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Verso Paper Corp. (NYSE:VRS)

Q2 2010 Earnings Call

August 11, 2010 9:00 AM ET

Executives

Robert Mundy – Senior Vice President and CFO

Mike Jackson – President and CEO

Analysts

Bill Hoffmann – RBC Capital Markets

Claudia Hueston – JPMorgan

Tarek Hamid – JPMorgan

Kevin Cohen – Imperial Capital

Joe Stivaletti – Goldman Sachs

Bruce Klein – Credit Suisse

Sandy Burns – Sterne Agee

Jeff Harlib – Barclays Capital

Troy Gold – Oppenheimer

Richard Kus – Jefferies

James Daly – Deutsche Bank

Chip Dillon – Credit Suisse

Eric Anderson – Hartford Financial

James Eustice – ALJ Capital

Roger Spitz – Bank of America/Merrill Lynch

Sara Karim – Kingdom Capital

Allen Chachkes – ING

Operator

Good day, everyone. And welcome to the Verso Paper Corporation’s Second Quarter 2010 Earnings Call. Today’s conference is being recorded.

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

Robert Mundy

Thanks, Lisa. Good morning. And thank you for joining Verso Paper’s second quarter 2010 earnings conference call. 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 Mike, 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’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. Mike?

Mike Jackson

Thanks, Bob and good day, everyone. If you could go to page three, beginning with the volume graphs on the left, you can see that our second quarter volume was very strong. Year-over-year total Verso volume was up almost 36% and up 7% from the first quarter of 2010. Sales were up $37 million or 10% from Q1 and up almost 35% from the second quarter of ‘09.

Adjusted EBITDA was a positive $23 million, which was $32 million better than the second quarter of 2009 and $10 million better than this year’s first quarter.

Beginning now on page four, we will go into some of the specifics that drove the quarterly results and some of the other key second quarter items. As mentioned in our last call, we expected March prices to set the bar and that was the case, as prices in March slowly improved throughout the quarter.

As a reminder, we announced the $30 a ton increase for April on all grades and a $40 increase for coated freesheet and $60 increase for coated groundwood and SC for June. Total pricing was up over 3% from the first quarter, driven by both paper and pulp increases.

Realization of our paper price announcements, although, only seen slightly in our second-quarter numbers, will gain further impact in the third quarter and into the fourth. Second-quarter coated volume-only numbers were up 41% year-over-year and up 4% from the first quarter.

Year-to-date, our shipments for coated freesheet number three and coated groundwood number four and number five are up 39% as compared to industry numbers for coated freesheet number three of 32% and coated mechanical of a little over 19%. Our mills’ performance for the first time in over 13 quarters was below average.

We had two mill maintenance outages and a sub power performance in the month of June drove the majority of that shortfall. We expect the mills to be back on track in the third quarter. And in spite of the two planned mill outages and below average performance, our R-Gap savings are still on track for the year.

Input prices were positive for us in the second quarter, if you exclude the price of pulp. That equated to about $2 million better than the first quarter of 2010. If you added pulp back in, overall input prices were only slightly higher.

Our liquidity continues to be in good shape. And it has improved significantly year over year. It also improved over the first quarter this year which certainly supported, we believe, the decision by S&P in April to raise ratings on all of our debt.

For those who follow us, you know that we always have done a good job on working capital management. And for the quarter, we had a $28 million improvement.

Of particular importance was that, during the difficult times of 2009, we got even better at improving our working capital processes. That work has positively impacted our management of raw materials and our MRO inventory and it certainly showed in this quarter.

One more thing before I hand it back to Bob for some financial details, at the end of June, we, along with many community and governmental authorities, announced an energy project at our Quinnesec mill. This $43 million project falls within our CapEx budget that we committed to for 2010. The total cost of this initiative will be much lower than this as we feel very confident about receiving various grants and other incentives to lower our cash outlay to complete this project.

The project will reduce our costs at this facility by over $15 million a year while, at the same time, reducing our CO2 levels and drive the mills to very high levels of self-sufficiency, which will make a great asset even better. Our outside purchase of electricity will drop by 24 MW per year. So with that, I will hand it back to Bob.

Robert Mundy

Thanks, Mike. If you’ll turn to slide five, you can see a significant coated volume improvement as Mike mentioned versus last year of about 41% or almost 120,000 tons, and up about 4% versus the first quarter of 2010. As Mike said, we started to see coated prices increased during the second quarter and we expect a much greater increase in the third quarter.

We had no market downtime during the quarter versus about 153,000 tons in the second quarter of 2009. Pulp prices were up over $300 per ton above last year and about $100 a ton above the last quarter. Significantly higher pulp prices together with strong coated and new product volumes during the quarter resulted in revenues being up almost 35% versus last year and over 10% higher versus the first quarter of 2010.

Going to slide six, this gives you a view of the year-over-year adjusted EBITDA changes for the second quarter of 2010 versus the second quarter of 2009. The stronger volumes we mentioned had a positive impact of about $14 million although pulp prices were up significantly, the drop in coated prices of over $100 a ton resulted in a negative EBITDA impact of about $22 million.

Operations costs were about $4 million higher year over year, which is due to the fact that we took over 153,000 tons of downtime last year and shut a lot of the labor and other fixed costs due to not running at that point versus this year, we incurred those costs while we were running our machines full.

Overall input prices are favorable year over year due to lower wood and energy prices. The favorable market downtime bar represents the unabsorbed fixed costs we incurred last year versus zero this year.

