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Verso Paper Corp. (NYSE:VRS)

Q2 2011 Earnings Conference Call

August 11, 2011 9:00 AM ET

Executives

Robert Mundy - SVP and CFO

Mike Jackson - President and CEO

Analysts

James Armstrong - Vertical Research Partners

Joe Stivaletti - Goldman Sachs

James Daly - Deutsche Bank

Bruce Klein - Credit Suisse

Tariq Hamid - JPMorgan

Jeff Harlib - Barclays Capital

Richard Kus - Jefferies & Company

Bill Hoffmann - RBC Capital Markets

Gary Madia - Gleacher & Company

Roger Spitz - Bank of America Merrill Lynch

Michael Marczak - UBS

David Ross - Citi

Philip Birbara - RBS

Presentation:

Operator

Good day and welcome to the Verso Paper Corporation Second 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

Good morning and thank you for joining Verso Paper's second 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. Thanks for taking the time to join us today. If you could go to slide 3, Verso had adjusted EBITDA of $$4 million or $21 million better than second quarter of 2010. This number was also limited due to scheduled second quarter maintenance outages that impacted our EBITDA by a negative $5 million.

Operating income was $7 million versus a loss of $13 million last year considering some significant input cost pressures, we have continued with our positive quarterly operating results for the fourth consecutive quarter.

Our six month operating earnings were $21 million versus a $34 million loss with the same period in 2010 or $55 million swing. We again saw our price, sales price continued to move in a favorable direction both from a year-over-year in sequential basis. Total paper price net improvement from the first quarter was $31 a ton and that was $124 a ton better than last year.

Coated paper prices were $118 a ton above last year. This continued movement in price was supported by first half market data which showed magazine ad pages up 1.3% year-over-year and catalog mailings up 0.3% over last year.

As we mentioned, we had two major mills down for planned maintenance outages. We were very pleased that they were completed not only on time, certainly on budget, but more importantly during the time, we completed several projects that dealt with some significant and important cost control items. These outages were at our Quinnesec and Androscoggin facilities. And in spite of the outages, Quinnesec set a new record for break loss time in winder quality, while Andro established new daily and monthly craft in groundwood efficiency records as well.

Bob will discuss the details of our input cost a bit later, but clearly everybody on the call knows that it has been a challenge. We have mentioned also for at least the last six months that we needed to build both coated free sheet and coated freesheet and coated groundwood inventory with the busier third and fourth quarters.

You will clearly see this in our financials, but that build of tons is within our acceptable targeted levels and certainly we did have an increase in working capital and the increase is really a combination of those targeted increased levels on a ton basis as well as the fact that has increased cost value of the tons that we produced.

Lastly, before I turn it over to Bob, our safety performance, which we have talked about over the last few years, continues to have results that put us in the first quartile of all U.S. industries and this of course has both short and long-term positive cost inflation for our business.

So with that, I will turn it over to Bob and then I will be back to give you a view as we normally do of what the third quarter looks like from both the market and operating in a cost perspective. Bob?

Robert Mundy

Thanks Mike. If you turn to slide 4 as we mentioned on our last call, volume for the second quarter would be down we said I think between 10% and 15% versus last year and it ended up down 12%. Last year was one of our strongest second quarters from the volumes perspective, as the industry was recovering from the recession and as Mike mentioned, we need to build some inventory to meet the expected demand of the upcoming third and fourth quarters.

Some of this inventory build was necessary due to a very strong sales volume in the first quarter of this year, the second highest in our history. However, revenues were essentially flat with last year as prices were up 13% year-over-year. Sequentially, revenues were down from the lower volumes although prices were a bit over 3% higher. Operating income for the quarter was a positive $7 million versus a $13 million loss last year.

Turning to slide 5, you can see that coated volumes specifically were down for the same reasons I just described and coated prices are up almost $120 per ton versus last year and about $26 per ton versus the previous quarter. Pulp volumes were where we expected them to be and pulp prices were up over 2% versus the first quarter.

On slide 6, you can see the key changes between our second quarter 2011 adjusted EBITDA of $44 million versus the $23 million in the second quarter of 2010. As I mentioned earlier, overall volume was down and had a negative EBITDA impact of about $7 million, while improved pricing contributed $47 million.

