e10vq
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
|
|
|
þ |
|
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2008
OR
|
|
|
o |
|
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)
|
|
|
Delaware
(State or Other Jurisdiction of
Incorporation or Organization)
|
|
23-2956944
(I.R.S. Employer
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, a non-accelerated filer or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o | Accelerated filer o | Non-accelerated filer o (Do not check if a smaller reporting company) | Smaller reporting company 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
November 7, 2008: 6,328,986 shares.
ORCHIDS PAPER PRODUCTS COMPANY
TABLE OF CONTENTS
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2008
-2-
PART 1. FINANCIAL INFORMATION
ITEM 1. Financial Statements
ORCHIDS PAPER PRODUCTS COMPANY
BALANCE SHEETS
(Dollars in thousands, except share data)
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
|
|
2008 |
|
|
2007 |
|
|
|
(unaudited) |
|
|
|
|
|
ASSETS |
|
|
|
|
|
|
|
|
Current assets: |
|
|
|
|
|
|
|
|
Cash |
|
$ |
12 |
|
|
$ |
3 |
|
Accounts receivable, net of allowance of
$146 in 2008 and $100 in 2007 |
|
|
8,048 |
|
|
|
5,527 |
|
Inventories, net |
|
|
5,960 |
|
|
|
4,874 |
|
Income taxes receivable |
|
|
|
|
|
|
24 |
|
Prepaid expenses |
|
|
602 |
|
|
|
381 |
|
Deferred income taxes |
|
|
516 |
|
|
|
516 |
|
|
|
|
|
|
|
|
Total current assets |
|
|
15,138 |
|
|
|
11,325 |
|
|
|
|
|
|
|
|
|
|
Property, plant and equipment |
|
|
69,058 |
|
|
|
64,899 |
|
Accumulated depreciation |
|
|
(10,352 |
) |
|
|
(8,043 |
) |
|
|
|
|
|
|
|
Net property, plant and equipment |
|
|
58,706 |
|
|
|
56,856 |
|
|
|
|
|
|
|
|
|
|
Deferred debt issuance costs, net of accumulated
amortization of $595 in 2008 and $570 in 2007 |
|
|
97 |
|
|
|
122 |
|
|
|
|
|
|
|
|
Total assets |
|
$ |
73,941 |
|
|
$ |
68,303 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS EQUITY |
|
|
|
|
|
|
|
|
Current liabilities: |
|
|
|
|
|
|
|
|
Accounts payable |
|
$ |
5,034 |
|
|
$ |
4,760 |
|
Accrued liabilities |
|
|
2,950 |
|
|
|
2,460 |
|
Current portion of long-term debt |
|
|
2,728 |
|
|
|
2,391 |
|
|
|
|
|
|
|
|
Total current liabilities |
|
|
10,712 |
|
|
|
9,611 |
|
|
|
|
|
|
|
|
|
|
Long-term debt, less current portion |
|
|
23,379 |
|
|
|
23,264 |
|
Deferred income taxes |
|
|
8,613 |
|
|
|
7,386 |
|
Stockholders equity: |
|
|
|
|
|
|
|
|
Common stock, $.001 par value, 25,000,000
shares authorized, 6,328,986 and 6,322,648 issues and
outstanding in 2008 and 2007, respectively |
|
|
6 |
|
|
|
6 |
|
Additional paid-in capital |
|
|
22,160 |
|
|
|
21,879 |
|
Common stock warrants |
|
|
134 |
|
|
|
141 |
|
Retained earnings |
|
|
8,937 |
|
|
|
6,016 |
|
|
|
|
|
|
|
|
Total stockholders equity |
|
|
31,237 |
|
|
|
28,042 |
|
|
|
|
|
|
|
|
Total liabilities and stockholders equity |
|
$ |
73,941 |
|
|
$ |
68,303 |
|
|
|
|
|
|
|
|
See notes to financial statements.
-3-
ORCHIDS PAPER PRODUCTS COMPANY
STATEMENTS OF INCOME
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
Nine Months Ended September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
|
|
(unaudited) |
|
|
(unaudited) |
|
|
(unaudited) |
|
|
(unaudited) |
|
|
|
(Dollars in thousands, except share and per share data) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
23,312 |
|
|
$ |
19,218 |
|
|
$ |
65,902 |
|
|
$ |
54,370 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of sales |
|
|
19,518 |
|
|
|
15,997 |
|
|
|
56,297 |
|
|
|
46,664 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit |
|
|
3,794 |
|
|
|
3,221 |
|
|
|
9,605 |
|
|
|
7,706 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general and
administrative expenses |
|
|
1,551 |
|
|
|
1,296 |
|
|
|
4,427 |
|
|
|
3,525 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income |
|
|
2,243 |
|
|
|
1,925 |
|
|
|
5,178 |
|
|
|
4,181 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense |
|
|
310 |
|
|
|
635 |
|
|
|
1,041 |
|
|
|
2,216 |
|
Other income, net |
|
|
(3 |
) |
|
|
(2 |
) |
|
|
(9 |
) |
|
|
(29 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes |
|
|
1,936 |
|
|
|
1,292 |
|
|
|
4,146 |
|
|
|
1,994 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for income taxes: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
State (refund) |
|
|
(2 |
) |
|
|
|
|
|
|
(2 |
) |
|
|
|
|
Current |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred |
|
|
515 |
|
|
|
156 |
|
|
|
1,227 |
|
|
|
246 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
1,423 |
|
|
$ |
1,136 |
|
|
$ |
2,921 |
|
|
$ |
1,748 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
$ |
0.22 |
|
|
$ |
0.18 |
|
|
$ |
0.46 |
|
|
$ |
0.28 |
|
Diluted |
|
$ |
0.22 |
|
|
$ |
0.18 |
|
|
$ |
0.45 |
|
|
$ |
0.27 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares used in calculating net
income per share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
|
6,328,986 |
|
|
|
6,234,346 |
|
|
|
6,328,343 |
|
|
|
6,234,346 |
|
Diluted |
|
|
6,499,686 |
|
|
|
6,421,111 |
|
|
|
6,526,511 |
|
|
|
6,425,527 |
|
See notes to financial statements.