If you turn to slide seven, you can see the key changes between our second quarter 2010 adjusted EBITDA of $23 million versus the $13 million in the first quarter of this year. Total volume was up about 7% or a positive $6 million. The coated price appreciation we began to see during the second quarter, as well as the continued increase of pulp prices, resulted in a positive $9 million.

As Mike alluded to earlier, we had a couple of maintenance outages in the second quarter, in addition to the mills not running as well as normal during the month of June. That contributed to about a $2 million negative versus the first quarter of this year. Overall input prices, including pulp, were slightly negative quarter-over-quarter.

Moving on to slide eight, you can see the direction of our input prices and distribution costs, the direction they were moving versus last year and versus the first quarter of 2010. In the chemical area, it is a mixed bag of certain items going up and others flat or going down slightly.

Latex has been up the most this year due to the tightness in butadiene, but things such as starch and caustic should end up lower year-over-year. Wood prices were up slightly versus the first quarter, but continue to stay at a very good level for us.

And energy prices were lower than last year and lower than the first quarter of 2010, driven by gas prices moving down. Distribution costs are higher due to some changes in our transportation contracts and the cost of diesel.

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

Mike Jackson

Okay. Thanks, Bob. Before we go into the third quarter outlook, let me cover a few other items relating to imports, starting on slide nine. The point of this slide shows that, although demand has fallen, the reduction of imports as a percentage of demand has fallen at a faster rate. I think this data supports some of the comments that we have made in the past on our quarterly calls on the importance to our customers of that supply-chain reliability.

If you move to slide 10, we shared this data during our last call for the first quarter but wanted you to see the completed first-half data. Again, the conclusion was that since 2007, imports have declined and FX has had little correlation to that import number.

On slide 11, as you know, energy is becoming a larger part of Verso’s strategy driven by five fundamental key points. Number one, it allows us to leverage the efficiency of combined heat and power cycles.

Many of you know that non-CHP facilities like utilities are much less efficient than a pulp and paper mill. Additionally, by increasing the use of renewable fuels, we reduce our fossil fuel use at the same time as we reduce energy intensity which, of course, lowers our carbon footprint.

Our strategy of leveraging the infrastructure in our mills gives us the opportunity to both reduce costs as well as generate incremental revenue. This leads to the last point that few industries are positioned as well as pulp and paper to participate in the transformation of this sector to contribute to our nation’s goal for self-sufficiency in biofuels.

On slide 12, this is simply a picture of what Verso is doing with our energy strategy. Over the next six years, we will continue to consume less electrical power to generate more power internally and take our power sales to a new level. We foresee a return of 60% on our invested capital in this area.

If you move to slide 13, in our third-quarter outlook, we expect volumes to be higher on a year-over-year basis and, as in the second quarter, we do not expect to take any market downtime. Our inventories are at very, very low levels and need to be watched closely.

We are currently running at what we consider precarious levels. Total North American industry mill inventory at the end of June for coated freesheet was down 17% from June of 2009. Coated groundwood levels were down 48%. In both grades, days of inventory were down by 14 and 17 days, respectively. Based on both quarter activity, as well as these inventory levels, we expect prices to continue to move upward throughout the quarter, gaining momentum each month.

Supporting increased order activity, magazine ad pages for the quarter showed a slight gain. This was the first gain in about nine quarters.

A positive sign was that automotive, financial, and cosmetics were up 28%, 20 and 17%, respectively, while travel, hotels, and real estate were down a bit. Catalog mailing has not yet been posted but as you remember, in the first quarter they were up about 0.5% over 2009 and we expect that trend to continue.

As we look at our input cost of chemicals, wood energy and pulp, we expect to see a fairly stable environment, some up, some down, as Bob referenced, but fairly neutral compared to the second quarter. I refer to our production for the second quarter as certainly atypical.

I have great confidence in our manufacturing team to rebound as they have had a tremendous record, I think, as many of you on the call know, of delivering results. We expect to have continued improvement in EBITDA, which should be up significantly compared to these second quarter results. I also mentioned the Quinnesec project, but I wanted to update you on the 12 projects that we had announced a couple of quarters ago.

We have 12 projects that were 50% funded by a DOE grant. I think, we mentioned that we were only one of nine companies in the U.S. to receive that grant and that was from a pool of about 350 candidates or 350 applications. Of those 12 projects, we will have five up and running by the end of the third quarter and the balance of the 12 should be complete by year end.

These projects again will contribute to the 1.27 trillion BTU savings that we expect to see on a yearly basis. Again, that does not include the Quinnesec project of which 100% of that will be impacted in 2011.

As an aside, although a very detailed and onerous process, the DOE check disbursements have candidly been very, very timely and the DOE mentioned that Verso was the first company to have the process in place that’s both applied for and received those funds. I think that’s again a testament to our ability to execute.

Lastly, we’ve announced and communicated a supplier alignment meeting in conjunction with ASPI, which is the Association of Suppliers to the Paper Industry. Over 50 very important Verso suppliers will be attending this meeting which will be held in Memphis.

And, at that point in time, we will share our strategies and expectations and exchange opportunities to make us and them more competitive in the industry that we participate in.

So with that, Bob and I are ready to take questions, Lisa.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Bill Hoffmann with RBC Capital Markets. Please go ahead sir.

Bill Hoffmann – RBC Capital Markets

Good morning guys.