Operations were over a $1 million better than last year’s second quarter, but remember, we had about a $5 million negative impact this quarter due to the maintenance outages we spoke of. Input prices as Mike mentioned continue to be a challenge and we are about $18 million above last year’s price levels.

Slide 7 gives you a view of the adjusted EBITDA changes between the first and second quarters of 2011. Total volume about $7 million negative, but continued realization from our price increase announcements was worth about $13 million.

Manufacturing operations were $3 million higher on a sequential basis. However, we have to consider the fact there are differences in the two quarters relative to operating days and cost due to the second quarter maintenance outages.

Additionally, the implementation plan of our initiatives are not spread evenly across any give year, but it takes mill activities, resources and other events into consideration. And our implementation planning for 2011 relative to productivity, direct cost, materials usage and indirect cost initiatives ramp up as the year goes on and I think you will see a clear indication of this next quarter on both the year-over-year on a sequential basis.

Lastly, as we mentioned input prices continue to be a headwind. There is a bit more information related to input prices on slide 8 where you can see the direction of prices move versus last year’s second quarter and versus the first quarter this year. The largest negative impact is in the chemical area with starch and latex being the key drivers of higher prices versus the comparative periods.

Corn prices are approaching record levels and it takes a large high yield corn profit, we are able to see any near-term relief in starch prices. As for latex, butadiene prices continue to escalate driven by high crude prices during the quarter relative to natural gas in addition to some production outages and high demand in certain areas.

We do however expect to see a decrease in the price of our pulp purchases as we enter into the third quarter.

I will now turn it back over to Mike.

Mike Jackson

Thanks Bob. If you would go to slide 9, we are going to talk a little bit about the industry, coated freesheet levels on inventory, really a couple of points here. One is that even going back to 2006, you can see that there is always a build in pipeline inventory in the March, April and May timeframe and then, a decrease beginning in June that goes through normally into October, early November. Such is the case this year for coated freesheet.

The second point I would like to make is that the days of inventory are actually lower in June than they were last year. So, in spite of the ups and downs, if you will, of demand, coated freesheet is not in a bad position at all as it relates to inventory.

If you move to slide 10, coated groundwood shows the same downward trend in June, but as in the slide, we've seen some very and I think we talked about this on the last call, some very abnormal shipments in the first half of the year that if you looked at it on a pure monthly basis, it really gives a distorted view of the inventory. You know, really the point being that the first two months of every quarter this year has been relatively week and then the third month of each quarter has been strong.

And so, the impact on inventories has been like honestly, we've never seen before. And so, we try not to overreact to the first two months of any quarter and I think we actually talked about that on our last call that, and really two months doesn't make a trend and then all of a sudden in that third month it really demonstrates that point.

On slide 11, this is (Inaudible) view of operating rates that we will be averaging for the year, 92% of better on a yearly basis; this is their last consensus if you will. And if that happens, coupled with continued input cost pressures, which Bob just went over. We should see continued price movement for the next few years, at least that's our view today as we said.

Turning to slide 12, in our view of the third quarter, we clearly expect that third quarter results will be better than the third quarter of 2010. Total volume for the quarter will be comparable to the last year's third quarter with perhaps a slight shift in mix. Price realization should be slightly up from the second quarter of 2011. And if so, that would be our sixth consecutive quarter of upward momentum.

Given our two major second quarter maintenance outages, we expect a very strong operating performance. Bob touched on that a bit in terms of some of these cost projects hitting in the second half of the year. And we've also completed several significant energy and usage products including the final DOE projects that have been completed and now prepared to deliver results.

And as I mentioned earlier, both Quinnesec and Androscoggin set some all time usage and efficiency records, and those two mills continue to run very, very well. We feel very positive about our two green energy projects that we've spoken to you about from both the timing and a budget perspective at both Quinnesec and Bucksport. Quinnesec's 28-meg project is in line to start up in November as we had forecasted and things look very good there from a time perspective. To remind you, the EBITDA impact will be in 2012 of above $10 million. And again, that's, the payback is significant as you think about this project for us.

