KapStone Paper and Packaging Corporation Q4 2008 Earnings Call Transcript

KapStone Paper and Packaging Corporation (KPPC)

Q4 2008 Earnings Call Transcript

March 16, 2009 2:00 pm ET

Executives

Roger Stone – Chairman and CEO

Andrea Tarbox – CFO and VP

Analysts

Michael French – Morgan Joseph

Steve Chercover – DA Davidson

Rob Young – William Smith & Company

Peter Mark [ph] – Mark Capital Management [ph]

Tim Priadle [ph] – West Creek Capital

Todd Cohen – MTC Advisors

Tony Tristani – Astral Capital

Presentation

Operator

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the fourth quarter and year-end 2008 KapStone Paper and Packaging Corporation earnings conference call. My name is Amicia and I will be your operator for today. During the presentation, all participants will be in a listen-only mode. After the speakers’ remarks, you will be invited to participate in a question-and-answer session. As a reminder, ladies and gentlemen, this conference is being recorded.

Before we begin, the company has asked me to read the following statements. Statements in this call that are not historical are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements can often be identified by words such as may, will, should, would, expect, project, anticipate, intend, plan, believe, estimate, potential, outlook, or continue, the negative of these terms, or other similar expressions.

These statements reflect management’s current views and are subject to risks, uncertainties, and assumptions, many of which are beyond the company’s control that could cause actual results to differ materially from those expressed or implied in these statements.

Information regarding certain of these risks and uncertainties is provided under the caption Risk Factors in the company’s annual report on Form 10-K/A for the year ended December 31st, 2007 and quarterly report on Form 10-Q for the quarter ended September 30th, 2008, which is incorporated herein by reference, and elsewhere in reports that the company files or furnishes with the SEC. These filings can be found on the KapStone’s website at www.kapstonepaper.com and the SEC’s website at www.sec.gov.

Forward-looking statements included herein speak only as of the date hereof and the company disclaims any obligation to revise or update such statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events or circumstances.

I will now like to hand the call over to the host for today’s call, Mr. Roger Stone, Chairman and CEO of KapStone Paper and Packaging Corporation. Please proceed.

Roger Stone

Good afternoon, everyone and thank you for joining us. As usual, Andrea Tarbox, our CFO is with me. This morning, before the market opened, we released our fourth quarter and year-end results. We had a disappointing quarter, but relatively good for the industry in a very difficult period.

Andrea will give you an in-depth look at the numbers. Then I’ll return with more comments than usual and then we’ll take questions. Andrea?

Andrea Tarbox

Thank you, Roger. Good afternoon everybody. I believe that I started off our previous earnings call stating that it was a very active, complex, and interesting quarter for us. Well, given the economic environment that we entered in our fourth quarter when the economy fell off the cliff and so astutely noted by Warren Buffett, we are now stepping up to new challenges making sure that we don’t fall off the cliff.

Despite the 25,000 tons of market related downtime, our fourth quarter revenues were 182 million, up 117 million from $65 million a year ago. Fourth quarter adjusted EBITDA was $26 million, up 54% or $9 million. The acquisition of the Charleston Mill is a primary driver of the significant changes to our financial results over prior periods.

Our adjusted net income for the quarter was slightly over $4 million, down $4.7 million and adjusted diluted EPS, which is now essentially the same as basic, was $0.15, down $0.08 from a year ago. Both were down primarily on interest expense incurred on our new loan facility.

Full year revenues for 2008 were $525 million, up $258 million from 2007. Adjusted EBITDA was $86 million, up $28 million. Adjusted net income was $25 million, down $3 million from a year ago. And finally, adjusted diluted EPS was $0.73, down $0.06. However, when we discuss KapStone’s EPS, it should be noted that due to the substantial decline in our stock price, currently below the $5 strike price of our stock warrant, which expire in August 2009, the diluted EPS is not relevant.

Adjusted basic EPS for the year was $0.96, down $0.18 from a year ago. Because of the substantial change in the last six months of the year from the acquisition and the severe economic distress that emerged in the fourth quarter, on this call I will focus on our fourth quarter results.

Unbleached kraft segment sales were up $112 million or almost 200% to $170 million compared to $58 million in 2007. The acquisition added a $108 million, accounting for almost the entire increase. However, higher prices also added $4.7 million to our legacy operations while volumes modestly declined by about 1,100 tons.

