Table of Contents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

**FORM 10-Q**

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

 

**For the quarterly period ended March 31, 2010**

 

**OR**

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

 

**Commission File Number 001-32563**

 

**OrchidsPaper Products Company**

 (Exact name of Registrant as Specifiedin its Charter)

 

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

 

**4826 Hunt Street**

**Pryor, Oklahoma 74361**

(Address of Principal Executive Offices and Zip Code)

 

**(918) 825-0616**

(Registrant’s Telephone Number, Including Area Code)

 

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

 

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

 

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

 

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

 

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

 

Numberof shares outstanding of the issuer’s Common Stock, par value $.001 per share,as of April 30, 2010: 7,486,725 shares.

 

 

 

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**ORCHIDS PAPER PRODUCTS COMPANY**

**TABLE OF CONTENTS**

**QUARTERLY REPORT ON FORM 10-Q**

**FOR THE THREE MONTHS ENDED March 31, 2010**

 
| ** **                             | ** **                                                                                         | **Page**   |
|----------------------------------------|----------------------------------------------------------------------------------------------------|------------|
| ** **                             | ** **                                                                                         | ** ** |
| **PART I. FINANCIAL INFORMATION** |
| ** **                             | ** **                                                                                         | ** ** |
| **ITEM 1.**                            | **Financial Statements**                                                                           | ** ** |
| ** **                             | ** **                                                                                         | ** ** |
| ** **                             | **Balance Sheets as of  March 31, 2010 (Unaudited) and December 31, 2009**               | **3**      |
| ** **                             | ** **                                                                                         | ** ** |
| ** **                             | **Statements of Income  for the three months ended March 31, 2010 and 2009 (Unaudited)**      | **4**      |
| ** **                             | ** **                                                                                         | ** ** |
| ** **                             | **Statements of  Cash Flows for the three months ended March 31, 2010 and 2009  (Unaudited)** | **5**      |
| ** **                             | ** **                                                                                         | ** ** |
| ** **                             | **Notes  to Unaudited Interim Financial Statements**                                               | **6**      |
| ** **                             | ** **                                                                                         | ** ** |
| **ITEM 2.**                            | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations**    | **10**     |
| ** **                             | ** **                                                                                         | ** ** |
| **ITEM 3.**                            | **Quantitative and  Qualitative Disclosures about Market Risk**                                    | **19**     |
| ** **                             | ** **                                                                                         | ** ** |
| **ITEM 4.**                            | **Controls and  Procedures**                                                                       | **19**     |
| ** **                             | ** **                                                                                         | ** ** |
| **PART II.  OTHER INFORMATION**   |
| ** **                             | ** **                                                                                         | ** ** |
| **ITEM 1.**                            | **Legal Proceedings**                                                                              | **20**     |
| ** **                             | ** **                                                                                         | ** ** |
| **ITEM 1A.**                           | **Risk Factors**                                                                                   | **20**     |
| ** **                             | ** **                                                                                         | ** ** |
| **ITEM 2.**                            | **Unregistered  Sales of Equity Securities and Use of Proceeds**                                   | **20**     |
| ** **                             | ** **                                                                                         | ** ** |
| **ITEM 3.**                            | **Defaults Upon Senior  Securities**                                                               | **20**     |
| ** **                             | ** **                                                                                         | ** ** |
| **ITEM 4.**                            | **RESERVED**                                                                                       | **20**     |
| ** **                             | ** **                                                                                         | ** ** |
| **ITEM 5.**                            | **Other Information**                                                                              | **20**     |
| ** **                             | ** **                                                                                         | ** ** |
| **ITEM 6.**                            | **Exhibits**                                                                                       | **20**     |
| ** **                             | ** **                                                                                         | ** ** |
| ** **                             | **Signatures**                                                                                     | **21**     |

 

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**PART 1. FINANCIAL INFORMATION**

**ITEM 1.**Financial Statements

 

**ORCHIDS PAPER PRODUCTS COMPANY**

**BALANCESHEETS**

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

 
| ** **                                                                                                                                          | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                          | ** ** | **2010**           | ** ** | **2009**              | ** ** |
| ** **                                                                                                                                          | ** ** | **(unaudited)**    | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                          |       |               |       |                  |       |
| Current assets:                                                                                                                                     |       |               |       |                  |       |
| Cash                                                                                                                                                |       | $                  | 642        |                  | $          | 1,232 |   |
| Accounts receivable, net of allowance of $224 in  2010 and $209 in 2009                                                                             |       | 6,647              |       | 6,750                 |       |
| Inventories, net                                                                                                                                    |       | 8,419              |       | 7,569                 |       |
| Short term investments                                                                                                                              |       | 13,512             |       | 18,509                |       |
| Prepaid expenses                                                                                                                                    |       | 396                |       | 497                   |       |
| Deferred income taxes                                                                                                                               |       | 782                |       | 547                   |       |
| Total current assets                                                                                                                                |       | 30,398             |       | 35,104                |       |
|                                                                                                                                                |       |               |       |                  |       |
| Property, plant and equipment                                                                                                                       |       | 94,893             |       | 87,535                |       |
| Accumulated depreciation                                                                                                                            |       | (15,975            | )          | (14,844               | )          |
| Net property, plant and equipment                                                                                                                   |       | 78,918             |       | 72,691                |       |
|                                                                                                                                                |       |               |       |                  |       |
| Deferred debt issuance costs, net of accumulated amortization  of $639 in 2010 and $632 in 2009                                                     |       | 97                 |       | 104                   |       |
| Total assets                                                                                                                                        |       | $                  | 109,413    |                  | $          | 107,899 |   |
|                                                                                                                                                |       |               |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                       |       |               |       |                  |       |
| Current liabilities:                                                                                                                                |       |               |       |                  |       |
| Accounts payable                                                                                                                                    |       | $                  | 4,665      |                  | $          | 4,049 |   |
| Accrued liabilities                                                                                                                                 |       | 3,192              |       | 3,118                 |       |
| Current portion of long-term debt                                                                                                                   |       | 3,772              |       | 3,742                 |       |
| Total current liabilities                                                                                                                           |       | 11,629             |       | 10,909                |       |
|                                                                                                                                                |       |               |       |                  |       |
| Long-term debt, less current portion                                                                                                                |       | 18,578             |       | 19,533                |       |
| Deferred income taxes                                                                                                                               |       | 14,617             |       | 14,337                |       |
| Stockholders’ equity:                                                                                                                          |       |               |       |                  |       |
| Common stock, $.001 par value, 25,000,000 shares  authorized, 7,486,725 and 7,393,874 shares issued and outstanding in 2010 and  2009, respectively |       | 7                  |       | 7                     |       |
| Additional paid-in capital                                                                                                                          |       | 38,463             |       | 38,354                |       |
| Retained earnings                                                                                                                                   |       | 26,119             |       | 24,759                |       |
| Total stockholders’ equity                                                                                                                     |       | 64,589             |       | 63,120                |       |
| Total liabilities and stockholders’ equity                                                                                                     |       | $                  | 109,413    |                  | $          | 107,899 |   |

 

See notes to financial statements.

