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Executives

Bob Mundy - SVP and CFO

Mike Jackson - President and CEO

Analysts

Mark Connelly - Credit Suisse

Joe Stivaletti - Goldman Sachs

Bill Hoffman - UBS

Bruce Klein - Credit Suisse

Mark Wilde - Deutsche Bank

Taylor Oden - JP Morgan

Rick Skidmore - Goldman Sachs

Chip Dillion - Dillion Research

Matthew Armas - Goldman Sachs

John Carline - Scotia Capital

Verso Paper Corp. (VRS) Q3 208 Earnings Call November 7, 2008 9:00 AM ET

Operator

Good day everyone and welcome to the third quarter 2008 conference call for Verso Paper Corp. today’s call is being recorded. At this time, I would like to turn the call over to Bob Mundy, Senior Vice President and Chief Financial Officer.

Bob Mundy

Thanks, Michelle. Good morning and thank you for joining Verso Paper’s third quarter 2008 Earnings Call. Representing Verso today on this call is President and Chief Executive Officer, Mike Jackson, and myself, Bob Mundy, Senior Vice President and Chief Financial Officer.

Before turning the call over to Mike, I would like to remind everyone that in the course of this call, in order to give you a better understanding of our performance, we will be making certain forward-looking statements.

These forward-looking statements are subject to risks and uncertainties. Should one or more of these risks or uncertainties materialize or should underlying assumptions or estimates prove incorrect, actual results may vary materially from management’s expectations.

If you would like further information regarding the various risks and uncertainties associated with our business, please refer to our annual report, which has been posted to our website, www.versopaper.com, under the Investor Relations tab.

With that, I will turn it over to Mike Jackson.

Mike Jackson

That’s great. Thanks Bob and good day everyone. Verso Paper over the last year has shown continuous improvement in the categories of operating and financial performance of focused growth of customer segmentation, product mix and really [pass] through the environmental platform all within which has been a very tough business environment.

And our working capital is at levels at less than 3.8% of revenue through the great efforts of all of our employees. We built SG&A platform, which is effective and cost efficient and equates to just over 3.5% of net sales. Our market share through the third quarter has continued to grow, but not at the risks of price, as you will see later, on our slides.

We continue to be recognized by third-parties for our environmental and sustainability improvements and forward thinking relative to carbon footprint reduction. And in spite of demand challenges, since the carve-out from IP, we have never wavered in our commitment to manage supply demand and our inventory levels have demonstrated this.

With the foundation, I just mentioned our capability to generate cash is substantial. We have no legacy environmental or pension liabilities. Our tax liability is minimal for the next three or more years and we exist as the second largest coated manufacturer in North America where consolidation, we believe will continue.

And we have no principal payment due on our debt until 2013. In today's environment that’s quite a statement. There is no doubt that the global economic situation has put strips on many companies. But based on the points, I just mentioned, we built this business to weather the economic situation we all find ourselves in today.

In spite of the input costs year-over-year being up over $113 million year-to-date. We have improved the bottom line of this business driven by multiple fronts. With that as a backdrop, if you would move to slide number three given the economic situation we are very pleased with our third quarter performance and our results continued to improve despite increases in the prices for our key input.

Adjusted EBITDA of $81.4 million was up 55% year-over-year, which represented the fourth consecutive year-over-year and sequential EBITDA improvement. As some of you may remember, we did have a July 1st price increase, and our prices improved by $38 per ton, from the second quarter and average prices are up $178 per ton or 20% from last year.

Volume was also better than the second quarter, which we had mentioned in our conference call in August, but lower than third quarter of 2007, which was an unusually strong demand quarter.

Inventories at the end of the third quarter are below both last year’s levels as well as second quarter levels. These positive inventory results reinforce our efforts, relative to what we are doing to manage our inventory.

Input prices continue to be a challenge, as they remain at very high levels versus last year and are up versus the second quarter. Bob will cover specifically what these increases were and what we are looking at going forward. Our operations ran very well after coming up from some significant maintenance downtime in the second quarter. And again, Bob will highlight these improvements.

With that introduction, I will turn this over to Bob for further details.

Bob Mundy

Thanks Mike. If you go to slide four, you will see an overview of some of our key metrics during the third quarter versus last year. Our average paper prices are up significantly by $178 per tons. Revenue are $485 million were up almost 8% versus the third quarter of last year and adjusted EBITDA as Mike said, was up 55% at $81.4 million.

Volume reflected the lower coated paper demand in a difficult economic environment compared to unusually strong demand in the third quarter of last year versus the second quarter of this year, coated prices continued to increase and were $38 per ton higher than the second quarter. Volume in the third quarter was up versus Q2, as were revenues, which are over 7% higher.

You will note on slide five that the prices paid for our key materials, energy and freight are higher both year-over-year and versus the second quarter of this year. Raw material prices were the major item contributing to this and higher prices for things like caustic and latex resulted in higher chemical costs. Wood costs are being impacted by higher diesel prices as well as the slump in housing market.

