TREDEGAR CORP 10-Q

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 ("Form 10-Q") press release may constitute “forward-looking statements” within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. When the Company uses the words “believe,” “estimate,” “anticipate,” “appear to,” “expect,” “project,” “plan,” “likely,” “may” and similar expressions, it does so to identify forward-looking statements. Such statements are based on the Company's 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. It is possible that the Company's actual results and financial condition may differ, possibly materially, from the anticipated results and financial condition indicated in or implied by these forward-looking statements. In addition, the Company's current projections for its businesses could be materially affected by the highly uncertain impact of the COVID-19 pandemic. As a consequence, the Company's results could differ significantly from its projections, depending on, among other things, the ultimate impact of the pandemic on employees, supply chains, customers and the U.S. and world economies. Accordingly, you should not place undue reliance on these forward-looking statements. Factors that could cause actual results to differ from expectations include, without limitation, the following: • loss or gain of sales to significant customers on which the Company’s business is highly dependent; • inability to achieve sales to new customers to replace lost business; • inability to develop, efficiently manufacture and deliver new products at competitive prices; • failure of the Company’s customers to achieve success or maintain market share; • failure to protect our intellectual property rights; • risks of doing business in countries outside the U.S. that affect our international operations; • political, economic, and regulatory factors concerning the Company’s products; • uncertain economic conditions in countries in which the Company does business, including rising inflation and the effects of the Russian invasion of Ukraine; • competition from other manufacturers, including manufacturers in lower-cost countries and manufacturers benefiting from government subsidies; • impact of fluctuations in foreign exchange rates; • movement of pension plan assets and liabilities up through initiating hedging activities to fix underfunding amounts and assumptions thereafter relating to differences between the ultimate settlement benefit obligation and the projected benefit obligation, census data, administrative costs, the effectiveness of hedging activities and discounts required to liquidate non-public securities held by the plan; • an increase in the operating costs incurred by the Company’s business units, including, for example, the cost of raw materials and energy; • inability to successfully identify, complete or integrate strategic acquisitions; failure to realize the expected benefits of such acquisitions and assumption of unanticipated risks in such acquisitions; • disruptions to the Company’s manufacturing facilities, including those resulting from labor shortages; • the impact of public health epidemics on employees, production and the global economy, such as the COVID-19 pandemic; • an information technology system failure or breach; • the impact of the imposition of tariffs and sanctions on imported aluminum ingot used by Bonnell Aluminum; • the impact of new tariffs, duties or other trade restrictions imposed as a result of trade tensions between the U.S. and other countries; • the termination of anti-dumping duties on products imported to Brazil that compete with products produced by Flexible Packaging; • failure to establish and maintain effective internal control over financial reporting; and the other factors discussed in the reports Tredegar files with or furnishes to the Securities and Exchange Commission (the “SEC”) from time to time, including the risks and important factors set forth in additional detail in Part I, Item 1A of Tredegar’s Annual Report on Form 10-K for the year ended December 31, 2021 (the “2021 Form 10-K”). Readers are urged to review and consider carefully the disclosures Tredegar makes in its filings with the SEC. 18 Tredegar does not undertake, and expressly disclaims any duty, to update any forward-looking statement to reflect any change in management’s expectations or any change in conditions, assumptions or circumstances on which such statements are based, except as required by applicable law. References herein to “Tredegar,” “the Company,” “we,” “us” and “our” are to Tredegar Corporation and its subsidiaries, collectively, unless the context otherwise indicates or requires. Unless otherwise stated or indicated, all comparisons are to the prior year period. References to "Notes" are to notes to our condensed consolidated financial statements found in Part I, Item 1 of this Form 10-Q. Critical Accounting Policies and Estimates In the ordinary course of business, the Company makes 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 GAAP. The Company believes the estimates, assumptions and judgments described in the section “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates” in the 2021 Form 10-K have the greatest potential impact on our financial statements, so Tredegar considers these to be its critical accounting policies. Since December 31, 2021, there have been no changes in these policies that have had a material impact on our results of operations or financial position. Business Overview Tredegar Corporation is an industrial manufacturer with three primary businesses: custom aluminum extrusions for the North American