**FORM 10-Q**

** **

**SECURITIESAND EXCHANGE COMMISSION**

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

###  

**(Mark One)**

 

**ý****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHESECURITIES EXCHANGE ACT OF 1934**

 

### **For the quarterly period ended June 30,2005**

###  

**OR**

 

**o****TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHESECURITIES EXCHANGE ACT OF 1934**

 

### **For thetransition period from                        to                       **

 

**RegistrationNumber:  333-114032**

 

**BLUE RIDGEPAPER PRODUCTS INC.**

(Exact name of registrant asspecified in charter)

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

 

## **41 MAIN STREET**

**CANTON,NORTH CAROLINA  28716**

(Address of principal executiveoffice)

 

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

 

# Indicate by check mark whether the registrant(1) has filed all reports required to be filed by section 13 or 15(d) ofthe Securities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such report), and (2) hasbeen subject to such filing requirements 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 sharesoutstanding at June 30, 2005 was 1,000.

 

 

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**BLUERIDGE PAPER PRODUCTS INC.**

 

**ANDSUBSIDIARIES**

 

INDEX

 
| **PART 1.** |    | FINANCIAL INFORMATION                                                                                                                                                   |   |
|------------------|---------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|             |    |                                                                                                                                                                    |   |
|             | Item 1. | Condensed Consolidated Balance Sheets, June 30, 2005 (unaudited)  and December 31, 2004 (derived from audited financial statements)                           |   |
|             |    |                                                                                                                                                                    |   |
|             |    | Condensed Consolidated Statements of Operations, Three Months Ended June 30,  2005 and 2004 (unaudited), Six Months Ended June 30, 2005 and 2004  (unaudited) |   |
|             |    |                                                                                                                                                                    |   |
|             |    | Condensed Consolidated Statements of Cash Flows, Six Months Ended June 30,  2005 and 2004 (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                                                                                                                                                                |   |
|                  |         |                                                                                                                                                                         |        |  |

 

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| ** **  | ** **               | **PART 1. FINANCIAL INFORMATION** | ** ** |
|-------------|--------------------------|----------------------------------------|------------|
|        |                     |                                   |       |
| **ITEM 1.** | **FINANCIAL STATEMENTS** | ** **                             |

 

**BLUE RIDGEPAPER PRODUCTS INC.**

 

**Condensed Consolidated Balance SheetsJune 30, 2005 and December 31, 2004(Dollars in thousands)(unaudited)**

 
| ** **                                                                                                                      | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| **Assets**                                                                                                                      |       |                    |       |                        |       |
| Current  assets:                                                                                                                |       |                    |       |                        |       |
| Cash                                                                                                                            |       | $                       | 2,531      |                        | $          | 2,466 |   |
| Accounts  receivable, net of allowance for doubtful accounts and discounts of $1,129  and $1,820 in 2005 and 2004, respectively |       | 53,245                  |       | 45,814                      |       |
| Inventories                                                                                                                     |       | 49,120                  |       | 47,006                      |       |
| Prepaid  expenses                                                                                                               |       | 796                     |       | 1,715                       |       |
| Insurance  proceeds receivable                                                                                                  |       | 6,000                   |       | 10,539                      |       |
| Income tax  receivable                                                                                                          |       | 55                      |       | 76                          |       |
| Deferred tax  asset                                                                                                             |       | 3,860                   |       | 4,256                       |       |
| Total  current assets                                                                                                           |       | 115,607                 |       | 111,872                     |       |
| Property,  plant, and equipment, net of accumulated depreciation of $97,114 and $88,517  in 2005 and 2004, respectively         |       | 183,345                 |       | 187,336                     |       |
| Deferred  financing costs, net                                                                                                  |       | 5,819                   |       | 6,491                       |       |
| Other assets                                                                                                                    |       | 171                     |       | 55                          |       |
| Total assets                                                                                                                    |       | $                       | 304,942    |                        | $          | 305,754 |   |
|                                                                                                                            |       |                    |       |                        |       |
| **Liabilities  and Stockholder’s Equity (Deficit)**                                                                        |       |                    |       |                        |       |
|                                                                                                                            |       |                    |       |                        |       |
| Current  liabilities:                                                                                                           |       |                    |       |                        |       |
| Current  portion of senior debt                                                                                                 |       | $                       | 40         |                        | $          | 39 |   |
| Current  portion of capital lease obligation                                                                                    |       | 626                     |       | 603                         |       |
| Accounts  payable                                                                                                               |       | 35,202                  |       | 44,521                      |       |
| Accrued  expenses and other current liabilities                                                                                 |       | 30,049                  |       | 33,742                      |       |
| Interest  payable                                                                                                               |       | 1,667                   |       | 1,655                       |       |
| Total  current liabilities                                                                                                      |       | 67,584                  |       | 80,560                      |       |
| Senior debt,  net of current portion                                                                                            |       | 155,440                 |       | 144,075                     |       |
| Parent  Pay-In-Kind (PIK) Senior Subordinated Note                                                                              |       | 42,512                  |       | 40,681                      |       |
| Capital  lease obligations                                                                                                      |       | 1,169                   |       | 1,484                       |       |
| Pension and  postretirement benefits                                                                                            |       | 21,683                  |       | 21,211                      |       |
| Deferred tax  liability                                                                                                         |       | 3,860                   |       | 4,256                       |       |
| Other  liabilities                                                                                                              |       | 763                     |       | 1,271                       |       |
| Total  liabilities                                                                                                              |       | 293,011                 |       | 293,538                     |       |
| Obligation  to redeem ESOP shares                                                                                               |       | 38,516                  |       | 35,257                      |       |
| Obligation  to redeem restricted stock units of Parent                                                                          |       | 2,267                   |       | 2,119                       |       |
| Commitments  and contingencies (See notes)                                                                                      |       |                    |       |                        |       |
| Stockholder’s  equity (deficit):                                                                                           |       |                    |       |                        |       |
| Common stock  (par value $0.01, 1000 shares authorized and outstanding in 2005 and 2004,  respectively)                         |       | —                  |       | —                      |       |
| Additional  paid-in capital                                                                                                     |       | 51,588                  |       | 51,400                      |       |
| Accumulated  deficit                                                                                                            |       | (69,066                 | )          | (65,374                     | )          |
| Unearned  compensation                                                                                                          |       | (185                    | )          | —                      |       |
| Accumulated  other comprehensive loss                                                                                           |       | (4,524                  | )          | (4,524                      | )          |
|                                                                                                                            |       | (22,187                 | )          | (18,498                     | )          |
| Receivable  from Parent                                                                                                         |       | (6,665                  | )          | (6,662                      | )          |
| Total  stockholder’s equity (deficit)                                                                                      |       | (28,852                 | )          | (25,160                     | )          |
| Total  liabilities and stockholder’s equity (deficit)                                                                      |       | $                       | 304,942    |                        | $          | 305,754 |   |

 

See accompanying notes to condensedconsolidated financial statements.

