Table of Contents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

**FORM 10-Q**

** **
| **x** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|--------------------------------------------------------------------------------------------------------|

 

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

 

**OR**

 
| **o** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|-----------------------------------------------------------------------------------------------|

 

**Commission File Number 001-32563**

 

**OrchidsPaper Products Company**

 (Exact name of Registrant asSpecified 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)

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirement for the past 90 days.  Yes x  No o

 

Indicate by check mark whether the registrant has submittedelectronically and posted on its corporate Web site, if any, every InteractiveData File required to be submitted and posted pursuant to Rule 405 ofRegulation S-T during the preceding 12 months. Yes o  No o

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, a non-accelerated filer or a smaller reportingcompany.  See the definitions of “largeaccelerated filer”, “accelerated filer” and “smaller reporting company” inRule 12b-2 of 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 August 2, 2010: 7,486,725 shares.

 

 

 

----

Table ofContents

 

**ORCHIDS PAPER PRODUCTS COMPANY**

**TABLE OF CONTENTS**

**QUARTERLY REPORT ON FORM 10-Q**

**FOR THE THREE AND SIX MONTHS ENDED June 30, 2010**

 
| ** **                             | ** **                                                                                                                                                     | ** ** | **Page** | ** ** |
|----------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| **PART I. FINANCIAL INFORMATION** |                                                                                                                                                           |       |     |
|                                   |                                                                                                                                                           |       |     |       |
| **ITEM 1.**                            | **Financial Statements**                                                                                                                                       |       | **3**    |       |
|                                   |                                                                                                                                                           |       |     |       |
| ** **                             | **Balance Sheets as of June 30, 2010 (Unaudited)  and December 31, 2009**                                                                            |       | **3**    |       |
|                                   |                                                                                                                                                           |       |     |       |
| ** **                             | **Statements of Income  for the three months ended June 30, 2010 and 2009 (Unaudited) and the  six months ended June 30, 2010 and 2009 (Unaudited)** |       | **4**    |       |
|                                   |                                                                                                                                                           |       |     |       |
|                                   | **Statements of Cash  Flows for the six months ended June 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**                                                                                                | ** ** | **22**   | ** ** |
|                                   |                                                                                                                                                           |       |     |       |
| **ITEM 4.**                            | **Controls and  Procedures**                                                                                                                                   | ** ** | **22**   | ** ** |
|                                   |                                                                                                                                                           |       |     |       |
| **PART II.  OTHER INFORMATION**   |                                                                                                                                                           |       |     |
|                                   |                                                                                                                                                           |       |     |       |
| **ITEM 1.**                            | **Legal Proceedings**                                                                                                                                          | ** ** | **22**   | ** ** |
|                                   |                                                                                                                                                           |       |     |       |
| **ITEM 1A.**                           | **Risk Factors**                                                                                                                                               | ** ** | **22**   | ** ** |
|                                   |                                                                                                                                                           |       |     |       |
| **ITEM 2.**                            | **Unregistered  Sales of Equity Securities and Use of Proceeds**                                                                                               | ** ** | **22**   | ** ** |
|                                   |                                                                                                                                                           |       |     |       |
| **ITEM 3.**                            | **Defaults  Upon Senior Securities**                                                                                                                           | ** ** | **23**   | ** ** |
|                                   |                                                                                                                                                           |       |     |       |
| **ITEM 4.**                            | **RESERVED**                                                                                                                                                   | ** ** | **23**   | ** ** |
|                                   |                                                                                                                                                           |       |     |       |
| **ITEM 5.**                            | **Other Information**                                                                                                                                          | ** ** | **23**   | ** ** |
|                                   |                                                                                                                                                           |       |     |       |
| **ITEM 6.**                            | **Exhibits**                                                                                                                                                   | ** ** | **23**   | ** ** |
|                                   |                                                                                                                                                           |       |     |       |
| ** **                             | **Signatures**                                                                                                                                                 |       | **24**   |       |

 

2

----

Table of Contents

 

**PART I. FINANCIALINFORMATION**

 

**ITEM 1.  Financial Statements**

 

**ORCHIDS PAPER PRODUCTS COMPANY**

**BALANCESHEETS**

**(Dollars in thousands, except share data)**

 
| ** **                                                                                                                                          | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                          | ** ** | **2010**          | ** ** | **2009**              | ** ** |
| ** **                                                                                                                                          | ** ** | **(unaudited)**   | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                          |       |              |       |                  |       |
| Current assets:                                                                                                                                     |       |              |       |                  |       |
| Cash                                                                                                                                                |       | $                 | 380        |                  | $          | 1,232 |   |
| Accounts receivable, net of allowance of $239 in  2010 and $209 in 2009                                                                             |       | 7,166             |       | 6,750                 |       |
| Inventories, net                                                                                                                                    |       | 7,584             |       | 7,569                 |       |
| Short term investments                                                                                                                              |       | 9,513             |       | 18,509                |       |
| Prepaid expenses                                                                                                                                    |       | 776               |       | 497                   |       |
| Deferred income taxes                                                                                                                               |       | 680               |       | 547                   |       |
| Total current assets                                                                                                                                |       | 26,099            |       | 35,104                |       |
|                                                                                                                                                |       |              |       |                  |       |
| Property, plant and equipment                                                                                                                       |       | 106,233           |       | 87,535                |       |
| Accumulated depreciation                                                                                                                            |       | (17,067           | )          | (14,844               | )          |
| Net property, plant and equipment                                                                                                                   |       | 89,166            |       | 72,691                |       |
|                                                                                                                                                |       |              |       |                  |       |
| Deferred debt issuance costs, net of accumulated amortization  of $653 in 2010 and $632 in 2009                                                     |       | 108               |       | 104                   |       |
| Total assets                                                                                                                                        |       | $                 | 115,373    |                  | $          | 107,899 |   |
|                                                                                                                                                |       |              |       |                  |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                      |       |              |       |                  |       |
| Current liabilities:                                                                                                                                |       |              |       |                  |       |
| Accounts payable                                                                                                                                    |       | $                 | 5,842      |                  | $          | 4,049 |   |
| Accrued liabilities                                                                                                                                 |       | 3,091             |       | 3,118                 |       |
| Current portion of long-term debt                                                                                                                   |       | 9,262             |       | 3,742                 |       |
| Total current liabilities                                                                                                                           |       | 18,195            |       | 10,909                |       |
|                                                                                                                                                |       |              |       |                  |       |
| Long-term debt, less current portion                                                                                                                |       | 15,776            |       | 19,533                |       |
| Deferred income taxes                                                                                                                               |       | 14,367            |       | 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                                                                                                                          |       | 38,737            |       | 38,354                |       |
| Retained earnings                                                                                                                                   |       | 28,291            |       | 24,759                |       |
| Total stockholders’ equity                                                                                                                     |       | 67,035            |       | 63,120                |       |
| Total liabilities and stockholders’ equity                                                                                                     |       | $                 | 115,373    |                  | $          | 107,899 |   |

 

See notes to unaudited interim financial statements.

