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Verso Paper Corp. (NYSE:VRS)

Q2 2009 Earnings Call Transcript

August 6, 2009 9:00 am ET

Executives

Bob Mundy – SVP and CFO

Mike Jackson – President and CEO

Analysts

Bruce Klein – Credit Suisse

Joe Stivaletti – Goldman Sachs

Chip Dillon – Credit Suisse

Jeff Harlib – Barclays Capital

Claudia Hueston – JP Morgan

Sandy Burns – Sterne Agee

Eric Anderson – Hartford Financial

Richard Cust [ph] – Jefferies

Lindsay Drogin – Sumitomo Mitsui Banking Corp.

Operator

Welcome to the Verso Paper Corporation second quarter earnings call. Today's call is being recorded. At this time, I'd like to turn the conference over to your host, Mr. Bob Mundy, Chief Financial Officer. Please go ahead, sir.

Bob Mundy

Thank you, Jessica. Good morning and thank you for joining Verso Paper’s second quarter 2009 earnings conference call. Representing Verso today on this call is President and Chief Executive Officer, Mike Jackson, and myself, Bob Mundy, Senior Vice President and Chief Financial Officer.

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 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 turn to slide four, our EBITDA for the first quarter was $51.3 million and we had a net loss of about $10 million. This includes about $38 million relative to the alternative fuel mixture tax credit earned during the quarter and a $26 million gain on the early extinguishment of some debt. Excluding special items, our adjusted EBITDA for the quarter was a negative $8.8 million and our net income was a negative $70 million.

Our LTM adjusted EBITDA now stands at about $156 million. Our results continue to be challenged by 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 catalog circulation, coupled with the inventory buildup that occurred in early 2008 significantly influenced the consumption of coated paper during the second quarter of 2009 compared to the second quarter of 2008.

We, as most companies today, are managing through unprecedented economic conditions. During conditions like these, things like advertising spending and catalog circulation are impacted more than most other paper grades. However, the turnaround, when that occurs, can be almost as dramatic. We believe we have made it through the most difficult period and are at very good position as we enter a stronger second half of the year.

During the second quarter, we remained focused on making decisions and taking action in a way to deal with the short-term issues, but also to try and ensure we are prepared when market conditions become more favorable. For example, we kept choosing to run our machines and improve our EBITDA by over $34 million, however, the significant cash drain and inventory buildup that would have resulted does not make good business sense.

We make our downtime decisions in a manner to minimize both the unabsorbed fixed cost and the cash outlay throughout our supply chain. Our reduction in finished goods and other inventories of $39 million versus the previous quarter drove our sequential working capital improvement. Our cost-saving initiatives, which include an additional $8 million to $9 million of savings through workforce reductions, are ahead of our plan. And we significantly improved our cash and liquidity positions. We also successfully completed a refinancing of our senior secured term loan, which eliminated covenants and extended the maturity of our balance sheet.

Moving to slide five, our adjusted EBITDA results were heavily impacted by our decision to manage our capacity with our customers’ demand for our products, which was down over 30% versus last year. And the continued pressure on sales prices of paper and pulp.

We took 141,000 tons of coated paper downtime and 12,000 tons of pulp downtime during the quarter. However, this allowed us to reduce our finished goods inventories by 21% versus the first quarter of 2009, and we are continuing to grow our specialty paper volume at Bucksport. Our pulp volumes were up year-over-year, but you need to consider the fact that we had our pulp operation at Quinnesec down this time last year for maintenance.

On slide six, you can see the specific year-over-year and quarter-over-quarter results for some of our key revenue drivers. I’ve already mentioned that year-over-year demand was down over 30%, although sequentially volumes were up over 7%. The higher volume increased our quarter-over-quarter revenues by almost 4% in spite of lower sales prices, which we mentioned on our last call, would continue to be under some pressure. We believe pulp prices have bottomed out and at the end increased during the last month of the quarter.

The key components of input prices shown on slide seven are continuing to improve. Prices for almost everything are lower. And we expect that overall prices for our key inputs will continue to head down throughout the year. We still have some hedges on the majority of our gas consumption that are in place for the balance of the year, and that is mitigating the benefit of the current spot prices that are out there regarding gas.

On slide eight, you will see a bridge depicting the key year-over-year changes in our adjusted EBITDA. The recessionary market conditions and their impact on volume, price and downtime are what drove the decline. Operations and input prices were significantly better year-over-year, and we expect this trend to continue for the balance of 2009.

Moving to slide nine, in summary, our customers’ demand for our products is being severely impacted by the global economic conditions and its affect on ad dollars and retail spending through magazine and catalog 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 price.

On a positive note, input prices and distribution costs continue to move in the right direction. We are 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 debt repurchase discounts. We also successfully completed a refinancing that helped improve our liquidity, eliminate our key debt covenants and extended maturity of our balance sheet.

On slide ten, you will see our liquidity is about $105 million improved over the first quarter and now stands at $183 million. Also note that subsequent to the second quarter, we paid down an additional $27 million on our revolver. On the right side of the page, you can see our net debt at various levels of our capital structure.