 

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**BLUE RIDGEPAPER PRODUCTS INC.**

 

**Condensed Consolidated Statements of OperationsThree- and Six-Month Periods Ended June 30, 2005 and 2004(Dollars in thousands)(unaudited)**

 
| ** **                                                                                                               | ** ** | **Three-Month Period Ended  June 30** | ** ** | **Six-Month Period Ended  June 30** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                                                               | ** ** | **2005**                                   | ** ** | **2004**                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net sales                                                                                                                |       | $                                          | 125,206    |                                     | $          | 121,445 |   | $ | 253,753 |   | $ | 242,426 |   |
| Cost of  goods sold:                                                                                                     |       |                                       |       |                                     |       |   |   |   |   |
| Cost of  goods sold, excluding depreciation and amortization, flood-related losses and  repairs and insurance recoveries |       | 113,895                                    |       | 117,700                                  |       | 227,090 |   | 231,263 |   |
| Depreciation  and amortization                                                                                           |       | 3,833                                      |       | 4,062                                    |       | 7,737 |   | 8,324 |   |
| Flood-related  losses and repairs                                                                                        |       | 478                                        |       | —                                   |       | 1,326 |   | — |   |
| Insurance  recoveries                                                                                                    |       | —                                     |       | —                                   |       | (100 | ) | — |   |
| Gross profit  (loss)                                                                                                     |       | 7,000                                      |       | (317                                     | )          | 17,700 |   | 2,839 |   |
| Selling,  general and administrative expenses                                                                            |       | 5,042                                      |       | 6,545                                    |       | 10,189 |   | 13,124 |   |
| Depreciation  and amortization                                                                                           |       | 426                                        |       | 442                                      |       | 862 |   | 900 |   |
| Insurance  recoveries                                                                                                    |       | —                                     |       | —                                   |       | (23 | ) | — |   |
| ESOP expense                                                                                                             |       | 1,631                                      |       | 1,800                                    |       | 3,262 |   | 3,600 |   |
| Profit-sharing  expense                                                                                                  |       | —                                     |       | —                                   |       | 80 |   | — |   |
| Operating  profit (loss)                                                                                                 |       | (99                                        | )          | (9,104                                   | )          | 3,330 |   | (14,785 | ) |
| Other income  (expense):                                                                                                 |       |                                       |       |                                     |       |   |   |   |   |
| Interest  expense, excluding amortization of deferred financing costs                                                    |       | (4,397                                     | )          | (3,906                                   | )          | (8,655 | ) | (7,866 | ) |
| Amortization  of deferred financing costs                                                                                |       | (341                                       | )          | (298                                     | )          | (673 | ) | (587 | ) |
| Government  grant income                                                                                                 |       | 428                                        |       | —                                   |       | 2,306 |   | — |   |
|                                                                                                                     |       | (4,310                                     | )          | (4,204                                   | )          | (7,022 | ) | (8,453 | ) |
| Loss before  income taxes                                                                                                |       | (4,409                                     | )          | (13,308                                  | )          | (3,692 | ) | (23,238 | ) |
| Income tax                                                                                                               |       | —                                     |       | —                                   |       | — |   | — |   |
| Net loss                                                                                                                 |       | $                                          | (4,409     | )                                        | $          | (13,308 | ) | $ | (3,692 | ) | $ | (23,238 | ) |

 

See accompanying notes to condensedconsolidated financial statements.

 

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**BLUE RIDGEPAPER PRODUCTS INC.**

 

**Condensed Consolidated Statements of Cash FlowsSix months ended June 30, 2005 and 2004(Dollars in thousands)(unaudited)**

 
| ** **                                                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Cash flows  from operating activities:                                      |       |     |       |     |       |
| Net loss                                                                    |       | $        | (3,692     | )        | $          | (23,238 | ) |
| Adjustment  to reconcile net loss to net cash used in operating activities: |       |     |       |     |       |
| Depreciation  and amortization                                              |       | 8,599    |       | 9,224    |       |
| Compensation  expense for Parent restricted stock                           |       | 148      |       | 88       |       |
| Amortization  of deferred financing costs                                   |       | 673      |       | 587      |       |
| ESOP expense                                                                |       | 3,262    |       | 3,600    |       |
| Loss on sale  of assets                                                     |       | —   |       | 6        |       |
| Parent PIK  Senior Subordinated Note for interest                           |       | 1,872    |       | 1,711    |       |
| Changes in  operating assets and liabilities:                               |       |     |       |     |       |
| Accounts  receivable, net                                                   |       | (7,431   | )          | (11,392  | )          |
| Inventories                                                                 |       | (2,114   | )          | 8,224    |       |
| Prepaid  expenses                                                           |       | 919      |       | 311      |       |
| Insurance  proceeds receivable                                              |       | 4,539    |       | —   |       |
| Income tax  receivable                                                      |       | 21       |       | —   |       |
| Accounts  payable                                                           |       | (9,319   | )          | 5,888    |       |
| Accrued  expenses and other current liabilities                             |       | (3,693   | )          | 297      |       |
| Interest  payable                                                           |       | (29      | )          | 96       |       |
| Pension and  postretirement benefits                                        |       | 472      |       | 693      |       |
| Other assets  and liabilities                                               |       | (625     | )          | (848     | )          |
| Net cash  used in operating activities                                      |       | (6,398   | )          | (4,753   | )          |
| Cash flows  used in investing activities:                                   |       |     |       |     |       |
| Additions to  property, plant, and equipment                                |       | (4,608   | )          | (7,077   | )          |
| Proceeds  from sale of property, plant, and equipment                       |       | —   |       | 2        |       |
| Net cash  used in investing activities                                      |       | (4,608   | )          | (7,075   | )          |
| Cash flows  from financing activities:                                      |       |     |       |     |       |
| Repurchase  of Parent common and preferred stock                            |       | (3       | )          | (276     | )          |
| Payments on  separation notes payable                                       |       | —   |       | (1,615   | )          |
| Proceeds  from borrowings under line of credit                              |       | 84,090   |       | 69,225   |       |
| Repayment of  borrowings under line of credit                               |       | (72,705  | )          | (55,650  | )          |
| Cash paid  for refinancing credit facilities                                |       | —   |       | (151     | )          |
| Repayments  of long-term debt and capital lease obligations                 |       | (311     | )          | (253     | )          |
| Net cash  provided by financing activities                                  |       | 11,071   |       | 11,280   |       |
| Net increase  (decrease) in cash                                            |       | 65       |       | (548     | )          |
| Cash,  beginning of period                                                  |       | 2,466    |       | 2,123    |       |
| Cash, end of  period                                                        |       | $        | 2,531      |     | $          | 1,575 |   |
| Supplemental  disclosures of cash flow information:                         |       |     |       |     |       |   |   |
| Cash paid  for interest, including capitalized interest                     |       | $        | 6,839      |     | $          | 6,060 |   |
| Noncash  investing and financing activities:                                |       |     |       |     |       |
| Conversion  of accrued interest to note payable                             |       | 1,831    |       | 1,804    |       |
| Issuance of  restricted stock units                                         |       | 333      |       | —   |       |

 

See accompanying notes to condensedconsolidated financial statements.

 

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#### **NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Dollars in thousands)**

 

**(1)  Basis of Presentation**

 

The accompanying unaudited condensed consolidated interim financialstatements have been prepared in accordance with Regulation S-X related tointerim period financial statements and, in the opinion of management, includeall adjustments (consisting only of normal recurring accruals) that arenecessary for the fair presentation of results for the interim periods.  Results for the six months ended June 30,2005 may not necessarily be indicative of full-year results.  It is suggested that these condensedconsolidated interim financial statements be read in conjunction with theaudited consolidated financial statements of Blue Ridge PaperProducts Inc. (the “Company”) for the year ended December 31, 2004.

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make a number of estimates and assumptions relating to thereported amounts of assets and liabilities and disclosure of contingent assetsand liabilities at the date of the financial statements.  These estimates and assumptions also affectthe reported amounts of revenues and expenses during the reporting period.  Actual results could differ from thoseestimates.

 

**(2)  Liquidity**

 

TheCompany’s working capital needs are satisfied through its $50,000 revolvingcredit facility, which matures December 15, 2008.  The credit agreementrequires that the Company meet certain financial covenants, including a minimumborrowing availability threshold and a fixed charge coverage ratio.  At certain times during 2004, the creditagreement was amended to reduce the minimum borrowing availability thresholdfrom $15,000 to $5,000 for a specified period of time.  On December 21, 2004, the revolvingcredit agreement was amended to reduce the amount subject to borrowingavailability restrictions from $15,000 to $7,500 on a permanent basis.  On August 5, 2005, the credit agreementwas amended to include specified foreign account debtors as eligible accountsin determining borrowing base availability. This amendment was effective with the July borrowing base.  In addition, the Company must meet certainaffirmative and negative operating covenants. In the event of default or if the outstanding balance of the revolvingcredit facility is greater than $25,000, the borrowing availability falls below$7,500 and the fixed charge coverage ratio is less than 1.1 to 1.0, the creditagreement provides for activation of controlled bank accounts to apply dailycash collections toward the outstanding revolving loan balance.  Management believes the existing creditfacility is adequate for the Company’s cash flow needs through the next 12months.  Continued compliance with debtcovenants and sufficient liquidity is dependent upon business operationsconsistent with management’s plan for 2005. However, uncertainties exist within the Company’s markets that include,but are not limited to, availability and pricing of raw materials, unforeseendisruption in plant operations, labor disputes, significant competition,relationships with large customers, product demand, environmental compliance,litigation, loss of key managers and exposures to interest rate changes.

