UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

 Washington, D.C. 20549

 

FORM 10-K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2014

 

OR

 

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

  

For the transition period from                        to                       

 

Commission File Number: 001-32563

 

ORCHIDS PAPER PRODUCTS COMPANY

 

 

A Delaware corporation

(State or other jurisdiction of

incorporation or organization)

23-2956944

(I.R.S. Employer

Identification Number)

 

 

4826 Hunt Street

Pryor, Oklahoma 74361

(Address of principal executive offices)

 

          Registrant's telephone number, including area code: (918) 825-0616

 

          Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Common Stock, $0.001 Par Value

 

NYSE MKT

       

          Securities registered pursuant to Section 12(g) of the Act: None

 

          Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes     No 

 

          Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes     No 

 

          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 requirements for the past 90 days. Yes      No 

 

          Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes      No 

 

          Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    

 

          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 definition of "accelerated filer", "large accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check One).

 

Large Accelerated Filer 

Accelerated Filer 

Non-accelerated Filer 

(Do not check if a smaller reporting company)

Smaller Reporting Company 

      

          Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes     No 

 

          The aggregate market value of the registrant's common equity held by non-affiliates was approximately $251.0 million as of June 30, 2014.

 

          As of March 1, 2015, there were outstanding 8,759,225 shares of common stock, none of which are held in treasury.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

          Portions of the definitive Proxy Statement for the Registrant's 2015Annual Meeting of Stockholders (the "Annual Meeting of Stockholders") to be filed within 120 days after December 31, 2014, are incorporated by reference into Part III of this Form 10-K. 

 
 

 

 

TABLE OF CONTENTS

 

 

  Page
  Part I  
     

Item 1.

Business

3

Item 1A.

Risk Factors

12

Item 1B.

Unresolved Staff Comments

21

Item 2.

Properties

21

Item 3.

Legal Proceedings

22

Item 4.

Mine Safety Disclosures

22

     

 

Part II

 

     

Item 5.

Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

22

Item 6.

Selected Financial Data

24

Item 7.

Management's Discussion and Analysis of Financial Condition and Results of Operations

26

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

44

Item 8.

Financial Statements and Supplementary Data

45

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

72

Item 9A.

Controls and Procedures

72

Item 9B.

Other Information

72

     

 

Part III

 

     

Item 10.

Directors, Executive Officers and Corporate Governance

73

Item 11.

Executive Compensation

73

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

73

Item 13.

Certain Relationships and Related Transactions, and Director Independence

74

Item 14.

Principal Accountant Fees and Services

74

     

 

Part IV

 

     

Item 15.

Exhibits and Financial Statement Schedules

75

Signatures

76

 

 

 
2

 

 

PART I

 

            Throughout this Form 10-K we "incorporate by reference" certain information from parts of other documents filed with the Securities and Exchange Commission (the "SEC"). The SEC allows us to disclose important information by referring to it in that manner. Please refer to such information.

 

            In Item 1A, we discuss some of the business risks and factors that could cause the Company's actual results to differ materially from those stated in our forward-looking statements and from our historical results.

 

Item 1.    BUSINESS

 

Overview of Our Business

 

We are an integrated manufacturer of tissue products serving the private label, or "at-home" market and, to a lesser extent, the “away from 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 in the “at home” market 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. Our focus to date has been 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, premium tier and ultra-premium tier. Our core customer base in the “away from home” market consists of companies in the janitorial market and food service market. Most of the products we sell in the “away from home” market are included in the value tier. While we expect to continue to service this market in the near term, we do not consider the “away from home” market a growth vehicle for us.

 

Since 2006, we have systematically invested in our manufacturing assets to improve quality, increase capacity, expand our product offerings and strengthen our position as a low cost manufacturer across the market tier spectrum, including the value, premium and ultra-premium tiers. In 2010, we undertook an expansion project that included the purchase and installation of a converting line and the construction of a converted product warehouse. This project had three main objectives: increase the capacity of our converting operation, provide the capability to produce higher-quality premium and ultra-premium tier converted products and reduce warehousing costs by decreasing our utilization of third-party warehouses. In November of 2013, we announced projects to further increase our capacity to produce higher-quality premium and ultra-premium tier converted products and increase the flexibility of our manufacturing operation, including replacing two older paper machines with a new paper machine and installing a new converting line.

 

In June 2014, we completed a transaction with Fabrica de Papel San Francisco, S.A. de C.V. (“Fabrica”).  Fabrica is a privately owned company that started as a tissue converter in 1958 and produces parent rolls, paper towels, bathroom tissue and paper napkins.  It has grown to 165,000 tons of capacity, one of the largest tissue manufacturers by capacity in Mexico.  As part of the transaction, we acquired certain assets from Fabrica, including Fabrica’s U.S. business, which is primarily in the western United States. Additionally, we entered into a supply agreement (the “Supply Agreement”) with Fabrica that provides us the option to purchase up to 19,800 tons of product each year.  We may purchase up to an additional 7,700 tons annually in each of the first two years of the agreement. The Supply Agreement and related transactions with Fabrica further increases our capacity to service customers in the premium and ultra-premium market tiers primarily in the western United States. Fabrica also agreed to a non-compete in the United States until two years after the termination of the Supply Agreement, if the Supply Agreement is terminated prior to 18 years after the closing of the transaction, or 20 years after the closing of the transaction, if the Supply Agreement is not terminated prior to 18 years after such closing. The acquisition of certain assets and the U.S business of Fabrica and entrance into the Supply Agreement are referred to elsewhere in this document as the “Fabrica Transaction”

 

While we have customers located throughout the United States, we focus our sales efforts on areas within approximately 500 miles of our manufacturing facility in Oklahoma and Fabrica’s manufacturing facility in Mexicali, Mexico, as we believe this radius maximizes our freight cost advantage. Because we are one of the few tissue paper manufacturers in the areas around both our Oklahoma and Fabrica’s Mexicali facilities, we typically have lower freight costs to our customers' distribution centers located in our target regions. Our target region around our Oklahoma facility includes Texas, Oklahoma, Kansas, Missouri and Arkansas. The transaction with Fabrica has allowed us to more effectively service customers that are located on the West Coast by directly shipping them products that are produced in Mexico under the Supply Agreement. As a result, this transaction has allowed us to expand our target region to include California, Nevada, Arizona, New Mexico and Utah. Growth in the “at-home” tissue market has historically been closely correlated to population growth and as such, performs well in a variety of economic conditions. Our expanded target region has experienced strong population growth for the past fourteen 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 Colortex®, My Size®, Velvet®, Big Mopper®, Linen Soft®, Soft & Fluffy®, and Tackle®. The Fabrica Transaction gave us the exclusive right to sell products under Fabrica’s brand names into the United States, including under the names Virtue®, Truly Green®, Golden Gate Paper® and Big Quality®. All of our converted product net sales are derived through truck load purchase orders from our customers. Parent roll net sales are 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 generally no significant seasonal fluctuations. However, we 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, reduced promotional activity 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.

 

 
3

 

 

             Our profitability depends on several key factors, including but not limited to:

 

 

the volume of converted product sales;

 

the cost of fiber used in producing paper;

 

the market price of our products;

 

the efficiency of operations in our paper mill and converting facilities; 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 effect price increases. We expect these competitive conditions to continue.

 

            In 2014, we generated net sales of $142.7 million, of which 97% came from the sale of converted products and 3% came from the sale of parent rolls. Our converted product consisted of 53% from paper towels, 44% from bathroom tissue, and 3% from paper napkins. In 2014, 71% of our converted product net sales came from three discount retailers and one grocery store. The balance of 2014 converted product net sales came from other discount retailers, grocery stores, grocery wholesalers and cooperatives, convenience stores, janitorial supply companies and companies in the food service market.

 

            We purchase various types of fibers to manufacture bulk rolls of tissue paper, called "parent rolls," which we then convert into a broad line of finished tissue products. The fiber we source to manufacture our parent rolls primarily consists of pre-consumer recycled grades, with a lesser amount consisting of virgin kraft grades. As we continue our efforts to expand our product offerings into the higher quality tiers of the market, the percentage of virgin kraft grades that we purchase will likely increase. Our paper mill has a pulping process which takes recycled fibers and kraft fibers and processes them for use in our three paper machines. Our pulping operation has the ability to selectively process our basket of fibers by specific recipe to achieve maximum quality and to control costs. In March of 2015, we replaced two of our older paper machines with a new paper machine, which we expect will increase our tissue paper making capacity from approximately 57,000 tons to approximately 74,000 tons, depending upon the mix of paper grades produced. We also expect the new machine to reduce our manufacturing costs, improve product quality and increase manufacturing flexibility.

 

The capacity of our eleven converting lines is highly dependent upon the mix of products produced (e.g. bath tissue versus paper towels versus napkins) and the configuration of products produced (e.g. one roll pack versus multi-roll packs, the size of multi-roll packs (6-count versus 8-count versus 12-count), and sheet counts). Current and expected product configurations and efficiencies reflect an annual converting capacity of approximately 11.5 million cases, or 70,000 tons, of finished tissue products.

 

We adjust our paper making production based on our internal converting need for parent rolls and the open market demand for parent rolls. We intend to continue selling any surplus parent rolls into the open market. However, as parent rolls are a commodity product, they are subject to market pricing, generally resulting in lower margins than sales of our converted products. If our converting production needs exceed our paper making capacity, we supplement our paper making capacity by purchasing parent rolls on the open market, which we believe has an unfavorable impact on our gross profit margin. During the construction phase of our new paper machine, our total tissue paper production was reduced and we were required to purchase parent rolls on the outside market during the fourth quarter of 2014 and first quarter of 2015 to meet our converting requirements. In 2014, we ran all of our paper machines on a full-time basis until we began decommissioning two older paper machines in September of 2014 in preparation of construction and installation of the new paper machine.

 

 
4

 

 

History

 

            We were formed in April 1998 to acquire our present facilities located in Oklahoma out of a predecessor company's bankruptcy and subsequently changed our name to Orchids Paper Products Company. In March 2004, Orchids Acquisition Group, Inc. acquired us for a price of $21.6 million. Orchids Acquisition Group, Inc. was formed exclusively for the purpose of acquiring all of the outstanding shares of Orchids Paper Products Company, and was subsequently merged into us. In July 2005, we completed our initial public offering. The net proceeds of $15.0 million were used to partially finance the construction and start-up of a new paper machine. In 2009, we completed a follow-on offering to partially finance a major converting expansion project, which cost approximately $27 million. We received net proceeds of approximately $14.8 million from that offering, after deducting the underwriting discount and offering expenses. In 2014, in conjunction with the Fabrica Transaction, we acquired certain paper-making and converting assets located in Mexicali, Mexico, as well as Fabrica’s U.S. business.

 

            Our strategy is to be a national supplier of high quality consumer tissue products in the value, premium and ultra-premium tier product segments of the tissue market. We believe we will achieve this strategy by expanding our position as a low-cost provider of high-quality private label tissue products to the growing discount retail channel and others in the “at home” market while leveraging our competitive advantages to increase our presence in the premium and ultra-premium tier markets within the discount retail channel and other retail channels. We plan to accomplish this through the expansion of our product offerings through new product development, investment in manufacturing equipment that provides continued flexibility and the ability to produce higher-quality products at a lower cost structure, and leveraging our partnership with Fabrica to positively affect our national recognition, produce higher-quality products and further improve operational efficiencies.

 

            Since our inception, we have strategically expanded capacity and capability in both paper manufacturing and finished product converting to meet market demand and customers' quality requirements. Our strategy is to sell all of the parent rolls we manufacture as converted products, which generally carry higher margins than non-converted parent rolls. In 2014, we entered into the Fabrica Transaction, which provided additional capacity to service customers and additional capabilities to produce products for the premium and ultra-premium tier market segments. We believe installation of a new paper machine in our Oklahoma facility, which started up in early March 2015 and is anticipated to achieve full operating rates by the end of March 2015, and installation of a new converting line in our Oklahoma facility, which is expected in mid-2015, will bring our manufacturing capacity in line with our paper production capacity, at approximately 74,000 tons. The paper machine will produce a broad range of paper grades that are utilized in manufacturing value and premium tier products, reduce manufacturing costs and increase production flexibility. The new converting line will further improve manufacturing flexibility and capacity in our converting operation. 

 

Competitive Conditions

 

            We believe the principal competitive factors in the markets in which we operate are quality attributes, price and service, and that our competitive strengths with respect to other private label manufacturers include long-standing relationships with discount retailers, a broad line of products and flexible converting capabilities, which enables us to produce tissue products in a variety of sizes, packs and weights. This flexibility allows us to meet the particular demands of individual retailers. We believe the product quality attributes that can be produced from our converting lines, new processes on our newest paper machines and other new product development initiatives will allow us to effectively compete in the higher tier markets.

 

            Competition in the tissue market is significantly affected by geographic location, as freight costs represent a material portion of end product costs. We believe it is generally economically feasible for us to ship within an approximate 900-mile radius of the production site; however we primarily focus on an approximate 500-mile radius, as we believe this radius maximizes our freight cost advantage over our competitors. In Oklahoma and the surrounding area, we believe that Georgia-Pacific's Muskogee, Oklahoma plant, Cascades' Memphis, Tennessee plant, Pacific Paper's Memphis, Tennessee plant, Sofidel’s Tulsa, Oklahoma converting plant and Clearwater Paper Corporation's Oklahoma City, Oklahoma plant are the only significant competing plants in this region. Our competitors also have plants in the 500-mile radius from Fabrica’s Mexicali plant, including Royal Paper in Arizona, Cascades in Arizona, Clearwater in Nevada, Sofidel in Nevada and Asia Pulp and Paper in California. However, we face greater competition in the Southeast and Midwest regions of the United States. Georgia-Pacific has additional plants in Georgia, Louisiana and Wisconsin; Cascades has plants in Pennsylvania, Wisconsin, and North Carolina; and Clearwater Paper Corporation has plants in Georgia, Idaho, Illinois, Mississippi, New York, North Carolina and Wisconsin.

 

            The private label tissue market is highly fragmented and we believe the number of competitors in the private label market will not significantly increase in the near future because of the large capital expenditures required to establish a paper mill and converting facility and difficulties in obtaining environmental and local permits for parent roll manufacturing facilities.

 

 
5

 

 

Product Overview

 

            We offer our customers an array of private label products, including bathroom tissue, paper towels and paper napkins, across the value, premium and ultra-premium market segments. In 2014, 53% of our converted product case shipments were paper towels, 44% were bathroom tissue and 3% were paper napkins. Of our converted products sold in 2014, 74% were packaged as private label products in accordance with our customers' specifications. The remaining 26% were packaged under our brands and those licensed from Fabrica, including Colortex®, My Size®, Velvet®, Big Mopper®, Linen Soft®, Soft & Fluffy®, Tackle®, Virtue®, Truly Green®, Golden Gate Paper® and Big Quality®. We do not actively promote our brand names and do not believe our brand names have significant market recognition. Products with our brand names are primarily sold to smaller customers who use them as their in-store labels. Our core customer base consists of discount retailers (including dollar stores). We also sell our products to grocery stores, grocery wholesalers and cooperatives, convenience stores, janitorial supply stores and stores in the food service market. Our recent growth has come from providing products from all market tiers to discount retailers, primarily dollar stores, as well as grocery stores. We believe we were among the first to focus on serving customers in the discount retail channel and we have benefited from their increased emphasis on consumables, such as tissue products and the expansion of their private label product line into higher tiers as part of their merchandising strategies. By seeking to provide improved product quality, consistently competitive prices, and superior customer service, we believe we have differentiated ourselves from our competitors and generated momentum with discount retailers. In 2014, approximately 67% of our converted product net sales was derived from sales to the discount retail channel.

