e10vq
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2006
OR
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File Number 001-32563
Orchids Paper Products Company
(Exact name of Registrant as Specified in its Charter)
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Delaware
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23-2956944 |
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(State or Other Jurisdiction of
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(I.R.S. Employer |
Incorporation or Organization)
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Identification No.) |
4826 Hunt Street
Pryor, Oklahoma 74361
(Address of Principal Executive Offices and Zip Code)
(918) 825-0616
(Registrants Telephone Number, Including Area Code)
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 requirement for the past 90 days. Yes þ 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 o Non-accelerated filer
þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes o No þ
Number of shares outstanding of the issuers Common Stock, par value $.001 per share, as of May 10,
2006: 4,156,250 shares.
ORCHIDS PAPER PRODUCTS COMPANY
TABLE OF CONTENTS
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED MARCH 31, 2006
2
PART 1 FINANCIAL INFORMATION
ITEM 1. Financial Statements
ORCHIDS PAPER PRODUCTS COMPANY
BALANCE SHEETS
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As of |
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March 31, |
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December 31, |
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2006 |
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2005 |
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(unaudited) |
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(Dollars in thousands) |
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ASSETS |
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Current assets: |
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Cash |
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$ |
4 |
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$ |
378 |
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Accounts receivable, net of allowance of
$140 in 2006 and $125 in 2005 |
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3,719 |
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4,180 |
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Inventories, net |
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6,149 |
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4,420 |
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Restricted
certificate of deposit |
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1,500 |
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1,500 |
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Income taxes receivable |
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65 |
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94 |
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Prepaid expenses |
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324 |
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458 |
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Deferred income taxes |
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200 |
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200 |
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Total current assets |
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11,961 |
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11,230 |
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Property, plant and equipment |
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53,759 |
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44,983 |
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Accumulated depreciation |
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(3,182 |
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(2,789 |
) |
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Net property, plant and equipment |
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50,577 |
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42,194 |
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Deferred debt issuance costs, net of accumulated
amortization of $279 in 2006 and $232 in 2005 |
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239 |
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286 |
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Total assets |
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$ |
62,777 |
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$ |
53,710 |
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LIABILITIES AND STOCKHOLDERS EQUITY |
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Current liabilities: |
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Accounts payable |
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$ |
3,263 |
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$ |
2,877 |
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Accrued liabilities |
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2,201 |
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2,137 |
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Unrealized loss on forward currency exchange contracts |
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61 |
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74 |
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Current portion of long-term debt |
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1,663 |
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1,628 |
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Total current liabilities |
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7,188 |
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6,716 |
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Long-term debt, net of unamortized discount of $94 in 2006 and $101 in 2005 |
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25,332 |
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17,002 |
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Deferred income taxes |
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6,304 |
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6,280 |
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Stockholders equity: |
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Common stock, $.001 par value, 10,000,000 shares
authorized, 4,156,250 shares issued and outstanding
in 2006 and 2005 |
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4 |
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4 |
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Additional paid-in capital |
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20,940 |
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20,881 |
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Common stock warrants |
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141 |
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141 |
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Retained earnings |
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2,868 |
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2,686 |
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Total stockholders equity |
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23,953 |
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23,712 |
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Total liabilities and stockholders equity |
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$ |
62,777 |
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$ |
53,710 |
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See notes to financial statements.
3
ORCHIDS PAPER PRODUCTS COMPANY
STATEMENTS OF INCOME
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Three Months Ended March 31, |
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2006 |
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2005 |
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(unaudited) |
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(unaudited) |
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(Dollars in thousands, except |
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share and per share data) |
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Net sales |
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$ |
14,099 |
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$ |
12,542 |
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Cost of sales |
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12,536 |
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10,725 |
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Gross profit |
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1,563 |
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1,817 |
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Selling, general and administrative expenses |
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1,248 |
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959 |
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Operating income |
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315 |
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858 |
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Interest expense |
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47 |
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369 |
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Other (income) expense, net |
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(12 |
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(5 |
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Income before income taxes |
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280 |
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494 |
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Provision for income taxes: |
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Current |
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74 |
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92 |
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Deferred |
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24 |
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56 |
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98 |
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148 |
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Net income |
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$ |
182 |
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$ |
346 |
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Net income per share: |
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Basic |
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$ |
0.04 |
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$ |
0.17 |
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Diluted |
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$ |
0.04 |
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$ |
0.17 |
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Shares used in calculating net income per share: |
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Basic |
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4,156,250 |
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2,000,000 |
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Diluted |
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4,318,051 |
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2,052,538 |
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See notes to financial statements.
- 4 -
ORCHIDS PAPER PRODUCTS COMPANY
STATEMENTS OF CASH FLOWS
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Three Months Ended March 31, |
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2006 |
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2005 |
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(unaudited) |
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(unaudited) |
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(Dollars in thousands) |
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Cash Flows From Operating Activities |
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Net income |
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$ |
182 |
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$ |
346 |
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Adjustments to reconcile net income to net cash
provided by (used in) operating activities: |
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Depreciation and amortization |
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440 |
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364 |
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Provision for doubtful accounts |
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15 |
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15 |
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Deferred income taxes |
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24 |
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56 |
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Stock option plan expense |
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59 |
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Foreign currency transaction loss |
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18 |
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Unrealized gain on foreign exchange contracts |
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(13 |
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Changes in cash due to changes in operating assets
and liabilities: |
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Accounts receivable, net |
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446 |
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452 |
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Inventories |
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(1,729 |
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(1,982 |
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Prepaid expenses |
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134 |
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(275 |
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Income taxes receivable |
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29 |
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92 |
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Accounts payable |
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386 |
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120 |
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Accrued liabilities |
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46 |
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(327 |
) |
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Net cash provided by (used in) operating activities |
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37 |
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(1,139 |
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Cash Flows From Investing Activities |
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Purchases of property, plant and equipment |
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(8,776 |
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(1,555 |
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Purchases of investments |
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(1 |
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Net cash used in investing activities |
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(8,776 |
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(1,556 |
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Cash Flows From Financing Activities |
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Principal payments on long-term debt |
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(380 |
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(427 |
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Net borrowings on revolving credit line |
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610 |
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2,642 |
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Borrowings under construction loan |
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8,135 |
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Net cash provided by financing activities |
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8,365 |
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2,215 |
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Net decrease in cash |
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(374 |
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(480 |
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Cash, beginning |
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378 |
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485 |
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Cash, ending |
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$ |
4 |
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$ |
5 |
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Supplemental Disclosure: |
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Interest paid |
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$ |
417 |
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$ |
397 |
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Income taxes paid |
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$ |
45 |
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$ |
35 |
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Supplemental Disclosure of Non-Cash Investing and Financing Activities: |
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Contractual obligation for purchase of paper machine |
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$ |
698 |
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$ |
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See notes to financial statements.
