Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Michael A. Jackson – President & Chief Executive Officer

Robert P. Mundy - Chief Financial Officer

Analysts

James Armstrong for Chip Dillon - Citigroup

Claudia Hueston – JP Morgan

Mark Connelly - Credit Suisse

Bill Hoffman - UBS

Bruce Klein – Credit Suisse

Ross Gilardi - Merrill Lynch

Mark Wilde – Deutsche Bank

Joe Stivaletti – Goldman Sachs

Matthew [Armitz] – Goldman Sachs

Verso Paper Corp. (VRS) Q2 2008 Earnings Call August 7, 2008 9:00 AM ET

Operator

Welcome to today’s Verso Paper Corporation’s Second Quarter 2008 Earnings Conference Call. (Operator Instructions) At this time, for opening remarks, I would like to turn the call over to Mr. Bob Mundy, Verso’s Chief Financial Officer.

Robert P. Mundy

Good morning and thank you for joining Verso Paper’s Second Quarter 2008 Earnings Conference Call. Representing Verso today on this call is President and Chief Executive Officer, Mike Jackson, and myself, Bob Mundy, Senior Vice President and Chief Financial Officer.

Before turning the call over to Mike, I would 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 annual report, which has been posted to our website, www.versopaper.com, under the Investor Relations tab.

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

Michael A. Jackson

Thank you, Bob, and good day everyone.

Our comments today will be directed towards the slides in our deck, and of course, we look forward to your questions at the end. This call, as many of you aware, is our first quarterly call since our IPO so we welcome our new shareholders to the call, in addition to our existing bond holders.

Since our carve-out from International Paper two years we have taken great strides to build what we think is a very good company that is positioned for growth and prosperity. Since some of you on the call may be new to Verso, I would like to give a very quick overview of our business before discussing our second quarter results.

If you would move to Slide 3, Verso is North America’s second largest producer of coated paper. We have four paper mills in the U.S. that produce 1.8 million tons of paper. Our core market segments, where we have very strong market share, is focused on magazines and catalogues and coated free sheet and coated ground wood represent 87% of our revenue. LTM revenue was $1.8 billion and adjusted EBITDA was $243.0 million.

If you move to Slide 4, this really shows our main product focus and that revolves around No. 4 and No. 5 coated ground wood and No. 3 coated free sheet. This concentration on light weight and ultra-light weight basis products, along with our focus on rolled products only, as we do not produce sheets, leaves us less susceptible to foreign imports due to our light weight manufacturing expertise, Northern fiber accessibility, which really allows us to produce the light weight products, and transportation advantages.

If you move to Slide 5, in taking a look at the summary of our second quarter results, we are very pleased that the second quarter was a strong quarter for our business, as price and volume trends were robust and EBITDA grew by 94% year-over-year. Our top line volumes grew by 4% year-over-year, price grew 19%, and our net revenues grew 21%.

On a sequential basis, we continue to increase our coated paper selling prices. Prices improved by $32.00 per ton over first quarter levels. In addition, we’ve announced the further price increase of $60.00 per ton on our coated paper grades effective July 1. This price increase is being realized in line with our other price increases from earlier in the year and we would expect our average selling price to continue to increase in Q3 and Q4.

On the back of several straight quarters of strong volumes and market conditions, growth of inventory levels on June 30 were well below 2007 levels but pipeline inventory has begun to grow, which we will talk about a bit later in the call.

We continue to see improvement in operations due to our industry-leading R-GAP program, which delivered another $6.0 million to cost savings in the quarter. In addition, in Q2 we had three major planned maintenance outages that were very successful which impacted production volumes by 19,000 tons.

Moving to the earnings side, despite the absorption of some very high raw material headwinds, of which Bob will go into more detail later in the presentation, we grew our revenue base in excess of our cost inflation such that our second quarter adjusted EBITDA of $60.4 million was up 94% from second quarter 2007 levels. With this quarter our LTM adjusted EBITDA now stands at $243.0 million and we see further year-over-year increases as we move forward in 2008.

Our adjusted net loss was $2.6 million as compared to an adjusted loss of $35.2 million in the second quarter of 2007. The special items during the quarter were primarily related to the ITO we completed in May. A breakdown of those items and a reconciliation to GAAP can be seen in the appendix to this online presentation.

During the quarter we generated $29.0 million of free cash flow, which brought our cash balance to $48.0 million for the quarter. And as mentioned, we completed our IPO on May 20 and are proud to announce that the initiation of a $0.03 quarterly dividend to be paid on August 29 to shareholders of record on August 21. This dividend is an acknowledgment of managements’ and the Board’s faith in the cash flow generation of this company.