Looking at slide 11, you can see that we have no near-term maturities on our debt. As I mentioned earlier, we have extended the first significant payment on our debt by a year to 2014. And our refinancing has increased our operational flexibility and reduced our financial risk.

With that, I'll turn it over to Mike Jackson for an update on the second quarter and other comments.

Mike Jackson

Okay. Thanks, Bob. And good morning, everyone. Clearly the results for the second quarter, as Bob mentioned, were impacted by the continued fall-off in demand year-over-year of coated paper along with the continued pressure on prices driven by the pullback of advertising spending in catalogs. Although disappointed in our results, we went through what we view as the trough of coated paper market. We are and will be a stronger company as we come out of this.

Although quite painful, the second quarter market and maintenance downtime that we announced in our last earnings call when we said it would be in excess of the first quarter downtime was necessary. This added up to 161,000 tons or almost 36% of quarterly capacity. This number compared to 139,000 tons in the first quarter. Although this lowered our EBITDA by over $34 million, it, as it did in the first quarter, preserved cash and certainly had a more favorable impact on our balance sheet.

We have weathered what we believe to be the worst of the storm, and how we position ourselves for the future is really what I’d like to elaborate on this morning. Verso is and has been since late summer of 2008 focusing on leveraging our core competencies. These are clearly very difficult times, but Verso is not standing still. We are positioning the company to emerge from this stronger, more cost competitive and with greater opportunities to grow in high margin businesses.

One important outcome of our efforts to create a stronger company is shown slide 13. The most recent AF&PA data clearly shows Verso had the best safety lost workday record in the reported industry. These results positively impact both our cost structure and most importantly, our people. Good safety performance is a clear indicator of strong management focus.

Our focus has been on taking advantage, as I mentioned, of our company’s core competencies for developing products and services that really give us a competitive advantage and allow us to expand our revenue base into markets that complement those competencies and provide a balance to our magazine and catalog business.

Our core manufacturing competencies revolve around a few things. One is our lightweight manufacturing expertise in our coating applications, plus we have an infrastructure and a tremendous opportunity to produce more renewable energy, reduce our cost of goods sold, while at the same time generating new revenue opportunities from that infrastructure.

If you turn to page – slide 14, let me take you through part of what we have done in the past eight months and what it means to us longer term from a revenue perspective. In the next few years, we forecast these grades in the right to represent a key component of our revenue stream that will be incremental to our core product base business level.

During this call, I would like to focus on our new SCA+ grade called Clarity Plus, which is placed in the middle of the right hand stack, as you look at the slide. In subsequent calls, we will be taking or we will be talking about other products and services that we have developed as well.

Clarity Plus is a good example of our manufacturing flexibility and lightweight expertise. This product was launched two months ago, and we are in production and shipping product to customers, as we speak. SCA+ was a gap in our portfolio. 75% of this product used in States is manufactured in other [ph] countries, and we saw this as an opportunity. This quality product offers our customers a domestic sheet, competitively priced with superior bulk and, candidly, a fantastic playing surface.

Exchange rate concerns and consistency of delivery based on those rates are not an issue. This is a new customer, a new volume opportunity for us, and with the recent trend of strengthening of Euro and Canadian dollar, it’s really particularly timely. As important, this product is run on a scale machine at our Sartell Mill, which is fiber fed by our wood farm in Minnesota, which by the way is SFI certified. This product also allows us to reduce our coated groundwood production and market-related downtime.

As you have heard in the past, we have taken the smaller paper machine at Bucksport, which now becomes a scale machine and highly competitive in the growth markets of food packaging and eliminating substrates. We will also be talking to you about the impacts of these products later, as well as our energy strategy in the coming months. We have built Verso to do these types of strategic moves both efficiently and effectively.

We have a saying that we use at Verso, and basically it’s bad news early is better than bad news late, and conversely, good news early is better than good news late. We really tried to use that principle as we think about our quarterly calls with you and how we transparently represent business conditions in our company. Based on that philosophy and before we look to the third quarter, we thought we would highlight what our forward-looking comments on our last call were and what the outcome actually was.

Last quarter, we told you that we felt April order bookings had reached the bottom. This turned out to be the case. Since that time, our order bookings for May were up 20% from April levels and 32% from May to June booking levels. And I’ll say that July was another trend upwards. The seasonal pickup tends to occur obviously in the third quarter, and our booking levels are indicating that to be the case.

We stated in that call that we would be taking more downtime in the second quarter than in the first quarter. Total market and maintenance downtime I had mentioned earlier totaled 161,000 tons. If you combine that with our first half, the tons totaled almost 300,000 tons or an impact of over $65 million worth of EBITDA. During that call, we mentioned that prices would continue to be under pressure. This also was the case in the quarter. But really much less than historical supply and demand (inaudible) would indicate. Going forward, we will continue to balance supply with demand.

