**FORM 10-Q**

** **

**SECURITIES AND EXCHANGE COMMISSION**

### **Washington, D.C.  20549**

###  

**(MarkOne)**

 

| **ý****QUARTERLY REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|---------------------------------------------------------------------------------------------------------|
|                                                                                                    |   |   |
| **For the quarterly period ended June 30, 2004**                                                        |
|                                                                                                    |   |   |
| **OR**                                                                                                  |
|                                                                                                    |   |   |
| **o****TRANSITION REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**     |

 

### **For the transition period from                 to                                 **

###  

**RegistrationNumber:  333-114032**

 

**BLUE RIDGE PAPER PRODUCTS INC.**

(Exact name of registrant as specified in charter)

 

| **Delaware**             | ** ** | **56-2136509**                           |
|--------------------------|------------|------------------------------------------|
| (State of incorporation) |       | (I.R.S. Employer Identification  Number) |

 

## **41MAIN STREET**

**CANTON, NORTH CAROLINA  28716**

(Address of principal executive office)

 

Registrant’s telephone number, including area code:  **828-454-0676**

 

# Indicateby check mark whether the registrant (1) has filed all reports required to befiled by section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such report), and (2) has been subject to such filingrequirements for the past 90 days.

#  

# Yes o  No ý

#  

Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act).

 

# Yes o No ý

 

The number of common sharesoutstanding at June 30, 2004 was 10,074,288.

 

 

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**BLUE RIDGE PAPER PRODUCTS INC.**

 

**AND SUBSIDIARIES**

 

INDEX

 
|     |                                                                                                                                                         | **PAGE NO.** |
|----------|--------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------|
| PART 1.  | FINANCIAL INFORMATION                                                                                                                                        |         |
|     |                                                                                                                                                         |         |
| Item 1.  | Condensed Consolidated Balance Sheets, June  30, 2004 (unaudited) and December 31, 2003 (derived from audited financial statements)                          | 3            |
|     |                                                                                                                                                         |         |
|     | Condensed Consolidated Statements of  Operations, Three Months Ended June 30, 2004 and 2003 (unaudited) Six Months  Ended June 30, 2004 and 2003 (unaudited) | 4            |
|     |                                                                                                                                                         |         |
|     | Condensed Consolidated Statements of Cash  Flows, Six Months Ended June 30, 2004 (unaudited) and June 30, 2003  (unaudited)                                  | 5            |
|     |                                                                                                                                                         |         |
|     | Notes to Condensed Consolidated Financial Statements (unaudited)                                                                                             | 6-10         |
|     |                                                                                                                                                         |         |
| Item 2.  | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                                                  | 11-18        |
|     |                                                                                                                                                         |         |
| Item 3.  | Quantitative and Qualitative Disclosures  About Market Risk                                                                                                  | 18           |
|     |                                                                                                                                                         |         |
| Item 4.  | Controls and Procedures                                                                                                                                      | 18           |
|     |                                                                                                                                                         |
| PART II. | OTHER INFORMATION                                                                                                                                            |         |
|     |                                                                                                                                                         |
| Item 6.  | Exhibits and Reports on Form 8-K                                                                                                                             | 19-20        |
|          |                                                                                                                                                              |              |  |

 

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## **PART I.**  FINANCIALINFORMATION

## ** **

#### **ITEM 1**. FINANCIAL STATEMENTS

 

Blue Ridge Paper Products Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS (UNAUDITED)

 

**BLUE RIDGEPAPER PRODUCTS INC.**

 

**CondensedConsolidated Balance Sheets**

**June 30,2004 and December 31, 2003**

**(Dollars inthousands)**

**(Unaudited)**

 
| ** **                                                                                                                      | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|------------------------|------------|
| ** **                                                                                                                      | ** ** | ** **         | ** ** | ** **             | ** ** |
| **Assets**                                                                                                                      |       |               |       |                   |       |
| Current assets:                                                                                                                 |       |               |       |                   |       |
| Cash                                                                                                                            |       | $                  | 1,575      |                   | $          | 2,123 |   |
| Accounts receivable, net of allowance for  doubtful accounts and discounts of $2,545 and $2,621 in 2004 and 2003,  respectively |       | 54,038             |       | 42,646                 |       |
| Inventories                                                                                                                     |       | 50,839             |       | 59,063                 |       |
| Prepaid expenses                                                                                                                |       | 801                |       | 1,112                  |       |
| Income tax receivable                                                                                                           |       | 32                 |       | 32                     |       |
| Other current assets                                                                                                            |       | 501                |       | —                 |       |
| Total current assets                                                                                                            |       | 107,786            |       | 104,976                |       |
| Property, plant, and equipment, net                                                                                             |       | 190,018            |       | 192,671                |       |
| Deferred financing costs, net                                                                                                   |       | 7,007              |       | 7,443                  |       |
| Other assets                                                                                                                    |       | 62                 |       | 62                     |       |
| Total assets                                                                                                                    |       | $                  | 304,873    |                   | $          | 305,152 |   |
|                                                                                                                            |       |               |       |                   |       |
| **Liabilities and Stockholder’s Equity (Deficit)**                                                                         |       |               |       |                   |       |
|                                                                                                                            |       |               |       |                   |       |
| Current liabilities:                                                                                                            |       |               |       |                   |       |
| Current portion of senior debt                                                                                                  |       | $                  | 38         |                   | $          | 37 |   |
| Current portion of capital lease obligation                                                                                     |       | 484                |       | 474                    |       |
| Accounts payable                                                                                                                |       | 41,636             |       | 35,748                 |       |
| Accrued expenses and other current  liabilities                                                                                 |       | 31,791             |       | 33,109                 |       |
| Interest payable                                                                                                                |       | 1,498              |       | 1,495                  |       |
| Total current liabilities                                                                                                       |       | 75,447             |       | 70,863                 |       |
| Senior debt, net of current portion                                                                                             |       | 148,454            |       | 134,898                |       |
| Parent Pay-In-Kind (PIK) Senior  Subordinated Note                                                                              |       | 38,928             |       | 37,124                 |       |
| Capital lease obligations                                                                                                       |       | 1,114              |       | 1,359                  |       |
| Pension and postretirement benefits                                                                                             |       | 19,802             |       | 19,109                 |       |
| Other liabilities                                                                                                               |       | 1,983              |       | 2,824                  |       |
| Total liabilities                                                                                                               |       | 285,728            |       | 266,177                |       |
| Obligation to redeem ESOP shares                                                                                                |       | 35,988             |       | 32,389                 |       |
| Obligation to redeem restricted stock units  of Parent                                                                          |       | 2,589              |       | 2,519                  |       |
| Commitments and contingencies (See notes)                                                                                       |       |               |       |                   |       |
| Stockholder’s equity:                                                                                                      |       |               |       |                   |       |
| Common stock (par value $0.01, 1000 shares  authorized and outstanding in 2004 and 2003, respectively)                          |       | —             |       | —                 |       |
| Additional paid-in capital                                                                                                      |       | 47,271             |       | 47,344                 |       |
| Accumulated deficit                                                                                                             |       | (57,363            | )          | (34,125                | )          |
| Unearned compensation                                                                                                           |       | —             |       | (88                    | )          |
| Accumulated other comprehensive loss                                                                                            |       | (3,370             | )          | (3,370                 | )          |
|                                                                                                                            |       | (13,462            | )          | 9,761                  |       |
| Receivable from Parent                                                                                                          |       | (5,970             | )          | (5,694                 | )          |
| Total stockholder’s equity (deficit)                                                                                       |       | (19,432            | )          | 4,067                  |       |
| Total liabilities and stockholder’s equity  (deficit)                                                                      |       | $                  | 304,873    |                   | $          | 305,152 |   |

 

Seeaccompanying notes to condensed consolidated financial statements.