- 5 -
ORCHIDS PAPER PRODUCTS COMPANY
NOTES TO UNAUDITED INTERIM FINANCIAL STATEMENTS
Note 1 Basis of Presentation
Orchids Paper Products Company (Orchids or the Company) was formed in 1998 to acquire and
operate the paper manufacturing facility, built in 1976, in Pryor, Oklahoma. Orchids Acquisition
Group, Inc. (Orchids Acquisition) was established in November 2003, for the purpose of acquiring
the common stock of Orchids. Orchids Acquisition closed the sale of its equity and debt securities
on March 1, 2004, and immediately thereafter closed the acquisition of Orchids. In April 2005,
Orchids Acquisition merged with and into Orchids, with Orchids as the surviving entity.
On July 20, 2005, the Company completed its public offering of 2,156,250 shares of its common
stock. The public offering price of the shares was $8.00. The net proceeds from the offering were
$15,011,000 after deducting the underwriting discount and offering expenses. The Companys stock
trades on the American Stock Exchange under the ticker symbol TIS.
The accompanying financial statements have been prepared without an audit, pursuant to the rules
and regulations of the Securities and Exchange Commission (the Commission). Certain information
and footnote disclosures normally included in annual financial statements prepared in accordance
with accounting principles generally accepted in the United States have been condensed or omitted
pursuant to the rules and regulations. However, the Company believes that the disclosures made are
adequate to make the information presented not misleading when read in conjunction with the audited
financial statements and the notes thereto. Management believes that the financial statements
contain all adjustments necessary for a fair statement of the results for the interim periods
presented. All adjustments were of a normal, recurring nature. The results of operations for the
interim period are not necessarily indicative of the results for the entire fiscal year.
Note 2 Purchase Commitment and Foreign Currency Derivatives
During 2005, the Company entered into purchase agreements totaling $8,700,000 with suppliers to
construct a new paper machine. Down payments were required to these vendors with remaining
periodic payments through the second quarter of 2006. One of these agreements is denominated in
Euros. The Companys remaining minimum unpaid obligation under these agreements of $698,000 has
been accrued at March 31, 2006, and included in accrued liabilities.
The Company entered into foreign currency exchange contracts to purchase Euros at a fixed price in
conjunction with the foreign currency portion of its obligations for the acquisition of its new
paper machine. At March 31, 2006, the Company had one outstanding foreign exchange contract to
exchange U.S. Dollars for Euros totaling $760,000 for the final payment due on the equipment. The
exchange contract is carried at fair value on the balance sheet. The exchange contracts were not
identified as cash flow hedges as defined in SFAS No. 133, Accounting for Derivative Instruments
and Hedging Activities. SFAS No. 133 requires the Company to recognize all derivatives as either
assets or liabilities on the balance sheet and to measure those instruments at fair value.
Further, since the transaction is not considered a hedged transaction, fair value adjustments
affect the Companys periodic net income.
The net foreign currency transaction loss resulting from the Companys Euro denominated obligations
and Euro exchange contracts for the three months ended March 31, 2006, of $5,000 is included in
other (income) expense, net.
- 6 -
Note 3 Construction-in-Process and Capitalized Interest
During 2005, the Company incurred capitalized costs of $18.3 million on the new paper machine
project. Included in this total was $411,000 of capitalized interest based on the weighted average
borrowing rate incurred on the Companys outstanding debt applied to average cumulative spending.
During the first three months of 2006, the Company capitalized all current interest costs incurred,
totaling $481,000, because the average cumulative spending on the project exceeded the level of the
Companys outstanding debt during that period. At March 31, 2006, cumulative spending on the new
paper machine totaled $27.0 million, inclusive of capitalized interest of $892,000. Interest
expense reported in the income statement for the three-month period ended March 31, 2006 consists
of amortization of debt issuance costs.
Note 4 Credit Agreements
In June 2005, the Company entered into an amended and restated credit agreement. The credit
facility provides for a $5.0 million revolving credit line, a $14.1 million term loan and a $15.0
million construction loan. All of the loans under the credit agreement mature on April 30, 2007.
At March 31, 2006, $12.9 million was outstanding under the term loan, $8.1 million was outstanding
under the construction loan and $3.4 million was outstanding under the revolving credit line. In
addition, $529,000 of bank overdrafts were included in the long-term debt section of the balance
sheet. The borrowing base for the revolving credit line is determined by adding qualified
receivables and inventory. At March 31, 2006, the borrowing base for the revolving credit line was
$5.0 million.
All of the above loans bear interest at the Companys election at the prime rate or LIBOR, plus a
margin based on the ratio of funded debt to EBITDA less income taxes paid. The margin is set
quarterly and ranges from negative 50 basis points to 150 basis points for prime rate-based loans
and from 225 to 425 basis points for LIBOR-based loans. At March 31, 2006, the Companys weighted
average borrowing rate was 9.08% under this agreement. Obligations under the amended and restated
credit agreement are secured by substantially all of the assets of the Company. The agreement
contains various restrictive covenants that include requirements to maintain certain financial
ratios and to restrict capital expenditures and dividend payments. The Company is also required,
beginning in 2007, to reduce the outstanding principal amount of its term loan annually by an
amount equal to 40% of its excess cash flow, as defined in the credit agreement. The Company was
in compliance with all covenants as of March 31, 2006.
