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Verso Paper Corp. (NYSE:VRS)

Q1 2009 Earnings Call

May 07, 2009 09:00 AM ET

Executives

Robert P. Mundy - Senior Vice President and Chief Financial Officer

Michael A. Jackson - President and Chief Executive Officer

Analysts

Bruce Klein - Credit Suisse

Joe Stivaletti - Goldman Sachs

Chip Dillon - Credit Suisse

Jeffrey Harlib - Barclays Capital

Sandy Burns - Sterne Agee

Tyler Old - JPMorgan

Operator

Good day everyone and welcome to the First Quarter 2009 Conference Call for Verso Paper Corp. Today's call is being recorded. At this time, I'd like to turn the conference over to Mr. Bob Mundy, Senior Vice President and Chief Financial Officer. Please go ahead sir.

Robert P. Mundy

Thank you, Candice, and good morning. Representing Verso today on this call is President and Chief Executive Officer, Mike Jackson and myself, Robert Mundy, Senior Vice President and Chief Financial Officer.

Before turning the call over to the slides, I'd like 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 risk 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'd like further information regarding the various risks and uncertainties associated with our business, please refer to our various SEC filings which are posted on our website, versopaper.com under the Investor Relations tab.

If you will turn to slide three, you will see our actual EBITDA for the first quarter was $116 million and our net income was $55 million. This includes about $105 million relative to the alternative fuel mixture tax credit that we have either received or expect to receive for the period of September 2008 through the first quarter of 2009.

Excluding the alternative fuel mixture tax credit, our adjusted EBITDA for the quarter was $10 million and our net income was a negative $57 million.

These numbers are down significantly compared to our first quarter of 2008 due to the difficult economic conditions that exist globally and its impact on our customers' demand for our products.

The recession's impact on ad spending and magazine and catalogue circulation coupled with the inventory buildup that occurred back in 2008 had a significant impact on the consumption of coated paper during the first quarter of 2009 compared to a very strong first quarter of 2008. Mike will talk more about that in a moment.

We, as most companies in the world today, are having to manage through unprecedented economic conditions. During this challenging time, we remain focused on making decisions and taking actions and a way to do with the short-term issues, but also try and ensure we are prepared when market conditions become more favorable.

For example, we could have chosen to run our machines and improved our EBITDA by over $31 million this quarter. However, the significant cash drain that would have resulted did not make sense in our view. We make our downtime decisions in a manner to minimize unabsorbed costs and the cash outlay throughout our supply chain. We also take advantage of the downtime at our mills by expediting our work on numerous non-capital cost reduction initiatives and other projects that are not always possible to address while the machines are running.

We expect to achieve about $65 million in savings from all the initiatives we have undertaken, $10 million of which we achieved in the first quarter and we're spending capital only on must do projects.

Moving to slide four, we said during our last earnings call that volumes in this quarter will be down sequentially and year-over-year. And we also said that this coupled with downtime of over 100,000 tons will have a significant impact on first quarter 2009 EBITDA. Here you can see that our adjusted EBITDA dropped by about $60 million, which is about the total impact of the market downtime and resulting lower sales volume.

For paper and pulp in total, we took about 139,000 tons of downtime during the quarter, which is actually quite a bit more than we envisioned at this point.

We also told you on the last call that we expected to see a modest decline in prices as pressure persists. But we continue to balance our supply system to mitigate this pressure. Coated prices are higher than they were at this time last year, though, down sequentially by about 4%. Input prices continue to decline sequentially and we saw over $10 million of improvement here in the first quarter. We expect this trend to continue throughout the year.

On slide five, you can see that the specific year-over-year and quarter-over-quarter results for some of our key revenue drivers. Although our coated shipments are normally down seasonally moving from the fourth quarter to the first quarter of the year, in the first quarter of 2009, we experienced a much steeper drop. Pulp prices have been hit especially hard over the last couple of quarters, which helps us from the input side of our non-integrated mills but hurts on the revenue side of the equation. Hopefully, pulp prices are starting to bottom out and will improve somewhat over the balance of the year from where we are today.

Overall, the key segments of input prices shown on slide six are continuing to improve. Prices for almost everything except clay are headed down. And as I said earlier, we expect that overall prices for our key inputs will continue to head down throughout the year.

We still have some hedges on our gas consumption that are in place for a good part of the year and that is mitigating the benefit of current spot prices on gas.

On slide seven, we show a bridge depicting the key year-over-year changes in our adjusted EBITDA. As I said earlier, the recessionary market conditions are what drove the decline, accounting for almost the entire change. Sales prices and operations were better year-over-ear, and input prices; though higher year-over-year, have been trending down for couple of quarters now.

Moving to slide eight, in summary, our customers' demand for our products is being severely impacted by the global economic conditions and its effect on advertising dollars and retail spending for magazine and catalogue use. This has resulted in our taking unprecedented market downtime to balance this depressed demand with our supply. And even with this, there continues to be pressure on selling prices.

