** **

**FORM 10-Q**

 

**SECURITIESAND EXCHANGE COMMISSION**

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

 

**(Mark One)**

 

**ý****QUARTERLY REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE**

**SECURITIESEXCHANGE ACT OF 1934**

 

### **For thequarterly period ended September 30, 2004**

 

**OR**

 

**o****TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE**

**SECURITIESEXCHANGE ACT OF 1934**

 

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

 

**Registration Number:  333-114032**

 

**BLUERIDGE PAPER PRODUCTS INC.**

(Exact name of registrant as specified incharter)

#  

| **Delaware**                                                                     | ** ** | **56-2136509**                           |
|----------------------------------------------------------------------------------|------------|------------------------------------------|
| (State of incorporation)                                                         |       | (I.R.S. Employer Identification  Number) |
|                                                                             |       |                                     |
| **41 MAIN 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  ý   No o

 

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

 

# Yes  o   No ý

 

The number of common shares outstanding at September 30, 2004 was10,007,511.

 

 

----

 

**BLUE RIDGE PAPER PRODUCTS INC.**

 

**AND SUBSIDIARY**

** **

INDEX

 
| **PART 1.** | FINANCIAL INFORMATION                                            |                                                                                                                                                                    |
|-------------|------------------------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |                                                             |                                                                                                                                                                    |   |
|        | Item 1.                                                          | Condensed Consolidated Balance Sheets,  September 30, 2004 (unaudited) and December 31, 2003 (derived from audited  financial statements)                               |   |
|        |                                                             |                                                                                                                                                                    |   |
|        |                                                             | Condensed Consolidated Statements of  Operations, Three Months Ended September 30, 2004 and 2003 (unaudited) Nine  Months Ended September 30, 2004 and 2003 (unaudited) |   |
|        |                                                             |                                                                                                                                                                    |   |
|        |                                                             | Condensed Consolidated Statements of Cash  Flows, Nine Months Ended September 30, 2004 and 2003 (unaudited)                                                             |   |
|        |                                                             |                                                                                                                                                                    |   |
|        |                                                             | Notes to Condensed Consolidated Financial  Statements (unaudited)                                                                                                       |   |
|        |                                                             |                                                                                                                                                                    |   |
|        | Item 2.                                                          | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                                                             |   |
|        |                                                             |                                                                                                                                                                    |   |
|        | Item 3.                                                          | Quantitative and Qualitative Disclosures  About Market Risk                                                                                                             |   |
|        |                                                             |                                                                                                                                                                    |   |
|        | Item 4.                                                          | Controls and Procedures                                                                                                                                                 |   |
|        |                                                             |                                                                                                                                                                    |   |
| PART II.    | OTHER INFORMATION                                                |                                                                                                                                                                    |
|        |                                                             |                                                                                                                                                                    |   |
|        | Item  6.                                                         | Exhibits                                                                                                                                                                |   |
|        |                                                             |                                                                                                                                                                    |   |
|        |                                                             |                                                                                                                                                                    |   |
| ** **  | **PART 1. FINANCIAL INFORMATION**                                | ** **                                                                                                                                                              |
|        |                                                             |                                                                                                                                                                    |   |
| **ITEM 1.** | **FINANCIAL STATEMENTS**                                         | ** **                                                                                                                                                              |
| ** **  | ** **                                                       | ** **                                                                                                                                                              | ** ** |
| ** **  | **Blue Ridge Paper Products Inc. and  Subsidiaries**             | ** **                                                                                                                                                              |
| ** **  | **CONDENSED CONSOLIDATED STATEMENTS OF  OPERATIONS (UNAUDITED)** | ** **                                                                                                                                                              |

 

2

----

 

**BLUE RIDGE PAPER PRODUCTS INC.**

** **

**Condensed Consolidated Balance Sheets**

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

**(Dollars in thousands)**

**(Unaudited)**

 
| ** **                                                                                                                      | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                                                                                                                      | ** ** | ** **              | ** ** | ** **             | ** ** |
| **Assets**                                                                                                                      |       |                    |       |                   |       |
| Current assets:                                                                                                                 |       |                    |       |                   |       |
| Cash                                                                                                                            |       | $                       | 8,756      |                   | $          | 2,123 |   |
| Accounts receivable, net of allowance for  doubtful accounts and discounts of $2,444 and $2,621 in 2004 and 2003,  respectively |       | 44,951                  |       | 42,646                 |       |
| Inventories                                                                                                                     |       | 38,454                  |       | 59,063                 |       |
| Prepaid expenses                                                                                                                |       | 1,293                   |       | 1,112                  |       |
| Insurance proceeds receivable                                                                                                   |       | 11,056                  |       | —                 |       |
| Income tax receivable                                                                                                           |       | 76                      |       | 32                     |       |
| Other current assets                                                                                                            |       | 501                     |       | —                 |       |
| Total current assets                                                                                                            |       | 105,087                 |       | 104,976                |       |
| Property, plant, and equipment, net                                                                                             |       | 187,595                 |       | 192,671                |       |
| Deferred financing costs, net                                                                                                   |       | 6,814                   |       | 7,443                  |       |
| Other assets                                                                                                                    |       | 62                      |       | 62                     |       |
| Total assets                                                                                                                    |       | $                       | 299,558    |                   | $          | 305,152 |   |
| **Liabilities  and Stockholder’s Equity (Deficit)**                                                                        |       |                    |       |                   |       |
| Current liabilities:                                                                                                            |       |                    |       |                   |       |
| Current portion of senior debt                                                                                                  |       | $                       | 39         |                   | $          | 37 |   |
| Current portion of capital lease obligation                                                                                     |       | 489                     |       | 474                    |       |
| Accounts payable                                                                                                                |       | 42,272                  |       | 35,748                 |       |
| Accrued expenses and other current  liabilities                                                                                 |       | 35,240                  |       | 33,109                 |       |
| Interest payable                                                                                                                |       | 5,330                   |       | 1,495                  |       |
| Total current liabilities                                                                                                       |       | 83,370                  |       | 70,863                 |       |
| Senior debt, net of current portion                                                                                             |       | 144,429                 |       | 134,898                |       |
| Parent Pay-In-Kind (PIK) Senior  Subordinated Note                                                                              |       | 38,928                  |       | 37,124                 |       |
| Capital lease obligations                                                                                                       |       | 990                     |       | 1,359                  |       |
| Pension and postretirement benefits                                                                                             |       | 19,681                  |       | 19,109                 |       |
| Other liabilities                                                                                                               |       | 1,282                   |       | 2,824                  |       |
| Total liabilities                                                                                                               |       | 288,680                 |       | 266,177                |       |
| Obligation to redeem ESOP shares                                                                                                |       | 37,120                  |       | 32,389                 |       |
| Obligation to redeem restricted stock units  of Parent                                                                          |       | 2,639                   |       | 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                                                                                                      |       | 47,939                  |       | 47,344                 |       |
| Accumulated deficit                                                                                                             |       | (66,812                 | )          | (34,125                | )          |
| Unearned compensation                                                                                                           |       | —                  |       | (88                    | )          |
| Accumulated other comprehensive loss                                                                                            |       | (3,370                  | )          | (3,370                 | )          |
|                                                                                                                            |       | (22,243                 | )          | 9,761                  |       |
| Receivable from Parent                                                                                                          |       | (6,638                  | )          | (5,694                 | )          |
| Total stockholder’s equity (deficit)                                                                                       |       | (28,881                 | )          | 4,067                  |       |
| Total liabilities and stockholder’s equity  (deficit)                                                                      |       | $                       | 299,558    |                   | $          | 305,152 |   |

 

Seeaccompanying notes to condensed consolidated financial statements.