In spite of that significant downtime that I just mentioned, we expected our R-GAP process, which we said in the call to continue to deliver results and it did. Our second quarter number was $13 million better than last year’s second quarter number.

For those on the call last quarter, there were some questions and – good questions and discussions about our working capital level last quarter. And we suggested that the second quarter working capital would be a positive source of cash. It was, by $33 million. We also talked about continuing to pay down debt, and we did so, as Bob mentioned.

In addition, we extended further on our maturity schedule and eliminated our debt covenants. We announced a company-wide $65 million cost savings program. Our comment on that initiative was that almost all of these savings would be achieved in 2009. Based on that comment, we produced approximately $26 million of savings in the first six months. Last quarter, we referenced that pulp prices had hit the bottom by the beginning of May and expected prices to move up for the balance of the year. This certainly looks to be the case as we move forward.

During our call in May, we also told you that we would continue to invest in our people relative to computer-based skill and trading improvements that would allow us to staff at lower levels. This trend continues, as each quarter since January of 2007, we have lowered our employee base numbers and such was the case in this quarter.

Turning a moment to the purchasing area of our company, we said that in the second quarter we expected latex, starch and wood to continue to decline. That is what took place. And for the first time in months, we had a favorable quarterly year-over-year improvement, which will continue, as Bob mentioned, in the third quarter.

Let’s move to the future, if you would. Turn to slide 15. It really takes us to the latest view of inventory for both coated groundwood and coated freesheet at the mill and printer [ph] levels. You can see that these pipelines of inventory are low, an anticipated increase in demand levels that will certainly have an impact on the supply/demand balance, which will be more favorable as we move forward.

That said as the base, if you turn to slide 16, I’d like to make some main comments about the third quarter. The economy obviously continues to have a significant impact on the coated market. However, as I mentioned earlier, our order backlogs have improved going into the third quarter. And although volume will be down year-over-year, it will be up significantly over the second quarter, as we move into our busy season.

The Postal Service summer sale, which we talked about last quarter, was announced in June and runs from July 1st to September 30th. This, as many of you know, is the first postal’s [ph] discount of its kind and it’s really a very cost-effective way for major mailers to grow their business and should contribute to this fall’s pickup in demand. Although due to the quick timing of the announcement, candidly, the impact will be less than what we had hoped for.

Pricing will continue to be under pressure for the quarter, as Bob mentioned. We do expect input prices to continue to trend downward, and as happened in Q1 and Q2, expect a quarterly year-over-year improvement. Our manufacturing team will continue their cost savings, R-GAP deliverables. We are on track to deliver by year end approximately $40 million in savings.

During the third quarter, we expect downtime to be significantly less than in the second quarter, along with minimal swings in working capital. And as we did in the first half of the year, we will continue to evaluate the opportunity to pay down debt. Our remediation plan will continue to deliver results. And one last point, in June, we made further permanent reductions in both the hourly and salary areas and expect potential savings to be between $8 million and $9 million per year in addition to those cost savings announcements that we made last quarter.

We are continuing to work on making Verso a stronger company. This should be much more evident as the economy emerges from the deep recession, which has seen industry demand for the first half down 33% for coated freesheet and 31% for coated mechanical. These two grades, as Bob mentioned earlier, more than any others are influenced by economic conditions.

We really believe that better days are in front of us as we execute, what we’ve described today, our new product initiatives, continue to implement further cost reductions and our R-GAP improvements, capitalize on our energy strategy, which you will see more of in the coming months and see improvements in our core business.

With that, Bob and I would be happy to answer any of your questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) We will now take our first question from Bruce Klein with Credit Suisse.

Bruce Klein – Credit Suisse

Hi, good morning, guys.

Bob Mundy

Good morning, Bruce.

Bruce Klein – Credit Suisse

I think many of us don’t have the slides on our web forever, (inaudible) you guys are aware of that?

Bob Mundy

Okay, thanks.

Bruce Klein – Credit Suisse

I don’t know; all of us or some of us didn’t have access to the slides. What was the – I don’t – maybe I (inaudible) figure out. What was the black liquor money cash received in the quarter? I know in April you got $51 million. What was the cash for the full quarter, including April?

Bob Mundy

For the quarter, it was $95 million as far as, yes, cash received, yes.

Bruce Klein – Credit Suisse

And how is that going? Has it continued to come in sort of since quarter-end? Meaning, is it progressing as you planned? Has there been any trips to that or rums or how is that going?

Bob Mundy

You know, nothing has really – nothing has changed. Subsequent to the quarter, it’s – the program obviously is still in place. And so no, it just continues.

Bruce Klein – Credit Suisse

Okay. And then could you just touch on product pricing? It sounds like there is still pressure. Is the pressure abating? (inaudible) sort of had a big number. I think there is 50 for different grades of coated in the last month. It seems like a sort of bigger number. Again, I don’t have your – I didn’t have time to calculate the realizations yet. But is it getting any better out there? And is that sort of representative of what you are seeing? I forgot the amount in June that they were referencing. But could you touch on what you are seeing as –?

