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Verso Paper Corp. (NYSE:VRS)

Q1 2013 Earnings Conference Call

May 9, 2013 09:00 AM ET

Executives

David J. Paterson - President and CEO

Robert P. Mundy - SVP and CFO

Analysts

Joe Stivaletti - Goldman Sachs

Bill Hoffman - RBC Capital Markets

Tarek Hamid - JPMorgan

Bruce Klein - Credit Suisse

Richard Kus - Jefferies & Company, Inc.

Kevin Cohen - Imperial Capital

Nilay Mehta - ALJ Capital

Marc DuBois - Bowery Investment Management

Operator

Good day everyone and welcome to the Verso Paper Corporation First Quarter 2013 Earnings Call. Today’s conference is being recorded.

At this time, I’d like to turn the conference over to Mr. Robert Mundy, Senior Vice President and Chief Financial Officer. Please go ahead sir.

Robert P. Mundy

Thank you. Good morning and thank you for joining Verso Paper’s first quarter 2013 earnings conference call. Representing Verso today on this call is President and Chief Executive Officer, Dave Paterson; and myself, Robert Mundy, Senior Vice President and Chief Financial Officer.

Before turning the call over to Dave, I’d 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 various SEC filings, which are posted on our web site versopaper.com under the Investor Relations tab. Dave?

David J. Paterson

Thank you, Bob, and good morning to everyone on the call. Let me first look back at our first quarter 2013. As we look at the quarter, we saw pricing as flat on a sequential basis and year-over-year. On the inventory front we have substantial reduction in inventories, but partially that was due to the closure of the Sartell asset. But we’re still down 20,000 tons excluding the Sartell asset closure versus the first quarter of 2012.

One of the significant issues for us during the quarter was the price of – the delivered price of natural gas to our two mills in the State of Maine. And we’re referencing a $22 million increase in cost for that gas on a year-over-year basis and a $15 million sequential cost increase versus the fourth quarter of last year.

During the – we want to remind everyone that we successfully completed the sale of the Sartell Mill site and the Fiber Farm in Minnesota and we’re now – have mill assets remaining at the site or in the Fiber Farm. We do complete an exchange offer for senior unsecured holding company term loan. We have no significant debt maturities until 2016 with the balance of the maturities in 2019. And we received $13.7 million Section 1603 grant dollars relative to the Bucksport Renewable Energy Project. Bob?

Robert P. Mundy

Thanks, David. Turning to slide 4, our overall volume for the quarter was around 50,000 tons below the first quarter of 2012, which is about the same amount of tons from machines that then permanently shutdown since last year’s first quarter. Sequentially volumes were just over 7% lower due to the normal seasonal slowdown, moving from the fourth to the first quarter, which also allows us to build our inventories which had been very low for the stronger demand during the balance of the year.

Revenues followed a pattern similar to volumes as prices both year-over-year and on a sequential basis were essentially flat. Adjusted EBITDA and operating income were similar to last year’s levels.

On slide 5, you can see that coated volumes were almost 60,000 tons below last year of which 50,000 tons related to capacity that has since been permanently shutdown. Coated prices were down about $10 per ton from the fourth quarter with most of that being driven by lower coated groundwood prices.

Very good pulp volume for the quarter and pulp prices continue to move up. We expect that prices will be fairly flat again next quarter prior to moving up during the third and fourth quarters. You may have seen that we’ve announced price increases on all of our coated grades effective July 1st.

Turning to slide 6, you can see the key changes between our first quarter 2013 adjusted EBITDA of $20 million versus the $25 million in the first quarter of 2012. As I mentioned earlier, overall volume was down as a result of the shut capacity. Price mix was favorable by about $2 million. Operations had an excellent quarter, coupled with the operating cost we’ve had since last year relative to the four paper machines we’ve shutdown.

As David mentioned, the energy component of our input prices relative to our facilities in Maine was almost $22 million above last year’s levels and primarily because of lower wood prices, our overall input prices were $18 million above the first quarter of 2012.

Slide 7, gives you a view of the adjusted EBITDA changes between the fourth quarter of 2012 and the seasonally slower first quarter of ’13. Lower volumes represent at somewhere between $3 million to $4 million, while price mix was off less than a $1 million.

Manufacturing operations costs were above fourth quarter levels, primarily in the area of repairs and indirect cost spending, but nothing alarming here as we had budgeted for this and actually finished the quarter favorable to our budget. Again, the unfavorable input prices were due to the gas issues in Maine that [we spoke of], the other areas of input prices like wood, fiber and chemicals were lower that fourth quarter levels.