building and construction ("B&C"), automotive and specialty end-use markets through its Aluminum Extrusions segment; surface protection films for high-technology applications in the global electronics industry through its PE Films segment; and specialized polyester films primarily for the Latin American flexible packaging market through its Flexible Packaging Films segment. With approximately 2,400 employees, the Company operates manufacturing facilities in North America, South America, and Asia. Earnings before interest, taxes, depreciation and amortization (“EBITDA”) from ongoing operations is the measure of segment profit and loss used by Tredegar’s chief operating decision maker ("CODM") for purposes of assessing financial performance. The Company uses sales less freight (“net sales”) from continuing operations as its measure of revenues from external customers at the segment level. This measure is separately included in the financial information regularly provided to the CODM. Earnings before interest and taxes ("EBIT") from ongoing operations is a non-GAAP financial measure included in the reconciliation of segment financial information to consolidated results for the Company. It is not intended to represent the stand-alone results for Tredegar’s ongoing operations under generally accepted accounting standards in the United States ("GAAP") and should not be considered as an alternative to net income as defined by GAAP. We believe that EBIT is a widely understood and utilized metric that is meaningful to certain investors and that including this financial metric in the reconciliation of management’s performance metric, EBITDA from ongoing operations, provides useful information to those investors that primarily utilize EBIT to analyze the Company’s core operations. First Quarter Financial Results Highlights First quarter 2022 net income from continuing operations was $16.5 million ($0.49 per diluted share) compared with net income from continuing operations of $9.6 million ($0.29 per diluted share) in the first quarter of 2021. • EBITDA from ongoing operations for Aluminum Extrusions of $23.9 million was $10.6 million higher than the first quarter of 2021 • EBITDA from ongoing operations for PE Films of $7.0 million was $0.2 million lower than the first quarter of 2021 • EBITDA from ongoing operations for Flexible Packaging Films of $5.0 million was $4.6 million lower than the first quarter of 2021 All three of the Company's business segments continue to manage through supply chain disruptions and inflationary cost pressures, including raw material cost increases, shortages, transportation cost increases and delays. Refer to Quantitative and Qualitative Disclosures About Market Risk below for additional information on raw material price trends. The Company attempts to mitigate the effects of increased costs through price increases and contractual pass-through provisions. At Bonnell Aluminum, labor shortages associated with the COVID-19 operating environment have resulted in production challenges and inefficiencies. However, current bookings and backlog remain at record high levels. Other losses related to asset impairments and costs associated with exit and disposal activities for continuing operations were not material for the three months ended March 31, 2022 and 2021, respectively. Gains and losses associated with plant shutdowns, asset impairments, restructurings and other items are described in Results of Operations below. 19 Results of Operations First Quarter of 2022 Compared with the First Quarter of 2021 The following table presents a bridge of consolidated net income (loss) from continuing operations from first quarter of 2021 to first quarter of 2022 with related management's discussion and analysis below the table. (In thousands) Net income from continuing operations for the three months ended March 31, 2021 $ 9,618 Income tax expense (benefit) 3,097 Income (loss) from continuing operations before income taxes 12,715 Increase (decrease) in income from increases (decreases) in the following items: Sales 51,744 Other income (expense), net (1,027) Total 50,717 Increase (decrease) in income from (increases) decreases in the following items: Cost of goods sold (41,975) Freight (1,858) Selling, general and administrative (2,898) Other 534 Total (46,197) Income (loss) from continuing operations before income taxes 17,235 Income tax expense (benefit) 778 Net income from continuing operations for the three months ended March 31, 2022 $ 16,457 Sales in the first quarter of 2022 increased by $51.7 million compared with the first quarter of 2021. Net sales (sales less freight) in Aluminum Extrusions increased $40.0 million, primarily due to an increase in average selling prices to cover significantly higher aluminum raw material costs and higher operating costs, partially offset by lower sales volume. Net sales increased $3.2 million in PE Films, primarily due to higher volume in Surface Protection and higher selling prices for overwrap films. Net sales in Flexible Packaging Films increased $6.7 million, primarily due to higher selling prices from the pass-through of higher resin costs and favorable product mix, partially offset by lower sales volume. For more information on net sales and volume, see the Segment Operations Review below. Other income decreased $1.0 million in the first quarter of 2022 compared to the first quarter of 2021, primarily due to a 2021 gain on the Company's investment in kaléo inc., which was historically accounted for under the fair value option and sold in the fourth quarter of 2021, and the non-recurring 2021 transition