Table ofContents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,DC 20549**

 

**FORM 10-Q**

** **

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

 

**For thequarterly period ended June 30, 2009**

 

**OR**

 

**o****                     TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934**

 

**CommissionFile Number 001-32563**

 

**OrchidsPaper Products Company**

(Exact name ofRegistrant as Specified in its Charter)

 

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

 

**4826 HuntStreet**

**Pryor,Oklahoma 74361**

(Address ofPrincipal Executive Offices and Zip Code)

 

**(918)825-0616**

(Registrant’sTelephone Number, Including Area Code)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirement for thepast 90 days.  Yes x  No o

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12months (or for such shorter period that the registrant was required to submitand post such files).  Yes o  No o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer or a smaller reporting company.  See the definitions of “large acceleratedfiler”, “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act. (Check one):

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

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).  Yes o  No x

 

Number of sharesoutstanding of the issuer’s Common Stock, par value $.001 per share, as of August 12,2009: 6,518,272 shares.

 

 

 

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**ORCHIDS PAPER PRODUCTS COMPANY**

**TABLE OF CONTENTS**

**QUARTERLY REPORT ON FORM 10-Q**

**FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2009**

 
| ** **                              | ** **                                                                                                                                                    | **Page**   |
|-----------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **PART I.  FINANCIAL INFORMATION** |                                                                                                                                                          |       |
|                                    |                                                                                                                                                          |       |
| **ITEM 1.**                             | **Financial Statements**                                                                                                                                      |       |   |
|                                    |                                                                                                                                                          |       |   |
|                                    | **Balance Sheets as of June 30, 2009  (Unaudited) andDecember 31,  2008**                                                                           |       | **3** |
|                                    |                                                                                                                                                          |       |   |
|                                    | **Statements of Income for the three months  ended June 30, 2009and 2008 (Unaudited) and the six months ended June 30,  2009 and 2008 (Unaudited)** |       | **4** |
|                                    |                                                                                                                                                          |       |   |
|                                    | **Statements of Cash Flows for the six  months ended June 30, 2009and 2008 (Unaudited)**                                                                 |       | **5** |
|                                    |                                                                                                                                                          |       |   |
|                                    | **Notes to Unaudited Interim Financial Statements**                                                                                                           |       | **6** |
|                                    |                                                                                                                                                          |       |   |
| **ITEM 2.**                             | **Management’s  Discussion and Analysis of Financial Conditionand Results of Operations**                                                                |       | **11** |
|                                    |                                                                                                                                                          |       |   |
| **ITEM 3.**                             | **Quantitative  and Qualitative Disclosures about Market Risk**                                                                                               | ** ** | **21** |
|                                    |                                                                                                                                                          |       |   |
| **ITEM 4.**                             | **Controls and  Procedures**                                                                                                                                  | ** ** | **21** |
|                                    |                                                                                                                                                          |       |
| **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.**                             | **Submission of  Matters to a Vote of Security Holders**                                                                                                      | ** ** | **23** |
|                                    |                                                                                                                                                          |       |   |
| **ITEM 5.**                             | **Other Information**                                                                                                                                         | ** ** | **23** |
|                                    |                                                                                                                                                          |       |   |
| **ITEM 6.**                             | **Exhibits**                                                                                                                                                  | ** ** | **23** |
|                                    |                                                                                                                                                          |       |   |
|                                    | **Signatures**                                                                                                                                                |       | **24** |

 

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**PART I. FINANCIALINFORMATION**

 

**ITEM 1.  Financial Statements**

 

**ORCHIDSPAPER PRODUCTS COMPANY**

**BALANCE SHEETS**

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

 
| ** **                                                                                                                                          | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                          | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| ** **                                                                                                                                          | ** ** | **(unaudited)**   | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                          | ** ** | ** **        | ** ** | ** **            | ** ** |
| Current assets:                                                                                                                                     |       |              |       |                  |       |
| Cash                                                                                                                                                |       | $                 | 1,794      |                  | $          | 11 |   |
| Accounts receivable, net of allowance of $206 in  2009 and $186 in 2008                                                                             |       | 7,176             |       | 6,514                 |       |
| Inventories, net                                                                                                                                    |       | 6,267             |       | 6,253                 |       |
| Short term investments                                                                                                                              |       | 2,500             |       | —                |       |
| Income tax receivable                                                                                                                               |       | 869               |       | —                |       |
| Prepaid expenses                                                                                                                                    |       | 299               |       | 399                   |       |
| Deferred income taxes                                                                                                                               |       | 557               |       | 557                   |       |
| Total current assets                                                                                                                                |       | 19,462            |       | 13,734                |       |
|                                                                                                                                                |       |              |       |                  |       |
| Property, plant and equipment                                                                                                                       |       | 76,469            |       | 71,824                |       |
| Accumulated depreciation                                                                                                                            |       | (12,803           | )          | (11,165               | )          |
| Net property, plant and equipment                                                                                                                   |       | 63,666            |       | 60,659                |       |
|                                                                                                                                                |       |              |       |                  |       |
| Deferred debt issuance costs, net of accumulated amortization  of $618 in 2009 and $603 in 2008                                                     |       | 74                |       | 89                    |       |
| Total assets                                                                                                                                        |       | $                 | 83,202     |                  | $          | 74,482 |   |
|                                                                                                                                                |       |              |       |                  |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                      | ** ** | ** **        | ** ** | ** **            | ** ** |
| Current liabilities:                                                                                                                                |       |              |       |                  |       |
| Accounts payable                                                                                                                                    |       | $                 | 4,138      |                  | $          | 4,699 |   |
| Accrued liabilities                                                                                                                                 |       | 3,251             |       | 2,584                 |       |
| Current portion of long-term debt                                                                                                                   |       | 3,363             |       | 2,998                 |       |
| Total current liabilities                                                                                                                           |       | 10,752            |       | 10,281                |       |
|                                                                                                                                                |       |              |       |                  |       |
| Long-term debt, less current portion                                                                                                                |       | 19,268            |       | 21,067                |       |
| Deferred income taxes                                                                                                                               |       | 12,248            |       | 9,572                 |       |
| Stockholders’ equity:                                                                                                                          |       |              |       |                  |       |
| Common stock, $.001 par value, 25,000,000 shares  authorized, 6,494,304 and 6,328,986 shares issued and outstanding in 2009 and  2008, respectively |       | 6                 |       | 6                     |       |
| Additional paid-in capital                                                                                                                          |       | 23,149            |       | 22,215                |       |
| Common stock warrants                                                                                                                               |       | —            |       | 134                   |       |
| Retained earnings                                                                                                                                   |       | 17,779            |       | 11,207                |       |
| Total stockholders’ equity                                                                                                                     |       | 40,934            |       | 33,562                |       |
| Total liabilities and stockholders’ equity                                                                                                     |       | $                 | 83,202     |                  | $          | 74,482 |   |

 

See notes to financial statements.

 

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**ORCHIDS PAPER PRODUCTS COMPANY**

**STATEMENTSOF INCOME**

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

 
| ** **                                       | ** ** | **Three  Months Ended June 30,** | ** ** | **Six  Months Ended June 30,** | ** ** |
|--------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                       | ** ** | **2009**                              | ** ** | **2008**                            | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                       | ** ** | **(unaudited)**                       | ** ** | **(unaudited)**                     | ** ** | **(unaudited)** | ** ** | **(unaudited)** | ** ** |
|                                             |       |                                  |       |                                |       |   |   |   |   |
| Net sales                                        |       | $                                     | 24,131     |                                | $          | 22,315 |   | $ | 47,771 |   | $ | 42,590 |   |
|                                             |       |                                  |       |                                |       |   |   |   |   |
| Cost of sales                                    |       | 16,303                                |       | 19,193                              |       | 33,511 |   | 36,779 |   |
|                                             |       |                                  |       |                                |       |   |   |   |   |
| Gross profit                                     |       | 7,828                                 |       | 3,122                               |       | 14,260 |   | 5,811 |   |
|                                             |       |                                  |       |                                |       |   |   |   |   |
| Selling, general and administrative expenses     |       | 2,087                                 |       | 1,491                               |       | 3,917 |   | 2,876 |   |
|                                             |       |                                  |       |                                |       |   |   |   |   |
| Operating income                                 |       | 5,741                                 |       | 1,631                               |       | 10,343 |   | 2,935 |   |
|                                             |       |                                  |       |                                |       |   |   |   |   |
| Interest expense                                 |       | 135                                   |       | 320                                 |       | 294 |   | 731 |   |
| Other income, net                                |       | (1                                    | )          | (5                                  | )          | (4 | ) | (6 | ) |
|                                             |       |                                  |       |                                |       |   |   |   |   |
| Income before income taxes                       |       | 5,607                                 |       | 1,316                               |       | 10,053 |   | 2,210 |   |
|                                             |       |                                  |       |                                |       |   |   |   |   |
| Provision for income taxes:                      |       |                                  |       |                                |       |   |   |   |   |
| Deferred                                         |       | 1,782                                 |       | 429                                 |       | 2,676 |   | 712 |   |
| Current                                          |       | 50                                    |       | —                              |       | 805 |   | — |   |
|                                             |       | 1,832                                 |       | 429                                 |       | 3,481 |   | 712 |   |
|                                             |       |                                  |       |                                |       |   |   |   |   |
| Net income                                       |       | $                                     | 3,775      |                                | $          | 887 |   | $ | 6,572 |   | $ | 1,498 |   |
|                                             |       |                                  |       |                                |       |   |   |   |   |
| Net income per share:                            |       |                                  |       |                                |       |   |   |   |   |
| Basic                                            |       | $                                     | 0.58       |                                | $          | 0.14 |   | $ | 1.02 |   | $ | 0.24 |   |
| Diluted                                          |       | $                                     | 0.55       |                                | $          | 0.14 |   | $ | 0.97 |   | $ | 0.23 |   |
|                                             |       |                                  |       |                                |       |   |   |   |   |
| Shares used in calculating net income per share: |       |                                  |       |                                |       |   |   |   |   |
| Basic                                            |       | 6,468,529                             |       | 6,328,986                           |       | 6,421,441 |   | 6,328,017 |   |
| Diluted                                          |       | 6,891,208                             |       | 6,526,630                           |       | 6,778,918 |   | 6,541,066 |   |

 

See notes to financial statements.

