Table of Contents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, DC 20549**

** **

**FORM 10-Q**

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

 

**For the quarterly period ended March 31,2009**

 

**OR**

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

 

**Commission File Number 001-32563**

 

**OrchidsPaper Products Company**

 (Exact name of Registrant as Specifiedin its Charter)

 

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

 

**4826 Hunt Street**

**Pryor, Oklahoma 74361**

(Address of Principal Executive Offices and Zip Code)

 

**(918) 825-0616**

(Registrant’s Telephone Number, Including Area Code)

 

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

 

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

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, a non-accelerated filer or a smaller reportingcompany.  See the definitions of “largeaccelerated filer”, “accelerated filer” and “smaller reporting company” 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 mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

Number of shares outstanding of the issuer’s Common Stock, par value$.001 per share, as of April 30, 2009: 6,456,380 shares.

 

 

 

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**ORCHIDS PAPER PRODUCTS COMPANY**

**TABLE OF CONTENTS**

**QUARTERLY REPORT ON FORM 10-Q**

**FOR THE THREE MONTHS ENDED March 31, 2009**

 
| ** **   | ** **                                                                                         | **Page**   |
|--------------|----------------------------------------------------------------------------------------------------|------------|
| ** **   | ** **                                                                                         | ** ** |
| ** **   | **PART I. FINANCIAL INFORMATION**                                                             | ** ** |
| ** **   | ** **                                                                                         | ** ** |
| **ITEM 1.**  | **Financial Statements**                                                                           | ** ** |
| ** **   | ** **                                                                                         | ** ** |
| ** **   | **Balance Sheets as of  March 31, 2009 (Unaudited) and December 31, 2008**               | **3**      |
| ** **   | ** **                                                                                         | ** ** |
| ** **   | **Statements of Income  for the three months ended March 31, 2009 and 2008 (Unaudited)**      | **4**      |
| ** **   | ** **                                                                                         | ** ** |
| ** **   | **Statements of  Cash Flows for the three months ended March 31, 2009 and 2008  (Unaudited)** | **5**      |
| ** **   | ** **                                                                                         | ** ** |
| ** **   | **Notes to Unaudited Interim Financial Statements**                                                | **6**      |
| ** **   | ** **                                                                                         | ** ** |
| **ITEM 2.**  | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations**    | **10**     |
| ** **   | ** **                                                                                         | ** ** |
| **ITEM 3.**  | **Quantitative  and Qualitative Disclosures about Market Risk**                                    | **19**     |
| ** **   | ** **                                                                                         | ** ** |
| **ITEM 4.**  | **Controls and  Procedures**                                                                       | **19**     |
| ** **   | ** **                                                                                         | ** ** |
| ** **   | **PART II.  OTHER INFORMATION**                                                               | ** ** |
| ** **   | ** **                                                                                         | ** ** |
| **ITEM 1.**  | **Legal Proceedings**                                                                              | **20**     |
| ** **   | ** **                                                                                         | ** ** |
| **ITEM 1A.** | **Risk Factors**                                                                                   | **20**     |
| ** **   | ** **                                                                                         | ** ** |
| **ITEM 2.**  | **Unregistered  Sales of Equity Securities and Use of Proceeds**                                   | **20**     |
| ** **   | ** **                                                                                         | ** ** |
| **ITEM 3.**  | **Defaults Upon  Senior Securities**                                                               | **20**     |
| ** **   | ** **                                                                                         | ** ** |
| **ITEM 4.**  | **Submission of  Matters to a Vote of Security Holders**                                           | **20**     |
| ** **   | ** **                                                                                         | ** ** |
| **ITEM 5.**  | **Other Information**                                                                              | **20**     |
| ** **   | ** **                                                                                         | ** ** |
| **ITEM 6.**  | **Exhibits**                                                                                       | **20**     |
| ** **   | ** **                                                                                         | ** ** |
| ** **   | **Signatures**                                                                                     | **21**     |

 

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**PART 1. FINANCIALINFORMATION**

** **

**ITEM 1.**FinancialStatements

 