-4-
ORCHIDS PAPER PRODUCTS COMPANY
STATEMENTS OF CASH FLOWS
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
|
(unaudited) |
|
|
(unaudited) |
|
|
|
(Dollars in thousands) |
|
Cash Flows From Operating Activities |
|
|
|
|
|
|
|
|
Net income |
|
$ |
2,921 |
|
|
$ |
1,748 |
|
Adjustments to reconcile net income to net cash
provided by operating activities: |
|
|
|
|
|
|
|
|
Depreciation and amortization |
|
|
2,334 |
|
|
|
2,404 |
|
Provision for doubtful accounts |
|
|
46 |
|
|
|
15 |
|
Deferred income taxes |
|
|
1,227 |
|
|
|
246 |
|
Stock option plan expense |
|
|
259 |
|
|
|
331 |
|
|
|
|
|
|
|
|
|
|
Changes in cash due to changes in operating assets
and liabilities: |
|
|
|
|
|
|
|
|
Accounts receivable |
|
|
(2,568 |
) |
|
|
(975 |
) |
Inventories |
|
|
(1,085 |
) |
|
|
(484 |
) |
Income taxes receivable |
|
|
24 |
|
|
|
1,218 |
|
Prepaid expenses |
|
|
(221 |
) |
|
|
(166 |
) |
Accounts payable |
|
|
274 |
|
|
|
255 |
|
Accrued liabilities |
|
|
490 |
|
|
|
518 |
|
|
|
|
|
|
|
|
Net cash provided by operating activities |
|
|
3,701 |
|
|
|
5,110 |
|
|
|
|
|
|
|
|
|
|
Cash Flows From Investing Activities |
|
|
|
|
|
|
|
|
Purchases of property, plant and equipment |
|
|
(4,159 |
) |
|
|
(477 |
) |
Proceeds from the sale of restricted certificate of deposit |
|
|
|
|
|
|
1,500 |
|
|
|
|
|
|
|
|
Net cash provided by (used in) investing activities |
|
|
(4,159 |
) |
|
|
1,023 |
|
|
|
|
|
|
|
|
|
|
Cash Flows From Financing Activities |
|
|
|
|
|
|
|
|
New borrowings on long-term debt |
|
|
|
|
|
|
26,500 |
|
Retirement of borrowings on long-term debt |
|
|
|
|
|
|
(25,866 |
) |
Principal payments on long-term debt |
|
|
(1,668 |
) |
|
|
(1,720 |
) |
Net borrowings (repayments) on revolving credit line |
|
|
2,120 |
|
|
|
(4,903 |
) |
Proceeds from the exercise of warrants attached to subordinated debentures |
|
|
15 |
|
|
|
|
|
Deferred debt issuance costs |
|
|
|
|
|
|
(144 |
) |
|
|
|
|
|
|
|
Net cash provided by (used in) financing activities |
|
|
467 |
|
|
|
(6,133 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change in cash |
|
|
9 |
|
|
|
|
|
Cash, beginning of period |
|
|
3 |
|
|
|
3 |
|
|
|
|
|
|
|
|
Cash, end of period |
|
$ |
12 |
|
|
$ |
3 |
|
|
|
|
|
|
|
|
Supplemental Disclosure: |
|
|
|
|
|
|
|
|
Interest paid |
|
$ |
963 |
|
|
$ |
2,117 |
|
|
|
|
|
|
|
|
Income tax refund |
|
$ |
2 |
|
|
$ |
|
|
|
|
|
|
|
|
|
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 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.
For income statement purposes, the Company reclassified certain expenses from selling, general and
administrative expenses to cost of sales at year-end 2007. The income statements for the
three-month and nine-month periods ended September 30, 2007 have been restated to conform to the
revised classification.
Note 2 Commitments and Contingencies
On August 1, 2007, the Company received a new water discharge permit that requires the Company to
expand its existing pre-treatment facility to reduce biological oxygen demand and total suspended
solids from its discharge water. Under the permit, the Company is required to complete the
expansion and make operational its pre-treatment facility by August 1, 2009. The engineering phase
of the project has been completed and the project is expected to cost approximately $4.3 million.
The cost of this facility is expected to be financed through a $3.0 million construction loan from
the Companys bank lenders and from cash generated by the Company. As of September 30, 2008, there
were no amounts outstanding under this loan. This loan was included in the bank debt refinancing
that closed in April 2007. Based upon the engineering work completed to date, the Company expects
the project to be fully operational by July 2009.
In March 2008, the Company announced that its board of directors had approved a capital expenditure
of $4.75 million to automate certain processes in its converting operation. The
-6-
project will involve the purchase of case packers, conveyors and case unitizing equipment and should be
operational by the fourth quarter of 2008. Committed capital expenditures not yet paid for in
connection with this project totaled approximately $1.2 million at September 30, 2008.
Note 3 Earnings per Share
The computation of basic and diluted net income per share for the three-month and nine-month
periods ended September 30, 2008 and 2007 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
Nine Months Ended September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
Net income ($ thousands) |
|
$ |
1,423 |
|
|
$ |
1,136 |
|
|
$ |
2,921 |
|
|
$ |
1,748 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding |
|
|
6,328,986 |
|
|
|
6,234,346 |
|
|
|
6,328,343 |
|
|
|
6,234,346 |
|
Effect of stock options |
|
|
65,500 |
|
|
|
84,819 |
|
|
|
82,065 |
|
|
|
90,999 |
|
Effect of dilutive warrants |
|
|
105,200 |
|
|
|
101,946 |
|
|
|
116,103 |
|
|
|
100,182 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares
outstanding assuming dilution |
|
|
6,499,686 |
|
|
|
6,421,111 |
|
|
|
6,526,511 |
|
|
|
6,425,527 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per common share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
$ |
0.22 |
|
|
$ |
0.18 |
|
|
$ |
0.46 |
|
|
$ |
0.28 |
|
Diluted |
|
$ |
0.22 |
|
|
$ |
0.18 |
|
|
$ |
0.45 |
|
|
$ |
0.27 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stocks options not considered
above because they were
anti-dilutive |
|
|
53,750 |
|
|
|
|
|
|
|
86,250 |
|
|
|
|
|
Note 4 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 authorized up to 697,500 shares to be issued. In
May 2008, the shareholders approved increasing the number of authorized shares under the Plan from
697,500 to 897,500. The compensation committee in April 2005 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 vest 20% on the date of grant and then ratably 20% over
the following four years and have a ten-year term. All share and per share amounts have been
adjusted for the 3-for-2 stock split that was affected in July 2006. During the third quarter of
2007, unvested options for 93,000 shares were forfeited by Michael Sage, the Companys former
President and CEO who retired effective July 15, 2007. Mr. Sage exercised his vested options
covering 139,500 shares in October 2007. Options for 225,000 shares were granted effective August
20, 2007, to Robert Snyder, the Companys President and CEO, at an exercise price of $6.81, the
market price on the date of the grant. The options vest 20% on the date of grant and then ratably
20% over the following four years and have a ten-year term.