If you would refer to Slide 6, I would like to take a moment to mention some key items relative to the first half of 2008. Volumes and revenues were up 9% and 26%. We had price move up $150.00 a ton from second quarter 2007 levels and coated ground wood prices are up $215.00 a ton since June 2007.

Our adjusted EBITDA is up 94%, again, in spite of unprecedented input cost increases and our adjusted net income improved by $61.0 million versus the first half of 2007. We spent a tremendous amount of time educating our employees on the influence on working capital. This has really paid off for us, as our working capital is 3.5% of sales and we believe that this percent of working capital can be compared very favorably to any company in our industry.

We have built an efficient and cost-effective organization following our acquisition from IP with benchmark SG&A levels at 3.3% of net sales.

Our safety results continue to improve, which not only means that our employees are safer than ever, but safe facilities have a direct correlation to improved machine efficiencies, which continue to show improvement over 2007 levels. And we were one of only two forest-products companies in the U.S. recognized by AF&PA for significant environment results which we are very proud of as well.

At this time I’ll ask Bob to walk us through more of our specific results in the second quarter.

Robert P. Mundy

On Slide 7 you will see an overview of some of our key metrics during the second quarter versus last year. Our coated volume was about 16,000 tons higher and our average paper prices are up significantly by an average of $150.00 per ton. Revenues of $452.0 million were up 21% versus the second quarter of last year and adjusted EBITDA was up 94% at $60.4 million.

And versus the first quarter of this year, the prices continue to increase and we are $32.00 per ton higher than the first quarter. The volume in the second quarter was down versus Q1 due to the normal seasonal volume decline as well as the planned maintenance outages that we had at three of our four manufacturing locations. This also affected adjusted EBITDA quarter-over-quarter.

On Slide 8 you will note that the prices paid for our key materials, energy, and freight are higher both year-over-year and versus the first quarter of this year. Energy prices were the major item contributing to this as oil and gas prices have escalated at record levels during the quarter. Higher prices for things caustic latex and starch resulted in higher chemical costs and wood costs are being impacted by higher diesel prices as well as the slump in the housing market which impacts the availability of wood used for making paper.

Fortunately, in the pulp area we have a natural hedge against higher prices for pulp purchases as this is offset by the higher prices we receive for the pulp we sell to the market. In order to help mitigate these unprecedented increases in input prices, we have a great deal of effort, both through our R-GAP program that you’ve heard us talk about previously, as well as other initiatives focused at reducing our usage of materials, how we buy materials, and substituting alternative types used in making our products.

On Slide 9 you will see a bridge that reconciles the changes between the key components of adjusted EBITDA between the second quarter of 2007 and the second quarter of 2008. A few items stand out here, that being the significant improvement in the price and mix and the products we sell, which contributed about $71.0 million of year-over-year benefit. Last year we did have market down time at three of our facilities during the second quarter. Manufacturing operations costs were higher year-over-year but this was primarily due to the outages that I spoke of a few minutes ago. The other key item is the increase in the prices we paid for our key materials.

On Slide 10 you will see a similar bridge, although this is on the basis of earnings per share before special items. For comparative purposes we have used the current number of shares outstanding, just over 52.0 million, for the second quarter of 2007. On that basis, in the second quarter of last year we lost about $0.67 per share versus the loss before special items of $0.05 per share in the second quarter of 2008.

Slide 11 shows our capital spending summary. You will see we spent about $29.0 million during the quarter, which is a high number for us and is directly attributable to the work performed during our planned maintenance outages. We still expect to be around $79.0 million of cap-ex for the year 2008.

On Slide 12 is the summary of our capitalization and liquidity. Our net debt improvement from the first quarter of this year is the result of increasing our cash by $28.0 million as well as paying down a large portion of our holding company loan with some of the proceeds from our IPO. Also, we don’t have near-term maturities on any of our debt. Our liquidity position at the end of the quarter was $218.0 million.

So in summary, the second quarter of 2008 reflected solid year-over-year results in spite of unprecedented cost inflation and poor economic conditions. Our adjusted EBITDA of over $60.0 million and our net income before special items improved by over $33.0 million.

Our price realizations continue to increase as we’ve been very successful at getting our price announcements to the bottom line and have kept a close eye on the supply of our products versus our customer demand.

And even though we had a significant amount of planned maintenance activities during the quarter, they were all completed successfully and we still drove operational improvements from our R-GAP program as well as other key initiatives around work force development, maintenance, efficiency, and energy usage.