We continue to help mitigate these high material prices both through our R-GAP, our operating cost reduction program and other initiatives focused at reducing our usage of materials, how we buy materials and substituting alternative material types used in making our products. Fortunately, in September we did begin to see a favorable downward trend in prices for certain of these items.

On slide six, you will see a bridge that reconciles the changes between the key components of adjusted EBITDA between the third quarter of 2007 and the third quarter of 2008. This reflects a significant improvement in the price and mix of the products we sell which contributed about $82 million of improvement.

We did take about 13,000 tons of market downtime that resulted in approximately $3 million of unabsorbed fixed costs, manufacturing operations contributed about $11 million year-over-year through efforts from our R-GAP program and other material usage reductions. The other significant item is the increase in the prices we paid for our key materials.

Slide seven shows a similar bridge, although this is on the basis of earnings per share before special items. For comparative purposes, we have used the current number of shares outstanding just over $52 million for the third quarter of 2007. On that basis, in the third quarter of last year, we lost about $0.28 per share versus the earnings before special items of $0.38 per share in the third quarter 2008.

Slide eight reflects our gross margin at 20.5% and our adjusted EBITDA margin at 16.8%, both of which reflect improvement over last year and versus the second quarter of 2008.

On slide nine, you will see our capital spending summary. We spent about $17 million during the quarter primarily on maintenance and cost reduction projects. We still expect to be around $79 million of CapEx for the year 2008.

In summary, the third quarter of 2008 reflected solid results in spite of unprecedented cost inflation and poor economic conditions. Our adjusted EBIDTA was over $81 million and our net income improved by $44 million over last year.

Our price realizations continue to increase as we have been very successful at getting our price announcements to the bottom line and we have kept a close eye on the supply of our products versus our customers demand. This is evidenced by the fact that our coated inventory volumes are below last year and last quarter.

We drove operational improvements from our R-GAP program as well as other key initiatives around workforce development, maintenance efficiency and material usage. And even though prices for our key inputs remained at very high levels, we did begin to see a favorable downward trend for certain items late in the quarter.

I will now turn it over back to Mike, who will talk about our outlook for the fourth quarter.

Mike Jackson

Okay. Thanks Bob. Before we go into the Q&A portion of the call, I would like to give you current view of the fourth quarter, which will be on slide 11. Clearly, the economy in the coming months is the real question, both volume and costs certainly will continue to be challenges.

Clearly we have all seen a drop in oil and natural gas prices and time will tell where they go in the next few months. We are not currently by the way a tremendous user of oil, but we will certainly see some relief if oil stays, where it is.

Chemicals represent a significant percent of our cost of good sold it’s about 21% and as a coated producer our chemical makeup is quiet different than uncoated free, cramp, the board manufacturers. So it’s really difficult to compare our industry costs. But let me just give you some examples that [industries] are not only tied to oil and gas, as an example latex, caustic and clay makeup a significant portion of our chemical costs.

The index driver for latex is styrene and butadiene dye and caustic is linked to really supply and demand through housing starts, which is all about the demand for PVC. So again, they are not indexed to oil and I think that’s something that was important to understand

A very small portion of the cost of clay which is again, a very large user, we use a lot of clay is linked to gas and thus we will see an impact in the latter part of the quarter, but it won’t be significant.

Our targets on the cost side continue to focus on usage of chemicals, energy and water as well as the number of projects that deal with alternative chemicals, which we are very pleased about and continue to see cost improvements in these areas.

Wood however does continue to escalate primarily driven by biomass usage and the continued slump in the housing market, which you are all aware of and we have not yet felt the impact of lowering diesel prices and hopefully that will come in at later date.

As we go to the marketplace, volume to no one surprised continues to be a challenge, as customers really worked on inventories and adjusted the significant change in the economy. Forecasting, which I believe our company does a very, very good job on as really become a bit problematic, as our customers like many are trying to really weather the storm.

The fourth quarter will be the lightest shipping quarter of the year and as you know, we have announced 80,000 tons of downtime for the quarter. This does come and across, but we worked extremely hard as you have seen on the slides to improve price.

And as I mentioned earlier, we are committed to balance our supply with demand and to be very protective of both our working capital, while preserving as much prices we certainly can. We do by the way expect our average price to rise slightly during the quarter.

Our cost and R-GAP programs will help to offset some of the market declines. However, we remain realistic in how quickly the economy is going to turnaround. Yet, based-off of my opening comments, we believe our competitive position and our structure bodes well for the future. Our focus will be to position ourselves and our inventory for 2009 and to manage our working capital.

So, with that operator Bob and I will be happy to take questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instruction) And we'll hear from Mark Connelly with Credit Suisse.

