Note 16 — Subsequent Events
On October 26, 2016, the Board of Directors authorized a quarterly cash dividend of $0.35 per outstanding share of the Company’s common stock. The Company expects to pay this dividend on November 21, 2016 to stockholders of record at the close of business on November 7, 2016.
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Information
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements. These statements relate to, among other things:
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our business strategy;
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the market opportunity for our products, including expected demand for our products;
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●
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our estimates regarding our capital requirements; and
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●
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any of our other plans, objectives, and intentions contained in this report that are not historical facts.
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These statements relate to future events or future financial performance, and involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “would,” “target,” “expects,” “plans,” “intends,” “anticipates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of such terms or other comparable terminology, or by discussion of strategy that may involve risks and uncertainties. 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. The forward-looking statements contained in this Form 10-Q reflect our views and assumptions only as of the date hereof. You should not place undue reliance on forward-looking statements. We caution you that these forward-looking statements are only predictions, which are subject to risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements.
Some factors that could materially affect our actual results are detailed under the caption “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015, as filed with the SEC on March 7, 2016, subsequent filings with the SEC, and those identified in Part II, Item 1A of this Form 10-Q, which include but are not limited to:
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failure to complete the construction of our South Carolina facility on schedule or at all;
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●
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intense competition in our markets and aggressive pricing by our competitors could force us to decrease our prices and reduce our profitability;
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●
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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;
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disruption in our supply or increase in the cost of fiber;
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●
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Fabrica’s failure to execute under the Supply Agreement;
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●
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the additional indebtedness incurred to finance the construction of our South Carolina facility;
|
●
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new competitors entering the market and increased competition in our region;
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●
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changes in our retail trade customers’ policies and increased dependence on key retailers in developed markets;
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●
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excess supply in the market may reduce our prices;
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●
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the availability of, and prices for, energy;
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●
|
failure to purchase the contracted quantity of natural gas may result in financial exposure;
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●
|
our exposure to variable interest rates;
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●
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the loss of key personnel;
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●
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labor interruption;
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●
|
natural disaster or other disruption to our facilities;
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●
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ability to meet loan covenant conditions or renegotiate such conditions with lenders;
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●
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ability to finance the capital requirements of our business; and
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●
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other factors discussed from time to time in our filings with the SEC.
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If any of these risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may vary significantly from what we projected. Any forward-looking statement you read in the following Management’s Discussion and Analysis of Financial Condition and Results of Operations reflects our current views with respect to future events and is subject to the risks listed above and other risks, uncertainties, and assumptions relating to our operations, results of operations, growth strategy, and liquidity. We assume no obligation to publicly update or revise these forward-looking statements for any reason, whether as a result of new information, future events, or otherwise.
Overview of the Business
We are a customer focused, national supplier of high quality consumer tissue products. 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 typically sell parent rolls not required by our converting operations to other converters. Our integrated manufacturing facilities have flexible production capabilities, which allow us to produce high quality tissue products with short production times across all quality tiers for customers in our target markets. We predominately sell our products to our core customer-base in the “at home” market under private labels. Our customer base consists primarily of dollar stores, discount retailers and grocery stores that offer limited alternatives across a wide range of products. The “at home” tissue market consists of several quality levels, including a value tier, a premium tier and an ultra-premium tier.
Part of our strategy is to increase our volume of premium and ultra-premium tier products sold to customers, as these products typically have a higher gross margin than value tier products. The following graph shows shipments of our premium tier and ultra-premium tier products as a percentage of total cases shipped. Shipments of premium tier and ultra-premium tier products as a percentage of total cases shipped decreased following the Fabrica Transaction in June 2014 as a majority of the products shipped under the Supply Agreement are considered value tier products.
Comparative Three-Month Periods Ended
September 30, 2016 and 2015
Net Sales
|
|
Three Months Ended September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
Converted product net sales
|
|
$
|
38,284
|
|
|
$
|
43,675
|
|
Parent roll net sales
|
|
|
1,344
|
|
|
|
3,157
|
|
Net sales
|
|
$
|
39,628
|
|
|
$
|
46,832
|
|
Net sales in the quarter ended September 30, 2016 decreased $7.2 million, or 15%, from $46.8 million in 2015 to $39.6 million in 2016. Net sales figures represent the gross selling price, including freight, less discounts and pricing allowances. The decrease in net sales is due to a $5.4 million decrease in the sales of converted products and a $1.8 million decrease in the net sales of parent rolls.