 

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**ORCHIDSPAPER PRODUCTS COMPANY**

**STATEMENTS OF CASH FLOWS**

**(Dollarsin thousands)**

 
| ** **                                                                         | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                         | ** ** | **2009**                           | ** ** | **2008** | ** ** |
| ** **                                                                         | ** ** | **(unaudited)**                    | ** ** | **(unaudited)** | ** ** |
| **Cash Flows From Operating Activities**                                           |       |                               |       |   |   |
| Net  income                                                                        |       | $                                  | 6,572      |   | $ | 1,498 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                               |       |   |   |
| Depreciation  and amortization                                                     |       | 1,653                              |       | 1,544 |   |
| Provision  for doubtful accounts                                                   |       | 20                                 |       | 30 |   |
| Deferred  income taxes                                                             |       | 2,676                              |       | 712 |   |
| Stock  option plan expense                                                         |       | 435                                |       | 205 |   |
| Changes  in cash due to changes in operating assets and liabilities:               |       |                               |       |   |   |
| Accounts  receivable                                                               |       | (682                               | )          | (1,461 | ) |
| Inventories                                                                        |       | (14                                | )          | (475 | ) |
| Income  taxes receivable                                                           |       | (869                               | )          | (6 | ) |
| Prepaid  expenses                                                                  |       | 100                                |       | 192 |   |
| Accounts  payable                                                                  |       | (561                               | )          | 1,108 |   |
| Accrued  liabilities                                                               |       | 667                                |       | 359 |   |
| Net  cash provided by operating activities                                         |       | 9,997                              |       | 3,706 |   |
|                                                                               |       |                               |       |   |   |
| **Cash Flows From Investing Activities**                                           |       |                               |       |   |   |
| Purchases  of property, plant and equipment                                        |       | (4,645                             | )          | (2,736 | ) |
| Purchase  of investment securities                                                 |       | (2,500                             | )          | — |   |
| Net  cash used in investing activities                                             |       | (7,145                             | )          | (2,736 | ) |
|                                                                               |       |                               |       |   |   |
| **Cash Flows From Financing Activities**                                           |       |                               |       |   |   |
| Borrowings  under construction loan                                                |       | 1,526                              |       | — |   |
| Principal  payments on long-term debt                                              |       | (1,473                             | )          | (1,045 | ) |
| Net  borrowings (repayments) on revolving credit line                              |       | (1,487                             | )          | 318 |   |
| Proceeds  from the exercise of warrants attached to subordinated debentures        |       | 286                                |       | 15 |   |
| Proceeds  from the exercise of stock options                                       |       | 79                                 |       | — |   |
| Net  cash used in financing activities                                             |       | (1,069                             | )          | (712 | ) |
|                                                                               |       |                               |       |   |   |
| Net  change in cash                                                                |       | 1,783                              |       | 258 |   |
| Cash,  beginning                                                                   |       | 11                                 |       | 3 |   |
| Cash,  ending                                                                      |       | $                                  | 1,794      |   | $ | 261 |   |
| **Supplemental Disclosure:**                                                       |       |                               |       |   |   |
| Interest  paid                                                                     |       | $                                  | 294        |   | $ | 661 |   |
| Income  taxes paid                                                                 |       | $                                  | 1,735      |   | $ | 6 |   |

 

See notes tofinancial statements.

 

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**ORCHIDSPAPER PRODUCTS COMPANY**

**NOTES TO UNAUDITED INTERIM FINANCIAL STATEMENTS**

 

***Note 1 —Basis of Presentation***

 

Orchids Paper ProductsCompany (“Orchids” or the “Company”) was formed in 1998 to acquire and operatethe paper manufacturing facility, built in 1976, in Pryor, Oklahoma.  Orchids Acquisition Group, Inc. (“OrchidsAcquisition”) was established in November 2003, for the purpose ofacquiring the common stock of Orchids. Orchids Acquisition closed the sale of its equity and debt securities onMarch 1, 2004, and immediately thereafter closed the acquisition ofOrchids.  In April 2005, OrchidsAcquisition merged with and into Orchids, with Orchids as the surviving entity.

 

On July 20, 2005,the Company completed its public offering of 3,234,375 shares of its commonstock.  The public offering price of theshares was $5.33.  The net proceeds fromthe offering were $15,011,000 after deducting the underwriting discount andoffering expenses.  The Company’s stocktrades on the NYSE Amex under the ticker symbol “TIS.”

 

The accompanyingfinancial statements have been prepared without an audit, pursuant to the rules andregulations of the Securities and Exchange Commission (the “Commission”).  Certain information and footnote disclosuresnormally included in annual financial statements prepared in accordance withaccounting principles generally accepted in the United States have beencondensed 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 notesthereto.  Management believes that thefinancial statements contain all adjustments necessary for a fair statement ofthe results 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**

 

The Company haspreviously adopted Statement ofFinancial Accounting Standards (SFAS) No. 157, Fair ValueMeasurements (“SFAS 157”), for assets and liabilities which are required to bemeasured at fair value. SFAS 157 establishes a framework for measuring fairvalue and related disclosures. SFAS 157 has the following key elements:

 

·         Defines fair value as the exit price that would bereceived to sell an asset or paid to transfer a liability in an orderlytransaction between market participants at the measurement date;

 

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

 

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

 

·         Expands disclosures about instruments measured at fairvalue.

 

The valuation hierarchyconsiders the transparency of inputs used to value assets and liabilities as ofthe measurement date. The less transparent or observable the inputs used tovalue assets and liabilities, the lower the classification of the assets andliabilities in the valuation hierarchy. A financial instrument’s classificationwithin the valuation hierarchy is based on the lowest level of input that issignificant to its fair value measurement. The three levels of the valuationhierarchy and the classification of the Company’s financial assets andliabilities within the hierarchy are as follows:

 

Level 1 - Quoted prices(unadjusted) in active markets for identical assets or liabilities that thereporting entity has the ability to access at the measurement date.

 

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

 

Level 3 - Unobservableinputs for the asset or liability.

 

The Company considers thefollowing to be financial instruments: cash, short term investments, accounts receivable, accounts payable anddebt.  The estimated fair value of such instrumentsat June 30, 2009 approximates their carrying value as reported on theCompany’s balance sheet.

 

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The followingtable presents information about Orchids Paper Products Company’s assetsmeasured at fair value on a recurring basis as of June 30, 2009, andindicates the fair value hierarchy of the valuation techniques utilized todetermine such values.  Short term investments are valued as Level 1 inthe fair value hierarchy from independent pricing services utilized by ourinvestment custodians.  Short term debt and long term debt are valued asLevel 2 in the fair value hierarchy as these assets are not traded on the openmarket.  The fair value of the Company’sdebt is based on current rates offered to the Company for similar debt of thesame remaining maturities and additionally, the Company considers itscreditworthiness in determining the fair value of its debt.

 
| ** **              | ** ** | **Fair Value Measurements at June 30, 2009** | ** ** |
|-------------------------|------------|---------------------------------------------------|------------|
| ** **              | ** ** | **Using Inputs Considered as**                    | ** ** |
| ** **              | ** ** | **Level 1**                                       | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
|                    |       |                                              |       |   |   |   |   |
| Assets                  |       |                                              |       |   |   |   |   |
|                    |       |                                              |       |   |   |   |   |
| Short  term investments |       | $                                                 | 2,500      |   | $ | — |   | $ | — |   |
|                    |       |                                              |       |   |   |   |   |
| Liabilities             |       |                                              |       |   |   |   |   |
|                    |       |                                              |       |   |   |   |   |
| Short  term debt        |       | $                                                 | —     |   | $ | 3,363 |   | $ | — |   |
| Long  term debt         |       | —                                            |       | 19,268 |   | — |   |
|                    |       | $                                                 | —     |   | $ | 22,631 |   | $ | — |   |

 

**Note 3 —Commitments and Contingencies**

 

The Company is involvedfrom time to time in litigation arising from the normal course of business. Inmanagement’s opinion, the result from such litigation is not expected tomaterially affect the Company’s results of operations or financial condition.

 

On August 1, 2007,the Company received a new water discharge permit that requires the Company toreduce its biological oxygen demand and total suspended solids from itsdischarge water, thereby resulting in the need to expand its pre-treatmentfacility.  Under the permit, the Companywas required to meet the stricter limitations by August 1, 2009.  Construction of the $4.3 million project wascompleted in mid-July and as of August 1, 2009 our water dischargemet the requirements of the new water discharge permit.  The Company has approximately $1.0 million ofcommitted capital expenditures at June 30, 2009 in conjunction with thisproject that have not yet been paid.

 

Inthe fourth quarter of 2008, the Company entered into a contract to purchase334,000 MMBTU natural gas requirements at $7.50 per MMBTU plus a $0.07 perMMBTU management delivery fee for the period from April 2009 through March 2011.  The amount represents approximately 60% ofthe Company’s natural gas requirements based upon expected usage rates for2009.  If the Company is unable topurchase the contracted amounts and the market price at that time is less thanthe contracted price, the Company would be obligated under the terms of theagreement to reimburse an amount equal to the volume purchased that was lessthan the contracted amount multiplied by the difference between the contractprice and current spot price.  This fixed price natural gas contract meets the qualificationsof the normal purchases and normal sales exception for SFAS No. 133, “Accountingfor Derivative Instruments and Hedging Activities”.