Mark Connelly - Credit Suisse

Thank you. A couple of questions, folks. If you look at your closure end and downtime activity, how much meaningful impact is that having on the mix of product you're actually producing? And could you give us a sense of where in your mix, the greatest weakness is and whether that’s weakness in demand or inventory build weakness, I don’t know, if you (inaudible) that way?

Mike Jackson

Yeah, Mark, it’s Mike. I guess the best way to answer that is that, it’s really kind of a mixed bag. I would say it’s primarily driven by the falloff in catalogs and so I would just say that it’s the lighter bases weight that would be impacted. And in terms of the magazine, they have certainly fallen off a bit and that’s from a mix perspective basically they stay at the same area. So it’s kind of across the board to be honest with you.

Mark Connelly - Credit Suisse

Okay, that helps. When you look at what you are doing and what the industry is doing and you think about what customers are doing with their own inventories and how confident are you that the inventory situation is actually going to get better in the fourth quarter?

Mike Jackson

Mark, look all I can say is that we manage our business the way that we think is necessary. I really can’t comment on what others are going to do. I just know that we feel very, very strongly that what we have done for our business continues to show at the bottom line. And beyond that, I guess, others have to do what they have to do. But you talked to me to comment.

Mark Connelly - Credit Suisse

Can you talk about what you think customers are doing with inventories right now? I mean, you have just very successfully got into price X through. Are we confident that customers really are de-stocking?

Mike Jackson

Well. Yes. I mean you can tell by the shipments. I mean the fact is that we think that the inventory has reached a steady point and the last data that I saw showed that inventory is beginning to decline and I think you've seen some of the announcements for the fourth quarter. And I would think that we would see by the end of the fourth quarter a favorable number.

Mark Connelly - Credit Suisse

Okay. I guess I am just concerned that the consumption numbers maybe off a little bit. So, I am trying to get a clear window and what the customers are doing, but you are really probably right?

Mike Jackson

Well. I mean, clearly consumption is off that’s what we are looking at for the fourth quarter and I'll get into that at perhaps a later time. But clearly we are seeing consumption off for the fourth quarter.

Mark Connelly - Credit Suisse

And just one last question. You guys have clearly made some good progress on the cost side. When you talk about energy reductions, are you talking about the mill or including rate in there?

Bob Mundy

No primarily it’s about the mills. The distribution is about 8.5%of our cost of goods sold. So we really talking about the energy side and we continue to use less energy. We continue to and I think we have mentioned in our last quarterly call, we've invested in some pretty significant measurement devices and we do understand where we're using energy, how we are using it and how do we improve it. So, it’s really all being done at the mill level.

Mark Connelly - Credit Suisse

Okay, I appreciate it. Keep up your work.

Bob Mundy

Thanks Mark.

Operator

And next we’ll go to Joe Stivaletti with Goldman Sachs.

Joe Stivaletti - Goldman Sachs

Hi. Good morning guys. I really had two things. One is I was wondering if you could help us a little bit in trying to understand the impact of the 88,000 tons of downtime. When we look at the downtime, we took in the third quarter and a $3 million cost. I mean can you just talk a little bit about how we should be thinking about that?

Mike Jackson

Yes. Joe the 80,000 is should we take all of that will be a significant amount of unabsorbed fixed cost for the fourth quarter. Roughly that’s around $14 million worth of unabsorbed fixed cost. We will able to do some things based on the timing at the end of the year and hopefully get as much costs out of the mills as possible to mitigate that impact. But it will be a substantial cost to us.

Joe Stivaletti - Goldman Sachs

Okay. All right. That’s helpful. And the other thing is on prices just maybe understand. First of all I guess, you say that you are expecting your average price to be up a bit more in the fourth quarter that really from just because of the full realization of the July increase or and based on maybe how some of your contracts work?

But also bigger picture where we heard from some other companies that aren't quite at focused on coated paper but you participate in the market that they are starting to see quite a bit of pressure from customers and that they are hinting that prices could start to ease up a bit and I wondered if you are seeing that or what your view on that is?

Bob Mundy

Yes. Some of this is from the July increase. In July, we had an increase in coated groundwood and an increase on freesheet. But we also on October 1st, we had an increase on coated freesheet only. So some of that the comment that Mike made about the fourth quarter pricing being slightly higher will come from that coated freesheet announcement.

Obviously the pressure we're seeing is more on the coated groundwood side of the business. But, obviously, one of the reasons we're managing our inventories the way we are and taking the downtime even though it is painful, we need to protect that price that we work so hard to achieve.

And should there come a time you have to do things to keep some volume. We think it would be very, very minimal, where we're getting price, nothing like you may have seen two, three years ago.

Joe Stivaletti - Goldman Sachs

Okay. Thank you.

Bob Mundy

Okay.

Operator

And next we'll move to Bob Hoffman with UBS.

Bill Hoffman - UBS

Hi and it's Bill Hoffman.

Bob Mundy

Hi, Bill.