The following table details the options granted to certain members of the board of directors
and management during the nine months ended September 30, 2008 and 2007.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Grant |
|
Number |
|
Exercise |
|
Risk-Free |
|
Estimated |
|
Dividend |
|
Expected |
Date |
|
of Shares |
|
Price |
|
Interest Rate |
|
Volatility |
|
Yield |
|
Life |
Feb-07
|
|
|
3,750 |
|
|
$ |
8.58 |
|
|
|
4.83 |
% |
|
|
40 |
% |
|
None
|
|
5 years |
Jun-07
|
|
|
28,750 |
|
|
$ |
5.18 |
|
|
|
5.09 |
% |
|
|
38 |
% |
|
None
|
|
5 years |
Aug-07
|
|
|
225,000 |
|
|
$ |
6.81 |
|
|
|
4.63 |
% |
|
|
40 |
% |
|
None
|
|
5-7 years |
May-08
|
|
|
28,750 |
|
|
$ |
7.48 |
|
|
|
3.78 |
% |
|
|
41 |
% |
|
None
|
|
5 years |
Jun-08
|
|
|
20,000 |
|
|
$ |
7.80 |
|
|
|
3.98 |
% |
|
|
40 |
% |
|
None
|
|
5-7 years |
-7-
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. The Company recognized an expense of $54,000 and $163,000
for the three months ended September 30, 2008 and 2007, respectively, related to options granted
under the Plan. The Company recognized an expense of $259,000 and $331,000 for the nine months
ended September 30, 2008 and 2007, respectively, related to options granted under the Plan.
Note 5 Major Customers and Concentration of Credit Risk
The Company sells primarily all of its paper production in the form of converted products; however,
following the start-up of a new paper machine in the summer of 2006, the Company had excess paper
production which it began to sell in parent roll form. Revenues from converted product sales and
parent roll sales in the three-month and nine-month periods ended September 30, 2008 and 2007 were:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
Nine Months Ended September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
|
|
(in thousands) |
|
|
Converted product net sales |
|
$ |
19,300 |
|
|
$ |
16,482 |
|
|
$ |
53,798 |
|
|
$ |
48,068 |
|
Parent roll net sales |
|
|
4,012 |
|
|
|
2,736 |
|
|
|
12,104 |
|
|
|
6,302 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net sales |
|
$ |
23,312 |
|
|
$ |
19,218 |
|
|
$ |
65,902 |
|
|
$ |
54,370 |
|
Credit risk for the Company is concentrated in four significant customers. Three are converted
product customers, each of whom operates discount retail stores located throughout the United
States and one customer who accounts for most of the Companys third party sales of parent rolls.
During the three months ended September 30, 2008 and 2007, sales to the four significant customers
accounted for approximately 67% and 65% of the Companys total sales, respectively. For the nine
months ended September 30, 2008 and 2007, sales to the four significant customers accounted for
approximately 68% and 69% of the Companys total sales, respectively. At September 30, 2008 and
2007, respectively, approximately $5.6 million (68%) and $4.7 million (75%) of accounts receivable
was due from these four 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.
Note 6 New Accounting Standards
The Financial Accounting Standards Board (FASB) periodically issues new accounting standards in a
continuing effort to improve standards of financial accounting and reporting. The Company has
reviewed the recently issued pronouncements and concluded that the following new accounting
standards could be applicable to the Company:
In December 2007, the FASB revised SFAS No. 141 Business Combinations to clarify certain issues
regarding business combinations. The major impact on the Company would be the
-8-
requirement to write-off certain costs of completing an acquisition as incurred. The standard is effective for
periods beginning after December 15, 2008.
Also in December 2007, the FASB issued SFAS No. 160 Non-controlling Interests in Consolidated
Financial Statements. At present this standard would not apply to the Company as it has no
related entities which qualify for consolidation. The standard is effective for minority interest
accounting for periods beginning after December 15, 2008.
On October 10, 2008, the FASB issued FASB Staff Position (FSP) No. FAS 157-3, Determining the Fair
Value of a Financial Asset When the Market for That Asset is Not Active. As Orchids does not
currently own any such assets, this pronouncement is not applicable to the Company.
Note 7 Subsequent Events
On November 5, 2008, the Company amended its credit agreement with its existing bank group. The
amended terms are as follows:
|
|
|
the capital expenditures facility was increased to $4.0 million from $3.0 million, with
advances based on 90% of costs as compared to 80% of costs prior to the amendment; |
|
|
|
|
the capital expenditures covenant limit for 2008 was increased to $6.4 million from
$6.25 million, and was increased to $2.0 million annually thereafter from $1.5 million.
The annual capital expenditures limit will increase to $2.5 million if the Company reaches
an EBITDA threshold for two consecutive quarters, beginning with the third quarter of
2008; and |
|
|
|
|
the capital expenditures exclusion for the waste water pre-treatment project was
increased from $3.0 million to $4.3 million. |
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; |
|
|
|
|
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.
-9-
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 for the fiscal year ended December 31, 2007, as filed with the
Securities and Exchange Commission, and the following items:
|
|
|
intense competition in our market and aggressive pricing by our competitors could force
us to decrease our prices and reduce our profitability; |
|
|
|
|
a substantial percentage of our converted product revenues are attributable to three
large customers which may decrease or cease purchases at any time; |
|
|
|
|
the disruption in supply or cost of waste paper; |
|
|
|
|
significant indebtedness limits our free cash flow and subjects us to restrictive
covenants relating to the operation of our business; |
|
|
|
|
the availability of and prices for energy; |
|
|
|
|
our exposure to variable interest rates; |
|
|
|
|
the loss of key personnel; |
|
|
|
|
labor interruptions; |
|
|
|
|
the parent roll market is a commodity market and subject to fluctuations in demand and
pricing; |
|
|
|
|
natural disaster or other disruption to our facility; |
|
|
|
|
ability to finance the capital requirements of our business; |
|
|
|
|
cost to comply with government regulations; |
|
|
|
|
failure to purchase the contracted quantity of natural gas may result in financial
exposure ; 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.
-10-
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 discount retail market, primarily the 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. While we do not have supply contracts with any of our
customers, we do have commitments with certain customers to maintain our selling prices for up to
one year. 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.
Our profitability depends on several key factors, including:
|
|
|
the market price of our product; |
|
|
|
|
the cost of recycled paper used in producing paper; |
|
|
|
|
the efficiency of operations in both our paper mill and converting operations; and |
|
|
|
|
energy costs. |
The private label segment of the tissue industry is highly competitive, and discount retail
customers are extremely price sensitive. As a result, it is difficult to affect price increases.
We expect these competitive conditions to continue.
In June 2006, we began operating a new paper machine with an annual capacity of approximately
33,000 tons. The capacity of the new machine, in addition to the capacity of our older machines,
increased our total production capacity to approximately 54,000 tons per year. As a result,
beginning in the third quarter of 2006, we were able to eliminate the requirement to purchase
recycled parent rolls on the open market. In the second quarter of 2007, due to the relatively
high price of parent rolls, we began running all of our older machines on a full-time basis. Our
strategy is to sell all of our parent roll capacity as converted products which have higher margins
than parent rolls. We are focusing considerable efforts to improve our converting efficiencies in
order to achieve that goal. Those efforts included the hiring of a productivity consultant to
assist us during the third quarter of 2008 to design and implement a management operating system
and to help our management team implement a new work schedule and work practices. The management
operating system helped identify and confirm root causes of issues that impair production. This
engagement ended in mid-September. As a result of these efforts, converting productivity from the
beginning of September through mid-October improved approximately 20% compared with the run rate
experienced in the first eight months of 2008.