Net sales of converted product decreased $5.4 million, or 12%, from $43.7 million in 2015 to $38.3 million in 2016. The decrease in converted product net sales is primarily due to a 12% decrease in tonnage shipped. Net selling prices per ton remained approximately the same between the two periods, other than for product-line mix impacts. For example, the proportion of bathroom tissue sold, at a lower average price per ton than for towels, was greater in third quarter 2016. Converted product tons sold decreased primarily due to competitive pressures, including those upon our principal customers.
Net sales of parent rolls decreased $1.8 million, or 57%, in 2016. Parent roll production at Pryor, though 3% higher than in 2015, was used in part for the Barnwell, South Carolina start-up and in part to increase finished-goods inventory, thereby foregoing margin we would have received on parent roll sales in favor of margin we expect to gain when we sell this tonnage as converted product. In order to improve upon cash flows, Management is planning to resume the practice of selling excess parent rolls in the fourth quarter.
Cost of Sales
|
|
Three Months Ended September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
(in thousands, except gross profit margin %)
|
|
|
|
|
|
|
|
|
|
|
Cost of goods sold
|
|
$
|
30,504
|
|
|
$
|
34,432
|
|
Depreciation
|
|
|
2,909
|
|
|
|
2,555
|
|
Cost of sales
|
|
$
|
33,413
|
|
|
$
|
36,987
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
$
|
6,215
|
|
|
$
|
9,845
|
|
Gross profit margin %
|
|
|
15.7
|
%
|
|
|
21.0
|
%
|
The major components of cost of sales are the cost of raw materials, internally produced paper, direct labor and benefits, freight costs of products shipped to customers, repairs and maintenance, energy, utilities, depreciation, and the cost of converted products purchased under the Supply Agreement with Fabrica.
Cost of sales decreased $3.5 million, or 10%, to $33.4 million, compared to $36.9 million in the same period of 2015, due primarily to decreased sales. As a percentage of net sales, cost of sales increased to 84.3% in the 2016 quarter from 79.0% in the 2015 quarter due largely to increased depreciation related to the Barnwell converting facility, the addition of Barnwell’s overhead costs as a precursor to ramping-up production, and the spreading of fixed and semi-variable costs over decreased converted sales volumes.
Gross Profit
As a result of the foregoing factors, gross profit in the quarter ended September 30, 2016 decreased $3.6 million, or 37%, to $6.2 million compared to $9.8 million in the same period last year. Gross profit as a percentage of net sales in the 2016 quarter was 15.7% compared to 21.0% in the 2015 quarter. As a partial offset to items noted above, lower fiber prices contributed approximately $0.6 million more gross profit in the third quarter of 2016.
Selling, General and Administrative Expenses
|
|
Three Months Ended September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
(in thousands, except SG&A as a
% of net sales)
|
|
|
|
|
|
|
|
|
|
|
Commission expense
|
|
$
|
271
|
|
|
$
|
280
|
|
Other S,G&A expenses
|
|
|
2,286
|
|
|
|
2,157
|
|
Selling, General & administrative exp
|
|
$
|
2,557
|
|
|
$
|
2,437
|
|
SG&A as a % of net sales
|
|
|
6.5
|
%
|
|
|
5.2
|
%
|
Selling, general and administrative expenses include salaries, commissions to brokers and other expenses. Selling, general and administrative expenses increased $0.1 million, or 4.9%, in the quarter ended September 30, 2016 as compared to the same period in 2015 as the net result of various miscellaneous changes such as the hiring of sales personnel; lower administrative salaries, in part due to temporary vacancies; an increase in advertising; and a late-payment penalty.
Amortization of Intangibles
The Company recognized $233,000 and $376,000 of amortization expense related to the intangible assets acquired in the Fabrica Transaction during the quarters ended September 30, 2016 and 2015, respectively.
Operating Income
As a result of the foregoing factors, operating income for the quarter ended September 30, 2016 was $3.4 million compared to operating income of $7.0 million for the same period of 2015.