 

3

----

Table of Contents

 

**ORCHIDS PAPER PRODUCTS COMPANY**

**STATEMENTSOF INCOME**

**(Dollars in thousands, except share and per sharedata)**

 
| ** **                                       | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                                       | ** ** | **2010**                        | ** ** | **2009**                      | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                       | ** ** | **(unaudited)**                 | ** ** | **(unaudited)**               | ** ** | **(unaudited)** | ** ** | **(unaudited)** | ** ** |
|                                             |       |                            |       |                          |       |   |   |   |   |
| Net sales                                        |       | $                               | 24,685     |                          | $          | 24,131 |   | $ | 45,725 |   | $ | 47,771 |   |
|                                             |       |                            |       |                          |       |   |   |   |   |
| Cost of sales                                    |       | 19,610                          |       | 16,303                        |       | 36,789 |   | 33,511 |   |
| Gross profit                                     |       | 5,075                           |       | 7,828                         |       | 8,936 |   | 14,260 |   |
|                                             |       |                            |       |                          |       |   |   |   |   |
| Selling, general and administrative expenses     |       | 1,841                           |       | 2,087                         |       | 3,576 |   | 3,917 |   |
| Operating income                                 |       | 3,234                           |       | 5,741                         |       | 5,360 |   | 10,343 |   |
|                                             |       |                            |       |                          |       |   |   |   |   |
| Interest expense                                 |       | 211                             |       | 135                           |       | 426 |   | 294 |   |
| Other income                                     |       | (13                             | )          | (1                            | )          | (27 | ) | (4 | ) |
| Income before income taxes                       |       | 3,036                           |       | 5,607                         |       | 4,961 |   | 10,053 |   |
|                                             |       |                            |       |                          |       |   |   |   |   |
| Provision (benefit) for income taxes:            |       |                            |       |                          |       |   |   |   |   |
| Current                                          |       | 1,012                           |       | 50                            |       | 1,532 |   | 805 |   |
| Deferred                                         |       | (148                            | )          | 1,782                         |       | (103 | ) | 2,676 |   |
|                                             |       | 864                             |       | 1,832                         |       | 1,429 |   | 3,481 |   |
|                                             |       |                            |       |                          |       |   |   |   |   |
| Net income                                       |       | $                               | 2,172      |                          | $          | 3,775 |   | $ | 3,532 |   | $ | 6,572 |   |
|                                             |       |                            |       |                          |       |   |   |   |   |
| Net income per share:                            |       |                            |       |                          |       |   |   |   |   |
| Basic                                            |       | $                               | 0.29       |                          | $          | 0.58 |   | $ | 0.47 |   | $ | 1.02 |   |
| Diluted                                          |       | $                               | 0.28       |                          | $          | 0.55 |   | $ | 0.46 |   | $ | 0.97 |   |
|                                             |       |                            |       |                          |       |   |   |   |   |
| Shares used in calculating net income per share: |       |                            |       |                          |       |   |   |   |   |
| Basic                                            |       | 7,486,725                       |       | 6,468,529                     |       | 7,441,069 |   | 6,421,441 |   |
| Diluted                                          |       | 7,768,013                       |       | 6,891,208                     |       | 7,753,905 |   | 6,778,918 |   |

 

See notes to unaudited interim financialstatements.

 

4

----

Table of Contents

 

**ORCHIDSPAPER PRODUCTS COMPANY**

**STATEMENTSOF CASH FLOWS**

**(Dollars inthousands)**

 
| ** **                                                                         | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                         | ** ** | **2010**                      | ** ** | **2009** | ** ** |
| ** **                                                                         | ** ** | **(unaudited)**               | ** ** | **(unaudited)** | ** ** |
| **Cash Flows From Operating  Activities**                                          |       |                          |       |   |   |
| Net income                                                                         |       | $                             | 3,532      |   | $ | 6,572 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                          |       |   |   |
| Depreciation and amortization                                                      |       | 2,244                         |       | 1,653 |   |
| Provision for doubtful accounts                                                    |       | 30                            |       | 20 |   |
| Deferred income taxes                                                              |       | (103                          | )          | 2,676 |   |
| Stock option plan expense                                                          |       | 383                           |       | 435 |   |
| Changes in cash due to changes in operating assets  and liabilities:               |       |                          |       |   |   |
| Accounts receivable                                                                |       | (446                          | )          | (682 | ) |
| Inventories                                                                        |       | (15                           | )          | (14 | ) |
| Income taxes receivable                                                            |       | —                        |       | (869 | ) |
| Prepaid expenses                                                                   |       | (279                          | )          | 100 |   |
| Accounts payable                                                                   |       | 1,793                         |       | (561 | ) |
| Accrued liabilities                                                                |       | (27                           | )          | 667 |   |
| Net cash provided by operating activities                                          |       | 7,112                         |       | 9,997 |   |
|                                                                               |       |                          |       |   |   |
| **Cash Flows From Investing  Activities**                                          |       |                          |       |   |   |
| Purchases of property, plant and equipment                                         |       | (18,698                       | )          | (4,645 | ) |
| Purchase of investment securities                                                  |       | —                        |       | (2,500 | ) |
| Proceeds from the sale of investment securities                                    |       | 8,996                         |       | — |   |
| Net cash used in investing activities                                              |       | (9,702                        | )          | (7,145 | ) |
|                                                                               |       |                          |       |   |   |
| **Cash Flows From Financing  Activities**                                          |       |                          |       |   |   |
| Borrowings under construction loan                                                 |       | 3,628                         |       | 1,526 |   |
| Principal payments on long-term debt                                               |       | (1,865                        | )          | (1,473 | ) |
| Net repayments on revolving credit line                                            |       | —                        |       | (1,487 | ) |
| Proceeds from the exercise of warrants attached to  subordinated debentures        |       | —                        |       | 286 |   |
| Proceeds from the exercise of stock options                                        |       | —                        |       | 79 |   |
| Deferred issuance cost                                                             |       | (25                           | )          | — |   |
| Net cash provided by (used in) financing  activities                               |       | 1,738                         |       | (1,069 | ) |
|                                                                               |       |                          |       |   |   |
| Net increase (decrease) in cash                                                    |       | (852                          | )          | 1,783 |   |
| Cash, beginning                                                                    |       | 1,232                         |       | 11 |   |
| Cash, ending                                                                       |       | $                             | 380        |   | $ | 1,794 |   |
| **Supplemental Disclosure:**                                                       |       |                          |       |   |   |
| Interest paid                                                                      |       | $                             | 426        |   | $ | 294 |   |
| Income taxes paid                                                                  |       | $                             | 1,225      |   | $ | 1,735 |   |

 

See notes to unaudited interim financial statements.

 

5

----

 

Table of Contents

 

**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.

 

Thefollowing table details common stock outstanding as of June 30, 2010:

 
| 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 measured at fair value. This standard establishes aframework for measuring fair value and related disclosures. The standard hasthe following key elements:

 
| · | Defines  fair value as the exit price that would be received to sell an asset or paid  to transfer a liability in an orderly transaction between market participants  at the measurement date; |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                           |
| · | Establishes  a three-level hierarchy (“valuation hierarchy”) for fair value measurements;                                                                                            |
|   |                                                                                                                                                                                           |
| · | Requires  consideration of the Company’s creditworthiness when valuing liabilities; and                                                                                                   |

 

6

----

Table of Contents

 
| · | Expands  disclosures about instruments measured 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 orliabilities that the reporting entity has the ability to access at themeasurement 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.

