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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2012

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)

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 x  No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months.  Yes x  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):

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

Number of shares outstanding of the issuer’s Common Stock, par value $.001 per share, as of April 30, 2012: 7,533,975 shares.

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ORCHIDS PAPER PRODUCTS COMPANY

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QUARTERLY REPORT ON FORM 10-Q

FOR THE THREE MONTHS ENDED MARCH 31, 2012

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PART I. FINANCIAL INFORMATION

ITEM 1.  Financial Statements

ORCHIDS PAPER PRODUCTS COMPANY

BALANCE SHEETS

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

See notes to unaudited interim financial statements.

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ORCHIDS PAPER PRODUCTS COMPANY

STATEMENTS OF INCOME

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

See notes to unaudited interim financial statements.

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ORCHIDS PAPER PRODUCTS COMPANY

STATEMENTS OF CASH FLOWS

(Dollars in thousands)

See notes to unaudited interim 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.  The sale of equity and debt securities closed in March 2004 and Orchids Acquisition acquired Orchids for a price of $21.6 million.  Orchids Acquisition was subsequently merged into Orchids.  In July 2005, the Company completed its initial public offering of its common stock.  The Company’s stock trades on the NYSE Amex 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 (“SEC”).  Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted (“GAAP”) 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 in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011, filed with the SEC on March 7, 2012.  Management believes that the financial statements contain all adjustments necessary for a fair presentation 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.

Note 2 — Fair Value Measurements

The Company had $5,019,000 and $2,019,000 invested in commercial deposits at March 31, 2012 and December 31, 2011, respectively.  These short-term investments are measured at fair value on a recurring basis and are considered Level 1 measurements in the fair value valuation hierarchy.  The Company has no liabilities measured at fair value at March 31, 2012 or December 31, 2011.  The carrying value of the Company’s long-term debt is estimated by management to approximate fair value based on the obligations’ characteristics, including floating interest rate, credit rating, maturity and collateral.

There were no transfers between Level 1, Level 2 or Level 3 assets during the first three months in 2012 or 2011.

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Note 3 — Commitments and Contingencies

The Company may be involved from time to time in litigation 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 proceedings which individually or in the aggregate are expected to have a materially adverse effect on the Company’s results of operations or financial condition.

In October 2008, the Company entered into a contract to purchase 334,000 MMBTU per year of natural gas at $7.50 per MMBTU plus a $0.07 per MMBTU management delivery fee for the period from April 2009 through March 2011.  The amounts represented approximately 60% of the Company’s natural gas requirements.  Effective April 2013, the agreement has been extended to supply approximately 70% of the Company’s natural gas requirements, or approximately 380,000 MMBTU per year, through December 2015 as follows:

Purchases under the gas contract were $0.6 million and $0.7 million for the three months ended March 31, 2012 and 2011, respectively.  If the Company is unable to purchase the contracted amounts and the market price at that time is less than the contracted price, the Company would be obligated under the terms of the agreement to reimburse an amount equal to the difference between the contracted amount and the amount actually purchased, multiplied by the difference between the contract price and current spot price.

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Note 4 — Inventories

Inventories at March 31, 2012 and December 31, 2011 are as follows:

Note 5 — Income Taxes

For the quarter ended March 31, 2012, our effective income tax rate was 32.7%.  For the quarter ended March 31, 2011, our effective income tax rate was 30.3%.  These rates are lower than the statutory rate because of manufacturing tax credits and Oklahoma Investment Tax Credits primarily associated with our investments in a new paper machine in 2006 and new converting warehouse and new converting line that were completed in 2010.

Note 6 — Earnings per Share

The computation of basic and diluted net income per share for the three-month periods ended March 31, 2012 and 2011 is as follows:

Note 7 — 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.  Prior to May 2011, the Plan was authorized to distribute up to 897,500 shares.  In May 2011, the Company’s stockholders approved an amendment to the Plan to increase the number of authorized shares under the Plan to 1,097,500.