Note 5 Stock Split
In April 2005, the Companys and Orchids Acquisitions boards of directors approved the merger of
Orchids Acquisition into Orchids with Orchids as the surviving entity. The number of authorized
common shares was increased to 10,000,000 and the number of common shares outstanding was split on
a 2.744 for 1 basis. All common and per share amounts for 2005 have been restated to reflect the
2.744 for 1 stock split.
Note 6 Earnings per Share
The computation of basic and diluted net income per share for the three-month periods ended March
31, 2006 and 2005 is as follows:
- 7 -
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Three Months Ended March 31, |
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2006 |
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2005 |
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Net income ($ thousands) |
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$ |
182 |
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$ |
346 |
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Weighted average shares outstanding |
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4,156,250 |
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2,000,000 |
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Effect of stock options |
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80,690 |
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Effect of dilutive warrants |
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81,111 |
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52,538 |
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Weighted average shares outstanding assuming dilution |
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4,318,051 |
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2,052,538 |
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Earnings per common share: (2005 restated to
to reflect 2.744 for 1 stock split) |
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Basic |
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$ |
0.04 |
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$ |
0.17 |
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Diluted |
|
$ |
0.04 |
|
|
$ |
0.17 |
|
Note 7 Stock Incentive Plan
In April 2005, the board of directors and the stockholders approved the 2005 Stock Incentive Plan
(the Plan). The Plan provides for the granting of incentive stock options to employees selected
by the boards compensation committee. The Plan authorizes up to 465,000 shares to be issued. The
compensation committee subsequently awarded options for 270,000 shares to officers of the Company
at an exercise price of $8.00, which was equal to the initial public offering price of the stock.
The options vest 20% on the date of grant and then ratably 20% over the next four years and have a
ten-year term.
In September 2005, the board of directors authorized options totaling 7,500 shares of stock
pursuant to the Plan to certain directors of the Company at an exercise price of $9.80, which was
equal to the closing price of the Companys stock on the date of the grant. The options have a
ten-year term and were fully vested on the date of grant. In February 2006, the board of directors
authorized options for 2,500 shares of stock to a new member of the board of directors at an
exercise price of $11.42, the current market price on the date of the grant.
Fair
values were estimated at the date of grant of the options granted in
February 2006, using the
Black-Scholes option valuation model with the following weighted average assumptions: risk-free
interest rate of 4.56%, volatility factor of the expected market price of the Companys common
stock of 41%, no dividend yield on the Companys common stock, and a weighted average expected life
of the options of 5 years. The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options, which have no vesting restrictions and are fully
transferable. In addition, options valuation models require the input of highly subjective
assumptions including the expected stock price volatility.
In connection with the approval of the Plan, the Company adopted SFAS No. 123 (R) Share-Based
Payments and expenses the cost of options granted over the vesting period of the option based on
the grant-date fair value of the award. For the three months ended March 31, 2006, the Company
recognized an expense of $59,000 related to options granted under the Plan.
Note 8 Major Customers and Concentration of Credit Risk
Credit risk for the Company is concentrated in two major customers, each of whom operates discount
retail stores located throughout the United States. During the three month periods ended March 31,
2006 and 2005, sales to the two significant customers accounted for approximately 61% and 67% of
the Companys total sales, respectively. At March 31, 2006 and 2005, respectively, approximately
$1,914,000 (51%) and $1,963,000 (62%) of accounts receivable was due from these two significant
customers. No other customers of the Company accounted for more than 10% of sales during these
periods. The Company generally does not require collateral from its customers and has not incurred
any significant losses on uncollectible accounts receivable.
- 8 -
Note 9 New Accounting Standards
In February 2006, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 155
Accounting for Certain Hybrid Financial Instruments amending SFAS No. 133 and SFAS No. 140. SFAS
No. 155 eliminates the exemption from applying SFAS No. 133 to securitized financial assets. The
provisions of SFAS No. 155 are to be applied to financial instruments issued or acquired during
fiscal periods beginning after September 15, 2006. The adoption of SFAS No. 155 is not expected to
have a material impact on the Companys financial position or results of operations.
ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Information
The following Managements Discussion and Analysis of Financial Condition and Results of Operations
contains forward-looking statements. These statements relate to, among other things:
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our business strategy; |
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our value proposition; |
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the market opportunity for our products, including expected demand for our products; |
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our estimates regarding our capital requirements; and |
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any of our other plans, objectives, and intentions contained in this report that are not
historical facts. |
These statements relate to future events or future financial performance, and involve known and
unknown risks, uncertainties and other factors that may cause our actual results, levels of
activity, performance or achievements to be materially different from any future results, levels of
activity, performance or achievements expressed or implied by such forward-looking statements. In
some cases, you can identify forward-looking statements by terminology such as may, should,
could, expects, plans, intends, anticipates, believes, estimates, predicts,
potential or continue or the negative of such terms or other comparable terminology. Although
we believe that the expectations reflected in the forward-looking statements are reasonable, we
cannot guarantee future results, levels of activity, performance or achievements. These statements
are only predictions.
You should not place undue reliance on forward-looking statements because they involve known and
unknown risks, uncertainties, and other factors that are, in some cases, beyond our control and
that could materially affect actual results, levels of activity, performance or achievements.
