATION
 
Item 1.
Financial Statements.

Tredegar Corporation
Consolidated Balance Sheets
(In Thousands)
(Unaudited)

   
Sept. 30, 2006
 
Dec. 31, 2005
 
Assets
         
Current assets:
         
Cash and cash equivalents
 
$
29,842
 
$
23,434
 
Accounts and notes receivable, net of allowance for doubtful accounts and sales returns of $6,541 in 2006 and $5,423 in 2005
   
159,190
   
119,330
 
Income taxes recoverable
   
4,802
   
7,163
 
Inventories
   
58,773
   
62,438
 
Deferred income taxes
   
7,141
   
7,778
 
Prepaid expenses and other
   
3,388
   
4,224
 
Total current assets
   
263,136
   
224,367
 
Property, plant and equipment, at cost
   
667,139
   
632,717
 
Less accumulated depreciation
   
340,381
   
309,841
 
Net property, plant and equipment
   
326,758
   
322,876
 
Other assets and deferred charges
   
95,952
   
96,527
 
Goodwill and other intangibles
   
139,058
   
137,988
 
Total assets
 
$
824,904
 
$
781,758
 
               
Liabilities and Shareholders' Equity
             
Current liabilities:
             
Accounts payable
 
$
88,364
 
$
61,731
 
Accrued expenses
   
45,805
   
36,031
 
Current portion of long-term debt
   
1,179
   
-
 
Total current liabilities
   
135,348
   
97,762
 
Long-term debt
   
76,915
   
113,050
 
Deferred income taxes
   
86,429
   
74,287
 
Other noncurrent liabilities
   
11,315
   
11,297
 
Total liabilities
   
310,007
   
296,396
 
Commitments and contingencies (Notes 1 and 2)
             
Shareholders' equity:
             
Common stock, no par value
   
111,703
   
110,706
 
Common stock held in trust for savings restoration plan
   
(1,289
)
 
(1,284
)
Unearned compensation on restricted stock
   
-
   
(966
)
Unrealized gain on available-for-sale securities
   
-
   
23
 
Foreign currency translation adjustment
   
20,217
   
14,114
 
(Loss) gain on derivative financial instruments
   
(230
)
 
776
 
Minimum pension liability
   
(2,434
)
 
(2,434
)
Retained earnings
   
386,930
   
364,427
 
Total shareholders' equity
   
514,897
   
485,362
 
Total liabilities and shareholders' equity
 
$
824,904
 
$
781,758
 

See accompanying notes to financial statements.

2

 
Tredegar Corporation
Consolidated Statements of Income
(In Thousands, Except Per Share Data)
(Unaudited)

   
Three Months Ended Sept. 30
 
Nine Months Ended Sept. 30
 
   
2006
 
2005
 
2006
 
2005
 
Revenues and other items:
                 
Sales
 
$
296,256
 
$
240,716
 
$
846,711
 
$
717,197
 
Other income (expense), net
   
474
   
(394
)
 
734
   
3,104
 
     
296,730
   
240,322
   
847,445
   
720,301
 
Costs and expenses:
                         
Cost of goods sold
   
252,848
   
201,917
   
719,177
   
604,346
 
Freight
   
7,265
   
6,281
   
20,989
   
18,626
 
Selling, general and administrative
   
18,135
   
15,746
   
50,570
   
49,200
 
Research and development
   
2,016
   
1,851
   
6,114
   
7,217
 
Amortization of intangibles
   
37
   
50
   
112
   
262
 
Interest expense
   
1,331
   
1,196
   
4,231
   
3,252
 
Asset impairments and costs associated with exit and disposal activities
   
692
   
1,159
   
3,410
   
12,517
 
Total
   
282,324
   
228,200
   
804,603
   
695,420
 
Income before income taxes
   
14,406
   
12,122
   
42,842
   
24,881
 
Income taxes
   
4,716
   
4,465
   
15,687
   
9,542
 
Net income
 
$
9,690
 
$
7,657
 
$
27,155
 
$
15,339
 
                           
Earnings per share:
                         
Basic
 
$
.25
 
$
.20
 
$
.70
 
$
.40
 
Diluted
   
.25
   
.20
   
.70
   
.40
 
                           
Shares used to compute earnings per share:
                         
Basic
   
38,654
   
38,465
   
38,629
   
38,453
 
Diluted
   
39,123
   
38,565
   
38,876
   
38,598
 
                           
Dividends per share
 
$
.04
 
$
.04
 
$
.12
 
$
.12
 

See accompanying notes to financial statements.

3


Tredegar Corporation
Consolidated Statements of Cash Flows
(In Thousands)
(Unaudited)

   
Nine Months Ended Sept. 30
 
   
2006
 
2005
 
Cash flows from operating activities:
         
Net income
 
$
27,155
 
$
15,339
 
Adjustments for noncash items:
             
Depreciation
   
32,619
   
28,203
 
Amortization of intangibles
   
112
   
262
 
Deferred income taxes
   
10,135
   
6,801
 
Accrued pension and postretirement benefits
   
2,358
   
(1,611
)
Gain on sale of assets
   
(56
)
 
(2,507
)
Loss on asset impairments and divestitures
   
1,150
   
6,556
 
Changes in assets and liabilities, net of effects of acquisitions and divestitures:
             
Accounts and notes receivable
   
(37,600
)
 
(15,327
)
Inventories
   
5,180
   
12,631
 
Income taxes recoverable
   
2,353
   
(8,627
)
Prepaid expenses and other
   
870
   
789
 
Accounts payable
   
25,109
   
(3,169
)
Accrued expenses and income taxes payable
   
7,877
   
(1,132
)
Other, net
   
(938
)
 
(2,767
)
Net cash provided by operating activities
   
76,324
   
35,441
 
Cash flows from investing activities:
             
Capital expenditures
   
(31,714
)
 
(49,027
)
Novalux investment
   
(542
)
 
-
 
Proceeds from the sale of assets and property disposals
   
266
   
3,368
 
Other, net
   
-
   
737
 
Net cash used in investing activities
   
(31,990
)
 
(44,922
)
Cash flows from financing activities:
             
Dividends paid
   
(4,656
)
 
(4,641
)
Debt principal payments
   
(38,956
)
 
(33,875
)
Borrowings
   
4,000
   
45,620
 
Book overdrafts
   
-
   
3,642
 
Proceeds from exercise of stock options
   
1,162
   
406
 
Net cash (used in) provided by financing activities
   
(38,450
)
 
11,152
 
Effect of exchange rate changes on cash
   
524
   
(1,218
)
Increase in cash and cash equivalents
   
6,408
   
453
 
Cash and cash equivalents at beginning of period
   
23,434
   
22,994
 
Cash and cash equivalents at end of period
 
$
29,842
 
$
23,447
 

See accompanying notes to financial statements.

4

 
Tredegar Corporation
Consolidated Statement of Shareholders' Equity
(In Thousands, Except Per Share Data)
(Unaudited)

                   
Accumulated Other
Comprehensive Income (Loss)
     
   
Common Stock
 
Retained Earnings
 
Trust for Savings Restoration Plan
 
Unearned Restricted Stock Compensation
 
Unrealized Gain on Available-for-Sale Securities
 
Foreign Currency Translation
 
Gain (Loss) on Derivative Financial Instruments
 
Minimum Pension Liability
 
Total Share-holders' Equity
 
Balance December 31, 2005
 
$
110,706
 
$
364,427
 
$
(1,284
)
$
(966
)
$
23
 
$
14,114
 
$
776
 
$
(2,434
)
$
485,362
 
Comprehensive income:
                                                       
Net income
   
-
   
27,155
   
-
   
-
   
-
   
-
   
-
   
-
   
27,155
 
Other comprehensive income (loss):
                                                       
Available-for-sale securities adjustment (net of tax of $13)
   
-
   
-
   
-
   
-
   
(23
)
 
-
   
-
   
-
   
(23
)
Foreign currency translation adjustment (net of tax of $3,271)
   
-
   
-
   
-
   
-
   
-
   
6,103
   
-
   
-
   
6,103
 
Derivative financial instruments adjustment (net of tax of $581)
   
-
   
-
   
-
   
-
   
-
   
-
   
(1,006
)
 
-
   
(1,006
)
Comprehensive income
                                                   
32,229
 
Cash dividends declared ($.04 per share)
   
-
   
(4,656
)
 
-
   
-
   
-
   
-
   
-
   
-
   
(4,656
)
Elimination of unearned restricted stock compensation
   
(966
)
 
-
   
-
   
966
   
-
   
-
   
-
   
-
   
-
 
Stock options and restricted stock awards
   
783
   
-
   
-
   
-
   
-
   
-
   
-
   
-
   
783
 
Issued upon exercise of stock options and stock compensation plans (including related income tax benefits of $113)
   
1,180
   
4
   
(5
)
 
-
   
-
   
-
   
-
   
-
   
1,179
 
Balance September 30, 2006
 
$
111,703
 
$
386,930
 
$
(1,289
)
$
-
 
$
-
 
$
20,217
 
$
(230
)
$
(2,434
)
$
514,897
 

See accompanying notes to financial statements.