Total tons over 274,000, average revenue per ton increased to $621 per ton, up $65 or 11.7%, benefiting from price increases implemented during the second and fourth quarters of 2008. For the full year, total tons sold were 806,000, an increase of 389,000, driven by the acquisition of Charleston. Year-over-year average revenue per ton increased $56 per ton.

While we are experiencing some decline in pricing as we look at prices from the fourth quarter 2008 to first quarter of 2009, pricing in the earlier months of 2009 still exceeds prices a year ago with the exception of export linerboard. After this review of our results, Roger will go into more details regarding pricing.

For the fourth quarter, unbleached kraft operating income increased by $4 million or 25% to $19 million due to the acquisition of Charleston. Charleston’s operating income would have been $2 million higher, but was negatively impacted by the peculiarity of purchase accounting, which required a $2 million charge for the amortization of a coal contract.

Our legacy business received $5 million for higher prices on its sales, but those gains were offset by inflation on raw materials, primarily chemicals and delivery cost on wood. Sequentially, from fourth quarter of 2008 to first quarter of 2009, we expect to see some benefits in raw materials pricing as caustic soda, wood, and freight costs decrease. However, as we enter 2009, costs for most of our inputs remain higher than they were at this time in 2008. Unfortunately, as a sign of the times, we incurred $2 million of bad debt expense, a significant rise in the cost that had previously been almost nil for us.

Net sales for our other operating segments consisting of dunnage bag and the Summerville lumber mill increased $4 million year-over-year to $12 million on the addition of the Summerville business. Summerville added $5 million to our sales increase while dunnage bag sales declined. Lower volumes drove an operating loss of $1 million compared to 2007’s profit of $1.6 million.

Corporate expenses of $6 million were up $3 million over the prior year. The primary drivers were Charleston’s startup expenses of 800,000 and 1.7 million for MeadWestvaco’s transitional services support. We anticipate that we will continue to use MeadWestvaco’s transitional support services throughout most of 2009, but expect the cost to gradually decrease as we transition certain services to our own systems and staff. The expected savings from the complete transition from MeadWestvaco’s TSA to our own support services is expected to be approximately $900,000 per quarter. Offsetting these costs was the elimination of the transitional support services from International Paper of $500,000.

Interest expense was up $6.7 million to $7.6 million for the fourth quarter on the increased borrowings. Interest rates for the fourth quarter on the term loans approximated 6.1%. Those rates were in effect until January 2009 when the rates were reset to LIBOR plus 3% or about 4% for the majority of our borrowings, resulting in almost a $2.6 million expected quarterly savings at today’s interest rate.

The interest rate on the $40 million senior notes is fixed at 8.3% for the seven-year term of the loan. The effective tax rate for the quarter was 33.6%, essentially unchanged from the prior year. The full year tax rate was 38.8%, up 2.8% on the reduction of the manufacturing deduction due to increased depreciation from Charleston. However, the increase in depreciation expense provided a substantial reduction in our cash taxes for 2008 and we received a $9.3 million tax refund in early 2009.

Our adjusted EBITDA for fourth quarter of 2008 was 26 million including adjustments of 800,000 for the one-time Charleston startup expenses and $600,000 for non-cash restricted stock compensation. Adjusted EBITDA for the full year was $86 million and included $2 million for the one-time Charleston startup expenses, almost $2 million for non-cash stock compensation expenses, and $700,000 for non-cash purchase related inventory revaluation for Charleston.

Net cash from operating activities for the year totaled $47 million compared to $52 million in 2007. Cash flows were impacted by higher inventory levels of $15 million at 2008 year-end, coupled with higher refundable and prepaid taxes of $13.3 million. Our DSO was approximately 35 days at December 31st, 2008, down from 43 days a year earlier.

The majority of our accounts remain current. However, as I previously noted, a few of our accounts have deteriorated to the point where we felt it was appropriate to establish a $2 million reserve in case they prove uncollectible. We continue to closely monitor our accounts. Capital expenditures totaled $23 million for the year. Given the current economic situation, we are very carefully controlling 2009 expenditures and expect our total CapEx to be approximately $27 million, which includes $6 million for the Charleston ERP replacement.

The company ended the fourth quarter of 2008 with approximately $4 million of cash on hand, a decrease of $38 million as we paid down $42 million on our revolver. We ended the year with debt of $440 million. Working capital at December 31st, 2008 was $64 million. At year-end, we were in compliance with all bank covenants.

