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Edited Transcript of TIS earnings conference call or presentation 8-Aug-17 2:00pm GMT

Thomson Reuters StreetEvents

Q2 2017 Orchids Paper Products Co Earnings Call

Pryor Aug 12, 2017 (Thomson StreetEvents) -- Edited Transcript of Orchids Paper Products Co earnings conference call or presentation Tuesday, August 8, 2017 at 2:00:00pm 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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* DeForest Hinman

* Evan Greenberg

* Jackson Webster

* 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

* Michael N. Taglich

Taglich Brothers, Inc. - Co-Founder, President, and Chairman

* Naveed Uddin

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Presentation

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Operator [1]

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

On the call today are Mr. Jeff Schoen, President and Chief Executive Officer, and Mr. 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 attending Orchid's Second Quarter 2017 Earnings Call. I will begin with the standard notices and then review the second quarter's results. Jeff will then provide his perspective on our results and on our business. We'll conclude with a question-and-answer session.

Please remember that certain statements made during this conference call are forward-looking statements within the Private Securities 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 ended 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 statement.

During our remarks, we will make references to both GAAP and non-GAAP measures. The reconciliations between GAAP and non-GAAP measures are included in our earnings press release, which is also available on our website. Non-GAAP measures we use include EBITDA and adjusted EBITDA. I 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 into the cash flows and operating performance of the company. The EBITDA measures are required by our lenders and the non-GAAP measures should not be construed as alternative or better metrics than the GAAP measures.

I will now compare financial results in the second quarter of 2017 to those in the second quarter of 2016.

Net sales decreased $1.0 million, or 2%. Major factors leading to this decrease include parent roll sales volume increased to $3.7 million, while converted-product sales volume declined $2.3 million, and there was a decrease of $2.3 million in average converted-product prices, reflecting both the lower prices associated with new bids which became effective in 2017 and the product mix sold to a changing mix of customers.

Cost of sales increased $4.4 million, or 13%. Standard cost of sales for parent rolls increased $2.4 million due to the much higher number of parent-roll tons sold. This leaves a $2.0 million, or 7%, increase in cost of sales that is primarily attributable to converted product sales. Major contributors to this increase in their approximate order of significance include the addition of labor, overhead and start-up costs for Barnwell not yet being fully offset by production and absorption. This accounts for the largest portion of the relative cost increase. When sales and production volumes increased in June, absorption increased and [creative] costs decreased, but this was more than offset by the sale of older, higher-cost inventory manufactured when operating leverage and operating efficiencies were lower.

Next, the timing of healthcare claims filed by employees drove significant increases in benefit costs in the second quarter of 2017. Fiber usage increased and higher prices were paid for fiber on the West Coast for Mexicalli. Labor usage increased. And utility costs increased principally due to significant rate increases in Mexicalli.

Additionally, the second quarter of 2016 benefited from the recovery of $1.1 million in business interruption insurance proceeds, which did not reoccur in 2017.

SG&A expenses increased $0.8 million principally due to increased legal and professional fees and the timing of employee medical claims.

Interest expense increased $0.3 million, or 96%, due principally to increased debt levels. The interest rate is also variable and dependent upon our financial leverage, and was approximately 5.1% at the end of the second quarter of 2017. Most interest was capitalized to Barnwell, South Carolina's capital project, pending its completion.

The tax benefit of $0.4 million was recognized in the second quarter of 2017 compared to tax expense of $1.3 million in the second quarter of 2016, reflecting both the decline in pre-tax earnings and the company's recognition of tax credits. The effective combined tax rate estimated in the second quarter of 2017 is 21%, lower than the statutory rate principally due to Oklahoma tax incentives that are not proportional to income.

For those of you who have requested guidance as to the expected future tax rate, I believe it likely to increase to between 24% and 27% for the balance of 2017, and to move to within a 30% to 34% range for 2018.

As a result of the foregoing factors, a loss of $2 million, or $0.20 per basic share, was recognized in the second quarter of 2017 compared to net income of $2.6 million, or $0.25 per basic share, in the second quarter of 2016.

EBITDA was $1.6 million in second quarter of 2017 and $7.6 million in the second quarter of 2016. The change principally related to the change in pretax income. Adjusted EBITDA was $2.5 million in the second quarter of 2017 and $8.2 million in the second quarter of 2016.