 

We are in negotiations topurchase approximately 20 acres of land next to our existing Oklahoma facilityfor the construction of a new warehouse.

 

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**Note 4 —Inventories**

 

Inventories at June 30,2009 and December 31, 2008 are as follows:

 
| ** **                  | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                  | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| ** **                  | ** ** | ** **        | ** ** | ** **            | ** ** |
| Raw materials               |       | $                 | 1,742      |                  | $          | 1,904 |   |
| Bulk paper rolls            |       | 900               |       | 1,460                 |       |
| Converted finished          |       | 3,702             |       | 3,127                 |       |
| Inventory valuation reserve |       | (77               | )          | (238                  | )          |
|                        |       | $                 | 6,267      |                  | $          | 6,253 |   |

 

 

**Note 5 — Earnings per Share**

 

The computation of basic anddiluted net income per share for the three-month and six-month periods ended June 30,2009 and 2008 is as follows:

 
| ** **                                                          | ** ** | **Three  Months Ended June 30,** | ** ** | **Six  Months Ended June 30,** | ** ** |
|---------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                          | ** ** | **2009**                              | ** ** | **2008**                            | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net income - ($ thousands)                                     |       | $                                     | 3,775      |                                | $          | 887 |   | $ | 6,572 |   | $ | 1,498 |   |
|                                                                |       |                                  |       |                                |       |   |   |   |   |
| Weighted average shares outstanding                                 |       | 6,468,529                             |       | 6,328,986                           |       | 6,421,441 |   | 6,328,017 |   |
| Effect of stock options                                             |       | 316,365                               |       | 81,839                              |       | 265,676 |   | 91,154 |   |
| Effect of dilutive warrants                                         |       | 106,314                               |       | 115,805                             |       | 91,801 |   | 121,895 |   |
| Weighted average shares outstanding - assuming  dilution            |       | 6,891,208                             |       | 6,526,630                           |       | 6,778,918 |   | 6,541,066 |   |
| Net income (loss) per share:                                        |       |                                  |       |                                |       |   |   |   |   |
| Basic                                                               |       | $                                     | 0.58       |                                | $          | 0.14 |   | $ | 1.02 |   | $ | 0.24 |   |
| Diluted                                                             |       | $                                     | 0.55       |                                | $          | 0.14 |   | $ | 0.97 |   | $ | 0.23 |   |
|                                                                |       |                                  |       |                                |       |   |   |   |   |
| Stock options not considered above because they  were anti-dilutive |       | 33,750                                |       | 57,500                              |       | 49,750 |   | 33,750 |   |

 

**Note 6 — Stock Incentive Plan**

 

In April 2005, theboard of directors and the stockholders approved the 2005 Stock Incentive Plan(the “Plan”).  The Plan provides for thegranting of incentive stock options to employees selected by the board’scompensation committee.  The Planauthorized up to 697,500 shares to be issued. In May 2008, the shareholders approved increasing the number ofauthorized shares under the Plan from 697,500 to 897,500.  Generally, the options vest 20% on the dateof grant and then ratably 20% over the following four years and have a ten-yearterm.  Options for 20,000 shares weregranted effective January 20, 2009, to Keith Schroeder, the Company’sChief Financial Officer, at an exercise price of $10.205, the fair market valueof the stock on the date of grant.  Mr. Schroeder’soptions vest 50% on the 1st anniversary date of the grant and 50% on the 2ndanniversary date.  The options have a 10year life.

 

The following tabledetails the options granted to certain members of the board of directors andmanagement during the six months ended June 30, 2008 and 2009.

 
| **Grant**  | ** ** | **Number**    | ** ** | **Exercise** | ** ** | **Risk-Free**     | ** ** | **Estimated**  | ** ** | **Dividend** | ** ** | **Expected** | ** ** |
|------------|------------|---------------|------------|--------------|------------|-------------------|------------|----------------|------------|--------------|------------|--------------|------------|
| **Date**   | ** ** | **of Shares** | ** ** | **Price**    | ** ** | **Interest Rate** | ** ** | **Volatility** | ** ** | **Yield**    | ** ** | **Life**     | ** ** |
| May-08     |       | 28,750        |       | $            | 7.48       |              | 3.78       | %              | 41         | %            | None       |         | 5 years    |   |
| Jun-08     |       | 20,000        |       | $            | 7.80       |              | 3.98       | %              | 40         | %            | None       |         | 5 years    |   |
| January-09 |       | 60,000        |       | $            | 10.21      |              | 2.35       | %              | 46         | %            | None       |         | 5-7 years  |   |
| May-09     |       | 49,750        |       | $            | 17.48      |              | 3.30       | %              | 50         | %            | None       |         | 5-7 years  |   |

 

The Black-Scholes optionvaluation model was developed for use in estimating the fair value of tradedoptions, which have no vesting restrictions and are fully transferable.  In addition, options valuation models requirethe input of highly subjective assumptions including the expected stock pricevolatility.

 

In connection with theapproval of the Plan, the Company adopted SFAS No. 123 (R) “Share-BasedPayments” and expenses the cost of options granted over the vesting period ofthe option based on the grant-date fair value of the award.  The Company recognized an expense of $353,000and $154,000 for the three months ended June 30, 2009 and 2008,respectively, related to options granted under the Plan.  The Company recognized an expense of $435,000and $205,000 for the six months ended June 30, 2009 and 2008,respectively, related to options granted under the Plan.

 

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**Note 7 — Major Customers andConcentration of Credit Risk**

 

The Company sellsprimarily all of its paper production in the form of converted products;however, following the start-up of a new paper machine in the summer of 2006,the Company had excess paper production which it began to sell in parent rollform.  Revenues from converted productsales and parent roll sales in the three-month and six-month periods ended June 30,2009 and 2008 were:

 
| ** **                   | ** ** | **Three  Months Ended June 30,** | ** ** | **Six  Months Ended June 30,** | ** ** |
|------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                   | ** ** | **2009**                              | ** ** | **2008**                            | ** ** | **2009** | ** ** | **2008** | ** ** |
|                         |       |                                  |       |                                |       |   |   |   |   |
| Converted  product net sales |       | $                                     | 22,533     |                                | $          | 17,380 |   | $ | 43,591 |   | $ | 34,498 |   |
| Parent  roll net sales       |       | 1,598                                 |       | 4,935                               |       | 4,180 |   | 8,092 |   |
| Total  net sales             |       | $                                     | 24,131     |                                | $          | 22,315 |   | $ | 47,771 |   | $ | 42,590 |   |

 

Credit risk for theCompany is concentrated in three significant customers.  These are customers of the Company’sconverted product, each of whom operates discount retail stores locatedthroughout the United States.  During thethree months ended June 30, 2009, sales to the three significant customersaccounted for approximately 58% of total sales, comprised of customers of 31%,15%, and 12%, respectively.  For thethree months ended June 30, 2008, these three customers and one customerwho accounts for most of the Company’s third-party sales of parent rollsaccounted for approximately 69% of total sales, comprised of customers of 22%,18%, 16% and 13%, respectively.  For thesix months ended June 30, 2009, sales to the three significant convertedproduct customers accounted for approximately 56% of total sales, comprised ofcustomers of 28%, 15%, and 13%, respectively. For the six months ended June 30,2008, these three converted product customers plus the one customer of theCompany’s third-party sales of parent rolls accounted for approximately 67% oftotal sales, comprised of customers of 23%, 17%, 14% and 13%, respectively. At June 30,2009 and 2008, respectively, approximately $4.1 million (57%) of accountsreceivable was due from the three significant customers and $5.2 million (74%)of accounts receivable was due from the four significant customers.  No other customer of the Company accountedfor 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 8 — New Accounting Standards**

 

The Financial AccountingStandards Board (“FASB”) periodically issues new accounting standards in acontinuing effort to improve standards of financial accounting and reporting.We have reviewed the recently issued pronouncements and concluded that thefollowing new accounting standards could be applicable to the Company:

 

In April 2009, theFASB issued FSP No. 107-1 “Interim Disclosures about Fair Value ofFinancial Instruments.”  This FSPincreases the frequency of fair value disclosures to a quarterly instead of anannual basis.  This FSP is effective forinterim and annual periods ending after June 15, 2009.  Orchids adopted this standard and applicabledisclosures are reflected in Note 2.

 

In May 2009, theFASB issued SFAS No. 165 “Subsequent Events.”  This statement requires entities to disclosethe date through which they have evaluated subsequent events and whether thedate corresponds with the release of their financial statements.  This standard is effective for interim andannual periods ending after June 15, 2009. Orchids adopted this standard and the date has been added to Note 9 tothese financial statements.

 

In June 2009, theFASB issued SFAS No. 167, which amends FASB Interpretation No. 46(R) “Consolidationof Variable Interest Entities.”  Thisstatement amends FIN 46 (R) by altering how a company determines when anentity that is insufficiently capitalized or not controlled through votingshould be consolidated.  This standard iseffective at the start of the first fiscal year beginning after November 15,2009.  At this time, Orchids has novariable interest entities as defined by the standard.

 

In June 2009, theFASB issued SFAS No. 168, “The FASB Accounting Standards Codification and theHierarchy of Generally Accepted Accounting Principles.”  This codification represents a single sourceof authoritative nongovernmental U.S. generally accepted accounting principles(GAAP).  This Codification is effectivefor interim and annual periods after September 15, 2009.  Orchids will adopt this standard effectivewith the third quarter Form 10-Q filing.