Mike Jackson

Yes, Bruce – yes, I – we're continuing to see a bit of pressure as we go into the third quarter, but certainly it’s – I don’t know how to measure pressure here, but it’s certainly a little less than it had been in the first half of the year. But it’s certainly still out there, but I would say it’s abating in terms of the total pressure. I would expect, as we said, in our scripts, so to speak, to see a bit of continued pressure going into the third quarter. But I think obviously that, as we think about demand and whatever happens to demand, that’s going to have quite an influence on what that looks like. But it’s certainly abating, I would say.

Bruce Klein – Credit Suisse

You’re not really saying that abating means less variance kind of 3Q versus 2Q, then 2Q-1Q, or you wouldn’t go that far?

Mike Jackson

It would be certainly less swing – you know, I’ll go this far with the question. I think certainly it will be less than from first Q to second Q as you look at second Q to third Q, definitely – definitely less.

Bruce Klein – Credit Suisse

That’s helpful. And lastly, just the – there were some talk or thought about some of your power hydro assets and potentially monetizing that. Those are my words. But is there any thought there or status update on that?

Mike Jackson

Well, we are always looking at opportunities. We certainly have the ability to monetize any non-core assets, and we just – I guess – leave it at that, I guess, Bruce, we are always looking at what makes sense and all opportunities, the things that are not core to the business.

Bruce Klein – Credit Suisse

Okay. I’ll pass it on. Thanks, guys.

Mike Jackson

Thanks.

Operator

We’ll take our next question from Joe Stivaletti with Goldman Sachs.

Joe Stivaletti – Goldman Sachs

I just wanted to follow up a little bit when you are talking about less downtime and some volume pickup, as you are halfway – well, almost halfway through the third quarter here. I wonder – can you put some numbers on that or give us a little bit more of a framework in terms of the volume pickup that you’re seeing sequentially? And also how do you roughly think about downtime in the third quarter versus the 161,000 tons in the second?

Mike Jackson

Let me see. I think the best way for me to detail with the question is I think we mentioned in the beginning of the call that since – April was the bottom of our bookings. And I think we mentioned that during our call in May. We said, hey, we think this is the bottom. And sure enough, that was the case. In May, we picked up significantly in terms of what that booking level was. And then from June over May, we picked up another 32% from that level. I mean, recognizing these were extremely low levels, so the percent can maybe disguise some things.

In July, actually – to give you maybe a better feeling, in July we actually booked what we booked last July, which is pretty significant. And so that recovery not unexpected by the way, but that recovery for – July for us was very nice to see. So hopefully that gives you a little bit of a flavor for what we’re seeing as it relates to bookings. As it relates to downtime, I can say it will be significantly less than it was in the second quarter. But we monitor this pretty closely. And depending on the grade, and it’s very, very grade specific, I probably don’t want to put a number out there, but I’ll just say that it would certainly be less than certainly the second quarter, less the first quarter, and I would say, south of 50,000 tons.

Joe Stivaletti – Goldman Sachs

Okay. That’s very helpful to get that framework. The other thing, just to follow up on the tax credit, just because it’s so material, can you just review for us sort of on a – the second quarter was a full quarter. Can you just review sort of what the applicable credits were in the quarter related to your second quarter just so we can try to forecast the rest of the year, but also what as of June 30th you had in receivables from the government?

Bob Mundy

Yes, Joe. In the second quarter, we – as far as what we earned in the – what we sort of – we took out of our – to get to our sort of adjusted net income, we – which is what we actually earned during the second quarter, that was $38 million. As I mentioned to Bruce, we actually received $95 million because there were obviously some receivables sitting there at the end of the first quarter. At the end of the second, we had in receivables about $16 million.

Joe Stivaletti – Goldman Sachs

And do you think that $38 million is – is there any reason that we should not be thinking about that as an ongoing level? Is it going to change a lot? I mean, maybe I guess with lower downtime, you might actually have the number to be a bit higher or do you think that’s representative of how it’s going here like in the third quarter?

Bob Mundy

You sort of hit on the key point that – we did – there was downtime. We had a lot of pulp downtime as well as paper downtime that we won’t have in the third quarter. So if you are trying to model that, then you certainly want to consider that that certainly had an impact on what was earned during the second. And if you want to look – going out, then you sort of have to consider the downtime that Mike spoke of.

Joe Stivaletti – Goldman Sachs

Okay. All right. Thanks a lot.

Bob Mundy

Okay, Joe.

Operator

We’ll now take our next question from Chip Dillon with Credit Suisse.

Chip Dillon – Credit Suisse

Yes, good morning. First question is, let me just – let's clean up the black liquor. Your income that you reported was a third of the second quarter of what it was in the first, and yet it took similar downtime in both quarters. And I know the first quarter included some of the fourth. But I think the real key question is, every company this quarter has told us about what the quarterly run rate. So if we assume the 50,000, 60,000 downtime-type number you are talking, I mean, should we expect it to be what, 25 million per month or 20 million per month? What’s the good sort of rule of thumb of black liquor if it continues to be in place?

