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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 March 31, 2008
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
(Exact name of Registrant as Specified in 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 all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirement for the past 90 days.
Yes þ      No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large accelerated filer o   Accelerated filer o   Non-accelerated filer o   Smaller reporting company þ
        (Do not check if a smaller reporting company)    
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o      No þ
Number of shares outstanding of the issuer’s Common Stock, par value $.001 per share, as of April 30, 2008: 6,328,986 shares.
 
 


 

ORCHIDS PAPER PRODUCTS COMPANY
TABLE OF CONTENTS
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED MARCH 31, 2008
     
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 Supplier Agreement
 302 Certification of Chief Executive Officer
 302 Certification of Chief Financial Officer
 906 Certification of Chief Executive Officer
 906 Certification of Chief Financial Officer

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PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
ORCHIDS PAPER PRODUCTS COMPANY
BALANCE SHEETS
(Dollars in thousands, except share data)
                 
    March 31,     December 31,  
    2008     2007  
    (unaudited)          
ASSETS
               
Current assets:
               
Cash
  $ 3     $ 3  
Accounts receivable, net of allowance of $118 in 2008 and $100 in 2007
    6,837       5,527  
Inventories, net
    5,559       4,874  
Income taxes receivable
    30       24  
Prepaid expenses
    434       381  
Deferred income taxes
    516       516  
 
           
Total current assets
    13,379       11,325  
 
               
Property, plant and equipment
    65,258       64,899  
Accumulated depreciation
    (8,797 )     (8,043 )
 
           
Net property, plant and equipment
    56,461       56,856  
 
               
Deferred debt issuance costs, net of accumulated amortization of $579 in 2008 and $570 in 2007
    113       122  
 
           
Total assets
  $ 69,953     $ 68,303  
 
           
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
Accounts payable
  $ 4,557     $ 4,760  
Accrued liabilities
    2,694       2,460  
Current portion of long-term debt
    2,442       2,391  
 
           
Total current liabilities
    9,693       9,611  
 
               
Long-term debt, less current portion
    23,872       23,264  
Deferred income taxes
    7,669       7,386  
Stockholders’ equity:
               
Common stock, $.001 par value, 25,000,000 shares authorized in 2008 and 2007, 6,328,986 and 6,322,648 shares issued and outstanding in 2008 and 2007, respectively
    6       6  
Additional paid-in capital
    21,952       21,879  
Common stock warrants
    134       141  
Retained earnings
    6,627       6,016  
 
           
Total stockholders’ equity
    28,719       28,042  
 
           
Total liabilities and stockholders’ equity
  $ 69,953     $ 68,303  
 
           
See notes to financial statements.

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ORCHIDS PAPER PRODUCTS COMPANY
STATEMENTS OF INCOME
                 
    Three Months Ended March 31,  
    2008     2007  
    (unaudited)     (unaudited)  
    (Dollars in thousands, except  
    share and per share data)  
Net sales
  $ 20,275     $ 16,637  
 
               
 
               
Cost of sales
    17,586       14,905  
 
           
 
               
Gross profit
    2,689       1,732  
 
               
Selling, general and administrative expenses
    1,385       1,059  
 
           
 
               
Operating income
    1,304       673  
 
               
Interest expense
    411       873  
Other income, net
    (1 )     (20 )
 
               
 
           
Income (loss) before income taxes
    894       (180 )
 
               
Provision (benefit) for income taxes:
               
Deferred
    283       (49 )
 
           
 
               
Net income (loss)
  $ 611     $ (131 )
 
           
 
               
Net income (loss) per share:
               
Basic
  $ 0.10     $ (0.02 )
Diluted
  $ 0.09     $ (0.02 )
 
               
Shares used in calculating net income (loss) per share:
               
Basic
    6,327,049       6,234,346  
Diluted
    6,554,357       6,234,346  
See notes to financial statements.

