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
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For the quarterly period ended June 30, 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
or15(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 $.001 per share, as of
August 1, 2006: 6,234,346 shares.
ORCHIDS PAPER PRODUCTS COMPANY
TABLE OF CONTENTS
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED JUNE 30, 2006
-2-
PART 1 FINANCIAL INFORMATION
ITEM 1. Financial Statements
ORCHIDS PAPER PRODUCTS COMPANY
BALANCE SHEETS
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As of |
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June 30, |
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December 31, |
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2006 |
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2005 |
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(unaudited) |
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(Dollars in thousands) |
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ASSETS |
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Current assets: |
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Cash |
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$ |
5 |
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$ |
378 |
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Accounts receivable, net of allowance of
$155 in 2006 and $125 in 2005 |
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4,169 |
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4,180 |
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Inventories, net |
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4,663 |
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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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304 |
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94 |
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Prepaid expenses |
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209 |
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458 |
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Deferred income taxes |
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147 |
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200 |
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Total current assets |
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10,997 |
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11,230 |
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Property, plant and equipment |
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59,373 |
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44,983 |
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Accumulated depreciation |
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(3,576 |
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(2,789 |
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Net property, plant and equipment |
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55,797 |
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42,194 |
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Deferred debt issuance costs, net of accumulated
amortization of $325 in 2006 and $232 in 2005 |
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193 |
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286 |
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Total assets |
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$ |
66,987 |
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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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$ |
3,269 |
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$ |
2,877 |
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Accrued liabilities |
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1,610 |
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2,137 |
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Unrealized loss on forward currency exchange contracts |
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74 |
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Due to banks under credit agreement |
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30,031 |
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Current portion of long-term debt |
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1,628 |
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Total current liabilities |
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34,910 |
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6,716 |
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Long-term debt, net of unamortized discount of $87
in 2006 and $101 in 2005 |
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2,063 |
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17,002 |
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Deferred income taxes |
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6,260 |
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6,280 |
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Stockholders equity: |
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Common stock, $.001 par value, 10,000,000 shares
authorized, 6,234,346 shares issued and outstanding
in 2006 and 2005 |
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6 |
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6 |
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Additional paid-in capital |
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21,033 |
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20,879 |
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Common stock warrants |
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141 |
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141 |
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Retained earnings |
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2,574 |
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2,686 |
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Total stockholders equity |
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23,754 |
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23,712 |
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Total liabilities and stockholders equity |
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$ |
66,987 |
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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 June 30, |
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Six Months Ended June 30, |
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2006 |
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2005 |
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2006 |
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2005 |
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(unaudited) |
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(unaudited) |
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(unaudited) |
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(unaudited) |
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(Dollars in thousands, except share and per share data) |
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Net sales |
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$ |
13,675 |
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$ |
13,681 |
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$ |
27,774 |
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$ |
26,223 |
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Cost of sales |
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12,669 |
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11,700 |
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25,205 |
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22,425 |
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Gross profit |
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1,006 |
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1,981 |
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2,569 |
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3,798 |
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Selling, general and administrative expenses |
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1,281 |
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1,208 |
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2,529 |
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2,167 |
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Operating income (loss) |
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(275 |
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773 |
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40 |
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1,631 |
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Interest expense |
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243 |
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373 |
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290 |
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743 |
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Other (income) expense, net |
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(51 |
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154 |
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(63 |
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149 |
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Income (loss) before income taxes |
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(467 |
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246 |
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(187 |
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739 |
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Provision (benefit) for income taxes: |
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Current |
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(183 |
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124 |
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(109 |
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216 |
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Deferred |
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9 |
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8 |
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33 |
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64 |
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(174 |
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132 |
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(76 |
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280 |
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Net income (loss) |
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$ |
(293 |
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$ |
114 |
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$ |
(111 |
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$ |
459 |
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Net income (loss) per share: |
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Basic |
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($0.05 |
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$ |
0.04 |
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($0.02 |
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$ |
0.15 |
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Diluted |
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($0.05 |
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$ |
0.04 |
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($0.02 |
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$ |
0.15 |
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Shares used in calculating net income
(loss) per share: |
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Basic |
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6,234,346 |
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3,000,000 |
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6,234,346 |
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3,000,000 |
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Diluted |
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6,234,346 |
* |
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3,154,467 |
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6,234,346 |
* |
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3,116,846 |
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* Due to loss, option and warrant
shares are anti-dilutive. |
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See notes to financial statements.
-4-
ORCHIDS PAPER PRODUCTS COMPANY
STATEMENTS OF CASH FLOWS
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Six Months Ended June 30, |
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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 (loss) |
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$ |
(111 |
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$ |
459 |
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Adjustments to reconcile net income (loss) to net cash
provided by operating activities: |
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Depreciation and amortization |
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886 |
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839 |
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Provision for doubtful accounts |
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30 |
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31 |
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Deferred income taxes |
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33 |
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64 |
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Stock option plan expense |
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155 |
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242 |
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Foreign currency transaction loss |
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35 |
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(Gain) loss on foreign currency exchange contracts |
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(74 |
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374 |
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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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(18 |
) |
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(210 |
) |
Inventories |
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(243 |
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(1,336 |
) |
Prepaid expenses |
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250 |
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(215 |
) |
Income taxes receivable |
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(210 |
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101 |
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Accounts payable |
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391 |
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106 |
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Accrued liabilities |
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173 |
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(185 |
) |
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Net cash provided by operating activities |
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1,297 |
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270 |
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Cash
Flows From Investing Activities |
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Purchases of property, plant and equipment |
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(15,105 |
) |
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(3,416 |
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Proceeds from the sale of investment securities |
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750 |
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Net cash used in investing activities |
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(15,105 |
) |
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(2,666 |
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Cash Flows From Financing Activities |
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Principal payments on long-term debt |
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(773 |
) |
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(836 |
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Net borrowings on revolving credit line |
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909 |
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2,767 |
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Borrowings under construction loan |
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13,299 |
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Net cash provided by financing activities |
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13,435 |
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1,931 |
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Net decrease in cash |
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(373 |
) |
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(465 |
) |
Cash, beginning |
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378 |
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485 |
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Cash, ending |
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$ |
5 |
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$ |
20 |
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Supplemental Disclosure: |
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Interest paid |
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$ |
1,052 |
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$ |
675 |
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Income taxes paid |
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$ |
221 |
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$ |
115 |
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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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$ |
4,507 |
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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 3,234,375 shares of its common
stock. The public offering price of the shares was $5.33. The number of shares and offering price
have been restated to reflect the three-for-two stock split effected July 21, 2006. See Note 2
below. 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
annual 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 Stock Splits
On June 16, 2006, the Company announced that its board of directors had approved a three-for-two
split of the Companys common stock to be effected in the form of a stock dividend. The record
date for the stock split was July 7, 2006 and the distribution date was July 21, 2006. 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 in these financial statements have been
restated to reflect the stock splits.