Bob Mundy

Obviously, the first quarter numbers were much higher because that included the September of 2008, the fourth quarter of 2008, as well as the first quarter of 2009. And the second quarter was pretty much just the – the $38 million was for what we earned for those three months. And I would say, again, if nothing changes, then we will be taking less downtime in the third. And it would certainly be a little north of that $38 million.

Chip Dillon – Credit Suisse

Okay. So maybe like 50 would be more realistic?

Bob Mundy

It’s hard to put a number, Chip, but it certainly would be more than this quarter.

Chip Dillon – Credit Suisse

Okay. And again, the receivable coming out of June of the amount you’ve booked, 16 had not been received, is that right?

Bob Mundy

As of the end of the quarter, that’s correct.

Chip Dillon – Credit Suisse

Okay. I had another question. I’m a little confused by the working capital. If – actually I’m staring right in front of me both the third quarter balance sheet and the – sorry, the first quarter and the second quarter, and it’s pretty – I'm getting more like a $92 million reduction at least on the balance sheet. And I’ll be very specific. I mean, the receivables are down $41 million, including the related parties. The inventories are down $39 million. So that’s $80 million right there. Prepaid is down $2 million. That’s $82 million. And then on the other side, you’ve got accounts payables up $5 million and crude liabilities up $5 million. So that’s another $10 million that helps here [ph]. So could you help us understand why you’re telling us it’s $33 million when literally the balance sheets are saying $92 million?

Bob Mundy

Yes. If you look at the GAAP numbers, sort of GAAP as reported on the balance sheet, yes, you will get the numbers you referenced. When I look at it, I’ll kick out the cash. I’ll take the cash out that. We had a – as I mentioned, we had about $124 million improvement in cash. So I’ll take that out and also take out the receivables related to the alternative fuel credit. That was a big – it was $76 million or so in the first quarter versus what I mentioned it was $16 million or whatever in the second quarter. So that was – I just –

Chip Dillon – Credit Suisse

That’s (inaudible) get there?

Bob Mundy

Right, yes.

Chip Dillon – Credit Suisse

I see – I see [ph] business right there. I guess the next question is, if your downtime does – I mean, I guess when you think about the third quarters, you take a third as much downtime as you did and just sort of straight-lining that, that would seem to reduce that cost by $20 million or so, maybe $25 million. And then you’re going to probably sell more volume. So those are two positive things. And I’m guessing the costs would still be going down. I think costs (inaudible) average lower. I’m guessing your wood costs are going to average flat to down. You may correct me. The only negative thing I see is this price has been mentioned. And I’m just wondering, in your minds, do you think the impact of the lower prices as you have – and obviously you sell most of what you do under contract. We read about it in pulp and paper week [ph] every week. Did you think the impact of price will be more than offsetting the positives outside it or do you think you will be able to see a better quarter on an EBITDA basis even with low prices?

Mike Jackson

Yes, Chip, I don’t think the price is going to overcome what you just described in terms of the positives, no.

Chip Dillon – Credit Suisse

Got you. And I guess the last question just sort of make sure I understand this. Do you have $183 million or had at the end of the quarter of availability and you – with the cash on the balance sheet, the 43 on the revolver? And if I’m not mistaken, there is – you don’t owe anybody anything, including any kind of performance covenant or nothing until 2013. Is that clear?

Bob Mundy

That’s correct.

Chip Dillon – Credit Suisse

Great. Thank you.

Mike Jackson

You bet.

Operator

We’ll now hear from Jeff Harlib with Barclays Capital.

Jeff Harlib – Barclays Capital

Hi, good morning.

Mike Jackson

Hi, Jeff.

Jeff Harlib – Barclays Capital

Just for the comments you made on your downtime, which looks like it will be down over 100,000 tons. I’m just wondering are you expecting to build some inventory because that obviously would be a huge increase in shipments, and just maybe a feel for how you look at your inventories. If you work down this quarter, there is still a good amount above last year. Are they at the right level or are they still too high?

Mike Jackson

I would say – in general, I would say they are pretty close to where we would like them to be. I mean, with – our coated groundwood inventory is perhaps a bit lower than we would like. Our coated freesheet inventory maybe a little bit higher. But again, Jeff, as you think about this quarter, I mean, our third quarter is normally a busy season and certainly come off – coming off of a different phase. But I like – honestly, I like our inventory position. I think it’s okay. And that’s why I think I mentioned that I don’t expect any significant swings in working capital in the third quarter. So I – considering what we faced and how we managed through this, I feel pretty good about what we’ve done in our position.

Jeff Harlib – Barclays Capital

Okay. Can you talk a little bit end market-wise what you’re hearing from magazines, catalogs, commercial printing? Is it fairly uniform, the improvement you’re seeing more on the end demand side?