The Company uses the Black-Scholes option valuation model to estimate the grant date fair value of its options.  Option valuation models require the input of highly subjective assumptions including the expected stock price volatility.  The following table details the options granted to certain members of the board of directors and management and related assumptions during the three months ended March 31, 2012.

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There were no options granted under the Plan during the three months ended March 31, 2011.

The Company 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 expense of $76,000 and $62,000 for the three months ended March 31, 2012 and 2011, respectively, related to options granted under the Plan.

Note 8 — Major Customers and Concentration of Credit Risk

The Company sells its paper production in the form of parent rolls and converted products.  Revenues from converted product sales and parent roll sales in the three months ended March 31, 2012 and 2011 were:

Credit risk for the Company in the three months ended March 31, 2012 and 2011 was concentrated in the following customers who comprised more than 10% of the Company’s total net sales:

*Customer did not account for more than 10% of sales during the period indicated

At March 31, 2012 and December 31, 2011, respectively, the four significant customers accounted for the following amounts of the Company’s accounts receivable (in thousands):

No other customer 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.

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Note 9 — 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 there are no recently issued accounting pronouncements that the Company has yet to adopt that are expected to have a material effect on the Company’s financial position, results of operations or cash flows.

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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, 2011, as filed with the SEC on March 7, 2012, and include the following items:

·                                          intense competition in our markets and aggressive pricing by our competitors could force us to decrease our prices and reduce our profitability;

·                                          a substantial percentage of our converted product revenues are attributable to a small number of customers who may decrease or cease purchases at any time;

·                                          disruption in our supply or increase in the cost of fiber;

·                                          increased competition in our region;

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

·                                          excess supply in the market may reduce our prices;

·                                          the availability of and prices for energy;

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

·                                          our exposure to variable interest rates;

·                                          the loss of key personnel;

·                                          labor interruption;

·                                          natural disaster or other disruption to our facilities;

·                                          ability to finance the capital requirements of our business;

·                                          cost to comply with existing and new laws and regulations;

·                                          failure to maintain an effective system of internal controls necessary to accurately report our financial results and prevent fraud;

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

·                                          indebtedness limits our cash flow and subjects us to restrictive covenants relating to the operation of our business;

·                                          an inability to continue to implement our business strategies; and

·                                          inability to sell the capacity generated from our converting line.

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 reason, whether as a result of new information, future events, or otherwise.

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Overview

We are an integrated manufacturer of tissue products serving the private label consumer, or “at-home,” market. We produce bulk tissue paper, known as parent rolls, and convert parent rolls into finished products, including paper towels, bathroom tissue and paper napkins.  We sell any remaining parent rolls to other converters.  Our core customer base consists of dollar stores and other discount retailers. By dollar stores, we mean retailers that offer a limited selection across a broad range of products at everyday low prices in a smaller store format.  We have focused on the dollar stores (which are also referred to as value retailers) and the broader discount retail market because of their overall market growth, consistent order patterns and low number of stock keeping units (“SKUs”).  The at-home tissue market consists of several quality levels, including a value tier, mid-tier and premium tier. Our historical business strategy has focused on the value tier market, primarily due to the dollar stores’ concentration of product offerings in that market and, to some extent, limitations of certain manufacturing equipment. As part of our growth strategy, we began to systematically invest in manufacturing assets to improve quality, expand our product offerings and strengthen our position as a low cost manufacturer. This began with the start-up of a new paper machine in 2006 which provided the opportunity to produce parent rolls for value tier, mid-tier and premium tier converted products and improved our cost structure. Further, we undertook an expansion project that included the purchase and installation of a new converting line and the construction of a new converted product warehouse in mid-2010. This project had three main objectives: increase the capacity of our converting operation, provide the capability to produce higher-quality mid-tier and premium tier converted products and reduce warehousing costs by centralizing all warehousing and shipping.  While we have customers located throughout the United States, most of our products are distributed within an approximate 900-mile radius of our Oklahoma facility. However, our sales efforts are focused on an area within approximately 500 miles of our facility in northeast Oklahoma, which includes Texas, Oklahoma, Kansas, Missouri, Arkansas, Nebraska and Iowa. Because we are one of the few tissue paper manufacturers in this area, we typically have lower freight costs to our customers’ distribution centers located in our target region. At-home tissue market growth has historically been closely correlated to population growth and as such, performs well in a variety of economic conditions. Our target region has experienced strong population growth in the past ten years relative to the national average, and these trends are expected to continue.