I will now turn it back over to Mike who will talk about the outlook for the third quarter.

Michael A. Jackson

Before we go into the Q&A portion of the call I would like to give you a view of what we see ahead for the third quarter. We do expect to see continued high levels of wood, energy, transportation, and raw material costs. And certainly we are in the midst of a challenging economic time. The impact of the economy on demand is certainly not unusual and escalation in producer and customer inventory in the past few months was accentuated by a couple of events.

One was that inventories in the first and second quarters were at very low levels, certainly from a Verso-mill perspective, as customers began to ramp up their orders due to the memory of the 2007 paper shortage in the second half, as well as an effort to beat the announced and anticipated price increases. The impact of this customer inventory build, coupled with the obvious fall-off in the economy, has pushed inventory levels higher.

However, printer inventory kicked down just a bit in June, which is a positive sign. We do expect to have a slight increase in our third quarter volume over our second quarter results, and as Bob mentioned, we see continued price appreciation in the third quarter.

As we did in 2007, we have continued to balance our supply with demand. We noted earlier that in the second quarter of this year we curtailed 19,000 tons of production for maintenance outages and in spite of our inventories being significantly below 2007 first half levels, we have announced an additional two weeks of down time at our Bucksport, Maine, mill beginning September 8, which reinforces our commitment to balance our supply and demand. We will continue to monitor the situation and take appropriate and swift actions.

With continuing supply rationalization and no closures, we see coated operating rates for the year in the high 90s. In spite of increasing costs we expect continued operational improvements and R-GAP savings in the third quarter.

During the early part of 2007 we mentioned four initiative, beyond R-GAP, that were being worked relative to work-force planning, maintenance efficiency, energy usage, and our business management process. These initiatives carry a relatively small capital investment but we’re confident of the results that will continue to help offset cost pressures that we’re seeing.

Examples of the progress in these areas are that we are now losing 20% less fiber per ton of paper than we were a few years ago. Much of this is due to improvements in process reliability and in screening methods. Our thermal energy consumption on an MMBtu per ton basis is down 11%, while the electrical energy consumption on a kilowatt per ton is down 6% over the last few years.

And as we begin to harvest our plantation in Minnesota to replace third-party wood, we are also utilizing biomass from those acres to replace coal at our Sartell mill. And as Bob mentioned, unlike the second quarter, we have no planned maintenance outages.

Our second quarter results were Verso’s third consecutive quarter of year-over-year improvement and we expect that trend to continue. Our business has made a lot of progress since Verso was formed. Our shareholders expect much from the company and we can assure you that our employees recognize the expectations and opportunities in front of us.

So, Tom, at this time we would be happy to take some calls.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Chip Dillon with Citigroup.

James Armstrong for Chip Dillon - Citigroup

This is James Armstrong calling for Chip. Two questions. One, are you seeing anything on the demand side in the third quarter? And is the Christmas catalogue season picking up? Could you comment on that?

Michael A. Jackson

Yes, James, certainly the impact on demand from the economy is something we are seeing and that’s why I mentioned that I think our volume will certainly be above second quarter levels. And we’ve seen, by the way, demand move try to move across quarters rather than, if you will, all get moved into the third quarter. So we’ve seen that spread. But we certainly have seen an impact in demand and that’s why you’ve seen the steps that we’ve taken.

James Armstrong for Chip Dillon - Citigroup

So there is a pick up. Do you think you will see more of that demand move to the fourth quarter versus the third quarter?

Michael A. Jackson

I do. I think we saw that last year. That’s kind of interesting because we continue to see the catalogue season come later and later and that’s really, probably in the last three years, has moved in that cycle. So we’re optimistic that it will pick up but we’re not putting our head in the sand relative to where demand is.

James Armstrong for Chip Dillon - Citigroup

And secondly, what type of hedging strategy do you have on right now with natural gas falling off? Are you adding at this point? What level are you at current?

Michael A. Jackson

We do have a hedging strategy, primarily on gas right now. Because of the economics of oil and gas it doesn’t make a lot of sense to burn a lot of oil and we’re not this year. But we have seen, obviously, the drop off in gas prices recently and we have taken advantage of that where we saw that it makes sense, based on the strategy that we have within the company.

So I think that we will see some benefit from that in the third and fourth quarters.

James Armstrong for Chip Dillon - Citigroup

Could you tell me what your current average hedge level was at the end of the quarter?

Michael A. Jackson

At the end of the second quarter we were about 80% hedged, on gas.