5


TREDEGAR CORPORATION
NOTES TO THE CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Unaudited)

1.
In the opinion of management, the accompanying consolidated financial statements of Tredegar Corporation and Subsidiaries (“Tredegar”) contain all adjustments necessary to present fairly, in all material respects, Tredegar’s consolidated financial position as of September 30, 2006, the consolidated results of operations for the three and nine months ended September 30, 2006 and 2005, and the consolidated cash flows for the nine months ended September 30, 2006 and 2005. All such adjustments are deemed to be of a normal, recurring nature. These financial statements should be read in conjunction with the consolidated financial statements and related notes included in Tredegar’s Annual Report on Form 10-K for the year ended December 31, 2005. The results of operations for the three and nine months ended September 30, 2006, are not necessarily indicative of the results to be expected for the full year.

2.
Plant shutdowns, asset impairments and restructurings and related items in the third quarter of 2006 shown in the segment operating profit table in Note 8 include:

 
·
A net pretax gain of $1 million associated with the shutdown of the films manufacturing facility in LaGrange, Georgia, including a gain of $1.2 million for related LIFO inventory liquidations (included in "Cost of goods sold" in the consolidated statements of income), partially offset by other shutdown-related costs of $198,000;
 
·
A pretax charge of $920,000 related to expected future environmental costs at the aluminum extrusions facility in Newnan, Georgia (included in "Cost of goods sold" in the consolidated statements of income); and
 
·
A pretax charge of $494,000 related to the estimated loss on the sub-lease of a portion of the AFBS (formerly Therics) facility in Princeton, New Jersey.

Plant shutdowns, asset impairments and restructurings and related items in the third quarter of 2005 shown in the segment operating profit table in Note 8 include:

 
·
Pretax charges of $906,000 for severance and other employee-related costs in connection with restructurings in Film Products ($514,000), Aluminum Extrusions ($207,000), and at corporate headquarters ($185,000; included in "Corporate expenses, net" in the segment operating profit table);
 
·
A net pretax charge of $595,000 related to severance and other employee-related costs associated with the restructuring of the research and development operations in Film Products (of this amount, $657,000 in pretax charges for employee relocation and recruitment is included in "Selling, general and administrative expenses" in the consolidated statements of income);
 
·
A pretax charge of $198,000 related to the shutdown of the aluminum extrusions facility in Aurora, Ontario; and
 
·
Pretax charges of $117,000 for accelerated depreciation related to restructurings in Film Products.

Plant shutdowns, asset impairments and restructurings and related items in the first nine months of 2006 shown in the segment operating profit table in Note 8 include:

 
·
A net pretax gain of $1.4 million associated with the shutdown of the films manufacturing facility in LaGrange, Georgia, including a gain of $2.6 million for related LIFO inventory liquidations (included in "Cost of goods sold" in the consolidated statements of income), partially offset by severance and other costs of $1 million and asset impairment charges of $130,000;

6


 
·
Pretax charges of $1 million for asset impairments in Film Products;
 
·
A pretax charge of $920,000 related to expected future environmental costs at the aluminum extrusions facility in Newnan, Georgia (included in "Cost of goods sold" in the consolidated statements of income);
 
·
Pretax charges of $727,000 for severance and other employee-related costs in connection with restructurings in Film Products ($213,000) and Aluminum Extrusions ($514,000); and
 
·
A pretax charge of $494,000 related to the estimated loss on the sub-lease of a portion of the AFBS (formerly Therics) facility in Princeton, New Jersey.

Plant shutdowns, asset impairments and restructurings and related items in the first nine months of 2005 shown in the segment operating profit table in Note 8 include:

 
·
A pretax charge of $10 million related to the sale or assignment of substantially all of Therics' assets, including asset impairment charges of $5.6 million, lease-related losses of $3 million and severance and other transaction-related costs of $1.4 million;
 
·
Pretax charges of $1.8 million related to severance and other employee-related costs associated with restructurings in Film Products ($991,000), Aluminum Extrusions ($648,000) and at corporate headquarters ($185,000; included in "Corporate expenses, net" in the segment operating profit table);
 
·
A pretax gain of $1.6 million related to the shutdown of the films manufacturing facility in New Bern, North Carolina, including a $1.8 million gain on the sale of the facility (included in "Other income (expense), net" in the consolidated statements of income), partially offset by shutdown-related expenses of $225,000;
 
·
A pretax charge of $1 million for process reengineering costs associated with the implementation of a new information system in Film Products (included in "Costs of goods sold" in the consolidated statements of income);
 
·
A net pretax charge of $725,000 related to severance and other employee-related costs associated with the restructuring of the research and development operations in Film Products (of this amount, $1.2 million in pretax charges for employee relocation and recruitment is included in "Selling, general and administrative expenses" in the consolidated statements of income);
 
·
A pretax gain of $653,000 related to the shutdown of the films manufacturing facility in Carbondale, Pennsylvania, including a $630,000 gain on the sale of the facility (included in "Other income (expense), net" in the consolidated statements of income), and the reversal to income of certain shutdown-related accruals of $23,000;
 
·
A pretax charge of $597,000 related to the shutdown of the aluminum extrusions facility in Aurora, Ontario, including $1.1 million of shutdown-related costs, partially offset by the reversal to income of certain severance and employee-related accruals of $474,000; and
 
·
Pretax charges of $322,000 for accelerated depreciation related to restructurings in Film Products.

7


A reconciliation of the beginning and ending balances of accrued expenses associated with plant shutdowns and divestitures for the nine months ended September 30, 2006 is as follows:
                       
(In Thousands)
 
Severance
 
Asset Impairments
 
Accelerated Depreciation (a)
 
Other (b)
 
Total
 
Balance at December 31, 2005
 
$
1,485
 
$
-
 
$
-
 
$
5,487
 
$
6,972
 
Changes in 2006:
                               
Charges
   
1,371
   
1,150
   
-
   
937
   
3,458
 
Cash spent
   
(2,286
)
 
-
   
-
   
(1,538
)
 
(3,824
)
Charged against assets
   
-
   
(1,150
)
 
-
   
-
   
(1,150
)
Balance at September 30, 2006
 
$
570
 
$
-
 
$
-
 
$
4,886
 
$
5,456
 
(a)
Represents depreciation accelerated due to plant shutdowns based on a remaining useful life of less than one year.
(b)
Other includes primarily accrued losses on a sub-lease at a facility in Princeton, New Jersey.

In the nine months ended September 30, 2006, a pretax gain on the sale of public equity securities of $56,000 (proceeds also of $56,000) is included in “Other income (expense), net” in the consolidated statements of income and “Gain on the sale of corporate assets” in the segment operating profit table in Note 8. In the nine months ended September 30, 2005, a pretax gain on the sale of corporate real estate of $61,000 (proceeds of $151,000) is included in “Other income (expense), net” in the consolidated statements of income and “Gain on the sale of corporate assets” in the segment operating profit table in Note 8. In the nine months ended September 30, 2005, a pretax gain for interest receivable on tax refund claims of $508,000 is included in "Other income (expense), net" in the consolidated statements of income and "Corporate expenses, net" in the segment operating profit table in Note 8.
 