 

6

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The maximum and minimum borrowing availability at June 30, 2005and December 31, 2004 are as follows:

 
| ** **                    | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------|------------|-------------------------|------------|-----------------------------|------------|
|                          |       |                    |       |                        |       |
| Borrowing  base               |       | $                       | 47,517     |                        | $          | 41,763 |   |
| Revolver  balance             |       | 29,735                  |       | 18,350                      |       |
| Letters of  credit            |       | 5,800                   |       | 6,056                       |       |
| Maximum  availability         |       | 11,982                  |       | 17,357                      |       |
| Credit  agreement restriction |       | 7,500                   |       | 7,500                       |       |
| Minimum  availability         |       | $                       | 4,482      |                        | $          | 9,857 |   |

 

**(3)  Recent Developments**

 

*Flood losses related to Hurricanes Francesand Ivan*

 

On September 8, 2004, Western North Carolina experienced a floodfrom Hurricane Frances exceeding the Federal Emergency Management Association(FEMA) 100-year flood plain levels.  Thisforced the shutdown of the Canton pulp and paper mill.  The Company’s Corporate Headquarters buildingwas also flooded.  On September 17,2004, more serious flooding occurred from Hurricane Ivan.  The combined downtime of the Canton mill inwhole or in part from the two floods was 26 days.

 

Property damage losses and related repairs and maintenance from thesetwo floods through December 31, 2004 were $22,649.  Additional expenses were recorded of $478 and$1,326 during the three-month period and six-month period ended June 30,2005, respectively.  The Companyestimates its total losses from these floods (excluding business interruption)to range from $24,000 to $25,000, of which approximately $22,000 is recoverablethrough insurance proceeds and government grants.  For the year ended December 31, 2004,the Company had recorded insurance recoveries of $20,539.  For the six-month period ended June 30,2005, the Company had recorded an additional $123 for insurancerecoveries.  An insurance proceedsreceivable of $6,000 was recorded at June 30, 2005, which reflects totalinsurance recoveries collected of $14,662.

 

In the wake of these events, the Company has been awarded two grantsfor repairs and maintenance of the wastewater treatment facility located withinthe Canton mill that is also used by the Town of Canton.  The first grant was awarded by FEMA forrepairs incurred from the two floods. This grant was in the amount of $1,479, all of which was received by June 30,2005.  The second grant was awarded bythe State of North Carolina in the amount of $4,500 to be paid on areimbursement basis.  This grant providesfor flood control repairs and improvements to the wastewater treatmentfacilities.  The Company has recognizedthese grants to the extent they have incurred costs from repairs andimprovements resulting in the recognition of government grant income of $428 inthe three-month period ended June 30, 2005 and $2,306 in the six-monthperiod ended June 30, 2005.  Theremaining $3,673 is expected to be recognized as income over the next nine to15 months as costs are incurred.

 

*Parmalat Bankruptcy*

 

On February 24, 2004, Parmalat, USA (“Parmalat”), a significantcustomer, filed for Chapter 11 bankruptcy protection.  At that time, the Company had outstandingaccounts receivable of $1,158.  Inaddition, the Company had received cash payments of $2,984 related to accountsreceivable that were potentially subject to “preferential payment” treatment asdefined in Chapter 11 bankruptcy laws and regulations.  As of December 31, 2004, the

 

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Company assessed the potential of collecting the outstandingreceivables and the likelihood that cash payments deemed as preferential wouldbe unsuccessfully defended and recorded a valuation allowance of $1,158 relatedto this customer.

 

On February 18, 2005, the unsecured creditors committee ratified aplan of reorganization (the “Plan”) for Parmalat.  The U.S. Bankruptcy Court in the SouthernDistrict of New York confirmed the Plan on March 10, 2005.  The effective date of the Plan was April 13,2005.  The Plan provided that allpreference claims against trade vendors be waived.  The Plan also provided for the reimbursementof unsecured creditors’ claims in cash payments.  At June 30, 2005, the Company hadrecorded a receivable of $754 related to the Plan with a valuation allowance of$278.  The Plan calls for periodicpayments from the bankruptcy trust over approximately the next year.  On July 6, 2005, the first payment wasreceived in the amount of $53.

 

*Restricted Stock*

 

On January 1, 2005, BlueRidge Holding Corp., the Company’s parent (the “Parent”), entered intoagreements with certain of the Company’s management employees entitling thoseemployees to receive an aggregate of 37,338 restricted common stock units thatvest over 18 months.  During thethree-month period ended June 30, 2005, 600 units were cancelled.  The value of the remaining awards at theCompany’s current stock value of $9.06 per share is $333.  The vested portion of $148 was recorded ascompensation expense and is reflected in the obligation to redeem restrictedstock units of the Parent and the unvested portion of $185 is reflected asunearned compensation and additional paid in capital at June 30, 2005 onthe accompanying condensed consolidated balance sheet.

 

*Management Fees*

 

The Company accrued managementfees to the Parent’s majority stockholder based upon a commitment made in 1999equal to 0.5% of consolidated gross revenues. Due to restrictions within debt covenants, no management fees were paidsince September 2001, although such fees continued to be accrued.  On October 1, 2003, the management feeagreement with the Parent’s majority stockholder was amended to assignobligations related to the management fee to the Parent and to amend thetermination date to October 1, 2013. On January 28, 2005, the management fee agreement was amended againto terminate the future obligations related to the management fee effective January 1,2005.  As of June 30, 2005 and December 31,2004, the Company has recorded a liability of $6,736 for unpaid fees accruedunder the agreement in other accrued expenses on the condensed consolidatedbalance sheets.  The Company isrestricted from paying these accrued fees under the terms of its indenturegoverning the 9.5% notes issued by the Company in December 2003 (the “Notes”)and its working capital facility.

 

**(4)  Recent Accounting Developments**

 

In December 2004, the FASB issued Statement of Financial AccountingStandards (“SFAS”) No. 123R, “Share-Based Payment,” which requiresthe measurement of all share-based payments to employees, including grants ofemployee stock options, using a fair-value-based method and the recording ofsuch expense in the Company’s consolidated statements of income.  As amended by the SEC in April 2005, theaccounting provisions of SFAS No. 123R for a calendar year registrantare effective for reporting periods beginning after January 1, 2006.  The Company is required to adopt SFAS 123Rin the first quarter of 2006 and is currently evaluating the effect that theadoption of FASB 123R will have on its financial position and results ofoperation.

 

In December 2003, the FASB issued FASB Interpretation No. 46(revised December 2003), *Consolidationof Variable Interest Entities* (FIN 46R), which addresses how abusiness enterprise should evaluate whether it has a

 

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controlling financial interest in an entity through means other thanvoting rights and accordingly should consolidate the entity.  FIN 46R replaces FASB Interpretation No. 46,*Consolidation of Variable Interest Entities,*which was issued in January 2003. The Company will be required to apply FIN 46R to variable interestsin Variable Interest Entities (“VIEs”) created after December 31,2003.  For variable interests in VIEscreated before January 1, 2004, the interpretation will be appliedbeginning on January 1, 2005.  Forany VIEs that must be consolidated under FIN 46R that were created before January 1,2004, the assets, liabilities and non-controlling interests of the VIEinitially would be measured at their carrying amounts with any differencesbetween the net amount added to the balance sheet and any previously recognizedinterest being recognized as the cumulative effect of an accountingchange.  If determining the carryingamounts is not practicable, fair value at the date FIN 46R first appliesmay be used to measure the assets, liabilities and non-controlling interest ofthe VIE.  The adoption of FIN 46Rdid not have a material effect on the Company’s consolidated financialstatements.

