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Executives

Mike Jackson - President, Chief Executive Officer

Robert Mundy - Senior Vice President, Chief Financial Officer

Analysts

Joe Stivaletti - Goldman Sachs

Roger Spitz - Bank of America Merrill Lynch

Bill Hoffmann - RBC Capital Markets

Jeff Harlib - Barclays Capital

Richard Kus - Jefferies

Bruce Klein - Credit Suisse

Sandy Burns - Sterne Agee

Gary Madia - Gleacher & Company

Tom Koch - [Tenthaus Securities]

Michael Marczak - UBS

Verso Paper Corp (VRS) Q1 2011 Earnings Call Transcript May 9, 2011 9:00 AM ET

Operator

Good day and welcome to the Verso Paper Corporation first quarter 2011 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

Thank you. Good morning and thank you for joining Verso Paper's first quarter 2011 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 would like further information regarding the various risks and uncertainties associated with our business, please refer to our various SEC filings which are posted on our website, versopaper.com, under the Investor Relations tab.

Mike?

Mike Jackson

Thanks, Bob, and good morning, everyone. If you would move to slide 3, our first quarter results of $47 million resulted in EBITDA being $34 million above the first quarter of 2010. Operating income was a positive $14.1 million as compared to an operating loss of $21.5 million in the first quarter of 2010.

This result was driven by a number of positive factors. We continue to see favorable price realization both on a year-over-year and sequential quarter comparison. Gross margin for the quarter was 15.4%, up from 7.4% in the same quarter of last year.

Actual sales price for our products was 2.5% above fourth quarter 2010 and 13.3% better than the first quarter of 2010. Quarter volume was certainly better than expected as it was about 10,000 tons above the fourth quarter of 2010 as well as first quarter of 2010.

The combination of total price in volume increased our revenue by $53 million or almost 15% above the first quarter of 2010.

On the manufacturing front, our operations ran well and continued to improve relative to craft optimization, the usage of water, certainly recovery boiler efficiency and overall machine reliability.

Moving on to input prices, they were close to where our guidance was during our last call and they were certainly up versus the fourth quarter of 2010. Later on in the slides, Bob will give you a greater detail on that cost position.

As many of you know, we have announced a $40 a ton increase for April and the pipeline of inventory certainly supports that decision. Total tons at the end of user in the mills are from an industry perspective at good levels as it relates to this time of year.

Working capital was up seasonally, although a bit higher than in the past due to achieving such a low level of working capital in the fourth quarter of 2010 and a high amount of receivables during the latter part of March of this year.

Lastly, during the quarter, many of you know that we refinanced $372 million of debt and by doing so extended the maturity date of 2019 and lowered our interest expense. With that, I'll turn it back to Bob.

Robert Mundy

Thanks, Mike. If you'll turn to slide 4 you'll see our overall volume for the quarter was about 6000 tons above the first quarter of 2010 and comparable on a sequential basis with the fourth quarter of 2010. Revenues were up 15% versus the first quarter of last year due to a higher volume and prices being over 13% higher than last year.

Sequentially, sales were up resulting from the continued increase in sales price realization. Operating income from the first quarter of $14 million was up significantly versus the $22 million operating loss of last year.

On slide 5, you can see that coated volumes were up almost 10,000 tons versus a very strong fourth quarter of 2010 and about 11,000 above the first quarter of last year. We continued to see coated prices increase during the first quarter and we expect prices to continue to increase as we move into the second quarter of 2011 based on our April 1 price increase announcement.

Pulp volume was down about 8000 tons primarily resulting from increased coated [presheet] sales at our [Quinneseg] mill and the need to build some pulp inventory for usage during our outage in the second quarter at [Quinneseg]. Pulp prices were about flat versus the fourth quarter of 2010 and up almost $45 versus the first quarter of last year.

On slide 6 you can see the key changes between our first quarter 2011 adjusted EBITDA of $47 million versus the $13 million in the first quarter of 2010. As I mentioned earlier, overall volume was up.

