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TIS > SEC Filings for TIS > Form 10-K on 6-Mar-2014All Recent SEC Filings

Show all filings for ORCHIDS PAPER PRODUCTS CO /DE

Form 10-K for ORCHIDS PAPER PRODUCTS CO /DE


6-Mar-2014

Annual Report


Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion of our financial condition and results of operations in conjunction with the audited financial statements and the notes to those statements included elsewhere in this Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. You should specifically consider the various risk factors identified in this filing that could cause actual results to differ materially from those anticipated in these forward-looking statements.

Executive Overview

What were our key 2013 financial results?

º •
º Our net sales in 2013 increased 15.4% to a new record of $116.4 million compared to $100.8 million in 2012, including a 21.1% increase in net sales of converted product and a 34.4% decrease in parent roll sales.

º •
º Net sales of converted product were $109.6 million during 2013, a new twelve-month record. Converted product net sales increased $19.1 million, or 21.1%, to $109.6 million in 2013 compared to $90.5 million in 2012.

º •
º Our earnings per diluted common share in 2013 increased to $1.67 per diluted common share compared with $1.18 per diluted common share in 2012.

º •
º Our EBITDA in 2013 increased to $26.2 million compared to $21.3 million in 2012.

º •
º We continued our trend of positive operating cash flow in 2013 of $20.8 million. We have generated positive operating cash flow each of the last eleven years.

What did we focus on in 2013?

In 2013, we focused on continuing to increase sales of converted product to fill out our converting capacity. Our efforts centered on new product development in both paper making and converting and combining those efforts with an effective sales and marketing plan. As a result of these efforts, we continued to expand our product offerings into the mid/premium tier market, creating new sales opportunities which resulted in shipments of 8.2 million cases, or approximately 53,000 tons, in 2013, a 16.2% increase over cases shipped in 2012. We achieved a new record for annual converted product net sales at $109.6 million and surpassed $100 million in total net sales for the second year. We also focused considerable efforts on controlling production costs while improving quality attributes, such as bathroom tissue softness, to supplement the higher product quality production capabilities of the new converting line. These efforts will continue in 2014 as we continue our efforts to expand into the mid/premium and ultra-premium tier markets.


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The following graph shows shipments of our mid-tier and premium tier products as a percentage of total cases shipped:

[[Image Removed: GRAPHIC]]

What challenges and opportunities did our business face in 2013?

The price of recycled fiber, the primary cost component in the production of parent rolls, decreased 10% in 2013 compared to 2012. Additionally, increased production in our converted product operation allowed for improved absorption of fixed costs, while increased penetration into the mid/premium tier market provided higher selling prices and gross margins on our converted products. However, we incurred higher than normal labor costs in our converting operation and external warehousing costs due to higher converted product sales levels. Strong cost controls in our paper manufacturing operation allowed us to reduce paper production costs, excluding non-cash depreciation, from $754 per ton in 2012 to $734 in 2013.

What will we focus on in 2014?

In 2014, we intend to continue to focus our sales and marketing efforts on obtaining new business to fill out our expected converting capacity of approximately 11.5 million cases, or 70,000 tons, and to support our vision of being recognized as a 100% retailer-focused, national supplier of high-quality consumer tissue products in the value, premium and ultra-premium tier markets. We intend to continue to focus our sales efforts on the mid/premium tier product categories and to broaden our customer base, as well as take advantage of strategic opportunities with existing customers. Through our new product development efforts, we believe we have positioned ourselves to produce higher quality tissue products with attractive cost characteristics that provide good price points for retailers and good value for consumers. In 2014, we intend to further build upon the mid/premium tier sales achieved during 2012 and 2013 and look to expand into the ultra-premium tier market to further increase our converted product sales.