Interest Expense and Other Income
|
|
Three Months Ended September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
(in thousands)
|
|
Interest expense
|
|
$
|
639
|
|
|
$
|
11
|
|
Other (income) expense, net
|
|
$
|
(162
|
)
|
|
$
|
(169
|
)
|
|
|
|
|
|
|
|
|
|
Income before income taxes
|
|
$
|
2,948
|
|
|
$
|
7,190
|
|
Interest expense includes interest on all debt and amortization of deferred debt issuance costs. Interest expense for the third quarter of 2016 totaled $639,000 compared to interest expense of $11,000 in the same period in 2015. Interest expense for third quarter 2016 excludes $348,000 of interest capitalized on significant projects during the quarter, compared to $299,000 of capitalized interest in the same period of 2015. The higher level of total interest in 2016 resulted from higher debt balances, due primarily to additional borrowings to finance construction of the Barnwell, South Carolina facility.
Other (income) expense for the three months ended September 30, 2016 and 2015 includes $153,000 and $169,000, respectively, of income related to the Company’s pooled financing agreement with the Oklahoma Development Financing Authority (ODFA).
Income Before Income Taxes
As a result of the foregoing factors, income before income taxes decreased $4.2 million to $2.9 million in the quarter ended September 30, 2016, compared to $7.2 million in the same period in 2015.
Income Tax Provision
As of September 30, 2016, our annual estimated effective tax rate for the full year is estimated to be 32.25%, as compared to the 34.1% effective tax rate estimated at the end of the second quarter of 2016. The annual estimated effective tax rate for 2016 differs from the statutory rate due principally to Oklahoma, South Carolina, Indian Employment, and Foreign tax credits. The actual effective tax rate for the quarter ended September 30, 2016 was 24.9% as a result of a one-off adjustment to the tax credits. The actual effective tax rate for the third quarter of 2015 was 34.0%, as compared to an annual estimated effective tax rate of 33.9% as of September 30, 2015. The annual estimated effective tax rate for 2015 differed from the statutory rate due primarily to U. S. manufacturing tax credits and foreign and state income taxes.
Comparative
Nine
-Month Periods Ended
September 30, 2016 and 2015
Net Sales
|
|
Nine Months Ended September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
Converted product net sales
|
|
$
|
122,867
|
|
|
$
|
120,877
|
|
Parent roll net sales
|
|
|
3,918
|
|
|
|
5,665
|
|
Net sales
|
|
$
|
126,785
|
|
|
$
|
126,542
|
|
Net sales in the nine-month period ended September 30, 2016 increased $0.2 million, or 0.2%, from $126.5 million in 2015 to $126.8 million in 2016. Net sales figures represent the gross selling price, including freight, less discounts and pricing allowances. The increase in net sales is due to a $1.9 million increase in the sales of converted products and offset by a $1.7 million decrease in the net sales of parent rolls.
Net sales of converted product increased $1.9 million, or 2%, from $120.8 million in 2015 to $122.8 million in 2016 primarily due to a 3% increase in tonnage shipped. Net sales of parent rolls decreased $1.75 million, or 31%, in the nine months ended September 30, 2016. Parent roll production, though 26% higher than in 2015, was used in part for the Barnwell, South Carolina start-up and in part to increase finished-goods inventory, thereby foregoing margin we would have received on parent roll sales in favor of margin we expect to gain when we sell this tonnage as converted product.
Cost of Sales
|
|
Nine Months Ended September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
(in thousands, except gross profit margin %)
|
|
|
|
|
|
|
|
|
|
|
Cost of goods sold
|
|
$
|
93,675
|
|
|
$
|
97,216
|
|
Depreciation
|
|
|
8,641
|
|
|
|
6,976
|
|
Cost of sales
|
|
$
|
102,316
|
|
|
$
|
104,192
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
$
|
24,469
|
|
|
$
|
22,350
|
|
Gross profit margin %
|
|
|
19.3
|
%
|
|
|
17.7
|
%
|
Cost of sales decreased $1.8 million, or 1.8%, to $102.3 million, compared to $104.2 million in the same period of 2015, due primarily to lower fiber costs of $1.7 million, favorable costs from Fabrica due to the Mexican peso devaluation, the $1.1 million of business interruption proceeds received in second quarter 2016, favorable production overhead absorption in the Pryor paper mill of approximately $0.6 million, and other favorable cost reductions, partially offset by unfavorable overhead absorption in Pryor converting of approximately $2.1 million and $3.0 million in Barnwell. As a percentage of net sales, cost of sales decreased to 80.7% in the 2016 period from 82.3% in the 2015 period.