Finally, we are actively working on getting approved for the energy fuel credit under a federal program that allows incentive payments under circumstances for the use of alternative fuels and alternative fuel mixtures in lieu of fossil-based fuel. The credit is based on the amount of alternative fuel contained in the mixture. We filed our application in late January 2009 with the IRS for certification of our eligibility to receive these payments for the use of black liquor in alternative fuel mixtures using the recovery boilers at the Charleston and Roanoke Rapids mills.

We are accumulating information to file for the credits for eligible periods, generally subsequent to January 2009. If the credits are approved, the payments that KapStone may receive could be material. In fact, at our current production rates, the credits for 2009 could exceed $50 million. However, I want to emphasize that until we are approved we cannot be certain that we will receive these credits. At this point, we believe that we are fully complied with all requirements that would allow us to be qualified.

And at that point, I’m going to turn it back to Roger.

Roger Stone

Okay. Thank you, Andrea. I thought I would first bring you up-to-date on our view of demand inventories and prices of our major product lines, then review what’s happening to our purchase costs, and then cover the current – our current operating plan with a few additional comments about the alternative energy credits.

As to demand, historically except for December, monthly operating rates in linerboard usually range between 90 and 100%. Fourth quarter operating rate this year was about 81% compared to the prior year’s 97%. If you eliminated recycle linerboard and the contrast would be even greater. The November operating rate was 83%; December, 69; and January, 77%.

Export shipments are off with the domestic. For example, January is down 19% from December and 41% from the previous year. The surprisingly strong dollar and a weak global economy are the major reasons for this. Total unbleached kraft paper is off 30 to 40% from the first ten months of ’08. Consumption or shipments rather have been drifting down from there, November shipments were 95%, December’s 93, and January’s 90.

Capacity operating rates had averaged about 68% in the last three months and this compares to about a rate at the high 90 percents for the first ten months of last year. Kraftpak demand is holding up and actually running a little better than last year. Saturating kraft is a bit lower. There is no hard data since January, but our view is that it’s bottomed out, but it’s not getting better.

Inventories remain quite low so that any pickup in demand should reflect itself in higher operating rates. In fact, inventories are the good news story of the bad news situation. January linerboard operating rates were 4.4 weeks of supply using current consumption rates. Unbleached kraft paper also remains at very low levels.

Pricing, kraft linerboard still is higher than year-ago pricing, but down over the fourth quarter levels with a big gap between recycled linerboard and kraft products. Export linerboard prices are down last year – from last year in a major way. As I said, the strong dollar, but also aggressive competition and attempts by non-traditional exporters to enter the market are probably the major reasons. Kraftpak and saturating kraft prices are up and we have had very little pressure on the pricing of those products.

As to our purchase materials, wood is cheaper than the fourth quarter levels and at a 6 to 8% range. Key chemicals are down, some significantly, freight costs are down and still heading south. At Roanoke Rapids, coal is up because of a renewed contract, but we are able to reduce the increase by about 50%. Charleston has a very favorable contract, but in general, coal prices are dropping, electricity prices are up.

Plans have been put in place to optimize our mill system for the demand that we have. Although we all know that we can’t save ourselves to the prosperity, after training and severance costs our plan will reduce cost and maximize cash flow. For the duration of the economic slump, we in fact have gone from a five-machine, two-mill company to a four-machine company, two at Roanoke Rapids and two out of three at Charleston where we have trained our crews to move back and forth between machines, produce our entire product line.

We have temporarily and since January 1^st removed about 25,000 tons per month of production. Essentially, all of this is linerboard. It’s sort of a dubious distinction, but as a percentage of capacity, our downtime is probably higher than any other company. We have permanently eliminated 23 positions from the mills while – and after severance costs, that savings will be about $200,000 per month. We have stopped using 32 outside contractors and will perform their jobs inside the mills and that will save us about another 150,000 per month.

We have furloughed 120 operating and maintenance personnel and the savings will be about $400,000 a month. We have reduced all salaries on a graduated basis. In other words, the more you make the bigger your percentage decrease. For example, Matt and I have been reduced 15%; Tim and Andrea, 7.5%; and the balance of our salary workers on a sliding scale, down to 3.5%.

We have suspended all contributions to the salary personnel for 401(k) and retirement savings finance and we have suspended our short-term incentive plan. The last three items are worth about $1 million a month. And as Andrea reported, costs should drop about $900,000 a month or thereabout on our interest cost. Also, capital spending in our operations will be reduced $5 million to $20 million. So, costs without the – without the significant purchase cost reductions will be pushing about a $4 million per month savings. All this will help offset the lower operating rates and the reduced pricing situation.