We plan to use the additional converting production to further our penetration into existing
markets including grocery store chains whose distribution centers are located close to our facility
thereby allowing us to maximize our competitive freight cost advantage over our competitors who are
not located within our geographic region. We plan to continue to sell any excess parent roll
capacity on the open market as long as such sales are profitable.
-11-
Prior to the third quarter of 2006, we had purchased parent rolls on the open market since 1998
because our own parent roll production had not adequately supplied the requirements of our
converting facility. We purchased approximately 1,700, 7,000 and 12,000 tons of paper on the open
market in the years 2007, 2006 and 2005, respectively, to supplement our paper-making capacity.
We are obligated through March 2009 to purchase all of our natural gas requirements through a
program established by our broker that utilizes a combination of fixed price contracts, options and
spot purchases. Beginning in the latter part of the third quarter of 2008, prices for natural gas
futures began to decrease. In response, we entered into a fixed price contract in late October
2008 with our broker for approximately 60% of our natural gas requirements at $7.50 per MMBTU for
the period from April 2009 through March 2010. The remaining 40% of our requirements for the April
2009 through March 2010 time period will be purchased under a continuation of our current program
of a combination of fixed price contracts, options and spot purchases.
Comparative Three-Month Periods Ended September 30, 2008 and 2007
Net Sales
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
|
(in thousands, except average |
|
|
|
price per ton and tons) |
|
Converted product net sales |
|
$ |
19,300 |
|
|
$ |
16,482 |
|
Parent roll net sales |
|
|
4,012 |
|
|
|
2,736 |
|
|
|
|
|
|
|
|
Total net sales |
|
$ |
23,312 |
|
|
$ |
19,218 |
|
|
|
|
|
|
|
|
|
|
Total tons shipped |
|
|
13,837 |
|
|
|
13,390 |
|
Average price per ton |
|
$ |
1,685 |
|
|
$ |
1,435 |
|
Net sales increased 21%, to $23.3 million in the quarter ended September 30, 2008, compared to
$19.2 million in the same period of 2007. Net sales figures include gross selling price, including
freight, less discounts and pricing allowances. Net sales of converted product increased in the
quarter ended September 30, 2008 by $2.8 million, or 17%, to $19.3 million compared to $16.5
million in the same period last year. Net sales of parent rolls increased $1.3 million, or 47%, in
the 2008 quarter to $4.0 million compared to $2.7 million in the same period last year. Net sales
of converted product increased primarily due to a 21% increase in the selling price per ton which
was somewhat offset by lower tonnage shipped. The increase in net selling price per ton of
converted product was due to product content changes during 2008 and actual price increases which
actions were undertaken to counteract increasing waste paper and energy prices. The product
content changes were the primary reason for a 4% reduction in the tonnage of converted products
shipped. Parent roll net sales increased primarily due to 27% increase in tonnage shipped and a
15% increase in the selling price per ton. Total shipments in the 2008 quarter increased by 447
tons, or 3%, to 13,837 tons compared to 13,390 tons in the same period of 2007. The net selling
price of parent rolls increased in response to higher energy costs and waste paper prices paid in
the quarter over quarter comparison. The increase in parent roll tons shipped is primarily due to
increased paper making productivity.
-12-
Cost of Sales
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
|
(in thousands, except |
|
|
|
gross profit margin % |
|
|
|
and paper cost per ton) |
|
Cost of paper |
|
$ |
11,056 |
|
|
$ |
9,860 |
|
Non-paper materials, labor, supplies, etc. |
|
|
7,679 |
|
|
|
5,387 |
|
|
|
|
|
|
|
|
Sub-total |
|
|
18,735 |
|
|
|
15,247 |
|
Depreciation |
|
|
783 |
|
|
|
750 |
|
|
|
|
|
|
|
|
Cost of sales |
|
$ |
19,518 |
|
|
$ |
15,997 |
|
|
|
|
|
|
|
|
|
|
Gross Profit |
|
$ |
3,794 |
|
|
$ |
3,221 |
|
Gross Profit Margin % |
|
|
16.3 |
% |
|
|
16.8 |
% |
Total paper cost per ton consumed |
|
$ |
799 |
|
|
$ |
733 |
|
Major components of cost of sales are the cost of internally produced paper, 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 $3.5 million, or 22%, to $19.5 million for the quarter ended
September 30, 2008, compared to $16.0 million in the same period of 2007. Our cost of sales were
negatively affected by higher paper production costs and higher converting production costs. As a
percentage of net sales, cost of sales increased to 83.7% in the 2008 quarter from 83.2% of net
sales in the 2007 quarter. The increase in cost of sales as a percentage of net sales in the
quarter ended September 30, 2008 was primarily attributed to higher paper production costs and
higher converting production costs being partially offset by improved net selling prices and
tonnage.
Our overall cost of paper in the third quarter of 2008 was $799 per ton, an increase of $66 per ton
compared to the same period in 2007. Our cost per ton increased primarily due to increased waste
paper prices and the higher cost of natural gas. The prices we paid for waste paper increased
approximately 19% in the third quarter of 2008 compared with the same period in 2007, resulting in
an increased cost of waste paper consumed of approximately $880,000, as an overall tight waste
paper market resulted in significant price increases across all grades of waste paper. The rates
paid for natural gas increased approximately 34% in the third quarter of 2008 compared to the
prices paid in the same quarter of 2007, resulting in increased costs of approximately $330,000.
Converting production costs increased in the 2008 quarter over 2007 quarter primarily due to an
increase of $500,000 in our maintenance and repair costs, costs of $274,000 associated with a
productivity consultant and outside warehousing costs. The maintenance expense includes repair
parts, service technicians and consultants. We expect this level of quarterly expenditure to
decrease by approximately $250,000 in the fourth quarter of 2008 and by an additional $70,000
beginning in the first quarter of 2009 for a total reduction of $320,000. Late in the second
quarter of 2008, we engaged a productivity consultant to assist our management team in their ongoing
efforts to increase converting productivity. The project included the design and implementation of
a management operating system and assistance for our management team with the implementation of a
new work schedule and work practices. The project ended late in the third quarter. As a result of
these efforts, converting productivity from the beginning of September
-13-
through mid-October improved approximately 20% compared with the run rate experienced in the first eight months of 2008. We
began using a third-party warehouse late in the first quarter of 2008 to increase our shipping
capacity and provide better customer service to handle our increasing converting product shipments.
Gross Profit
Gross profit in the quarter ended September 30, 2008 increased $573,000 or 18%, to $3.8 million
compared to $3.2 million in the same period last year. Gross profit as a percentage of net sales
in the 2008 quarter was 16.3% compared to 16.8% in the 2007 quarter. The effect of higher paper
costs and higher converting production costs which were partially offset by higher net selling
prices of converted products and higher parent rolls sales were the major reasons for the decrease
in gross profit as a percentage of net sales.
