Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

**FORM 10-Q**

** **

**x****      QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended September 30, 2010**

 

**OR**

 

**o****         TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**Commission File Number 001-32563**

 

**Orchids Paper Products Company**

(Exact name of Registrant as Specified in its Charter)

 

| **Delaware**                    | ** ** | **23-2956944**      |
|---------------------------------|------------|---------------------|
| (State or Other Jurisdiction of |       | (I.R.S. Employer    |
| Incorporation or Organization)  |       | Identification No.) |

 

**4826 Hunt Street**

**Pryor, Oklahoma 74361**

(Address of Principal Executive Offices and Zip Code)

 

**(918) 825-0616**

(Registrant’s Telephone Number, Including Area Code)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirement for the past 90 days. Yes x  No o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files). Yes o  No o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large acceleratedfiler”, “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act. (Check one):

 

| Large accelerated filer o |   | Accelerated filer x         |
|---------------------------|--------|-----------------------------|
|                      |   |                        |
| Non-accelerated filer o   |   | Smaller reporting company o |

 

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

 

Number of shares outstanding of the issuer’s Common Stock, par value$.001 per share, as of November 1, 2010: 7,486,725 shares

 

 

 

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**ORCHIDS PAPER PRODUCTS COMPANY**

**TABLE OF CONTENTS**

**QUARTERLY REPORT ON FORM 10-Q**

**FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2010**

 
| ** **                             | ** **                                                                                                                                                                | ** ** | **Page** |
|----------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|
|                                   |                                                                                                                                                                      |       |     |
| **PART I. FINANCIAL INFORMATION** |                                                                                                                                                                      |       |
|                                   |                                                                                                                                                                      |       |     |
| **ITEM 1.**                            | **Financial Statements**                                                                                                                                                  |       |     |
|                                   |                                                                                                                                                                      |       |     |
| ** **                             | **Balance Sheets as of  September 30, 2010 (Unaudited) and December 31, 2009**                                                                                  |       | **3**    |
|                                   |                                                                                                                                                                      |       |     |
| ** **                             | **Statements of Income  for the three months ended September 30, 2010 and 2009 (Unaudited) and  the nine months ended September 30, 2010 and 2009 (Unaudited)** |       | **4**    |
|                                   |                                                                                                                                                                      |       |     |
| ** **                             | **Statements of  Cash Flows for the nine months ended September 30, 2010 and 2009  (Unaudited)**                                                                     |       | **5**    |
|                                   |                                                                                                                                                                      |       |     |
| ** **                             | **Notes to Unaudited Interim Financial Statements**                                                                                                                       |       | **6**    |
|                                   |                                                                                                                                                                      |       |     |
| **ITEM 2.**                            | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations**                                                                           |       | **10**   |
|                                   |                                                                                                                                                                      |       |     |
| **ITEM 3.**                            | **Quantitative  and Qualitative Disclosures about Market Risk**                                                                                                           |       | **20**   |
|                                   |                                                                                                                                                                      |       |     |
| **ITEM 4.**                            | **Controls and  Procedures**                                                                                                                                              |       | **20**   |
|                                   |                                                                                                                                                                      |       |     |
| **PART II.  OTHER INFORMATION**   |                                                                                                                                                                      |       |
|                                   |                                                                                                                                                                      |       |     |
| **ITEM 1.**                            | **Legal Proceedings**                                                                                                                                                     |       | **21**   |
|                                   |                                                                                                                                                                      |       |     |
| **ITEM 1A.**                           | **Risk Factors**                                                                                                                                                          |       | **21**   |
|                                   |                                                                                                                                                                      |       |     |
| **ITEM 2.**                            | **Unregistered  Sales of Equity Securities and Use of Proceeds**                                                                                                          |       | **21**   |
|                                   |                                                                                                                                                                      |       |     |
| **ITEM 3.**                            | **Defaults  Upon Senior Securities**                                                                                                                                      |       | **21**   |
|                                   |                                                                                                                                                                      |       |     |
| **ITEM 4.**                            | **RESERVED**                                                                                                                                                              |       | **21**   |
|                                   |                                                                                                                                                                      |       |     |
| **ITEM 5.**                            | **Other Information**                                                                                                                                                     |       | **21**   |
|                                   |                                                                                                                                                                      |       |     |
| **ITEM 6.**                            | **Exhibits**                                                                                                                                                              |       | **21**   |
|                                   |                                                                                                                                                                      |       |     |
| ** **                             | **Signatures**                                                                                                                                                            |       | **22**   |

 

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**PART I. FINANCIALINFORMATION**

 

**ITEM 1.  Financial Statements**

 

**ORCHIDSPAPER PRODUCTS COMPANY**

**BALANCESHEETS**

**(Dollars inthousands, except share data)**

 
| ** **                                                                                                                                          | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                          | ** ** | **2010**               | ** ** | **2009**              | ** ** |
| ** **                                                                                                                                          | ** ** | **(unaudited)**        | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                          |       |                   |       |                  |       |
| Current assets:                                                                                                                                     |       |                   |       |                  |       |
| Cash                                                                                                                                                |       | $                      | 6          |                  | $          | 1,232 |   |
| Accounts receivable, net of allowance of $254 in  2010 and $209 in 2009                                                                             |       | 7,468                  |       | 6,750                 |       |
| Inventories, net                                                                                                                                    |       | 7,487                  |       | 7,569                 |       |
| Income taxes receivable                                                                                                                             |       | 2,653                  |       | —                |       |
| Short term investments                                                                                                                              |       | 9,516                  |       | 18,509                |       |
| Prepaid expenses                                                                                                                                    |       | 703                    |       | 497                   |       |
| Deferred income taxes                                                                                                                               |       | 693                    |       | 547                   |       |
| Total current assets                                                                                                                                |       | 28,526                 |       | 35,104                |       |
|                                                                                                                                                |       |                   |       |                  |       |
| Property, plant and equipment                                                                                                                       |       | 110,864                |       | 87,535                |       |
| Accumulated depreciation                                                                                                                            |       | (18,764                | )          | (14,844               | )          |
| Net property, plant and equipment                                                                                                                   |       | 92,100                 |       | 72,691                |       |
|                                                                                                                                                |       |                   |       |                  |       |
| Deferred debt issuance costs, net of accumulated amortization  of $669 in 2010 and $632 in 2009                                                     |       | 92                     |       | 104                   |       |
| Total assets                                                                                                                                        |       | $                      | 120,718    |                  | $          | 107,899 |   |
|                                                                                                                                                |       |                   |       |                  |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                      |       |                   |       |                  |       |
| Current liabilities:                                                                                                                                |       |                   |       |                  |       |
| Accounts payable                                                                                                                                    |       | $                      | 5,688      |                  | $          | 4,049 |   |
| Accrued liabilities                                                                                                                                 |       | 4,077                  |       | 3,118                 |       |
| Current portion of long-term debt                                                                                                                   |       | 8,839                  |       | 3,742                 |       |
| Total current liabilities                                                                                                                           |       | 18,604                 |       | 10,909                |       |
|                                                                                                                                                |       |                   |       |                  |       |
| Long-term debt, less current portion                                                                                                                |       | 17,105                 |       | 19,533                |       |
| Deferred income taxes                                                                                                                               |       | 16,442                 |       | 14,337                |       |
| Stockholders’ equity:                                                                                                                          |       |                   |       |                  |       |
| Common stock, $.001 par value, 25,000,000 shares  authorized 7,486,725, and 7,393,874 shares issued and outstanding in 2010 and  2009, respectively |       | 7                      |       | 7                     |       |
| Additional paid-in capital                                                                                                                          |       | 38,827                 |       | 38,354                |       |
| Retained earnings                                                                                                                                   |       | 29,733                 |       | 24,759                |       |
| Total stockholders’ equity                                                                                                                     |       | 68,567                 |       | 63,120                |       |
| Total liabilities and stockholders’ equity                                                                                                     |       | $                      | 120,718    |                  | $          | 107,899 |   |

 

See notes to unaudited interim financialstatements.

 

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**ORCHIDSPAPER PRODUCTS COMPANY**

**STATEMENTSOF INCOME**

**(Dollars inthousands, except share and per share data)**

 
| ** **                                            | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                            | ** ** | **2010**                                                 | ** ** | **2009**                                                | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                            | ** ** | **(unaudited)**                                          | ** ** | **(unaudited)**                                         | ** ** | **(unaudited)** | ** ** | **(unaudited)** | ** ** |
|                                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| Net sales                                             |       | $                                                        | 24,523     |                                                    | $          | 24,557 |   | $ | 70,248 |   | $ | 72,328 |   |
|                                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| Cost of sales                                         |       | 20,494                                                   |       | 17,128                                                  |       | 57,283 |   | 50,639 |   |
| Gross profit                                          |       | 4,029                                                    |       | 7,429                                                   |       | 12,965 |   | 21,689 |   |
|                                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| Selling, general and administrative expenses          |       | 1,649                                                    |       | 1,772                                                   |       | 5,225 |   | 5,689 |   |
| Operating income                                      |       | 2,380                                                    |       | 5,657                                                   |       | 7,740 |   | 16,000 |   |
|                                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| Interest expense                                      |       | 249                                                      |       | 174                                                     |       | 675 |   | 468 |   |
| Other income                                          |       | (24                                                      | )          | (5                                                      | )          | (51 | ) | (9 | ) |
| Income before income taxes                            |       | 2,155                                                    |       | 5,488                                                   |       | 7,116 |   | 15,541 |   |
|                                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| Provision (benefit) for income taxes:                 |       |                                                     |       |                                                    |       |   |   |   |   |
| Current                                               |       | (1,350                                                   | )          | 748                                                     |       | 182 |   | 1,554 |   |
| Deferred                                              |       | 2,063                                                    |       | 925                                                     |       | 1,960 |   | 3,600 |   |
|                                                  |       | 713                                                      |       | 1,673                                                   |       | 2,142 |   | 5,154 |   |
|                                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| Net income                                            |       | $                                                        | 1,442      |                                                    | $          | 3,815 |   | $ | 4,974 |   | $ | 10,387 |   |
|                                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| Earnings per share of common stock:                   |       |                                                     |       |                                                    |       |   |   |   |   |
| Basic                                                 |       | $                                                        | 0.20       |                                                    | $          | 0.56 |   | $ | 0.67 |   | $ | 1.58 |   |
| Diluted                                               |       | $                                                        | 0.18       |                                                    | $          | 0.52 |   | $ | 0.64 |   | $ | 1.49 |   |
|                                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| Weighted average number of common shares outstanding: |       |                                                     |       |                                                    |       |   |   |   |   |
| Basic                                                 |       | 7,486,725                                                |       | 6,838,726                                               |       | 7,456,455 |   | 6,562,051 |   |
| Diluted                                               |       | 7,762,210                                                |       | 7,304,226                                               |       | 7,757,773 |   | 6,955,133 |   |

 

See notes to unaudited interim financialstatements.