**ORCHIDS PAPER PRODUCTS COMPANY**

**BALANCESHEETS**

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

 
| ** **                                                                                                                                                           | ** ** | **March 31,**   | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|------------|------------------|------------|
| ** **                                                                                                                                                           | ** ** | **2009**        | ** ** | **2008**         | ** ** |
| ** **                                                                                                                                                           | ** ** | **(unaudited)** | ** ** | ** **       | ** ** |
| **ASSETS**                                                                                                                                                           | ** ** | ** **      | ** ** | ** **       | ** ** |
| Current assets:                                                                                                                                                      |       |            |       |             |       |
| Cash                                                                                                                                                                 |       | $               | 1,552      |             | $          | 11 |   |
| Accounts receivable, net of allowance of  $203 in 2009 and $187 in 2008                                                                                              |       | 6,967           |       | 6,514            |       |
| Inventories, net                                                                                                                                                     |       | 6,141           |       | 6,253            |       |
| Prepaid expenses                                                                                                                                                     |       | 336             |       | 399              |       |
| Deferred income taxes                                                                                                                                                |       | 557             |       | 557              |       |
| Total current assets                                                                                                                                                 |       | 15,553          |       | 13,734           |       |
|                                                                                                                                                                 |       |            |       |             |       |
| Property, plant and equipment                                                                                                                                        |       | 73,114          |       | 71,824           |       |
| Accumulated depreciation                                                                                                                                             |       | (11,970         | )          | (11,165          | )          |
| Net property, plant and equipment                                                                                                                                    |       | 61,144          |       | 60,659           |       |
|                                                                                                                                                                 |       |            |       |             |       |
| Deferred debt issuance costs, net of  accumulated amortization of $611 in 2009 and $603 in 2008                                                                      |       | 81              |       | 89               |       |
| Total assets                                                                                                                                                         |       | $               | 76,778     |             | $          | 74,482 |   |
|                                                                                                                                                                 |       |            |       |             |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                       |       |            |       |             |       |
| Current liabilities:                                                                                                                                                 |       |            |       |             |       |
| Accounts payable                                                                                                                                                     |       | $               | 4,282      |             | $          | 4,699 |   |
| Accrued liabilities                                                                                                                                                  |       | 3,416           |       | 2,584            |       |
| Current portion of long-term debt                                                                                                                                    |       | 3,138           |       | 2,998            |       |
| Total current liabilities                                                                                                                                            |       | 10,836          |       | 10,281           |       |
|                                                                                                                                                                 |       |            |       |             |       |
| Long-term debt, less current portion                                                                                                                                 |       | 18,751          |       | 21,067           |       |
| Deferred income taxes                                                                                                                                                |       | 10,465          |       | 9,572            |       |
| Stockholders’ equity:                                                                                                                                           |       |            |       |             |       |
| Common stock, $.001 par value, 25,000,000  shares authorized in 2009 and 2008, 6,452,030 and 6,328,986 shares issued and  outstanding in 2009 and 2008, respectively |       | 6               |       | 6                |       |
| Additional paid-in capital                                                                                                                                           |       | 22,716          |       | 22,215           |       |
| Common stock warrants                                                                                                                                                |       | —          |       | 134              |       |
| Retained earnings                                                                                                                                                    |       | 14,004          |       | 11,207           |       |
| Total stockholders’ equity                                                                                                                                      |       | 36,726          |       | 33,562           |       |
| Total liabilities and stockholders’ equity                                                                                                                      |       | $               | 76,778     |             | $          | 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 March 31,** | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|
| ** **                                        | ** ** | **2009**                         | ** ** | **2008** | ** ** |
| ** **                                        | ** ** | **(unaudited)**                  | ** ** | **(unaudited)** | ** ** |
|                                              |       |                             |       |   |   |
| Net sales                                         |       | $                                | 23,640     |   | $ | 20,275 |   |
|                                              |       |                             |       |   |   |
| Cost of sales                                     |       | 17,208                           |       | 17,586 |   |
| Gross profit                                      |       | 6,432                            |       | 2,689 |   |
|                                              |       |                             |       |   |   |
| Selling, general and administrative  expenses     |       | 1,830                            |       | 1,385 |   |
| Operating income                                  |       | 4,602                            |       | 1,304 |   |
|                                              |       |                             |       |   |   |
| Interest expense                                  |       | 159                              |       | 411 |   |
| Other income                                      |       | (3                               | )          | (1 | ) |
| Income before income taxes                        |       | 4,446                            |       | 894 |   |
|                                              |       |                             |       |   |   |
| Provision for income taxes:                       |       |                             |       |   |   |
| Current                                           |       | 756                              |       | 0 |   |
| Deferred                                          |       | 893                              |       | 283 |   |
|                                              |       | 1,649                            |       | 283 |   |
|                                              |       |                             |       |   |   |
| Net income                                        |       | $                                | 2,797      |   | $ | 611 |   |
|                                              |       |                             |       |   |   |
| Net income per share:                             |       |                             |       |   |   |
| Basic                                             |       | $                                | 0.44       |   | $ | 0.10 |   |
| Diluted                                           |       | $                                | 0.42       |   | $ | 0.09 |   |
|                                              |       |                             |       |   |   |
| Shares used in calculating net income per  share: |       |                             |       |   |   |
| Basic                                             |       | 6,409,182                        |       | 6,327,049 |   |
| Diluted                                           |       | 6,683,704                        |       | 6,554,357 |   |

 

See notes to financial statements.

 

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**ORCHIDS PAPER PRODUCTS COMPANY**

**STATEMENTSOF CASH FLOWS**

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

 
| ** **                                                                                   | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                   | ** ** | **2009**                         | ** ** | **2008** | ** ** |
| ** **                                                                                   | ** ** | **(unaudited)**                  | ** ** | **(unaudited)** | ** ** |
| **Cash Flows From Operating Activities**                                                     | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Net income                                                                                   |       | $                                | 2,797      |   | $ | 611 |   |
| Adjustments to reconcile net income to net  cash provided by (used in) operating activities: |       |                             |       |   |   |
| Depreciation and amortization                                                                |       | 813                              |       | 763 |   |
| Provision for doubtful accounts                                                              |       | 16                               |       | 15 |   |
| Deferred income taxes                                                                        |       | 893                              |       | 283 |   |
| Stock option plan expense                                                                    |       | 81                               |       | 51 |   |
| Changes in cash due to changes in operating  assets and liabilities:                         |       |                             |       |   |   |
| Accounts receivable                                                                          |       | (469                             | )          | (1,325 | ) |
| Inventories                                                                                  |       | 112                              |       | (685 | ) |
| Income taxes receivable                                                                      |       | 0                                |       | (6 | ) |
| Prepaid expenses                                                                             |       | 63                               |       | (53 | ) |
| Accounts payable                                                                             |       | (417                             | )          | (203 | ) |
| Accrued liabilities                                                                          |       | 832                              |       | 234 |   |
| Net cash provided by (used in) operating  activities                                         |       | 4,721                            |       | (315 | ) |
|                                                                                         |       |                             |       |   |   |
| **Cash Flows From Investing Activities**                                                     | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Purchases of property, plant and equipment                                                   |       | (1,290                           | )          | (359 | ) |
|                                                                                         |       |                             |       |   |   |
| **Cash Flows From Financing Activities**                                                     | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Principal payments on long-term debt                                                         |       | (689                             | )          | (413 | ) |
| Net borrowings (repayments) on revolving  credit line                                        |       | (1,487                           | )          | 1,072 |   |
| Proceeds from the exercise of warrants  attached to subordinated debentures                  |       | 286                              |       | 15 |   |
| Net cash provided by (used in) financing  activities                                         |       | (1,890                           | )          | 674 |   |
|                                                                                         |       |                             |       |   |   |
| Net increase in cash                                                                         |       | $                                | 1,541      |   | $ | — |   |
| Cash, beginning                                                                              |       | 11                               |       | 3 |   |
| Cash, ending                                                                                 |       | $                                | 1,552      |   | $ | 3 |   |
| **Supplemental Disclosure:**                                                                 | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Interest paid                                                                                |       | $                                | 159        |   | $ | 338 |   |
| Income taxes paid                                                                            |       | $                                | 70         |   | $ | 6 |   |

 

See notes to financial statements.

 

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**ORCHIDS PAPER PRODUCTS COMPANY**

**NOTES TO UNAUDITED INTERIMFINANCIAL STATEMENTS**

 

***Note 1 — Basis ofPresentation***

*** ***

OrchidsPaper Products Company (“Orchids” or the “Company”) was formed in 1998 toacquire and operate the paper manufacturing facility, built in 1976, in Pryor,Oklahoma.  Orchids Acquisition Group, Inc.(“Orchids Acquisition”) was established in November 2003, for the purposeof acquiring 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.