 

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**BLUE RIDGE PAPER PRODUCTS INC.**

 

**CondensedConsolidated Statements of Operations**

**Three and Six Month Period Ended June 30, 2004 and 2003**

**(Dollars in thousands)**

**(Unaudited)**

 
| ** **                                                            | ** ** | **Three Month Period Ended  June 30** | ** ** | **Six Month Period Ended  June 30** | ** ** |
|-----------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                            | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net sales                                                             |       | $                                     | 121,445    |                                | $          | 115,398 |   | $ | 242,426 |   | $ | 233,343 |   |
| Cost of goods sold:                                                   |       |                                  |       |                                |       |   |   |   |   |
| Cost of goods sold, excluding depreciation  and amortization          |       | 117,692                               |       | 108,659                             |       | 231,257 |   | 214,679 |   |
| Depreciation and amortization                                         |       | 4,062                                 |       | 3,563                               |       | 8,324 |   | 8,078 |   |
| Gross profit (loss)                                                   |       | (309                                  | )          | 3,176                               |       | 2,845 |   | 10,586 |   |
| Selling, general and administrative  expenses                         |       | 6,545                                 |       | 6,373                               |       | 13,124 |   | 12,335 |   |
| Depreciation and amortization                                         |       | 442                                   |       | 436                                 |       | 900 |   | 860 |   |
| ESOP expense                                                          |       | 1,800                                 |       | 2,031                               |       | 3,600 |   | 4,061 |   |
| Loss on disposal of assets                                            |       | 8                                     |       | 141                                 |       | 6 |   | 141 |   |
| Operating loss                                                        |       | (9,104                                | )          | (5,805                              | )          | (14,785 | ) | (6,811 | ) |
| Other income (expense):                                               |       |                                  |       |                                |       |   |   |   |   |
| Interest expense, excluding amortization of  deferred financing costs |       | (3,906                                | )          | (3,530                              | )          | (7,866 | ) | (6,661 | ) |
| Amortization of deferred financing costs                              |       | (298                                  | )          | (449                                | )          | (587 | ) | (830 | ) |
|                                                                  |       | (4,204                                | )          | (3,979                              | )          | (8,453 | ) | (7,491 | ) |
| Loss before income taxes                                              |       | (13,308                               | )          | (9,784                              | )          | (23,238 | ) | (14,302 | ) |
| Income tax                                                            |       | —                                |       | —                              |       | — |   | — |   |
| Net loss                                                              |       | $                                     | (13,308    | )                                   | $          | (9,784 | ) | $ | (23,238 | ) | $ | (14,302 | ) |

 

Seeaccompanying notes to condensed consolidated financial statements.

 

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**BLUE RIDGE PAPER PRODUCTS INC.**

 

**CondensedConsolidated Statements of Cash Flows**

**Six months ended June 30, 2004 and 2003**

**(Dollars in thousands)**

**(Unaudited)**

 
| ** **                                                                                | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Cash flows from operating activities:                                                     |       |     |       |     |       |
| Net loss                                                                                  |       | $        | (23,238    | )        | $          | (14,302 | ) |
| Adjustment to reconcile net loss to net  cash provided by (used in) operating activities: |       |     |       |     |       |
| Depreciation and amortization                                                             |       | 9,224    |       | 8,938    |       |
| Compensation expense for Parent restricted  stock                                         |       | 88       |       | 270      |       |
| Amortization of deferred financing costs                                                  |       | 587      |       | 830      |       |
| ESOP expense                                                                              |       | 3,600    |       | 4,061    |       |
| Loss on disposition of equipment                                                          |       | 6        |       | 141      |       |
| Changes in operating assets and liabilities:                                              |       |     |       |     |       |
| Accounts receivable, net                                                                  |       | (11,392  | )          | 4,807    |       |
| Inventories                                                                               |       | 8,224    |       | 2,554    |       |
| Prepaid expenses                                                                          |       | 311      |       | 896      |       |
| Accounts payable                                                                          |       | 5,888    |       | (3,942   | )          |
| Accrued and other current liabilities                                                     |       | 297      |       | 1,539    |       |
| Interest payable                                                                          |       | 3        |       | (946     | )          |
| Change in Parent PIK Senior Subordinated  Note for interest                               |       | 1,804    |       | 1,818    |       |
| Pension and postretirement benefits                                                       |       | 693      |       | 774      |       |
| Other assets and liabilities                                                              |       | (848     | )          | (1,260   | )          |
| Net cash provided by (used in) operating  activities                                      |       | (4,753   | )          | 6,178    |       |
| Cash flows used in investing activities:                                                  |       |     |       |     |       |
| Additions to property, plant, and equipment                                               |       | (7,077   | )          | (6,112   | )          |
| Proceeds from sale of property, plant, and  equipment                                     |       | 2        |       | 10       |       |
| Net cash used in investing activities                                                     |       | (7,075   | )          | (6,102   | )          |
| Cash flows from financing activities:                                                     |       |     |       |     |       |
| Repurchase of Parent common and preferred  stock                                          |       | (276     | )          | (832     | )          |
| Payments on separation notes payable                                                      |       | (1,615   | )          | (1,221   | )          |
| Proceeds from borrowings under line of  credit                                            |       | 69,225   |       | 74,384   |       |
| Repayment of borrowings under line of  credit                                             |       | (55,650  | )          | (61,255  | )          |
| Cash paid for refinancing credit facilities                                               |       | (151     | )          | (719     | )          |
| Repayments of long-term debt and capital  lease obligations                               |       | (253     | )          | (6,417   | )          |
| Net cash provided by financing activities                                                 |       | 11,280   |       | 3,940    |       |
| Net increase (decrease) in cash                                                           |       | (548     | )          | 4,016    |       |
| Cash, beginning of period                                                                 |       | 2,123    |       | 332      |       |
| Cash, end of period                                                                       |       | $        | 1,575      |     | $          | 4,348 |   |
| Supplemental disclosures of cash flow  information:                                       |       |     |       |     |       |
| Cash paid for interest, including  capitalized interest                                   |       | $        | 6,060      |     | $          | 5,788 |   |
| Noncash investing and financing activities:                                               |       |     |       |     |       |
| Conversion of accrued interest to note  payable                                           |       | 1,804    |       | 1,818    |       |
| Separation notes payable                                                                  |       | —   |       | 514      |       |
| Equipment acquired through capital lease                                                  |       | —   |       | 1,400    |       |

 

See accompanying notes to condensed consolidated financial statements.

 

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**NOTES TO CONDENSED****CONSOLIDATED FINANCIAL STATEMENTS**

 

**(1) Basis of Presentation**

 

The accompanyingunaudited condensed consolidated interim financial statements have beenprepared in accordance with Regulation S-X related to interim periodfinancial statements and, in the opinion of management, include all adjustmentsthat are necessary for the fair presentation of results for the interimperiods. Results for the three-and six-month periods ended June 30, 2004 maynot necessarily be indicative of full-year results.  It is suggested that these condensedconsolidated interim financial statements be read in conjunction with theaudited consolidated financial statements and notes of Blue Ridge PaperProducts Inc. (the Company) as of and for the year ended December 31,2003, included in the Company’s Amendment No. 1 to the Registration Statementon Form S-4 filed with the Securities and Exchange Commission (the “S-4Registration Statement”).

