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Edited Transcript of TIS earnings conference call or presentation 8-Nov-17 3:00pm GMT

Thomson Reuters StreetEvents

Q3 2017 Orchids Paper Products Co Earnings Call

Pryor Nov 12, 2017 (Thomson StreetEvents) -- Edited Transcript of Orchids Paper Products Co earnings conference call or presentation Wednesday, November 8, 2017 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jeffrey S. Schoen

Orchids Paper Products Company - CEO, President and Director

* Rodney D. Gloss

Orchids Paper Products Company - CFO

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Conference Call Participants

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* John Nobile

Taglich Brothers, Inc., Research Division - Senior Equity Analyst

* Michael Fawzy Malouf

Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst & Head of Boston Team

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Presentation

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Operator [1]

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Good morning, and welcome to the Orchids Paper Products Third Quarter 2017 Earnings Conference Call. (Operator Instructions) Please note this event is being recorded.

On the call today are Jeff Schoen, President and Chief Executive Officer; and Rod Gloss, Chief Financial Officer.

I will now turn the call over to Mr. Gloss. Please go ahead.

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Rodney D. Gloss, Orchids Paper Products Company - CFO [2]

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Good morning, and thank you for joining Orchids' Third Quarter 2017 Earnings Conference Call. During this call, I will provide a review of the third quarter's results, and then Jeff will provide an update of the business and guidance for the fourth quarter. We'll then conclude with a question-and-answer session.

Before we begin, I'd like to draw your attention to the safe harbor statement issued in yesterday's press release. Please remember that certain statements made during this conference call are forward-looking statements within the Private Securities and Litigation Reform Act of 1995, as amended. These forward-looking statements are based on current expectations, estimates, assumptions and projections that are subject to change, and actual results may differ materially from the forward-looking statements.

Factors that could cause actual results to differ materially include those risks and uncertainties described in our filings with the Securities and Exchange Commission, including our Form 10-K for the year December 31, 2016, as well as our earnings release and any supplemental information. Any forward-looking statements are made only as of this date, and the company assumes no obligation to update any forward-looking statements.

During our remarks, we will be making references to both GAAP and non-GAAP measures. The reconciliation between GAAP and non-GAAP measures is included in our earnings press release, which is also available on our website. Non-GAAP measures we use include EBITDA and adjusted EBITDA. We will also be making a distinction between operating cash flows attributable to changes in working capital and other operating sources and uses of cash.

Management believes that these non-GAAP measures provide incremental information useful in understanding the cash flows and operating performance of the company. The EBITDA measures are also required and evaluated by our lenders. The non-GAAP measures should not be construed as alternative or better metrics than the GAAP measures.

Moving forward with the comparison of the financial results in the third quarter of 2017 relative to the third quarter of 2016. Revenues, net of discounts, increased $5.5 million or 14% in the third quarter of 2017 compared to the same period in the prior year. Net sales of converted product benefited approximately $4.2 million from the increased volume, while a lower average selling price per ton, net of discounts, had a negative impact of approximately $500,000. Additionally, parent roll sales increased $1.8 million, resulting directly from ramping of capacity at the new mill in Barnwell, South Carolina, making more conventional parent rolls from Pryor available for sale.

Gross margin in the third quarter of 2017 was 6.1%, down from 15.7% in the third quarter of 2016. The 960 basis point decline was driven by several factors. First, lower pricing, inclusive of changes in freight, negatively impacted gross margins by roughly 330 basis points. This was a result of an elevated competitive environment as well as competitive pricing for new business.

Second, higher material costs hurt margins by approximately 380 basis points. Higher material costs were principally due to lower-than-expected ramp of the fiber recovery at Barnwell as well as a general increase in fiber prices. We also saw a general increase in other material prices. The fiber recovery system at Barnwell is currently fully operational, and we expect to drive an increase in future margins as a result.

Third, utility and recycled fiber costs in Mexicali increased, driving margins down by approximately 280 basis points. We expect that the ramp of new business in the new Barnwell facility over the next 2 quarters will drive additional sales growth as well as improved margins. In addition, the company is currently in process of engaging in various cost reduction programs that we believe will expand margins in the coming quarters.