 

            With strategic capital investments and new product development work on our paper machines and converting equipment, we are able to provide higher quality products and broaden our product offering into the higher tier markets through improved quality of paper, increased packaging configurations, enhanced graphics and improved embossing. In 2011, we began to place premium and ultra-premium tier products with certain of our customers and have been able to achieve significant growth in these market segments. The following graph shows shipments of our premium and ultra-premium tier products as a percentage of total cases shipped:

 

 

 

        

Our ability to increase net sales depends significantly upon the growth of our largest customers, as well as our ability to increase business with other discount retailers, increase business in the grocery chain market, increase our share of the premium and ultra-premium tier markets and take market share from our competitors. We are focusing on diversifying our customer base and reducing customer concentration by implementing private label programs with grocery store customers and new discount retailers, but it is likely our business will remain concentrated among discount retailers for the foreseeable future.

 

 

 
6

 

 

            Our largest customers are Dollar General, Family Dollar, HEB and Wal-Mart. Sales to these four customers represented 71% of our converted product sales in 2014.

 

            The following provides additional details regarding our relationships with our largest customers:

 

            Dollar General.    Dollar General is our largest customer, accounting for approximately 40% of our net sales in 2014. With annual revenue of $17.5 billion and more than 11,000 stores in 40 states, Dollar General is the largest small-box discount retailer in the United States. We currently supply value tier products to over half of Dollar General's eleven distribution centers and supply premium tier products to less than half of Dollar General's distribution centers.

 

            HEB.    HEB became our second largest customer in 2014, primarily due to business gained in the Fabrica Transaction, accounting for approximately 12% of our net sales. HEB is one of the largest independent food retailers in the United States with stores in more than 150 communities in Texas and Mexico. We currently supply value and premium tier products to HEB. We currently supply value tier products to all of the HEB distribution centers.

        

Family Dollar.    Family Dollar is our third largest customer, accounting for approximately 11% of our net sales in 2014. Family Dollar has become one of the leading discount retailers in the industry with more than 8,100 stores in 46 states and sales in excess of $10 billion. Family Dollar currently has ten distribution centers throughout the United States. We currently supply value tier products to six of Family Dollar's distribution centers and premium tier products to half of Family Dollar's distribution centers.

 

            Wal-Mart.    Wal-Mart is our fourth largest customer, accounting for approximately 9% of our net sales in 2014. Wal-Mart is the largest discount retailer in the United States, with U.S. sales of more than $279 billion and more than 4,000 stores in the U.S. We currently serve 25 distribution centers with value tier products.

 

Sales and Marketing Team

 

            We maintain an internal sales team of six employees led by our Vice President of Sales and Marketing. Our sales staff directly services six customers representing approximately 30% of our sales in 2014 and indirectly services all other customers by supervising our network of approximately 40 brokers. Our sales staff and broker network are instrumental in establishing and maintaining strong relationships with our customers. Our management team recognizes that these brokers have relationships with many of our customers and we work with these brokers in an effort to increase our business with these accounts. Our sales and marketing organization seeks to collaborate with our brokers to leverage these relationships. With each of our key customers, however, our senior management team participates with the independent brokers in all critical customer meetings to establish and maintain direct customer relationships.

 

            A majority of our brokers provide marketing support to their retail accounts which includes shelf placement of products and in-store merchandising activities to support our product distribution. We generally pay our brokers commissions ranging from 1% to 3% of the sales they generate. Commissions totaling $1.6 million and $1.9 million were paid in the years ended December 31, 2014 and 2013, respectively.

 

 
7

 

 

Manufacturing

 

We own and operate a paper mill, converting facility and a finished goods warehouse, which are all located at our headquarters in Pryor, Oklahoma. Additionally, as a result of the Fabrica Transaction, we own paper making and converting assets in Mexicali, Mexico, which are operated by Fabrica under a lease agreement (“Equipment Lease Agreement”). The following table sets forth our volume, in tons, of parent rolls manufactured, sold, purchased and converted for each of the past five years, including products produced in Mexico by Fabrica subsequent to the Fabrica Transaction in June 2014:

 

   

2014

   

2013

   

2012

   

2011

   

2010

 

Total Manufactured

    68,023       57,734       56,775       56,145       55,765  

Sold to Third Parties

    (4,922 )     (6,726 )     (10,334 )     (16,410 )     (20,537 )

Purchased from Third Parties

    492       1,155       -       -       -  

Converted

    63,593       52,163       46,441       39,735       35,228  

 

Oklahoma Facility

 

            Our Oklahoma paper mill, which consists of two facilities totaling 162,000 square feet and a 23,000 square foot paper warehouse, produces parent rolls that are then converted into tissue products at our adjacent converting facility or are sold to other converters. The paper mill facility has three paper machines which produce paper made primarily from pre-consumer solid bleached sulfate paper, or "SBS paper." We utilize these high grades of recycled fiber along with a basket of other fibers, including virgin bleached pulp kraft fiber such as northern bleached softwood, eucalyptus and northern bleached hardwood, to produce our parent rolls. The mix of fiber used is dependent upon the quality attributes required for the particular grades of product. As we continue our efforts to gain converted product business in the higher quality premium and ultra-premium tier markets, we expect to increase our use of virgin bleached pulp kraft fiber to produce a portion of the paper that will service these higher tier markets.

        

Generally, our Oklahoma paper mill operates 24 hours a day, 362 days a year, with a three-day annual planned maintenance shutdown. Our parent roll production capacity typically exceeds the requirements of our converting operation and any excess parent rolls that we have we sell into the open market. However, in September of 2014, we demolished two older paper machines in order to begin construction of the new paper machine. As a result, we purchased parent rolls from third parties during the fourth quarter of 2014. During 2013, we purchased parent rolls from third parties due to an anticipated short-term increase in converted product shipments that we believed would exceed our parent roll manufacturing capacity.

 

            We convert parent rolls into finished tissue products at our converting facility. The converting process, which varies slightly by product category, generally includes embossing, laminating, and perforating or cutting the parent rolls as they are unrolled; pressing two or more plies together in the case of multiple-ply products; printing designs for certain products and cutting into rolls or stacks; wrapping in polyethylene film; and packing in corrugated boxes or on display-ready pallets for shipment.

 

            In our 300,000 square-foot converting facility, we operate our higher-speed, more flexible converting lines on a 24 hours a day 7 days a week schedule and utilize our other converting lines as needed. We believe this schedule allows us to provide world-class customer service while optimizing our operating costs. Planned strategic upgrades in 2015 are expected to result in another high-speed, flexible converting line. The converting facility produced approximately 8.0 million cases, or 51,000 tons, in 2014.

 

            One of the key advantages of our converting plant is its flexible manufacturing capabilities, which enables us to provide our customers with a variety of package sizes and format options and enables our customers to fit products into particular price categories. We believe our converting facility, together with our low direct labor costs and overhead, combine to produce relatively low overall operating costs.

 

            Our 245,000 square foot finished goods warehouse is located adjacent to our converting facility and has the capacity to hold approximately 600,000 cases of finished product. Our normal finished goods inventory level is three to four weeks of sales. Current sales projections for 2015 indicate that we will be required to continue to utilize third-party warehousing space obtained in 2013 to accommodate the inventory required to meet our sales forecast and to maintain our high level of customer service.

 

Mexico Assets

 

The paper making and converting equipment we own in Mexico, which has a net book value of $6.9 million at December 31, 2014, is operated by Fabrica under the Equipment Lease Agreement entered into in conjunction with the Fabrica Transaction. In accordance with the terms of the transaction, Fabrica has discretion on the most effective manner in which to use these assets. Fabrica may use these assets to provide parent rolls or products under the Supply Agreement and or to manufacture products sold to its customers. The terms of the Supply Agreement allow us to purchase up to 19,800 annual tons (27,500 tons in the first two years of the agreement) of converted products or parent rolls from Fabrica. In accordance with terms of the transaction, items produced under the Supply Agreement may also be manufactured on Fabrica’s paper making assets, which can produce quality grades ranging from the value tier to the ultra-premium tier, using the latest paper machine technology.

 

 
8

 

 

Distribution

 

            Our products are delivered to our customers in truckload quantities. For shipments from our Oklahoma location, most of our customers arrange for transportation of our products to their distribution centers. In 2014, approximately 76% of our shipments from Pryor were picked up by the customer or their agent. For our remaining shipments, we arrange for third-party freight companies to deliver the products. In 2014, Fabrica arranged for third-party freight companies to deliver shipments under the Supply Agreement.

 

Raw Materials and Energy

 

            In our Oklahoma facility, the principal raw materials used to manufacture our parent rolls are fiber, primarily recycled fibers and to a lesser extent virgin kraft fibers, and water. Currently, recycled fiber accounts for a majority of the fiber used to produce our parent rolls. The pulping process at the paper mill is currently configured to primarily process a particular class of recycled fiber known as SBS paper. Pursuant to an exclusive supply agreement, Dixie Pulp and Paper, Inc. supplies all of our recycled fiber needs under an evergreen contract. Under the terms of the contract, unless either party gives notice at least ninety days prior to the end of the term, the agreement automatically renews each year for one additional year. This agreement is intended to ensure our long-term supply of quality recycled fiber on terms that we believe are reasonable. If we were unable to purchase a sufficient quantity of SBS paper or if prices materially increased, we could reconfigure our pulping plant to process other forms of fiber, or we could use an alternative type of fiber with our existing pulping process. Reconfiguring our pulping plant would require additional capital expenditures, which could be substantial. Purchasing alternative types of fiber could result in higher fiber costs. We seek to assure we have adequate supplies of SBS paper by maintaining approximately a three-week inventory. We use virgin kraft fibers in the production of premium and ultra-premium tier products. As our business in that market segment continues to grow, we expect our consumption of virgin kraft fiber will increase.

 

             Energy is a key cost factor in our business operations. We source our electricity from the Grand River Dam Authority. In 2006, in connection with our purchase of a new paper machine, we installed a natural gas fired boiler to supply our own steam. We utilize a third-party energy supplier to purchase all of our natural gas requirements through a combination of fixed price contracts and a program established by the third party that utilizes a combination of fixed price contracts, options and spot purchases. We have the following fixed price contracts in effect:

 

Effective April 1, 2009, we entered into a fixed price contract to supply approximately 60% of our natural gas requirements, or 334,000 MMBTUs per year. Subsequently, the agreement has been extended to supply approximately 70% of our natural gas requirements through December 2017 as follows:

 

Period

 

MMBTUs

   

Price per MMBTU

   

Management fee per MMBTU

 

April 2011 - March 2012

    334,207     $ 6.50     $ 0.07  

April 2012 - March 2013

    334,207     $ 5.50     $ 0.07  

April 2013 - December 2014

    556,886     $ 4.905     $ 0.07  

April 2013 - September 2013

 

additional 5,000/month

    $ 4.70     $ 0.07  

October 2013 - March 2014

 

additional 5,000/month

    $ 4.75     $ 0.07  

April 2014 - December 2014

 

additional 5,000/month

    $ 4.70     $ 0.07  

January 2015 - March 2015

    95,900     $ 4.50     $ 0.07  

April 2015 - June 2015

    93,600     $ 4.30     $ 0.07  

July 2015 - September 2015

    92,300     $ 4.35     $ 0.07  

October 2015 - December 2015

    91,900     $ 4.50     $ 0.07  

January 2016 - March 2016

    95,900     $ 4.53     $ 0.07  

April 2016 - June 2016

    93,600     $ 4.17     $ 0.07  

July 2016 - September 2016

    92,300     $ 4.26     $ 0.07  

October 2016 - December 2016

    91,900     $ 4.42     $ 0.07  

January 2017 - December 2017

    467,505     $ 4.06     $ -  

 

 
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The remainder of our natural gas requirements through December 2017 are expected to be purchased on the open market.

 

Backlog

 

        Our tissue products generally require short production times. Typically, we have a backlog of approximately two weeks of sales. As of December 31, 2014, our backlog of customer orders was 549,792 cases, or approximately $7.4 million, of finished converted products for shipments from Oklahoma and from Mexico under the Supply Agreement and no backlog of parent rolls. As of December 31, 2013, our backlog of customer orders was 286,119 cases of finished converted products and 140 tons of parent rolls, or approximately $4.1 million.

 

Trademarks and Trade Names

 

            We sell some of our tissue products under our various brand names, including Colortex®, My Size®, Velvet®, Big Mopper®, Linen Soft®, Soft & Fluffy®, and Tackle®. We also sell tissue products under brand names licensed from Fabrica, such as, Virtue®, Truly Green®, Golden Gate Paper® and Big Quality®. Our brand names are trademarked with the United States Patent and Trademark Office. We intend to renew our registered trademarks prior to expiration. We do not believe these trademarks are significant corporate assets. Products with our brand names are primarily sold to smaller customers, who use them as their in-store labels.

 

Employee and Labor Relations

 

            As of December 31, 2014, we had approximately 313 full time employees of whom 254 were union hourly employees and 59 were non-union salaried employees. Of our employees, approximately 289 were engaged in manufacturing and production, 24 were engaged in sales, clerical and administration, and 2 were engaged in engineering. Our hourly employees are represented under collective bargaining agreements with the United Steel, Paper and Forestry, Rubber, Manufacturing, Energy, Allied Industrial & Service Workers International Union Local 5-930 and Local 5-1480 at the mill and converting facility, respectively. In 2015, we negotiated a new three-year contract with our hourly employees at the mill which expires in February 2018. In 2012, we negotiated a new four-year contract with our hourly employees in the converting plant which expires on June 25, 2016. We have not experienced a work stoppage in the last ten years and no grievance proceedings, material arbitrations, labor disputes, strikes or labor disturbances are currently pending or threatened against us. We believe we have good relations with our union employees at each of our facilities.

 

 
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Environmental, Health and Safety Matters

 

            Our operations are subject to various environmental, health and safety laws and regulations promulgated by federal, state and local governments. These laws and regulations impose stringent standards on us regarding, among other things, air emissions, water discharges, use and handling of hazardous materials, use, handling and disposal of waste, and remediation of environmental contamination. Since our products are made primarily from SBS paper, we do not make extensive use of chemicals.

 

            The U.S. Environmental Protection Agency (the "EPA") requires that certain pulp and paper mills meet stringent air emissions and waste water discharge standards for toxic and hazardous pollutants. These standards are commonly known as the "Cluster Rules." Our operations are not subject to the current "Cluster Rules." If however, due to a revision in the Cluster Rules or a change in our operations we were to become subject to the Cluster Rules, we might need to incur significant capital expenditures in order to become compliant.

 

            We believe our manufacturing facilities are in compliance in all material respects with all existing federal, state and local environmental regulations, but we cannot predict whether more stringent air, water and solid waste disposal requirements will be imposed by government authorities in the future. Pursuant to applicable federal, state and local statutes and regulations, we believe that we possess, either directly or through the Oklahoma Ordinance Works Authority ("OOWA"), all of the environmental permits and approvals necessary for the operation of our facilities.

 

            OOWA, the operator of the industrial park in which we operate, holds the waste water permit that covers our facilities and controls, among other things, the level of biological oxygen demand ("BOD") and total suspended solids ("TSS") we are allowed to send to the OOWA following pre-treatment at our facility. The OOWA reduced our BOD and TSS limits effective with a permit issued August 1, 2007. We have invested capital in recent years to improve the capability and increase capacity in our waste water treatment facility and believe our facility is well suited to meet our current permit limits.