 

**(2) Liquidity**

 

In December 2003, the Company issued $125,000 of 9.5% Senior SecuredNotes due 2008 (the “Notes” or the “Old Notes”) in a private offering.  Proceeds from issuance of the Notes were usedto repay the Company’s Term Loans A and B and its existing revolving creditfacility under the 1999 Credit Agreement. In addition, the Company paid $7,000 on the Parent PIK SubordinatedNote.  The Company entered into a new$45,000 revolving credit facility in December 2003, of which the maximumborrowing availability at December 31, 2003 and June 30, 2004 was $31,611 and$17,858, respectively.  The new revolvingcredit facility contains covenant restrictions, which requires covenantavailability to exceed $15,000.  Ifcovenant availability does not meet the required minimum, a fixed charge coverageratio covenant is triggered.  At June 30,2004, the Company had covenant availability of $24,470, which is $9,470 inexcess of the required minimum.

 

**(3) Recent Developments**

 

 *Gainfrom the Sale of Emission Allowances*

 

Under section 126 of the Clean Air Act, new regulations foremissions of nitrogen oxides (NOx) from coal fired boilers will requireaffected facilities to reduce these emissions during the “ozone season”, whichis defined as May 1 through September 30.  The Environmental Protection Agency (EPA) hasestablished emission levels that each facility must meet in 2004 and 2005 bygranting emission allowances, which are measured in units based on tons of NOxemitted and are commonly referred to as NOx credits.  A facility is permitted by the EPA to sell ortransfer NOx credits at any time prior to their expiration.  At the conclusion of each ozone season, eachfacility must report its actual emissions to the EPA and own sufficient NOxcredits to cover their emission levels; otherwise, the facility must purchasecredits or be subject to certain fines and penalties.

 

Through engineering studies in 2003, the Company estimated that its NOxemissions would be below its EPA allowance levels by 200 units in 2004 and 300units in 2005.  Consequently, the Companysold these units for cash through an open market created specifically to tradeEPA emission credits, which resulted in a deferred gain of $1,716 at December31, 2003.

 

Updated engineering studies in June 2004 revealed that the NOxemissions for the 2004 season would be below EPA allowances by an additional 50units.  Consequently, another 50 unitswere sold on July 1, 2004.At June 30, 2004, $213 of the 2004 units were earnedand recorded as miscellaneous income in the accompanying interim financialstatements.  The remaining portion of the2004 units and the current portion of the 2005 units are recorded as current

 

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deferred revenue of $787.  The remaining 2005 units are recorded aslong-term deferred revenue of approximately $716.  The deferred revenue is expected to berecorded as income in the quarter that the units are earned.

 

*Closure of Fort Worth, Texas DairyPakFacility*

 

On February 26, 2004, management announced plans to close theCompany’s Fort Worth, Texas, DairyPak facility in the second quarter of2004.  Production ceased on June 4, 2004at the Fort Worth facility and the Company has transferred the facility’sproduction to the other existing DairyPak facilities.  The Company plans to sell the land andbuildings within the next year. Consequently, at June 30, 2004, the assets held for sale have beenreclassified from property, plant, and equipment to other current assets in theamount of $501.  As a result of thisclosure, the Company does not expect to reduce overall production.  The closure costs, which consist primarily ofseverance costs, are estimated to be $2,244 and are expected to be paid in2004. For the six months ended June 30, 2004, the Company recorded $1,991 ofseverance costs related to this closure and $253 loss related to assetdisposals.

 

 *ParmalatBankruptcy*

 

On February 24, 2004, a significant customer filed for Chapter 11bankruptcy protection.  As ofDecember 31, 2003 and June 30, 2004, the Company had outstanding accountsreceivable of $2,501 and $1,158, respectively. In addition, the Company received cash payments of $993 and $2,984 as ofDecember 31, 2003 and June 30, 2004, respectively, related to accountsreceivable that are potentially subject to “preferential payment” treatment asdefined in Chapter 11 bankruptcy laws and regulations.  The Company assessed the collectibility ofoutstanding receivables and the likelihood that cash payments deemed aspreferential are unsuccessfully defended and recorded a valuation allowance of$1,875 and $2,001 as of December 31, 2003 and June 30, 2004, respectively,related to this customer.

 

 *HeadcountReduction*

 

On February 3, 2004, the Company announced plans to eliminateapproximately 90 salaried and hourly positions through voluntary terminationplans.  The Company offered severalvoluntary severance and termination packages for salaried employees and hourlyunion employees.  The salaried employeesplan offers a severance package based on current compensation and years of service.  The hourly union employeespackage accelerates five years of vested service towards an employee’sunion pension plan benefit.

 

As of June 30, 2004, the Company had accepted 74 employees’ voluntarytermination agreements.  Additionally, 16positions were eliminated through attrition where no severance was paid.  As a result, the Company recorded $1,336 ofseverance costs in the first quarter and an additional $1,029 in the quarterended June 30, 2004.  The accruedseverance cost is recorded in accrued and other current liabilities in theaccompanying condensed consolidated balance sheet and is expected to be paid byDecember 2004.

 

**(4) Recent Accounting Developments**

 

 In December 2003, FinancialAccounting Standards Board (FASB) issued Statement No. 132 (revised), *Employers’ Disclosures about Pensions and OtherPostretirement Benefits.* Statement 132 (revised) prescribesemployers’ disclosures about pension plans and other postretirement benefitplans.  It does not change themeasurement or recognition of those plans. The Statement retains and revises the disclosure requirements containedin the original Statement 132. It also requires additional disclosuresabout the assets, obligations, cash flows and net periodic benefit cost ofdefined benefit pension plans and other postretirement benefit plans.  The Statement generally is effective forfiscal years ending after December 15, 2003.

 

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In December 2003, the FASB issued FASB Interpretation No. 46 (revisedDecember 2003), *Consolidation of VariableInterest Entities*(FIN 46R)*,*which addresses how a business enterprise should evaluate whether it has acontrolling financial interest in the entity through means other than votingrights and accordingly should consolidate the entity. FIN 46R replacesFASB Interpretation No. 46, *Consolidationof Variable Interest Entities,* which was issued in January2003.  The Company will be required toapply FIN 46R to variable interests in Variable Interest Entities (VIEs) createdafter December 31, 2003.  Forvariable interests in VIEs created before January 1, 2004, theinterpretation will be applied beginning on January 1, 2005.  For any VIEs that must be consolidated underFIN 46R that were created before January 1, 2004, the assets,liabilities and non-controlling interests of the VIE initially would bemeasured at their carrying amounts with any differences between the net amountadded to the balance sheet and any previously recognized interest beingrecognized as the cumulative effect of an accounting change.  If determining the carrying amounts is notpracticable, fair value at the date FIN 46R first applies may be used tomeasure the assets, liabilities and non-controlling interest of the VIE.  The adoption of FIN 46R has not had amaterial effect on the Company’s consolidated financial statements.

 

In accordance with the provisions of Staff Position (FSP) 106-1, theCompany elected at December 31, 2003 to defer the recognition of the MedicarePrescription Drug, Improvement, and Modernization Act of 2003 (Act).  In June 2004, the FASB issued FSP 106-2,which provided guidance for recording the effect of the Act on thepostretirement benefit obligation and the periodic postretirement benefitcost.  The Company determined the effectof the Act on the postretirement benefit cost as of its December 31, 2004measurement date.  The calculationyielded an estimated reduction in the benefit obligation as of December 31,2003 of $2,121 and periodic postretirement benefit cost for 2004 of $241.  At December 31, 2003, the APBO would havebeen $15,190 with an unrecognized gain of $1,880.  As of June 30, 2004, $120 was recorded as areduction in the benefit obligation and cost in the accompanying interimfinancial statements.