Gross Profit
As a result of the foregoing factors, Gross profit in the nine-month period ended September 30, 2016 increased $2.1 million, or 9.5%, to $24.5 million compared to $22.4 million in the same period last year. Gross profit as a percentage of net sales in the 2016 period was 19.3% compared to 17.7% in the 2015 period.
Selling, General and Administrative Expenses
|
|
Nine Months Ended September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
(in thousands, except SG&A as a %
of net sales)
|
|
|
|
|
|
|
|
|
|
|
Commission expense
|
|
$
|
884
|
|
|
$
|
911
|
|
Other S,G&A expenses
|
|
|
6,899
|
|
|
|
6,263
|
|
Selling, General & administrative exp
|
|
$
|
7,783
|
|
|
$
|
7,174
|
|
SG&A as a % of net sales
|
|
|
6.1
|
%
|
|
|
5.7
|
%
|
Selling, general and administrative expenses include salaries, commissions to brokers and other miscellaneous expenses. Selling, general and administrative expenses increased $0.6 million, or 8.5%, in the nine-month period ended September 30, 2016 as compared to the same period in 2015 primarily due to higher professional and consulting fees, artwork and design fees, payroll processing fees, recruitment and relocation costs, travel, and advertising, partially offset by reduced administrative salaries. As a percentage of net sales, selling, general and administrative expenses increased to 6.1% in the 2016 period compared to 5.7% in the same period of 2015.
Amortization of Intangibles
The Company recognized $1.0 million and $1.1 million of amortization expense related to the intangible assets acquired in the Fabrica Transaction during the nine-month periods ended September 30, 2016 and 2015, respectively.
Operating Income
As a result of the foregoing factors, operating income for the nine-month period ended September 30, 2016 was $15.7 million compared to operating income of $14.0 million for the same period of 2015.
Interest Expense and Other Income
|
|
Nine Months Ended September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
(in thousands)
|
|
Interest expense
|
|
$
|
1,187
|
|
|
$
|
289
|
|
Other (income) expense, net
|
|
$
|
(527
|
)
|
|
$
|
(507
|
)
|
|
|
|
|
|
|
|
|
|
Income before income taxes
|
|
$
|
15,040
|
|
|
$
|
14,264
|
|
Interest expense includes interest on all debt and amortization of deferred debt issuance costs. Interest expense for the nine-month period ended September 30, 2016 totaled $1.2 million compared to interest expense of $0.3 million in the same period in 2015. Interest expense for 2016 excludes $1.2 million of interest capitalized on significant projects during the period, compared to $423,000 of capitalized interest in the same period of 2015. The higher level of total interest in 2016 resulted from higher debt balances due primarily to additional debt incurred to finance capital expenditures.
Other (income) expense for the nine-month period ended September 30, 2016 and 2015 includes $500,000 and $514,000, respectively, of income related to the Company’s pooled financing agreement with the ODFA.
Income Before Income Taxes
As a result of the foregoing factors, income before income taxes increased $776,000 to $15.0 million in the nine-month period ended September 30, 2016, compared to $14.3 million in the same period in 2015.
Income Tax Provision
As of September 30, 2016, our annual estimated effective tax rate for the full year is estimated to be 32.25%, as compared to the 34.1% effective tax rate estimated at the end of the second quarter of 2016. The actual effective tax rate for the nine-month period ended September 30, 2016 was 32.2%. Primarily as a result of a change in our estimated state tax liabilities, the actual effective tax rate for the nine-month period ended September 30, 2015 was 30.9%, as compared to an annual estimated effective tax rate of 33.9% as of September 30, 2015. The annual estimated effective tax rates for 2015 and for 2016 differ from the statutory rate due primarily to U. S. manufacturing tax credits and foreign and state income taxes.
Liquidity and Capital Resources
Liquidity refers to the liquid financial assets available to fund our business operations and pay for near-term obligations. These liquid financial assets consist of cash as well as unused borrowing capacity under our credit facility. Our cash requirements have historically been satisfied through a combination of cash flows from operations and debt and equity financings. We expect this trend to continue.