 

Thefollowing table presents information about the Company’s assets measured atfair value on a recurring basis as of June 30, 2010 and indicates the fairvalue hierarchy of the valuation techniques utilized to determine suchvalues.  Short-term investments are valued as Level 1 in the fair valuehierarchy based on independent pricing services utilized by the Company’sinvestment custodians.

 
| ** **             | ** ** | **Fair Value Measurements at June 30, 2010** | ** ** |
|------------------------|------------|---------------------------------------------------|------------|
| ** **             | ** ** | **Using Inputs Considered as**                    | ** ** |
| ** **             | ** ** | **Level 1**                                       | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| ** **             | ** ** | **(in thousands)**                                | ** ** |
| Assets                 |       |                                              |       |   |   |   |   |
|                   |       |                                              |       |   |   |   |   |
| Short term investments |       | $                                                 | 9,513      |   | $ | — |   | $ | — |   |
|                        |            |                                                   |            |  |  |  |  |  |  |  |

 

**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.

 

**Note 4 —Commitments and Contingencies**

 

The Company may be involvedfrom time to time in litigation arising from the normal course of business. Inmanagement’s opinion, as of the date of this report, the Company is not engagedin legal proceedings which individually or in the aggregate are expected tohave a material adverse effect on 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 at $7.50 per MMBTU plus a $0.07 per MMBTUmanagement delivery fee for the period from April 2009 throughMarch 2011.  The amounts representapproximately 60% of the Company’s natural gas requirements based upon expectedusage rates for 2009.  If the Company isunable to purchase the contracted amounts and the market price at that time isless than the contracted price, the Company would be obligated under the termsof the agreement to reimburse an amount equal to the volume purchased that wasless than the contracted amount multiplied by the difference between thecontract price and current spot price.  In November 2009, the agreement wasextended for one year to March 2012 for 334,000 MMBTU per year at a priceof $6.50 per MMBTU plus a $0.07 per MMBTU management delivery fee.

 

7

----

Table of Contents

 

**Note 5 —Inventories**

 

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

 
| ** **                  | ** ** | **June 30,**  | ** ** | **December 31,** | ** ** |
|-----------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                  | ** ** | **2010**           | ** ** | **2009**              | ** ** |
| ** **                  | ** ** | **(in thousands)** | ** ** |
| Raw materials               |       | $                  | 1,940      |                  | $          | 1,901 |   |
| Bulk paper rolls            |       | 1,113              |       | 908                   |       |
| Converted finished goods    |       | 4,778              |       | 5,138                 |       |
| Inventory valuation reserve |       | (247               | )          | (378                  | )          |
|                        |       | $                  | 7,584      |                  | $          | 7,569 |   |

 

**Note 6 —Earnings per Share**

 

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

 
| ** **                                               | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                               | ** ** | **2010**                             | ** ** | **2009**                           | ** ** | **2010** | ** ** | **2009** | ** ** |
| Net income — ($ thousands)                     |       | $                                    | 2,172      |                               | $          | 3,775 |   | $ | 3,532 |   | $ | 6,572 |   |
|                                                     |       |                                 |       |                               |       |   |   |   |   |
| Weighted average shares outstanding                      |       | 7,486,725                            |       | 6,468,529                          |       | 7,441,069 |   | 6,421,441 |   |
| Effect of stock options                                  |       | 281,288                              |       | 316,365                            |       | 312,836 |   | 265,676 |   |
| Effect of dilutive warrants                              |       | —                               |       | 106,314                            |       | — |   | 91,801 |   |
| Weighted average shares outstanding - assuming  dilution |       | 7,768,013                            |       | 6,891,208                          |       | 7,753,905 |   | 6,778,918 |   |
| Net income per share:                                    |       |                                 |       |                               |       |   |   |   |   |
| Basic                                                    |       | $                                    | 0.29       |                               | $          | 0.58 |   | $ | 0.47 |   | $ | 1.02 |   |
| Diluted                                                  |       | $                                    | 0.28       |                               | $          | 0.55 |   | $ | 0.46 |   | $ | 0.97 |   |
|                                                     |       |                                 |       |                               |       |   |   |   |   |
| Anti-dilutive stock options not considered above         |       | 57,250                               |       | 33,750                             |       | 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 originally authorized up to 697,500 shares to be issued and wasamended in May 2008 to increase the number of authorized shares under thePlan to 897,500.  Options for 20,000shares were granted effective January 20, 2009,  to an officer of the Company, at an exerciseprice of $10.205, the fair market value of the stock on the date of grant.  The options vest 50% on the first anniversarydate 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 six months ended June 30, 2009 and2010.

 
| **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.

 

8

----

Table ofContents

 

TheCompany expenses the cost of options granted over the vesting period of theoption based on the grant-date fair value of the award.  The Company recognized expense of $274,000and $353,000 for the three months ended June 30, 2010 and 2009,respectively, related to options granted under the Plan.  The Company recognized expense of $383,000and $435,000 for the six months ended June 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 had excess paper production which it began to sell inparent roll form.  Revenues fromconverted product sales and parent roll sales in the three-month and six-monthperiods ended June 30, 2010 and 2009 were: 

 
| ** **                  | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                  | ** ** | **2010**                             | ** ** | **2009**                           | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                  | ** ** | **(in thousands)**                   | ** ** | **(in thousands)**                 | ** ** |
|                        |       |                                 |       |                               |       |   |   |   |   |
| Converted product net sales |       | $                                    | 20,187     |                               | $          | 22,533 |   | $ | 37,824 |   | $ | 43,591 |   |
| Parent roll net sales       |       | 4,498                                |       | 1,598                              |       | 7,901 |   | 4,180 |   |
| Net sales                   |       | $                                    | 24,685     |                               | $          | 24,131 |   | $ | 45,725 |   | $ | 47,771 |   |

 

Creditrisk for the Company in the three months ended June 30, 2010 isconcentrated in three major converted product customers, each of whom operatesdiscount retail stores located throughout the United States.  During the three months ended June 30,2010, sales to the three significant customers accounted for approximately 59%of total sales, comprised of customers of 32%, 15%, and 12%, respectively.  For the three months ended June 30,2009, these same three customers accounted for approximately 58% of totalsales, comprised of customers of 31%, 15%, and 12%, respectively.  For the six months ended June 30, 2010,three customers, two converted product customers and one customer who accountsfor most of  the Company’s third-partysales of parent rolls, accounted for approximately 57% of total sales,comprised of customers of 33%, 14%, and 10%, respectively. For the six monthsended June 30, 2009, the three converted product customers previouslynoted above accounted for approximately 56% of total sales, comprised ofcustomers of 28%, 15%, and 13%, respectively. At June 30, 2010 and 2009,respectively, approximately $4.4 million (61%) of accounts receivable was duefrom the two converted products customers and the one parent roll customer and$4.1 million (57%) of accounts receivable was due from the three convertedproduct customers.  No other customer ofthe Company accounted for more than 10% of sales during these periods.  The Company generally does not requirecollateral from its customers and has not incurred any significant losses onuncollectible accounts receivable.

 

**Note 9 —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 FASB issued, *ASU 2010-06 ImprovingDisclosures about Fair Value Measurements*.  This ASU requires reporting entities toprovide information about the movements of assets among Levels 1 and 2 of thethree-tier fair value hierarchy.  Theguidance is effective for any fiscal year that begins after December 15,2010, and it should be used for quarterly and annual filings.  The Company will adopt this guidance in thefourth quarter of the 2010 fiscal year and will provide information for anyasset movement between Levels 1 and 2.