 

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**Note 9 — Subsequent Events**

 

On July 31, 2009 theCompany amended its credit facility with Bank of Oklahoma and CommerceBank.  The amended facility was changedas follows:

 

·                  Establishment of a construction loan thatprovides for periodic loan advances with a maximum principal amount of $6.7million to finance a warehouse expansion project, which includes the purchaseof land and the construction of a new 270,000 square foot warehouse.  The construction loan will convert to a termloan in August 2010 and will mature in July 2016.  The loan will be based on an eighty percent(80%) advance rate of the costs of construction of the project;

 

·                  The term of the existing revolving creditfacility is extended to April 9, 2011;

 

·                  The annual unfunded capital expenditureslimit is increased to $3.5 million;

 

·                  Changes to LIBOR margin grid and theinclusion of a 3.5% all-in interest rate floor; and

 

·                  A reduction of the Funded-Debt-To-EBITDAcovenant limit to 3.25 to one from 4.0 to one.

 

Subsequent events havebeen evaluated through August 12, 2009.

 

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

 

**Forward-LookingInformation**

 

The following Management’sDiscussion and Analysis of Financial Condition and Results of Operationscontains forward-looking statements. These statements relate to, among other things:

 

·                  our business strategy;

·                  the market opportunity for our products, includingexpected demand for our products;

·                  our estimates regarding our capital requirements; and

·                  any of our other plans, objectives, and intentionscontained in this report that are not historical facts.

 

These statements relateto future events or future financial performance, and involve known and unknownrisks, uncertainties and other factors that may cause our actual results,levels of activity, performance or achievements to be materially different fromany future results, levels of activity, performance or achievements expressedor implied by such forward-looking statements. In some cases, you can identify forward-looking statements by terminologysuch as “may,” “should,” “could,” “expects,” “plans,” “intends,” “anticipates,”“believes,” “estimates,” “predicts,” “potential” or “continue” or the negativeof such terms or other comparable terminology. Although we believe that the expectations reflected in theforward-looking statements are reasonable, we cannot guarantee future results,levels of activity, performance or achievements.  These statements are only predictions.

 

You should not placeundue reliance on forward-looking statements because they involve known andunknown risks, uncertainties, and other factors that are, in some cases, beyondour control and that could materially affect actual results, levels ofactivity, performance or achievements. Factors that could materially affect our actual results, levels ofactivity, performance or achievements include, without limitation, thosedetailed under the caption “Risk Factors” in our Annual Report on Form 10-Kfor the fiscal year ended December 31, 2008, as filed with the Securitiesand Exchange Commission, and the following items:

 

·                  intense competition in our market andaggressive pricing by our competitors could force us to decrease our prices andreduce our profitability;

·                  a substantial percentage of our convertedproduct revenues are attributable to three large customers which may decreaseor cease purchases at any time;

·                  significant indebtedness limits our freecash flow and subjects us to restrictive covenants relating to the operation ofour business;

·                  the availability of and prices forenergy;

·                  failure to purchase the contractedquantity of natural gas may result in financial exposure;

·                  our exposure to variable interest rates;

·                  disruption in our supply or increase inthe cost of waste paper;

·                  the loss of key personnel;

·                  labor interruptions;

·                  natural disaster or other disruption toour facility;

·                  ability to finance the capitalrequirements of our business;

·                  cost to comply with existing and new lawsand regulations;

·                  failure to maintain an effective systemof internal controls necessary to accurately report our financial results andprevent fraud;

·                  the parent roll market is a commoditymarket and subject to fluctuations in demand and pricing;

·                  excess supply in the market may reduceour prices;

·                  an inability to continue to implement ourbusiness strategies;

·                  inability to sell the capacity generatedfrom our new converting line;

·                  failure to complete our project to add anew converting line successfully or timely; and

·                  a significant decline in sales causing usto no longer need the new converting line.

 

If any of these risks oruncertainties materialize, or if our underlying assumptions prove to beincorrect, actual results may vary significantly from what we projected.  Any forward-looking statement you read in thefollowing Management’s Discussion and Analysis of Financial Condition andResults of Operations reflects our current views with respect to future eventsand is subject to these and other risks, uncertainties, and assumptionsrelating to our operations, results of operations, growth strategy, and liquidity.  We

 

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assume no obligation topublicly update or revise these forward-looking statements for any reason,whether as a result of new information, future events, or otherwise.

 

**Overview**

 

We manufacture bulktissue paper, known as parent rolls, and convert parent rolls into a full lineof tissue products, including paper towels, bathroom tissue and paper napkinsfor the private label segment of the consumer, or “at home,” market.  We have focused our product design andmanufacturing on the discount retail market, primarily the dollar storeretailers, due to their consistent order patterns, limited number of stockkeeping units, or SKUs, offered and the growth being experienced in thischannel of the retail market.  While wehave customers located throughout the United States, we distribute most of ourproducts within approximately 900 miles of our northeast Oklahoma facility,which we consider to be our cost-effective shipping area.  However, we focus our sales efforts on anarea within an approximate 500-mile radius of our northeast Oklahoma facility.  Our products are sold primarily under ourcustomers’ private labels and, to a lesser extent, under our brand names suchas Colortex®, Velvet®, My Size® and our environmentally friendly care®line.  All of our revenue is derivedpursuant to truck load purchase orders from our customers.  We do not have supply contracts with any ofour customers.  Revenue is recognizedwhen title passes to the customer. Because our product is a daily consumable item, the order stream fromour customer base is fairly consistent with no significant seasonalfluctuations.  Changes in the nationaleconomy do not materially affect demand for our converted products.

 

Our profitability dependson several key factors, including:

 

·              themarket price of our products;

·              thecost of recycled paper used in producing our products;

·              theefficiency of operations in both our paper mill and converting operations; and

·              energycosts.

 

The private label segmentof the tissue industry is highly competitive, and discount retail customers areextremely price sensitive.  As a result,it is difficult to affect price increases. We expect these competitive conditions to continue.

 

In June 2006, webegan operating a new paper machine with an annual capacity of approximately33,000 tons.  As a result, beginning inthe third quarter of 2006, we were able to eliminate the requirement topurchase recycled parent rolls on the open market.  In the second quarter of 2007, due to therelatively high price of parent rolls, we began running all of our oldermachines on a full-time basis.  Thecapacity of the new machine, in addition to the capacity of our older machines,increased our total production capacity to approximately 56,000 tons peryear.   We have been taking limiteddowntime on some of our older machines in 2009 due to a soft parent rollmarket, primarily due to a soft market in the away-from-home business, which iswhere a majority of our parent roll sales occur.  Our strategy is to sell all of our parentroll capacity as converted products which generally carry higher margins thanparent rolls. We are focusing considerable efforts to improve our convertingefficiencies in order to achieve that goal. 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.

 

We currently utilizewarehouse space within our converting facility and rent additional space withina third-party warehouse located in Tulsa, Oklahoma to store converted productsprior to shipping.  We plan to purchaseapproximately 20 acres of land next to our converting facility and construct a270,000 square foot warehouse in which we will consolidate all of our convertedproduct storage.  We plan to utilize thefreed space in our converting facility by purchasing and installing a newconverting line.  The project cost forthe new converting line is expected to be $18.6 million and the project costfor the new warehouse is expected to be $8.4 million.  The new converting line project is expectedto add up to 4 million annual cases of incremental converted product capacityand broaden our product offering through increased packaging configurations,enhanced graphics and improved embossing. We expect to begin construction of the new warehouse in August 2009and to be fully operational by June 2010. The new converting line is expected to be in start-up mode by June 2010and reach full operating speeds by the end of the third quarter.

 

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 be accomplished through our continued highservice levels, increased total manufacturing capacity and expansion of ourhigh perceived value product offering.

 

Withour steady sales growth over the last eleven years, we have strategicallyexpanded capacity to meet demand. We are currently approaching full capacityutilization of our converting operations. We plan to increase our convertingcapacity by approximately four million cases annually with the installation ofa new converting line and construction of a warehouse. This additional capacitywill enable us to both increase sales of existing products and to provide theflexibility to manufacture higher tier products for sales to our core customerbase and into new retail channels.

 

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

 
| · | maintain  and strengthen our core customer relationships;                      |
|--------|--------------------------------------------------------------------------------|
| · | increase  our flexibility to meet a wider array of customer needs;             |
| · | further  expand our customer base in other retail channels; and                |
| · | continue to improve  operating efficiencies and to reduce manufacturing costs. |

 

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**Comparative Three-Month PeriodsEnded June 30, 2009 and 2008**

 

**Net Sales**

 
| ** **                  | ** ** | **Three  Months Ended June 30,** | ** ** |
|-----------------------------|------------|---------------------------------------|------------|
| ** **                  | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| ** **                  | ** ** | **(in  thousands, except average**    | ** ** |
| ** **                  | ** ** | **price  per ton and tons)**          | ** ** |
| Converted product net sales |       | $                                     | 22,533     |   | $ | 17,380 |   |
| Parent roll net sales       |       | 1,598                                 |       | 4,935 |   |
| Total net sales             |       | $                                     | 24,131     |   | $ | 22,315 |   |
|                        |       |                                  |       |   |   |
| Total tons shipped          |       | 12,297                                |       | 14,226 |   |
| Average price per ton       |       | $                                     | 1,962      |   | $ | 1,569 |   |

 

Net sales increased 8%,to $24.1 million in the quarter ended June 30, 2009, compared to $22.3million in the same period of 2008.  Netsales figures represent the gross selling price, including freight, lessdiscounts and pricing allowances.  Netsales of converted product increased in the quarter ended June 30, 2009 by$5.1 million, or 30% to $22.5 million compared to $17.4 million in the sameperiod last year.  Net sales of parentrolls decreased $3.3 million or 68% to $1.6 million in the quarter ended June 30,2009 compared to $4.9 million in the same period last year.  The increase in net sales of convertedproduct is primarily the result of a 19% increase in the net selling price perton of converted product shipments and a 9% increase in tons of convertedproduct shipped.  The increased tonnageshipped is a result of the improved production in our converting plant, whichprovided additional converted product for sale into the market.  Net sales of parent rolls decreased primarilyas a result of a 58% decrease in parent roll tonnage shipped, as well as a 22%decrease in the net selling price.