Mike Jackson

Hi, Bill.

Bill Hoffmann – RBC Capital Markets

Mike, I just wonder if you could talk a little bit about sort of two things. One, you talked about the inventory situation being relatively precarious. I mean, as we see seasonal demand pickup here in the third quarter, what are the risks that you see to not being able to supply the chain right now?

Mike Jackson

Well, I think, Bill, that we are running at low levels and you know, normally, we have quite a buildup in the first and second quarter and, candidly, we did not have an opportunity to do that. So I think what you are going to see is that -- that -- and we have seen this. We have seen that, that in the last maybe 18 months, there’s been more of a spreading out of the demand you know versus that huge build in the third quarter. So I expect it to be less because it’s been spread over a course of, really, four quarters and then I expect it to move deeper into the fourth quarter. So it’s tight, but I don’t see a significant downside, if you will.

Bill Hoffmann – RBC Capital Markets

Okay. Thanks. And then the other thing is, with the sales of the other products you guys have been diversifying into that’s helped you keep your mills running, I guess $42 million in the quarter sort of captures that. What is the sort of ultimate target of selling into these other markets, dollar wise or volume wise at this point, now that you are running your system relatively full?

Mike Jackson

Yeah. I think we are going to continue on the track, what we’ve said in the past is that -- that 20 -- that 20% number would probably be -- of our mixes -- is where we would like to target it. I think beyond that we would not be interested in.

Bill Hoffmann – RBC Capital Markets

Okay. And then…

Mike Jackson

Up to 20%.

Bill Hoffmann – RBC Capital Markets

Okay. And then just another question about these DOE power projects.

Mike Jackson

Yeah.

Bill Hoffmann – RBC Capital Markets

What kind of dollar cost savings do we expect to see out of that or by the end of the year or on a run rate basis?

Robert Mundy

Bill, they will have a -- it will be something shy of about $10 million a year from those projects. And as Mike said, will be pretty much at that run rate by the time we hit the end of the year going into 2011.

Mike Jackson

Yeah. And Bill, the Quinnesec project won’t be up and running until December of 2011. So that is additional to the number that Bob just gave you.

Robert Mundy

Yeah. That was just for the DOE projects.

Bill Hoffmann – RBC Capital Markets

Correct. Thank you.

Robert Mundy

You’re welcome.

Operator

Our next question comes from Claudia Hueston with JPMorgan. Please go ahead.

Claudia Hueston – JPMorgan

Hi. Thanks very much. Good morning.

Robert Mundy

Good morning.

Mike Jackson

Good morning.

Claudia Hueston – JPMorgan

I was hoping you could just comment a little bit more on where the production problems were most acute and maybe just comment on your pulp volumes which were a little bit weaker than I had expected.

Robert Mundy

Well, there -- it just, as Mike said we have a great track record of remainder manufacturing operations. It was just a -- sometimes things happen it was just one of those, not particularly in the month of June versus the overall quarter, but you know a couple of the facilities, they just did not have a very good month as far as runnability. And it was nothing -- it’s nothing that is permanent there’s really nothing broken. They just weren’t good operational months. And that’s already through -- in July, we saw that turnaround. So we feel good about that.

Claudia Hueston – JPMorgan

Okay. And then just on the pulp volume?

Robert Mundy

And on the pulp volume part of it is it gets to the inventory. The paper inventory levels that we are talking we need to be ready to service the customers in this peak period that we are -- in the third quarter and making more paper versus pulp would be one of the outcomes of that.

Claudia Hueston – JPMorgan

Okay. And then just, you talked about your inventories and sort of industry inventories. Do you have any sense of where customer inventories are right now and what’s happening there?

Mike Jackson

You know, Claudia, Any view that we have into customer inventories basically show the same things, that they are at levels that are lower than certainly historical levels. But the truth is, is that new levels are being set. So you would expect them to be lower because when you think about demand being off from the peak of 2007, it kind of equates to that, but we don’t see -- I guess to your point, we don’t see anything significant in terms of customer build at all.

Claudia Hueston – JPMorgan

Okay. That’s helpful. And then, just finally, do you have any -- I know you said probably no market related downtime, but is there any maintenance in the third quarter?

Mike Jackson

No. We have none.

Claudia Hueston – JPMorgan

Great. Thank you.

Mike Jackson

You bet.

Operator

Our next question comes from Tarek Hamid with JPMorgan.

Tarek Hamid – JPMorgan

Good morning.

Mike Jackson

Good morning.

Robert Mundy

Good morning.

Tarek Hamid – JPMorgan

I was wondering if you guys could talk a little bit about price protection, with these price increases going through, kind of, rough sense of what the implementation timeline is?

Mike Jackson

Well, good question. Let me kind of, back up a little bit. I think part of what we have seen in terms of the slowness, if you will, of the implementation really goes back to when some of these contracts were negotiated which was in a very tough time at the end of 2009. And some of the contracts were a bit longer than we have done in the past. But I think, going forward, you’re going to see the announcements that we’ve made, certainly in the April, June, June timeframe really begin to pick up momentum into the third quarter and certainly into the fourth quarter with certainly less expended terms, so to speak.

Tarek Hamid – JPMorgan

Okay. I guess, going back to the slide 12 you showed, obviously these energy projects are incredibly high returns.

Mike Jackson

Yeah.

Tarek Hamid – JPMorgan

Kind of wondering if you could -- as you look forward on this plan do you expect CapEx to support these energy projects to be similar to 2010 or are there future products that are going to be a little bit lumpy or just given the size of the potential power sales, you have forecasted out?