Note 3 Purchase Commitment and Foreign Currency Derivatives
During 2005, the Company, as part of its $33 million project to construct a new paper machine,
entered into purchase agreements totaling $8,700,000 with suppliers. Down payments were required
to these vendors with remaining periodic payments through the second quarter of 2006. One of these
agreements was denominated in Euros. All of the Companys obligations under these agreements have
been discharged as of June 30, 2006.
The Company entered into foreign currency exchange contracts in April 2005 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. In May 2006, the Company made the final payment due on the paper machine
and settled the last outstanding foreign currency exchange contract to exchange U.S. Dollars for
Euros totaling $760,000. The exchange contracts were carried at fair value on the balance sheet
while they were outstanding. 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 affected the Companys periodic net
income.
-6-
The net foreign currency gain resulting from the Companys Euro-denominated obligations and Euro
exchange contracts for the three months and six months ended June 30, 2006, of $44,000 and $39,000,
respectively and the net foreign currency loss of $153,000 for the three months and six months
ended June 30, 2005 are included in other (income) expense, net.
Note 4 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.
The new paper machine began producing saleable paper on June 9, 2006. Accordingly, interest costs
for first five months of 2006 and for the first eight days of June 2006 totaling $992,000 have been
capitalized. At June 30, 2006, cumulative spending on the new paper machine totaled $32.6 million,
inclusive of capitalized interest of $1,403,000.
Note 5 Credit Agreement
In June 2005, the Company entered into an amended and restated credit agreement. All of the loans
under the credit agreement mature on April 30, 2007. Accordingly, the outstanding balances under
this agreement have been classified as a current liability in the balance sheet as of June 30,
2006. The Company intends to refinance these debts on a long-term basis prior to the maturity
date. In June 2006, the Company amended its credit agreement to increase the Funded Debt to EBITDA
covenant limit for the quarter ended June 30, 2006 to 4.6 to 1 from the previous limit of 4.0 to 1.
The covenant limit reverts to the 4.0 to 1 limit for all future quarterly measurement periods for
the remainder of credit agreement term. 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. At June
30, 2006, $12.5 million was outstanding under the term loan, $13.3 million was outstanding under
the construction loan and $3.2 million was outstanding under the revolving credit line. In
addition, $1.0 million of bank overdrafts were included with the bank debt. The borrowing base for
the revolving credit line is determined by adding qualified receivables and inventory. At June 30,
2006, the borrowing base for the revolving credit line was $4.3 million.
All of the above loans bear interest at the Companys election at the prime rate or LIBOR, plus a
margin based on the ratio of funded debt to EBITDA less income taxes paid. The margin is set
quarterly and ranges from negative 50 basis points to 150 basis points for prime rate-based loans
and from 225 to 425 basis points for LIBOR-based loans. At June 30, 2006, the Companys weighted
average borrowing rate was 9.42% under this agreement. Obligations under the amended and restated
credit agreement are secured by substantially all of the assets of the Company. The agreement
contains various restrictive covenants that include requirements to maintain certain financial
ratios and to restrict capital expenditures and dividend payments. The Company is required,
beginning in 2007, to reduce the outstanding principal amount of its term loans annually by an
amount equal to 40% of its excess cash flow, as defined in the credit agreement. The Company was
in compliance with all covenants, as amended, as of June 30, 2006.
Note 6 Earnings per Share
The computation of basic and diluted net income per share for the three-month periods ended June
30, 2006 and 2005 and the six-month periods ended June 30, 2006 and 2005 is as follows:
-7-
|
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|
Three Months Ended June 30, |
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Six Months Ended June 30, |
|
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|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
|
|
|
|
|
Net income (loss) ($ thousands) |
|
$ |
(293 |
) |
|
$ |
114 |
|
|
$ |
(111 |
) |
|
$ |
459 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding |
|
|
6,234,346 |
|
|
|
3,000,000 |
|
|
|
6,234,346 |
|
|
|
3,000,000 |
|
Effect of stock options |
|
|
|
|
|
|
75,660 |
|
|
|
|
|
|
|
38,039 |
|
Effect of dilutive warrants |
|
|
|
|
|
|
78,807 |
|
|
|
|
|
|
|
78,807 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding assuming dilution |
|
|
6,234,346 |
|
|
|
3,154,467 |
|
|
|
6,234,346 |
|
|
|
3,116,846 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per common share: (restated to reflect 2006
3-for-2 stock split and 2005 2.744-for-1 stock split) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
$ |
(0.05 |
) |
|
$ |
0.04 |
|
|
$ |
(0.02 |
) |
|
$ |
0.15 |
|
Diluted |
|
$ |
(0.05 |
) |
* |
$ |
0.04 |
|
|
$ |
(0.02 |
) |
* |
$ |
0.15 |
|
* Due to net loss, option and warrant shares are anti-dilutive and thus not considered.