 

3

----

** **

**Condensed Consolidated Statements of Operations**

**Three and Nine Month PeriodsEnded September 30, 2004 and 2003**

**(Dollars in thousands)**

**(Unaudited)**

 
| ** **                                                            | ** ** | **Three Month Period Ended  September 30** | ** ** | **Nine Month Period Ended  September 30** | ** ** |
|-----------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                            | ** ** | **2004**                                   | ** ** | **2003**                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net sales                                                             |       | $                                          | 117,448    |                                      | $          | 118,301 |   | $ | 359,874 |   | $ | 351,644 |   |
| Cost of goods sold:                                                   |       |                                       |       |                                      |       |   |   |   |   |
| Cost of goods sold, excluding depreciation  and amortization          |       | 107,473                                    |       | 103,278                                   |       | 338,730 |   | 317,957 |   |
| Depreciation and amortization                                         |       | 4,050                                      |       | 3,980                                     |       | 12,374 |   | 12,058 |   |
| Flood related loss and repairs                                        |       | 18,056                                     |       | —                                    |       | 18,056 |   | — |   |
| Insurance recoveries                                                  |       | (16,056                                    | )          | —                                    |       | (16,056 | ) | — |   |
| Gross profit                                                          |       | 3,925                                      |       | 11,043                                    |       | 6,770 |   | 21,629 |   |
|                                                                  |       |                                       |       |                                      |       |   |   |   |   |
| Selling, general and administrative  expenses                         |       | 6,832                                      |       | 6,168                                     |       | 19,956 |   | 18,503 |   |
| Depreciation and amortization                                         |       | 476                                        |       | 436                                       |       | 1,376 |   | 1,296 |   |
| ESOP expense                                                          |       | 1,800                                      |       | 2,030                                     |       | 5,400 |   | 6,091 |   |
| Gain on sale of assets                                                |       | (58                                        | )          | (3,691                                    | )          | (52 | ) | (3,550 | ) |
| Operating profit (loss)                                               |       | (5,125                                     | )          | 6,100                                     |       | (19,910 | ) | (711 | ) |
|                                                                  |       |                                       |       |                                      |       |   |   |   |   |
| Other income (expense):                                               |       |                                       |       |                                      |       |   |   |   |   |
| Interest expense, excluding amortization of  deferred financing costs |       | (4,003                                     | )          | (3,382                                    | )          | (11,869 | ) | (10,043 | ) |
| Amortization of deferred financing costs                              |       | (321                                       | )          | (472                                      | )          | (908 | ) | (1,302 | ) |
|                                                                  |       | (4,324                                     | )          | (3,854                                    | )          | (12,777 | ) | (11,345 | ) |
| Profit (loss) before income taxes                                     |       | (9,449                                     | )          | 2,246                                     |       | (32,687 | ) | (12,056 | ) |
| Income tax                                                            |       | —                                     |       | —                                    |       | — |   | — |   |
| Net income (loss)                                                     |       | $                                          | (9,449     | )                                         | $          | 2,246 |   | $ | (32,687 | ) | $ | (12,056 | ) |

 

See accompanying notes to condensedconsolidated financial statements.

 

4

----

** **

**BLUE RIDGE PAPER PRODUCTS INC.**

** **

**CondensedConsolidated Statements of Cash Flows**

**Nine months ended September 30, 2004 and 2003**

**(Dollars in thousands)**

**(Unaudited)**

 
| ** **                                                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Cash flows from operating activities:                                           |       |     |       |     |       |
| Net loss                                                                        |       | $        | (32,687    | )        | $          | (12,056 | ) |
| Adjustment to reconcile net loss to net  cash provided by operating activities: |       |     |       |     |       |
| Depreciation and amortization                                                   |       | 13,750   |       | 13,354   |       |
| Asset impairment due to flood related  losses                                   |       | 706      |       | —   |       |
| Compensation expense for Parent restricted  stock                               |       | 138      |       | 490      |       |
| Amortization of deferred financing costs                                        |       | 908      |       | 1,302    |       |
| ESOP expense                                                                    |       | 5,400    |       | 6,091    |       |
| Gain on sale of assets                                                          |       | (52      | )          | (3,550   | )          |
| Changes in operating assets and  liabilities:                                   |       |     |       |     |       |
| Accounts receivable, net                                                        |       | (2,305   | )          | (6,081   | )          |
| Inventories                                                                     |       | 20,609   |       | (1,495   | )          |
| Prepaid expenses                                                                |       | (181     | )          | 386      |       |
| Insurance proceeds receivable                                                   |       | (11,056  | )          | —   |       |
| Income tax receivable                                                           |       | (44      | )          | —   |       |
| Accounts payable                                                                |       | 6,524    |       | 966      |       |
| Accrued and other current liabilities                                           |       | 3,746    |       | 3,590    |       |
| Interest payable                                                                |       | 3,835    |       | 1,477    |       |
| Change in Parent PIK Senior Subordinated  Note for interest                     |       | 1,804    |       | 1,818    |       |
| Pension and postretirement benefits                                             |       | 572      |       | 854      |       |
| Other assets and liabilities                                                    |       | (1,545   | )          | 816      |       |
|                                                                            |       |     |       |     |       |
| Net cash provided by operating activities                                       |       | 10,122   |       | 7,962    |       |
|                                                                            |       |     |       |     |       |
| Cash flows used in investing activities:                                        |       |     |       |     |       |
| Additions to property, plant, and equipment                                     |       | (9,900   | )          | (8,308   | )          |
| Proceeds from sale of property, plant, and  equipment                           |       | 70       |       | 5,770    |       |
|                                                                            |       |     |       |     |       |
| Net cash used in investing activities                                           |       | (9,830   | )          | (2,538   | )          |
|                                                                            |       |     |       |     |       |
| Cash flows from financing activities:                                           |       |     |       |     |       |
| Repurchase of Parent common and preferred  stock                                |       | (944     | )          | (319     | )          |
| Payments on separation notes payable                                            |       | (1,615   | )          | (2,453   | )          |
| Proceeds from borrowings under line of  credit                                  |       | 102,315  |       | 100,739  |       |
| Repayment of borrowings under line of  credit                                   |       | (92,755  | )          | (89,687  | )          |
| Cash paid for refinancing credit facilities                                     |       | (279     | )          | (759     | )          |
| Proceeds from issuance of long term debt                                        |       | —   |       | 819      |       |
| Repayments of long-term debt and capital  lease obligations                     |       | (381     | )          | (12,462  | )          |
|                                                                            |       |     |       |     |       |
| Net cash provided by (used in) financing  activities                            |       | 6,341    |       | (4,122   | )          |
|                                                                            |       |     |       |     |       |
| Net increase in cash                                                            |       | 6,633    |       | 1,302    |       |
|                                                                            |       |     |       |     |       |
| Cash, beginning of period                                                       |       | 2,123    |       | 332      |       |
| Cash, end of period                                                             |       | $        | 8,756      |     | $          | 1,634 |   |
| Supplemental disclosures of cash flow  information:                             |       |     |       |     |       |
| Cash paid for interest, including  capitalized interest                         |       | $        | 7,348      |     | $          | 6,828 |   |
| 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                                        |       | —   |       | 1,502    |       |

 

See accompanying notes to condensedconsolidated financial statements.

 

5

----

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

 

**(1)  Basisof Presentation**

 

Theaccompanying unaudited condensed consolidated interim financial statements havebeen prepared in accordance with Regulation S-X related to interim periodfinancial statements and, in the opinion of management, include all adjustments(consisting only of normal recurring accruals) that are necessary for the fairpresentation of results for the interim periods.  Results for the three and nine months endedSeptember 30, 2004 may not necessarily be indicative of full-year results.  It is suggested that these condensedconsolidated interim financial statements be read in conjunction with the auditedconsolidated financial statements of Blue Ridge Paper Products Inc. (theCompany) for the year ended December 31, 2003.