 

Our assets in Mexicali are operated by Fabrica under the Equipment Lease Agreement entered into as part of the Fabrica Transaction. In accordance with the terms of this agreement, Fabrica has indemnified us from and against any and all claims, actions, suits, losses, damage, demands and liabilities of every nature in any way arising directly or indirectly from the use, possession, maintenance, operations or control of the equipment located in Mexico, including environmental matters.

 

Executive Officers and Key Employees

 

             Set forth below is the name, age as of March 5, 2015, position and a brief account of the business experience of each of our executive officers. Each of Messrs. Schoen and Schroeder served in the capacities set forth below as of December 31, 2014 and continue to serve in such capacities as of the date of this report.

 

Name

 

Age

 

Position

Jeffrey S. Schoen

    54  

Chief Executive Officer and President, Director

           

Keith R. Schroeder

    59  

Chief Financial Officer

 

 

 
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Jeffrey S. Schoen, 54, Chief Executive Officer and President, Director

 

            Mr. Schoen was appointed President and Chief Executive Officer of Orchids Paper Products in November 2013. Mr. Schoen joined the Board of Directors of Orchids Paper Products in February 2007 and served as Chairman from May 2013 to November 2013. Mr. Schoen worked for Cumberland Swan Holdings, Inc., a manufacturer of private label personal care products, from 2002 to 2006, last serving as Executive Vice President and General Manager. Mr. Schoen worked for Paragon Trade Brands, Inc., a manufacturer of private label disposable diapers and training pants, from 1999 to 2002, last serving as Vice President-Operations. Mr. Schoen held various positions when he worked for Kimberly Clark—Infant Care, from 1985 to 1993, last serving as Maintenance & Stores Manager.

 

Keith R. Schroeder, 59, Chief Financial Officer

 

            Mr. Schroeder has been our Chief Financial Officer since January 2002. Prior to joining us, he served as Corporate Finance Director for Kruger, Inc.'s tissue operations from October 2000 to December 2001 and as Vice President of Finance and Treasurer of Global Tissue from 1996 to October 2000. Global Tissue was acquired by Kruger, Inc. in 1999. Prior to joining Global Tissue, Mr. Schroeder held a number of finance and accounting positions with Cummins, Inc. and Atlas Van Lines. Mr. Schroeder is a certified public accountant and holds a BS degree in Business Administration with an accounting major from the University of Evansville.

 

Available Information

 

             We file annual, quarterly and current reports and other information with the Securities and Exchange Commission (the "SEC"). You may read and copy any document we file with the SEC at the SEC's public reference room at 100 F Street, NE, Washington, DC 20549. Please call the SEC at 1-800-SEC-0330 for information on the public reference room. The SEC maintains an internet site that contains annual, quarterly and current reports, proxy and information statements and other information that issuers (including Orchids Paper Products Company) file electronically with the SEC. The SEC's internet site is www.sec.gov. In addition, we make available free of charge our annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K through our website at www.orchidspaper.com. Such reports are made available as soon as reasonably practicable after they are filed with or furnished to the SEC. Information available on the website is not incorporated by reference and is not deemed to be part of this Form 10-K.

 

Item 1A.    RISK FACTORS

 

            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 below may cause our actual results, performances or 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 risk factors set forth below are not exhaustive and are not the only risks that may affect our business. Our business could also be affected by additional risks not currently known to us or described below. We may amend or supplement the risk factors described below from time to time in other reports we file with the SEC in the future.

 

Risks Related To Our Business

 

We face intense competition and if we cannot successfully compete in the marketplace, our business, financial condition and operating results may be materially adversely affected.

 

            The consumer market for private label tissue products is highly competitive. Many of our competitors have greater financial, managerial, sales and marketing and capital resources than we do, which may allow them to respond more quickly to new opportunities or changes in customer requirements. These competitors may also be larger in size or scope than us, which may allow them to achieve greater economies of scale or allow them to better withstand periods of declining prices and adverse operating conditions.

 

 
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             Our ability to successfully compete depends upon a variety of factors, including:

 

 

aggressive pricing by competitors, which may force us to decrease prices in order to maintain market share;

 

our ability to improve plant efficiencies and operating rates and lower manufacturing costs;

 

the availability, quality and cost of labor and raw materials, particularly recycled fiber; and

 

the cost of energy.

 

            Our tissue paper products are commodity products, and if we do not maintain competitive prices, we may lose significant market share. Our ability to keep our prices at competitive levels depends in large part on our ability to control our costs. In addition, consolidation among retailers in the discount retail channel may put additional pressure on us to reduce our prices in order to maintain market share. If we are unable to effectively adjust our cost structure to address such increased competitive pressures, our sales level and profitability could be harmed and our operations could be materially adversely affected.

 

Increased competition in our region may affect our business.

 

            In recent years, our competitors have added plants in the region in which we primarily focus our sales efforts. In 2014, Sofidel opened a converting plant in Tulsa, Oklahoma. In 2010, Clearwater Paper Corporation, via its acquisition of Cellu Tissue, started production from a new converting plant in Oklahoma City, Oklahoma, and in 2009, Pacific Paper added a new converting plant in Memphis, Tennessee. All plants are in our focused 500-mile sales area of our Oklahoma facility. Furthermore, our competitors also have plants in the 500-mile radius from Fabrica’s Mexicali plant, including Royal Paper and Cascades in Arizona, Clearwater and Sofidel in Nevada, and Asia Pulp and Paper in California. The increased presence of competition in our focused region may reduce some of our competitive cost advantage which could result in the loss of business or force us to reduce prices, either of which could have a material adverse effect on our business.

 

A substantial percentage of our net sales are attributable to four large customers, any or all of which may decrease or cease purchases at any time.

 

            Our largest customer, Dollar General, accounted for 40% of our net sales in 2014. Family Dollar, HEB and Wal-Mart accounted for 11%, 12% and 9%, respectively, of our net sales in 2014. We expect that sales to a limited number of customers will continue to account for a substantial portion of our net sales for the foreseeable future. Sales to these customers are made pursuant to purchase orders and not supply agreements. We may not be able to keep our key customers, or these customers may cancel purchase orders or reschedule or decrease their level of purchases from us. Any substantial decrease or delay in sales to one or more of our key customers would harm our sales and financial results. In particular, the loss of sales to one or more distribution centers would result in a sudden and significant decrease in our sales. If sales to current key customers cease or are reduced, we may not obtain sufficient orders from other customers necessary to offset any such losses or reductions.

 

We recently installed a new paper machine and intend to install a new converting line. Our failure to realize the benefits that we anticipate from these investments could adversely affect our financial position and results of operations.

 

We recently installed a new paper machine, which is in the process of ramping up to full production. The new paper machine is expected to deliver approximately $6 million in increased EBITDA, so a successful startup and continued operation is important to our financial results for 2015. Significant delays in ramping up the new paper machine to full production may require us to purchase a substantial amount of parent rolls in the open market, which costs significantly more than producing the rolls in our mill, or may result in a short-term disruption in our ability to provide products to customers. We also intend to install a new converting line in our Oklahoma facility, which we expect to be operational before mid-2015. Significant delays in the installation or ramping up production on the new converting line may result in missed sales opportunities or increased costs, which could have a material adverse effect on our operating results.

  

We primarily use pre-consumer solid bleached sulfate paper, or SBS paper, and, to a lesser extent, virgin kraft fibers to produce parent rolls and any disruption in our supply or increase in the cost of pre-consumer SBS paper or virgin kraft could disrupt our production and harm our ability to produce tissue at competitive prices.

 

            We do not produce any of the fiber we use to produce our parent rolls. We depend heavily on access to sufficient, reasonably priced quantities of fiber to manufacture our tissue products. Our paper mill is configured to convert recycled fiber, specifically SBS paper, and virgin kraft fiber into paper pulp for use in our paper production lines. In 2014, we purchased approximately 59,000 tons of SBS paper at a total cost of $14.1 million compared to 60,000 tons of SBS paper at a total cost of $13.3 million in 2013. In 2014, we purchased approximately 8,000 tons of virgin kraft at a total cost of $5.0 million compared to 9,000 tons of virgin kraft at a total cost of $5.8 million in 2013. Prices for SBS paper and virgin kraft have fluctuated significantly in the past and will likely continue to fluctuate significantly in the future, principally due to market imbalances between supply and demand. In addition, the market price of SBS fiber can also be influenced by market swings in the price of virgin pulp and other fiber grades. If either the available supply of SBS paper and/or virgin kraft diminishes or the demand for SBS paper and/or virgin kraft increases, it could substantially increase our cost of fiber, require us to purchase alternate fiber grades at increased costs, or cause a production slow-down or stoppage until we are able to identify new sources of fiber or reconfigure our pulping plant to process other available forms of paper fiber. We could experience a material adverse effect on our business, financial condition and results of operations should the price or supply of SBS paper and/or virgin kraft be disrupted. Further, we currently obtain all of our recycled fiber from a single supplier, Dixie Pulp and Paper, Inc. ("Dixie") and the majority of our virgin kraft from Marubeni America Corporation (“Marubeni”). If our relationship with Dixie and/or Marubeni is altered or terminated for any reason, we will have to seek alternative channels to obtain our recycled and virgin kraft fiber, and there can be no assurance that we would be able to make arrangements that adequately meet our needs or on reasonable terms.

 

 
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Fabrica’s failure to execute under the Supply Agreement could adversely affect our business.

 

Under the Supply Agreement with Fabrica de Papel San Francisco, S.A. de C.V. (“Fabrica”), we have the right to purchase up to 19,800 tons of parent rolls and equivalent converting capacity for certain specified product during each twelve month period following the effective date of the Supply Agreement. We may purchase up to an additional 7,700 tons annually in each of the first two years of the agreement, which has an initial term of twenty years.  Fabrica’s failure to execute under this agreement could result in our inability to service existing customers, thereby reducing sales volumes and profitability. A failure to execute would also harm the relationships we have established with those customers serviced under the Supply Agreement. Furthermore, Fabrica’s failure to execute under this agreement could require us to look for other sources of capacity that are less favorable to us, thereby increasing costs and reducing profits.

 

Failure to successfully integrate the Fabrica business into our existing operations, and the additional indebtedness incurred to finance the Fabrica Transaction, could adversely impact the price of our common stock and future business and operations.

 

On June 3, 2014, we closed upon a transaction whereby we acquired various assets and business operations from Fabrica pursuant to an Asset Purchase Agreement.  The on-going integration of those assets and business into our existing operations likely will be a complex and time-consuming process that may not be wholly successful.  The primary areas of focus for successfully integrating Fabrica’s business with our operations include, among others: integrating information, communications and other systems; managing our growth; and integrating the supply chain.  Even if we successfully integrate Fabrica’s business into our existing operations, there can be no assurance that we will realize the anticipated benefits of the transaction.  The anticipated benefits may not be realized fully, or at all, or may take longer to realize than expected.

 

Increased competition and or deterioration in business conditions could adversely affect our ability to realize anticipated growth from the Fabrica Transaction.

 

We desired to acquire assets and certain operations from Fabrica with the expectation that the acquisition will result in various benefits for us, including, among others, a competitive manufacturing cost, business and growth opportunities, and increased revenue streams.  Increased competition and/or deterioration in business conditions may limit our ability to expand upon Fabrica’s business.  As such, we may not be able to realize the synergies, goodwill, business opportunities and growth prospects anticipated in connection with the Fabrica Transaction.

 

 
14

 

 

Changes in the policies of our retail trade customers and increasing dependence on key retailers in developed markets may adversely affect our business.

 

            Our products are sold in a highly competitive marketplace, which is experiencing increased concentration and the growing presence of large format retailers and discounters. With the consolidation of retail trade, especially in developed markets, we are increasingly dependent on key retailers, and some of these retailers, including the large format retailers, may have greater bargaining power than we do. They may use this leverage to demand higher trade discounts or allowances which could lead to reduced profitability. We may also be negatively affected by changes in the policies of retail trade customers, such as inventory de-stocking, limitations on access to shelf space, and delisting of our products. If we lose a significant customer or if sales of our products to a significant customer materially decrease, our business, financial condition and results of operations may be materially adversely affected.

 

Excess supply in the markets may reduce the prices we are able to charge for our products.

 

            New paper machines or new converting equipment may be built or idle machines may be activated by other paper companies, which would add more capacity to the tissue markets. Increased production capacity could cause an oversupply resulting in lower market prices for our products and increased competition, either of which could have a material adverse effect on our business, financial condition and operating results.

 

The availability of and prices for energy will significantly impact our business.

 

            The production of our products requires a significant amount of energy and we rely primarily on natural gas and electric energy for our energy needs. The prices of these inputs are subject to change based on many factors that are beyond our control, such as worldwide supply and demand and government regulation. In particular, natural gas prices are highly volatile. Beginning in April 2009 and continuing through December 2017, approximately 70% of our natural gas requirements were covered by a fixed price contract, as described above in Item 1—Business, Raw Materials and Energy. The remainder of our requirements through December 2017 are expected to be purchased on the open market. Our average price per MMBTU was $5.05 in 2014 compared to $4.86 in 2013 and $5.28 in 2012. During the year ended December 31, 2014, we consumed 500,000 MMBTU of natural gas at a total cost of $2.5 million and 57.2 million kilowatt hours of electricity at a total cost of $3.3 million. If our energy costs increase, our cost of sales will increase, and our operating results may be materially adversely affected. Furthermore, we may not be able to pass increased energy costs on to our customers if the market does not allow us to raise the prices of our finished products. If price adjustments significantly trail the increase in energy costs or if we cannot effectively hedge against these costs, our operating results may be materially adversely affected.

 

 
15

 

 

Failure to purchase the contracted quantity of natural gas may result in financial exposure.

 

            As discussed above in Item 1—Business, Raw Materials and Energy, we have entered into a fixed price contract to purchase approximately 70% of our natural gas requirements, or 374,000 to approximately 468,000 MMBTUs per year, through December 2017, with the remainder purchased on the open market. 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 we are unable to purchase the contracted amounts and the market price at that time is less than the contracted price, we would be obligated under the terms of our agreement to reimburse an amount equal to the difference between the contracted amount and the amount actually purchased multiplied by the difference between our contract price and a price designed in the contract, which typically approximates spot price.

 

Our exposure to variable interest rates may affect our financial health.

 

            Debt incurred under our existing revolving credit and term loan agreements accrues interest at a variable rate. Specifically, our interest is calculated on LIBOR plus an interest rate margin which is calculated quarterly. As of December 31, 2014, our weighted average bank debt interest rate was 1.42% compared to a weighted average interest rate of 1.99% at December 31, 2013. Any increase in the interest rates on our debt would result in a higher interest expense which would require us to dedicate more of our cash flow from operations to make payments on our debt and reduce funds available to us for our operations and future business opportunities which could have a material adverse effect on our results of operations. For more information on our liquidity, see "Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources."

 

We depend on our management team to operate the Company and execute our business plan.

 

            We are highly dependent on the principal members of our management staff, in particular Jeffrey Schoen, our Chief Executive Officer, and Keith Schroeder, our Chief Financial Officer. We have entered into employment agreements with Jeffrey Schoen and Keith Schroeder. Mr. Schoen's employment is "at will" and, subject to certain conditions (such as the potential obligation to pay severance benefits), may be terminated by either party at any time, for any reason, with or without notice. Mr. Schroeder's employment agreement expired on December 31, 2011, but includes automatic one-year extensions unless either party provides notice of termination. The loss of either of our executive officers or our inability to attract and retain other qualified personnel could harm our business and our ability to compete.

 

Labor interruptions would adversely affect our business.