Factors that could materially affect our actual results, levels of activity, performance or
achievements include, without limitation, those detailed under the caption Risk Factors in our
Annual Report on Form 10-K dated March 28, 2006, as filed with the Securities and Exchange
Commission, and the following items:
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we face intense competition in our market and our profitability would be reduced if
aggressive pricing by our competitors forces us to decrease our prices; |
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a substantial percentage of our revenues are attributable to two large customers which may
decrease or cease purchases at any time; |
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we may experience cost overruns in and delays in the start up of our project to expand our paper mill; |
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we have significant indebtedness which limits our free cash flow and subjects us to restrictive covenants relating to the
operation of our business; |
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the availability of and prices for energy will significantly affect our business; |
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our exposure to variable interest rates may affect our financial health; |
- 9 -
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the loss of key personnel; |
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the disruption in supply or cost of waste paper; |
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the disruption in availability or cost of parent rolls; |
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labor interruptions; |
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natural disaster or other disruption to our facility; |
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ability to finance the capital requirements of our business; |
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cost to comply with government regulations; |
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increased expenses and administrative workload associated with being a public company; and |
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failure to maintain an effective system of internal controls necessary to accurately report
our financial results and prevent fraud. |
If any of these risks or uncertainties materialize, or if our underlying assumptions prove to be
incorrect, actual results may vary significantly from what we projected. Any forward-looking
statement you read in the following Managements Discussion and Analysis of Financial Condition and
Results of Operations reflects our current views with respect to future events and is subject to
these and other risks, uncertainties, and assumptions relating to our operations, results of
operations, growth strategy, and liquidity. We assume no obligation to publicly update or revise
these forward-looking statements for any reasons, whether as a result of new information, future
events, or otherwise.
Overview
We manufacture bulk tissue paper, known as parent rolls, and convert parent rolls into a full line
of tissue products, including paper towels, bathroom tissue and paper napkins for the private label
segment of the consumer, or at home, market. We have focused our product design and
manufacturing on the value, or dollar store retailers due to their consistent order patterns,
limited number of stock keeping units, or SKUs, offered and the growth being experienced in this
channel of the retail market. While we have customers located throughout the United States, we
distribute most of our products within approximately 900 miles of our northeast Oklahoma facility,
which we consider to be our cost-effective shipping area. Our products are sold primarily under
our customers private labels and, to a lesser extent, under our brand names such as Colortex® and
Velvet®. All of our revenue is derived pursuant to truck load purchase orders from our
customers. We do not have supply contracts with any of our customers. Revenue is recognized when
title passes to the customer. Because our product is a daily consumable item, the order stream
from our customer base is fairly consistent with no significant seasonal fluctuations. Changes in
the national economy do not materially affect the market for our product. Large dollar store
customers usually allocate business for a range of SKUs by distribution center, and customarily
award such business on an annual basis.
The private label segment of the tissue industry is highly competitive, and value retail customers
are extremely price sensitive. As a result, it is difficult to effect price increases. We expect
these competitive conditions to continue.
We have purchased parent rolls in the open market since 1998 because our own parent roll production
has not adequately supplied the requirements of our converting facility. We purchased
approximately 12,200, 5,000 and 3,300 tons of paper on the open market in 2005, 2004 and 2003,
respectively, to supplement our paper-making capacity. For the first three months of 2006, we
converted 3,343 tons of paper purchased on the open market, which represented 36% of the total tons
consumed. Parent rolls are a commodity product and thus are subject to market price and
availability. We have experienced significantly higher parent roll prices in recent periods, as
well as limited availability, which have negatively affected our profitability. We anticipate the
trend of higher prices and tight supply
- 10 -
to continue for the foreseeable future. We intend to reduce or eliminate purchases of parent rolls
by purchasing a new paper machine, which project is underway and is expected to be fully
operational by October 2006. The total cost of this project is estimated at $31.4 million. Until
the paper machine is operational, we will continue to be subject to price volatility and limited
availability of parent rolls.
Our profitability depends on several key factors, including:
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the market price of our product; |
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the cost of parent rolls purchased on the open market to meet our converting needs; |
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the successful start-up and operation of our new paper machine; |
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the cost of recycled paper used in producing paper; |
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the efficiency of operations in both our paper mill and converting plant; and |
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energy costs. |
Comparative Three-Month Periods Ended March 31, 2006 and 2005
Net Sales
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Three Months Ended March 31, |
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2006 |
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2005 |
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|
(in thousands, except average price per case) |
Net sales |
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$ |
14,099 |
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$ |
12,542 |
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|
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Cases shipped |
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1,253 |
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1,144 |
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Average price per case |
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$ |
11.25 |
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$ |
10.96 |
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Net sales increased $1.6 million, or 12%, to $14.1 million in the quarter ended March 31,
2006, compared to $12.5 million in the same period of 2005. Net sales figures include gross
selling price, including freight, less discounts and pricing allowances. The increase in net sales
is the result of higher overall business with several of our larger customers which was partially
offset by lower business with our largest customer. Shipments increased by 109,000 cases, or 10%,
to 1.25 million cases of finished product in the quarter compared to 1.14 million cases in the same
period of 2005. Our net selling price in the first quarter of 2006 was $11.25 per case compared
with $10.96 per case in the same period of 2005. The net selling price per case increased
primarily due to price increases which were implemented during the first and second quarters of
2005.
Cost of Sales
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Three Months Ended March 31, |
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2006 |
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2005 |
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(in thousands, except gross profit margin %) |
|
Cost of paper |
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$ |
7,991 |
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$ |
6,811 |
|
Non-paper materials, labor, supplies, etc. |
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4,152 |
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3,593 |
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Sub-total |
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12,143 |
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10,404 |
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Depreciation |
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393 |
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321 |
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|
|
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Cost of sales |
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$ |
12,536 |
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$ |
10,725 |
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Gross Profit |
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$ |
1,563 |
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$ |
1,817 |
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Gross Profit Margin % |
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11.1 |
% |
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14.5 |
% |
- 11 -
Major components of cost of sales are the cost of internally produced paper, the cost of
parent rolls purchased from third parties, raw materials, direct labor and benefits, freight costs
of products shipped to customers, insurance, repairs and maintenance, energy, utilities and
depreciation.