Operator

Your next question comes from Claudia Hueston with JP Morgan.

Claudia Hueston – JP Morgan

Just a couple of questions. One, in terms of the allocation of the special items you cited in the release, did all of that pretty much fall in the coated paper operating loss that was recorded in the 10-K?

Michael A. Jackson

Yes.

Claudia Hueston – JP Morgan

And then I just was wondering if you could comment in terms of where coated paper prices were as you were coming out of the quarter? Were they higher than the average? Any color there?

Michael A. Jackson

When you say coming out of the quarter, help me with that, what’s the reference point, Claudia?

Claudia Hueston – JP Morgan

So your prices were up I think 19% or so year-over-year on average in the quarter. Do you have any insight in what they were at the end of the quarter, so June 30?

Michael A. Jackson

If I understand your question, you know, prices June-over-June were up about $150.00 per ton. Coated ground wood was up $215.00 per ton from June 2007 levels.

Claudia Hueston – JP Morgan

That’s exactly what I wanted.

Michael A. Jackson

And then we had a realization from first quarter to second quarter on appreciation of about $32.00 per ton.

Claudia Hueston – JP Morgan

Is it possible to provide a little bit of detail on the R-GAP cost savings you realized in the quarter in relation to the input cost pressures that you incurred?

Michael A. Jackson

The R-GAP, we talked about the outages, Claudia, and the way we do our EBITDA bridge and we have an operations category and it’s actually had a lot of moving parts this particular quarter and it sort of varies the impact of the improvement from our R-GAP program. Because the outages cost up about $8.0 million, year-over-year.

The fact that we had market down time last year, and you get costs out of the mill when you take market down time. Well, in this current quarter, when you don’t have market down time, that labor, some of those indirects, they’re in your numbers so you sort of have a negative effect from that as well. That was about $2.0 million.

So that negative $10.0 million is offset by $6.0 million of R-GAP improvements. That’s how you get sort of the negative $4.0 million that we show in that operations column.

Those R-GAP improvements are focused heavily on usage reductions. I think we made a comment about trying to combat what’s going on in the input price arena. That gives us the biggest bang for the buck right now, no doubt. And we had a lot of things built into the plan for this year but we certainly have moved up some other things to help reduce usage of materials, and that’s the majority of that benefit.

Operator

Your next question comes from Mark Connelly with Credit Suisse.

Mark Connelly - Credit Suisse

If we could go back to the demand issue, I wonder if you could give us a sense of where you are seeing softness in the coated space, which end markets? And whether you’re leaning towards the lighter weights is helping or not in that mix this time around. Just a little bit better sense of where the weakness is, or is it just across the board and does the light weight/heavier weight not matter?

Michael A. Jackson

Sure, Mark. To answer your question directly I think we’re seeing more demand swings on the catalogue side than we are on the magazine side. And there’s a number of factors, obviously, there which included the postal increase. But to your point, the lighter basis weight strategy, for us, has really proven to be successful, whereas people migrate from heavier weight to lighter weight, part of the reason is that lighter weight products obviously cost less to ship.

And I guess another piece that really falls into our strategy is with our ability to manufacture light-weight products, we also have what we call great bulking properties, so it give the feel of a heavier-weight product. And so we feel that we are very well positioned as that migration takes place.

Mark Connelly - Credit Suisse

And do you expect to move further towards light weights over the next couple of year? Is there any concerted effort underway to move even further, or do you have the right amount of tonnage for now?

Michael A. Jackson

I think right now, our lowest basis weight is about 26 pounds and if you get far beyond that you are really moving into a whole different category and really catalogue and magazine, your publishers are really not interested in getting much lighter than that because of the quality perspective. Again, that’s from a coated product perspective. So I think we’ve got the right niche.

The key for us is to continue to have product lines that go from the 45s to the 40s to the 38s to the 34s to the 32s and on down. And again, I think we’ve got a very good spread of a product to deal with that.

Mark Connelly - Credit Suisse

If we could go back to the inventory question. In the last 20 years I’ve never seen inventories rise as fast as they did in coated ground wood, which raises questions about how well the coated producers, as a group, really understand what’s going on out there. Certainly with the decline that we saw over the six months in 2007, you know, I think the market pretty well understood that customers were building inventories. Do you think that producers as a group did not understand that? I’m just trying to get a sense of why we’re seeing down town and closure announcements now and why we didn’t see them last quarter.