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ORCHIDS PAPER PRODUCTS COMPANY
STATEMENTS OF CASH FLO WS
                 
    Three Months Ended March 31,  
    2008     2007  
    (unaudited)     (unaudited)  
    (Dollars in thousands)  
Cash Flows From Operating Activities
               
Net income (loss)
  $ 611     $ (131 )
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
               
Depreciation and amortization
    763       849  
Provision for doubtful accounts
    15       15  
Deferred income taxes
    283       (49 )
Stock option plan expense
    51       60  
Changes in cash due to changes in operating assets and liabilities:
               
Accounts receivable
    (1,325 )     (388 )
Inventories
    (685 )     (106 )
Income taxes receivable
    (6 )      
Prepaid expenses
    (53 )     (10 )
Accounts payable
    (203 )     571  
Accrued liabilities
    234       119  
 
           
Net cash provided by (used in) operating activities
    (315 )     930  
 
               
Cash Flows From Investing Activities
               
Purchases of property, plant and equipment
    (359 )     (77 )
 
               
Cash Flows From Financing Activities
               
Principal payments on long-term debt
    (413 )     (630 )
Net borrowings (repayments) on revolving credit line
    1,072       (223 )
Proceeds from the exercise of warrants attached to subordinated debentures
    15        
 
           
Net cash provided by (used in) financing activities
    674       (853 )
 
           
 
               
Net change in cash
           
Cash, beginning
    3       3  
 
           
Cash, ending
  $ 3     $ 3  
 
           
Supplemental Disclosure:
               
Interest paid
  $ 338     $ 778  
 
           
Income taxes paid
  $ 6     $  
 
           
See notes to financial statements.

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ORCHIDS PAPER PRODUCTS COMPANY
NOTES TO UNAUDITED INTERIM FINANCIAL STATEMENTS
Note 1 — Basis of Presentation
Orchids Paper Products Company (“Orchids” or the “Company”) was formed in 1998 to acquire 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 purpose of acquiring the common stock of Orchids. Orchids Acquisition closed the sale of its equity and debt securities on March 1, 2004, and immediately thereafter closed the acquisition of Orchids. In April 2005, Orchids Acquisition merged with and into Orchids, with Orchids as the surviving entity.
On July 20, 2005, the Company completed its public offering of 3,234,375 shares of its common stock. The public offering price of the shares was $5.33. The net proceeds from the offering were $15,011,000 after deducting the underwriting discount and offering expenses. The Company’s stock trades on the American Stock Exchange under the ticker symbol “TIS.”
The accompanying financial statements have been prepared without an audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the “Commission”). Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to the rules and regulations. However, the Company believes that the disclosures made are adequate to make the information presented not misleading when read in conjunction with the audited financial statements and the notes thereto. Management believes that the financial statements contain all adjustments necessary for a fair statement of the results for the interim periods presented. All adjustments were of a normal, recurring nature. The results of operations for the interim period are not necessarily indicative of the results for the entire fiscal year.
For income statement purposes, the Company reclassified certain expenses from selling, general and administrative expenses to cost of sales at year-end 2007. The income statement for the three months ended March 31, 2007 has been restated to conform to the revised classification.
Note 2 — Commitments and Contingencies
On August 1, 2007, the Company received a new water discharge permit that requires the Company to expand its existing pre-treatment facility to reduce biological oxygen demand and total suspended solids from its discharge water. Under the permit, the Company is required to complete the expansion and make operational its pre-treatment facility by August 1, 2009. The project is in the pre-engineering phase and is expected to cost approximately $3 million. The cost of this facility is expected to be financed through a construction loan from the Company’s bank lenders. This loan was included in the bank debt refinancing that closed in April 2007.
In March 2008, the Company announced that its board of directors had approved a capital expenditure of $4.75 million to automate certain processes in its converting operation. The project will involve the purchase of case packers, conveyors and case unitizing equipment and should be operational by the fourth quarter of 2008. Contractual commitments in connection with this project were not material at March 31, 2008.

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Note 3 — Credit Agreements
On April 9, 2007, the Company entered into a credit agreement with its existing bank group, which was subsequently amended on March 6, 2008. The amended terms were as follows:
    The revolving line of credit facility was increased from $6.0 million to $8.0 million.
 
    The annual limit on unfinanced capital expenditures was increased from $1.5 million to $6.25 million for fiscal year 2008. The limit reverts to $1.5 million for 2009 and thereafter.
Note 4 — Earnings per Share
The computation of basic and diluted net income per share for the three-month periods ended March 31, 2008 and 2007 is as follows:
                 
    Three Months Ended March 31,  
    2008     2007  
Net income (loss) — ($ thousands)
  $ 611     $ (131 )
 
           
 
Weighted average shares outstanding
    6,327,049       6,234,346  
Effect of stock options
    99,642         (1)
Effect of dilutive warrants
    127,666         (1)
 
           
Weighted average shares outstanding — assuming dilution
    6,554,357       6,234,346  
 
           
Net income (loss) per share:
               
Basic
  $ 0.10     $ (0.02 )
Diluted
  $ 0.09     $ (0.02 ) (1)
 
               
Stock options not considered above because they were anti-dilutive
    33,750       18,750  
 