 

OnJuly 20, 2005, the Company completed its public offering of 3,234,375shares of its common stock.  The publicoffering price of the shares was $5.33. The net proceeds from the offering were $15,011,000 after deducting theunderwriting discount and offering expenses. The Company’s stock trades on the NYSE Amex under the ticker symbol “TIS.”

 

Theaccompanying financial statements have been prepared without an audit, pursuantto the rules and regulations of the Securities and Exchange Commission(the “Commission”).  Certain informationand footnote disclosures normally included in annual financial statementsprepared in accordance with accounting principles generally accepted in theUnited States have been condensed or omitted pursuant to the rules andregulations.  However, the Companybelieves that the disclosures made are adequate to make the informationpresented not misleading when read in conjunction with the audited financialstatements and the notes thereto. Management believes that the financial statements contain alladjustments necessary for a fair statement of the results for the interimperiods presented.  All adjustments wereof a normal, recurring nature.  Theresults of operations for the interim period are not necessarily indicative ofthe results for the entire fiscal year.

 

**Note 2 —Summary of Significant Accounting Policies**

 

*Fair value of financial instruments*

* *

Thecarrying amounts of the Company’s cash, accounts receivable, accounts payableand accrued liabilities approximate fair value due to their short maturity. Thecarrying value of the Company’s long-term debt is estimated by management toapproximate fair value based on the obligations’ characteristics, includingfloating interest rate, credit ratings, maturity and collateral.

 

**Note 3 — Commitments and Contingencies**

** **

TheCompany may be involved from time to time in litigation arising from the normalcourse of business. In management’s opinion, this litigation is not expected tomaterially affect the Company’s results of operations or financial condition.

 

OnAugust 1, 2007, the Company received a new water discharge permit thatrequires the Company to reduce its biological oxygen demand and total suspendedsolids from its discharge water thereby resulting in the need to expand itsexisting pre-treatment facility.  Underthe permit, the Company is required to meet the stricter limitations by August 1,2009.  The project is under constructionand is expected to cost approximately $4.3 million.  The cost of this facility is expected to befinanced through a $4.0 million construction loan from the Company’s banklenders and from cash generated by the Company. As of March 31, 2009, there were no amounts outstanding under thisloan.  This loan was included in the bankdebt refinancing that closed in 

 

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April 2007.   This project is expected to be completed in July 2009.  Committed capital expenditures not yet paidfor in conjunction with this project totaled $1.6 million as of March 31,2009.

 

In the fourth quarter of 2008, the Company enteredinto a contract to purchase 334,000 MMBTU natural gas requirements at $7.50 perMMBTU plus a $0.07 per MMBTU management delivery fee for the period from April 2009through March 2011.  The amountsrepresent approximately 60% of the Company’s natural gas requirements basedupon expected usage rates for 2009.  Ifthe Company is unable to purchase the contracted amounts and the market priceat that time is less than the contracted price, the Company would be obligatedunder the terms of the agreement to reimburse an amount equal to the volumepurchased that was less than the contracted amount multiplied by the differencebetween the contract price and current spot price.  Thisfixed pricenatural gascontract meets the qualifications of the normal purchases and normal salesexception for Statement of Financial Accounting Standards No. 133, “Accountingfor Derivative Instruments and Hedging Activities”.

** **

**Note 3 — Inventories**

** **

Inventories at March 31, 2009 and December 31, 2008 were:

 
| ** **                  | ** ** | **March 31,**          | ** ** | **December 31,** | ** ** |
|-----------------------------|------------|------------------------|------------|------------------|------------|
| ** **                  | ** ** | **2009**               | ** ** | **2008**         | ** ** |
| ** **                  | ** ** | **($ thousands)** | ** ** |
| Raw materials               |       | $                      | 1,556      |             | $          | 1,904 |   |
| Bulk paper rolls            |       | 920                    |       | 1,460            |       |
| Converted finished goods    |       | 3,918                  |       | 3,127            |       |
| Inventory valuation reserve |       | (253                   | )          | (238             | )          |
|                        |       | $                      | 6,141      |             | $          | 6,253 |   |

 

**Note 4 — Earnings per Share**

** **

Thecomputation of basic and diluted net income per share for the three-monthperiods ended March 31, 2009 and 2008 is as follows:

 
| ** **                                                          | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                          | ** ** | **2009**                                             | ** ** | **2008** | ** ** |
| Net income - ($ thousands)                                     |       | $                                                    | 2,797      |   | $ | 611 |   |
|                                                                |       |                                                 |       |   |   |
| Weighted average  shares outstanding                                |       | 6,409,182                                            |       | 6,327,049 |   |
| Effect of stock  options                                            |       | 192,434                                              |       | 99,642 |   |
| Effect of  dilutive warrants                                        |       | 82,088                                               |       | 127,666 |   |
| Weighted average  shares outstanding - assuming dilution            |       | 6,683,704                                            |       | 6,554,357 |   |
| Net income  (loss) per share:                                       |       |                                                 |       |   |   |
| Basic                                                               |       | $                                                    | 0.44       |   | $ | 0.10 |   |
| Diluted                                                             |       | $                                                    | 0.42       |   | $ | 0.09 |   |
|                                                                |       |                                                 |       |   |   |
| Stock options  not considered above because they were anti-dilutive |       | —                                               |       | 33,750 |   |

 

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** **

**Note 5 —Stock Incentive Plan**

** **

InApril 2005, the board of directors and the stockholders approved the 2005Stock Incentive Plan (the “Plan”).  ThePlan provides for the granting of incentive stock options to employees selectedby the board’s compensation committee. The Plan authorized up to 697,500 shares to be issued.  In May 2008, the shareholders approvedincreasing the number of authorized shares under the Plan from 697,500 to897,500.  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.  Theoptions vest 50% on the 1st anniversary date of the grantand 50% on the 2nd anniversary date.  The options have a 10 year life.