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 697,500 shares to be issued. The
compensation committee subsequently awarded options for 405,000 shares to officers of the Company
at an exercise price of $5.33, which was equal to the initial public offering price of the stock.
The options vested 20% on the date of grant and then ratably 20% over the following four years and
have a ten-year term.
In June 2006, the board of directors authorized the issuance of options totaling 11,250 shares of
stock pursuant to the Plan to certain directors of the Company at an exercise price of $10.05,
which was equal to the arithmetic mean of the high and low price of the Companys stock on the date
of the grant. In February 2006, the board of directors authorized the issuance of options for
3,750 shares of stock to a new member of the board of directors at an exercise price of $7.61, the
current market price on the date of the grant. In September 2005, the board of directors
authorized the issuance of options totaling 11,250 shares of stock pursuant to the Plan to certain
directors of the Company at an exercise price of $6.53, the current market price on the date of the
grant. All of the Board options have a ten-year term and were fully vested on the date of grant.
Fair values were estimated at the date of grant of the options granted in June 2006, using the
Black-Scholes option valuation model with the following weighted average assumptions: risk-free
interest rate of 4.97%, volatility factor of the expected market price of the Companys common
stock of 40%, 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 June 30, 2006 and 2005, the
Company recognized an expense of $96,000 and $242,000, respectively, related to options granted
under the Plan. For the six months ended June 30, 2006 and 2005, the Company recognized an expense
of $155,000 and $242,000, respectively.
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 June 30,
2006 and 2005, sales to the two significant customers accounted for approximately 65% and 71% of
the Companys total sales, respectively. For the six months ended June 30, 2006 and 2005, sales to
the two significant customers accounted for approximately 63% and 69% of the Companys total sales,
respectively. At June 30, 2006 approximately 66% of accounts receivable was due from these two
significant customers. No other customers of the Company accounted for more than 10% of sales
-8-
during these periods. The Company generally does not require collateral from its customers and has
not incurred any significant losses on uncollectible accounts receivable.
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:
|
|
our business strategy; |
|
|
|
our value proposition; |
|
|
|
the market opportunity for our products, including expected demand for our products; |
|
|
|
our estimates regarding our capital requirements; and |
|
|
|
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:
|
|
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; |
|
|
|
a substantial percentage of our revenues are attributable to two large customers which may
decrease or cease purchases at any time; |
|
|
|
we may experience delays in reaching full production rates during the start-up phase on our new paper machine; |
|
|
|
we have significant indebtedness which limits our free cash flow and subjects us to restrictive covenants relating to the
operation of our business; |
-9-
|
|
the availability of and prices for energy will significantly affect our business; |
|
|
|
our exposure to variable interest rates may affect our financial health; |
|
|
|
the loss of key personnel; |
|
|
|
the disruption in supply or cost of waste paper; |
|
|
|
the disruption in availability or cost of parent rolls; |
|
|
|
labor interruptions; |
|
|
|
natural disaster or other disruption to our facility; |
|
|
|
ability to finance the capital requirements of our business; |
|
|
|
cost to comply with government regulations; |
|
|
|
increased expenses and administrative workload associated with being a public company; and |
|
|
|
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. In the three-month and six-month period
ending June 30, 2006, we converted 2,373 and 5,716 tons, respectively, of paper purchased on the
open market, which represented 27% and 32% respectively, of the total tons consumed. Parent rolls
are a commodity product and thus are subject to market price and availability. We have
-10-
experienced significantly higher parent roll prices beginning in the third quarter of 2004, as well
as limited availability, which have negatively affected our profitability. We anticipate the trend
of higher prices and tight supply to continue for the foreseeable future. We intend to reduce or
eliminate purchases of parent rolls with the additional production capacity provided by our new
paper machine. The start-up phase of this project began in early June 2006. We expect the machine
to be running at full operating rates by October 2006. The total cost of this project is estimated
at $33.0 million, excluding capitalized interest of $1.4 million. Beginning in the third quarter
of 2006, we do not expect to purchase significant quantities of parent rolls in the open market.
Our profitability depends on several key factors, including:
|
|
the market price of our product; |
|
|
|
until our new paper machine reaches sufficient operating rates, the cost of parent rolls
purchased on the open market to meet our converting needs; |
|
|
|
the successful start-up and cost effective operation of our new paper machine; |
|
|
|
the cost of recycled paper used in producing paper; |
|
|
|
the efficiency of operations in both our paper mill and converting plant; and |
|
|
|
energy costs. |
Comparative Three-Month Periods Ended June 30, 2006 and 2005
Net Sales
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, |
|
|
|
2006 |
|
|
2005 |
|
|
|
(in thousands, except
average price per case) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
13,675 |
|
|
$ |
13,681 |
|
|
|
|
|
|
Cases shipped |
|
|
1,233 |
|
|
|
1,267 |
|
|
|
|
|
|
Average price per case |
|
$ |
11.09 |
|
|
$ |
10.80 |
|
Net sales were flat in the quarter ended June 30, 2006 million compared to the same period of 2005
at $13.7 million. Net sales figures include gross selling price, including freight, less discounts
and pricing allowances. Net sales remained largely unchanged with slightly lower shipment levels
being offset by higher net selling prices. Shipments decreased by 34,000 cases, or 3%, to 1.23
million cases of finished product in the quarter compared to 1.27 million cases in the same period
of 2005. The decrease in shipments is the result of lower business with our largest customer being
largely offset with higher overall business with several of our larger customers. Our net selling
price in the second quarter of 2006 was $11.09 per case compared with $10.80 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 second quarter of 2005.
