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TIS > SEC Filings for TIS > Form 10-Q on 31-Jul-2013All Recent SEC Filings

Show all filings for ORCHIDS PAPER PRODUCTS CO /DE | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for ORCHIDS PAPER PRODUCTS CO /DE


31-Jul-2013

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

                          Forward-Looking Information



The following Management's 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.

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, 2012, as filed with the SEC on March 11, 2013, and include the following items:

† intense competition in our markets 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 a small number of customers who may decrease or cease purchases at any time;

†         disruption in our supply or increase in the cost of fiber;

†         increased competition in our region;

†         changes in our retail trade customers' policies and increased
dependence on key retailers in developed markets;

†         excess supply in the market may reduce our prices;

†         the availability of and prices for energy;

†         failure to purchase the contracted quantity of natural gas may result
in financial exposure;

†         our exposure to variable interest rates;

†         the loss of key personnel;

†         labor interruption;

†         natural disaster or other disruption to our facilities;

†         ability to finance the capital requirements of our business;

†         cost to comply with existing and new laws and regulations;

†         failure to maintain an effective system of internal controls necessary
to accurately report our financial results and prevent fraud;

†         the parent roll market is a commodity market and subject to
fluctuations in demand and pricing;

†         indebtedness limits our free cash flow and subjects us to restrictive
covenants relating to the operation of our business;

†         an inability to continue to implement our business strategies; and

†         inability to sell the capacity generated from our converting lines.

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 Management's Discussion and Analysis of Financial Condition and Results of Operations reflects our current views with respect to future events and is subject to the risks listed above 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 reason, whether as a result of new information, future events, or otherwise.


Table of Contents

Overview

We are an integrated manufacturer of tissue products serving the private label segment of the "at-home" market. We produce bulk tissue paper, known as parent rolls, and convert parent rolls into finished products, including paper towels, bathroom tissue and paper napkins. We sell any remaining parent rolls to other converters. Our core customer base consists of dollar stores and other discount retailers. By dollar stores, we mean retailers that offer a limited selection across a broad range of products at everyday low prices in a smaller store format. We have focused on the dollar stores (which are also referred to as discount retailers) and the broader discount retail market because of their overall market growth, consistent order patterns and low number of stock keeping units ("SKUs"). The at-home tissue market consists of several quality levels, including a value tier, mid-tier and premium tier. Our historical business strategy has focused on the value tier market, primarily due to the dollar stores' concentration of product offerings in that market and, to some extent, limitations of certain manufacturing equipment. As part of our growth strategy, we began to systematically invest in manufacturing assets to improve quality, expand our product offerings and strengthen our position as a low cost manufacturer. This began with the investment in a new paper machine in 2006 which provided the opportunity to produce parent rolls for value tier, mid-tier and premium tier converted products and improved our cost structure. Further, we undertook an expansion project that included the purchase and installation of a new converting line and the construction of a new converted product warehouse in mid-2010. This project had three main objectives: increase the capacity of our converting operation, provide the capability to produce higher-quality mid-tier and premium tier converted products and reduce warehousing costs by centralizing all warehousing and shipping. While we have customers located throughout the United States, most of our products are distributed within an approximate 900-mile radius of our Oklahoma facility. However, our sales efforts are focused on an area within approximately 500 miles of our facility in northeast Oklahoma, which includes Texas, Oklahoma, Kansas, Missouri, Arkansas, Nebraska and Iowa, as we believe this radius maximizes our freight cost advantage over our competitors. Because we are one of the few tissue paper manufacturers in this area, we typically have lower freight costs to our customers' distribution centers located in our target region. At-home tissue market growth has historically been closely correlated to population growth and as such, performs well in a variety of economic conditions. Our target region has experienced strong population growth in the past ten years relative to the national average, and these trends are expected to continue.

Our products are sold primarily under our customers' private labels and, to a lesser extent, under our brand names such as Colortexฎ, My Sizeฎ, Velvetฎ, Big Mopperฎ, Soft & Fluffyฎ, Tackleฎ, Nobleฎ and Linen Softฎ. All of our converted product revenue is derived through truck load purchase orders from our customers. Parent roll revenue is derived from purchase orders that generally cover a one-month time period. We do not have supply contracts with any of our customers, which is normal practice within our industry. 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, in general, do not materially affect the market for our converted products.

Our profitability depends on several key factors, including:

† the market price of our product;

† the cost of fiber used in producing paper;

† the efficiency of operations in both our paper mill and converting facility; and

† the cost of energy.