The largest potential cash benefit will come from the federal government’s incentive program to use alternative fuels. We believe we qualify for this program and we should be certified by the IRS. At current operating rates its worth about $15 million a quarter. Let me run full, that would be about $22 million a quarter. At the moment, we are in the process of certification. Credits could go back to the date of the application. Therefore, it’ll only be a partial first quarter if and when we receive them. We do not know as of this date whether credits will be extended beyond the year 2009, but obviously it’s an exciting potential event.

In closing, we are obviously going through unprecedented times. I believe your company is responding in every possible way to manage the company effectively. We will continue top pursue other initiatives. We should emerge as global price is stronger than ever and we believe we have great products with good long-term demand characteristics, excellent facilities with competitive advantages, and more importantly, outstanding people who have responded to the challenging times proactively, positively, and aggressively. I’m proud of our group and I still believe that we have a great future and should build significant shareholder value.

With that, I’d now open it up to questions.

Question-and-Answer Session

Operator

(Operator instructions) And the first question comes from the line of Mr. Michael French with Morgan Joseph. Please proceed.

Michael French – Morgan Joseph

Good afternoon, Roger and Andrea.

Andrea Tarbox

Hi.

Michael French – Morgan Joseph

Hi. The first question, on this coal contract, how is it going to be amortized over the years? It is straight line or is it consistent with what we saw this quarter?

Andrea Tarbox

Hi, no, it’s not straight line. We adjust it for the amount that we use each quarter that we actually use around, but it does – it will terminate by the end of the year.

Michael French – Morgan Joseph

So for modeling purposes, can you give us a sense of what we should expect?

Andrea Tarbox

I would say if you’re taking about 2.5 per quarter for the remaining quarters, so you have that whole intangible written off by the end of the year that’s probably a reasonable amount.

Michael French – Morgan Joseph

Okay, very well. And on the tax incentive or the energy fuel credit, how would – how could we quantify this?

Roger Stone

It’s basically by using alternative fuels other than fossil fuels that we use and that really comes from the fuel we generate in our recovery boilers. As I said, if we’re certified and we believe we are complying with the regulations, that savings at our current operating rate is $15 million a quarter, not for the first quarter because it implies on late January, that will be somewhere around 9 million. And if we ever get to be running full and demand picks up, that could go as high as $22 million a quarter.

Michael French – Morgan Joseph

Okay. And Andrea, did you mention a $9 million refund in the first quarter?

Andrea Tarbox

Yes, yes. Well, we have received $9.3 million in Q1, but that’s for just our regular income tax refund. That is not a fuel credit refund.

Michael French – Morgan Joseph

Right.

Andrea Tarbox

Okay.

Michael French – Morgan Joseph

But that’s going to apply to the current quarter?

Andrea Tarbox

Yes, the cash, but the – the cash taxes versus book taxes.

Michael French – Morgan Joseph

Okay, got you.

Andrea Tarbox

Yes.

Michael French – Morgan Joseph

And Roger, on the last call you talked about potentially having a couple of new customers this quarter. Is there anything – is there an update on that?

Roger Stone

Well, we actually brought all those customers that we expected to have, we do have. And it’s nice, but as you would imagine, with volume being off 25, 30% there is – everyone is having a hard time living up to all of their obligations with their new and old suppliers. So, the good news is they are buying from us and they’re very happy with us. The bad news, obviously, is the volume what we – is the volume isn’t what we expected, but would things returned to normal we’ll get what we expected.

Michael French – Morgan Joseph

Okay. And then a last one. On the bad debt expense -

Andrea Tarbox

Yes.

Michael French – Morgan Joseph

Can we expect more of this or it was just a one-time thing do you think or if you can provide any color on what happened and –

Andrea Tarbox

Well, I mean I’d love to hope that it’s a one-time thing, but the reality is that’s not probably reasonable. At this point, we haven’t identified anything else, but companies are having tough times. So, I think we are monitoring as close as we can. The fact is we reserved this amount, I mean we are still hopeful we are going to collect it. And if we do, we will be able to reverse this, but –

Roger Stone

Yes, but as to the rest of the major accounts, just a feeling because god know what’s really happening in corporations today, but we feel pretty comfortable with our receivables and that we will get paid. So, we are always subject to surprises.

Andrea Tarbox

Right.