Cost of Sales
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, |
|
|
|
2006 |
|
|
2005 |
|
|
|
(in thousands, except gross profit margin %) |
|
|
|
|
|
|
|
|
|
|
Cost of paper |
|
$ |
7,549 |
|
|
$ |
6,929 |
|
Non-paper materials, labor, supplies, etc. |
|
|
4,727 |
|
|
|
4,338 |
|
|
|
|
|
|
|
|
Sub-total |
|
|
12,276 |
|
|
|
11,267 |
|
Depreciation |
|
|
393 |
|
|
|
433 |
|
|
|
|
|
|
|
|
Cost of sales |
|
$ |
12,669 |
|
|
$ |
11,700 |
|
|
|
|
|
|
|
|
|
|
Gross Profit |
|
$ |
1,006 |
|
|
$ |
1,981 |
|
Gross Profit Margin % |
|
|
7.4 |
% |
|
|
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 $1.0 million, or 8%, to $12.7 million for the quarter ended
June 30, 2006, compared to $11.7 million in the same period of 2005. As a percentage of net sales,
cost of sales increased to 92.6% 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 June 30, 2006 was unfavorably
affected by a higher average cost of internally produced parent rolls and, to a lesser extent, a
higher quantity of purchased parent rolls, higher packaging costs and higher converting labor
costs. The following chart depicts the major factors that influence our paper costs.
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, |
|
|
|
2006 |
|
|
2005 |
|
|
|
|
|
|
|
|
|
|
Paper usage (tons) |
|
|
|
|
|
|
|
|
Manufactured |
|
|
6,383 |
|
|
|
6,723 |
|
Purchased |
|
|
2,373 |
|
|
|
1,903 |
|
Converted |
|
|
8,756 |
|
|
|
8,626 |
|
|
|
|
|
|
|
|
|
|
Paper costs per ton |
|
|
|
|
|
|
|
|
Cost per ton produced internally |
|
$ |
790 |
|
|
$ |
730 |
|
Cost per ton purchased from third parties |
|
$ |
1,056 |
|
|
$ |
1,062 |
|
Total cost per ton consumed |
|
$ |
862 |
|
|
$ |
803 |
|
|
|
|
|
|
|
|
|
|
Total paper costs (in thousands) |
|
|
|
|
|
|
|
|
Cost of internally produced paper |
|
$ |
5,043 |
|
|
$ |
4,908 |
|
Cost of paper purchased from third parties |
|
|
2,506 |
|
|
|
2,021 |
|
|
|
|
|
|
|
|
Total paper costs |
|
$ |
7,549 |
|
|
$ |
6,929 |
|
Our cost of internally produced paper increased $60 per ton to $790 per ton in the quarter ended
June 30, compared to $730 per ton in the same period in 2005. Higher waste paper costs and direct
labor costs were the major reasons for the increased cost of production. Waste paper costs
increased primarily due to changes in mix and lower yields associated with the start-up phase of
the new paper machine project. We consumed an increased quantity of parent rolls purchased from
third parties during the second quarter of 2006 as the result of our efforts to significantly
reduce our inventory of those parent rolls in anticipation of the start-up of our new paper
machine.
Gross Profit
Gross profit in the quarter ended June 30, 2006 decreased $975,000, or 49%, to $1.0 million
compared to $2.0 million in the same period last year. Gross profit as a percentage of net sales
decreased to 7.4% in the second quarter of 2006 compared to 14.5% in the second 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, the higher quantity of purchased paper, higher packaging
costs and higher converting labor costs.
Selling, General and Administrative Expenses
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, |
|
|
|
2006 |
|
|
2005 |
|
|
|
(In thousands, except SG&A as a % of net sales) |
|
|
|
|
|
|
|
|
|
|
Commission expense |
|
$ |
193 |
|
|
$ |
218 |
|
Other S,G&A expenses |
|
|
1,088 |
|
|
|
990 |
|
|
|
|
|
|
|
|
Selling, General & Adm exp |
|
$ |
1,281 |
|
|
$ |
1,208 |
|
SG&A as a % of net sales |
|
|
9.4 |
% |
|
|
8.8 |
% |
-12-
Selling, general and administrative expenses include salaries, commissions to brokers and other
miscellaneous expenses. Selling, general and administrative expenses increased $73,000, or 6%, to
$1.3 million in the three months ended June 30, 2006 compared to $1.2 million in the same period in
2005. An increase in spending due to public company costs was largely offset by lower stock-based
compensation expense and commissions. In the second quarter of 2006, we recognized approximately
$195,000 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,
expenses related to our annual report, proxy statement and annual stockholder meeting, premiums for
directors and officers insurance, increased internal accounting costs and others. We anticipate
our annual costs of being public will be approximately $500,000. In the quarter ended June 30,
2006, we recognized $96,000 of stock-based compensation expense resulting from the grant of options
for an aggregate of 405,000 shares of stock in the second quarter of 2005 to certain members of
management and for the grant of options for 11,250 shares of stock to certain board members in the
second quarter of 2006. Stock option expense for the second quarter of 2005 amounted to $242,000
and was all attributable to the management grants. 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 vested 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 the management 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 (Loss)
As a result of the foregoing factors, we experienced an operating loss for the quarter ended June
30, 2006 of $275,000 compared to an operating income of $773,000 for the same period of 2005.