While improved pricing contributed $44 million, operations were about $4 million better than last year's first quarter and overall input prices were about where we expected at $10 million higher than last year. Distribution costs were also higher than last year's first quarter due to escalating diesel prices.

On slide 7 it just gives you a view of the adjusted EBITDA changes between the fourth quarter of 2010 and the first quarter of 2011. Total volume was about flat but continued realization from our price increase announcement was worth about $8 million.

Manufacturing operations were $7 million higher on a sequential basis, however, this does not mean we're not on track to achieve the cost savings we have mentioned to you before. You have to consider the fact that there are differences in the two quarters relative to calendar or operating days and costs, especially as it relates to a much higher energy cost during the winter months of the first quarter versus those of the fourth quarter.

Additionally, the implementation plan of our initiatives are not spread evenly across any given year but takes real activities, resources and other events into consideration.

Our implementation planning for 2011 relative to productivity, direct cost and materials usage and indirect cost initiatives ramps up as the year goes on. As far as input prices, as you would expect, they were higher and primarily driven by energy and chemical prices which you can see a bit more about our input prices on the next slide, slide 8.

You can see the direction of the prices were moving versus last year and verus the previous quarter. The largest negative impact is in the chemical area, which starts with latex deemed the key drivers of higher prices versus the comparative periods.

Corn prices are approaching record levels and that will take a very large and high yield corn crop if we are to see any near-term relief in starch prices. As for latex, the dying prices continue to escalate driven by high crude prices relative to natural gas in addition to some production outages and high demand in certain areas.

Now I'll turn it back to Mike.

Mike Jackson

So I mentioned in my opening comments the coated free sheet and coated ground wood inventory levels. On slide 9 you can see that pipeline inventories for coated free sheet are in balance not only for this time of year but it's clearly set a new inventory norm from both a total tons and days availability respect.

If you go to slide 10, the same can be said for coated ground wood. In fact, 300,000 tons of inventory have been taken out of the system and have been maintained since about January of 2010. So I'd say, all in all, a good level as we move into the second half of the year.

On slide 11, certainly one of our key drivers in our magazine business is advertising and you can see that ad pages, which we actually talked about during our last quarter call, continues its quarterly positive year-over-year change. You can also see the categories that really heavily influence those gains at the bottom of the page.

On slide 12, let me briefly address the outlook for the second quarter. For the fourth consecutive quarter, we should see our coated prices continue to rise. Shipments, however, will be down seasonally, as they always are, at this time of year prior to the seasonably stronger second half of the year.

We say that, as well, thinking about the second half of the year because certainly retail sales, consumer confidence and actually the latest data, which was certainly nice to see even on home starts from March was up 11.2%, so all in all you're beginning to get a bit of little positive feel from the consumer perspective which certainly impacts our business. So we're looking for some really healthy operating rates in the second half of the year.

We do have scheduled maintenance outages, as Bob had mentioned, on the pulp side. We had builds a little [tall] and that'll have about a negative $5 million impact for the quarter. Finally, input prices are expected to be higher than Q1 due to certainly the increases in fuel prices, which really have an impact on multiple fronts both not only in the transportation side but certainly on the chemical side.

So with that, [Laura], Bob and I will be happy to take the questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Joe Stivaletti - Goldman Sachs.

Joe Stivaletti - Goldman Sachs

I was just wondering on the volume side of things, which seem particularly good, is it your opinion that you're picking up market share or is that just more indicative of the market overall?

Robert Mundy

Joe, I would say it's a combination of both. I think -- well, actually three things. I think that we've probably picked up a little bit of market share. I would say that the volume, the activities was honestly better than we had thought it would be for the quarter.

I think lastly -- and we'd be foolish not to say so -- but there was probably a little bit of build of inventory a sit relates to the price increase that was announced. So I think those are the three factors that drove it.

Joe Stivaletti - Goldman Sachs

So on the pricing side of things, would you say that the first quarter fully reflects all of the increases that were announced for 2010 or would there be any more carry over of that into the second?

Mike Jackson

I think that is pretty close to getting whatever we’re going to get out of those 2010 announcements there, Joe.