Selling, General and Administrative Expenses
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
|
(In thousands, except SG&A as a % of net sales) |
|
Commission expense |
|
$ |
260 |
|
|
$ |
224 |
|
Other S,G&A expenses |
|
|
1,291 |
|
|
|
1,072 |
|
|
|
|
|
|
|
|
Selling, General & Adm exp |
|
$ |
1,551 |
|
|
$ |
1,296 |
|
SG&A as a % of net sales |
|
|
6.7 |
% |
|
|
6.7 |
% |
Selling, general and administrative expenses include salaries, commissions to brokers and other
miscellaneous expenses. Selling, general and administrative expenses increased $255,000 to $1.6
million, or 20% compared to the $1.3 million in the prior year quarter. Costs associated with
additions to our senior management team and, to a lesser extent, increased packaging-related
selling costs due to product content changes were the major reasons for the increase. As a percent
of net sales, selling, general and administrative expenses remained unchanged between the two
periods.
Operating Income
As a result of the foregoing factors, operating income for the quarter ended September 30, 2008
increased $318,000, or 17%, to $2.2 million from $1.9 million in the same period in 2007.
Interest Expense and Other Income
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
|
(In thousands) |
|
Interest expense |
|
$ |
310 |
|
|
$ |
635 |
|
Other (income) expense, net |
|
$ |
(3 |
) |
|
$ |
(2 |
) |
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 $325,000 to $310,000 in the quarter ended September 30, 2008, compared
to $635,000 in the quarter ended September 30, 2007. Lower LIBOR interest rates and, to a lesser
extent, lower margins over LIBOR reflecting improved performance under our debt covenants,
-14-
the absence of interest on our $2.15 million aggregate principal amount of 12% subordinated debentures,
which were retired in December 2007 and lower average bank borrowings all contributed to the
decrease.
Income Before Income Taxes
As a result of the foregoing factors, income before income taxes increased $644,000 to $1.9 million
in the quarter ended September 30, 2008 compared to $1.3 million in the same period in 2007.
Income Tax Provision
For the quarter ended September 30, 2008, our effective income tax rate was 27%. It is lower than
the statutory rate because of Oklahoma Investment Tax Credits associated with our investment in a
new paper machine and the extension of the Federal Indian Employment Credits. These factors were
partially offset by state income taxes. For the quarter ended September 30, 2007, our annual
effective income tax rate was 12%. The 2007 effective tax rate was lower than the statutory rate
because of the Oklahoma Investment Tax Credits cited above, the utilization of Federal Indian
Employment Credits and the recognition of deferred tax benefits associated with non-qualified
option grants to our directors and officers, including a true-up.
No current taxes are owed to either state or federal taxing authorities because of net operating
loss carry forwards for both state and federal tax purposes, Federal Indian Employment Credit carry
forwards and Oklahoma Investment Tax Credit carry forwards.
Comparative Nine-Month Periods Ended September 30, 2008 and 2007
Net Sales
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
|
(in thousands, except |
|
|
|
price per ton and tons) |
|
Converted product net sales |
|
$ |
53,798 |
|
|
$ |
48,068 |
|
Parent roll net sales |
|
|
12,104 |
|
|
|
6,302 |
|
|
|
|
|
|
|
|
Total net sales |
|
$ |
65,902 |
|
|
$ |
54,370 |
|
|
Total tons shipped |
|
|
41,025 |
|
|
|
37,367 |
|
Average price per ton |
|
$ |
1,606 |
|
|
$ |
1,455 |
|
Net sales increased 21% to $65.9 million in the nine months ended September 30, 2008, compared to
$54.4 million in the same period of 2007. Net sales figures include gross selling price, including
freight, less discounts and pricing allowances. Net sales of converted products increased $5.7
million, or 12%, to $53.8 million in the nine months ended September 30, 2008 compared to $48.1
million in the same period in 2007. Net sales of parent rolls increased $5.8 million, or 92%, to
$12.1 million in the 2008 period compared to $6.3 million in the same period of 2007. The increase
in converted product net sales was due to a 15% increase in selling prices per ton being somewhat
offset by a 3% decrease in tonnage shipped. The increase in net selling price per ton of converted
product was due to product content changes implemented during 2007 and 2008 and actual price
increases. The product content changes were the primary reason for the reduced tonnage shipped of
converted products. Net sales of parent rolls increased primarily due to a 62% increase in tonnage
shipped and, to a lesser extent, a 19% increase in selling prices.
-15-
Tonnage of parent roll sales increased due to our decision in April 2007 to begin running all of
our older paper machines on a full-time basis and due to improved productivity in our paper making
operation.
Cost of Sales
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
|
(in thousands, except |
|
|
|
gross profit margin % |
|
|
|
and paper cost per ton) |
|
Cost of paper |
|
$ |
33,240 |
|
|
$ |
27,950 |
|
Non-paper materials, labor,
supplies, etc. |
|
|
20,747 |
|
|
|
16,466 |
|
|
|
|
|
|
|
|
Sub-total |
|
$ |
53,987 |
|
|
$ |
44,416 |
|
Depreciation |
|
|
2,310 |
|
|
|
2,248 |
|
|
|
|
|
|
|
|
Cost of sales |
|
$ |
56,297 |
|
|
$ |
46,664 |
|
|
|
|
|
|
|
|
|
|
Gross Profit |
|
$ |
9,605 |
|
|
$ |
7,706 |
|
Gross Profit Margin % |
|
|
14.6 |
% |
|
|
14.2 |
% |
Total paper cost per ton consumed |
|
$ |
810 |
|
|
$ |
748 |
|
Major components of cost of sales are the cost of internally produced paper, 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 $9.6 million, or 21%, to $56.3 million for the nine months
ended September 30, 2008, compared to $46.7 million in the same period of 2007. As a percentage of
net sales, cost of sales decreased slightly to 85.4% in the 2008 period compared to 85.8% in the
same period in 2007. Cost of sales as a percent of net sales was slightly improved as the increase
in sales prices in both converted products and parent rolls was basically offset by increased paper
making costs and increased costs of converting operations.
In the nine months ended September 30, 2008, the overall cost of paper was $810 per ton, an
increase of $62 per ton when compared to the $748 per ton experienced in the same period in 2007.
The cost per ton increased primarily due to increased waste paper prices and, to a lesser extent,
increased prices in the cost of natural gas and downtime experienced on our new paper machine in
January 2008 being partially offset by the effects of increased production on fixed and
semi-variable costs. The prices paid for waste paper increased approximately 19% in the nine-month
period of 2008 compared to the same period in 2007, resulting in an increased cost of approximately
$2.5 million. Natural gas prices increased approximately 24% in the 2008 period compared to the
same period of 2007, resulting in increased costs of approximately $790,000.