 

Thefollowing table details the options granted to certain members of managementduring the three months ended March 31, 2009 and 2008.

 
| **Grant**  | ** ** | **Number**         | ** ** | **Exercise** | ** ** | **Risk-Free**          | ** ** | **Estimated**  | ** ** | **Dividend** | ** ** | **Expected** | ** ** |
|------------|------------|--------------------|------------|--------------|------------|------------------------|------------|----------------|------------|--------------|------------|--------------|------------|
| **Date**   | ** ** | **of Shares** | ** ** | **Price**    | ** ** | **Interest Rate** | ** ** | **Volatility** | ** ** | **Yield**    | ** ** | **Life**     | ** ** |
|       |       |               |       |         |       |                   |       |           |       |         |       |         |       |
| January-09 |       | 60,000             |       | $            | 10.205     |                   | 2.35       | %              | 46         | %            | None       |         | 5-7 years  |   |
|            |            |                    |            |              |            |                        |            |                |            |              |            |              |            |  |

 

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

 

Inconnection with the approval of the Plan, the Company adopted SFAS No. 123(R) “Share-Based Payments” and expenses the cost of options granted overthe vesting period of the option based on the grant-date fair value of theaward.  The Company recognized expense of$81,000 and $51,000 for the three months ended March 31, 2009 and 2008,respectively, related to options granted under the Plan.

 

**Note 6 —Major Customers and Concentration of Credit Risk**

** **

TheCompany sells primarily all of its paper production in the form of convertedproducts; however, following the start-up of a new paper machine in the summerof 2006, the Company had excess paper production which it began to sell inparent roll form.  Revenues fromconverted product sales and parent roll sales in the three-month periods ended March 31,2009 and 2008 were:

 
| ** **                  | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------|------------|----------------------------------|------------|
| ** **                  | ** ** | **2009**                         | ** ** | **2008** | ** ** |
| ** **                  | ** ** | **(in thousands)**               | ** ** |
|                        |       |                             |       |   |   |
| Converted product net sales |       | $                                | 21,057     |   | $ | 17,117 |   |
| Parent roll net sales       |       | 2,583                            |       | 3,158 |   |
| Net sales                   |       | $                                | 23,640     |   | $ | 20,275 |   |

 

Creditrisk for the Company is concentrated in three significant customers.  These are customers of our converted product,each of whom operates discount retail stores located throughout the UnitedStates.  During the three months ended March 31,2009, sales to the three significant customers accounted for approximately 53%of the total sales, comprised of customers of 25%, 

 

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14%,and 14%, a slight decrease from the three months ended March 31, 2008 whenthese three customers accounted for approximately 55% of the total sales,comprised of customers of 23%, 18%, and 14%. At March 31, 2009 and 2008, respectively, approximately $3.4million (49%) and $3.6 million (55%) of accounts receivable was due from thesethree significant customers.  No othercustomers of the Company accounted for more than 10% of sales during theseperiods.  The Company generally does notrequire collateral from its customers and has not incurred any significantlosses on uncollectible accounts receivable.

 

**Note 7 —New Accounting Pronouncements**

** **

TheFinancial Accounting Standards Board (“FASB”) periodically issues newaccounting standards in a continuing effort to improve standards of financialaccounting and reporting. The Company has reviewed the recently issuedpronouncements and concluded that the following new accounting standards couldbe applicable to the Company:

 

InApril 2009, the FASB issued FASB Staff Position (FSP) No. 141(R) —1 “Accounting for Assets Acquired and Liabilities Assumed in a BusinessCombination that Arise from Contingencies.” This FSP deals with the initial recognition and measurement of an assetacquired or a liability assumed in a business combination that arises from acontingency provided the asset or liability’s fair value on the date ofacquisition can be determined.  This iseffective for assets or liabilities arising from contingencies in businesscombinations that occur following the start of the first fiscal year thatbegins on or after December 15, 2008. At this time, this FSP is not applicable to Orchids.

 

InApril 2009, the FASB issued FSP No. 107-1 “Interim Disclosures aboutFair Value of Financial Instruments.” This FSP increases the frequency of fair value disclosures to aquarterly instead of annual basis.  Thisis effective for interim and annual periods ending after June 15, 2009 butentities may early adopt this standard for the interim and annual periodsending after March 15, 2009.  TheCompany has chosen to early adopt the FSP and has included the disclosure inNote 2 to these financial statements.

 

InApril 2009, the FASB issued FSP No. 115-2 and 124-2 “Recognition andPresentation of Other-Than-Temporary Impairments.”  Segregates credit and noncredit components ofimpaired debt securities that are not expected to be sold.  This revision to the standard is effectivefor interim and annual periods ending after June 15, 2009.  At this time, Orchids does not have any debtsecurities that are covered by this FSP.

 

InApril 2009, the FASB issued FSP No. 157-4 “Determining Fair ValueWhen the Volume and Level of Activity for the Asset or Liability HaveSignificantly Decreased and Indentifying Transactions That Are Not Orderly.”  This FSP provides guidelines for a broadinterpretation of when to apply market-based fair value measurements.  The FSP reaffirms management’s needs to usejudgment to determine when a market that was once active has become inactiveand in determining fair values in markets that are no longer active.  This standard is effective for interim andannual periods ending after June 15, 2009, but entities may earlyadopt.  At this time, this FSP is notapplicable to Orchids.

 

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** **

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

** **

**Forward-Looking Information**

** **

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

 

·                  our business strategy;

·                  the market opportunity for our products,including expected demand for our products;

·                  our estimates regarding our capitalrequirements; and

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

 

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

 

Youshould not place undue reliance on forward-looking statements because theyinvolve known and unknown risks, uncertainties, and other factors that are, insome cases, beyond our control and that could materially affect actual results,levels of activity, performance or achievements.  Factors that could materially affect ouractual results, levels of activity, performance or achievements include,without limitation, those detailed under the caption “Risk Factors” in ourAnnual Report on Form 10-K for the fiscal year ended December 31,2008, as filed with the Securities and Exchange Commission, and the followingitems:

 

·                  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 free cashflow and subjects us to restrictive covenants relating to the operation of ourbusiness;

·                  the availability of and prices for energy;

·                  failure to purchase the contracted quantityof natural gas may result in financial exposure;

·                  our exposure to variable interest rates;

·                  disruption in our supply or increase in thecost of waste paper;

·                  the loss of key personnel;

·                  labor interruptions;

·                  natural disaster or other disruption to ourfacility;

·                  ability to finance the capital requirementsof our business;

·                  cost to comply with government regulations;

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

 

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

·                  excess supply in the market may reduce ourprices; and

·                  an inability to continue to implement ourbusiness strategies.