3.
The components of other comprehensive income or loss are as follows:
           
   
Three Months Ended Sept. 30
 
Nine Months Ended Sept. 30
 
(In Thousands)
 
2006
 
2005
 
2006
 
2005
 
Net income
 
$
9,690
 
$
7,657
 
$
27,155
 
$
15,339
 
Other comprehensive income (loss), net of tax:
                 
Available-for-sale securities adjustment:
                         
Unrealized net holding gains (losses) arising during the period
   
-
   
8
   
(2
)
 
39
 
Reclassification adjustment for net gains realized in income
   
-
   
-
   
(21
)
 
-
 
Available-for-sale securities adjustment
   
-
   
8
   
(23
)
 
39
 
Foreign currency translation adjustment
   
1,536
   
3,043
   
6,103
   
(4,073
)
Derivative financial instrument adjustment
   
669
   
736
   
(1,006
)
 
(620
)
Minimum pension liability adjustment
   
-
   
-
   
-
   
191
 
Comprehensive income (loss) 
 
$
11,895
 
$
11,444
 
$
32,229
 
$
10,876
 
 
4.
The components of inventories are as follows:
           
(In Thousands)
 
Sept. 30 2006
 
Dec. 31, 2005
 
Finished goods
 
$
11,477
 
$
12,838
 
Work-in-process
   
3,685
   
3,685
 
Raw materials
   
29,028
   
33,043
 
Stores, supplies and other
   
14,583
   
12,872
 
Total
 
$
58,773
 
$
62,438
 
 
8

 
5.
Basic earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding. Diluted earnings per share is computed by dividing net income by the weighted average common and potentially dilutive common equivalent shares outstanding, determined as follows:
           
   
Three Months Ended Sept. 30
 
Nine Months Ended Sept. 30
 
(In Thousands)
 
2006
 
2005
 
2006
 
2005
 
Weighted average shares outstanding used to compute basic earnings per share
   
38,654
   
38,465
   
38,629
   
38,453
 
Incremental shares attributable to stock options and restricted stock
   
469
   
100
   
247
   
145
 
Shares used to compute diluted earnings per share
   
39,123
   
38,565
   
38,876
   
38,598
 

Incremental shares attributable to stock options and restricted stock are computed using the average market price during the related period. During the three and nine months ended September 30, 2006 and three and nine months ended September 30, 2005, 1,196,722, 1,324,817, 2,102,035 and 1,974,576, respectively, of average out-of-the-money options to purchase shares were excluded from the calculation of incremental shares attributable to stock options and restricted stock.

6.
Effective January 1, 2006, Tredegar adopted Statement of Financial Accounting Standards No. 123(R), Share-Based Payment (“SFAS 123(R)”). SFAS 123(R) requires us to record compensation expense for all share-based awards. We previously applied Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations and provided the required pro forma disclosures of SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS 123”). Because we used the modified prospective method in adopting SFAS 123(R), prior periods have not been restated. In addition, the cumulative adjustment (estimated forfeitures) relating to the adoption of SFAS 123(R) in the first quarter of 2006 of $96,000 has not been separately shown in the income statement due to immateriality.

Our stock-based compensation is comprised of restricted and phantom stock awards (which we have historically recognized as compensation expense under APB Opinion No. 25) and stock option grants (which we have not historically recognized as compensation expense but provided pro forma compensation expense disclosures under SFAS 123). Compensation expense related to restricted and phantom stock awards included in determining net income during the three and nine months ended September 30, 2006 and three and nine months ended September 30, 2005 was $66,000 less a credit of $96,000 for changes in forfeiture assumptions, $126,000, $215,000 and $377,000, respectively. Stock option-based compensation expense included in determining net income in the three and nine months ended September 30, 2006 was $215,000 ($138,000 after taxes or less than one cent per share) and $708,000 ($508,000 after taxes or one cent per share), respectively. Pro forma stock option-based compensation expense included in determining pro forma net income in the three and nine months ended September 30, 2005 was $286,000 ($271,000 after taxes or less than one cent per share) and $859,000 ($814,000 after taxes or one cent per share), respectively. We expect to recognize stock option-based compensation expenses under the new standard of approximately $1 million in 2006 (2 cents per share after taxes).

9


We granted stock options with a two-year vesting period and a seven-year term in the first and third quarters of 2006 (none were granted in the second quarter of 2006). The assumptions used to determine the estimated fair value of options granted under the Black-Scholes options pricing model, the number of stock options granted, and the estimated fair value of options granted are as follows:
   
Assumptions Used in Determining Compensation Expense for Stock Options Granted in 2006 & Other Data
 
Dividend yield
   
1.1
%
 
Stock options granted (number of shares):
       
Expected volatility percentage
   
37.3%-39.1
%
 
Officers
   
97,500
 
Weighted-average volatility
   
38.4
%
 
Management
   
330,800
 
Weighted average risk-free interest rate
   
4.7
%
 
Other employees
   
-
 
Expected holding period (years):
         
Total
   
428,300
 
Officers
   
6.0
             
Management
   
5.0
   
Estimated weighted average fair value of
       
Other employees
   
n/a
   
options per share at date of grant:
       
Estimated weighted-average annual forfeiture rate
         
Officers
 
$
6.22
 
at date of grant:
         
Management
   
5.64
 
Officers
   
2.0
%
 
Other employees
   
-
 
Management
   
5.0
%
           
Weighted average exercise prices at date of grant:
                   
Officers
 
$
15.11
   
Total estimated fair value of stock
       
Management
 
$
15.18
   
options granted (in thousands)
 
$
2,472
 

The dividend yield is the dividend yield on our common stock at the date of grant, which we believe is a reasonable estimate of the expected yield during the holding period. We calculate expected volatility based on the historical volatility of our common stock using a sequential period of historical data equal to the expected holding period of the option. We have no reason to believe that future volatility is likely to differ from the past. The assumed risk-free interest rate is based on observed interest rates (zero coupon U.S. Treasury debt securities) appropriate for the expected holding period. The expected holding period and forfeiture assumptions are based on historical experience. Estimated forfeiture assumptions are reviewed through the vesting period. Adjustments are made if actual forfeitures differ from previous estimates. The cumulative effect of a change in estimated forfeitures is recognized in the period of the change.
 
A summary of our stock options outstanding at September 30, 2006 and December 31, 2005 and changes during the nine months and year ended, respectively, is presented below:
           
       
Option Exercise Price/Share
 
   
Number of Options
 
Range
 
Wgted. Ave.
 
Outstanding at 12/31/04
   
2,661,990
 
$
4.17
   
to
 
$
46.63
 
$
22.01
 
Granted
   
-
   
n/a
   
to
   
n/a
   
n/a
 
Forfeited and Expired
   
(274,575
)
 
13.95
   
to
   
46.63
   
21.90
 
Exercised
   
(137,075
)
 
4.17
   
to
   
16.55
   
7.51
 
Outstanding at 12/31/05
   
2,250,340
   
7.38
   
to
   
46.63
   
22.90
 
Granted
   
428,300
   
15.11
   
to
   
16.48
   
15.16
 
Forfeited and Expired
   
(765,975
)
 
7.38
   
to
   
46.63
   
31.47
 
Exercised
   
(107,510
)
 
7.38
   
to
   
14.56
   
11.01
 
Outstanding at 9/30/06
   
1,805,155
 
$
13.95
   
to
 
$
29.94
 
$
18.14
 
 
10

 
The following table summarizes additional information about stock options outstanding and exercisable and non-vested restricted stock outstanding at September 30, 2006:
           
   
Options Outstanding at
 
Options Exercisable at
 
   
September 30, 2006
 
September 30, 2006
 
               
Weighted Average
 
Aggregate
         
Aggregate
 
               
Remaining
     
Intrinsic
     
Weighted
 
Intrinsic
 
               
Contract-
     
Value
     
Average
 
Value
 
Range of
     
ual Life
 
Exercise
 
(In
     
Exercise
 
(In
 
Exercise Prices
 
Shares
 
(Years)
 
Price
 
Thousands)
 
Shares
 
Price
 
Thousands)
 
$    13.95
   
to
 
$
17.88
   
840,550
   
4.3
 
$
15.18
 
$
1,317
   
461,750
 
$
15.20
 
$
718
 
      17.89
   
to
   
19.75
   
667,650
   
1.5
   
19.22
   
-
   
667,650
   
19.22
   
-
 
19.76
   
to
   
25.65
   
216,300
   
0.4
   
21.95
   
-
   
216,300
   
21.95
   
-
 
25.66
   
to
   
29.94
   
80,655
   
1.7
   
29.85
   
-
   
80,655
   
29.85
   
-
 
$    13.95
   
to
 
$
29.94
   
1,805,155
   
2.7
 
$
18.14
 
$
1,317
   
1,426,355
 
$
18.93
 
$
718
 
           
Non-vested Restricted Stock
 
Number of Shares
 
Wgtd. Ave. Grant
Date Fair Value/Sh.
 
Outstanding at 12/31/05
   
109,000
 
$
13.88
 
Granted
   
-
   
-
 
Vested
   
(17,333
)
 
13.95
 
Forfeited
   
(24,167
)
 
13.80
 
Outstanding at 9/30/06
   
67,500
 
$
13.90
 
 
The total intrinsic value of stock options exercised during the three and nine months ended September 30, 2006 was $62,000 and $471,000, respectively. The grant-date fair value of stock option-based awards vested during the nine months ended September 30, 2006 was $1.3 million (no awards vested during the third quarter). As of September 30, 2006, there was $1.5 million and $366,000 of unrecognized compensation cost related to stock option-based awards and non-vested restricted stock, respectively. This cost is expected to be recognized over the remaining weighted average period of 1.45 years for stock option-based awards and 2.54 years for non-vested restricted stock. Compensation costs for non-vested restricted stock is subject to accelerated vesting based on meeting certain financial targets.