(1)   Due to net loss, option and warrant shares of 270,764 for the three months ended March 31, 2007 are anti-dilutive and thus not considered.
Note 6 — Stock Incentive Plan
In April 2005, the board of directors and the stockholders approved the 2005 Stock Incentive Plan (the “Plan”). The Plan provides for the granting of incentive stock options to employees selected by the board’s compensation committee. The Plan authorizes up to 697,500 shares to be issued. The compensation committee in April 2005 awarded options for 405,000 shares to officers of the Company at an exercise price of $5.33, which was equal to the initial public offering price of the stock. The options vest 20% on the date of grant and then ratably 20% over the following four years and have a ten-year term. All share and per share amounts have been adjusted for the 3-for-2 stock split that was effected in July 2006. During the third quarter of 2007, unvested options for 93,000 shares were forfeited by Michael Sage, the Company’s former President and CEO who retired effective July 15, 2007. Mr. Sage exercised his vested options covering 139,500 shares in October 2007. Options for 225,000 shares were granted effective August 20, 2007, to Robert Snyder, the Company’s new President and CEO, at an exercise price of $6.81, the market price on the date of the grant. The options vest 20% on the date of grant and then ratably 20% over the following four years and have a ten-year term.

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During the first three months of 2007, options covering 3,750 shares were granted to a new member of the Company’s board of directors at an exercise price of $8.58 for a ten-year term. The assumptions used in the Black-Scholes option valuation model for that option grant were as follows: risk-free interest rate of 4.83%, estimated volatility of 40%, no dividend yield or expected forfeitures and an expected life of 5 years. No options were granted in the first three months of 2008.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, options valuation models require the input of highly subjective assumptions including the expected stock price volatility.
In connection with the approval of the Plan, the Company adopted SFAS No. 123 (R) “Share-Based Payments” and expenses the cost of options granted over the vesting period of the option based on the grant-date fair value of the award. The Company recognized an expense of $51,000 and $60,000 for the three months ended March 31, 2008 and 2007, respectively, related to options granted under the Plan.
Note 6 — Major Customers and Concentration of Credit Risk
Credit risk for the Company is concentrated in four significant customers. Three are converted product customers, each of whom operates discount retail stores located throughout the United States and one customer who accounts for most of the Company’s third party sales of parent rolls. During the three months ended March 31, 2008 and 2007, sales to the four significant customers accounted for approximately 65% and 68% of the Company’s total sales, respectively. At March 31, 2008 and 2007, respectively, approximately $5.0 million (73%) and $4.0 million (71%) of accounts receivable was due from these four significant customers. No other customers of the Company accounted for more than 10% of sales during these periods. The Company generally does not require collateral from its customers and has not incurred any significant losses on uncollectible accounts receivable.
Note 7 — New Accounting Standards
The Financial Accounting Standards Board (“FASB”) periodically issues new accounting standards in a continuing effort to improve standards of financial accounting and reporting. We have reviewed the recently issued pronouncements and concluded that the following new accounting standards could be applicable to the Company.
In December 2007, the FASB revised SFAS No. 141 “Business Combinations” to clarify certain issues regarding business combinations. The major impact on the Company would be the requirement to write-off certain costs of completing an acquisition as incurred. The standard is effective for periods beginning after December 15, 2008.
Also in December 2007, the FASB issued SFAS No. 160 “Non-controlling Interests in Consolidated Financial Statements.” At present this standard would not apply to the Company as it has no subsidiaries. The standard is effective for minority interest accounting for periods beginning after December 15, 2008.

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Information
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements. These statements relate to, among other things:
.   our business strategy;
 
.   the market opportunity for our products, including expected demand for our products;
 
.   our estimates regarding our capital requirements; and
 
.   any of our other plans, objectives, and intentions contained in this report that are not historical facts.
These statements relate to future events or future financial performance, and involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. In some cases, you can identify forward-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 comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. These statements are only predictions.
You should not place undue reliance on forward-looking statements because they involve known and unknown risks, uncertainties, and other factors that are, in some cases, beyond our control and that could materially affect actual results, levels of activity, performance or achievements. Factors that could materially affect our actual results, levels of activity, performance or achievements include, without limitation, those detailed under the caption “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2007, as filed with the Securities and Exchange Commission, and the following items:
.   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 converted product revenues are attributable to three large customers which may decrease or cease purchases at any time;
 
.   we have significant indebtedness which limits our free cash flow and subjects us to restrictive covenants relating to the operation of our business;
 