The principal difference between EBITDA of $1.6 million in the second quarter of 2017 to adjusted EBITDA of $2.5 million was an add-back of $760,000 for startup costs incurred at Barnwell in the quarter.

Operating cash flows excluding changes in working capital decreased $2.2 million comparing second quarter 2017 to second quarter 2016 primarily reflecting the decrease in net income less the noncash impact of deferred taxes.

Changes in working capital nominally used $5.1 million of operating cash flows in the second quarter of 2017 compared to $1.2 million in the second quarter of 2016. However, this $5.1 million net use includes a $5.4 million increase in tax refunds receivable expected to be carried forward to future years, and this is another noncash transaction. Exclusive of this increase in tax refunds receivable in 2017, working capital provided $0.3 million in cash.

This $0.3 million net figure principally reflects receipt of $3.5 million of tax refunds in the current quarter and an increase in accounts payable, largely offset by increased inventories and accounts receivable that are in support of our new business.

Turning to a comparison of second quarter 2017 relative to the immediately preceding quarter, net sales increased $3.1 million, or 9%, as the previously announced business began to be produced and shipped in the second quarter of 2017. Parent roll sales increased $1.3 million. Converted-product revenues increased $1.8 million. A $2.4 million increase resulted from an increase in volume and a $0.6 million decrease resulted from a decrease in the average price.

Cost of sales increased $3.5 million, or 11%. Standard cost of sales for parent rolls increased $1.3 million, with $0.9 million of this increase being attributable to the greater number of parent roll tons sold. This leaves $2.2 million, or 7%, increase in cost of sales that is attributable to converted-product sales, freight costs and manufacturing variances. The converted-product tons sold increased 7%, roughly the same relative figure as the cost of sales, exclusive of the parent rolls.

There was a net $0.4 million increase in costs, principally attributable to the sales of higher-cost inventory produced in first quarter and to the unfavorable material usage variances. Barnwell's startup costs are estimated to have been $760,000 in the second quarter of 2017, versus $312,000 in the first quarter of 2017.

SG&A expenses increased $0.7 million principally due to increased legal and professional fees, the timing of employee medical benefits and the timing of recognition of stock options.

Interest expense remained relatively flat at $0.6 million in the second quarter of 2017 compared to $0.5 million in the first quarter of 2017. Most interest incurred was capitalized to the Barnwell, South Carolina project, pending its completion.

A tax benefit of $0.4 million was recognized in both the second quarter of 2017 and the first quarter of 2017.

EBITDA was $1.6 million in second quarter of 2017 and $2.7 million in the second quarter of 2016. The change principally related to the change in pretax income. Adjusted EBITDA was $2.5 million in the second quarter of 2017 and $3.1 million in the first quarter of 2017, Barnwell startup costs being the most significant adjustment to EBITDA in both quarters.

Operating cash flows excluding changes in working capital decreased $0.8 million compared to the first quarter of 2017, primarily reflecting a decrease in net income net of noncash changes in deferred taxes.

Changes in working capital provided $0.3 million of operating cash flows in the second quarter of 2017, net of the noncash $5.4 million increase in tax refunds receivable expected to be carried forward to future years. This is compared to $1.2 million net source of funds in the first quarter of 2017, also net of the noncash change of $5.0 million in the tax refunds receivable in that quarter.

At June 30, 2017, debt not having been netted with unamortized deferred debt issuance costs was $167.6 million and was largely incurred to finance the construction of our integrated converting facility in Barnwell, South Carolina. The total project expenditure for the Barnwell facility is approximately $160 million, of which $155 million had been expended as of June 30, 2017.

The fiber processing plant in Barnwell is expected to be completed this week. Otherwise, the Barnwell plant was completed in June. Roughly $5 million of related invoices payable -- unbilled amounts remains to be paid.

At June 30, 2017 our leverage ratio was 8.8 and fixed charge coverage ratio was negative 0.2. Our lenders waived the leverage ratio and fixed-charge coverage ratio requirements for June 30, 2017. As of June 30, 2017, the borrowing under the credit agreement and the term loan that are due in 2022 were reclassified as current on the balance sheet due to uncertainties regarding our ability to meet the existing debt covenants over the next 12-month period. There can be no assurances that our lenders will agree to further waivers or amendments to the existing debt covenants. While management intends to amend or refinance the debt, there can be no assurance that we will be able to obtain additional financing on terms that are satisfactory to us or at all.

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.