Currently, the most significant event effecting liquidity and capital needs is the construction of our integrated converting facility in Barnwell, South Carolina, which has a total estimated cost of $150 million. In April 2015, we issued and sold 1,500,000 shares of common stock at $23.00 per share in an underwritten public offering resulting in aggregate net proceeds to us of approximately $32.2 million, after giving effect to the underwriting discount and estimated expenses. We used the net proceeds from the offering, together with new bank financing and cash generated through operations, to construct the Barnwell facility, consisting of two converting lines, a converting building, a paper mill building, a paper machine capable of producing structured tissue, equipment capable of utilizing recycled paper, warehouse facilities, and other supporting equipment and facility-space. In June 2015, we entered into an agreement with US Bank National Association which: (i) combined our then existing $20 million revolving line of credit designated for the purchase and construction of a paper machine and converting line in Pryor, Oklahoma and $27.3 million then outstanding under our existing term loan into a $47.3 million term loan due in 2020; (ii) increased our delayed draw term loan facility from $40 million to $115 million; (iii) extended the maturity of the delayed draw facility from August 2015 to June 2020; and (iv) added a $50 million accordion feature. Proceeds from the delayed draw term loan must be used solely to finance the acquisition and construction of buildings and equipment at our Barnwell facility. Advances under the facility bear interest at variable rates. The term loan is payable in quarterly installments of $675,000 through June 2016 and $1 million per quarter thereafter, while borrowings against the delayed draw term loan facility are payable in quarterly installments of 1.5% of the June 30, 2017 outstanding balance beginning in September 2017.
In December 2015, we entered into a NMTC transaction, which provided $16.2 million of loan proceeds to be used to finance capital expenditures associated with the Barnwell, South Carolina facility. This transaction allowed the Company to fix the interest on $11.1 million of its long-term debt for seven years and includes the potential for future debt forgiveness of approximately $5.1 million in seven years. In connection with this transaction, the maximum borrowing capacity under our delayed draw facility was reduced from $115 million to $99.6 million.
During the nine-month period ended September 30, 2016, cash increased $4.2 million, to $8.6 million at September 30, 2016, compared to $4.4 million at December 31, 2015. During the 2016 period, we incurred $74.1 million of capital expenditures, removed restrictions on $10.7 million of cash, received $1.9 million of proceeds from economic incentives related to the construction of our South Carolina facility, received $58.6 million of borrowings under our revolving credit lines (including our delayed draw loan), paid $2.7 million of principal payments on long-term debt, and paid $10.8 million in dividends to stockholders. In August and September 2016, we received $1.46 million of invoices for equipment purchased for our South Carolina facility, which were paid in October 2016.
As of September 30, 2016, Debt outstanding was $131.5 million. Cash as of September 30, 2016 totaled $8.6 million. This compares to $75.6 million in Debt and cash of $4.4 million as of December 31, 2015. We had $16.4 million and $60.7 million outstanding under our $25.0 million revolving line of credit and our $99.6 million delayed draw term loan, respectively, as of September 30, 2016. “Debt” as used here means the sum of current and long-term debt, not having been netted with unamortized deferred debt issuance costs. The Adjusted EBITDA leverage ratio reportable to the banks at September 30, 2016 was 3.71, as compared to a covenant limitation of 4.0. The Company does not expect to exceed the 4.0x limitation in the fourth quarter of 2016. The ratio calculation is calculated using Debt and a rolling historic 12-month period of Adjusted EBITDA. Given the Adjusted EBITDA performance in the second and third quarters of 2016, there is an increased risk of exceeding the leverage covenant threshold, particularly in the first and second quarters of 2017. As this leverage ratio is temporary in nature, we expect that the risk that the Company exceeds the covenant limitation will be confined to approximately two quarters. Furthermore, the Company expects to be able to negotiate a favorable temporary waiver of the covenant with the lenders and does not expect to have to curtail dividends. The Company is prepared to commit to a more rapid repayment of the debt that previously agreed upon if necessary to satisfy the lenders. There is no assurance that the lenders will work with the Company on this temporary issue or that the Company’s expectations in this regard will be realized, in which event the lenders could pursue other remedies.