service fee income, net of corporate costs associated with the divested Personal Care Films business. See Note 5 for additional information. Consolidated gross profit (sales minus cost of goods sold and freight) as a percentage of sales (gross profit margin) was 19.1% in the first quarter of 2022 compared to 20.2% in the first quarter of 2021. The gross profit margin in Aluminum Extrusions increased primarily due to an increase in average selling prices to cover significantly higher aluminum raw material costs and higher operating costs. The gross profit margin in PE Films decreased primarily due to lower Surface Protection sales related to previously disclosed customer product transitions, pricing pressures for products unrelated to the customer product transitions, higher freight expense, partially offset by higher volume, favorable mix and the pass-through lag associated with resin costs. The gross profit margin in Flexible Packaging Films decreased primarily due to higher raw material costs, higher variable costs and lower sales volume, partially offset by higher selling prices from the pass-through of higher resin costs, favorable absorption of fixed costs and favorable product mix. As a percentage of sales, selling, general and administrative (“SG&A”) and research and development ("R&D") expenses were 9.6% in the first quarter of 2022, compared with 10.9% in the first quarter of 2021. SG&A expenses and net sales increased year-over-year, while R&D expenses remained consistent with prior year. Increased SG&A spending is primarily due to higher employee-related compensation, higher professional fees associated with business development activities, higher professional fees associated with internal controls over financial reporting, net unfavorable foreign currency translation of Real-denominated operating costs, partially offset by lower stock-based compensation. 20 The effective tax rate used to compute income taxes for continuing operations in the first three months of 2022 was 4.5%, compared to 24.4% in the first three months of 2021. The decrease in the effective tax rate for continuing operations is primarily due to a discrete benefit recorded in the first quarter of 2022 resulting from the implementation of new U.S. tax regulations associated with foreign tax credits published by the U.S. Treasury and Internal Revenue Service on January 4, 2022. These regulations overhaul various components of the foreign tax credit regime including the determination of creditable foreign taxes and limit the amount of foreign taxes that are creditable against U.S. income taxes. This one-time discrete benefit is expected to reduce the effective tax rate for the remainder of 2022, which will be offset by an expected increase to the effective tax rate as the result of Brazilian income tax no longer being creditable in the U.S. for the foreseeable future. See Note 9 for additional information. Pre-tax gains and losses associated with plant shutdowns, asset impairments, restructurings and other items for continuing operations in the first quarters of 2022 and 2021 detailed below are shown in the statements of net sales and EBITDA from ongoing operations by segment table in Note 10 and are included in “Asset impairments and costs associated with exit and disposal activities, net of adjustments” in the condensed consolidated statements of income, unless otherwise noted. Three Months Ended March 31, ($ in millions) 2022 2021 Aluminum Extrusions: (Gains) losses from sale of assets, investment writedowns and other items: COVID-19-related expenses, net of relief 2 0.1 (0.2) Total for Aluminum Extrusions $ 0.1 $ (0.2) PE Films: (Gains) losses from sale of assets, investment writedowns and other items: COVID-19-related expenses 2 $ 0.1 $ 0.2 Total for PE Films $ 0.1 $ 0.2 Corporate: (Gains) losses associated with plant shutdowns, asset impairments and restructurings: (Gain), net of costs associated with the sale of the Lake Zurich manufacturing facility assets $ — 0.2 (Gains) losses from sale of assets, investment writedowns and other items: Professional fees associated with business development activities and other 1 1.5 0.8 Professional fees associated with internal control over financial reporting 1 0.4 0.2 Write-down of investment in Harbinger Capital Partners Special Situations Fund 2 — 0.1 Stock compensation expense associated with the fair value remeasurement of awards granted at the time of the 2020 special dividend 1 — 0.4 Transition service fees, net of corporate costs associated with the divested Personal Care Films business 2 — (0.3) Net periodic benefit cost for the frozen defined benefit pension plan in process of termination 4 3.4 — Total for Corporate $ 5.3 $ 1.4 1. Included in “Selling, general and administrative expenses” in the condensed consolidated statements of income. 2. Included in “Other income (expense), net” in the condensed consolidated statements of income. 3. Included in “Cost of goods sold” in the condensed consolidated statements of income. 4. Prior to the $50 million contribution made to the pension plan ("Special Contribution") (see “Corporate Expenses, Interest, & Other” section of this report), GAAP pension expense was a reasonable proxy for the Company’s required minimum cash contribution to the pension plan. The Company estimates that, with the Special Contribution, there will be no required minimum cash contributions until final settlement. Pension expense under GAAP is projected to be approximately $14 million in 2022, which is mainly comprised of non-cash amortization of deferred net actuarial losses reflected in the Company’s shareholders’ equity as accumulated other comprehensive losses. Beginning in 2022, and consistent with no expected required minimum cash contributions, no pension expense is included in calculating earnings before interest, taxes, depreciation and amortization as defined in the Company’s revolving credit agreement, which is used to compute certain borrowing ratios. See Note 4 for additional information. 