 

            All of our hourly paid employees are represented by the United Steel, Paper and Forestry, Rubber, Manufacturing, Energy, Allied Industrial & Service Workers International Union. The collective bargaining agreement with Local 5-930, which represents the paper mill workers, will expire in February 2018, and the collective bargaining agreement with Local 5-1480, which represents the converting facility workers, will expire in June 2016. Negotiations of new collective bargaining agreements may result in significant increases in the cost of labor or could break down and result in a strike or other disruption of our operations. If any of the preceding were to occur, it could impair our ability to manufacture our products and result in increased costs and/or decreased operating results. In addition, some of our key customers and suppliers are also unionized. Disruption in their labor relations could also have an adverse effect on our business.

 

 
16

 

 

Our manufacturing operations may experience shutdowns due to unforeseen operational problems or maintenance outages which may cause significant lost production which would adversely affect our financial position and results of operations.

 

            We currently manufacture and process the majority of our tissue paper products from our headquarters located in Pryor, Oklahoma. Any natural disaster or other serious disruption to our facilities due to tornado, fire or any other calamity could damage our capital equipment or supporting infrastructure and materially impair our ability to manufacture and process tissue paper products. Even a short-term disruption in our production output could damage relations with our customers, causing them to reduce or eliminate the amount of finished products they purchase from us. Any such disruption could result in lost sales, increased costs and reduced profits.

 

        Furthermore, unexpected production disruptions due to any number of circumstances, including shortages of raw materials, disruptions in the availability of transportation, labor disputes and mechanical or process failures, could cause us to shut down our paper mill or our converting operation, or any part thereof.

 

            If any part of our facilities is shut down, it may experience a prolonged start-up period, regardless of the reason for the shutdown. Those start-up periods could range from several days to several months, depending on the reason for the shutdown and other factors. The shutdown of our facilities for a substantial period of time for any reason could have a material adverse effect on our financial position and results of operations. Additionally, we recently installed a new paper machine, which is in the process of ramping up to full production. Significant delays in ramping up the new paper machine to full production may require us to purchase a substantial amount of parent rolls in the open market, which costs significantly more than producing the rolls in our mill, or may result in a short-term disruption in our ability to provide products to customers.

 

Our operations require substantial capital, and we may not have adequate capital resources to provide for all of our cash requirements.

 

            Our operations require substantial capital. Expansion or replacement of existing facilities or equipment may require substantial capital expenditures. For example, in 2010, we built a new finished goods warehouse and installed a new converting line which cost approximately $27.0 million. In 2009 and 2010, under new environmental standards we were required to build a water treatment facility costing approximately $7.0 million to reduce BOD and TSS from our discharge water. We are currently in the construction phase of two projects totaling $38.9 million to build a new paper machine and converting line during 2014 and 2015. If our capital resources are inadequate to provide for our operating needs, capital expenditures and other cash requirements, this shortfall could have a material adverse effect on our business and liquidity.

 

 
17

 

 

Our business is subject to governmental regulations and any imposition of new regulations or failure to comply with existing regulations could involve significant additional expense.

 

            Our operations are subject to various environmental, health and safety laws and regulations promulgated by federal, state and local governments. These laws and regulations impose stringent standards on us regarding, among other things, air emissions, water discharges, use and handling of hazardous materials, use, handling and disposal of waste, and remediation of environmental contamination. Any failure to comply with applicable environmental laws, regulations or permit requirements may result in civil or criminal fines or penalties or enforcement actions. These may include regulatory or judicial orders enjoining or curtailing operations or requiring corrective measures, installing pollution control equipment or remedial actions, any of which could involve significant expenditures. Future development of such laws and regulations may require capital expenditures to ensure compliance. We may discover currently unknown environmental problems or conditions in relation to our past or present operations, or we may face unforeseen environmental liabilities in the future. These conditions and liabilities may require site remediation or other costs to maintain compliance or correct violations of environmental laws and regulations; or result in governmental or private claims for damage to person, property or the environment, any of which could have a material adverse effect on our financial condition and results of operations. In addition, we may be subject to strict liability and, under specific circumstances, joint and several liabilities for the investigation and remediation of the contamination of soil, surface and ground water, including contamination caused by other parties, at properties that we own or operate and at properties where we or our predecessors arranged for the disposal of regulated materials.

 

If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud and, as a result, our business could be harmed and current and potential stockholders could lose confidence in us, which could cause our stock price to fall.

 

            We have completed an evaluation of our internal control systems to allow management to report on, and our independent registered public accounting firm to attest to, our internal control over financial reporting in compliance with the management assessment and auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002. In our report under Section 404, which is included in Item 9A of this report, we have concluded that our internal control over financial reporting is effective.

 

            A material weakness or significant deficiency in internal control over financial reporting could materially affect our reported financial results and the market price of our stock could significantly decline. Additionally, adverse publicity related to the disclosure of a material weakness or significant deficiency in internal controls could have a negative effect on our reputation, business and stock price. Although management's assessment and auditor's attestation may provide some level of comfort to the investing public, even the best designed and executed systems of internal controls can only provide reasonable assurance against misreported results and the prevention of fraud.

 

The parent roll market is a commodity market and subject to fluctuations in demand and pricing.

 

            Overall demand for parent rolls can fluctuate due to changes in the demand for converted products and due to new paper machine start-ups. A significant reduction in demand or increase in paper making capacity can result in an over-supply of parent rolls, which could negatively affect the market price for parent rolls. A significant reduction in parent roll selling prices could reduce our net sales, decrease our profits and cause us to shut down some of our excess paper making capacity.

 

We have indebtedness which limits our free cash flow and subjects us to restrictive covenants relating to the operation of our business.

 

            As a result of closing the Fabrica Transaction, our indebtedness is now greater than our indebtedness prior to the transaction. At December 31, 2014, we had $36.4 million of indebtedness. In 2015, under the terms of our existing loan agreement, we anticipate making principal payments of $2.7 million and interest payments of approximately $398,000. Operating with this amount of leverage may require us to direct a significant portion of our cash flow from operations to make payments on our debt, which reduces the funds otherwise available for operations, capital expenditures, payment of dividends, the pursuit of future business opportunities and other corporate purposes. It may also limit our flexibility in planning for or reacting to changes in our business and our industry and may impair our ability to obtain additional financing.

 

 
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            The terms of our loan agreements require us to meet specified financial ratios and other financial and operating covenants which restrict our ability to incur additional debt, place liens on our assets, make capital expenditures, effect mergers or acquisitions, dispose of assets or pay dividends in certain circumstances. If we fail to meet those financial ratios and covenants and our lenders do not waive them, we may be required to pay fees and penalties, and our lenders could accelerate the maturity of our debt and proceed against any pledged collateral, which could force us to seek alternative financing, or otherwise adversely affect our business operations and/or liquidity. If this were to happen, we may be unable to obtain additional financing or it may not be available on terms acceptable to us.

 

            Additionally, the Company's indebtedness is secured by all or substantially all of the Company's assets. Therefore, if the Company defaults on any of its debt obligations, it could result in the lenders foreclosing on our assets. In such an event, the lenders' rights to such assets would likely be superior to those of our shareholders.

 

If we are unable to continue to implement our business strategies, our financial conditions and operating results could be materially affected.

 

            Our future operating results will depend, in part, on the extent to which we can successfully implement our business strategies in a cost effective manner. However, our strategies are subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. If we are unable to successfully implement our business strategies, our business, financial condition and operating results could be materially adversely affected.

 

We may not be able to sell the capacity generated from our converting lines.

 

            We continue to focus on increasing the capacity of our eleven converting lines and are in the process of adding an additional converting line at our Pryor location; however, we may not be able to sell enough of our products to fully utilize such capacity. Our strategy includes converting and selling more of our parent roll tonnage as converted product. Converted products sell at a higher price per ton than parent rolls and typically carry a higher margin on a tonnage basis. If we are unable to increase our sales of converted product to fully utilize the capacity from our converting lines, it could result in lost opportunity for increased margins and the need to temporarily or permanently curtail the production of one or more of our converting lines.

 

Risks Related To Our Common Stock

 

We may not sustain our quarterly dividend.

 

            On February 21, 2011, our Board of Directors initiated a quarterly cash dividend. We paid quarterly dividends totaling $1.40 per share in 2014, $1.35 per share in 2013 and $0.85 per share in 2012. However, we may not sustain regular quarterly dividend payments. The declaration and payment of future dividends to holders of our common stock will be at the discretion of our Board of Directors, and will depend upon many factors, including our financial condition, earnings, capital requirements of our businesses, legal requirements, regulatory constraints, industry practice and other factors that the Board of Directors deems relevant. Further, our credit agreement contains an indirect restriction on the amount of dividends we may pay in that the amount of any dividends paid is included in the calculation of our fixed charge coverage ratio.

 

 
19

 

 

Our certificate of incorporation, bylaws and Delaware law contain provisions that could discourage a takeover.

 

            Our certificate of incorporation, bylaws and Delaware law contain provisions that might enable our management to resist a takeover. These provisions may:

 

 

discourage, delay or prevent a change in the control of the Company or a change in our management;

 

adversely affect the voting power of holders of common stock; and

 

limit the price that investors might be willing to pay in the future for shares of our common stock.

 

Our future operating results may be below securities analysts' or investors' expectations, which could cause our stock price to decline.

 

            Our revenue and income potential depends on expanding our production capacity and finding buyers for our additional production, and we may be unable to generate significant revenues or grow at the rate expected by securities analysts or investors. In addition, our costs may be higher than we, securities analysts or investors expect. If we fail to generate sufficient revenues or our costs are higher than we expect, our results of operations will suffer, which in turn could cause our stock price to decline. Our results of operations will depend upon numerous 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.

 

            Our operating results in any particular period may not be a reliable indication of our future performance. In some future quarters, our operating results may be below the expectations of securities analysts or investors. If this occurs, the price of our common stock will likely decline.

 

Our common stock has low average trading volume, and we expect that the price of our common stock could fluctuate substantially.

 

            The average daily trading volume of our common stock in 2014 was approximately 56,000 shares. The market price for our common stock is affected by a number of factors, including:

 

 

actual or anticipated variations in our results of operations or those of our competitors;

 

changes in earnings estimates or recommendations by securities analysts or our failure to achieve analysts' earnings estimates; and

 

developments in our industry.

 

            The stock prices of many companies in the paper products industry have experienced wide fluctuations that have often been unrelated to the operating performance of these companies. Because of the low trading volume, our stock price is subject to greater potential volatility. Following periods of volatility in the market price of a company's securities, stockholders have often instituted class action securities litigation against those companies. Class action securities litigation, if instituted against us, could result in substantial costs and a diversion of our management resources, which could significantly harm our business.

 

 
20

 

 

Our directors have limited personal liability and rights of indemnification from us for their actions as directors.

 

            Our certificate of incorporation limits the liability of directors to the maximum extent permitted by Delaware law. Delaware law provides that directors of a corporation will not be personally liable for monetary damages for breach of their fiduciary duties as directors, except liability for:

 

 

any breach of their duty of loyalty to the corporation or its stockholders;

 

acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law;

 

unlawful payments of dividends or unlawful stock repurchases or redemptions; or

 

any transaction from which the director derived an improper personal benefit.

 

            This limitation of liability does not apply to liabilities arising under the federal securities laws and does not affect the availability of equitable remedies such as injunctive relief or rescission.

 

            Our certificate of incorporation and bylaws provide that we will indemnify our directors and executive officers and other officers and employees and agents to the fullest extent permitted by law.

 

            We entered into separate indemnification agreements with each of our directors and officers which are broader than the specific indemnification provision under Delaware law. Under these agreements, we are required to indemnify them against all expenses, judgments, fines, settlements and other amounts actually and reasonably incurred, in connection with any actual, or any threatened, proceeding if any of them may be made a party because he or she is or was one of our directors or officers.

 

            If any litigation or proceeding were pursued against any of our directors, officers, employees or agents where indemnification is required or permitted, we could incur significant legal expenses and be responsible for any resulting settlement or judgment.

 

Item 1B.    UNRESOLVED STAFF COMMENTS

 

        None.

 

Item 2.    PROPERTIES

 

    We own a 36-acre property in Pryor, Oklahoma that serves as the Company’s headquarters and main production facilities. Parent roll production is housed in our paper mill, which consists of two facilities. The older paper making facility is approximately 135,000 square feet and, as of March 2015, houses two paper machines and related processing equipment. The newer paper making facility is approximately 27,000 square feet and houses one paper machine and a 23,000 square foot parent roll warehouse. Adjacent to our paper mill, we have an approximately 300,000 square feet converting facility which has eleven lines of converting equipment. We also own a 245,000 square foot finished goods warehouse which adjoins the converting facility. Under the Supply Agreement we have with Fabrica, up to 19,800 tons (27,500 tons in the first two years of the agreement) of our products or parent rolls may be manufactured at Fabrica’s location in Mexicali, Mexico.

 

             

Annual

   
         

Owned or

 

Estimated

 

2014

Facility

 

Sq. Ft.

 

Leased

 

Capacity (tons) (1)

 

Production (tons)

                   

Paper Mill

    162,000  

Owned

 

57,000

 

54,349

                   

Paper Mill - Paper Warehouse

    23,000  

Owned

       
                   

Converting

    300,000  

Owned

 

70,000

 

51,250

                   

Converting - Warehouse

    245,000  

Owned

       

 

 

 

(1)

Annual estimated capacity can vary significantly depending upon several factors. Paper mill capacity is heavily dependent upon the mix of paper grades produced, including the effects of basis weight on tonnage produced. Converting capacity is heavily dependent upon the mix of converted products produced, including the product configurations. We believe we can effectively use 85% to 90% of the converting capacity and still maintain a high level of customer service. Paper mill production for 2014 was less than estimated capacity due to the decommissioning of two older paper machines in September 2014. These paper machines were replaced with a new paper machine in March 2015.

 

 
21

 

 

            Additionally, in conjunction with the Fabrica Transaction, we acquired certain paper making and converting equipment which is located in Mexico and operated by Fabrica under the terms of the Equipment Lease Agreement signed as part of the transaction. This equipment includes one paper machine and two converting lines with capacity of approximately 19,800 annual tons. In accordance with the terms of the transaction, Fabrica has discretion on the most effective manner in which to use these assets. Fabrica may use these assets to provide parent rolls or converted products under the Supply Agreement or may use these assets to manufacture products sold to its customers. Furthermore, in accordance with terms of the transaction, items produced under the Supply Agreement may be manufactured on Fabrica’s paper making assets, which can produce quality grades ranging from the value tier to the ultra-premium tier, using the latest paper machine technology.

 

We believe our facilities in Pryor, Oklahoma are well maintained and, with the addition of the capacity obtained under the Fabrica Transaction, are adequate to serve our present and near term operating requirements. While we currently do not have any specific plans to do so, we believe we have adequate land available to add additional paper making capacity at our Oklahoma site. Any future expansion of converting capacity at the Pryor location would likely result in the need to acquire land adjacent to our facility and to construct additional manufacturing space. During 2013, we entered into an option to purchase land adjacent to our converting facility. Additionally, we entered into a third-party storage agreement and began utilizing the third-party storage to facilitate the warehousing requirement of increasing converted product shipments.

 

Item 3.    LEGAL PROCEEDINGS

 

            From time to time, we are involved in litigation relating to claims arising out of our operations in the normal course of business. As of the date of this report, we were not engaged in any legal proceedings which are expected, individually or in the aggregate, to have a material adverse effect on us.

 

Item 4.    MINE SAFETY DISCLOSURES

 

            Not applicable.