The following table summarizes key cash flow information for the nine-month periods ended September 30, 2016 and 2015:
|
|
Nine Months Ended September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
(in thousands)
|
|
Cash flows provided by (used in):
|
|
|
|
|
|
|
|
|
Operating activities
|
|
$
|
20,259
|
|
|
$
|
13,183
|
|
|
|
|
|
|
|
|
|
|
Investing activities
|
|
$
|
(63,424
|
)
|
|
$
|
(35,485
|
)
|
|
|
|
|
|
|
|
|
|
Financing activities
|
|
$
|
47,365
|
|
|
$
|
29,831
|
|
Cash flows provided by operating activities were $20.3 million in the nine-month period ended September 30, 2016. For the nine months ended September 30, 2016, operating cash flows following from changes in cash due to changes in operating assets and liabilities used $7.0 million while all other sources and uses of operating cash flows provided $27.3 million. $6.9 million of the use of cash from changes in operating assets and liabilities related to increased inventories due to the start-up of converting operations at the Barnwell, South Carolina facility and an increase in inventories, planned to be worked-down through future sales. Other than net income and the depreciation add-back, other cash flows from operations were driven by a $6.6 million deferral of income tax payments into future periods. For the nine months ended September 30, 2015, operating cash flows following from changes in cash due to changes in operating assets and liabilities used $4.9 million while all other sources and uses of operating cash flows provided $18.1 million, the latter principally driven by net income and the depreciation add-back. The use of $4.9 million for changes in operating assets and liabilities was principally driven by a $3.6 million increase in receivables and a $2.4 million increase in inventories. The variation in the receivables in 2015 was a normal timing difference and did not indicate any significant issue with late or delinquent accounts.
Cash flows used in investing activities in the first nine months of 2016 included $74.1 million of expenditures on capital projects during the period, partially offset by the release of $10.7 million of restricted cash to finance capital expenditures associated with our South Carolina facility. Cash flows used in investing activities in the first nine months of 2015 consisted entirely of $35.5 million in expenditures on capital projects during the period.
Cash flows provided by financing activities were $47.4 million in the nine-month period ended September 30, 2016, primarily due to $58.6 million of borrowings under our credit facility and $1.9 million of proceeds from economic incentives associated with our South Carolina facility, which were partially offset by $2.7 million of principal payments on long-term debt and $10.8 million of cash dividends paid to stockholders. 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 many factors, including our financial condition, earnings, cash requirements of our business, legal requirements, regulatory constraints, industry practice and other factors that the Board deems relevant. Our credit agreement contains an indirect restriction on the amount of cash dividends we pay in that the amount of dividends paid is included in the calculation of our fixed charge coverage ratio. Cash flow provided by financing activities was $29.8 million in the nine-month period ended September 30, 2015, primarily due to $32.2 million of net proceeds received from our follow-on stock offering in April 2015, and $12.3 million of net borrowings under our credit facility, which were partially offset by $10.3 million of cash dividends paid to stockholders, $2.0 million of debt principal repayments, and a $1.7 million reduction in bank overdrafts.
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 the nine-month periods ended September 30, 2016 and 2015, no accounts receivable were written off against the allowance for doubtful accounts, nor was the provision for bad debts increased or decreased based on sales levels, historical experience and an evaluation of the quality of existing accounts receivable, resulting in no change to the allowance.
Inventory.
Our inventory consists of converted finished goods, bulk paper rolls and raw materials and is stated at the lower of cost or market based on standard cost, specific identification, or FIFO (first-in, first-out). 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 first nine months of 2016, the inventory allowance was increased $253,000 based on a specific review of estimated slow moving or obsolete inventory items and was decreased $229,000 due to actual write-offs of obsolete and unrealizable inventory items, resulting in a net increase in the allowance of $24,000. During the first nine months of 2015, the inventory allowance was increased $181,000 based on a specific review of estimated slow moving or obsolete inventory items and was decreased $139,000 due to actual write-offs of obsolete inventory items, resulting in a net increase in the allowance of $42,000.
Property,
Plant and
Equipment.
Significant capital expenditures are required to establish and maintain paper mills and converting facilities. 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.
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 65,000 and 68,600 shares of our common stock in the first nine months of 2016 and 2015, respectively. We recorded stock-based compensation expense of $600,000 and $743,000 during the nine-month periods ended September 30, 2016 and 2015, respectively, in connection with the option grants. In February 2013, we granted 16,000 shares of restricted stock. We recorded stock-based compensation expense of $4,000 and $34,000 during the nine–month periods ended September 30, 2016 and 2015, 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 $31.33.
Prior to July 1, 2016, 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, with adjustments for any known future changes in the rate.
Effective July 1, 2016, 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. Such expected option terms were used to estimate volatility and the discount 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 exercises prices ranging from $25.24 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.