 

**(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 $745 at June 30,2005.

 

On December 17, 2003, the Company sold $125,000 of the Notesthrough a private placement offering under Rule 144A.  The Notes have a term of five years, are dueon December 15, 2008 and bear interest at a stated rate of 9.5%, which ispayable semiannually in arrears on June 15 and December 15.  The Notes are collateralized by a seniorsecured interest in substantially all of the Company’s tangible and intangibleassets and have a subordinated secured interest in the outstanding tradeaccounts receivable and inventories.  TheCompany has the right to redeem the Notes at 104.75% and 100.00%, plus accruedinterest on or after December 15, 2006 and December 15, 2007,respectively.  Terms of the indentureunder which the Notes have been issued contain certain covenants, includinglimitations on certain restricted payments and the incurrence of additionalindebtedness.

 

On December 17, 2003, the Company entered into a revolving creditfacility with a financial institution, which provided for maximum borrowings of$45,000, subject to a borrowing base calculated using eligible accountsreceivable and inventories.  On September 15,2004, the credit agreement was amended to increase the maximum borrowings to$50,000 on a permanent basis.  Therevolving credit facility is collateralized by a senior secured interest in theCompany’s outstanding trade accounts receivable and inventories and by asubordinated secured interest in substantially all of the Company’s tangibleand intangible assets.  The revolvingcredit facility matures on December 15, 2008, and requires the Company topay an annual fee of 0.375% on the unused facility amount.  The Company had an outstanding balance of$29,735 and $18,350 at June 30, 2005 and December 31, 2004,respectively, and letters of credit outstanding as of June 30, 2005 and December 31,2004 were $5,800 and $6,056, respectively. The maximum borrowing availability at June 30, 2005 was $11,982,subject to the availability restriction described in Note 2.

 

**(6)  Commitments and Contingencies**

 

(a) *Purchase Commitments*

 

The Company has an agreement with International Paper for supply ofwood chips.  The agreement’s firstfive-year term expired in May 2004. The Company has exercised its first renewal option for an additionalfive-year period through May 2009 and has a second five-year option at itsdiscretion.  The agreement requiresminimum volume purchases and deliveries of 815,000 tons of wood chips duringeach contract year.  These chips aresupplied by two

 

9

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International Paper facilities in South Carolina and Tennessee and accountfor approximately 41% of the total mill requirements.  As of June 30, 2005, the Company hascommitments to purchase wood chips of approximately $115,230 over the remainingcurrent term of the agreements.

 

(b) *Labor Agreements*

 

The Company has entered intocollective bargaining labor agreements with the United Steel, Paper andForestry, Rubber, Manufacturing, Energy, Allied Industrial and ServiceWorkers,International Union (“USW”), formerly the Paper, Allied-Industrial, Chemicaland Energy Workers International Union, and the Bellwood Printing Pressmen,Assistants and Specialty Workers Union. The USW union contract is due for renewal in May 2006.  The Company has exercised its right under thelabor contract to notify USW that it desires to negotiate certain provisions ofthe labor contract before renewal.  If nonew agreement is reached between the parties, the existing contract remains inplace until May 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 a defendant.  The lawsuit isbeing brought on behalf of approximately 300 residents owning propertyadjoining the Pigeon River upon which the Canton mill is located, and intowhich the Company has a permit to discharge. The plaintiffs are seeking damages for private nuisance in the periodcommencing June 1, 1999, and thereafter until present.  The plaintiffs in this action allege 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 June 30, 2005.

 

The Company is subject tolitigation that may arise in the normal course of business.  In the opinion of management, the Company’sliability, if any, under any pending litigation will not materially impact itsfinancial 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 $763 for closure of landfills as ofJune 30, 2005.  In addition, priorto June 30, 2005, the Company had carried an estimated liability of $500for environmental remediation that existed prior to the Company’sformation.  During the three-month periodended June 30, 2005, management performed a detailed analysis of projectsidentified and released the $500 reserve.

 

**(7)  Segment Information**

 

The Company’s management makes financial decisions and allocatesresources based on sales and operating income of the paper and packagingsegments.  Although raw materials, theproduction processes, distribution methods and the regulatory environment aresimilar, management believes it is appropriate to separately disclose thesesegments.  The Company does not allocateselling, research and administration expenses to each segment, but managementuses operating income to measure the performance of the segments.  The financial information attributed to thesesegments is included in the following tables:

 

10

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**Blue RidgePaper Products Inc.**

**Three Months Ended June 30,2005 and 2004**

**(Dollars inThousands)**

 
| ** **                     | ** ** | ** ** | ** ** | **Paper** | ** ** | **Packaging** | ** ** | **Corporate** | ** ** | **Total** | ** ** |
|--------------------------------|------------|------------|------------|-----------|------------|---------------|------------|---------------|------------|-----------|------------|
|                           |       |       |       |      |       |          |       |          |       |      |       |
| Net sales                      |       | 2005       |       | $         | 49,878     |          | $          | 75,328        |       | —    |       | $ | 125,206 |   |
|                           |       | 2004       |       | 50,182    |       | 71,26         |       | —        |       | 121,445   |       |
| Operating  income (loss)       |       | 2005       |       | 2,895     |       | 4,105         |       | (7,099        | )          | (99       | )          |
|                           |       | 2004       |       | (1,483    | )          | 1,166         |       | (8,787        | )          | (9,104    | )          |
| Depreciation  and amortization |       | 2005       |       | 3,006     |       | 827           |       | 426           |       | 4,259     |       |
|                           |       | 2004       |       | 3,172     |       | 890           |       | 442           |       | 4,504     |       |
| Total assets                   |       | 2005       |       | 199,181   |       | 90,459        |       | 15,302        |       | 304,942   |       |
|                           |       | 2004       |       | 201,800   |       | 91,054        |       | 12,019        |       | 304,873   |       |
| Capital  expenditures          |       | 2005       |       | 1,696     |       | 892           |       | —        |       | 2,588     |       |
|                           |       | 2004       |       | 4,018     |       | 531           |       | 363           |       | 4,912     |       |
|                                |            |            |            |           |            |               |            |               |            |           |            |  |  |  |

 

**Blue RidgePaper Products Inc.**

**Six MonthsEnded June 30, 2005 and 2004**

**(Dollars inThousands)**

 
| ** **                     | ** ** | ** ** | ** ** | **Paper** | ** ** | **Packaging** | ** ** | **Corporate** | ** ** | **Total** | ** ** |
|--------------------------------|------------|------------|------------|-----------|------------|---------------|------------|---------------|------------|-----------|------------|
|                           |       |       |       |      |       |          |       |          |       |      |       |
| Net sales                      |       | 2005       |       | $         | 103,792    |          | $          | 149,961       |       | —    |       | $ | 253,753 |   |
|                           |       | 2004       |       | 98,211    |       | 144,215       |       | —        |       | 242,426   |       |
| Operating  income (loss)       |       | 2005       |       | 9,446     |       | 8,254         |       | (14,370       | )          | 3,330     |       |
|                           |       | 2004       |       | (3,020    | )          | 5,859         |       | (17,624       | )          | (14,785   | )          |
| Depreciation  and amortization |       | 2005       |       | 6,091     |       | 1,646         |       | 862           |       | 8,599     |       |
|                           |       | 2004       |       | 6,343     |       | 1,981         |       | 900           |       | 9,224     |       |
| Total assets                   |       | 2005       |       | 199,181   |       | 90,459        |       | 15,302        |       | 304,942   |       |
|                           |       | 2004       |       | 201,800   |       | 91,054        |       | 12,019        |       | 304,873   |       |
| Capital  expenditures          |       | 2005       |       | 3,283     |       | 1,325         |       | —        |       | 4,608     |       |
|                           |       | 2004       |       | 6,046     |       | 668           |       | 363           |       | 7,077     |       |
|                                |            |            |            |           |            |               |            |               |            |           |            |  |  |  |

 

**(8)  Inventories**

 

Components of inventory at June 30, 2005 and December 31,2004 are as follows:

 

| ** **        | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------|------------|-------------------------|------------|-----------------------------|------------|
|              |       |                    |       |                        |       |
| Raw  materials    |       | $                       | 15,194     |                        | $          | 15,206 |   |
| Work in  progress |       | 18,382                  |       | 15,936                      |       |
| Finished  goods   |       | 15,544                  |       | 15,864                      |       |
| Total             |       | $                       | 49,120     |                        | $          | 47,006 |   |

 

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

 

#### **FORWARD-LOOKINGSTATEMENTS**

 

This filing includes “forward-lookingstatements” within the meaning of the Private Securities Litigation Reform Actof 1995.  Forward-looking statements arethose that do not relate solely to historical fact.  They include, but are not limited to, anystatement that may predict, forecast, indicate or imply future results,performance, achievements or events. They may contain words such as “believe,” “anticipate,” “expect,” “estimate,”“intend,” “project,” “plan,” “will” or words or phrases of 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 andtechnological factors outside of our control, that may cause actual results todiffer materially from trends, plans or expectations set forth in theforward-looking statements.  Given theserisks and uncertainties, actual future results may be materially different fromwhat we plan or expect.  We will notupdate these forward-looking statements even if our situation changes in thefuture.