.   the availability of and prices for energy could significantly affect our business;
 
.   our exposure to variable interest rates may affect our financial health;
 
.   the disruption in supply or cost of waste paper;
 
.   the loss of key personnel;
 
.   labor interruptions;

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.   natural disaster or other disruption to our facility;
 
.   ability to finance the capital requirements of our business;
 
.   cost to comply with government regulations; and
 
.   failure to maintain an effective system of internal controls necessary to accurately report our financial results and prevent fraud.
If any of these risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may vary significantly from what we projected. Any forward-looking statement you read in the following Management’s Discussion and Analysis of Financial Condition and Results of Operations reflects our current views with respect to future events and is subject to these and other risks, uncertainties, and assumptions relating to our operations, results of operations, growth strategy, and liquidity. We assume no obligation to publicly update or revise these forward-looking statements for any reasons, whether as a result of new information, future events, or otherwise.
Overview
We manufacture bulk tissue paper, known as parent rolls, and convert parent rolls into a full line of tissue products, including paper towels, bathroom tissue and paper napkins for the private label segment of the consumer, or “at home,” market. We have focused our product design and manufacturing on the discount retail market, primarily the dollar store retailers, due to their consistent order patterns, limited number of stock keeping units, or SKUs, offered and the growth being experienced in this channel of the retail market. While we have customers located throughout the United States, we distribute most of our products within approximately 900 miles of our northeast Oklahoma facility, which we consider to be our cost-effective shipping area. Our products are sold primarily under our customers’ private labels and, to a lesser extent, under our brand names such as Colortex® and Velvet®. All of our revenue is derived pursuant to truck load purchase orders from our customers. We do not have supply contracts with any of our customers. Revenue is recognized when title passes to the customer. Because our product is a daily consumable item, the order stream from our customer base is fairly consistent with no significant seasonal fluctuations. Changes in the national economy do not materially affect the market for our product.
Our profitability depends on several key factors, including:
.   the market price of our product;
 
.   the cost of recycled paper used in producing paper;
 
.   the efficiency of operations in both our paper mill and converting operations; and
 
.   energy costs.
The private label segment of the tissue industry is highly competitive, and discount retail customers are extremely price sensitive. As a result, it is difficult to effect price increases. We expect these competitive conditions to continue.
In June 2006, we began operating a new paper machine with an annual capacity of approximately 33,000 tons. As a result, beginning in the third quarter of 2006, we were able to eliminate the requirement to purchase recycled parent rolls on the open market. In the second quarter of 2007,

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we began running all of our older machines on a full-time basis. The capacity of the new machine, in addition to the capacity of our older machines, increased our total production capacity to approximately 54,000 tons per year. Prior to the third quarter of 2006, we had purchased parent rolls on the open market since 1998 because our own parent roll production had not adequately supplied the requirements of our converting facility. We purchased approximately 1,675, 6,970 and 12,200 tons of paper on the open market in the years 2007, 2006 and 2005, respectively, to supplement our paper-making capacity. Parent rolls are a commodity product and thus are subject to market price and availability.
Comparative Three-Month Periods Ended March 31, 2008 and 2007
Net Sales
                 
    Three Months Ended March 31,
    2008   2007
    (in thousands, except average
    price per ton and tons)
Net sales
  $ 20,275     $ 16,637  
 
               
Total tons shipped
    12,962       11,161  
Average price per ton
  $ 1,564     $ 1,491  
Net sales increased 22%, to $20.3 million in the quarter ended March 31, 2008, compared to $16.6 million in the same period of 2007. Net sales figures include gross selling price, including freight, less discounts and pricing allowances. The increase in net sales is primarily the result of a more than two-fold increase in the shipment of parent rolls and a 9% increase in the net selling price per ton of converted product shipments and, to a lesser extent, a 20% increase in the selling price of parent rolls. Total shipments in the 2008 quarter increased by 1,801 tons, or 16%, to 12,962 tons compared to 11,161 tons in the same period of 2007, primarily due to higher levels of parent roll shipments, which was attributable to the increased production provided by our paper mill. Shipments of converted product increased 2% in the first quarter of 2008 compared to the prior year quarter. Our overall net selling price per ton increased by 5% in the first quarter of 2008 to $1,564 compared to the prior year quarter. This increase was negatively affected by the increased sales of parent rolls, which are sold at lower prices than converted products.
Cost of Sales
                 
    Three Months Ended March 31,  
    2008     2007  
    (in thousands, except  
    gross profit margin %  
    and paper cost per ton)  
Cost of paper
  $ 10,604     $ 8,672  
Non-paper materials, labor, supplies, etc.
    6,227       5,484  
 