Interest and Other Expense
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, |
|
|
|
2006 |
|
|
2005 |
|
|
|
(In thousands) |
|
|
|
|
|
|
|
|
|
|
Interest expense |
|
$ |
243 |
|
|
$ |
373 |
|
Other (income) expense, net |
|
$ |
(51 |
) |
|
$ |
154 |
|
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 $130,000 to $243,000 in the quarter ended June 30, 2006, compared to
$373,000 in the same period in 2005. Interest expense decreased as a result of the capitalization
of $511,000 of interest related to our new paper machine project. Excluding the interest
capitalization, interest expense increased $381,000 in the second quarter of 2006 compared to the
same period in 2005. The primary reason for the increase was $13.3 million in new borrowings in
the first half 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) expense improved to an income of $51,000 due to a net foreign currency exchange gain
of $44,000 and income earned from the restricted certificate of deposit with our lending
institution. In the three months ended June 30, 2005, we recognized a foreign currency exchange
loss of $153,000. We entered into certain purchase agreements related to our project to build a
new paper machine. One of these purchase agreements was denominated in Euros. We entered into
foreign currency exchange contracts in the second quarter of 2005 to fix the price of this purchase
agreement. As of June 30, 2006 the purchase agreements had all been settled as had the exchange
contracts.
Income (Loss) Before Income Taxes
As a result of the foregoing factors, income (loss) before income taxes decreased $713,000 to a
loss of $467,000 in the quarter ended June 30, 2006, compared to an income of $246,000 in the same
period in 2005.
-13-
Income Tax Provision (Benefit)
As of June 30, 2006, we estimate our annual effective income tax rate to be 40.6%. It is higher
than the statutory rate primarily because of the previously discussed non-deductible stock option
expense. Adjustment of the estimated annual effective tax rate resulted in an effective rate of
37.3% in the second quarter of 2006. For the quarter ended June 30, 2005, our effective income tax
rate was 53.7%. It was higher than statutory rate due to the previously discussed non-deductible
stock option expense and a payment to the Internal Revenue Service for an audit of the 2003 tax
year, partially offset by the utilization of Indian employment credits. Congress has not yet
extended the tax benefits relating to Indian employment and accelerated depreciation of capital
assets located on former Indian lands as of August 1, 2006, and, accordingly, these tax benefits
are not reflected in the 2006 provisions.
Comparative Six-Month Periods Ended June 30, 2006 and 2005
Net Sales
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, |
|
|
|
2006 |
|
|
2005 |
|
|
|
(in thousands, except average price per case) |
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
27,774 |
|
|
$ |
26,223 |
|
|
|
|
|
|
Cases shipped |
|
|
2,486 |
|
|
|
2,410 |
|
|
|
|
|
|
Average price per case |
|
$ |
11.17 |
|
|
$ |
10.88 |
|
Net sales increased $1.6 million, or 5.9 %, to $27.8 million in the six-month period ended June 30,
2006, compared to $26.2 million in the same period of 2005. The increase in net sales is the
result of higher net selling prices and higher shipment levels. Shipment levels increased due to
higher overall business with several of our larger customers which was partially offset by lower
business with our largest customer. Shipments increased by 76,000 cases, or 3.2 %, to 2.5 million
cases of finished product in the six-month period ended June 30, 2006 compared to 2.4 million cases
in the same period of 2005. Our net selling price in the six-month period of 2006 was $11.17 per
case compared with $10.88 per case in the 2005 period. 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
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, |
|
|
|
2006 |
|
|
2005 |
|
|
|
(in thousands, except gross
profit margin %) |
|
|
|
|
|
|
|
|
|
|
Cost of paper |
|
$ |
15,540 |
|
|
$ |
13,994 |
|
Non-paper materials, labor, supplies, etc. |
|
|
8,879 |
|
|
|
7,677 |
|
|
|
|
|
|
|
|
Sub-total |
|
|
24,419 |
|
|
|
21,671 |
|
Depreciation |
|
|
786 |
|
|
|
754 |
|
|
|
|
|
|
|
|
Cost of sales |
|
$ |
25,205 |
|
|
$ |
22,425 |
|
Gross Profit |
|
$ |
2,569 |
|
|
$ |
3,798 |
|
Gross Profit Margin % |
|
|
9.2 |
% |
|
|
14.5 |
% |
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 cost of
products shipped to customers, insurance, repairs and maintenance, energy, utilities and
depreciation.
-14-
Cost of sales increased $2.8 million, or 12.4%, to $25.2 million in the six-month period ending
June 30, 2006 compared to $22.4 million in the same period of 2005. As a percentage of net sales,
cost of sales increased to 90.8% in the six months ended June 30, 2006 compared to 85.5% in the
same period of 2005. Cost of sales as a percentage of net sales was unfavorably affected by a
higher average cost of internally produced parent rolls, higher volumes of paper purchased from
third parties, higher costs of packaging materials and higher converting labor costs. The
following chart depicts the major factors that influence our paper costs.
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, |
|
|
|
2006 |
|
|
2005 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Paper usage (tons) |
|
|
|
|
|
|
|
|
Manufactured |
|
|
12,258 |
|
|
|
12,393 |
|
Purchased |
|
|
5,716 |
|
|
|
4,815 |
|
Converted |
|
|
17,974 |
|
|
|
17,208 |
|
|
|
|
|
|
|
|
|
|
Paper costs per ton |
|
|
|
|
|
|
|
|
Cost per ton produced internally |
|
$ |
782 |
|
|
$ |
727 |
|
Cost per ton purchased from third parties |
|
$ |
1,042 |
|
|
$ |
1,035 |
|
Total cost per ton consumed |
|
$ |
865 |
|
|
$ |
813 |
|
|
|
|
|
|
|
|
|
|
Total paper costs (in thousands) |
|
|
|
|
|
|
|
|
Cost of internally produced paper |
|
$ |
9,584 |
|
|
$ |
9,010 |
|
Cost of paper purchased from third parties |
|
|
5,956 |
|
|
|
4,984 |
|
|
|
|
|
|
|
|
Total paper costs |
|
$ |
15,540 |
|
|
$ |
13,994 |
|
Our cost of internally produced paper increased $55 per ton to $782 per ton in the six months ended
June 30, 2006. Higher energy costs, a higher net waste paper cost due to mix changes and lower
yields associated with the start-up phase of the new paper machine project, and higher direct labor
costs comprised most of increase in cost per ton.