11

 
7.
The components of net periodic benefit income (cost) for our pension and other post-retirement benefit programs are shown below:
           
   
Pension Benefits for
3 Months Ended Sept. 30
 
Other Post-Retirement Benefits for
3 Months Ended Sept. 30
 
(In Thousands)
 
2006
 
2005
 
2006
 
2005
 
Service cost
 
$
(1,425
)
$
(1,616
)
$
(22
)
$
(23
)
Interest cost
   
(3,384
)
 
(3,172
)
 
(135
)
 
(116
)
Employee contributions
   
-
   
113
   
-
   
-
 
Other
   
(36
)
 
(29
)
 
-
   
-
 
Expected return on plan assets
   
5,434
   
5,526
   
-
   
-
 
Amortization of prior service costs, gains or losses and net transition asset
   
(1,111
)
 
(185
)
 
4
   
1
 
Net periodic benefit (cost) income
 
$
(522
)
$
637
 
$
(153
)
$
(138
)
           
   
Pension Benefits for
9 Months Ended Sept. 30
 
Other Post-Retirement Benefits for
9 Months Ended Sept. 30
 
(In Thousands)
 
2006
 
2005
 
2006
 
2005
 
Service cost
 
$
(4,313
)
$
(4,892
)
$
(66
)
$
(80
)
Interest cost
   
(10,051
)
 
(9,463
)
 
(406
)
 
(407
)
Employee contributions
   
-
   
340
   
-
   
-
 
Other
   
(93
)
 
40
   
-
   
-
 
Expected return on plan assets
   
16,102
   
16,550
   
-
   
-
 
Amortization of prior service costs, gains or losses and net transition asset
   
(3,544
)
 
(476
)
 
13
   
(1
)
Net periodic benefit (cost) income
 
$
(1,899
)
$
2,099
 
$
(459
)
$
(488
)

We expect required contributions to our pension plans to be about $800,000 for the year ending December 31, 2006. We fund our other post-retirement benefits (life insurance and health benefits) on a claims-made basis, which were $645,000 and $525,000 for the years ended December 31, 2005 and 2004, respectively.

On October 26, 2006, we announced changes to our U.S. defined benefit (pension) and savings plans covering salaried and certain other employees. The changes will have no impact on our net income or earnings per share in 2006. We expect that the changes relating to the pension plan will reduce our projected benefit obligation by approximately $10 million as of December 31, 2006. In 2007, the changes to the pension plan are expected to reduce our service cost, interest cost and amortization of prior service cost components of pension expense by approximately $600,000, $600,000 and $1.5 million, respectively, and the savings plan changes are expected to increase charges for company matching contributions by approximately $700,000.

12


8.
Information by business segment is reported below. There are no accounting transactions between segments and no allocations to segments. There have been no significant changes to identifiable assets by segment. Net sales (sales less freight) and operating profit from ongoing operations are the measures of sales and operating profit used by the chief operating decision maker of each segment for purposes of assessing performance.

Tredegar Corporation
Net Sales and Operating Profit by Segment
(In Thousands)
(Unaudited)

   
Three Months Ended Sept. 30
 
Nine Months Ended Sept. 30
 
   
2006
 
2005
 
2006
 
2005
 
Net Sales
                 
Film Products
 
$
134,961
 
$
116,350
 
$
382,697
 
$
344,305
 
Aluminum Extrusions
   
154,030
   
118,085
   
443,025
   
354,014
 
AFBS (formerly Therics)
   
-
   
-
   
-
   
252
 
Total net sales
   
288,991
   
234,435
   
825,722
   
698,571
 
Add back freight
   
7,265
   
6,281
   
20,989
   
18,626
 
Sales as shown in the Consolidated Statements of Income
 
$
296,256
 
$
240,716
 
$
846,711
 
$
717,197
 
                           
Operating Profit
                         
Film Products:
                         
Ongoing operations
 
$
13,770
 
$
13,822
 
$
42,611
 
$
36,796
 
Plant shutdowns, asset impairments and restructurings, net of gain on sale of assets and related income from LIFO inventory liquidations
   
1,022
   
(1,225
)
 
207
   
(812
)
                           
Aluminum Extrusions:
                         
Ongoing operations
   
5,407
   
4,362
   
15,947
   
14,580
 
Plant shutdowns, asset impairments and restructurings
   
(920
)
 
(406
)
 
(1,434
)
 
(1,246
)
                           
AFBS (formerly Therics):
                         
Ongoing operations
   
-
   
-
   
-
   
(3,467
)
Loss on investment in Therics, LLC
   
-
   
(91
)
 
(25
)
 
(91
)
Plant shutdowns, asset impairments and restructurings
   
(494
)
 
-
   
(494
)
 
(10,049
)
                           
Total
   
18,785
   
16,462
   
56,812
   
35,711
 
Interest income
   
315
   
146
   
822
   
386
 
Interest expense
   
1,331
   
1,196
   
4,231
   
3,252
 
Gain on sale of corporate assets
   
-
   
-
   
56
   
61
 
Stock option-based compensation costs
   
215
   
-
   
708
   
-
 
Corporate expenses, net
   
3,148
   
3,290
   
9,909
   
8,025
 
Income before income taxes
   
14,406
   
12,122
   
42,842
   
24,881
 
Income taxes
   
4,716
   
4,465
   
15,687
   
9,542
 
Net income
 
$
9,690
 
$
7,657
 
$
27,155
 
$
15,339
 
 
13


9.
In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 158, Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No 87, 88, 106 and 132(R), effective for public companies for fiscal years ending after December 15, 2006. Accordingly, we will be required to recognize the funded status of our pension plans in our December 31, 2006 financial statements. The funded status of our pension plans at December 31, 2005 was plan assets at fair value in excess of benefit obligations of $18.6 million ($28.6 million on a pro forma basis including the pension plan changes discussed in Note 7). On a pro forma basis at December 31, 2005 (including the pension plan changes discussed in Note 7), we estimate that the new standard would have resulted in a decrease in prepaid pension cost of $57 million (included in “Other assets and deferred charges” in the consolidated balance sheet), a decrease in non-current deferred income tax liabilities of $20 million and a decrease in shareholders’ equity of $37 million. Adjustments from the new standard are not expected to impact our debt covenant computations since our credit agreement allows us to elect to use generally accepted accounting principles in effect when the agreement was signed.

In September 2006, the FASB issued FASB Staff Position ("FSP") No. AUG AIR-1, Accounting for Planned Major Maintenance Activities. The FSP is effective for the first fiscal year beginning after December 31, 2006. The FSP eliminates the accrual method of accounting for major maintenance activities, but continues to permit the use of the direct expensing, built-in overhaul and deferral methods. The FSP also continues to require accruals or deferrals for interim periods of annual costs that clearly benefit two or more interim periods. We are evaluating the FSP and have not determined whether or not it will have a material effect on our financial position or results of operations.

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, clarifying the accounting for uncertain tax positions. The interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation is effective for fiscal years beginning after December 15, 2006 with earlier application encouraged. We are evaluating the interpretation and have not determined whether or not it will have a material effect on our financial position or results of operations.

14


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

Forward-looking and Cautionary Statements

Some of the information contained in this quarterly report on Form 10-Q may constitute “forward-looking statements” within the meaning of the “safe-harbor” provisions of the Private Securities Litigation Reform Act of 1995. When we use words such as “believe,” “hope,” “expect,” “are likely,” “project” and similar expressions, we do so to identify forward-looking statements. Such statements are based on our then current expectations and are subject to a number of risks and uncertainties that could cause actual results to differ materially from those addressed in the forward-looking statements. Risk factors that may cause such a difference are summarized on pages 32-34 and are incorporated herein.

Executive Summary

General. Third-quarter 2006 net income was $9.7 million (25 cents per share) compared with $7.6 million (20 cents per share) in the third quarter of 2005. Net income was $27.2 million (70 cents per share) for the first nine months of 2006 compared with $15.3 million (40 cents per share) for the first nine months of 2005. Gains on the sale of assets and other items and losses related to plant shutdowns, assets impairments and restructurings are described in Note 2 on page 6. The business segment review is provided below and beginning on page 22.