Our products are sold primarily under our customers’ private labels and, to a lesser extent, under our brand names such as Colortex®, My Size®, Velvet®, Big Mopper®, Soft & Fluffy®, Tackle® , Noble® and care®.  All of our converted product revenue is derived through truck load purchase orders from our customers.  Parent roll revenue is derived from purchase orders that generally cover a one-month time period. We do not have supply contracts with any of our customers.  Because our product is a daily consumable item, the order stream from our customer base is fairly consistent with no significant seasonal fluctuations. However, we may experience mild seasonal softness in the first and fourth quarters of each year, primarily due to the effects of winter weather on consumers’ buying habits and occasional effects of holidays on shipping schedules.  Changes in the national economy, in general, do not materially affect the market for our converted products.

Our profitability depends on several key factors, including but not limited to:

·                                          the market price of our product;

·                                          the cost of fiber used in producing paper;

·                                          the efficiency of operations in both our paper mill and converting facility; and

·                                          the cost of energy.

The private label market of the tissue industry is highly competitive, and discount retail customers are extremely price sensitive.  As a result, it is difficult to affect price increases.  We expect these competitive conditions to continue.

Background

Since June 2006, when we began operations of a new paper machine, our paper-making capacity of approximately 56,000 tons per year has exceeded the demand requirements of our converting operations. We sell the excess supply into the market in the form of parent rolls.  We adjust our paper making production based on our internal converting needs for parent rolls and the open market demand for parent rolls.  Parent rolls are a commodity product and thus are subject to market pricing.  We plan to continue to sell any excess parent roll capacity on the open market as long as market pricing is profitable.

Our parent rolls are processed into paper towels, bathroom tissue and napkins in our adjacent converting facility. Our eleven converting lines have a total annual capacity of approximately 12.5 million cases of finished tissue products.  Our strategy is to sell all of our parent roll capacity as converted products, which generally carry higher margins than parent rolls. To help achieve that goal, we continue to focus considerable efforts to improve our converting efficiencies.  In addition, we are placing significant focus on improving our sales efforts to sell this additional capacity.

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Our strategy is to expand our position as a low cost provider of high-quality private label tissue products to the growing discount retail channel while leveraging our competitive advantages to increase our presence in the mid-tier and premium tier markets with the discount retail channel as well as other retail channels. This will be accomplished through the expansion of our product offerings through new product development, our continued high service levels and increased total manufacturing capacity.

We are implementing this strategy through our key initiatives set forth below:

·                                          maintain and strengthen our core customer relationships;

·                                          improve the product quality of our higher tier offerings to meet and or exceed the required attributes;

·                                          increase our flexibility to meet a wider array of customer needs;

·                                          further expand our customer base in other retail channels; and

·                                          continue to improve operating efficiencies and reduce manufacturing costs.

Since our inception in 1998, we have strategically expanded capacity and capability in both paper manufacturing and finished product converting to meet market demand and quality requirements.  In 2010, we increased our annual converting capacity by approximately 4.0 million cases with the installation of a new converting line, which, along with other strategic investments, increased our annual converting capacity to 12.5 million cases per year.  This additional converting capacity will enable us both to increase sales of existing products and to provide the flexibility to manufacturing higher tier products for sales to our core customer base and into new retail channels.

Although we have an annual converting capacity of approximately 12.5 million cases, our in-house supply of parent rolls provides enough to convert approximately 9.5 million cases.  In order to convert at an annual capacity above approximately 9.5 million cases, we would have to supplement our supplies by purchasing parent rolls in the open market.

