##### 



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, DC 20549
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended June 30, 2006
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 Commission File Number 001-32563
 Orchids Paper Products Company
  Delaware
    
    23-2956944(State or Other Jurisdiction of
    
    (I.R.S. EmployerIncorporation or Organization)
    
    Identification No.)
 4826 Hunt Street
Pryor, Oklahoma 74361
 (918) 825-0616
 þ o
 o o þ
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ORCHIDS PAPER PRODUCTS COMPANY
TABLE OF CONTENTS
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED JUNE 30, 2006
 
 PagePART I. FINANCIAL INFORMATIONITEM 1.
    
    Financial StatementsBalance Sheets as of June 30, 2006 (Unaudited) and December 31, 2005
    
    
    3Statements of Income for the three months ended June 30, 2006 and
2005 (Unaudited) and the six months ended June 30, 2006 and
2005 (Unaudited)
    
    
    4Statements of Cash Flows for the six months ended June 30, 2006
and 2005 (Unaudited)
    
    
    5Notes to Unaudited Interim Financial Statements
    
    
    6ITEM 2.
    
    Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    
    9ITEM 3.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    21ITEM 4.
    
    Controls and Procedures
    
    
    21PART II. OTHER INFORMATIONITEM 1.
    
    Legal Proceedings
    
    
    22ITEM 1A.
    
    Risk Factors
    
    
    22ITEM 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    22ITEM 3.
    
    Defaults Upon Senior Securities
    
    
    22ITEM 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    22ITEM 5.
    
    Other Information
    
    
    23ITEM 6.
    
    Exhibits
    
    
    23Signatures
    
    
    24
 -2-




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##### 



PART 1  FINANCIAL INFORMATION
 
 ITEM 1. Financial Statements
 ORCHIDS PAPER PRODUCTS COMPANY
BALANCE SHEETS
 As ofJune 30,
    
    
    December 31,2006
    
    

2005(unaudited)(Dollars in thousands)ASSETSCurrent assets:Cash
    
    $
    5
    
    
    $
    378Accounts receivable, net of allowance of
$155 in 2006 and $125 in 2005
    
    
    4,169
    
    
    
    4,180Inventories, net
    
    
    4,663
    
    
    
    4,420Restricted certificate of deposit
    
    
    1,500
    
    
    
    1,500Income taxes receivable
    
    
    304
    
    
    
    94Prepaid expenses
    
    
    209
    
    
    
    458Deferred income taxes
    
    
    147
    
    
    
    200Total current assets
    
    
    10,997
    
    
    
    11,230Property, plant and equipment
    
    
    59,373
    
    
    
    44,983Accumulated depreciation
    
    
    (3,576
    )
    
    
    (2,789
    )Net property, plant and equipment
    
    
    55,797
    
    
    
    42,194Deferred debt issuance costs, net of accumulated
amortization of $325 in 2006 and $232 in 2005
    
    
    193
    
    
    
    286Total assets
    
    $
    66,987
    
    
    $
    53,710LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    3,269
    
    
    $
    2,877Accrued liabilities
    
    
    1,610
    
    
    
    2,137Unrealized loss on forward currency exchange contracts
    
    
    
    
    
    
    74Due to banks under credit agreement
    
    
    30,031
    
    
    
    Current portion of long-term debt
    
    
    
    
    
    
    1,628Total current liabilities
    
    
    34,910
    
    
    
    6,716Long-term debt, net of unamortized discount of $87
in 2006 and $101 in 2005
    
    
    2,063
    
    
    
    17,002Deferred income taxes
    
    
    6,260
    
    
    
    6,280Stockholders equity:Common stock, $.001 par value, 10,000,000 shares
authorized, 6,234,346 shares issued and outstanding
in 2006 and 2005
    
    
    6
    
    
    
    6Additional paid-in capital
    
    
    21,033
    
    
    