As expected, June sales increased significantly, reflecting the new business we announced last January. Our current sales run rate, including July results, is in the range of $180 million to $190 million, with case sales rates in the range of 12 million to 13 million cases annually.

Strategically this new business helps us broaden our customer base and sales concentration, although we must continue to diversify our customer base and further reduce the risks associated with customer concentration.

On a positive note, I expect the new business we started in June to be stable for at least 3 years, assuming Orchids executes well in terms of quality and service. This particular retailer believes good processes take a lot of time and people resources that can be better focused by working with key suppliers and applying those resources to areas that add more value, like product development, cost management, supply chain management and speed to market.

Although our operating costs came down significantly in June, the overhang of higher-cost inventory produced in April and May resulted in over $2 million in costs flowing out of inventory and into cost of sales in June. The April and May cost structure represented the highest cost structure we experienced this year, due to reduced sales and production volumes.

Moving forward, the higher-cost inventory will be fully replaced by the end of August since we use a 3-month lagging inventory average as the basis for inventory valuation. Also keep in mind that the cash cost of the inventory is being recovered as we sell the old inventory. EBITDA will be positively impacted by cost savings as the older inventory is replaced, which will be reflected in Q3 earnings. In addition, as we sync up production to sales, the company will increase its absorption, which will have a further positive impact on EBITDA.

Moving on to Barnwell, we designed Barnwell to give Orchids the capability to compete effectively in the ultra-premium products segment, where higher selling prices and less competition presently exist. Right now ultra-premium paper capacity in the industry appears to be tight, reflecting the growth rates in the ultra-premium products segment.

Only a few years ago private label competitors announced new ultra-premium TAD capacity expansions in the amount, I believe, of about 500,000 tons. Today that capacity appears to be fully utilized as both national brand and private label companies have announced new expansions in TAD and NTT capacity scheduled to start up in 2019 and 2020, reflecting what I believe is a shift by the consumer to higher quality products, as well as private label quality approaching national brand quality.

The new QRT product capabilities, as well as the limited ultra-premium capacity position Orchids well to enter the ultra-premium space. QRT is the hybrid machine that includes one of the best parts of the TAD, NTT and light dry crepe machine. The quality of the paper rivals TAD without the higher cost structure associated with TAD.

We have successfully passed a product qualification for ultra-premium bath tissue with a potential major new customer and are in the process of finalizing the qualification of an ultra-premium kitchen towel. In addition, we are qualifying ultra-premium bath tissue and kitchen towel business for private label bids that are currently underway and for which we expect shipments in 2018.

Finally, we are qualifying existing ultra-premium converters with TAD-equivalent paper that will allow us to sell parent rolls at higher average selling prices per ton than conventional paper, while we work to sell off the converted-product capacity.

We believe any more ultra-premium business will increase our average selling price per ton EBITDA contribution relative to our current conventional paper averages. As we sell out our existing available capacity, which is in the range of 4 million to 5 million cases on an annual basis, along with cost optimizations we expect EBITDA margins to recover to a range within -- between 18% and 22%.

Given the early success we're having on the quality of the products and our expected cost structure, we're highly optimistic we will be able to sell out our new capacity in 2018.

We expect Barnwell to complete its ramp-up curve by the end of the year. The paper machine is currently operating at a rate of about 20,000 to 25,000 tons on an annualized basis. Given the complexity of this project, although not satisfied, we are happy with this project progress and expect all current line speed and delayed bottlenecks to be resolved in Q3, with continued optimization to occur in Q4.

Right now Orchid's complete focus is on our execution from a quality and service standpoint to existing customers, selling out our new capacity, cost management and debt management. We have substantially completed our capital expansion plans. Looking forward we expect minimal capital spending in 2018, averaging in the range of $4 million to $5 million on an annual basis.

We have implemented a margin improvement plan that includes both selling price increase on some existing business, as well as cost management plans targeting material spends, efficiencies and services.

As Rod mentioned, we are working closely with our banks, who have been very supportive as we complete the capital projects and begin to realize the associated benefits.

We believe the stock is grossly undervalued relative to the potential of the company. Concentration risk has been reduced with the addition of 3-plus-million cases outside of the dollar channel. Execution and risk has been reduced with the startup of Barnwell. As we move forward our cost structure will be improved significantly as we sell out the new capacity and implement our cost management plans. We are positioned to sell out our new capacity in the premium and ultra-premium segments, given the tight capacity in some of these product segments.