Robert Mundy

No, I think our CapEx range of CapEx will not -- you won’t see anything very lumpy. I think you know we feel good about as I’ve said before, our must do CapEx is sort of in that 50ish type of 40 or 50 type number. And everything else on top of that has to have a very good high rate of return, which these energy projects do and but somewhere in that around that 80 less than 80 type of numbers is what we’re seeing right now for the next few years.

Tarek Hamid – JPMorgan

Great. Thank you very much.

Operator

Our next question comes from Kevin Cohen with Imperial Capital.

Kevin Cohen – Imperial Capital

Good morning. Thanks. I’m wondering if you could talk about a little bit as to whether you think maybe rising prices might catalyze increasing substitution to alternative media?

Mike Jackson

Well, Kevin you never know until you see the impacts of this. But I guess, I would say to you that even with the increases that are out there now, they’re still about $100 below where they were at the high of 2008. So I think everybody has to run their business a certain way. We certainly need to move prices and for certain obvious reasons.

And I think the folks that are in the magazine and catalog business have to consider what -- how meaningful that product is to them. And I will tell you that the catalogers, I think when they decreased their circulation in 2009, really felt an impact on their business. So we remain cautiously optimistic. We know that demand has fallen, I think we have been very open about thinking that 11% or 12% will be gone forever. And I think we’re going to stick to that story until things change.

Kevin Cohen – Imperial Capital

Great. And then I was wondering your thoughts in terms of the number of new magazine launches in the first half of the year? You did mention ad pages in magazines rose, but the number of new magazines launched was down pretty sharply. What do you sort of infer from that or what do you think that means for the magazine space?

Mike Jackson

Well, you know Kevin maybe you’ve got some data that I don’t, but the last that I looked at this was about two weeks ago. There were actually were 77 launches in May. There were 310 year-to-date.

Now what was down was that a lot of these magazines weren’t monthlies they were going to quarterly or even less than quarterly. So maybe offline you can give Bob a call and you can compare that graph. But I get a pretty good report and that’s what it tells me. They are not huge, but in terms of circulation, but in numbers they were up.

Kevin Cohen – Imperial Capital

Okay. Fair enough. I can take that on offline. And then just in terms of coated paper volumes for the industry in the second half, what do you guys kind of, think it looks like?

Mike Jackson

Well, I think with what you’ve seen in terms of demand in the first half, I think you are going to see a continuation of that trend. And again, from the peak of ‘07 I think we are probably going to find ourselves off about 12, so, and you can see what we’ve been up and I think we are going to continue that pace throughout the end of the year.

Kevin Cohen – Imperial Capital

Great. Thanks. Good luck, guys.

Mike Jackson

Thanks.

Operator

Our next question comes from Joe Stivaletti with Goldman Sachs. Please go ahead, sir.

Joe Stivaletti – Goldman Sachs

Hi. Good morning. I was wondering if you could just, on the pricing side can you tell us of the $70 and $90 increases that you announced during Q2, how much of that you have that you are getting as of today? I know you didn’t get a whole lot in the second quarter. Just trying to figure out if the bulk of that is in for your business or…

Robert Mundy

Yeah. We can’t get into really what is happening today. We can really just talk other than what Mike gave as guidance in the third quarter regarding pricing which was -- we expect to get a very -- a significant bump in the third quarter versus the small realization we had in the second.

Joe Stivaletti – Goldman Sachs

But the -- so on the price protection that a lot of customers had running through June, as that type of protection rolled off was it the case that, given the market conditions having changed so much that you weren’t finding it necessary to continue to give price protection? So just trying to see if these new price increases should roll in much more rapidly?

Robert Mundy

I think, yeah. That’s pretty much what we are saying. We still don’t have a lot of protection that goes out for an extended period of time. We did do some things as Mike referenced earlier, but that is why you’ll start to see that in the third quarter and even a little bit into the fourth, those realizations starting to come to the bottom line.

Joe Stivaletti – Goldman Sachs

And the other thing that I wanted to ask about was following up on your comments on catalog retailers, given the importance of them. Can you just talk about -- you said that you felt that they lost business because they cut back too much and a lot of people have said that they very much focus on consumer confidence numbers when looking at increasing circulation.

I wondered, if you could just talk about what you see them doing at this juncture? And whether you see them starting to really pick up a lot in volumes looking out over the next six months or so?

Robert Mundy

Joe, I think the thing that they would say that perhaps they missed last year was the prospecting. They did not do a lot of that and that’s where they cut back on and I think that’s where they found that their growth was stymied by that and so I don’t expect a cascade, if you will, of catalogs, I think we have again spoke to that in terms of what we think may be gone, gone forever. But we do feel that there will be -- and it shown in the numbers a pickup in that prospecting. And I think that most catalogers hopefully would tell you the same thing.

Joe Stivaletti – Goldman Sachs

Okay. Thank you.

Robert Mundy

You’re welcome.

Operator

Our next question comes from Bruce Klein with Credit Suisse. Please go ahead.

Bruce Klein – Credit Suisse

Hi. Good morning.

Robert Mundy

Good morning, Bruce.

Bruce Klein – Credit Suisse

Just if you can help us a little bit more on what your customers are saying and maybe on the commercial print side and any other anecdotes on catalog and magazine? And secondly, just on the prices, did everyone to your knowledge go with a third quarter price hike? And then with regard to the business you’re booking now, is it less, it sounded like it was shorter duration contracts or less contracts. Was that the implication you were trying to suggest? So those are two questions.