 

9

----

Table ofContents

 

**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 bematerially different from any future results, levels of activity, performanceor achievements 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 or achievements.  These statements are only predictions.

 

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;

·                  the loss of keypersonnel;

·                  laborinterruption;

·                  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.

 

10

----

Table of Contents

 

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. We have tailored our operations to serve our corecustomer base of dollar stores and other discount retailers. We focus on thedollar stores or value retailers and discount retail market because of theirconsistent order patterns and low number of stock keeping units or SKUs in thismarket. By dollar stores, we mean retailers that offer a limited selectionacross a broad range of products at everyday low prices in a smaller storeformat.

 

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 revenueis derived 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 supplycontracts with any of our customers. Revenue is recognized when title passes tothe customer. Because our product is a daily consumable item, the order streamfrom our 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.

 

**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. We sell the excess supplyinto the market in the form of a parent roll. Parent rolls are a commodity product and thus are subject to marketpricing.  We plan to continue to sell anyexcess parent roll capacity on the open market as long as market pricing isprofitable.

 

Priorto June 2006, our paper-making capacity was less than the requirements ofour converting operations and we supplemented our paper-making capacity bybuying parent rolls in the open market. Our parent rolls are processed intopaper towels, bathroom tissue and napkins in our adjacent converting facility.We adjust our paper making production based on our internal converting needsfor parent rolls and the open market demand for parent rolls. Our strategy isto sell all of our parent roll capacity as converted products which generallycarry higher margins than parent rolls. To help achieve that goal, we continueto focus 

 

11

----

Table of Contents

 

considerableefforts to improve our converting efficiencies in order to achieve that goaland have realized incremental improvements in production output over the lasttwo years.  In addition, we are placingsignificant focus on improving our sales efforts to sell this additionalcapacity.

 

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 total manufacturingcapacity and expansion of our highly perceived value product offering.

 

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

 

·  maintain and strengthen ourcore customer relationships;

·  increase our flexibility to meeta wider array of customer needs;

·  further expand our customerbase in other retail channels; and

·  continue to improve operatingefficiencies and reduce manufacturing costs.

 

Withour steady sales growth since our inception in 1998, we have strategicallyexpanded capacity to meet demand.  Wehave recently completed an expansion project which added an eleventh convertingline to our converting capacity and a new 245,000 square foot warehouse.  The new line has a rated annual capacity ofapproximately four million annual cases of either kitchen towel or bathroomtissue products.  With the new line, wehave total annual converting capacity of approximately twelve million casesfrom eleven lines.  The new convertingline is in the start-up phase and is expected to be at full operating speeds bythe end of the third quarter of 2010. The new converting line will provide higher quality products and broadenour product offering through increased packaging configurations, enhancedgraphics and improved embossing.  Weoccupied the first half of the new warehouse during the middle of the secondquarter and we now occupy the entire warehouse. With the completion of the warehouse, we will be able to consolidate allof our converted product inventory and shipping into this location andeliminate third-party warehouse storage and shipping costs which will allow usto improve our customer service and logistics performance and reduce operatingcosts.  The total cost of the expansionproject is $27.1 million, with the new line costing $20.3 million and thewarehouse costing $6.8 million.

 

Atan annual converting production rate of approximately ten million cases, theparent roll requirements of our converting operation will match our papermaking capacity.  At annual convertingproduction levels above approximately ten million cases, we will supplement ourpaper-making capacity by purchasing parent rolls in the open market.

 

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

 

**Net Sales**

** **
| ** **                  | ** ** | **Three Months Ended June 30,**                       | ** ** |
|-----------------------------|------------|------------------------------------------------------------|------------|
| ** **                  | ** ** | **2010**                                                   | ** ** | **2009** | ** ** |
| ** **                  | ** ** | **(in thousands, except average price per ton and  tons)** | ** ** |
|                        |       |                                                       |       |   |   |   |   |
| Converted product net sales |       | $                                                          | 20,187     |   | $ | 22,533 |   |
| Parent roll net sales       |       | 4,498                                                      |       | 1,598 |   |
| Total net sales             |       | $                                                          | 24,685     |   | $ | 24,131 |   |
|                        |       |                                                       |       |   |   |
| Total tons shipped          |       | 14,614                                                     |       | 12,297 |   |
| Average price per ton       |       | $                                                          | 1,689      |   | $ | 1,962 |   |

 

Netsales in the quarter ended June 30, 2010, increased 2%, to $24.7 million,compared to $24.1 million in the same period of 2009.  Net sales figures represent the gross sellingprice, including freight, less discounts and pricing allowances.  The increase in net sales is due to a $2.9million increase in parent roll net sales being mostly offset by a $2.3 milliondecrease in net sales of converted product. Net sales of converted product decreased in the quarter ended June 30,2010, by $2.3 million, or 10% to $20.2 million compared to $22.5 million in thesame period last year. The decrease in net sales of converted product isprimarily the result of a 5% decrease in both the tonnage shipped and in thenet selling price per ton.  The decreasein converted product tonnage shipped is a result of the softer demand for ourproducts from existing customers arising in part due to continued aggressivepricing by major brand producers.  Thedecrease in net selling price is primarily due to a shift in mix and did notmaterially affect gross margin.  

 

12

----

Table of Contents

 

Netsales of parent rolls increased $2.9 million, or 182%, to $4.5 million in thequarter ended June 30, 2010 compared to $1.6 million in the same periodlast year.  Net sales of parent rollsincreased primarily as a result of a 145% increase in parent roll tonnageshipped and a 15% increase in the net selling price. The improvement in parentroll tonnage shipments is due to lower requirements by our converting operationresulting in additional excess paper available to sell in parent roll form anda stronger parent roll market.  The improvementin parent roll net selling prices is due to the stronger parent roll market andmarket reaction to higher waste paper prices.

 

Totalshipments in the second quarter of 2010 increased by 2,317 tons, or 19%, to14,614 tons compared to 12,297 tons in the same period of 2009.  This increase is primarily the result of astronger parent roll market which allowed us to sell all of our excess parentrolls into the market.  In the 2009quarter, we took intermittent downtime on certain paper machines due to a softparent roll market which restricted our ability to sell all of our excesscapacity.  As a result, a higherpercentage of our parent roll production was sold in parent roll form in thesecond quarter of 2010 compared to the second of 2009.  This mix change was the primary reason ouroverall net selling price per ton decreased in the 2010 quarter to $1,689 perton compared to the $1,962 per ton experienced in the second quarter of2009.  Additionally affecting the changein net selling prices was the 5% decrease in net selling prices for convertedproducts which was partially offset by the 15% increase in the net sellingprice for parent rolls.