Film Products. Third-quarter net sales in Film Products were $135.0 million, up 16.0% from $116.4 million in the third quarter of 2005 while operating profit from ongoing operations was flat at $13.8 million. Profits were adversely affected by the lag in the pass-through of higher average resin costs (estimated negative impact of $1.5 million in the third quarter of 2006 versus none in the third quarter of 2005). The increase in sales and operating profit excluding the resin pass-through lag over last year’s third quarter was primarily due to continued growth in the sale of higher value surface protection films, elastic materials and new apertured topsheets. Volume was 64.4 million pounds compared with 66.1 million pounds in the third quarter of 2005. Volume declines were mainly due to lower sales of certain barrier films that are being discontinued in conjunction with the shutdown of the plant in LaGrange, Georgia. Net sales, operating profit and volume in the second quarter of 2006 were $121.4 million, $13.3 million ($12.8 million excluding the estimated positive resin pass-through lag of $500,000) and 61.9 million pounds, respectively.

Film Products has index-based pass-through raw material cost agreements for the majority of its business. However, under certain agreements, changes in resin prices are not passed through for an average period of 90 days. Average quarterly prices of low-density polyethylene resin (“LDPE”) in the U.S. increased 6-7 cents per pound in the third quarter of 2006 after decreasing 8 and 6 cents per pound in the first and second quarters of 2006, respectively. LDPE prices in the U.S. decreased in September 2006 by 2-3 cents per pound. Average LDPE prices in Europe and Asia also increased in the third quarter of 2006. Since 2002, U.S. LDPE prices have more than doubled. Resin prices in Europe, Asia and South America have also increased significantly during this time.

Net sales were $382.7 million in the first nine months of 2006, up 11.2% versus $344.3 million in 2005. Operating profit from ongoing operations was $42.6 million in the first nine months of 2006, up 15.8% compared to $36.8 million in 2005. Year-to-date volume decreased to 190.8 million pounds from 197.8 million pounds in 2005. Net sales, operating profit and volume changes for the first nine months of 2006 compared with 2005 were primarily due to the factors noted above in the third quarter analysis.

Film Products continues to expand capacity to support growth in new products. Capital expenditures were $26.1 million in the first nine months of 2006 and are expected to be approximately $40 million for the year versus $50 million last year. Approximately half of the forecasted capital expenditures relates to expanding the production capacity for surface protection films. Other planned capital expenditures include capacity additions for elastic materials and a new information system, which is currently being rolled out in U.S. locations. Depreciation expense was $23.5 million in the first nine months of 2006 compared with $19.2 million in the first half of last year, and is projected to increase by approximately $5 million to $32 million for the year.

15


Aluminum Extrusions. Third-quarter net sales in Aluminum Extrusions were $154.0 million, up 30.4% from $118.1 million in the third quarter of 2005 primarily due to improved volume and higher selling prices. Operating profit from ongoing operations increased to $5.4 million, up 23% from $4.4 million in the third quarter of 2005. The increase in operating profit was mainly due to higher volume (up 7.1%). Lower energy costs of approximately $1 million and higher selling prices partially offset the adverse impact of appreciation of the Canadian Dollar (approximately $1 million), charges for possible uncollectible accounts ($800,000) and sales mix changes. Volume increased to 68.4 million pounds versus 63.9 million pounds in the third quarter of 2005. Growth in shipments continued to be driven by demand for extrusions used in commercial construction and hurricane protection products. However, we are concerned about near-term performance based on a recent slow down in orders in most markets that appears to be more significant than normal seasonal factors.
 
Net sales were $443.0 million in the first nine months of 2006, up 25.1% versus $354.0 million in 2005. Operating profit from ongoing operations was $15.9 million in the first nine months of 2006, up 8.9% compared to $14.6 million in 2005. Year-to-date volume increased to 201.5 million pounds, up 8.5% compared to 185.7 million pounds in 2005. Year-to-date net sales improved due to higher volume and higher selling prices. The increase in operating profit during the first nine months was primarily due to higher volume and selling prices, partially offset by appreciation of the Canadian Dollar ($2.7 million), charges for possible uncollectible accounts ($1.2 million), margin compression caused by rapidly increasing aluminum costs (adverse impact estimated of $1.1 million) and higher energy costs ($1 million). We believe margin compression from rapid movements in aluminum costs should be mitigated for extruded products in the future since pricing on normal customer orders has changed from the order date to the shipment date.

Capital expenditures in Aluminum Extrusions in the first nine months of 2006 were $5.6 million and are expected to be approximately $8 million for the year.

Other Developments. Consolidated net pension expense was $1.9 million in the first nine months of 2006, an increase of $4.0 million (7 cents per share after taxes) from the net pension income of $2.1 million recognized in the first nine months of 2005. We expect net pension expense of $2.5 million in 2006, an unfavorable change of $5.2 million (9 cents per share after taxes) versus 2005. Most of this change relates to a pension plan that is reflected in “Corporate expenses, net” in the segment operating profit table on page 22. We expect required contributions to our pension plans to be about $800,000 in 2006.

On October 26, 2006, we announced changes to our U.S. defined benefit (pension) and savings plans covering salaried and certain other employees. The changes will have no impact on our net income or earnings per share in 2006. We expect that the changes relating to the pension plan will reduce our projected benefit obligation by approximately $10 million as of December 31, 2006. In 2007, the changes to the pension plan are expected to reduce our service cost, interest cost and amortization of prior service cost components of pension expense by approximately $600,000, $600,000 and $1.5 million, respectively, and the savings plan changes are expected to increase charges for company matching contributions by approximately $700,000.

During the first quarter of 2006, we adopted Statement of Financial Accounting Standards No. 123(R), Share-Based Payment (“SFAS 123(R)”), which requires all stock-based compensation to be expensed and accounted for using a fair value-based method. The adoption of SFAS 123(R) and the granting of stock options in 2006 resulted in first-, second- and third- quarter pretax charges for stock option-based compensation of $211,000, $282,000 and $215,000, respectively. We expect to recognize stock option-based compensation costs under the new standard of approximately $1 million in 2006 (2 cents per share after taxes).

16


Consolidated net capitalization and other credit measures are provided in the liquidity and capital resources section beginning on page 23.

Critical Accounting Policies

In the ordinary course of business, we make a number of estimates and assumptions relating to the reporting of results of operations and financial position in the preparation of financial statements in conformity with generally accepted accounting principles. We believe the estimates, assumptions and judgments described in the section “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies” of our Annual Report on Form 10-K for the year ended December 31, 2005, have the greatest potential impact on our financial statements, so we consider these to be our critical accounting policies. These policies include our accounting for impairment of long-lived assets and goodwill, pension benefits and income taxes. These policies require management to exercise judgments that are often difficult, subjective and complex due to the necessity of estimating the effect of matters that are inherently uncertain. Actual results could differ materially from those estimates under different assumptions and conditions. We believe the consistent application of these policies enables us to provide readers of our financial statements with useful and reliable information about our operating results and financial condition. There has been no significant change in these policies except for the accounting for stock-based compensation discussed in the executive summary. See Note 2 on page 6 for losses related to plant shutdowns, assets impairments and restructurings occurring during 2006 and the comparable period in 2005.

Recently Issued Accounting Standards

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 158, Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No 87, 88, 106 and 132(R), effective for public companies for fiscal years ending after December 15, 2006. Accordingly, we will be required to recognize the funded status of our pension plans in our financial statements for the fiscal year ending December 31, 2006. The funded status of our pension plans at December 31, 2005 was plan assets at fair value in excess of benefit obligations of $18.6 million ($28.6 million on a pro forma basis including the pension plan changes discussed in the executive summary). On a pro forma basis at December 31, 2005 (including the pension plan changes discussed in the executive summary), we estimate that the new standard would have resulted in a decrease in prepaid pension cost of $57 million (included in “Other assets and deferred charges” in the consolidated balance sheet), a decrease in non-current deferred income tax liabilities of $20 million and a decrease in shareholders’ equity of $37 million. Adjustments from the new standard are not expected to impact our debt covenant computations since our credit agreement allows us to elect to use generally accepted accounting principles in effect when the agreement was signed.

In September 2006, the FASB issued FASB Staff Position ("FSP") No. AUG AIR-1, Accounting for Planned Major Maintenance Activities. The FSP is effective for the first fiscal year beginning after December 31, 2006. The FSP eliminates the accrual method of accounting for major maintenance activities, but continues to permit the use of the direct expensing, built-in overhaul and deferral methods. The FSP also continues to require accruals or deferrals for interim periods of annual costs that clearly benefit two or more interim periods. We are evaluating the FSP and have not determined whether or not it will have a material effect on our financial position or results of operations.

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, clarifying the accounting for uncertain tax positions. The interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation is effective for fiscal years beginning after December 15, 2006 with earlier application encouraged. We are evaluating the interpretation and have not determined whether or not it will have a material effect on our financial position or results of operations.