Bill Hoffman - UBS

Just to follow-up to this earlier question, we talk about managing prices as you go into next year. I mean theoretically with some cut in price and obviously I don't want to do that across the system.

But, I would think that everybody’s budget is going to be slashed, who is buying from you next year. And just wondering how if at all possible, it would be to manage that those kind of price discussions?

Bob Mundy

Yeah. Well, Bill I guess, just like anything else, it's a trip-by-trip so to speak. I mean, you've got to deal with each customer as the issue comes up. I mean clearly 2009 for all businesses is not just paper business, there will be a challenge.

And I think what we always do is just take the approach that listen, understand and honestly let our customers know that our goal obviously is to by the way stay in business and make money and so is theirs and so how do we come to an agreement, where we can both do that.

I mean that’s the only way you can approach this thing. I know it’s kind of a simple answer. But honestly we are in discussions right now and I think as people look at the first half of 2009 their expectations or their understanding of their own business is rather they don’t have a clear view.

So, we are just going to have to go through this and they recognize I believe that we are trying to run our business differently than has been run in the past. And hopefully they respect that and we respect the fact that they are trying to manage their business differently as well. And beyond that I am not sure what else to say Bill.

Bill Hoffman - UBS

I think, maybe one way for us sort of on the outside looking in to think about this. If we look at Q4 versus Q3, obviously you have got some cost pullback in a number of places not quite yet in some of the chemicals like there is some caustic. But certainly in wood, energy, freight etc, could you help us understand today where you are in Q4 versus Q3 on maybe a cost per ton basis, is it $10, $20 bucks a ton type of cost differential pullback?

Bob Mundy

Well. Bill, we obviously, we will have the downtime costs that I just referred to.

Bill Hoffman - UBS

Sure.

Bob Mundy

We do expect to see improvements in our operational costs though less usage and some of our indirect areas around maintenance cost and so forth. Input prices, as we said we started to see some easing in the latter part of the third quarter.

And we think we'll continue to see some of that into the fourth and maybe even more into the first. So, all in all, I think the cost should be fairly comparable I would expect. But we do have that unabsorbed cost from the downtime that we will have to deal with.

Bill Hoffman - UBS

Okay. Thanks. It was helpful. And then just final question, have you [thought] all about CapEx next year and maybe how far you can turn it back in this kind of environment?

Bob Mundy

Well of course, we thought a lot about CapEx and we're putting together finalizing sort of '09 view as we speak and knowing that the first half is like we're saying and first half will be challenging for all businesses. '09 will not be the CapEx as it was in '08. '08 it was a high number of us just because of the significant outages we had at three of our mills in the second quarter.

So, I mean '09 will be down from those levels and we're going to do the right thing to manage with what's going on in the economy and our volumes and everything else to make sure that we're smart about our CapEx spending and the cash flow.

Bill Hoffman - UBS

Could you give us any dollar numbers, $50 million, $60 million type of targets?

Bob Mundy

We've always said that somewhere that $60 to $70 is something I think we used in the past and I think that's probably still a good range.

Bill Hoffman - UBS

Great. Thank you.

Operator

And next we’ll move to Bruce Klein with Credit Suisse.

Bruce Klein - Credit Suisse

Hi, good morning.

Mike Jackson

Good morning, Bruce.

Bruce Klein - Credit Suisse

A couple of questions. But I guess just remind us on the bank liability covenants my understanding they don’t exist, maintenance, I am just taking about just confirm that, that would be helpful?

Bob Mundy

Yeah. Well, we have the one covenant Bruce on our bank loan a 3.25 and we’re at a 0.9 is that’s your question?

Bruce Klein - Credit Suisse

Right. That’s in covenants, right?

Bob Mundy

Right.

Bruce Klein - Credit Suisse

Okay. And no other maintenance test?

Bob Mundy

Not on our bank, no.

Bruce Klein - Credit Suisse

Okay. And then back on the pricing issue. Could you just remind us in terms of contract, maybe how you think about contract business, maybe what roughly percentage of your business might represent and typically how long they might be?

I am wondering if that is part of the reason, if the fourth quarter prices are holding up and maybe just touch on the pricing you’re seeing out there overall for freesheet and groundwood?

Mike Jackson

Well, I think Bob really hit it in terms of why we think we’re going to get a slight and I repeat a slight improvement in the fourth quarter is because of the freesheet price. And as it relates to the question relative to the contracts, I think we’ve been pretty consistent in the last couple of calls about trying to move our business to a shorter-term pricing perspective.

And of course, I guess, it depends on if prices are going up or going down, how that really is, but of the success of that. But we just feel that we’ve done a very good job of getting away from long-term contracts that will allow us to realize some type of cost increases and not absorb them totally ourselves.

And I think we’ve done a very good job of that. You know as a percent, Bruce I would prefer not to get into percent, I would just say that we have improved our portfolio relative to the contracts that we have and our ability to recover cost and we'll just continue to do that as we move forward.