 

Total shipments in thesecond quarter of 2009 decreased by 1,929 tons, or 13.6%, to 12,297 tonscompared to 14,226 tons in the same period of 2008.  This decrease is the result of a 58% declinein parent roll shipments for the second quarter of 2009, primarily due to thecontinued softness in the away-from-home market for tissue products, which waspartially offset by a 9% increase in shipments of converted products.  We continue to manage our parent rollinventory by taking downtime on some of our older paper machines.  Additionally, the improved converting productioncited above resulted in less parent roll tonnage available for sale into theopen market.  Our overall net sellingprice per ton increased by 25% in the second quarter of 2009 compared to theprior year quarter due mainly to higher net selling prices for convertedproducts.  The increase in net sellingprice per ton of converted product was primarily the result of price increasesand product content changes achieved during 2008 and early 2009 to counteractincreased waste paper and energy prices.

 

**Cost of Sales**

 
| ** **                                 | ** ** | **Three  Months Ended June 30,** | ** ** |
|--------------------------------------------|------------|---------------------------------------|------------|
| ** **                                 | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| ** **                                 | ** ** | **(in  thousands, except**            | ** ** |
| ** **                                 | ** ** | **gross  profit margin %**            | ** ** |
| ** **                                 | ** ** | **and  paper cost per ton)**          | ** ** |
| Cost of paper                              |       | $                                     | 7,895      |   | $ | 11,580 |   |
| Non-paper materials, labor, supplies, etc. |       | 7,574                                 |       | 6,841 |   |
| Sub-total                                  |       | 15,469                                |       | 18,421 |   |
| Depreciation                               |       | 834                                   |       | 772 |   |
| Cost of sales                              |       | $                                     | 16,303     |   | $ | 19,193 |   |
|                                       |       |                                  |       |   |   |
| Gross Profit                               |       | $                                     | 7,828      |   | $ | 3,122 |   |
| Gross Profit Margin %                      |       | 32.4                                  | %          | 14.0 | % |
| Total paper cost per ton consumed          |       | $                                     | 642        |   | $ | 814 |   |

 

The major components ofcost of sales are the cost of internally produced paper, raw materials, directlabor and benefits, freight costs of products shipped to customers, insurance,repairs and maintenance, energy, utilities and depreciation.

 

Cost of sales decreasedapproximately $2.9 million, or 15%, to $16.3 million for the quarter ended June 30,

 

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2009, compared to $19.2million in the same period of 2008.  Thisdecrease in our cost of sales was primarily attributable to lower paperproduction costs, lower converting direct labor costs and converted productpackaging costs which were partially offset by higher converting overheadcosts.  As a percentage of net sales,cost of sales decreased to 68% in the 2009 quarter from 86% of net sales in the2008 quarter.  Cost of sales as apercentage of net sales for the second quarter of 2009 was favorable to theprior year quarter due to higher converted product net selling prices and lowerpaper production costs.

 

Our overall cost of paperin the second quarter of 2009 was $642 per ton, a decrease of $172 per toncompared to the same period in 2008. Paper production costs decreased primarily due to lower waste paperprices and, to a lesser extent, lower natural gas prices.  The prices we paid for waste paper in thesecond quarter of 2009 decreased approximately 49% compared to the prices paidin the prior year quarter.  As a result,our cost of waste paper consumed decreased approximately $2.6 million in 2009compared to the second quarter of 2008. Natural gas costs decreased approximately 30% or $380,000 in the secondquarter of 2009 compared to the same period in 2008, mainly driven by reducedrates.

 

Converting direct laborcosts decreased in the 2009 quarter compared to the 2008 quarter by approximately23% on a per unit basis due to both reduced headcount resulting from ourautomation project completed in the first quarter of 2009 and higherproductivity.  The lower labor costsimproved our gross profit margin by approximately $600,000.  Due to favorable market conditions, we wereable to negotiate lower costs for our packaging materials.  Converting overhead costs increased in the2009 quarter over the 2008 quarter by approximately $880,000, primarily due toan increase of $235,000 in cost of outside warehousing, a $191,000 increase inoverhead labor, $189,000 in relocation and recruitment costs and a $150,000increase in our maintenance and repair costs. The year over year increase in outside warehousing expense is due toincreased storage space requirements resulting from a higher level of convertedproduct production and shipments experienced in the second quarter of2009.   Overhead labor increasedprimarily due to additions to our management team.  The level of maintenance and repair costsexperienced in the second quarter of 2009 is expected to continue into thefuture.

 

**Gross Profit**

 

Gross profit in thequarter ended June 30, 2009, increased $4.7 million, or 151%, to $7.8million compared to $3.1 million in the same period last year.  Gross profit as a percentage of net sales inthe 2009 quarter was 32% compared to 14% in the 2008 quarter.  The gross profit increase was the result oflower waste paper prices, increased converted product net sales prices, anincrease in converted product tonnage shipped and lower converting direct laborcosts.  As a result of the increasedconverting production, more tonnage was consumed in our converting operationrather than being sold as parent rolls, which positively affected our grossprofit because sales of converted products typically carry a higher margin thansales of parent rolls.

 

**Selling, General andAdministrative Expenses**

** **
| ** **                          | ** ** | **Three  Months Ended June 30,** | ** ** |
|-------------------------------------|------------|---------------------------------------|------------|
| ** **                          | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| ** **                          | ** ** | **(In  thousands, except**            | ** ** |
| ** **                          | ** ** | **SG&A  as a % of net sales)**    | ** ** |
|                                |       |                                  |       |   |   |
| Commission expense                  |       | $                                     | 346        |   | $ | 251 |   |
| Other S,G&A expenses            |       | 1,741                                 |       | 1,240 |   |
| Selling, General & Adm exp |       | $                                     | 2,087      |   | $ | 1,491 |   |
| SG&A as a % of net sales        |       | 8.6                                   | %          | 6.7 | % |

 

 

Selling, general andadministrative expenses include salaries, commissions to brokers and othermiscellaneous expenses.  Selling, generaland administrative expenses increased $596,000, or 40%, to $2.1 million in thequarter ended June 30, 2009 compared to $1.5 million in the comparable2008 period.  The increase was primarilydue to higher stock option expense, increased accruals under our incentivebonus plan, increased commission expense related to our increased convertedproduct sales, and costs associated with additions to our senior managementteam.  Stock option expense increasedprimarily due to the effect the year-over-year increase in the price of ourcommon stock had on the Black-Scholes calculation of the expense related tostock options granted to our board of directors.  As a percentage of net sales, selling,general and administrative expenses increased to 8.6% in the second quarter of2009 compared to 6.7% in the same period of 2008.

 

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**Operating Income**

 

As a result of theforegoing factors, operating income for the quarters ended June 30, 2009increased $4.1 million from the same period in 2008.

 

**Interest Expense and Other Income**

 
| ** **        | ** ** | **Three  Months Ended June 30,** | ** ** |
|-------------------|------------|---------------------------------------|------------|
| ** **        | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| ** **        | ** ** | **(In  thousands)**                   | ** ** |
| Interest  expense |       | $                                     | 135        |   | $ | 320 |   |
| Other  income     |       | $                                     | (1         | ) | $ | (5 | ) |

 

Interest expense includesinterest on all debt and amortization of deferred debt issuance costs.  Interest expense decreased $185,000 to$135,000 in the quarter ended June 30, 2009, compared to $320,000 in thequarter ended June 30, 2008.  LowerLIBOR interest rates, lower margins over LIBOR, reflecting our improvedfinancial performance, and, to a lesser extent, the effect of lower borrowings,were the primary reasons for the decrease in interest expense.

 

**Income Before Income Taxes**

 

As a result of theforegoing factors, income before income taxes increased $4.3 million to $5.6million in the quarter ended June 30, 2009, compared to $1.3 million inthe same period in 2008.

 

**Income Tax Provision**

 

As of June 30, 2009,we estimate our full-year effective income tax rate to be 34.6%.  Because the first quarter of 2009 wasrecorded at a higher rate, our effective income tax rate for the quarter ended June 30,2009 was 32.7%.  Our rate is lower thanthe statutory rate because of the Oklahoma Investment Tax Credits associatedwith capital equipment investments and the utilization of Federal Indian Employmentcredits.  The Oklahoma Investment TaxCredits offset our Oklahoma state tax liability.  As of June 30, 2008, our annualeffective income tax rate was 33%.

 

We have extinguished ourFederal Net Operating Losses and, as a result have paid approximately $1.7million in quarterly estimated tax payments in 2009.  No current taxes are owed to state taxingauthorities because of the Oklahoma Investment Tax Credit carryforwards.