Joe Stivaletti - Goldman Sachs

So then the only other question I had was you had previously indicated that an expectation -- and I realize there are some very big variables here -- that R-GAP and efficiency programs would approximately offset the type of cost inflation that you were looking at for the full year. I wonder if that was still a reasonable way to look at things as we continue to see a lot of cost pressure.

Robert Mundy

Yes, I think it may be -- inflation might be a bit above where we were planning and hoping it would be. So I think it may be more of a bit of a headwind than we first thought at the beginning of the year.

Mike Jackson

Yes, Joe, let me just add to that. I think certainly when Bob and I were addressing that, we had the view of where oil was and perhaps where it was going and I think that anybody that follows this would probably say that that movement in oil was a bit more aggressive than probably most had thought when we were 90 days ago talking about this. But we're still very optimistic about our ability to deliver the R-GAP process but I think Bob captured it well. It's just a bit of a different time sequence there.

Robert Mundy

Yes, and the other thing, Joe, is some of that is pulp prices. As you know, we have a hedge on the other side for our pulp sales which helps mitigate some of that increase.

Operator

Your next question comes from the line of Roger Spitz - Bank of America Merrill Lynch.

Roger Spitz - Bank of America Merrill Lynch

Can you speak to how much the $40 a ton quoted price increase announce is [stuck]? Just so I understand, the April 1 effectiveness, does that hit your contractual customers on April 1 or does the delay that they might have, price protection kick in starting April 1.

Mike Jackson

It's variable. As we had said on our last call, we've moved more and more to, instead of six months or nine month pricing. We've been aggressive relative to quarterly or less pricing. So it really, Roger, does very by customer.

I would say that your first question about how is it going, we're always pretty careful about that. But I would say it is going as we probably expected it to go. I think I mentioned supported by the inventory levels it certainly was a positive offering rate as well in the first quarter going into the second quarter.

Many of us take downtime during this second quarter, so I think that will even tighten up things a bit more. So I would say it's going as planned and I think the implementation, the timing is variable by customer but we don't have that significant overhang that perhaps we did late 2009,e early 2010 as it relates to your guarantee pricing.

Roger Spitz - Bank of America Merrill Lynch

[Inaudible] in price has moved up very substantially in April and [Cap 2] prices continue their march up. My question here is when you came out a while back with the $40 increase maybe that -- I don't know if that had some look ahead but the question is how much of that, if it had any look ahead, of those future April price increases -- how much of that was expected when you put out the $40 or is this new April price increase on [inaudible], which is probably due to latex, just you've got to have another price increase to offset that?

Mike Jackson

Well, our price increases are primarily driven by, Roger, by supply and demand. That was the basis for the $40 that we announced on April 1 and obviously we are doing everything we can to combat the higher input prices in certain areas but that was not the primary motivation for the price increase.

Operator

Your next question comes from the line of Bill Hoffmann - RBC Capital Markets.

Bill Hoffmann - RBC Capital Markets

Mike, I just wondered if you could talk a little bit about the specialty grades of paper that you diversified into how much of that you produced in the first quarter, maybe just some thoughts on operating rate especially because obviously your quoted rates were up? Are you running into issues where you might need more coated this year?

Mike Jackson

We've held steady, Bill, in terms of the amount of specialty that we're running off of B1, so we committed -- we had said it earlier -- we've committed to a certain line of products. We called some that certainly didn't make sense but we've grown others that have made sense to us. So we've held steady as it relates to the percent of product that we're running off of B1 and we hope to stay in that category as well. We have some interesting products and feeling pretty good about it.

Bill Hoffmann - RBC Capital Markets

I guess as you look forward, though, how do you look at your current capacity base on the coated side versus with the anticipation, let's say, the 2011 at least should be reasonably consistent with 2010 levels but you're still facing a little bit of secular challenge. I just wonder how you think about balancing your system going forward.

Mike Jackson

Well, I think, right now, Bill, as we look at our forecast for the second half of the year, we look at where perhaps I think we already commented earlier today that we expected the volume in the second quarter to be less than -- certainly less than it was in the first quarter.