PART II

 

Item 5.    MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Market Information

 

            Since July 15, 2005, our common stock has been traded on the NYSE MKT (formerly known as NYSE Amex), under the symbol "TIS". The following table sets forth the high and low closing prices of our common stock for the periods indicated and reported by the NYSE MKT.

 

   

HIGH

   

LOW

 

Year Ended December 31, 2013:

               

First Quarter

  $ 23.98     $ 21.26  

Second Quarter

  $ 27.02     $ 20.82  

Third Quarter

  $ 28.27     $ 26.27  

Fourth Quarter

  $ 33.02     $ 27.50  

Year Ended December 31, 2014:

               

First Quarter

  $ 33.97     $ 27.72  

Second Quarter

  $ 32.04     $ 26.53  

Third Quarter

  $ 32.67     $ 24.56  

Fourth Quarter

  $ 29.90     $ 23.22  

 

            As of February 17, 2015, there were nine holders of record of an aggregate 8,759,225 shares of our common stock. The actual number of stockholders is greater than the number of record holders, and includes stockholders who are beneficial owners, but whose shares are held in street name by brokers and other nominees. We estimate that we have approximately 9,700 beneficial owners of our common stock. On March 2, 2015, the last reported sale price of our common stock on the NYSE MKT was $28.25.

 

 
22

 

 

Performance Graph

 

            The following graph compares the cumulative total stockholder return on our common stock since December 31, 2009, with the cumulative total return of the Standard & Poor's Small Cap Price Index, the Standard & Poor's Composite 600 Paper Products Index and our selected peer group companies comprised of Clearwater Paper Products, Wausau Paper, and Cascades. These comparisons assume the investment of $100 on December 31, 2009, and the reinvestment of dividends.

 

            These indices are included only for comparative purposes as required by the SEC and do not necessarily reflect management's opinion that such indices are an appropriate measure of the relative performance of the common stock. They are not intended to forecast possible future performance of our common stock.

 

  

   

December 31, 2009

   

December 31, 2010

   

December 31, 2011

   

December 31, 2012

   

December 31, 2013

   

December 31, 2014

 

Orchids Paper Products Company

  $ 100.00     $ 61.13     $ 90.91     $ 101.00     $ 164.04     $ 145.40  

Peer Group

  $ 100.00     $ 106.40     $ 97.85     $ 115.12     $ 137.29     $ 150.01  

S & P Small Cap

  $ 100.00     $ 124.98     $ 124.78     $ 143.27     $ 200.08     $ 208.96  

S & P Composite 600 Paper Products

  $ 100.00     $ 116.73     $ 130.90     $ 143.43     $ 227.62     $ 236.18  

 

 

Common Stock Dilution

 

            As of December 31, 2014, we had 8,757,975 shares of common stock outstanding. We have outstanding options to purchase shares of our common stock, which once fully vested, represent approximately 8% of the current outstanding shares. As of December 31, 2014, we had options outstanding to purchase 734,250 shares of our common stock at an exercise price ranging from $5.18 to $31.125. The options expire on various dates from 2015 to 2024.

 

 
23

 

 

Dividends

 

            On February 21, 2011, our Board of Directors initiated a quarterly cash dividend. We paid the following dividends on each share of the Company's common stock then outstanding in 2012, 2013 and 2014:

 

   

2012

   

2013

   

2014

 

First Quarter

  $ 0.20     $ 0.30     $ 0.35  

Second Quarter

  $ 0.20     $ 0.35     $ 0.35  

Third Quarter

  $ 0.20     $ 0.35     $ 0.35  

Fourth Quarter

  $ 0.25     $ 0.35     $ 0.35  

Total

  $ 0.85     $ 1.35     $ 1.40  

 

 

            On February 4, 2015, the Board of Directors authorized a quarterly cash dividend of $0.35 per outstanding share of the Company's common stock. The Company paid this dividend on March 3, 2015 to stockholders of record at the close of business on February 17, 2015.

 

            The declaration and payment of future dividends to holders of our common stock will be at the discretion of our Board of Directors, and will depend upon many factors, including our financial condition, earnings, capital requirements of our business, legal requirements, regulatory constraints, industry practice and other factors that the Board of Directors deems relevant. Our credit agreement contains an indirect restriction on the amount of cash dividends we may pay in that the amount of any dividends paid is included in the calculation of our fixed charge coverage ratio.

 

Recent Sales of Unregistered Securities

 

        On June 3, 2014, we closed on an asset purchase agreement (“Purchase Agreement”) with Fabrica. Pursuant to the terms of the Purchase Agreement, we acquired a paper machine, two converting lines, Fabrica’s U.S. customer list, exclusive rights to all of Fabrica’s trademarks in the United States and Fabrica’s covenant not to compete in the United States for a purchase price of 411,650 shares of the Company’s common stock valued at $12 million. We also entered into an Assignment and Assumption of Supply Agreement with Elgin Finance & Investment Corp for $16.7 million in cash and 274,433 shares of the Company’s common stock valued at $8 million, in exchange for the assignment to us of Elgin’s supply agreement with Fabrica which provided Elgin with exclusive supply rights with respect to Fabrica’s U.S. business.

 

 The issuance and sale of the shares was conducted in reliance on the exemption from registration provided by Section 4(a)(2) of the Securities Act, as the transactions did not involve a public offering. The shares have not been registered under the Securities Act and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements.

 

Repurchase of Equity Securities

 

        We do not have any programs to repurchase shares of our common stock and no such repurchases were made during the year ended December 31, 2014.

 

Item 6.    SELECTED FINANCIAL DATA

 

            The following selected financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" following this section and our financial statements and related notes included in Item 8 of this Form 10-K. The following tables set forth selected financial data as of and for the years ended December 31, 2014, 2013, 2012, 2011, and 2010, which were derived from our audited financial statements. Our audited financial statements as of December 31, 2014 and 2013, and for each of the three years in the period ended December 31, 2014, are included below under Item 8 of this Form 10-K. The historical results are not necessarily indicative of the operating results to be expected in any future period. The results for the year ended December 31, 2014 include the impacts of the Fabrica Transaction discussed in Note 2 of the notes to the audited financial statements included below under Item 8 of this Form 10-K.

 

 
24

 

 

 

   

Year Ended

   

Year Ended

   

Year Ended

   

Year Ended

   

Year Ended

 
   

December 31,

   

December 31,

   

December 31,

   

December 31,

   

December 31,

 
   

2014

   

2013

   

2012

   

2011

   

2010

 
   

(in thousands, except per share and Tons)

 

Converted Product Net Sales

  $ 138,382     $ 109,611     $ 90,505     $ 81,949     $ 74,078  

Parent Roll Net Sales

    4,342       6,763       10,314       15,894       18,426  

Net Sales

    142,724       116,374       100,819       97,843       92,504  

Cost of Sales

    115,985       88,494       78,253       81,886       76,752  

Gross Profit

    26,739       27,880       22,566       15,957       15,752  

Selling, General and Administrative Expenses

    11,675       9,471       8,456       6,810       6,618  

Intangibles Amortization

    753       -       -       -       -  

Operating Income

    14,311       18,409       14,110       9,147       9,134  

Interest Expense

    271       371       407       647       934  

Other (Income) Expense, net

    181       (173 )     302       (42 )     (65 )

Income Before Income Taxes

    13,859       18,211       13,401       8,542       8,265  

Provision for Income Taxes

    4,394       4,892       4,144       2,344       2,351  

Net Income

  $ 9,465     $ 13,319     $ 9,257     $ 6,198     $ 5,914  
                                         

Net income per common share - Diluted

  $ 1.11     $ 1.67     $ 1.18     $ 0.80     $ 0.76  

Cash dividends declared per share

  $ 1.40     $ 1.35     $ 0.85     $ 0.50     $ -  
                                         

Operating Data

                                       

Converted product tons shipped

    67,870       52,592       43,661       39,104       36,126  

Parent roll tons shipped

    4,922       6,726       10,334       16,410       20,537  

Total Tons Shipped

    72,792       59,318       53,995       55,514       56,663  
                                         

Cash Flow Data

                                       

Cash Flow Provided by (Used in):

                                       

Operating Activities

  $ 20,152     $ 20,796     $ 17,451     $ 15,655     $ 12,648  

Investing Activities

  $ (37,434 )   $ (12,179 )   $ (9,788 )   $ 1,969     $ (17,795 )

Financing Activities

  $ 11,098     $ (7,146 )   $ (6,226 )   $ (13,469 )   $ 4,057  
                                         
                                         

 

   

As of December 31,

 
   

2014

   

2013

   

2012

   

2011

   

2010

 

Working Capital

  $ 6,488     $ 22,440     $ 20,454     $ 15,342     $ 10,429  

Net Property, Plant and Equipment

  $ 119,720     $ 95,745     $ 91,188     $ 92,285     $ 93,805  

Total Assets

  $ 170,739     $ 127,092     $ 119,358     $ 114,968     $ 122,571  

Long-Term Debt, net of current portion

  $ 33,662     $ 13,927     $ 15,079     $ 16,231     $ 16,615  

Total Stockholders' Equity

  $ 100,513     $ 84,849     $ 77,178     $ 72,649     $ 69,596  

 

 
25

 

 

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 2014 financial results?

 

 

Our net sales in 2014 increased 23% to a new record of $142.7 million compared to $116.4 million in 2013, including a 26% increase in net sales of converted product, primarily due to sales related to the Fabrica Transaction.

 

 

Net sales of converted product were $138.4 million during 2014, a new twelve-month record. Converted product net sales increased $28.8 million, or 26%, to $138.4 million in 2014 compared to $109.6 million in 2013, primarily due to sales related to the Fabrica Transaction.

 

 

Converted product shipments from our Pryor location were 8,405,000 cases, or approximately 54,000 tons in 2014, a new twelve-month record and an increase of 3% compared to 8,179,000 cases (approximately 53,000 tons) shipped in 2013.

 

 

Our earnings per diluted common share in 2014 decreased to $1.11 per diluted common share compared with $1.67 per diluted common share in 2013, primarily due to the impacts of our project to construct and install a new paper machine, costs related to the Fabrica Transaction and additional non-cash compensation expense related to options granted to management during 2014.

 

 

Our EBITDA in 2014 decreased to $23.8 million compared to $26.2 million in 2013, primarily due to the factors cited above.

 

 

What did we focus on in 2014?

 

            In 2014, we took our initial steps to achieve our mission of being a national supplier of high quality consumer tissue products by acquiring manufacturing capacity to service the western United States in June of 2014. Through the Fabrica Transaction, we acquired paper making and converting capacity at Fabrica’s Mexicali, Mexico facility and acquired the U.S. business of Fabrica. Since the completion of the transaction, we focused on integrating this acquisition into our operations, increasing sales and partnering with the Fabrica organization to jointly improve production techniques and new product development efforts. As a result of these efforts, we realized record net sales, converted product sales and shipments from our Pryor location and increased sales under the supply agreement since June. 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 our newer converting lines and improving utilization of current converting equipment to improve capacity. In the last half of 2014, we decommissioned two older paper machines in our paper making facility and began construction and installation of a new paper machine, which is expected to improve our cost structure and provide increased capacity to produce parent rolls. These efforts will continue in 2015 as we seek to optimize the new paper machine following its installation and start up in March 2015, and seek additional ways to increase capacity and converted product sales levels.

 

 
26

 

 

             We also continue to focus on our vision of being recognized as a national supplier of high quality consumer tissue products in the value, premium and ultra-premium tier product segments. The following graph shows shipments of our premium and ultra-premium tier products as a percentage of total cases shipped:

 

 

 

 

 

What challenges and opportunities did our business face in 2014?

 

            During the first half of 2014, our net sales were affected by increased promotions on branded products by our competitors, which significantly affected private label sales, and inventory reductions by our customers. In the second half of 2014, the paper machine project, in which we decommissioned two older paper machines in our paper making facility and began construction and installation of a new paper machine, presented a significant challenge during the construction phase. Removing two paper machines in September of 2014 resulted in reduced absorption of fixed costs in our paper making operation, required external purchases of parent rolls, resulted in lost margins on parent roll sales, as there were no excess parent rolls to sell in the open market, and resulted in $400,000 of demolition costs. Furthermore, during 2014, the average price across our fiber basket increased 8% compared to 2013 and we experienced increased production costs in our converting operation, primarily due to higher maintenance and repair costs, relocating newly hired employees and a one-time charge related to our project to install a new converting line, which is expected to start up in the second quarter of 2015. Finally, we incurred $1.6 million of expenses related to the Fabrica Transaction.

 

However, our sales recovered quickly in the second half of 2014, due to increased customer sponsored promotional business, gaining new business with existing customers, and shipments to the west coast under the Supply Agreement with Fabrica. Excluding the transaction costs related to the Fabrica Transaction and additional non-cash compensation expense due to stock options granted to management in 2014, selling, general and administrative costs decreased to 5.9% of net sales in 2014, compared to 7.9% in 2013.

 

What will we focus on in 2015?

 

In 2015, our primary focus will be on the successful, timely start-up of our new paper machine and new converting line in Oklahoma. The new paper machine is expected to deliver approximately $6 million in increased EBITDA, so a successful startup is important to our financial results for 2015. A successful startup of the new converting line will provide additional converting capacity of approximately 2.5 million cases, or approximately 16,000 tons, and will improve manufacturing flexibility and product quality. Another main area of focus will be the further expansion of our partnership with Fabrica, which we expect to improve the new product development efforts and manufacturing techniques and processes of each site. We expect these efforts to improve our overall production costs and operating margins.

 

We intend to continue to focus our sales and marketing efforts on obtaining new business, broadening our customer base and further expansion into the premium and ultra-premium tier markets to support our vision of being recognized as a national supplier of high quality consumer tissue products in the value, premium and ultra-premium tier product segments. Through our new product development efforts and our partnership with Fabrica, 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. We will continue to focus on optimizing the capacity of our current assets, especially our converting lines, and efficient start up and full utilization of assets scheduled to start up in 2015 in both converting and paper mill operations.

        

 
27

 

 

Our paper-making operation will continue to work on quality improvement to provide enhanced product attributes for our converting operation. During the first quarter of 2015, we expect to purchase approximately 1,400 tons of parent rolls to support the converting operation, which we believe will increase our operating costs by approximately $0.4 million. With the startup of our new paper machine in 2015, we expect our annual paper making capacity will be approximately 74,000 tons once the machine is operating at full capacity. We will continue our efforts to utilize this increased paper making capacity in our converting operation.

 

Business Overview

 

            We are an integrated manufacturer of tissue products serving the private label, or "at-home" market, and, to a lesser extent, the “away from 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 in the “at-home” market 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, premium tier and ultra-premium tier. Our core customer base in the “away from home” market consists of companies in the janitorial market and food service market. Most of the products we sell in the “away from home” market are included in the value tier. While we expect to service this market in the near term, we do not consider the “away from home” market a growth vehicle for us.

 

            Since 2006, we have systematically invested in manufacturing assets to improve quality, increase capacity, expand our product offerings and strengthen our position as a low cost manufacturer across the market tier spectrum, including the value, premium and ultra-premium tiers. In 2010, we undertook an expansion project that included the purchase and installation of a converting line and the construction of a converted product warehouse. This project had three main objectives: increase the capacity of our converting operation, provide the capability to produce higher-quality premium tier converted products and reduce warehousing costs by decreasing our utilization of third-party warehouses. 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 premium tier converted products and increase the flexibility of our manufacturing operation, including replacing two existing paper machines with a new paper machine and installing a new 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®, and Tackle®. The Fabrica Transaction gave us the exclusive right to sell products into the United States under Fabrica’s brand names, including Virtue®, Truly Green®, Golden Gate Paper® and Big Quality®. All of our converted product net sales are derived pursuant to truck load purchase orders from our customers. Parent roll net sales are 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.