Given all of this, we believe the stock is grossly undervalued. Given our story is a positive one, we expect to resolve the debt concerns through a refinancing program with our existing banks or with an alternative debt structure in Q3.

Finally, Orchids is well positioned to sell out its new capacity at higher selling prices and margins. The timing associated with these new wins will be a function of product quality qualification, timing of new premium and ultra-premium bids, and opportunities that present themselves due to tight ultra-premium capacity.

With that final thought, I will turn the call back to the operator.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Mike Malouf of 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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Some of the encouraging signs you pointed out is nice, but I think the key question continues to be around the debt. I know that on the first part of the prepared comments you said there's no assurances, but then later you say that you have pretty good conversations with your banks right now with regards to refinancing in this quarter. So can you talk a little bit more about how that process is going, what kind of options you have and what we should sort of expect with regards to the debt side?

Jeffrey Schoen: Well, we have an active process going on with our banks to look at all different scenarios in terms of refinancing. I think most people know that there are several options. There is the term lending market, which is what we're currently in, term loan B. There is an ABL scenario that could exist. There's mezzanine. All these things are being evaluated to determine what's best for Orchids. I would say, though, that I know people are looking at operating leverage and are concerned, as we are. But if you think about the company from an asset perspective, our debt is $167 million. $160 million of that is because of Barnwell. Over the past 3 years we've invested probably $40 million in Pryor, another $37 million in our Mexican operation on the West Coast. When you look at that number, that's 48, 30, something -- 70-some million dollars, of which $7 million of that is left. So we have built an asset base in the company that book value is probably $360 million. Replacement value is probably $460 million. So when you think about the debt from the perspective of assets, $160 million relative to those numbers, or looking at a debt-to-equity ratios even, I think our debt-to-equity ratio is about 0.5, we're in a good position to get the financing done. The question is: what's the right way to get it done? That's what we're focused on. And that's the path that we're on. As opposed to the equity side, and of course that's still an option. There are lots of people who want to invest in the company at this stage. But it's not the best option. The best option for us is to pursue the path that we're on.

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Michael Fawzy Malouf, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst & Head of Boston Team [3]

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Okay. And then a quick question on the operating leverage. You mentioned sort of targets of 18% to 22% with regards to EBITDA. And what kind of revenue run rate on a quarterly basis would that be, sort of achievable?

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Rodney D. Gloss, Orchids Paper Products Company - CFO [4]

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We sell, you mean with (inaudible)?

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

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Mike, do you mean we were kind of sold out in capacity, which we expect in 2018? Or are you talking about present situation?

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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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You mentioned that you think the leverage is able to get up to the 18% to 20% range. And I'm just wondering what type of revenue rate does that equate to in your model

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Rodney D. Gloss, Orchids Paper Products Company - CFO [7]

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It's basically loading up the capacity and the EBITDA levels that we would expect in 2018.

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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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And what would that be on a revenue basis?

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Rodney D. Gloss, Orchids Paper Products Company - CFO [9]

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On the -- sorry -- don't have the dollar figure on the tip of my tongue, and the dollar figure depends greatly on mix. But some of your outer capacity, we're thinking about 135,000 tons of capacity, which -- what's that equate to in cases, about -- multiply that 135,000 tons by about 150 or 160 cases per ton and you have a case figure. But in terms of dollars it depends on the mix. To the extent we're --

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Jeffrey S. Schoen, Orchids Paper Products Company - CEO, President and Director [10]

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Let me answer that. We're at $180 million to $190 million. We've got 5 million more cases. That puts us at the 250-plus range in terms of revenue. The 18% to 20% puts us at $50 million of EBITDA. That's what our model says we will attain by increasing our mix from -- of more ultra-premium to what our current base is. And the cost structure that we've developed at Barnwell will support that.

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Michael Fawzy Malouf, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst & Head of Boston Team [11]

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And you still feel that that's a target to reach on an annual sort of run rate basis by the end of 2018. Is that sort of your target?

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

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Yes. Yes.

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Michael Fawzy Malouf, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst & Head of Boston Team [13]

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Got it.

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Operator [14]

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Our next question comes from John Nobile of Taglich Brothers.

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

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I just wanted to get some clarification on the $180 million to 190 million range of sales for June. Now is this converted product we're talking about, or is this total?

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

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It's -- Jeff is basically quoting converted product.

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

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That is converted. Okay. And what type of gross margins are we looking at with that annual run rate of $180 million to $190 million? I know your June figure was that. And did you say that July was also at that rate right now, so we're currently at that run rate?