On a positive note, input prices continue to move in the right direction. Distribution costs continue to move lower. We are we're getting good results from our profit improvement program, made up of our R-GAP process and other efforts. We had gains from our alternative fuel mixture tax credit and we have improved our capital structure in spite of these difficult times.

On slide nine, you'll see our liquidity stands at just under $80 million and on the right side of the page we show our debt at various levels of our capital structure.

On slide ten, you also can see that we have no near-term maturities on our debt. And so that's also again something that we are certainly taking... have some benefit with nothing coming due anytime soon.

So with that, I'll turn it over to Mike Jackson who will update you on the second quarter and some other comments.

Michael A. Jackson

Thanks Bob and good morning. Before we address the outlook for the second quarter, I'd like to talk about what we have done and what we are doing to allow Verso to move through these incredibly challenging times and come out stronger for it.

And actually going back to the summer of 2008, in our earnings call in August, we anticipated a slowing economy and therefore announced 80,000 tons of market downtime for the fourth quarter.

In our year-end call, we announced another 100,000 tons of downtime to be taken in the first half of 2009. Conditions in the coated market deteriorated further and we moved 100,000 tons plus another 39,000 tons of downtime into the first quarter of 2009. Although this lowered our first quarter EBITDA by $31 million, this preserved, as Bob mentioned, cash and left our balance sheet in better condition.

During the fourth quarter of 2008 and for the first four months of 2009, we've been very aggressive in focusing on further cost reduction efforts, yet at the same using the downtime to accelerate our efforts in new product development as well as innovative process improvements to drive long-term results.

Let me give you some examples of these efforts.

Organizationally, we made a change relative to resources assigned to our new product work at all of our mills which has improved the pace of progress. Along with receiving FDA approval for some of our food packaging items, we feel strongly that our focus will lead to a second half run rate that will hit capacity on our transform B1 machine, which you know we removed from our coated groundwood production late in 2008.

Some of these grades are highly technical and qualification has been quite intensive. But we're turning a challenge of downtime into an opportunity of innovation.

Another example of these efforts is we've developed and executed a process at our Quinnesec mill which now gives us the flexibility to produce both hardwood and softwood pulp at this which would have traditionally required a significant capital investment. This allows us to swing the facility as pulp markets change, which we were unable to do prior to this time and this will have in the long run a very positive cash impact.

We've also used the time on our machines at locations beyond Bucksport to develop products that are light weight and an extension of our product line. This falls in our area of expertise and will offer our customers broader, domestic paper solutions. The introduction of these products as they become qualified will allow us to continue to make capacity reduction decisions of grades that have seen significant fall off in demand.

We've also worked with our vendors to accelerate trials of chemical substitutions that offer both quality and price opportunities. Our size really gives us the ability to respond quickly on experiments of design projects; something, by the way our suppliers like very much. We're beginning to see the impact on chemical substitutions which are positive from a cost, quality and usage perspective. As volume levels return, we will see more cost benefits coming from this strategy.

Our team has also finished its work on identifying the specifics at all four mill sites relative to energy projects that offer very high returns and are shovel ready once we move to the trough of this demand situation. These projects will positively contribute long term to both our cost position and carbon emission reduction. It's also a tribute to our people that in spite of having machines with unprecedented downtime that when they do run, we have OME, or operating machine efficiencies that are better than last year.

Our usage (ph) numbers on a per ton basis continue to improve as well and after the first quarter, we also have our best year-to-date safety number, which really speaks volumes to the dedication of our people and really what we're going through in these unprecedented times.

In the last six months, we have spent time with local, state and government officials telling our story and encouraging the states that we reside in to work as partners, to find ways to reduce our cost structure as well as contribute to the state's economic wellbeing.

During a recent press conference, we presented to the Governor of Maine a whitepaper entitled Maine on Paper: An Industry We Can't Afford to Lose. In this document, we presented what Verso had done in the areas of energy, sustainability, transportation, workforce planning, cost structure and environmental regulations. We offered both challenges and solutions. We believe that this will make a difference in how states like Maine respond to the competitive marketplace.

Verso has been very visible on this front. Examples of support would be an LNG facility as an option in Maine, support relative to truck weights, which is really significant when you think about the cost per ton which has been passed and expediting the work that we're doing on... or they're doing on force certification. All of those elements make us a better business in the long run.

Moving to the marketplace, the shipment to capacity ratio averaged 69% during the first quarter of 2009. Coming off of March, it's hard to look at coated groundwood numbers being off 41% or coated freesheet being off 31% without feeling concerned. However, let me point a few things out

One thing that must be remembered is that year-over-year comparisons are affected by comparisons to a very strong first quarter 2008. Last year at this time, coated mechanical grades were showing over 11% year-over-year gains, which was driven by customers pre-buying due to concerns relative to proposed paper and postal increases for the first half of the year as well as the concerns of simply getting carted, which was an issue as you know in late 2007.