In June 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 September 30, 2016, we had goodwill of $7.6 million and identifiable intangible assets, net of accumulated amortization, of $14.7 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:
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the expected use of the asset by the entity;
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the expected useful life of another asset or group of assets to which the useful life of the intangible asset may relate;
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any legal, regulatory or contractual provisions that may limit the useful life;
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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);
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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
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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).
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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 Goodwill and Other 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.
The Company performed its initial goodwill impairment test on October 1, 2015 by performing the first step, a qualitative impairment test, to determine whether it was more likely than not that goodwill was impaired.
Goodwill is tested at a level of reporting referred to as the “reporting unit”. The Company has two reporting units, which are defined as the “at home” business and the “away from home” business. Based on this qualitative test, we determined it was more likely than not that the fair value of the Company’s reporting units were greater than their carrying amounts; as such, we determined that performing the second and third steps of the impairment test were not necessary and that goodwill was not impaired. In performing this qualitative assessment, we considered factors including, but not limited to, the following:
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Macroeconomic conditions, including general economic conditions, limitations on accessing capital, and other developments in equity and credit markets;
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Industry and market considerations, including any deterioration in the environment in which we operate, an increased competitive environment, a decline in market-dependent multiples or metrics, a change in the market for our products or services, and regulatory or political developments;
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Cost factors such as increases in raw materials, labor, exchange rates or other costs that have a negative effect on earnings and cash flows;
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Overall financial performance, including negative or declining cash flows or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods;
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Other relevant entity-specific events, such as changes in management, key personnel, strategy, customers, or litigation; and
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Whether a sustained, material decrease in share price had occurred.
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Subsequent to October 1, 2015 we did not note any additional qualitative factors that would indicate that the Company’s goodwill was impaired.
New Accounting Pronouncements
Refer to the discussion of recently adopted/issued accounting pronouncements under Part I, Notes to Unaudited Interim Financial Statements Note 15 — New and Recently Adopted Accounting Pronouncements.
Non-GAAP Discussion
In addition to our GAAP results, we also consider non-GAAP measures of our performance for a number of purposes. The two non-GAAP financial measures used within this report are: (1) EBITDA and (2) Adjusted EBITDA.
We use EBITDA and Adjusted EBITDA as a supplemental measure 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 flows from operating activities as 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. We believe EBITDA and Adjusted EBITDA facilitate operating performance comparisons from period to period and company to company by eliminating potential differences caused by variations in capital structures (affecting relative interest expense), tax positions (such as the impact on periods or companies of changes in effective tax rates or net operating losses), the age and book depreciation of facilities and equipment (affecting relative depreciation expense), and non-cash compensation and valuation (affecting stock compensation expense).
EBITDA and Adjusted EBITDA have limitations as an analytical tool, and you should not consider them in isolation, or as a substitute for any of our results as reported under GAAP. Some of these limitations are:
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they do not reflect our cash expenditures for capital assets;
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they do not reflect changes in, or cash requirements for, our working capital requirements;
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they do not reflect cash requirements for cash dividend payments;
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they do not reflect the interest expense, or the cash requirements necessary to service interest or principal payments on our indebtedness;
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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
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other companies, including other companies in our industry, may calculate these measures differently than we do, limiting their usefulness as a comparative measure.
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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 three months ended September 30, 2016 and 2015:
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Three Months Ended September 30,
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2016
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2015
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|
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(in thousands, except % of net sales)
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|
|
|
|
|
|
|
|
Net income
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|
$
|
2,213
|
|
|
$
|
4,742
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|
Plus: Interest expense, net
|
|
|
639
|
|
|
|
11
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|
Plus: Income tax expense
|
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|
735
|
|
|
|
2,448
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|
Plus: Depreciation
|
|
|
2,909
|
|
|
|
2,555
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|
Plus: Intangibles amortization
|
|
|
233
|
|
|
|
376
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|
EBITDA
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|
$
|
6,729
|
|
|
$
|
10,132
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% of net sales
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17.0
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%
|
|
|
21.6
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%
|
|
|
|
|
|
|
|
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Plus: Stock compensation expense
|
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|
69
|
|
|
|
87
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|
Adjusted EBITDA
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|
$
|
6,798
|
|
|
$
|
10,219
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% of net sales
|
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|
17.2
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%
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|
21.8
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%
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Adjusted EBITDA decreased $3.4 million, or 33.4%, to $6.8 million in the quarter ended September 30, 2016, compared to $10.2 million in the same period in 2015. Adjusted EBITDA as a percent of net sales decreased to 17.2% in the third quarter of 2016 from 21.8% in the third quarter of 2015. EBITDA decreased $3.4 million, or 33.6%, to $6.7 million in the quarter ended September 30, 2016, compared to $10.1 million in the same period in 2015. EBITDA as a percent of net sales decreased to 17.0% in the third quarter of 2016 from 21.6% in the third quarter of 2015. The foregoing factors discussed in the net sales, cost of sales and selling, general and administrative expenses sections are the reasons for the decrease.