 

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

** **

**Overview**

** **

Wemanufacture bulk tissue paper, known as parent rolls, and convert parent rollsinto a full line of tissue products, including paper towels, bathroom tissueand paper napkins for the private label segment of the consumer, or “at-home,”market.  We have focused our productdesign and manufacturing on the discount retail market, primarily the dollarstore retailers, 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 approximately 400 miles of Pryor, Oklahoma.  Our products are sold primarily under ourcustomers’ private labels and, to a lesser extent, under our brand names suchas Colortex®, My-Size®, Velvet®, and care®. Our care® brand name is a recently announced product line that focuseson consumers’ desire for environmentally friendly products.  All of our converted product revenue is derivedpursuant to truck load purchase orders from our customers.  While we do not have supply contracts withany of our customers, we do have commitments with certain customers to maintainour selling prices for up to two years. Revenue is recognized when title passes to the customer.  Because our product is a daily consumableitem, the order stream from our customer base is fairly consistent with nosignificant seasonal fluctuations. Changes in the national economy do not materially affect the market forour converted product.

 

Ourprofitability depends on several key factors, including:

 

·                  the market price of our product;

·                  the cost of waste paper used in producingpaper;

·                  the efficiency of operations in both ourpaper mill and converting operations; and

·                  the cost of energy.

 

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

 

InJune 2006, we began operating a new paper machine with an annual capacityof approximately 33,000 tons.  Thecapacity of the new machine, in addition to the capacity of our older machines,increased our total production capacity to approximately 56,000 tons per year.  As a result, beginning in the third quarterof 2006, we were able to eliminate the requirement to purchase recycled parentrolls on the open market.  In the secondquarter of 2007, due to the relatively high 

 

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priceof parent rolls, we began running all of our older machines on a full-timebasis.  Our strategy is to sell all ofour parent roll capacity as converted products which have higher margins thanparent rolls. We have focused considerable efforts to improve our convertingefficiencies in order to achieve that goal. Those efforts included the hiring of a productivity consultant to assistus during the second quarter of 2008 to design and implement a management operatingsystem and to help our management team implement a new work schedule and workpractices.  The management operatingsystem helped identify and confirm root causes of issues that impairproduction.  As a result of theseefforts, converting productivity levels in the first quarter of 2009 exceededby 19 % those experienced in the first eight months of 2008.

 

Wecurrently are reviewing our logistics operations and our strategy of using athird-party warehouse.  The results ofthis review may indicate a need to expand our current warehouse facility andeliminate the use of the third-party warehouse. The cost of expanding our warehouse facility is estimated at $8.0million.  Funding for this project wouldcome from either cash earnings, a new borrowing agreement or a combination ofboth.  We are also studying a project topurchase a new converting line to aid in our strategy to increase sales andprofitability and to consume all of our paper making production in our convertingoperation.  This project is in the earlystages of evaluation and is expected to cost between $15 million and $18million.

 

Wewill pursue profitable sales growth of our increased output in our convertingoperations by increasing sales to established customers as well as continuingto focus on obtaining new customers in the grocery sales channels.

** **

**ComparativeThree-Month Periods Ended March 31, 2009 and 2008**

** **

**NetSales**

** **
| ** **                  | ** ** | **Three Months Ended March 31,**                | ** ** |
|-----------------------------|------------|-------------------------------------------------|------------|
| ** **                  | ** ** | **2009**                                        | ** ** | **2008** | ** ** |
| ** **                  | ** ** | **(in thousands, except average**               | ** ** |
| ** **                  | ** ** | **price per ton and tons)** | ** ** |
| ** **                  | ** ** | ** **                                      | ** ** | ** ** | ** ** |
| Converted product net sales |       | $                                               | 21,057     |   | $ | 17,117 |   |
| Parent roll net sales       |       | 2,583                                           |       | 3,158 |   |
| Net sales                   |       | $                                               | 23,640     |   | $ | 20,275 |   |
|                        |       |                                            |       |   |   |
| Total tons shipped          |       | 12,429                                          |       | 12,962 |   |
| Net selling price per ton   |       | $                                               | 1,902      |   | $ | 1,564 |   |

** **

Netsales increased 17%, to $23.6 million in the quarter ended March 31, 2009,compared to $20.3 million in the same period of 2008.  Net sales figures include gross sellingprice, including freight, less discounts and pricing allowances.  Net sales of converted product increased inthe quarter ended March 31, 2009, by $3.9 million, or 23%, to $21.0million compared to $17.1 million in the same period last year.  Net sales of parent rolls decreased $600,000,or 18%, in the 2009 quarter to $2.6 million compared to $3.2 million in thesame period last year.  Net sales ofconverted product increased primarily due to a 23% increase in the sellingprice per ton which was slightly offset by lower tonnage shipped.  The increase in net selling price per ton ofconverted product was due to price increases undertaken to counteractincreasing waste paper and energy prices and product content changes during2008.  The product content changes werethe primary reason for a 1% reduction in the tonnage of converted productsshipped.  Parent roll net sales decreasedprimarily due to a 14% decrease in tonnage shipped and a 4% decrease in theselling price per ton.  The decrease inparent roll sales is primarily due to a softened away-from-home

 

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marketwhich accounts for a majority of our parent roll sales.  In response, we took an immaterial amount ofdown time on our older paper machines in the first quarter of 2009 to adjustour parent roll inventory and we expect to take a similar amount of down timein the second quarter of 2009.

 

**Cost ofSales**

** **
| ** **                                 | ** ** | **Three Months Ended March 31,**                | ** ** |
|--------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                 | ** ** | **2009**                                        | ** ** | **2008** | ** ** |
| ** **                                 | ** ** | **(in thousands, except**                       | ** ** |
| ** **                                 | ** ** | **gross profit margin %**                       | ** ** |
| ** **                                 | ** ** | **and paper cost per ton)** | ** ** |
| Cost of paper                              |       | $                                               | 8,539      |   | $ | 10,604 |   |
| Non-paper materials, labor, supplies, etc. |       | 7,865                                           |       | 6,228 |   |
| Sub-total                                  |       | $                                               | 16,404     |   | 16,832 |   |
| Depreciation                               |       | 804                                             |       | 754 |   |
| Cost of sales                              |       | $                                               | 17,208     |   | $ | 17,586 |   |
| Gross profit                               |       | $                                               | 6,432      |   | $ | 2,689 |   |
| Gross profit margin %                      |       | 27.2                                            | %          | 13.3 | % |
| Total paper cost per ton consumed          |       | $                                               | 687        |   | $ | 818 |   |

 

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

 

Costof sales decreased approximately $400,000, or 2%, to $17.2 million for thequarter ended March 31, 2009, compared to $17.6 million in the same periodof 2008.  Our cost of sales waspositively affected by lower paper production costs partially offset by higherconverting production costs.  As apercentage of net sales, cost of sales decreased to 72.8% in the 2009 quarterfrom 86.7% of net sales in the 2008 quarter. Cost of sales as a percentage of net sales for the first quarter of 2009was favorable to the prior quarter due to higher converting net selling pricesand lower paper production costs.