Our paper-making operation will continue to work on quality improvement to provide enhanced product attributes for our converting operation, which will aid in our sales efforts to penetrate the higher quality mid/premium and ultra-premium tier market. We will begin installation of a new paper machine, which will replace two existing paper machines and provide improved quality and


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manufacturing flexibility, increased capacity and lower production costs beginning in the second quarter of 2015. We intend to begin dismantling the two existing paper machines in the fourth quarter of 2014 and start up the new paper machine in the first quarter of 2015. During this period, we expect to purchase approximately 4,800 tons of parent rolls to support the converting operation, which we believe will increase our operating costs by approximately $1.4 million. Following startup of the new machine in 2015, we expect our annual paper making capacity will increase to approximately 70,000 tons. We will continue our efforts to utilize this increased paper making capacity in our converting operation.

We intend to continue to focus on optimizing our existing operating assets in both converting and paper mill operations. Specific emphasis will be placed on maximizing the efficiency of our converting lines. Emphasis will continue to be placed on identifying root causes of issues that impede productivity and to identify ways to improve our overall production costs.

Business Overview

We are an integrated manufacturer of tissue products serving the private label, or "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 parent rolls not required by our converting operation to other converters. Our core customer base consists of dollar stores and other discount 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, their 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/premium tier and ultra-premium tier.

While our historical business strategy was 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, we have systematically invested in manufacturing assets to improve quality, expand our product offerings and strengthen our position as a low cost manufacturer in the mid/premium tier market. This began with the investment in a new paper machine in 2006 which provided the opportunity to produce parent rolls for value tier and mid/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. In 2013, we upgraded an existing converting line to increase manufacturing flexibility and capacity. In November of 2013, we announced projects to further increase our capacity to produce higher-quality mid/premium tier converted products and increase the flexibility of our manufacturing operation, including replacing two existing paper machines with a new paper machine and upgrading an existing converting line. Our products are sold primarily under our customers' private labels and, to a lesser extent, under our brand names such as Colortex®, My Size®, Velvet®, Big Mopper®, Linen Soft®, Soft & Fluffy®, Tackle® and Noble®. All of our converted product revenue is derived pursuant to 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. However, we do typically experience some mild seasonal softness in the first and fourth quarters of each year, primarily due to the effects of winter weather on consumers buying habits and occasional effects of holidays on shipping schedules. Changes in the national economy, in general, do not materially affect the market for our converted products.


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Our profitability depends on several key factors, including:

º •
º the market price of our product;

º •
º the cost of fiber used in producing paper;

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

º •
º 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 effect price increases. We expect these competitive conditions to continue.

At present, our parent roll production capacity exceeds the requirements of our converting operation. As result, we have excess parent rolls that we sell into the open market. Our strategy is to sell all of the parent rolls we manufacture as converted products which generally carry higher margins than parent rolls. We estimate that at 9.5 million cases, or 57,000 tons, of annual converted product production, we will consume all of our parent roll production in our converting operation and therefore any production beyond that estimate will result in the need to purchase parent rolls on the open market, which we expect would have an unfavorable impact on our gross profit margin. We expect our parent roll production capacity to increase to over 70,000 tons in 2015 with the completion of our previously announced project to replace two existing paper machines with a new machine.

Comparative Years Ended December 31, 2013, 2012 and 2011

Net Sales

                                                Years Ended December 31,
                                           2013             2012           2011
                                          (in thousands, except price per ton
                                                       and tons)
      Converted product net sales       $    109,611     $     90,505    $ 81,949
      Parent roll net sales                    6,763           10,314      15,894


      Total net sales                   $    116,374     $    100,819    $ 97,843
      Converted product tons shipped          52,592           43,661      39,104
      Parent roll tons shipped                 6,726           10,334      16,410