Mike Jackson

I think it varies. I think it is more pressure longer term perhaps on the magazine side and the catalog. I think the catalogers, honestly, they really stopped – I don’t want to say totally stopped, but they really pulled back on any of the committee [ph] type of prospects. And I think they recognize that that’s something they need to increase in essence. And so I think – I would say the catalog side is maybe a bit more positive as the momentum builds in as people in the retail sector get a bit more confident. I think the magazines kind of going through this thought process around what that model looks like and how that’s all going to fit long-term. And I think commercial printing is, candidly, somewhere in between right now.

And as people kick in their advertising as they feel better about that discretionary spend, I think we’re going to see that rebound. The question obviously is, at what level does it rebound. And I think what we’ve done is taken a really good view of that. And that’s why you’ve seen what we’ve done with some of these new products. We’ve said, hey, we think we’re going to take our core competency. We’re going to do what we do. Well, we are not going to stray that far from the barn, but we’re going to be in these markets where lightweight is critical, because it’s more cost-effective, you can ship cheaper from a postage perspective, and it’s what we do well. So I think hopefully that kind of answers your questions about commercial print, catalog and the magazine piece.

Jeff Harlib – Barclays Capital

Okay. And then SCA+ product, how much capacity you’re ramping there? How big is that machine? And what are the customers end markets there?

Mike Jackson

Well, the total output of that machine is in excess of about 220,000 tons. The beauty of that and what we’ve done there is we can swing. So as we grow that business and depending on where the coated groundwood market goes, we will just take out the coated groundwood capacity and replace it with the SCA+. And – to answer your question specifically, it’s about 220,000 tons.

Jeff Harlib – Barclays Capital

Okay. And input costs, I think you do a year-over-year reconciliation. How did input costs look sequentially? And as you look at 3Q, do you see a smaller decline or a bigger decline in Q1 to Q2?

Bob Mundy

Sequentially, Jeff, it was – it's about $11 million lower prices. And I think that will continue some – something, maybe even a little better than that for the balance of the year as far as sequential improvement.

Jeff Harlib – Barclays Capital

Okay. And then just lastly, natural gas hedges, what’s left for 2009 and 2010?

Bob Mundy

We have about 60% or so of our remaining – of our usage – of our expected usage for the balance of the year is we’re still hedged. Obviously, it’s under water. But that’s – so we get through about $3 per MMBTU. And so – obviously – you now, you continue to roll that forward. We’ve done some things for 2010 at much lower prices. So we feel good once we sort of get out from under the balance of this year.

Jeff Harlib – Barclays Capital

Okay. Are you significantly hedged for 2010?

Bob Mundy

No.

Jeff Harlib – Barclays Capital

No. Okay. Thank you.

Operator

We’ll now take our next question from Claudia Hueston with JP Morgan.

Claudia Hueston – JP Morgan

Thanks very much. Good morning.

Bob Mundy

Good morning.

Claudia Hueston – JP Morgan

Just a couple of questions. First is in terms of end market for coated paper. I was wondering if you could comment on what you’ve been seeing in terms of trade flows. Has the dollar had much of an impact on European shipments to the US? And then just what are you seeing from Asia?

Mike Jackson

Yes, Claudia. Certainly, the imports from Europe have been down significantly, and they really track at or more than the decline in the demand of coated free and coated groundwood. We have seen some increase certainly from Asia. But I have to be honest with you. Some of the way the classification goes, first of all, the majority of the product coming in is really sheet related. So it doesn’t certainly impact at this point our roll business. But I guess the other thing is that from a month-to-month, I’m not sure if they call it coated groundwood or coated freesheet. And – but it is up. And I guess you have to kind of put those numbers together and call it whatever that you happen to be calling it, during that month that they report. But so anyways, Asia is up. Europe is down pretty, pretty significantly.

Claudia Hueston – JP Morgan

Okay, that’s helpful. And then as you talk to your customers, how much visibility do you think they have? I mean, do you they have a pretty good sense of what the end of the year looks like? And then, are they getting any early read yet on 2010 and what advertising budgets will look like then?

Mike Jackson

It really varies by customer. They do have a view. I will say it’s more positive than it was as we spoke to our customers in the first quarter and really during the middle of the second quarter. So it is a bit more positive. But I think there is kind of a realism that’s set in that says we are not going to say anything until really the third quarter. And I’m talking about our customers, and get a better sense for, is this truly a rebound or is it just a bump. And – but I would say that I believe the purse strings are opening a bit. How far? I’m not sure yet.

Claudia Hueston – JP Morgan

Yes. I mean, what’s – I don’t know if you have any sense of or view on what the trend-based advertising market looks like as we come out of this recovery. I mean, do you think we got back to the levels of catalogs and magazine ad pages that we were at a year or two ago?

Mike Jackson

No, I don’t. I don’t. I think there is going to be a reset. I think that’s why we’ve done what we’ve done with our product line. And I think that’s what we’re going to gear up for and that’s what we’ve done.

Claudia Hueston – JP Morgan

Okay. And as you think about that product lines, much what you’ve done, it was very much investment that you’ve had to make there? And as you switch back and forth, or if you switch back and forth on the machines, is there a lot of downtime that gets taken or incremental cost there?