Bruce Klein - Credit Suisse

Okay. And it sounds like the cost overall as a guess, there might be flattish input cost or cost inflation in 4Q versus 3Q. I am wondering, I know, you kind of give us 3Q year-over-year, I think it was $53 million input. Do you have a sense of what it might have been versus 2Q in terms of cost inflation?

Bob Mundy

Yeah. It was $19 million.

Bruce Klein - Credit Suisse

Okay. And that's 3Q versus 2Q costs. Are they R-GAP or the savings that you might have garnered in 3Q versus 2Q I am wondering which was higher --

Bob Mundy

It's a pretty much a push, Bruce.

Bruce Klein - Credit Suisse

Okay. So, you held the cost. Okay. I know downtime is obviously very, very expensive for 4Q. But I'm wondering does the R-GAP numbers start to slowdown? I guess, when you run machines Bob, I would imagine it does. But if your input costs are roughly estimating flat, I am wondering if the R-GAP will help a little bit or is it just gets masked by the downtime?

Bob Mundy

Yeah. Well, R-GAP that the operations will certainly help. You'll see a number in the fourth quarter versus the third like you did in the third versus the second because the second had the outages that I spoke of earlier. But with input prices we expect to be flat to maybe slightly up. I think you'll see the operations cost mitigate anything we would see there in the fourth quarter.

Bruce Klein - Credit Suisse

Okay. Great. Thanks guys.

Bob Mundy

Thanks Bruce.

Operator

And Mark Wilde with Deutsche Bank will have our next question.

Mark Wilde - Deutsche Bank

Good morning. Bob or Mike is it possible to just give us a sense or reminder of kind of how your seasonal demand patterns were kind of fourth quarter and then looking into the first quarter?

Bob Mundy

Traditionally Mark, I would say and it’s really changed interestingly enough over the last maybe couple of years. But traditionally you would say that the, it goes from low to high, okay. It would be first quarter is the lowest and then second, third would be your best. First quarter would be your worst. Second quarter would be kind of (inaudible) and the fourth quarter would be a little bit better than your second and that’s kind of the way it always goes.

Now what’s really changed is that we have really tried to move through and balance that out a bit. So, our second quarter, we work with customers to really take more products in the second quarter than they would normally have taken because as you know during the third quarter demand traditionally has been significant.

In fact it would outstrip capacity. And so, we will try to balance that a little bit. But anyways to answer your questions, it would be, first, second quarter would be the weakest, third quarter your best and the fourth quarter would be a little bit better than second.

Mark Wilde - Deutsche Bank

Okay. So, just kind of, it’s hard enough to tell what the fourth quarter is going to be. But just looking into the first quarter it’s quite conceivable, if the economy stays the way it is right now that you may need to make some supply adjustments in the first quarter, is that fair.

Mike Jackson

I think that’s correct. Well, we’ll certainly see. In some of the 80,000 tons that we announced recently Mark in the release, we said most of it will be in the fourth quarter. Some of that actually spills over into the first quarter, a small amount of that. But we're just continuing to keep an eye on that.

Mark Wilde - Deutsche Bank

Okay. Second question, I noticed that your volume in that other segment was actually quite strong on a year-over-year basis. Can you just give us, remind us of what's in there and why that seems to be outperforming the business or the industry there so much?

Mike Jackson

Well really the other segment for us Mark is sort of an holdover from and it’s pretty much that International Paper entered into with Jay, Maine prior to divesting coated papers business. There is a machine at our Androscoggin mill that makes specialty papers, release packing and grease proof type papers.

It was a 12 year agreement at the time, where we will continue to use that machine at Androscoggin to send to Jay, Maine and is basically here is no cost, but we will recover all the cost associated with that. So, that’s what the volume is.

Mark Wilde - Deutsche Bank

Okay. And then finally, is it possible to just give us some sense of how you're thinking about the pulp business in the fourth quarter?

Mike Jackson

Well, Mark, clearly and certainly you will see the numbers, I mean, the pulp market is under stress right now You’ve got the highest inventory levels that have been out there I believe ever. But the good part about our business is and I think you’ve heard us say this before is we're basically hedged on the positive side, where we sell as much pulp as we buy. So, as prices decline obviously with what we buy it’s the same rate as what we sell and so it won't be an impact to our business.

Mark Wilde - Deutsche Bank

Okay. And so on the Quinnesec, you just would continue to produce kind of normal volumes, is that right?

Mike Jackson

Exactly.

Mark Wilde - Deutsche Bank

Okay. And finally can you give some sense of where the downtime is actually going to be in the fourth quarter, which are the mills?

Mike Jackson

Well obviously its coated groundwood related so that lease out will don’t affect. It will be quite around more. It will be among the other three mills, one on the coated groundwood machines and we will do it in a manner that obviously what we think, where we need to take the downtime based on where the hole is and also we want to make sure we can minimize the cost impact of that.