 

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**ORCHIDS PAPER PRODUCTS COMPANY**

**STATEMENTSOF INCOME**

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

 
| ** **                                       | ** ** | **Three  Months Ended March 31,** | ** ** |
|--------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                       | ** ** | **2010**                               | ** ** | **2009** | ** ** |
| ** **                                       | ** ** | **(unaudited)**                        | ** ** | **(unaudited)** | ** ** |
|                                             |       |                                   |       |   |   |
| Net sales                                        |       | $                                      | 21,040     |   | $ | 23,640 |   |
|                                             |       |                                   |       |   |   |
| Cost of sales                                    |       | 17,179                                 |       | 17,208 |   |
| Gross profit                                     |       | 3,861                                  |       | 6,432 |   |
|                                             |       |                                   |       |   |   |
| Selling, general and administrative expenses     |       | 1,735                                  |       | 1,830 |   |
| Operating income                                 |       | 2,126                                  |       | 4,602 |   |
|                                             |       |                                   |       |   |   |
| Interest expense                                 |       | 215                                    |       | 159 |   |
| Other income                                     |       | (14                                    | )          | (3 | ) |
| Income before income taxes                       |       | 1,925                                  |       | 4,446 |   |
|                                             |       |                                   |       |   |   |
| Provision for income taxes:                      |       |                                   |       |   |   |
| Current                                          |       | 520                                    |       | 756 |   |
| Deferred                                         |       | 45                                     |       | 893 |   |
|                                             |       | 565                                    |       | 1,649 |   |
|                                             |       |                                   |       |   |   |
| Net income                                       |       | $                                      | 1,360      |   | $ | 2,797 |   |
|                                             |       |                                   |       |   |   |
| Net income per share:                            |       |                                   |       |   |   |
| Basic                                            |       | $                                      | 0.18       |   | $ | 0.44 |   |
| Diluted                                          |       | $                                      | 0.18       |   | $ | 0.42 |   |
|                                             |       |                                   |       |   |   |
| Shares used in calculating net income per share: |       |                                   |       |   |   |
| Basic                                            |       | 7,394,906                              |       | 6,409,182 |   |
| Diluted                                          |       | 7,729,468                              |       | 6,683,704 |   |

 

See notes tofinancial statements.

 

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**ORCHIDS PAPER PRODUCTS COMPANY**

**STATEMENTSOF CASH FLOWS**

**(Dollars in thousands)**

 
| ** **                                                                         | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2010**                                             | ** ** | **2009** | ** ** |
| ** **                                                                         | ** ** | **(unaudited)**                                      | ** ** | **(unaudited)** | ** ** |
| **Cash Flows From Operating  Activities**                                          |       |                                                 |       |   |   |
| Net income                                                                         |       | $                                                    | 1,360      |   | $ | 2,797 |   |
| Adjustments to reconcile net income to net cash provided  by operating activities: |       |                                                 |       |   |   |
| Depreciation and amortization                                                      |       | 1,138                                                |       | 813 |   |
| Provision for doubtful accounts                                                    |       | 15                                                   |       | 16 |   |
| Deferred income taxes                                                              |       | 45                                                   |       | 893 |   |
| Stock option plan expense                                                          |       | 109                                                  |       | 81 |   |
| Changes in cash due to changes in operating assets and  liabilities:               |       |                                                 |       |   |   |
| Accounts receivable                                                                |       | 88                                                   |       | (469 | ) |
| Inventories                                                                        |       | (850                                                 | )          | 112 |   |
| Prepaid expenses                                                                   |       | 101                                                  |       | 63 |   |
| Accounts payable                                                                   |       | 616                                                  |       | (417 | ) |
| Accrued liabilities                                                                |       | 74                                                   |       | 832 |   |
| Net cash provided by operating activities                                          |       | 2,696                                                |       | 4,721 |   |
|                                                                               |       |                                                 |       |   |   |
| **Cash Flows From Investing  Activities**                                          |       |                                                 |       |   |   |
| Purchases of property, plant and equipment                                         |       | (7,358                                               | )          | (1,290 | ) |
| Proceeds from the sale of investment securities                                    |       | 4,997                                                |       | — |   |
| Net cash used in investing activities                                              |       | (2,361                                               | )          | (1,290 | ) |
|                                                                               |       |                                                 |       |   |   |
| **Cash Flows From Financing  Activities**                                          |       |                                                 |       |   |   |
| Principal payments on long-term debt                                               |       | (925                                                 | )          | (689 | ) |
| Net repayments on revolving credit line                                            |       | —                                               |       | (1,487 | ) |
| Proceeds from the exercise of warrants attached to  subordinated debentures        |       | —                                               |       | 286 |   |
| Net cash used in financing activities                                              |       | (925                                                 | )          | (1,890 | ) |
|                                                                               |       |                                                 |       |   |   |
| Net increase (decrease) in cash                                                    |       | (590                                                 | )          | 1,541 |   |
| Cash, beginning                                                                    |       | 1,232                                                |       | 11 |   |
| Cash, ending                                                                       |       | $                                                    | 642        |   | $ | 1,552 |   |
| **Supplemental Disclosure:**                                                       |       |                                                 |       |   |   |
| Interest paid                                                                      |       | $                                                    | 215        |   | $ | 159 |   |
| Income taxes paid                                                                  |       | $                                                    | —     |   | $ | 70 |   |

 

See notes tofinancial statements.