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

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Yes. July ran at the same sort of sales rate as June. And Jeff has put in his comments that we're expecting 18% to 22% EBITDA margins going forward on the sales.

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Jeffrey S. Schoen, Orchids Paper Products Company - CEO, President and Director [19]

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Oh, not that -- that's (inaudible).

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John Nobile, Taglich Brothers, Inc., Research Division - Senior Equity Analyst [20]

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That's in the new curve.

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Jeffrey S. Schoen, Orchids Paper Products Company - CEO, President and Director [21]

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That's in the new curve.

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John Nobile, Taglich Brothers, Inc., Research Division - Senior Equity Analyst [22]

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That should be 2018, I believe, for 18% to 22% margins.

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Jeffrey S. Schoen, Orchids Paper Products Company - CEO, President and Director [23]

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Correct.

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John Nobile, Taglich Brothers, Inc., Research Division - Senior Equity Analyst [24]

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I'm just saying at this point here -- because EBITDA margins to be at that rate you're looking at nearer to a $250 million revenue rate, I believe. Correct?

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Rodney D. Gloss, Orchids Paper Products Company - CFO [25]

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Right. That's correct. We're not there yet, because of Barnwell's startup curve and optimization we have to do relative to the volume and rightsizing the organization as we go through this ramp-up.

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John Nobile, Taglich Brothers, Inc., Research Division - Senior Equity Analyst [26]

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Okay. Actually, interest expense, I noticed it seemed like a small amount on the income statement. However, I imagine a great portion of it was capitalized. Could you give us that number, how much interest expense in the second quarter was indeed capitalized?

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Rodney D. Gloss, Orchids Paper Products Company - CFO [27]

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If you take roughly $160 million of debt times about 5% interest rate, you should come up with the annualized number, and then divide by 4 to get to the total.

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John Nobile, Taglich Brothers, Inc., Research Division - Senior Equity Analyst [28]

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Total (inaudible).

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Rodney D. Gloss, Orchids Paper Products Company - CFO [29]

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Sorry I'm not remembering it off the top of my head, but you are correct that the lion's share of the interest was capitalized in the quarter because we didn't complete Barnwell until late June.

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John Nobile, Taglich Brothers, Inc., Research Division - Senior Equity Analyst [30]

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Okay. So with Barnwell complete into the third quarter right now, there should be no more capitalization of interest. Am I correct we'll see the full interest on the income statement?

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Rodney D. Gloss, Orchids Paper Products Company - CFO [31]

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With a small exception. We're completing the paper processing plant at Barnwell. It should be completed this week. It's someplace -- it's less than a $5 million investment, so that part of it hasn't been capitalized yet.

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John Nobile, Taglich Brothers, Inc., Research Division - Senior Equity Analyst [32]

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Okay. It's relatively insignificant.

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Rodney D. Gloss, Orchids Paper Products Company - CFO [33]

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But with that exception, yes.

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John Nobile, Taglich Brothers, Inc., Research Division - Senior Equity Analyst [34]

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Okay. And how much of the newly won business that was announced earlier in the year -- I think it was in January you had the 8-K out there. How much of that actually contributed to the second quarter sales? Now you say it ramped up in June. So I just wanted to get a feel for either revenue, or if you can quantify that in tonnage, I'd appreciate that.

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Rodney D. Gloss, Orchids Paper Products Company - CFO [35]

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Okay. So I'm sorry, you're asking how many cases or dollars we sold in June at sort of incremental basis?

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John Nobile, Taglich Brothers, Inc., Research Division - Senior Equity Analyst [36]

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The newly announced business, which I think was at least 30%, 35% over I believe it was last year's third quarter, that you were looking to have an increase in converted tonnage. So I'm just curious, now that June sales have that in there, what -- well, actually the second quarter how much of that really was from this new business that was mentioned earlier in the year?

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Rodney D. Gloss, Orchids Paper Products Company - CFO [37]

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Well, basically all of it, almost all of it, was [implemented] in June. So there's probably another 10%, 20% that we were promised that hasn't been placed on order as yet. So there should be a little bit more uptick in sales. But basically all of that 30%, 35% that we were promised, it kicked in in June.

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John Nobile, Taglich Brothers, Inc., Research Division - Senior Equity Analyst [38]

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Okay. And I was just hoping to get a breakout of either the revenue or the tonnage that that contributed in your second quarter. I mean, roughly.