SG&A expenses increased $0.5 million, principally due to contributions of excess inventory to support hurricane relief efforts and due to increased legal and professional fees. Interest expense increased $200,000 or 29% to $0.8 million due principally to increased debt levels. Our interest rate is largely variable and dependent upon our financial leverage and was 5.2% at the end of the third quarter of 2017. Interest expense for the third quarter of 2017 excludes $1.5 million of interest capitalized to the Barnwell, South Carolina capital project, pending its completion, compared to capitalized interest of $300,000 for the same period in 2016.

A tax benefit of $2 million was recognized in the third quarter of 2017 compared to tax expense of about $700,000 in the third quarter of 2016, reflecting both a decline in pretax earnings and the company's recognition of tax credits on a year-to-date basis.

As a result of the foregoing factors, net income of $700,000 or $0.07 per basic share was recognized in the third quarter of 2017 compared to net income of $2.2 million or $0.21 per basic share in the third quarter of 2016. Adjusted EBITDA in the third quarter of 2017 was $3.9 million compared to $7.1 million in the third quarter of 2016.

Operating cash flows, excluding changes in working capital, decreased $7.6 million compared to the third quarter of 2016, primarily reflecting the decrease in net income, net of changes in deferred taxes. Changes in working capital provided $0.9 million of operating cash flows in the third quarter of 2017, principally as accounts payable decreased a bit more than accounts receivable increased. Cash from borrowings in both periods was used to finance investments in the Barnwell facility.

Comparing the third quarter of 2017 with the second quarter of 2017, revenue grew 17.5% and gross margins improved by roughly 2 margin points. The margin improvement was primarily impacted by better product mix, improved absorption at our Pryor plant, driven by increased production and sales volumes. As opposed to the increases in SG&A expenses noted in the prior comparison, SG&A expenses declined about $300,000 due to the avoidance of timing issues noted in the prior quarter such as a high degree of employee claims, medical claims, and a higher level of legal and consulting fees.

I will now turn the call over to Mr. Schoen.

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Jeffrey S. Schoen, Orchids Paper Products Company - CEO, President and Director [3]

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Good morning. Sales in Q3 experienced strong growth due to new business that started shipping in June, leading to an annualized revenue level of about $180 million. We successfully replaced the business lost to branded and other competitors in 2016, but had an approximate 3% margin hit including reductions in net selling prices plus higher freight costs related to a higher mix of delivered pricing. Looking forward, we are pursuing specific cost management programs in the range of $4 million to $5 million to recover margin. We are on track to complete the startup curve of the Barnwell facility by the end of 2017, as we stated previously. Relative to our startup curves, the paper machine has met all expectations from a product quality and cost standpoint. The fiber prep and recovery systems, which are part of the overall papermaking system, ramped up slower than expected, resulting in a temporary increase in fiber costs. The fiber prep and recovery system is now fully operational, which should drive an improvement in future margins.

In August, we announced the addition of a new ultra-premium customer that, when fully implemented by Q2 2018, will increase total company sales to a range of $220 million to $240 million. I am pleased to announce that starting in December, we expect to ship 50% of the final sales run rate and ramp to full production by the end of the first quarter of 2018. As I've previously stated, the Barnwell plant was designed to produce ultra-premium products at higher selling prices per ton and margins than the value and premium segments of our business. The paper machine has met all startup expectations and is fully capable of delivering the product quality and capacity to support the new business. This new business will load the Barnwell facility at approximately 80% and will provide 40% to 50% contribution margins. Our largest cost increase of the last year has been the overhead and infrastructure at the new Barnwell, South Carolina plant. As we ramp up our recent customer win with ultra-premium converted product business at this facility, we expect to see a substantial increase in selling prices per ton and gross margin as this new business will significantly offset the margin deterioration we have seen in the value and premium product segments.

Our banks granted us with a covenant waiver in the third quarter as we are in the final stages of ramping production at our new Barnwell facility, which we again expect to drive a significant increase in revenue and margins. The company is focused on working with the bank to properly finance the debt structure in a way that allows Orchids to implement its business plan in a lower-risk environment.