The following table reconciles EBITDA and Adjusted EBITDA to net income for the nine months ended September 30, 2016 and 2015:
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Nine Months Ended September 30,
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2016
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|
2015
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|
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(in thousands, except % of net sales)
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|
|
|
|
|
|
|
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|
Net income
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|
$
|
10,190
|
|
|
$
|
9,856
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|
Plus: Interest expense, net
|
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|
1,187
|
|
|
|
289
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|
Plus: Income tax expense
|
|
|
4,850
|
|
|
|
4,408
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|
Plus: Depreciation
|
|
|
8,641
|
|
|
|
6,976
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|
Plus: Intangibles amortization
|
|
|
986
|
|
|
|
1,130
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|
EBITDA
|
|
$
|
25,854
|
|
|
$
|
22,659
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|
% of net sales
|
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|
20.4
|
%
|
|
|
17.9
|
%
|
|
|
|
|
|
|
|
|
|
Plus: Stock compensation expense
|
|
|
604
|
|
|
|
777
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|
Adjusted EBITDA
|
|
$
|
26,458
|
|
|
$
|
23,436
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|
% of net sales
|
|
|
20.9
|
%
|
|
|
18.5
|
%
|
Adjusted EBITDA increased $3.0 million, or 13%, to $26.5 million in the nine-month period ended September 30, 2016, compared to $23.4 million in the same period in 2015. Adjusted EBITDA as a percent of net sales increased to 20.9% in the 2016 period from 18.5% in the same period of 2015. EBITDA increased $3.2 million, or 14%, to $25.9 million in the nine-month period ended September 30, 2016, compared to $22.7 million in the same period in 2015. EBITDA as a percent of net sales increased to 20.4% in the 2016 period from 17.9% in the same period of 2015. The foregoing factors discussed in the net sales, cost of sales and selling, general and administrative expenses sections are the reasons for the increase.
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
There has been no material change in the information provided in response to Item 7A of the Company’s Form 10-K for the year ended December 31, 2015.
ITEM 4. Controls and Procedures
Our management, under the supervision and with the participation of our chief executive and interim principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended), as of the end of the period covered by this Quarterly Report on Form 10-Q. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Based on such evaluation, our chief executive and interim principal financial officer has concluded that our disclosure controls and procedures were effective at a reasonable assurance level as of September 30, 2016.
There were no significant changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended September 30, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
From time to time, we may become party to various legal proceedings arising in the ordinary course of business. There can be no assurance that we will prevail in any such litigation. In management’s opinion, as of the date of this report, the Company is not engaged in legal proceedings which individually or in the aggregate are expected to have a materially adverse effect on the Company’s results of operations or financial condition.
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. Factors that could materially affect our actual results, levels of activity, performance or achievements include, but are not limited to, those detailed below, those under the caption “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015, as filed with the SEC on March 7, 2016, and those in our subsequent filings with the SEC. Such risks, uncertainties and other factors may cause our actual results, performances and achievements to be materially different from those expressed or implied by our forward-looking statements. If any of these risks or events occur, our business, financial condition or results of operations may be adversely affected.
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
(a) Unregistered Sales of Equity Securities
None.
(b) Initial Public Offering and Use of Proceeds from the Sale of Registered Securities
None.
(c) Repurchases of Equity Securities
We do not have any programs to repurchase shares of our common stock and no such repurchases were made during the three months ended September 30, 2016.
ITEM 3. Defaults Upon Senior Securities
None.
ITEM 4. Mine Safety Disclosures
Not applicable.
ITEM 5. Other Information
None.
ITEM 6. Exhibits
See the Exhibit Index following the signature page to this Form 10-Q, which Exhibit Index is hereby incorporated by reference herein.