    20,879Common stock warrants
    
    
    141
    
    
    
    141Retained earnings
    
    
    2,574
    
    
    
    2,686Total stockholders equity
    
    
    23,754
    
    
    
    23,712Total liabilities and stockholders equity
    
    $
    66,987
    
    
    $
    53,710
  -3-




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ORCHIDS PAPER PRODUCTS COMPANY
STATEMENTS OF INCOME
 Three Months Ended June 30,
    
    
    Six Months Ended June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(unaudited)
    
    
    (unaudited)
    
    
    (unaudited)
    
    
    (unaudited)(Dollars in thousands, except share and per share data)Net sales
    
    $
    13,675
    
    
    $
    13,681
    
    
    $
    27,774
    
    
    $
    26,223Cost of sales
    
    
    12,669
    
    
    
    11,700
    
    
    
    25,205
    
    
    
    22,425Gross profit
    
    
    1,006
    
    
    
    1,981
    
    
    
    2,569
    
    
    
    3,798Selling, general and administrative expenses
    
    
    1,281
    
    
    
    1,208
    
    
    
    2,529
    
    
    
    2,167Operating income (loss)
    
    
    (275
    )
    
    
    773
    
    
    
    40
    
    
    
    1,631Interest expense
    
    
    243
    
    
    
    373
    
    
    
    290
    
    
    
    743Other (income) expense, net
    
    
    (51
    )
    
    
    154
    
    
    
    (63
    )
    
    
    149Income (loss) before income taxes
    
    
    (467
    )
    
    
    246
    
    
    
    (187
    )
    
    
    739Provision (benefit) for income taxes:Current
    
    
    (183
    )
    
    
    124
    
    
    
    (109
    )
    
    
    216Deferred
    
    
    9
    
    
    
    8
    
    
    
    33
    
    
    
    64(174
    )
    
    
    132
    
    
    
    (76
    )
    
    
    280Net income (loss)
    
    $
    (293
    )
    
    $
    114
    
    
    $
    (111
    )
    
    $
    459Net income (loss) per share:Basic
    
    
    ($0.05
    )
    
    $
    0.04
    
    
    
    ($0.02
    )
    
    $
    0.15Diluted
    
    
    ($0.05
    )
    
    $
    0.04
    
    
    
    ($0.02
    )
    
    $
    0.15Shares used in calculating net income
(loss) per share:Basic
    
    
    6,234,346
    
    
    
    3,000,000
    
    
    
    6,234,346
    
    
    
    3,000,000Diluted
    
    
    6,234,346
    *
    
    
    3,154,467
    
    
    
    6,234,346
    *
    
    
    3,116,846* Due to loss, option and warrant
shares are anti-dilutive.
  -4-




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ORCHIDS PAPER PRODUCTS COMPANY
STATEMENTS OF CASH FLOWS
 Six Months Ended June 30,2006
    
    
    2005(unaudited)
    
    
    (unaudited)(Dollars in thousands)Cash Flows From Operating ActivitiesNet income (loss)
    
    $
    (111
    )
    
    $
    459Adjustments to reconcile net income (loss) to net cash
provided by operating activities:Depreciation and amortization
    
    
    886
    
    
    
    839Provision for doubtful accounts
    
    
    30
    
    
    
    31Deferred income taxes
    
    
    33
    
    
    
    64Stock option plan expense
    
    
    155
    
    
    
    242Foreign currency transaction loss
    
    
    35
    
    
    
    (Gain) loss on foreign currency exchange contracts
    
    
    (74
    )
    
    
    374Changes in cash due to changes in operating assets
and liabilities:Accounts receivable, net
    
    
    (18
    )
    
    
    (210
    )Inventories
    
    
    (243
    )
    
    
    (1,336
    )Prepaid expenses
    
    
    250
    
    
    
    (215
    )Income taxes receivable
    
    
    (210
    )
    
    
    101Accounts payable
    
    
    391
    
    
    