Beginning this quarter, we are going to start providing earnings guidance to our investors. Taking into account seasonality factors and the beginning of the ramp-up of the new business, we expect fourth quarter revenue to be in the range of $43 million to $46 million and adjusted EBITDA to be between $4 million and $5 million.

With that, I will now turn the call back to the operator for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Mike Malouf with Craig-Hallum Capital Group.

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Michael Fawzy Malouf, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst & Head of Boston Team [2]

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If we could -- you kind of guided the $220 million to $240 million run rate when -- at the end of the first quarter when everything is up and running. Can you give us a sense of what would cause you to be at sort of the lower end or the higher end of that range? And then within kind of the new business pipeline, is there -- does this pretty much gets you to where you want to be as far as capacity? Or do you have any more that you can squeeze out? And is there any other obviously smaller prospect in the wings?

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Jeffrey S. Schoen, Orchids Paper Products Company - CEO, President and Director [3]

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So starting with the new business and the range that we provided. I think what we've learned in the past with some of the customers is sometimes, the ramps are slower than they expect. And so that would -- that's what would drive a lower number. It's not really a function of not getting the business. It's a function of how fast we roll it out. And it's a combination of a couple of things. One is, the orders that come in, they come in based on historical, where they are. That's one factor, so the rate at which they come in and the rate at which they are managing their business is a factor. I will tell you though that a bigger factor from our perspective is the ability of us to ramp up. They want us to ramp up faster, if we can. Right now, with Barnwell up and running, we're at that 50% run rate. The other 50% is dependent on Pryor coming up. And all that they need are certain change parts, which we expect to arrive by the end of December. So really, a combination of those 2 things is the reason we have the range for that particular business. The -- regarding -- sorry.

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Michael Fawzy Malouf, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst & Head of Boston Team [4]

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And then -- go ahead.

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Jeffrey S. Schoen, Orchids Paper Products Company - CEO, President and Director [5]

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Regarding overall capacity, we said that this business will -- this business and existing business at Barnwell will sell us out at about 80%. If you think about the total tons in the company, we've got about 130,000 tons, so we probably got in the range of 15,000 to 20,000 tons available, which represents a couple of million cases probably in that range. So really from a company perspective and absorption, we're in that sweet spot, where we can really start to drive cost, cost savings and cost management, by becoming more efficient. And the marginal capacity that we increase because of that, I think, gives us another 20,000 tons and a couple of million cases of incremental sales opportunity.

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Michael Fawzy Malouf, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst & Head of Boston Team [6]

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Okay, great. And then when you look into 2018, and let's assume by, say, the end of June, you are fully ramped, can you give us a sense of where the gross profit -- given some of the cost controls that you've tried -- that you started to implement and some of the obviously savings with regards to fiber that you're going to get now that you're operational. So can you just give us a sense of where that gross profit you think will shake out once you are fully ramped with these 2 large clients?

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Jeffrey S. Schoen, Orchids Paper Products Company - CEO, President and Director [7]

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I think when we look at our models right now, I'm not -- I'm trying not -- I really want to give better guidance on the year after we get the fourth quarter. But I think our models are saying we're in the 18% to 20% EBITDA run rate by the time we fully ramp up this new business and execute some of our cost management programs.

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Michael Fawzy Malouf, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst & Head of Boston Team [8]

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Okay. All right. Great. And then with regards to the debt, there's obviously a lot of movement going on. So your banks have given you how much time to sort of refinance this? And are the banks considering just doing it on their own? Can you just give us a little bit more color on that? Because it seems like it's taken a long time to get something in place. And maybe you just needed to get this thing ramped up before they were going to give you to greenlight, but I'd love some color on that.

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Jeffrey S. Schoen, Orchids Paper Products Company - CEO, President and Director [9]

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Obviously, we all want to do what's right for all of the stakeholders in this process. It's difficult for me to talk about specifics because there are several windows that we are still pursuing. I do think though that the longer -- the position that we're at right now, I do think that is very valuable knowing that we have this new business and that we're completing the Barnwell ramp for the investors who have been looking at this with us and coming up with terms that are acceptable to everybody. Being at this position with these headwinds effectively behind us give me a pretty high confidence that we will be able to get where we want to be within this quarter. We're actually being somewhat held accountable to that, so there's a high sense of urgency to deliver that. And as I said, there are several options that we are exploring right now that we think lead to a path that satisfies all stakeholders.