 

**Cost ofSales**

** **
| ** **                                      | ** ** | **Three Months Ended June 30,**                                      | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                      | ** ** | **2010**                                                                  | ** ** | **2009** | ** ** |
| ** **                                      | ** ** | **(in thousands, except  gross profit margin %  and paper cost per ton)** | ** ** |
|                                            |       |                                                                      |       |   |   |
| Cost of paper                                   |       | $                                                                         | 10,763     |   | $ | 7,895 |   |
| Non-paper materials, labor, supplies, etc. |       | 7,700                                                                     |       | 7,574 |   |
| Sub-total                                       |       | 18,463                                                                    |       | 15,469 |   |
| Depreciation                                    |       | 1,147                                                                     |       | 834 |   |
| Cost of sales                                   |       | $                                                                         | 19,610     |   | $ | 16,303 |   |
|                                            |       |                                                                      |       |   |   |
| Gross Profit                                    |       | $                                                                         | 5,075      |   | $ | 7,828 |   |
| Gross Profit as a % net sales                   |       | 20.6                                                                      | %          | 32.4 | % |
| Total paper cost per ton consumed               |       | $                                                                         | 782        |   | $ | 642 |   |

 

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 $3.3 million, or 20%, to $19.6 million for thequarter ended June 30, 2010, compared to $16.3 million in the same periodof 2009.  The increase in our cost ofsales was primarily attributable to higher waste paper costs.  As a percentage of net sales, cost of salesincreased to 79.4% in the 2010 quarter from 67.6% in the 2009 quarter.  Cost of sales as a percentage of net salesfor the second quarter of 2010 was unfavorable to the prior year quarter due tohigher waste paper costs, lower converting shipments volumes and the resultanthigher converting production costs, a higher percentage of parent roll salesand higher depreciation expense.

 

Ouroverall cost of paper in the second quarter of 2010 was $782 per ton, anincrease of $140 per ton compared to the same period in 2009.  Paper production costs increased primarilydue to higher waste paper prices.  Wastepaper prices increased approximately 69% in the second quarter of 2010 comparedto the same quarter in 2009, thereby increasing our cost of sales byapproximately $2.1 million in the quarter over quarter comparison.

 

Convertingproduction costs increased in the 2010 quarter compared to the 2009 quarter byapproximately 21% on a per unit basis as a result of a temporary curtailment ofsome converting assets to match production with lower shipmentrequirements.  As previously discussed,the percentage of our parent roll production sold as a parent roll increased inthe second quarter of 2010 compared to the same quarter last year, which had anegative effect on our gross margin percentage as parent roll sales generallygenerate a lower margin than the sale of converted product.  Depreciation expense increased $313,000 inthe second 

 

13

----

Table ofContents

 

quarterof 2010 compared to the same quarter last year primarily due to the completionof a converting automation project and a waste water treatment plant expansionin 2009, as well as normal recurring capital expenditures.

 

**GrossProfit**

 

Grossprofit in the quarter ended June 30, 2010, decreased $2.7 million, or 35%,to $5.1 million compared to $7.8 million in the same period last year.  Gross profit as a percentage of net sales inthe 2010 quarter was 20.6% compared to 32.4% in the 2009 quarter.  The gross profit decrease as a percent of netsales was primarily the result of higher waste paper prices, lower convertedproduct shipments and the resultant higher converted production costs, a higherpercentage of parent roll sales and higher depreciation.

 

**Selling,General and Administrative Expenses**

** **
| ** **                          | ** ** | **Three Months Ended June 30,**                     | ** ** |
|-------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                          | ** ** | **2010**                                                 | ** ** | **2009** | ** ** |
| ** **                          | ** ** | **(in thousands, except  SG&A as a % of net sales)** | ** ** |
|                                |       |                                                     |       |   |   |   |   |
| Commission expense                  |       | $                                                        | 331        |   | $ | 346 |   |
| Other S,G&A expenses            |       | 1,510                                                    |       | 1,741 |   |
| Selling, General & Adm exp |       | $                                                        | 1,841      |   | $ | 2,087 |   |
| SG&A as a % of net sales        |       | 7.5                                                      | %          | 8.6 | % |

 

Selling,general and administrative expenses include salaries, commissions to brokersand other miscellaneous expenses. Selling, general and administrative expenses decreased $246,000, or11.8%, to $1.8 million in the quarter ended June 30, 2010 compared to $2.1million in the comparable 2009 period. The reduction was primarily due to decreased accruals under ourincentive bonus plan and lower stock option expense.  Lower profits resulted in the decrease in therequired accruals under the incentive bonus plan.  Stock option expense decreased primarily dueto the effect the year-over-year decrease in the price of our common stock hadon the Black-Scholes calculation of the expense related to stock optionsgranted to our board of directors.   As apercentage of net sales, selling, general and administrative expenses decreasedto 7.5% in the second quarter of 2010 compared to 8.6% in the same period of2009.

 

**OperatingIncome**

 

Asa result of the foregoing factors, operating income for the quarters ended June 30,2010 decreased $2.5 million from the same period in 2009.

 

**Interest Expense and Other Income**

 

| ** **                 | ** ** | **Three Months Ended June 30,** | ** ** |
|----------------------------|------------|---------------------------------|------------|
| ** **                 | ** ** | **2010**                        | ** ** | **2009** | ** ** |
| ** **                 | ** ** | **(in thousands)**              | ** ** |
| Interest expense           |       | $                               | 211        |   | $ | 135 |   |
| Other income               |       | $                               | (13        | ) | $ | (1 | ) |
|                       |       |                            |       |   |   |
| Income before income taxes |       | $                               | 3,036      |   | $ | 5,607 |   |

 

Interestexpense includes interest on all debt and amortization of deferred debtissuance costs.  Interest expenseincreased $76,000 to $211,000 in the quarter ended June 30, 2010, comparedto $135,000 in the quarter ended June 30, 2009.  The increase in interest expense is relatedto higher interest rates and higher average borrowing levels.  Interest rates increased in the secondquarter of 2010 compared to the second quarter of 2009 due to the inclusion ofa 3.5% interest rate floor in our amended credit facility effective July 2009.  Our average borrowings increased due toborrowings on two construction loans to help finance capital projects beginningin the third quarter of 2009.

 

14

----

Table ofContents

 

**IncomeBefore Income Taxes**

 

Asa result of the foregoing factors, income before income taxes decreased $2.6million to $3.0 million in the quarter ended June 30, 2010, compared to$5.6 million in the same period in 2009.

 

**IncomeTax Provision**

 

Forthe quarter ended June 30, 2010, our effective income tax rate was28.8%.  This rate is lower than thestatutory rate because of Oklahoma Investment Tax Credits associated with ourinvestments in a new paper machine, new converting warehouse and new convertingline.  Our effective rate does notreflect the Federal Indian Employment Credits (“IEC”) as this tax regulationexpired as of December 31, 2009 and has not been reauthorized for 2010.  Additionally, in 2009, we extinguished all ofour federal net operating loss carryforwards and carryforwards of IECs.  We are now eligible for a 9% manufacturingcredit which was not reflected in our tax rate for the 2009 quarter.  For the quarter ended June 30, 2009, ourannual effective income tax rate was 34.6%. The effective tax rate is lower than the statutory rate because of theOklahoma Investment Tax Credits associated with capital equipment investmentsand the utilization of IECs.