Roger Stone

But we are not taking a lot of risk.

Andrea Tarbox

Right, right. So – I mean, we feel that this reserve was appropriate and hopefully we don’t have to reduce it and hopefully we’ll collect some of the money that – or most of the money or all of the money that we reserved this against.

Michael French – Morgan Joseph

Okay. And actually, I hate to lie, but final question, this is it. You mentioned there were some layoffs down in the cost savings. What was the severance expense or when – what will be the timing of that expense?

Roger Stone

Well, the severance expense would be paid this quarter.

Michael French – Morgan Joseph

Right.

Roger Stone

And it’s significant. We are – most of these people are – came from the Charleston acquisition and we are using and paying it according to the MeadWestvaco severance program, which is our obligation under the contract.

Michael French – Morgan Joseph

Okay, but you can’t give me a number?

Roger Stone

No, I can’t.

Michael French – Morgan Joseph

Okay. Well, thank you and good luck.

Roger Stone

Thank you.

Operator

And the next question comes from the line of Mr. Steve Chercover with DA Davidson. Please proceed.

Steve Chercover – DA Davidson

Thank you and good morning or afternoon.

Roger Stone

Hi, Steve.

Steve Chercover – DA Davidson

I guess it depends which time zone you’re in. I wanted to also drill a little bit more into the black liquor sales. So, would you – assuming it goes through, is that going to be basically additional revenue without expense, something you’re already doing or it’s a credit back?

Roger Stone

Well, we don’t know yet how it’s going to be treated. And normally, I would view it as a reduction of cost.

Steve Chercover – DA Davidson

Okay.

Roger Stone

And similar to tall oil or those kinds of things. But that’s what I would do. We do not have opinion – only thing we know at this point is it’s cash, okay? We don’t know if it’s going to be applied to earnings or it’s not going to be applied to earnings.

Steve Chercover – DA Davidson

Okay. And when did you actually submit it?

Andrea Tarbox

January 30th.

Steve Chercover – DA Davidson

Thanks, Andrea. And then obviously, it looks like we should be going forward as if the warrants will not be exercised. Is that how you are playing it from this point on?

Roger Stone

Well, yes. I think that Andrea’s comment is it’s unlikely at this time. So, dilution is probably not there for anything other than the shareholders. Yes, I would hope that they will be exercised and the stock in the market will come back and the value will be appreciated, but it’s a low probability at this point.

Steve Chercover – DA Davidson

Well, I think the market signaled that. So, I wasn’t trying to ask a silly question, but you Roger, have also said that you were kind of agnostic about that.

Roger Stone

Yes.

Steve Chercover – DA Davidson

So, the lack of dilution is somewhat beneficial, the lack of cash coming against the debt I guess is the flipside. You mentioned that there is no covenants that were breeched at year-end. How are you feeling going forward and how your bankers feel since you are in constant dialog?

Roger Stone

Well, it’s a good question. We don’t predict. I guess if I felt we had covenant issues, I would say it. So, we plan to fully meet our financial obligations.

Steve Chercover – DA Davidson

Okay. And can you give us a sense, then, are you still running full on your saturating kraft?

Roger Stone

Saturating kraft is a little lower demand, but still pretty good. So, we’re running – saturating kraft is running well, kraftpak is running well. Where demand is off is kraft paper and linerboard.

Steve Chercover – DA Davidson

And you did get a – an increase in saturating kraft?

Roger Stone

Yes, we got our increase in saturating kraft as predicted and as I said, prices are pretty stable both there and in kraftpak where the increases we achieved last year are holding as well.

Steve Chercover – DA Davidson

Great. Thank you very much.

Operator

And the next question comes from the line of Mr. Rob Young with William Smith & Company. Please proceed.

Rob Young – William Smith & Company

Hi, yes. Good morning.

Roger Stone

Good morning.

Andrea Tarbox

Good morning, Rob.

Rob Young – William Smith & Company

Just a question relative to the depreciation on Charleston and KPP. Do you have a breakout of that?

Andrea Tarbox

Not right here, I can get that for you later.

Rob Young – William Smith & Company

Okay, that’d be fantastic.

Roger Stone

Hold it. While we’re on that subject, something is interacted [ph] you may or not realize. It is probably the people taking guard at downtime. It affects earnings in a different way. Some companies take their depreciation on a units of production basis over the useful life of the equipment. Other companies like us take it their useful life overtime X amount of years. So, those people that doing on a units production basis when they produce less, their depreciation is less in constant per ton. Those people, but do act overtime, their depreciation per ton is more, but it’s always relatively the same number per month and per quarter, and per year. I don’t know why I wanted to pointed that out, but I’ve always wanted to say that.