Lastly, before we open it up for questions, we do have a view that input prices will continue to move upward from second quarter levels. We will of course continue to push on the cost side of our business. And again, I would like to reinforce that we're going to have really an accelerated R-Gap closure in the second half, as the majority of those R-Gap projects, which are well above 200 by the way, projects will have been finished and we will be getting to really see, as Bob mentioned, the impact of those projects in the second half.

So, that's a brief overview of the third quarter of what we think is going to take place and with that Doris, we would be happy to take questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question comes from James Armstrong with Vertical Research Partners.

James Armstrong - Vertical Research Partners

Good morning, just a couple of questions. First, how much of the second quarter pricing should we expect to see in the third quarter? I know you've been getting some pricing or said another way, how much of your business on a three-month price lag and how much is it on longer at this point?

Robert Mundy

Most of our business, the majority of our business James is in that quarterly timeframe. We had very few fields that are longer than that. So when it hits, it hits in that timeframe.

James Armstrong - Vertical Research Partners

Okay that helps. Next, what are you seeing in terms of grade mix? In other words, are you seeing grades that are doing better demand wise and others between coated and supercalendered and the number three and number five papers, could you help me with that?

Robert Mundy

Yeah, I would say that coated freesheet is your stronger grade currently and then, I would go down the list and I would say that probably SC-A+ might be the second and then, I would say groundwood and then probably the last on the list would be SC-A and SC-B, that's the way I would kind of categorize the activity.

James Armstrong - Vertical Research Partners

So, the higher coatings seem to be doing better than the groundwood at this point?

Robert Mundy

That’s correct.

James Armstrong - Vertical Research Partners

Right, okay. And then finally, how does the third quarter look thus far in terms of volume? And also, are you seeing any volume pushed into the fourth quarter as you have in recent years or is there any sign of volume moving back into the third quarter?

Robert Mundy

Yeah, you know James; I think I'm going to stick with the guidance that we just gave in the prepared text. I mean, we believe if you look at last year's volume numbers, we think we're going to be fairly close to that number and that's, we are sitting here at August, whatever it is 10th or something and so, that's our view.

James Armstrong - Vertical Research Partners

Okay.

Robert Mundy

And I don't know and I don’t see, to maybe answer your final question, I don't necessarily see things being pushed out. I think what we have continued to see in the last year is lead times get shorter and shorter. So, that's been a view that's been there for the last six months or so. And so, I think the other thing that I would say though is the catalog business. Again, this is our view. The catalog business is a little later than normal and so, I see that shifting out a little bit to the fourth quarter. And by the way, that was the case actually last year. If you remember the October-November catalog season was surprisingly strong. And so, we're hoping that some of that moves into the fourth quarter.

James Armstrong - Vertical Research Partners

Okay, that helps a lot, thank you.

Robert Mundy

You bet.

Operator

And our next question comes from Joe Stivaletti with Goldman Sachs.

Joe Stivaletti - Goldman Sachs

Yeah good morning. Just following on, on a couple of those topics. So, I was just wondering if you could characterize what your customer base is sort of, what kind of indication you're getting out of them as it relates to the second half of the year as a whole. I mean you gave us great guidance in the third quarter, volumes being similar for you guys. I mean, should we be thinking about the fourth quarter being similar last year as well or I don't know if you have enough visibility out into the fourth quarter yet or if it's too early because of all the economic volatility?

Mike Jackson

You know Joe; I think that's a great way to capture it, your last comment. Based on the recent economic news, looking at the fourth quarter, I think it would be foolish for us not to think that volume is going to be a challenge, but we intend to manage our business as we have in the past. We think we've been very prudent in terms of balancing supply and demand and I guess with that view, perhaps not as clear as we would like, because of this last 10 days of economic news, I can't be any more specific than that. I think there will be a challenge, but we will, I guarantee we will manage it as we have in the past.

Joe Stivaletti - Goldman Sachs

Right. Now well, that's understandable. On the pricing side, if I'm looking at slide 5, it looks like your coated prices per ton from Q1 to Q2 were up by about $26 per ton on average. And we know that there is a $40 increase in the market and then additional increase in groundwood for July. So, I just was trying to reconcile that with your comments that you thought prices would be up slightly in the third quarter on a sequential basis, because it seems like if you're going to get the whole remainder of that $40 April increase plus presumably some of the July increase flowing in, it might be actually somewhat noticeable in terms of price realization improvement in Q3 versus Q2. Can you just maybe clarify that a little bit?