Converting production costs increased primarily in the areas of repair and maintenance, the
previously discussed cost of a productivity consultant and outside warehouse expense. Repair and
maintenance costs, which includes parts, service technicians and consultants, for the nine-month
period ended September 30, 2008 increased approximately $750,000 over the same period in 2007. The
previously discussed cost of the productivity consultant engagement that was completed in
mid-September was approximately $345,000 in the nine-month period. The
previously discussed utilization of an outside warehouse beginning in the first quarter or 2008
resulted in an expense of approximately $290,000 in the 2008 period. The down time experienced on
our new paper machine in January 2008 totaled approximately three days of lost
-16-
production time in order to affect repairs. The unplanned shutdown was required to correct certain issues with the
surface of the yankee dryer and resulted in approximately $200,000 of increased production costs.
Gross Profit
Gross profit in the nine months ended September 30, 2008 increased $1.9 million, or 25%, to $9.6
million compared to $7.7 million in the same period last year. Gross profit as a percentage of net
sales in the nine-month period ended September 30, 2008 was 14.6% compared to 14.2% in the
comparable 2007 period. Gross profit as a percentage of net sales improved slightly as the effects
of the increase in net selling prices for both converted product and parent roll shipments and
increased overall shipment tonnage were basically offset by higher paper costs and increased
converting production costs.
The previously discussed unplanned shutdown of our new paper machine negatively affected gross
profit by approximately $330,000 due to lost production and certain related out of pocket expenses.
Selling, General and Administrative Expenses
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
|
(In thousands, except |
|
|
|
SG&A as a % of net sales) |
|
|
|
|
|
|
|
|
|
|
Commission expense |
|
$ |
753 |
|
|
$ |
702 |
|
Other S,G&A expenses |
|
|
3,674 |
|
|
|
2,823 |
|
|
|
|
|
|
|
|
Selling, General & Adm exp |
|
$ |
4,427 |
|
|
$ |
3,525 |
|
SG&A as a % of net sales |
|
|
6.7 |
% |
|
|
6.5 |
% |
Selling, general and administrative expenses include salaries, commissions to brokers and other
miscellaneous expenses. Selling, general and administrative expenses increased $902,000, or 26%,
to $4.4 million in the nine months ended September 30, 2008 compared to $3.5 million in the
comparable 2007 period, mainly as a result of costs associated with additions to our senior
management team, accruals under our incentive bonus plan, and increased packaging costs related to
product content changes. As a percent of net sales, selling, general and administrative expenses
increased to 6.7% in the nine months ended September 30, 2008 compared to 6.5% in the same period
of 2007.
Operating Income
As a result of the foregoing factors, operating income for the nine months ended September 30, 2008
was $5.2 million compared to operating income of $4.2 million for the same period of 2007.
Interest Expense and Other Income
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, |
|
|
2008 |
|
2007 |
|
|
(In thousands) |
Interest expense |
|
$ |
1,041 |
|
|
$ |
2,216 |
|
Other (income) expense, net |
|
$ |
(9 |
) |
|
$ |
(29 |
) |
-17-
Interest expense decreased by $1.2 million from $2.2 million in the nine months ended September 30,
2007 to $1.0 million in the same period in 2008. The decrease was attributable to lower LIBOR
interest rates and, to a lesser extent, lower margins over LIBOR reflecting the terms of our
amended and restated credit agreement entered into in April 2007 and improved financial performance
under our debt covenants since that time, the absence of interest on our subordinated debentures,
which we retired in December 2007, and decreased average outstanding bank borrowings.
Other income decreased from $29,000 in the first nine months of 2007 to $9,000 in the first nine
months of 2008, primarily due to the absence of interest on the restricted certificate of deposit
which was released in connection with the closing of our credit facility.
Income Before Income Taxes
As a result of the foregoing factors, income before income taxes increased $2.2 million to $4.2
million in the nine months ended September 30, 2008 compared to $2.0 in the same period in 2007.
Income Tax Provision
For the nine months ended September 30, 2008, our effective income tax rate was 30%. It is lower
than the statutory rate because of Oklahoma Investment Tax Credits associated with our investment
in a new paper machine and the extension of the Federal Indian Employment Credits. These factors
were partially offset by state income taxes. As of September 30, 2007, our effective income tax
rate was 12%. The 2007 effective tax rate was lower than the statutory rate because of the
Oklahoma Investment Tax Credits cited above, the utilization of Federal Indian Employment Credits
and the recognition of deferred tax benefits associated with non-qualified option grants to our
directors and officers, including a true-up.
No current taxes are owed to either state or federal taxing authorities because of net operating
loss carry forwards for both state and federal tax purposes, Federal Indian Employment Credit carry
forwards and Oklahoma Investment Tax Credit carry forwards.
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 unused
borrowing capacity under our revolving credit facility. Our cash requirements have historically
been satisfied through a combination of cash flows from operations and debt financings.
On November 5, 2008, we amended our credit agreement with our existing bank group as follows:
|
|
|
the capital expenditures facility was increased to $4.0 million from $3.0 million, with
advances based on 90% of costs as compared to 80% of costs prior to the amendment; |
|
|
|
|
the capital expenditures covenant limit for 2008 was increased to $6.4 million from
$6.25 million, and was increased to $2.0 million annually thereafter from $1.5 million.
The annual capital expenditures limit will increase to $2.5 million if we reach an EBITDA
threshold of $3.0 million for two consecutive quarters, beginning with the third quarter of
2008; and |
-18-
|
|
|
the capital expenditures exclusion for the waste water pre-treatment project was
increased from $3.0 million to $4.3 million. |
We amended the capital expenditures facility to accommodate the anticipated increase in the total
cost of the waste water pre-treatment project from $3.0 million to $4.3 million. The cost of the
project increased from the original estimate due to several factors, including increased project
capacity requirements, which resulted in increased equipment costs.
Our loan agreement, which is more fully discussed later in this section, is a floating rate
agreement, primarily based on LIBOR. We set our LIBOR rates on a 30, 60 or 90-day basis. The
current economic and credit crisis has resulted in major swings in many markets, including LIBOR.
As an example, during the third quarter of 2008, our LIBOR rate averaged approximately 2.47%. The
30-day rate we entered into on October 10, 2008 was 4.29%, an increase of approximately 200 basis
points. As of November 6, the 30-day LIBOR rate available to us was 1.96%. The 200 basis point
increase we experienced in October would result in approximately $500,000 in increased interest
expense, if the higher rate was in effect for a full twelve months. Our total debt service
requirement would remain unchanged because our monthly payments are a set amount, and changes in
interest rates only affect the amount of the payment allocated between principal and interest.
A copy of this amendment to the credit agreement is attached as Exhibit 10.2 to this report and is
incorporated herein by reference.
Cash increased in the nine months ended September 30, 2008 by $9,000 to $12,000.
The following table summarizes key cash flow information for the nine-month periods ended September
30, 2008 and 2007:
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, |
|
|
2008 |
|
2007 |
|
|
(in thousands) |
|
Cash flow provided by (used in): |
|
|
|
|
|
|
|
|
Operating activities |
|
$ |
3,701 |
|
|
$ |
5,110 |
|
|
Investing activities |
|
$ |
(4,159 |
) |
|
$ |
1,023 |
|
|
Financing activities |
|
$ |
467 |
|
|
$ |
(6,133 |
) |
Cash flow provided by operating activities was $3.7 million in the nine-month period ended
September 30, 2008, which primarily resulted from earnings before non-cash charges, higher accounts
payable and accrued expenses, partly offset by increased trade receivables and inventories.