Robert Mundy

Well, as far as the durations, yeah, I mean that is -- we had some -- as Mike indicated, we did some things probably at the end of last year that we worked through in the first half. And but the price realization is, again, it will pick up in the third quarter. And the announcements that we’ve had, the first two announcements that we had we feel real good about getting those to the bottom line pretty darn quick.

Mike Jackson

And then your second question had to do with our third quarter recently announced increase which was $40 in coated freesheet, $16 groundwood, $60 in SC and then $75 for heavyweight coated groundwood. I can only talk about ourselves, Bruce in terms of our announcement. I think you have seen publicly some of the other companies that have announced as well.

Bruce Klein – Credit Suisse

Okay. Thanks. And then, the commercial print market and any other color, what do you…

Mike Jackson

Yeah. I think the commercial print market is -- that’s one that we’ve been fairly successful in terms of new channels and new markets for us. And I would say the commercial print market has really held up surprisingly well and we look to have some fairly stable business going into the third and fourth quarters of this year. So it is up and data, our data supports that.

Bruce Klein – Credit Suisse

Okay. Thanks. And my last question, Bob was just the CapEx, it sounds like, if I understood you, it was going to be sort of less than 80, but if I use 75 as a number can you remind us how much is energy projects in there? And then, of the energy projects, how much is funded by the government?

Robert Mundy

Well, we have several things working relative to energy projects. It is not just the grants that Mike mentioned. We have some -- we have -- there are various programs in the States that we have operations.

And I -- as far as the specific energy component of our totals capital spending program I don’t think I’ve ever mentioned that before, but it’s -- I could just say that it’s within that $75 million that you mentioned.

Bruce Klein – Credit Suisse

Okay. Thanks.

Operator

Our next question comes from Sandy Burns with Sterne Agee.

Sandy Burns – Sterne Agee

Hi. Good morning.

Robert Mundy

Hi, Sandy.

Sandy Burns – Sterne Agee

Just wondering if you could comment, as we start to see pulp prices decline here, what do you think could be the impact on coated paper prices, maybe as we get into 2011? Do you think the historical correlation we have seen between pulp and coated paper prices will remain or have there been enough changes in the industry that you think those -- that correlation has just permanently changed?

Robert Mundy

Yeah. I think it’s permanently changed. I mean, I think the proof in the pudding was the fact that when pulp has been on the rise for the last 12 months and it certainly didn’t help the coated price. So, I think that day is gone that there’s a correlation.

Sandy Burns – Sterne Agee

Okay. Thanks.

Robert Mundy

You’re welcome.

Operator

Our next question comes from Jeff Harlib with Barclays Capital. Please go ahead.

Jeff Harlib – Barclays Capital

Hi. Good morning.

Robert Mundy

Good morning, Jeff.

Jeff Harlib – Barclays Capital

The 3Q, just can you help us how, given you were running full out in Q2 and your inventories are low, it looks like you’re looking for a decent improvement in shipments. How are you going to meet that with your current capacity?

Robert Mundy

Yeah. It -- we do expect an improvement over the second quarter and it was a strong second quarter from a volume perspective. Mike mentioned our inventory situation is low, but we feel comfortable that we will be able to service everything we need and you know, we did have those couple of maintenance outages in the second quarter, Jeff and did not run particularly well in one of those months during the quarter. So sort of add that up and we feel that volumes will be up and that we will be okay.

Jeff Harlib – Barclays Capital

Okay. And just on your water backlog and lead times, headed into the seasonally strong period here, can you comment on that? And also picking coated groundwood versus coated freesheet, it appeared that ground wood is a good amount tighter than freesheet. What do you think?

Mike Jackson

Yeah. I would say with your last comment that coated groundwood is tighter than coated freesheet. I would say that maybe I’ll take you back a it, but we saw some pretty significant increases in demand really early on. And we went into an allocation process really months ago.

And so I think to Bob’s point, where we’re giving our customers what we allocated and what we committed to supply and I think that has worked out well. We caught this thing early on so we were able to communicate it. We could see it coming and I think Bob made an excellent point in terms of our manufacturing.

I mean we -- even though we’re low on inventory, we have the capacity or the capability to deal with these two-order call-in orders, if you will and it’s being demonstrated already in the third quarter. So I think between those -- the allocation process, better productivity and we do have inventory. It’s just not as high as it has been in the past. I think we will be in good shape.

Jeff Harlib – Barclays Capital

Okay. Thanks.

Operator

Our next question comes from [Troy Gold] with Oppenheimer.

Troy Gold – Oppenheimer

Can you talk about postal rate hikes or the potential for them and then also over a traditional cycle when postal rates, if they go higher, do you see a slight decline or any change in volumes from the catalog?

Robert Mundy

Yeah. Well, it’ll certainly, if it does go through, there’s no question in our mind that there will be an impact. However, there’s a tremendous amount of opposition to that increase. You know, one is if you look at some of the details behind asking for the increase, it really doesn’t fit the definition of how the postal service can go and ask for an increase. I guess, the other thing I would say is, from an industry perspective it’s both magazines and ourselves, as paper suppliers and many other folks are participating in some pretty significant discussions with the government around this doesn’t really make sense. And, they haven’t even executed the Saturday, the No Saturday Delivery and now they are asking for another 8%. So I think there’s a long way to go before this thing is put to bed.