Gross Profit
Gross profit in the six months ended June 30, 2006 decreased $1.2 million, or 32%, to $2.6 million
compared to $3.8 million for the same period in 2005. Gross profit as a percentage of sales
decreased to 9.2% in the 2006 period compared to 14.5% in the 2005 period. The major reason for
the reduced gross profit and the decline in gross profit percentage was the higher cost of
internally produced paper and higher volumes of paper purchased from third parties.
Selling, General and Administrative Expenses
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, |
|
|
|
2006 |
|
|
2005 |
|
|
|
(In thousands, except SG&A as a % of net sales) |
|
|
|
|
|
|
|
|
|
|
Commission expense |
|
$ |
391 |
|
|
$ |
429 |
|
Other S,G&A expenses |
|
|
2,138 |
|
|
|
1,738 |
|
|
|
|
|
|
|
|
Selling, General & Adm exp |
|
$ |
2,529 |
|
|
$ |
2,167 |
|
SG&A as a % of net sales |
|
|
9.1 |
% |
|
|
8.3 |
% |
Selling, general and administrative expenses include salaries, commission to brokers and other
miscellaneous expenses. Selling, general and administrative expenses increased $362,000, or 16.7%,
to $2.5 million in the six months ended June 30, 2006 compared to $2.2 million in the same period
of 2005. The increase was primarily due to public company costs and higher artwork-related
expenditures being partially offset by reduced stock-based compensation expense. In the first half
of 2006 we incurred approximately $345,000 of public company expenses which we did not incur in the
same period of 2005 when we were a privately held company. Artwork expense increased approximately
$95,000 in the first half of 2006 compared to the same period last year. A higher than normal
number of packaging changes by existing customers and packaging development with new customers
accounted for the increase, which was mostly incurred in the first quarter of 2006. In the six
months ended June 30,
-15-
2006, we recognized $155,000 of stock-based compensation expense resulting from the ongoing charges
for the management options granted in April 2005, coupled with the grants to certain members of our
Board of Directors in February 2006 and June 2006. During 2005, we recognized $242,000 of expense
for the management options. The management options vest 20% on the date of the grant and then 20%
on each anniversary of the grant over the succeeding four years. The board options vested 100% on
the date of grant. Quarterly charges for the management stock options will approximate $47,000
through the vesting period ending in the first quarter of 2009.
Operating Income
As a result of the foregoing factors, operating income for the six months ended June 30, 2006 was
$40,000 compared to $1.6 million for the same period of 2005.
Interest and Other Expense
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, |
|
|
|
2006 |
|
|
2005 |
|
|
|
(In thousands) |
|
|
|
|
|
|
|
|
|
|
Interest expense |
|
$ |
290 |
|
|
$ |
743 |
|
Other (income) expense, net |
|
$ |
(63 |
) |
|
$ |
149 |
|
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 $453,000 to $290,000 in the six months ended June 30, 2006 compared to
$743,000 in the same period in 2005. Interest expense decreased as a result of the capitalization
of $992,000 of interest cost related to our new paper machine project. Excluding the interest
capitalization, interest expense increased $539,000 in the six months ended June 30, 2006 compared
to the same period in 2005. The primary reason for the increase was $13.3 million in new
borrowings during the six months ended June 30, 2006 on the construction loan for our paper machine
project, higher borrowings under our revolving credit facility and an increase in interest rates.
Other (income) expense increased to an income of $63,000 primarily due to a net foreign currency
transaction gain of $39,000 in the six months ended June 30, 2006 compared to a net foreign
currency transaction loss of $153,000 in the same period of 2005 and, to a lesser extent, income
earned from the restricted certified deposit with our lending institution. We entered into certain
purchase agreements related to our project to build a new paper machine in 2005. One of these
purchase agreements was denominated in Euros. We entered into foreign currency exchange contracts
in the second quarter of 2005 to fix the price of this purchase agreement. We made the final
payment under the exchange contract and on the purchase order in the second quarter of 2006. The
exchange contract was carried at fair value and adjustments to fair value affected net income.
Income
(Loss) Before Income Taxes
As a result of the foregoing factors, income (loss) before income taxes decreased $926,000 in the
six-month period ended June 30, 2006 to a loss of $187,000 compared to an income of $739,000 in the
same period in 2005.
Income Tax Provision (Benefit)
As of June 30, 2006, we estimate our annual effective tax rate to be 40.6%. It is higher than the
statutory rate primarily because of the previously discussed non-deductible stock option expense.
For the six months ended June 30, 2005, our effective income tax rate was 37.9%. It was higher
than the statutory rate reflecting the previously discussed non-deductible stock option expense and
a payment to the Internal Revenue Service for an audit of the 2003 tax year, partially offset by
the utilization of Indian employment credits. Congress has not yet extended the tax benefits
relating to Indian employment and accelerated depreciation of capital assets located on former
Indian lands as of August 1, 2006, and, accordingly, these tax benefits are not reflected in the
2006 provisions.