 

**(2) Liquidity**

 

In December 2003, the Company issued $125,000 of 9.50% SeniorSecured Notes due 2008 (the 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.  The new revolving credit facility containedcovenant restrictions, which requires availability to exceed $15,000.  The maximum borrowing availability atDecember 31, 2003 and September 30, 2004 was $31,611 and $24,681, respectively.

 

On September 15, 2004, the revolving credit facility was amended  to increase the maximum borrowings to $50,000on a permanent basis.  The amendment alsoreduced the $15,000 availability restriction to $10,000 (as thereafter furtherreduced as described below) during the period beginning September 15, 2004 andending January 15, 2005, after which time the availability restriction revertsback to $15,000.

 

On October 8, 2004, the revolving creditfacility was further amended.  Thisamendment reduced the $10,000 availability restriction to $5,000 during theperiod beginning October 8, 2004 and ending January 15, 2005, after which timethe availability restriction reverts back to $15,000.

 

**(3) Recent Developments**

 

*Flood losses related to Hurricanes Francesand Ivan*

 

On September 8, 2004, Western North Carolina experienced flooding as aresult of Hurricane Frances, with flood levels exceeding the Federal EmergencyManagement Agency (FEMA) 100-year flood plain levels.  This forced the shutdown of the Canton pulpand paper mill.  The Company’s corporateheadquarters building was also flooded. On September 17, 2004, additional flooding occurred from HurricaneIvan.  The combined downtime of theCanton mill in whole or in part from the two floods was 23 days.

 

Property damage losses and related repairs and maintenance from thesetwo floods were  $18,785 and have beenrecorded in the period ending September 30, 2004 of which $18,056 is reflectedas a reduction to gross profit and $729 is included in selling, general andadministrative expenses in the accompanying condensed consolidated financialstatements.  As of September 30, 2004,the Company recorded insurance recoveries of $16,056 of which $5,000 had beencollected prior to September 30, 2004 and an additional $5,000 was received onOctober 7, 2004.

 

6

----

 

*Gain from the Sale of Emission Allowances*

 

Under section 126 of the Clean Air Act,new regulations for emissions of nitrogen oxides (NOx) from coal fired boilerswill require affected facilities to reduce these emissions during the “ozoneseason,” which is defined as May 1 through September 30. TheEnvironmental Protection Agency (EPA) has established emission levels that eachfacility must meet in 2004 and 2005 by granting emission allowances, which aremeasured in units based on tons of NOx emitted and are commonly referred to asNOx credits.  A facility is permitted bythe EPA to sell or transfer NOx credits at any time prior to theirexpiration.  At the conclusion of eachozone season, each facility must report its actual emissions to the EPA and ownsufficient NOx credits to cover its emission levels; otherwise, the facilitymust purchase credits 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.

 

Engineering studies in June 2004 revealedthat the NOx emissions for the 2004 season would be below EPA allowances by anadditional 50 tons.  Consequently, another50 units were sold on July 1, 2004.

 

Due to operating efficiencies and the Canton mill downtime in September2004, the Company was able to sell an additional 210 units from the 2004 NOxseason during the third quarter.  For the2004 season, which ended on September 30, 2004, the EPA allocated 1,257 unitsto the Company.  Emissions totaled 762.4tons and units sold totaled 460 leaving a balance of 34.6 units.  The Company has elected to carry over theseunits into the 2005 season.  The value ofthese units is approximately $67 as of September 30, 2004.

 

Furthermore, engineering studies in August revealed that the NOxemissions for the 2005 season would be below EPA allowances.  Consequently, another 250 units for 2005 weresold in the third quarter.

 

At September 30, 2004, $1,142 of the 2004 units sold and previouslydeferred were earned and recorded as miscellaneous income in the accompanyinginterim financial statements.  The 2005units sold are recorded as current deferred revenue of approximately $1,783.  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 its FortWorth, Texas DairyPak facility in the second quarter of 2004. Production ceasedon June 4, 2004 at the Fort Worth facility, and the Company transferred thefacility’s production to its other existing DairyPak facilities.  The Company plans to sell the land andbuilding  within the next year.  Consequently, at September 30, 2004, theassets held for sale are classified in other current assets in the amount of$501.  Closure costs, which consistprimarily of severance costs, are estimated to be $2,198 in total and areexpected to be paid in 2004.  For thenine months ended September 30, 2004, the Company recorded $1,936 of severancecosts related to this closure and $262 of loss related to asset disposals.

 

*Parmalat Bankruptcy*

 

On February 24, 2004, a significant customer filed for Chapter 11bankruptcy protection.  As ofDecember 31, 2003 and September 30, 2004, the Company had outstandingaccounts receivable of $2,501 and $1,158, respectively.  In addition, the Company has received cashpayments of $993 and $2,984 as of December 31, 2003 and September 30,2004, respectively, related to accounts receivable that are potentially subjectto “preferential payment” treatment as

 

7

----

 

defined in Chapter 11 bankruptcy laws and regulations.  The Company assessed the potential ofcollecting the outstanding receivables and the likelihood that cash paymentsdeemed as preferential are unsuccessfully defended and recorded a valuationallowance of $1,875 and $2,001 as of December 31, 2003 and September 30,2004, respectively, related to this customer.

 

*Headcount Reduction*

 

On February 3, 2004, the Companyannounced plans to eliminate approximately 90 salaried and hourly positions inthe Paper and Corporate divisions through voluntary termination plans.  The Company offered several voluntaryseverance and termination packages for salaried employees and hourly unionemployees.  The salaried employees planoffers a severance package based on current compensation and years of service.  The hourly union employees package acceleratesfive years of vested service towards the union pension plan benefit.

 

As of September 30, 2004, the Company had accepted 74 employees’voluntary termination agreements. Additionally, 16 positions were eliminated through attrition where noseverance was paid.  As a result, theCompany recorded $1,336 of severance costs in the first quarter, $1,029 for thesecond quarter, and $51 in the third quarter of 2004.  The Company disbursed $1,290 to the PACEIndustry Union – Management Pension Fund to fund the severance benefits for thehourly employees affected.  The remainingaccrued severance of $643 is recorded in accrued and other current liabilitiesin the accompanying consolidated balance sheet and is expected to be paid bySeptember 2005.

 

**(4)   RecentAccounting Developments**

 

In January 2004, the FASB issued a Staff Position (FSP), FAS 106-1,addressing the Accounting and Disclosure Requirements related to the MedicarePrescription Drug, Improvement and Modernization Act of 2003.  In accordance with the provisions of this FSPthe Company elected at December 31, 2003 to defer the recognition of theeffects of this act in any measurement of the benefit obligation or cost.  In June 2004, the Company actuarially calculatedthe effect of the act as of its December 31, 2003 measurement date.  The calculation yielded a net reduction inthe 2004 benefit obligation and cost of $241. At September 30, 2004, $180 was recorded as a reduction in the benefitobligation and cost in the accompanying condensed consolidated interimfinancial statements.

 

In August 2004, the Company changed the postretirement medical programto provide Medigap policy coverage for individuals over age 65.  Medigap policies provide insurance protectionin addition to Medicare.  Before this change,the Company provided an indemnity style health care arrangement that wasintegrated with Medicare coverage.  Thischange allows individuals the opportunity to purchase Medigap style plans H, Ior J at the cost sharing percentage (employer/employee) determined based on ageand years of service at retirement.  Thisplan replaces the individually designed major medical plan with prescriptiondrug coverage that had been expected to be in effect for future retirees.

 

The FAS 106 expense reflected year-to-date incorporates an analysis ofthe potential impact of Medicare Reform and the new Medicare Part D in2006.  This analysis was based oninformation prior to this plan change. Details continue to be developed regarding the potential integration ofthe new Medicare Part D with existing Medigap policies.  The Company will continue to monitor thedevelopment of regulations defining this new Medicare program.  When the provisions of Medicare Part D arefinalized management anticipates they will not materially affect the Company’scurrent costs associated with this plan.

