Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND 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 thequarterly period ended September 30, 2009**

 

**OR**

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

 

**CommissionFile Number 001-32563**

 

**Orchids Paper Products Company**

 (Exact name of Registrant as Specified in itsCharter)

 

| **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 checkmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirement for the past 90 days. Yes x  No o

 

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

 

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

 

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

 

Number of sharesoutstanding of the issuer’s Common Stock, par value $.001 per share, as of November 4,2009: 7,391,374 shares.

 

 

 

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Table ofContents

 

**ORCHIDS PAPER PRODUCTS COMPANY**

**TABLE OF CONTENTS**

**QUARTERLY REPORT ON FORM 10-Q**

**FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009**

 
| ** **                              | ** ** | ** **                                                                                                                                                                | ** ** | **Page** |
|-----------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|
|                                    |       |                                                                                                                                                                      |       |     |
| **PART I.  FINANCIAL INFORMATION** |       |                                                                                                                                                                      |
|                                    |       |                                                                                                                                                                      |       |     |
| **ITEM 1.**                             | ** ** | **Financial  Statements**                                                                                                                                                 |       |     |
|                                    |       |                                                                                                                                                                      |       |     |
| ** **                              | ** ** | **Balance Sheets as of  September 30, 2009 (Unaudited) and December 31, 2008**                                                                                  |       | **3**    |
|                                    |       |                                                                                                                                                                      |       |     |
|                                    |       | **Statements of Income for  the three months ended September 30, 2009 and 2008 (Unaudited) and the  nine months ended September 30, 2009 and 2008 (Unaudited)** |       | **4**    |
|                                    |       |                                                                                                                                                                      |       |     |
| ** **                              | ** ** | **Statements of Cash  Flows for the nine months ended September 30, 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**                                                                           |       | **11**   |
|                                    |       |                                                                                                                                                                      |       |     |
| **ITEM 3.**                             | ** ** | **Quantitative and Qualitative  Disclosures about Market Risk**                                                                                                           | ** ** | **23**   |
|                                    |       |                                                                                                                                                                      |       |     |
| **ITEM 4.**                             | ** ** | **Controls and Procedures**                                                                                                                                               | ** ** | **23**   |
|                                    |       |                                                                                                                                                                      |       |     |
| **PART II.  OTHER INFORMATION**    |       |                                                                                                                                                                      |
|                                    |       |                                                                                                                                                                      |       |     |
| **ITEM 1.**                             | ** ** | **Legal Proceedings**                                                                                                                                                     | ** ** | **23**   |
|                                    |       |                                                                                                                                                                      |       |     |
| **ITEM 1A.**                            | ** ** | **Risk Factors**                                                                                                                                                          | ** ** | **23**   |
|                                    |       |                                                                                                                                                                      |       |     |
| **ITEM 2.**                             | ** ** | **Unregistered Sales of Equity  Securities and Use of Proceeds**                                                                                                          | ** ** | **23**   |
|                                    |       |                                                                                                                                                                      |       |     |
| **ITEM 3.**                             | ** ** | **Defaults Upon Senior Securities**                                                                                                                                       | ** ** | **23**   |
|                                    |       |                                                                                                                                                                      |       |     |
| **ITEM 4.**                             | ** ** | **Submission of Matters to a Vote  of Security Holders**                                                                                                                  | ** ** | **24**   |
|                                    |       |                                                                                                                                                                      |       |     |
| **ITEM 5.**                             | ** ** | **Other Information**                                                                                                                                                     | ** ** | **24**   |
|                                    |       |                                                                                                                                                                      |       |     |
| **ITEM 6.**                             | ** ** | **Exhibits**                                                                                                                                                              | ** ** | **24**   |
|                                    |       |                                                                                                                                                                      |       |     |
| ** **                              | ** ** | **Signatures**                                                                                                                                                            |       | **25**   |

 

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**PART I. FINANCIALINFORMATION**

 

**ITEM 1.  Financial Statements**

 

**ORCHIDSPAPER PRODUCTS COMPANY**

**BALANCE SHEETS**

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

 
| ** **                                                                                                                                          | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                          | ** ** | **2009**               | ** ** | **2008**              | ** ** |
| ** **                                                                                                                                          | ** ** | **(unaudited)**        | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                          | ** ** | ** **             | ** ** | ** **            | ** ** |
| Current assets:                                                                                                                                     |       |                   |       |                  |       |
| Cash                                                                                                                                                |       | $                      | 317        |                  | $          | 11 |   |
| Accounts receivable, net of allowance of $194 in  2009 and $186 in 2008                                                                             |       | 8,930                  |       | 6,514                 |       |
| Inventories, net                                                                                                                                    |       | 6,626                  |       | 6,253                 |       |
| Short term investments                                                                                                                              |       | 22,502                 |       | —                |       |
| Income tax receivable                                                                                                                               |       | 430                    |       | —                |       |
| Prepaid expenses                                                                                                                                    |       | 738                    |       | 399                   |       |
| Deferred income taxes                                                                                                                               |       | 557                    |       | 557                   |       |
| Total current assets                                                                                                                                |       | 40,100                 |       | 13,734                |       |
|                                                                                                                                                |       |                   |       |                  |       |
| Property, plant and equipment                                                                                                                       |       | 78,379                 |       | 71,824                |       |
| Accumulated depreciation                                                                                                                            |       | (13,806                | )          | (11,165               | )          |
| Net property, plant and equipment                                                                                                                   |       | 64,573                 |       | 60,659                |       |
|                                                                                                                                                |       |                   |       |                  |       |
| Deferred debt issuance costs, net of accumulated amortization  of $624 in 2009 and $603 in 2008                                                     |       | 110                    |       | 89                    |       |
| Total assets                                                                                                                                        |       | $                      | 104,783    |                  | $          | 74,482 |   |
|                                                                                                                                                |       |                   |       |                  |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                      | ** ** | ** **             | ** ** | ** **            | ** ** |
| Current liabilities:                                                                                                                                |       |                   |       |                  |       |
| Accounts payable                                                                                                                                    |       | $                      | 3,695      |                  | $          | 4,699 |   |
| Accrued liabilities                                                                                                                                 |       | 4,039                  |       | 2,584                 |       |
| Current portion of long-term debt                                                                                                                   |       | 3,140                  |       | 2,998                 |       |
| Total current liabilities                                                                                                                           |       | 10,874                 |       | 10,281                |       |
|                                                                                                                                                |       |                   |       |                  |       |
| Long-term debt, less current portion                                                                                                                |       | 20,910                 |       | 21,067                |       |
| Deferred income taxes                                                                                                                               |       | 13,173                 |       | 9,572                 |       |
| Stockholders’ equity:                                                                                                                          |       |                   |       |                  |       |
| Common stock, $.001 par value, 25,000,000 shares  authorized, 7,391,374 and 6,328,986 shares issued and outstanding in 2009 and  2008, respectively |       | 7                      |       | 6                     |       |
| Additional paid-in capital                                                                                                                          |       | 38,226                 |       | 22,215                |       |
| Common stock warrants                                                                                                                               |       | —                 |       | 134                   |       |
| Retained earnings                                                                                                                                   |       | 21,593                 |       | 11,207                |       |
| Total stockholders’ equity                                                                                                                     |       | 59,826                 |       | 33,562                |       |
| Total liabilities and stockholders’ equity                                                                                                     |       | $                      | 104,783    |                  | $          | 74,482 |   |

 

Seenotes to financial statements.