Mike Jackson

Yeah, Joe, on the groundwood side, the April increase, we feel very good about that realization and maybe there is a little residual into the third, same thing on the freesheet side. As far as the July announcements we made, we expect to see more traction on the groundwood side in the third quarter and maybe into the fourth, but as you probably know on the freesheet side, that doesn't – right now it just doesn't look like the second announcement is going to go very far.

Joe Stivaletti - Goldman Sachs

Okay and just one final thing I had. Could you give us a little bit more guidance on input prices, I mean given that we're starting to see some cost, some things going the other way. I wondered if you saw a sequential hit of $5 million from Q1 to Q2. Do you think that that will, I know you said input costs are still going up, but do you think that delta will moderate a little bit on a sequential basis based on what you're seeing so far through the first half of the third quarter?

Mike Jackson

I think as I mentioned I think on the pulp side for any softwood that we buy, we will see some moving back in the other direction a bit, but I would say on a sequential basis Joe, right now I would expect it to be something similar to the movement we saw between the first and second quarters.

Joe Stivaletti - Goldman Sachs

Okay, thanks a lot.

Operator

And next, we'll go to James Daly with Deutsche Bank.

James Daly - Deutsche Bank

Good morning guys, a great quarter.

Mike Jackson

Thanks.

James Daly - Deutsche Bank

Just a couple of follow-ups and some clarification here. All the projects you seem to have completed in the first half here. Could you kind of give us an idea of what the effect on profitability would be in the second half and maybe on an annualized basis on those projects?

Mike Jackson

Well, yeah. I think that if you go back and you look at the Quinnesec that I mentioned is really that impact won’t show until when we start up sometime in November. And so, that impact is really going to be a 2012 and that's a $10 million plus impact. The DOE projects, I mean you'll begin to see that heavily in the second half. Those projects, there were 12 projects and the impact of that is another $10 million a year EBITDA. The R-Gap that I mentioned, that's probably I would say another $5 million. So, going into the second half, you would see the DOE and R-Gap right away and certainly with Quinnesec that will be a 2012 event as will Bucksport that will be up and running sometime in May of 2012 as well and that's another probably a $11 million impact.

Robert Mundy

Yeah Jim, the year-over-year changes in the first quarter versus last year, second quarter versus last year, we do the bridges, you can see that the operations bars haven’t been huge, because like I said, a lot of our initiatives start to appear in the second half and as Mike just spoke to as well. And we also had a lot of one-off things going on in the first half of the year that we don't have in the second half, so you should see those bars really increase over the next two quarters from a year-over-year basis as we move forward and we are pretty excited about that.

James Daly - Deutsche Bank

That's great. That's very helpful, thank you. And just kind of going back here a little bit, you kind of ranked what you thought your strongest businesses were, coated freesheet, I think then you said SC and then coated groundwood. And then, kind of on the pricing front, it seems to be kind of taking an opposite direction. What's your take on that? What are we missing there?

Mike Jackson

Well, that’s a great question. I think the groundwood, let me back up and just say with coated groundwood, there are an awful lot of cost pressures in that whole arena, because most of the mills are non-integrated. And so, you have more of a need to certainly keep up with certainly input prices and just the fact that you got to become profitable. Coated freesheet is really a different story and I think we live in a competitive environment and I guess the best thing I can say is to leave at that. We have to be competitive and I think different companies look at their businesses differently and we have tried to move price in the second quarter and we have to be competitive. So, we could only move as far as we can move, if you know what I'm saying James.

James Daly - Deutsche Bank

I completely understand. All right, that’s very helpful. Thank you.

Mike Jackson

You bet.

Operator

And from Credit Suisse, our next question comes from Bruce Klein.

Bruce Klein - Credit Suisse

Hi good morning.

Mike Jackson

Good morning.