 

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**ORCHIDSPAPER PRODUCTS COMPANY**

**STATEMENTSOF CASH FLOWS**

**(Dollars inthousands)**

 
| ** **                                                                         | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2010**                                                | ** ** | **2009** | ** ** |
| ** **                                                                         | ** ** | **(unaudited)**                                         | ** ** | **(unaudited)** | ** ** |
| **Cash Flows From Operating Activities**                                           |       |                                                    |       |   |   |
| Net income                                                                         |       | $                                                       | 4,974      |   | $ | 10,387 |   |
| Adjustments to reconcile net income to net cash provided  by operating activities: |       |                                                    |       |   |   |
| Depreciation and amortization                                                      |       | 4,011                                                   |       | 2,661 |   |
| Provision for doubtful accounts                                                    |       | 45                                                      |       | 46 |   |
| Deferred income taxes                                                              |       | 1,959                                                   |       | 3,601 |   |
| Stock option plan expense                                                          |       | 473                                                     |       | 518 |   |
| Changes in cash due to changes in operating assets  and liabilities:               |       |                                                    |       |   |   |
| Accounts receivable                                                                |       | (763                                                    | )          | (2,462 | ) |
| Inventories                                                                        |       | 82                                                      |       | (373 | ) |
| Income taxes receivable                                                            |       | (2,653                                                  | )          | (430 | ) |
| Prepaid expenses                                                                   |       | (206                                                    | )          | (339 | ) |
| Accounts payable                                                                   |       | 1,639                                                   |       | (1,004 | ) |
| Accrued liabilities                                                                |       | 959                                                     |       | 1,455 |   |
| Net cash provided (used in) by operating  activities                               |       | 10,520                                                  |       | 14,060 |   |
|                                                                               |       |                                                    |       |   |   |
| **Cash Flows From Investing  Activities**                                          |       |                                                    |       |   |   |
| Purchases of property, plant and equipment                                         |       | (23,383                                                 | )          | (6,554 | ) |
| Purchase of investment securities                                                  |       | —                                                  |       | (22,502 | ) |
| Proceeds from the sale of investment securities                                    |       | 8,993                                                   |       | — |   |
| Net cash provided by (used in) investing  activities                               |       | (14,390                                                 | )          | (29,056 | ) |
|                                                                               |       |                                                    |       |   |   |
| **Cash Flows From Financing  Activities**                                          |       |                                                    |       |   |   |
| Proceeds from secondary issuance of common stock                                   |       | —                                                  |       | 14,848 |   |
| Borrowings under construction loan                                                 |       | 5,197                                                   |       | 3,756 |   |
| Principal payments on long-term debt                                               |       | (2,820                                                  | )          | (2,284 | ) |
| Net borrowings (repayments) on revolving credit  line                              |       | 292                                                     |       | (1,487 | ) |
| Proceeds from the exercise of warrants attached to  subordinated debentures        |       | —                                                  |       | 286 |   |
| Proceeds from the exercise of stock options                                        |       | —                                                  |       | 226 |   |
| Deferred issuance cost                                                             |       | (25                                                     | )          | (43 | ) |
| Net cash provided by (used in) financing  activities                               |       | 2,644                                                   |       | 15,302 |   |
|                                                                               |       |                                                    |       |   |   |
| Net increase (decrease) in cash                                                    |       | (1,226                                                  | )          | 306 |   |
| Cash, beginning                                                                    |       | 1,232                                                   |       | 11 |   |
| Cash, ending                                                                       |       | $                                                       | 6          |   | $ | 317 |   |
| **Supplemental Disclosure:**                                                       |       |                                                    |       |   |   |
| Interest paid                                                                      |       | $                                                       | 675        |   | $ | 468 |   |
| Income taxes paid                                                                  |       | $                                                       | 2,675      |   | $ | 1,735 |   |

 

See notes to unaudited interim financialstatements.

 

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**ORCHIDS PAPER PRODUCTS COMPANY**

**NOTES TO UNAUDITED INTERIMFINANCIAL STATEMENTS**

 

**Note 1 — Basis of Presentation**

 

OrchidsPaper Products Company (“Orchids” or the “Company”) was formed in 1998 toacquire and operate the paper manufacturing facility, built in 1976, in Pryor,Oklahoma.  Orchids AcquisitionGroup, Inc. (“Orchids Acquisition”) was established in November 2003,for the purpose of acquiring the common stock of Orchids.  The sale of equity and debt securities closedin March 2004 and Orchids Acquisition Group, Inc. acquired Orchidsfor a price of $21.6 million.  Orchids Acquisitionwas subsequently merged into Orchids.

 

InJuly, 2005, the Company completed its initial public offering of 2,156,250shares of its common stock.  Followingthe offering, 4,156,250 shares of common stock were outstanding.  In July 2006, the Company effected a3-for-2 stock split resulting in outstanding shares of 6,234,346.  The Company’s stock trades on the NYSE Amexunder the ticker symbol “TIS.”

 

OnAugust 26, 2009, the Company closed a follow-on public offering of 750,000shares of its common stock at an offering price of $18.50 per share. TheCompany received net proceeds of approximately $12.8 million from the offering,after deducting the underwriting discount and offering expenses.  On September 2, 2009, the underwriterexercised its over-allotment option and purchased an additional 112,500 sharesof common stock at a price of $18.50 per share. The Company received approximately $2.0 million in net proceeds fromthis exercised option.  The Company isusing the proceeds from the offering for the construction of a new warehouse,the purchase and installation of a new converting line, and general corporatepurposes.

 

**Common Stock Outstanding**

 
| March 2004 Orchids Acquisition  Group, Inc. Shares |   | 2,000,000 |   |
|--------------------------------------------------------------|--------|-----------|--------|
| July 2005 Initial Public Common Stock  Offering         |   | 2,156,250 |   |
| July 2006 3-for-2 Stock Split                           |   | 2,078,096 |   |
| August 2009 Common Stock Offering                       |   | 862,500   |   |
| Stock Options and Warrants Exercised                         |   | 389,879   |   |
|                                                         |   | 7,486,725 |   |

 

Theaccompanying financial statements have been prepared without an audit, pursuantto the rules and regulations of the Securities and Exchange Commission (“SEC”).  Certain information and footnote disclosuresnormally included in annual financial statements prepared in accordance withaccounting principles generally accepted (“GAAP”) in the United States havebeen condensed or omitted pursuant to the rules and regulations.  However, the Company believes that thedisclosures made are adequate to make the information presented not misleadingwhen read in conjunction with the audited financial statements and the notes inthe Company’s Annual Report on Form 10-K filed March 12, 2010.  Management believes that the financialstatements contain all adjustments necessary for a fair presentation of theresults for the interim periods presented. All adjustments were of a normal, recurring nature.  The results of operations for the interimperiod are not necessarily indicative of the results for the entire fiscalyear.

 

**Note 2**— **Fair Value Measurements**

 

TheCompany has previously adopted the Financial Accounting Standards Board (“FASB”)Accounting Standards Codification (FASB ASC) 820-10-50 Fair Value Measurements and Disclosures for assets andliabilities which are required to be measured at fair value.  This standard establishes a framework formeasuring fair value and related disclosures. The standard has the followingkey elements:

 

·                  Defines fair value as the exit price thatwould be received to sell an asset or paid to transfer a liability in anorderly transaction between market participants at the measurement date;

 

·                  Establishes a three-level hierarchy (“valuationhierarchy”) for fair value measurements;

 

·                  Requires consideration of the Company’screditworthiness when valuing liabilities; and

 

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·                  Expands disclosures about instrumentsmeasured at fair value.

 

Thevaluation hierarchy considers the transparency of inputs used to value assetsand liabilities as of the measurement date. The less transparent or observablethe inputs used to value assets and liabilities, the lower the classificationof the assets and liabilities in the valuation hierarchy. A financialinstrument’s classification within the valuation hierarchy is based on thelowest level of input that is significant to its fair value measurement. Thethree levels of the valuation hierarchy and the classification of the Company’sfinancial assets and liabilities within the hierarchy are as follows:

 

Level1 - Quoted prices (unadjusted) in active markets for identical assets or liabilitiesthat the reporting entity has the ability to access at the measurement date.

 

Level2 - Observable inputs other than quoted prices included within Level 1 for theasset or liability, either directly or indirectly.  If an asset orliability has a specified term, a Level 2 input must be observable forsubstantially the full term of the asset or liability.

 

Level3 - Unobservable inputs for the asset or liability.

 

TheCompany considers the following to be financial instruments:  cash, short term investments, accountsreceivable, accounts payable and debt. The estimated fair value of such instruments at September 30, 2010approximates their carrying value as reported on the Company’s balance sheet.