 

**Comparative Six-Month PeriodsEnded June 30, 2009 and 2008**

 

**Net Sales**

** **
| ** **                   | ** ** | **Six  Months Ended June 30,** | ** ** |
|------------------------------|------------|-------------------------------------|------------|
| ** **                   | ** ** | **2009**                            | ** ** | **2008** | ** ** |
| ** **                   | ** ** | **(in  thousands, except**          | ** ** |
| ** **                   | ** ** | **price  per ton and tons)**        | ** ** |
| Converted  product net sales |       | $                                   | 43,591     |   | $ | 34,498 |   |
| Parent  roll net sales       |       | 4,180                               |       | 8,092 |   |
| Total  net sales             |       | $                                   | 47,771     |   | $ | 42,590 |   |
|                         |       |                                |       |   |   |
| Total  tons shipped          |       | 24,726                              |       | 27,188 |   |
| Average  price per ton       |       | $                                   | 1,932      |   | $ | 1,566 |   |

 

Net sales increased 12%to $47.8 million in the six months ended June 30, 2009, compared to $42.6million in the same period of 2008.  Netsales figures represent gross selling price, including freight, less discountsand pricing allowances.  Net sales ofconverted product increased for the six months ended June 30, 2009, by$9.1 million, or 26% to $43.6 million compared to $34.5 million in the sameperiod last year.  Net sales of parentrolls decreased $3.9 million or 48% to $4.2 million in the six months ended June 30,2009 compared to $8.1 million in the same period last year.  The overall increase in net sales isprimarily the result of a 22% increase in the net selling price per ton ofconverted product shipments and a 16% increase in tons of converted productshipped which was partially offset by a 41% decrease in parent roll 

 

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tonnage shipped and a 13%decrease in parent roll net selling price per ton.

 

Total shipments in thesix-month period of 2009 decreased by 2,462 tons, or 9%, to 24,726 tonscompared to 27,188 tons in the same period of 2008, primarily due to a 41%decrease in parent roll shipments.  Ouroverall net selling price per ton increased by 23% in the first six months of2009 compared to the comparable prior year period.  This increase was attributable to higherprices for converted products, primarily due to product content reductionactions taken during the last twelve months to counteract increased rawmaterial and energy costs.

 

**Cost of Sales**

** **
| ** **                                 | ** ** | **Six  Months Ended June 30,** | ** ** |
|--------------------------------------------|------------|-------------------------------------|------------|
| ** **                                 | ** ** | **2009**                            | ** ** | **2008** | ** ** |
| ** **                                 | ** ** | **(in  thousands, except**          | ** ** |
| ** **                                 | ** ** | **gross  profit margin %**          | ** ** |
| ** **                                 | ** ** | **and  paper cost per ton)**        | ** ** |
| Cost of paper                              |       | $                                   | 16,434     |   | $ | 22,133 |   |
| Non-paper materials, labor, supplies, etc. |       | 15,439                              |       | 13,120 |   |
| Sub-total                                  |       |                                | 31,873     |   |   | 35,253 |   |
| Depreciation                               |       | 1,638                               |       | 1,526 |   |
| Cost of sales                              |       | $                                   | 33,511     |   | $ | 36,779 |   |
|                                       |       |                                |       |   |   |
| Gross Profit                               |       | $                                   | 14,260     |   | $ | 5,811 |   |
| Gross Profit Margin %                      |       | 29.9                                | %          | 13.6 | % |
| Total paper cost per ton consumed          |       | $                                   | 664        |   | $ | 809 |   |

 

The major components ofcost of sales are the cost of internally produced paper, raw materials, directlabor and benefits, freight costs of products shipped to customers, insurance,repairs and maintenance, energy, utilities and depreciation.

 

Cost of sales decreasedapproximately $3.3 million, or 9%, to $33.5 million for the six months ended June 30,2009, compared to $36.8 million in the same period of 2008.  As a percentage of net sales, cost of salesdecreased to 70.1% of net sales in the six-month period ended June 30,2009 from 86.4% of net sales in the six-month period ended June 30,2008.  The decrease in cost of sales as apercentage of net sales in the six months ended June 30, 2009, wasprimarily attributed to lower paper production costs, higher converted productselling prices per ton, and lower converting direct labor costs which weresomewhat offset by higher converting overhead costs.

 

In the six months ended June 30,2009, our overall cost of paper was $664 per ton, a decrease of $145 per tonwhen compared to the same period in 2008. Our cost per ton decreased primarily due to decreased waste paper pricesand, to a lesser extent, decreased prices of natural gas.  Average waste paper prices have decreasedapproximately 40%, which reduced our cost of waste paper consumed by $4.1million in the first six months of 2009 compared to the same period of 2008.  Natural gas prices decreased 27% in the 2009period compared to the same period in 2008, resulting in decreased cost ofapproximately $728,000.

 

Direct labor costs in thefirst six months of 2009 were lower than the same period in 2008 by 25% on aper unit basis for the same reasons cited for the three-month comparison.  This had a favorable effect of approximately$1.3 million on our gross profit margin. Converting overhead expenses for the six months ended June 30,2009, were higher than the same period of 2008, primarily due to increasedmaintenance and repair costs of approximately $457,000, increased utilizationof outside warehousing resulting in increased costs of approximately $428,000,and higher costs associated with additions to our management team ofapproximately $294,000.

 

**Gross Profit**

 

Gross profit in the sixmonths ended June 30, 2009, increased $8.5 million, or 145 %, to $14.3million compared to $5.8 million in the same period last year.  Gross profit as a percentage of net sales inthe six-month period ended June 30, 2009, was 29.9% compared to 13.6% inthe same period in 2008.  The effect oflower paper production costs, particularly as a result of lower waste paperprices as well as energy costs, higher converted product selling prices andhigher converted product shipments all contributed to the 

 

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increase in grossprofit.  Additionally, sales of lowermargin parent rolls declined while sales of higher margin converted productsales increased.

 

**Selling, General andAdministrative Expenses**

** **
| ** **                           | ** ** | **Six  Months Ended June 30,** | ** ** |
|--------------------------------------|------------|-------------------------------------|------------|
| ** **                           | ** ** | **2009**                            | ** ** | **2008** | ** ** |
| ** **                           | ** ** | **(In  thousands, except**          | ** ** |
| ** **                           | ** ** | **SG&A  as a % of net sales)**  | ** ** |
|                                 |       |                                |       |   |   |
| Commission  expense                  |       | $                                   | 678        |   | $ | 493 |   |
| Other  S,G&A expenses            |       | 3,239                               |       | 2,383 |   |
| Selling,  General & Adm exp |       | $                                   | 3,917      |   | $ | 2,876 |   |
| SG&A  as a % of net sales        |       | 8.2                                 | %          | 6.8 | % |

 

Selling, general andadministrative expenses include salaries, commissions to brokers and othermiscellaneous expenses.  Selling, generaland administrative expenses increased $1.0 million, or 36%, to $3.9 million inthe six months ended June 30, 2009, compared to $2.9 million in thecomparable 2008 period, mainly as a result of increased accruals under ourincentive bonus plan, costs associated with additions to our senior managementteam, increased stock option expense, primarily due to an increase in the priceof our stock, increased sales commissions due to the increase in convertedproduct sales and increased professional and legal fees.  As a percentage of net sales, selling,general and administrative expenses increased to 8.2% in the six months ended June 30,2009, compared to 6.8% in the same period of 2008.

 

**Operating Income**

 

As a result of theforegoing factors, operating income for the six months ended June 30, 2009was $10.3 million compared to operating income of $3.0 million for the sameperiod of 2008.

 

**Interest Expense and Other Income**

** **
| ** **       | ** ** | **Six  Months Ended June 30,** | ** ** |
|------------------|------------|-------------------------------------|------------|
| ** **       | ** ** | **2009**                            | ** ** | **2008** | ** ** |
| ** **       | ** ** | **(In  thousands)**                 | ** ** |
| Interest expense |       | $                                   | 294        |   | $ | 731 |   |
| Other income     |       | $                                   | (4         | ) | $ | (6 | ) |

 

Interest expensedecreased by $437,000 from $731,000 in the six months ended June 30, 2008,to $294,000 in the same period in 2009. The decrease was attributable to lower LIBOR rates, lower margins overLIBOR attributable to our improved financial performance, and lower averageoutstanding bank borrowings.

 

**Income Before Income Taxes**

 

As a result of theforegoing factors, income before income taxes increased $7.9 million to $10.1million in the six months ended June 30, 2009 compared to $2.2 million inthe same period in 2008.

 

**Income Tax Provision**

 

As of June 30, 2009,we estimate our full-year effective income tax rate to be 34.6%.  It is lower than the statutory rate becauseof Oklahoma Investment Tax Credits associated with our investment in 2006 in apaper machine as well as continued capital investment in our mill andconverting production facilities and the utilization of Federal IndianEmployment Credits.  Our tax rate ishigher than 2008 as we have depleted all of our Federal net operating losscarryforwards.  For the six months ended June 30,2008, our effective income tax rate was 32%.

 

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**Liquidity and Capital Resources**

 

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

 

Cash increased in the sixmonths ended June 30, 2009, by $1.8 million.  Additionally, we generated enough cash topurchase $2.5 million in short term investments, consisting of institutionalmoney market funds.  Cash increased by$258,000 the six months ended June 30, 2008.

 

The following tablesummarizes key cash flow information for the six-month periods ended June 30,2009 and 2008:

 
| ** **                       | ** ** | **Six  Months Ended June 30,** | ** ** |
|----------------------------------|------------|-------------------------------------|------------|
| ** **                       | ** ** | **2009**                            | ** ** | **2008** | ** ** |
| ** **                       | ** ** | **(in  thousands)**                 | ** ** |
|                             |       |                                |       |   |   |
| Cash flow provided by (used in): |       |                                |       |   |   |
| Operating activities             |       | $                                   | 9,997      |   | $ | 3,706 |   |
|                             |       |                                |       |   |   |
| Investing activities             |       | $                                   | (7,145     | ) | $ | (2,736 | ) |
|                             |       |                                |       |   |   |
| Financing activities             |       | $                                   | (1,069     | ) | $ | (712 | ) |

 

Cash flow provided byoperating activities was $10.0 million in the six-month period ended June 30,2009, which primarily resulted from earnings before non-cash charges and a netincrease in accounts payable and accrued liabilities partly offset by anincrease in trade receivables.