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Operator [10]

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(Operator Instructions) The next question comes from John Nobile with Taglich Brothers.

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John Nobile, Taglich Brothers, Inc., Research Division - Senior Equity Analyst [11]

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I wanted to start with the converted sales was $42 million in the third quarter, and I remember last call, it was mentioned that in June and July, the converted sales volumes were at an annual run rate of about $180 million to $190 million. And that, at the low end, is really about $45 million a quarter. And you just reiterated that with the -- saying about $180 million run rate. Now I look at the numbers at $42 million and I found that's about $3 million shy from the lower end of the run rate. So I just wanted to get a handle on the $42 million versus, really, the run rate that was mentioned, the $45 million. What were the mechanics in that? And were there any manufacturing issues in that? Did the customers require less? Was it selling prices? I just wanted to get a handle on that.

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Jeffrey S. Schoen, Orchids Paper Products Company - CEO, President and Director [12]

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Well, $180 million run rate includes parent rolls, John. So that's what I was talking...

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John Nobile, Taglich Brothers, Inc., Research Division - Senior Equity Analyst [13]

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Oh, I thought that was converted, okay. I thought -- because I remember bringing that up on the last call, and it was mentioned that, that was converted sales.

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Jeffrey S. Schoen, Orchids Paper Products Company - CEO, President and Director [14]

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Well, we're at $180 million run rate. Well, let me talk about the converted sales. So in June, we saw -- you have a pipeline fill that occurred. So we were higher as a run rate in June than we were in July because we saw July come down, and then we saw August come up to close to normal levels, I would say. Then the hurricanes hit us, which impacted us probably somewhere in the neighborhood of 50,000 cases between the 2 things. It was really a big deal in terms of shipping down there as well as having higher freight costs to get it done. So cleaning it up, what I'm saying is our run rate's about $180 million. Now you load on this new business, and you're $220 million to $240 million.

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John Nobile, Taglich Brothers, Inc., Research Division - Senior Equity Analyst [15]

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Okay, so -- because I do remember you did say that it was on the converted sales. I brought that up specific last call, that's why I was looking at really about a $45 million rate. But now we're looking at total with converted -- excuse me, parent roll sales. So okay, all right. I'll take that into consideration. One other thing, there was -- well, it was supposed to be minimal, and this was brought up on the other call too, interest being capitalized from the Barnwell project in the third quarter. So I look and I see that this quarter, you really capitalized about $1.6 million of the interest in the third quarter. And I just wondered why that much was capitalized. I think there was still only about $5 million of CapEx for the project. I was surprised to see that high of capitalized interest in the third quarter. And that leads me to a question to ask if there's anything left to be capitalized in the fourth quarter.

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Rodney D. Gloss, Orchids Paper Products Company - CFO [16]

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John, first part of that, on the interest, we didn't finish up the project as early as we thought on our last call. We're capitalizing all of Barnwell, except for the recycling plant, at the end of Q3. So September 30, the lion's share of the capitalized interest stopped. But the quarter had a full allocation of capitalized interest. The only thing we'll be capitalizing interest on in Q4 is the recycled fiber plant at Barnwell that was completed in November. So we'll just have 1 month or 1.5 months of capitalized interest on a small piece of the project in Q4.

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John Nobile, Taglich Brothers, Inc., Research Division - Senior Equity Analyst [17]

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Which should be pretty minimal as far as what we're going to see capitalized in Q4.

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Rodney D. Gloss, Orchids Paper Products Company - CFO [18]

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Correct. We should see minimal capitalization of interest in Q4. I think there was another part to your question.

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John Nobile, Taglich Brothers, Inc., Research Division - Senior Equity Analyst [19]

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Well, that was the other part as far as what's left to be capitalized in the fourth quarter. But with the new business mentioned in August, I'm curious if you'll be able to satisfy that with your existing paper machines. And I'm curious if you would need purchase parent rolls in the secondary market at that $220 million to $240 million run rate.