 

Thefollowing table presents information about Orchids Paper Products Company’sassets measured at fair value on a recurring basis as of September 30,2010, and indicates the fair value hierarchy of the valuation techniquesutilized to determine such values.  Short term investments are valued asLevel 1 in the fair value hierarchy from independent pricing services utilizedby our investment custodians.

 
| ** **                                      | ** ** | **Fair Value Measurements at September 30, 2010** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                                      | ** ** | **Using Inputs Considered as**                                   | ** ** |
| ** **                                      | ** ** | **Level 1**                                                                | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| ** **                                      | ** ** | **(in thousands)**                                                         | ** ** |
| Assets                                          |       |                                                                            |       |   |   |   |   |
|                                            |       |                                                                            |       |   |   |   |   |
| US Government Guaranteed Certificate of Deposit |       | $                                                                               | 5,000      |   |   |   |   |   |
| Commercial Deposit                              |       | 3,016                                                                           |       |   |   |   |   |
| Certificate of Deposit                          |       | 1,500                                                                           |       |   |   |   |   |
| Total Short Term Investments                    |       | $                                                                               | 9,516      |   | $ | — |   | $ | — |   |
|                                                 |            |                                                                                 |            |  |  |  |  |  |  |  |

 
| ** **                                      | ** ** | **Fair Value Measurements at December 31, 2009** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------------------------------------------|------------|
| ** **                                      | ** ** | **Using Inputs Considered as**                                  | ** ** |
| ** **                                      | ** ** | **Level 1**                                                               | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| ** **                                      | ** ** | **(in thousands)**                                                        | ** ** |
| Assets                                          |       |                                                                           |       |   |   |   |   |
|                                            |       |                                                                           |       |   |   |   |   |
| US Government Guaranteed Certificate of Deposit |       | $                                                                              | 13,000     |   |   |   |   |   |
| Commercial Deposit                              |       | 3,009                                                                          |       |   |   |   |   |
| Certificate of Deposit                          |       | 1,500                                                                          |       |   |   |   |   |
| Money Market                                    |       | 1,000                                                                          |       |   |   |   |   |
| Total Short Term Investments                    |       | $                                                                              | 18,509     |   | $ | — |   | $ | — |   |
|                                                 |            |                                                                                |            |  |  |  |  |  |  |  |

 

**Note 3— Fair Value Financial Instruments**

 

Thecarrying value of the Company’s long-term debt is estimated by management toapproximate fair value based on the obligations’ characteristics, includingfloating interest rate, credit ratings, maturity and collateral.

 

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**Note 4— Commitments and Contingencies**

 

TheCompany is involved from time to time in litigation arising from the normalcourse of business. In management’s opinion, the result from such litigation isnot expected to materially affect the Company’s results of operations orfinancial condition.

 

Inthe fourth quarter of 2008, the Company entered into a contract to purchase334,000 MMBTU per year of natural gas requirements at $7.50 per MMBTU plus a$0.07 per MMBTU management delivery fee for the period from April 2009through March 2011.  The amountrepresents approximately 60% of the Company’s natural gas requirements basedupon expected usage rates for 2009. In November 2009, theagreement was extended for one year to March 2012 for 334,000 MMBTU peryear at a price of $6.50 per MMBTU plus a $0.07 per MMBTU management deliveryfee.  In August 2010, the Company extended thecontract through March 2013 for 334,000 MMBTU per year at a price of $5.50per MMBTU plus a $.07 per MMBTU management delivery fee.

 

If the Company is unable to purchase the contractedamounts and the market price at that time is less than the contracted price,the Company would be obligated under the terms of the agreement to reimburse anamount equal to the volume purchased that was less than the contracted amountmultiplied by the difference between the contract price and current spot price. This fixed price naturalgas contract meets the qualifications of the normal purchases and normal salesexception for derivatives and hedging.

 

**Note 5— Inventories**

 

Inventoriesat September 30, 2010 and December 31, 2009 are as follows:

 
| ** **                  | ** ** | **September 30,**  | ** ** | **December 31,** | ** ** |
|-----------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                  | ** ** | **2010**                | ** ** | **2009**              | ** ** |
| ** **                  | ** ** | **(in thousands)** | ** ** |
| Raw materials               |       | $                       | 1,978      |                  | $          | 1,901 |   |
| Bulk paper rolls            |       | 853                     |       | 908                   |       |
| Converted finished goods    |       | 4,834                   |       | 5,138                 |       |
| Inventory valuation reserve |       | (178                    | )          | (378                  | )          |
|                        |       | $                       | 7,487      |                  | $          | 7,569 |   |

 

**Note 6 — Earnings per Share**

 

Thecomputation of basic and diluted net income per share for the three-month andnine-month periods ended September 30, 2010 and 2009 is as follows:

 
| ** **                                               | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                               | ** ** | **2010**                                                 | ** ** | **2009**                                                | ** ** | **2010** | ** ** | **2009** | ** ** |
| Net income - ($ thousands)                          |       | $                                                        | 1,442      |                                                    | $          | 3,815 |   | $ | 4,974 |   | $ | 10,387 |   |
|                                                     |       |                                                     |       |                                                    |       |   |   |   |   |
| Weighted average shares outstanding                      |       | 7,486,725                                                |       | 6,838,726                                               |       | 7,456,455 |   | 6,562,051 |   |
| Effect of stock options                                  |       | 275,485                                                  |       | 103,749                                                 |       | 301,318 |   | 90,314 |   |
| Effect of dilutive warrants                              |       | —                                                   |       | 361,751                                                 |       | — |   | 302,768 |   |
| Weighted average shares outstanding - assuming  dilution |       | 7,762,210                                                |       | 7,304,226                                               |       | 7,757,773 |   | 6,955,133 |   |
| Net income per share:                                    |       |                                                     |       |                                                    |       |   |   |   |   |
| Basic                                                    |       | $                                                        | 0.20       |                                                    | $          | 0.56 |   | $ | 0.67 |   | $ | 1.58 |   |
| Diluted                                                  |       | $                                                        | 0.18       |                                                    | $          | 0.52 |   | $ | 0.64 |   | $ | 1.49 |   |
|                                                     |       |                                                     |       |                                                    |       |   |   |   |   |
| Anti-dilutive stock options not considered above         |       | 57,250                                                   |       | —                                                  |       | 57,250 |   | 49,750 |   |

 

**Note 7 — Stock Incentive Plan**

 

InApril 2005, the board of directors and the stockholders approved the 2005Stock Incentive Plan (the “Plan”).  ThePlan provides for the granting of incentive stock options to employees selectedby the board’s compensation committee. The Plan authorized up to 697,500 shares to be issued.  In May 2008, the shareholders approvedincreasing the number of authorized shares under the Plan from 

 

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697,500to 897,500.  Options for 20,000 shareswere granted effective January 20, 2009, to an officer of the Company, atan exercise price of $10.205, the fair market value of the stock on the date ofgrant.  The options vest 50% on the firstanniversary date of the grant and 50% on the second anniversary date.  The options have a 10 year life.

 

Thefollowing table details the options granted to certain members of the board ofdirectors and management during the nine months ended September 30, 2010and 2009:

 
| **Grant**  | ** ** | **Number**         | ** ** | **Exercise** | ** ** | **Risk-Free**          | ** ** | **Estimated**  | ** ** | **Dividend** | ** ** | **Expected** | ** ** |
|------------|------------|--------------------|------------|--------------|------------|------------------------|------------|----------------|------------|--------------|------------|--------------|------------|
| **Date**   | ** ** | **of Shares** | ** ** | **Price**    | ** ** | **Interest Rate** | ** ** | **Volatility** | ** ** | **Yield**    | ** ** | **Life**     | ** ** |
|       |       |               |       |         |       |                   |       |           |       |         |       |         |       |
| January-09 |       | 60,000             |       | $            | 10.205     |                   | 2.35       | %              | 46         | %            | None       |         | 5-7  years |   |
| May-09     |       | 49,750             |       | $            | 17.480     |                   | 3.30       | %              | 50         | %            | None       |         | 5-7  years |   |
| January-10 |       | 10,000             |       | $            | 20.825     |                   | 3.82       | %              | 49         | %            | None       |         | 5-7  years |   |
| May-10     |       | 28,750             |       | $            | 13.840     |                   | 3.36       | %              | 49         | %            | None       |         | 5-7  years |   |

 

TheBlack-Scholes option valuation model was developed for use in estimating thefair value of traded options, which have no vesting restrictions and are fullytransferable.  In addition, optionsvaluation models require the input of highly subjective assumptions includingthe expected stock price volatility.

 

Inconnection with the approval of the Plan, the Company expenses the cost ofoptions granted over the vesting period of the option based on the grant-datefair value of the award.  The Companyrecognized expense of $90,000 and $84,000 for the three months endedSeptember 30, 2010 and 2009, respectively, related to options grantedunder the Plan.  The Company recognizedexpense of $473,000 and $518,000 for the nine months ended September 30,2010 and 2009, respectively, related to options granted under the Plan.

 

**Note 8— Major Customers and Concentration of Credit Risk**

 

TheCompany sells primarily all of its paper production in the form of convertedproducts; however, following the start-up of a new paper machine in the summerof 2006, the Company’s paper production capacity exceeded its convertingproduction requirements resulting in excess paper production which it began tosell in parent roll form.  Revenues fromconverted product sales and parent roll sales in the three-month and nine-monthperiods ended September 30, 2010 and 2009 were:

 
| ** **                  | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                  | ** ** | **2010**                                                 | ** ** | **2009**                                                | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                  | ** ** | **(in thousands)**                                  | ** ** | **(in thousands)**                                 | ** ** |
|                        |       |                                                     |       |                                                    |       |   |   |   |   |
| Converted product net sales |       | $                                                        | 19,669     |                                                    | $          | 22,160 |   | $ | 57,492 |   | $ | 65,750 |   |
| Parent roll net sales       |       | 4,854                                                    |       | 2,397                                                   |       | 12,756 |   | 6,578 |   |
| Net sales                   |       | $                                                        | 24,523     |                                                    | $          | 24,557 |   | $ | 70,248 |   | $ | 72,328 |   |

 

Thecredit risk for the Company in the third quarter of 2010 is concentrated with foursignificant customers.  Three arecustomers of the Company’s converted products, each of whom operates discountretail stores located throughout the United States and one is a customer whoaccounts for most of the Company’s third party sales of parent rolls.  During the three months endedSeptember 30, 2010, sales to these four significant customers accountedfor approximately 71% of total sales, comprised of customers of 33%, 16%, 11%and 11%, respectively.  During the threemonths ended September 30, 2009, sales to two of the significant convertedproduct customers plus the purchaser of the majority of our parent rollsaccounted for approximately 62% of total sales, comprised of customers of 34%,18%, and 10%, respectively.