      Total tons shipped                      59,318           53,995      55,514

Net sales for the year ended December 31, 2013 increased $15.6 million, or 15.4%, to $116.4 million compared to $100.8 million for the year ended December 31, 2012. These net sales figures include gross selling price, including freight, less discounts and sales promotions. Net sales of converted product increased $19.1 million, or 21.1%, in the year ended December 31, 2013, to $109.6 million compared to $90.5 million in 2012. Net sales of parent rolls decreased $3.6 million, or 34.4%, in 2013, to $6.8 million compared to $10.3 million in 2012. The increase in converted product sales was primarily due to a 20% increase in converting tonnage shipped, and a 1% increase in net selling prices per ton in 2013 compared to 2012. The increased tonnage shipped was primarily due to new product sales, which were primarily in the mid and premium-tier markets. The decrease in parent roll sales was due to a 35% decrease in parent rolls shipped being partially offset by a 1% increase in the net sales price per ton. The decrease in parent roll shipments was primarily due to increased paper requirements in our converting operation due to the 20% increase in converted product shipments.

Net sales for the year ended December 31, 2012 increased $3.0 million, or 3.0%, to $100.8 million compared to $97.8 million for the year ended December 31, 2011. These net sales figures include gross selling price, including freight, less discounts and sales promotions. Net sales of converted product


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increased $8.6 million, or 10.4%, in the year ended December 31, 2012, to $90.5 million compared to $81.9 million in 2011. Net sales of parent rolls decreased $5.6 million, or 35.1%, in 2012, to $10.3 million compared to $15.9 million in 2011. The increase in converted product sales was primarily due to a 12% increase in converting tonnage shipped, partially offset by a 1% decrease in net selling prices per ton in 2012 compared to 2011. The increased tonnage shipped was primarily due to new products sold to existing customers, which were primarily mid-tier products, and increased sales of existing products. The decrease in parent roll sales was due to a 37% decrease in parent rolls shipped being partially offset by a 3% increase in the net sales price per ton. The decrease in parent roll shipments was due to increased paper requirements in our converting operation due to the 12% increase in converted product shipments.

Cost of Sales

                                                      Years Ended December 31,
                                                  2013             2012          2011
                                                 (in thousands, except gross profit
                                                     margin % and price per ton)
Cost of paper                                   $    43,949     $    42,566    $ 46,337
Non-paper materials, labor, supplies, etc.           36,932          28,146      28,497


Sub-total                                       $    80,881     $    70,712    $ 74,834
Depreciation                                          7,613           7,541       7,052


Cost of sales                                   $    88,494     $    78,253    $ 81,886
Gross Profit                                    $    27,880     $    22,566    $ 15,957
Gross Profit Margin %                                  24.0 %          22.4 %      16.3 %
Total paper cost per ton consumed               $       746     $       754    $    823

Major components of cost of sales are the cost of internally produced paper, raw materials, direct labor and benefits, freight on products shipped to customers, insurance, repairs and maintenance, energy, utilities and depreciation.

Cost of sales for the year ended December 31, 2013 increased $10.2 million, or 13.1%, to $88.5 million compared to $78.3 million in the year ended December 31, 2012. Cost of sales as a percentage of net sales was 76.0% in the 2013 period compared to 77.6% in the 2012 period. Cost of sales as a percent of net sales was positively affected by lower fiber costs, the effects of increased converted product shipments, and lower paper production costs, which were partially offset by external warehousing costs.

Paper production costs were $746 per ton in the year ended December 31, 2013, a decrease of $8 per ton compared to $754 per ton in the 2012 period. Paper product costs decreased primarily due to lower fiber prices, maintenance and repair costs and utility costs. Our cost of fiber in the year ended December 31, 2013 decreased approximately 8% compared to the same period of 2012, which decreased our cost of sales by approximately $1.1 million.

Depreciation expense increased slightly in 2013 due to 2012 and 2013 capital expenditures. Converting per unit production costs were unfavorable by approximately 4% to the prior year due to higher labor costs and external warehousing costs.

Cost of sales for the year ended December 31, 2012 decreased $3.6 million, or 4.4%, to $78.3 million compared to $81.9 million in the year ended December 31, 2011. This decrease in cost of sales was primarily attributable to lower cost of fiber. Cost of sales as a percentage of net sales was 77.6% in the 2012 period compared to 83.7% in the 2011 period. Cost of sales as a percent of net sales was positively affected by lower fiber costs, the effects of increased converted product shipments, and


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lower per unit converting production costs, which were partially offset by higher maintenance and repair costs in the paper manufacturing operation.