Troy Gold – Oppenheimer

Okay. Great. And then, also, on a seasonal basis, just to get a sense of how much it -- on a sequential basis from the second quarter to third quarter, how much in volumes do you get just on – just pickup from the catalog season, in a traditional cycle?

Robert Mundy

Well, it’s, traditionally and Mike, I think, Mike made a reference to this earlier, you would see the third quarter has always been our largest volume quarter primarily because of the buildup for the catalog season. We’ve seen that sort of -- it’s a little more spread and it’s in the third, but even somewhat now into the fourth and that has actually been happening for the last few years. But that is something that we will -- we’re ready -- we anticipate happening and that is why we think our volumes will be improved even though they have been very strong in the first half.

Troy Gold – Oppenheimer

Okay. Great. Thank you.

Operator

Our next question comes from Richard Kus with Jefferies.

Richard Kus – Jefferies

Hey, guys. Can you actually put a number around the tonnage you think you might have lost as a result of some of those outage issues in June?

Robert Mundy

It would -- something less than 20,000 tons.

Richard Kus – Jefferies

Okay. And then as we look at the other product sales, a pretty big jump in the quarter, could you talk a little bit about what you guys are seeing there? Just give a little additional color on it?

Mike Jackson

Well, it’s really coming from various, various categories. We have got certainly new products in printing and publishing. We’ve got new products and flexible packaging. We got label and release and we’ve got technical papers.

So it is a pretty broad, broad spectrum and I would say that, because we are still -- and I think we said this the last quarter, some of these technical papers and release papers, they take a number -- in the flexible packaging, they take a number of trial runs and these are small runs, they are LTLs with pretty expensive freight.

So I would say in terms of the breakdown of it, printing and publishing, the new grades there, would kind of kind of be leading the pack. They would move into the flexible packaging. The technical papers and then the label and releases, is probably the one that we are the furthest behind the end, but you throw that all together and that gives you that 50,000 plus tons of shipments.

Richard Kus – Jefferies

Okay. Great. Thanks a lot, guys.

Operator

Our next question comes from James Daly with Deutsche Bank.

James Daly – Deutsche Bank

Good morning.

Mike Jackson

Hi, Jim.

James Daly – Deutsche Bank

Most of my questions have been answered, just so --. You say that Q3 ‘10 MDA should be significantly above Q2. Can you give us any contact or flavor of what do you think it will be year over year, versus ‘09?

Robert Mundy

I think -- I’m thinking something comparable, Jim.

James Daly – Deutsche Bank

Okay. That’s very helpful. Thank you.

Robert Mundy

That’s welcome.

Operator

Our next question comes from Chip Dillon with Credit Suisse. Please go ahead.

Chip Dillon – Credit Suisse

Hi. Good morning.

Robert Mundy

Good morning, Jim

Chip Dillon – Credit Suisse

Looking at the volumes, you mentioned that you thought you would be up in coated paper in third quarter ‘10 versus last year. And I noticed last year you had very strong volumes, looking at the slides 3 -- 426,000 tons. And that would seem to be quite a big number to get to when your inventories are so low and I would have presumed in this past quarter when you ship less than that, your inventories went down further. So could you just tell me understand how you are going to get the volume back above last year’s third quarter?

Robert Mundy

Well, it’s -- I think we sort of touched on it, that we will get some tonnage back because we did not run that well in the second quarter. We managed our inventories very well last year. We didn’t run up inventories of last year and we still met all of the needs and did have a good strong third quarter. But we did that from very well managed low inventories and we will get a bump from not having some outages in this third quarter.

From a coated perspective, I think the volume -- I think, overall, we will definitely be up and as we’ve said, but not all of that is coming from coated either. And that is primarily where our -- what our inventories are comprised of, but as you know we are into some other things and we will be getting a volume bump from those areas as well.

But when we talk inventories, obviously, we are primarily talking about coated freesheet and coated groundwood.

Chip Dillon – Credit Suisse

Got you. Okay. And then if you look at -- we look at slide 12, can you just help us understand how you to read that? You are giving, I guess, there’s also the power you are buying on the outside, but it looks like your internal generation obviously ramps up to 12. Let’s say between 12 and 14 stays flat and your power sales -- this looks like they don’t -- the three numbers don’t add up. That the amount you are generating and the amount you are selling is different than the amount you are consuming. Is that difference basically what you’re buying?

Mike Jackson

Yeah. It is.

Chip Dillon – Credit Suisse

Okay. So that’s the way to look at that. And then last question is, you quantified the outage issue in pulp in June. I think you said less than 20,000 tons and but there usually is a pretty decent rule of thumb. I don’t know, I guess at these prices you’ve got to think in terms of at least, I would hope, $300 of EBITDA impact on a ton.

So I mean it looks like you are telling us it’s somewhere ballpark in the $3 million to $5 million range that you probably would have seen higher in terms of EBITDA in the past quarter if you hadn’t had those problems?

Robert Mundy

That is a very good range.

Chip Dillon – Credit Suisse

Okay. Great. Thanks very much.

Robert Mundy

Yeah.

Operator

The next question comes from Eric Anderson with Hartford Financial.

Eric Anderson – Hartford Financial

Yeah. Good morning. I was reading RISI today and they referenced a $40 a ton increase that NewPage had announced. And I’m wondering if that is something that is sort of new in the marketplace or is that -- are they playing catch-up to sort of what you announced back in June?