           
Sub-total
  $ 16,831       14,156  
Depreciation
    755       749  
 
           
Cost of sales
  $ 17,586     $ 14,905  
 
               
Gross profit
  $ 2,689     $ 1,732  
Gross profit margin %
    13.3 %     10.4 %
Total paper cost per ton consumed
  $ 818     $ 777  

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Major components of cost of sales are the cost of internally produced paper, raw materials, direct labor and benefits, freight costs of products shipped to customers, insurance, repairs and maintenance, energy, utilities and depreciation.
Cost of sales increased approximately $2.7 million, or 18%, to $17.6 million for the quarter ended March 31, 2008, compared to $14.9 million in the same period of 2007. As a percentage of net sales, cost of sales declined from 90% to 87% of net sales. The decline in cost of sales as a percentage of net sales in the quarter ended March 31, 2008 was primarily attributed to higher selling prices and higher tonnage volumes being partially offset by higher paper production costs.
Our cost of sales in the first quarter of 2008 was negatively affected by down time experienced on our new paper machine in January that totaled approximately three days of lost production time in order to effect repairs. The unplanned shutdown was required to correct certain issues with the surface of the yankee dryer and resulted in approximately $200,000 of increased production costs. The surface issues causing the shutdown were corrected during the month of January.
Our overall cost of paper in the first quarter of 2008 was $818 per ton, an increase of $41 per ton compared to the same period in 2007. Our cost per ton increased primarily due to increased waste paper prices being partially offset by the effects of higher production on fixed and semi-variable costs. The prices we paid for waste paper increased approximately 19% in the first quarter of 2008 compared with the same period in 2007, resulting in an increased cost of waste paper consumed of approximately $1.0 million, as an overall tight waste paper market resulted in significant price increases across all grades of waste paper.
Gross Profit
Gross profit in the quarter ended March 31, 2008 increased $1.0 million, or 55%, to $2.7 million compared to $1.7 million in the same period last year. The previously discussed unplanned shutdown of our new paper machine negatively affected gross profit by approximately $330,000 due to lost production and certain related out of pocket expenses. Gross profit as a percentage of net sales in the 2008 quarter was 13.3% compared to 10.4% in the 2007 quarter. The effect of higher selling prices and higher tonnage volumes, which were partially offset by higher waste paper costs and the effects of the previously discussed unplanned paper machine shutdown, were the major reasons for the increase in gross profit and gross profit as a percentage of net sales.
Selling, General and Administrative Expenses
                 
    Three Months Ended March 31,  
    2008     2007  
    (In thousands, except SG&A  
    as a % of net sales)  
Commission expense
  $ 242     $ 222  
Other S,G&A expenses
    1,143       837  
 
           
Selling, General & Adm exp
  $ 1,385     $ 1,059  
SG&A as a % of net sales
    6.8 %     6.4 %
Selling, general and administrative expenses include salaries, commissions to brokers and other miscellaneous expenses. Selling, general and administrative expenses increased $326,000, or 31%, to $1.4 million in the quarter ended March 31, 2008 compared to $1.1 million in the comparable 2007 period, mainly as a result of higher accruals under our incentive bonus plan, higher costs associated with additions to our senior management team and increased legal and

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other professional fees. As a percent of net sales, selling, general and administrative expenses increased to 6.8% in the first quarter of 2008 compared to 6.4% in the same period of 2007.
Operating Income
As a result of the foregoing factors, operating income for the quarter ended March 31, 2008 was $1.3 million compared to operating income of $673,000 for the same period of 2007.
Interest Expense and Other Income
                 