 

Forthe nine months ended September 30, 2010, sales to two significantconverted product customers plus one parent roll customer accounted forapproximately 57% of total sales, comprised of customers of 33%, 14%, and 10%,respectively.  For the nine months endedSeptember 30, 2009, sales to three significant converted product customersaccounted for approximately 57% of total sales, comprised of customers of 30%,16%, and 11%, respectively. At September 30, 2010 and 2009, approximately$5.1 million (68%) and $5.3 million (58%), respectively, of accounts receivablewas due from the significant customers noted.  No other customer of the Company accounted for more than 10% of salesduring these periods.  The Companygenerally does not require collateral from its customers and has not incurredany significant losses on uncollectible accounts receivable.

 

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**Note 9 —Income Tax Receivable**

 

Asof September 30, 2010, the company has classified $2.7 million as anincome tax receivable.  In September 2010,the eligibility period for Bonus depreciation was extended which resulted in asignificant decrease in the Company’s current tax liability. The extension ofthe eligibility period occurred after the Company made quarterly tax paymentsfor the first, second, and third quarters of 2010.

 

**Note 10— New Accounting Standards**

 

TheFinancial Accounting Standards Board (“FASB”) periodically issues newaccounting standards in a continuing effort to improve standards of financialaccounting and reporting. We have reviewed the recently issued pronouncementsand concluded that no new standards were issued this quarter that applied tothe Company.

 

InJanuary 2010, the Financial Accounting Standards Board (“FASB”) issuedguidance to amend the disclosure requirements related to recurring andnonrecurring fair value measurements. The guidance requires newdisclosures on the transfers of assets and liabilities between Level 1 andLevel 2 of the fair value measurement hierarchy, including the reasons and thetiming of the transfers. Additionally, the guidance requires a rollforward of activities on purchases, sales, issuance, and settlements of theassets and liabilities measured using significant unobservable inputs. Theguidance became effective for us with the reporting period beginningJanuary 1, 2010, except for the disclosure on the roll forward activitiesfor Level 3 fair value measurements, which will become effective for us withthe reporting period beginning January 1, 2011. Other than requiringadditional disclosures, adoption of this new guidance did not have a materialimpact on our financial statements.

 

**ITEM 2.  Management’s Discussionand Analysis of Financial Condition and Results of Operations**

 

**Forward-Looking Information**

 

Thefollowing Management’s Discussion and Analysis of Financial Condition andResults of Operations contains forward-looking statements.  These statements relate to, among otherthings:

 

·                  our businessstrategy;

·                  the marketopportunity for our products, including expected demand for our products;

·                  our estimatesregarding our capital requirements; and

·                  any of ourother plans, objectives, and intentions contained in this report that are nothistorical facts.

 

Thesestatements relate to future events or future financial performance, and involveknown and unknown risks, uncertainties and other factors that may cause ouractual results, levels of activity, performance or achievements to be materiallydifferent from any future results, levels of activity, performance orachievements expressed or implied by such forward-looking statements.  In some cases, you can identifyforward-looking statements by terminology such as “may,” “should,” “could,” “expects,”“plans,” “intends,” “anticipates,” “believes,” “estimates,” “predicts,” “potential”or “continue” or the negative of such terms or other comparableterminology.  Although we believe thatthe expectations reflected in the forward-looking statements are reasonable, wecannot guarantee future results, levels of activity, performance orachievements.  These statements are onlypredictions.

 

Youshould not place undue reliance on forward-looking statements because theyinvolve known and unknown risks, uncertainties, and other factors that are, insome cases, beyond our control and that could materially affect actual results,levels of activity, performance or achievements.  Factors that could materially affect ouractual results, levels of activity, performance or achievements include,without limitation, those detailed under the caption “Risk Factors” in ourAnnual Report on Form 10-K for the fiscal year ended December 31,2009, as filed with the SEC on March 12, 2010, and include the followingitems:

 

·                  intensecompetition in our market and aggressive pricing by our competitors could forceus to decrease our prices and reduce our profitability;

·                  a substantialpercentage of our converted product revenues are attributable to a small numberof customers which may decrease or cease purchases at any time;

·                  disruption inour supply or increase in the cost of waste paper;

·                  increasedcompetition in our region;

·                  changes in ourretail trade customers’ policies and increased dependence on key retailers indeveloped markets;

·                  indebtednesslimits our free cash flow and subjects us to restrictive covenants relating tothe operation of our business;

·                  theavailability of and prices for energy;

·                  failure topurchase the contracted quantity of natural gas may result in financialexposure;

·                  our exposure tovariable interest rates;

 

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·                  the loss of keypersonnel;

·                  labor interruption;

·                  naturaldisaster or other disruption to our facility;

·                  ability tofinance the capital requirements of our business;

·                  cost to complywith existing and new laws and regulations;

·                  failure tomaintain an effective system of internal controls necessary to accuratelyreport our financial results and prevent fraud;

·                  the parent rollmarket is a commodity market and subject to fluctuations in demand and pricing;

·                  excess supplyin the market may reduce our prices;

·                  an inability tocontinue to implement our business strategies;

·                  inability tosell the capacity generated from our new converting line; and

·                  a significantdecline in sales causing us to no longer need the new converting line.

 

Ifany of these risks or uncertainties materialize, or if our underlyingassumptions prove to be incorrect, actual results may vary significantly fromwhat we projected.  Any forward-lookingstatement you read in the following Management’s Discussion and Analysis ofFinancial Condition and Results of Operations reflects our current views withrespect to future events and is subject to these and other risks,uncertainties, and assumptions relating to our operations, results ofoperations, growth strategy, and liquidity. We assume no obligation to publicly update or revise theseforward-looking statements for any reason, whether as a result of newinformation, future events, or otherwise.

 

**Overview**

 

Weare an integrated manufacturer of private label tissue products, includingpaper towels, bathroom tissue and paper napkins for the consumer, or “at-home,”market. We produce bulk tissue paper, known as parent rolls and convert parentrolls into finished products. Historically, we have tailored our operations toserve a core customer base of dollar stores and other discount retailers. Wehave focused on the dollar stores or value retailers and discount retail marketbecause of their consistent order patterns and low number of stock keepingunits or SKUs in this market. By dollar stores, we mean retailers that offer alimited selection across a broad range of products at everyday low prices in asmaller store format.  In mid-2010, wecompleted the purchase and installation of a new converting line to increaseour converted product capacity, increase our product offerings and providehigher quality products, which is discussed in more detail in the backgroundsection.  The production from the newline provides the capability to supply converted products into the higherquality, mid-tier product category to both existing and new customers.

 

Whilewe have customers located throughout the United States, most of our productsare distributed within an approximate 900-mile radius of our Oklahoma facility.However, our sales efforts are focused on an area within approximately 500miles of our facility in northeast Oklahoma, which includes Texas, Oklahoma,Kansas, Missouri, Arkansas, Nebraska and Iowa. Because we are one of the fewtissue paper manufacturers in this area, we typically have lower freight coststo our customers’ distribution centers located in our target region. At-hometissue market growth has historically been closely correlated to populationgrowth and as such, performs well in a variety of economic conditions. Ourtarget region has experienced strong population growth in the past five yearsrelative to the national average and these trends are expected to continue.

 

Ourproducts are sold primarily under our customers’ private labels and, to alesser extent, under our brand names such as Colortex®, My Size®, Velvet®, Big Mopper®, Tackle®, and care®.  All of our converted product revenue isderived pursuant to truck load purchase orders from our customers.  Parent roll revenue is derived from purchaseorders that generally cover a one month time period. We do not have supply contractswith any of our customers. Revenue is recognized when title passes to thecustomer. Because our product is a daily consumable item, the order stream fromour customer base is fairly consistent with no significant seasonalfluctuations. Changes in the national economy, in general, do not materiallyaffect the market for our converted products.

 

Ourprofitability depends on several key factors, including:

 

·                  the marketprice of our product;

·                  the cost ofwaste paper used in producing paper;

·                  the efficiencyof operations in both our paper mill and converting operations; and

·                  the cost ofenergy.

 

Theprivate label segment of the tissue industry is highly competitive, anddiscount retail customers are extremely price sensitive.  As a result, it is difficult to affect priceincreases.  We expect these competitiveconditions to continue.

 

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**Background**

 

SinceJune 2006, when we began operations of a new paper machine, ourpaper-making capacity of approximately 56,000 tons per year has exceeded thedemand requirements of our converting operations. Any excess supply is soldinto the market in the form of a parent roll. We adjust our paper making production based on our internal convertingneeds for parent rolls and the open market demand for parent rolls. Parentrolls are a commodity product and thus are subject to market pricing.  We plan to continue to sell any excess parentroll capacity on the open market as long as market pricing is profitable.

 

Ourparent rolls are processed into paper towels, bathroom tissue and napkins inour adjacent converting facility. Our strategy is to sell all of our parentroll capacity as converted products which generally carry higher margins thanparent rolls. To help achieve that goal, we continue to focus considerableefforts to improve our converting efficiencies and have realized incrementalimprovements in production output over the last two years.  In addition, we are placing significant focuson improving our sales efforts to sell this additional capacity.