 

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**ORCHIDS PAPER PRODUCTS COMPANY**

**NOTES TO UNAUDITED INTERIMFINANCIAL STATEMENTS**

 

***Note 1 — Basis ofPresentation***

 

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

 

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

 

On August 26, 2009,the Company closed a follow-on public offering of 750,000 shares of its commonstock at an offering price of $18.50 per share. The Company received netproceeds of approximately $12.8 million from the offering, after deducting theunderwriting discount and offering expenses. On September 2, 2009, the underwriter exercised theirover-allotment option and purchased an additional 112,500 shares of commonstock at a price of $18.50 per share. The Company received approximately $2.0 million in net proceeds fromthis exercised option.  The Companyintends to use the proceeds from the offering for the construction of a newwarehouse, the purchase and installation of a new converting line, and generalcorporate purposes.

 

The following tabledetails common stock outstanding as of March 31, 2010:

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

 

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

 

**Note 2****—****FairValue 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 measured at fair value.  Thisstandard establishes a framework for measuring fair value and relateddisclosures. 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;

 

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

 

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

 

·      Expands disclosures about instruments measured at fairvalue.

 

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

 

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 following tablepresents information about the Company’s assets measured at fair value on arecurring basis as of March 31, 2010 and indicates the fair valuehierarchy of the valuation techniques utilized to determine such values. Short-term investments are valued as Level 1 in the fair value hierarchy basedon independent pricing services utilized by the Company’s investmentcustodians.

 
| ** **              | ** ** | **Fair Value Measurements at March 31, 2010** | ** ** |
|-------------------------|------------|-----------------------------------------------------------------------------|------------|
| ** **              | ** ** | **Using Inputs Considered as**                               | ** ** |
| ** **              | ** ** | **Level 1**                                                            | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| ** **              | ** ** | ** **                                                                  | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
| Assets                  |       |                                                                        |       |   |   |   |   |
|                    |       |                                                                        |       |   |   |   |   |
| Short  term investments |       | $                                                                           | 13,512     |   | $ | — |   | $ | — |   |
|                         |            |                                                                             |            |  |  |  |  |  |  |  |

 

**Note 3 — Fair Value Financial Instruments**

 

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

 

**Note 4 — Commitments and Contingencies**

 

The Company may be involved from time to time inlitigation arising from the normal course of business. In management’s opinion,as of the date of this report, the Company is not engaged in legal proceedingswhich individually or in the aggregate are expected to have a materiallyadverse effect on the Company’s results of operations or financial condition.

 

Inthe fourth quarter of 2008, the Company entered into a contract to purchase334,000 MMBTU per year of natural gas at $7.50 per MMBTU plus a $0.07 per MMBTUmanagement delivery fee for the period from April 2009 through March 2011.  The amounts represent 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 

 

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toreimburse an amount equal to the volume purchased that was less than thecontracted amount multiplied by the difference between the contract price andcurrent spot price.  In November 2009, the agreement wasextended for one more year to March 2012 for 334,000 MMBTU per year at aprice of $6.50 per MMBTU plus a $0.07 per MMBTU management delivery fee.

 

**Note 5 — Inventories**

 

Inventoriesat March 31, 2010 and December 31, 2009 were:

 
| ** **                  | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-----------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                  | ** ** | **2010**           | ** ** | **2009**              | ** ** |
| ** **                  | ** ** | **(in thousands)** | ** ** |
| Raw materials               |       | $                  | 1,853      |                  | $          | 1,901 |   |
| Bulk paper rolls            |       | 897                |       | 908                   |       |
| Converted finished goods    |       | 5,897              |       | 5,138                 |       |
| Inventory valuation reserve |       | (228               | )          | (378                  | )          |
|                        |       | $                  | 8,419      |                  | $          | 7,569 |   |

 

**Note 6 — Earnings per Share**

 

Thecomputation of basic and diluted net income per share for the three-monthperiods ended March 31, 2010 and 2009 is as follows:

 
| ** **                                                          | ** ** | **Three  Months Ended March 31,** | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                          | ** ** | **2010**                               | ** ** | **2009** | ** ** |
| Net income - ($ thousands)                                     |       | $                                      | 1,360      |   | $ | 2,797 |   |
|                                                                |       |                                   |       |   |   |
| Weighted average shares outstanding                                 |       | 7,394,906                              |       | 6,409,182 |   |
| Effect of stock options                                             |       | 334,562                                |       | 192,434 |   |
| Effect of dilutive warrants                                         |       | —                                 |       | 82,088 |   |
| Weighted average shares outstanding - assuming  dilution            |       | 7,729,468                              |       | 6,683,704 |   |
| Net income per share:                                               |       |                                   |       |   |   |
| Basic                                                               |       | $                                      | 0.18       |   | $ | 0.44 |   |
| Diluted                                                             |       | $                                      | 0.18       |   | $ | 0.42 |   |
|                                                                |       |                                   |       |   |   |
| Stock options not considered above because they were  anti-dilutive |       | 10,000                                 |       | — |   |

 

**Note 7— Stock Incentive Plan**

 

InApril 2005, the board of directors and the stockholders approved the 2005Stock Incentive Plan (the “Plan”).  ThePlan provides for the granting of incentive stock options to employees selectedby the board’s compensation committee. The Plan is authorized to distribute up to 897,500 shares.  Options for 20,000 shares were grantedeffective January 20, 2009, to Keith Schroeder, the Company’s ChiefFinancial Officer, at an exercise price of $10.205, the fair market value ofthe stock on the date of grant.  Theoptions vest 50% on the first anniversary date of the grant and 50% on thesecond anniversary date.  The optionshave a 10 year life.

 

Thefollowing table details the options granted to certain members of managementduring the three months ended March 31, 2010 and 2009.

 

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

 

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

 

In connection with the approval of the Plan, theCompany expenses the cost of options granted over the vesting period of theoption based on the grant-date fair value of the award.  The Company recognized expense of $109,000 and$81,000 for the three months ended March 31, 2010 and 2009, respectively,related to options granted under the Plan.