Mark Wilde - Deutsche Bank

All right. Well it’s been a tough market. But I think so far you have done a good job of maintaining supply and demand and hopefully maintaining pricing?

Mike Jackson

Thanks Mark.

Operator

Then Claudia Hueston with JP Morgan will have our next question.

Taylor Oden - JP Morgan

Hi this is actually [Taylor Oden] for Claudia. I was wondering if you could talk a little bit about trade flows with the dollar showing some strength here. Are you seeing much in the way of import pressures or is that [out of] Europe help prevent some of that?

Mike Jackson

Honestly we've not seen a tremendous change and in fact everybody talks about the exchange rate. But if go back and you look at history exchange rate really doesn't not seem to have a tremendous impact in terms of the imports and I know that's kind of hard to believe but its true. It’s been very steady over the years and in the last three years, there has been a bit of a decline but we've not seen anything in terms of increase.

And I think to your point with the capacity that comes out of Europe, they have I guess decided to manage their business a bit differently and I think that's what they're doing. And so we've not seen a tremendous impact.

Taylor Oden - JP Morgan

Great. Thanks. And then just working capital was a little bit larger use of cash than I had expected in the quarter. Is there any reason we should not expect the working capital build to reverse in the fourth quarter and be a pretty substantial source of cash?

Mike Jackson

Yeah. I don't think you'll see the build that you had in the third quarter and a lot of that Taylor you have to do with the timing of interest payments the causes a big swing. We built up our wood inventories as well actually in the second quarter, they've gotten very low and now we needed to build those up to get to comfortable levels before we hit the fourth quarter in the first part of next year. So, that was part of that as well. But I would expect that you will not see a change like that in the fourth quarter.

Taylor Oden - JP Morgan

Okay. And then just when should we begin to see the benefit from the fiber farms?

Mike Jackson

Well actually, we're seeing the benefit now. Its part of the IPO that business now rolls into Verso Paper Corp. They are harvesting from the plantation and supplying our Quinnesec mill with some of the hardwood needs and that will just continue to ramp up or just continue to get the benefit in our wood costs there at Sartell.

Taylor Oden - JP Morgan

Okay. And then just lastly, what should we be thinking about in book tax rate going forward?

Mike Jackson

Well. As you know, we don't pay any cash taxes right now and I don't expect to for the next few years. With our NOLs and the tax situation resulting from the divestiture out of IP that just cash taxes and so forth, it’s not something we have in front of us right now.

Taylor Oden - JP Morgan

Okay. Thanks very much.

Mike Jackson

Thanks.

Operator

And then we will move on to Rick Skidmore with Goldman Sachs.

Rick Skidmore - Goldman Sachs

Good Morning Mike and Bob. Mike just wanted to ask a question with regards to industry demand, bigger picture. I heard recently of a weekly news magazine essentially went to bimonthly and now has moved to monthly. Are you seeing much of that in your business with your customers and customers moving to less frequently publishing their magazines and that may have an impact on demand trends longer term?

Mike Jackson

I think that’s really what we are seeing right now. To answer your question directly, yes. I mean, there is a switch. There is a people are just making different decisions. But and I think that’s what we are finding ourselves in right now.

And again we will adjust to that and some are going from monthly to ten publications and we have page count changes. We have size changes and really that’s what we are going through.

And so we will take all this in and we will adjust and I mean the bottom line is, for me it’s really kind of interesting is that I believe that companies have to continue to advertise to grow their business and I mean it’s a fundamental. And so I think they are going through this change but in the end you are going to have to spend money to grow your business.

And I think its temporary and they've got to work through the economic issues and will come out of this. It’s the same thing as 2001, when you think about it different circumstance but we work through that and then people said look I have got to grow my business and how do I grow my business, I can't grow my business by just being on the internet and hoping that somebody clicks into my website and that’s a belief that we have and I think that’s how we feel.

Rick Skidmore - Goldman Sachs

Okay. So the commentary from customers right now is it more of just retrenching in the cyclical environment that we're in and that longer term the secular trends will still be there. We haven’t seen some sort of secular shift in demand trends in the coated paper market?

Mike Jackson

Well, what that’s great question. I think time will tell. But I would say that compared to newsprint I don’t think we are in that same type of cycle. I just don’t. I think it’s a whole different market. It’s a whole different approach and I don’t think what we're facing. And again, I am not suggesting that we'll go back to 2%, 3% growth, but I just feel that it is not a newsprint situation at all.

Rick Skidmore - Goldman Sachs

Great. Thank you.

Mike Jackson

Thank you.

Operator

And we will move on to Chip Dillion with [Dillion Research].

Chip Dillion - Dillion Research

Good morning.

Mike Jackson

Good morning.

Bob Mundy

Good morning.