17


Results of Operations

Third Quarter 2006 Compared with Third Quarter 2005

Overall, sales in the third quarter of 2006 increased by 23.1% compared with 2005. Net sales (sales less freight) increased 16.0% in Film Products primarily due to growth in higher value-added products, including surface protection, elastic and apertured materials. Net sales in Film Products also increased from higher selling prices, which were driven by higher raw material costs. Net sales increased 30.4% in Aluminum Extrusions due to higher volume (up 7.1%) and selling prices. For more information on net sales and volume, see the executive summary beginning on page 15.

Consolidated gross profit (sales minus cost of goods sold and freight) as a percentage of sales decreased to 12.2% in the third quarter of 2006 from 13.5% in 2005 due to a decline in the gross profit margin in Film Products. The gross profit margin in Film Products declined as a result of higher average selling prices to cover higher average resin costs over the last 12 months and the lag in the pass-through of higher average resin costs in the third quarter compared with the second quarter of 2006, partially offset by a gain of $1.2 million for LIFO inventory liquidations (included in "Cost of goods sold" in the consolidated statements of income) related to the shutdown of the facility in LaGrange, Georgia. The estimated resin pass-through lag was negative $1.5 million in the third quarter of 2006 versus none in the third quarter of 2005. 

As a percentage of sales, selling, general and administrative (“SG&A”) expenses decreased to 6.1% in the third quarter of 2006 compared with 6.5% in 2005 due primarily to higher sales.

R&D expenses increased to $2.0 million in the third quarter of 2006 from $1.9 million in 2005 and relate entirely to Film Products.

Plant shutdowns, asset impairments and restructurings and related items in the third quarter of 2006 shown in the segment operating profit table on page 22 include:

 
·
A net pretax gain of $1 million associated with the shutdown of the films manufacturing facility in LaGrange, Georgia, including a gain of $1.2 million for related LIFO inventory liquidations (included in "Cost of goods sold" in the consolidated statements of income), partially offset by other shutdown-related costs of $198,000;
 
·
A pretax charge of $920,000 related to expected future environmental costs at the aluminum extrusions facility in Newnan, Georgia (included in "Cost of goods sold" in the consolidated statements of income); and
 
·
A pretax charge of $494,000 related to the estimated loss on the sub-lease of a portion of the AFBS (formerly Therics) facility in Princeton, New Jersey.

Plant shutdowns, asset impairments and restructurings and related items in the third quarter of 2005 shown in the segment operating profit table on page 22 include:

 
·
Pretax charges of $906,000 for severance and other employee-related costs in connection with restructurings in Film Products ($514,000), Aluminum Extrusions ($207,000), and at corporate headquarters ($185,000; included in "Corporate expenses, net" in the segment operating profit table);

18


 
·
A net pretax charge of $595,000 related to severance and other employee-related costs associated with the restructuring of the research and development operations in Film Products (of this amount, $657,000 in pretax charges for employee relocation and recruitment is included in "Selling, general and administrative expenses" in the consolidated statements of income);
 
·
A pretax charge of $198,000 related to the shutdown of the aluminum extrusions facility in Aurora, Ontario; and
 
·
Pretax charges of $117,000 for accelerated depreciation related to restructurings in Film Products.
 
Interest income, which is included in “Other income (expense), net” in the consolidated statements of income, was $315,000 in the third quarter of 2006 and $146,000 in 2005. Interest expense increased to $1.3 million in the third quarter of 2006 compared with $1.2 million in 2005. Average debt outstanding and interest rates were as follows:
       
   
Three Months Ended Sept. 30
 
(In Millions)
 
2006
 
2005
 
Floating-rate debt with interest charged on a rollover basis at one-month LIBOR:
         
Average outstanding debt balance
 
$
83.8
 
$
112.0
 
Average interest rate
   
6.2
%
 
4.8
%
Fixed-rate and other debt:
             
Average outstanding debt balance
 
$
3.8
 
$
5.8
 
Average interest rate
   
4.0
%
 
5.8
%
Total debt:
             
Average outstanding debt balance
 
$
87.6
 
$
117.8
 
Average interest rate
   
6.1
%
 
4.8
%

The effective tax rate declined to 32.7% in the third quarter of 2006 compared with 36.8% in 2005 primarily due to favorable adjustments aggregating $658,000 (4.6% of income before income taxes for the third quarter of 2006) for income tax rate changes relating to deferred income tax assets and liabilities, an investment tax credit refund claim in Canada and accrual-to-return adjustments.

First Nine Months of 2006 Compared with First Nine Months of 2005

Overall, sales in the first nine months of 2006 increased by 18.1% compared with 2005. Net sales (sales less freight) increased 11.2% in Film Products primarily due to growth in higher value-added products, including surface protection, elastic and apertured materials, and higher selling prices, which were driven by higher raw material costs. Net sales increased 25.1% in Aluminum Extrusions due to higher volume (up 8.5%) and selling prices. For more information on net sales and volume, see the executive summary beginning on page 15.

Consolidated gross profit (sales minus cost of goods sold and freight) as a percentage of sales decreased to 12.6% in the first nine months of 2006 from 13.1% in 2005.  At Film Products, an overall higher gross profit margin was driven primarily by growth in higher value-added products, including surface protection, elastic and apertured materials. Margins also benefited from a favorable lag in the pass-through to customers of changes in resin costs (about $1 million in the first nine months of 2006 compared with $1.5 million in 2005) and a gain of $2.6 million for LIFO inventory liquidations (included in "Cost of goods sold" in the consolidated statements of income) related to the shutdown of the facility in LaGrange, Georgia. At Aluminum Extrusions, gross profit increased but the gross profit margin percentage declined primarily due to higher selling prices to cover higher aluminum costs and margin compression caused by rapidly increasing aluminum costs.

19


As a percentage of sales, selling, general and administrative (“SG&A”) expenses decreased to 6.0% in the first nine months of 2006 compared with 6.9% in 2005 due primarily to higher sales and the divestiture of substantially all of our interest in AFBS, Inc. (formerly known as Therics, Inc.) at the end of the second quarter of 2005.

R&D expenses declined to $6.1 million in the first nine months of 2006 from $7.2 million in 2005 primarily due to the divestiture of substantially all of our interest in AFBS.

Plant shutdowns, asset impairments and restructurings and related items in the first nine months of 2006 shown in the segment operating profit table on page 22 include:

 
·
A net pretax gain of $1.4 million associated with the shutdown of the films manufacturing facility in LaGrange, Georgia, including a gain of $2.6 million for related LIFO inventory liquidations (included in "Cost of goods sold" in the consolidated statements of income), partially offset by severance and other costs of $1 million and asset impairment charges of $130,000;
 
·
Pretax charges of $1 million for asset impairments in Film Products;
 
·
A pretax charge of $920,000 related to expected future environmental costs at the aluminum extrusions facility in Newnan, Georgia (included in "Cost of goods sold" in the consolidated statements of income);
 
·
Pretax charges of $727,000 for severance and other employee-related costs in connection with restructurings in Film Products ($213,000) and Aluminum Extrusions ($514,000); and
 
·
A pretax charge of $494,000 related to the estimated loss on the sub-lease of a portion of the AFBS (formerly Therics) facility in Princeton, New Jersey.

Plant shutdowns, asset impairments and restructurings and related items in the first nine months of 2005 shown in the segment operating profit table on page 22 include:

 
·
A pretax charge of $10 million related to the sale or assignment of substantially all of Therics' assets, including asset impairment charges of $5.6 million, lease-related losses of $3 million and severance and other transaction-related costs of $1.4 million;
 
·
Pretax charges of $1.8 million related to severance and other employee-related costs associated with restructurings in Film Products ($991,000), Aluminum Extrusions ($648,000) and at corporate headquarters ($185,000; included in “Corporate expenses, net” in the segment operating profit table);
 
·
A pretax gain of $1.6 million related to the shutdown of the films manufacturing facility in New Bern, North Carolina, including a $1.8 million gain on the sale of the facility (included in "Other income (expense), net" in the consolidated statements of income), partially offset by shutdown-related expenses of $225,000;
 
·
A pretax charge of $1 million for process reengineering costs associated with the implementation of a new information system in Film Products (included in "Costs of goods sold" in the consolidated statements of income);
 
·
A net pretax charge of $725,000 related to severance and other employee-related costs associated with the restructuring of the research and development operations in Film Products (of this amount, $1.2 million in pretax charges for employee relocation and recruitment is included in "Selling, general and administrative expenses" in the consolidated statements of income);
 
·
A pretax gain of $653,000 related to the shutdown of the films manufacturing facility in Carbondale, Pennsylvania, including a $630,000 gain on the sale of the facility (included in "Other income (expense), net" in the consolidated statements of income), and the reversal to income of certain shutdown-related accruals of $23,000;

20


 
·
A pretax charge of $597,000 related to the shutdown of the aluminum extrusions facility in Aurora, Ontario, including $1.1 million of shutdown-related costs, partially offset by the reversal to income of certain severance and employee-related accruals of $474,000; and
 
·
Pretax charges of $322,000 for accelerated depreciation related to restructurings in Film Products.