Comparative Three-Month Periods Ended March 31, 2012 and 2011

Net Sales

Net sales in the quarter ended March 31, 2012, increased 13% to $25.7 million, compared to $22.7 million in the same period of 2011.  Net sales figures represent the gross selling price, including freight, less discounts and pricing allowances.  The increase in net sales is due to a $5.6 million increase in net sales of converted product which was partially offset by a $2.6 million decrease in parent roll net sales.  Net sales of converted product increased in the quarter ended March 31, 2012, by $5.6 million, or 31%, to $23.6 million compared to $18.0 million in the same period last year. The increase in net sales of converted product is primarily the result of a 33% increase in the tonnage shipped, which was partially offset by a 1% decrease in the net selling price per ton.  The increase in converted product tonnage shipped is a result of both new product offerings, primarily in the mid-tier market, and increased product distribution with certain existing customers.

Net sales of parent rolls decreased $2.6 million, or 55%, to $2.1 million in the quarter ended March 31, 2012, compared to $4.7 million in the same period last year.  Net sales of parent rolls decreased primarily as a result of a 57% decrease in tonnage shipped, offset by a 6% increase in the net selling price per ton of parent rolls. The decrease in parent roll tonnage shipments is due to higher requirements by our converting operation resulting in less excess paper available to sell in parent roll form.  The improvement in parent roll net selling prices is due to the stronger parent roll market and market reaction to higher fiber prices during the first nine months of 2011.

Total shipments in the first quarter of 2012 decreased by 159 tons, or 1%, to 13,469 tons compared to 13,628 tons in the same period of 2011.  This decrease is primarily the result of an increase in the percentage of tonnage shipped in converted product form and the resulting yield loss typically associated with converting parent rolls into converted products.  The increase in selling price per ton of $246, or 15%, to $1,910 in the first quarter of 2012 compared to $1,664 in the first quarter of 2011 is primarily due to an increased percentage of converted product tons shipped and the 6% increase in the net selling price per ton of parent rolls, as discussed above.

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Cost of Sales

The 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 in the quarter ended March 31, 2012, decreased 2% to $19.6 million, compared to $20.0 million in the same period of 2011.  As a percentage of net sales, cost of sales decreased to 76.2% in the 2012 quarter from 88.1% in the 2011 quarter.  Cost of sales as a percentage of net sales for the first quarter of 2012 was favorable to the prior year quarter due to lower paper production costs, which was primarily due to lower fiber costs, being partially offset by the effects of increased converted product shipments.  Converted product shipments increased as a percent of total sales.  This positively affected cost of sales as a percent of net sales due to converted product shipments generally earning a higher margin on a per ton basis than parent roll sales.

Our overall cost of paper in the first quarter of 2012 was $732 per ton, a decrease of $87 per ton, or 11%, compared to the same period in 2011.  Paper production costs decreased primarily due to lower fiber prices.  Fiber prices decreased approximately 25% in the first quarter of 2012 compared to the same quarter in 2011, thereby decreasing our cost of sales by approximately $1.3 million in the quarter-over-quarter comparison.

Excluding depreciation, converting production costs on a per unit basis were 14% lower in the 2012 quarter compared to the 2011 quarter primarily as a result of a 32% increase in the number of cases produced, which resulted in a 15% decrease in labor cost per case and a 13% decrease in overhead cost per case.

Gross Profit

Gross profit in the quarter ended March 31, 2012, increased $3.4 million, or 126%, to $6.1 million compared to $2.7 million in the same period last year.  Gross profit as a percentage of net sales in the 2012 quarter was 23.8% compared to 11.9% in the 2011 quarter.  The gross profit increase as a percent of net sales was primarily the result of lower fiber prices and increased converting production shipments.

Selling, General and Administrative Expenses

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Selling, general and administrative expenses include salaries, commissions to brokers and other miscellaneous expenses.  Selling, general and administrative expenses increased $707,000 to $2.3 million in the 2012 quarter from $1.6 million in the 2011 quarter, mainly as a result of increased professional fees, higher commission expense due the higher level of converted product sales, increased bonus accruals under our incentive bonus plan and higher artwork and packaging related expenditures.  As a percentage of net sales, selling, general and administrative expenses increased to 8.9% in the first quarter of 2012 compared to 7.0% in the same period of 2011.