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Jeffrey S. Schoen, Orchids Paper Products Company - CEO, President and Director [20]

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The answer is, at this point, no. Our goal is to sell Barnwell out with 100% ultra-premium paper, frankly. That's what we get the highest selling prices and margins and EBITDA contribution from. So at this point, we're not anticipating buying parent rolls.

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John Nobile, Taglich Brothers, Inc., Research Division - Senior Equity Analyst [21]

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Okay. So no problem even with -- towards the higher end. If it was $240 million, you should satisfy that with your own machines, right?

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Jeffrey S. Schoen, Orchids Paper Products Company - CEO, President and Director [22]

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Yes. And we can go even a little bit higher there in terms of overall parent roll sales. It depends on the mix.

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John Nobile, Taglich Brothers, Inc., Research Division - Senior Equity Analyst [23]

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Okay. And that just leads me to another question because you're still working on qualifying the ultra-premium products with certain retailers. I believe that's still ongoing. I was wondering if you can elaborate on how well that's actually going. Haven't heard anything short of the August release as far as winning that business. But how is that going with the qualification of other retailers? And I'm just curious, if you do get a significant further increase in business, are you going to need to expand further from where you are now?

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Jeffrey S. Schoen, Orchids Paper Products Company - CEO, President and Director [24]

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Well, keep in mind, John, that the new business we announced in August is 100% ultra-premium paper, so we have qualified very robust process with this particular customer, took us several months, even pre the machine starting up, to work through this. So as far as I'm concerned, it's been qualified by one of the best qualifiers in the country. Having said that, we've also qualified with a couple of other customers that are in the final stages of looking at pricing. But I'm very happy and confident with the fact that the paper that we produced on this machine matches what we expected when we bought the assets 2 years ago.

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John Nobile, Taglich Brothers, Inc., Research Division - Senior Equity Analyst [25]

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Okay. Only because you had mentioned earlier that you're going to be near capacity, well, about 80% capacity with the new business, which really bumps you up nicely. Congratulations on that, but I'm just -- call it a good concern about another significant retailer jumping on ship and hitting your capacity or going beyond it. But I guess we'll address that if and when we get there.

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Jeffrey S. Schoen, Orchids Paper Products Company - CEO, President and Director [26]

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Yes. I think you ask, when we get there, there's definitely opportunity. Of course, our focus right now is really managing the debt structure of the company and getting that where it needs to be before we talk about moving any further beyond that.

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John Nobile, Taglich Brothers, Inc., Research Division - Senior Equity Analyst [27]

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Just one final question. I don't want to hog up the whole call here. But your higher cost inventory affected the second quarter. And I believe it was supposed to be exhausted in the third quarter, which obviously affected your margins. So I just wanted to find out if indeed that higher cost inventory has been fully exhausted. And if we could expect a significant -- an improvement in your margin starting in the current fourth quarter.

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Rodney D. Gloss, Orchids Paper Products Company - CFO [28]

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John, mixed answer on that. The cost adjustment that you're referring to was at Pryor. As we've loaded volume back on Pryor, its cost per unit has been declining, and so we're -- we've got a lower cost inventory now at Pryor. We haven't hit that same benchmark at Barnwell yet. But we should hit that benchmark in Q4 with a new business being loaded on. So we will be working off high-cost inventory at Barnwell late in the fourth quarter and first quarter of next year. So yes, we've sustained all that for Pryor, but we've got some high-cost inventory at Barnwell we'll be working through in Q4 and Q1.

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Operator [29]

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This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Schoen for any closing remarks.

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Jeffrey S. Schoen, Orchids Paper Products Company - CEO, President and Director [30]

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Wow, that's probably the fewest questions I've ever had. Well, anyway, I want to thank everybody for their time. Obviously, Orchids with -- if I look back 6 quarters on this business and where we were Q1 of '16, it's a reference point that I've used, we've come a long way to mitigate the volume that we ended up losing, but we've recovered it. And I really believe that with Orchids selling ultra-premium on our QRT line, that that's a game changer for this company, and we should see significant improvements in results in Q4 and Q1 moving forward. So I appreciate your time.

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Operator [31]

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The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.