Cost of sales increased approximately $1.8 million, or 17%, to $12.5 million for the quarter ended
March 31, 2006, compared to $10.7 million in the same period of 2005. As a percentage of net
sales, cost of sales increased to 88.9% in the 2006 quarter compared to 85.5% in the same quarter
of 2005. Cost of sales as a percentage of net sales in the quarter ended March 31, 2006 was
unfavorably affected by a higher average cost of internally produced parent rolls and, to a lesser
extent, a higher cost and quantity of purchased parent rolls. The following chart depicts the
major factors that influence our paper costs.
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Three Months Ended March 31, |
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2006 |
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2005 |
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Paper usage (tons) |
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Manufactured |
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5,875 |
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5,470 |
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Purchased |
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3,343 |
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2,801 |
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Converted |
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9,218 |
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8,271 |
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Paper costs per ton |
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Cost per ton produced internally |
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$ |
773 |
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$ |
724 |
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Cost per ton purchased from third parties |
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$ |
1,032 |
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$ |
1,018 |
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Total cost per ton consumed |
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$ |
867 |
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$ |
824 |
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Total paper costs (in thousands) |
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Cost of internally produced paper |
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$ |
4,541 |
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$ |
3,960 |
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Cost of paper purchased from third parties |
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3,450 |
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2,851 |
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Total paper costs |
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$ |
7,991 |
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$ |
6,811 |
|
Our cost of internally produced paper increased $49 per ton to $773 per ton in the quarter
ended March 31, 2006, compared to $724 per ton in the same period in 2005. Higher energy costs
comprised most of the increase in cost per ton. Our increase in cases shipped in the first quarter
of 2006 required us to increase purchases of parent rolls from third parties.
Gross Profit
Gross profit in the quarter ended March 31, 2006 decreased $254,000, or 14%, to $1.6 million
compared to $1.8 million in the same period last year. Gross profit as a percentage of net sales
decreased to 11.1% in the first quarter of 2006 compared to 14.5% in the first quarter of 2005.
The major reasons for the reduced gross profit and the decline in gross profit percentage was the
higher cost of internally produced paper and the higher cost and quantity of purchased paper.
Selling, General and Administrative Expenses
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Three Months Ended March 31, |
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2006 |
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2005 |
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(In thousands, except SG&A as a % of net sales) |
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Commission expense |
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$ |
199 |
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$ |
212 |
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Other S,G&A expenses |
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1,049 |
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747 |
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Selling, General & Adm exp |
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$ |
1,248 |
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$ |
959 |
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SG&A as a % of net sales |
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8.9 |
% |
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7.6 |
% |
- 12 -
Selling, general and administrative expenses include salaries, commissions to brokers and
other miscellaneous expenses. Selling, general and administrative expenses increased $289,000, or
30%, to $1.2 million in the quarter ended March 31, 2006, compared to $959,000 in the same period
of 2005. The increase was primarily due to public company costs, higher artwork-related
expenditures and stock-based compensation expense. In the first quarter of 2006, we recognized
approximately $100,000 of public company expenses which we did not incur in the same period in 2005
when we were a privately held company. These costs include fees for increased legal and auditing
services, premiums for directors and officers insurance, increased internal accounting costs and
others. While we have not completed a full year as a public company, we anticipate our annual
costs of being public will be approximately $400,000 to $500,000. Artwork expense increased
approximately $110,000 in the first quarter of 2006 compared to the same period last year. A
higher than normal number of packaging changes by existing customers and graphics and packaging
development with new customers accounted for the increase. In the quarter ended March 31, 2006, we
recognized $59,000 of stock-based compensation expense resulting from the grant of options for an
aggregate of 270,000 shares of stock in the second quarter of 2005 to certain members of management
and for the grant of options for 2,500 shares of stock to a board member in the first quarter of
2006. The options were granted pursuant to the 2005 Stock Incentive Plan which was approved by the
board of directors and stockholders in April 2005. The management options vest 20% on date of
grant and then 20% on each anniversary of the grant date over the succeeding four years. The board
options vested 100% on the date of grant. Quarterly charges for stock options granted in the
second quarter of 2005 will approximate $47,000 for the remainder of 2006 and will continue through
the vesting period ending in the first quarter of 2009.
Operating Income
As a result of the foregoing factors, operating income for the quarter ended March 31, 2006 was
$315,000 compared to $858,000 for the same period of 2005.
Interest and Other Expense
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Three Months Ended March 31, |
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2006 |
|
2005 |
|
|
(In thousands) |
Interest expense |
|
$ |
47 |
|
|
$ |
369 |
|
Other (income) expense, net |
|
$ |
(12 |
) |
|
$ |
(5 |
) |
Interest expense includes interest on all debt and amortization of both deferred debt issuance
costs and the discount on our subordinated debt related to warrants issued with that debt.
Interest expense decreased $322,000 to $47,000 in the quarter ended March 31, 2006, compared to
$369,000 in the same period in 2005. Interest expense decreased as a result of the capitalization
of $481,000 of interest related to our new paper machine project. Excluding the interest
capitalization, interest expense increased $159,000 in the first quarter of 2006 compared to the
same period in 2005. The primary reason for the increase was $8.1 million in new borrowings in the
first quarter of 2006 on the construction loan for our paper machine project, increased borrowings
under the revolving credit facility and an increase in interest rates for the year-over-year
comparison.
Other income increased to $12,000 due to income earned from the restricted certificate of deposit
with our lending institution. This income was partially offset by a net foreign currency exchange
loss of $5,000. We have entered into certain purchase agreements related to our project to build
a new paper machine. One of these purchase agreements is denominated in Euros. Our minimum unpaid
obligation under this purchase agreement as of March 31, 2006 was US $698,000 and has been recorded
in accrued liabilities. We entered into foreign currency exchange contracts in the second quarter
of 2005 to fix the price of this purchase agreement. At March 31, 2006, our outstanding foreign
exchange contract totaled US $760,000. The exchange contract is carried at fair value and any
adjustments to fair value affect net income. The net foreign currency transaction loss resulting
from our Euro denominated obligations and Euro exchange contracts for the three months ended March
31, 2006 was $5,000.