Operating Income

As a result of the foregoing factors, operating income for the quarter ended March 31, 2012 increased to $3.8 million compared to $1.1 million in the same period in 2011.

Interest Expense and Other Income

Interest expense includes interest on all debt and amortization of deferred debt issuance costs.  Interest expense decreased $142,000 to $107,000 in the quarter ended March 31, 2012, compared to $249,000 in the quarter ended March 31, 2011.  The decrease in interest expense resulted from our debt refinancing in April 2011 at lower interest rates and lower average borrowing levels subsequent to the debt refinancing.

Income Before Income Taxes

As a result of the foregoing factors, income before income taxes increased $2.9 million to $3.7 million in the quarter ended March 31, 2012, compared to $888,000 in the same period in 2011.

Income Tax Provision

For the quarter ended March 31, 2012, our effective income tax rate was 32.7%.  For the quarter ended March 31, 2011, our effective income tax rate was 30.3%.  These rates are lower than the statutory rate because of manufacturing tax credits and Oklahoma Investment Tax Credits primarily associated with our investments in a new paper machine in 2006, and new converting warehouse and new converting line that were completed in 2010.

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.

During the three months ended March 31, 2012, cash decreased $1.6 million to $2.7 million at March 31, 2012.  During the 2012 period, we utilized $3.0 million of cash to purchase short-term investments, spent $1.5 million on capital expenditures, and paid dividends to stockholders totaling $1.5 million.

As of March 31, 2012, total debt outstanding was $17.1 million.  Cash and short-term investments as of March 31, 2012, totaled $7.8 million, resulting in a net debt level of $9.3 million.  This compares to $17.4 million in total debt and $6.3 million in total cash and short-term investments as of December 31, 2011, resulting in a net debt level of $11.1 million.  In the three months ended March 31, 2012, we repaid $288,000 of outstanding debt under our existing credit facility.

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The following table summarizes key cash flow information for the three-month periods ended March 31, 2012 and 2011:

Cash flows provided by operating activities was $4.7 million in the three-month period ended March 31, 2012, which primarily resulted from earnings before non-cash charges and an increase in accrued liabilities, partially offset by increases in accounts receivable and inventories.  The increase in accrued liabilities is primarily related to an increase in income taxes payable due to higher income in the first quarter of 2012.  The increase in accounts receivable and inventories is primarily related to increased overall sales levels.

Cash flows used in investing activities was $4.5 million in the first three months of 2012 as the result of the purchase of $3.0 million of short-term investments and $1.5 million in expenditures on capital projects.

Cash flows used in financing activities was $1.8 million in the three-month period ended March 31, 2012, primarily as the result of $288,000 of payments on long-term debt and $1.5 million in cash dividends paid to stockholders.  While we expect to continue to declare quarterly dividends, the payment of future dividends is at the discretion of the Board of Directors and the timing and amount of any future dividends will depend upon earnings, cash requirements and financial condition of the Company.

Cash flows provided by operating activities was $4.4 million in the three-month period ended March 31, 2011, which primarily resulted from cash earnings, a decrease in income taxes receivable and an increase in accrued liabilities, partially offset by a decrease in accounts payable.  Income taxes receivable decreased due to the receipt of $2.7 million in cash of 2010 federal income tax overpayments and because we determined $1.2 million of eligible federal tax carrybacks will be applied to future periods.  Accrued liabilities increased primarily due to increased freight accruals, sales promotions and commissions due to timing of payments.  The decrease in accounts payable is primarily due to timing.

Cash flows used in investing activities was $717,000 in the first three months of 2011 due to expenditures on capital projects.

Cash flows used in financing activities was $3.8 million in the three-month period ended March 31, 2011, which consisted primarily of $1.0 million of normally scheduled principal payments on our bank term loans and $2.0 million of net repayments on our revolving credit line.  Additionally, we paid $749,000 in dividends to stockholders.