 

 
28

 

 

             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 our paper mill and converting facilities; 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 effect price increases. We expect these competitive conditions to continue.

 

            Prior to the demolition of two older paper machines in the second half of 2014, our parent roll production capacity of approximately 57,000 tons exceeded the requirements of our converting operation. As result, we had excess parent rolls that we sold 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. Once our new paper machine and converting line are fully operational, which is expected to occur in mid-2015, we believe our paper making capacity and converting production requirements will be approximately in balance.

 

Comparative Years Ended December 31, 2014, 2013 and 2012

 

Net Sales

 

     

Years Ended December 31,

 
     

2014

   

2013

   

2012

 
     

(in thousands, except price per ton and tons)

 

Converted product net sales

  $ 138,382     $ 109,611     $ 90,505  

Parent roll net sales

    4,342       6,763       10,314  
 

Total net sales

  $ 142,724     $ 116,374     $ 100,819  
                           

Converted product tons shipped

    67,870       52,592       43,661  

Parent roll tons shipped

    4,922       6,726       10,334  

Total tons shipped

    72,792       59,318       53,995  

 

 

Net sales for the year ended December 31, 2014 increased $26.3 million, or 23%, to $142.7 million compared to $116.4 million for the year ended December 31, 2013. These net sales figures include gross selling price, including freight, less discounts and sales promotions. Net sales of converted product increased $28.8 million, or 26%, to $138.4 million compared to $109.6 million in 2013. Net sales of parent rolls decreased $2.4 million, or 36%, in 2014, to $4.3 million compared to $6.8 million in 2013. The increase in converted product sales was primarily due to a 29% increase in converted product tonnage shipped, which was partially offset by a 2% decrease in net selling prices per ton. Converted product tons shipped increased primarily due to the effect of the U.S. business acquired from Fabrica, which accounted for 90% of the increase in tonnage shipped, and due to increased sales to existing customers. The selling price decrease is due to the mix of business obtained in the Fabrica Transaction, which contained some “away from home” business, which typically sells at a lower price per ton. The decrease in parent roll sales was due to a 27% decrease in parent rolls shipped and a 12% decrease in the net sales price per ton. The decrease in parent roll shipments was primarily due to the demolition of two paper machines in September 2014, which reduced parent roll output from the paper mill. The decrease in selling price per ton is primarily due to a continued soft market for parent rolls.

 

            Net sales for the year ended December 31, 2013 increased $15.6 million, or 15%, to $116.4 million compared to $100.8 million for the year ended December 31, 2012. Net sales of converted product increased $19.1 million, or 21%, 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%, 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.

 

 
29

 

 

Cost of Sales

 

   

Years Ended December 31,

 
   

2014

   

2013

   

2012

 
   

(in thousands, except gross profit margin % and price per ton)

 

Cost of goods sold

  $ 107,049     $ 80,881     $ 70,712  

Depreciation

    8,936       7,613       7,541  

Cost of sales

  $ 115,985     $ 88,494     $ 78,253  
                         

Gross Profit

  $ 26,739     $ 27,880     $ 22,566  

Gross Profit Margin %

    18.7 %     24.0 %     22.4 %

Total paper cost per ton consumed

  $ 781     $ 746     $ 754  

 

 

            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, depreciation and the cost of converted products purchased under the Supply Agreement with Fabrica.

 

            Cost of sales for the year ended December 31, 2014 increased $27.5 million, or 31%, to $116.0 million compared to $88.5 million in the year ended December 31, 2013. Cost of sales as a percentage of net sales was 81.3% in the 2014 period compared to 76.0% in the 2013 period. Cost of sales as a percent of net sales was negatively affected by higher fiber costs, higher production costs in both converting and the paper production operations, higher depreciation and lower parent roll selling prices.

 

Paper production costs increased approximately 5%, or $2.1 million, in the year ended December 31, 2014 compared to the 2013 period. Paper production costs increased primarily due to the new paper machine project in which two paper machines were de-commissioned in September of 2014. This had the effect of reducing production and raising production costs during the construction phase of the project. Average fiber prices across our fiber basket increased approximately 8% in 2014 compared to the same period of 2013, which increased our cost of sales by approximately $1.1 million. The reduced production also resulted in the need to purchase parent rolls in the open market to supplement our paper making capacity.

 

            Depreciation expense increased by $1.3 million in 2014 due to 2013 and 2014 capital expenditures. Converting per unit production costs were unfavorable by approximately 7% to the prior year primarily due to higher maintenance and repair costs, and, to a lesser extent, relocating newly hired employees and a one-time charge related to the project to install a new converting line.

 

Cost of sales for the year ended December 31, 2013 increased $10.2 million, or 13%, 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 decreased approximately 1% in the year ended December 31, 2013 compared to the 2012 period. Paper production 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.

 

 
30

 

 

Gross Profit

 

Gross profit decreased by $1.1 million, or 4%, to $26.7 million in the year ended December 31, 2014, compared to $27.9 million in 2013. As a percentage of net sales, gross profit decreased to 18.7% in 2014 compared to 24.0% in 2013. The decrease in gross profit margin was primarily due to higher fiber costs, higher production costs in both converting and the paper production operations, higher depreciation and lower parent roll selling prices. Fiber costs, converting production costs, paper production costs and depreciation increased primarily due to the reasons noted above under Cost of Sales. The decrease in parent roll selling prices is primarily due to a continued soft market for parent rolls and reduced our gross margin by approximately $607,000 in 2014.

 

            Gross profit increased by $5.3 million, or 23%, 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.

 

 

Selling, General and Administrative Expenses

 

   

Years Ended December 31,

 
   

2014

   

2013

   

2012

 
   

(In thousands, except SG&A as a % of net sales)

 
                         

Commission expense

  $ 1,587     $ 1,879     $ 1,401  

Other S,G&A expenses

    10,088       7,592       7,055  

Selling, General & Adm expenses

  $ 11,675     $ 9,471     $ 8,456  

SG&A as a % of net sales

    8.2 %     8.1 %     8.4 %

 

            Selling, general and administrative (SG&A) expenses include salaries, commissions to brokers and other miscellaneous expenses. SG&A expenses increased $2.2 million, or 23%, to $11.7 million in the year ended December 31, 2014 compared to $9.5 million in 2013. The higher expenses were primarily due to $1.6 million of expenses related to the Fabrica Transaction and $1.4 million of additional non-cash compensation expense related to stock options granted to management in 2014, which were partially offset by lower commission expense due to the mix of converted products sold and lower artwork related expenses. As a percentage of net sales, SG&A increased slightly to 8.2% in 2014 compared to 8.1% in 2013.

 

SG&A expenses increased $1.0 million, or 12%, 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.

 

Amortization of Intangibles

 

The Company recognized $753,000 of amortization expense related to the intangible assets acquired in the Fabrica Transaction during 2014.

 

 
31

 

 

Operating Income

 

            As a result of the foregoing factors, operating income for the years ended December 31, 2014, 2013 and 2012 was $14.3 million, $18.4 million, and $14.1 million, respectively.

 

Interest and Other (Income) Expense

 

   

Years Ended December 31,

 
   

2014

   

2013

   

2012

 
   

(In thousands)

 

Interest expense

  $ 271     $ 371     $ 407  

Other (income) expense, net

  $ 181     $ (173 )   $ 302  
                         

Income before income taxes

  $ 13,859     $ 18,211     $ 13,401  

 

 

            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, 2014 was $271,000 compared to $371,000 in the same period in 2013. Interest expense for 2014 excludes $252,000 of interest capitalized on significant projects during the period. The higher level of total interest in 2014 resulted from higher debt balances in the last half of 2014 due primarily to additional debt incurred in conjunction with the Fabrica Transaction, additional borrowings to finance capital expenditures, and writing off $38,000 of deferred debt costs when we refinanced our debt with a new creditor.

 

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.

 

Income Before Income Taxes

 

            As a result of the foregoing factors, income before income taxes decreased $4.4 million, or 24%, to $13.9 million for the year ended December 31, 2014 compared to $18.2 million for the year ended December 31, 2013. Income before income taxes increased $4.8 million, or 36%, to $18.2 million for the year ended December 31, 2013 compared to $13.4 million for the year ended December 31, 2012.

 

Income Tax Provision

 

For the year ended December 31, 2014, income tax expense was $4.4 million, resulting in an effective tax rate of 31.7%. This rate is lower than the statutory rate primarily due to a change in estimate recognized in 2014, as we believe our deferred assets and liabilities will be recognized at rates other than previously estimated, manufacturing tax deductions and Oklahoma Investment Tax Credits (“OITC”) associated with investments in our manufacturing operations.

 

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 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").

 

Our current Oklahoma tax obligations for the years ended December 31, 2014 and 2013 were satisfied by using our OITC carryforward. Our current Oklahoma tax obligations for the year ended December 31, 2012 were satisfied by utilizing our OITC carryforward and our net operating loss ("NOL") carryforward.

 

In 2014, due to effects of the Fabrica Transaction, we began recording current and deferred income taxes in the state of California and the country of Mexico. Taxes related to California increased our effective tax rate by approximately 3.1%. The effects of foreign taxes was not material to our effective tax rate due to U.S. income tax credits related to foreign-sourced income.

 

 
32

 

 

Future Expected Stock Option Expense

 

In the first nine months of 2014, the Board of Directors granted options to purchase 145,000 shares of the Company’s common stock to certain members of management. Additionally, on April 9, 2014, the Company’s shareholders approved the option to purchase 400,000 shares of the Company’s common stock granted to Mr. Jeffrey S. Schoen, the Company’s President and Chief Executive Officer, on November 8, 2013. These options will become exercisable in four equal tranches, if at all, if and when the share price of the common stock closes at or above a certain percentage of the purchase price of the option for three consecutive business days, in accordance with the following vesting schedule:

 

   

Share price required to achieve vesting

 

Tranche 1

  $ 34.788  

Tranche 2

  $ 42.350  

Tranche 3

  $ 51.425  

Tranche 4

  $ 60.500  

 

The grant of these options will have a material impact on the Company’s future results of operations and on the comparability of the Company’s results from period to period. The Company expenses the cost of these options granted on a straight-line basis over the implicit, or derived service period of the option based on the grant-date fair value of the award. The Company expects to expense the remaining compensation cost associated with these options based on the following schedule:

 

   

2015

   

2016

 
   

Total

   

Total

 
      (in thousands)  

Tranche 1

  $ -     $ -  

Tranche 2

    240       -  

Tranche 3

    289       59  

Tranche 4

    189       136  

Total expense

  $ 718     $ 195  

 

However, if the market condition is achieved for any tranche of these options prior to the end of the derived service period, all remaining expense related to that tranche would be recognized in the period in which the market condition is achieved.

 

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 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 equity and debt financings. We expect this trend to continue.

 

            As of December 31, 2014, we had a net bank overdraft of $685,000 and no short-term investments, compared to cash on hand of $7.2 million and $5.0 million in short-term investments as of December 31, 2013. During 2014, our most significant events effecting liquidity were funding the Fabrica Transaction and financing capital expenditures. In order to provide funding for these events, as well as provide appropriate liquidity for remaining expenditures under our $38.9 million new paper machine and converting capacity expansion currently underway and expected future business growth, we entered into a new $75 million credit facility with U.S. Bank National Association (“U.S. Bank”). As part of the new facility, we refinanced our long-term debt into a $30.0 million term loan to obtain additional borrowing capacity, which was utilized to pay the $16.7 million cash consideration portion of the purchase price in the Fabrica Transaction.  In conjunction with entering into the new credit agreement with U.S. Bank, we paid off $14.6 million in long-term debt with JPMorgan Chase.  Our new credit arrangement with U.S. Bank includes access to a $45 million revolving line of credit; $25 million to be used for working capital purposes and $20 million to be used to finance future capital expenditures related to the 2014-2015 paper machine and converting line projects at our Oklahoma facility.  Net borrowings under the revolving line of credit were $7.7 million as of December 31, 2014.  We sold $5.0 million of short-term investments during 2014, incurred $25.8 million of capital expenditures, paid $11.8 million in dividends to stockholders and paid $7.3 million in income taxes.  The remaining purchase consideration for the Fabrica Transaction of $20.0 million was paid with shares of the Company’s common stock that had a fair market value of $16.0 million at the time of the transaction.

 

 
33

 

 

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:

 

   

2012

   

2013

   

2014

 

First Quarter

  $ 0.20     $ 0.30     $ 0.35  

Second Quarter

  $ 0.20     $ 0.35     $ 0.35  

Third Quarter

  $ 0.20     $ 0.35     $ 0.35  

Fourth Quarter

  $ 0.25     $ 0.35     $ 0.35  

Total

  $ 0.85     $ 1.35     $ 1.40  

 

             On February 4, 2015, the Board of Directors authorized a quarterly cash dividend of $0.35 per outstanding share of the Company's common stock. The Company paid this dividend on March 3, 2015 to stockholders of record at the close of business on February 17, 2015.

 

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 our Oklahoma facility in 2015 are estimated at $22.4 million, including approximately $4.1 million for normal recurring capital expenses, $2.3 million for converting line upgrade projects and $16.0 million for improvement projects, including the remaining expenditures on the new paper machine and converting line projects. We believe approximately $7.0 million related to building the new paper machine and $8.6 million related to the new converting line will be incurred in 2015. We expect to fund the improvement projects with a combination of cash from operations and additional borrowings under our revolving credit facility. Significant future expansion or capacity improvement projects beyond those discussed will likely be funded by a combination of additional bank financing and equity offerings, consistent with our past practices. Our initial public offering in 2005 was entered into to fund a portion of a new paper machine project, and a major expansion of our converting capacity was funded in part by a follow-on offering completed in 2009.        

 

As of December 31, 2014, we estimate that Oklahoma Investment Tax credits ("OITC") will likely eliminate all Oklahoma income tax liability for the next few years. As of December 31, 2014, $634,000 was recorded as an income tax receivable due to overpayments of estimated quarterly tax payments. This amount will be used to offset quarterly tax payments due in 2015.

 

 
34

 

 

            The following table summarizes key cash flow information for the years ended December 31, 2014, 2013 and 2012:

 

    Years Ended December 31,  
   

2014

   

2013

   

2012

 
   

(in thousands)

 
                         

Cash flow provided by (used in):

                       

Operating activities

  $ 20,152     $ 20,796     $ 17,451  
                         

Investing activities

  $ (37,434 )   $ (12,179 )   $ (9,788 )
                         

Financing activities

  $ 11,098     $ (7,146 )   $ (6,226 )

 

 

Cash flows provided by operating activities decreased slightly from $20.8 million in 2013 to $20.2 million in 2014 primarily due to lower earnings, changes in deferred taxes, and increases in accounts receivable and other assets, which were partially offset by an increase in accounts payable and a decrease in inventories. Deferred taxes changed primarily due to changes in estimates, including the rate at which the deferred taxes are expected to become current tax liabilities. Accounts receivable increased primarily due to increased sales during 2014 from the Fabrica Transaction, while other assets increased primarily due to the timing of value-added tax (“VAT”) payments, which are primarily due to equipment purchased from Fabrica. The increase in accounts payable was primarily due to items purchased from Fabrica under the Supply Agreement and timing of related payments, while inventories decreased due to increased sales during 2014.

 

Cash flows used in investing activities increased from $12.2 million in 2013 to $37.4 million in 2014 primarily due to the Fabrica Transaction and increased capital expenditures. We paid $16.7 million in cash for the assets acquired in the Fabrica Transaction in 2014. Furthermore, capital expenditures in 2014 were $25.8 million, compared to $12.2 million in 2013, primarily due to the $38.9 million capacity expansion projects currently underway. These expenditures were partially offset by the sale of $5.0 million of short-term investments during 2014 to help finance these expenditures.