Chip Dillion - Dillion Research

First question is on the inventories, you mentioned that they actually went down in the third quarter from the second and by the way it’s very helpful to have the Q up so quickly. But I noticed that both the total inventories and the finished goods were actually up at September from where they were in June.

And I know if there is like a cost issue that would cause. For example finished goods went from $65 million to $81 million. Was there a cost producing that made the dollar value go up even though I think you said the tonnage was down?

Bob Mundy

Yeah. That’s exactly. Chip the volumes are down versus the second quarter of this year and versus the third quarter of last year. But it’s just the all the input prices and so forth is what’s driven the value of those inventory. S, on a dollar basis, it is a bit higher.

Chip Dillion - Dillion Research

Got you. And then another question that is sort of the elephant in the room I think a little bit is, if you look at your mix and your availability under your revolver, which happens to be 10 times what your flow is not one time or 0.1, but 10 times.

And why would you not throw out a ridiculous like goods sold cancelled [limit] order at $0.80 or $1 or you named the price and start buying some of your shares since you have that availability unless there is something in your credit agreement, even though you are three times over the covenant level on EBITDA is that something that would prevent you from doing that?

Bob Mundy

No. I mean, that’s certainly something we talk about Chip and we continue to evaluate and we feel like it’s certainly enticing and we’re going to continue to look at it and see what makes the more sense for us.

Chip Dillion - Dillion Research

Okay. And then one more thing about the working capital, you mentioned, I know, Frank was outlining, how the seasonality works for the shipments and it would seem that the shipments fall in the fourth quarter and as you take the downtime that’s probably the next two quarters at least maybe the next two quarters you could actually see working capital come down. Is there something I’m missing as to why that wouldn’t happen?

Bob Mundy

I think that’s probably a good view.

Chip Dillion - Dillion Research

Okay. And then lastly on the input question, I know was asked earlier. Absolutely, we can see overtime that there is not a huge amount of volatility there. But there is a lot of correlation with currency. And what's different, I guess with the dollar having strengthened a bit although it's historically not that strong.

You also at this time around have a lot of actions especially in Europe either tied to shutdowns or tied to the wood costs because it seem like the Russian’s are backing off. Are you seeing any different pricing strategies or more directly, are you seeing any discounting coming in at least from Europe in the last few weeks?

Mike Jackson

Chip I have not, but I am not sure what's tomorrow is going to bring in terms of what somebody comes forward with that. Again, I'll go back to say that look, I think that with the capacity shuts in Europe, clearly there has been a strategic change and how people think about those businesses over there. And, I mean, the shut capacity and then try to close dump in the US it doesn't make a lot of sense to me. But, I've not seen it but who knows.

Chip Dillion - Dillion Research

Yeah. Got it. And then while, we are on the topic, are you seeing any real change from say China or Asia, and I know that there has been some back and forth over recent years with dumping in and how. They said they were in violations. So, they tweak the mix of the fibers and make the groundwood qualified. Any change in what you're seeing from the Far East in terms of either volumes coming in less or more or how they are pricing them?

Mike Jackson

You probably heard me say this before Chip but primarily the imports that coming from Asia are sheets and we don't really compete in the sheet business. So, I think, there has been a slight increase in the imports but it really doesn’t impact our business as it relates to sheets because we don’t sell sheets. And the product that we focus on which again is light basis weight groundwood it can only be made with Northern softwood fiber. So we just don’t see the impact that others do.

Chip Dillion - Dillion Research

Okay. And the last question, Mike you laid out very well, the way to view costs and if I heard you right, what you are sort of suggesting is don’t get too excited too quickly about the falling costs. And I think the reason is and just verify this is that the wood situation especially in Maine continues to be kind of tough, you mentioned diesel. But also did you say that the mix of chemicals you use say versus uncoated would be less likely to fall as fast in terms of the cost?

Bob Mundy

Well Chip it is not only less likely to fall as fast but really it’s the makeup. I mean, I have an example when people compare uncoated freesheet and craft and bleachboard. We use clay as an example. The other industries that I just mentioned do not and I think people are just kind of throw everything into one pot and say well, that’s what’s going to happen to cost structure.

But our chemical makeup again is quite different and again it’s 21% of our cost. So I am just simply saying, look let’s kind of be reasonable and how we think about this and the fact that you can’t put everybody into the same pot so to speak and really that’s the point I was trying to make.

Chip Dillion - Dillion Research

Got you. Thank you.

Operator

And next we will move to [Matthew Armas] with Goldman Sachs.

Matthew Armas - Goldman Sachs

Good Morning. Thanks for the call and taking the questions. A couple of quick ones. Can you talk about wood availability in your attachment areas now that pulp has been under pressure is it eased up the availability of pulp wood in those markets?

Bob Mundy

Availability is obviously still an issue Matt. You do have Biomass. Biomass is something that’s getting a lot of attention now and that causes some competition. I wouldn’t say that there has been an easing of the availability to any great extent right now.