On slide 8, there is a bit more information related to input prices where you can see the direction prices were move versus last year and versus the previous quarter. Overall, things were generally favorable except for the gas price situation in Maine. We expect input prices especially energy to move in a favorable direction in the second quarter versus the first quarter.

If you look at slide 9, we wanted to provide a bit more color regarding what we had recently experienced at our mills in Bucksport and Androscoggin relative to gas prices. As you can see the price of the commodity itself represent about the green line has remained fairly stable. But the cost to get the gas, delivered to these facilities went to unprecedented levels beginning around November of last year through March of this year.

The constraints in the delivery system driven by a general lack of infrastructure were exacerbated by a number of issues including an increase in natural gas bio-generation, storage levels going negative compared to last year’s levels, sustained cold weather due to winter months, competition for gas from further south of this particular area of the Northeast as well as the utility in Russian and Canada causing increased competition for gas supply.

On slide 10, we’re showing on a quarterly basis with the delivered cost of gas looks like in the State of Maine versus what we pay in the Upper Peninsula of Michigan, which is where our Quinnesec Mill is. You can see the spikes that occurred in every year during the coldest months which are driven by delivery charges, again with the most recent winter months reaching historical levels.

I will now turn it back to David.

David J. Paterson

Thanks, Bob. On slide 11, just look for the second quarter of this year. We continue to see strong volumes across our system and continued reduction in our inventories through the quarter. For the quarter paper pricing is fairly flat, pulp prices show continued increases coming through as Bob had mentioned, across our coated paper segments, we see in July 1st price announcements in the marketplace.

Our manufacturing operations are continuing to perform well, though we’ve a second quarter maintenance outage at Androscoggin, which is a normal maintenance outage. Input prices, particularly in the energy side of move lower as we move out of the cold winter months and some of the excessive demand on the delivery system in Maine East. And the working capital will show the decline through the quarter, driven by sales and reduction in our inventories.

So with that, operator we will turn it over to questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) We will take the first question from Joe Stivaletti from Goldman Sachs.

Joe Stivaletti - Goldman Sachs

Good morning, guys. I was wondering first if you could – regarding the gas situation, obviously quite a challenge there. You noted that it was $22 million unfavorable in the quarter year-over-year. I wonder if you could give us any rough idea of what the improvement might be from Q1 to Q2 on that particular line item, the gas situation you said – you thought that things would improve in the second quarter?

Robert P. Mundy

Yes Joe. I would think that will move as I said in a positive direction and somewhere between $7 million and $10 million, I would think.

Joe Stivaletti - Goldman Sachs

Okay. And then you mentioned also the Androscoggin maintenance outage in the second quarter. Can you quantify the cost of that and also remind us when that was last year?

Robert P. Mundy

The cost is somewhere between $4 million and $5 million. Last year – actually I’m drawing a blank on that, it may have been in the – it probably was in the second quarter, obviously outages are different, they’re not identical, you’re not exactly doing the same things every year. But I would assume it was in the second quarter, but I have to check Joe.

Joe Stivaletti - Goldman Sachs

Yeah I can look it up. The other question I had was looking at your debt structure, obviously you established quite a bit of flexibility with liquidity and whatnot, with your next maturity being the senior sub notes that leftover. I wondered if you could just talk to us about your thoughts on timing of adjusting that maturity, I know its not for a number of years, but I did know it – that was something that would be should we think about that as a near-term goal or something that you figure you just can lead for a while?

David J. Paterson

Obviously we’ve been doing a lot with our debt structure over the last 18 plus months and I think we’re probably just take a break for a little while and that’s just not real high on the priority list right at this time.

Joe Stivaletti - Goldman Sachs

Okay. Thank you. Those were my questions.

David J. Paterson

Thanks, Joe.

Operator

We will move on to Bill Hoffman from RBC Capital Markets.

Bill Hoffman - RBC Capital Markets

Yeah, good morning.

Robert P. Mundy

Good morning, Bill.

Bill Hoffman - RBC Capital Markets

I wonder if you can talk a little bit about the system market conditions, I mean, it seems like the markets are reasonably down to this point in time, but really we’re trying to get a sense of as we look forward in the – really in the back half of this year what you guys are hearing from customers with regards to order books, changing substrates after the difficulties caused by the SC grades last year, just give us some more color on that?