 

Ouroverall cost of paper in the first quarter of 2009 was $687 per ton, a decreaseof $131 per ton compared to the same period in 2008.  Paper production costs decreased primarilydue to lower waste paper prices and, to a lesser extent, lower natural gasprices.  The prices we paid for wastepaper in the first quarter of 2009 decreased approximately 30% compared to thecost paid in the prior year quarter.  Asa result, our cost of waste paper consumed decreased approximately $1.4 millionin 2009 compared to the first quarter of 2008. Natural gas costs decreased approximately 20% in the first quarter of2009 compared to the same period in 2008, resulting in decreased costs ofapproximately $260,000.

 

Convertingproduction costs were unfavorably affected by higher overhead costs which werepartially offset by lower direct labor costs. Overhead costs for converting production increased in the 2009 quarterover the 2008 quarter by approximately $525,000, primarily due to an increaseof $250,000 in our maintenance and repair costs and an increase of $190,000 inthe cost of outside warehousing.  Themaintenance expense includes repair parts, service technicians andconsultants.  Our level of spending onmaintenance and repair costs in the first quarter of 2009 was approximately$150,000 higher than our expected levels of spending for future quarters.

 

Webegan using a third-party warehouse late in the first quarter of 2008 toincrease our shipping capacity and provide better customer service to handleour increasing converted product 

 

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shipments.   Direct labor costs in the convertingoperation were approximately $240,000 lower in the first quarter of 2009compared to the same period in 2008 due to the converting automation projectwhich was completed in February of 2009.

 

**GrossProfit**

** **

Grossprofit in the quarter ended March 31, 2009, increased $3.7 million or139%, to $6.4 million compared to $2.7 million in the same period lastyear.  Gross profit as a percentage ofnet sales in the 2009 quarter was 27.2% compared to 13.2% in the 2008 quarter.  The major reasons for the increase in grossprofit as a percentage of net sales is the lower cost of waste paper and thehigher selling prices for converted products. In addition, improved productivity in our converting operation resultedin a 16% increase in cases shipped in the quarter ended March 31, 2009compared to the same period of 2008, which basically offset the effect ofproduct content changes completed during 2008. As a result of the increased converting production, more tonnage wasconsumed in our converting operation rather than being sold as a parent roll,which positively affected our gross profit because sales of converted productstypically carry a higher margin than sales of parent rolls.

 

**Selling,General and Administrative Expenses**

** **
| ** **                     | ** ** | **Three Months Ended March 31,**   | ** ** |
|--------------------------------|------------|------------------------------------|------------|
| ** **                     | ** ** | **2009**                           | ** ** | **2008** | ** ** |
| ** **                     | ** ** | **(In thousands, except SG&A** | ** ** |
| ** **                     | ** ** | **as a % of net sales)**           | ** ** |
| Commission expense             |       | $                                  | 332        |   | $ | 242 |   |
| Other S,G&A expenses       |       | 1,498                              |       | 1,143 |   |
| Selling, General & Adm exp |       | $                                  | 1,830      |   | $ | 1,385 |   |
| SG&A as a % of net sales   |       | 7.7                                | %          | 6.8 | % |
|                           |       |                               |       |   |   |
| Operating income               |       | $                                  | 4,602      |   | $ | 1,304 |   |

** **

Selling,general and administrative expenses include salaries, commissions to brokersand other miscellaneous expenses. Selling, general and administrative expenses increased $400,000, or 32%,to $1.8 million compared to $1.4 million in the prior year quarter.  Higher accruals under our incentive bonusprogram, higher sales commission expense due to increased sales levels,increased packaging-related selling costs, higher legal and professional feesand costs associated with additions to our senior management team were themajor reasons for the increase.  As apercentage of net sales, selling, general and administrative expenses increasedto 7.7% in the first quarter of 2009 compared to 6.8% in the same quarter of2008.

 

**OperatingIncome**

** **

Asa result of the foregoing factors, operating income for the quarter ended March 31,2009 increased $3.3 million or 253%, to $4.6 million from $1.3 million in thesame period in 2008.

 

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**InterestExpense and Other Income**

** **
| ** **                 | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------|------------|---------------------------------------|------------|
| ** **                 | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| ** **                 | ** ** | **(In thousands)**                    | ** ** |
| Interest expense           |       | $                                     | 159        |   | $ | 411 |   |
| Other income, net          |       | $                                     | (3         | ) | $ | (1 | ) |
|                       |       |                                  |       |   |   |
| Income before income taxes |       | $                                     | 4,446      |   | $ | 894 |   |

 

Interestexpense includes interest on all debt and amortization of deferred debtissuance costs.  Interest expensedecreased $252,000 to $159,000 in the quarter ended March 31, 2009,compared to $411,000 in the quarter ended March 31, 2008.  Lower LIBOR interest rates and lower marginsover LIBOR, reflecting our improved financial performance, were the primaryreasons for the decrease in interest expense.

 

**IncomeBefore Income Taxes**

 

Asa result of the foregoing factors, income before income taxes increased $3.6million to $4.4 million in the quarter ended March 31, 2009 compared to$894,000 in the same period in 2008.

 

**IncomeTax Provision**

 

Forthe quarter ended March 31, 2009, our effective income tax rate was37.1%.  It is lower than the statutoryrate because of Oklahoma Investment Tax Credits associated with our investmentin a new paper machine and the utilization of the Federal Indian EmploymentCredits.  These factors were partiallyoffset by state income taxes.  For thequarter ended March 31, 2008, our annual effective income tax rate was32%.  The 2008 effective tax rate waslower than the statutory rate because of the Oklahoma Investment Tax Creditscited above, the utilization of Federal Indian Employment Credits and therecognition of deferred tax benefits associated with non-qualified optiongrants to our directors and officers, including a true-up.