 

**(5)  Long-Termand Short-Term Debt**

 

In July 2003, the Company entered into a note payable with a bankfor $819 due in 2010.  Interest on thenote bears interest at a fixed rate at 5.5%. Land and office buildings in Canton, North Carolina, collateralize thenote.  The balance of the note payablewas $782 and $800 at June 30, 2004 and December 31, 2003, respectively.

 

On December 17, 2003, the Company sold $125,000 of Notes through aprivate placement offering under Rule 144A.  The Notes have a term of five years, are dueon December 15, 2008 and bear interest at a stated rate of 9.5%, which ispayable semi-annually in arrears on June 15 and December 15.  The Notes are collateralized by a seniorsecured interest in substantially all of the Company’s tangible and intangibleassets and have a subordinated secured interest in the outstanding tradeaccounts receivable and inventories.  TheCompany has the right to redeem the Notes at 104.75% and 100.00%, plus accruedinterest, on or after December 15, 2006 and December 15, 2007,respectively.  The indenture under whichthe Notes have been issued contains certain covenants, including limitations oncertain restricted payments and the incurrence of additional indebtedness.  On June 17, 2004, we completed an exchangeoffer wherein we exchanged $125,000 aggregate principal amount of our 9.5%Senior Secured Exchange Notes due 2008 (the “New Notes”), which have beenregistered under the Securities Act of 1933, as amended (the “Securities Act”),for $125,000 aggregate principal amount of our issued and outstanding OldNotes, which were not registered under the Securities Act.  The terms of the New Notes are substantiallyidentical to the Old Notes, except that certain transfer restrictions andregistration rights relating to the Old Notes do not apply to the New Notes.

 

On December 15, 2003, the Company entered into a revolving creditfacility with a financial institution which provides for maximum borrowings of$45,000, subject to a borrowing base calculated using eligible accountsreceivable and inventories.  Therevolving credit facility is collateralized by a senior secured interest in theCompany’s outstanding trade accounts receivable and inventories and by asubordinated secured interest in substantially all of the Company’s tangibleand intangible assets.  The revolvingcredit facility matures on

 

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December 15, 2008, and requires the Company to pay an annual feeof 0.375% on the unused facility amount. The Company had an outstanding balance of $22,710 and $9,135 at June 30,2004 and December 31, 2003, respectively, and letters of credit outstandingwere $4,432 and $4,254 at June 30, 2004 and December 31, 2003,respectively.  The maximum borrowingavailability was $17,858 and $31,611 at June 30, 2004 and December 31, 2003,respectively.

 

**(6) Commitments and Contingencies**

 

(a)* Purchase Commitments*

 

The Company hasagreements with suppliers of wood chips. Two of the wood chip agreements are with two subsidiaries of InternationalPaper.  The agreements are for afive-year period with two renewable five-year periods beginning inMay 1999.  The Company renewed thesecond five-year term with International Paper beginning in May 2004.  The terms of the agreements require minimumvolume purchases of 740,000 tons of chips each contract year during thefive-year period.  The agreements providean agreed-upon price per ton for product delivered but are negotiable based onmarket conditions.   As of June 30, 2004,the Company has commitments to purchase wood chips of approximately $130,537over the remaining terms of the agreements.

 

(b)* Labor Agreements*

 

The Company is committed to collective bargaining labor agreements withlocal unions, the larger of whose terms extend through May 14, 2006.

 

(c)* Litigation, Claims and Assessments*

 

On April 15, 2003, a lawsuit seeking class action certificationwas filed in the Circuit Court for Cocke County, Tennessee, in which theCompany is the defendant.  The lawsuit isbeing brought on behalf of approximately 300 residents owning propertyadjoining the Pigeon River upon which the Canton mill is located, and theCompany has a permit to discharge.  Theplaintiffs are seeking damages for private nuisance in the period commencingJune 1, 1999, and thereafter until present.  The plaintiff in this action alleges that thedischarge of colored water from the Canton mill has resulted in a diminution ofproperty value, but does not contain any allegation relating to health orsafety matters.  The demand for damagesis limited to a maximum of $74 (exclusive of interest and costs) per individuallandowner.  Discovery is to be completedby November 2004 and trial is scheduled for March 2005.   Management has not recorded a liability forany amount related to this lawsuit as of June 30, 2004.

 

The Company is subject to litigation that may arise in the normalcourse of business.  In the opinion ofmanagement, the Company’s liability, if any, under any pending litigation willnot materially impact its financial condition or operations.

 

(d)* Environmental Liabilities*

 

As part of its environmental management program, the Company recognizesobligations for closure of landfills in accordance with SFAS No. 143“Accounting for Asset Retirement Obligations”. The Company has currently accrued approximately $767 for closure oflandfills as of June 30, 2004.

 

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**(7) Segment Information**

 

The Company’s management makes financial decisions and allocatesresources based on sales and operating income of the paper and packagingsegments.  Although raw materials, theproduction processes, distribution methods and the regulatory environment aresimilar, management believes it is appropriate to separately disclose thesesegments. The Company does not allocate selling, general and administrationexpenses to each segment, but management uses operating income to measure theperformance of the segments.  Thefinancial information attributed to these segments is included in the followingtable for the six months ended June 30, 2004 and 2003:

 
| ** **                    | ** ** | ** ** | ** ** | **Paper**  | ** ** | **Packaging** | ** ** | **Corporate** | ** ** | **Total**  | ** ** |
|-------------------------------|------------|------------|------------|------------|------------|---------------|------------|---------------|------------|------------|------------|
| ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** **    | ** ** | ** **    | ** ** | ** ** | ** ** |
| Net sales                     |       | 2004       |       | $          | 98,211     |          | $          | 144,215       |       | —     |       | $ | 242,426 |   |
|                          |       | 2003       |       | 94,407     |       | 138,936       |       | —        |       | 233,343    |       |
|                          |       |       |       |       |       |          |       |          |       |       |       |
| Operating income (loss)       |       | 2004       |       | (3,020     | )          | 5,859         |       | (17,624       | )          | (14,785    | )          |
|                          |       | 2003       |       | 2,899      |       | 7,637         |       | (17,347       | )          | (6,811     | )          |
|                          |       |       |       |       |       |          |       |          |       |       |       |
| Depreciation and amortization |       | 2004       |       | 6,343      |       | 1,981         |       | 900           |       | 9,224      |       |
|                          |       | 2003       |       | 6,357      |       | 1,721         |       | 860           |       | 8,938      |       |
|                          |       |       |       |       |       |          |       |          |       |       |       |
| Total assets                  |       | 2004       |       | 201,800    |       | 91,054        |       | 12,019        |       | 304,873    |       |
|                          |       | 2003       |       | 199,243    |       | 87,296        |       | 15,085        |       | 301,624    |       |
|                          |       |       |       |       |       |          |       |          |       |       |       |
| Capital expenditures          |       | 2004       |       | 6,046      |       | 668           |       | 363           |       | 7,077      |       |
|                          |       | 2003       |       | 5,735      |       | (72           | )     | 449           |       | 6,112      |       |
|                               |            |            |            |            |            |               |            |               |            |            |            |  |  |  |

 

 

**(8) Inventories**

 

Components of inventory at June 30, 2004 and December 31, 2003 are asfollows:

 
| ** **       | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------|------------|----------|------------|----------|------------|
|             |       |     |       |     |       |
| Raw Materials    |       | $        | 14,317     |     | $          | 17,023 |   |
| Work in Progress |       | 17,515   |       | 19,359   |       |
| Finished Goods   |       | 19,007   |       | 22,681   |       |
| Total            |       | $        | 50,839     |     | $          | 59,063 |   |

 

10

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**ITEM 2****.****MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS**

** **

#### **FORWARD-LOOKINGSTATEMENTS**

#### ** **

This filing includes “forward-looking statements”within the meaning of the Private Securities Litigation Reform Act of1995.  Forward-looking statements arethose that do not relate solely to historical fact.  They include, but are not limited to, anystatement that may predict, forecast, indicate or imply future results,performance, achievements or events. They may contain words such as “believe,” “anticipate,” “expect,”“estimate,” “intend,” “project,” “plan,” “will” or words or phrases of similarmeaning.