Matthew Armas - Goldman Sachs

Right. When you look at your capacity base then you look at what it looks to be a sizeable reduction in demand maybe some secular, some typical. How do you feel about the size of our existing capacity base and is there an another round of consolidation required in this industry in order to manage down any excess capacity?

Bob Mundy

Well, I think I mentioned that in my comments Matt again this is a Verso view is that I do think that consolidation is certainly on the horizon and with our position, I think that’s good being the second largest coated producer and so I look at that as a positive.

And again, look all we can do is wakeup in the morning, we don’t wakeup in the morning in hope for something, but when we wakeup in the morning, we will adjust to whatever the demand situation is. We have continued to do that over the last year and half and that's what we’ll do. And beyond that we'll have to see in terms of consolidation. But I do think that certainly something that is on the horizon.

Matthew Armas - Goldman Sachs

And lastly, can you talk to what demand progress like through the quarter and into September not so much, you can get the shift in data. But as far as your conservation with your customers did it get significantly worse as we went into October, as the economic fears mounted and has that kind of changed, as we moved into November?

Bob Mundy

I guess, I would say that our answer to that question is that we announced 80,000 tons of downtime and I think that pretty much tells you where folks are in terms of our customers. And they would be very, very conservative and again look at any industry, if you get the paper business, look at any industry everybody is taking the same approach.

Let's look at the fourth quarter, let's get through it and let's be conservative and that’s where I think every industry is and that’s certainly where we are. The key is that we are doing something about it. We are just not sitting still hoping that the sun will come up, which is running the business as we have for the last year and half and I think it will certainly as shown in the bottom line.

Matthew Armas - Goldman Sachs

Great. Thank you very much.

Bob Mundy

You bet.

Operator

We’ll move to [John Carline] with Scotia Capital.

John Carline - Scotia Capital

Good morning guys.

Bob Mundy

Good morning.

John Carline - Scotia Capital

Congratulation on a good quarter.

Bob Mundy

Thank you.

John Carline - Scotia Capital

I just wanted to follow-up at the end of the Q you guys talk about NewPage claiming a patent infringement against Verso. I was hoping to get a little more color about potential merger amounts maybe like the grades that are affected in this dispute?

Bob Mundy

Yeah that’s certainly any open or current litigation issues. We don’t talk about those. Anything that other than the public records is you can view that but other than that we don’t make comments on ongoing legal proceedings.

John Carline - Scotia Capital

Okay. And I know, you guys filed a declaratory judgment?

Bob Mundy

Like I said we don’t comment on going legal proceedings.

John Carline - Scotia Capital

All right. Thank you very much.

Operator

And we will take a follow-up question from Joe Stivaletti with Goldman Sachs.

Joe Stivaletti - Goldman Sachs

I just had one quick one. I mean, have you guys made any termination on paying cash versus fixed interest on your [Alto] debt?

Bob Mundy

Have we made any determination?

Joe Stivaletti - Goldman Sachs

I know, in the past, I believe you've always paid it in cash. I didn't know if that was the plan.

Bob Mundy

Our last payment was November 1 and that was paid in cash.

Joe Stivaletti - Goldman Sachs

Okay. Thanks.

Bob Mundy

Michelle, I think we have time for one more question, if there is one.

Operator

Just one moment. And next we'll hear from (inaudible) Capital.

Unidentified Analyst

Good morning, gentlemen. You're commentary on chemical costs has been really helpful. So when I look at the global industry, globally that's pretty much of fixed percent of cost is that right? Cost of clay things like that for coated paper making?

Bob Mundy

Say that again, I am sorry.

Unidentified Analyst

When I look at the percentage of cash costs that you referred to as being different from other paper credits. It’s pretty much consistent percent of the cash costs worldwide, correct versus your global peers?

Bob Mundy

Yeah. I would certainly think so.

Unidentified Analyst

So, those are dollar denominated primarily, is that correct internationally as well?

Bob Mundy

Yes.

Unidentified Analyst

Okay. So, they have changed a less in euro prices or whatever. I mean, it’s more impactful to your overseas competitors if I think of it’s simplistically from a currency affected basis. Is that fair to say?

Bob Mundy

I am not sure, how to answer the question. I mean --

Unidentified Analyst

I mean, I guess these guys are buying dollar based chemicals in euros and everyone assumes that the euro coming in is the good thing and I am not sure it is for the cost curve of your international peer. So I guess whether that’s a valid thesis I guess, is what I am looking for.

Bob Mundy

That’s certainly possible. I certainly can’t disagree with your assumptions there.

Unidentified Analyst

Okay. The guidance has been helpful. Thank you.

Bob Mundy

Thank you

Operator

And that will conclude today’s call. We thank you for your participation.

Mike Jackson

Thank you.

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Source: Verso Paper Corp. Q3 208 Earnings Call Transcript
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