During the first part of this year, the magazine demand side was distorted a bit in part by a disagreement over an increase in newsstand distribution charges, which certainly impacted sales. The issue has since been resolved. Magazines are still being impacted by an over 25% falloff in advertising. But having this channel of the market issue taken care of is a positive.

Postal rates will be rising by 2.3% on May 11. However, based on a new CPI formula, rates should be relatively stable in 2010 and this should drive improved catalogue use, which, of course, is very postal and paper price sensitive. Additionally, coated groundwood inventory levels at the printer and end user continue to fall on a ton basis and there are further production downtime announcements for the second quarter.

As for Verso, we've taken a large share of downtime as a percent of our production capacity. For example, our coated ground wood inventory is now 20% below our August 2008 level.

If you turn to page 11, going forward, we expect to take significant downtime in the second quarter to balance our system. In fact, we anticipate that our downtime in Q2 could be more than in our first quarter.

Beyond the demand issue, we have decided to extend our cold mill outages an extra 10 days at two of our four mills. This will have an additional impact of 40,000 tons beyond our already scheduled production downtime and includes pulp downtime as well. By extending the cold outages, we are using primarily internal resources instead of third party maintenance and will eliminate over $6 million of cash outflow.

In spite of our downtime, we expect prices to continue to be under pressure. The impact of pricing has, however, been much less severe than historical market demand challenges. And we believe that balancing our supply with customer demand has supported this. We believe volume will come back; the question is how much.

Bob mentioned that costs will continue to decline on a quarterly basis. However, please remember that raw materials that have shown tremendous decreases like OCC are not part of our raw material make up. Our major chemical makeup is, as many of you know, latex, clay and starch.

Although still higher than the first quarter of last year, latex and starch are declining from Q4 '08 levels, which is certainly a positive. Clay, however, is up 5% from Q4 '08 levels and we expect latex and starch to continue its decline while clay should be up slightly Q1 to Q2. Wood, you may remember was still at relatively stable price levels in the first quarter of '08, then over the next nine months escalated significantly. Therefore, we expect sequential costs being down in the second quarter but flat to slightly up year-over-year.

R-GAP, as Bob mentioned, in spite of low machine utilization, continues to deliver results and we expect that certainly to continue.

Our cost remediation plans continue to drive year-over-year improvements. With this quarter's results, we are announcing a comprehensive, companywide $65 million cost savings program. This program includes salary freezes, headcount freezes, significant cuts in incentive targets, SG&A reductions, chemical substitution which I mentioned and the suspension of our company match on 401(k) and deferred comp contributions for our salaried employees. During Q1, approximately $10 million of this $65 million expense savings was achieved. We expect to achieve almost all of these savings in 2009.

In addition, we took steps to improve our cash position beyond the aforementioned downtime by suspending our dividends and closely managing CapEx.

How a company positions itself for the future is critical. Since Verso became a company, we have recognized that trading short-term gain versus long-term success is not the way we wanted to run the business.

That being said, we recognized long ago that our training system was inadequate and through all the different past owners not cohesive at the mill level and was technically a bit dated.

Throughout this slowdown, we've continued to invest in our workforce planning. This includes the training governance, a computer based training solution, a redesign of work and a standard testing platform that will have significant cost benefits. We've combined five discrete training programs into one robust platform.

Our people will have the skill and knowledge that will allow us to staff at lower levels as 40% of our workforce will be eligible for retirement over the next three to four years. This commitment has allowed us to reduce costs as people depart, and this cost improvement will continue to escalate over time and will help position Verso for continued improvement in our financial and operating performance as the economy recovers.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). We'll go first to Bruce Klein with Credit Suisse.

Bruce Klein - Credit Suisse

Hi, good morning guys.

Michael Jackson

Hi Bruce.

Bruce Klein - Credit Suisse

I wanted to just understand better the alternative fuel tax in terms of how the cash payments sort of came in. I think in February you guys stated there was $30 million that came in and if you could just help us fill in the gap if March came in, et cetera.

Robert Mundy

Yes, as referred in our numbers, we had... there was $105 million for the period September through March that we applied for and we had received, prior to close of the quarter $30 million, which is the same $30 million that I noted in the, I think, in the 10-K.

Bruce Klein - Credit Suisse

That was February, Bob?

Robert Mundy

Yes. And the balance of that, so about 75 or so was still in the receivable at the close of the quarter. But we've since received a better portion of that, a good portion of that subsequent to the first quarter.

Bruce Klein - Credit Suisse

Okay, so you... the 75, you got most of that in 2Q or, I guess, April, May, I guess.

Robert Mundy

Right.