 

8

----

 

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

 

In July 2003, the Company entered into a note payable with a bankfor $819 due in 2010.  The note bears interestat a fixed rate at 5.5%.  Land and officebuildings in Canton, North Carolina collateralize the note.  The balance of the note payable was $773 atSeptember 30, 2004.

 

On December 17, 2003, the Company sold$125,000 of 9.5% Senior Secured Notes (Notes) through a private placementoffering under Rule 144A.  The Noteshave a term of five years, are due on December 15, 2008 and bear interestat a stated rate of 9.5%, which is payable semi-annually in arrears onJune 15 and December 15.  TheNotes are collateralized by a senior secured interest in substantially all ofthe Company’s tangible and intangible assets and have a subordinated securedinterest in the outstanding trade accounts receivable and inventories.  The Company has the right to redeem the Notesat 104.75% and 100.00%, plus accrued interest on or after December 15,2006 and December 15, 2007, respectively. Terms of the indenture under which the Notes have been issued containcertain covenants, including limitations on certain restricted payments and theincurrence of additional indebtedness.

 

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.  On September15, 2004 the credit agreement was amended to increase  the maximum borrowings to $50,000.  The revolving credit facility iscollateralized by a senior secured interest in the Company’s outstanding tradeaccounts receivable and inventories and by a subordinated secured interest insubstantially all of the Company’s tangible and intangible assets.  The revolving credit facility matures onDecember 15, 2008, and requires the Company to pay an annual fee of 0.375%on the unused facility amount.  TheCompany had an outstanding balance of $9,135 and $18,695 at December 31, 2003and September 30, 2004, respectively and letters of credit outstanding as ofDecember 31, 2003 and September 30, 2004 were $4,254 and $5,932,respectively.  The maximum borrowingavailability at September 30, 2004 was $24,681, subject to the availabilityrestriction described in Note 2.

 

**(6) Commitments and Contingencies**

 

(a)* Purchase Commitments*

 

The Company has agreements with suppliers ofwood pulp and wood chips.  The agreementsare for a five-year period with two renewable five-year periods beginning inMay 1999.  The Company renewed thesecond five-year term with International Paper  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.  Two of the wood chipagreements are with two subsidiaries of International Paper.  As of September 30, 2004, the Company hascommitments to purchase wood chips of approximately $123,570 over the remainingterms 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 andAssessments*

 

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 downstream from which the Canton mill is located,and the Company has a permit to discharge. The plaintiffs are seeking damages for private nuisance in the period

 

9

----

 

commencing June 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.  Management has not recorded aliability for any amount related to this lawsuit as of September 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 “Accountingfor Asset Retirement Obligations”.  TheCompany has currently accrued approximately $782 on balance sheet for closureof landfills as of September 30, 2004.

 

**(7) Segment Information**

 

The Company’s management makes financialdecisions and allocates resources based on sales and operating income of thepaper and packaging segments.  Althoughraw materials, the production processes, distribution methods and theregulatory environment are similar, management believes it is appropriate toseparately disclose these segments. The Company does not allocate selling,research and administration expenses to each segment, but management usesoperating income to measure the performance of the segments.  The financial information attributed to thesesegments is included in the following table for the nine months ended September30, 2004 and 2003:

 
| ** **                    | ** ** | ** ** | ** ** | **Paper** | ** ** | **Packaging** | ** ** | **Corporate** | ** ** | **Total** | ** ** |
|-------------------------------|------------|------------|------------|-----------|------------|---------------|------------|---------------|------------|-----------|------------|
|                          |       |       |       |      |       |          |       |          |       |      |       |
| Net sales                     |       | 2004       |       | $         | 145,031    |          | $          | 214,843       |       | ¥    |       |   | $ | 359,874 |   |
|                          |       | 2003       |       | 140,190   |       | 211,454       |       | ¥        |       |      | 351,644    |   |
|                          |       |       |       |      |       |          |       |          |       |      |       |
| Operating profit (loss)       |       | 2004       |       | (2,379    | )          | 9,201         |       | (26,732       | )          | (19,910   | )          |
|                          |       | 2003       |       | 7,262     |       | 18,003        |       | (25,977       | )          | (712      | )          |
|                          |       |       |       |      |       |          |       |          |       |      |       |
| Depreciation and amortization |       | 2004       |       | 9,538     |       | 2,836         |       | 1,376         |       | 13,750    |       |
|                          |       | 2003       |       | 9,472     |       | 2,586         |       | 1,296         |       | 13,354    |       |
|                          |       |       |       |      |       |          |       |          |       |      |       |
| Total assets                  |       | 2004       |       | 195,108   |       | 85,576        |       | 18,874        |       | 299,558   |       |
|                          |       | 2003       |       | 203,978   |       | 93,592        |       | 12,435        |       | 310,005   |       |
|                          |       |       |       |      |       |          |       |          |       |      |       |
| Capital expenditures          |       | 2004       |       | 8,248     |       | 1,040         |       | 612           |       | 9,900     |       |
|                          |       | 2003       |       | 7,536     |       | 100           |       | 672           |       | 8,308     |       |
|                               |            |            |            |           |            |               |            |               |            |           |            |  |  |  |  |

 

 

10

----

 

**(8) Inventories**

 

Components of inventory at September 30, 2004and December 31, 2003 are as follows:

 
| ** **       | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------|------------|----------|------------|----------|------------|
|             |       |     |       |     |       |
| Raw Materials    |       | $        | 15,428     |     | $          | 17,023 |   |
| Work in Progress |       | 13,368   |       | 19,359   |       |
| Finished Goods   |       | 9,658    |       | 22,681   |       |
| Total            |       | $        | 38,454     |     | $          | 59,063 |   |

** **

**11**

----

** **

**ITEM 2. MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

#### **FORWARD-LOOKINGSTATEMENTS**

 

This filing includes “forward-looking statements” within the meaning ofthe Private Securities Litigation Reform Act of 1995.  Forward-looking statements are those that donot relate solely to historical fact. They include, but are not limited to, any statement that may predict,forecast, indicate or imply future results, performance, achievements orevents.  They may contain words such as “believe,”“anticipate,” “expect,” “estimate,” “intend,” “project,” “plan,” “will” orwords or phrases of similar meaning.

 

These forward-looking statements are not guarantees of futureperformance.  Forward-looking statementsare based on management’s expectations that involve risks and uncertainties,including, but not limited to, economic, competitive, governmental and technologicalfactors outside of our control, that may cause actual results to differmaterially from trends, plans or expectations set forth in the forward-lookingstatements.  Given these risks anduncertainties, actual future results may be materially different from what weplan or expect.  We will not update theseforward-looking statements even if our situation changes in the future.

 

#### **OVERVIEW**

#  

# Marketconditions continued to improve during the three months ended September 30,2004 (the “2004 three-month period”) compared to prior quarters in 2004.  Aggregate revenue per ton of all productsincreased 6.8% over the three months ended June 30, 2004.  Order backlogs maintained their strengththroughout the 2004 three-month period. Our cost improvement efforts continued on schedule as we began torealize the impact of the shutdown of our Fort Worth DairyPak convertingfacility and headcount reductions at our Canton mill and corporate staff.

#  

# OnSeptember 8, 2004, Western North Carolina experienced heavy rains and floodingas a result of Hurricane Frances.  Floodlevels exceeded Federal Emergency Management Agency (FEMA) 100-year flood plainlevels resulting in the area being declared a Federal disaster area.  Due to the severe nature of the flooding, ourpulp and paper mill located in Canton, North Carolina, undertook flood controlprocedures resulting in an orderly shutdown of the mill.  The Canton mill was in the process of  restoring operations when, on September 17,2004, the area experienced a second, more extensive flooding as a result ofHurricane Ivan, which also exceeded FEMA 100-year flood plain levels.  The mill resumed full paperboard and partialpaper production by September 27, 2004. Complete operations at the Canton mill were restored by October 4,2004.  The total financial impact for the2004 three-month period was $9.0 million which is net of insurance  recoveries recorded (including receivablesrepresenting probable future insurance reimbursements) as a result of thefloods in an aggregate amount of $16.1 million. The following table summarizes the impact of the floods on earnings bysegment for the 2004 three-month period.