 

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**ORCHIDS PAPER PRODUCTS COMPANY**

**STATEMENTSOF INCOME**

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

 
| ** **                                       | ** ** | **Three  Months Ended September 30,** | ** ** | **Nine  Months Ended September 30,** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                       | ** ** | **2009**                                   | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                       | ** ** | **(unaudited)**                            | ** ** | **(unaudited)**                           | ** ** | **(unaudited)** | ** ** | **(unaudited)** | ** ** |
|                                             |       |                                       |       |                                      |       |   |   |   |   |
| Net sales                                        |       | $                                          | 24,557     |                                      | $          | 23,312 |   | $ | 72,328 |   | $ | 65,902 |   |
|                                             |       |                                       |       |                                      |       |   |   |   |   |
| Cost of sales                                    |       | 17,128                                     |       | 19,518                                    |       | 50,639 |   | 56,297 |   |
|                                             |       |                                       |       |                                      |       |   |   |   |   |
| Gross profit                                     |       | 7,429                                      |       | 3,794                                     |       | 21,689 |   | 9,605 |   |
|                                             |       |                                       |       |                                      |       |   |   |   |   |
| Selling, general and administrative expenses     |       | 1,772                                      |       | 1,551                                     |       | 5,689 |   | 4,427 |   |
|                                             |       |                                       |       |                                      |       |   |   |   |   |
| Operating income                                 |       | 5,657                                      |       | 2,243                                     |       | 16,000 |   | 5,178 |   |
|                                             |       |                                       |       |                                      |       |   |   |   |   |
| Interest expense                                 |       | 174                                        |       | 310                                       |       | 468 |   | 1,041 |   |
| Other income, net                                |       | (5                                         | )          | (3                                        | )          | (9 | ) | (9 | ) |
|                                             |       |                                       |       |                                      |       |   |   |   |   |
| Income before income taxes                       |       | 5,488                                      |       | 1,936                                     |       | 15,541 |   | 4,146 |   |
|                                             |       |                                       |       |                                      |       |   |   |   |   |
| Provision for income taxes:                      |       |                                       |       |                                      |       |   |   |   |   |
| Deferred                                         |       | 925                                        |       | 515                                       |       | 3,600 |   | 1,227 |   |
| Current                                          |       | 748                                        |       | (2                                        | )          | 1,554 |   | (2 | ) |
|                                             |       | 1,673                                      |       | 513                                       |       | 5,154 |   | 1,225 |   |
|                                             |       |                                       |       |                                      |       |   |   |   |   |
| Net income                                       |       | $                                          | 3,815      |                                      | $          | 1,423 |   | $ | 10,387 |   | $ | 2,921 |   |
|                                             |       |                                       |       |                                      |       |   |   |   |   |
| Net income per share:                            |       |                                       |       |                                      |       |   |   |   |   |
| Basic                                            |       | $                                          | 0.56       |                                      | $          | 0.22 |   | $ | 1.58 |   | $ | 0.46 |   |
| Diluted                                          |       | $                                          | 0.52       |                                      | $          | 0.22 |   | $ | 1.49 |   | $ | 0.45 |   |
|                                             |       |                                       |       |                                      |       |   |   |   |   |
| Shares used in calculating net income per share: |       |                                       |       |                                      |       |   |   |   |   |
| Basic                                            |       | 6,838,726                                  |       | 6,328,986                                 |       | 6,562,051 |   | 6,328,343 |   |
| Diluted                                          |       | 7,304,226                                  |       | 6,499,686                                 |       | 6,955,133 |   | 6,526,511 |   |

 

See notes to financial statements.

 

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**ORCHIDSPAPER PRODUCTS COMPANY**

**STATEMENTS OF CASH FLOWS**

**(Dollarsin thousands)**

 
| ** **                                                                         | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                         | ** ** | **2009**                                 | ** ** | **2008** | ** ** |
| ** **                                                                         | ** ** | **(unaudited)**                          | ** ** | **(unaudited)** | ** ** |
| **Cash Flows From Operating  Activities**                                          |       |                                     |       |   |   |
| Net income                                                                         |       | $                                        | 10,387     |   | $ | 2,921 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                                     |       |   |   |
| Depreciation and amortization                                                      |       | 2,661                                    |       | 2,334 |   |
| Provision for doubtful accounts                                                    |       | 46                                       |       | 46 |   |
| Deferred income taxes                                                              |       | 3,601                                    |       | 1,227 |   |
| Stock option plan expense                                                          |       | 518                                      |       | 259 |   |
| Changes in cash due to changes in operating assets  and liabilities:               |       |                                     |       |   |   |
| Accounts receivable                                                                |       | (2,462                                   | )          | (2,568 | ) |
| Inventories                                                                        |       | (373                                     | )          | (1,085 | ) |
| Income tax receivable                                                              |       | (430                                     | )          | 24 |   |
| Prepaid expenses                                                                   |       | (339                                     | )          | (221 | ) |
| Accounts payable                                                                   |       | (1,004                                   | )          | 274 |   |
| Accrued liabilities                                                                |       | 1,455                                    |       | 490 |   |
| Net cash provided by operating activities                                          |       | 14,060                                   |       | 3,701 |   |
|                                                                               |       |                                     |       |   |   |
| **Cash Flows From Investing  Activities**                                          |       |                                     |       |   |   |
| Purchases of property, plant and equipment                                         |       | (6,554                                   | )          | (4,159 | ) |
| Purchase of investment securities                                                  |       | (22,502                                  | )          | — |   |
| Net cash used in investing activities                                              |       | (29,056                                  | )          | (4,159 | ) |
|                                                                               |       |                                     |       |   |   |
| **Cash Flows From Financing  Activities**                                          |       |                                     |       |   |   |
| Proceeds from secondary issuance of common stock                                   |       | 14,848                                   |       | — |   |
| Borrowings under construction loan                                                 |       | 3,756                                    |       | — |   |
| Principal payments on long-term debt                                               |       | (2,284                                   | )          | (1,668 | ) |
| Net borrowings (repayments) on revolving credit  line                              |       | (1,487                                   | )          | 2,120 |   |
| Proceeds from the exercise of warrants attached to  subordinated debentures        |       | 286                                      |       | 15 |   |
| Proceeds from the exercise of stock options                                        |       | 226                                      |       | — |   |
| Deferred issuance cost                                                             |       | (43                                      | )          | — |   |
| Net cash provided by financing activities                                          |       | 15,302                                   |       | 467 |   |
|                                                                               |       |                                     |       |   |   |
| Net change in cash                                                                 |       | 306                                      |       | 9 |   |
| Cash, beginning                                                                    |       | 11                                       |       | 3 |   |
| Cash, ending                                                                       |       | $                                        | 317        |   | $ | 12 |   |
| **Supplemental Disclosure:**                                                       |       |                                     |       |   |   |
| Interest paid                                                                      |       | $                                        | 468        |   | $ | 963 |   |
| Income taxes paid                                                                  |       | $                                        | 1,735      |   | $ | 2 |   |

 

See notes tofinancial statements.

 

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**ORCHIDSPAPER PRODUCTS COMPANY**

**NOTES TO UNAUDITED INTERIM FINANCIAL STATEMENTS**

 

***Note 1 — Basis of Presentation***

 

Orchids Paper Products Company(“Orchids” or the “Company”) was formed in April 1998 to acquire andoperate the paper manufacturing facility, built in 1976, in Pryor, Oklahoma outof a predecessor company’s bankruptcy. Orchids Acquisition Group, Inc. (“Orchids Acquisition”) was establishedin November 2003 for the purpose of acquiring the common stock ofOrchids.  The sale of equity and debtsecurities closed in March 2004 and Orchids Acquisition Group, Inc.acquired Orchids for a price of $21.6 million. Orchids Acquisition was subsequentlymerged into Orchids.

 

In July 2005, theCompany completed its initial public offering of 2,156,250 shares of commonstock. Following the offering, 4,156,250 shares of common stock wereoutstanding. In July 2006, the Company effected a 3-for-2 stock splitresulting in outstanding shares of 6,234,346.  The Company’s stock trades on the NYSE Amex under the ticker symbol“TIS.”

 

On August 26, 2009,the Company closed a public offering of 750,000 shares of its common stock atan offering price of $18.50 per share. The Company received net proceeds ofapproximately $12.8 million from the offering, after deducting the underwritingdiscount and offering expenses.  On September 2,2009, the underwriter exercised their over-allotment option and purchased anadditional 112,500 shares of common stock at a price of $18.50 per share.  The Company received $2.0 million in netproceeds from this exercised option.  TheCompany intends to use the proceeds from the offering for the construction of anew warehouse, the purchase and installation of a new converting line, andgeneral corporate purposes.

 

**Common Stock Outstanding**

 
| March 2004 Orchids Acquisition  Group, Inc. Shares |   | 2,000,000 |   |
|--------------------------------------------------------------|--------|-----------|--------|
| July 2005 Initial Public Common Stock Offering          |   | 2,156,250 |   |
| July 2006 3 for 2 Stock Split                           |   | 2,078,096 |   |
| August 2009 Common Stock Offering                       |   | 862,500   |   |
| Stock Options and Warrants Exercised                         |   | 294,528   |   |
|                                                         |   | 7,391,374 |   |

 

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 included in the Company’s Form 10-K filed March 12,2009.  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 the Financial Accounting Standards Board (“FASB”) AccountingStandards Codification (FASB ASC) 820-10-50Fair Value Measurements and Disclosures for assets and liabilities whichare required to be measured at fair value. This standard establishes a framework for measuring fair value andrelated disclosures. The standard has the following key elements:

 

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

 

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

 

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

 

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·                  Expands disclosures about instrumentsmeasured at fair value.