Robert Mundy

No. I think, they are -- all I can do is to really comment about our announcement, which we made in the last few days. You know, last week, actually, on Friday. And that was $40 on coated freesheet, $60 on SC and $60 on coated groundwood and $75 for heavyweight coated groundwood. And that is honestly all I can say.

Eric Anderson – Hartford Financial

That’s fair enough. Appreciate it.

Robert Mundy

You bet.

Operator

Our next question comes from James Eustice. ALJ Capital.

James Eustice – ALJ Capital

I’m here for -- just following up on the price issues. So these prices you just announced, these are on top of what you said for June already in your slide 4?

Mike Jackson

That’s correct.

James Eustice – ALJ Capital

And just maybe on sort of newer to the industry, but when you look at, like, I guess your coated price was $774 as a weighted average in the first quarter, sorry, in the second quarter. I mean, how do you usually correlate adding these price increases? Do you just add that to 774 or is it just -- I mean, how does that process work?

Robert Mundy

Certainly you would expect the average, which is a lot of mixed going on within that coated price. There’s coated freesheet, coated groundwood and SC papers. And there are different amounts of price increases for each of those major grades. So but I mean the quick answer to your question is, yeah, you would expect the average to move up.

It’s just for the mix of the products that you sold during a particular quarter versus the previous quarter and the amount of the price increase for those products. It’s – but yeah, it would certainly be additive.

James Eustice – ALJ Capital

I mean, is there a lag time in implementing in a sense of just your -- how people purchase paper from you?

Mike Jackson

Yeah. I mean, you have different customers purchasing at different times during the month, during a quarter and you have different amounts of price increases on different products. So it’s not just you take what we announced and added to the numbers. It is not quite that easy.

James Eustice – ALJ Capital

And just to clarify on your third quarter on the -- I think it was the prior caller that said that you’re saying it would be comparable to third quarter of ‘09 or something in that range?

Robert Mundy

I think, I think it should be in that ballpark. That’s what we would expect to see, based on what we see regarding pricing, a little bit in volumes getting some of our manufacturing costs back. But in the second quarter into the third and know the thing’s being fairly flat.

James Eustice – ALJ Capital

And that would be from a revenue standpoint?

Robert Mundy

I’m speaking from more of an EBITDA standpoint.

James Eustice – ALJ Capital

Okay. Great. I appreciate the time.

Robert Mundy

Thank you

Operator

Our next question comes from Roger Spitz with Bank of America/Merrill Lynch.

Roger Spitz – Bank of America/Merrill Lynch

Thank you. I wanted to see if we could get more clarity on what percent of your paper cells that are sold under contract with price protection through the end of this past June?

Robert Mundy

We’ve never really given that number out, Roger. That’s just not something we’ve ever gotten into any detail on.

Roger Spitz – Bank of America/Merrill Lynch

Okay. Can you say what percent of your paper sales, if any, have price protection that are longer than six months?

Mike Jackson

Really not. We just never get into that.

Roger Spitz – Bank of America/Merrill Lynch

Okay. But they exist, right? There are some, you just -- ?

Robert Mundy

There are some. There are some, but you tend to have more -- groundwood tends to be more contract in nature as opposed to coated freesheet but within each of those two major grades there’s various types of agreements or contracts and but, the majority of which are not what we would call on an extended period basis.

Mike Jackson

And they are not significant.

Roger Spitz – Bank of America/Merrill Lynch

Not significant. Okay. And lastly, is there any background you can provide on why coated groundwood potentially more sold under longer-term price protection contracts versus coated freesheet, which I understand is more spot?

Mike Jackson

It really has to do with the end use. On freesheet, there’s a lot of commercial printing. And commercial printing is kind of a quick turn to order cycle and really, that’s the primary difference.

Roger Spitz – Bank of America/Merrill Lynch

Got it. Thanks very much.

Operator

Our next question comes from [Mike Pulley] with Kingdom Capital.

Sara Karim – Kingdom Capital

Hi. It’s [Sara Karim] from Kingdom Capital. Could you just comment on your cost per ton I should expect for the third quarter? If I look back to the third-quarter ‘09, you had 26,000 tons of market downtime. So should I assume that your cost of ton, your -- based on what input costs have done year-over-year should be comparable if not better, given the lack of market downtime?

Robert Mundy

Well, you would certainly get the benefit of not having that unabsorbed fixed cost that we had in the third quarter of last year. So yeah, you would expect a pickup from that offset somewhat by the cost and the direct cost that you have to incur to run full versus not running last year.

So, but net-net you would see a benefit from that from a change. And input prices, even though pulp is starting to come down some, I think it will not be anything significant. It will be a bit higher, we think, versus the second quarter which, obviously, goes into our direct cost numbers as well. But we expect our productivity to improve which will help offset some of that.

Sara Karim – Kingdom Capital

And I think in the past you gave some sensitivities around what market downtime versus EBITDA might look like. Could you just refresh us on that?

Mike Jackson

I guess if your question is, how much does a ton of downtime cost us?

Sara Karim – Kingdom Capital

Right.

Mike Jackson

We’ve said somewhere in that low $200 type range per ton.

Sara Karim – Kingdom Capital

Okay. And then in pulp, can you just comment on kind of -- spot market seems to be weakening a bit and just kind of what you expect for price realizations in the third quarter, just versus kind of what your -- the trade publications are reflecting?