Bruce Klein - Credit Suisse

Okay. And that reflects... I guess you have two mills that are certified now, is that right?

Robert Mundy

Yes, that's right.

Bruce Klein - Credit Suisse

Okay. Is it fair to say you would... the goal or the intention is to apply those two mills quarterly or monthly for the rest of the year? Is that the plan or is there a different plan?

Robert Mundy

No, I mean the legislation is in effect until year-end. And as I think we've said in our Q that we will intend to continue to file for the credit. And although there are no guarantees, obviously, there's been a lot of discussion about it. But we're fully confident in what we're doing and how we're doing it as are many other paper companies. So, yes, we'll continue to file and it's just no guarantee that this would last to the end of the year.

Bruce Klein - Credit Suisse

Right. And my last... one more question I just had was the working capital looked like it was different kind of trends than we'd seen prior on I think all three of the major items. Can you just help us understand that better?

Robert Mundy

Yes, the first quarter is really our... we always have our largest use of working capital from the end of the year to the end of the first quarter. We have some rather large... so this one, yes, I agree. This one was a bit larger than normal and then I'll explain that a bit. But in general, it's always a big use of working capital for some key reasons.

We have our largest interest payment of the year early in the first quarter. So that's a bit large accrual that's sitting there at year end as are some large customer rebates that we have sitting in as accruals that are paid out during the first quarter and then at the end of this particular year 2008 where prices and volumes and revenues were up and those... that accrual was larger than our normal year end.

We have some companywide... every employee in the company had some form of gain sharing or incentive comp and everything. That was something newly implemented during in the year, so there was a large accrual there, more than previous year ends. That again is paid out during the first quarter, so another drain on working capital. But we always have to build our wood prior to the spring volume where our mills are located. Once the ice and snow melts, you cannot get wood out of the forest. So you have to build up your inventory before that happens.

And we do build some pulp for the outages that we're currently going through now. We do build that up to run the machines, to make the products that we can that customers are ordering. We've got to make sure we have an adequate pulp supply when those mills are down for their outages. So again we normally have a large use of working capital during this period; it's just this one was a little bit larger for some of those reasons.

Bruce Klein - Credit Suisse

And does it reverse in... I mean, I think looking back historically, I think it does typically reverse 2Q, should we see more than normal reversal in 2Q?

Robert Mundy

I think you will see it swing, swing back and it won't be obviously near the magnitude that it is the first quarter. I think that's fair, Bruce.

Bruce Klein - Credit Suisse

I'll pass it on. Thanks guys.

Robert Mundy

Okay.

Operator

We'll go now to Goldman Sachs, Joe Stivaletti.

Joe Stivaletti - Goldman Sachs

Yes, a couple of things. Just following up on the tax credit, you said you've gotten $105.5 million recorded so far through March. How much of that relates to just the first quarter? I'm just trying to understand what a normal quarter versus those tax credits is roughly.

Robert Mundy

Yes, Joe, you didn't state that correctly. What I said in my comments was that... and I think it's in the slide, but this 105 has not been received yet. Although it's not been received as I just mentioned to Bruce, that's what we have applied for the period of September to fourth quarter and the first quarter of '09.

Joe Stivaletti - Goldman Sachs

Right. No, I read all that, I'm just trying to understand because you didn't have... you didn't get everything starting from October one, if I remember right, you didn't... hadn't filed the paperwork as of October one or maybe you had, maybe you can clarify that.

Robert Mundy

We didn't... it did come become qualified until early 2009. So I guess, so the $105 million is covering six, seven months of our black liquor alternative fuel mixture. That seven month period relates to the $105 million, of which we received $30 million during the quarter and the balance of that $105 million, most of that we've received subsequent to the first quarter.

Joe Stivaletti - Goldman Sachs

Right. So is it accurate then to take the $105.5 million and divided it by 7 and say that it's reasonable for modeling purposes assuming $15 million a month?

Robert Mundy

Every month is different in how we operate the mills. It's different from week-to-week to month-to-month. I mean you can model it that way, but there's no guarantee that's a precise way to do it, but... and of course, we can just assume how we are going to run the mills for the rest of year. So it's just sort of a moving number, but that's one way to get at it.

Joe Stivaletti - Goldman Sachs

Can you give us the amount that was accrued specifically related to January, February and March?

Robert Mundy

I think what we've... the 105 relates to that seven month period and again, every month was a little bit different. So I don't know if I had by month here with me, Joe.

Joe Stivaletti - Goldman Sachs

Okay. And then on the business front, I just wondered if you could give us any additional color. I mean there is such a lack of visibility that I know you guys are dealing with, but clearly investors are dealing with too. And I wondered if have any kind of feedback or initial indications from customers in terms of getting into the bigger, the busier catalogue season and what they are thinking about as they get further into towards the middle of the year, or if it's just too early for that. Just trying to get your impressions on when you think some of these fairly dramatic volume fall trends might ease up a bit.