Bruce Klein - Credit Suisse

If you could just give maybe some more on the seasonal improvement that we typically see in the second half, I think you said catalogs maybe later, one of your competitor I think thought the season wasn't happening as quickly or as robust as prior seasons, would you sort of agree with that? And then secondly, I think cost inflation versus the R-Gap savings, which it sounds like it's going to be more robust in the second half. Do you get a sense that one will exceed the other in terms of the R-Gap or the cost inflation?

Robert Mundy

Yeah, I'll answer the second question there Bruce. Yeah, I do, I think it definitely will exceed the inflation that I indicated earlier.

Bruce Klein - Credit Suisse

Okay.

Mike Jackson

And Bruce, as it relates to your first question, I still believe or our view is that the catalog season is going to be a bit later than normal. However, I don't disagree with whoever made the comment that you just talked about, and that's really based on the events over the last couple of weeks. I mean, I think you know there is a lot of uncertainty out there and when it has to do with people spending cash, they're more conservative and I think that's the best thing that I can say is that, I think people are going to look very carefully about where they're spending their money and we'll have to wait and see what that really looks like. But again, the best view that we have over our third quarter is what we just described. And if you go back and you look at our volume in the third quarter of last year, it was a decent quarter.

Bruce Klein - Credit Suisse

Yeah, that's helpful. And then, electronic media, anything new or different in terms of what you customer strategy is in that area or any trends you would want to note?

Robert Mundy

Well, I think you see continued migration Time Inc. just announced of their 21 or 22 magazines that they were all going to be put certainly in an application for the iPad and they continue to offer, you got to get print to get the electronic version. The thing that's really been interesting to me is Travel and Leisure as an example was something that during the recession had kind of backed off. If you look at the data today, I believe through the first part of the year, that advertising piece is up 9% and this is to do with paper. You look at Martha Stewart; I think they are up like 7% or 8%, their ad pages are up 12%. So, you honestly have a mixed bag. You have more availability of online magazines, but those travel and entertainment and special items seem to be growing, but beyond that I think it's still a wait and see attitude as to how do we make, if I'm a publisher, how do we make money and with what model do we make money? And I think that's still debatable.

Bruce Klein - Credit Suisse

Thanks a lot guys.

Operator

And our next question comes from Tariq Hamid with JPMorgan.

Tariq Hamid - JPMorgan

Good morning.

Mike Jackson

Good morning.

Robert Mundy

Good morning.

Tariq Hamid - JPMorgan

The revolver mature is down a little under a year. Do you have any sort of plans on redoing that revolver anytime soon, anything you would like to share?

Mike Jackson

No, and certainly we are looking at our options there and we will be very timely and prudent in how we address that, but that is certainly something that we're taking a look at right now.

Tariq Hamid - JPMorgan

Okay. And then I guess with the volatility in the markets your bonds are trading at sort of depressed levels again. Do you have a certain payment capacity to repurchase bonds any more (Inaudible) or do you not have the capacity to do so?

Robert Mundy

Well, we have some capacity to do some things, but I would say that's just not something that in today's market right now that I'm putting a lot of focus on.

Tariq Hamid - JPMorgan

All right. And then this is sort of been asked a couple of different ways, but given just the volatility over the last couple of weeks with the markets, are you seeing really the order pattern to customers change at all or is it too early to tell?

Mike Jackson

I think they have been conservative. That’s the best word I could use.

Tariq Hamid - JPMorgan

Okay. Thank you very much.

Mike Jackson

Thank you.

Operator

And from Barclays Capital, we will go next to Jeff Harlib.

Jeff Harlib - Barclays Capital

Hi good morning.

Mike Jackson

Hi Jeff.

Jeff Harlib - Barclays Capital

Just on the energy projects, can you just talk about, you mentioned the $10 million from completing Quinnesec, I think you talked about $50 million of improvements starting in late 2012. Can you just talk about the role forward and how you get to that number?

Mike Jackson

Well, we have got the Quinnesec project; these are all round numbers right, so a little more than $10 million. You have got the Bucksport, which will be a little more than $10 million. You have got the DOE that I mentioned which will be $10 million, maybe $10 million plus. And then we have got, as I mentioned, when you think about R-Gap, we separate R-Gap now into two categories. One is usage and efficiency and the other is energy, so the balance of that $50 million will be coming right out of the R-Gap bucket. We have got, I think I already mentioned, over 200 projects, I would say 60 of those are really focused on the energy side of our business, so those are the three components that make up that $50 million.