 

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 aspecified term, a Level 2 input must be observable for substantially the fullterm of the asset or 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 suchinstruments at September 30, 2009 approximates their carrying value asreported on the Company’s balance sheet.

 

The following tablepresents information about Orchids Paper Products Company’s assets measured atfair value on a recurring basis as of September 30, 2009, and indicatesthe fair value hierarchy of the valuation techniques utilized to determine suchvalues.  Short term investments are valued as Level 1 in the fair valuehierarchy from independent pricing services utilized by our investmentcustodians.

 
| ** **              | ** ** | **Fair Value Measurements at September 30, 2009** | ** ** |
|-------------------------|------------|--------------------------------------------------------|------------|
| ** **              | ** ** | **Using Inputs Considered as**                         | ** ** |
| ** **              | ** ** | **Level 1**                                            | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
|                    |       |                                                   |       |   |   |   |   |
| Assets                  |       |                                                   |       |   |   |   |   |
|                    |       |                                                   |       |   |   |   |   |
| Short  term investments |       | $                                                      | 22,502     |   | $ | — |   | $ | — |   |
|                         |            |                                                        |            |  |  |  |  |  |  |  |

 

**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.

 

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 derivatives and hedging.

 

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**Note 4 —Inventories**

 

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

 
| ** **                  | ** ** | **September 30,** | ** **  | **December 31,** | ** ** |
|-----------------------------|------------|------------------------|-------------|-----------------------|------------|
| ** **                  | ** ** | **2009**               | ** **  | **2008**              | ** ** |
| ** **                  | ** ** | **(unaudited)**        | ** **  | ** **            | ** ** |
| Raw materials               |       | $                      | 1,721       |                  | $          | 1,904 |   |
| Bulk paper rolls            |       | 733                    |        | 1,460                 |       |
| Converted finished          |       | 4,238                  |        | 3,127                 |       |
| Inventory valuation reserve |       | (66                    | )           | (238                  | )          |
|                        |       | $                      |  6,626 |                  | $          | 6,253 |   |

 

**Note 5 — Earnings per Share**

 

The computation of basicand diluted net income per share for the three-month and nine-month periodsended September 30, 2009 and 2008 is as follows:

 
| ** **                                                          | ** ** | **Three  Months Ended September 30,** | ** ** | **Nine  Months Ended September 30,** | ** ** |
|---------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                          | ** ** | **2009**                                   | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net income - ($ thousands)                                     |       | $                                          | 3,815      |                                      | $          | 1,423 |   | $ | 10,387 |   | $ | 2,921 |   |
|                                                                |       |                                       |       |                                      |       |   |   |   |   |
| Weighted average shares outstanding                                 |       | 6,838,726                                  |       | 6,328,986                                 |       | 6,562,051 |   | 6,328,343 |   |
| Effect of dilutive warrants                                         |       | 103,749                                    |       | 65,500                                    |       | 90,314 |   | 82,065 |   |
| Effect of stock options                                             |       | 361,751                                    |       | 105,200                                   |       | 302,768 |   | 116,103 |   |
| Weighted average shares outstanding - assuming  dilution            |       | 7,304,226                                  |       | 6,499,686                                 |       | 6,955,133 |   | 6,526,511 |   |
| Net income per share:                                               |       |                                       |       |                                      |       |   |   |   |   |
| Basic                                                               |       | $                                          | 0.56       |                                      | $          | 0.22 |   | $ | 1.58 |   | $ | 0.46 |   |
| Diluted                                                             |       | $                                          | 0.52       |                                      | $          | 0.22 |   | $ | 1.49 |   | $ | 0.45 |   |
|                                                                |       |                                       |       |                                      |       |   |   |   |   |
| Stock options not considered above because they  were anti-dilutive |       | —                                     |       | 53,750                                    |       | 49,750 |   | 86,250 |   |

 

**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 nine months ended September 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       |         | 5-7 years  |   |
| Jun-08     |       | 20,000        |       | $            | 7.80       |              | 3.98       | %              | 40         | %            | None       |         | 5-7 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 expenses the cost of options granted over thevesting period of the option based on the grant-date fair value of theaward.  The Company recognized expense of$84,000 and $54,000 for the three months ended September 30, 2009 and2008, respectively, related to options granted 

 

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under the Plan.  The Company recognized expense of $519,000and $259,000 for the nine months ended September 30, 2009 and 2008,respectively, related to options granted under the Plan.

 

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

 

The Company sells primarily all of its paperproduction in the form of converted products; however, following the start-upof a new paper machine in the summer of 2006, the Company had excess paperproduction which it began to sell in parent roll form.  Revenues from converted product sales andparent roll sales in the three-month and nine-month periods ended September 30,2009 and 2008 were:

 
| ** **                   | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                   | ** ** | **2009**                                                 | ** ** | **2008**                                                | ** ** | **2009** | ** ** | **2008** | ** ** |
|                         |       |                                                     |       |                                                    |       |   |   |   |   |
| Converted  product net sales |       | $                                                        | 22,160     |                                                    | $          | 19,300 |   | $ | 65,750 |   | $ | 53,798 |   |
| Parent  roll net sales       |       | 2,397                                                    |       | 4,012                                                   |       | 6,578 |   | 12,104 |   |
| Total  net sales             |       | 24,557                                                   |       | 23,312                                                  |       | $ | 72,328 |   | $ | 65,902 |   |
|                              |            |                                                          |            |                                                         |            |  |  |  |  |  |  |  |  |

 

The credit risk for theCompany in the third quarter of 2009 is concentrated with three significantcustomers.  Two are customers of theCompany’s converted product, each of whom operates discount retail storeslocated throughout the United States and one is a customer who accounts formost of the Company’s third party sales of parent rolls.  During the three months ended September 30,2009, sales to these three significant customers accounted for approximately62% of total sales, comprised of customers of 34%, 18%, and 10%,respectively.  For the  three months ended September 30, 2008,these three customers plus an additional converted product customer accountedfor approximately 67% of  total sales,comprised of customers of 20%, 20%, 14% and 13%, respectively.  For the nine months ended September 30,2009, sales to the three significant converted product customers accounted forapproximately 57% of total sales, comprised of customers of 30%, 16%, and 11%,respectively. For  the nine months ended September 30,2008, these three converted product customers plus the one customer of theCompany’s parent rolls accounted for approximately 68% of total sales,comprised of customers of 22%, 18%, 14% and 14%, respectively. At September 30,2009 and 2008, respectively, approximately $5.3 million (58%) of accountsreceivable was due from the three significant customers and $5.6 million (68%)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 FASB periodicallyissues new accounting standards in a continuing effort to improve standards offinancial accounting and reporting. We have reviewed the recently issuedpronouncements and concluded that the following new accounting standards couldbe applicable to the Company:

 

**FASB Establishes AccountingStandards CodificationTM**

 

In June 2009, theFASB issued Accounting Standards Update No. 2009-01, “Generally AcceptedAccounting Principles” (ASC Topic 105) which establishes the FASB AccountingStandards Codification (the “Codification” or “ASC”) as the official singlesource of authoritative U.S. generally accepted accounting principles (“GAAP”).All existing accounting standards are superseded. All other accounting guidancenot included in the Codification will be considered non-authoritative. TheCodification also includes all relevant Securities and Exchange Commission(“SEC”) guidance organized using the same topical structure in separatesections within the Codification.

 

Following theCodification, the FASB will not issue new standards in the form of Statements,FASB Staff Positions or Emerging Issues Task Force Abstracts. Instead, it willissue Accounting Standards Updates (“ASU”) which will serve to update theCodification, provide background information about the guidance and provide thebasis for conclusions on the changes to the Codification.

 

The Codification is notintended to change GAAP, but it will change the way GAAP is organized andpresented. The Codification is effective for third-quarter 2009 financialstatements and the principal impact on our financial statements is limited todisclosures as all future references to authoritative accounting literaturewill be referenced in accordance with the Codification. In order to ease thetransition to the Codification, the Company is providing 

 

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the Codification cross-reference alongsidethe references to the standards issued and adopted prior to the adoption of theCodification.