 

These forward-lookingstatements are not guarantees of future performance.  Forward-looking statements are based onmanagement’s expectations that involve risks and uncertainties, including, butnot limited to, economic, competitive, governmental and technological factorsoutside of our control, that may cause actual results to differ materially fromtrends, plans or expectations set forth in the forward-looking statements.  Given these risks and uncertainties, actualfuture results may be materially different from what we plan or expect.  We will not update these forward-lookingstatements even if our situation changes in the future.

 

#### **OVERVIEW**

 

# Marketconditions relating to price in the three months ended June 30, 2004 (the “2004three-month period”) have improved from the weak conditions in the fourthquarter of 2003 and first quarter of 2004, although they have not yet achievedthe levels reached in the three months ended June 30, 2003 (the “2003three-month period”).  Our total shipmentvolume for the 2004 three-month period increased 6.3% compared to the 2003three-month period. Improvements in price, shipments and productivity werepartially offset by increased healthcare and energy costs.  The 2004 three-month period was negativelyimpacted by one of our annual pulp mill outages, as described below, andseasonally high maintenance expenses. Our cost improvement efforts continued as we ceased production at ourFort Worth DairyPak converting facility and further reduced headcount at ourCanton mill specifically and for our corporate staff in general.  We anticipate that we will meet our targetedheadcount reductions on or prior to schedule.

#  

#### **Resultsof Operations**

 

The following table sets forthcertain sales and operating data for our business segments for the periodsindicated:

 

11

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| ** **                      | ** ** | **Three Month Period****Ended June 30** | ** ** | **Six Month Period****Ended**** ****June 30** | ** ** |
|---------------------------------|------------|-----------------------------------------|------------|----------------------------------------------------|------------|
| ** **                      | ** ** | **2004**                                | ** ** | **2003**                                           | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net sales:                      | ** ** | ** **                              | ** ** | ** **                                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Packaging                       |       | $                                       | 71.2       |                                               | $          | 69.1 |   | $ | 144.2 |   | $ | 138.9 |   |
| Paper                           |       | 50.2                                    |       | 46.3                                               |       | 98.2 |   | 94.4 |   |
| Total                           |       | $                                       | 121.4      |                                               | $          | 115.4 |   | $ | 242.4 |   | $ | 233.3 |   |
|                            |       |                                    |       |                                               |       |   |   |   |   |
| Operating profit (loss):        |       |                                    |       |                                               |       |   |   |   |   |
| Packaging                       |       | $                                       | 1.2        |                                               | $          | 3.7 |   | $ | 5.8 |   | $ | 7.7 |   |
| Paper                           |       | (1.5                                    | )          | (0.5                                               | )          | (3.0 | ) | 2.9 |   |
| Total Segments Operating Profit |       | $                                       | (0.3       | )                                                  | $          | 3.2 |   | $ | 2.8 |   | $ | 10.6 |   |
|                            |       |                                    |       |                                               |       |   |   |   |   |
| Corporate Expenses              |       | 8.8                                     |       | 9.0                                                |       | 17.6 |   | 17.4 |   |
| Total                           |       | $                                       | (9.1       | )                                                  | $          | (5.8 | ) | $ | (14.8 | ) | $ | (6.8 | ) |
|                            |       |                                    |       |                                               |       |   |   |   |   |
| Percentage of net sales:        |       |                                    |       |                                               |       |   |   |   |   |
| Packaging                       |       | 58.6                                    | %          | 59.9                                               | %          | 59.5 | % | 59.5 | % |
| Paper                           |       | 41.4                                    | %          | 40.1                                               | %          | 40.5 | % | 40.5 | % |
| Total                           |       | 100.0                                   | %          | 100.0                                              | %          | 100.0 | % | 100.0 | % |
|                            |       |                                    |       |                                               |       |   |   |   |   |
| Operating margin:               |       |                                    |       |                                               |       |   |   |   |   |
| Packaging                       |       | 1.7                                     | %          | 5.4                                                | %          | 4.0 | % | 5.5 | % |
| Paper                           |       | (3.0                                    | )%         | (1.1                                               | )%         | (3.1 | )% | 3.1 | % |
| Total                           |       | (0.2                                    | )%         | 2.8                                                | %          | 1.2 | % | 4.5 | % |
|                            |       |                                    |       |                                               |       |   |   |   |   |
| Shipments (tons):               |       |                                    |       |                                               |       |   |   |   |   |
| Packaging segment               |       | 64,230                                  |       | 63,905                                             |       | 126,831 |   | 125,900 |   |
| Paper segment                   |       | 80,049                                  |       | 71,862                                             |       | 161,208 |   | 143,982 |   |
| Total                           |       | 144,279                                 |       | 135,767                                            |       | 288,039 |   | 269,882 |   |
|                            |       |                                    |       |                                               |       |   |   |   |   |
| Average price ($per ton):       |       |                                    |       |                                               |       |   |   |   |   |
| Packaging segment               |       | $                                       | 1,109      |                                               | $          | 1,081 |   | $ | 1,137 |   | $ | 1,103 |   |
| Paper segment                   |       | 627                                     |       | 644                                                |       | 609 |   | 656 |   |
| Average price                   |       | $                                       | 841        |                                               | $          | 850 |   | $ | 842 |   | $ | 864 |   |

 

**THREEMONTHS ENDED JUNE 30, 2004 COMPARED TO THREE MONTHS ENDED JUNE 30, 2003**

 

*Net Sales.*   Net sales for the 2004 three-month periodincreased $6.0 million or 5.2% to $121.4 million compared to $115.4 million forthe same period in 2003.  Net sales inour packaging segment increased $2.1 million, while total net sales in ourpaper segment increased by $3.9 million.

 

Netsales for our packaging segment for the 2004 three-month period increased $2.1million or 3.0% to $71.2 million compared to $69.1 million for the same periodin 2003.  For the 2004 three-monthperiod, our packaging segment sold 64,230 tons of coated and convertedpaperboard products at an average price of $1,109 per ton, compared to 63,905tons sold for the same period in 2003 at an average price of $1,081 per ton.  The increase in packaging segment sales isprimarily attributable to an increase in average revenue per unit sold for bothcartons and non-converted coated paperboard coupled with an increase in volumeof cartons and non-converted paperboard tons shipped.  In addition, effective June 1, 2004, weannounced a 5% increase to list prices for a portion of our cartonbusiness.  For certain of thesecustomers, the price increase will be delayed to a later date as specified inthe respective customer supply contracts.