 

Ourstrategy is to expand our position as a low cost provider of private labeltissue products to the growing discount retail channel within our geographicarea while leveraging our competitive advantages to increase our presence inother retail channels.  This will beaccomplished through our continued high service levels, increased totalmanufacturing capacity and expansion of our highly perceived value productoffering.

 

Weintend to implement this strategy through our key initiatives set forth below:

 

·  maintain and strengthen ourcore customer relationships;

·  increase our flexibility tomeet a wider array of customer needs;

·  further expand our customerbase in other retail channels; and

·  continue to improve operatingefficiencies and reduce manufacturing costs.

 

Sinceour inception in 1998, we have strategically expanded capacity to meetdemand.  We have recently completed anexpansion project which added an eleventh converting line to our convertingcapacity and a 245,000 square foot warehouse.  The new line has a rated annual capacity ofapproximately four million cases of either kitchen towel or bathroom tissueproducts, bringing our total annual converting capacity to approximately twelvemillion cases from eleven lines.  The newline provides higher quality products and broadens our product offerings tosupply the higher-quality, mid-tier market segment through increased packagingconfigurations, enhanced graphics and improved embossing.  We expect to sell the majority of the outputfrom this new line to new customers, particularly in the grocery segment.  Start-up of the new line began in July 2010.  The completion of the new warehouse hasallowed us to consolidate all warehousing and shipping in our Pryor location,thereby eliminating third-party warehouse charges beginning in September.

 

Althoughwe have an annual converting capacity of approximately 12 million cases, our inhouse supply of parent rolls provides enough to convert only approximately 10million cases.  In order to convert at anannual capacity above approximately 10 million cases, we must supplement oursupplies by purchasing parent rolls in the open market.

 

**ComparativeThree-Month Periods Ended September 30, 2010 and 2009**

 

**NetSales**

 
| ** **                  | ** ** | **Three Months Ended September 30,** | ** ** |
|-----------------------------|------------|----------------------------------------------------------|------------|
| ** **                  | ** ** | **2010**                                                 | ** ** | **2009** | ** ** |
| ** **                  | ** ** | **(in thousands, except average**         | ** ** |
| ** **                  | ** ** | **price per ton and tons)**          | ** ** |
| Converted product net sales |       | $                                                        | 19,669     |   | $ | 22,160 |   |
| Parent roll net sales       |       | 4,854                                                    |       | 2,397 |   |
| Total net sales             |       | $                                                        | 24,523     |   | $ | 24,557 |   |
|                        |       |                                                     |       |   |   |
| Total tons shipped          |       | 14,720                                                   |       | 13,755 |   |
| Average price per ton       |       | $                                                        | 1,666      |   | $ | 1,785 |   |

 

Netsales in the quarter ended September 30, 2010 were $24.5 million whichremained fairly flat from the prior year quarter net sales of $24.6million.  Net sales figures represent thegross selling price, including freight, less discounts and pricingallowances.  Net sales of convertedproduct decreased in the quarter ended September 30, 2010 by $2.5 million,or 11.2% to $19.7 million compared to $22.2 

 

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millionin the same period last year.  Net salesof parent rolls increased $2.5 million or 102.5% to $4.9 million in the quarterended September 30, 2010 compared to $2.4 million in the same period lastyear.  The decrease in net sales ofconverted product primarily resulted from a 10.8% decrease in tonnageshipped.  The net selling price per tonwas essentially flat in the year over year quarterly comparison.  The lower converted product shipment tonnageresulted from a promotional program by a major customer in the third quarter oflast year which did not recur this year and continued aggressive promotionalpricing by branded producers.  Net sales ofparent rolls increased as a result of a 66.6% increase in parent roll tonnageshipped, as well as a 21.6% increase in the net selling price.  Parent roll sales benefited from the lowerrequirements of our converting operation which resulted in more excess parentroll tons being available for sale.  Astronger away-from-home market and higher waste paper prices were the principalreasons for the increase in parent roll pricing.

 

Totaltons shipped in the third quarter of 2010 increased by 7.0% compared to thesame period of 2009.  The increase intotal tonnage shipped was the result of a stronger parent roll market whichallowed us to run all of our paper machines on a full-time basis in the thirdquarter of 2010 compared to the prior year quarter when we incurredintermittent downtime on some of our older paper machines due to the softparent roll market in order to balance our parent roll production with marketdemand.  As a result, the lower tonnageshipment of converted product in the third quarter of 2010 was more than offsetby the higher tonnage shipments of excess parent rolls.

 

**Cost ofSales**

 
| ** **                                      | ** ** | **Three Months Ended September 30,** | ** ** |
|-------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                      | ** ** | **2010**                                                 | ** ** | **2009** | ** ** |
| ** **                                      | ** ** | **(in thousands, except**                      | ** ** |
| ** **                                      | ** ** | **gross profit margin %**                 | ** ** |
| ** **                                      | ** ** | **and paper cost per ton)**          | ** ** |
| Cost of paper                                   |       | $                                                        | 11,324     |   | $ | 9,329 |   |
| Non-paper materials, labor, supplies, etc. |       | 7,474                                                    |       | 6,796 |   |
| Sub-total                                       |       | 18,798                                                   |       | 16,125 |   |
| Depreciation                                    |       | 1,696                                                    |       | 1,003 |   |
| Cost of sales                                   |       | $                                                        | 20,494     |   | $ | 17,128 |   |
|                                            |       |                                                     |       |   |   |
| Gross Profit                                    |       | $                                                        | 4,029      |   | $ | 7,429 |   |
| Gross Profit Margin %                           |       | 16.4                                                     | %          | 30.3 | % |
| Total paper cost per ton consumed               |       | $                                                        | 773        |   | $ | 678 |   |

 

Themajor components of cost of sales are the cost of internally produced paper,raw materials, direct labor and benefits, freight costs of products shipped tocustomers, insurance, repairs and maintenance, energy, utilities anddepreciation.

 

Costof sales increased approximately $3.4 million, or 19.7%, to $20.5 million forthe quarter ended September 30, 2010, compared to $17.1 million in thesame period of 2009.  This increase incost of sales was primarily attributable to higher cost of paper, higherconverting production costs due to lower production levels, and higherdepreciation expense, which was partially offset by decreased external warehouseexpenses.   As a percentage of net sales,cost of sales increased to 83.6% of net sales in the 2010 quarter from 69.7% ofnet sales in the 2009 quarter.  Cost ofsales as a percentage of net sales for the third quarter of 2010 wasunfavorable to the prior year quarter primarily due to higher paper productioncosts.

 

Ouroverall cost of paper in the third quarter of 2010 was $773 per ton, anincrease of $95 per ton compared to the same period in 2009.  The primary reason for the increased cost ofpaper production is higher waste paper prices. Our cost of waste paper in the third quarter of 2010 was 38% higher thanthe same quarter in 2009, resulting in an increase in cost of sales ofapproximately $1.5 million.  Following asharp decrease in waste paper prices in the first half of 2009, waste paperprices began to rise in the third quarter of last year.  However, compared to the second quarter of2010, our cost of waste paper was relatively flat in the third quarter of 2010.

 

Depreciationexpense increased primarily because the new converting line assets were placedin service in the third quarter of 2010.  Largely due to lower converting production requirements and, to a lesserextent, additional staffing for our new converting line, converting productioncosts increased 24% in the third quarter of 2010 compared to the prior yearquarter.    External warehousing costsdecreased by $325,000 due to the phasing out of a third-party warehouse duringthe current year quarter.  Usage of athird-party warehouse was ceased in September and we are now warehousingand shipping all converted product from our Pryor, Oklahoma location.

 

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**GrossProfit**

 

Grossprofit in the quarter ended September 30, 2010, decreased $3.4 million, or45.8%, to $4.0 million compared to $7.4 million in the same period lastyear.  Gross profit as a percentage ofnet sales in the 2010 quarter was 16.4% compared to 30.3% in the 2009quarter.  The gross profit decrease as apercent of net sales was primarily the result of higher waste paper prices,lower converted product shipments, which also caused an increase in per caseconverting production costs, a higher percentage of lower margin parent rollsales, and higher depreciation expense.

 

**Selling,General and Administrative Expenses**

** **
| ** **                          | ** ** | **Three Months Ended September 30,** | ** ** |
|-------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                          | ** ** | **2010**                                                 | ** ** | **2009** | ** ** |
| ** **                          | ** ** | **(in thousands, except SG&A**        | ** ** |
| ** **                          | ** ** | **as a % of net sales)**        | ** ** |
| ** **                          | ** ** | ** **                                               | ** ** | ** ** | ** ** |
| Commission expense                  |       | $                                                        | 310        |   | $ | 329 |   |
| Other SG&A expenses             |       | 1,339                                                    |       | 1,443 |   |
| Selling, General & Adm exp |       | $                                                        | 1,649      |   | $ | 1,772 |   |
| SG&A as a % of net sales        |       | 6.7                                                      | %          | 7.2 | % |

 

Selling,general and administrative expenses include salaries, commissions to brokersand other miscellaneous expenses. Selling, general and administrative expenses decreased $123,000, or6.9%, to $1.6 million in the quarter ended September 30, 2010 compared to$1.8 million in the comparable 2009 period. The decrease was primarily due to decreased accruals under our incentivebonus plan, which was partially offset by higher artwork and packaging relatedcosts.

 

**OperatingIncome**

 

Asa result of the foregoing factors, operating income for the quarter endedSeptember 30, 2010 decreased $3.3 million to $2.4 million, compared to$5.7 million in the same period in 2009.