In the nine months ended September 30, 2006, a pretax gain on the sale of public equity securities of $56,000 (proceeds also of $56,000) is included in “Other income (expense), net” in the consolidated statements of income and “Gain on the sale of corporate assets” in the segment operating profit table on page 22. In the nine months ended September 30, 2005, a pretax gain on the sale of corporate real estate of $61,000 (proceeds of $151,000) is included in “Other income (expense), net” in the consolidated statements of income and “Gain on the sale of corporate assets” in the segment operating profit table on page 22. In the nine months ended September 30, 2005, a pretax gain for interest receivable on tax refund claims of $508,000 is included in "Other income (expense), net" in the consolidated statements of income and "Corporate expenses, net" in the segment operating profit table on page 22.
 
Interest income, which is included in “Other income (expense), net” in the consolidated statements of income, was $822,000 in the first nine months of 2006 and $386,000 in 2005. Interest expense increased to $4.2 million in the first nine months of 2006 compared with $3.3 million in 2005. Average debt outstanding and interest rates were as follows:
       
   
Nine Months Ended Sept. 30
 
(In Millions)
 
2006
 
2005
 
Floating-rate debt with interest charged on a rollover basis at one-month LIBOR:
         
Average outstanding debt balance
 
$
98.2
 
$
110.5
 
Average interest rate
   
5.8
%
 
4.3
%
Fixed-rate and other debt:
             
Average outstanding debt balance
 
$
4.9
 
$
5.9
 
Average interest rate
   
5.9
%
 
5.3
%
Total debt:
             
Average outstanding debt balance
 
$
103.1
 
$
116.4
 
Average interest rate
   
5.8
%
 
4.4
%

The effective tax rate declined to 36.6% in the first nine months of 2006 compared with 38.4% in 2005 primarily due to favorable adjustments aggregating $658,000 (1.5% of income before income taxes for the first nine months of 2006) for income tax rate changes relating to deferred income tax assets and liabilities, an investment tax credit refund claim in Canada and accrual-to-return adjustments.

21


Business Segment Review
 
The following tables present Tredegar’s net sales and operating profit by segment for the three and nine months ended September 30, 2006 and 2005:

   
Three Months Ended Sept. 30
 
Nine Months Ended Sept. 30
 
   
2006
 
2005
 
2006
 
2005
 
Net Sales
                 
Film Products
 
$
134,961
 
$
116,350
 
$
382,697
 
$
344,305
 
Aluminum Extrusions
   
154,030
   
118,085
   
443,025
   
354,014
 
AFBS (formerly Therics)
   
-
   
-
   
-
   
252
 
Total net sales
   
288,991
   
234,435
   
825,722
   
698,571
 
Add back freight
   
7,265
   
6,281
   
20,989
   
18,626
 
Sales as shown in the Consolidated Statements of Income
 
$
296,256
 
$
240,716
 
$
846,711
 
$
717,197
 
                           
Operating Profit
                         
Film Products:
                         
Ongoing operations
 
$
13,770
 
$
13,822
 
$
42,611
 
$
36,796
 
Plant shutdowns, asset impairments and restructurings, net of gain on sale of assets and related income from LIFO inventory liquidations
   
1,022
   
(1,225
)
 
207
   
(812
)
                           
Aluminum Extrusions:
                         
Ongoing operations
   
5,407
   
4,362
   
15,947
   
14,580
 
Plant shutdowns, asset impairments and restructurings
   
(920
)
 
(406
)
 
(1,434
)
 
(1,246
)
                           
AFBS (formerly Therics):
                         
Ongoing operations
   
-
   
-
   
-
   
(3,467
)
Loss on investment in Therics, LLC
   
-
   
(91
)
 
(25
)
 
(91
)
Plant shutdowns, asset impairments and restructurings
   
(494
)
 
-
   
(494
)
 
(10,049
)
                           
Total
   
18,785
   
16,462
   
56,812
   
35,711
 
Interest income
   
315
   
146
   
822
   
386
 
Interest expense
   
1,331
   
1,196
   
4,231
   
3,252
 
Gain on sale of corporate assets
   
-
   
-
   
56
   
61
 
Stock option-based compensation costs
   
215
   
-
   
708
   
-
 
Corporate expenses, net
   
3,148
   
3,290
   
9,909
   
8,025
 
Income before income taxes
   
14,406
   
12,122
   
42,842
   
24,881
 
Income taxes
   
4,716
   
4,465
   
15,687
   
9,542
 
Net income
 
$
9,690
 
$
7,657
 
$
27,155
 
$
15,339
 
 
22


Net sales (sales less freight) and operating profit from ongoing operations are the measures of sales and operating profit used by the chief operating decision maker of each segment for purposes of assessing performance.

Film Products
 
See the executive summary beginning on page 15 for discussion of operating results and planned capital expenditures for Film Products.

Aluminum Extrusions
 
See the executive summary beginning on page 15 for discussion of operating results and planned capital expenditures for Aluminum Extrusions.

AFBS
 
On June 30, 2005, substantially all of the assets of AFBS, Inc., a wholly-owned subsidiary of Tredegar (formerly known as Therics, Inc.), were sold or assigned to a newly-created limited liability company, Therics, LLC, controlled and managed by an individual not affiliated with Tredegar. AFBS received a 17.5% equity interest in Therics, LLC, valued at $170,000 and a 3.5% interest in Theken Spine, LLC, valued at $800,000, along with potential future payments based on the sale of certain products by Therics, LLC. AFBS retained substantially all of its liabilities in the transaction, which included customary indemnification provisions for pre-transaction liabilities. Tredegar has no obligation or intent to fund any future losses that may occur at Therics, LLC or Theken Spine, LLC. The ownership interest in Therics, LLC is accounted for under the equity method of accounting with losses limited to its initial carrying value of $170,000. The ownership interest in Theken Spine, LLC is accounted for under the cost method, with an impairment loss recognized and a new cost basis established for any write-down to estimated fair value, if necessary. The potential future payments due from Therics, LLC based on the sale of certain products will be recognized as income when earned.
 
Liquidity and Capital Resources

Changes in operating assets and liabilities from December 31, 2005 to September 30, 2006 are summarized below:

 
·
Accounts receivable increased significantly by $39.9 million (33%).
 
-
Accounts receivable in Film Products increased by $17.0 million due to higher sales. Days sales outstanding (“DSO”) was 51 at September 30, 2006 compared with an average of 50 over the last four quarters.
 
-
Accounts receivable in Aluminum Extrusions increased by $24.4 million due to higher sales. DSO was about 45, consistent with the average over the last four quarters.
 
·
Inventories decreased by $3.7 million (5.9%).
 
-
Inventory days were 38 in Film Products, which was about 6 days below the average over the last four quarters and indicative of the success achieved by our inventory management program initiated at the beginning of the year.
 
-
Inventory days were 24 in Aluminum Extrusions consistent with the level at June 30, 2006, and about 2 days below the average over the last four quarters.
 
·
Net property, plant and equipment was up $3.9 million (1.2%) due primarily to appreciation of foreign currencies relative to the U.S. Dollar ($6.6 million), capital expenditures of $31.7 million compared with depreciation of $32.6 million, and asset impairments in Film Products of $1.2 million.
 
·
Accounts payable increased significantly by $26.6 million (43%).

23


 
-
Accounts payable days were 30 in Film Products, about 1 day above the average over the last four quarters.
 
-
Accounts payable days were 33 in Aluminum Extrusions, about even with the average over the last four quarters.
 
·
Accrued expenses increased by $9.8 million (27.1%) primarily due to incentive compensation accruals ($2.5 million), revenue received in advance of shipment ($2.1 million), timing of payroll and related tax disbursements ($1.9 million), higher estimated liabilities for healthcare, workers compensation, property and casualty loss claims ($1.1 million) and the accrual for expected future environmental costs at the aluminum extrusions facility in Newnan, Georgia ($920,000).
 
·
Deferred income tax liabilities increased by $12.1 million (16.3%) primarily due to utilization of income tax credit carry-forwards ($7.6 million) and an increase in the foreign currency translation adjustment included in shareholders’ equity ($3.3 million).