 

#### **OVERVIEW**

 

Our results in the three-month period ended June 30, 2005, or the2005 three-month period, were negatively impacted by the combination of demandmoderation in our paper markets, the routine scheduled maintenance outage ofour pulp mill, and higher raw material and energy costs.  While paper demand softened during the 2005three-month period, the industry has maintained a reasonable supply and demandbalance by removing additional capacity from the market this year.  Our packaging markets continued to enjoystable demand and we are experiencing moderate price improvement.

 

The uncoated paper market had mixed results in the 2005 three-monthperiod.  While pricing was slightlyhigher, total volume was down.  A portionof the lower volume was due to strong demand in March 2005 in anticipationof an announced price increase in April 2005.  We anticipate that demand for the three-monthperiod ending September 30, 2005 will return to levels experienced in thethree-month period ended March 31, 2005. Demand for our bleached paperboard products was up 4.4% in the 2005three-month period when compared to the three-month period ended March 31,2005.  Our coated paperboard segment ofthe bleached paperboard market continues to show moderate improvement indemand, which we are forecasting to continue into the three-month period endingSeptember 30, 2005.

 

Our operating results continued to be negatively affected by highercosts for raw materials and energy. Transportation and shipping costs also continue to increase reflectinghigher fuel prices, availability of containers, and the impact of the newDepartment of Transportation rules limiting hours of driving.  Our Six Sigma and Lean Manufacturinginitiatives have gained momentum during the 2005 three-month period.  These initiatives have improved theproductivity, efficiencies and quality of our products, which have reduced theimpact of the raw material and energy cost increases.  As of June 30, 2005, over 264 of ouremployees have received Six Sigma training. We anticipate that by the end of the year, over 300 employees will havereceived Six Sigma training.

 

In April 2005, our Canton mill conducted a scheduled annualmaintenance outage of our pine pulp mill. The impact of this planned outage on the 2005 three-month periodearnings was approximately $2.6 million. The negative impact was primarily due to increased maintenance costs andthe cost of purchased pine fiber used during the outage to meet paper machinerequirements.

 

Flood prevention activities continued in the 2005 three-monthperiod.  In the three-month period ended March 31,2005, we recognized government grant income totaling $1.9 million.  This compared to $0.4 million in the 2005

 

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three-month period.  The grantincome is being used to repair and more permanently protect our wastewaterfacility, which also serves the town of Canton, North Carolina.

 

#### **Results ofOperations**

 

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

 

**(Dollars inmillions, except per ton amounts)**

 

| ** **                                    | ** ** | **Three-Month Period  Ended June 30** | ** ** | **Six-Month Period  Ended June 30** | ** ** |
|-----------------------------------------------|------------|--------------------------------------------|------------|------------------------------------------|------------|
| ** **                                    | ** ** | **2005**                                   | ** ** | **2004**                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                          |       |                                       |       |                                     |       |   |   |   |   |
| Net sales:                                    |       |                                       |       |                                     |       |   |   |   |   |
| Packaging                                     |       | $                                          | 75.3       |                                     | $          | 71.2 |   | $ | 150.0 |   | $ | 144.2 |   |
| Paper                                         |       | 49.9                                       |       | 50.2                                     |       | 103.8 |   | 98.2 |   |
| Total                                         |       | $                                          | 125.2      |                                     | $          | 121.4 |   | $ | 253.8 |   | $ | 242.4 |   |
|                                          |       |                                       |       |                                     |       |   |   |   |   |
| Operating  profit (loss):                     |       |                                       |       |                                     |       |   |   |   |   |
| Packaging                                     |       | $                                          | 4.1        |                                     | $          | 1.2 |   | $ | 8.3 |   | $ | 5.8 |   |
| Paper                                         |       | 2.9                                        |       | (1.5                                     | )          | 9.4 |   | (3.0 | ) |
| Total  segments’ operating profit (loss) |       | $                                          | 7.0        |                                     | $          | (0.3 | ) | $ | 17.7 |   | $ | 2.8 |   |
|                                          |       |                                       |       |                                     |       |   |   |   |   |
| Corporate  expense                            |       | 7.1                                        |       | 8.8                                      |       | 14.4 |   | 17.6 |   |
| Total  operating profit (loss)                |       | $                                          | (0.1       | )                                        | $          | (9.1 | ) | $ | 3.3 |   | $ | (14.8 | ) |
|                                          |       |                                       |       |                                     |       |   |   |   |   |
| Percentage  of net sales:                     |       |                                       |       |                                     |       |   |   |   |   |
| Packaging                                     |       | 60.1                                       | %          | 58.6                                     | %          | 59.1 | % | 59.5 | % |
| Paper                                         |       | 39.9                                       | %          | 41.4                                     | %          | 40.9 | % | 40.5 | % |
| Total                                         |       | 100.0                                      | %          | 100.0                                    | %          | 100.0 | % | 100.0 | % |
|                                          |       |                                       |       |                                     |       |   |   |   |   |
| Operating  margin:                            |       |                                       |       |                                     |       |   |   |   |   |
| Packaging                                     |       | 5.4                                        | %          | 1.7                                      | %          | 5.5 | % | 4.0 | % |
| Paper                                         |       | 5.8                                        | %          | (3.0                                     | )%         | 9.1 | % | (3.1 | )% |
| Total                                         |       | 5.6                                        | %          | (0.2                                     | )%         | 7.0 | % | 1.2 | % |
|                                          |       |                                       |       |                                     |       |   |   |   |   |
| Shipments  (tons):                            |       |                                       |       |                                     |       |   |   |   |   |
| Packaging  segment                            |       | 66,473                                     |       | 64,230                                   |       | 130,134 |   | 126,831 |   |
| Paper  segment                                |       | 70,108                                     |       | 80,049                                   |       | 146,181 |   | 161,208 |   |
| Total                                         |       | 136,581                                    |       | 144,279                                  |       | 276,315 |   | 288,039 |   |
|                                          |       |                                       |       |                                     |       |   |   |   |   |
| Average price  ($ per ton):              |       |                                       |       |                                     |       |   |   |   |   |
| Packaging  segment                            |       | $                                          | 1,133      |                                     | $          | 1,109 |   | $ | 1,153 |   | $ | 1,137 |   |
| Paper  segment                                |       | 712                                        |       | 627                                      |       | 710 |   | 609 |   |
| Average  price                                |       | $                                          | 917        |                                     | $          | 841 |   | $ | 919 |   | $ | 842 |   |

 

**THREE MONTHS ENDED JUNE 30, 2005COMPARED TO THREE MONTHS ENDED JUNE 30, 2004**

 

*Net Sales.*  Net sales for the 2005 three-month periodincreased $3.8 million or 3.1% to $125.2 million compared to $121.4 million forthe 2004 three-month period.  Net salesin our packaging segment increased $4.1 million, while total net sales in ourpaper segment decreased by $0.3 million.