    Three Months Ended March 31,
    2008   2007
    (In thousands)
Interest expense
  $ 411     $ 873  
Other income, net
  $ (1 )   $ (20 )
Interest expense includes interest on all debt and amortization of both deferred debt issuance costs and the discount on our subordinated debt related to warrants issued with that debt. Interest expense decreased $462,000 to $411,000 in the quarter ended March 31, 2008, compared to $873,000 in the quarter ended March 31, 2007, primarily as a result of lower overall borrowing levels, lower LIBOR interest rates and reduced interest margins under our new credit agreement that closed on April 9, 2007. Our average bank borrowings in the quarter ended March 31, 2008 were $25.7 million compared with $30.0 million in the same period of 2007. Additionally in December 2007, we retired all of our outstanding 12% subordinated debentures totaling $2.15 million.
Other income decreased from $20,000 in the first quarter of 2007 to $1,000 in the first quarter of 2008, primarily due to the absence of interest on the restricted certificate of deposit which was released in connection with the closing of our new credit facility.
Income (Loss) Before Income Taxes
As a result of the foregoing factors, income (loss) before income taxes increased $1.1 million to income of $894,000 in the quarter ended March 31, 2008 compared to a loss of $180,000 in the same period in 2007.
Income Tax Provision (Benefit)
For the quarter ended March 31, 2008, our effective income tax rate was 32%. It is lower than the statutory rate because of Oklahoma Investment Tax Credits associated with our investment in a new paper machine. This factor was partially offset by state income taxes. As of March 31, 2007, we estimated our annual effective income tax rate to be 27%. The 2007 effective tax rate was lower than the statutory rate because of the Oklahoma Investment Tax Credits cited above and the utilization of Federal Indian Employment Credits. The first quarter of 2008 does not reflect any benefit for the Indian Employment Tax Credit because the credit expired as of December 31, 2007 and as of the date of this filing it has not been extended.
No current taxes are owing to either state or federal taxing authorities because of net operating loss carryforwards for both state and federal tax purposes, Federal Indian Employment Credit carryforwards and Oklahoma Investment Tax Credit carryforwards.

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Liquidity and Capital Resources
Liquidity refers to the liquid financial assets available to fund our business operations and pay for near-term obligations. These liquid financial assets consist of cash as well as unused borrowing capacity under our revolving credit facility. Our cash requirements have historically been satisfied through a combination of cash flows from operations and debt financings.
Cash was unchanged in the three months ended March 31, 2008 at $3,000. Cash was also unchanged at $3,000 in the three months ended March 31, 2007.
The following table summarizes key cash flow information for the three-month periods ended March 31, 2008 and 2007:
                 
    Three Months Ended March 31,
    2008   2007
    (in thousands)
Cash flow provided by (used in):
               
Operating activities
  $ (315 )   $ 930  
 
Investing activities
  $ (359 )   $ (77 )
 
Financing activities
  $ 674     $ (853 )
Cash flow used in operating activities was $315,000 in the three-month period ended March 31, 2008, which primarily resulted from increased trade receivables and inventories, partly offset by earnings before non-cash charges.
Cash flows used in investing activities were $359,000 in the first quarter of 2008 as the result of expenditures on capital projects.
Cash provided by financing activities was $674,000 in the three-month period ended March 31, 2008 and was primarily attributable to $1.1 million in borrowings under the revolving credit agreement, which were partially offset by principal payments of $413,000 on our term loans.
On April 9, 2007, we closed the re-financing of our credit facility with our existing bank group. On March 6, 2008 we amended the facility to increase the revolving credit facility and the 2008 capital expenditures limit. Following the amendment, the credit facility consists of the following:
.   a $8.0 million revolving credit facility with a three-year term; ($1.37 million outstanding at March 31, 2008). In addition, $489,000 of bank overdrafts are included with long-term debt at March 31, 2008. The borrowing base for the revolving credit facility is determined by adding qualified receivables and inventory. At March 31, 2008, the borrowing base for the revolving credit facility was $7.5 million;
 
.   a $10.0 million term loan A with a ten-year term that has no principal repayments for the first 24 months of the loan and then will be amortized as if the loan had an 18-year life ($10.0 million outstanding at March 31, 2008);
 
.   a $16.5 million term loan B with a four-year term that is being amortized as if the loan had a six-year life ($14.4 million outstanding at March 31, 2008); and