    106Accrued liabilities
    
    
    173
    
    
    
    (185
    )Net cash provided by operating activities
    
    
    1,297
    
    
    
    270Cash
Flows From Investing ActivitiesPurchases of property, plant and equipment
    
    
    (15,105
    )
    
    
    (3,416
    )Proceeds from the sale of investment securities
    
    
    
    
    
    
    750Net cash used in investing activities
    
    
    (15,105
    )
    
    
    (2,666
    )Cash Flows From Financing ActivitiesPrincipal payments on long-term debt
    
    
    (773
    )
    
    
    (836
    )Net borrowings on revolving credit line
    
    
    909
    
    
    
    2,767Borrowings under construction loan
    
    
    13,299
    
    
    
    Net cash provided by financing activities
    
    
    13,435
    
    
    
    1,931Net decrease in cash
    
    
    (373
    )
    
    
    (465
    )Cash, beginning
    
    
    378
    
    
    
    485Cash, ending
    
    $
    5
    
    
    $
    20Supplemental Disclosure:Interest paid
    
    $
    1,052
    
    
    $
    675Income taxes paid
    
    $
    221
    
    
    $
    115Supplemental Disclosure of Non-Cash Investing
and Financing Activities:Contractual obligation for purchase of paper machine
    
    
    
    
    
    $
    4,507
  -5-




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ORCHIDS PAPER PRODUCTS COMPANY
 
 NOTES TO UNAUDITED INTERIM FINANCIAL STATEMENTS
 Note 1  Basis of Presentation
    Note 2  Stock Splits
  Note 3  Purchase Commitment and Foreign Currency Derivatives
   -6-




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Note 4  Construction-in-Process and Capitalized Interest
  Note 5  Credit Agreement
   Note 6  Earnings per Share
  -7-




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Three Months Ended June 30,
    
    
    Six Months Ended June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Net income (loss)  ($ thousands)
    
    $
    (293
    )
    
    $
    114
    
    
    $
    (111
    )
    
    $
    459Weighted average shares outstanding
    
    
    6,234,346
    
    
    
    3,000,000
    
    
    
    6,234,346
    
    
    
    3,000,000Effect of stock options
    
    
    
    
    
    
    75,660
    
    
    
    
    
    
    
    38,039Effect of dilutive warrants
    
    
    
    
    
    
    78,807
    
    
    
    
    
    
    
    78,807Weighted average shares outstanding  assuming dilution
    
    
    6,234,346
    
    
    
    3,154,467
    
    
    
    6,234,346
    
    
    
    3,116,846Earnings per common share: (restated to reflect 2006
3-for-2 stock split and 2005 2.744-for-1 stock split)Basic
    
    $
    (0.05
    )
    
    $
    0.04
    
    
    $
    (0.02
    )
    
    $
    0.15Diluted
    
    $
    (0.05
    )
    *
    $
    0.04
    
    
    $
    (0.02
    )
    *
    $
    0.15
  Note 7  Stock Incentive Plan
     Note 8  Major Customers and Concentration of Credit Risk
  -8-




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Note 9  New Accounting Standards
  
 ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 Forward-Looking Information
  
    
    our business strategy;
    
    our value proposition;
    
    the market opportunity for our products, including expected demand for our products;
    
    our estimates regarding our capital requirements; and
    
    any of our other plans, objectives, and intentions contained in this report that are not historical facts.
   
    
    we face intense competition in our market and our profitability would be reduced if
aggressive pricing by our competitors forces us to decrease our prices;
    
    a substantial percentage of our revenues are attributable to two large customers which may
decrease or cease purchases at any time;
    
    we may experience delays in reaching full production rates during the start-up phase on our new paper machine;
    
    we have significant indebtedness which limits our free cash flow and subjects us to restrictive covenants relating to the
operation of our business;
 -9-