 

**ComparativeSix-Month Periods Ended June 30, 2010 and 2009**

 

**NetSales**

 

| ** **                  | ** ** | **Six Months Ended June 30,**                         | ** ** |
|-----------------------------|------------|------------------------------------------------------------|------------|
| ** **                  | ** ** | **2010**                                                   | ** ** | **2009** | ** ** |
| ** **                  | ** ** | **(in thousands, except average price per ton and  tons)** | ** ** |
|                        |       |                                                       |       |   |   |
| Converted product net sales |       | $                                                          | 37,824     |   | $ | 43,591 |   |
| Parent roll net sales       |       | 7,901                                                      |       | 4,180 |   |
| Net sales                   |       | $                                                          | 45,725     |   | $ | 47,771 |   |
|                        |       |                                                       |       |   |   |
| Total tons shipped          |       | 27,793                                                     |       | 24,726 |   |
| Net selling price per ton   |       | $                                                          | 1,645      |   | $ | 1,932 |   |

 

Netsales decreased 4% to $45.7 million in the six months ended June 30, 2010,compared to $47.8 million in the same period of 2009.  Net sales figures represent gross sellingprice, including freight, less discounts and pricing allowances.  The decrease in net sales is due to a $5.8million decrease in the net sales of converted product being partially offsetby a $3.7 million increase in the sales of parent rolls.  Net sales of converted product decreased forthe six months ended June 30, 2010, by $5.8 million, or 13% to $37.8million compared to $43.6 million in the same period last year. The decrease innet sales of converted products is the result of a 7% decrease in the both thetons of product shipped and net selling prices. The decrease in shipments of converted product were primarily due toaggressive pricing by branded product manufacturers, and unusually inclementweather in the first quarter of 2010. The decrease in net selling prices is primarily the result of a shift inmix and, to a lesser extent, increased promotional pricing.  Net sales of parent rolls increased $3.7million or 89% to $7.9 million in the six months ended June 30, 2010compared to $4.2 million in the same period last year.  Net sales of parent rolls increased due to a94% increase in parent roll tonnage shipped, which was partially offset by a 3%decrease in net selling prices.  Aspreviously discussed in the second quarter analysis, the lower requirements ofour converting operation combined with a strengthening parent roll marketprovided the opportunity to sell all of our excess parent roll production inthe current year.

 

Totalshipments in the six-month period of 2010 increased by 3,067 tons, or 12%, to27,793 tons compared to 24,726 tons in the same period of 2009, primarily dueto a 94% increase in parent roll shipments. Overall tonnage shipments improved primarily due to the previouslydiscussed strengthening of the parent roll market and a decrease in convertedproduct shipments.  Our overall netselling price per ton decreased by 15% in the first six months of 2010 comparedto the comparable prior year period. This decrease was primarily attributable to the increased percent ofparent rolls production shipped in parent roll form and, to a lesser extent,lower prices for converted products.

 

15

----

 

Table of Contents

 

**Cost ofSales**

** **
| ** **                                      | ** ** | **Six Months Ended June 30,**                                        | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                      | ** ** | **2010**                                                                  | ** ** | **2009** | ** ** |
| ** **                                      | ** ** | **(in thousands, except  gross profit margin %  and paper cost per ton)** | ** ** |
| Cost of paper                                   |       | $                                                                         | 21,253     |   | $ | 16,434 |   |
| Non-paper materials, labor, supplies, etc. |       | 13,258                                                                    |       | 15,439 |   |
| Sub-total                                       |       | $                                                                         | 34,511     |   | $ | 31,873 |   |
| Depreciation                                    |       | 2,278                                                                     |       | 1,638 |   |
| Cost of sales                                   |       | $                                                                         | 36,789     |   | $ | 33,511 |   |
|                                            |       |                                                                      |       |   |   |
| Gross Profit                                    |       | $                                                                         | 8,936      |   | $ | 14,260 |   |
| Gross Profit a % net sales                      |       | 19.5                                                                      | %          | 29.9 | % |
| Total paper cost per ton consumed               |       | $                                                                         | 789        |   | $ | 664 |   |

 

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 $3.3 million, or 10%, to $36.8 million for thesix months ended June 30, 2010, compared to $33.5 million in the sameperiod of 2009.  As a percentage of netsales, cost of sales increased to 80.5% of net sales in the six-month periodended June 30, 2010 compared to 70.1% of net sales in the six-month periodended June 30, 2009.  The increasein cost of sales as a percentage of net sales in the six months ended June 30,2010, was primarily attributed to higher waste paper costs, lower convertedproduct sales and the resultant effect on production costs, a higher percentageof parent roll sales and higher depreciation expense.

 

Inthe six months ended June 30, 2010, our overall cost of paper was $789 perton, an increase of $125 per ton when compared to the same period in 2009.  Our cost per ton increased primarily due toincreased waste paper prices.  Averagewaste paper prices increased 64%, which raised the cost of our waste paper byapproximately $3.8 million in the first six months of 2010 compared to the sameperiod of 2009.

 

Convertingproduction costs increased in the first six months of 2010 quarter compared tothe same period in 2009 by approximately 22% on a per unit basis for the samereasons cited in the three-month discussion. The previously discussed increase in the percentage of our parent rollproduction sold as a parent roll negatively affected our gross marginpercentage.  Depreciation expenseincreased $640,000 in the first six months of 2010 compared to the same periodlast year primarily due to base level capital expenditures and the completionof a converting automation project and a waste water treatment plant expansionin 2009.

 

**GrossProfit**

 

Grossprofit in the six months ended June 30, 2010, decreased $5.4 million, or37 %, to $8.9 million compared to $14.3 million in the same period lastyear.  Gross profit as a percentage ofnet sales in the six-month period ended June 30, 2010, was 19.5% comparedto 29.9% in the same period in 2009.  Thedecrease in gross profit as a percent of net sales was primarily due to higherwaste paper costs, lower converted product shipments and the resultant effecton per unit production costs, a higher percentage of parent roll sales and higherdepreciation expense.

 

16

----

Table ofContents

 

**Selling,General and Administrative Expenses**

 
| ** **                          | ** ** | **Six Months Ended June 30,**                       | ** ** |
|-------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                          | ** ** | **2010**                                                 | ** ** | **2009** | ** ** |
| ** **                          | ** ** | **(in thousands, except  SG&A as a % of net sales)** | ** ** |
|                                |       |                                                     |       |   |   |   |   |
| Commission expense                  |       | $                                                        | 631        |   | $ | 678 |   |
| Other S,G&A expenses            |       | 2,945                                                    |       | 3,239 |   |
| Selling, General & Adm exp |       | $                                                        | 3,576      |   | $ | 3,917 |   |
| SG&A as a % of net sales        |       | 7.8                                                      | %          | 8.2 | % |

 

Selling,general and administrative expenses include salaries, commissions to brokersand other miscellaneous expenses. Selling, general and administrative expenses decreased $341,000, or 9%,to $3.6 million in the six months ended June 30, 2010, compared to $3.9million in the comparable 2009 period, mainly as a result of decreased accrualsunder our incentive bonus plan, decreased professional and legal fees anddecreased stock option expense, primarily due to a decrease in the price of ourstock.  As a percentage of net sales,selling, general and administrative expenses decreased to 7.8% in the sixmonths ended June 30, 2010, compared to 8.2% in the same period of 2009.

 

**OperatingIncome**

 

Asa result of the foregoing factors, operating income for the six months ended June 30,2010 was $5.4 million compared to operating income of $10.3 million for thesame period of 2009.