 

**Note 8 — Major Customersand Concentration of Credit Risk**

 

The Company sells primarilyall of its paper production in the form of converted products; however,following the start-up of a new paper machine in the summer of 2006, theCompany had excess paper production which it began to sell in parent rollform.  Revenues from converted productsales and parent roll sales in the three-month periods ended March 31,2010 and 2009 were:

 
| ** **                  | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------|------------|------------------------------------------------------|------------|
| ** **                  | ** ** | **2010**                                             | ** ** | **2009** | ** ** |
| ** **                  | ** ** | **(in thousands)**                              | ** ** |
|                        |       |                                                 |       |   |   |
| Converted product net sales |       | $                                                    | 17,637     |   | $ | 21,057 |   |
| Parent roll net sales       |       | 3,403                                                |       | 2,583 |   |
| Net sales                   |       | $                                                    | 21,040     |   | $ | 23,640 |   |

 

Creditrisk for the Company in first quarter 2010 is concentrated in one majorconverted product customer, who operates discount retail stores throughout theUnited States and one customer who accounts for most of the Company’sthird-party sales of parent rolls. During the three months ended March 31, 2010, sales to these twosignificant customers accounted for approximately 50% of the total sales,comprised of customers of 35% and 15%, respectively.   The Company’s credit risk for 2009 wasconcentrated in three significant converted product customers.  During the three months ended March 31,2009, sales to these three customers accounted for approximately 53% of thetotal Company sales, comprised of customers of 25%, 14%, and 14%,respectively.  At March 31, 2010 and2009, respectively, approximately $3.1 million (47%) and $3.4 million (49%) ofaccounts receivable was due from the customers noted above.  No other customers 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 9— New Accounting Pronouncements**

 

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

 

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

 

**Forward-Looking Information**

 

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

 

·      our businessstrategy;

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

·      our estimatesregarding our capital requirements; and

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

 

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

 

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

 

·      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 a small number of customers which maydecrease or cease purchases at any time;

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

·      increased competition in our region;

·      changes in our retail trade customers’policies and increased dependence on key retailers in developed markets;

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

·      theavailability of and prices for energy;

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

·      our exposure tovariable interest rates;

·      the loss of keypersonnel;

·      laborinterruption;

·      naturaldisaster or other disruption to our facility;

·      ability tofinance the capital requirements of our business;

·      cost to complywith existing and new laws and regulations;

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

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

·      excess supplyin the market may reduce our prices;

·      an inability tocontinue to implement our business strategies;

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

·      failure tocomplete our project to add a new converting line successfully or timely; and

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

 

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

 

**Overview**

 

Weare an integrated manufacturer of private label tissue products, includingpaper towels, bathroom tissue and paper napkins for the consumer, or “at-home,”market. We produce bulk tissue paper, known as parent rolls and convert parentrolls into finished products. We have tailored our operations to serve our corecustomer base of dollar stores and other discount retailers. We focus on thedollar stores or value retailers and discount retail market because of theirconsistent order patterns and low number of stock keeping units or SKUs in thismarket. By dollar stores, we mean retailers which offer a limited selectionacross a broad range of products at everyday low prices in a smaller storeformat.

 

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

 

Ourproducts are sold primarily under our customers’ private labels and, to alesser extent, under our brand names such as Colortex®, My Size®, Velvet®, Big Mopper®, Tackle® , and care®. All of our converted product revenue is derivedpursuant to truck load purchase orders from our customers. Parent roll revenueis derived from purchase orders that generally cover a one month time period.We do not have supply contracts with any of our customers. Revenue isrecognized when title passes to the customer. Because our product is a dailyconsumable item, the order stream from our customer base is fairly consistentwith no significant seasonal fluctuations. Changes in the national economy, ingeneral, do not materially affect the market for our converted products.

 

Ourprofitability depends on several key factors, including:

 

·      the marketprice of our product;

·      the cost ofwaste paper used in producing paper;

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

·      the cost ofenergy.

 

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

 

**Background**

 

Since June 2006,when we began operations of a new paper machine, our paper-making capacity ofapproximately 56,000 tons per year has exceeded the demand requirements of ourconverting operations.   We sell theexcess supply into the market in the form of a parent roll.  Prior to June 2006, our paper-makingcapacity was less than the requirements of our converting operations and wesupplemented our paper-making capacity by buying parent rolls in the openmarket.  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 8.0 million cases of finished tissueproducts.  We adjust our paper makingproduction based on our internal converting needs for parent rolls and the openmarket demand for parent rolls.   Ourstrategy is to sell all of our parent roll capacity as converted 

 

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products which generallycarry higher margins than parent rolls. To help achieve that goal, we continueto focus considerable efforts to improve our converting efficiencies in orderto achieve that goal and have realized incremental improvements in productionoutput over the last two years.  Inaddition, we are placing significant focus on improving our sales efforts tosell this additional capacity.  Parentrolls are a commodity product and thus are subject to market pricing.  We plan to continue to sell any excess parentroll capacity on the open market as long as market pricing is profitable.

 

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 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.  Wehave re-aligned our sales team and have placed significant focus on our salesefforts in order to sell the additional capacity of the new converting line asquickly as possible.

 

In early October 2009,construction began on the new 245,000 square foot warehouse, which is locatedadjacent to our existing converting facility. The warehouse project is expected to cost approximately $6.8 million.  We took occupancy of the first half of thefacility on April 16, 2010 and expect to occupy the remainder by July 2010.  Following completion of the warehouse, wewill be able to consolidate all of our converted product inventory and shippinginto this location and eliminate third-party warehouse storage and shipping costswhich will allow us to improve our customer service and logistics performanceand reduce operating costs. Additionally, the project will allow us to free up the necessary spacein our existing converting facility to house the new converting line.  The new converting line, which will be ableto produce both paper towels and bathroom tissue, will provide higher qualityproducts and broaden our product offering through increased packagingconfigurations, enhanced graphics and improved embossing. The line is expectedto be in start-up mode by the end of the second quarter of 2010, with fulloperating speeds expected to be achieved by the end of the third quarter of2010.  The new converting line isexpected to cost approximately $20.3 million.