 

**Fair Value Accounting**

 

In August 2009, theFASB issued ASU No. 2009-05 which amends Fair Value Measurements andDisclosures — Overall (ASC Topic 820-10) to provide guidance on the fairvalue measurement of liabilities. This update requires clarification forcircumstances in which a quoted price in an active market for the identicalliability is not available, a reporting entity is required to measure fairvalue using one or more of the following techniques: 1) a valuation techniquethat uses either the quoted price of the identical liability when traded as anasset or quoted prices for similar liabilities or similar liabilities whentraded as an asset; or 2) another valuation technique that is consistent withthe principles in ASC Topic 820 such as the income and market approach tovaluation. The amendments in this update also clarify that when estimating thefair value of a liability, a reporting entity is not required to include aseparate input or adjustment to other inputs relating to the existence of arestriction that prevents the transfer of the liability.  This updatefurther clarifies that if the fair value of a liability is determined by referenceto a quoted price in an active market for an identical liability, that pricewould be considered a Level 1 measurement in the fair value hierarchy.Similarly, if the identical liability has a quoted price when traded as anasset in an active market, it is also a Level 1 fair value measurement if noadjustments to the quoted price of the asset are required.  Thisupdate is effective for the fourth quarter 2009.

 

**Note 9 — Subsequent Events**

 

Management has evaluatedsubsequent events through November 4, 2009.

 

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

 

**Forward-LookingInformation**

 

The followingManagement’s Discussion and Analysis of Financial Condition and Results ofOperations contains 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 two large customers which may decrease orcease 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 assume no obligation to publicly update orrevise these forward-looking statements for any reason, whether as a result ofnew information, future events, or otherwise.

 

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**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 napkins,for 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.  Becauseour product is a daily consumable item, the order stream from our customer baseis fairly consistent with no significant seasonal fluctuations.  Changes in the national economy do notmaterially affect demand for our converted products.

 

While we have customerslocated throughout the United States, we distribute most of our products withinapproximately 900 miles of our northeast Oklahoma facility, which we considerto be our cost-effective shipping area. However, we focus our sales efforts on an area within an approximate500-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.  We do not have supply contractswith any of our customers, and all of our revenue is derived pursuant to truckload purchase orders from our customers. Revenue is recognized when title passes to the customer.

 

Our profitability dependson several key factors, including:

 

·  the market price of our products;

·  the cost of recycled paper used in producingour products;

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

 

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.   Our parent rolls are processedinto paper towels, bathroom tissue and napkins in our adjacent convertingfacility.  Our ten converting lines havea total annual capacity of approximately 7.5 million cases of finished tissueproducts.  At present, our papermakingcapacity exceeds our converting capacity and we sell the resulting surplusparent rolls into the open market.  We adjustour paper making production based on our internal converting needs for parentrolls and the open market demand for parent rolls.   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.

 

Our strategy is to expandour position as a low cost provider of private label tissue products to thegrowing discount retail channel within our geographic area while leveraging ourcompetitive advantages to increase our presence in other retail channels.  This will be accomplished through ourcontinued high service levels, increased total manufacturing capacity andexpansion of our high perceived value product offering.

 

We intend to implementthis strategy through our key initiatives set forth below:

 

·  maintain and strengthen our core customerrelationships;

·  increase our flexibility to meet a widerarray of customer needs;

·  further expand our customer base in otherretail channels; and

·  continue to improve operating efficienciesand to reduce manufacturing costs.

 

With our steady salesgrowth since our inception in 1998, we have strategically expanded capacity tomeet demand.  Our latest strategicexpansion plan is intended to increase our converting capacity by approximatelyfour million annual cases with the installation of a new converting line andconstruction of a warehouse.  Thisadditional capacity will enable us to both increase sales of existing productsand to provide the flexibility to manufacture higher tier products for sales toour core customer base and into new retail channels.  The total cost of this project is estimatedto be approximately $27.1 million.

 

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Construction began on thenew 245,000 square foot warehouse, which will be located adjacent to ourexisting converting facility on land we already own, in early October 2009.   The warehouse project is expected to costapproximately $6.8 million with occupancy of the first half of the facilityavailable by May 2010 and complete occupancy by July 2010.  Following completion of the warehouse, wewill be able to consolidate all of ourconverted product inventory and shipping into thislocation and eliminate third-party warehouse storage and shipping costs whichwill allow us to improve our customer service and logistics performance andreduce operating costs.  Additionally,the project will allow us to free up the necessary space in our existingconverting facility to house the new converting line.  The new converting line, which will be ableto produce both kitchen towels and bathroom tissue, will provide higher qualityproducts and broaden our product offering through increased packagingconfigurations, enhanced graphics and improved embossing. The line has beenplaced on order and we expect it to be in start-up mode by the end of thesecond quarter of 2010, with full operating speeds expected to be achieved bythe end of the third quarter of 2010. The new converting line is expected to cost approximately $20.3million.  Initial plans to purchase landnext to our existing operations and build the warehouse on the acquired land werechanged due to the lack of a timely resolution of easement issues.  We continue to pursue negotiations on thistract of land for future expansion purposes.

 

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

 

**Net Sales**

 
| ** **                  | ** ** | **Three  Months Ended September 30,** | ** ** |
|-----------------------------|------------|--------------------------------------------|------------|
| ** **                  | ** ** | **2009**                                   | ** ** | **2008** | ** ** |
| ** **                  | ** ** | **(in  thousands, except average**         | ** ** |
| ** **                  | ** ** | **price  per ton and tons)**               | ** ** |
| Converted product net sales |       | $                                          | 22,160     |   | $ | 19,300 |   |
| Parent roll net sales       |       | 2,397                                      |       | 4,012 |   |
| Total net sales             |       | $                                          | 24,557     |   | $ | 23,312 |   |
|                        |       |                                       |       |   |   |
| Total tons shipped          |       | 13,755                                     |       | 13,837 |   |
| Average price per ton       |       | $                                          | 1,785      |   | $ | 1,685 |   |

 

Net sales increased 5.3%,to $24.6 million in the quarter ended September 30, 2009, compared to$23.3 million in the same period of 2008. Net sales figures represent the gross selling price, including freight,less discounts and pricing allowances. Net sales of converted product increased in the quarter ended September 30,2009 by $2.9 million, or 14.8% to $22.2 million compared to $19.3 million inthe same period last year.  Net sales ofparent rolls decreased $1.6 million or 40.3% to $2.4 million in the quarterended September 30, 2009 compared to $4.0 million in the same period lastyear.  The increase in net sales ofconverted product primarily resulted from an 8.5% increase in the net sellingprice per ton of converted product shipments and a 5.8% increase in tonnageshipped.  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.  The increased tonnage shipped was the resultof the improved production in our converting plant, which provided additionalconverted product for sale into the market. Net sales of parent rolls decreased primarily as a result of a 17.3%decrease in parent roll tonnage shipped, as well as a 40.2% decrease in the netselling price.

 

Total shipments in thethird quarter of 2009 were relatively flat compared to the same period of2008.  The decrease in parent rollshipments in the third quarter of 2009 was primarily due to the continuedsoftness in the away-from-home market for tissue products, which was mostlyoffset by the increase in shipments of converted products.  During the third quarter of 2009, wecontinued to manage our parent roll inventory by taking downtime on some of ourolder paper machines.  Due to thecontinued improvement in our converting production and demand for convertedproduct and some strengthening in the parent roll market, we began running allof our paper machines as of September 2009.  Additionally, the improved convertingproduction cited above resulted in less parent roll tonnage available for saleinto the open market.