Cash flows used in investing activities were $4.2 million in the first nine months of 2008 as the
result of expenditures on capital projects, primarily the previously announced $4.75 million
project to automate certain operations in our converting plant.
Cash provided by financing activities was $467,000 in the nine-month period ended September 30,
2008 and was primarily attributable to 2.1 million of net borrowings under the revolving
-19-
credit agreement, which were partially offset by $1.7 million of principal payments on our term loans.
Cash flow provided by operating activities was $5.1 million in the nine-month period ended
September 30, 2007, which primarily consisted of earnings before non-cash charges and an increase
in accounts payable and accrued liabilities, which was partially offset by an increase in accounts
receivable reflecting increased sales in the third quarter.
Cash flows from investing activities were $1.0 million in the nine-month period ended September 30,
2007, reflecting the release of the $1.5 million restricted certificate of deposit in connection
with the re-financing of the Companys credit facility. Several maintenance capital expenditure
projects were partly offsetting.
Cash used in financing activities was $6.1 million in the nine-month period ended September 30,
2007 and was primarily attributable to a net reduction in the revolving credit balance reflecting,
in part, the application of the $1.5 million restricted certificate of deposit and repayments of
principal on our term loans, partly offset by net additional term loan borrowings in connection
with the re-financing of the Companys bank debt in April 2007. The effect of these incremental
term loan borrowings was to reduce the revolving credit balance.
On November 5, 2008, we amended our credit facility as previously described. Following the
amendment, the credit facility consists of the following:
|
|
|
an $8.0 million revolving credit facility with a three-year term; ($2.2 million
outstanding at September 30, 2008). In addition, $681,000 of bank overdrafts are included
with long-term debt at September 30, 2008. The borrowing base for the revolving credit
facility is determined by adding qualified receivables and inventory. At September 30,
2008, the borrowing base for the revolving credit facility was $8.0 million; |
|
|
|
|
a $10.0 million term loan A with a ten-year term that has no principal repayments for
the first 24 months of the loan and then will be amortized as if the loan had an 18-year
life ($10.0 million outstanding at September 30, 2008); |
|
|
|
|
a $16.5 million term loan B with a four-year term that is being amortized as if the
loan had a six-year life ($13.2 million outstanding at September 30, 2008); and |
|
|
|
|
a $4.0 million capital expenditures facility with a four-year term that will be
amortized as if the loan had a five-year life ($0 outstanding at September 30, 2008). |
Under the terms of the amended credit agreement, amounts outstanding under the revolving credit
facility bear interest at our election at the prime rate or LIBOR plus a margin and amounts
outstanding under term loans A and B and the capital expenditures facility bear interest at LIBOR
plus a margin. The margin is set quarterly and based on the ratio of funded debt to EBITDA less
income taxes paid. Amounts outstanding under term loan A bear interest at LIBOR plus 180 basis
points. For the revolving credit facility, the margin ranges from a negative 50 basis points to
150 basis points for prime rate loans and 200 to 375 basis points for LIBOR-based loans. For term
loan B, the margin ranges from 200 basis points to 300 basis points over LIBOR. For the capital
expenditures facility, which we expect to utilize in conjunction with the construction of our new
environmental pre-treatment facility by August 1, 2009, the margin ranges from 150 basis points to
250 basis points over LIBOR. Additionally, the interest rate under the capital expenditures
facility is the greater of LIBOR plus the applicable margin or 4%. At September 30, 2008, our
weighted average borrowing rate was 4.71% under this credit agreement as compared to 7.89% at
September 30, 2007.
-20-
The credit agreement contains covenants that, among other things, require us to maintain a specific
funded debt to EBITDA ratio, debt service coverage ratio and an annual limit on un-financed capital
expenditures. In connection with the re-financing, the $1.5 million restricted certificate of
deposit was released and applied to the revolving credit facility. 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 $8.0 million. Obligations under the
amended and restated credit agreement are secured by substantially all of our assets. 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 in the agreement require us to maintain
specific ratios of funded debt to EBITDA and debt service coverage which are tested as of the end
of each quarter and places a limit on the amount of annual non-financed capital expenditures. The
maximum allowable funded debt to EBITDA ratio is 4.0-to-1.0 and the minimum allowable debt service
coverage ratio is 1.25-to-1.0. Our annual expenditures for non-financed capital equipment are
limited to $6.4 million for fiscal year 2008 and $2.0 million per fiscal year thereafter until we
achieve an EBITDA level of $3.0 million for two consecutive quarters at which time the annual limit
will increase to $2.5 million.
The capital expenditures facility is intended to fund an expansion of our wastewater pre-treatment
facilities. A new water discharge permit was issued effective August 1, 2007 which requires us to
expand our existing pre-treatment facility to reduce biological oxygen demand and total suspended
solids from our discharge water. Under the new permit, we are required to complete the expansion
and make operational our pre-treatment facility by August 1, 2009. The engineering phase of the
project has been completed and the project is expected to cost approximately $4.3 million. The
cost of this facility is expected to be financed through a $4.0 million construction loan from our
bank lenders and from the cash we generate. As of September 30, 2008, there were no amounts
outstanding under this loan. Based upon the engineering work completed to date, we expect the
project to be fully operational by July 2009.
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.
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
-21-
customers and maintain an allowance 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 allowance provided, there can be no assurance that we will
continue to experience the same credit loss rates as in the past. During the nine-month periods
ended September 30, 2008 and 2007, provisions for doubtful accounts were recognized in the amount
of $46,000 and $15,000, respectively for each period. In addition, $3,000 of recoveries of
accounts previously written off was credited to the allowance during the first nine months of 2008.
There were no recoveries credited during the first nine months of 2007. One accounts receivable
balance of $3,000 was written off in the nine-month period ended September 30, 2008 and nothing was
written off in the first nine months of 2007.
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 first nine months of 2008, $90,000 was provided
and there were charges totaling $74,000 against the valuation reserve. The charges against the
reserve were primarily the result of the product content changes made or in the process of being
made to our converted products and the resultant effect on certain raw materials, primarily poly
wrapping material, used in the converting process. During the first nine months of 2007, $65,000
was provided and $8,000 was charged against the reserve.
New Accounting Pronouncements
The Financial Accounting Standards Board (FASB) periodically issues new accounting standards in a
continuing effort to improve standards of financial accounting and reporting. We have reviewed the
recently issued pronouncements and concluded that the following new accounting standards could be
applicable to us:
In December 2007, the FASB revised SFAS No. 141 Business Combinations to clarify certain issues
regarding business combinations. The major impact on us would be the requirement to write-off
certain costs of completing an acquisition as incurred. The standard is effective for periods
beginning after December 15, 2008.