Paper production costs were $754 per ton in the year ended December 31, 2012, a decrease of $69 per ton compared to $823 per ton in the 2011 period. Paper product costs decreased primarily due to lower fiber prices, which were partially offset by higher maintenance expenses. Our cost of fiber in the year ended December 31, 2012 decreased approximately 23% compared to the same period of 2011, which decreased our cost of sales by approximately $5.0 million.

Depreciation expense increased due to 2012 capital expenditures. Converting per unit production costs were favorable by approximately 5% to the prior year due to the effects of increased converted product shipments on cost absorption and improved efficiencies in our converting plant.

Gross Profit

Gross profit increased by $5.3 million, or 23.5%, to $27.9 million in the year ended December 31, 2013, compared to $22.6 million in 2012. As a percentage of net sales, gross profit increased to 24.0% in 2013 compared to 22.4% in 2012. The gross profit margin increase was primarily due to higher converted product sales, lower fiber prices, and lower paper production costs, which were partially offset by external warehousing costs. As a result of the increased converted product sales, more tonnage was sold as converted products rather than parent rolls. This change in product mix positively affects our gross profit margin because converted products typically carry a higher margin than parent rolls.

Gross profit increased by $6.6 million, or 41.4%, to $22.6 million in the year ended December 31, 2012, compared to $16.0 million in 2011. As a percentage of net sales, gross profit increased to 22.4% in 2012 compared to 16.3% in 2011. The gross profit margin increase was primarily due to lower fiber prices, higher converted product sales and lower per unit converting production costs, which were partially offset by higher maintenance and repair costs in the paper manufacturing operation. As a result of the increased converted product sales, more tonnage was sold as converted products rather than parent rolls. This change in product mix positively affects our gross profit margin because converted products typically carry a higher margin than parent rolls.

Selling, General and Administrative Expenses

                                              Years Ended December 31,
                                            2013           2012       2011
                                           (In thousands, except SG&A as
                                                 a % of net sales)
           Commission expense             $    1,879       $ 1,401   $ 1,242
           Other S,G&A expenses                7,592         7,055     5,568


           Selling, General & Adm exp     $    9,471       $ 8,456   $ 6,810
           SG&A as a % of net sales              8.1 %         8.4 %     7.0 %

Selling, general and administrative (SG&A) expenses include salaries, commissions to brokers and other miscellaneous expenses. Selling, general and administrative expenses increased $1.0 million, or 12.0%, to $9.5 million in the year ended December 31, 2013 compared to $8.5 million in 2012. This increase was attributable to $504,000 in costs related to the transition to our new President and CEO, $478,000 in higher sales commissions due to higher converted product sales and, to a lesser extent, higher director related fees and expenses, including stock option expense, which were partially offset by lower professional fees. As a percentage of net sales, SG&A expenses decreased to 8.1% in 2013 compared to 8.4% in 2012.


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SG&A expenses increased $1.6 million, or 24.2%, to $8.5 million in the year ended December 31, 2012 compared to $6.8 million in 2011. This increase was attributable to higher professional fees, higher expense under our incentive bonus plan due to our higher earnings, higher artwork related expenses due to our new product development efforts, and higher commission expense due to the increase in converted product sales. As a percentage of net sales, SG&A increased to 8.4% in 2012 compared to 7.0% in 2011.

Operating Income

    As a result of the foregoing factors, operating income for the years ended
December 31, 2013, 2012 and 2011 was $18.4 million, $14.1 million and
$9.1 million, respectively.