Mike Jackson

You know what? It’s – I guess, this is maybe the good part of whatever happened in this recession. We have done something that honestly two years ago people would have said you couldn’t do. You have to spend capital or you have to do whatever to do some of the things we’ve done. Our capital spend has been insignificant relative to what we’ve been able to do in these facilities. And to me, it’s just – it's a very, very positive thing that we’ve been able to do this, run quality products, make changeover grades, reduce our call, just significant things that really have done to the ingenuity of our people. So it’s been very sobering. I’ll tell you, it’s been something else. So, to answer your question, no. We haven’t spent very much at all. And if you look at our capital spend, I think for the first – and I’m sorry about these slides here, but –

Claudia Hueston – JP Morgan

That’s okay [ph]. I actually have them –

Mike Jackson

Yes, okay. I think we spent like $29 million through the first six months, and the balance of the year, we’d probably only going to spend another maybe $4 million or so. I mean, a really good job.

Claudia Hueston – JP Morgan

Okay. Thank you very much.

Mike Jackson

You bet.

Operator

We’ll take our next question from Sandy Burns with Sterne Agee.

Sandy Burns – Sterne Agee

Hi, good morning.

Mike Jackson

Good morning.

Sandy Burns – Sterne Agee

Just wondering if you could kind of reconcile two different comments you made. First, if I heard you correctly, you said July was actually flat on a year-over-year basis, but then I think you also said that in the third quarter overall you do expect paper volumes would still be down year-over-year. I guess, is it more just as you’re looking forward for the next two months? Are you starting to see a little bit more weakness, or is it just maybe more timing issue in terms of how would July look versus the entire quarter?

Mike Jackson

Yes. Actually [ph] I think what I’ve said was that July bookings were flat year-over-year, which really was pretty decent when you think about it. So it was the booking comment. But remember, we’ve come from such a low base as it relates to quarter-over-quarter, third quarter ’08 versus ’09, that – I mean, third quarter ’08 was strong, very strong. In fact, it was our best quarter that we have had in a long time. So I guess it’s a relative statement.

Sandy Burns – Sterne Agee

Okay. So then I guess given that also – and I know you’re not in the business of putting out projections, but could you maybe kind of somewhat [ph] handicap how much you think 3Q will be down year-over-year? I mean, do you think it will still be down double digits, but to certainly a lesser extent than we’ve seen in the first half of the year, or do you think you could maybe get below 10%?

Bob Mundy

I think it will be something closer to what you just said. It will be – it's been – as we talked about, this 30% year-over-year comparisons are going to be something much closer to certainly less than 15 and 10, 11-ish over time.

Sandy Burns – Sterne Agee

Okay, great. That’s very helpful. And then I guess in addition to the SC grade that you introduced, you had also put out a release recently. It looks like you are looking at some new products in the uncoated side of the business. I just wonder maybe if you could talk about that a little bit and what the size of the machine is there and the opportunity you see there, particularly given how the uncoated market has kind of held up relatively better than the coated market.

Mike Jackson

Yes. Maybe couple comments. First of all, the majority of that is uncoated mechanical. It’s not uncoated freesheet. So this is – we are being very specific about the products that we are going to make, the grades that we’re going to make and the markets we’re going to go after. So again, it’s a mechanical grade focused on lightweight. So it’s the pharmaceutical side. It’s areas – by the way, it’s a 212-inch machine, which when you get into the pharmaceutical areas and the lighter weight, that machine, which was not scaled with coated groundwood, now becomes a scale machine and the products that we are going after. And so very, very competitive, but again, not heavy basis weight. It’s that 26-pound, 28-pound, 30-pound, 32-pound, which is what we do well. And that is what we are going after, that market, that niche market.

Sandy Burns – Sterne Agee

Could you share about the size of the machine?

Mike Jackson

Yes, 212 inches.

Sandy Burns – Sterne Agee

I guess, what that like tons per year?

Mike Jackson

About 80.

Sandy Burns – Sterne Agee

80,000. Okay. And then just also kind of big picture, as you’re looking at the demand environment and your asset base, when did the company start to really seriously think about taking permanent machine or mill shuts? And what do you think the savings could be if you decided to go in that route as you saw to right-size the business relative to what the ultimate demand may be out there?

Mike Jackson

Well, we look at that everyday and I think a good example of – someone could have said nine months ago, look, let’s just take B1 [ph] out, which is the 212-inch machine up in Bucksport. But we look at our asset base as something that we’re glad we have it. So how do you maximize what you have? And that’s what we’ve done. It doesn’t – anybody can shut down a machine. But how do you look at your markets? What are you good at? And can you compete in those areas that you think are going to be profitable long-term? So I choose to say, we’ve been blessed with $1.5 billion worth of assets. So what are we going to do with it? And we get to the point that we don’t know. Then we’ll say, well, let’s shut something down. But to me, that’s your last step. If you got assets, you know you can go into the marketplace and produce products that you can compete with competitively and that other way or in [ph] at least even to growing markets. And that’s what we’ve done.