The private label market 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.

Background

Since June 2006, when we began operations of a new paper machine, our paper-making capacity of approximately 57,000 tons per year has exceeded the demand requirements of our converting operations. We sell the excess supply into the market in the form of parent rolls. We adjust our paper making production based on our internal converting needs for parent rolls and the open market demand for parent rolls. Parent rolls are a commodity product and thus are subject to market pricing. We plan to continue to sell any excess parent roll capacity on the open market as long as market pricing is profitable. When converting production requirements exceed paper mill capacity, we will purchase bulk rolls in the open market to meet those converting requirements.

Our parent rolls are converted into paper towels, bathroom tissue and napkins in our adjacent converting facility. Our eleven converting lines currently have a total annual estimated capacity of approximately 11.5 million cases of finished tissue products, depending upon the mix of converted products produced, including the product configurations. Our strategy is to sell all of our parent roll capacity as converted products, which generally carry higher margins than parent rolls. To help achieve that goal, we are placing significant focus on improving our sales efforts to sell all of our converting capacity. In addition, we continue to focus considerable efforts to improve our converting efficiencies.


Table of Contents

Our strategy is to expand our position as a low cost provider of high-quality private label tissue products to the growing discount retail channel while leveraging our competitive advantages to increase our presence in the mid-tier and premium tier markets with the discount retail channel as well as other retail channels. This will be accomplished through the expansion of our product offerings through new product development, our continued high service levels and increased total manufacturing capacity.

We are implementing this strategy through our key initiatives set forth below:

†††††††††††† maintain and strengthen our core customer relationships;

†††††††††††† improve the product quality of our higher tier offerings to meet and or exceed customers' required attributes;

†††††††††††† increase our flexibility to meet a wider array of customer needs;

†††††††††††† further expand our customer base in other retail channels; and

†††††††††††† continue to improve operating efficiencies and reduce manufacturing costs.

We continue to focus our efforts on growth of our converted product sales and expansion of our product offerings through development of mid-tier and premium tier products. The following graph shows shipments of our mid-tier and premium tier products as a percentage of total cases shipped:

[[Image Removed: GRAPHIC]]

Since our inception in 1998, we have strategically expanded capacity and capability in both paper manufacturing and finished product converting to meet market demand and customers' quality requirements. In 2010, we increased our annual converting capacity with the installation of a new converting line, which, along with other strategic investments, increased our annual converting capacity to 11.5 million cases per year, depending upon the mix of converted products produced, including the product configurations. This additional converting capacity will enable us to both increase sales of existing products and to provide the flexibility to manufacture higher tier products for sales to our core customer base and into new retail channels.

Although we have an annual estimated converting capacity of approximately 11.5 million cases, our in-house supply of parent rolls provides enough to convert approximately 9.5 million cases. In order to convert at an annual capacity above approximately 9.5 million cases, we would have to supplement our supplies by purchasing parent rolls in the open market, which we believe would have an unfavorable impact on our gross profit margin.

Comparative Three-Month Periods Ended June 30, 2013 and 2012



Net Sales



                                   Three Months Ended June 30,
                                      2013              2012
                                   (in thousands, except tons)

Converted product net sales      $       27,803    $       22,330
Parent roll net sales                     1,429             2,949
Net sales                        $       29,232    $       25,279

Converted product tons shipped           13,354            10,901
Parent roll tons shipped                  1,364             3,014
Total tons shipped                       14,718            13,915

Net sales in the quarter ended June 30, 2013, increased 16% to $29.2 million, compared to $25.3 million in the same period of 2012. Net sales figures represent the gross selling price, including freight, less discounts and pricing allowances. The increase in net sales is due to a $5.5 million increase in net sales of converted product which was partially offset by a $1.5 million decrease in parent roll net sales.

Net sales of converted product increased in the quarter ended June 30, 2013, by $5.5 million, or 25%, to $27.8 million compared to $22.3 million in the same period last year. The increase in net sales of converted product is primarily the result of a 23% increase in the tonnage shipped and a 2% increase in the net selling price per ton. The increase in converted product tonnage shipped is primarily due to increased sales of our mid and premium tier product lines to both existing and new customers. The increase in net selling price per ton is primarily due to a change in product mix towards the mid and premium tier markets.