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
    
    the availability of and prices for energy will significantly affect our business;
    
    our exposure to variable interest rates may affect our financial health;
    
    the loss of key personnel;
    
    the disruption in supply or cost of waste paper;
    
    the disruption in availability or cost of parent rolls;
    
    labor interruptions;
    
    natural disaster or other disruption to our facility;
    
    ability to finance the capital requirements of our business;
    
    cost to comply with government regulations;
    
    increased expenses and administrative workload associated with being a public company; and
    
    failure to maintain an effective system of internal controls necessary to accurately report
our financial results and prevent fraud.
  Overview
 ® ®
   -10-




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
    
    the market price of our product;
    
    until our new paper machine reaches sufficient operating rates, the cost of parent rolls
purchased on the open market to meet our converting needs;
    
    the successful start-up and cost effective operation of our new paper machine;
    
    the cost of recycled paper used in producing paper;
    
    the efficiency of operations in both our paper mill and converting plant; and
    
    energy costs.
 Comparative Three-Month Periods Ended June 30, 2006 and 2005
 Net Sales
 Three Months Ended June 30,2006
    
    
    2005(in thousands, except
average price per case)Net sales
    
    $
    13,675
    
    
    $
    13,681Cases shipped
    
    
    1,233
    
    
    
    1,267Average price per case
    
    $
    11.09
    
    
    $
    10.80
  Cost of Sales
 Three Months Ended June 30,2006
    
    
    2005(in thousands, except gross profit margin %)Cost of paper
    
    $
    7,549
    
    
    $
    6,929Non-paper materials, labor, supplies, etc.
    
    
    4,727
    
    
    
    4,338Sub-total
    
    
    12,276
    
    
    
    11,267Depreciation
    
    
    393
    
    
    
    433Cost of sales
    
    $
    12,669
    
    
    $
    11,700Gross Profit
    
    $
    1,006
    
    
    $
    1,981Gross Profit Margin %
    
    
    7.4
    %
    
    
    14.5
    %
 -11-




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Three Months Ended June 30,2006
    
    
    2005Paper usage (tons)Manufactured
    
    
    6,383
    
    
    
    6,723Purchased
    
    
    2,373
    
    
    
    1,903Converted
    
    
    8,756
    
    
    
    8,626Paper costs per tonCost per ton produced internally
    
    $
    790
    
    
    $
    730Cost per ton purchased from third parties
    
    $
    1,056
    
    
    $
    1,062Total cost per ton consumed
    
    $
    862
    
    
    $
    803Total paper costs (in thousands)Cost of internally produced paper
    
    $
    5,043
    
    
    $
    4,908Cost of paper purchased from third parties
    
    
    2,506
    
    
    
    2,021Total paper costs
    
    $
    7,549
    
    
    $
    6,929
  Gross Profit
  Selling, General and Administrative Expenses
 Three Months Ended June 30,2006
    
    
    2005(In thousands, except SG&A as a % of net sales)Commission expense
    
    $
    193
    
    
    $
    218Other S,G&A expenses
    
    
    1,088
    
    
    
    990Selling, General & Adm exp
    
    $
    1,281
    
    
    $
    1,208SG&A as a % of net sales
    
    
    9.4
    %
    
    
    8.8
    %
 -12-




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Operating
Income (Loss)
  Interest and Other Expense
 Three Months Ended June 30,2006
    
    
    2005(In thousands)Interest expense
    
    $
    243
    
    
    $
    373Other (income) expense, net
    
    $
    (51
    )
    
    $
    154






Income (Loss) Before Income Taxes




-13-



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Income Tax Provision (Benefit)
  Comparative Six-Month Periods Ended June 30, 2006 and 2005
 Net Sales
 Six Months Ended June 30,2006
    
    
    2005(in thousands, except average price per case)Net sales
    
    $
    27,774
    
    
    $
    26,223Cases shipped
    
    
    2,486
    
    
    
    2,410Average price per case
    
    $
    11.17
    
    
    $
    10.88
  Cost of Sales
 Six Months Ended June 30,2006
    
    
    2005(in thousands, except gross
profit margin %)Cost of paper
    
    $
    15,540
    
    
    $
    13,994Non-paper materials, labor, supplies, etc.
    