 

**InterestExpense and Other Income**

 
| ** **                 | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------|------------|------------------------------------|------------|
| ** **                 | ** ** | **2010**                           | ** ** | **2009** | ** ** |
| ** **                 | ** ** | **(in thousands)**                 | ** ** |
| Interest expense           |       | $                                  | 426        |   | $ | 294 |   |
| Other income               |       | $                                  | (27        | ) | $ | (4 | ) |
|                       |       |                               |       |   |   |
| Income before income taxes |       | $                                  | 4,961      |   | $ | 10,053 |   |

 

Interestexpense increased by $132,000 to $426,000 in the six months ended June 30,2010 compared to $294,000 in the same period in the prior year.  The increase was attributable to higherinterest rates due to the amendment to the credit agreement and higher averageborrowing levels, as previously discussed in the quarter over quarter analysis.

 

**IncomeBefore Income Taxes**

 

Asa result of the foregoing factors, income before income taxes decreased $5.1million to $5.0 million in the six months ended June 30, 2010 compared to$10.1 million in the same period in 2009.

 

**IncomeTax Provision**

 

Asof June 30, 2010, we estimate our full-year effective income tax rate tobe 28.8%.  It is lower than the statutoryrate because of Oklahoma Investment Tax Credits associated with our investmentin 2006 in a paper machine as well as the converting expansion project and thecontinued capital investment in our mill and converting plant.   Also, we are now eligible for a 9%manufacturing credit which was not reflected in our tax rate for the 2009quarter.  As of June 30, 2009, ourestimated effective income tax rate was 34.6%.

 

**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 as well as unused borrowing capacityunder our revolving credit facility.  Ourcash requirements have historically been satisfied through a combination ofcash flows from operations and debt financings.

 

17

----

Table ofContents

 

OnApril 12, 2010, the board of directors approved an expansion of our wastewater treatment facility in the amount of $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 thenecessary capacity to independently meet our permit limits.  We began construction on the project early inthe third quarter and expect completion by the end of the fourth quarter of2010.  Subsequently, we amended ourcredit agreement in June of this year, which among other things, increasedour capital expenditures limit for the current year.  No significant level of expenditures was madeon the project during the reporting period.

 

Duringthe six months ended June 30, 2010, cash decreased $852,000.  In addition, we utilized $9.0 million ofshort term investments.  The primarydrivers of this use of cash and short term investments was our $27.1 millionexpansion project, which was completed by the end of the second quarter of2010.  During the first six months of2010, we spent approximately $15.8 million on the project, including $12.4million towards the converting line portion of the expansion project and $3.4million towards the new warehouse. Additional funding for the project was provided from borrowings of $3.6million under a construction loan which provides funding for 80% of theconstruction cost of the warehouse. There is approximately $3.0 million in payments remaining on the projectwhich we expect to incur in the third quarter of 2010.

 

Asof June 30, 2010, total debt outstanding was $25.0 million.  Cash and short-term investments as of June 30,2010, totaled $9.9 million, resulting in a net debt level of $15.1million.  This compares to $23.3 millionin total debt and $19.8 million in total cash and short-term investments, as ofDecember 31, 2009, resulting in a net debt level of $3.5 million.  Total debt increased $1.8 million in the sixmonths ended June 30, 2010 as borrowings on a construction loan to helpfinance the new warehouse expansion of $3.6 million were partially offset by$1.8 million in scheduled debt repayments. Two of the loans under our credit facility have termination dates of April 2011,the revolving credit facility and Term Loan B, and accordingly the outstandingbalances of these two loans of $8.3 million have been classified as currentobligations in the accompanying balance sheet. The revolving credit line has no amounts outstanding and the Term Loan Bhas $8.3 million outstanding as of June 30, 2010.  We intend to refinance the entire creditfacility by early 2011.

 

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

 
| ** **                       | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------|------------|------------------------------------|------------|
| ** **                       | ** ** | **2010**                           | ** ** | **2009** | ** ** |
| ** **                       | ** ** | **(in thousands)**                 | ** ** |
|                             |       |                               |       |   |   |
| Cash flow provided by (used in): |       |                               |       |   |   |
| Operating activities             |       | $                                  | 7,112      |   | $ | 9,997 |   |
|                             |       |                               |       |   |   |
| Investing activities             |       | $                                  | (9,702     | ) | $ | (7,145 | ) |
|                             |       |                               |       |   |   |
| Financing activities             |       | $                                  | 1,738      |   | $ | (1,069 | ) |

 

Cashflow provided by operating activities was $7.1 million in the six-month periodended June 30, 2010, which primarily resulted from earnings beforenon-cash charges and an increase in accounts payable partly offset by anincrease in trade receivables.   Theincrease in accounts payable is primarily related to the timing of invoicesrelated to the converting expansion project. The increase in trade receivables is primarily due to timing.

 

Cashflow used in investing activities was $9.7 million in the first six months of2010 as the result of $18.7 million in expenditures on capital projects,primarily for the converting expansion project, partially offset by the sale of$9.0 million of short term investments.

 

Cashflows provided by financing activities was $1.7 million in the six-month periodended June 30, 2010, as the result of, $3.6 million in borrowings under aconstruction loan to partially fund  ourfinished goods warehouse being partially offset by $1.9 million in loanrepayments.

 

Cashflow provided by operating activities was $10.0 million in the six-month periodended June 30, 2009, which primarily resulted from earnings beforenon-cash charges and a net increase in accounts payable and accrued liabilitiespartly offset by an increase in trade receivables.

 

18

----

Table ofContents

 

Cashflow used in investing activities were $7.1 million in the first six months of2009 as the result of $4.6 million in expenditures on capital projects,primarily for the waste water treatment project, as well as the purchase of$2.5 million in short term investment securities.

 

Cashflows used in financing activities was $1.1 million in the six-month periodended June 30, 2009, and was primarily attributable to $1.5 million ofprincipal payments on our term loans, $1.5 million repayment of our revolvingline of credit which was partially offset by $1.5 million of borrowings underour construction loan for the waste water treatment project.

 

OnJune 1, 2010, we amended our credit facility with Bank of Oklahoma andCommerce Bank as follows:

 

·                  increase theannual unfunded capital expenditures limit for the fiscal year ended December 31,2010 from $11.0 million to $13.0 million, to cover the cost of expanding thecapacity of the wastewater treatment facility;

 

·                  remove therestriction on the payment of dividends, under certain circumstances, includingdividends payable solely in additional shares of Company’s common stock andcash dividends not exceeding $8,000,000 in the aggregate in any fiscal year;

 

·                  eliminate therequirement to maintain a Debt Service Coverage Ratio;

 

·                  add therequirement that to maintain a Fixed Charge Coverage Ratio of not less than1.25 to 1.00, commencing with the fiscal quarter ending June 30, 2010; and

 

·                  add a quarterlyTangible Net Worth covenant pursuant to which required the maintenance of aTangible Net Worth of not less than the sum of (i) $50,000,000, plus(ii) 50% of the Company’s net income, plus (iii) 100% of thenet proceeds from any offering of equity securities after December 31,2009.

 

**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 future circumstances.  We have identified the following critical accountingpolicies that affect the more significant judgments and estimates used in thepreparation 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 lossesbased on historical experience and specific customer collection issues that wehave identified.  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 allowance provided,there can be no assurance that we will continue to experience the same creditloss rates as in the past.  During thesix-month periods ended June 30, 2010 and 2009, provisions for doubtfulaccounts were recognized in the amount of $30,000 for each period.  There were no recoveries credited during thefirst six months of 2010 or 2009.  Noaccounts receivable balances were written off in the six-month period ended June 30,2010.  One accounts receivable balance of$10,000 was written off during the same period ended June 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 six months of 2010, $60,000was provided and there were charges totaling $191,000 

 

19

----

Table ofContents

 

againstthe valuation reserve.  The chargesagainst the reserve were primarily the result of the product content changesmade, or in the process of being made, to our converted products and theresultant effect on certain raw materials, primarily poly wrapping material,used in the converting process. During the first six months of 2009, $30,000was provided and there were charges totaling $192,000 against the valuationreserve.