- 13 -
Income Before Income Taxes
As a result of the foregoing factors, income before income taxes decreased $214,000 to $280,000 in
the quarter ended March 31, 2006, compared to $494,000 in the same period in 2005.
Income Tax Provision
As of March 31, 2006, we estimate our annual effective income tax rate to be 35%. It is higher
than the statutory rate because of the previously discussed non-deductible stock option expense and
state income taxes, largely offset by the recently enacted domestic production deduction. For the
quarter ended March 31, 2005, an estimated annual effective tax rate of 30% was applied. The
utilization of Indian employment credits was the major reason for the variance from the statutory
rate.
Liquidity and Capital Resources
Liquidity refers to the liquid financial assets available to fund our business operations and pay
for near-term obligations. These liquid financial assets consist of cash as well as short-term
investments. Our cash requirements have historically been satisfied through a combination of cash
flows from operations and debt financings. Our strategy to eliminate the need to purchase paper
from third-party suppliers through the purchase of a new paper machine is being funded through the
use of substantially all of the net proceeds of our initial public offering, additional bank
financing, and, if necessary, cash reserves and cash flows from operations. The total cost of this
project is estimated at $31.4 million. Cumulative spending on the new paper machine project
totaled $27.0 million as of March 31, 2006, including $892,000 of capitalized interest. The $26.1
million of project expenditures, excluding capitalized interest, were funded using all of the $15.0
million in net proceeds from the initial public offering on July 14, 2005, borrowings of $8.1
million under the construction loan facility, borrowings under our revolving credit line and
available cash . Remaining project costs of approximately $5.3 million are expected to be funded
using the construction loan facility, which is capped at $15.0 million.
Cash decreased $374,000 at March 31, 2006, to $4,000 compared with $378,000 as of December 31,
2005. The remaining unused net proceeds from our previously discussed initial public offering of
$373,000 at year-end 2005 were applied to the paper machine project during January 2006.
We have entered into various purchase agreements with suppliers for our project to build a new
paper machine. One of the purchase agreements is payable in Euros and our minimum obligation under
the agreement at March 31, 2006 was US $698,000 which was included in accrued liabilities. When
this obligation comes due, it will be paid from the construction loan facility.
The following table summarizes key cash flow information for the three-month periods ended March
31, 2006 and 2005:
Cash Flow Data:
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|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
2006 |
|
2005 |
|
|
(in thousands) |
Cash flow provided by (used in): |
|
|
|
|
|
|
|
|
Operating activities |
|
$ |
37 |
|
|
$ |
(1,139 |
) |
|
|
|
|
|
|
|
|
|
Investing activities |
|
$ |
(8,776 |
) |
|
$ |
(1,556 |
) |
|
|
|
|
|
|
|
|
|
Financing activities |
|
$ |
8,365 |
|
|
$ |
2,215 |
|
- 14 -
Cash flow provided by operating activities was $37,000 in the three-month period ended March
31, 2006, which primarily consisted of earnings before non-cash charges, a draw-down in customer
accounts receivable and a build-up of accounts payable, being offset by a substantial increase in
inventory. The increase in inventory is the result of purchases of parent rolls from
third-parties that exceeded converting requirements in anticipation of draw-downs during the
start-up of the new paper machine and production of finished case products in excess of customer
requirements for the quarter.
Cash used in investing activities was $8.8 million in the three-month period ended March 31, 2006.
The amount is attributable to capital expenditures on our new paper machine.
Cash provided by financing activities was $8.4 million in the three-month period ended March 31,
2006, and was primarily attributable to borrowings under our construction loan facility.
Cash used in operating activities in the three-month period ended March 31, 2005, was $1.1 million
due primarily to a build-up of inventories, which had been abnormally low at year-end 2004 due to
tight supplies of outside parent rolls. Also contributing to the negative cash flow from
operations was a reduction of accrued liabilities and an increase in spending charged to prepaid
expenses, partially offset by reduced trade accounts receivable.
Cash used in investing activities was $1.6 million for the three-month period ended March 31,
2005, and was primarily attributable to a down payment for the new paper machine.
Cash provided by financing activities totaled $2.2 million for the three-month period ended March
31, 2005. The Company borrowed $2.6 million under the revolving credit line, primarily to finance
the rebuilding of inventories and to make the aforementioned down payment on the new paper machine.
In June 2005, the Company entered into an amended and restated credit agreement. The credit
facility provides for a $5.0 million revolving credit line, a $14.1 million term loan and a $15.0
million construction loan. All of the loans under the credit agreement mature April 30, 2007. At
March 31, 2006, $12.9 million was outstanding under the term loan, $8.1 million was outstanding
under the construction loan and $3.4 million was outstanding under the revolving credit line. In
addition, $529,000 of bank overdrafts were included in the long-term debt section of the balance
sheet. At March 31, 2006, the borrowing base for the revolving credit line was $5,000,000.
Amounts outstanding under the revolving line of credit, term loan and construction loan bear
interest at our election at the prime rate or LIBOR plus a margin based on the ratio of funded debt
to EBITDA less income taxes paid. The margin is set quarterly and ranges from negative 50 basis
points to 150 basis points for prime rate loans and from 225 to 425 basis points for LIBOR-based
loans. At March 31, 2006 our weighted average borrowing rate was 9.08%. Amounts outstanding under
the construction loan are excluded from the calculation of funded debt until seven months after the
date the certificate of completion related to the project is issued.
As a condition of funding the construction loan, the agreement required us to invest at least $10
million in our paper mill expansion project and to establish an interest reserve account of at
least $1.5 million. The interest reserve account must be maintained until a date which is seven
months after the certificate of completion is issued, at which time the funds will be used to
reduce the principal balance of the term loan. The amount available under the revolving credit
line may be reduced in the event that our borrowing base, which is based upon our qualified
receivables and qualified inventory, is less than $5.0 million. We are also required, beginning in
2007, to reduce the outstanding principal amount of our term loan annually by an amount equal to
40% of excess cash flow, as defined. Obligations under the amended and restated credit agreement
are secured by substantially all of our assets. The agreement contains various restrictive
covenants that include requirements to maintain certain financial ratios, restricts capital
expenditures and the payment of dividends.