Sandy Burns – Sterne Agee

Right. Is it fair to say that the company sounds like you certainly want to keep everything open through – into 2010 to see how the ultimate demand environment plays out in that year given that – I mean, obviously this year is a challenging year for everybody involved?

Mike Jackson

I wouldn’t go that far. Honestly, I guess I would only go as far as I just said, is that we’re going to look at our machine set. I think Sartell is a good example. I mean, there were questions early on two years ago about Sartell and what we’re going to do with Sartell. Well, we go to fiber farm. (inaudible) hard to end the facility. We’re doing some, I think, interesting things on the energy side. And we’ve taken a machine that was running 100% groundwood and we brought up to a swing machine. And so – I mean, in a sense, that’s taking out a little bit of capacity as it relates to the groundwood market and we did the same thing with B1. So we certainly are capable of shutting down a machine, but we will do it at the right time based on demand.

Sandy Burns – Sterne Agee

Okay, great. Thanks and good luck.

Mike Jackson

Thank you.

Operator

We’ll take our next question from Eric Anderson with Hartford Financial.

Eric Anderson – Hartford Financial

Yes, good morning. I’m wondering if you could add little color as to how sensitive imports of coated papers are to the US given all the currency fluctuations you’ve talked about earlier.

Mike Jackson

I would – certainly there is an impact as to where the euro is today. But even when – maybe this morning it’s 1.42 or – I'm not sure what it is this morning, but – you know, when it was down in that 1.20, 1.21, 1.22 area, we didn’t see a significant change. So it’s less than it had been in the past in terms of the relationship between the currency and imports. And I think part of the reason is that people here in the States need to run their business consistently. And with the change in the economy and the ups and downs of that, to make a commitment to an overseas manufacturer is really quite a step to take. And so I think they are kind of backing away from that, and I think it helps the domestic producer.

Eric Anderson – Hartford Financial

It’s more of an evolution over time slowly rather than things will move around radically?

Mike Jackson

Yes. Yes, I think that’s a good way to put it. The spot market relative to those types of tons are not as dynamic as they used to be.

Eric Anderson – Hartford Financial

Okay. Appreciate it. Good quarter.

Mike Jackson

Thank you.

Operator

We’ll take our next question from Richard Cust [ph] with Jefferies.

Richard Cust – Jefferies

Hi, guys. Can you talk a little bit about any potential demand from restocking, both in the third quarter and maybe your outlook there for the rest of the year?

Mike Jackson

You mean, restocking from (inaudible) side?

Richard Cust – Jefferies

Yes, exactly. Are you seeing any of that? And do you expect to see some of that?

Mike Jackson

You know what, it all really depends on the demand side. We are seeing a little bit of restocking, but I mean we are at such low levels right now of inventory that any meaningful impact or any meaningful increase in demand will have a significant impact on that question. So I think people are just kind of holding their partner [ph] right now. I think they are just kind of waiting to see, okay, how does this thing go and are we feeling better about our business, have we gone through the trough. And – I would expect there to be a bit of a pickup. But I think people are managing their business a bit differently. I think that maybe the fundamental restock that you would have seen two years ago, you’re not going to see as much as today, so to speak.

Richard Cust – Jefferies

All right. Great. Thanks, guys.

Operator

We do have time for one more question. We’ll take our next question from Lindsay Drogin with Sumitomo Mitsui Banking Corp.

Lindsay Drogin – Sumitomo Mitsui Banking Corp.

Thanks, guys. Good morning. I’d like some more clarity as to what’s going on with the black liquor tax credit on a macro level. I understand the original expiration date of the tax credit was at the end of 2009 calendar year. President Obama’s budget called for the tax credit to expire October 1st, which would imply that you would get tax credits for the third quarter of 2009. And then Chairman of the Finance Committee of the Senate, Max Baucus, is just – keep seeming to try and kill the credit. And what’s the status and how many quarters can it really strictly be expected that you’re going to be able to get the tax credit?

Bob Mundy

Yes. I guess – you asked for clarity. Well, that’s certainly not something we can really provide because of the reasons you just mentioned. There is discussion about ending the credit at the end of the third quarter, but there is also a lot of support for this thing to continue through its original expiration, which is at the end of the calendar year. So it’s – Lindsay, it’s just – everyone has a view on it. Right now, we just – we continue to appreciate the support that is being given to our industry to let this thing at least run through its original expiration.

Lindsay Drogin – Sumitomo Mitsui Banking Corp.

Thank you.

Operator

This does conclude today’s question-and-answer session. At this time, I would like to turn the conference over back to Mr. Robert Mundy.

Bob Mundy

Thank you. I think – I appreciate you calling in today, and everyone have a great day. Thank you.

Operator

This does conclude today’s conference. We thank you for your participation.

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Source: Verso Paper Corp. Q2 2009 Earnings Call Transcript
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