 

**InterestExpense and Other Income**

 
| ** **                 | ** ** | **Three Months Ended September 30,** | ** ** |
|----------------------------|------------|----------------------------------------------------------|------------|
| ** **                 | ** ** | **2010**                                                 | ** ** | **2009** | ** ** |
| ** **                 | ** ** | **(in thousands)**                                  | ** ** |
| Interest expense           |       | $                                                        | 249        |   | $ | 174 |   |
| Other income, net          |       | $                                                        | (24        | ) | $ | (5 | ) |
|                       |       |                                                     |       |   |   |
| Income before income taxes |       | $                                                        | 2,155      |   | $ | 5,488 |   |

 

Interestexpense includes interest on all debt and amortization of deferred debtissuance costs.  Interest expenseincreased $75,000 to $249,000 in the quarter ended September 30, 2010,compared to $174,000 in the quarter ended September 30, 2009.  The primary reason for the increase ininterest expense was our higher total debt as a result of the full quarterinclusion of the waste water treatment and warehouse construction loans.

 

**IncomeBefore Income Taxes**

 

Asa result of the foregoing factors, income before income taxes decreased $3.3million to $2.2 million in the quarter ended September 30, 2010, comparedto $5.5 million in the same period in 2009.

 

**IncomeTax Provision**

 

Asof September 30, 2010, we estimate our full-year effective income tax rateto be 30.1%.  The effective rate includesthe effects of the recently passed extension of the bonus depreciation rule,which has lowered the current tax portion of our tax liability to 2.6 %.  Our full-year estimated rate is lower thanthe statutory rate because of the Oklahoma Investment Tax Credits associatedwith capital equipment investments and the Section 199 manufacturingdeduction.  The Oklahoma Investment TaxCredits offset our Oklahoma state tax liability.  Our effective rate does not reflect theFederal Indian Employment Credits (“IEC”) as this tax regulation expired as 

 

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ofDecember 31, 2009 and has not been reauthorized for 2010.  As of September 30, 2009, our annualeffective income tax rate was 33.2%.

 

**ComparativeNine-Month Periods Ended September 30, 2010 and 2009**

 

**NetSales**

 
| ** **                  | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------|------------|---------------------------------------------------------|------------|
| ** **                  | ** ** | **2010**                                                | ** ** | **2009** | ** ** |
| ** **                  | ** ** | **(in thousands, except average**        | ** ** |
| ** **                  | ** ** | **price per ton and tons)**         | ** ** |
| Converted product net sales |       | $                                                       | 57,492     |   | $ | 65,750 |   |
| Parent roll net sales       |       | 12,756                                                  |       | 6,578 |   |
| Net sales                   |       | $                                                       | 70,248     |   | $ | 72,328 |   |
|                        |       |                                                    |       |   |   |
| Total tons shipped          |       | 42,513                                                  |       | 38,481 |   |
| Net selling price per ton   |       | $                                                       | 1,652      |   | $ | 1,880 |   |

 

Netsales decreased 2.9% to $70.2 million in the nine months ended September 30,2010, compared to $72.3 million in the same period of 2009.  Net sales figures represent gross sellingprice, including freight, less discounts and pricing allowances.  Net sales of converted product decreased forthe nine months ended September 30, 2010, by $8.3 million, or 12.6%, to$57.5 million compared to $65.8 million in the same period last year.  Net sales of parent rolls increased $6.2million, or 93.9%, to $12.8 million in the nine months ended September 30,2010 compared to $6.6 million in the same period last year.  Net sales of converted product were negativelyaffected by an 8% decrease in tonnage shipped and a 5% decrease in net sellingprices.  The reduction in tonnageshipments was due to the factors cited in the quarterly discussion.  The reduction in selling prices was primarilyproduct mix related.  Net sales of parentrolls benefited from the lower requirements from our converting operation andfrom a 6% increase in net selling prices.

 

Totalshipments in the nine-month period of 2010 increased by 4,032 tons, or 10.5%,to 42,513 tons compared to 38,481 tons in the same period of 2009.  The overall increase in tonnage shipped isdue to the factors cited in the quarterly discussion.

 

**Cost of Sales**

 
| ** **                                      | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                      | ** ** | **2010**                                                | ** ** | **2009** | ** ** |
| ** **                                      | ** ** | **(in thousands, except**                     | ** ** |
| ** **                                      | ** ** | **gross profit margin %**                | ** ** |
| ** **                                      | ** ** | **and paper cost per ton)**         | ** ** |
| Cost of paper                                   |       | $                                                       | 32,415     |   | $ | 25,763 |   |
| Non-paper materials, labor, supplies, etc. |       | 20,894                                                  |       | 22,235 |   |
| Sub-total                                       |       | $                                                       | 53,309     |   | $ | 47,998 |   |
| Depreciation                                    |       | 3,974                                                   |       | 2,641 |   |
| Cost of sales                                   |       | $                                                       | 57,283     |   | $ | 50,639 |   |
|                                            |       |                                                    |       |   |   |
| Gross profit                                    |       | $                                                       | 12,965     |   | $ | 21,689 |   |
| Gross profit margin %                           |       | 18.5                                                    | %          | 30.0 | % |
| Total paper cost per ton consumed               |       | $                                                       | 783        |   | $ | 669 |   |

 

Themajor components of cost of sales are the cost of internally produced paper,raw materials, direct labor and benefits, freight costs of products shipped tocustomers, insurance, repairs and maintenance, energy, utilities anddepreciation.

 

Costof sales increased approximately $6.6 million, or 13.1%, to $57.3 million forthe nine months ended September 30, 2010, compared to $50.6 million in thesame period of 2009.  As a percentage ofnet sales, cost of sales increased to 81.5% of net sales in the nine-monthperiod ended September 30, 2010 from 70.0% of net sales in the nine-monthperiod ended September 30, 2009. The increase in cost of sales as a percentage of net sales in the ninemonths ended September 30, 2010 was primarily attributed to higher wastepaper prices, higher converting production costs due to lower productionlevels, a higher percentage of parent roll sales, and higher depreciationexpense.

 

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Inthe nine months ended September 30, 2010, our overall cost of paper was$783 per ton, an increase of $114 per ton compared to the same period in2009.  Our increased production cost perton was primarily associated with a 48% increase in our cost of waste paper,which accounted for $4.9 million in increased cost of sales.  Converting production costs increased for thefirst nine months of 2010 compared to the same period in 2009 by approximately14% on a per unit basis for the same reasons cited in the quarterlydiscussion.  The previously discussedincrease in the percentage of parent roll production being sold as a parentroll negatively affected our gross margin percentage.  Depreciation expense increased $1.3 millionin the first nine months of 2010 compared to the same period last year due tothe new converting line assets being placed in service in the third quarter aswell as other major capital projects. External warehousing costs decreased by approximately $520,000 in thenine months ended September 30, 2010 compared to the same period in 2009due to the previously discussed phasing out of the use of a third partywarehouse.

 

**GrossProfit**

 

Grossprofit in the nine months ended September 30, 2010, decreased $8.7million, or 40.2 %, to $13.0 million compared to $21.7 million in the sameperiod last year.  Gross profit as apercentage of net sales in the nine-month period ended September 30, 2010,was 18.5% compared to 30.0% in the same period in 2009.  The effect of higher waste paper prices,lower converted product shipments, and a higher percentage of lower marginparent roll sales and higher depreciation expense all contributed to thedecrease in gross profit as a percentage of net sales.

 

**Selling,General and Administrative Expenses**

 
| ** **                          | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                          | ** ** | **2010**                                                | ** ** | **2009** | ** ** |
| ** **                          | ** ** | **(in thousands, except SG&A**       | ** ** |
| ** **                          | ** ** | **as a % of net sales)**       | ** ** |
| Commission expense                  |       | $                                                       | 940        |   | $ | 1,007 |   |
| Other SG&A expenses             |       | 4,285                                                   |       | 4,682 |   |
| Selling, General & Adm exp |       | $                                                       | 5,225      |   | $ | 5,689 |   |
| SG&A as a % of net sales        |       | 7.4                                                     | %          | 7.9 | % |

 

Selling,general and administrative expenses include salaries, commissions to brokersand other miscellaneous expenses.  Selling, general and administrative expensesdecreased $464,000, or 8.2%, to $5.2 million in the nine months ended September 30,2010, compared to $5.7 million in the comparable 2009 period.  The decrease is mainly attributable to loweraccruals under our incentive bonus plans due to lower earnings, and decreasedstock option expense primarily due to a decrease in the price of our stock,which was partially offset by an increase in artwork and packaging relateddesign cost.  As a percentage of netsales, selling, general and administrative expenses decreased to 7.4% in thenine months ended September 30, 2010, compared to 7.9% in the same periodof 2009.

 

**OperatingIncome**

 

Asa result of the foregoing factors, operating income for the nine months ended September 30,2010 was $7.7 million compared to operating income of $16.0 million for thesame period of 2009.

 

**InterestExpense and Other Income**

 
| ** **                 | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------|------------|---------------------------------------------------------|------------|
| ** **                 | ** ** | **2010**                                                | ** ** | **2009** | ** ** |
| ** **                 | ** ** | **(in thousands)**                                 | ** ** |
| Interest expense           |       | $                                                       | 675        |   | $ | 468 |   |
| Other income, net          |       | $                                                       | (51        | ) | $ | (9 | ) |
|                       |       |                                                    |       |   |   |
| Income before income taxes |       | $                                                       | 7,116      |   | $ | 15,541 |   |

 

Interestexpense increased by $207,000 from $468,000 in the nine months ended September 30,2009, to $675,000 in the same period in 2010. The increase was primarily attributable to higher interest rates andhigher levels of debt as a result of the construction loans.

 

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**IncomeBefore Income Taxes**

 

Asa result of the foregoing factors, income before income taxes decreased $8.4million to $7.1 million in the nine months ended September 30, 2010,compared to $15.5 million in the same period in 2009.