The agreement contains representations and warranties, and affirmative and negative covenants
customary for financings of this type, including, but not limited to, a covenant prohibiting us
from declaring or paying dividends. The financial covenants measure our performance against
standards for leverage, tangible net worth, debt service
- 15 -
coverage, tested as of the end of each quarter, and a limit on the amount of annual capital
expenditures. The maximum allowable leverage ratio is 4.0 to 1.0, the minimum allowable debt
service coverage ratio is 1.25 to 1.0 and the minimum tangible net worth is $19.5 million. The
effects of the interest reserve account and borrowings under the construction loan are excluded
from the calculation of financial covenants until seven months after the date the certificate of
completion related to the project is issued. Our annual expenditures for capital equipment,
excluding the new paper machine, are limited to $1.0 million per fiscal year.
Finally, the agreement contains customary events of defaults for financings of this type,
including, but not limited to:
|
|
|
the occurrence of a change in management such that Michael P. Sage is no longer our chief
executive officer without the prior written consent of the banks, which consent may not be
unreasonably withheld, conditioned or delayed; |
|
|
|
|
the failure to complete the new paper machine project by October 31, 2006, provided that the
agent shall not unreasonably withhold its consent to extend this date if it receives (i) a copy of
a written extension agreement of the construction contract, (ii) there is no other default under
the credit agreement and (iii) we execute any related amendments to the credit agreement or related
documents which are reasonably requested by the agent; and |
|
|
|
|
a material variance from the plans submitted to the banks in connection with the expansion
of the paper machine facility or any work stoppage for a period of five consecutive business days,
unless the work stoppage is a result of a cause we are unable to prevent or overcome. |
If an event of default occurs, the agent may declare the banks obligation to make loans terminated
and all outstanding indebtedness, and all other amounts payable under the credit agreement, due and
payable.
On March 1, 2004, we sold units consisting of $2.2 million principal amount of subordinated
debentures and common stock warrants. The subordinated debentures were sold in units of $1,000
bearing interest at 12% per year, payable quarterly, with each note including a warrant to purchase
38 shares of common stock at an exercise price of $3.64 per share. We have the right to prepay,
without premium or penalty, any unpaid principal on the subordinated debentures. The subordinated
debentures are expressly subordinated to the prior payment in full of amounts owed under our
revolving line of credit and term loans. The subordinated debentures contain customary covenants
and events of default.
Critical Accounting Policies and Estimates
The preparation of our financial statements and related disclosures in conformity with accounting
principles generally accepted in the United States requires management to make estimates and
judgments that affect our reported amounts of assets and liabilities, revenue and expense, and
related disclosures of contingent assets and liabilities. On an ongoing basis, we evaluate our
estimates and assumptions based upon historical experience and various other factors and
circumstances. Management believes that our estimates and assumptions are reasonable under the
circumstances; however, actual results may vary from these estimates and assumptions under
different future circumstances. We have identified the following critical accounting policies that
affect the more significant judgments and estimates used in the preparation of our financial
statements.
Accounts Receivable. Accounts receivable consist of amounts due to us from normal business
activities. Our management must make estimates of accounts receivable that will not be collected.
We perform ongoing credit evaluations of our customers and adjust credit limits based upon payment
history and the customers creditworthiness as determined by our review of their current credit
information. We continuously monitor collections and payments from our customers and maintain a
provision for estimated losses based on historical experience and specific customer collection
issues that we have identified. Trade receivables are written-off when all reasonable collection
efforts have been exhausted, including, but not limited to, external third party collection efforts
and litigation. While such credit
- 16 -
losses have historically been within managements expectations and the provision established, there
can be no assurance that we will continue to experience the same credit loss rates as in the past.
During the three-month periods ended March 31, 2006 and 2005, provisions for doubtful accounts were
recognized in the amount of $15,000 for each period. There were no accounts receivable balances
written-off in the three-month periods ended March 31, 2006 and 2005.
Inventory. Our inventory consists of finished goods and raw materials and is stated at the lower
of cost or market. Our management regularly reviews inventory quantities on hand and records a
provision for excess and obsolete inventory based on the age of the inventory and forecasts of
product demand. A significant decrease in demand could result in an increase in the amount of
excess inventory quantities on hand. There were no changes in the inventory valuation reserve
during the three-month periods ended March 31, 2006 and 2005.
New Accounting Pronouncements
In February 2006, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 155
Accounting for Certain Hybrid Financial Instruments amending SFAS No. 133 and SFAS No. 140. SFAS
No. 155 eliminates the exemption from applying SFAS No. 133 to securitized financial assets. The
provisions of SFAS No. 155 are to be applied to financial instruments issued or acquired during
fiscal periods beginning after September 15, 2006. The adoption of SFAS No. 155 is not expected to
have a material impact on the Companys financial position or results of operations.
Non-GAAP Discussion
In addition to our GAAP results, we also consider non-GAAP measures of our performance for a number
of purposes. We use EBITDA as a supplemental measure of our performance that is not required by,
or presented in accordance with, GAAP. EBITDA is not a measurement of our financial performance
under GAAP and should not be considered as an alternative to net income, operating income or any
other performance measure derived in accordance with GAAP, or as an alternative to cash flow from
operating activities or a measure of our liquidity.
EBITDA represents net income before net interest expense, income tax expense, depreciation and
amortization. We believe EBITDA facilitates operating performance comparisons from period to
period and company to company by eliminating potential differences caused by variations in capital
structures (affecting relative interest expense), tax positions (such as the impact on periods or
companies of changes in effective tax rates or net operating losses) and the age and book
depreciation of facilities and equipment (affecting relative depreciation expense).