That will give us time to -- and you've heard us talk about this -- we've build a little bit but we need to build a bit more inventory, so I believe our supply demand balance, given our current set of assets is appropriate.

If we see a significant swing one way or the other, then, like we've demonstrated in the past, we will look at those assets and make decisions based on that supply demand scenario. So but to answer your question right now, I think we're in really good shape as it relates to what our capacity looks like and what we expect for demand in the next six to nine months.

Bill Hoffmann - RBC Capital Markets

Then just with regards to market share, have you seen the number of inquiries or the quantity of inquiries from your customers increasing to produce extra paper for them? Or what do you see going on in the market share side of the equation?

Mike Jackson

Well, I would probably say that in the first quarter we saw a little bit of a bump and I think I referred to why I thought that took place. But I've seen -- we've seen nothing in the second quarter that is abnormal, as relates to this time of year, at all. So I would just say no.

Operator

Your next question comes from the line of Jeff Harlib - Barclays Capital.

Jeff Harlib - Barclays Capital

Can you just talk about demand trends you're seeing and also how your overall coated looks heading into the second quarter?

Mike Jackson

Jeff, you may want to repeat. I don't know if we heard the very first of your question there.

Jeff Harlib - Barclays Capital

Just a little bit from the different market segments -- magazine, catalog and commercial print -- and then just your overall order book entering the second quarter how that looks relative to normal.

Mike Jackson

Yes, Jeff, I would say that -- and I don’t know when you think about this what's normal because we've had '07, '08, '09, 2010 and now 2011 -- you've had quite a different change in terms of what's normal. But if I go back to -- if I take out '09 and then end of '08, I would say our bookings are normal, if there is such a thing.

I mean, really balancing itself out from what we know is gone from the marketplace. So I would say activity is normal for this time of year. I would say that the commercial print market, not surprisingly, is a bit stronger than the catalogs because the catalogs really, as you know, don't hit heavily until the third and fourth quarter.

I would say that the coated free sheet business, which obviously impacts commercial prints, but the coated free sheet business is steady and I guess that's the way I would characterize those three markets.

Jeff Harlib - Barclays Capital

Just with respect to the cost reduction, the $56 million you were looking for this year largely from the energy projects at [Quinneseg] and [Buxport] -- how do you see those phasing in? I don’t expect you to be exact but roughly and how much was realized in Q1?

Robert Mundy

Yes, on that $56 million you have to remember that the two projects you mentioned, Jeff, are a big piece of that. But they don't really start phasing in. [Quinneseg], late this year and [Buxport] late next year. So you have to keep that in consideration as those projects are just now in the works.

However, we are on track for what we expect to realize this year. I'd say we've got around $8 million of improvements in the first quarter, which had to overcome -- I think on the bridge I showed $4 million but you have to remember that some of that you have to overcome the changes that -- and we had more production, so you have higher costs that you have to -- you have in this current quarter than you did in the same quarter last year.

So you also have inflation on repairs and maintenance and some other things that you have to overcome. So I'd say we're on track.

Jeff Harlib - Barclays Capital

Lastly, on the downtime, you mentioned pulp will cost you around $5 million in 2Q. What about -- how much coated paper downtime are you taking in 2Q and how much did you take, if any, in Q1?

Robert Mundy

We didn't take any in Q1 and there'll just be some maintenance related downtime in the second quarter, I'd say, somewhere between 12,000 and 15,000 tons.

Operator

Your next question comes from the line of Richard Kus - Jefferies.

Richard Kus - Jefferies

Can you talk a little bit about -- I know you said volumes you're expecting to be lower in the second quarter. Seasonally I expect second quarter to usually be stronger than first quarter but can you talk about what's driving that down a little bit? Is it the prebuy that you guys were mentioning?

Mike Jackson

Well, actually, the second quarter -- talked a little bit about what's normal anymore. I think that actually the second quarter for us over the last couple of years has really been the weakest quarter. So I would say that those things have changed over time and then you have certainly the big bang, so to speak, in the third and fourth quarter.

To your question, I do think that there was, as I mentioned earlier, there was certainly more activity because of the announced price increase and I think that the customers certainly saw that and I think they utilized whatever they could to get those tons in.