 

Net sales for our packagingsegment for the 2005 three-month period increased $4.1 million or 5.8% to $75.3million compared to $71.2 million for the 2004 three-month period.  For the 2005 three-month period, our packagingsegment sold 66,473 tons of coated and converted paperboard products at anaverage price of $1,133 per ton, compared to 64,230 tons sold for the 2004three-month period at an average price of $1,109 per ton.  The increase in packaging segment sales isattributable to a 3.5% increase in volume shipped and a 2.2% increase inaverage revenue per ton shipped.

 

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Net sales for our paper segmentfor the 2005 three-month period decreased $0.3 million or 0.6% to $49.9 millioncompared to $50.2 million in the three-month period ended June 30, 2004,or the 2004 three-month period.  Netsales volume in our paper segment declined 9,941 tons to 70,108 tons shipped inthe 2005 three-month period as compared to 80,049 tons shipped in the 2004three-month period.  Nearly half of thenet sales volume decline was due to reduced sales of non-converted bleachedboard, which resulted from increased transfers to our packaging segment forfurther converting into value-added products. The remaining decline in net sales volume was attributable to lowerdemand in our uncoated paper grades. Average pricing in our paper segment improved to $712 per ton shipped inthe 2005 three-month period as compared to $627 per ton shipped in the 2004three-month period.

 

*Operating Profit (Loss)*.  Total segments’ operating profit increased$7.3 million to $7.0 million in the 2005 three-month period compared to anoperating loss of $0.3 million for the 2004 three-month period.  As a percentage of sales, total segments’operating profit increased to 5.6% in the 2005 three-month period from a 0.2%loss in the 2004 three-month period.

 

Thefollowing table sets forth significant items that increased (decreased) totalsegments’ operating profit:

 
| **Segment Operating Profit (Loss)**                            | ** ** | **Three-Month Period  Ended June 30, 2005** | ** ** | **Three-Month Period  Ended June 30, 2004** | ** ** | **Change** | ** ** |
|----------------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|------------|------------|
|                                                           |       |                                             |       |                                             |       |       |       |
|                                                           |       | $                                                | 7.0        |                                             | $          | (0.3)      |       | $ | 7.3 |   |
|                                                           |       |                                             |       |                                             |       |       |       |
| Product  pricing improvement                                   |       |                                             |       |                                             |       | $          | 8.5        |   |
|                                                           |       |                                             |       |                                             |       |       |       |
| Outbound  transportation costs                                 |       |                                             |       |                                             |       | (1.2       | )          |
|                                                           |       |                                             |       |                                             |       |       |       |
| One-time  severance expenses in 2004 over 2005                 |       |                                             |       |                                             |       | 2.1        |       |
|                                                           |       |                                             |       |                                             |       |       |       |
| Reduced wage  and benefit costs                                |       |                                             |       |                                             |       | 2.6        |       |
|                                                           |       |                                             |       |                                             |       |       |       |
| Plastic  resin costs of coating materials                      |       |                                             |       |                                             |       | (2.6       | )          |
|                                                           |       |                                             |       |                                             |       |       |       |
| Energy costs  at the Canton, NC mill                           |       |                                             |       |                                             |       | (2.4       | )          |
|                                                           |       |                                             |       |                                             |       |       |       |
| Reduced operating and fixed expenses –  packaging segment |       |                                             |       | 0.8                                              |       |
|                                                           |       |                                             |       |                                             |       |       |       |
| Reduced  productivity in paper segment                         |       |                                             |       |                                             |       | (0.8       | )          |
|                                                           |       |                                             |       |                                             |       |       |       |
| Other  miscellaneous items                                     |       |                                             |       |                                             |       | 0.3        |       |
|                                                           |       |                                             |       |                                             |       |       |       |
| Total                                                          |       |                                             |       |                                             |       | $          | 7.3        |   |
|                                                                |            |                                                  |            |                                                  |            |            |            |  |  |  |

 

Operating profit for our packaging segment increased $2.9 million inthe 2005 three-month period to $4.1 million or 5.4% of packaging segment sales,compared to $1.2 million or 1.7% of packaging segment sales for the 2004three-month period.  The increase inoperating profit for our packaging segment was due primarily to: (i) increasedpricing on non-converted coated board sales of $2.2 million and on carton salesof $0.9 million; (ii) severance expenses of $1.2 million incurred in the2004 three-month period related to the shutdown of our Fort Worth, Texasconverting facility; (iii) reduced wage and benefit costs of $1.1 milliondue to headcount reductions and the impact of our healthcare initiatives; (iv) reducedoperating and fixed expenses of $0.8 million primarily due to the consolidationof capacity within our liquid packaging business; and (v) othermiscellaneous variances totaling a

 

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favorable $0.2 million.  Theincrease in packaging segment operating profit in the 2005 three-month periodwas partially offset by a $2.6 million increase in the price of plastic/resin,one of our primary raw materials used at our Waynesville converting facility,as well as a $0.9 million increase in outbound transportation costs dueprimarily to higher fuel pricing.

 

Operating profit for our paper segment increased $4.4 million in the2005 three-month period to $2.9 million or 5.8% of paper segment sales,compared to a loss of $1.5 million or 3.0% of paper segment sales for the 2004three-month period.  The increase inoperating profit for our paper segment was due primarily to: (i) increasedpricing on paper sales of $4.9 million and on uncoated board sales of $0.5million; (ii) severance expenses of $0.9 million incurred in the 2004three-month period related to headcount reductions at our Canton, NorthCarolina manufacturing facility; (iii) reduced wage and benefit costs of$1.5 million primarily due to the headcount reductions completed at the Canton,North Carolina facility; and (iv) other miscellaneous variances totaling afavorable $0.1 million.  The increase inpaper segment operating profit for the 2005 three-month period was partiallyoffset by a $2.4 million increase in purchase pricing on fuels and electricityconsumed at our Canton, North Carolina manufacturing facility, a $0.3 millionincrease in outbound transportation costs due primarily to higher fuel pricingand productivity declines resulting in an approximate loss of $0.8 million inproduction opportunity.

 

*Selling, General and AdministrativeExpenses. *Totalselling, general and administrative expenses decreased $1.5 million or 23.1% to$5.0 million in the 2005 three-month period compared to $6.5 million for the2004 three-month period.  The decrease inselling, general and administrative expenses for the 2005 three-month periodwas primarily attributable to: (i) incurrence of $0.3 million in startupcosts for our medical clinic in Canton, North Carolina during the 2004three-month period; (ii) beginning in January 2005, termination of futureobligations under the management fee agreement, as amended, with the majoritystockholder of Blue Ridge Holding Corp., our parent, resulting in a savings of$0.6 million in the 2005 three-month period as compared to the 2004 three-monthperiod; (iii) release of a $0.5 million environmental reserve in the 2005three-month period; and (iv) other miscellaneous variances totaling afavorable $0.1 million.

 

*Interest and Amortization Expenses. *Interest andamortization expenses increased $0.5 million to $4.7 million for the 2005three-month period compared to $4.2 million for the 2004 three-monthperiod.  This is due primarily to anincreased borrowing level on our revolving line of credit as well as anincrease in the balance on our Parent Pay-In-Kind (PIK) Senior SubordinatedNote.

 

*Government Grant Income.*  Flood prevention activities continue at ourCanton, North Carolina manufacturing facility following the flood damageincurred at that facility in the third quarter of 2004.  In the 2005 three-month period, we recognizedgovernment grant income totaling $0.4 million. The grant income is being used to repair and more permanently protectour wastewater facility, which also serves the town of Canton, North Carolina.