 

12

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Net sales for our paper segment for the 2004three-month period increased $3.9 million or 8.4% to $50.2 million compared to$46.3 million in the second quarter of 2003. The increase is entirely attributable to an increase in shipment volumeof 11.4% to 80,049 tons in 2004 as compared to 71,862 tons for the same periodin 2003.  The increase in volume is dueto: (i) the five-day cold mill maintenance outage conducted at our Canton,North Carolina manufacturing facility in the second quarter of 2003, which isrequired every five years to perform certain maintenance functions at the mill;(ii) improved production performance on our paper machines in the 2004three-month period; and (iii) increased market demand for our uncoatedfree-sheet papers in the 2004 three-month period, which also resulted in adecrease in our finished goods paper inventories.  The average net sales price per ton for ourpaper segment products decreased 2.6% in the 2004 three-month period comparedto the same period in 2003, although prices have begun to increase since thefirst quarter of 2004.  By June 2004,average pricing on our paper products had returned to levels in excess of the2003 three-month period with an additional increase on specific gradesannounced for July 2004.  Order backlogsfor our paper products also continued to be strong entering into the thirdquarter of 2004.

 

*Operating Profit (Loss)*.  Total segment operating profit (loss)declined $3.5 million to a loss of $0.3 million in the 2004 three-month periodcompared to an operating profit of $3.2 million for the same period in2003.  Operationally, our production andsales performance improved, with total sales volume increasing 6.3% from 135,767tons shipped in the 2003 three-month period to 144,279 tons in the 2004three-month period.  We continued ourprocess of consolidating our converting facilities to match capacity with themarket and completed the transfer of manufacturing and customer service fromour Fort Worth DairyPak facility to the remaining facilities in the DairyPakdivision.  This reorganization will allowus to service our DairyPak customers more cost effectively and eliminatesignificant overhead from our cost structure. We also recognized severance expenses in the 2004 three-month periodrelated to the elimination of 81 hourly and salaried positions at our Canton,North Carolina facility.  In order tocomplete these reorganizations, we incurred $2.1 million in severance-relatedexpenses in the 2004 three-month period, as well as $0.7 million in additionaltransitional expense related to the Fort Worth closure.

 

At our Canton, North Carolinafacility, it is necessary to conduct two pulp mill outages per year, one eachin the spring and fall, to complete necessary maintenance items in the pulpmill and chemical recovery areas.  Theseoutages normally require four to six days to complete and usually only involvethe pulp mill and chemical recovery areas. The 2004 spring outage was extended to ten days in order to performadditional non-routine maintenance projects. During this extended period, we used the downtime to complete additionalmaintenance activity at the mill.  Thisadditional pulp mill downtime (along with additional maintenance work completedin April 2004) increased the cost of this outage from a normal range ofapproximately $2.0 - $2.5 million to an estimated $4.1 million in lost pulpproduction and maintenance costs.  Duringthe 2003 three-month period, the spring pulp mill outage was conducted concurrentlywith the cold mill outage.  Totalincreased costs related to the 2003 cold mill outage, including lost pulp,paper and uncoated paperboard production, were approximately $6.0 million.

 

As discussed above, althoughaverage net revenue in our paper segment has steadily increased in the 2004three-month period, it remains below average net revenue in the 2003three-month period, resulting in a loss of approximately $1.5million.  Pricing for our primary rawmaterial, wood chips, has decreased, resulting in a 5.8% decrease in our woodchip costs from their peak prices in the fourth quarter of 2003.  Barring any significant unfavorable weatherpattern in the southeastern United States, we anticipate further reductions inwood costs in the third quarter of 2004. Despite the favorable movement in wood chip prices, average wood chipprices remain above prices experienced in the 2003 three-month period.  This has resulted in an approximate $0.7million increase in wood costs for the 2004 three-month period as compared tothe same period in 2003.  In addition,operating profit in the 2004 three-month period was negatively impacted byunfavorable cost trends in plastic/resin pricing at our Waynesville extrusioncoating facility, inbound/outbound freight costs due to diesel fuel pricing andtrucking regulation changes, and increases in employee medical benefits costs.

 

13

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Operating profit for ourpackaging segment decreased $2.5 million or 67.6% in the 2004 three-monthperiod to $1.2 million or 1.7% of packaging segment sales, compared to $3.7million or 5.4% of packaging segment sales for the 2003 three-monthperiod.  The decrease in operatingprofits was due primarily to severance costs and transition expenses related tothe closure and sale of the Fort Worth, Texas converting facility, increasedoutbound freight costs, increased costs associated with employee healthbenefits, and increased costs for certain raw materials at our Waynesvilleextrusion facility.  We have recognizedsubstantially all of the costs associated with the Fort Worth closure.  In addition, in the 2004 three-month period,our average revenue per ton in our carton business has increased approximately3.3% or $1.5 million, and we have instituted several initiatives to control ourhealthcare spending.

 

Our paper segment realized anoperating loss of $1.5 million in the 2004 three-month period, or a $1.0million increase in operating loss, as compared to an operating loss of $0.5million for the 2003 three-month period. The increase in operating loss was due primarily to: (i) severance costsassociated with the planned elimination of 81 salary and hourly positions atour Canton, North Carolina facility; (ii) a reduction in average net salesprices for our paper segment products; (iii) increased medical benefit costsfor our Canton employees; and (iv) increased pricing for our key raw material,wood chips, as compared to pricing for the same period in 2003.  The increase in operating loss was partiallyoffset by approximately $3.0 million in increased production and sales at ourCanton, North Carolina mill.  Theproduction increase is primarily attributable to the machine downtime incurredduring the cold mill outage completed in the 2003 three-month period.  The next cold mill outage is currentlyplanned for fiscal year 2008.

 

*Selling, General and Administrative Expenses.** *Totalselling, general and administrative expenses increased $0.1 million or 1.6% to$6.5 million in the 2004 three-month period compared to $6.4 million for thesame period in 2003.  These costs consistof normal operating expenses such as salaries and benefits, legal andconsulting, travel.

 

*Interest and Amortization Expenses.** *Interestand amortization expenses increased $0.2 million to $4.2 million for the 2004three-month period compared to $4.0 million for the same period in 2003.  This is due to the change in rates for theNotes.

 

**SIXMONTHS ENDED JUNE 30, 2004 COMPARED TO SIX MONTHS ENDED JUNE 30, 2003**

 

*Net Sales.** *Net sales for thesix months ended June 30, 2004 (the “2004 six-month period”) increased to$242.4 million or 3.9*%*comparedto**$233.3 million for the sameperiod in 2003.  This increase in totalrevenue is primarily attributable to an increase in total shipment volume to288,039 tons, an increase of 6.7%, compared to 269,882 tons reported for thesame period in 2003, resulting in an additional $15.3 million of total salesrevenue.  The increase in our salesvolume for the 2004 six-month period was partially offset by a 2.5% decline inthe average selling price for our products as compared to the same period in2003.  This decline in average revenueper ton sold resulted primarily from an increase in sales mix originating fromour lower revenue paper segment in the 2004 three-month period compared to thesame period in 2003, along with depressed market prices in our papersegment.  The decline in average revenueper unit sold resulted in an approximate $6.2 million reduction in totalrevenue in the 2004 six-month period compared to the same period in 2003.  Market pricing in our paper segment reached alow in the first quarter of 2004 but has shown significant recovery beginningin the latter part of the first quarter of 2004 and improving through June 2004with an additional increase announced for most paper grades in July 2004.

 

Net sales for our packagingsegment for the 2004 six-month period increased $5.3 million or 3.8% to $144.2million compared to $138.9 million for the same period in the prior year.  The increase in net sales is attributable toa 2.4%  increasein carton volume shipments in addition to an increase in average sales pricefor both cartons and

 

14

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non-convertedcoated paperboard.  Average net sales priceper ton increased 3.1% for cartons and 1.4% for coated paperboard in the 2004six-month period compared to the same period in 2003.