 

**IncomeTax Provision**

 

Asof September 30, 2010, we estimate our full-year effective income tax rateto be 30.1%.    It is lower than thestatutory rate because of Oklahoma Investment Tax Credits associated with ourinvestment in 2006 in a paper machine as well as continued capital investmentin our mill and converting production facilities, and the Section 199manufacturing credits.  For the ninemonths ended September 30, 2009, our effective income tax rate was 33.1%.

 

**Liquidityand Capital Resources**

 

Liquidityrefers to the liquid financial assets available to fund our business operationsand pay for near-term obligations.  Theseliquid financial assets consist of cash and short term investments as well asunused borrowing capacity under our revolving credit facility.  Our cash requirements have historically beensatisfied through a combination of cash flows from operations and debtfinancings.

 

OnApril 12, 2010, the board of directors approved an expansion of our wastewater treatment facility costing approximately $2.6 million.  The expansion, which includes an additionalwater clarifying tank, an aeration basin and new diffused air system, increasesthe capacity of our facility by approximately 50% and will provide us with anability to independently meet our water discharge permit limits.  We began this expansion project early in thethird quarter and expect completion by the end of the fourth quarter of2010.  Subsequently, we amended ourcredit agreement in June 2010, which among other things, increased ourcapital expenditures limit for the current year.  Cash outlays to date for this project havebeen approximately $1.1 million.

 

Duringthe nine months ended September 30, 2010, cash decreased $1.2 million. Inaddition, we utilized $9.0 million of short term investments in theperiod.   The primary driver of this useof cash and short term investments was capital projects for which we spent$23.2 million in the first nine months of 2010, including $14.1 million for thenew converting line, $4.3 million for the new warehouse and $1.1 million forthe waste water treatment plant expansion. Additional funding for the warehouseproject was provided from borrowings of $5.2 million under a construction loanwhich provides funding for 80% of the construction cost of the warehouse.  Capital expenditures for the fourth quarterof 2010 are expected to be approximately $3.3 million.  The capital expenditures estimate for thefourth quarter includes $500,000 for the new converting line, $1.4 million onthe waste water treatment expansion project and $1.4 million for normal,recurring projects.

 

Asof September 30, 2010, total debt outstanding was $25.9 million.  Cash and short-term investments as of September 30,2010, totaled $9.5 million, resulting in a net debt level of $16.4million.  The revolving credit facilityand Term Loan B have termination dates of April 2011, and accordingly theoutstanding balances of these two loans of $292,000 and $7.9 million,respectively, have been classified as current obligations in the accompanyingbalance sheet.    It is our intention torefinance the entire credit facility by early 2011.

 

Asof September 30, 2010, approximately $2.7 million was recorded as aFederal income tax receivable.  Thereceivable resulted from the extension of the eligibility period for Bonus depreciation,which significantly decreased our current federal income tax liability.  The extension occurred after deposits weremade for the first three quarters of 2010. A refund of this receivable is expected after the filing of the 2010federal tax return in mid-2011.

 

Thefollowing table summarizes key cash flow information for the nine-month periodsended September 30, 2010 and 2009:

 
| ** **                       | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------------|------------|---------------------------------------------------------|------------|
| ** **                       | ** ** | **2010**                                                | ** ** | **2009** | ** ** |
| ** **                       | ** ** | **(in thousands)**                                 | ** ** |
|                             |       |                                                    |       |   |   |
| Cash flow provided by (used in): |       |                                                    |       |   |   |
| Operating activities             |       | $                                                       | 10,520     |   | $ | 14,060 |   |
|                             |       |                                                    |       |   |   |
| Investing activities             |       | $                                                       | (14,390    | ) | $ | (29,056 | ) |
|                             |       |                                                    |       |   |   |
| Financing activities             |       | $                                                       | 2,644      |   | $ | 15,302 |   |

 

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Cashflows provided by operating activities was $10.5 million in the nine-monthperiod ended September 30, 2010, which primarily resulted from earningsbefore non-cash charges and an increase in accounts payable which was partiallyoffset by an increase in accounts receivable. The increase in both accounts receivable and accounts payable areprimarily related to timing.

 

Cashflows used in investing activities was $14.4 million in the first nine monthsof 2010 largely due to $23.4 million in expenditures on capital projects,primarily for our converting expansion project. We used $9.0 million of short-term investments to help finance thisproject.

 

Cashflows provided by financing activities was $2.6 million in the nine-monthperiod ended September 30, 2010, which consisted primarily of $5.2 millionof borrowings on a construction loan for our finished goods warehouse.  This inflow was partially offset by $2.8million of principal payments on term loans.

 

Cashflows provided by operating activities was $14.1 million in the nine-monthperiod ended September 30, 2009, which primarily resulted from earningsbefore non-cash charges which was partially offset by an increase in accountsreceivable.

 

Cashflows used in investing activities was $29.1 million in the first nine monthsof 2009 due to the purchase of $22.5 million in short-term investments from theproceeds from our common stock offering as well as from cash provided fromoperations.  Additionally, we had $6.6million in expenditures on capital projects, primarily for the construction ofthe waste water treatment facility, which was completed in August.

 

Cashflows provided by financing activities was $15.3 million in the nine-monthperiod ended September 30, 2009, which was primarily attributable to $14.8million in net proceeds from our common stock offering and $3.8 million ofborrowings under a construction loan related to the waste water treatment plantproject.  These inflows were partiallyoffset by principal payments of $2.3 million on our term loans and a $1.5million repayment on our revolving line of credit.

 

**CriticalAccounting Policies and Estimates**

 

Thepreparation of our financial statements and related disclosures in conformitywith accounting principles generally accepted (“GAAP”) in the United Statesrequires management to make estimates and judgments that affect our reportedamounts of assets and liabilities, revenue and expense, and related disclosuresof contingent assets and liabilities.  Onan ongoing basis, we evaluate our estimates and assumptions based uponhistorical experience and various other factors and circumstances.  Management believes that our estimates andassumptions are reasonable under the circumstances; however, actual results mayvary from these estimates and assumptions under different futurecircumstances.  We have identified thefollowing critical accounting policies that affect the more significantjudgments and estimates used in the preparation of our financial statements:

 

*AccountsReceivable*.  Accountsreceivable consist of amounts due to us from normal business activities.  Our management must make estimates ofaccounts receivable that will not be collected. We perform ongoing credit evaluations of our customers and adjust creditlimits based upon payment history and the customer’s creditworthiness asdetermined by our review of their current credit information.  We continuously monitor collections andpayments from our customers and maintain an allowance for estimated losses basedon historical experience and specific customer collection issues that we haveidentified.  Trade receivables arewritten-off when all reasonable collection efforts have been exhausted,including, but not limited to, external third party collection efforts andlitigation.  While such credit losseshave historically been within management’s expectations and the allowanceprovided, there can be no assurance that we will continue to experience thesame credit loss rates as in the past. During the nine-month periods ended September 30, 2010 and 2009,provisions for doubtful accounts were recognized in the amount of $45,000 and$46,000 respectively. In the first nine months of 2010, no recoveries ofpreviously written off accounts were received. In the first nine months of 2009, $3,000 of recoveries werereceived.  No accounts receivablebalances were written off in nine-month period of 2010 and $39,000 were writtenoff in the same period ended September 30, 2009.

 

*Inventory.*  Our inventory consists of finished goods andraw materials and is stated at the lower of cost or market.  Our management regularly reviews inventoryquantities on hand and records a provision for excess and obsolete inventorybased on the age of the inventory and forecasts of product demand.  A significant decrease in demand could resultin an increase in the amount of excess inventory quantities on hand.  During the first nine months of 2010, $90,000was provided and there were charges totaling $124,000 against the valuationreserve.  During the first nine months of2009, $45,000 was provided and there were charges totaling $233,000 against thevaluation reserve.

 

**NewAccounting Pronouncements**

 

Referto the discussion of recently adopted/issued accounting pronouncements underPart I, Notes to Unaudited Interim Financial Statements Note 10 — NewAccounting Standards.

 

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**Non-GAAPDiscussion**

 

Inaddition to our GAAP results, we also consider non-GAAP measures of ourperformance for a number of purposes.

 

Weuse EBITDA as a supplemental measure of our performance that is not requiredby, or presented in accordance with GAAP. EBITDA should not be considered as analternative to net income, operating income or any other performance measurederived in accordance with GAAP, or as an alternative to cash flows fromoperating activities or a measure of our liquidity.

 

EBITDArepresents net income before net interest expense, income tax expense,depreciation and amortization. We believe EBITDA facilitates operatingperformance comparisons from period to period and company to company byeliminating potential differences caused by variations in capital structures (affectingrelative interest expense), tax positions (such as the impact on periods orcompanies of changes in effective tax rates or net operating losses) and theage and book depreciation of facilities and equipment (affecting relativedepreciation expense).

 

EBITDAhas limitations as an analytical tool, and you should not consider it inisolation, or as a substitute for any of our results as reported underGAAP.  Some of these limitations are:

 

·                                    it does not reflect our cashexpenditures for capital assets;

 

·                                    it does not reflect changesin, or cash requirements for, our working capital requirements;

 

·                                    it does not reflect theinterest expense, or the cash requirements necessary to service interest orprincipal payments on our indebtedness;

 

·                                    although depreciation andamortization are non-cash charges, the assets being depreciated and amortizedwill often have to be replaced in the future, and EBITDA does not reflect cashrequirements for such replacements; and

 

·                                    other companies, includingother companies in our industry, may calculate these measures differently thanwe do, limiting their usefulness as a comparative measure.

 

Becauseof these limitations, EBITDA should not be considered as a measure ofdiscretionary cash available to us to invest in the growth of our business orto reduce our indebtedness.  Wecompensate for these limitations by relying primarily on our GAAP results andusing EBITDA on a supplemental basis.