 

**SIX MONTHS ENDED JUNE 30, 2005 COMPARED TOSIX MONTHS ENDED JUNE 30, 2004**

 

*Net Sales. *Net sales for the six months ended June 30,2005, or the 2005 six-month period, increased to $253.8 million or 4.7*%*compared to**$242.4 million for the six months ended June 30, 2004,or the 2004 six-month period.  Thisincrease in total revenue is attributable to an increase in the weightedaverage revenue per ton shipped to $918 per ton in the 2005 six-month periodfrom $842 per ton in the 2004 six-month period. This increase in average revenue per ton sold was primarily due toimproved pricing in all four of our major grade lines: paper, uncoated board,coated board and cartons.  The increasein revenue per unit sold resulted in an approximate $19.2 million

 

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increase in total revenue in the 2005 six-month period as compared tothe 2004 six-month period.  Total salesvolume declined 11,724 tons or 4.1% to 276,315 tons in the 2005 six-monthperiod compared to 288,039 tons for the 2004 six-month period.  The reduction in sales volume reflectedreduced productivity in our paper segment and a reduction in sales ofnon-converted bleached board, which resulted from increased transfers to ourpackaging segment for further converting into value-added products.

 

Net sales for our packaging segment for the 2005 six-month periodincreased $5.8 million or 4.0% to $150.0 million compared to $144.2 million forthe 2004 six-month period.  The increasein net sales is attributable to: (i) an average net sales price per tonincrease of 1.7% for cartons and 7.7% for non-converted coated paperboard inthe 2005 six-month period compared to the 2004 six-month period; and (ii) a12.3% increase in volume of our non-converted coated paperboard shipments inthe 2005 six-month period as compared to the 2004 six-month period.  Conversely, shipment volume for our convertedcartons declined 4.7% in the 2005 six-month period as compared to the 2004six-month period.

 

Sales for our paper segment for the 2005 six-month period increased$5.6 million or 5.7% to $103.8 million compared to $98.2 million for the 2004six-month period.  This increase isattributable to an average net sales price per ton increase of 15.2% for ourpaper grades and 19.2% for uncoated paperboard in the 2005 six-month period ascompared to the 2004 six-month period. Total segment shipment volume declined 15,027 tons or 9.3% to 146,181tons in the 2005 six-month period compared to 161,208 tons in the 2004six-month period.  The reduction in salesvolume reflected reduced productivity in our paper segment and a reduction insales of non-converted bleached board, which resulted from increased transfersto our packaging division for further converting into value-added products.

 

*Operating Profit (Loss)*.  Total segments’ operating profit increased$14.9 million to $17.7 million in the 2005 six-month period compared to anoperating profit of $2.8 million for the 2004 six-month period.  As a percentage of sales, total segments’operating profit increased to 7.0% in the 2005 six-month period from 1.2% inthe 2004 six-month period.

 

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Thefollowing table sets forth significant items that increased (decreased) totalsegments’ operating profit:

 
| **Segment Operating Profit (Loss)**                                      | ** ** | **Six-Month Period  Ended June 30, 2005** | ** ** | **Six-Month Period  Ended June 30, 2004** | ** ** | **Change** | ** ** |
|--------------------------------------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|------------|------------|
|                                                                     |       |                                           |       |                                           |       |       |       |
|                                                                     |       | $                                              | 17.7       |                                           | $          | 2.8        |       | $ | 14.9 |   |
|                                                                     |       |                                           |       |                                           |       |       |       |
| Product  pricing improvement                                             |       |                                           |       |                                           |       | $          | 19.2       |   |
|                                                                     |       |                                           |       |                                           |       |       |       |
| Net flood  impact to 2005 six-month period                               |       |                                           |       |                                           |       | (1.2       | )          |
|                                                                     |       |                                           |       |                                           |       |       |       |
| Outbound  transportation costs                                           |       |                                           |       |                                           |       | (2.7       | )          |
|                                                                     |       |                                           |       |                                           |       |       |       |
| One-time  severance expenses in 2004 over 2005                           |       |                                           |       |                                           |       | 4.7        |       |
|                                                                     |       |                                           |       |                                           |       |       |       |
| Reduced wage  and benefit costs                                          |       |                                           |       |                                           |       | 4.3        |       |
|                                                                     |       |                                           |       |                                           |       |       |       |
| Inventory capitalization due to increased  raw material and energy costs |       |                                           |       | 1.7                                            |       |
|                                                                     |       |                                           |       |                                           |       |       |       |
| Major raw  material pricing (plastic resin and chemicals)                |       |                                           |       |                                           |       | (7.6       | )          |
|                                                                     |       |                                           |       |                                           |       |       |       |
| Energy costs  at the Canton, NC mill                                     |       |                                           |       |                                           |       | (4.8       | )          |
|                                                                     |       |                                           |       |                                           |       |       |       |
| Reduced operating and fixed expenses –  packaging segment           |       |                                           |       | 0.9                                            |       |
|                                                                     |       |                                           |       |                                           |       |       |       |
| Other  miscellaneous items                                               |       |                                           |       |                                           |       | 0.8        |       |
|                                                                     |       |                                           |       |                                           |       |       |       |
| Total                                                                    |       |                                           |       |                                           |       | $          | 14.9       |   |
|                                                                          |            |                                                |            |                                                |            |            |            |  |  |  |

 

Operating profit for our packaging segment in the 2005 six-month periodincreased $2.5 million to $8.3 million compared to $5.8 million for the 2004six-month period.  The increase wasprimarily due to: (i) increases to the average net selling prices forcoated paperboard and carton products of 7.7% and 1.7%, respectively, comparedto the 2004 six-month period.  Thisincrease in average selling price added $5.3 million to revenues and operatingprofit for the 2005 six-month period as compared to the 2004 six-month period; (ii) severanceexpenses of $2.5 million incurred in the 2004 six-month period related to theshutdown of our Fort Worth, Texas converting facility; (iii) reduced wageand benefit costs of $1.8 million; (iv) reduced operating and fixedexpenses of $0.9 million primarily due to the consolidation of capacity withinour liquid packaging business; and (v) increased inventory capitalizationof $1.2 million reflecting increased costs for raw materials and energy.  The increase in packaging segment operatingprofit in the 2005 six-month period was partially offset by: (i) a $5.1million increase in the price of plastic/resin, one of our primary rawmaterials used at our Waynesville converting facility; (ii) a $2.0 millionincrease in outbound transportation costs due primarily to higher fuel pricing;(iii) increased transfer cost of rawstock paperboard of $2.0 million; and (iv) othermiscellaneous items totaling a negative $0.1 million.

 

Operating profit for our paper segment increased $12.4 million in the2005 six-month period to $9.4 million as compared to an operating loss of $3.0million for the 2004 six-month period. The increase in operating profit for our paper segment was due primarilyto: (i) increased pricing on paper sales of $13.0 million and on uncoatedboard sales of $0.9 million; (ii) severance expenses that were $2.2million higher in the 2004 six-month period related to headcount reductions atour Canton, North Carolina manufacturing facility; (iii) reduced wage andbenefit costs of $2.5 million primarily due to the headcount reductionscompleted at the Canton, North Carolina facility and the impact of ourhealthcare initiatives; (iv) increased transfer revenue for the rawstocksent to our Waynesville facility of $2.0 million; (v) increased inventorycapitalization of $0.5 million reflecting increased costs for raw materials andenergy; and (vi) other miscellaneous items totaling $0.9 million.  The increase in paper segment operatingprofit in the 2005 six-month period was partially offset by: (i) a $4.8million increase in purchase pricing on fuels and electricity consumed at ourCanton, North Carolina manufacturing facility; (ii) a $0.7 millionincrease in outbound transportation costs due primarily to higher fuel pricing;(iii) an approximate $2.5 million increase in pricing for chemicalsutilized in our pulping process; and (iv) net expenses of approximately

 

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$1.2 million to effect repairs to the Canton mill infrastructureresulting from flood damage incurred at that facility in the third quarter of2004.

 

*Selling, General and AdministrativeExpenses. *Totalselling, general and administrative expenses decreased $2.9 million or 22.1% to$10.2 million in the 2005 six-month period compared to $13.1 million for the2004 six-month period.  The decrease inselling, general and administrative expenses for the 2005 period was primarilyattributable to: (i) incurrence of $0.3 million in startup costs for ourmedical clinic in Canton, North Carolina during the 2004 six-month period; (ii) beginningin January 2005, termination of future obligations under the managementfee agreement, as amended, with the majority stockholder of our parent,resulting in a savings of $1.2 million in the 2005 six-month period as comparedto the 2004 six-month period; (iii) release of a $0.5 millionenvironmental reserve in the 2005 six-month period; (iv) severanceexpenses of $0.2 million incurred in the 2004 six-month period related toheadcount reduction at our headquarters facility; (v) reduction of a $0.5million severance reserve resulting from lower-than-projected healthcare costsof terminated employees of our closed Fort Worth, Texas DairyPak facility; and (vi) othermiscellaneous variances totaling $0.2 million.