 

Cash flow used ininvesting activities were $7.1 million in the first six months of 2009 as theresult of $4.6 million in expenditures on capital projects, primarily for thewaste water treatment project, as well as the purchase of $2.5 million in shortterm investment securities.

 

Cash flows used infinancing activities was $1.1 million in the six-month period ended June 30,2009, and was primarily attributable to $1.5 million of principal payments onour term loans, $1.5 million repayment of our revolving line of credit whichwas partially offset by $1.5 million of borrowings under our construction loanfor the waste water treatment project.

 

Cash flows provided byoperating activities was $3.7 million in the six-month period ended June 30,2008, which primarily resulted from earnings before non-cash charges, higheraccounts payable and accrued expenses, partly offset by increased tradereceivables and inventories.

 

Cash flows used ininvesting activities were $2.7 million in the six-month period ended June 30,2008, as a result of expenditures on capital projects, primarily the previouslyannounced $4.75 million project to automate certain operations in ourconverting plant.

 

Cash flows used infinancing activities was $712,000 in the six-month period ended June 30,2008, and was primarily attributable to $1.0 million of principal payments onour term loans, which were partially offset by $318,000 of borrowings under therevolving credit agreement.

 

On July 31, 2009 theCompany amended its credit facility with Bank of Oklahoma and CommerceBank.  The amendments to the facility arenoted below:

 

·                  Establishment of a construction loan thatprovides for periodic loan advances with a maximum principal amount of $6.7million to finance a warehouse expansion project, which includes the purchaseof land and the construction of a new 270,000 square foot warehouse.  The construction loan will convert to a termloan in August 2010 and will mature in July 2016.  The loan will be based on an eighty percent(80%) advance rate of the costs of construction of the project;

 

·                  The term of the existing revolving creditfacility is extended to April 9, 2011;

 

·                  The annual unfunded capital expenditureslimit is increased to $3.5 million;

 

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·      Changes to LIBOR margin grid and theinclusion of a 3.5% all-in interest rate floor and;

 

·      A reduction of the Funded-Debt-To-EBITDAcovenant limit to 3.25 to one from 4.0 to one.

 

We currently utilizewarehouse space within our converting facility and rent additional space withina third-party warehouse located in Tulsa, Oklahoma to store converted productsprior to shipping.  We plan to purchaseapproximately 20 acres of land next to our converting facility and construct a270,000 square foot warehouse in which we will consolidate all of our convertedproduct storage.  We plan to utilize thefreed space in our converting facility by purchasing and installing a newconverting line.  The project cost forthe new converting line is expected to be $18.6 million and the project costfor the new warehouse is expected to be $8.4 million.  Funding for these projects is expected tocome from an equity offering in our common stock, borrowings under our creditfacility and funds from operations.  Thenew converting line project is expected to add up to 4 million annual cases ofincremental converted product capacity and broaden our product offering throughincreased packaging configurations, enhanced graphics and improvedembossing.  We expect to beginconstruction of the new warehouse in August 2009 and to be fullyoperational by June 2010.  The newconverting line is expected to be in start-up mode by June 2010 and reachfull operating speeds by the end of the third quarter.

 

**Critical Accounting Policies andEstimates**

 

The preparation of ourfinancial statements and related disclosures in conformity with accountingprinciples generally accepted in the United States requires management to makeestimates and judgments that affect our reported amounts of assets andliabilities, revenue and expense, and related disclosures of contingent assetsand liabilities.  On an ongoing basis, weevaluate our estimates and assumptions based upon historical experience andvarious other factors and circumstances. Management believes that our estimates and assumptions are reasonableunder the circumstances; however, actual results may vary from these estimatesand assumptions under different future circumstances.  We have identified the following criticalaccounting policies that affect the more significant judgments and estimatesused in the preparation of our financial statements:

 

*Accounts Receivable*. Accounts receivable consist of amounts due to us from normal businessactivities.  Our management must makeestimates of accounts receivable that will not be collected.  We perform ongoing credit evaluations of ourcustomers and adjust credit limits based upon payment history and the customer’screditworthiness as determined by our review of their current creditinformation.  We continuously monitorcollections and payments from our customers and maintain an allowance forestimated losses based on historical experience and specific customer collectionissues that we have identified.  Tradereceivables are written-off when all reasonable collection efforts have beenexhausted, including, but not limited to, external third party collectionefforts and litigation.  While suchcredit losses have historically been within management’s expectations and theallowance provided, there can be no assurance that we will continue toexperience the same credit loss rates as in the past.  During the six-month periods ended June 30,2009 and 2008, provisions for doubtful accounts were recognized in the amountof $30,000 for each period.  There wereno recoveries credited during the first six months of 2009.  In the first six months of 2008, $3,000 ofrecoveries of accounts previously written off were credited back to theallowance.  One accounts receivablebalance of $10,000 was written off in the six-month period ended June 30,2009 and one accounts receivable balance of $3,000 was written off in the sametime period of 2008.

 

*Inventory.* Our inventory consists of finished goods and raw materials and is statedat the lower of cost or market.  Ourmanagement regularly reviews inventory quantities on hand and records aprovision for excess and obsolete inventory based on the age of the inventoryand forecasts of product demand.  Asignificant decrease in demand could result in an increase in the amount ofexcess inventory quantities on hand. During the first six months of 2009, $30,000 was provided and there werecharges totaling $192,000 against the valuation reserve.  The charges against the reserve wereprimarily the result of the product content changes made, or in the process ofbeing made, to our converted products and the resultant effect on certain rawmaterials, primarily poly wrapping material, used in the converting process.During the first six months of 2008, $55,000 was provided and there werecharges totaling $74,000 against the valuation reserve.

 

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**New Accounting Pronouncements**

 

The Financial AccountingStandards Board (“FASB”) periodically issues new accounting standards in acontinuing effort to improve standards of financial accounting and reporting.We have reviewed the recently issued pronouncements and concluded that thefollowing new accounting standards could be applicable to the Company:

 

In April 2009, theFASB issued FSP No. 107-1 “Interim Disclosures about Fair Value ofFinancial Instruments.”  This FSPincreases the frequency of fair value disclosures to a quarterly instead ofannual basis.  This FSP is effective forinterim and annual periods ending after June 15, 2009.  Orchids adopted this standard and applicabledisclosures are reflected in Note 2.

 

In May 2009, theFASB issued SFAS No. 165 “Subsequent Events.”  This statement requires entities to disclosethe date through which they have evaluated subsequent events and whether thedate corresponds with the release of their financial statements.  This standard is effective for interim andannual periods ending after June 15, 2009. Orchids adopted this standard and the date has been added to Note 9 tothese financial statements.

 

In June 2009, theFASB issued SFAS No. 167, which amends FASB Interpretation No. 46(R) “Consolidationof Variable Interest Entities.”  Thisstatement amends FIN 46(R) by altering how a company determines when anentity that is insufficiently capitalized or not controlled through votingshould be consolidated.  This standard iseffective at the start of the first fiscal year beginning after November 15,2009.  At this time, Orchids has novariable interest entities as defined by the standard.

 

In June 2009, theFASB issued SFAS No. 168, “The FASB Accounting Standards Codification andthe Hierarchy of Generally Accepted Accounting Principles.”  This codification represents a single sourceof authoritative nongovernmental U.S. generally accepted accounting principles(GAAP).  This Codification is effectivefor interim and annual periods after September 15, 2009.  Orchids will adopt this standard with thethird quarter form 10-Q filing.

** **

**Non-GAAP Discussion**

 

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 is not a measurement of our financial performance under GAAP andshould not be considered as an alternative to net income, operating income orany other performance measure derived in accordance with GAAP, or as analternative to cash flow from operating activities or a measure of ourliquidity.

 

EBITDA represents netincome before net interest expense, income tax expense, depreciation andamortization.  We believe EBITDAfacilitates operating performance comparisons from period to period and companyto company by eliminating potential differences caused by variations in capitalstructures (affecting relative interest expense), tax positions (such as theimpact on periods or companies of changes in effective tax rates or netoperating losses) and the age and book depreciation of facilities and equipment(affecting relative depreciation expense).

 

EBITDA has limitations asan analytical tool, and you should not consider it in isolation, or as asubstitute for any of our results as reported under GAAP.  Some of these limitations are:

 

·              it does not reflect our cash expenditures for capitalassets;

 

·              it does not reflect changes in, or cash requirementsfor, our working capital requirements;

 

·              itdoes not reflect the interest expense, or the cash requirements necessary toservice interest or principal payments on our indebtedness;

 

·              althoughdepreciation and amortization are non-cash charges, the assets beingdepreciated and amortized will often have to be replaced in the future, andEBITDA does not reflect cash requirements for such replacements; and

 

·              othercompanies, including other companies in our industry, may calculate thesemeasures differently than we do, limiting their usefulness as a comparativemeasure.

 

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Because of theselimitations, EBITDA should not be considered as a measure of discretionary cashavailable to us to invest in the growth of our business or to reduce ourindebtedness.  We compensate for theselimitations by relying primarily on our GAAP results and using EBITDA on asupplemental basis.