21 Average debt outstanding and interest rates were as follows: Three Months Ended March 31, (In millions) 2022 2021 Floating-rate debt with interest charged on a rollover basis at one-month LIBOR plus a credit spread: Average outstanding debt balance $ 103.4 $ 138.1 Average interest rate 1.9 % 1.7 % Segment Operations Review Aluminum Extrusions A summary of results for Aluminum Extrusions is provided below: Three Months Ended Favorable/ (Unfavorable) % Change (In thousands, except percentages) March 31, 2022 2021 Sales volume (lbs) 43,010 44,365 (3.1)% Net sales $ 158,110 $ 118,125 33.8% Ongoing operations: EBITDA $ 23,919 $ 13,302 79.8% Depreciation & amortization (4,261) (4,130) (3.2)% EBIT* $ 19,658 $ 9,172 114.3% Capital expenditures $ 2,881 $ 2,447 *See the table in Note 10, "Business Segments," of this Form 10-Q ("Note 10") for a reconciliation of this non-GAAP measure to the most comparable measure calculated in accordance with GAAP. First Quarter 2022 Results vs. First Quarter 2021 Results Net sales (sales less freight) in the first quarter of 2022 increased by 33.8 % versus 2021 primarily due to an increase in average selling prices to cover significantly higher aluminum raw material costs and higher operating costs, partially offset by lower sales volume. Sales volume in the first quarter of 2022 decreased by 3.1% versus 2021. Sales volume in the specialty market, which represented 34% of total volume in 2021, decreased 5.2% in the first quarter of 2022 versus 2021. Sales volume in the automotive market, which represented 8% of total volume in 2021, declined 20.0% versus the first quarter of 2021. Non-residential B&C sales volume, which represented 51 % o f 2021 volume, increased 1.3% in the first quarter of 2022 versus 2021. Strong market demand in this sector has not been fully reflected in Bonnell Aluminum's first quarter 2022 results, due to pandemic-related labor shortages and resulting production inefficiencies. While the average number of direct labor employees at Bonnell Aluminum facilities increased approximately 5% and 3% in the first quarter of 2022 compared to the first and fourth quarters of 2021, respectively, the estimated average labor shortage levels was 143, 133 and 147 workers in the first quarter of 2022 and first and fourth quarters of 2021, respectively. Moreover, onboarding new employees has resulted in higher hiring and training costs in 2022 versus last year. However, current bookings and backlog remain at record high levels. EBITDA from ongoing operations in the first quarter of 2022 increased by $10.6 million in comparison to the first quarter of 2021 primarily due to: • Higher pricing ($14.7 million, net of the pass-through of aluminum raw material costs), partially offset by: lower volume ($0.4 million); higher labor and employee-related costs ($1.3 million) and lower labor productivity ($1.1 million); higher maintenance costs ($1.1 million); higher supply expense, including significant price increases in paint, chemicals, packaging and other supplies ($3.8 million); higher freight rates ($1.1 million); and increased selling, general and administrative expenses ($1.5 million); and • The timing of the flow through under the first-in first-out method of aluminum raw material costs passed through to customers, previously acquired at lower prices in a quickly rising commodity pricing environment, resulted in a benefit of $7.1 million in the first quarter of 2022 versus a benefit of $1.0 million in the first quarter of 2021. The benefit in the first quarter of 2022 was net of an adverse impact from the lag in pricing ($1.8 million), in which products promised to customers at a specified price were shipped in a later period. Aluminum Extrusions believes that it has adequate supply agreements for aluminum raw materials in 2022 and is in the process of securing supply sources to meet expected needs in 2023. R efer to Item 3. Q uantitative and Qualitative Disclosures About Market Risk in this Form 10-Q f or additional information on aluminum prices. 22 Projected Capital Expenditures and Depreciation & Amortization Capital expenditures for Bonnell Aluminum are projected to be $31 million in 2022, including $15 million for new enterprise resource planning and manufacturing execution systems ("ERP/MES"), $6 million for infrastructure upgrades at the facilities located in Niles, Michigan, Carthage, Tennessee and Newnan, Georgia and $3 million for other strategic projects. The ERP/MES project is expected to cost $28 million over a two-year time span. In addition to strategic projects, approximately $7 million will be required to support continuity of current operations. Depreciation expense is projected to be $14 million in 2022. Amortization expense is projected to be $2 million in 2022. PE Films A summary of results for PE Films is provided below: Three Months Ended Favorable/ (Unfavorable) % Change (In thousands, except percentages) March 31, 2022 2021 Sales volume (lbs) 10,553 10,244 3.0% Net sales $ 31,131 $ 27,953 11.4% Ongoing operations: EBITDA $ 7,047 $ 7,213 (2.3)% Depreciation & amortization (1,595) (1,420) (12.3)% EBIT* $ 5,452 $ 5,793 (5.9)% Capital expenditures $ 581 $ 1,233 * See the table in Note 10 for a reconciliation of this