 

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**Cost of Sales**

 
| ** **                                 | ** ** | **Three  Months Ended September 30,** | ** ** |
|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                 | ** ** | **2009**                                   | ** ** | **2008** | ** ** |
| ** **                                 | ** ** | **(in  thousands, except**                 | ** ** |
| ** **                                 | ** ** | **gross  profit margin %**                 | ** ** |
| ** **                                 | ** ** | **and  paper cost per ton)**               | ** ** |
| Cost of paper                              |       | $                                          | 9,329      |   | $ | 11,056 |   |
| Non-paper materials, labor, supplies, etc. |       | 6,796                                      |       | 7,679 |   |
| Sub-total                                  |       | 16,125                                     |       | 18,735 |   |
| Depreciation                               |       | 1,003                                      |       | 783 |   |
| Cost of sales                              |       | $                                          | 17,128     |   | $ | 19,518 |   |
|                                       |       |                                       |       |   |   |
| Gross Profit                               |       | $                                          | 7,429      |   | $ | 3,794 |   |
| Gross Profit Margin %                      |       | 30.3                                       | %          | 16.3 | % |
| Total paper cost per ton consumed          |       | $                                          | 678        |   | $ | 799 |   |

 

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 $2.4 million, or 12.2%, to $17.1 million for the quarter ended September 30,2009, compared to $19.5 million in the same period of 2008.  This decrease in our cost of sales wasprimarily attributable to lower cost of paper production, converting direct laborand converted product packaging which were partially offset by higherconverting overhead costs.  As apercentage of net sales, cost of sales decreased to 69.8% in the 2009 quarterfrom 83.7% of net sales in the 2008 quarter. Cost of sales as a percentage of net sales for the third quarter of 2009was favorable to the prior year quarter primarily due to higher convertedproduct net selling prices and lower paper production costs.

 

Our overall cost of paperin the third quarter of 2009 was $678 per ton, a decrease of $121 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.  Our cost of waste paper in the third quarterof 2009 decreased approximately 32% compared to our costs in the prior yearquarter.  As a result, our cost of wastepaper consumed decreased approximately $1.6 million in the third quarter of2009 compared to the third quarter of 2008. The rates we paid for natural gas decreased approximately 25% in thethird quarter of 2009 compared to the same period in 2008, which reduced our costsby approximately $288,000.  Compared tothe second quarter of 2009, our cost of waste paper increased in the thirdquarter of 2009 by approximately $600,000 or 21%.  Prior to the third quarter, waste paperprices decreased significantly from December 2008 through the beginning ofthe second quarter of 2009 following a rapid increase from late 2007 throughthe end of the third quarter of 2008.

 

Converting direct laborcosts decreased in the 2009 quarter compared to the 2008 quarter byapproximately 17.3% on a per unit basis due to both reduced headcount resultingfrom our automation project completed in the first quarter of 2009 and higherproductivity.  The lower labor costsimproved our gross profit margin by approximately $435,000.  Due to favorable market conditions andnegotiations of supply agreements, we were able to lower costs for ourpackaging materials which contributed $340,000 to our gross profit for thequarter.  Converting overhead costsincreased in the 2009 quarter compared to the 2008 quarter by approximately$133,000, which was primarily due to a $269,000 increase in the cost of outsidewarehousing, a $220,000 increase in overhead labor and $220,000 in higherdepreciation expense primarily due to the $4.7 million converting automationproject being placed in service in 2009. These costs were offset by a $285,000 decrease in maintenance and repaircosts as well as the non-recurrence of $274,000 expenditure for a productivityconsultant used in the 2008 quarter.  Theyear over year increase in outside warehousing expense is due to increasedstorage space requirements resulting from a higher level of converted productproduction and shipments experienced in the third quarter of 2009.   Overhead labor increased primarily due toadditions to our converting management team. Maintenance and repair costs in the third quarter 2008 were higher thannormal due to a program initiated during that quarter to improve productivity.

 

**Gross Profit**

 

Gross profit in thequarter ended September 30, 2009, increased $3.6 million, or 95.7%, to$7.4 million compared to $3.8 million in the same period last year.  Gross profit as a percentage of net sales inthe 2009 quarter was 30.2% compared to 16.3% in the 2008 quarter.  The gross profit increase was primarily theresult of lower waste paper prices, increased converted product net salesprices, an increase in converted product tonnage shipped, lower 

 

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natural gas costs andlower converting direct labor costs.  Asa result of the increased converting production, more tonnage was consumed inour converting operation rather than being sold as parent rolls, whichpositively affected our gross profit because sales of converted productstypically carry a higher margin than sales of parent rolls.

 

**Selling, General and AdministrativeExpenses**

 
| ** **                          | ** ** | **Three  Months Ended September 30,** | ** ** |
|-------------------------------------|------------|--------------------------------------------|------------|
| ** **                          | ** ** | **2009**                                   | ** ** | **2008** | ** ** |
| ** **                          | ** ** | **(In  thousands, except**                 | ** ** |
| ** **                          | ** ** | **SG&A  as a % of net sales)**         | ** ** |
|                                |       |                                       |       |   |   |
| Commission expense                  |       | $                                          | 329        |   | $ | 260 |   |
| Other SG&A expenses             |       | 1,443                                      |       | 1,291 |   |
| Selling, General & Adm exp |       | $                                          | 1,772      |   | $ | 1,551 |   |
| SG&A as a % of net sales        |       | 7.2                                        | %          | 6.7 | % |
|                                |       |                                       |       |   |   |
| Operating income                    |       | $                                          | 5,657      |   | $ | 2,243 |   |

 

Selling, general andadministrative expenses include salaries, commissions to brokers and othermiscellaneous expenses.  Selling, generaland administrative expenses increased $221,000, or 14.2%, to $1.8 million inthe quarter ended September 30, 2009 compared to $1.6 million in thecomparable 2008 period.  The increase wasprimarily due to increased accruals under our incentive bonus plan, higherlegal and professional fees and increased commission expense related to ourincreased converted product sales.

 

**Operating Income**

 

As a result of theforegoing factors, operating income for the quarter ended September 30,2009 increased $3.4 million to $5.7 million, compared to $2.2 million in thesame period in 2008.

 

**Interest Expense and Other Income**

 
| ** **                  | ** ** | **Three  Months Ended September 30,** | ** ** |
|-----------------------------|------------|--------------------------------------------|------------|
| ** **                  | ** ** | **2009**                                   | ** ** | **2008** | ** ** |
| ** **                  | ** ** | **(In  thousands)**                        | ** ** |
| Interest  expense           |       | $                                          | 174        |   | $ | 310 |   |
| Other  income               |       | $                                          | (5         | ) | $ | (3 | ) |
|                        |       |                                       |       |   |   |
| Income  before income taxes |       | $                                          | 5,488      |   | $ | 1,936 |   |

 

Interest expense includesinterest on all debt and amortization of deferred debt issuance costs.  Interest expense decreased $136,000 to$174,000 in the quarter ended September 30, 2009, compared to $310,000 inthe quarter ended September 30, 2008. Lower LIBOR interest rates and lower margins over LIBOR, reflecting ourimproved financial performance, were the primary reasons for the decrease ininterest expense.

 

**Income Before Income Taxes**

 

As a result of theforegoing factors, income before income taxes increased $3.6 million to $5.5million in the quarter ended September 30, 2009, compared to $1.9 millionin the same period in 2008.

 

**Income Tax Provision**

 

As of September 30,2009, we estimate our full-year effective income tax rate to be 33.2%.  This is lower than our estimate as of the endof June 30, 2009 of 34.6%, due to the utilization of IRC Section 199manufacturing deduction for which we are now eligible due to the depletion ofour Federal Net Operating Losses.  As aresult, our effective tax rate for the quarter ended September 30, 2009was 30.5%.  Our full-year estimated rateis lower than the statutory rate because of the Oklahoma Investment Tax Creditsassociated with capital equipment investments, the utilization of FederalIndian Employment credits and the Section 199 manufacturingdeduction.  The Oklahoma Investment TaxCredits offset our Oklahoma state tax liability.  As of September 30, 2008, our annualeffective income tax rate was 30%.