Interest and Other (Income) Expense

                                              Years Ended December 31,
                                              2013        2012      2011
                                                   (In thousands)
             Interest expense               $     371   $    407   $   647
             Other (income) expense, net    $    (173 ) $    302   $   (42 )
             Income before income taxes     $  18,211   $ 13,401   $ 8,542

Interest expense includes interest paid and accrued on all debt and amortization of deferred debt issuance costs. See "Liquidity and Capital Resources" below. Interest expense for the year ended December 31, 2013 was $371,000, a decrease of $36,000 compared to $407,000 in the same period in 2012. This decrease was primarily attributable to lower borrowing levels and interest rates. For the year ended December 31, 2012, other (income) expense includes 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 year.

Interest expense for the year ended December 31, 2012 was $407,000, a decrease of $240,000 compared to $647,000 in the same period in 2011. This decrease was primarily attributable to lower borrowing levels and interest rates.

Income Before Income Taxes

As a result of the foregoing factors, income before income taxes increased $4.8 million, or 35.9%, to $18.2 million for the year ended December 31, 2013 compared to $13.4 million for the year ended December 31, 2012. Income before income taxes increased $4.9 million, or 57.6%, to $13.4 million for the year ended December 31, 2012 compared to $8.5 million for the year ended December 31, 2011.

Income Tax Provision

For the year ended December 31, 2013, income tax expense was $4.9 million, resulting in an effective tax rate of 26.9%. This rate is lower than the statutory rate primarily due to Oklahoma Investment Tax Credits ("OITC") associated with investments in our manufacturing operations, , tax benefits recognized when employees and board members exercised stock options during the year and Federal Indian Employment Credits ("IEC").

For the year ended December 31, 2012, income tax expense was $4.1 million, resulting in an effective tax rate of 30.9%. This rate is lower than the statutory rate primarily due to Oklahoma Investment Tax Credits ("OITC") associated with investments in our manufacturing operations and tax benefits recognized when employees and board members exercised stock options during the year.

Our current Oklahoma tax obligations for the year ended December 31, 2013 were satisfied by using our OITC carryforward. Our current Oklahoma tax obligations for the year ended December 31,


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2012 were satisfied by utilizing our OITC carryforward and our net operating loss ("NOL") carryforward. Our current Oklahoma tax obligations for the year ended December 31, 2011 were satisfied by using our NOL carryforward.

LIQUIDITY AND CAPITAL RESOURCES

Overview

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 and short-term investments. Our cash requirements have historically been satisfied through a combination of cash flows from operations and equity and debt financings.

As of December 31, 2013, we had cash on hand of $7.2 million and $5.0 million in short-term investments, compared to $5.7 million and $5.0 million as of December 31, 2012, respectively. On February 21, 2011, we initiated a quarterly cash dividend. The initial quarterly dividend payment was established at $0.10 per share and the per share dividends that have been paid are as follows:

                                         2011     2012     2013
                       First Quarter    $ 0.10   $ 0.20   $ 0.30
                       Second Quarter   $ 0.10   $ 0.20   $ 0.35
                       Third Quarter    $ 0.10   $ 0.20   $ 0.35
                       Fourth Quarter   $ 0.20   $ 0.25   $ 0.35


                       Total            $ 0.50   $ 0.85   $ 1.35

Quarterly dividends are approved and the payment amount is established based on our board of directors' review of our expected future cash flows, our balance sheet leverage and future capital requirements. The Board of Directors will evaluate the appropriate dividend payment on a quarterly basis. While we expect to continue to declare quarterly dividends, the payment of future dividends is at the discretion of the board of directors and the timing and amount of any future dividends will depend upon earnings, cash requirements and financial condition of the Company.

Capital expenditures for 2014 are estimated at $22.9 million, including approximately $3.9 million for normal recurring capital expenses and $19.0 million for improvement projects, including building a new paper machine in our paper mill and upgrading a current converting line. We believe approximately $8.0 million related to building the new paper machine will be incurred in 2015. We expect to fund the improvement projects with a combination of cash and short-term investments on hand, cash from operations and additional borrowings of up to $20 million.

. . .

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