 

Sales for our paper segment forthe 2004 six-month period have increased by $3.8 million or 4.0% to $98.2million compared to $94.4 million for the same period in 2003.  This increase was attributable to increasedsales volume with total shipment volumes increasing 17,226 tons or 12% to 161,208tons in the 2004 six-month period compared to143,982 tons in the 2003 six-month period.  Average net sales price per unit solddecreased by 7.2% due primarily to lower product pricing in the uncoatedfree-sheet markets.  This decline inaverage net sales price (coupled with a slightly unfavorable mix resulting froma higher percentage of uncoated paperboard sales versus paper sales) resultedin a loss of  $7.5million in the 2004 six-month period compared to the sameperiod in 2003.

 

*Operating Profit (Loss).** *Totalsegment operating profit decreased $7.8 million in the 2004 six-month period to$2.8 million compared to $10.6 million for the same period in 2003.  Despite increased production and salesvolumes, total segment operating profit declined primarily due to: (i) lowerpricing for our paper grades that reflected a 7.2% reduction from the sameperiod in the prior year, or a decrease of $6.9 million in revenue; (ii) increased purchase costs for some of ourlarger raw materials, such as wood chips, resulting in a decrease of $2.0million; (iii) $4.4 million in severance payments related to consolidation ofcapacity and the shutdown of our Fort Worth, Texas DairyPak facility, as wellas the planned elimination of 81 positions at our Canton, North Carolinafacility; (iv) increased outbound freight costs of approximately $1.6 millionarising from higher carrier fuel costs, increased trucking regulations and, toa lesser extent, increased distances to serve customers from our remainingDairyPak converting locations; and (v) $2.4 million increase in medical benefits at our operatinglocations.  With respect to item (ii),pricing on supplemental fiber has increased with the improving paper markets,resulting in a loss of approximately $0.7 million.  In addition, plastic and resin prices used atour Waynesville facility have increased by approximately $1.6 million.  With respect to item (iii), the shutdown ofour Fort Worth facility is primarily completed and the costs associated withthe shutdown have been recognized in the first and second quarters of2004.  We do not expect any additionalsignificant severance costs in the future from this capacityconsolidation.  In addition, we haverecognized the majority of the costs associated with the headcount reductionsat our Canton, North Carolina facility and do not expect any significantadditional severance costs to complete that reorganization.  With respect to item (v), our healthcarebenefit costs have increased substantially in 2004, due primarily to anincrease in catastrophic health claims (those in excess of $75,000 each) We have a stop-loss of $150,000 per claim.  For the 2003 six-month period, such claimswere approximately $0.5 million compared to approximately $1.4 million for the2004 six-month period.  General medicalcost inflation accounts for the remainder of the increase.

 

The decrease in operatingprofit in the 2004 six-month period was partially offset by: (i) a $5.1 millionincrease in production and sales; (ii) increases in our average net salesprices for coated paperboard and carton products resulting in an approximate$3.6 million increase in revenues; (iii) increased pulp mill production at ourCanton, North Carolina facility, as well as improved management of our fiberutilization, resulting in an approximate $1.8 million cost savings compared tothe 2003 six-month period; and (iv) $0.5 million decrease in repair materialand service costs due primarily to the cold mill outage conducted in the 2003 six-monthperiod without a corresponding similar outage in the 2004 six-month period.

 

Looking forward to the thirdquarter of 2004, we anticipate continued improvement in our sales pricing forboth our paper products, as well as our carton products.  An additional increase onmost of our uncoated paper grades has been announced for July 2004 and webelieve that increase should be materially realized.  Further increases have been announced forsome of our paper packaging grades in August and for offset, reply card andtablet grades in September 2004.  We alsoanticipate improved average carton pricing in the third quarter from theincrease announced in June 2004 on a portion of our carton grades.  We have substantially

 

15

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concludedthe recognition of severance expenses related to the closure of the Fort Worth,Texas converting facility along with the headcount reductions at our facilityin Canton, North Carolina.  We do,however, anticipate increases to our energy costs, particularly at our Canton,North Carolina mill, as we have recently materially completed contractnegotiations for the purchase of coal for that facility.  Under terms of the recently negotiatedcontract, coal costs at the Canton, North Carolina facility could increase byas much as 45%, or $6.0- $8.0 millionannually, unless we can secure a suitable and more cost effectivesupplier.  This increase in coal costs iscurrently expected to phase in through the third quarter of 2004, with the fullimpact expected by September 2004.  Ourfall pulp mill outage is scheduled for September 2004 and is expected to be ofsimilar duration and scope to the outage completed in the second quarter 2004.

 

Operating profit for ourpackaging segment in the 2004 six-month period declined $1.9 million to $5.8million compared to $7.7 million for the same period in 2003.  The decrease was primarily due to: (i)severance and other transitional costs related to the Fort Worth facilityclosure in the amount of $3.1 million; (ii) increased pricing for our key rawmaterial, plastic/resin, at the Waynesville facility of $1.6 million; (iii)increased costs for outbound freight of $1.2 million; and (iv) increasedmedical benefit costs of $1.2 million for the packaging segment employees.

 

The decrease in operatingprofit was partially offset by increases to the average net selling prices forcoated paperboard and carton products of 1.4% and 3.1%, respectively, comparedto the same period in 2003.  In addition,coated paperboard production at our Waynesville facility increased 7.6% in the2004 six-month period compared to the same period in 2003, resulting in anadditional $1.2 million.  Going forward,we expect to realize cost synergies related to the consolidation in ourDairyPak converting facilities as we incur more of the benefits from theclosure of our Fort Worth plant in the second half of this year.  In addition, we expect to realize additionalrevenue improvement from the announced carton price increase, which weimplemented in June 2004.

 

Operating profit for our papersegment decreased $5.9 million in the 2004 six-month period to an operatingloss of $3.0 million as compared to an operating profit of $2.9 million for thesame period in 2003.  The decline inoperating profit was primarily attributable to: (i) lower pricing for our papergrades, resulting in a 7.2% decrease from the same period in the prior year;(ii) increased wood chip costs, resulting in a loss of $2.0 million; (iii)severance costs of $2.1 million related to reduction of 81 hourly and salariedpositions; and (iv) increases of $1.3 million in medical benefit costs forpaper segment employees.

 

The decline in operating profitwas offset by increased production and sales volumes in the amount of $4.2million, increased pulp mill production and improved management of our fiberutilization, resulting in an approximate $1.8 million cost savings, and reducedexpenditures of $0.9 million for repair materials and services.

 

*Selling, General and Administrative Expenses.** *Totalselling, general and administrative expenses increased 6.5% to $13.1 million inthe 2004 six-month period compared to $12.3 million for the same period in2003.  The increase is primarily attributableto $0.6 million increased audit and attorney’s fees relating to the issuance ofthe Notes, as well as approximately $0.3 million in startup costs for the newmedical clinic/pharmacy in Canton, North Carolina.   We also recognized severance expenses of$0.3 million related to the elimination of 7 salaried positions at corporate.

 

*Interest and Amortization Expenses.**  *Interestand amortization expenses increased $1.0 million to $8.5 million for the 2004six-month period compared to $7.5 million for the same period in 2003.  The increase is due to the change in ratesfor the Notes.