Rob Young – William Smith & Company

Okay. So, you’re more on a straight line basis with your deprecation schedule?

Roger Stone

Yes, we – overtime, we are not on the units of production basis.

Rob Young – William Smith & Company

Right. Okay. Then in terms of just operating outlook for Charleston throughout fiscal year ’09, if you could just comment on that a little bit?

Roger Stone

Well, our plan calls for a running because we have only made kraft paper in Roanoke Rapids. So, our plan is to run the Roanoke Rapids mill full and as said, run two out of our three machines in Charleston. And we believe all of that – generally that downtime at 25,000 tons per month is all related to the linerboard market although our sales in kraft paper are off, but linerboard fills-in in that regard. Does that answer your question?

Rob Young – William Smith & Company

Yes, that’s great, I appreciate it. And then, kind of the same type of question for export linerboard. I know that you’re trying to get out of that as kind of as quickly possible. Is there any thoughts on that going into ’09?

Roger Stone

Well, our plan was obviously to shift our demand from export to domestic in terms of overall mix generally because the prices were more stable and better and two, because of – we had solid relationships on which we hope to build. It was a good plan and we’re certainly working that. I mean, export demand being down and being far more competitive, obviously, is forcing us in that direction any way, but clearly, we’ll always be an exporter because of our location and our products, but we want the domestic percentage to increase as much as possible. As I said, we are adding the customers, we are not adding the tons the way we would like.

Rob Young – William Smith & Company

Okay. Perfect. And then in terms of cash utilization, with this tax refund, as well as possible tax credits from the alternative fuel mix, if that were to come about, what’s the possible deployment of that cash in fiscal year ’09 and going forward?

Roger Stone

Well, it will obviously go to debt reduction.

Rob Young – William Smith & Company

Okay. And then, how long are these cost savings expected to last assuming – obviously I’m sure that they are fairly correlated with the market and how well the economic environment is going, but assuming that it comes – assuming that the market comes back say in second half, is that when these cost savings will kind of dissipate?

Roger Stone

Well, the – clearly, if the market comes back, the savings in terms of running two machines versus three, we are running three, and a number of those expenses will come back. The permanent reduction in staff, that will stay no matter what happens to the market. The suspended programs – the salary cuts and suspended programs as the business improves and profitability and returns for our shareholders improve, those things will be put back in place overtime.

Rob Young – William Smith & Company

Okay, I appreciate it. That’s all I have. Thank you.

Operator

And the next question comes from the line of Mr. Peter Mark [ph] with Mark Capital Management [ph]. Please proceed.

Peter Mark – Mark Capital Management

How are you guys doing?

Andrea Tarbox

Good.

Peter Mark – Mark Capital Management

I just had a quick question regarding the reset on the loans and it was in January, right?

Andrea Tarbox

Right.

Peter Mark – Mark Capital Management

With LIBOR and that resets yearly then on those loans, on both the term A and term B or?

Andrea Tarbox

No, we have an option to choose whether we want to take it for fifth month, one month, three month. So, when we initially we took the loan out at July 1, we had taken a six-month reset to January, but now we’re doing month to month because that rate is so much lower.

Roger Stone

Right. The month wise, the LIBOR number is substantially than the three-month LIBOR.

Andrea Tarbox

Right.

Peter Mark – Mark Capital Management

Okay. And so, then month to month that resets. If LIBOR spikes or goes down, your interest rate, your – what you’re paying is adjusted in terms of interest expense?

Andrea Tarbox

That’s correct.

Peter Mark – Mark Capital Management

Okay. Is there a cap on that or is it just whatever LIBOR is?

Andrea Tarbox

It’s whatever LIBOR is.

Peter Mark – Mark Capital Management

LIBOR is?

Roger Stone

Or the basic rate, which is – or the prime rate.

Andrea Tarbox

Yes, right. Right, we have no bottom fortunately, yes.

Peter Mark – Mark Capital Management

Okay, that’s all I had.

Andrea Tarbox

Yes.

Operator

(Operator instructions) And the next question comes from the line of Mr. Tim Priadle [ph] with West Creek Capital. Please proceed.