Of course, we monitor that pretty closely and if normally a customer orders 1000 tons a month and all of a sudden comes in much more than that, we're pretty careful about what we call our allocation process. So we're always watching that. But I would say it's -- second quarter is becoming the norm relative to our weakest quarter.

Richard Kus - Jefferies

Then can you remind us how much chemicals are as a percent of your cost of goods sold?

Mike Jackson

Yes, it's a total of about 24%, 25%.

Richard Kus - Jefferies

Then lastly, on the cost savings side of things, would you just update us? I now you said you thought you got about $8 million of improvement in the first quarter. How much did you actually expect to get for this whole year?

Robert Mundy

Of that $56 million that we announced, we expect to get the better part of that. I'll just say that.

Operator

Your next question comes from the line of Bruce Klein - Credit Suisse.

Bruce Klein - Credit Suisse

Did you guys -- I'm sorry. On the demand side I heard you mention [personal] print color [presheet]. Did you mention what you're seeing in magazines on that side and catalogs? I missed that. I apologize.

Mike Jackson

Yes, I did. I said that the catalogs expectedly were not as robust as the commercial print side and that's normally the case in this period of time, Bruce. I said the commercial print was probably the most active and the magazines, based off of some of the ad pages that we showed you, we see a little bit of an uptick in terms of the magazines. So I would say catalogs is slowest, magazines the second and commercial print the best.

Bruce Klein - Credit Suisse

Then just on what's going on globally or imports in terms of what you're seeing come in and pricing, how that's pricing versus the US.

Mike Jackson

Well, I guess a couple of things on the import side -- and actually as recently as this weekend, this past weekend or maybe even late last week, you saw that maybe it's not totally out there but the EU has slapped some tariffs on the Chinese as it relates to product that was going into Europe, number one.

Number two, we have not seen any increase in imports and I think the last couple of times that we've had our calls we talked about the fact that over the last four years imports have actually lost market share, about 3% market share for the last four years as it relates to North American consumption.

That seems to be just about where we are today. You know where the Euro is and that certainly has had an impact but we've not seen any disturbing signs relative to both the number of tons nor the price that is being charged coming into the US. I think you know our position on coated free sheets a little bit different.

The only thing that we would be concerned about is in the sense rolls and we've not seen any significant increase in that, as well. So most of that has been sheet and that's been South Korean sheets.

Operator

Your next question comes from the line of Sandy Burns - Sterne Agee.

Sandy Burns - Sterne Agee

I guess when you mentioned that 2Q is expected to be down seasonally and that there's been a shift in order patterns because I guess I would agree with the other speaker where I thought historically that you see a seasonal uptick. Have you seen some of those orders now get pushed back more to the second half of the year as you get closer to the holiday selling season?

Robert Mundy

No, I think second quarter really historically is one of our slowest quarters. You have to look back at '10 and '09, 2010 and 2009. There was some, I think maybe last year it was up from the first quarter but that was a very unusual period. But I think in normal situations, second quarter is normally the slowest.

It's when you have a lot of your maintenance outages, your production is going to be down, as I mentioned earlier, which translates into normally -- and you're trying to build a little bit of inventory for later in the year to satisfy the obligations you have there. So the second quarter is normally about your slowest quarter.

Sandy Burns - Sterne Agee

Then you mentioned you expect some maintenance downtime in the quarter, about 12,000 to 15,000 tons. Could you put a dollar cost on that approximately or should we use the numbers for ton, maintenance downtime that you had incurred in the past when things were -- ?

Robert Mundy

Yes, that's a good way to get at it.

Operator

Your next question comes from the line of Gary Madia - Gleacher & Company.

Gary Madia - Gleacher & Company

Bob, on the working capital side, I saw certainly bigger than expected investment in that in the first quarter. Can you speak to that a little bit in whether or not you expect to get all of that back throughout the year?

Then my second question is a follow-up to the earlier question regarding the lag on the price increase. Knowing that a portion of your business, a smaller portion of your business, is spot versus contract, is it fair to assume that the majority of the $40 that we're going to see is going to be more of a third-quarter event?