Jeff Harlib - Barclays Capital

Okay. And just on the business, are you seeing any increase in imports from Europe given some softness there and if you could just comment on relative demand for magazines, catalogs, commercial prints as you look into 3Q?

Mike Jackson

Yeah. Let me answer the question about the imports. Coated freesheet even though it was up 14%, that was all sheet, basically that was sheet. When you look at rolls, coated free sheet rolls they were down 5%, so basically they follow the market trend. When you think about coated groundwood, coated groundwood was down 11%, now this is year-over-year, it was down 11%. So, the imports have not changed significantly and if anything, they are down compared to what the market is. Your second question I think related to magazines, catalogs, direct mail, I would put it in this category. I would say I think direct mail would be the strongest, catalogs the second and I think probably the weakest depending on the title, I would say the weakest is the magazine at this point in time.

Jeff Harlib - Barclays Capital

Okay. And just lastly, just an update on CapEx for the full year and potentially 2012 and how much of that is being financed or in restricted cash?

Mike Jackson

Well, CapEx really hasn’t changed much from I think we said it would be around 90 and I think it will still be around that type of number and maybe not that dissimilar in 2012. And the restricted cash, as we talked about before, there was restricted cash for the Quinnesec project and that is helping of about I think it was $24 million when we started that project and that goes down every quarter as we fund the construction of that and that will be basically zero at the end of the year, because that project will have been placed in service.

Jeff Harlib - Barclays Capital

Okay. Thank you.

Operator

And we will go next to Richard Kus with Jefferies.

Richard Kus - Jefferies & Company

Hey guys. Based on your commentary around having to be competitive out there in the market place especially on coated freesheet, have you guys actually seen any price erosion on any grades?

Mike Jackson

Not to this point.

Richard Kus - Jefferies & Company

Okay. And then secondly, I noticed in the other segment you guys had a favorable mix change there that contributed to some positive pricing. Can you give a little bit more color on what’s going on there?

Mike Jackson

Yeah. I think we started to address this in our last call, but we have been very tactical in how we viewed this area. Uncoated printing paper was a fairly large part of that mix when we began to explore that area and we really sorted through the grade structure and we have minimized in a sense our involvement in that area, which according to the data that you see is down like 56%. Our true focus has been in the packaging side and that is something that certainly is less sensitive to advertising and certainly that business has grown and that’s that one that we expect to continue to grow. In fact, we did have a positive margin this quarter for the first time since we started to experiment, so we are pretty pleased with the direction that we are headed in that. Bob you might want to.

Robert Mundy

Maybe there were some things in this other segment as we talked about before that some things work out and some don’t as we capitalized on the flexibility of our machines. And so, some of the things that weren’t going so well when you take those out and add as Mike said, focus on the things that are more profitable, we really saw for the first time a positive gross margin and that is something that we expect to sustain and continue as we get the right mix going forward on these other products.

Richard Kus - Jefferies & Company

All right. Thanks a lot guys.

Robert Mundy

You bet.

Operator

And from RBC Capital Markets, we will go next to Bill Hoffmann.

Bill Hoffmann - RBC Capital Markets

Hi guys. Good morning. And just to follow-up on the last question on these packaging grades, what is the tonnage of these packaging grades that you guys are producing at this point?

Robert Mundy

I don’t know if we have ever given that out Bill, because it moves around, in the other segment it includes packaging grades, it includes the tolling agreement we have with Thilmany or packaging dynamics, there is just a lot of stuff in there.

Bill Hoffmann - RBC Capital Markets

Okay, thanks. And then Mike, I just wonder the catalogs you have I mean, historically these catalogers, we thought they had learned to not give up printing their catalogs in the season and sometimes it pushed them back, but do you see any risk of guidance not going forward with them this year?