Cash provided by operating activities was $76.3 million in the first nine months of 2006 compared with $35.4 million in 2005. The increase is due primarily to improved operating results, higher deferred income taxes and lower incremental working capital investment.

Cash used in investing activities was $32.0 million in the first nine months of 2006 compared with $44.9 million in 2005 due primarily to lower capital expenditures.

Capital expenditures in the first nine months of 2006 in Film Products primarily included the continued expansion of capacity for surface protection films and elastic materials, a new information system and normal replacement of machinery and equipment. Capital expenditures for all of 2006 are expected to be approximately $40 million in Film Products and about $8 million in Aluminum Extrusions.

24


Net capitalization and indebtedness as defined under our revolving credit agreement as of September 30, 2006 are as follows:
   
Net Capitalization and Indebtedness as of Sept. 30, 2006
 
(In Thousands)
 
Net capitalization:
     
Cash and cash equivalents
 
$
29,842
 
Debt:
       
$300 million revolving credit agreement maturing December 15, 2010
   
75,000
 
Other debt
   
3,094
 
Total debt
   
78,094
 
Debt net of cash and cash equivalents 
   
48,252
 
Shareholders' equity
   
514,897
 
Net capitalization
 
$
563,149
 
         
Indebtedness as defined in revolving credit agreement:
       
Total debt
 
$
78,094
 
Face value of letters of credit
   
5,907
 
Liabilities relating to derivative financial instruments
   
401
 
Indebtedness
 
$
84,402
 

Under the revolving credit agreement, borrowings are permitted up to $300 million, and $224 million was available to borrow at September 30, 2006. The credit spread and commitment fees charged on the unused amount under the revolving credit agreement at various indebtedness-to-adjusted EBITDA levels are as follows:
   
Pricing Under Revolving Credit Agreement (Basis Points)
 
Indebtedness-to-Adjusted
 
Credit Spread
 
 Commitment
 
EBITDA Ratio
 
Over LIBOR
 
 Fee
 
> 2.50x but <= 3x
   
125
   
25
 
> 1.75x but <= 2.50x
   
100
   
20
 
> 1x but <=1.75x
   
87.5
   
17.5
 
<= 1x
   
75
   
15
 

At September 30, 2006, the interest rate on debt under the revolving credit agreement was priced at one-month LIBOR plus the applicable credit spread of 87.5 basis points.

25


The computations of adjusted EBITDA, adjusted EBIT, the leverage ratio and interest coverage ratio as defined in the revolving credit agreement are presented below along with the related most restrictive covenants. Adjusted EBITDA and adjusted EBIT as defined in the revolving credit agreement are not intended to represent cash flow from operations as defined by GAAP and should not be considered as either an alternative to net income or to cash flow.
   
Computations of Adjusted EBITDA, Adjusted EBIT, Leverage Ratio and
 
Interest Coverage Ratio as Defined in Revolving Credit Agreement Along with Related Most
 
Restrictive Covenants
 
As of September 30, 2006 (In Thousands)
 
Computations of adjusted EBITDA and adjusted EBIT as defined in revolving credit agreement for the twelve months ended September 30, 2006:
     
Net income
 
$
28,045
 
Plus:
       
After-tax losses related to discontinued operations
   
-
 
Total income tax expense for continuing operations
   
16,118
 
Interest expense
   
5,552
 
Charges related to stock option grants and awards accounted for under the fair value-based method
   
708
 
Losses related to the application of the equity method of accounting
   
79
 
Depreciation and amortization expense for continuing operations
   
43,055
 
All non-cash losses and expenses, plus cash losses and expenses not to exceed $10,000, for continuing operations that are classified as unusual, extraordinary or which are related to plant shutdowns, asset impairments and/or restructurings (cash-related of $4,236)
   
13,311
 
Minus:
       
After-tax income related to discontinued operations
   
-
 
Total income tax benefits for continuing operations
   
-
 
Interest income
   
(1,022
)
All non-cash gains and income, plus cash gains and income not to exceed $10,000, for continuing operations that are classified as unusual, extraordinary or which are related to plant shutdowns, asset impairments and/or restructurings (cash-related of $1,723)
   
(4,332
)
Plus or minus, as applicable, pro forma EBITDA adjustments associated with acquisitions and asset dispositions
   
-
 
Adjusted EBITDA as defined in revolving credit agreement
   
101,514
 
Less: Depreciation and amortization expense for continuing operations (including pro forma for acquisitions and asset dispositions)
   
(43,055
)
Adjusted EBIT as defined in revolving credit agreement
 
$
58,459
 
Shareholders' equity at September 30, 2006
 
$
514,897
 
Computations of leverage and interest coverage ratios as defined in revolving credit agreement:
       
Leverage ratio (indebtedness-to-adjusted EBITDA)
   
0.83x
 
Interest coverage ratio (adjusted EBIT-to-interest expense)
   
10.53x
 
Most restrictive covenants as defined in revolving credit agreement:
       
Maximum permitted aggregate amount of dividends that can be paid by Tredegar during the term of the revolving credit agreement ($100,000 plus 50% of net income generated after October 1, 2005)
 
$
114,023
 
Minimum adjusted shareholders' equity permitted ($351,918 plus 50% of net income generated after October 1, 2005)
 
$
365,941
 
Maximum leverage ratio permitted:
       
Ongoing
   
3.00x
 
Pro forma for acquisitions
   
2.50x
 
Minimum interest coverage ratio permitted
   
2.50x
 
 
26


We believe that as of September 30, 2006, we were, and currently we are, in compliance with all of our debt covenants. Noncompliance with any one or more of the debt covenants may have an adverse effect on financial condition or liquidity in the event such noncompliance cannot be cured or should we be unable to obtain a waiver from the lenders. Renegotiation of the covenant through an amendment to the revolving credit agreement may effectively cure the noncompliance, but may have an effect on financial condition or liquidity depending upon how the covenant is renegotiated.

We believe that the borrowing availability under our revolving credit agreement, our current cash balances and our cash flow from operations will be sufficient to satisfy our working capital, capital expenditure and dividend requirements for the foreseeable future. 
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk.

Tredegar has exposure to the volatility of interest rates, polyethylene and polypropylene resin prices, aluminum ingot and scrap prices, energy prices, foreign currencies and emerging markets. See the section on liquidity and capital resources beginning on page 23 regarding the revolving credit agreement and interest rate exposures.

Changes in resin prices, and the timing of those changes, could have a significant impact on profit margins in Film Products. Profit margins in Aluminum Extrusions are sensitive to fluctuations in aluminum ingot and scrap prices as well as energy costs. There is no assurance of our ability to pass through higher raw material and energy costs to our customers.
 
Average quarterly prices of low density polyethylene resin (a primary raw material for Film Products) are shown in the chart below.
 
 
Resin prices in Europe, Asia and South America have exhibited similar trends, except average resin prices were up 2-4 cents per pound in Europe and Asia while average prices in the U.S. were down 6 cents per pound in the second quarter of 2006 compared with the first quarter of 2006. The price of resin is driven by several factors including supply and demand and the prices of oil, ethylene and natural gas. To address fluctuating resin prices, we have indexed pass-through or cost-sharing agreements covering a majority of our sales, but many have a 90-day lag. Most new customer contracts contain resin pass-through arrangements.

27


In the normal course of business, we enter into fixed-price forward sales contracts with certain customers for the sale of fixed quantities of aluminum extrusions at scheduled intervals. In order to hedge our exposure to aluminum price volatility (see the chart below) under these fixed-price arrangements, which generally have a duration of not more than 12 months, we enter into a combination of forward purchase commitments and futures contracts to acquire or hedge aluminum, based on the scheduled deliveries.
 

 
In Aluminum Extrusions, we hedge from time-to-time a portion of our exposure to natural gas price volatility (see the chart below) by entering into fixed-price forward purchase contracts with our natural gas suppliers. As of September 30, 2006, we had fixed prices through natural gas suppliers for a portion of our expected usage through the first quarter of 2007. We estimate that, in an unhedged situation, every $1 per mmBtu per month change in the market price of natural gas has a $150,000 impact on the monthly operating profit of Aluminum Extrusions.
 

 
28


We sell to customers in foreign markets through our foreign operations and through exports from our U.S. plants. The percentage of sales from manufacturing operations related to foreign markets for the first nine months of 2006 and 2005 are as follows:
   
Percentage of Net Sales from Manufacturing
 
Operations Related to Foreign Markets*
 
   
Nine Months Ended Sept. 30
 
   
2006
 
2005
 
   
Exports
 
Foreign
 
Exports