Michael Jackson

Yes, Joe, this is Mike. A couple of things. One is that let's maybe start with the inventory levels that certainly on the coated groundwood side, the trend is pretty significant in terms of the falloff. I mean if from a high of above 850,000 tons, and this is the pipeline which includes both the printer level and the mill level, about 850,000 tons probably six months ago and now it's dipped below the 700,000 tons, probably about 690,000 tons. So that's a positive as it relates to coated groundwood. Obviously, the days of inventory are pretty high because of the demand. But in pure terms of inventory, that's a decent sign.

Coated freesheet was certainly trending up, although I will say that March, it looks like it fell about 10,000 or 12,000 tons across the industry. But again there is a consumption or a demand issue as it relates to freesheet at the moment. So that's kind of the inventory situation.

I think the positive side is that the Postal Service seems to be coming up with some very innovative ideas relative to offering discounts, depending on the type of mailer that you are. And I think there's also a consideration in June that's going to hit the table that will deal with the June to September Postal opportunity as well. And I think that that will create a demand perhaps that isn't there today.

With those inventory levels as low as they are and the fact that I think that retailers are recognizing that to generate any type of revenue, they're going to have to touch the customer differently than they certainly have in the last six to seven months. We do see that improving. The question is what's the acceleration, what's that going to look like. But we do know we're going have a catalogue season. We're seeing signs of, as I said, bit of a better inventory. I think people, from a positive perspective, feel a little better. I think the stock exchange is moving in a positive fashion. I think our customers are feeling a bit better. But the key is going to be advertising and they've got to free those dollars up. And until that happens, we're not going to see a tremendous increase certainly on the magazine side. But catalogues will come; I think the magazine's going to be a bit later until the purse strings open up in a sense.

Joe Stivaletti - Goldman Sachs

Just finally I mean, can you give us an update on sort of what's going on the pricing front, or on a sort of real-time basis if you're seeing... I mean is the downtime working or are prices continuing to go down?

Michael Jackson

Well, I think as we said in the opening comments, we still have pressure on price. But certainly, Joe, based off of the inventory... I'm sorry, based off of the downtime that we've taken, the impact of the price pressure is in our view significantly less than it would have been. If you historically go back and look at these businesses, at these operating rates, you would never come to the pricing level that you are today, and I think that's a positive. I think that speaks for what we're trying to move towards, which is a much more disciplined approach in terms of how we think about our business. So, yes, the pressure continues, but if you went back three or four years, I think it would have been significantly more pressure that there is today. And as Bob said, I think our prices fell about 4% quarter-over-quarter, which could have been a lot worse candidly.

Joe Stivaletti - Goldman Sachs

Okay, thank you.

Michael Jackson

You bet.

Operator

Now to Chip Dillon with Credit Suisse.

Chip Dillon - Credit Suisse

Yes, good morning.

Michael Jackson

Good morning, Chip.

Chip Dillon - Credit Suisse

First of all, in terms of the tax credit as it rolls in, does it make sense to and can you apply it to the first lien debt so it just helps take pressure off of the covenants, which may become more of a concern later in the year?

Robert Mundy

Yes, Chip, I think we have flexibility there for what we could use that for and we evaluate all of our options and that could be one of them.

Chip Dillon - Credit Suisse

Okay. And then secondly, so you can't... there is nothing that restricts you from paying down that... obviously, the revolver, but even the term B debt, if you so chose to?

Robert Mundy

That's right.

Chip Dillon - Credit Suisse

Okay, and then in terms of running your pulp mills, I know that you don't... certainly, you use some virgin hardwood at the mills that aren't integrated, I guess that would like Bucksport and Sartell. So even as you take downtime across your system, are you able to run your pulp mills pretty fully and either trade or actually ship the pulp to those other mills if you don't deem it... make sense to buy in the market?

Robert Mundy

Yes, and in fact we do that. As Mike mentioned in his comments, we now have the ability to make softwood pulp at our Quinnesec mill, which we've never done before, which gives us a lot of flexibility. And even with... to supply our non-integrated mills and even those spot prices for softwood are down as you know. If you can keep that money and how, so to speak, it makes a lot more sense to do that. And obviously when pulp prices are volatile too and when those come back to normal levels or wherever they may go at some point, obviously, we bake down a new internal advantage for us by being able to supply our non-integrated mills with softwood pulp, not totally, but to a much larger extent than we have in the past.

Chip Dillon - Credit Suisse

And it makes sense to actually ship it or to swap for it?

Robert Mundy

We do both. I mean we do both.

Chip Dillon - Credit Suisse

Okay, okay, and then drilling a little bit into the working capital, which shot off $170 million more... less. Even when you net out the... clearly, the credit was about $76 million of that increase in the number. So the non-credit was up 100 and it looks like a lot of that was just the payables going down and... or the accrued liabilities and the payables. Is some of that because I guess that those were held out at the end of the year or is it more that with the lower volumes, you just don't have as many accrued liabilities and accounts payable?