Net sales of parent rolls decreased $1.5 million, or 52%, to $1.4 million in the quarter ended June 30, 2013, compared to $2.9 million in the same period last year. Net sales of parent rolls decreased due to the higher requirements by our converting operation resulting in less excess paper available to sell in parent roll form. The higher converting requirements are due to the increased sales of converted product. Tonnage shipments decreased 55%, which was somewhat offset by a 7% increase in the net selling price per ton of parent rolls. The improvement in parent roll net selling prices is due to the stronger parent roll market and market reaction to higher virgin fiber prices.


Table of Contents

Cost of Sales



                                                               Three Months Ended June 30,
                                                           2013                           2012
              (in thousands, except gross profit margin % and paper cost per ton consumed)

Cost of paper                                    $                  10,691      $                  10,664
Non-paper materials, labor, supplies, etc.                           9,664                          7,178
Sub-total                                                           20,355                         17,842
Depreciation                                                         1,881                          1,833
Cost of sales                                    $                  22,236      $                  19,675

Gross profit                                     $                   6,996      $                   5,604
Gross profit margin %                                                 23.9 %                         22.2 %
Total paper cost per ton consumed                $                     771      $                     769

The 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 13% to $22.2 million, compared to $19.7 million in the same period of 2012, due to the previously discussed higher net sales amounts.
Outside warehousing expense and increased fiber costs due to mix were offset by reduced paper production costs. As a percentage of net sales, cost of sales decreased to 76.1% in the 2013 quarter from 77.8% in the 2012 quarter. Cost of sales as a percentage of net sales for the second quarter of 2013 was favorable to the prior year quarter due to a higher percentage of converted product sales, lower paper production costs and lower recycled fiber costs being partially offset by external warehousing costs.

Our overall cost of paper in the second quarter of 2013 was $771 per ton, an increase of $2 per ton compared to the same period in 2012. Paper production costs increased primarily due to a higher percentage of virgin fiber utilized to meet the quality characteristics of our mid and premium tier products which was partially offset by lower maintenance and repair costs and the effects of favorable production rates on fixed cost absorption. Average recycled fiber prices decreased approximately 8% in the second quarter of 2013 compared to the same quarter in 2012, thereby decreasing our cost of sales by approximately $251,000 in the quarter-over-quarter comparison. Virgin fibers represented approximately 18% of our fiber consumption in the 2013 quarter compared with approximately 1% in the prior year quarter. Maintenance and repair costs in the paper mill were approximately $246,000 lower in the 2013 quarter than in the prior year quarter.

Excluding the effects of depreciation and external warehousing costs, converting production costs on a per unit basis were flat in the 2013 quarter compared to the 2012 quarter. The Company incurred $448,000 of outside warehousing expense during the 2013 quarter; costs that were not incurred during the 2012 quarter.
As previously discussed, the percentage of our parent roll production sold as converted products increased in the second quarter of 2013 compared to the same quarter last year, which had a positive effect on our gross margin percentage as converted product sales generally generate a higher margin than the sale of parent rolls.

Gross Profit

Gross profit in the quarter ended June 30, 2013, increased $1.4 million, or 25%, to $7.0 million compared to $5.6 million in the same period last year. Gross profit as a percentage of net sales in the 2013 quarter was 23.9% compared to 22.2% in the 2012 quarter. The gross profit increase as a percent of net sales was primarily the result of a higher percentage of converted product sales, lower paper production costs, and lower recycled fiber costs.


Table of Contents

Selling, General and Administrative Expenses



                                          Three Months Ended June 30,
                                      2013                          2012
                                (in thousands, except SG&A as a % of net sales)

Commission expense           $                   492       $                   339
Other S,G&A expenses                           2,025                         1,773
Selling, General & Adm exp   $                 2,517       $                 2,112
SG&A as a % of net sales                         8.6 %                         8.4 %

Selling, general and administrative expenses include salaries, commissions to brokers and other miscellaneous expenses. Selling, general and administrative expenses increased $405,000, or 19%, in the quarter ended June 30, 2013 as compared to the same period in 2012 primarily due to: (i) higher commission expense due to the improved level of converted product sales, (ii) higher artwork and packaging related expenditures, (iii) higher director related fees and expenses, including higher stock option expense resulting from increased options issued and a higher market price of the Company's stock and (iv) higher recruitment and relocation expenses, which were partially offset by lower professional fees. As a percentage of net sales, selling, general and administrative expenses increased to 8.6% in the second quarter of 2013 compared to 8.4% in the same period of 2012.