David J. Paterson

Sure. Well, I think our customer base remains cautious based on their activity. Having said that, order – our order volumes are tracking at or above our business plan. Our inventories are below our business plan. So in general, I think this activity is slightly better than most people thought going into the year, but people still are – there is not a confidence in our customer base to really forecast much beyond the quarter that we’re in. Having said that, I think generally the attitude is better. People are more optimistic about economic activity, but still very cautious on what the forecast.

In our case, I think that’s a combination of – we do a significant amount of capacity either by design or by the Sartell accident last year and then we were able to resort our order book, so we were out of the SC business when the mill restarted in Canada. And I think the grade shifting that you referenced took place late in the first quarter, early first quarter as people made those decisions for the 2013 buying pattern. So, the market is quite in terms of grade shifting right now. Most of the activity took place late last year, and early this year, and typically customers will make that commitment for a grade per year and stick to it. So, that noise is died down. And of course you saw, on the pricing front the SC producers came out first and came out strongest. So, that’s how I see it.

Bill Hoffman - RBC Capital Markets

Thanks. And then, with respect to imports, we’ve also seen a lot of closures over in Europe, and it sounds like just from (indiscernible) consolidation over there. Are you seeing much new import pressure from Europe, or what are you seeing at the markets right now?

David J. Paterson

No, I think that in terms of, what you call it market share shifting. I don’t think we’ve seen a big attempt by the international producers to take share of the North American market, so we see it pretty quite. You will see and occasionally some minor tons coming in that aren’t normal, but it's nothing to get – nothing beyond the normal market noise.

Bill Hoffman - RBC Capital Markets

Okay, thanks. And just a question for Bob, the inventory build in the quarter; do you have much more to go in the second quarter to get yourself prepared for the back half of the year?

Robert P. Mundy

No.

David J. Paterson

Well, we have the opposite problem.

Robert P. Mundy

Yeah.

David J. Paterson

We’re worried that we’ve got commitments to customers and some of those are stocking programs, and we need to make sure that our stocking programs are adequate to meet our customer demand. So, from a purely (indiscernible) review point we’re very tight on inventories and that’s a good thing for us.

Bill Hoffman - RBC Capital Markets

Okay. Thank you.

David J. Paterson

Thank you.

Operator

Tarek Hamid from JPMorgan has your next question.

Tarek Hamid - JPMorgan

Good morning.

Robert P. Mundy

Good morning.

David J. Paterson

Good morning.

Tarek Hamid - JPMorgan

I guess, going back to the natural gas situation a bit, I mean, is this something that we should probably expect that 4Q and 1Q are going to be challenging for a while. Are there any sort of way’s you guys can look to kind of mitigate this as we go through seasonally on gas prices in Maine?

David J. Paterson

Well, that’s a great question, because a lot of what we think is happening in Maine is there is not a short term fix for it, that it's going to require investment in infrastructure, it's going to require new supplies or new sourcing to be available or being accessible to the State of Maine, and it's going to require, I’ll call it a New England or North East strategy because it's, some of the issues are related to what's going on to the South of Maine in terms of Maine being sort of at the end of the pipeline so to speak relying on other states to give us access to gas. So, we are working with Federal and State and Regional authorities to try to begin a dialogue to create a new energy strategy in New England, and we’re very hopeful in that, and that’s not a short-term solution. So, in the short-term we basically have two vehicles. One, we’ve already begun modifying our hedging policy, and looking at what we just experienced. So what the normal seasonal volatility is really around the delivery cost in Maine, and of course this was exceptionally higher, unprecedentedly higher this year. So, we’ve begun a policy to hedge for the delivery cost and not just the gas itself. And the gas is reasonably stable, but so we’ve changed our hedging strategies getting ready for the next winter. And then secondarily, we have to look at the way we operate our facilities in what we call the 16 months of winter in or severe winter in that part of the country, so we can actually reduce our draw on gas at periods of peek demand. So, we’re rethinking our manufacturing strategies, and we’ll have those in place in time for the next winter.

Tarek Hamid - JPMorgan

Great. And then, I think you guys had sort of talked about $200 million year end liquidity target last quarter; is that target still in place or [early in the finish]?

Robert P. Mundy

Yes. It's still the target.

David J. Paterson

We talked a lot about gas and the impact, but actually operationally and from a marketing point of view we’re encouraged by what we’re seeing through the first quarter. We take gas out of the mix. I think the Company performed well.