 

12

----

 

($ Millions)

#  

| **Impact on 2004 three-month period**    | ** ** | **Paper** | ** ** | **Packaging** | ** ** | **SG&A** | ** ** | **Total** | ** ** |
|------------------------------------------|------------|-----------|------------|---------------|------------|--------------|------------|-----------|------------|
|                                     |       |      |       |          |       |         |       |      |       |
| Property damage, repairs and maintenance |       | $         | 18.1       |          | $          | 0.0          |       | $         | 0.7        |   | $ | 18.8 |   |
|                                     |       |      |       |          |       |         |       |      |       |
| Business Interruption                    |       | 4.8       |       | 1.5           |       | 0.0          |       | 6.3       |       |
|                                     |       |      |       |          |       |         |       |      |       |
| Total                                    |       | 22.9      |       | 1.5           |       | 0.7          |       | 25.1      |       |
|                                     |       |      |       |          |       |         |       |      |       |
| Insurance Recoveries Booked              |       | (16.1     | )          | 0.0           |       | 0.0          |       | (16.1     | )          |
|                                     |       |      |       |          |       |         |       |      |       |
| Net Impact on 2004 three-month period    |       | $         | 6.8        |          | $          | 1.5          |       | $         | 0.7        |   | $ | 9.0 |   |

 

The Company expects to incur additional costs in future periods forrepairs and business interruption ranging from $7.0 million to $10.0 million, aportion of which may be related to capital expenditures.  The Company expects to receive insurancerecoveries of $5.2 million to offset these costs.

 

# TheCompany’s flood insurance reimburses losses for property damage, repairs andmaintenance up to $10 million per event after a $1.0 million deductible.  The flood insurance also covers businessinterruption after a ten-day time element deductible.  It is the Company’s belief that the claimassociated with each flood will fully utilize both payout maximums.  The Company is currently in the process ofreviewing and implementing additional flood prevention measures which willenable the Company to reacquire flood coverage for the balance of the policyyear.

#  

# Despitethe loss of production from September 8 to October 4, we were able to meet ourcustomers’ order requirements with minimal disruptions.  While the flood had a significant impact onour financial results, we had sufficient liquidity to resume normal operationsdue to: (i) $10 million of initial insurance proceeds received through October7 and (ii) continued shipments of product to our customers during the time themill was down.

 

#### **Resultsof Operations**

 

The following table sets forth certain sales and operating data for ourbusiness segments for the periods indicated:

 

13

----

 
| ** **                      | ** ** | **Three Month Period  Ended September 30** | ** ** | **Nine Month Period****Ended September 30** | ** ** |
|---------------------------------|------------|--------------------------------------------|------------|---------------------------------------------|------------|
| ** **                      | ** ** | **2004**                                   | ** ** | **2003**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net sales:                      | ** ** | ** **                                 | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Packaging                       |       | $                                          | 70.6       |                                        | $          | 72.5 |   | $ | 214.9 |   | $ | 211.4 |   |
| Paper                           |       | 46.8                                       |       | 45.8                                        |       | 145.0 |   | 140.2 |   |
| Total                           |       | $                                          | 117.4      |                                        | $          | 118.3 |   | $ | 359.9 |   | $ | 351.6 |   |
|                            |       |                                       |       |                                        |       |   |   |   |   |
| Operating profit (loss):        |       |                                       |       |                                        |       |   |   |   |   |
| Packaging                       |       | $                                          | 3.4        |                                        | $          | 10.3 |   | $ | 9.2 |   | $ | 18.0 |   |
| Paper                           |       | 0.6                                        |       | 4.4                                         |       | (2.4 | ) | 7.3 |   |
| Total Segments Operating Profit |       | $                                          | 4.0        |                                        | $          | 14.7 |   | $ | 6.8 |   | $ | 25.3 |   |
|                            |       |                                       |       |                                        |       |   |   |   |   |
| Corporate Expenses              |       | 9.1                                        |       | 8.6                                         |       | 26.7 |   | 26.0 |   |
| Total                           |       | $                                          | (5.1       | )                                           | $          | 6.1 |   | $ | (19.9 | ) | $ | (0.7 | ) |
|                            |       |                                       |       |                                        |       |   |   |   |   |
| Percentage of net sales:        |       |                                       |       |                                        |       |   |   |   |   |
| Packaging                       |       | 60.1                                       | %          | 61.3                                        | %          | 59.7 | % | 60.1 | % |
| Paper                           |       | 39.9                                       | %          | 38.7                                        | %          | 40.3 | % | 39.9 | % |
| Total                           |       | 100.0                                      | %          | 100.0                                       | %          | 100.0 | % | 100.0 | % |
|                            |       |                                       |       |                                        |       |   |   |   |   |
| Operating margin:               |       |                                       |       |                                        |       |   |   |   |   |
| Packaging                       |       | 4.8                                        | %          | 14.2                                        | %          | 4.3 | % | 8.5 | % |
| Paper                           |       | 1.3                                        | %          | 9.6                                         | %          | (1.7 | )% | 5.2 | % |
| Total                           |       | 3.4                                        | %          | 12.4                                        | %          | 1.9 | % | 7.2 | % |
|                            |       |                                       |       |                                        |       |   |   |   |   |
| Shipments (tons):               |       |                                       |       |                                        |       |   |   |   |   |
| Packaging segment               |       | 61,963                                     |       | 65,697                                      |       | 188,794 |   | 191,597 |   |
| Paper segment                   |       | 68,896                                     |       | 75,059                                      |       | 230,104 |   | 219,041 |   |
| Total                           |       | 130,859                                    |       | 140,756                                     |       | 418,898 |   | 410,638 |   |
|                            |       |                                       |       |                                        |       |   |   |   |   |
| Average price ($ per ton): |       |                                       |       |                                        |       |   |   |   |   |
| Packaging segment               |       | $                                          | 1,139      |                                        | $          | 1,104 |   | $ | 1,138 |   | $ | 1,103 |   |
| Paper segment                   |       | 679                                        |       | 610                                         |       | 630 |   | 640 |   |
| Average price                   |       | $                                          | 897        |                                        | $          | 840 |   | $ | 859 |   | $ | 856 |   |

 

**THREE MONTHS ENDED SEPTEMBER 30, 2004COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2003**

 

*Net Sales*

 

Net sales for the 2004 three-month period decreased $0.9 million or 0.8%to $117.4 million compared to $118.3 million for the same period in 2003.  Net sales in our packaging segment decreased$1.9 million, while total net sales in our paper segment increased by $1.0million.

 

Net sales for our packaging segment for the 2004 three-month perioddecreased $1.9 million or 2.6% to $70.6 million compared to $72.5 million forthe same period in 2003.  For the 2004three-month period, our packaging segment sold 61,963 tons of coated and convertedpaperboard products at an average price of $1,139 per ton, compared to 65,697tons sold for the same period in 2003 at an average price of $1,104 perton.  The decrease in packaging segmentsales is primarily attributable to decreased volume of non-converted coatedboard sales out of our Waynesville facility. The decrease in volume was primarily due to reduced availability ofrawstock brought about by flood-related downtime at our Canton, North Carolinamill.  Sales volumes from our cartonbusiness

 

14

----

 

increased modestly for the 2004 three-month period as compared to thesame period in 2003.  Sales volume out ofour DairyPak facilities was not impacted by the flood curtailment as theCompany had inventory levels sufficient to meet customer requirements.