 

Weexpect that our net operating loss carryforwards for federal tax purposes willbe extinguished in 2009.  No currentincome taxes are owed to state taxing authorities because of net operating losscarryforwards for state purposes and Oklahoma Investment Tax Creditcarryforwards.

 

**Liquidityand Capital Resources**

 

Liquidity refers to the liquid financial assetsavailable to fund our business operations and pay for near-termobligations.  These liquid financialassets consist of cash as well as unused borrowing capacity under our revolvingcredit facility.  Our cash requirementshave historically been satisfied through a combination of cash flows fromoperations and debt financings.

 

   The detailsof our credit agreement are as follows:

 

·                  $8.0 million revolvingcredit facility with a three-year term, expiring April 2010; ($0outstanding at March, 31, 2009)

·                  $10.0 million term loan Awith a ten-year term, expiring April 2017, no principal repayments for thefirst 24 months and then will be amortized as if the loan had an 18-year life($10.0 million outstanding at March 31, 2009);

 

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·                  $16.5 million term loan Bwith a four-year term, expiring April 2011, that is being amortized as ifthe loan had a six-year life ($11.9 million outstanding at March 31,2009); and

·                  $4.0 million capitalexpenditures facility with a four-year term, expiring April 2011, thatwill be amortized as if the loan had a five-year life ($0 outstanding at March 31,2009).

 

Cashincreased in the three months ended March 31, 2009 from $11,000 to $1.5million.

 

Thefollowing table summarizes key cash flow information for the three monthperiods ended March 31, 2009 and 2008:

 
| ** **                       | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------|------------|---------------------------------------|------------|
| ** **                       | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| ** **                       | ** ** | **(in thousands)**                    | ** ** |
|                             |       |                                  |       |   |   |
| Cash flow provided by (used in): |       |                                  |       |   |   |
| Operating activities             |       | $                                     | 4,721      |   | $ | (315 | ) |
|                             |       |                                  |       |   |   |
| Investing activities             |       | $                                     | (1,290     | ) | $ | (359 | ) |
|                             |       |                                  |       |   |   |
| Financing activities             |       | $                                     | (1,890     | ) | $ | 674 |   |

 

Cashflow provided by operating activities increased by $5.0 million to $4.7 millionin the three month period ended March 31, 2009, which primarily resultedfrom an increase in cash earnings and increased accrued expenses, which werepartially offset by increased trade receivables due to the higher sales levelsand a decrease in accounts payable.

 

Cashflow used in investing activities was $1.3 million in the first three months of2009 as the result of expenditures on capital projects, primarily due toexpenditures on the previously discussed waste water plant pretreatmentproject.

 

Cashflow used in financing activities was $1.9 million in the three month periodended March 31, 2009 and was primarily attributable to $1.5 million inrepayments under the revolving credit agreement, $688,000 in normally scheduledprincipal payments on our bank term loans which were partially offset by$286,000 in proceeds from the exercise of common stock warrants associated withour 12% subordinated debentures that were retired in 2007.

 

**CriticalAccounting Policies and Estimates**

 

Thepreparation of our financial statements and related disclosures in conformitywith accounting principles generally accepted in the United States requiresmanagement to make estimates and judgments that affect our reported amounts ofassets and liabilities, revenue and expense, and related disclosures ofcontingent assets and liabilities.  On anongoing basis, we evaluate our estimates and assumptions based upon historicalexperience and various other factors and circumstances.  Management believes that our estimates andassumptions are reasonable under the circumstances; however, actual results mayvary from these estimates and assumptions under different futurecircumstances.  We have identified thefollowing critical accounting policies that affect the more significantjudgments and estimates used in the preparation of our financial statements:

 

*AccountsReceivable*.  Accountsreceivable consist of amounts due to us from normal business activities.  Our management must make estimates ofaccounts receivable that will not be collected. We perform ongoing credit evaluations of our customers and adjust creditlimits based 

 

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uponpayment history and the customer’s creditworthiness as determined by our reviewof their current credit information.  Wecontinuously monitor collections and payments from our customers and maintainan allowance for estimated losses based on historical experience and specificcustomer collection issues that we have identified.  Trade receivables are written-off when allreasonable collection efforts have been exhausted, including, but not limitedto, external third party collection efforts and litigation.  While such credit losses have historicallybeen within management’s expectations and the allowance provided, there can beno assurance that we will continue to experience the same credit loss rates asin the past.  During the three monthperiod ended March 31, 2009 and 2008, provisions for doubtful accountswere recognized in the amount of $16,000 and $15,000, respectively for eachperiod.  In addition, $3,000 ofrecoveries of accounts previously written off was credited to the allowanceduring the first three months of 2008. There were no recoveries credited during the first three months of 2009.  There were no accounts receivable balanceswritten off in the three month periods ended March 31, 2009 or 2008.

 

*Inventory.*  Our inventory consists of finished goods andraw materials and is stated at the lower of cost or market.  Our management regularly reviews inventoryquantities on hand and records a provision for excess and obsolete inventorybased on the age of the inventory and forecasts of product demand.  A significant decrease in demand could resultin an increase in the amount of excess inventory quantities on hand.  During the first three months of 2009 and2008, $15,000 was provided and there were no charges against the valuationreserve.

 

**New AccountingPronouncements**

 

TheFinancial Accounting Standards Board (“FASB”) periodically issues newaccounting standards in a continuing effort to improve standards of financialaccounting and reporting. We  havereviewed the recently issued pronouncements and concluded that the followingnew accounting standards could be applicable to us:

 

InApril 2009, the FASB issued FASB Staff Position (FSP) No. 141(R) —1 “Accounting for Assets Acquired and Liabilities Assumed in a BusinessCombination that Arise from Contingencies.” This FSP deals with the initial recognition and measurement of an assetacquired or a liability assumed in a business combination that arises from acontingency provided the asset or liability’s fair value on the date ofacquisition can be determined.  This iseffective for assets or liabilities arising from contingencies in businesscombinations that occur following the start of the first fiscal year thatbegins on or after December 15, 2008. At this time, this FSP is not applicable to us.