-16-
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 entirely of cash. 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 following the start-up of our new paper machine has been funded through the use of all of
the net proceeds of our initial public offering, additional bank financing, and cash flows from
operations. The total cost of this project is estimated at $33.0 million, excluding capitalized
interest of $1.4 million. The estimated total cost of the project increased approximately $1.6
million from the amount reported in our report on Form 10-Q dated May 11, 2006. Additional
engineering costs and additional project costs resulting from engineering changes were the major
reasons for the increase. Cumulative spending on the project totaled $31.2 million, excluding
capitalized interest of $1.4 million, at June 30, 2006. The $31.2 million of project expenditures
were funded using all of the $15.0 million in net proceeds from the initial public offering on July
14, 2005, borrowings of $13.3 million under the construction loan facility, borrowings under our
revolving credit line and available cash. Remaining project costs of approximately $1.8 million
are expected to be funded using the construction loan facility, which is capped at $15.0 million,
and to the extent necessary, cash from operations.
We announced on June 16, 2006, that our Board of Directors approved a three-for-two split of our
common stock to be effected in the form of a stock dividend. The record date for the stock split
was July 7, 2006, and the distribution date was July 21, 2006. Stockholders of record on the
record date received on the distribution date one additional share of our common stock for each two
shares owned. In lieu of distributing fractional shares, we distributed cash. The stock split
increased the number of outstanding shares of common stock from 4,156,250 to 6,234,346 shares.
Authorized shares total 10,000,000 shares.
Cash decreased $373,000 at June 30, 2006, to $5,000 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.
The following table summarizes key cash flow information for the six-month periods ended June 30,
2006 and 2005:
Cash Flow Data:
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, |
|
|
|
2006 |
|
|
2005 |
|
|
|
(In thousands) |
|
|
|
|
|
|
|
|
|
|
Cash flow provided by (used in): |
|
|
|
|
|
|
|
|
Operating activities |
|
$ |
1,297 |
|
|
$ |
270 |
|
|
|
|
|
|
|
|
|
|
Investing activities |
|
$ |
(15,105 |
) |
|
$ |
(2,666 |
) |
|
|
|
|
|
|
|
|
|
Financing activities |
|
$ |
13,435 |
|
|
$ |
1,931 |
|
Cash flow provided by operating activities was $1.3 million in the six-month period ended June 30,
2006, which primarily consisted of earnings before non-cash charges plus an increase in trade
accounts payable, partially offset by an increase in inventory.
Cash used in investing activities was $15.1 million in the six-month period ended June 30, 2006.
The amount is almost entirely attributable to capital expenditures on our new paper machine.
Cash provided by financing activities was $13.4 million in the six-month period ended June 30,
2006, and was primarily attributable to borrowings under our construction loan facility.
Cash provided by operating activities in the six-month period ended June 30, 2005, was $270,000
which consisted of earnings before non-cash charges, largely offset by a build-up of inventories,
which had been abnormally low at year-end 2004 due to tight supplies of outside parent rolls.
-17-
Cash used in investing activities was $2.7 million for the six-month period ended June 30, 2005,
and was primarily attributable to payments for the new paper machine and associated capital
improvements, partially offset by $750,000 in proceeds from the sale of short-term investment
securities.
Cash provided by financing activities totaled $1.9 million for the six-month period ended June 30,
2005. The Company borrowed $2.8 million under the revolving credit line, primarily to finance the
previously mentioned rebuilding of inventories and capital expenditures for the new paper machine.
In June 2005, the Company entered into an amended and restated credit agreement. All of the loans
under the credit agreement mature on April 30, 2007. Accordingly, the outstanding balances under
this agreement have been classified as a current liability in the balance sheet as of June 30,
2006. The Company intends to refinance these debts on a long-term basis prior to the maturity
date. In June 2006, we amended our credit agreement in order to increase the Funded Debt to EBITDA
covenant limit for the quarter ended June 30, 2006 to 4.6 to 1.0 from the previous limit of 4.0 to
1.0. The covenant limit reverts to the 4.0 to 1.0 limit for all future quarterly measurement
periods during the term of the credit agreement. The amendment was required to avoid
non-compliance with the Funded Debt to EBITDA covenant as of June 30, 2006. The credit facility
provides for a $5.0 million revolving credit line, a $14.1 million term loan and a $15.0 million
interest-only construction loan. At June 30, 2006, $12.5 million was outstanding under the term
loan, $13.3 million was outstanding under the construction loan and $3.2 million was outstanding
under the revolving credit line. In addition, $1.0 million of bank overdrafts were included with
bank debt in the balance sheet. At June 30, 2006, the borrowing base for the revolving credit line
was $4.3 million.
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 June 30, 2006 our weighted average borrowing rate was 9.42%. 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 construction loan is converted into a term loan
at the completion of the project or no later than October 31, 2006. 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 loans 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 coverage, tested as of the end of each
quarter, and a limit on the amount of annual capital expenditures. As a result of the recent
amendment to our credit agreement, the maximum allowable leverage ratio is 4.6 to 1.0 for the
quarter ended June 30, 2006 and 4.0 to 1.0 for the future quarters, 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:
-18-
|
|
|
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 $2.15 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
57 shares of common stock at an exercise price of $2.43 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 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 and six month periods ended June 30,
2006, provisions for doubtful accounts were recognized in the amount of $15,000 and $30,000.
Comparable provisions for the three-month and six-month periods ended June 30, 2005 were $16,000
and $31,000. There were no accounts receivable balances written-off in the three-month or six-month
periods ended June 30, 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. During the six months ended June 30,
-19-
2006 the inventory valuation reserve increased by $11,000, due to provisions charged against cost
of sales, partially offset by write-offs of obsolete packaging materials. During the six months
ended June 30, 2005 the inventory valuation reserve was reduced by $30,000, primarily due to the
write-off of obsolete packaging materials against the reserve.