 

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#### **LIQUIDITYAND CAPITAL RESOURCES**

 

Our principle liquidityrequirements are to service our debt and fund our operations and capitalexpenditure needs.  Our total seniordebt, defined as total debt less the Parent PIK Senior Subordinated Note, atJune 30, 2004 was approximately $150.1 million. Subject to our performance, which if adversely affected could affect theavailability of funds, we expect to be able to meetour liquidity requirements for 2004 through cash provided by operations andthrough borrowings available under our working capital facility.  We cannot assure you, however, that this willbe the case.  In December 2003, we issued$125.0 million of the Notes in a private offering.  Proceeds from issuance of the Notes were usedto repay our Term Loans A and B and our existing revolving credit facilityunder the 1999 Credit Agreement.  Inaddition, we paid $7.0 million on the Parent PIK Subordinated Note.  We entered into a new $45.0 million revolvingcredit facility in December 2003, of which the maximum borrowing availabilityat December 31, 2003 and June 30, 2004 was $31.6 million and $17.9 million,respectively.  The new revolving creditfacility contains covenant restrictions, which requires covenant availabilityto exceed $15.0 million.  If covenantavailability does not meet the required minimum, a fixed charge coverage ratiocovenant is triggered.  At June 30, 2004,we had covenant availability of $24.5 million, which is $9.5 million in excessof the required minimum.  Based onimprovements to our cost structure, increased production volumes, and productprice increases scheduled to take effect in the third quarter of 2004, we donot believe that we will be subject to the fixed charge coverage ratio.

 

Summary of Cash Flow ($ inmillions):

 
| ** **                                           | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                           | ** ** | **2004**                      | ** ** | **2003** | ** ** |
| Net cash (used in)/provided by operating  activities |       | $                             | (4.8       | ) | $ | 6.2 |   |
|                                                 |       |                          |       |   |   |
| Net cash used in investing activities                |       | (7.1                          | )          | (6.1 | ) |
|                                                 |       |                          |       |   |   |
| Net cash provided by financing activities            |       | 11.3                          |       | 3.9 |   |
|                                                 |       |                          |       |   |   |
| Net increase (decrease) in cash                      |       | (.6                           | )          | 4.0 |   |
|                                                 |       |                          |       |   |   |
| Cash balance                                         |       | $                             | 1.6        |   | $ | 4.3 |   |

 

Net cash used in operations was $4.8 million for the2004 six-month period compared to net cash provided by operations of $6.2million during the same period in 2003. The reduction in cash provided by operations was primarily attributableto increased net losses in 2004.  Duringthe 2004 six-month period, total net losses were $23.2 million compared to$14.3 million for the same period in 2003. The increase in net losses was primarily due to a decrease in pricingfor our uncoated free-sheet papers, increases to certain raw material pricing,severance expenses, freight increases, and increases to employee healthcarecosts as discussed above.

 

Net cash used in investingactivities was $7.1 million and $6.1 million for the six months ended June 30,2004 and 2003, respectively.  Theincrease in net cash used in investing activities was due to an increase incapital spending for the 2004 six-month period compared to the same period in2003.  Capital spending for the 2004six-month period totaled $7.1 million, which included expenditures forenvironmental projects of approximately $3.5 million.  Major environmental projects included: (i)$1.8 million to comply with nitrous oxide (NOx) gas emission regulations; (ii)a recovery boiler precipitator rebuild totaling approximately $0.9 million; and(iii) $0.6 million to comply with Maximum Achievable Control Technology I andII federal standards.   Capitalexpenditures for the 2003 six-month period were $6.1 million, of whichapproximately $0.5 million was categorized as environmental

 

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spending.  We currently estimate that our capitalspending will be approximately $13.3 million for fiscal year 2004 (69% ofannual depreciation).

 

Net cash provided by financingactivities was $11.3 million for the 2004 six-month period compared to $3.9million for the same period in 2003.  Thenet change in net cash provided by financing activities in the 2004 six-monthperiod was primarily due to a $13.6 million increase in borrowings under ourworking capital facility.  This increasein borrowings was primarily used to fund our operations, provide funding forour capital expenditures and make interest payments to our noteholders in June2004 for $5.9 million.

 

#### **ITEM 3**. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKETRISK

#### ** **

We are exposed to certainmarket risks, including interest rate risk. Risk exposure relating to this market risk is summarized below.  This information should be read in connectionwith the consolidated financial statements and the related notes thereto includedelsewhere in this Quarterly Report on Form 10-Q.

 

###### ***InterestRate Risk***

###### *** ***

We manage interest cost using acombination of fixed and variable rate debt. As of June 30, 2004, we have $125.0 million Notes at 9.5% and a $45.0million working capital credit facility at variable rates of interest.  As of June 30, 2004, approximately $22.7million was outstanding under our working capital credit facility consisting ofshort-term interest rates of 1.25% over Applicable Revolver Index Margin and3.0% over Applicable Revolver Libor Margin. Our working capital facility offers two options for interest rates:  Applicable Revolver Libor Margin ranging from2.5% - 3.0% or Applicable Revolver Index Margin ranging from .75% - 1.25%.  The rate is based on revolver availability.  During the first six months of the agreement,we use the highest percent in each option. In addition, as of June 30, 2004, we have a $0.8 million mortgage notewith a maximum interest rate of 5.5% and a remaining duration of six years.

 

#### **ITEM 4**. CONTROLS AND PROCEDURES

#### ** **

(A) Evaluation of DisclosureControls and Procedures

 

Our Chief Executive Officer and Chief FinancialOfficer have evaluated the effectiveness of our disclosure controls andprocedures (as defined in Rule 13a-15(e) and 15d-15(e)) under the SecuritiesExchange Act of 1934.  Based on theirevaluation, our Chief Executive Officer and Chief Financial Officer haveconcluded that, as of June 30, 2004, our disclosure controls and procedureswere effective in ensuring that material information was properly disclosed inits filings with the Securities and Exchange Commission.

 

(B) Changes in Internal Controls OverFinancial Reporting

 

There have been no significant changes in our internalcontrols over financial reporting during the three months ended June 30, 2004that have materially affected or are reasonably likely to materially affect ourinternal control over financial reporting.

 

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## **PART II.**  OTHER INFORMATION

 

 

#### **ITEM 6**. EXHIBITS AND REPORTS ON FORM 8-K

#### ** **

(a) Exhibits required by Item601 of Regulation S-K

 

31.1 Certification of CEOpursuant to Section 302 of Sarbanes-Oxley Act of 2002

31.2 Certification of CFOpursuant to Section 302 of Sarbanes-Oxley Act of 2002

32.1 Certification of CEO andCFO pursuant to Section 906 of Sarbanes-Oxley Act of 2002

 

(b)  Reports on Form 8-K during Second Quarter of2004:

 

None

 

 

## **SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 

 

**BLUE RIDGE PAPER PRODUCTS INC.**

 

 
| Date:  August 12, 2004 |                                 |
|-----------------------------|--------------------------------------|
|                        | /S/  JOHN B. WADSWORTH          |   |
|                        | John B.  Wadsworth                   |
|                        | Chief  Financial Officer             |
|                        |                                 |
|                        | (On behalf  of the Registrant and as |
|                        | Principal  Financial Officer)        |

 

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### EXHIBITINDEX

TO

FORM 10-Q

OF

BLUE RIDGE PAPER PRODUCTS INC.

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004

Pursuant to Section 102(d) of Regulation S-T

(17 C.F.R. Section 232.102(d))

 

The following exhibits are filed as part of thisreport:

 

31.1                           Certification of CEOpursuant to Section 302 of Sarbanes-Oxley Act of 2002

31.2                           Certificationof CFO pursuant to Section 302 of Sarbanes-Oxley Act of 2002

32.1                           Certificationof CEO and CFO pursuant to Section 906 of Sarbanes-Oxley Act of 2002

 

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