 

The following tablereconciles EBITDA to net income for the three months ended June 30, 2009and 2008:

 
| ** **                | ** ** | **Three  Months Ended June 30,** | ** ** |
|---------------------------|------------|---------------------------------------|------------|
| ** **                | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| ** **                | ** ** | **(In  thousands,**                   | ** ** |
| ** **                | ** ** | **except  % of net sales)**           | ** ** |
|                      |       |                                  | ** ** | ** ** | ** ** |
| Net  income               |       | $                                     | 3,775      |   | $ | 887 |   |
| Plus:  Interest expense   |       | 135                                   |       | 320 |   |
| Plus:  Income tax expense |       | 1,832                                 |       | 429 |   |
| Plus:  Depreciation       |       | 834                                   |       | 772 |   |
| EBITDA                    |       | $                                     | 6,576      |   | $ | 2,408 |   |
| % of  net sales           |       | 27.3                                  | %          | 10.8 | % |

 

EBITDA increased $4.2million to $6.6 million for the quarter ended June 30, 2009, compared to$2.4 million for the same period in 2008. EBITDA as a percent of net sales increased to 27.3% in the secondquarter of 2009 from 10.8% in the second quarter of 2008.  The foregoing factors discussed in the netsales, cost of sales and selling, general and administrative expenses sectionsare the reasons for the increase.

 

The following tablereconciles EBITDA to net income for the six months ended June 30, 2009 and2008:

 
| ** **               | ** ** | **Six  Months Ended June 30,** |       |
|--------------------------|------------|-------------------------------------|------------|
| ** **               | ** ** | **2009**                            | ** ** | **2008** |   |
| ** **               | ** ** | **(In  thousands,**                 |       |
|                     | ** ** | **except  % of net sales)**         |       |
|                     | ** ** | ** **                          | ** ** | ** ** |   |
| Net  income              |       | $                                   | 6,572      |   | $ | 1,498 |   |
| Plus: Interest expense   |       | 294                                 |       | 731 |   |
| Plus: Income tax expense |       | 3,481                               |       | 712 |   |
| Plus: Depreciation       |       | 1,638                               |       | 1,526 |   |
| EBITDA                   |       | $                                   | 11,985     |   | $ | 4,467 |   |
| % of net sales           |       | 25.1                                | %          | 10.5 | % |

 

EBITDAincreased $7.5 million to $12.0 million for the six months ended June 30,2009, compared to $4.5 million for the same period of 2008.  EBITDA as a percent of net sales increased to25.1% in the current six-month period from 10.5% in the prior year six-monthperiod.  The foregoing factors discussed inthe net sales, cost of sales and selling, general and administrative sectionsare the reasons for these changes.

 

**ITEM 3.  Quantitative and Qualitative Disclosuresabout Market Risk**

 

There has been no material change in the informationprovided in response to Item 7A of the Company’s Form 10-K for the yearended December 31, 2008.

 

**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, 2009.

 

Therewere no changes in the Company’s internal control over financial reporting (asdefined in Rule 13a-15(f) under the Exchange Act) during the quarterended June 30, 2009, that have materially affected,

 

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orare reasonably likely to materially affect, our internal control over financialreporting.

 

**PART II.  OTHER INFORMATION**

 

**ITEM 1.  Legal Proceedings**

 

None.

 

**ITEM 1A. Risk Factors**

 

Otherthan as set forth below, as of the date of this filing, there have been nomaterial changes from the risk factors disclosed in the Company’s Annual Reporton Form 10-K dated March 12, 2009. We operate in a changing environment that involves numerous known andunknown risks and uncertainties that could materially affect our operations.The risks, uncertainties and other factors set forth in our Annual Report on Form 10-Kand below may cause our actual results, performances and achievements to bematerially different from those expressed or implied by our forward-lookingstatements. If any of these risks or events occur, our business, financialcondition or results of operations may be adversely affected.

 

***We may not be able to sell the capacitygenerated from our new converting line*****.**

 

Theaddition of the new converting line will substantially increase our convertedproduct production capacity and we may not be able to sell enough of ourproducts to fully utilize such capacity.  We currently have excess parentroll production capacity and our strategy includes converting and selling moreof our parent roll tonnage as converted product.  Converted products sellat a higher price per ton than parent rolls and typically carry a higher marginon a tonnage basis.  If we are unable to increase our sales of convertedproduct we will not be able to utilize the increased capacity from our newconverting line, resulting in lost opportunity for increased margins and theneed to temporarily or permanently curtail the production of one or more of ourexisting converting lines.

 

***We may experience problems with our new converting line which couldcause delayed or cancelled customer orders.***

 

Thecompletion of the new converting line could be delayed or the converting linemay not provide the capacity, capability or efficiency which we haveprojected.  Our goal is to utilize theincreased capacity from our new line as rapidly as possible.  To that end, we will begin our sales effortsfor the additional capacity prior to completion of the line.  If the converting line completion is delayedor if it has less capacity or efficiency, or the capabilities are not asexpected, customer orders could be delayed or canceled.  Any such delays or cancellations could causesignificant harm to the relationships we have with new or existing customers,and  we may experience a material adverseeffect on our business.

 

***If sales decline significantly we may determine that it is no longerfeasible to purchase a new converting line.***

 

Weexpect the new converting line will add capacity, efficiency and flexibility toour current production capabilities.  Ifwe experience a material decline in sales due to market, economic or otherconditions we may determine that it is no longer economically feasible topurchase the new converting line. Without the new converting line we may not have the flexibility toexpand in our target markets, or to execute on our strategy, includingincreasing our flexibility to meet a wider array of customer needs, furtherexpanding in other retail channels, improving efficiencies and reducingmanufacturing costs.

 

**ITEM 2.  Unregistered Sales of Equity Securities andUse of Proceeds**

* *

*(a) Unregistered Sales ofEquity Securities*

 

None.

 

*(b) Initial Public Offeringand Use of Proceeds from the Sale of Registered Securities*

 

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None.

* *

*(c) Repurchases of EquitySecurities*

 

Wedo not have any programs to repurchase shares of our common stock and no suchrepurchases were made during the three months ended June 30, 2009.

 

**ITEM 3.  Defaults Upon Senior Securities**

 

None.

 

**ITEM 4.  Submission of Matters to a Vote of SecurityHolders**

 

TheAnnual Meeting of Stockholders of Orchids Paper Products Company was held on May 19,2009.  At the meeting, the followingmatters were submitted to a vote of the stockholders:

 

(1)   To elect seven directors for one-year terms expiringat the conclusion of the Company’s annual meeting in 2010.  The vote with respect to each nominee was asfollows:

 
| **Nominee**       | ** ** | **For**   | ** ** | **Withheld** | ** ** |
|-------------------|------------|-----------|------------|--------------|------------|
| Gary P. Arnold    |       | 5,466,032 |       | 67,669       |       |
| Steven R. Berlin  |       | 5,460,532 |       | 73,169       |       |
| John C. Guttilla  |       | 5,466,032 |       | 67,669       |       |
| Douglas E. Hailey |       | 5,466,032 |       | 67,669       |       |
| Jeffrey S. Schoen |       | 5,456,207 |       | 77,494       |       |
| Jay Shuster       |       | 5,392,813 |       | 140,888      |       |
| Robert A. Snyder  |       | 5,463,782 |       | 69,919       |       |

 

(2)          To ratify the appointment of HoganTaylor LLP as the Company’sindependent registered public accounting firm for 2009:

 

| **For**   | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|-----------|------------|-------------|------------|-------------|------------|
| 5,508,250 |       | 17,367      |       | 8,083       |       |

 

Allof the directors listed above were elected and HoganTaylor LLP was ratified asour independent registered public accounting firm for 2009.

 

**ITEM 5.  Other Information**

 

On July 31,2009, we amended our credit agreement with our existing bank group. Thisamendment is described in more detail in “Management’s Discussion andAnalysis of Financial Condition and Results of Operations - Liquidity andCapital Resources.”

 

**ITEM 6.  Exhibits**

 

Seethe Exhibit Index following the signature page to this Form 10-Q,which Exhibit Index is hereby incorporated by reference herein.

 

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###### **SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

**ORCHIDSPAPER PRODUCTS COMPANY**

 
| Date:    August 13,  2009 |   | By:    | /s/ Keith R. Schroeder                                         |
|----------------------------------------------------|--------|--------|----------------------------------------------------------------|
|                                               |   |   | Keith R. Schroeder                                             |
|                                               |   |   | Chief Financial Officer                                        |
|                                               |   |   | (On behalf of the  registrant and as Chief Accounting Officer) |

 

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**Exhibit Index**

 
| **Exhibit** | ** ** | **Description**                                                                                                                                                                                                                                                                             |
|-------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1         |       | Amended and Restated  Certificate of Incorporation of the Registrant incorporated by reference to  Exhibit 3.1 to the Registrant’s Registration Statement on Form S-1  (File No. 333-124173) filed with the Securities and Exchange Commission  on April 19, 2005. |
|        |       |                                                                                                                                                                                                                                                                                        |
| 3.1.1       |       | Amendment to the  Amended and Restated Certificate of Incorporation of the Registrant  incorporated by reference to the Form 10-Q filed with the Securities and  Exchange Commission on August 14, 2007.                                                                          |
|        |       |                                                                                                                                                                                                                                                                                        |
| 3.2         |       | Amended and Restated  Bylaws of the Registrant incorporated by reference to Exhibit 3.2 to the  Registrant’s Registration Statement on Form S-1 (File  No. 333-124173) filed with the Securities and Exchange Commission on  April 19, 2005.                       |
|        |       |                                                                                                                                                                                                                                                                                        |
| 31.1        |       | Certification of Chief  Executive Officer Pursuant to Section 302.                                                                                                                                                                                                                     |
|        |       |                                                                                                                                                                                                                                                                                        |
| 31.2        |       | Certification of Chief  Financial Officer Pursuant to Section 302.                                                                                                                                                                                                                     |
|        |       |                                                                                                                                                                                                                                                                                        |
| 32.1        |       | Certification of Chief  Executive Officer Pursuant to Section 906.                                                                                                                                                                                                                     |
|        |       |                                                                                                                                                                                                                                                                                        |
| 32.2        |       | Certification of Chief  Financial Officer Pursuant to Section 906.                                                                                                                                                                                                                     |

 

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