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Jeffrey S. Schoen, Orchids Paper Products Company - CEO, President and Director [39]

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Well I'll tell you the run rate that I quoted is $180 million, $190 million. Our sales were at that run rate in June. So I don't -- the quarter number, take that minus $16 million and that's the difference.

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John Nobile, Taglich Brothers, Inc., Research Division - Senior Equity Analyst [40]

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Okay. Let me just ask one more question. In the first quarter, the call you had mentioned that results were impacted by a drawdown of inventory by a specific customer. I'm just curious if that's been alleviated in the second quarter. Or has that customer -- is he still drawing down inventory?

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Rodney D. Gloss, Orchids Paper Products Company - CFO [41]

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No. That is no longer in play. That's been reconciled.

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John Nobile, Taglich Brothers, Inc., Research Division - Senior Equity Analyst [42]

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Great.

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Operator [43]

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Our next question comes from DeForest Hinman of Walthausen and Co.

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DeForest Hinman, [44]

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As it relates to options for financing, have we considered a rights offering at all?

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Rodney D. Gloss, Orchids Paper Products Company - CFO [45]

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My hearing is off today or something. I apologize. Could you repeat the question?

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DeForest Hinman, [46]

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Have you guys considered a rights offering at all in terms of a financing option?

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Rodney D. Gloss, Orchids Paper Products Company - CFO [47]

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Not really. We'd like to make a rights offering available to existing stockholders and give them the advantage of this low price. But any form of equity issuance at this point just seems a poor judgment because of the low price that we would be receiving for it. Again, we think the stock price is grossly undervalued and hesitant to do anything on the equity side because of that.

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DeForest Hinman, [48]

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Okay, that's helpful. And then a way to help us understand how you're working with the banks -- and obviously this is a trough and June is really this inflection point and it sounds like things kind of build from there. But do we have an ability within our accounting systems to give the banks or people who are looking at doing this financing, monthly financial reports or even weekly financial reports that could really help them understand the story more on a forward basis?

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Rodney D. Gloss, Orchids Paper Products Company - CFO [49]

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We can give them monthly reporting. Our bank syndicate has asked for that going forward. So we'll be doing that going forward.

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DeForest Hinman, [50]

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Okay. And you also brought up a few important things on the qualifications for some of these customers. Could you clarify if those are existing customers or these would be entirely new customers?

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Jeffrey S. Schoen, Orchids Paper Products Company - CEO, President and Director [51]

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Some of them are existing customers, but the vast portion of what I've been discussing are new customers.

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DeForest Hinman, [52]

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Okay, that's helpful. And to help us further understand that, when you talk about a product being qualified, historically what's the time lag between a customer approving -- they negotiate the price, we agree on that, and then that potentially turning into a sale in terms of case shipments?

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Jeffrey S. Schoen, Orchids Paper Products Company - CEO, President and Director [53]

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Usually 3 months, something like that, because once you get the product qualified you have to go through the process of setting up the item. In some cases there's capital to invest in. And then you have to produce, build the inventory to hit their ship dates. So typically when they say "go" it's within 3 months.

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Operator [54]

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Our next question comes from Evan Greenberg of Legend Capital Opportunity Fund.

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Evan Greenberg, [55]

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So I wanted to ask -- can you hear me now? Okay.

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Rodney D. Gloss, Orchids Paper Products Company - CFO [56]

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Yes.

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Evan Greenberg, [57]

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I wanted to ask about the parent roll shipments were way up, which I assume was because you had some I guess downtime in the facility in April and May so you wanted to just keep the factory busy. Is that correct in terms of product mix that impacted the quarter significantly?

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Rodney D. Gloss, Orchids Paper Products Company - CFO [58]

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I'd phrase it a little bit differently, that the mills can run independently at the converting facilities. So we run the mills all out and make as much paper as we can. And then to the extent we don't need the paper for converted product sales we sell the parent rolls. So we cover cash flow and generate a small margin on the parent rolls.

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Evan Greenberg, [59]

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Right. Okay. So we could assume that the parent roll shipments will be dropping significantly over the next 2 quarters as the converted-product gets sold.

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Rodney D. Gloss, Orchids Paper Products Company - CFO [60]

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That's correct. As converted-product goes up, parent roll sales go down, with the exception that we're bringing on the mill at Barnwell, so it will be adding capacity on parent rolls. So until we fill up Barnwell's converting operation, we may still have parent rolls, or we should still have parent rolls.