Robert Mundy

No, and that's... Frank, thanks for bringing that up because I should have mentioned that when Bruce asked his question because that's the other key component that's different versus previous periods, at least during the end of the year to the first quarter is with this amount of downtime we've taken our payables from where they were in the fourth quarter to now are down significantly and that accounted for another large use of working capital.

Chip Dillon - Credit Suisse

Okay. And then last question is the stuff we see from the AF&PA about imports and exports is woefully delayed and you guys are in the frontlines. I mean you look at how cheap it is to ship paper, you look at how low pulp is. Given that, has there been any increase or any stickiness to the level of imports either coming from Asia or where they redefine things or from Europe?

Michael Jackson

Chip, this is Mike. The latest data that we have, which was through the end of March in terms of imports, showed coated freesheet down 18% and coated groundwood down 13% sequentially... I mean year-over-year. So we see that trend, and you're right, it is... you can get product over here fairly cheaply. But when you think of exchange rate, it's back to... or at least yesterday I think was 13.19 or something like that. And so there's still an issue with the exchange.

The other thing is, and I think we've talked about this before, is like any business, there's pressure from many obviously to get to better performance levels. And I think that coming over in a sense, dumping product here in North America, I'm not sure really helps what many companies are trying to do, and that is manage their businesses better. So I think it's a combination of both, but we've not seen a significant increase at all.

Chip Dillon - Credit Suisse

Okay. And then when you look at the financial situation, is there any reason for you to look at trying to change any of the your debt structure? I mean you have nothing due till 2013. It would which seem to me that with the tax credits rolling in that you pretty much would just chose to operate the business and ride this thing out.

Michael Jackson

I think we feel confident that that's the right approach, Chip and don't need to do anything fancy at this point.

Chip Dillon - Credit Suisse

All right. And then a very last question, on the tax credit, obviously, it's literally day-to-day, but are you aware of any bill and committee that has actually put a date down on paper that stop... would be a stop date or is it not gotten to that point?

Michael Jackson

It's not gotten to that point Chip.

Chip Dillon - Credit Suisse

Okay, thank you.

Michael Jackson

You bet.

Operator

We'll go now to Jeff Harlib with Barclays Capital.

Jeffrey Harlib - Barclays Capital

Hi good morning.

Michael Jackson

Hi Jeff.

Jeffrey Harlib - Barclays Capital

Could you just talk about how your seeing your kind of orders and shipments into April and May versus where they were in March just in terms of the level of business generally?

Michael Jackson

Yeah, I guess I would describe it as probably the first quarter from a volume perspective I believe was the bottom. And I think that we've kind of leveled out, and I haven't quite seen an uptick yet, but we've certainly leveled out. And I guess that would be true certainly looking at through the end of May. We'll normally see... begin to see bookings increase towards the middle of June. And I guess time will tell if that's going to happen. But I can clearly say that we seem to have bottomed out relative to our booking level.

Jeffrey Harlib - Barclays Capital

Okay. And then first on the inventories, where would you say are they... if you look at pulp, if you look at freesheet, groundwood, where are they still too high? And I just want to understand the downtime in Q2. Are you saying it's 140, about 140 or higher? Are you including the 40,000 of maintenance downtime in that?

Michael Jackson

No, it'd be a bit higher than the 140.

Jeffrey Harlib - Barclays Capital

Okay.

Michael Jackson

Yes, I think I said in my opening comments that we expect to take a bit more downtime in the second quarter. And in terms of, as I mentioned, I think our inventory levels as you coated groundwood, if your talking about Verso specifically our coated groundwood inventory is 20% less than it was in august of 2008, at which time I think ding a good job with inventory management then. So, we I think we are very well positioned as it relates to any spring back and of course of these two grades with your unlike any other paper grades. They have the ability opt bounce back, as they did to go down, significantly and very quickly and that's certainly different than the encoding grades and bleach grades et cetera, I mean this clearly tied to the economy and some of these bounce backs are just very, very fast and very accelerated. So, we think we are in a good position there, on the coated freesheet side, we are taking some downtime on the freesheet side to get a freesheet in a little bit better condition.

Jeffrey Harlib - Barclays Capital

Okay. So it sounds like in Q2 you hope to reduce inventories?

Michael Jackson

That's correct.

Jeffrey Harlib - Barclays Capital

Okay. Okay. And then just on the... you gave a bridge for Q1 to the prior year. Can you give a rough bridge on 4Q to 1Q impact of pricing downtime or input costs, if you have that?