Mike Jackson

Bill, I put it in the same category as some of the decisions that were made not quite as drastically, but that were made in, or some of the learnings that were made 2008, I think that the one thing that I believe that they have learned to your point is they have got to continue to prospect. And in 2008, you may remember, they went away from prospecting, they kind of tied the purse strings down and they didn’t spend any money and I think it came back to bite them. So, my belief is they will cut back, but my belief is they will continue to prospect, because that’s the life blood of their business. So, I do expect to see a decline, it’s not going to surprise me at all, but I think those that I have spoken to have reinforced what I just said to you and I guess time will tell if it’s true or not.

Bill Hoffmann - RBC Capital Markets

And I don’t know if you gave this information, but in Q2 and Q3, sort of up-to-date, where are the catalogers running and shipping volume wise this year versus last year?

Mike Jackson

Yeah, well I think I mentioned that. Through the first half of the year, I don’t have the current data, because it’s not out, but through the first half of the year Bill, catalog mailings were up 0.3%.

Bill Hoffmann - RBC Capital Markets

Okay, good. That’s helpful. That’s it, thanks.

Mike Jackson

Okay Bill.

Operator

Our next question comes from Gary Madia with Gleacher & Company.

Gary Madia - Gleacher & Company

Thank you. Most of my questions were answered, but just a couple of smaller things, Bob. The first half of the year has been a heavy investment, much more than we saw last year, for example, in working capital. Are you expecting to get most of that back in the second half of the year?

Robert Mundy

We will get some of it back, but with part of that, what Mike alluded to earlier, even though from a timing standpoint as we ended the second quarter, we were where we needed to be. The value of those tons were higher in big part due to much higher input prices we were having to pay and so, the cost of manufacturing those tons are high, but we will get some of that back through managing our supply versus the demand of our finished products as well as some tighter management on some of our non-finished goods inventory like our wood inventories and our raw materials and so on and so forth, so we will certainly get some of that back. And then, certainly in sales, sales will fluctuate, it will certainly be up in the third and then moderate a bit probably in the fourth, so the receivables you will see a bit of a change there too as well as payables.

Gary Madia - Gleacher & Company

Okay. And just one final thing, I know that the adjusted EDITDA numbers got an add-back, I think it’s approximately 3.7, it’s in the presentation at the end in the appendix. Can you give some additional detail, because it basically says, is this new product development or other? Can you help flush that out a little bit specifically as to what the add-back is?

Robert Mundy

Well, some of it is, we continue to try and experiment on new things in that other, but I think we stated in the press release and in the 10-Q it falls out of that SG&A area and we mentioned in those releases that it has to do with some professional fees and severance costs. And just to add a little more color to that, we certainly have a strategy, a three, five, seven-year strategy for the company and we have been spending a lot of time taking a fresh look at that, getting some people to help us take a look at that, making sure we are still on track, tweaking things where we need to and to make sure that we are still headed in the right direction and that required a lot of resources and time and effort to get through that. And the part of that, you are also looking at your SG&A and making sure it stays where it needs to be and that’s where you see a little bit of that severance in this particular quarter. So, certainly don’t run rate whatever I think it was $20 million something for the quarter, you don’t run rate that and expect that to be our annual SG&A, because it’s not.

Gary Madia - Gleacher & Company

Okay. I appreciate the color. Thank you.

Robert Mundy

Yeah.

Operator

And from Bank of America Merrill Lynch, we will go next to Roger Spitz.

Roger Spitz - Bank of America Merrill Lynch

Thank you and good morning.

Robert Mundy

Hello.

Roger Spitz - Bank of America Merrill Lynch

You said that chemicals represented around 24% to 25% of the COGS in the last call. Are you able to provide any breakout of what percent of COGS or what percent of chemicals might SB latex and starch and/or titanium dioxide be?

Robert Mundy

Well, latex and starch are certainly the biggest movers of our chemical COGS, so they are at sort of the top of the list Roger.

Roger Spitz - Bank of America Merrill Lynch

Or another way to ask it is, can you say how much latex and/or starch or titanium do you purchase on an annual basis?

Robert Mundy

I don’t think we have ever really gotten to that level of detail on our raw material purchases, but I can tell you that obviously like I said they move the needle and so, it’s significant being a coated paper maker, there are significant volumes.

Robert Spitz - Bank of America Merrill Lynch

Sure. All right, thank you very much.