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Evan Greenberg, [61]

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Right. The next question relates to the internal controls and processes that you put in at Barnwell and the startup costs that you incurred. I'm sure you incur normal startup issues, as you have in any facility. What kind of issues did you see that you've already been able to say, "We can eliminate that cost" or "We can eliminate that process," and adding to the increased EBITDA margin in the future?

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Jeffrey S. Schoen, Orchids Paper Products Company - CEO, President and Director [62]

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Well, I think the main thing that we look at from the cost structure at Barnwell is the startup curve, so the paper machine coming up your first month, your debugging, et cetera, et cetera. The first month we produced at a rate of, say, 30% of total capacity. When I quoted you the number now we're at 20 to 25, that's at approximately 2/3 of capacity. And we expect in the fourth quarter to be averaging 85%, 90% with 100% going into January of 2018. So you're going through an optimization process. The cost structure of Barnwell, we have relatively few converting assets. So the labor you can assume for the most part is fixed. So you get a lot of leverage as you're adding in converting capacity into that facility. Of course we will now get the absorption associated with the improved tonnage that will come out of the mill. And depending on how we sell it out, we will gain selling price and margin because this paper is more valuable than conventional paper, so to speak.

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Evan Greenberg, [63]

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Okay. And my final --

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Rodney D. Gloss, Orchids Paper Products Company - CFO [64]

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I'd add 2 comments to that. One is adjusted EBITDA for the quarter includes $760,000 of pure startup costs that were added back to adjusted EBITDA. So on that line we are adding back that figure, that $760,000. Cost of goods sold and EBITDA figures that are being quoted still include those startup costs. More to Jeff's point, the other point I'd make is that the main startup cost is simply a lack of production. We've added all the expense, particularly the fixed expenses for running the plant. And the ramp-up curve, we just don't have the offsetting production for a while. So it's not so much that they're startup costs as a lack of production, as you ramp up the -- not a lack of, but a delay in production as you ramp up the facility.

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Evan Greenberg, [65]

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Right. My final question had to do with I know the company owns some of its facilities. Is the debt -- is any of the current debt -- none of the current debt is attached to that. So could you do a sale-leaseback in the Pryor for financing? Is that a possibility?

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Rodney D. Gloss, Orchids Paper Products Company - CFO [66]

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As a refinancing, yes. Jeff was referring to one of the possibilities as some sort of asset-based loan where we'd use all of our fixed assets as -- more as collateral and use it for a refinancing. That is an option. It's not like the facilities are unencumbered at the moment. All of the equipment is technically security provided to our bank syndicate. So it's not unencumbered at the moment. It would require refinancing.

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Evan Greenberg, [67]

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But is there any real estate attached to the valuation right now of the company?

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Rodney D. Gloss, Orchids Paper Products Company - CFO [68]

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Yes.

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Jeffrey S. Schoen, Orchids Paper Products Company - CEO, President and Director [69]

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We own our plants. We do not lease anything back at this point.

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Evan Greenberg, [70]

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Okay.

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Operator [71]

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Our next question comes from Mike Taglich of Taglich Brothers.

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Michael N. Taglich, Taglich Brothers, Inc. - Co-Founder, President, and Chairman [72]

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The Q2 inventory adjustment, if you adjust the EBITDA for the high-cost inventory you blew out in June, is it wrong to look at the company as having kind of a $25 million EBITDA run rate at the present?

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Rodney D. Gloss, Orchids Paper Products Company - CFO [73]

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Mike, I'll try answering that. There's a lot of background noise on your line. But anyway --

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Michael N. Taglich, Taglich Brothers, Inc. - Co-Founder, President, and Chairman [74]

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I'll move.

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Rodney D. Gloss, Orchids Paper Products Company - CFO [75]

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Okay, thanks. One month does not make a trend, so I've got to qualify it with that. Plus there are other factors going on that could add some uncertainties. But if we look at June's EBITDA rate, we add back $2.2 million of costs that we believe were liquidations of high-value inventory and we add back other timing anomalies like medical expenses and legal fees and certain things that just were running at a well-above-average rate, we would be looking at something closer to about $3.5 million of EBITDA in June. So you annualize that times 12, you're almost at a $40 million EBITDA run rate. But, again, that's one data point. It assumes that these anomalies don't continue. A lot of the anomalies are timing differences as opposed to one-time events. So a lot of qualification in that. We still have to prove out that sort of run rate. But, again, June, if you take out all the anomalies it does look like a good month and an inflection point.