 

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**ComparativeThree-Month Periods Ended March 31, 2010 and 2009**

 

**NetSales**

 
| ** **                  | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------|------------|------------------------------------------------------|------------|
| ** **                  | ** ** | **2010**                                             | ** ** | **2009** | ** ** |
| ** **                  | ** ** | **(in thousands, except average**     | ** ** |
| ** **                  | ** ** | **price per ton and tons)**      | ** ** |
|                        |       |                                                 |       |   |   |
| Converted product net sales |       | $                                                    | 17,637     |   | $ | 21,057 |   |
| Parent roll net sales       |       | 3,403                                                |       | 2,583 |   |
| Net sales                   |       | $                                                    | 21,040     |   | $ | 23,640 |   |
|                        |       |                                                 |       |   |   |
| Total tons shipped          |       | 13,179                                               |       | 12,429 |   |
| Net selling price per ton   |       | $                                                    | 1,597      |   | $ | 1,902 |   |

 

Netsales decreased 11% to $21.0 million in the quarter ended March 31, 2010,compared to $23.6 million in the same period of 2009.  Net sales figures include gross sellingprice, including freight, less discounts and pricing allowances.  Net sales of converted product decreased inthe quarter ended March 31, 2010, by $3.4 million, or 16%, to $17.6million compared to $21.0 million in the same period last year.  Net sales of parent rolls increased $820,000,or 32%, to $3.4 million in the 2010 quarter compared to $2.6 million in thesame period last year.  Net sales ofconverted product decreased primarily due to a 9% decrease in the selling priceper ton combined with an 8% decrease in tonnage shipped.  The decrease in price is due to a shift inproduct mix and higher promotional pricing on our branded products.  Shipment volumes were negatively affected bysoft demand from most of our major customers, primarily resulting fromincreased promotional activity by our competitors’ branded products andunusually inclement weather conditions during the current year quarter.  Parent roll net sales increased primarily dueto a 57% increase in tonnage shipped but this was offset by a 16% decrease inthe selling price per ton.  The increasein parent roll shipment volumes is primarily the result of lower requirementsfrom our converting operations due to the lower converted product shipmentsand, to a lesser extent, a slow but steady strengthening of the away from hometissue market.  The decrease in parentroll pricing is due to a lag in market pricing in 2009 and the still softparent roll market in 2010.  Parent rollprices in the first quarter of 2009 still reflected the high waste paper andkraft pulp prices from late 2008.  Inaddition, the contraction of the away from home market, where we sell amajority of our parent rolls, began during the first quarter last year.  The effect of these two factors did not fullyreflect on our parent roll pricing until the second quarter of 2009.  Parent roll prices continue to increase inthe current year due to the continued strengthening of the away from homemarket and higher waste paper and virgin bleached kraft pulp prices.

 

**Cost ofSales**

 
| ** **                                                                                                                                   | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                                                                   | ** ** | **2010**                                             | ** ** | **2009** | ** ** |
| **(in thousands, except gross profit margin % and paper cost per ton consumed)** |
| ** **                                                                                                                                   | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Cost of paper                                                                                                                                |       | $                                                    | 10,490     |   | $ | 8,539 |   |
| Non-paper materials, labor, supplies, etc.                                                                                                   |       | 5,558                                                |       | 7,865 |   |
| Sub-total                                                                                                                                    |       | $                                                    | 16,048     |   | $ | 16,404 |   |
| Depreciation                                                                                                                                 |       | 1,131                                                |       | 804 |   |
| Cost of sales                                                                                                                                |       | $                                                    | 17,179     |   | $ | 17,208 |   |
|                                                                                                                                         |       |                                                 |       |   |   |
| Gross profit                                                                                                                                 |       | $                                                    | 3,861      |   | $ | 6,432 |   |
| Gross profit margin %                                                                                                                        |       | 18.4                                                 | %          | 27.2 | % |
| Total paper cost per ton consumed                                                                                                            |       | $                                                    | 796        |   | $ | 687 |   |

 

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

 

Costof sales in the first quarter of 2010 were basically flat compared to the 2009levels on an 11% reduction in net sales. Our cost of sales was negatively affected by higher waste paper costs,higher converting production costs, and higher depreciation expense, which waspartially offset by lower costs of packaging materials in the convertingoperation.  As a percentage of net sales,cost of sales increased to 81.6% in the 2010 quarter from 72.8% of net sales inthe 2009 quarter.  Cost of sales as apercentage of net sales for the first quarter of 2010 was unfavorable to theprior year quarter primarily due to higher waste paper costs, higher convertingproduction costs, lower selling prices, and higher depreciation costs.

 

Ourcost of parent roll production in the first quarter of 2010 was $796 per ton,an increase of $109 per ton compared to the same period in 2009.  Parent roll production costs increasedprimarily due to higher waste paper prices. The price for waste paper in the first quarter of 2010 increased 40%over the same period in the prior year, which increased our cost of sales byapproximately $1.3 million.  Convertingproduction costs increased in the current year quarter compared to the prioryear quarter primarily due to higher per unit production costs due to temporarycurtailment of some converting assets undertaken to match production with thelower shipment requirements. Depreciation expense in the first quarter of 2010 increased $327,000compared to the prior year quarter due to the capital projects completed in2009, primarily the converting automation project and waste water treatmentproject.

 

**GrossProfit**

 

Grossprofit in the quarter ended March 31, 2010, decreased $2.5 million or 40%,to $3.9 million compared to $6.4 million in the same period last year.  Gross profit as a percentage of net sales inthe 2010 quarter was 18.4% compared to 27.2% in the 2009 quarter.  The major reasons for the decrease in grossprofit as a percentage of net sales are the higher cost of waste paper, lowerconverted product shipment volumes and its resultant affect on production costsand a decrease in net selling price of converted product and parent rolls.

 

**Selling,General and Administrative Expenses**

 
| ** **                           | ** ** | **Three Months Ended March 31,**                                                 | ** ** |
|--------------------------------------|------------|------------------------------------------------------------------------------------------------------|------------|
| ** **                           | ** ** | **2010**                                                                                             | ** ** | **2009** | ** ** |
| ** **                           | ** ** | **(in thousands, except SG&A as a % of net sales)** | ** ** |
| ** **                           | ** ** | ** **                                                                                           | ** ** | ** ** | ** ** |
| Commission  expense                  |       | $                                                                                                    | 299        |   | $ | 332 |   |
| Other  S,G&A expenses            |       | 1,436                                                                                                |       | 1,498 |   |
| Selling,  General & Adm exp |       | $                                                                                                    | 1,735      |   | $ | 1,830 |   |
| SG&A  as a % of net sales        |       | 8.2                                                                                                  | %          | 7.7 | % |
|                                 |       |                                                                                                 |       |   |   |
| Operating  income                    |       | $                                                                                                    | 2,126      |   | $ | 4,602 |   |

 

Selling,general and administrative expenses include salaries, commissions to brokersand other miscellaneous expenses. Selling, general and administrative expenses decreased $95,000, or 5%,to $1.7 million compared to $1.8 million in the prior year quarter.  Lower accruals under our incentive bonusprogram and lower sales commission expense due to decreased sales levels werethe main reasons for the decrease.  As apercentage of net sales, selling, general and administrative expenses increasedto 8.2% in the first quarter of 2010 compared to 7.7% in the same quarter of2009.