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:
|
|
it does not reflect our cash expenditures for capital assets; |
|
|
|
it does not reflect changes in, or cash requirements for, our working capital requirements; |
|
|
|
it does not reflect the interest expense, or the cash requirements necessary to service interest
or principal payments on our indebtedness; |
|
|
|
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 |
|
|
|
other companies, including other companies in our industry, may calculate these measures
differently than we do, limiting their usefulness as a comparative measure. |
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 June 30, 2006 and 2005:
-20-
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, |
|
|
|
2006 |
|
|
2005 |
|
|
|
(In thousands, except % of net sales) |
|
|
|
|
|
|
|
|
|
|
Net (loss) income |
|
$ |
(293 |
) |
|
$ |
114 |
|
Plus: Interest expense, net |
|
|
243 |
|
|
|
373 |
|
Plus: Income tax (benefit) expense |
|
|
(174 |
) |
|
|
132 |
|
Plus: Depreciation |
|
|
393 |
|
|
|
433 |
|
|
|
|
|
|
|
|
EBITDA |
|
$ |
169 |
|
|
$ |
1,052 |
|
% of net sales |
|
|
1.2 |
% |
|
|
7.7 |
% |
EBITDA decreased $883,000, or 83.9%, to $169,000 in the quarter ended June 30, 2006, compared to
$1.1 million in the same period of 2005. EBITDA as a percent of net sales declined to 1.2% in the
current year quarter compared to 7.7% 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 cause of the decrease in EBITDA as a percentage of net
sales was higher parent roll costs.
The following table reconciles EBITDA to net income for the six-month periods ended June 30, 2006
and 2005:
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, |
|
|
|
2006 |
|
|
2005 |
|
|
|
(In thousands, except % of net sales) |
|
|
|
|
|
|
|
|
|
|
Net (loss) income |
|
$ |
(111 |
) |
|
$ |
459 |
|
Plus: Interest expense, net |
|
|
290 |
|
|
|
743 |
|
Plus: Income tax (benefit) expense |
|
|
(76 |
) |
|
|
280 |
|
Plus: Depreciation |
|
|
786 |
|
|
|
754 |
|
|
|
|
|
|
|
|
EBITDA |
|
$ |
889 |
|
|
$ |
2,236 |
|
% of net sales |
|
|
3.2 |
% |
|
|
8.5 |
% |
EBITDA decreased $1.3 million or 60.2% to $889,000 in the six months ended June 30, 2006, compared
to $2.2 million in the same period of 2005. EBITDA as a percent of sales declined to 3.2% in the
current year-to-date period compared to 8.5% in the prior year. 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 factors in the decrease in EBITDA as a percentage of net
sales were higher parent roll 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 June 30, 2006, we have borrowings totaling $29.0 million that carry a variable
interest rate. Outstanding balances under our line of credit, construction loan and term loan 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
$290,000 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
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executive officer and chief financial officer have concluded that our disclosure controls and
procedures were effective as of June 30, 2006.
PART II OTHER INFORMATION
ITEM 1. Legal Proceedings
Not applicable.
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
Previously reported on Form 10-Q Report for the First Quarter ended March 31, 2006.
(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 June 30, 2006.
ITEM 3. Defaults Upon Senior Securities
None.
ITEM 4. Submission of Matters to a Vote of Security Holders
The Annual Meeting of Stockholders of Orchids Paper Products Company was held on June 13, 2006. At
the meeting, the following matters were submitted to a vote of the stockholders:
(1) |
|
To elect five directors to hold office until the 2007 annual meeting of stockholders
and until their successors are duly elected and qualified. The vote with respect to each
nominee was as follows: |
|
|
|
|
|
|
|
|
|
Nominee |
|
For |
|
|
Withheld |
|
|
|
|
|
|
|
|
|
|
Gary P. Arnold |
|
|
3,145,215 |
|
|
|
10,500 |
|
Steven R. Berlin |
|
|
3,145,215 |
|
|
|
10,500 |
|
John C. Guttilla |
|
|
3,145,215 |
|
|
|
10,500 |
|
Douglas E. Hailey |
|
|
3,145,215 |
|
|
|
10,500 |
|
Michael P. Sage |
|
|
3,145,215 |
|
|
|
10,500 |
|
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(2) |
|
To ratify the appointment of Tullius Taylor Sartain & Sartain as the Companys
independent registered public accounting firm for 2006: |
|
|
|
|
|
|
|
|
|
|
|
|
|
For |
|
Against |
|
|
Abstain |
|
|
Broker Non Vote |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,145,715 |
|
|
5,500 |
|
|
|
4,500 |
|
|
|
|
|
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.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized.
|
|
|
|
|
|
ORCHIDS PAPER PRODUCTS COMPANY
|
|
Date: August 4, 2006 |
By: |
/s/ Keith R. Schroeder
|
|
|
|
Keith R. Schroeder |
|
|
|
Chief Financial Officer
(On behalf of the registrant and as Chief Accounting Officer) |
|
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Exhibit Index
|
|
|
Exhibit |
|
Description |
|
|
|
3.1
|
|
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. |
|
|
|
3.2
|
|
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. |
|
|
|
4.1
|
|
Amendment One to Amended and Restated Agented Credit Agreement
dated June 30, 2006 among the Registrant, Bank of Oklahoma,
N.A., BancFirst and Commerce Bank, N.A. |
|
|
|
31.1
|
|
Certification of Chief Executive Officer Pursuant to Section 302. |
|
|
|
31.2
|
|
Certification of Chief Financial Officer Pursuant to Section 302. |
|
|
|
32.1
|
|
Certification of Chief Executive Officer Pursuant to Section 906. |
|
|
|
32.2
|
|
Certification of Chief Financial Officer Pursuant to Section 906. |
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