 

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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 Nine-Month PeriodsEnded September 30, 2009 and 2008**

 

**Net Sales**

 
| ** **                   | ** ** | **Nine  Months Ended September 30,** | ** ** |
|------------------------------|------------|--------------------------------------|------------|
| ** **                   | ** ** | **2009**                             | ** ** | **2008** | ** ** |
| ** **                   | ** ** | **(in  thousands, except**           | ** ** |
| ** **                   | ** ** | **price  per ton and tons)**         | ** ** |
| Converted  product net sales |       | $                                    | 65,750     |   | $ | 53,798 |   |
| Parent  roll net sales       |       | 6,578                                |       | 12,104 |   |
| Total  net sales             |       | $                                    | 72,328     |   | $ | 65,902 |   |
|                         |       |                                 |       |   |   |
| Total  tons shipped          |       | 38,481                               |       | 41,025 |   |
| Average  price per ton       |       | $                                    | 1,880      |   | $ | 1,606 |   |

 

Net sales increased 9.8%to $72.3 million in the nine months ended September 30, 2009, compared to $65.9million in the same period of 2008.  Netsales figures represent gross selling price, including freight, less discountsand pricing allowances.  Net sales of convertedproduct increased for the nine months ended September 30, 2009, by $12.0million, or 22.2%, to $65.8 million compared to $53.8 million in the sameperiod last year.  Net sales of parentrolls decreased $5.5 million, or 45.7%, to $6.6 million in the nine monthsended September 30, 2009 compared to $12.1 million in the same period lastyear.  The overall increase in net salesis primarily the result of a 16.9% increase in the net selling price per ton ofconverted product shipments and a 4.6% increase in tons of converted productshipped which was partially offset by a 33.1% decrease in parent roll tonnageshipped and an 18.7% decrease in parent roll net selling price per ton.

 

Total shipments in thenine-month period of 2009 decreased by 2,544 tons, or 6.2%, to 38,481 tonscompared to 41,025 tons in the same period of 2008, primarily due to a 33.1%decrease in parent roll shipments.  Ouroverall net selling price per ton increased by 17.0% in the first nine monthsof 2009 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.

 

**Cost of Sales**

 
| ** **                                 | ** ** | **Nine  Months Ended September 30,** | ** ** |
|--------------------------------------------|------------|--------------------------------------|------------|
| ** **                                 | ** ** | **2009**                             | ** ** | **2008** | ** ** |
| ** **                                 | ** ** | **(in  thousands, except**           | ** ** |
| ** **                                 | ** ** | **gross  profit margin %**           | ** ** |
| ** **                                 | ** ** | **and  paper cost per ton)**         | ** ** |
| Cost of paper                              |       | $                                    | 25,763     |   | $ | 33,240 |   |
| Non-paper materials, labor, supplies, etc. |       | 22,235                               |       | 20,747 |   |
| Sub-total                                  |       | $                                    | 47,998     |   | $ | 53,987 |   |
| Depreciation                               |       | 2,641                                |       | 2,310 |   |
| Cost of sales                              |       | $                                    | 50,639     |   | $ | 56,297 |   |
|                                       |       |                                 |       |   |   |
| Gross Profit                               |       | $                                    | 21,689     |   | $ | 9,605 |   |
| Gross Profit Margin %                      |       | 30.0                                 | %          | 14.6 | % |
| Total paper cost per ton consumed          |       | $                                    | 669        |   | $ | 810 |   |

 

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 $5.7 million, or 10.1%, to $50.6 million for the nine monthsended September 30, 2009, compared to $56.3 million in the same period of2008.  As a percentage of net sales, costof sales decreased to 70.0% of net sales in the nine-month period ended September30, 2009 from 85.4% of net sales in the nine-month period ended September 30,2008.  The decrease in cost of sales as apercentage of net sales in the nine months ended September 30, 2009, wasprimarily attributed to lower paper production costs, higher

 

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converted product sellingprices per ton, and lower converting direct labor costs which were somewhatoffset by higher converting overhead costs.

 

In the nine months ended September30, 2009, our overall cost of paper was $669 per ton, a decrease of $141 perton when compared to the same period in 2008. Our cost per ton decreased primarily due to decreased waste paper pricesand, to a lesser extent, decreased natural gas prices.  Our waste paper costs decreased approximately35%, which reduced our cost of waste paper consumed by $5.1 million in thefirst nine months of 2009 compared to the same period of 2008.  Natural gas prices decreased 23% in the 2009period compared to the same period in 2008, resulting in decreased cost ofapproximately $815,000.

 

Direct labor costs in ourconverting operation in the first nine months of 2009 were lower than the sameperiod in 2008 by 20.63% on a per unit basis for the same reasons cited for thethree-month comparison.  This had afavorable effect of approximately $1.6 million on our gross profit margin.  Converting overhead expenses for the ninemonths ended September 30, 2009, were higher than the same period of 2008 byapproximately $1.5 million, primarily due to increased outside warehouseexpense of $697,000 due to higher space needs associated with our increasedconverting product production and sales. Other factors contributing to the increased overhead costs includehigher overhead labor of approximately $500,000 due to additions to ourconverting management team, higher depreciation of 297,000 primarily due tocompletion of capital projects as well as increased maintenance and repaircosts of approximately $115,000.  Theseincreases were partly offset by the non-recurrence of the costs of aproductivity consultant of $323,000 utilized in the converting operation in the2008 period.

 

**Gross Profit**

 

Gross profit in the ninemonths ended September 30, 2009, increased $12.1 million, or 125.8 %, to $21.7million compared to $9.6 million in the same period last year.  Gross profit as a percentage of net sales inthe nine-month period ended September 30, 2009, was 30.0% compared to 14.6% inthe same period in 2008.  The effect oflower waste paper prices and utility costs, higher converted product sellingprices and higher converted product shipments all contributed to the increasein gross profit.  Additionally, sales oflower margin parent rolls declined.

 

**Selling, General andAdministrative Expenses**

 
| ** **                      | ** ** | **Nine  Months Ended September 30,** | ** ** |
|---------------------------------|------------|--------------------------------------|------------|
| ** **                      | ** ** | **2009**                             | ** ** | **2008** | ** ** |
| ** **                      | ** ** | **(In  thousands, except**           | ** ** |
| ** **                      | ** ** | **SG&A  as a % of net sales)**   | ** ** |
|                            |       |                                 |       |   |   |
| Commission  expense             |       | $                                    | 1,007      |   | $ | 753 |   |
| Other  SG&A expenses        |       | 4,682                                |       | 3,674 |   |
| Selling,  General & Adm exp |       | $                                    | 5,689      |   | $ | 4,427 |   |
| SG&A  as a % of net sales   |       | 7.9                                  | %          | 6.7 | % |
|                            |       |                                 |       |   |   |
| Operating  income               |       | $                                    | 16,000     |   | $ | 5,178 |   |

 

Selling, general andadministrative expenses include salaries, commissions to brokers and othermiscellaneous expenses.  Selling, generaland administrative expenses increased $1.3 million, or 28.5%, to $5.7 millionin the nine months ended September 30, 2009, compared to $4.4 million in the comparable2008 period, mainly as a result of increased accruals under our incentive bonusplan, increased sales commissions due to the increase in converted product sales,increased stock option expense, primarily due to an increase in the marketprice of our stock, higher legal and professional fees and costs associatedwith additions to our senior management team. As a percentage of net sales, selling, general and administrativeexpenses increased to 7.9% in the nine months ended September 30, 2009,compared to 6.7% in the same period of 2008.

 

**Operating Income**

 

As a result of theforegoing factors, operating income for the nine months ended September 30,2009 was $16.0 million compared to operating income of $5.2 million for thesame period of 2008.

 

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**Interest Expense and Other Income**

 
| ** **                 | ** ** | **Nine  Months Ended September 30,** | ** **   |
|----------------------------|------------|--------------------------------------|--------------|
| ** **                 | ** ** | **2009**                             | ** **   | **2008** | ** ** |
| ** **                 | ** ** | **(In  thousands)**                  | ** **   |
| Interest expense           |       | $                                    |  468    |   | $ |  1,041 |   |
| Other income               |       | $                                    |  (9     | ) | $ |  (9 | ) |
|                       |       |                                 |         |   |   |
| Income before income taxes |       | $                                    |  15,541 |   | $ |  4,146 |   |

 

Interest expensedecreased by $573,000 from $1.0 million in the nine months ended September 30,2008, to $468,000 in the same period in 2009. The decrease was primarily attributable to lower LIBOR rates and lowermargins over LIBOR attributable to our improved financial performance.

 

**Income Before Income Taxes**

 

As a result of theforegoing factors, income before income taxes increased $11.4 million to $15.5million in the nine months ended September 30, 2009 compared to $4.1 million inthe same period in 2008.