Robert Mundy

Well, it is weakening a bit and I think what you see in the trade publications is an excellent indicator of what is going on. And to go beyond the third quarter is a little bit difficult because the Chinese are now just beginning to get into their order books. And they were very, very slow there for about seven weeks. Our inventory levels, in spite of their drawback, are fairly decent. And so I don’t think you’re going to see a significant spike down would be my -- you know.

Mike Jackson

Yeah. Especially not in the third quarter. I think if it is, it will be more in the fourth but the third still ought to be a pretty good pulp price.

Sara Karim – Kingdom Capital

Okay. And then last question. Just how should we think about your price realizations versus what gets reflected in Pulp and Paper Week? I think through July, coated freesheet was up on an order of magnitude of about $40 a ton and coated groundwood was about $55 a ton versus the $70 to $90 that you guys have announced?

Robert Mundy

Let see – we certainly, if you go back over time we certainly track fairly well with what’s happening in the industry publication except there always is a lag. A lot of what they -- what you see in those publications are probably more reflective of what is going on in the spot market.

And, as I said, we have a good percentage of -- more so in groundwood than in free sheet -- of our tons are under some type of contract, but normally not anything in -- with a long duration. So there is a lagging effect. They’re lagging when prices are going up versus from those -- in those publications we may be lagging a bit before as we work through our agreements.

But -- and the reverse happens when prices are going down. Our prices are probably staying up a bit higher than what you may see in those publications because, again, they are more -- probably a more, a better indicator of what is happening in the true spot market.

Sara Karim – Kingdom Capital

So is your expectation that those, like as we progress maybe through August and September before we get to the next price increase that pulp paper would catch up to the full price increases that were announced?

Mike Jackson

Yeah. I would suspect. That’s probably you’ll see that probably pick up quicker than what’s going on in the business where you have some contracts. Because as I said that’s more reflective of the -- today’s spot and you don’t sell everything at today’s spot price. You sort of have to catch up to that a bit, but over time, it stays pretty darn tight.

Sara Karim – Kingdom Capital

Okay. I guess I just wanted to get the sense -- it doesn’t sound like that the price increase is kind of dead at what Pulp and Paper Week has reflected through July. But you think there’s potentially that there is still more to come from those?

Mike Jackson

Oh, absolutely.

Robert Mundy

Yeah.

Sara Karim – Kingdom Capital

Okay. All right. Great. Thank you.

Operator

Our next question comes from Allen Chachkes with ING.

Allen Chachkes – ING

Hi, guys. I think you have commented on this before, but can you give us a sense of what -- I think you guys, before had like a $10 price increase, what that would do to EBITDA, all else is equal?

Robert Mundy

I’m sorry, that sort of faded out at the end there.

Allen Chachkes – ING

What a $10 price increase or a $5 price increase to pricing would do to EBITDA?

Robert Mundy

Well, you can look at our volumes. We sell anywhere from close to -- on an annual basis over 2 million tons. So there’s a little bit of seasonal fluctuations in the quarters, but $10 you can sort of do that math.

Allen Chachkes – ING

Right. I think you guys have actually quantified it before. Is that right?

Mike Jackson

I’m sorry. We couldn’t hear you.

Allen Chachkes – ING

I think you guys -- have you guys quantified it before in other presentations?

Mike Jackson

Quantified what -- we’ve given a -- we’ve given a sensitivity on what they -- and there are some slides out on our website still from some presentations we have done in the past that will give you probably -- I don’t have that slide in front of me right now, but that may be what you want to look for. If you can’t find it, just give me a shout later and I can guide you there.

Allen Chachkes – ING

I’ll take a look at it. And I think I might have missed this, but in your guidance it says Q3, that was significantly above Q2. Can you quantify that relative to third quarter of ‘09?

Robert Mundy

Well, I think I did that earlier and I think I said I think I expect it to be in a similar ballpark.

Allen Chachkes – ING

Okay. Great. Thank you.

Operator

And we have time for one more question. That question comes from Kevin Cohen with Imperial Capital. Please go ahead.

Kevin Cohen – Imperial Capital

Thanks. Just a quick follow-up. What do you attributes the decline in imports as a percentage of U.S. coated paper consumption to? Do you think it’s just due to the preliminary duties? Or are there other factors? And how do you see that progressing maybe in the second half, assuming coated prices rise?

Robert Mundy

Hey, Kevin, I think it will remain the same. That trend has been going in that direction since 2007. I think we had a couple of slides in the presentation that kind of talk to that. The FX correlation was not there as it related to the imports. I do think that -- and maybe I’m overselling this, but I did say that I thought the supply-chain reliability was a key factor. And I think that with shorter lead times, it becomes an issue. And for the foreign imports to come in and I think that’s given us a little bit of an advantage in the marketplace. So I would think that would continue.

Kevin Cohen – Imperial Capital

Great. And then just as a little follow-up, the Pulp and Paper from July 16, that’s when I was referring to in terms of the number of new magazine launches. They had mentioned 90 versus 187 and 1H 09 but I will follow-up off-line on that. Thanks.

Robert Mundy

Okay. Thank you.

Operator

I would like to turn the conference back over to our speakers for any additional or closing remarks.

Robert Mundy

Thanks, Lisa. I think that pretty much wraps it up for us and we appreciate everyone listening in today. Have a great day. Take care.

Operator

And that concludes today’s teleconference. Thank you for your participation.

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