 

**OperatingIncome**

 

Asa result of the foregoing factors, operating income for the quarter ended March 31,2010 decreased $2.5 million or 54%, to $2.1 million from $4.6 million in thesame period in 2009.

 

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**InterestExpense and Other Income**

 
| ** **                  | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------|------------|------------------------------------------------------|------------|
| ** **                  | ** ** | **2010**                                             | ** ** | **2009** | ** ** |
| ** **                  | ** ** | **(in thousands)**                              | ** ** |
| Interest  expense           |       | $                                                    | 215        |   | $ | 159 |   |
| Other  income, net          |       | $                                                    | (14        | ) | $ | (3 | ) |
|                        |       |                                                 |       |   |   |
| Income  before income taxes |       | $                                                    | 1,925      |   | $ | 4,446 |   |

 

Interestexpense includes interest on all debt and amortization of deferred debtissuance costs.  Interest expenseincreased $56,000 to $215,000 in the quarter ended March 31, 2010,compared to $159,000 in the quarter ended March 31, 2009.  The main reason for the increase is higherinterest rates resulting from an amendment to our credit facility in July 2009which changed our interest structure to the greater of LIBOR plus an applicablemargin or 3.5%.  This had the effect ofraising our average borrowing rate in the quarter ended March 31, 2010 to3.5% compared to 2.6% in the same period last year.

 

**IncomeBefore Income Taxes**

 

Asa result of the foregoing factors, income before income taxes decreased $2.5million to $1.9 million in the quarter ended March 31, 2010 compared to$4.4 million in the same period in 2009.

 

**IncomeTax Provision**

 

Forthe quarter ended March 31, 2010, our effective income tax rate was29.4%.  This rate is lower than thestatutory rate because of Oklahoma Investment Tax Credits associated with ourinvestments in a new paper machine, new converting warehouse and new convertingline.  Our effective rate does notreflect the Federal Indian Employment Credits (“IEC”) as this tax regulationexpired as of December 31, 2009 and has not been reauthorized for2010.  Additionally, in 2009, weextinguished all of our federal net operating loss carryforwards andcarryforwards of IECs.  We are noweligible for a 9% manufacturing credit which was not reflected in our tax ratefor the 2009 quarter.  For the quarterended March 31, 2009, our annual effective income tax rate was 37.1%.  The effective tax rate was lower than thestatutory rate because of the Oklahoma Investment Tax Credits cited above, theutilization of Federal Indian Employment Credits and the recognition ofdeferred tax benefits associated with non-qualified option grants to ourdirectors and officers, including a true-up.

 

Nocurrent income taxes are owed to state taxing authorities because of OklahomaInvestment Tax Credit carryforwards.

 

**Liquidityand Capital Resources**

 

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

 

On April 12, 2010, the board of directorsapproved an expansion of our waste water treatment facility in the amount of$2.6 million.  The expansion, whichincludes an additional water clarifying tank, an aeration basin and newdiffused air system, increases the capacity of our facility by approximately50% and will provide the necessary capacity to meet our permit limits.  We expect to start on this project in May 2010and it is expected to take seven months to complete.  This project will require an amendment to ourcredit facility.

 

Inthe third quarter of 2009, we closed an offering of 862,500 shares of ourcommon stock at an offering price of $18.50 per share.  We received net proceeds of approximately$14.8 million from the offering, after deducting the 

 

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underwritingdiscount and offering expense.  In thesecond quarter of 2009, we announced our intention to pursue an expansion plan,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 $27.1 million, whichconsists of $6.8 million for the new warehouse and $20.3 million for the newconverting line.  Funding for thisproject has come from the proceeds of our 2009 sale of common stock, aconstruction loan from our existing bank group that will fund 80% of the costof the new warehouse and cash generated from operations.  Payments required under the project began inthe third quarter of 2009 and will continue through the third quarter of 2010.

 

OnApril 9, 2007, we re-financed our existing credit facility with theexisting bank group. The facility has been amended from time to time. Followingthe amendments, the credit facility consists of the following at March 31,2010:

 

·      a$8.0 million revolving credit facility ($0 outstanding at March 31,2010);

 

·      a$10.0 million Term Loan A with a ten-year term, no principal repaymentsfor the first 24 months and then amortized as if it had an 18-year life($9.7 million outstanding at March 31, 2010);

 

·      a$16.5 million Term Loan B with a four year-term and is being amortized asif it had a six-year life ($9.0 million outstanding at March 31,2010);

 

·      a$4.0 million capital expenditures facility with a four-year term that willbe amortized as if it had a five-year life ($3.7 million outstanding at March 31,2010); and

 

·      a$6.72 million construction loan with a seven-year term, interest onlypayments through October 31, 2010, and then amortized as if it had a15-year life ($0 outstanding at March 31, 2010).

 

Asof March 31, 2010, the amount outstanding under our credit facilitytotaled $22.4 million as described above. The balance of cash and short-term investments on hand as of March 31,2010 was $642,000 and $13.5 million, respectively, resulting in a net debtlevel of $8.2 million.

 

Cashdecreased in the three months ended March 31, 2010 by $590,000, from $1.2million as of December 31, 2009 to $642,000 as of the end of the currentquarter.  During the 2010 quarter wespent $7.4 million on capital expenditures, including $5.9 million on ourexpansion project.  We funded theseexpenditures through $2.7 million generated from operations and the sale of$5.0 million in short-term investments. In addition, we paid down $925,000 on our bank term loans.  We have capacity to borrow up to 80% of theconstruction costs of the new warehouse, which we did not utilize as of the endof the first quarter of 2010.  We intendto fully utilize this credit facility during the second and third quarters ofthis year.