Robert Mundy

Yes, Jeff, obviously, the big driver is between those two... there is about a $20 million, $25 million difference in the two between the fourth quarter and first quarter. Volume was about $7 million, price was about say 15 or so, or downtime was 15 or 16. And it was offset by operations were up a couple of million, input prices, as I think I may have indicated, were up about $10 million sequentially and we had some savings and SG&A and some other areas. So that roughly should get you there. I didn't do the math as I was talking, but that should be close.

Jeffrey Harlib - Barclays Capital

Okay. And lastly the alternative fuel tax credits, are they... is there a tax payable on receiving those or no?

Robert Mundy

I'm sorry?

Jeffrey Harlib - Barclays Capital

In other words, on those credits that you get, is there tax paid against those credits?

Robert Mundy

Well it's included in our tax loss for the quarter. It's included in our numbers and as I'm sure your aware, we have some large NOLs that are in place. But it goes into our calculation for the quarter. So it's just that these NOLs, we still don't anticipate paying taxes for a while.

Jeffrey Harlib - Barclays Capital

Okay, thank you.

Robert Mundy

Yes.

Operator

We'll go now turn to Sterne Agee's Sandy Burns.

Sandy Burns - Sterne Agee

Hi, good morning.

Robert Mundy

Hi Sandy.

Michael Jackson

Good morning.

Sandy Burns - Sterne Agee

Maybe just following up on the tax credit issue. Does that amount count as EBITDA for the company for bank covenant calculation purposes?

Robert Mundy

No that's why when you got to look at our actual EBITDA to our adjusted, I back that out.

Sandy Burns - Sterne Agee

Right. Okay. And just kind of asking... following up on an early question about applying the proceeds, is there any requirement that the company must immediately apply the proceeds to the revolver or term loan, or can you keep that as cash on the balance sheet until the cash flow sweep is calculated at the end of the year?

Robert Mundy

Well there are certain things that you could encounter could require you to use any excess cash flow to pay your term loan or your revolver. But there is some flexibility there and we've got some options, Sandy, and we want to obviously take advantage of get the biggest bang for our buck as we sort of take a look at how to our improve our capital structure.

Sandy Burns - Sterne Agee

But if you just wanted to keep this cash to improve your liquidity, is that one of the options you can...

Robert Mundy

That's an option.

Sandy Burns - Sterne Agee

Okay, great. And then just in terms of thinking about the second quarter, I guess there is two kind of opposing trends going on. You have increased downtime, which will obviously increase the cost there. But then on the other hand, you have the cost saving initiatives continue to kick in as well. This may be hard to answer, but net-net, do you think the increased downtime cost will be greater or less than the cost savings you are anticipating in the second quarter?

Robert Mundy

Well, I think it would be a bit less. However, as Mike indicated, there is still some pressure on pricing and that may be down sequentially as well. So you had to throw that into the mix.

Sandy Burns - Sterne Agee

Right. But I guess the two areas that you have some control on, the downtime and the cost saves, you feel like the downtime cost, cost savings initiative should exceed your downtime costs?

Robert Mundy

Yes.

Sandy Burns - Sterne Agee

Okay, great. And then also on the cost saving initiatives, are there any material cash costs involved as you're taking these costs out of the business?

Robert Mundy

No, no, no there is not Sandy. The things that are in our program right now are... there's no significant cash outlay at all really for any of these, which is... obviously gives us the most benefit in this environment.

Sandy Burns - Sterne Agee

Okay, great. And last question, CapEx, still thinking $50 million for the year or just given current conditions, is there are some further reductions there?

Robert Mundy

No, I think we'll be down below that, maybe well below that is sort of what we are thinking now with some things we've been able to do during these outages. We've been able to take advantage of certain things and actually put off some capital that in normal operating conditions, you would not have been able to do that. So actually, that's helped us in a weird sort of way to minimize our CapEx for this year. So I think it will be closer to sub 40 for the year.

Sandy Burns - Sterne Agee

Okay, great. Thank you and good luck.

Robert Mundy

Thanks.

Michael Jackson

Thanks Andy.

Operator

We'll go now to Tyler Old, JPMorgan.

Tyler Old - JPMorgan

Hi good morning.

Michael Jackson

Good morning Tyler.

Tyler Old - JPMorgan

Mike, just following up on your comments on inventory. If you had to guess where are we in the current inventory cycle. I'm particularly interested in more of the customer level. Are we in the six or seventh inning here or customers pretty much believe these stock there (ph).

Michael Jackson

I think we've been pretty consistent in this answer in the last three or four months. And that is that by the end of May, the beginning of June, I think we'll be in the last of the eight, so to speak. And that's the way I would describe where we are as it relates to the inventory situation. And I think one thing I think very interesting is that when you look at printer inventory on the coated freesheet side. It is currently at its lowest level in history, so that's quite a telling piece of data.