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.   a $3.0 million capital expenditures facility with a four-year term that will be amortized as if the loan had a five-year life ($0 outstanding at March 31, 2008).
Under the terms of the credit agreement, amounts outstanding under the revolving credit facility bear interest at our election at the prime rate or LIBOR plus a margin and amounts outstanding under term loan B and the capital expenditures facility bear interest at LIBOR plus a margin. The margin is set quarterly and based on the ratio of funded debt to EBITDA less income taxes paid. Amounts outstanding under term loan A bear interest at LIBOR plus 180 basis points. For the revolving credit facility, the margin ranges from a negative 50 basis points to 150 basis points for prime rate loans and 200 to 375 basis points for LIBOR-based loans. For term loan B, the margin ranges from 200 basis points to 300 basis points over LIBOR. For the capital expenditures facility, which we expect to utilize in conjunction with the construction of our new environmental pre-treatment facility by August 1, 2009, the margin ranges from 150 basis points to 250 basis points over LIBOR. At March 31, 2008, our weighted average borrowing rate was 4.83% under this credit agreement.
The credit agreement contains covenants that, among other things, require us to maintain a specific funded debt to EBITDA ratio, debt service coverage ratio and an annual limit on un-financed capital expenditures. In connection with the re-financing, the $1.5 million restricted certificate of deposit was released and applied to the revolving credit facility. The amount available under the revolving credit line may be reduced in the event that our borrowing base, which is based upon our qualified receivables and qualified inventory, is less than $8.0 million. Obligations under the amended and restated credit agreement are secured by substantially all of our assets. The agreement contains representations and warranties, and affirmative and negative covenants customary for financings of this type, including, but not limited to, a covenant prohibiting us from declaring or paying dividends. The financial covenants in the agreement require us to maintain specific ratios of funded debt to EBITDA and debt service coverage which are tested as of the end of each quarter and places a limit on the amount of annual non-financed capital expenditures. The maximum allowable funded debt-to-EBITDA ratio is 4.0-to-1.0 and the minimum allowable debt service coverage ratio is 1.25-to-1.0. Our annual expenditures for non-financed capital equipment are limited to $6.25 million for fiscal year 2008 and $1.5 million per fiscal year thereafter.
The capital expenditures facility is intended to fund an expansion of our wastewater pre-treatment facilities. A new water discharge permit was issued effective August 1, 2007 which requires us to expand our existing pre-treatment facility to reduce biological oxygen demand and total suspended solids from our discharge water. Under the new permit, we are required to complete the expansion and make operational our pre-treatment facility by August 1, 2009. The project is in the pre-engineering phase and is expected to cost approximately $3 million.
If an event of default occurs, the agent may declare the banks’ obligation to make loans terminated and all outstanding indebtedness, and all other amounts payable under the credit agreement, due and payable.
Critical Accounting Policies and Estimates
The preparation of our financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires management to make estimates and judgments that affect our reported amounts of assets and liabilities, revenue and expense, and related disclosures of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates and assumptions based upon historical experience and various other factors and

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circumstances. Management believes that our estimates and assumptions are reasonable under the circumstances; however, actual results may vary from these estimates and assumptions under different future circumstances. We have identified the following critical accounting policies that affect the more significant judgments and estimates used in the preparation of our financial statements:
Accounts Receivable. Accounts receivable consist of amounts due to us from normal business activities. Our management must make estimates of accounts receivable that will not be collected. We perform ongoing credit evaluations of our customers and adjust credit limits based upon payment history and the customer’s creditworthiness as determined by our review of their current credit information. We continuously monitor collections and payments from our customers and maintain an allowance for estimated losses based on historical experience and specific customer collection issues that we have identified. Trade receivables are written-off when all reasonable collection efforts have been exhausted, including, but not limited to, external third party collection efforts and litigation. While such credit losses have historically been within management’s expectations and the allowance provided, there can be no assurance that we will continue to experience the same credit loss rates as in the past. During the three-month periods ended March 31, 2008 and 2007, provisions for doubtful accounts were recognized in the amount of $15,000 for each period. In addition, $3,000 of recoveries of accounts previously written off were credited to the allowance during the first three months of 2008. There were no recoveries credited during the first three months of 2007. There were no accounts receivable balances written off in the three-month periods ended March 31, 2008 and 2007.
Inventory. Our inventory consists of finished goods and raw materials and is stated at the lower of cost or market. Our management regularly reviews inventory quantities on hand and records a provision for excess and obsolete inventory based on the age of the inventory and forecasts of product demand. A significant decrease in demand could result in an increase in the amount of excess inventory quantities on hand. During the first three months of 2008, $15,000 was provided and there were no charges against the valuation reserve. During the first three months of 2007, $15,000 was provided and there were no charges against the reserve.
New Accounting Pronouncements
The Financial Accounting Standards Board (“FASB”) periodically issues new accounting standards in a continuing effort to improve standards of financial accounting and reporting. We have reviewed the recently issued pronouncements and concluded that the following new accounting standards could be applicable to us.
In December 2007, the FASB revised SFAS No. 141 “Business Combinations” to clarify certain issues regarding business combinations. The major impact on Orchids would be the requirement to write-off certain costs of completing an acquisition as incurred. The standard is effective for periods beginning after December 15, 2008.
Also in December 2007, the FASB issued SFAS No. 160 “Non-controlling Interests in Consolidated Financial Statements.” At present this standard would not apply to Orchids as we have no subsidiaries. The standard is effective for minority interest accounting for periods beginning after December 15, 2008.