    
    8,879
    
    
    
    7,677Sub-total
    
    
    24,419
    
    
    
    21,671Depreciation
    
    
    786
    
    
    
    754Cost of sales
    
    $
    25,205
    
    
    $
    22,425Gross Profit
    
    $
    2,569
    
    
    $
    3,798Gross Profit Margin %
    
    
    9.2
    %
    
    
    14.5
    %
  -14-




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Six Months Ended June 30,2006
    
    
    2005Paper usage (tons)Manufactured
    
    
    12,258
    
    
    
    12,393Purchased
    
    
    5,716
    
    
    
    4,815Converted
    
    
    17,974
    
    
    
    17,208Paper costs per tonCost per ton produced internally
    
    $
    782
    
    
    $
    727Cost per ton purchased from third parties
    
    $
    1,042
    
    
    $
    1,035Total cost per ton consumed
    
    $
    865
    
    
    $
    813Total paper costs (in thousands)Cost of internally produced paper
    
    $
    9,584
    
    
    $
    9,010Cost of paper purchased from third parties
    
    
    5,956
    
    
    
    4,984Total paper costs
    
    $
    15,540
    
    
    $
    13,994
  Gross Profit
  Selling, General and Administrative Expenses
 Six Months Ended June 30,2006
    
    
    2005(In thousands, except SG&A as a % of net sales)Commission expense
    
    $
    391
    
    
    $
    429Other S,G&A expenses
    
    
    2,138
    
    
    
    1,738Selling, General & Adm exp
    
    $
    2,529
    
    
    $
    2,167SG&A as a % of net sales
    
    
    9.1
    %
    
    
    8.3
    %
  -15-




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Operating Income
  Interest and Other Expense
 Six Months Ended June 30,2006
    
    
    2005(In thousands)Interest expense
    
    $
    290
    
    
    $
    743Other (income) expense, net
    
    $
    (63
    )
    
    $
    149
   Income
(Loss) Before Income Taxes
  Income Tax Provision (Benefit)
  -16-




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Liquidity and Capital Resources
     Cash Flow Data:
 Six Months Ended June 30,2006
    
    
    2005(In thousands)Cash flow provided by (used in):Operating activities
    
    $
    1,297
    
    
    $
    270Investing activities
    
    $
    (15,105
    )
    
    $
    (2,666
    )Financing activities
    
    $
    13,435
    
    
    $
    1,931
     -17-




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-18-




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##### 




    
    the occurrence of a change in management such that Michael P. Sage is no longer our chief
executive officer without the prior written consent of the banks, which consent may not be
unreasonably withheld, conditioned or delayed;
    
    the failure to complete the new paper machine project by October 31, 2006, provided that the
agent shall not unreasonably withhold its consent to extend this date if it receives (i) a copy of
a written extension agreement of the construction contract, (ii) there is no other default under
the credit agreement and (iii) we execute any related amendments to the credit agreement or related
documents which are reasonably requested by the agent; and
    
    a material variance from the plans submitted to the banks in connection with the expansion
of the paper machine facility or any work stoppage for a period of five consecutive business days,
unless the work stoppage is a result of a cause we are unable to prevent or overcome.
   Critical Accounting Policies and Estimates
  Accounts Receivable
 Inventory.
 -19-