Tyler Old - JPMorgan

And secondly, can you remind me how much of your business is contract and your generally what the length and terms of those tend to be? I guessed asked a different way, if coated markets snap back in the second half of the year, to what extent are you limited here on what you could pass through on price?

Michael Jackson

Yes, we're... we've changed that model over time in the last couple of years where we have a much shorter timeframe relative to guaranteeing prices. And I think we've kind of learned through trial and error that long extensions of pricing can be pretty damaging to your business. So freesheet is a lot of spot business, if you will. There are some contracts, but we don't have a tremendous amount of 6 to 12 month contracts at all in coated freesheet. We do contract long term per tons as relates to coated groundwood. But we'll have openers on perhaps a quarterly basis, based on where the marketplace is. So I think we've got a much more flexible market-oriented agreement with our customers than in the past.

Tyler Old - JPMorgan

Okay. And it looked like the downtime in the first quarter cost about $220 a ton or so in loss of EBITDA. Is that a reasonable assumption to use as we think about downtime for the balance of the year?

Robert Mundy

Yes, I think that's probably a good ballpark number there, yes.

Tyler Old - JPMorgan

Okay, great. And then just lastly, how much of your natural gas have you hedged and at what levels?

Robert Mundy

We've hedged probably just under three quarters or so of our gas and that will run through the better part of this year, nothing beyond that though.

Tyler Old - JPMorgan

Okay. And do you have a dollar value?

Robert Mundy

I don't have that with me right now.

Tyler Old - JPMorgan

Okay, thanks.

Operator

We'll move to Gary Madea (ph) with Broadpoint Capital.

Unidentified Analyst

Thank you. All my questions have been answered.

Michael Jackson

Okay.

Operator

We'll hear next from Terry Cannon (ph) with JPMorgan.

Unidentified Analyst

Good morning.

Michael Jackson

Good morning.

Unidentified Analyst

A question I guess on the pulp side, with the alternate energy tariffs out there, are you seeing market discipline slip a little bit on pulp?

Michael Jackson

We have not, and I guess can only speak for our market discipline. We've been very disciplined. The only thing that we, as Bob already mentioned, we have built a little bit of pulp inventory for our outages. But I have not seen what many have claimed and I can just say that I know that Verso has not participated in that. And I think just thinking about our downtime that we're taking in April, it's a great indication of that. We are going to run our business for the long term and, yes, it's enticing, but we've been very disciplined in how we think about this business and we're going to continue to do that.

Unidentified Analyst

I guess with the... you are getting a bunch of money in from your alternative energy incentive payments, you have a lot of options. Can you talk a little bit about sort of how you are thinking about keeping cash in the balance sheet versus buying back bonds or buying back more bonds versus paying down bank debt?

Robert Mundy

Well, I probably said all about that, all I can say there we have options, we have bonds trading at different levels, we have a term loan at the holding company level. Obviously, we have the revolver in the operating company term loan and so it gives us a lot of options and we're just going make sure that we, in this environment, try to get in those the biggest bank for the dollar and staying in compliance with obviously the agreements with our... our credit agreement and our indenture agreements.

Unidentified Analyst

Thank you very much.

Michael Jackson

You're welcome.

Operator

And we will take our final question from Richard Duetsche (ph) with Lenninburg Thulman.

Unidentified Analyst

Yes, good morning, thank you for taking my call.

Michael Jackson

Good morning.

Unidentified Analyst

In this quarter, the downtime that you're going to be taking, are you still going be running your recovery boilers through any of this downtime at endraskogen (ph) and Quinnesec?

Robert Mundy

We'll run those as need be. We still need to generate power... a certain amount of power for the mills during outages. And so we will follow our normal protocol for the energy load that's required to run the mills as we're taking the mills sort of down at various stages during the outages.

Unidentified Analyst

Just to understand this, so even though the mills maybe into a cold period, you'll still be running your recovery somewhat at a percentage of your recovery boilers for the energy, is that right?

Robert Mundy

Well, if you're cold, you won't be running your recovery... they won't be running the whole time or you would... that's sort of the nature of what cold outage is, everything is out. So obviously, you would run them then.

Michael Jackson

It's the start up and then the shutdown rate and then the startup rate is really what you're talking about.

Unidentified Analyst

Okay. And my final question is on the demand side. Could you tell me who is your biggest customer and who you think your greatest demand increase is going to come from towards the end of the year when you get it to season?

Michael Jackson

We don't normally give out, for a lot of good reasons, and forgive me for this, who our largest customers are. But I think you could probably think about the magazine producers and the big names there would probably give you a good view into that. But I really can't comment on who our top customer is.

Unidentified Analyst

Okay. All right, well thank you very much. Congratulations on a really good outcome for a very difficult quarter.

Michael Jackson

Thank you.

Robert Mundy

Thank you.

Operator

That does conclude our conference for today. Thank you all for your participation.

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Source: Verso Paper Q1 2009 Earnings Call Transcript

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