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Non-GAAP Discussion
In addition to our GAAP results, we also consider non-GAAP measures of our performance for a number of purposes. We use EBITDA as a supplemental measure of our performance that is not required by, or presented in accordance with, GAAP. EBITDA is not a measurement of our financial performance under GAAP and should not be considered as an alternative to net income, operating income or any other performance measure derived in accordance with GAAP, or as an alternative to cash flow from operating activities or a measure of our liquidity.
EBITDA represents net income before net interest expense, income tax expense, depreciation and amortization. We believe EBITDA facilitates operating performance comparisons from period to period and company to company by eliminating potential differences caused by variations in capital structures (affecting relative interest expense), tax positions (such as the impact on periods or companies of changes in effective tax rates or net operating losses) and the age and book depreciation of facilities and equipment (affecting relative depreciation expense).
EBITDA has limitations as an analytical tool, and you should not consider it in isolation, or as a substitute for any of our results as reported under GAAP. Some of these limitations are:
.   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.
Because of these limitations, EBITDA should not be considered as a measure of discretionary cash available to us to invest in the growth of our business or to reduce our indebtedness. We compensate for these limitations by relying primarily on our GAAP results and using EBITDA on a supplemental basis.
The following table reconciles EBITDA to net income for the quarters ended March 31, 2008 and 2007:
                 
    Three Months Ended March 31,  
    2008     2007  
    (In thousands, except % of net sales)  
Net income (loss)
  $ 611     $ (131 )
Plus: Interest expense, net
    411       873  
Plus: Income tax expense (benefit)
    283       (49 )
Plus: Depreciation
    754       749  
 
           
EBITDA
  $ 2,059     $ 1,442  
% of net sales
    10.2 %     8.7 %

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EBITDA increased $617,000 to $2.06 million in the quarter ended March 31, 2008, compared to $1.44 million in the same period of 2007. EBITDA as a percent of net sales increased to 10.2% in the current year quarter compared to 8.7% in the prior year quarter. The foregoing factors discussed in the net sales, cost of sales and selling, general and administrative sections are the reasons for these changes. The largest causes of the increase in EBITDA as a percentage of net sales were higher selling prices and higher selling volumes.
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
Our market risks relate primarily to changes in interest rates. Our revolving line of credit and our term loans carry variable interest rates that are tied to market indices and, therefore, our statement of income and our cash flows will be exposed to changes in interest rates. As of March 31, 2008, we have borrowings totaling $25.8 million that carry a variable interest rate. Outstanding balances under our line of credit and term loans bear interest at the prime rate or LIBOR, plus a margin based upon the debt service coverage ratio or a fixed margin over LIBOR. Based on the borrowings on March 31, 2008, a 100 basis point change in interest rates would result in a $258,000 change to our annual interest expense.
ITEM 4. Controls and Procedures
Our management, under the supervision and with the participation of our chief executive officer and our chief financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended), as of the end of the period covered by this Quarterly Report on Form 10-Q. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Based on such evaluation, our chief executive officer and our chief financial officer have concluded that our disclosure controls and procedures were effective as of March 31, 2008.
There were no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended March 31, 2008, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
None.
ITEM 1A. Risk Factors
There have been no material changes from the risk factors disclosed in the Company’s Annual Report on Form 10-K dated March 18, 2008.
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
(a) Unregistered Sales of Equity Securities
None.
(b) Initial Public Offering and Use of Proceeds from the Sale of Registered Securities
None.
(c) Repurchases of Equity Securities
We do not have any programs to repurchase shares of our common stock and no such repurchases were made during the three months ended March 31, 2008.
ITEM 3. Defaults Upon Senior Securities
None.
ITEM 4. Submission of Matters to a Vote of Security Holders
None.
ITEM 5. Other Information
None.
ITEM 6. Exhibits
See the Exhibit Index following the signature page to this Form 10-Q, which Exhibit Index is hereby incorporated by reference herein.

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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
         
ORCHIDS PAPER PRODUCTS COMPANY
 
 
Date: May 2, 2008  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*
  Supplier Agreement, dated February 20, 2008, between Dixie Pulp & Paper, Inc. and the Registrant.
 
   
10.2
  Amendment Two to Second Amended and Restated Agented Credit Agreement, dated March 6, 2008, 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 11, 2008.
 
   
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.
 
   
*
  Confidential treatment has been requested with respect to certain portions of this exhibit. Omitted portions have been filed separately with the Securities and Exchange Commission.

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