** **

**NewAccounting Pronouncements**

 

Referto the discussion of recently adopted/issued accounting pronouncements under Part I,Notes to Unaudited Interim Financial Statements Note 8 — New AccountingStandards.

** **

**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 from operatingactivities 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(affecting relative interest expense), tax positions (such as the impact onperiods or companies of changes in effective tax rates or net operating losses)and the age and book depreciation of facilities and equipment (affectingrelative depreciation 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 cash expenditures for capital assets;                                                                                                                                                                    |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                              |
| · | it  does not reflect changes in, or cash requirements for, our working capital  requirements;                                                                                                                                     |
|   |                                                                                                                                                                                                                              |
| · | it  does not reflect the interest expense, or the cash requirements necessary to  service interest or principal payments on our indebtedness;                                                                                     |
|   |                                                                                                                                                                                                                              |
| · | although  depreciation and amortization are non-cash charges, the assets being  depreciated and amortized will often have to be replaced in the future, and  EBITDA does not reflect cash requirements for such replacements; and |
|   |                                                                                                                                                                                                                              |
| · | other  companies, including other companies in our industry, may calculate these  measures differently than we 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.

 

20

----

Table ofContents

 

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

 
| ** **               | ** ** | **Three Months Ended June 30,** | ** ** |
|--------------------------|------------|--------------------------------------|------------|
| ** **               | ** ** | **2010**                             | ** ** | **2009** | ** ** |
| ** **               | ** ** | **(In thousands,**                   | ** ** |
| ** **               | ** ** | **except % of net sales)**           | ** ** |
| ** **               | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Net income               |       | $                                    | 2,172      |   | $ | 3,775 |   |
| Plus: Interest expense   |       | 211                                  |       | 135 |   |
| Plus: Income tax expense |       | 864                                  |       | 1,832 |   |
| Plus: Depreciation       |       | 1,147                                |       | 834 |   |
| EBITDA                   |       | $                                    | 4,394      |   | $ | 6,576 |   |
| % of net sales           |       | 17.8                                 | %          | 27.3 | % |

 

EBITDAdecreased $2.2 million to $4.4 million in the quarter ended June 30, 2010,compared to $6.6 million in the same period in 2009.  EBITDA as a percent of net sales decreased to17.8% in the second quarter of 2010 from 27.3% in the second quarter of2009.  The foregoing factors discussed inthe net sales, cost of sales and selling, general and administrative expensessections are the reasons for the decrease.

 

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

 
| ** **               | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------|------------|------------------------------------|------------|
| ** **               | ** ** | **2010**                           | ** ** | **2009** | ** ** |
| ** **               | ** ** | **(In thousands,**                 | ** ** |
| ** **               | ** ** | **except % of net sales)**         | ** ** |
| ** **               | ** ** | ** **                         | ** ** | ** ** | ** ** |
| Net income               |       | $                                  | 3,532      |   | $ | 6,572 |   |
| Plus: Interest expense   |       | 426                                |       | 294 |   |
| Plus: Income tax expense |       | 1,429                              |       | 3,481 |   |
| Plus: Depreciation       |       | 2,278                              |       | 1,638 |   |
| EBITDA                   |       | $                                  | 7,665      |   | $ | 11,985 |   |
| % of net sales           |       | 16.8                               | %          | 25.1 | % |

 

EBITDAdecreased $4.3 million to $7.7 million in the six months ended June 30,2010, compared to $12.0 million in the same period of 2009.  EBITDA as a percent of net sales decreased to16.8% in the current six-month period from 25.1% in the prior year six-monthperiod.  The foregoing factors discussedin the net sales, cost of sales and selling, general and administrativesections 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 measure derivedin accordance with GAAP. Net Debt represents total debt reduced by cash andshort-term investments. We use this figure as a means to evaluate our abilityto repay our indebtedness and to measure the risk of our financial structure.

 

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$15.1 million on June 30, 2010, as a result of a decrease in our cashand short-term investments and an increase in total debt.  The reduction of the cash and short terminvestment balances is due to payments on our converting expansion project,primarily the cost of the new converting line. The increase in total debt is due to the borrowings under a constructionloan to finance 80% of the cost of the warehouse component of the expansionproject.

 

21

----

Table ofContents

 

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

 
| ** **                     | ** ** | **As of**          | ** ** |
|--------------------------------|------------|--------------------|------------|
| ** **                     | ** ** | **June 30,**  | ** ** | **December 31,** | ** ** |
| ** **                     | ** ** | **2010**           | ** ** | **2009** | ** ** |
| ** **                     | ** ** | **(in thousands)** | ** ** |
| Current portion long term debt |       | $                  | 9,262      |   | $ | 3,742 |   |
| Long-term debt                 |       | 15,776             |       | 19,533 |   |
| Total debt                     |       | 25,038             |       | 23,275 |   |
| Less cash                      |       | (380               | )          | (1,232 | ) |
| Less short term investments    |       | (9,513             | )          | (18,509 | ) |
| Net debt                       |       | $                  | 15,145     |   | $ | 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 Exchange Act of 1934, as amended), as ofthe end of the period covered by this Quarterly Report on Form 10-Q.  Any controls and procedures, no matter howwell designed and operated, can provide only reasonable assurance of achievingthe desired control objectives.  Based onsuch evaluation, our chief executive officer and our chief financial officerhave concluded that our disclosure controls and procedures were effective as ofJune 30, 2010.

 

There were no changes in the Company’s internal control over financialreporting (as defined in Rule 13a-15(f) under the Exchange Act)during the quarter ended June 30, 2010, that have materially affected, orare reasonably likely to materially affect, our internal control over financialreporting.

 

**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 filedMarch 12, 2010.  We operate in achanging environment that involves numerous known and unknown risks anduncertainties that could materially affect our operations.  The risks, uncertainties and other factorsset forth in our Annual Report on Form 10-K may cause our actual results,performances and achievements to be materially different from those expressedor implied by our forward-looking statements. If any of these risks or events occur, our business, financial conditionor results of operations may be adversely affected.

 

**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.

 

22

----

Table of Contents

 

*(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 June 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 this Form 10-Q,which Exhibit Index is hereby incorporated by reference herein.

 

23

----

Table of Contents

 

**SIGNATURES**

 

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

 
| **ORCHIDS  PAPER PRODUCTS COMPANY** |   |                                                             |
|-------------------------------------|--------|------------------------------------------------------------------|
|                                |   |                                                             |
| Date: August 4,  2010     | By:    | /s/  Keith R. Schroeder                                          |
|                                |   | Keith  R. Schroeder                                              |
|                                |   | Chief  Financial Officer                                         |
|                                |   | (On  behalf of the registrant and as   Chief Accounting Officer) |

 

24

----

Table of Contents

 

**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.                                                                                                                                                                                                                     |

 

25

----