 

Net sales for our paper segment for the 2004 three-month periodincreased $1.0 million or 2.2% to $46.8 million compared to $45.8 million inthe second quarter of 2003.  The increaseis attributable to an average revenue of $679 per ton for the 2004 three-monthperiod compared to $610 per ton for the three months ended September 30, 2003(the “2003 three-month period”).  Theincreased average revenue per ton reflects announced price increasesimplemented in the first, second and third quarters of 2004.  The latest increase took effect on September1, 2004, and we expect to realize additional improvement to our average paperrevenue in the fourth quarter as that increase is fully implemented.  An additional price increase on our highbrightness grades takes effect on October 1, 2004.  In the short term, we anticipate pricing inthe paper market to stabilize following this latest round of increases.  Net sales volume in our paper segmentdeclined 6,163 tons to 68,896 tons shipped in the 2004 three-month period ascompared to 75,059 tons shipped in the same period of 2003.  Operations at our Canton, North Carolinamanufacturing facility were interrupted from the floods, either in whole or inpart, for the last 23 days of the 2004 three-month period resulting in lostproduction and availability of product to ship.

 

*Operating Profit (Loss)*

 

Total segment operating profit declined $10.7 million to $4.0 millionin the 2004 three-month period compared to an operating profit of $14.7 millionfor the same period in 2003.  As statedabove, our Canton, North Carolina facility suffered flood-related downtime inthe 2004 three-month period due to Hurricanes Frances and Ivan.  This downtime resulted in curtailment to bothpaper and uncoated board production at the Canton facility and ultimately, to alesser extent, lost production of coated board at our Waynesville coatingfacility.  Inventories of board allowedus to maintain production at our DairyPak converting facilities through theperiod and our inventory of finished paper stock allowed us to service ourpaper segment customers at a reduced level. Production losses totaled over 17,000 tons of paper and 13,000 tons ofboard in September at the Canton facility. Despite this production setback, sales volume in the 2004 three-monthperiod declined only 6,163 tons in our paper segment and 3,734 tons in ourpackaging segment as compared to the 2003 three-month period.  Looking forward, we expect the volume ofsales in subsequent quarters to be reduced slightly as stocks are replenishedin our finished goods and in process inventories.

 

Other items contributing to the $10.7 million decline in total segmentoperating profit for the 2004 three-month period as compared to the 2003three-month period included: (i) gain on sale of assets for $3.7 million in the2003 three-month period primarily related to the disposition of our MorristownDairyPak facility; (ii) coal price increases of $1.2 million at our Canton,North Carolina facility; (iii) increases to outbound freight costs for ourproducts sold of approximately $1.3 million due to higher carrier fuel costs;(iv) increases to plastic/resin pricing, our primary raw material at ourWaynesville plant, of $0.7 million; and (v) an increase in routine maintenancespending of $1.6 million in the 2004 three-month period as compared to the sameperiod in 2003.  The decrease inoperating profit was partially offset by a $5.9 million improvement in ouraverage revenue per unit shipped in our paper and packaging segments as well as$0.9 million in sales of NOx emission credits in the 2004 three-month period ascompared to the same period in 2003. Business interruption losses associated with the two hurricanes areestimated to be approximately $4.8 million dollars at our Canton, NorthCarolina facility and approximately $1.5 million at our Waynesville, NorthCarolina coating facility.

 

Operating profit for ourpackaging segment decreased $6.9 million or 67.0% in the 2004 three-monthperiod to $3.4 million or 4.8% of packaging segment sales, compared to $10.3million or 14.2% of packaging segment sales for the 2003 three-monthperiod.  The decrease in operating profitfor our packaging segment was due primarily to: (i) flood-related business interruptionlosses of $1.5 million at our Waynesville facility in the 2004 three-month

 

15

----

 

period as described above;(ii) gain on disposition of assets of $3.7 million primarily related to thesale of our Morristown DairyPak facility in the 2003 three-month period; (iii)increased pricing for our key raw material, plastic/resin, at the Waynesvillefacility of $0.7 million; (iv) increased costs for outbound freight of $1.1million; and (v) reduced finishing efficiencies at our Waynesville plant of $0.7million in the 2004 three-month period as compared to the same period in2003.  The decrease in operating profitin the 2004 three-month period was partially offset by an increase in theaverage revenue per ton shipped in the amount of $1.1 million due to improvedpricing in our converted carton business.

 

Operating profit for our paper segment decreased $3.8 million or 86.4%in the 2004 three-month period to $0.6 million or 1.3% of paper segment sales,compared to $4.4 million or 9.6% of paper segment sales for the 2003three-month period.  The decrease inoperating profit for our paper segment was due primarily to: (i) flood-relatedlosses at our Canton mill in the 2004 three-month period consisting of anestimated $4.8 million in business interruption losses, $18.1 million inrecorded property damage, repairs and maintenance offset by $16.1 million ininsurance recoveries recorded; (ii) impact from new coal pricing used to fuelpower boilers at our Canton, North Carolina facility by $1.2 million; and (iii)increased repair material and services expenditures in the amount of $1.6million in the 2004 three-month period as compared to the same period in 2003due to the timing of routine maintenance activities.  The decrease in operating profit in the 2004three-month period was partially offset by: (i) a $4.8 million improvement inaverage revenue per ton shipped in the 2004 period as compared to the sameperiod in 2003; (ii) revenue received of $0.9 million from the sale of NOxemission credits for the 2004 three-month period with no corresponding similarsale in the 2003 three-month period; and (iii) various and miscellaneousfavorable variances netting $0.2 million.

 

*Selling, General and Administrative Expenses*

 

Total selling, general and administrative expenses increased $0.6million or 9.7% to $6.8 million in the 2004 three-month period compared to $6.2million for the same period in 2003.  Wemaintain our corporate headquarters in Canton, North Carolina, which also incurredflood damage during the same two hurricanes that affected the operations at theCanton, North Carolina mill.  As aresult, we incurred $0.7 million in flood-related property damage to buildings,furniture, fixtures and supplies to our headquarters office and medical clinicduring the 2004 three-month period.  Thisdamage is also covered for full replacement value with no additional deductibleon these losses.  An insurance receivablehas not been recorded for this loss since this portion of the claim has yet tobe fully reviewed by our insurance carrier; however, we do expect reimbursementfor these losses in future periods. Recovery on these losses are not restricted by the $20.0 million maximumbenefits applicable to our operating facilities nor will they affect recoveryon the losses associated with those operations.

 

*Interest and Amortization Expense.*

 

Interest and amortization expenses increased $0.4 million to $4.3million for the 2004 three-month period compared to $3.9 million for the sameperiod in 2003.  This is due to an increasein total debt and to the increased rates for the Notes compared to the old bankdebt rates.

 

**NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPAREDTO NINE MONTHS ENDED SEPTEMBER 30, 2003**

 

*Net Sales*

 

Net sales for the nine months ended September 30, 2004 (the “2004nine-month period”) increased to $359.9 million or 2.4*%*compared to**$351.6 million for the same period in 2003.  This increase in total revenue isattributable to an increase in total shipment volume to 418,898 tons, anincrease of 2.0%, compared to 410,638

 

16

----

 

tons reported for the same period in 2003, as well as an increase inthe weighted average revenue per ton shipped to $859 per ton in the 2004nine-month period from $856 per ton in the same period of 2003.  This increase in average revenue per ton soldresulted primarily from improved pricing in our converted carton businessreflecting contractual price increases for many of our carton customers.  The increase in average weighted revenue perunit sold resulted in an approximate $1.2 million increase in total revenue inthe 2004 nine-month period compared to the same period in 2003.  Pricing for our paper segment productscontinues to improve and the 2004 nine-month period average is reflective ofextremely depressed pricing in the first half of 2004 which has improvedsignificantly in the second half of 2004.