 

Thefollowing table summarizes key cash flow information for the three-monthperiods ended March 31, 2010 and 2009:

 
| ** **                         | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------|------------|------------------------------------------------------|------------|
| ** **                         | ** ** | **2010**                                             | ** ** | **2009** | ** ** |
| ** **                         | ** ** | **(in thousands)**                              | ** ** |
|                               |       |                                                 |       |   |   |
| Cash  flows provided by (used in): |       |                                                 |       |   |   |
| Operating  activities              |       | $                                                    | 2,696      |   | $ | 4,721 |   |
|                               |       |                                                 |       |   |   |
| Investing  activities              |       | $                                                    | (2,361     | ) | $ | (1,290 | ) |
|                               |       |                                                 |       |   |   |
| Financing  activities              |       | $                                                    | (925       | ) | $ | (1,890 | ) |

 

Cashflows provided by operating activities was $2.7 million in the three-monthperiod ended March 31, 2010, which primarily resulted from cash earningsand increases in accounts payable being partially offset by an increase ininventory.  The increase in accountspayable is primarily due to timing.  Theincrease in inventory is primarily 

 

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dueto an increase in finished goods inventory resulting from the lower shipmentlevels experienced in the first quarter of 2010 and due to higher per casecosts of finished goods due to increasing waste paper costs, which affects thecarrying value of our inventory.

 

Cashflows used in investing activities was $2.4 million in the first three monthsof 2010 as a result of $7.4 million in capital expenditures, which wereprimarily for our converting warehouse and new converting line.  This was offset by the use of $5.0 millionfrom short-term investments to help fund the capital investments.

 

Cashflows used in financing activities was $925,000 in the three-month period endedMarch 31, 2010 which was associated with normally scheduled principalpayments on our bank term loans.

 

**CriticalAccounting Policies and Estimates**

 

Thepreparation of our financial statements and related disclosures in conformity withGAAP in the United States requires management to make estimates and judgmentsthat affect our reported amounts of assets and liabilities, revenue andexpense, and related disclosures of contingent assets and liabilities.  On an ongoing basis, we evaluate ourestimates and assumptions based upon historical experience and various otherfactors and circumstances.  Managementbelieves that our estimates and assumptions are reasonable under thecircumstances; however, actual results may vary from these estimates andassumptions 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:

 

*AccountsReceivable*.  Accountsreceivable consist of amounts due to us from normal business activities.  Our management must make estimates ofaccounts receivable that will not be collected. We perform ongoing credit evaluations of our customers and adjust creditlimits based upon payment history and the customer’s creditworthiness asdetermined by our review of their current credit information.  We continuously monitor collections andpayments from our customers and maintain an allowance for estimated lossesbased on historical experience and specific customer collection issues that wehave identified.  Trade receivables arewritten-off when all reasonable collection efforts have been exhausted,including, but not limited to, external third party collection efforts andlitigation.  While such credit losseshave historically been within management’s expectations and the allowanceprovided, there can be no assurance that we will continue to experience thesame credit loss rates as in the past. During the three-month period ended March 31, 2010 and 2009,provisions for doubtful accounts were recognized in the amount of $15,000 and$16,000, respectively for each period. There were no recoveries credited during the first three months of 2010.  There were no accounts receivable balanceswritten off in the three-month periods ended March 31, 2010 or 2009.

 

*Inventory.*  Our inventory consists of finished goods andraw materials and is stated at the lower of cost or market.  Our management regularly reviews inventoryquantities on hand and records a provision for excess and obsolete inventorybased on the age of the inventory and forecasts of product demand.  A significant decrease in demand could resultin an increase in the amount of excess inventory quantities on hand.  During the first three months of 2010, theallowance was increased $30,000, an increase of $15,000 over the increase inallowance in the same period in 2009.  In2010, we charged $179,000 against the valuation reserve compared to no chargesto the reserve in the first quarter of 2009.

 

**New AccountingPronouncements**

 

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

 

**Non-GAAPDiscussion**

 

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

 

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

 

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

 

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

 

·      it does notreflect our cash expenditures for capital assets;

 

·      it does notreflect changes in, or cash requirements for, our working capital requirements;

 

·      it does notreflect the interest expense, or the cash requirements necessary to serviceinterest or principal payments on our indebtedness;

 

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

 

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

 

Becauseof these limitations, EBITDA should not be considered as a measure ofdiscretionary cash available to us to invest in the growth of our business orto reduce our indebtedness. We compensate for these limitations by relyingprimarily on our GAAP results and using EBITDA on a supplemental basis.

 

Thefollowing table reconciles EBITDA to net income for the three months ended March 31,2010 and 2009:

 
| ** **                   | ** ** | **Three Months Ended March 31,**                    | ** ** |
|------------------------------|------------|-------------------------------------------------------------------------|------------|
| ** **                   | ** ** | **2010**                                                                | ** ** | **2009** | ** ** |
| ** **                   | ** ** | **(in thousands, except % of net sales)** | ** ** |
|                         | ** ** | ** **                                                              | ** ** | ** ** | ** ** |
| Net  income                  |       | $                                                                       | 1,360      |   | $ | 2,797 |   |
| Plus:  Interest expense, net |       | 215                                                                     |       | 159 |   |
| Plus:  Income tax expense    |       | 565                                                                     |       | 1,649 |   |
| Plus:  Depreciation          |       | 1,131                                                                   |       | 804 |   |
| EBITDA                       |       | $                                                                       | 3,271      |   | $ | 5,409 |   |
| % of  net sales              |       | 15.6                                                                    | %          | 22.9 | % |

 

EBITDAdecreased $2.1 million to $3.3 million for the quarter ended March 31,2010, compared to $5.4 million in the same period in 2009.  EBITDA as a percent of net sales decreasedfrom 22.9% in 2009 to 15.6% in 2010. The foregoing factors discussed in the netsales, cost of sales and selling, general and administrative expenses sectionsare the reasons for the change.

 

Weuse Net Debt as a supplemental measure of our leverage that is not required by,or presented in accordance with, GAAP. Net Debt should not be considered as analternative to total debt, total liabilities or any other performance measurederived in accordance with GAAP. Net Debt represents total debt reduced by cashand short-term 

 

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investments.We use this figure as a means to evaluate our ability to repay our indebtednessand to measure the risk of our financial structure.

 

NetDebt represents the amount that Cash and Cash Equivalents is less than totalDebt of the Company. The amounts included in Net Debt calculation are derivedfrom amounts included in the historical Balance Sheets. We have reported NetDebt because we regularly review Net Debt as a measure of the Company’sleverage. However, the Net Debt measure presented in this document may not becomparable to similarly titled measures reported by other companies due todifferences in the components of the calculation.