 

*Interest and Amortization Expenses. *Interest andamortization expenses increased $0.8 million to $9.3 million for the 2005six-month period compared to $8.5 million for the 2004 six-month period.  This increase is due primarily to anincreased borrowing level on our revolving line of credit as well as anincrease on our Parent PIK Senior Subordinated Note.

 

*Government Grant Income.*  Flood prevention activities continue at ourCanton, North Carolina manufacturing facility following the flood damageincurred at that facility in the third quarter of 2004.  In the 2005 six-month period, we recognizedgovernment grant income totaling $2.3 million. The grant income is being used to repair and more permanently protectour wastewater facility, which also serves the town of Canton, North Carolina.

 

#### **LIQUIDITY ANDCAPITAL RESOURCES**

 

Our principal liquidity requirements are to service our debt and fundour operations and capital expenditure needs. Our total senior debt, defined as total debt less the Parent PIK SeniorSubordinated Note, at June 30, 2005 was approximately $157.3 million.  Subject to our performance, which ifadversely affected could affect the availability of funds, we expect to be ableto meet our liquidity requirements for the remainder of 2005 through cashprovided by operations and through borrowings available under our workingcapital facility.  We cannot assure you,however, that this will be the case.  In December 2003,we issued $125.0 million of Notes in a private offering.  Proceeds from issuance of the Notes were usedto repay our Term Loan A and B and our existing revolving credit facility underthe 1999 credit agreement.  In addition,we paid $7.0 million on the Parent PIK Subordinated Note.  We entered into a $45.0 million revolvingcredit facility in December 2003. On September 15, 2004, the credit agreement was amended to increasethe facility from $45.0 million to $50.0 million on a permanent basis.  On August 5, 2005, the credit agreementwas amended to include specified foreign account debtors as eligible accountsin determining borrowing base availability. This amendment was effective with the July borrowing base and hasincreased our borrowing availability by approximately $5.5 million subject tomaximum borrowing availability restrictions. The maximum borrowing availability at December 31, 2004 and June 30,2005 was $17.4 million and $12.0 million, respectively.  The revolving credit facility containscovenant restrictions, which require covenant availability to exceed $7.5million (as amended December 21, 2004). If the covenant availability does not meet the required minimum, a fixedcharge coverage ratio covenant of 1.1 to 1.0 will be triggered.  We do not believe that we will be subject tothe fixed charge coverage ratio for the remainder of 2005 based on: (i) improvedmarket conditions; (ii) improvements to our cost structure; (iii) reductionsto working capital; and (iv) amendment to our credit agreement.

 

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As of June 30, 2005, we had a covenant availability of $12.0million, which is $4.5 million in excess of the required minimum.

 

Summary of Cash Flow ($ in millions):

 
| ** **                                 | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------|------------|------------------------------------|------------|
| ** **                                 | ** ** | **2005**                           | ** ** | **2004** | ** ** |
| Net cash  used in operating activities     |       | $                                  | (6.4       | ) | $ | (4.8 | ) |
| Net cash  used in investing activities     |       | (4.6                               | )          | (7.1 | ) |
| Net cash  provided by financing activities |       | 11.1                               |       | 11.3 |   |
| Net increase  (decrease) in cash           |       | $                                  | 0.1        |   | $ | (0.6 | ) |
|                                       |       |                               |       |   |   |
| Cash balance                               |       | $                                  | 2.5        |   | $ | 1.6 |   |

 

The cash used in operations was $6.4 million for the 2005 six-monthperiod.  The cash used by operations wasattributable to increases in accounts receivable and inventory and decreases inaccounts payable, accrued expenses and other liabilities and the net loss forthe 2005 six month period.  Accountspayable decreased as we continued to pay invoices related to the September 2004flooding at our Canton mill site.  Wereceived a $1.0 million payment from our insurance carrier in July 2005and expect to finalize our claims with a final payment of $5.0 million inAugust.  Our accounts receivable growthis due to an increase in foreign sales, which carry longer terms than domesticsales.  The current level of inventoryturns is 8.9 times and our goal is to reduce our inventory in the last half of2005.

 

The cash used in investing activities was $4.6 million and $7.1 millionfor the 2005 six-month period and the 2004 six-month period, respectively.  The decrease in net cash used in investingactivities was due to a decrease in capital spending for the 2005 six-monthperiod compared to the 2004 six-month period. The decrease is due to timing of capital projects for 2005.  For the calendar year 2005, we currentlyestimate that our capital spending will be approximately $21.2 million, ofwhich $3.2 million will be funded by a grant from the State of North Carolinafor flood prevention.  The remaining $1.3million of state grant funds will be spent in 2006.

 

Net cash provided by financing activities was $11.1 million for the2005 six-month period, which was primarily attributable to net borrowings onour revolving line of credit.

 

**ITEM 3.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 consolidated financialstatements and the related notes thereto included elsewhere in this quarterlyreport on Form 10-Q.

 

We manage interest cost using a combination of fixed and variable ratedebt.  As of June 30, 2005, we have$125.0 million of Notes outstanding and a $50.0 million working capital creditfacility at variable rates of interest. As of June 30, 2005, approximately $29.7 million was outstandingunder our working capital credit facility consisting of short-term interestrates of 1.0% over Applicable Revolver Index Margin and 2.75% over ApplicableRevolver Libor Margin, as defined.  Ourworking capital facility offers two options for interest rates:  Applicable Revolver Libor margin ranging from2.5% - 3.0% or Applicable Revolver Index Margin ranging from .75% - 1.25%.  The rate is based on revolver availability.  At the end of June 2005, we were at themid-point of the interest rate range.  Inaddition, as of June 30, 2005, we have a $0.7 million mortgage note with amaximum interest rate of 5.5% and a remaining duration of five years.

 

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

 

(A) Evaluation of Disclosure Controls and Procedures

 

Our Chief Executive Officer andChief Financial Officer have evaluated the effectiveness of our disclosurecontrols and procedures (as defined in Rule 13a-15(e) and 15d-15(e))under the Securities Exchange Act of 1934. Based on their evaluation, our Chief Executive Officer and ChiefFinancial Officer have concluded that, as of June 30, 2005, our disclosurecontrols and procedures were effective in ensuring that material informationwas properly disclosed in its filings with the Securities and ExchangeCommission.

 

(B) Changes in InternalControls Over Financial Reporting

 

There have been no significantchanges in our internal controls over financial reporting during the threemonths ended June 30, 2005 that have materially affected or are reasonablylikely to materially affect our internal control over financial reporting.

 

**PART II.  OTHER INFORMATION**

 

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

 

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

31.1 Certification of CEO pursuant to Section 302 ofSarbanes-Oxley Act of 2002

31.2 Certification of CFO pursuant to Section 302 ofSarbanes-Oxley Act of 2002

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

 

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## **SIGNATURES**

 

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

 

 
| **BLUE RIDGE PAPER PRODUCTS INC.** |
|------------------------------------|
|                               |
|                               |
| Date:   August 15, 2005  |
|                               | /S/ JOHN B. WADSWORTH |   |
|                               | John B. Wadsworth |
|                               | Chief Financial Officer |
|                               |   |
|                               | (On behalf of the Registrant and as |
|                               | Principal Financial Officer) |

 

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### EXHIBIT INDEX

TO

FORM 10-Q

OF

BLUE RIDGE PAPER PRODUCTS INC.

FOR THE QUARTERLY PERIOD ENDED JUNE 30,2005

Pursuant to Section 102(d) ofRegulation S-T

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

 

The following exhibits arefiled 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

 

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