 

Net sales for our packaging segment for the 2004 nine-month periodincreased $3.5 million or 1.7% to $214.9 million compared to $211.4 million forthe same period in the prior year.  Theincrease in net sales is attributable to a 2.2% increase in carton volumeshipments in addition to an increase in average sales price for cartons.  Average net sales price per ton increased2.6% for cartons and declined 0.7% for coated paperboard in the 2004 nine-monthperiod compared to the same period in 2003. Volume of our non-converted coated paperboard shipments declined 5.8%due to the flood-related downtime at our Canton, North Carolina facility andthe downstream effect on our coated paperboard production.

 

Sales for our paper segment for the 2004 nine-month period haveincreased by $4.8 million or 3.4% to $145.0 million compared to $140.2 millionfor the same period in 2003.  Thisincrease was attributable to increased sales volume with total shipment volumesincreasing 11,063 tons or 5.1% to 230,104 tons in the 2004 nine-month periodcompared to 219,041 tons in the 2003 nine-month period.  Average net sales price per unit solddecreased by 1.6% due primarily to lower product pricing in the uncoatedfree-sheet markets during the first half of 2004.  This decline in weighted average net salesprice resulted in a loss of $2.2 million in the 2004 nine-month period comparedto the same period in 2003.  Our pricingfor our paper segment products has rebounded and is considerably higher at theend of  the 2004 nine-month period thanit was at the end of the nine months ended September 30, 2003 (the “2003nine-month period”).

 

*Operating Profit (Loss)*

 

Total segment operating profit decreased $18.5 million in the 2004nine-month period to $6.8 million compared to $25.3 million for the same periodin 2003.  Prior to the hurricanes andrelated flooding at the Canton, North Carolina facility, production and salesrates in the 2004 nine-month period exceeded rates in the 2003 nine-monthperiod and comparative periods in prior years in both the paper segment and thepackaging segment.  Flood-relateddowntime resulted in 23 days of reduced or eliminated production at our Canton,North Carolina facility as well as downstream production losses at ourWaynesville coating facility in the 2004 nine-month period.  This production downtime translates intoapproximately $6.3 million in lost opportunity/business interruption impactingthe 2004 nine-month period.

 

Other items contributing to the $18.5 million decline in total segmentoperating profit included: (i) flood-related property damage at our Canton,North Carolina mill of $2.0 million net of realized or accrued insurance recoveries;(ii) lower revenue per ton for our paper segment products of $1.8 million dueto depressed pricing in the first half of 2004; (iii) increased purchase costsfor some of our larger raw materials, such as wood chips, plastic/resin,purchased fiber and packing materials totaling approximately $6.2 million; (iv)$2.4 million in severance payments related to elimination of positions at ourCanton, North Carolina facility; (v) increased outbound freight costs ofapproximately $2.9 million arising from higher carrier fuel costs, increasedtrucking regulations and, to a lesser extent, increased distances to servecustomers from our remaining DairyPak converting locations; (vi) $1.5 millionincrease in medical benefit costs at our operating locations; (vii) increasedpricing for coal utilized at our Canton facility of $1.4 million; and (viii)gain on sale of assets in the 2003 nine-month period exceeded the 2004nine-month period amount by $3.5 million primarily due to the sale of ourMorristown plant in the nine-month period of

 

17

----

 

2003.  With respect to item (iv),we also incurred severance related expenses in the 2003 nine-month periodrelated to the Morristown facility closure of approximately $2.2 million andseverance related expenses in the 2004 nine-month period applicable to theclosure of our Fort Worth facility of $1.9 million.  We do not expect any additional significantseverance costs in the future from this capacity consolidation.  With respect to item (vi), our healthcarebenefit costs have increased substantially in 2004, due primarily to anincrease in catastrophic health claims (those in excess of $75,000 each).

 

The decrease in operating profit in the 2004 nine-month period waspartially offset by: (i) increases in our average net sales prices forconverted carton products resulting in an approximate $4.9 million increase inrevenues; (ii) sale of excess NOx emission credits at our Canton, NorthCarolina facility of $1.1 million in the 2004 nine-month period with no similarcorresponding sales in the 2003 nine-month period; and (iii) impact of theplanned cold mill maintenance outage of $3.2 million during the 2003 nine-monthperiod.  With respect to item (iii), itis necessary to complete certain maintenance activity approximately every fiveyears that requires the complete shutdown of the Canton mill for approximatelyfive days.  That process was complete in2003 and was not repeated in the 2004 nine-month period.

 

Looking forward to the fourth quarter of 2004, we anticipate slightlyreduced operating rates in our packaging and paper segments due to additionalflood-related downtime at our Canton mill, as well as some additional losses atour Waynesville facility.  Intermittentelectrical and mechanical issues at the Canton facility are anticipated poststartup.  However, we anticipate that ouroperating locations will return to the pre-flood production levels that were inexcess of 2003 performance levels prior to the downtime.  Markets for our products remain firm in boththe paper and the packaging segments.  Wehave substantially concluded the closure of our Fort Worth, Texas convertingfacility and the headcount reductions. On November 1, 2004, the Company entered into a Purchase and Sale Agreementto sell the Fort Worth, Texas converting facility.  The agreement includes a closing date on orbefore December 22, 2004.

 

Operating profit for our packaging segment inthe 2004 nine-month period declined $8.8 million to $9.2 million compared to$18.0 million for the same period in 2003. The decrease was primarily due to: (i) flood-related businessinterruption costs of approximately $1.5 million incurred as the supply ofboard available for coating at the Waynesville facility was exhausted followingextended downtime at the Canton, North Carolina production facility; (ii)increased pricing for key raw materials, plastic/resin and packing materials,at the Waynesville facility of $3.2 million; (iii) increased costs for outboundfreight of $2.4 million; (iv) increased medical benefit costs of $0.7 millionfor the packaging segment employees; (v) gain on sale of assets reduced $3.7million due to the realization of gain related to the sale of the Morristownfacility in the 2003 nine-month period; and (vi) a $1.9 million increase incosts of internally produced board received from the Canton mill and passed onto the packaging division through interdivisional transfer pricing.

 

The decrease in operating profit was partially offset by increases tothe average net selling prices for coated paperboard and carton products of0.7% and 2.6%, respectively, compared to the same period in 2003.  This increase in average selling price added$4.9 million to revenues and operating profit for the 2004 nine-month period ascompared to the same period in 2003. Going forward, we expect to realize slightly lower sales volume as wework to rebuild inventories depleted as a result of the flood-related downtimeat the Canton mill.

 

Operating profit for our paper segmentdecreased $9.7 million in the 2004 nine-month period to an operating loss of$2.4 million as compared to an operating profit of $7.3 million for the sameperiod in 2003.  The decline in operatingprofit was primarily attributable to: (i) business interruption losses of $4.8million and property damage costs of $18.1 million attributable to flood damageresulting from Hurricanes Frances and Ivan which were partially offset by $16.1million in insurance recoveries recorded; (ii) lower pricing for our papergrades, resulting in a 1.6% decrease from the same period in the prior year;(iii) increased wood chip and purchased supplemental

 

18

----

 

fiber costs, resulting in a loss of $2.9million; (iv) severance costs of $2.4 million for hourly and salary positioneliminations; (v) increases of $0.8 million in medical benefit costs for papersegment employees; (vi) increased outbound freight costs of approximately $0.5million.

 

The decrease in operating profit waspartially offset by the five-year cold mill outage executed in the 2003nine-month period reflecting a reduction in expense of $3.2 million, and thesale of excess NOx emission credits totaling $1.1 million during the 2004nine-month period with no corresponding similar sales in the 2003 nine-monthperiod.

 

*Selling, General and Administrative Expenses*

 

Total selling, general and administrative expenses increased 8.1% to$20.0 million in the 2004 nine-month period compared to $18.5 million for thesame period in 2003.  The increase isprimarily attributable to approximately $0.7 million in repair costs and bookvalue losses to our headquarters building, furniture, fixtures and supplies dueto flood damage that affected our Canton mill; $0.8 million increased audit andattorney’s fees relating to Securities and Exchange Commission reportingrequirements, as well as approximately $0.3 million in startup costs for thenew medical clinic/pharmacy in Canton, North Carolina.