 

Cash flows provided by investing activities were $11.1 million in 2014 compared to cash flows used in investing activities of $7.1 million in 2013. The increase in cash flows provided by investing activities was primarily due to $39.4 million of borrowings under our credit facility with U.S. Bank in 2014, which were partially offset by $16.4 million of repayments of long-term debt, including $14.6 million of debt paid to our previous creditor when we refinanced our debt with U.S. Bank. This compares to $1.2 million of debt repayments in 2013. Additionally, we paid $11.8 million in dividends to stockholders in 2014, compared to $10.7 million in 2013. Finally, cash flows used in investing activities in 2013 were partially offset by $4.7 million of benefits related to stock option exercises. These benefits were minimal in 2014.

 

Cash flows provided by operating activities increased from $17.5 million in 2012 to $20.8 million in 2013 primarily due to higher earnings and an increase in accrued liabilities, which were partially offset by decreases in accounts receivable and inventory. Accrued liabilities increased due to timing of annual bonus payments and accrued severance associated with the departure of the Company's former CEO during 2013, while accounts receivable decreased due to timing of cash receipts from customers.

 

            Cash flows used in investing activities increased $2.4 million in 2013 to $12.2 million compared to $9.8 million in 2012, primarily due to $12.2 million of capital expenditures in 2013 compared to $6.8 million of capital expenditures in 2012 and $3.0 million of cash moved into a short-term investment account during 2012. Capital expenditures in 2013 were primarily related to upgrading an existing converting line to improve manufacturing flexibility, a project to reclaim fiber lost during the paper manufacturing process, building a warehouse for parent roll storage and approximately $3.1 million related to the two strategic projects announced in November 2013.

 

            Cash flows used in financing activities were $7.1 million in 2013, primarily attributable to $10.7 million of dividends paid to stockholders and $1.2 million of debt repayments, which were partially offset by $3.3 million of cash received from the exercise of stock options and $1.4 million of excess tax benefits recognized on stock options exercised.

 

 
35

 

 

As noted above, in June 2014, the Company entered into a Credit Agreement (the “Credit Agreement”) with U.S. Bank consisting of the following:

 

 

a $45 million revolving credit line due June 2019:

 

 

$25 million permitted for domestic working capital purposes; and

 

$20 million permitted for the purchase and construction of a paper machine and upgrade of one of the converting lines at the Company’s Pryor, Oklahoma facility.

 

 

a $30 million term loan with a 6-year term due June 2020 and amortized as follows:

 

 

Real estate debt amortized as if it had a 22-year life;

 

Equipment debt amortized as if it had a 7-year life; and

  Debtincurred in connection with the acquisition of a supply agreement with Fabrica (see Note 2) amortized as if it had a 10-year life.

 

The Credit Agreement had the effect of (i) extending and increasing the Company’s revolving working capital line of credit from $15 million to $25 million, (ii) increasing the Company’s revolving line of credit to include $20 million for the purchase and construction of assets in Oklahoma, and (iii) refinancing and extending the Company’s $10.8 million Real Estate loan ($9.5 million outstanding) and $7.2 million Machinery and Equipment loan ($5.1 million outstanding) into a single $30 million term loan, used to provide funding for the $16.7 million paid to close the strategic alliance with Fabrica described in Note 2 of the notes to the consolidated financial statements.

 

Under the terms of the Credit Agreement, amounts outstanding will bear interest at a variable rate of LIBOR plus a specified margin, depending upon the Company’s quarterly Leverage Ratio, as defined in the Credit Agreement.  Additionally, the Company will pay a commitment fee for the available portion of its revolving credit line at the applicable rate, as follows:

 

   

Interest

   

Commitment

 

Leverage Ratio

 

Margin

   

Fee

 

Less than or equal to 1.00

    1.00 %     0.15 %

Greater than 1.00 but less than or equal to 2.00

    1.25 %     0.20 %

Greater than 2.00 but less than or equal to 3.00

    1.50 %     0.25 %

Greater than 3.00

    2.00 %     0.30 %

 

            The Company’s leverage ratio at December 31, 2014 was 1.26.

 

The amount available under the revolving credit line permitted for domestic working capital purposes may be reduced in the event that the Company's borrowing base, which is based upon qualified receivables, qualified inventory and qualified equipment purchases, is less than $25.0 million. As of December 31, 2014, our borrowing base was $24.5 million, including $7.2 million of eligible accounts receivable, $4.3 million of eligible inventory and $13.0 million of eligible equipment purchases.

 

            Obligations under the Credit Agreement are secured by substantially all of the Company's assets. The Credit Agreement contains representations and warranties, and affirmative and negative covenants customary for financings of this type, including, but not limited to, limitations on additional borrowings, additional investments and asset sales. The financial covenants, which are tested as of the end of each fiscal quarter, require the Company to maintain the following specific ratios: fixed charge coverage (minimum of 1.20 to 1.0) and leverage (maximum of 3.50 to 1.0). The table below compares the actual ratios as of December 31, 2014 with the limits specified in the credit agreement.

 

   

Actual as of 12/31/14

   

Required in Credit Agreement

   

Excess

 
                         

Leverage ratio

    1.26       3.5       2.24  
                         

Fixed charge coverage ratio

    1.77       1.20       0.57  

 

 
36

 

 

Contractual Obligations

 

            As of December 31, 2014, our contractual cash obligations were our long-term debt and associated interest, our natural gas contract, and equipment purchase obligations primarily related to the two strategic projects announced in November 2013. We do not have any material leasing commitments or debt guarantees outstanding as of December 31, 2014. We do not have any defined benefit pension plans or any obligation to fund any postretirement benefit obligations for our work force.

 

            Maturities of these contractual obligations consist of the following:

 

   

Payments Due by Period

 
   

Years

 
                                         

Contractual Cash Obligations

 

Total

      1    

2 and 3

   

4 and 5

   

after 5

 
   

( in thousands)

 

Long-term debt (1)

  $ 36,362     $ 2,700     $ 7,350     $ 15,712     $ 10,600  

Interest payments (2)

  $ 1,567     $ 398     $ 661     $ 435     $ 73  

Natural Gas Contract (3)

  $ 5,223     $ 1,675     $ 3,548     $ -     $ -  

Equipment purchase obligations (4)

  $ 10,107     $ 10,107     $ -     $ -     $ -  

Total

  $ 53,259     $ 14,880     $ 11,559     $ 16,147     $ 10,673  

 

 

 

(1)

Under our revolving credit and term loan agreements, the maturity of outstanding debt could be accelerated if we do not maintain certain financial covenants. At December 31, 2014, we were in compliance with our loan covenants.

 

 

(2)

Our long-term debt carries interest at variable rates. These amounts have been calculated based on the interest rate in effect as of December 31, 2014, which was 1.42%.

 

 

(3)

In October 2008, we entered into a contract to purchase 334,000 MMBTU per year of natural gas requirements at $7.50 per MMBTU plus a $0.07 per MMBTU management fee for the period from April 2009 through March 2011. Subsequently, the agreement has been extended as follows:

 

Period

 

MMBTUs

   

Price per MMBTU

   

Management fee per MMBTU

 

April 2011 - March 2012

    334,207     $ 6.50     $ 0.07  

April 2012 - March 2013

    334,207     $ 5.50     $ 0.07  

April 2013 - December 2014

    556,886     $ 4.905     $ 0.07  

April 2013 - September 2013

 

additional 5,000/month

    $ 4.70     $ 0.07  

October 2013 - March 2014

 

additional 5,000/month

    $ 4.75     $ 0.07  

April 2014 - December 2014

 

additional 5,000/month

    $ 4.70     $ 0.07  

January 2015 - March 2015

    95,900     $ 4.50     $ 0.07  

April 2015 - June 2015

    93,600     $ 4.30     $ 0.07  

July 2015 - September 2015

    92,300     $ 4.35     $ 0.07  

October 2015 - December 2015

    91,900     $ 4.50     $ 0.07  

January 2016 - March 2016

    95,900     $ 4.53     $ 0.07  

April 2016 - June 2016

    93,600     $ 4.17     $ 0.07  

July 2016 - September 2016

    92,300     $ 4.26     $ 0.07  

October 2016 - December 2016

    91,900     $ 4.42     $ 0.07  

January 2017 - December 2017

    467,505     $ 4.06     $ -  

 

If we are unable to purchase the contracted amounts and the market price at that time is less than the contracted price, we would be obligated under the terms of our agreements to reimburse an amount equal to the difference between the contracted amount and the amount actually purchased, multiplied by the difference between our contract price and a price designated in the contract (approximates spot price).

 

 
37

 

 

 

(4)

In the fourth quarter of 2013, as part of our projects to build a new paper machine in our paper mill and upgrade an existing converting line, we entered into purchase orders to purchase, construct and install a paper machine and a converting rewinder. During 2014, we entered into additional significant purchase orders to purchase other production equipment unrelated to these projects. The purchase order for the paper machine is denominated in Euros. The related amounts shown in the table were translated to US dollars using the spot exchange rate as of December 31, 2014.

 

Off-Balance Sheet Arrangements

 

            We have not entered into any transactions, agreements or other contractual arrangements that would result in significant off-balance sheet liabilities.

 

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 of America requires management to make estimates and judgments that affect our reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an on-going 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 customer's creditworthiness as determined by our review of their current credit information. We continuously monitor collections and payments from our customers and maintain a provision for estimated losses based on historical experience and specific customer collection issues that we have identified. Trade receivables are written-off when all reasonable collection efforts have been exhausted, including, but not limited to, external third-party collection efforts and litigation. While such credit losses have historically been within management's expectations and the provisions established, there can be no assurance that we will continue to experience the same credit loss rates as in the past. During 2014, no accounts receivable were written off against the allowance for doubtful accounts, while the provision was increased by $19,000 based on sales levels, historical experience and an evaluation of the quality of existing accounts receivable. Additionally, $1,000 of accounts receivable previously written off were recovered, resulting in a net increase in the allowance of $20,000. During 2013, $35,000 of accounts receivable not expected to be collected were written off against the allowance for doubtful accounts, while the provision was increased by $45,000 based on sales levels, historical experience and an evaluation of the quality of existing accounts receivable, resulting in a net increase of $10,000 in the allowance. During 2012, no accounts receivable were written off, while the allowance was reduced by $20,000, resulting in a net decrease of $20,000 in the allowance.

 

            Inventory.    Our inventory consists of converted finished goods, bulk paper rolls and raw materials and is based on standard cost, specific identification, or first-in, first-out (“FIFO”). Standard costs approximate actual costs on a FIFO basis. Material, labor and factory overhead necessary to produce the inventories are included in the standard cost. 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 year ended December 31, 2014, the inventory allowance was increased $193,000 based on a specific review of estimated slow moving or obsolete inventory items was decreased $100,000 due to actual write offs of obsolete inventory items, resulting in a net increase in the allowance of $93,000. During the year ended December 31, 2013, the inventory allowance was increased $6,000 based on a specific review of estimated slow moving or obsolete inventory items and was decreased by $79,000 due to actual write offs of obsolete inventory items, resulting in a net decrease in the allowance of $73,000. During the year ended December 31, 2012, the inventory allowance was increased by $103,000 due to the introduction of new products during 2012 and obsolescence of certain chemicals used in our paper mill operation and was reduced by $75,000 due to actual write offs of obsolete inventory items, resulting in a net increase in the allowance of $28,000.

 

 
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            Property, plant and equipment.    Significant capital expenditures are required to establish and maintain a paper mill and converting facility. Our property, plant and equipment consists of land, buildings and improvements, machinery and equipment, vehicles, parts and spares and construction-in-process, which are stated at cost, net of accumulated depreciation. Depreciation of property, plant and equipment is calculated using the straight-line method over the estimated useful lives of the assets. Our management regularly reviews estimated useful lives to determine whether any changes are necessary to reflect the related assets' actual productive lives. The lives of our property, plant and equipment currently range from 2.5 to 40 years. As of December 31, 2014, we estimate that a 1 year decrease in useful lives would have increased our depreciation expense by approximately $1.0 million, which would result in a corresponding reduction in our gross profit and operating income.

 

Stock-based Compensation. U.S. GAAP requires equity-classified, share-based payments to employees, including grants of employee stock options, to be valued at fair value on the date of grant and to be expensed over the applicable vesting period. We recognize this expense on a straight-line basis over the options’ expected terms. We issue stock options that vest over a specified period (time-based vesting) and stock options that vest when the price of the Company’s common stock reaches a certain price (market-based vesting).  We also issue restricted stock.

 

We granted options to purchase 585,000 and 43,750 shares of our common stock in 2014 and 2013, respectively. We recorded stock-based compensation expense of $1,828,000 and $293,000 during 2014 and 2013, respectively, in connection with the option grants.  During 2013, we granted 16,000 shares of restricted stock pursuant to the 2005 Stock Incentive Plan. We recorded stock-based compensation expense of $51,000 and $53,000 during 2014 and 2013, respectively, in connection with the restricted stock grants. Grants of restricted stock are valued using the closing market price of our common stock on the date of grant.

 

We estimate the grant date fair value of time-based stock option awards using the Black-Scholes option valuation model, which requires assumptions involving an estimate of the fair value of the underlying common stock on the date of grant, the expected term of the options, volatility, discount rate and dividend yield.  Separate values were determined for options having exercise prices ranging from $5.18 to $30.09. For options valued using the Black-Scholes option valuation model, we calculated expected option terms based on the “simplified” method for “plain vanilla” options, due to the Company’s limited exercise information. The “simplified method” calculates the expected term as the average of the vesting term and the original contractual term of the options. We calculated volatility using the daily volatilities of our common stock since our Initial Public Offering (“IPO”), while the discount rate was estimated using the interest rate for a treasury note with the same contractual term as the options granted.  Dividend yield is estimated at our current dividend rate, which adjustments for any known future changes in the rate.

 

We have engaged a valuation specialist to estimate the grant date fair value of market-based stock option awards.  Separate values were determined for options having exercise prices ranging from $28.185 to $31.125. The specialist utilizes a Monte Carlo valuation method to estimate the grant date fair value of the options granted in order to simulate a range of our possible future stock prices.  Significant assumptions to the Monte Carlo method include the expected life of the option, volatility and dividend yield.  The expected life of the option is based on the average of the service period and the contractual term of the option, using the “simplified” method for “plain vanilla” options.  Volatility is calculated based on a mix of historical and implied volatility during the expected life of the options.  Historical volatility is considered since our IPO and implied volatility is based on the publicly traded options of a three company peer group within the paper industry.  Dividend yield is estimated based on our average historical dividend yield and our current dividend yield as of the grant date.  The Monte Carlo analysis is performed under a risk-neutral premise, under which price drift is modeled using treasury note yields matching the expected life of the options.

 

Under U.S. GAAP, we expense the compensation cost related to the marked-based stock option awards on a straight-line basis over the derived service periods of the options as calculated under the Monte Carlo valuation method.  However, if the market condition is achieved for any tranche of these options prior to the end of the derived service period, all remaining expense related to that tranche would be recognized in the period in which the market condition is achieved.  Additionally, if the service period is met but the share price target required for the options to become exercisable is never achieved, no compensation cost may be reversed.  As such, we may recognize expense for options that never become exercisable.