non-GAAP measure to the most comparable measure calculated in accordance with GAAP. First Quarter 2022 Results vs. First Quarter 2021 Results Net sales increased by $3.2 million in the first quarter of 2022 versus the first quarter of 2021 primarily due to higher volume in Surface Protection and higher selling prices for overwrap films. Sales volume in Surface Protection increased 5% versus the first quarter of 2021. EBITDA from ongoing operations in the first quarter of 2022 decreased by $0.2 million versus the first quarter of 2021, primarily due to: • A $0.9 million decrease from Surface Protection associated with lower sales related to previously disclosed customer product transitions ($1.5 million), competitive pricing pressures for products unrelated to the customer product transitions ($1.4 million) and higher freight expense ($0.2 million), partially offset by higher volume, favorable mix ($1.0 million) and the pass-through lag associated with resin costs (benefit of $0.6 million in the first quarter of 2022 vs. charge of $0.5 million in the first quarter of 2021); and • A $0.7 million increase from overwrap films primarily related to a benefit from the pass-through lag associated with resin costs (benefit of $0.3 million in the first quarter of 2022 versus a charge of $0.3 million in the first quarter of 2021) and favorable selling, general and administrative expenses ($0.4 million), partially offset by unfavorable mix ($0.2 million). R efer to Item 3. Q uantitative and Qualitative Disclosures About Market Risk in this Form 10-Q f or additional information on resin prices. Customer Product Transitions and Other Factors in Surface Protection The Surface Protection component of PE Films supports manufacturers of optical and other specialty substrates used in flat panel display products. These films are primarily used by customers to protect components of displays in the manufacturing and transportation processes and then discarded. The Company previously reported the risk that a portion of its film products used in surface protection applications would be made obsolete by customer product transitions to less costly alternative processes or materials. The Company estimates that these transitions, which principally relate to one customer, adversely impacted pre-tax income from continuing operations as reported under GAAP and EBITDA from ongoing operations for PE Films by $14.8 million during 2021 versus 2020. A total decline of $7 million in pre-tax income from continuing operations as reported under GAAP and EBITDA from ongoing operations due to the transitions is expected in 2022 versus 2021, at which time the transitions are expected to be complete. The Surface Protection business is also experiencing competitive pricing pressures, unrelated to the customer product transitions, that are expected to adversely impact pre-tax income from continuing operations as reported under GAAP and 23 EBITDA from ongoing operations by approximately $6 million for full year 2022 versus 2021. To offset the expected adverse impact of the customer transitions and pricing pressures, the Company is aggressively pursuing and making progress in generating contribution from sales of new surface protection products, applications and customers and driving production efficiencies and cost savings. Annual contribution to pre-tax income from continuing operations as reported under GAAP and EBITDA from ongoing operations for PE Films from sales of products unrelated to previously disclosed customer product transitions increased $7 million for the two-year period ended December 31, 2021, which excludes the impact of resin pass-through lag but includes the adverse impact of customer inventory corrections, customer production slowdowns associated with COVID-19-related factors, and a slowdown in the television market in the fourth quarter of 2021. Projected Capital Expenditures and Depreciation & Amortization Capital expenditures for PE Films are projected to be $5 million in 2022, including $2 million for productivity projects and $3 million for capital expenditures required to support continuity of current operations. Depreciation expense is projected to be $7 million in 2022. There is no amortization expense for PE Films. Flexible Packaging Films A summary of results for Flexible Packaging Films is provided below: Three Months Ended Favorable/ (Unfavorable) % Change (In thousands, except percentages) March 31, 2022 2021 Sales volume (lbs) 26,005 27,408 (5.1)% Net sales $ 39,244 $ 32,521 20.7% Ongoing operations: EBITDA $ 5,035 $ 9,623 (47.7)% Depreciation & amortization (550) (466) (18.0)% EBIT* $ 4,485 $ 9,157 (51.0)% Capital expenditures $ 1,545 $ 1,271 * See the table in Note 10 for a reconciliation of this non-GAAP measure to the most comparable measure calculated in accordance with GAAP. First Quarter 2022 Results vs. First Quarter 2021 Results Sales volume declined by 5.1% during the first quarter of 2022 versus the first quarter of 2021, which reflected the surge in pandemic-related demand. Net sales in the first quarter of 2022 increased 20.7% compared to the first quarter of 2021, primarily due to higher selling prices from the pass-through of higher resin costs and favorable product mix, partially offset by lower sales volume. EBITDA from ongoing operations in the first quarter of 2022 decreased by $4.6 million versus the first quarter of 2021 primarily due to: • Higher raw material costs ($6.0 million), higher variable costs ($1.6 million) and lower sales volume ($0.8 million), partially offset by higher selling prices ($4.9 million) from the pass-through of higher