Tim Priadle – West Creek Capital

Hi, good afternoon. I just had two quick items. First in the text of the release, the debt number was listed as 440 million. The number on the balance sheet was 430. Is there a discrepancy there, a typo?

Andrea Tarbox

No, I think it’s – when you see the detail on the K, you’ll see how you get to that, but you got the amortization and there’s a bunch of things and the currency that gets pulled out. So and those – I mean, those numbers are correct.

Tim Priadle – West Creek Capital

So, it’s actual debt number –

Andrea Tarbox

440 is a face value. 440 is a face value of that loan – of the loan.

Tim Priadle – West Creek Capital

440 is the face value?

Andrea Tarbox

Yes.

Tim Priadle – West Creek Capital

Okay. And that $9 million refund you referred to, you use that for debt paydown?

Andrea Tarbox

Yes.

Tim Priadle – West Creek Capital

Okay. And then just on this black liquor IRS item, have you guys gotten a legal opinion on that? Is that a new law? Why do you think that – why are you confident that you are going to get that?

Roger Stone

Well, the – as law is written and (inaudible) other countries, if you look at their footnotes, have received it or have been certified. And the way that law is written, we definitely feel we comply. We will have an opinion as to that certification and as to – the IRS will certify that we are operating under the provisions of that law and that we qualify. So, we – we feel pretty good about it, but things – people can change laws.

Tim Priadle – West Creek Capital

Right. Is that a new law written on the books in 2008?

Andrea Tarbox

No.

Roger Stone

It really came into being what – yes, 2008 or 2009.

Andrea Tarbox

Right.

Roger Stone

As we understand.

Tim Priadle – West Creek Capital

Okay, great. Thank you.

Operator

And the next question comes from the line of Mr. Todd Cohen with MTC Advisors. Please proceed.

Todd Cohen – MTC Advisors

Yes, good morning. Just a question on the cost savings you alluded to. I think I heard you say it was going to be about 4 million a month. Is that correct?

Roger Stone

Yes, not including the savings that we make on purchase cost, wood or others, right.

Todd Cohen – MTC Advisors

Not including purchase cost? Okay. And so, could you then break out just – you went through some of those items fairly quickly. Other than permanent reduction in staff, what are the other major – what part is actually variable?

Roger Stone

Well, the salary cuts are actually variable, they can be restated – reinstated. The company’s contribution to the 401(k) and savings plans can be restated because they were suspended.

Todd Cohen – MTC Advisors

Okay.

Roger Stone

So, the only thing that is in theory gone forever is the permanent reductions in staff.

Todd Cohen – MTC Advisors

Okay. So, it’s just those three items that equal the 4 million a month?

Roger Stone

Plus the interest cost savings.

Todd Cohen – MTC Advisors

Plus interest cost savings? Okay, thanks.

Operator

And the next question comes from the line of Mr. Tony Tristani with Astral Capital. Please proceed.

Tony Tristani – Astral Capital

Hi, thank you for taking my call. Did you guys quantify how much more downtime you’ll have in Q1 than in Q4 because you mentioned that your operating rate was up in January for December, or is that only in Charleston?

Roger Stone

Those are industry numbers. We took 25,000 tons down the whole quarter in fourth – in the fourth quarter. In Q1, we’re taking 25,000 a month out.

Tony Tristani – Astral Capital

I see, okay.

Roger Stone

Yes, and to answer that question before you, the reduction staff and the furloughs at the mills are in those cost savings. That’s right. I’m sorry, I did interrupt you.

Tony Tristani – Astral Capital

Okay. No, that’s okay. That made that clear, thank you. On the black liquor, is that a tax credit or is that just a cash payment? I thought it was maybe a tax credit.

Roger Stone

It comes in a cash payment, okay? So, it is cash and how it’s credited exactly, we are not sure.

Andrea Tarbox

It’s not a credit against income taxes per se. It’s like an excise tax credit.

Tony Tristani – Astral Capital

Okay. That’s obviously significant. So, you guys would just go back and calculate the pluses and minuses, more downtime, ongoing savings, and then the possible credit partially in Q1 and then more obviously in Q2?

Roger Stone

Yes. Yes, let me – yes, let me freeze this. We think that by optimizing a system per day’s current demand running (inaudible) we’re running as cost effectively as we can and servicing our customers. It isn’t running at a lower cost than if we were running all five machines. So, our cost is higher, but very cost effective for what we are doing given the alternatives. You have to combine that with price increases, price decreases, and purchase price cost increases.