 

In addition, we are required to develop an estimate of the number of share-based awards that will be forfeited due to employee turnover. The guidance on stock compensation requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates in order to derive our best estimate of awards ultimately expected to vest. We estimate forfeitures based on historical experience related to our own stock-based awards granted. We anticipate that these estimates will be revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

 

Intangible Assets and Goodwill. We allocate the cost of business acquisitions to the assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition (commonly referred to as the purchase price allocation). As part of the purchase price allocations for our business acquisitions, identifiable intangible assets are recognized as assets apart from goodwill if they arise from contractual or other legal rights, or if they are capable of being separated or divided from the acquired business and sold, transferred, licensed, rented or exchanged.  We have engaged a valuation specialist to estimate the fair value of our purchase price and the related intangible assets acquired.

 

 
39

 

 

During 2014, we acquired certain assets and the U.S. business of Fabrica.  Due to these transactions, we separately recognized the fair values of a combined Supply and Lease Agreement, trademarks, a non-compete agreement and customer relationships. The fair value of these assets was determined using an income approach, as follows: Supply and Lease Agreement - discounted cash flows method, trademarks — “relief from royalty” method, non-compete agreement - “with and without” method, and customer relationships - excess earnings method.  An income approach requires estimates of future income.  Under the discounted cash flow method, we utilized assumptions related to the term of the agreements, the net benefit from the agreements and any changes in that benefit over the term of the agreement, future tax rates and discount rates.  Under the relief from royalty method, we estimated the useful lives of the trademarks, future revenues associated with the trademarks, a royalty rate and a discount rate.  The with and without method requires assumptions related to the probability of competition in the absence of the non-compete agreement, the loss of future revenues due to competition and discount rates.  Under the excess earnings method, we must estimate future revenues, including growth and attrition rates, income tax rates, a rate of return on assets, and discount rates.  Future revenues and estimated benefits from the agreements are based on management’s knowledge of the industry, customers, operations and the agreements.  Tax rates are based on current effective tax rates.  The royalty rate is based on analysis of current royalty rates for corporate and product trademarks for similar products and evaluation of factors such as alternative trademarks available, legal defensibility, remaining useful life, licensing power, net revenue margin, market share, barriers to entry, capital requirements and customers’ bargaining power.  The discount rate used to determine the present value of future cash flows was based on the weighted average cost of capital method.

 

The value assigned to goodwill equals the amount of the purchase price of the business acquired in excess of the sum of the amounts assigned to identifiable acquired assets, both tangible and intangible, less liabilities assumed. At December 31, 2014, we had goodwill of $7.6 million and identifiable intangible assets, net of accumulated amortization, of $17.2 million.

 

Intangible assets are amortized over their respective estimated useful lives ranging from two to twenty years. The useful life of an intangible asset is the period over which the asset is expected to contribute directly or indirectly to our future cash flows rather than the period of time that it would take us to internally develop an intangible asset that would provide similar benefits. The estimate of the useful lives of our intangible asset is based on an analysis of all pertinent factors, in particular:

 

 

the expected use of the asset by the entity;

 

the expected useful life of another asset or group of assets to which the useful life of the intangible asset may relate;

 

any legal, regulatory or contractual provisions that may limit the useful life;

 

any legal, regulatory, or contractual provisions that enable renewal or extension of the asset’s legal or contractual life without substantial cost (provided there is evidence to support renewal or extension and renewal or extension can be accomplished without material modifications of the existing terms and conditions);

 

the effects of obsolescence, demand, competition and other economic factors (such as the stability of the industry, known technological advances, legislative action that results in an uncertain or changing regulatory environment, and expected changes in distribution channels); and

 

the level of regular maintenance expenditures (but not enhancements) required to obtain the expected future cash flows from the asset (for example, a material level of required maintenance in relation to the carrying amount of the asset may suggest a limited useful life).

 

If no legal, regulatory, contractual, competitive, economic, or other factors limit the useful life of an intangible asset, the useful life of the asset is considered to be indefinite. The term indefinite does not mean infinite. An intangible asset with a finite useful life is amortized over that useful life; an intangible asset with an indefinite useful life is not amortized. We have no intangible assets with indefinite useful lives. Under U.S. GAAP, goodwill is not amortized.

 

Impairment of Long-Lived Assets. We review long-lived assets such as property, plant and equipment, intangible assets and goodwill for impairment whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable, and also review goodwill annually.  U.S. GAAP requires that goodwill be tested, at a minimum, annually for each reporting unit. The first step in testing goodwill to assess qualitative factors to determine whether it is more likely than not that goodwill is impaired as a basis for determining whether it is necessary to perform the quantitative impairment test.  If the first step indicates a quantitative test must be performed, the second step is to identify any potential impairment by comparing the carrying value of the reporting unit to its fair value. If a potential impairment is identified, the third step is to measure the impairment loss by comparing the implied fair value of goodwill with the carrying value of goodwill of the reporting unit. Alternatively, the Company may bypass the qualitative assessment in any period and proceed directly to performing the second step.

 

As the goodwill on the consolidated balance sheet as of December 31, 2014 is related to the acquisition that occurred in June of 2014, the Company plans to perform its initial goodwill impairment test in 2015.

 

New Accounting Pronouncements

 

        Refer to the discussion of recently adopted/issued accounting pronouncements under Item 8, Financial Statements and Supplementary Data, Footnote 1—New accounting pronouncements.

 

 
40

 

 

Non-GAAP Discussion

 

            In addition to our GAAP results, we also consider non-GAAP measures of our performance for a number of purposes including EBITDA, Adjusted EBITDA and Net Debt, each of which is defined below.

 

EBITDA and Adjusted EBITDA

 

We use EBITDA and Adjusted EBITDA as supplemental measures of our performance that is not required by, or presented in accordance with GAAP. EBITDA and Adjusted EBITDA 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. Amortization of deferred debt issuance costs is included in net interest expense. Adjusted EBITDA represents EBITDA before non-cash stock compensation expense and sporadic expenses, such as costs of business acquisitions. We believe EBITDA and Adjusted EBITDA facilitate operating performance comparisons from period to period 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), the age and book depreciation of facilities and equipment (affecting relative depreciation expense), non-cash compensation and valuation (affecting stock compensation expense) and sporadic expenses (including costs of business acquisitions).

 

            EBITDA and Adjusted EBITDA have 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 include:

 

 

they do not reflect our cash expenditures for capital assets;

 

they do not reflect changes in, or cash requirements for, our working capital requirements;

 

they do not reflect cash requirements for cash dividend payments;

 

they do 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 and Adjusted EBITDA do 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.

 

 
41

 

 

            Because of these limitations, EBITDA and Adjusted 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 and Adjusted EBITDA on a supplemental basis.

 

            The following table reconciles EBITDA and Adjusted EBITDA to net income for the years ended December 31, 2014, 2013 and 2012:

 

     

Years Ended December 31,

 
     

2014

   

2013

   

2012

 
     

(In thousands, except % of net sales)

 
                           

Net income

  $ 9,465     $ 13,319     $ 9,257  
Plus: Interest expense, net     271       371       407  
Plus: Income tax expense     4,394       4,892       4,144  
Plus: Depreciation     8,936       7,613       7,541  
Plus: Intangibles Amortization     753       -       -  

EBITDA

  $ 23,819     $ 26,195     $ 21,349  
% of net sales     16.7 %     22.5 %     21.2 %
                         
Plus: Stock compensation expense     1,879       346       346  
Plus: Acquisition costs     1,572       -       -  
Plus: Demolition costs     400       -       -  

Adjusted EBITDA

  $ 27,670     $ 26,541     $ 21,695  
% of net sales     19.4 %     22.8 %     21.5 %

 

 

            Adjusted EBITDA increased $1.1 million to $27.7 million for the year ended December 31, 2014, compared to $26.5 million in the same period in 2013. Adjusted EBITDA as a percent of net sales decreased from 22.8% in 2013 to 19.4% in 2014. EBITDA decreased $2.4 million to $23.8 million for the year ended December 31, 2014, compared to $26.2 million in the same period in 2013. EBITDA as a percent of net sales decreased from 22.5% in 2013 to 16.7% in 2014. The foregoing factors discussed in the net sales, cost of sales, and selling, general and administrative expenses sections are the reasons for the change.

 

Adjusted EBITDA increased $4.8 million to $26.5 million for the year ended December 31, 2013, compared to $21.7 million in the same period in 2012. Adjusted EBITDA as a percent of net sales increased from 21.5% in 2012 to 22.8% in 2013. EBITDA increased $4.8 million to $26.2 million for the year ended December 31, 2013, compared to $21.3 million in the same period in 2012. EBITDA as a percent of net sales increased from 21.2% in 2012 to 22.5% in 2013. The foregoing factors discussed in the net sales, cost of sales and selling, general and administrative expenses sections are the reasons for the change.

 

Net Debt

 

             We use Net Debt as a supplemental measure of our leverage that is not required by, or presented in accordance with, GAAP. Net Debt should not be considered as an alternative to total debt, total liabilities or any other performance measure derived in accordance with GAAP. Net Debt represents total debt reduced by cash and short-term investments. We use this figure as a means to evaluate our ability to repay our indebtedness and to measure the risk of our financial structure.

 

             Net Debt represents the amount that Cash and Short-Term Investments is less than total Debt of the Company. The amounts included in the Net Debt calculation are derived from amounts included in the historical Balance Sheets. We have reported Net Debt because we regularly review Net Debt as a measure of the Company's leverage. However, the Net Debt measure presented in this document may not be comparable to similarly titled measures reported by other companies due to differences in the components of the calculation.

 

Net Debt increased from $2.8 million on December 31, 2013 to $37.0 million on December 31, 2014 primarily as a result of an increase in total debt and a decrease in our total cash and short-term investments. The increase in total debt is primarily due to additional debt incurred related to the Fabrica Transaction and borrowings to fund capital expenditures in 2014. The decrease in cash and short-term investments was primarily due to a decrease in cash provided by operations in 2014 and increased capital expenditures in 2014.

 

 
42

 

 

            The following table presents Net Debt as of December 31, 2014 and December 31, 2013:

 

   

As of

 
   

December 31,

   

December 31,

 

Net Debt Reconciliation:

 

2014

   

2013

 

Current Portion Long-Term Debt

  $ 2,700     $ 1,152  

Long-Term Debt

    33,662       13,927  

Total Debt

    36,362       15,079  

Less Cash, net of Bank Overdrafts

    685       (7,205 )

Less Short-Term Investments

    -       (5,035 )

Net Debt

  $ 37,047     $ 2,839  

 

 

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

            This Form 10-K, including the sections entitled "Business," "Risk Factors" and "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, expectations and intentions contained in this Form 10-K 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 achievement 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", “will” 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, but are not limited to, those detailed under the caption "Risk Factors" and 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;

 

Fabrica’s failure to execute under the Supply Agreement;

 

failure to successfully integrate the Fabrica business into our existing operations and the additional indebtedness incurred to finance the Fabrica Transaction;

 

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;

 

 
43

 

 

 

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.

 

            You should read this Form 10-K completely and with the understanding that our actual results may be materially different from what we expect. We undertake no duty to update these forward-looking statements after the date of this Form 10-K, even though our situation may change in the future. We qualify all of our forward-looking statements by these cautionary statements.

 

Item 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Interest Rate Risk

 

            Our market risks relate primarily to changes in interest rates. Our revolving line of credit and our term loan carry a variable interest rate that is tied to market indices and, therefore, our statement of income and our cash flows will be exposed to changes in interest rates. As of December 31, 2014, we had floating-rate borrowings of $36.4 million. The amounts outstanding under all loans bear interest at a variable rate of LIBOR plus a specified margin of 1.0% to 2.0%. The margin is set quarterly and based on our leverage ratio.

 

            We considered the historical volatility of short-term interest rates and determined that it would be reasonably possible that an adverse change of 100 basis points could be experienced in the near term. Based on current borrowing levels and interest rate structures, a 100 basis point increase in interest rates would result in a pre-tax $357,000 increase to our annual interest expense. We attempt to mitigate interest rate risk by refinancing our debt at lower interest rates when it is deemed cost-effective to do so.

 

Commodity Price Risk

 

            We are subject to commodity price risk, the most significant of which relates to the price of fiber. Selling prices of tissue products are influenced by the market price of fiber, which is determined by industry supply and demand. The effect of a fiber price increase of $10.00 per ton would be approximately $669,000 per year. As previously discussed under Item 1A, "Risk Factors," increases in fiber prices could adversely affect earnings if selling prices are not adjusted or if such adjustments trail the increase in fiber prices. We attempt to mitigate commodity price risk by entering into supply agreements that provide discounts to current market prices.

 

Natural Gas Price Risk

 

            We are exposed to market risks for changes in natural gas commodity pricing. We partially mitigate this risk through our natural gas firm price contract that started in April 2009 and continues through December 2017, for approximately 70% of our natural gas requirements for our manufacturing facilities. The effect of a $1.00/MMBTU increase on the 30% not under firm price contract would be approximately $121,000 a year.

 

 
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Item 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

INDEX TO FINANCIAL STATEMENTS

 

 

 

 

Report of Independent Registered Public Accounting Firm

 

46

     

Consolidated Balance Sheets as of December 31, 2014 and 2013

 

47

     

Consolidated Statements of Income for the Years ended December 31, 2014, 2013 and 2012

 

48

     

Consolidated Statements of Changes in Stockholders' Equity for the Years ended December 31, 2012, 2013 and 2014

 

49

     

Consolidated Statements of Cash Flows for the Years ended December 31, 2014, 2013 and 2012

 

50

     

Notes to Consolidated Financial Statements

 

51 - 71

 

 
45

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Stockholders

Orchids Paper Products Company

 

        We have audited the accompanying consolidated balance sheets of Orchids Paper Products Company as of December 31, 2014 and 2013, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2014, and the financial statement schedule of Orchids Paper Products Company listed in Item 15(a). We also have audited Orchids Paper Products Company's internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. Orchids Paper Products Company's management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the Company's internal control over financial reporting based on our audits.

 

        We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

 

        A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (a) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (b) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (c) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

 

        Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

        In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Orchids Paper Products Company and subsidiaries as of December 31, 2014 and 2013, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2014, in conformity with accounting principles generally accepted in the United States of America, and in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. Also in our opinion, Orchids Paper Products Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013.

 

/s/ HOGANTAYLOR LLP

 

Tulsa, Oklahoma

March 9, 2015

 

 
46

 

 

 

ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

 

(Dollars in thousands, except share and per share data)

 

   

As of December 31,

 
   

2014

   

2013

 
                 

ASSETS

               

Current assets:

               

Cash

  $ 1,021     $ 7,205  

Accounts receivable, net of allowance of $155 in 2014 and $135 in 2013

    9,121       6,585  

Inventories, net

    9,650       10,921  

Short-term investments

    -       5,035  

Income taxes receivable

    634       -  

Prepaid expenses

    1,285       863  

Receivable from related party

    1,086       -  

VAT receivable

    1,734       -  

Other current assets

    887       146  

Deferred income taxes

    614       552  

Total current assets

    26,032       31,307  

Property, plant and equipment

    169,551       137,750  

Accumulated depreciation

    (49,831 )     (42,005 )

Net property, plant and equipment

    119,720       95,745  
                 

Intangible assets, net of accumulated amortization of $753 in 2014

    17,237       -  

Goodwill

    7,560       -  

Deferred debt issuance costs, net of accumulated amortization of $20 in 2014 and $18 in 2013

    190       40  

Total assets

  $ 170,739     $ 127,092  
                 

LIABILITIES AND STOCKHOLDERS' EQUITY

               

Current liabilities:

               

Bank overdrafts

  $ 1,706     $ -  

Accounts payable

    4,796       3,685  

Accounts payable to related party