 

Thefollowing table reconciles EBITDA to net income for the three months ended September 30,2010 and 2009:

 
| ** **               | ** ** | **Three Months Ended September 30,** | ** ** |
|--------------------------|------------|----------------------------------------------------------|------------|
| ** **               | ** ** | **2010**                                                 | ** ** | **2009** | ** ** |
| ** **               | ** ** | **(In thousands,**                                  | ** ** |
| ** **               | ** ** | **except % of net sales)**           | ** ** |
| ** **               | ** ** | ** **                                               | ** ** | ** ** | ** ** |
| Net income               |       | $                                                        | 1,442      |   | $ | 3,815 |   |
| Plus: Interest expense   |       | 249                                                      |       | 174 |   |
| Plus: Income tax expense |       | 713                                                      |       | 1,673 |   |
| Plus: Depreciation       |       | 1,696                                                    |       | 1,003 |   |
| EBITDA                   |       | $                                                        | 4,100      |   | $ | 6,665 |   |
| % of net sales           |       | 16.7                                                     | %          | 27.1 | % |

 

EBITDAdecreased $2.6 million to $4.1 million in the quarter ended September 30,2010, compared to $6.7 million in the same period in 2009.  EBITDA as a percent of net sales decreased to16.7% in the third quarter of 2010 from 27.1% in the same quarter of 2009.  The foregoing factors discussed in the netsales, cost of sales and selling, general and administrative expenses sectionsare the reasons for the decrease in EBITDA for the third quarter of 2010.

 

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Thefollowing table reconciles EBITDA to net income for the nine months endedSeptember 30, 2010 and 2009:

 
| ** **               | ** ** | **Nine Months Ended September 30,** | ** ** |
|--------------------------|------------|---------------------------------------------------------|------------|
| ** **               | ** ** | **2010**                                                | ** ** | **2009** | ** ** |
| ** **               | ** ** | **(In thousands,**                                 | ** ** |
| ** **               | ** ** | **except % of net sales)**          | ** ** |
| ** **               | ** ** | ** **                                              | ** ** | ** ** | ** ** |
| Net income               |       | $                                                       | 4,974      |   | $ | 10,387 |   |
| Plus: Interest expense   |       | 675                                                     |       | 468 |   |
| Plus: Income tax expense |       | 2,142                                                   |       | 5,154 |   |
| Plus: Depreciation       |       | 3,974                                                   |       | 2,641 |   |
| EBITDA                   |       | $                                                       | 11,765     |   | $ | 18,650 |   |
| % of net sales           |       | 16.7                                                    | %          | 25.8 | % |

 

EBITDAdecreased $6.9 million to $11.8 million in the nine months endedSeptember 30, 2010, compared to $18.7 million in the same period of2009.  EBITDA as a percent of net salesdecreased to 16.7% in the current nine-month period from 25.8% in the prioryear nine-month period.  The foregoingfactors discussed in the net sales, cost of sales and selling, general andadministrative sections are the reasons for these changes.

 

Weuse Net Debt as a supplemental measure of our leverage that is not required by,or presented in accordance with, GAAP. Net Debt should not be considered as analternative to total debt, total liabilities or any other performance measurederived in accordance with GAAP. Net Debt represents total debt reduced by cashand short-term investments. We use this figure as a means to evaluate ourability to repay our indebtedness and to measure the risk of our financialstructure.

 

NetDebt represents the amount that Cash and Cash Equivalents is less than totalDebt of the Company. The amounts included in Net Debt calculation are derivedfrom amounts included in the Balance Sheets. We have reported Net Debt becausewe regularly review Net Debt as a measure of the Company’s leverage. However,the Net Debt measure presented in this document may not be comparable tosimilarly titled measures reported by other companies due to differences in thecomponents of the calculation.

 

NetDebt has increased from $3.5 million on December 31, 2009, to $16.4million on September 30, 2010 as a result of a $10.2 million decrease incash and short term investments as the proceeds from our secondary offeringhave been used to purchase our new converting line and 20% of our finishedgoods warehouse.  Our total debt hasincreased $2.7 million as we funded 80% of our warehouse in our credit facilitywhich was partially offset by $2.8 million in principal payments.

 

Thefollowing table presents Net Debt as of September 30, 2010 andDecember 31, 2009:

 
| ** **                     | ** ** | **As of**          | ** ** |
|--------------------------------|------------|-------------------------|------------|
| ** **                     | ** ** | **September 30,**  | ** ** | **December 31,** | ** ** |
| ** **                     | ** ** | **2010**                | ** ** | **2009** | ** ** |
| ** **                     | ** ** | **(in thousands)** | ** ** |
| Current portion long term debt |       | $                       | 8,839      |   | $ | 3,742 |   |
| Long-term debt                 |       | 17,105                  |       | 19,533 |   |
| Total debt                     |       | 25,944                  |       | 23,275 |   |
| Less cash                      |       | (6                      | )          | (1,232 | ) |
| Less short term investments    |       | (9,516                  | )          | (18,509 | ) |
| Net debt                       |       | $                       | 16,422     |   | $ | 3,534 |   |

 

**ITEM 3.  Quantitative andQualitative Disclosures about Market Risk**

 

Therehas been no material change in the information provided in response to Item 7Aof the Company’s Form 10-K for the year ended December 31, 2009.

 

**ITEM 4.  Controls and Procedures**

 

Ourmanagement, under the supervision and with the participation of our chiefexecutive officer and our chief financial officer, has evaluated theeffectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Securities 

 

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ExchangeAct of 1934, as amended), as of the end of the period covered by this QuarterlyReport on Form 10-Q.  Any controlsand procedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired control objectives.  Based on such evaluation, our chief executiveofficer and our chief financial officer have concluded that our disclosurecontrols and procedures were effective as of September 30, 2010.

 

Therewere no changes in the Company’s internal control over financial reporting (asdefined in Rule 13a-15(f) under the Exchange Act) during the quarterended September 30, 2010, that have materially affected, or are reasonablylikely to materially affect, our internal control over financial reporting.

 

**PART II.  OTHER INFORMATION**

 

**ITEM 1.  Legal Proceedings**

 

None

 

**ITEM 1A. Risk Factors**

 

Asof the date of this filing, there have been no material changes from the riskfactors disclosed in the Company’s Annual Report on Form 10-K filed forthe year ended December 31, 2009. We operate in a changing environment that involves numerous known andunknown risks and uncertainties that could materially affect ouroperations.  The risks, uncertainties andother factors set forth in our Annual Report on Form 10-K may cause ouractual results, performances and achievements to be materially different fromthose expressed or implied by our forward-looking statements.  If any of these risks or events occur, ourbusiness, financial condition or results of operations may be adverselyaffected.

 

**ITEM 2.  Unregistered Sales ofEquity Securities and Use of Proceeds**

 

*(a) UnregisteredSales of Equity Securities*

 

None

 

*(b) InitialPublic Offering and Use of Proceeds from the Sale of Registered Securities*

 

None

 

*(c) Repurchasesof Equity Securities*

 

Wedo not have any programs to repurchase shares of our common stock and no suchrepurchases were made during the three months ended September 30, 2010.

 

**ITEM 3.  Defaults Upon SeniorSecurities**

 

None

 

**ITEM 4.  RESERVED**

 

**ITEM 5.  Other Information**

 

None

 

**ITEM 6.  Exhibits**

 

Seethe Exhibit Index following the signature page to thisForm 10-Q, which Exhibit Index is hereby incorporated by referenceherein.

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized. 

 

**ORCHIDS PAPER PRODUCTS COMPANY**

 
| Date: November 3, 2010 | By:    | /s/ Keith R. Schroeder                |
|-----------------------------|--------|---------------------------------------|
|                        |   | Keith R. Schroeder                    |
|                        |   | Chief  Financial Officer              |
|                        |   | (On  behalf of the registrant and  as |
|                        |   | Chief  Accounting Officer)            |

 

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**Exhibit Index**

 
| **Exhibit** | ** ** | **Description**                                                                                                                                                                                                                                                                             |
|-------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1         |       | Amended  and Restated Certificate of Incorporation of the Registrant incorporated by  reference to Exhibit 3.1 to the Registrant’s Registration Statement on  Form S-1 (File No. 333-124173) filed with the Securities and  Exchange Commission on April 19, 2005. |
|        |       |                                                                                                                                                                                                                                                                                        |
| 3.1.1       |       | Amendment  to the Amended and Restated Certificate of Incorporation of the Registrant  incorporated by reference to the Form 10-Q filed with the Securities and  Exchange Commission on August 14, 2007.                                                                          |
|        |       |                                                                                                                                                                                                                                                                                        |
| 3.2         |       | Amended  and Restated Bylaws of the Registrant incorporated by reference to  Exhibit 3.2 to the Registrant’s Registration Statement on Form S-1  (File No. 333-124173) filed with the Securities and Exchange Commission  on April 19, 2005.                       |
|        |       |                                                                                                                                                                                                                                                                                        |
| 10.1        |       | Amendment  Five to Second Amended and Restated Agented Credit Agreement dated  June 1, 2010, incorporated by reference to Orchids Paper Products  Company Form 8-K (File No. 001-32563) filed with the Securities and  Exchange Commission on June 2, 2010.             |
|        |       |                                                                                                                                                                                                                                                                                        |
| 31.1        |       | Certification  of Chief Executive Officer Pursuant to Section 302.                                                                                                                                                                                                                     |
|        |       |                                                                                                                                                                                                                                                                                        |
| 31.2        |       | Certification  of Chief Financial Officer Pursuant to Section 302.                                                                                                                                                                                                                     |
|        |       |                                                                                                                                                                                                                                                                                        |
| 32.1        |       | Certification  of Chief Executive Officer Pursuant to Section 906.                                                                                                                                                                                                                     |
|        |       |                                                                                                                                                                                                                                                                                        |
| 32.2        |       | Certification  of Chief Financial Officer Pursuant to Section 906.                                                                                                                                                                                                                     |

 

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