 

InApril 2009, the FASB issued FSP No. 107-1 “Interim Disclosures aboutFair Value of Financial Instruments.” This FSP increases the frequency of fair value disclosures to aquarterly instead of annual basis.  Thisis effective for interim and annual periods ending after June 15, 2009 butentities may early adopt this standard for the interim and annual periodsending after March 15, 2009.  We havechosen to early adopt the FSP and have included the disclosure in Note 2 tothese financial statements.

 

InApril 2009, the FASB issued FSP No. 115-2 and 124-2 “Recognition andPresentation of Other-Than-Temporary Impairments.”  Segregates credit and noncredit components ofimpaired debt securities that are not expected to be sold.  This revision to the standard is effectivefor interim and annual periods ending after June 15, 2009.  At this time, we do not have any debtsecurities that are covered by this FSP.

 

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InApril 2009, the FASB issued FSP No. 157-4 “Determining Fair ValueWhen the Volume and Level of Activity for the Asset or Liability HaveSignificantly Decreased and Indentifying Transactions That Are Not Orderly.”  This FSP provides guidelines for a broadinterpretation of when to apply market-based fair value measurements.  The FSP reaffirms management’s needs to usejudgment to determine when a market that was once active has become inactiveand in determining fair values in markets that are no longer active.  This standard is effective for interim andannual periods ending after June 15, 2009, but entities may earlyadopt.  At this time, this FSP is notapplicable to us.

 

**Non-GAAPDiscussion**

 

In addition to our Generally Accepted AccountingPrinciples (“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.

 

EBITDArepresents net income before net interest expense, income tax expense, depreciationand amortization.  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).

 

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

 

·                  it does not reflect our cash expenditures forcapital assets;

·                  it does not reflect changes in, or cashrequirements for, our working capital requirements;

·                  it does not reflect the interest expense, orthe cash requirements necessary to service interest or principal payments onour indebtedness;

·                  it does not reflect tax obligations whethercurrent or deferred;

·                  although depreciation and amortization arenon-cash charges, the assets being depreciated and amortized will often have tobe replaced in the future, and EBITDA does not reflect cash requirements forsuch replacements; and

·                  other companies, including other companies inour industry, may calculate these measures differently than we do, limitingtheir usefulness as a comparative measure.

 

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

 

Thefollowing table reconciles EBITDA to net income for the three months ended March 31,2009 and 2008:

 

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| ** **                  | ** ** | **Three Months Ended March 31,**     | ** ** |
|-----------------------------|------------|-------------------------------------------|------------|
| ** **                  | ** ** | **2009**                                  | ** ** | **2008** | ** ** |
| ** **                  | ** ** | **(In thousands, except % of net sales)** | ** ** |
|                        |       |                                      |       |   |   |
| Net income                  |       | $                                         | 2,797      |   | $ | 611 |   |
| Plus: Interest expense, net |       | 159                                       |       | 411 |   |
| Plus: Income tax expense    |       | 1,649                                     |       | 283 |   |
| Plus: Depreciation          |       | 804                                       |       | 754 |   |
| EBITDA                      |       | $                                         | 5,409      |   | $ | 2,059 |   |
| % of net sales              |       | 22.9                                      | %          | 10.2 | % |

 

EBITDA increased $3.3 million to $5.4 million in thethree months ended March 31, 2009, compared to $2.1 million in the sameperiod of 2008.  EBITDA as a percentageof net sales was 22.9% in the 2009 period compared to 10.2% in the prior yearperiod.  The foregoing factors discussedin the net sales, cost of sales and selling, general and administrativesections are 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. Controlsand Procedures**

 

Our management, under the supervision and with theparticipation of our chief executive officer and our chief financial officer,has evaluated the effectiveness of our disclosure controls and procedures (asdefined in Rules 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act of 1934, as amended), as of the end of the period covered by thisQuarterly Report on Form 10-Q.  Anycontrols and procedures, no matter how well designed and operated, can provideonly reasonable assurance of achieving the desired control objectives.  Based on such evaluation, our chief executiveofficer and our chief financial officer have concluded that our disclosurecontrols and procedures were effective as of March 31, 2009.

 

There were no changes in the Company’s internalcontrol over financial reporting (as defined in Rule 13a-15(f) underthe Exchange Act) during the quarter ended March 31, 2009, that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

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**PART II.  OTHER INFORMATION**

 

**ITEM 1.  Legal Proceedings**

 

None.

 

**ITEM 1A. RiskFactors**

 

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 ouroperations.  The risks, uncertainties andother factors set forth in our Annual Report on Form 10-K may cause ouractual results, performances and achievements to be materially different fromthose expressed or implied by our forward-looking statements.  If any of these risks or events occur, ourbusiness, financial condition or results of operations may be adverselyaffected.

 

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

 

*(a) UnregisteredSales of Equity Securities*

 

None.

 

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

 

None.

 

 *(c) Repurchases of Equity Securities*

 

We do not have any programs to repurchase shares ofour common stock and no such repurchases were made during the three monthsended March 31, 2009.

 

**ITEM 3.  Defaults Upon Senior Securities**

 

None.

 

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

 

None.

 

**ITEM 5.  Other Information**

 

None.

 

**ITEM 6.  Exhibits**

 

See the Exhibit Index following the signature page tothis Form 10-Q, which Exhibit Index is hereby incorporated byreference herein.

 

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###### **SIGNATURES**

###### ** **

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

 

**ORCHIDS PAPER PRODUCTS COMPANY**

 
| Date:    May 4,  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.                                                      |
|        |       |                                                                                                                                                                                                                                                                                                                       |
| 10.1#       |       | Form of  Incentive Stock Option Agreement incorporated by reference to  Exhibit 10.1 to the Registrant’s Current Report on Form 8-K (File  No. 001-32563) filed with the Securities and Exchange Commission on  January 26, 2009.                                                            |
|        |       |                                                                                                                                                                                                                                                                                                                       |
| 10.2#       |       | Executive  Employment Agreement, dated February 27, 2009, between Keith R.  Schroeder and the Registrant incorporated by reference to Exhibit 10.1  to the Registrant’s Current Report on Form 8-K (File No. 001-32563)  filed with the Securities and Exchange Commission on March 2, 2009. |
|        |       |                                                                                                                                                                                                                                                                                                                       |
| 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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#Indicates management contract or compensatory plan

 

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