 

**Income Tax Provision**

 

As of September 30, 2009,we estimate our full-year effective income tax rate to be 33.1%.  This is lower than our estimate as of the endof June 30, 2009 of 34.6%, due to the utilization of IRC Section 199manufacturing deduction for which we are now eligible due to the depletion ofour Federal Net Operating Losses.  It islower than the statutory rate because of Oklahoma Investment Tax Creditsassociated with our investment in 2006 in a paper machine as well as continuedcapital investment in our mill and converting production facilities, theutilization of Federal Indian Employment Credits and the Section 199manufacturing credits.  Our tax rate ishigher than 2008 as we have depleted all of our Federal Net Operating Losscarryforwards.  For the nine months endedSeptember 30, 2008, our effective income tax rate was 30%.

 

**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 debt financings.

 

Inthe second quarter of 2009, we announced our intention to pursue an expansionplan, which included the construction of a new warehouse and the purchase andinstallation of a new converting line. The current estimated cost of this project is $25.4 million, whichconsists of $5.8 million for the new warehouse and $18.6 million for the newconverting line.  Funding for thisproject will come from the proceeds of our recently completed sale of commonstock, a construction loan from our existing bank group that will fund 80% ofthe cost of the new warehouse and from cash generated from operations.  Payments required under the project began inthe third quarter of 2009 and will continue through the third quarter of 2010.  On August 26, 2009, we closed an offering of750,000 shares of our common stock at an offering price of $18.50 per share. Wereceived net proceeds of approximately $12.8 million from the offering, afterdeducting the underwriting discount and offering expenses.  On September 2, 2009, the underwriterexercised their over-allotment option and purchased an additional 112,500shares of common stock at a price of $18.50 per share.  We received $2.0 million in net proceeds fromthis exercised option.

 

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.  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.

 

Cash increased in thenine months ended September 30, 2009 by $306,000.  In addition, we purchased $22.5 million ofshort-term investments as a result of proceeds from the previously discussedcommon stock offering and cash generated by operations.  The short term investments consist primarilyof FDIC insured certificates of deposit and institutional money market funds.  Cash increased by $9,000 in the nine monthsended September 30, 2008.

 

The following tablesummarizes key cash flow information for the nine-month periods ended September30, 2009 and 2008:

 
| ** **                       | ** ** | **Nine  Months Ended September 30,** | ** **    |
|----------------------------------|------------|--------------------------------------|---------------|
| ** **                       | ** ** | **2009**                             | ** **    | **2008** | ** ** |
| ** **                       | ** ** | **(in  thousands)**                  | ** **    |
| Cash flow provided by (used in): |       |                                 |          |   |   |
| Operating activities             |       | $                                    |  14,060  |   | $ |  3,701 |   |
|                             |       |                                 |          |   |   |
| Investing activities             |       | $                                    |  (29,056 | ) | $ |  (4,159 | ) |
|                             |       |                                 |          |   |   |
| Financing activities             |       | $                                    |  15,302  |   | $ |  467 |   |

 

Cash flow provided byoperating activities was $14.1 million in the nine-month period ended September30, 2009, which primarily resulted from earnings before non-cash charges whichwas partially offset by an increase in accounts receivable.

 

Cash flow used ininvesting activities was $29.1 million in the first nine months of 2009 due tothe purchase of $22.5 million in short-term investments from the proceeds fromour common stock offering as well as from cash provided from operations.  Additionally, we had $6.6 million inexpenditures on capital projects, primarily for a waste water treatmentproject, which was completed in August.

 

Cash flow provided byfinancing activities was $15.3 million in the nine-month period ended September30, 2009, which was primarily attributable to $14.8 million in net proceedsfrom our common stock offering and $3.8 million of borrowings under aconstruction loan related to the waste water treatment plant project.  These inflows were partially offset byprincipal payments of $2.3 million on our term loans and a $1.5 millionrepayment on our revolving line of credit.

 

Cash flows provided byoperating activities was $3.7 million in the nine-month period ended September 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 $4.2 million in the nine-month period ended 2008, asa result of expenditures on capital projects, primarily the previouslyannounced $4.75 million project to automate certain operations in ourconverting plant, which was completed in the first quarter of 2009.

 

Cashflows provided by financing activities was $467,000 in the nine-month periodended September 30, 2008, and was primarily attributable to $2.1 million of netborrowings under the revolving credit agreement, which were partially offset by$1.7 million of principal payments on our term loans.

 

**Critical Accounting Policies andEstimates**

 

The preparation of ourfinancial statements and related disclosures in conformity with accounting principlesgenerally accepted in the United States requires management to make estimatesand judgments that affect our reported amounts of assets and liabilities,revenue and expense, and related disclosures of contingent assets andliabilities.  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:

 

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*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 thecustomer’s creditworthiness 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 customercollection issues that we have identified. Trade receivables are written-off when all reasonable collection effortshave been exhausted, including, but not limited to, external third partycollection efforts and litigation.  Whilesuch credit losses have historically been within management’s expectations andthe allowance provided, there can be no assurance that we will continue toexperience the same credit loss rates as in the past.  During the nine-month periods ended September30, 2009 and 2008, provisions for doubtful accounts were recognized in theamount of $46,000 each period.  In thefirst nine months of 2009, $1,000 of recoveries of accounts previously writtenoff was credited back to the allowance and in 2008, $3,000 was recovered.  Accounts receivable balances totaling $39,000were written off in the nine-month period ended September 30, 2009 and accountsreceivable balances of $3,000 were written off in the same period of 2008.

 

*Inventory.* Our inventory consists of finished goods and raw materials and is statedat the lower of cost or market.  Our managementregularly reviews inventory quantities on hand and records a provision forexcess and obsolete inventory based on the age of the inventory and forecastsof product demand.  A significantdecrease in demand could result in an increase in the amount of excessinventory quantities on hand.  During thefirst nine months of 2009, $45,000 was provided and there were charges totaling$233,000 against the valuation reserve.  Duringthe first nine months of 2008, $90,000 was provided and there were charges totaling$74,000 against the valuation reserve.

 

**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:

 

**FASB Establishes AccountingStandards Codification**TM

 

In June 2009, the FASBissued Accounting Standards Update No. 2009-01, “Generally Accepted AccountingPrinciples” (ASC Topic 105) which establishes the FASB Accounting StandardsCodification (the “Codification” or “ASC”) as the official single source ofauthoritative U.S. generally accepted accounting principles (“GAAP”). Allexisting accounting standards are superseded. All other accounting guidance notincluded in the Codification will be considered non-authoritative. TheCodification also includes all relevant Securities and Exchange Commission(“SEC”) guidance organized using the same topical structure in separatesections within the Codification.

 

Following theCodification, the FASB will not issue new standards in the form of Statements,FASB Staff Positions or Emerging Issues Task Force Abstracts. Instead, it willissue Accounting Standards Updates (“ASU”) which will serve to update theCodification, provide background information about the guidance and provide thebasis for conclusions on the changes to the Codification.

 

The Codification is notintended to change GAAP, but it will change the way GAAP is organized andpresented. The Codification is effective for our third-quarter 2009 financialstatements and the principal impact on our financial statements is limited todisclosures as all future references to authoritative accounting literaturewill be referenced in accordance with the Codification. In order to ease thetransition to the Codification, we are providing the Codificationcross-reference alongside the references to the standards issued and adoptedprior to the adoption of the Codification.

 

**Fair Value Accounting**

 

In August 2009, the FASBissued ASU No. 2009-05 which amends Fair Value Measurements and Disclosures —Overall (ASC Topic 820-10) to provide guidance on the fair value measurement ofliabilities. This update requires clarification for circumstances in which aquoted price in an active market for the identical liability is not available,a reporting entity is required to measure fair value using one or more of thefollowing techniques: 1) a valuation technique that uses either the quotedprice of the identical liability when traded as an asset or quoted prices forsimilar liabilities or similar liabilities when traded as an asset; or 2)another valuation technique that is consistent with the principles in ASC Topic820 such as the income and market approach to valuation. The amendments in thisupdate also clarify that when estimating the fair value of a liability, areporting entity is not required to include

 

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a separate input oradjustment to other inputs relating to the existence of a restriction thatprevents the transfer of the liability.  Thisupdate further clarifies that if the fair value of a liability is determined byreference to a quoted price in an active market for an identical liability,that price would be considered a Level 1 measurement in the fair valuehierarchy. Similarly, if the identical liability has a quoted price when tradedas an asset in an active market, it is also a Level 1 fair value measurement ifno adjustments to the quoted price of the asset are required.  This update is effective for our fourthquarter 2009.