EBITDA has limitations as an analytical tool, and you should not consider it in isolation, or as a
substitute for any of our results as reported under GAAP. Some of these limitations are:
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it does not reflect our cash expenditures for capital assets; |
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it does not reflect changes in, or cash requirements for, our working capital requirements; |
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it does not reflect the interest expense, or the cash requirements necessary to service interest
or principal payments on our indebtedness; |
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although depreciation and amortization are non-cash charges, the assets being depreciated and
amortized will often have to be replaced in the future, and EBITDA does not reflect cash
requirements for such replacements; and |
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other companies, including other companies in our industry, may calculate these measures
differently than we do, limiting their usefulness as a comparative measure. |
- 17 -
Because of these limitations, EBITDA should not be considered as a measure of discretionary cash
available to us to invest in the growth of our business or to reduce our indebtedness. We
compensate for these limitations by relying primarily on our GAAP results and using EBITDA on a
supplemental basis.
The following table reconciles EBITDA to net income for the quarters ended March 31, 2006 and 2005:
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Three Months Ended March 31, |
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2006 |
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2005 |
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(In thousands, except % of net sales) |
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Net income |
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$ |
182 |
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$ |
346 |
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Plus: Interest expense, net |
|
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47 |
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|
369 |
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Plus: Income tax expense |
|
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98 |
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|
|
148 |
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Plus: Depreciation |
|
|
393 |
|
|
|
321 |
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|
|
|
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EBITDA |
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$ |
720 |
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$ |
1,184 |
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% of net sales |
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5.1 |
% |
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9.4 |
% |
EBITDA decreased $464,000, or 39%, to $720,000 in the quarter ended March 31, 2006, compared
to $1.2 million in the same period of 2005. EBITDA as a percent of net sales declined to 5.1% in
the current year quarter compared to 9.4% in the prior year quarter. The foregoing factors
discussed in the net sales, cost of sales and selling, general and administrative expenses sections
are the reasons for these changes. The largest causes of the decrease in EBITDA as a percentage of
net sales were higher paper costs and higher selling, general and administrative expenses.
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
Our market risks relate primarily to changes in interest rates. Our revolving line of credit, our
construction loan and our term loan carry variable interest rates that are tied to market indices
and, therefore, our statement of income and our cash flows will be exposed to changes in interest
rates. As of March 31, 2006, we have borrowings totaling $24.4 million that carry a variable
interest rate. Outstanding balances under our line of credit and term loans bear interest at the
prime rate or LIBOR, plus a margin based upon the debt service coverage ratio. Based on the
current borrowings, a 100 basis point change in interest rates would result in a $244,000 change to
our annual interest expense.
ITEM 4. Controls and Procedures
Our management, under the supervision and with the participation of our chief executive officer and
chief financial officer, has evaluated the effectiveness of our disclosure controls and procedures
(as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
amended), as of the end of the period covered by this Quarterly Report on Form 10-Q. Any controls
and procedures, no matter how well designed and operated, can provide only reasonable assurance of
achieving the desired control objectives. Based on such evaluation, our chief executive officer
and chief financial officer have concluded that our disclosure controls and procedures were
effective as of March 31, 2006.
PART II OTHER INFORMATION
ITEM 1. Legal Proceedings
Not applicable.
- 18 -
ITEM 1A. Risk Factors
There have been no material changes from the risk factors disclosed in the Companys Annual Report
on Form 10-K dated March 28, 2005.
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
(a) Unregistered Sales of Equity Securities
None.
(b) Initial Public Offering and Use of Proceeds from the Sale of Registered Securities
On July 20, 2005, the Company consummated its initial public offering with the sale of 2,156,250
shares of common stock, including 281,250 shares of common stock issued pursuant to the
underwriters overallotment option. The public offering price of the common stock was $8.00 per
share and Taglich Brothers, Inc. acted as the underwriter in connection with the offering.
The net proceeds to the Company from the offering were $15.0 million. From the effective date of
the registration statement on Form S-1 through March 31, 2006, we had used all of the net proceeds
to pay project costs related to the purchase and installation of our new paper machine, the
construction of a building to house the paper machine and the purchase of related capital
equipment.
(c) Repurchases of Equity Securities.
The Company does not have any programs to repurchase shares of its common stock and no such
repurchases were made during the three months ended March 31, 2006.
ITEM 3. Defaults Upon Senior Securities
None.
ITEM 4. Submission of Matters to a Vote of Security Holders
None.
ITEM 5. Other Information
None.
ITEM 6. Exhibits
See the Exhibit Index following the signature page to this Form 10-Q, which Exhibit Index is hereby
incorporated by reference herein.
- 19 -
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized.
ORCHIDS PAPER PRODUCTS COMPANY
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Date: May 11, 2006
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By:
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/s/ Keith R. Schroeder |
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Keith R. Schroeder |
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Chief Financial Officer |
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(On behalf of the registrant and as Chief Accounting Officer) |
- 20 -
Exhibit Index
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Exhibit |
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Description |
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3.1 |
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Amended and Restated Certificate of Incorporation of the
Registrant. Incorporated by reference to Exhibit 3.1 to the
Registrants Registration Statement on Form S-1 (File No.
333-124173) filed with the Securities and Exchange Commission on
April 19, 2005. |
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3.2 |
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Amended and Restated Bylaws of the Registrant. Incorporated by
reference to Exhibit 3.2 to the Registrants Registration
Statement on Form S-1 (File No. 333-124173) filed with the
Securities and Exchange Commission on April 19, 2005. |
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31.1 |
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Certification of Chief Executive Officer Pursuant to Section 302. |
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31.2 |
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Certification of Chief Financial Officer Pursuant to Section 302. |
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32.1 |
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Certification of Chief Executive Officer Pursuant to Section 906. |
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32.2 |
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Certification of Chief Financial Officer Pursuant to Section 906. |
21