Operating Income

As a result of the foregoing factors, operating income for the quarter ended June 30, 2013, was $4.5 million compared to operating income of $3.5 million for the same period of 2012.

Interest Expense and Other Income



                                  Three Months Ended June 30,
                                   2013                2012
                                        (in thousands)
Interest expense              $            95     $           102
Other (income) expense, net   $            (7 )   $           323

Income before income taxes    $         4,391     $         3,067

Interest expense includes interest on all debt and amortization of deferred debt issuance costs. Interest expense decreased $7,000 to $95,000 in the quarter ended June 30, 2013, compared to $102,000 in the quarter ended June 30, 2012.
The decrease in interest expense resulted from lower average borrowing levels. Other expense for the quarter ended June 30, 2012 included a loss of approximately $336,000 due to the disposal of several pieces of converting equipment, including a wrapper and two case packers, following the completion of three capital expenditure projects totaling $2.1 million during the quarter.

Income Before Income Taxes

As a result of the foregoing factors, income before income taxes increased $1.3 million to $4.4 million in the quarter ended June 30, 2013, compared to $3.1 million in the same period in 2012.

Income Tax Provision

As of June 30, 2013, we estimate our annual effective income tax rate to be 29.7%. This compares to the 31.1% we estimated as of the end of the first quarter of 2013. As a result, for the quarter ended June 30, 2013, our effective income tax rate was 28.4%, while our effective income tax rate was 27.1% for the quarter ended June 30, 2012. These rates are lower than the statutory rate because of manufacturing tax credits, Indian employment tax credits ("IECs") and Oklahoma Investment Tax Credits primarily associated with our investments in a new paper machine in 2006 and new converting warehouse and new converting line that were completed in 2010.


Table of Contents

Comparative Six-Month Periods Ended June 30, 2013 and 2012



Net Sales



                                    Six Months Ended June 30,
                                      2013             2012
                                   (in thousands, except tons)

Converted product net sales      $       52,411    $      45,935
Parent roll net sales                     3,430            5,071
Net sales                        $       55,841    $      51,006

Converted product tons shipped           25,276           22,188
Parent roll tons shipped                  3,305            5,196
Total tons shipped                       28,581           27,384

Net sales increased 9% to $55.8 million in the six months ended June 30, 2013, compared to $51.0 million in the same period of 2012. Net sales figures represent gross selling price, including freight, less discounts and pricing allowances. The increase in net sales is due to a $6.5 million increase in the sales of converted products being partially offset by a $1.6 million decrease in the net sales of parent rolls.

Net sales of converted product increased for the six months ended June 30, 2013, by $6.5 million, or 14%, to $52.4 million compared to $45.9 million in the same period last year. The increase in net sales of converted products is the result of a 14% increase in the tons of product shipped. Net selling price remained flat when compared to the same period last year. Sales of new mid and premium tier products to both existing and new customers and increased demand for existing products from current customers were the primary reasons for the increased shipments.

Net sales of parent rolls decreased $1.6 million, or 32%, to $3.4 million in the six months ended June 30, 2013, compared to $5.1 million in the same period last year. Net sales of parent rolls decreased due to a 36% decrease in parent roll tonnage shipped offset by a 6% increase in net selling prices. Higher converting requirements due to increased sales were the primary reason for the decreased parent roll sales, while net selling prices increased for the same reasons cited in the quarterly discussion.

Cost of Sales



                                                                 Six Months Ended June 30,
                                                             2013                          2012
              (in thousands, except gross profit margin % and paper cost per ton consumed)

Cost of paper                                      $                 21,211      $                 20,914
Non-paper materials, labor, supplies, etc.                           17,333                        14,706
Sub-total                                                            38,544                        35,620
Depreciation                                                          3,774                         3,649
Cost of sales                                      $                 42,318      $                 39,269

Gross profit                                       $                 13,523      $                 11,737
Gross profit margin %                                                  24.2 %                        23.0 %
Total paper cost per ton consumed                  $                    751      $                    750

The 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.


Table of Contents

Cost of sales increased approximately $3.0 million, or 8%, to $42.3 million for the six months ended June 30, 2013, compared to $39.3 million in the same period of 2012, due to higher net sales levels. As a percentage of net sales, cost of sales decreased to 75.8% of net sales in the six-month period ended June 30, 2013, compared to 77.0% of net sales in the six-month period ended June 30, . . .

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