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Management’s Discussion and Analysis of
Financial Condition and Results of Operations

Liquidity and Capital Resources

Liquidity Sources and Risks. Our primary sources of liquidity are cash from operations and borrowings under the various debt facilities described below. Downturns in operations can significantly affect our ability to generate cash. For example, in the difficult operating climate we experienced in 2001, we generated $25.5 million less cash from operations than we did in 2000. However, despite the lower operating cash flow in 2001, we managed to improve our 2001 year-end cash position by $55.3 million over 2000 due primarily to conservative cash management. We also believe that our existing cash and liquidity position will be further strengthened through the sale of the real estate at our Baltimore, Maryland, Camden, New Jersey and Chicago, Illinois paperboard mills, which we anticipate will occur in 2002. Additionally, we expect to receive a federal tax refund of approximately $16.0 million in the first half of 2002. If, however, we were to face unexpected liquidity needs, we could require additional funds from external sources such as our senior credit facility.

The availability of liquidity from borrowings is primarily affected by our continued compliance with the terms of the debt agreements governing these facilities, including the payment of interest and compliance with various covenants and financial maintenance tests. In addition, as described below under "–Joint Venture Financings," to the extent we are unable to comply with financial maintenance tests under our senior credit facility, we will fail to comply with identical financial maintenance covenant tests under our guarantees of the credit facilities of our joint ventures, which could potentially materially and adversely affect us through a series of cross-defaults under both our joint ventures' and our own obligations if we were unable to obtain appropriate waivers or amendments with respect to the underlying violations and any related cross-defaults.

At December 31, 2000 and December 31, 2001, we were not in compliance with the leverage ratio and interest coverage ratio, respectively, under both our senior credit facility and our joint venture guarantees, but in each case were able to obtain appropriate amendments and waivers with respect to each instance of non-compliance (and with respect to any technical cross-default). Absent further material deterioration of the U.S. economy as a whole or the specific sectors on which our business depends, we believe it is unlikely that we will breach our covenants under our debt agreements or joint venture guarantees during 2002. We also believe that in the event of such a breach due to a further deterioration in economic or industry conditions, our lenders would provide us with the necessary waivers and amendments. However, we cannot assure you that we will achieve our expected future operating results or continued compliance with our debt covenants, or that, in such event, necessary waivers and amendments would be available at all or on acceptable terms. If our debt or that of our joint ventures were placed in default, or if we were called upon to satisfy our joint venture guarantees, our liquidity and financial condition would be materially and adversely affected.

Borrowings. At December 31, 2001 and 2000, total debt (consisting of current maturities of debt, senior credit facility, and other long-term debt, as reported on our consolidated balance sheets) was as follows (in thousands):

2001 2000
Senior credit facility $ – $194,000
9 7/8% senior
subordinated notes		 277,326 –
7 1/4% senior notes 25,449 –
7 3/8% senior notes 197,716 198,791
7.74% senior notes – 66,200
Other notes payable 8,248 9,081
Total debt $508,739 $468,072


On March 29, 2001, we completed a series of financing transactions pursuant to which we (i) issued $29.0 million in aggregate principal amount of 7 1/4% senior notes due May 1, 2010 and $285.0 million in aggregate principal amount of 9 7/8% senior subordinated notes due April 1, 2011, (ii) used the proceeds from these notes to repay in full our former senior credit facility and 7.74% senior notes, and (iii) obtained a new $75.0 million senior credit facility. The 7 1/4% senior notes and 9 7/8% senior subordinated notes were issued at a discount to yield effective interest rates of 9.4% and 10.5%, respectively. Aggregate proceeds from the sale of these notes, net of issuance costs, was approximately $291.2 million. In connection with the repayment of the 7.74% senior notes, we incurred a prepayment penalty of approximately $3.6 million. We recorded an extraordinary loss of $2.7 million which includes the prepayment penalty and unamortized issuance costs of $705 thousand, net of tax benefit of $1.6 million. The difference between issue price and principal amount at maturity of our 7 1/4% senior notes and 9 7/8% senior subordinated notes will be accreted each year as interest expense in our financial statements. These notes are unsecured, but are guaranteed, on a joint and several basis, by all of our domestic subsidiaries, other than one that is not wholly-owned.

Our credit facility provides for a revolving line of credit in the aggregate principal amount of $75.0 million for a term of three years, including subfacilities of $10.0 million for swingline loans and $15.0 million for letters of credit, usage of which reduces availability under the facility. No borrowings were outstanding under the facility as of December 31, 2001, versus $194.0 million outstanding on our former senior credit facility on December 31, 2000; however, an aggregate of $9.8 million in letter of credit obligations were outstanding on December 31, 2001. We intend to use the facility for working capital, capital expenditures and other general corporate purposes. Although the facility is unsecured, our obligations under the facility are unconditionally guaranteed, on a joint and several basis, by all of our existing and subsequently acquired wholly-owned domestic subsidiaries.

Borrowings under the facility bear interest at a rate equal to, at our option, either (1) the base rate (which is equal to the greater of the prime rate most recently announced by Bank of America, N.A., the administrative agent under the facility, or the federal funds rate plus one-half of 1%) or (2) the adjusted Eurodollar Interbank Offered Rate, in each case plus an applicable margin determined by reference to our leverage ratio (which is defined under the facility as the ratio of our total debt to our total capitalization). Based on our leverage ratio at December 31, 2001, the current margins are 2.0% for Eurodollar rate loans and 0.75% for base rate loans. Additionally, the undrawn portion of the facility is subject to a facility fee at an annual rate that is currently set at 0.5% based on our leverage ratio at December 31, 2001.

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Caraustar Industries, Inc.