Operator

And our next question comes from Michael Marczak with UBS.

Michael Marczak - UBS

Good morning guys.

Robert Mundy

Good morning.

Michael Marczak - UBS

Just a clarification around your comment on lead times, where are they now and how do they compare to historical standard?

Robert Mundy

I’m sorry, did you say lead time?

Michael Marczak - UBS

That’s correct. And now they are around 30 days, are they 60 to 90?

Robert Mundy

It’s not, no it’s much less. I would say what used to be the 60 to 90 is now 30 to 60.

Michael Marczak - UBS

And is that similar across your different end markets, magazines, catalogs?

Robert Mundy

It is, yes.

Michael Marczak - UBS

Great. And then maybe a follow up on a prior question with regards to kind of market share trends within the industry. Do you feel that you are gaining market share at this time?

Robert Mundy

Our market share in both coated freesheet and coated groundwood, I mean SC we are not a big player in. So both coated freesheet and coated groundwood, we have been very consistent with that number for the last couple of years. We may have gained 8%, but I think we have been pretty clear that we don’t want to gain market share by market share in a sense, we have been very careful just not to do that and to grow where we think we can grow profitably.

Michael Marczak - UBS

Got it. Thank you.

Robert Mundy

You are welcome.

Operator

And we will go next to David Ross with Citi.

David Ross - Citi

Yeah. Good morning guys. Can you comment a little bit on the export market as far as what you are seeing as far as foreign imports and your ability to export?

Robert Mundy

You are talking about our export market?

David Ross - Citi

Just in general in the coated paper market?

Robert Mundy

I think it’s variable by grade whether it be uncoated free, coated groundwood, coated freesheet I would say of the three, probably it would go coated freesheet, coated groundwood, uncoated freesheet would be the way that I would rank those grades. Certainly not significant for us, I can’t comment at all on anybody else’s business obviously, but we are a very small player in export, very small.

David Ross - Citi

And are you seeing anybody, any players, merchants out there kind of undercutting on price, I know you guys aren’t, but is that happening in kind of the light volumes of Q2?

Robert Mundy

It’s all variable. I mean, it depends on the customer, it depends on the distributor and I can’t give any specifics, so I would just say you see our price realization, it has continued to move and I will probably stick with that story for a while.

David Ross - Citi

Thanks guys.

Robert Mundy

Yeah.

Operator

And our next question comes from Philip Birbara with RBS.

Philip Birbara - RBS

Hi, good morning.

Robert Mundy

Good morning.

Philip Birbara - RBS

Were your volumes at all affected in the second quarter due to the maintenance downtime that you took?

Robert Mundy

Maybe a bit. I mean, there was certainly 19,000 to 20,000 tons of impact, so there was some of that, but as Mike alluded to, we need to build some inventory. We got a much stronger I think first quarter volume than we anticipated, so we need to get inventories back to the levels that we saw for meeting the third and fourth quarter demand.

Philip Birbara - RBS

Okay. And then your outlook for the third quarter of flat volumes versus a year ago, do you expect the mix to remain relatively unchanged or do you expect any change in the mix, say between pulp and paper, or between the various grades of paper?

Robert Mundy

I think it will be basically the same, I mean, pretty close. It’s nothing dramatic. I think I mentioned we might have a slight mix change, but I don’t think it will be anything significant. If anything, it maybe a little bit more freesheet, but not much.

Philip Birbara - RBS

Okay. And then just your outlook on pulp, you didn’t really give much of an outlook in terms of pricing, but I would just like to get your thoughts on that?

Robert Mundy

Yeah. I think we are going to see a third quarter reduction maybe in the $30 ton range or maybe less than that because that’s a contracted event and probably closer to $10, sorry.

Philip Birbara - RBS

Okay. And any thoughts then on the fourth quarter?

Robert Mundy

You know what, I’m going to stick with the view of the third quarter and given that view, which for us is I think fairly positive here, I would rather not talk about the fourth quarter until I am a little closer.

Philip Birbara - RBS

Okay. All right, thank you.

Robert Mundy

Thank you.

Operator

And ladies and gentlemen, that does conclude today’s question and answer session. We thank you for your participation in today’s presentation. You may now disconnect.

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