Robert Mundy

Your first question, relative to working capital, typically the first quarter is always our largest use of working capital. On average, over the last -- since our existence -- I think it's been -- it's averaged around $73 million, $75 million of change going from the fourth to the first.

However, this particular first quarter, the change from the end of the year is larger than normal and when you consider the fact that we ended 2010 with the lowest working capital or any prior year period -- it was about $24 million below our historical average -- and we had a significant amount of sales in the latter part of March. That increased our AR balance by almost $20 million above normal.

So when you consider that in addition to it's always a large use of cash change period, it seems to make sense. Relative to the price increase, I think we'll get -- we expect to get some of that in the second quarter and whatever we don't we expect to get in the third. I think you may see a bit more on the ground wood side than the free sheet side in the second quarter but our intention when we announced $40 is to get $40 and we would expect most of that in the second quarter.

Operator

(Operator Instructions). Your next question comes from the line of Tom Koch - [Tenthaus Securities].

Tom Koch - [Tenthaus Securities]

I just had two questions. One was on the outlook page. You talked about looking for a price increase for the fourth consecutive quarter. Would that not really be the fifth consecutive quarter? Didn't you start Q2 last year, Q3, Q4, Q1, now we're going in to Q2 would be the fifth quarter?

Robert Mundy

Yes, we do expect prices to increase in the second quarter. So that -- yes, maybe it is five -- one, two, three -- yes, it could be.

Tom Koch - [Tenthaus Securities]

It looks like you guys troughed out around 766 and now you're up around 866.

Mike Jackson

I think prices went up from the second to the third and then from the third to the fourth, fourth to the first, first to the second. So that's four. That is four.

Tom Koch - [Tenthaus Securities]

One other -- it just seems like this question regarding the volume in Q2 and I just quickly went online here and went back as much as I could on the website but I can't really go back to those Q2 to Q1 that quickly for years going back '07, '06, '05.

But there just seems to be a little confusion I guess on the thought about this seasonality issue, especially given the last year was up Q1 to Q2. Can you give us any better indication numerically as to what to expect other than just a general statement that it will be down?

Robert Mundy

Just to repeat, the second quarter is normally the slowest quarter. The last couple of years have been abnormal for various reasons, so you really can't look at that as an indicator. You can look at last year and say, yes -- and I admit it. We were up second quarter versus first but that's not normal.

What's normal is what we're seeing now is normally our slowest quarter as we build inventory to satisfy the high demand in the third and the fourth and we have outages that limit our production capabilities. So that's about -- I don't know what else to say.

Tom Koch - [Tenthaus Securities]

Could I just ask if we're talking about a single digit decline, a double? Can you give us some sort of order of magnitude as to what to expect?

Robert Mundy

It will be down in the high 10%, 15%.

Mike Jackson

If I could just add a comment to what Bob said, another thing is as you look at quarter over quarter in that same timeframe that you're talking about is that last year, as an example, we moved some maintenance outages out of the second quarter into the fourth quarter, as an example. So that could have an impact. Oh, that did have an impact on what we produced.

The other thing that you really have to remember is the timing of price increases are always important as you go back and look at the volume for that quarter. I think -- so those are two elements is how you think about your maintenance downtime and where you move that that impacts the second quarter, which is normally when we have our maintenance.

Again, the second point is the price increase. If you remember, last year, we didn't have a second quarter price increase. It all began to take place in the third and fourth quarter. So hopefully that gives you a little bit more color in terms of the sensitivity.

Operator

Your next question comes from the line of Michael Marczak - UBS.

Michael Marczak - UBS

I apologize. I think I missed your last point. When you talked about high 10% to 15%, was that year over year or quarter over quarter?

Robert Mundy

No, that's moving sequentially.

Michael Marczak - UBS

Then just a quick follow-up, too; somebody asked you about chemical cost. I was wondering if you could remind us how much distribution cost accounted as a percentage of your [cost].

Robert Mundy

Distribution would be 8% to 9%.

Operator

That concludes today's conference, ladies and gentlemen. We do thank you for your participation.

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