Tarek Hamid - JPMorgan

Great. And then just one last one, just kind of big picture on just sort of consolidation in the industry kind of any updated thoughts, anything you guys have seen that sort of would suggest the consolidation is sooner or rather than later or that coated versus un-coated versus other grades are becoming kind of more in vogue?

David J. Paterson

Well, we think clearly we’ve seen some consolidation in different sectors of the power industry and we’re starting to see some consolidation moves in our customer base most notably U.S. (indiscernible). So yes, we look for those opportunities. We want to be a participant in those opportunities, and we’ll just have to see how it plays out for the balance of the year.

Tarek Hamid - JPMorgan

Okay, great. Thank you guys very much.

David J. Paterson

Thank you.

Operator

We’ll go next to Bruce Klein from Credit Suisse.

Bruce Klein - Credit Suisse

Hi, good morning guys. Wondering on – for on the gas, I guess, it explains, I guess the seasonality obviously is worsened for Q1, was it still higher impact, I mean, it's still higher than quote normal impact in 2Q and 3Q or is it just, it's not an issue in those quarters, it was just better but not near what it used to be?

David J. Paterson

Well, I think the take away is we had an unprecedented pricing of the cost to deliver gas in the first quarter. Normally seasonally first quarter was our toughest quarter for gas for the obviously reasons mostly pertaining to weather. So, we sort of blew through all historical marks in the first quarter this year, and it will return to normal pattern we believe because the consumption, those demand on the pipeline drops off as the weather warms up in the north east, and we get less competition for natural gas from I’ll call the New York, Connecticut, Massachusetts markets. And I think that, just looking at the weather map, I think you had a fairly warm early spring in doing one in New York, so that’s good news in terms of these type of cost issues. Structurally the issue is still there and in our view upset -- the system can’t handle upsets without this kind of price behavior coming into the marketplace. So, that means a structural change has to take place which means it's not a short-term fix. So yes, for the balance of the year we think gas will return to normal pattern, that’s why Bob referenced in a quarter-over-quarter significant lower gas prices and that should continue until we get into the next cold, whenever the winter starts in New England that’s when we get to risk the highest level of risk around gas pricing.

Bruce Klein - Credit Suisse

All right. That’s helpful. And was there about maintenance cost in 1Q or that was pretty clean?

Robert P. Mundy

It was pretty clean Bruce, yeah.

Bruce Klein - Credit Suisse

Okay. All right, good. Thank you, guys.

David J. Paterson

Thank you.

Operator

Moving next to Richard Kus from Jefferies.

Richard Kus - Jefferies & Company, Inc.

Hey, good morning guys.

David J. Paterson

Good morning.

Richard Kus - Jefferies & Company, Inc.

I just want to dig in on pricing a little bit. You guys said that you expect 2Q to be fairly flat here. Recently you’ve been showing some declines, is this something that you guys aren’t really seeing?

David J. Paterson

No, not really. I mean, we just did a review with our guys this week. I think there is some, we don’t see it, let’s put it that way.

Robert P. Mundy

I’d mentioned Richard, in my remarks we did see some coated groundwood pricing was down about $10 a ton. Overall our prices were flat. So we are seeing somewhat of it, I don’t think to this, today’s point to the extent that what you maybe reading.

Richard Kus - Jefferies & Company, Inc.

Okay, that sounds good. And then, as far as cash items are concerned, I saw you guys completed the Fiber Farm sale, completed the Sartell Mill sale, you received the grants. What other cash items are there, that are -- and I guess, outside of normal cash items?

Robert P. Mundy

Well, in the quarter?

Richard Kus - Jefferies & Company, Inc.

Yeah, no, going forward is there anything left that you guys have to receive yet?

Robert P. Mundy

Nothing out of the – obviously those were one time events, so we don’t anticipate any of those really.

David J. Paterson

We’re not waiting for any settlements with any major issues at this point.

Richard Kus - Jefferies & Company, Inc.

Okay, great. That’s all I have. Thank you, guys.

Robert P. Mundy

Thank you.

David J. Paterson

Thank you.

Operator

Kevin Cohen from Imperial Capital has your next question.

Kevin Cohen - Imperial Capital

Thanks. Most of my questions have been answered, but I guess when you look at the coated markets, do you believe that you guys maintained your market share during the quarter?

Robert P. Mundy

Yes.