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##### 



New Accounting Pronouncements
  Non-GAAP Discussion
    
    
    it does not reflect our cash expenditures for capital assets;
    
    it does not reflect changes in, or cash requirements for, our working capital requirements;
    
    it does not reflect the interest expense, or the cash requirements necessary to service interest
or principal payments on our indebtedness;
    
    although depreciation and amortization are non-cash charges, the assets being depreciated and
amortized will often have to be replaced in the future, and EBITDA does not reflect cash
requirements for such replacements; and
    
    other companies, including other companies in our industry, may calculate these measures
differently than we do, limiting their usefulness as a comparative measure.
   -20-




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##### 



Three Months Ended June 30,2006
    
    
    2005(In thousands, except % of net sales)Net (loss) income
    
    $
    (293
    )
    
    $
    114Plus: Interest expense, net
    
    
    243
    
    
    
    373Plus: Income tax (benefit) expense
    
    
    (174
    )
    
    
    132Plus: Depreciation
    
    
    393
    
    
    
    433EBITDA
    
    $
    169
    
    
    $
    1,052% of net sales
    
    
    1.2
    %
    
    
    7.7
    %
   Six Months Ended June 30,2006
    
    
    2005(In thousands, except % of net sales)Net (loss) income
    
    $
    (111
    )
    
    $
    459Plus: Interest expense, net
    
    
    290
    
    
    
    743Plus: Income tax (benefit) expense
    
    
    (76
    )
    
    
    280Plus: Depreciation
    
    
    786
    
    
    
    754EBITDA
    
    $
    889
    
    
    $
    2,236% of net sales
    
    
    3.2
    %
    
    
    8.5
    %
  
 ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
  
 ITEM 4. Controls and Procedures
  -21-




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##### 



PART II  OTHER INFORMATION
 
 ITEM 1. Legal Proceedings
  
 ITEM 1A. Risk Factors
  
 ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
 (a) Unregistered Sales of Equity Securities
  (b) Initial Public Offering and Use of Proceeds from the Sale of Registered Securities
  (c) Repurchases of Equity Securities.
  
 ITEM 3. Defaults Upon Senior Securities
  
 ITEM 4. Submission of Matters to a Vote of Security Holders
  (1)
    
    To elect five directors to hold office until the 2007 annual meeting of stockholders
and until their successors are duly elected and qualified. The vote with respect to each
nominee was as follows:
 Nominee
    
    For
    
    
    WithheldGary P. Arnold
    
    
    3,145,215
    
    
    
    10,500Steven R. Berlin
    
    
    3,145,215
    
    
    
    10,500John C. Guttilla
    
    
    3,145,215
    
    
    
    10,500Douglas E. Hailey
    
    
    3,145,215
    
    
    
    10,500Michael P. Sage
    
    
    3,145,215
    
    
    
    10,500
 -22-




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##### 



(2)
    
    To ratify the appointment of Tullius Taylor Sartain & Sartain as the Companys
independent registered public accounting firm for 2006:
 For
    
    Against
    
    
    Abstain
    
    
    Broker Non Vote3,145,715
    
    
    5,500
    
    
    
    4,500
    
    
    
    
 
 ITEM 5. Other Information
  
 ITEM 6. Exhibits
  -23-




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##### 



SIGNATURES
  ORCHIDS PAPER PRODUCTS COMPANYDate:  August 4, 2006
    By:
    /s/ Keith R. SchroederKeith R. SchroederChief Financial Officer

(On behalf of the registrant and as Chief Accounting Officer) -24-




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##### 



Exhibit Index
 Exhibit
    
    Description3.1
    
    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, 2005.3.2
    
    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, 2005.4.1
    
    Amendment One to Amended and Restated Agented Credit Agreement
dated June 30, 2006 among the Registrant, Bank of Oklahoma,
N.A., BancFirst and Commerce Bank, N.A.31.1
    
    Certification of Chief Executive Officer Pursuant to Section 302.31.2
    
    Certification of Chief Financial Officer Pursuant to Section 302.32.1
    
    Certification of Chief Executive Officer Pursuant to Section 906.32.2
    
    Certification of Chief Financial Officer Pursuant to Section 906.
 -25-