resin costs, favorable absorption of fixed costs ($0.4 million) and favorable product mix ($0.3 million); • Net unfavorable foreign currency translation of Real-denominated operating costs ($0.3 million); and • Foreign currency transaction losses ($0.9 million) in the first quarter of 2022 compared to foreign currency transaction gains ($0.4 million) in the first quarter of 2021. Refer to Item 3. Quantitative and Qualitative Disclosures About Market Risk in this Form 10-Q f or additional information on polyester fiber and component price trends. Projected Capital Expenditures and Depreciation & Amortization Capital expenditures for Flexible Packaging Films are projected to be $8 million in 2022, including $4 million for new capacity for value-added products and productivity projects and $4 million for capital expenditures required to support continuity of current operations. Depreciation expense is projected to be $2 million in 2022. Amortization expense is projected to be $0.4 million in 2022. Corporate Expenses, Interest & Other Corporate expenses, net in the first three months of 2022 remained consistent with the first three months of 2021 as lower stock-based compensation ($0.8 million) was substantially offset by higher professional fees associated with remediation 24 activities related to the Company's previously disclosed material weaknesses in internal control over financial reporting ($0.3 million), non-recurring 2021 transition service fee income, net of corporate costs associated with the divested Personal Care Films business ($0.3 million) and higher professional fees associated with business development activities ($0.1 million). Interest expense of $0.8 million in the first three months of 2022 remained consistent with the first three months of 2021 as lower average debt levels were offset by higher average interest rates. Pension expense under GAAP of $3.5 million in the first three months of 2022 remained consistent with the first three months of 2021. On February 10, 2022, Tredegar announced the initiation of a process to terminate and settle its frozen defined benefit pension plan, which could take up to 24 months to complete. In connection therewith, the Company borrowed funds under its revolving credit agreement and made a $50 million contribution to the pension plan (the “Special Contribution”) to reduce its underfunding and as part of a program within the pension plan to hedge or fix the expected future contributions that will be needed by the Company through the settlement process. The Company expects to realize income tax cash benefits on the Special Contribution of approximately $11 million in 2022. Administrative costs for the pension plan through the settlement process are estimated at $4 to $5 million. Tredegar’s frozen defined benefit pension plan was underfunded on a GAAP basis by $69 million at December 31, 2021, comprised of investments at fair value of $245 million and a projected benefit obligation (“PBO”) of $314 million. GAAP accounting requires adjustment for changes in values of assets and the PBO only at the end of each year, even though these values change daily. The Company estimates that the Special Contribution and changes to the values of pension plan assets and liabilities resulted in a decrease in the underfunding on a GAAP basis from $69 million at December 31, 2021 to approximately $13 million at March 31, 2022. The ultimate settlement benefit obligation may differ from the PBO, depending on market factors for buyers of pension obligations at the time of settlement. Prior to the Special Contribution, GAAP pension expense was a reasonable proxy for the Company’s required minimum cash contribution to the pension plan. The Company estimates that, with the Special Contribution, there will be no required minimum cash contributions until final settlement. Pension expense under GAAP is projected to be approximately $14 million in 2022, which is mainly comprised of non-cash amortization of deferred net actuarial losses reflected in the Company’s shareholders’ equity as accumulated other comprehensive losses. Beginning in 2022, and consistent with no expected required minimum cash contributions, no pension expense is included in calculating earnings before interest, taxes, depreciation and amortization as defined in the Company’s revolving credit agreement. Net capitalization and other credit measures are provided in Liquidity and Capital Resources below. Liquidity and Capital Resources The Company continues to focus on improving working capital management. Measures such as days sales outstanding (“DSO”), days inventory outstanding (“DIO”) and days payables outstanding (“DPO”) are used to evaluate changes in working capital. Changes in operating assets and liabilities from continuing operations from December 31, 2021 to March 31, 2022 are summarized below. Cash flows for discontinued operations have not been separately disclosed in the condensed consolidated statements of cash flows. • Accounts and other receivables increased $26.2 million (25.4%). ◦ Accounts and other receivables in Aluminum Extrusions increased by $20.1 million primarily due to an increase in average selling prices to cover significantly higher aluminum raw material costs and higher operating costs, partially offset by lower sales volume. DSO (represents trailing 12 months net sales divided by a rolling 12-month average of accounts and other receivables balances) was approximately 48.2 days for the 12 months ended March 31, 2022 and 47.6 days for the 12 months ended December 31, 2021. ◦ Accounts and other receivables in PE Films increased by $1.9 million