 

NetDebt has increased from $3.5 million on December 31, 2009, to$8.2 million on December 31, 2010 as a result of a decrease in ourcash and short-term investments.  Thereduction in these balances is due to payments on our converting expansionproject.

 

Thefollowing table presents Net Debt as of March 31, 2010 and December 31,2009:

 
| ** **                      | ** ** | **As of**          | ** ** |
|---------------------------------|------------|-------------------------|------------|
| ** **                      | ** ** | **March 31,**      | ** ** | **December 31,** | ** ** |
| ** **                      | ** ** | **2010**                | ** ** | **2009** | ** ** |
| ** **                      | ** ** | **(in thousands)** | ** ** |
| Current  portion long term debt |       | $                       | 3,772      |   | $ | 3,742 |   |
| Long-term  debt                 |       | 18,578                  |       | 19,533 |   |
| Total  debt                     |       | 22,350                  |       | 23,275 |   |
| Less  cash                      |       | (642                    | )          | (1,232 | ) |
| Less  short term investments    |       | (13,512                 | )          | (18,509 | ) |
| Net  debt                       |       | $                       | 8,196      |   | $ | 3,534 |   |

 

**ITEM 3.  Quantitative and Qualitative Disclosures about MarketRisk**

 

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, 2009.

 

**ITEM 4. Controlsand Procedures**

 

Our management, under the supervision and with theparticipation of our chief executive officer and our chief financial officer,has evaluated the effectiveness of our disclosure controls and procedures (asdefined in Rules 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act of 1934, as amended), as of the end of the period covered by thisQuarterly Report on Form 10-Q.  Anycontrols and procedures, no matter how well designed and operated, can provideonly reasonable assurance of achieving the desired control objectives.  Based on such evaluation, our chief executiveofficer and our chief financial officer have concluded that our disclosurecontrols and procedures were effective as of March 31, 2010.

 

There were no changes in the Company’s internalcontrol over financial reporting (as defined in Rule 13a-15(f) underthe Exchange Act) during the quarter ended March 31, 2010, that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

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**PART II.  OTHER INFORMATION**

 

**ITEM 1.  Legal Proceedings**

 

None.

 

**ITEM 1A. RiskFactors**

 

As of the date of this filing, there have been nomaterial changes from the risk factors disclosed in the Company’s Annual Reporton Form 10-K filed March 12, 2010. We operate in a changing environment that involves numerous known andunknown risks and uncertainties that could materially affect ouroperations.  The risks, uncertainties andother factors set forth in our Annual Report on Form 10-K may cause ouractual results, performances and achievements to be materially different fromthose expressed or implied by our forward-looking statements.  If any of these risks or events occur, ourbusiness, financial condition or results of operations may be adverselyaffected.

 

**ITEM 2.  Unregistered Sales of Equity Securities and Use ofProceeds**

 

*(a) UnregisteredSales of Equity Securities*

 

None.

 

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

 

None.

 

*(c) Repurchasesof Equity Securities*

 

We do not have any programs to repurchase shares ofour common stock and no such repurchases were made during the three monthsended March 31, 2010.

 

**ITEM 3.  Defaults Upon Senior Securities**

 

None.

 

**ITEM 4.  RESERVED**

 

 

**ITEM 5.  Other Information**

 

None.

 

**ITEM 6.  Exhibits**

 

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

 

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###### **SIGNATURES**

 

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

 

**ORCHIDSPAPER PRODUCTS COMPANY**

 
| Date:  May 6,  2010 | By:    | /s/  Keith R. Schroeder           |
|------------------------------------|--------|-----------------------------------|
|                               |   | Keith  R. Schroeder               |
|                               |   | Chief  Financial Officer          |
|                               |   | (On  behalf of the registrant and |
|                               |   | as  Chief Accounting Officer)     |

 

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**Exhibit Index**

 
| **Exhibit** | ** ** | **Description**                                                                                                                                                                                                                                                                                                            |
|-------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                                                                                                                                                                                                       |
| 3.1         |       | Amended  and Restated Certificate of Incorporation of the Registrant incorporated by  reference to Exhibit 3.1 to the Registrant’s Registration Statement on  Form S-1 (File No. 333-124173) filed with the Securities and  Exchange Commission on April 19, 2005.                                |
|        |       |                                                                                                                                                                                                                                                                                                                       |
| 3.1.1       |       | Amendment  to the Amended and Restated Certificate of Incorporation of the Registrant  incorporated by reference to the Form 10-Q filed with the Securities and  Exchange Commission on August 14, 2007.                                                                                                         |
|        |       |                                                                                                                                                                                                                                                                                                                       |
| 3.2         |       | Amended  and Restated Bylaws of the Registrant incorporated by reference to  Exhibit 3.2 to the Registrant’s Registration Statement on Form S-1  (File No. 333-124173) filed with the Securities and Exchange Commission  on April 19, 2005.                                                      |
|        |       |                                                                                                                                                                                                                                                                                                                       |
| 10.1#       |       | Form of  Incentive Stock Option Agreement incorporated by reference to  Exhibit 10.1 to the Registrant’s Current Report on Form 8-K (File  No. 001-32563) filed with the Securities and Exchange Commission on  January 26, 2009.                                                            |
|        |       |                                                                                                                                                                                                                                                                                                                       |
| 10.2#       |       | Executive  Employment Agreement, dated February 27, 2009, between Keith R. Schroeder  and the Registrant incorporated by reference to Exhibit 10.1 to the  Registrant’s Current Report on Form 8-K (File No. 001-32563) filed  with the Securities and Exchange Commission on March 2, 2009. |
|        |       |                                                                                                                                                                                                                                                                                                                       |
| 31.1        |       | Certification  of Chief Executive Officer Pursuant to Section 302.                                                                                                                                                                                                                                                    |
|        |       |                                                                                                                                                                                                                                                                                                                       |
| 31.2        |       | Certification  of Chief Financial Officer Pursuant to Section 302.                                                                                                                                                                                                                                                    |
|        |       |                                                                                                                                                                                                                                                                                                                       |
| 32.1        |       | Certification  of Chief Executive Officer Pursuant to Section 906.                                                                                                                                                                                                                                                    |
|        |       |                                                                                                                                                                                                                                                                                                                       |
| 32.2        |       | Certification  of Chief Financial Officer Pursuant to Section 906.                                                                                                                                                                                                                                                    |

 

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#Indicates management contract or compensatory plan

 

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