Kevin Cohen - Imperial Capital

And then the second question, not the (indiscernible), but in terms of the year-end total liquidity goal, was that reaffirmed or you were saying you would like to be at that number or higher of $200 million or you believe that you will be at or above $200 million?

Robert P. Mundy

Okay, that was our goal early in the year and we don’t see any reason to come off of that.

Kevin Cohen - Imperial Capital

Great. Thanks a lot guys.

David J. Paterson

Thank you.

Operator

Nilay Mehta from ALJ Capital. Please go ahead.

Nilay Mehta - ALJ Capital

Hey, guys. Just on the natural gas, you mentioned $7 million to $10 million sequential improvement. But if I just, if you looked at year-over-year in 2Q, ’13 versus 2Q, ’12 on an absolute basis, are the natural gas cost going to be, and deliver cost going to be fairly flat versus last year or is it still going to be up year-over-year, and same for the third quarter, guess?

Robert P. Mundy

Yeah, well for the second quarter I think it will be flat to, maybe just year-over-year a bit negative.

Nilay Mehta - ALJ Capital

Okay.

Robert P. Mundy

And that’s just more in the commodity of the price of gas …

David J. Paterson

The base price of gas is slightly higher.

Nilay Mehta - ALJ Capital

Okay, that’s fine.

David J. Paterson

There’s $22 million in the first quarter, $3 million of it was gas price and $19 was delivery charges.

Robert P. Mundy

Yeah. But for the second quarter I think it will probably be a bit negative, nothing significant year-over-year.

Nilay Mehta - ALJ Capital

Okay. So, delivery not an issue in 2Q, more pricing issues.

Robert P. Mundy

I don’t see it.

David J. Paterson

We don’t see it or feel it, no.

Nilay Mehta - ALJ Capital

Okay, great. And then going into the winter actually you mentioned modifying the hedging policy with respect to delivery costs. Can you just talk about that a little more because sort of an interesting concept and how that might work and how it might help you actually save money?

David J. Paterson

Well, sure, well it's in any hedging policy if you’re trying to stabilize the cost of the commodity or the currency you’re trading in, and historically the company had had a policy around hedging the natural gas itself, and they’ve done that for several years. And clearly it's become clear to us that the biggest volatile part of that cost structure is not the gas itself, but actually the delivery cost. And we’re able to fix the cost of that delivery charge through a hedging mechanism on a script basis, so we’ve chosen to do that trying to put a capping effect on how high that price can go in the first quarter. And we think that’s a prudent investment on our part to avoid the tremendous spikes that we think are clearly possible now and maybe the norm going forward, and so we have a longer term solution to the supply and infrastructure constraints that we’ve touched on. So, it's a change in hedging strategy for us. And on top of that we have to rethink our in effect our manufacturing strategy in the cold weather months and can we reduce our absolute consumption of units of gas to also de-risk the price spikes and that part is being developed, but clearly we would have to understand the marginal cost of manufacturing better in the cold winter months to make some decisions around how many tons we make and where we make them.

Nilay Mehta - ALJ Capital

So, just sort of per forma hypothetical, but had you put the same hedging mechanisms in that you’re planning on doing for the winter -- upcoming winter in the first quarter this year. What would the impact have looked like instead of $22 million, would it have been significantly lower, what would it have been?

Robert P. Mundy

Yeah, it would be significantly lower, half maybe, again but that’s obviously you said very theoretical and but, yeah because we don’t know what the commodity necessarily will do next year, but I would think around half or better.

Nilay Mehta - ALJ Capital

Okay.

David J. Paterson

But we’re hedging both. We’ve begun to hedge the delivery and we’ve continued to hedge the commodity. So, we’ve got a two layered hedging strategy particularly for the cold winter months in Maine.

Nilay Mehta - ALJ Capital

Okay, great. Thanks.

David J. Paterson

Thank you.

Operator

Moving next to Marc DuBois from Bowery Investment Management.

Marc DuBois - Bowery Investment Management

Hi, thanks. My questions have been answered.

David J. Paterson

All right, Marc. Thank you.

Operator

(Operator Instructions).

David J. Paterson

Okay, operator we’re in good shape. So, I think if anyone has any follow-up calls please contact Bob or myself, and we would be glad to try to answer them for you. We appreciate your participation in the call and look forward to speaking with you again in the second quarter call. So, thank you all very much.

Operator

Again, that does conclude today’s teleconference. We thank you all for your participation.

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