Critical Accounting Policies and Estimates

The preparation of our financial statements and related disclosures in conformity with GAAP 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 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

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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 provisions established, there can be no assurance that we will continue to experience the same credit loss rates as in the past.  No provision for doubtful accounts was recognized during the three-month periods ended March 31, 2012 and 2011, respectively. The provision for doubtful accounts was reduced by $20,000 during the three-month period ended March 31, 2012 based on historical experience and an evaluation of the quality of existing accounts receivable.  There were no recoveries credited during the first three months of 2012 or 2011.  No accounts receivable balances were written off in the three-month periods ended March 31, 2012 or 2011.

Inventory.  Our inventory consists of converted finished goods, bulk paper rolls 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 2012 and 2011, the inventory allowance was decreased $30,000 and $45,000, respectively, due to write-offs of and a reduction in slow moving or obsolete items.

New Accounting Pronouncements

Refer to the discussion of recently adopted/issued accounting pronouncements under Part I, Notes to Unaudited Interim Financial Statements Note 8 — New Accounting Pronouncements.

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 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 flows from operating activities or a measure of our liquidity.

EBITDA represents net income before net interest expense, income tax expense, depreciation and amortization. Amortization of deferred debt issuance costs is included in net interest expense.  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:

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.

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The following table reconciles EBITDA to net income for the three months ended March 31, 2012 and 2011:

EBITDA increased $2.8 million to $5.7 million in the quarter ended March 31, 2012, compared to $2.9 million in the same period in 2011.  EBITDA as a percent of net sales increased to 22.0% in the first quarter of 2012 from 12.7% in the first quarter of 2011.  The foregoing factors discussed in the net sales, cost of sales and selling, general and administrative expenses sections are the reasons for the decrease.

We use Net Debt as a supplemental measure of our leverage that is not required by, or presented in accordance with GAAP. Net Debt should not be considered as an alternative to total debt, total liabilities or any other performance measure derived in accordance with GAAP. Net Debt represents total debt reduced by cash and short-term investments. We use this figure as a means to evaluate our ability to repay our indebtedness and to measure the risk of our financial structure.

Net Debt represents the amount that Cash and Short-Term Investments is less than total Debt of the Company. The amounts included in the Net Debt calculation are derived from amounts included in the historical Balance Sheets. We have reported Net Debt because we regularly review Net Debt as a measure of the Company’s leverage. However, the Net Debt measure presented in this document may not be comparable to similarly titled measures reported by other companies due to differences in the components of the calculation.

Net Debt decreased from $11.1 million on December 31, 2011, to $9.3 million on March 31, 2012, as a result of a decrease in total debt and an increase in our cash and short-term investments.  The decrease in total debt is due to the required principal repayments of our debt.  The increase in the cash and short-term investment balances is due to cash received from operating activities.

The following table presents Net Debt as of March 31, 2012, and December 31, 2011:

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ITEM 3.  Quantitative and Qualitative Disclosures about Market Risk

There has been no material change in the information provided in response to Item 7A of the Company’s Form 10-K for the year ended December 31, 2011.

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, 2012.

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, 2012, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II.  OTHER INFORMATION

ITEM 1.  Legal Proceedings

None.

ITEM 1A. Risk Factors

As of the date of this filing, there have been no material changes from the risk factors disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011 as filed with the SEC on March 7, 2012.  We operate in a changing environment that involves numerous known and unknown risks and uncertainties that could materially affect our operations.  The risks, uncertainties and other factors set forth in our Annual Report on Form 10-K may cause our actual results, performances and achievements to be materially different from those expressed or implied by our forward-looking statements.  If any of these risks or events occur, our business, financial condition or results of operations may be adversely affected.

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, 2012.

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ITEM 3.  Defaults Upon Senior Securities

None.

ITEM 4.  Mine Safety Disclosures

Not applicable.

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.

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Exhibit Index

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