due to higher volume in Surface Protection and the timing of cash receipts. DSO was approximately 27.9 days for the 12 months ended March 31, 2022 and 28.5 days for the 12 months ended December 31, 2021. ◦ Accounts and other receivables in Flexible Packaging Films increased by $4.3 million primarily due to higher selling prices from the pass-through of higher resin costs and favorable product mix, partially offset by lower sales volume. DSO was approximately 41.4 days for the 12 months ended March 31, 2022 and 40.0 days for the 12 months ended December 31, 2021. • Inventories increased $16.0 million (18.1%). ◦ Inventories in Aluminum Extrusions increased by $8.1 million due to higher average aluminum prices and the impact of COVID-19-related operational and production inefficiencies on the timing of shipments. DIO (represents trailing 12 months costs of goods sold calculated on a first-in first-out basis divided by a rolling 12-month average of inventory balances calculated on the first-in first-out basis) was approximately 43.9 days for the 12 months ended March 31, 2022 and 41.4 days for the 12 months ended December 31, 2021. 25 ◦ Inventories in PE Films increased $1.2 million due to higher planned raw material levels. DIO (represents trailing 12 months costs of goods sold calculated on a first-in first-out basis divided by a rolling 12-month average of inventory balances calculated on the first-in first-out basis) was approximately 59.2 days for the 12 months ended March 31, 2022 and 62.8 days for the 12 months ended December 31, 2021. ◦ Inventories in Flexible Packaging Films increased by $6.7 million primarily due to the impact of higher average resin prices on raw materials and higher finished good levels due to lower than anticipated sales demand. DIO was approximately 95.0 days for the 12 months ended March 31, 2022 and 93.1 days for the 12 months ended December 31, 2021. • Net property, plant and equipment increased $2.2 million primarily due to capital expenditures of $4.7 million and a change in the value of the U.S. dollar relative to foreign currencies (an increase of approximately $3.5 million), partially offset by depreciation expense of $5.8 million. • Identifiable intangible assets, net decreased by $0.5 million (3.7%) due to amortization expense. • Deferred income tax assets decreased $4.3 million during the first quarter of 2022 compared to December 31, 2021 primarily due to changes in other comprehensive income and the projected utilization of foreign tax credits partially offset by the change in the deferred tax liability as a result of the implementation of new U.S. tax regulations associated with foreign tax credits published by the U.S. Treasury and Internal Revenue Service on January 4, 2022. See Note 9 for additional information. • Accounts payable increased $20.8 million (16.8%). ◦ Accounts payable in Aluminum Extrusions increased by $15.7 million primarily due to higher average aluminum prices. DPO (represents trailing 12 months costs of goods sold calculated on a first-in first-out basis divided by a rolling 12-month average of accounts payable balances) was approximately 61.0 days for the 12 months ended March 31, 2022 and 60.1 days for the 12 months ended December 31, 2021. ◦ Accounts payable in PE Films increased by $2.8 million primarily due to higher resin costs related to raw material purchases. DPO was approximately 47.0 days for the 12 months ended March 31, 2022 and 44.0 days for the 12 months ended December 31, 2021. ◦ Accounts payable in Flexible Packaging Films increased $3.0 million due to higher resin costs related to raw material purchases and the impact from the change in the U.S. dollar value of currencies related to operations outside of the U.S. DPO was approximately 69.2 days for the 12 months ended March 31, 2022 and 68.2 days for the 12 months ended December 31, 2021. Net cash used in operating activities was $54.7 million in the first three months of 2022 compared to net cash provided by operating activities of $9.9 million in the first three months of 2021. The change in operating activities is primarily due to the Special Contribution ($50 million) to the pension plan and lower net working capital ($16.0 million). Net cash used in investing activities decreased during the first three months of 2022 compared to the first three months of 2021 due to lower capital expenditure spending ($0.2 million). Net cash provided by financing activities of $53.8 million in the first three months of 2022, compared to $5.9 million in the first three months of 2021, increased primarily due to higher net borrowings ($49.3 million) under the Credit Agreement (as defined below) to fund the $50 million Special Contribution to the pension plan. The Company believes that existing borrowing availability, current cash balances and cash flow from operations will be sufficient to satisfy short term material cash requirements related to working capital, capital expenditure, debt repayments and dividend requirements for at least the next twelve months. In the longer term, liquidity will depend on many factors, including results of operations, the timing and extent of capital expenditures, changes in operating plans, or other events that would cause the Company to seek additional financing in future periods. At March 31, 2022, the Company had cash and cash equivalents of $25.6 million, including cash and cash equivalents held by locations outside the U.S. of $8.4 million. Tredegar has a five-year secured revolving credit agreement (the “Credit Agreement”) providing for aggregate borrowings in an amount of $375 million, which matures in June 2024. 