 

**Non-GAAP Discussion**

 

Inaddition to our GAAP results, we also consider non-GAAP financial measures fora 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:

 

·              itdoes not reflect our cash expenditures for capital assets;

 

·              itdoes not reflect changes in, or cash requirements for, our working capitalrequirements;

 

·                                          it does not reflect the interest expense, or the cashrequirements necessary to service interest or principal payments on ourindebtedness;

 

·                                          although depreciation and amortization are non-cashcharges, the assets being depreciated and amortized will often have to bereplaced in the future, and EBITDA does not reflect cash requirements for suchreplacements; and

 

·                                          other companies, including other companies in ourindustry, may calculate these measures differently than we do, limiting theirusefulness as a comparative measure.

 

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 September 30, 2009 and2008:

 
| ** **                | ** ** | **Three  Months Ended September 30,** | ** ** |
|---------------------------|------------|---------------------------------------|------------|
| ** **                | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| ** **                | ** ** | **(In  thousands,**                   | ** ** |
| ** **                | ** ** | **except  % of net sales)**           | ** ** |
| ** **                | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Net  income               |       | $                                     | 3,815      |   | $ | 1,423 |   |
| Plus:  Interest expense   |       | 174                                   |       | 310 |   |
| Plus:  Income tax expense |       | 1,673                                 |       | 513 |   |
| Plus:  Depreciation       |       | 1,003                                 |       | 783 |   |
| EBITDA                    |       | $                                     | 6,665      |   | $ | 3,029 |   |
| % of  net sales           |       | 27.1                                  | %          | 13.0 | % |

 

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EBITDA increased $3.7million to $6.7 million in the quarter ended September 30, 2009, comparedto $3.0 million in the same period in 2008. EBITDA as a percent of net sales increased to 27.1% in the third quarterof 2009 from 13.0% in the same quarter of 2008. The foregoing factors discussed in the net sales, cost of sales andselling, general and administrative expenses sections are the reasons for theincrease.

 

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

 
| ** **                | ** ** | **Nine  Months Ended September 30,** | ** ** |
|---------------------------|------------|-------------------------------------------|------------|
| ** **                | ** ** | **2009**                                  | ** ** | **2008** | ** ** |
| ** **                | ** ** | **(In  thousands,**                       | ** ** |
| ** **                | ** ** | **except  % of net sales)**               | ** ** |
| ** **                | ** ** | ** **                                | ** ** | ** ** | ** ** |
| Net  income               |       | $                                         | 10,387     |   | $ | 2,921 |   |
| Plus:  Interest expense   |       | 468                                       |       | 1,041 |   |
| Plus:  Income tax expense |       | 5,154                                     |       | 1,225 |   |
| Plus:  Depreciation       |       | 2,641                                     |       | 2,310 |   |
| EBITDA                    |       | $                                         | 18,650     |   | $ | 7,497 |   |
| % of  net sales           |       | 25.8                                      | %          | 11.4 | % |

 

EBITDAincreased $11.2 million to $18.7 million in the nine months ended September 30,2009, compared to $7.5 million in the same period of 2008.  EBITDA as a percent of net sales increased to25.8% in the current nine-month period from 11.4% in the prior year nine-monthperiod.  The foregoing factors discussedin the net sales, cost of sales and selling, general and administrativesections are the reasons for these changes.

 

Weuse Net Debt as a supplemental measure of our leverage that is not required by,or presented in accordance with, GAAP. Net Debt should not be considered as an alternative to total debt, totalliabilities or any other performance measure derived in accordance withGAAP.  Net Debt represents total debtreduced by cash and cash equivalents.  We use this figure as a means to evaluate our ability to repay ourindebtedness and to measure the risk of our financial structure.

 

NetDebt represents the amount that Cash and Cash Equivalents is less than totalDebt of the Company.  The amountsincluded in Net Debt calculation are derived from amounts included in thehistorical Balance Sheets.   We havereported Net Debt because we regularly review Net Debt as a measure of theCompany’s leverage.   However, the NetDebt measure presented in this document may not be comparable to similarlytitled measures reported by other companies due to differences in thecomponents of the calculation.

 

NetDebt has decreased from $24.1 million on December 31, 2008, to $1.2million on September 30, 2009 as a result of increases in our cash andshort term investments primarily due to cash proceeds from our common stockoffering of $14.8 million as well as $14.1 million in cash generated fromoperations.  We have reduced our TotalDebt only slightly during the period.

 

Thefollowing table presents Net Debt as of September 30, 2009 and December 31,2008:

 
| ** **                      | ** ** | **As  of**             | ** ** |
|---------------------------------|------------|------------------------|------------|
| ** **                      | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| ** **                      | ** ** | **2009**               | ** ** | **2008** | ** ** |
| ** **                      | ** ** | **(in  thousands)**    |
| Net  Debt Reconciliation        |       |                   |       |   |   |
| Current  Portion Long Term Debt |       | $                      | 3,140      |   | $ | 2,998 |   |
| Long  Term Debt                 |       | 20,910                 |       | 21,067 |   |
| Total  Debt                     |       | $                      | 24,050     |   | $ | 24,065 |   |
| Less:  Cash                     |       | (317                   | )          | (11 | ) |
| Less:  Short Term Investments   |       | (22,502                | )          | — |   |
| Net  Debt                       |       | $                      | 1,231      |   | $ | 24,054 |   |

 

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**ITEM 3.  Quantitative andQualitative Disclosures about 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 andProcedures**

 

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 ofSeptember 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 September 30, 2009, that have materially affected, or are reasonablylikely to materially affect, our internal control over financial reporting.

 

**PART II.  OTHERINFORMATION**

 

**ITEM 1.  LegalProceedings**

 

None

 

**ITEM 1A. Risk Factors**

 

Asof the date of this filing, there have been no material changes from the riskfactors disclosed in our Annual Report on Form 10-K for the fiscal yearended December 31, 2008 and our Quarterly Report on Form 10-Q for thequarterly period ended June 30, 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 our Quarterly Report on Form 10-Q may cause our actual results,performances and achievements to be materially different from those expressedor implied by our forward-looking statements. If any of these risks or events occurs,our business, financial condition or results of operations may be adverselyaffected.

 

**ITEM 2.  UnregisteredSales of Equity Securities and Use of Proceeds**

 

*(a) Unregistered Sales ofEquity Securities*

 

None

 

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

 

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 September 30, 2009.

 

**ITEM 3.  DefaultsUpon Senior Securities**

 

None

 

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**ITEM 4.  Submissionof Matters to a Vote of Security Holders**

 

None

 

**ITEM 5.  Other Information**

 

None

 

**ITEM 6.  Exhibits**

 

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

 

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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:  November 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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Table ofContents

 

**Exhibit Index**

 
| **Exhibit** | ** ** | **Description**                                                                                                                                                                                                                                                                     |
|-------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **  | ** ** | ** **                                                                                                                                                                                                                                                                          |
| 1.1         |       | Underwriting Agreement  dated August 21, 2009, by and between the Registrant and Stephens Inc.  incorporated by reference to the Registrant’s Form 8-K (File  No. 001-32563) filed with the Securities and Exchange Commission on  August 21, 2009.        |
|        |       |                                                                                                                                                                                                                                                                                |
| 3.1         |       | Amended and Restated  Certificate of Incorporation of the Registrant incorporated byreference to Exhibit 3.1 to the  Registrant’s Registration Statement on Form S-1 (File No.333-124173) filed with the Securities  and Exchange Commission on April 19, 2005. |
|        |       |                                                                                                                                                                                                                                                                                |
| 3.1.1       |       | Amendment to the  Amended and Restated Certificate of Incorporation of the Registrant  incorporated by reference to the Form 10-Q filed with the Securities and  Exchange Commission on August 14, 2007.                                                             |
|        |       |                                                                                                                                                                                                                                                                                |
| 3.2         |       | Amended and Restated  Bylaws of the Registrant incorporated by reference to Exhibit 3.2 to the  Registrant’s Registration Statement on Form S-1 (File  No. 333-124173) filed with the Securities and Exchange Commission on  April 19, 2005.               |
|        |       |                                                                                                                                                                                                                                                                                |
| 10.1        |       | Amendment Four to  Second Amended and Restated Agented Credit Agreement dated July 31,  2009, incorporated by reference to Orchids Paper Products Company  Form 8-K (File No. 001-32563) filed with the Securities and  Exchange Commission on August 6, 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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