Tony Tristani – Astral Capital

Right, okay. On the covenant, I guess the most stringent covenant on your credit line is the fourth quarter look-back on EBITDA to debt.

Andrea Tarbox

Correct, yes.

Tony Tristani – Astral Capital

And so, is that like a 4 – like 4.5 or 4.3 as a minimum?

Andrea Tarbox

No, it was 4 times initially. Then it went down to 3.75 at December 31st, ’08 and at the end of first quarter ’09, it goes down to 3.5 times and stays that way until the end of the year.

Tony Tristani – Astral Capital

So, that implies that you’re expecting if you don’t think you have any issues in 2009 that your EBITDA with the cost cuts, et cetera should improve from the Q4 adjusted EBITDA of 25 million?

Roger Stone

Clearly, we would not make our covenants if we made only 25 million a quarter, right?

Tony Tristani – Astral Capital

Right. I mean, but that didn’t come out very clear I think from this call and from my perspective that the pluses and minuses, but actually you’ve taken a lot of cost out, et cetera that actually could show improvement at this lower operating rate because of the cost you took out and other savings.

Roger Stone

Well, we don’t make predictions, but that’s right, that’s -

Tony Tristani – Astral Capital

Okay. And the last question is, obviously with a pretty reduced operating rate for containerboards in the industry and yourself, I mean I don’t think end product demand is down that much? Are your customers saying that – I mean, if the economy – consensus forecast for the economy to kick back in the third quarter, if the economy does recover and end demand strengthens, should there be an inventory snapback the other way or is that your reductions in operating rates surely – purely just you think the end demand? I’ve been trying – I’m trying to understand the inventory snapback if that could come back and you have your operating rates pick up in the second half of the year if the economy does improve like the consensus kind of forecast.

Roger Stone

Well, what I’m – what I tried to convey is that inventories are low and that any increase in end use demand would go straight to improving operating rates because there isn’t much inventory reduction potential to take up the slack. So, that’s the good news. The other thing is that in containerboard, linerboard, when operating ratio is in the 90%, 56% of that goes to food and beverage customers. So, obviously a higher percentage of today’s rate is going to them and about 80% goes to the stuff that’s consumed, I mean like toilet paper and other chemicals. So, it would seem to us that demand has to come back in a substantial way and that the reduction of packaged good inventories is a good place to look to see if you want to try to figure out when demand is coming back.

Tony Tristani – Astral Capital

Okay. And I guess running a total of what now four machines instead of five?

Roger Stone

Right.

Tony Tristani – Astral Capital

Could you – I mean, could you meet demand if your – I mean, are you running with the four machines you are out, winning about what 80% of capacity?

Roger Stone

Yes, we’re running at about 80% of capacity, it would be – yes, four of five.

Tony Tristani – Astral Capital

Right. So –

Roger Stone

Yes.

Tony Tristani – Astral Capital

I mean, is that –

Roger Stone

A little more than the machine we are taking out is a little larger than the paper machines, but right.

Tony Tristani – Astral Capital

Right, but that fifth machine could come back?

Roger Stone

Yes, and I – and we all hope that will.

Tony Tristani – Astral Capital

Your permanent reduction doesn’t – I mean, you had a permanent reduction in force too. So, I was just wondering how much you could snap back if the demand was – came back from your customers, I mean hypothetically of course?

Roger Stone

If the demand – well, if demand comes back, you can get more out of the four machines that are running because you can schedule them better, because you’ll have backlogs and therefore, you don’t have to swing your machines as much. So, we can get more productivity out of the mill than we have – are currently getting with four machines. But when demand comes back beyond that and backlogs grow, we will be putting back the fifth machine and maybe running the other machines more slowly, but taking advantage of the added tops. So, our scheme [ph] is that this is the best way to optimize our system with demand at current levels and if it’s going to stay at current levels, this is our plan. But when demand picks up and the sooner the better, we’ll be anxiously able to take care of it.

Tony Tristani – Astral Capital

Okay, thank you very much.

Roger Stone

Welcome.

Operator

Ladies and gentlemen, this concludes the question-and-answer session of today’s call. I will now like to turn the call over to Mr. Roger Stone for closing remarks.

Roger Stone

Well, thank you. Actually, I think I made my closing remarks when I – made my closing remarks before questions. Thank you all for joining us, it’s an interesting time, the Chinese curse, and I think we are in good shape to handle it and it will pay us, and we’re optimistic about the future. Thanks very much.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect.

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