26 Net capitalization and indebtedness as defined under the Credit Agreement as of March 31, 2022 were as follows: Net Capitalization and Indebtedness as of March 31, 2022 (In thousands) Net capitalization: Cash and cash equivalents $ 25,648 Debt: Credit Agreement 131,250 Debt, net of cash and cash equivalents 105,602 Shareholders’ equity 211,868 Net capitalization $ 317,470 Indebtedness as defined in Credit Agreement: Total debt $ 131,250 Indebtedness $ 131,250 Borrowings under the Credit Agreement bear an interest rate of LIBOR plus a credit spread and commitment fees charged on the unused amount under the Credit Agreement at various indebtedness-to-Credit EBITDA levels as follows: Pricing Under The Credit Agreement (Basis Points) Indebtedness-to-Credit EBITDA Ratio Credit Spread Over LIBOR Commitment Fee > 3.5x but <= 4.0x 200.0 40 > 3.0x but <= 3.5x 187.5 35 > 2.0x but <= 3.0x 175.0 30 > 1.0x but <= 2.0x 162.5 25 <= 1.0x 150.0 20 At March 31, 2022, the interest rate on debt under the Credit Agreement existing at that date was priced at one-month LIBOR plus the applicable credit spread of 150.0 basis points. The most restrictive covenants in the Credit Agreement include: • Maximum indebtedness-to-Credit EBITDA (“Leverage Ratio”) of 4.00x; • Minimum Credit EBITDA-to-interest expense of 3.00x; and • Maximum aggregate distributions to shareholders over the remaining term of the Credit Agreement of $75 million; provided, that if the Leverage Ratio of equal to or greater than 3.00x, a limitation on such payments for the succeeding quarter at the greater of (i) $4.75 million and (ii) 50% of consolidated net income for the most recent fiscal quarter. The Credit Agreement is secured by substantially all of the Company’s and its domestic subsidiaries’ assets, including equity in certain material first-tier foreign subsidiaries. At March 31, 2022, based upon the most restrictive covenant within the Credit Agreement, available credit under the Credit Agreement was approximately $244 million. Total debt outstanding was $131 million and $73 million as of March 31, 2022 and December 31, 2021, respectively. Credit EBITDA is not intended to represent net income (loss) or cash flow from operations as defined by GAAP and should not be considered as an alternative to either net income (loss) or to cash flow. The computations of Credit EBITDA and the leverage ratio and interest coverage ratio as defined in the Credit Agreement are presented below. 27 Computations of Credit EBITDA and Leverage Ratio and Interest Coverage Ratio as Defined in the Credit Agreement Along with Related Most Restrictive Covenants as of and for the Twelve Months Ended March 31, 2022 (In Thousands) Computation of Credit EBITDA for the twelve months ended March 31, 2022: Net income (loss) $ 65,217 Plus: After-tax losses related to discontinued operations (441) Total income tax expense for continuing operations 6,965 Interest expense 3,350 Depreciation and amortization expense for continuing operations 24,090 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 $9,753) 10,161 Charges related to stock option grants and awards accounted for under the fair value-based method 2,658 Losses related to the application of the equity method of accounting — Losses related to adjustments in the estimated fair value of assets accounted for under the fair value method of accounting — Minus: After-tax income related to discontinued operations — Total income tax benefits for continuing operations — Interest income (95) All non-cash gains and income, plus cash gains and income in excess of $10,000, for continuing operations that are classified as unusual, extraordinary or which are related to plant shutdowns, asset impairments and/or restructurings (3,859) Income related to changes in estimates for stock option grants and awards accounted for under the fair value-based method — Income related to the application of the equity method of accounting — Income related to adjustments in the estimated fair value of assets accounted for under the fair value method of accounting (12,062) Plus cash dividends declared on investments in an amount not to exceed $10,000 for such period — Plus or minus, as applicable, pro forma EBITDA adjustments associated with acquisitions and asset dispositions — Plus or minus, as applicable, pro forma EBITDA adjustments to pension expense associated with the early payment of pension obligations 13,950 Credit EBITDA as defined in Credit Agreement $ 109,934 Computations of leverage and interest coverage ratios as defined in the Credit Agreement at March 31, 2022: Leverage ratio (indebtedness-to-Credit EBITDA) 1.19x Interest coverage ratio (Credit EBITDA-to-interest expense) 32.82x Most restrictive covenants as defined in the Credit Agreement: Available balance of maximum permitted aggregate amount of dividends that can be paid by Tredegar during the remaining term of the Credit Agreement ($75,000 minus $24,246 of dividends paid after December 1, 2020) 50,754 Maximum leverage ratio permitted 4.00x Minimum interest coverage ratio permitted 3.00x Tredegar was in compliance with all of its debt covenants as of March 31, 2022. Noncompliance with any of the debt covenants may have a material adverse effect on its financial condition or liquidity, in the event such noncompliance cannot be cured or should the Company be unable to obtain a waiver from the lenders. Renegotiation of the covenant through an amendment to the Credit Agreement may effectively cure the noncompliance, but may have an effect on its financial condition or liquidity depending upon how the covenant is renegotiated. 28