 

*Interest and Amortization Expenses.*

 

Interest and amortization expenses increased $1.5 million to $12.8million for the 2004 nine-month period compared to $11.3 million for the sameperiod in 2003.  This is due to totaldebt (including capital leases) increasing from $157.7 million at September 30,2003 to $184.9 million at September 30, 2004 and a change in interest rates forthe Notes compared to the old bank debt rates.

 

#### **LIQUIDITYAND CAPITAL RESOURCES**

 

We entered into a new $45.0 million revolving credit facility inDecember, 2003.  On September 15, 2004, thecredit agreement was amended to increase the facility from $45.0 million to$50.0 million on a permanent basis.  Themaximum borrowing availability at December 31, 2003 and September 30, 2004 was$31.6 million and $24.7 million, respectively. The new revolving credit facility contains covenant restrictions whichrequire covenant availability to exceed $15.0 million.  On September 15, 2004, the Credit Agreementwas amended to reduce the $15.0 million minimum availability to $10.0 million(as thereafter further reduced as described below) during the period beginningSeptember 15, 2004 and ending January 15, 2005, at which time the minimumreverts back to $15.0 million.  Ifcovenant availability does not meet the required minimum, a fixed chargecoverage ratio covenant is triggered.  AtSeptember 30, 2004, we had covenant availability of $24.7 million, which is$14.7 million in excess of the required minimum.  On October 8, 2004, the credit agreement wasfurther amended to reduce the minimum covenant availability from $10.0 millionto $5.0 million during the period beginning October 8, 2004 and ending January15, 2005, after which time the  minimumcovenant availability reverts back to $15.0 million.  We do not believe that we will be subject tothe fixed charge coverage ratio for the remainder of 2004 based on: (i)improved market conditions; (ii) improvements to our cost structure; (iii) $10million of flood insurance proceeds received as of October 7, 2004; (iv)relaxation of minimum excess availability covenants in our revolving creditfacility; and (v) reductions to working capital.

 

19

----

 

Summary of Cash Flow ($ in millions):

 
| ** **                                           | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                           | ** ** | **2004**                            | ** ** | **2003** | ** ** |
| ** **                                           | ** ** | ** **                          | ** ** | ** ** | ** ** |
| Cash, beginning period                               |       | $                                   | 2.1        |   | $ | 0.3 |   |
|                                                 |       |                                |       |   |   |
| Net cash provided by operating activities            |       | 10.1                                |       | 7.9 |   |
|                                                 |       |                                |       |   |   |
| Net cash used in investing activities                |       | (9.8                                | )          | (2.5 | ) |
|                                                 |       |                                |       |   |   |
| Net cash provided by (used in) financing  activities |       | 6.4                                 |       | (4.1 | ) |
|                                                 |       |                                |       |   |   |
| Cash, ending period                                  |       | $                                   | 8.8        |   | $ | 1.6 |   |

 

Net cash provided by operations was $10.1 million for the 2004nine-month period compared to net cash provided by operations of $7.9 millionduring the same period in 2003.  Theincrease in cash provided by operations was primarily attributable to decreasesin working capital partially offset by increased net losses in 2004.  Both the changes in working capital andincreased net losses were primarily driven by the impact from HurricanesFrances and Ivan.  The change in workingcapital was the result of: (i) reduction in paper and packaging inventories dueto our ability to ship product during the time the machines were being repairedfrom flood damage; and (ii) increases in accounts payable and accruedliabilities due to flood-related expenses. The increase in net losses was primarily due to flood-related propertydamage and business interruption, increases to certain raw material pricing,severance expenses, freight increases and increases to employee healthcarecosts as discussed above.

 

Net cash used in investing activities was $9.8 million and $2.5 millionfor the 2004 and 2003 nine-month periods, respectively.  Capital spending for the 2004 nine-monthperiod totaled $9.9 million, which included expenditures for environmentalprojects of approximately $4.8 million. Major environmental projects included: (i) $2.1 million to comply withnitrous oxide (NOx) gas emission regulations; (ii) a recovery boilerprecipitator rebuild totaling approximately $0.8 million; and (iii) $1.6million to comply with Maximum Achievable Control Technology I and II Federalstandards (MACT I and II).  We currentlyestimate that our capital spending will be approximately $13.3 million forfiscal year 2004.  In the 2003 nine-monthperiod net cash used in investing activities included proceeds of $5.8 millionprimarily due to the sale of the Morristown, New Jersey DairyPak facility andcapital spending of $8.3 million.

 

Net cash provided by financing activities was $6.4 million for the 2004nine-month period compared to net cash used in financing activities of $4.1million for the same period in 2003.  Thenet change in net cash provided by financing activities in the 2004 nine-monthperiod was primarily due to a $9.6 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 of $5.9 million.

 

#### **ITEM3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

We are exposed to certain market risks, including interest raterisk.  Risk exposure relating to thismarket risk is summarized below.  Thisinformation should be read in connection with the condensed consolidatedfinancial statements and the related notes thereto included elsewhere in thisQuarterly Report on Form 10-Q.

 

20

----

 

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

 

We manage interest cost using a combination of fixed and variable ratedebt.  As of September 30, 2004, we have$125.0 million of Notes at 9.5% and a $50.0 million working capital creditfacility at variable rates of interest. As of September 30, 2004, approximately $18.7 million was outstandingunder our working capital credit facility consisting of short-term interestrates of 1.25% over Applicable Revolver Index Margin and 3.0% over ApplicableRevolver Libor Margin.  Our workingcapital 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 revolveravailability.  During the first ninemonths of the agreement, we used the highest percent in each option.  In addition, as of September 30, 2004, wehave a $0.8 million mortgage note with a maximum interest rate of 5.5% and aremaining duration of six years.

 

#### **ITEM 4. CONTROLS ANDPROCEDURES**

 

(A) Evaluation of Disclosure Controls and Procedures

 

Our Chief Executive Officer and ChiefFinancial Officer have evaluated the effectiveness of our disclosure controlsand procedures (as defined in Rule 13a-15(e) and 15d-15(e)) under theSecurities Exchange Act of 1934.  Basedon their evaluation, our Chief Executive Officer and Chief Financial Officerhave concluded that, as of September 30, 2004, our disclosure controls andprocedures were effective in ensuring that material information was properlydisclosed in its filings with the Securities and Exchange Commission.

 

(B) Changes in Internal Controls OverFinancial Reporting

 

There have been no significant changes in ourinternal controls over financial reporting during the three months endedSeptember 30, 2004 that have materially affected or are reasonably likely tomaterially affect our internal control over financial reporting.

 

## **PART II.  OTHER INFORMATION**

## ** **

#### **ITEM 6. EXHIBITS**

 

(a) Exhibits required by Item 601 of Regulation S-K

31.1 Certification of CEO pursuant to Section 302 of Sarbanes-Oxley Actof 2002

31.2 Certification of CFO pursuant to Section 302 of Sarbanes-Oxley Actof 2002

32.1 Certification of CEO and CFO pursuant to Section 906 ofSarbanes-Oxley Act of 2002

 

21

----

 

## **SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 

**BLUE RIDGE PAPER PRODUCTS INC.**

 
| Date: November 15, 2004 |                                |
|-------------------------|-------------------------------------|
|                    |                                |
|                    |                                |
|                    | /S/ JOHN B. WADSWORTH               |   |
|                    | John B. Wadsworth                   |
|                    | Chief Financial Officer             |
|                    |                                |
|                    | (On behalf of the Registrant and as |
|                    | Principal Financial Officer)        |

 

22

----

 

EXHIBIT INDEX

TO

FORM 10-Q

OF

BLUE RIDGE PAPER PRODUCTS INC.

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 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 this report:

 

31.1                           Certificationof CEO pursuant 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

 

23

----