Also in December 2007, the FASB issued SFAS No. 160 Non-controlling Interests in Consolidated
Financial Statements. At present this standard would not apply to us as we have no related
entities which qualify for consolidation. The standard is effective for minority interest
accounting for periods beginning after December 15, 2008.
On October 10, 2008, the FASB issued FASB Staff Position (FSP) No. FAS 157-3, Determining the Fair
Value of a Financial Asset When the Market for That Asset is Not Active. As Orchids does not
currently own any such assets, this pronouncement is not applicable to the Company.
Non-GAAP Discussion
In addition to our Generally Accepted Accounting Principles (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
-22-
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 three months ended September 30, 2008
and 2007:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
|
(In thousands, |
|
|
|
except % of net sales) |
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
1,423 |
|
|
$ |
1,136 |
|
Plus: Interest expense |
|
|
310 |
|
|
|
635 |
|
Plus: Income tax expense |
|
|
513 |
|
|
|
156 |
|
Plus: Depreciation |
|
|
783 |
|
|
|
750 |
|
|
|
|
|
|
|
|
EBITDA |
|
$ |
3,029 |
|
|
$ |
2,677 |
|
% of net sales |
|
|
13.0 |
% |
|
|
13.9 |
% |
EBITDA increased $352,000 to $3.0 million in the quarter ended September 30, 2008, compared to $2.7
million in the same period in 2007. EBITDA as a percent of net sales decreased to 13.0% in the
third quarter of 2008 from 13.9% in the third quarter of 2007. The foregoing factors
discussed in the net sales, cost of sales and selling, general and administrative expenses are the
reasons for the decline.
-23-
The following table reconciles EBITDA to net income for the nine months ended September 30, 2008
and 2007:
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
|
(In thousands, |
|
|
|
except % of net sales) |
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
2,921 |
|
|
$ |
1,748 |
|
Plus: Interest expense |
|
|
1,041 |
|
|
|
2,216 |
|
Plus: Income tax expense |
|
|
1,225 |
|
|
|
246 |
|
Plus: Depreciation |
|
|
2,310 |
|
|
|
2,248 |
|
|
|
|
|
|
|
|
EBITDA |
|
$ |
7,497 |
|
|
$ |
6,458 |
|
% of net sales |
|
|
11.4 |
% |
|
|
11.9 |
% |
EBITDA increased $1.0 million to $7.5 million in the nine months ended September 30, 2008, compared
to $6.5 million in the same period of 2007. EBITDA as a percent of net sales declined 0.5% to
11.4% in the current nine-month period from 11.9% in the prior year nine-month period. The
foregoing factors discussed in the net sales, cost of sales and selling, general and administrative
sections are the reasons for these changes.
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
Our market risks relate primarily to changes in interest rates. Our revolving line of credit and
our term loans 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
September 30, 2008, we have borrowings totaling $25.4 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 or a fixed margin over LIBOR.
Based on the borrowings on September 30, 2008, a 100 basis point change in interest rates would
result in a $254,000 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
our 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 our chief financial officer have concluded that our disclosure controls and
procedures were effective as of September 30, 2008.
There were no changes in the Companys internal control over financial reporting (as defined in
Rule 13a-15(f) under the Exchange Act) during the quarter ended September 30, 2008, that have
materially affected, or are reasonably likely to materially affect, our internal control over
financial reporting.
-24-
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
None.
ITEM 1A. Risk Factors
Other than as set forth below, as of the date of this filing, there have been no material changes
from the risk factors disclosed in the Companys Annual Report on Form 10-K dated March 18, 2008.
We operate in a changing environment that involves numerous known and unknown risks and
uncertainties that could materially affect our operations. The risks, uncertainties and other
factors set forth in our Annual Report on Form 10-K and below may cause our actual results,
performances and achievements to be materially different from those expressed or implied by our
forward-looking statements. If any of these risks or events occur, our business, financial
condition or results of operations may be adversely affected.
The parent roll market is a commodity market and subject to fluctuations in demand and pricing.
Following the start-up of our new paper machine in July 2006, our parent roll production exceeded
the requirements of our converting operation, which excess tonnage we sell as parent rolls. In
addition, in the second quarter of 2007, due to relatively high parent roll prices, we began
running all of our older paper machines on a full-time basis, thereby increasing the amount of
excess paper. The demand for parent rolls has been relatively high compared to supply for several
years, however fluctuations in demand, primarily in the away-from-home market, can affect the
supply-demand balance. A significant reduction in demand can result in an over-supply situation if
parent roll producers do not adjust capacity, which could negatively affect the market price for
parent rolls. A significant reduction in parent roll selling prices could reduce our revenues and
decrease our profits and could cause us to shut down some of our excess paper making capacity.
Failure to purchase the contracted quantity of natural gas may result in financial exposure.
In October 2008, we entered into a contract to purchase 334,000 MMBTU natural gas requirements at
$7.50 per MMBTU for the period from April 2009 through March 2010. This represents approximately
60% of our natural gas requirements based on our usage rates for 2009. A significant interruption
in our parent roll production due to tornado, fire, or other natural disaster, adverse market
conditions or mechanical failure could reduce our natural gas requirements to a level below that of
our contracted amount. If this situation occurs and the market price for natural gas at that time
is less than our contracted price, we could be required under the terms of our agreement to
reimburse our gas supplier for their lost revenue on the pricing difference on the amount of
natural gas purchased under the contract amount.
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
(a) Unregistered Sales of Equity Securities
None.
-25-
(b) Initial Public Offering and Use of Proceeds from the Sale of Registered Securities
None.
(c) Repurchases of Equity Securities
We do not have any programs to repurchase shares of our common stock and no such repurchases were
made during the three months ended September 30, 2008.
ITEM 3. Defaults Upon Senior Securities
None.
ITEM 4. Submission of Matters to a Vote of Security Holders
None.
ITEM 5. Other Information
On November 5, 2008, we amended our credit agreement with our existing bank group. This amendment
is described in more detail in Managements Discussion and Analysis of Financial Condition and
Results of Operations Liquidity and Capital Resources.
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.
-26-
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: November 10, 2008 |
By: |
/s/ Keith R. Schroeder
|
|
|
|
Keith R. Schroeder |
|
|
|
Chief Financial Officer
(On behalf of the registrant and
as Chief Accounting Officer) |
|
-27-
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. |
|
|
|
3.1.1
|
|
Amendment to the Amended and Restated Certificate of Incorporation
of the Registrant incorporated by reference to the Form 10-Q
filed with the Securities and Exchange Commission on August 14,
2007. |
|
|
|
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. |
|
|
|
10.1#
|
|
Amendment to Executive Employment Agreement dated August 22, 2008,
between Robert A. Snyder and the Company. |
|
|
|
10.2
|
|
Amendment Three to Second Amended and Restated Agented Credit
Agreement dated November 5, 2008 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. |
|
|
|
# |
|
Indicates management contract or compensatory plan |
-28-