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Operator [76]

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Our next question comes from Naveed Uddin of Manalapan Oracle Advisors.

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Naveed Uddin, [77]

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I believe you filed a registration statement quite recently to raise capital. So just wanted to know what's the capital plan going forward.

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Rodney D. Gloss, Orchids Paper Products Company - CFO [78]

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We don't have any specific projects on the table going forward. But as Jeff mentioned in his comments, just based on some sort of improvement projects that we'd like to do, we're envisioning someplace around an annualized capital spend rate of about $4 million starting in 2018. Really don't expect anything else this year other than finishing paying off the Barnwell bills.

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Operator [79]

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(Operator Instructions) Our next question comes from Jackson Webster of Boston Hill Advisors.

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Jackson Webster, [80]

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My question is more concerning cash and cash flow going forward. So it looks like in this quarter you burned somewhere $4 million to $5 million in cash and down just above a $1 million cash position. So going forward, can you just talk about through the remainder of the year how you see cash flow evolving, and just to add on to that, how confident you are that this really was the inflection point, not only in EBITDA and maybe revenue, but also cash flow going forward?

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Rodney D. Gloss, Orchids Paper Products Company - CFO [81]

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I'll address the cash flow and maybe Jeff can jump in with his confidence level and the inflection point. The $1 million, getting down to $1 million, I think in a sense just reflects good treasury management. There was no reason to have a bunch of idle cash. The cash was better applied to keeping the debt down. We had about $7 million of headroom under our revolver at the end of the quarter that, with the increase in receivables and inventory and being able to manage down our revolver with our bank syndicate, we actually created a fair amount of headroom there. So it in many respects just reflects a better treasury management and we still have that headroom on our revolver. The main issue in the liquidity and the cash situation going forward is really dependent on the refinancing or the bank syndicate sticking with us. We will -- we did and we will be generating enough cash flow from operations to cover off any other requirements we have. So it will basically be a matter of taking excess cash and paying down the debt going forward. So I don't expect any liquidity shortage as long as we can work out something with the refinancing. We are generating enough cash and so forth to manage the situation. It's not a -- nowhere close to a crisis on cash management or liquidity. The operating cash flow number is a bit misleading, that under GAAP you look at all the changes in, I'll call it, working capital in the operating cash flow. But we've built up our taxes receivable by about $2 million this year. The tax receivable is an accounting calculation. We won't actually invest in (inaudible) and we won't get the cash back from the IRS until some future year, possibly even like 2020. So a $10 million use that shows up on the cash flow statement is really a noncash item and is unrealistic. So it's making the cash flow look worse than it actually is. Jeff, do you have comments about your confidence in the inflection point?

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Jeffrey S. Schoen, Orchids Paper Products Company - CEO, President and Director [82]

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Well, I don't like that. I'm not forecasting what we're doing. I would say the key to success for our business, one, was getting this new volume in place in June and having it actually represent what we were told it would represent. And so we're very happy with that. And that run rate really puts us back to where we were in Q1 of '16. Over and above that, the quality of the products we're producing out of Barnwell, I'm very pleased with where that's at, finishing the project. We're happy that that headwind is not in front of us anymore. The key to success, again, is getting the thing sold out. And we have active plans to do that. On top of that, when you think about the business model that we're operating against, we started off with a 5-year plan. We've invested all the capital that we're going to invest in terms of expansion. We've created about 8 million cases of capacity with all the investments we've made. We're sold out at about 12 to 13. We've got another 4 to 5 to go. And from a pure expansion standpoint, really 2018 is just about harvesting the investments, getting our ROIC up where it should be, and really cleaning up the business. So I'm confident that all of that will happen. I'm optimistic that it will happen. As I've found with most of these things, it's all about timing. And of course the competitive landscape has changed significantly over the last few years. And that probably will continue.

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Operator [83]

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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 [84]

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Well, I think the last comment I made was probably the way I wanted to summarize the business. I just wanted to thank all of the employees of Orchids who have been working tirelessly to execute Barnwell and are working smart. The key to success for everybody is that our stakeholders, including our suppliers, our board, our employees, are all working together to accomplish the mission that we set up to do three years ago. So with that, thank you for your time. We'll talk to you soon.

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Operator [85]

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