Michael A. Jackson

Well, I think two things have really happened. One is the build was certainly significant, but people forget what happened last year and the panic that took place as inventory dropped to very, very, very low levels. When we moved into the first quarter of 2008 the industry had very little product, from the mill perspective. And obviously the printers and our customers knew coming off of 2007 that it was a little scary relative to supply/demand balance, and they built inventory.

But I would like to make a, really, it’s hard for me to talk for the industry, but I do want to mention Verso. We mentioned our inventory level at the end of June and it’s the lowest that we’ve had in five years. And so what we continue to do is take the appropriate actions and balance our supply and demand. I don’t even want to tell you how low our inventories were, but they were very, very, very low. So hopefully, we’ve got to run our business that the way that we think.

I do, however, think that we’ve seen some other announcements. Certainly Kruger and Domtar and others and so I think appropriate action is being taken.

Mark Connelly - Credit Suisse

A couple of housekeeping questions. Are we going to see more deal-related charges in the next quarter or are all of those booked at this point?

Robert P. Mundy

That should be, obviously if something new comes up, but as far as the IPO and such, not that’s all booked.

Mark Connelly - Credit Suisse

And then planned outages. You said there’s nothing for Q3. Is there anything in Q4?

Robert P. Mundy

No.

Operator

Your next question comes from Bill Hoffman with UBS.

Bill Hoffman - UBS

I just wanted to probe a little further on what you guys are hearing from the catalogers for this holiday season. It feels like there’s a bit of hold back for the catalogue season. I was just wondering if you’re hearing the same thing and whether there’s potential here that we could actually see a more of a pick up here later in the third quarter than you normally would?

Michael A. Jackson

Well, I think there is a hold back. How significant it is, to be candid with you, I don’t think we really know. I think what we’re seeing today is a little bit of page count reduction in some instances, a little bit of size reduction, and I think with the economy you’ve got a lot of businesses that are obviously under stress.

But I think the important thing to remember is the catalogue is the driver for these companies of Internet sales. And you can only go so far in terms of any type of cut back. And when you really begin to cut back so far that it impacts your revenue, I truly believe that people are looking at that very, very closely and they made their changes in demand and now I think we’re going to see that throughout the third quarter.

And as we had already mentioned, including last year, we began to see demand more to the back side of the year, of the fourth quarter, if you will, than we had normally seen in the past.

Robert P. Mundy

And I think we mentioned on the slides that we do expect volumes to be up in the third quarter and it will be a healthy volume quarter. But the key thing is our price is increasing, we’re continuing to get that realization and we’re going to continue to do what we have to do to make sure that momentum continues and we certainly aren’t going to go backward on price.

Getting a dollar price is worth a heck of a lot more than a ton of volume and we’re going to do the right thing there to keep that in check.

Bill Hoffman - UBS

And then, Bob, can you explain a little more about your energy hedging program? Are you using caps? You said you benefit here from natural gas coming back down, could you just help us get some quantification of that?

Robert P. Mundy

Well, just say for our purchases to come versus what, where gas has been, we feel like with the strategy we have employed that we are going to see some benefit versus some of the prices that gas has been at in the last few months.

Bill Hoffman - UBS

Is that suggesting that your hedge levels are lower than the 80% you were indicating coming into the quarter?

Robert P. Mundy

No, we constantly are working our hedge, we have certain volumes, based on our strategy that we’ll hedge going out and we can hedge up to 80% for the balance of the year, each month. That’s what our strategy allows us to do and that’s pretty close to where we’re at.

Bill Hoffman - UBS

Mike, I wonder if you could just comment a little on your mill mixture and asset base, strategically maybe a little bit longer term, and whether you see good-return capital projects as you go forward, and assuming your cash generation is decent? Any thoughts on capital spending as you go into 2009?

Michael A. Jackson

Yes, I think that we certainly haven’t finished our capital slate for 2009 but I think we’ve been very steadfast in terms of our interest is spending money to reduce our cost structure. And I think we’ve done a very good job of that. This year we’ve had a number of projects really focused on, and Bob mentioned it, the usage area. Both in the chemical side and the energy side and some of the results that we’ve gotten are fairly significant for what we would call the not-significant capital investments.

And I’m talking about in the $2.5 million and maybe $4.0 million dollar range where we have 40%, 50%, 60% returns. And that’s where our focus is going to be. I think I mentioned perhaps in one of our last calls, is we’ve spent a couple of million dollars putting some pretty significant measuring devices inside of all of our mills.

You know, we had the ability to obviously at the end of the day understand what the cost was but we really didn’t have a good way to measure it throughout the process. So as it comes in, where is it used, what are the things we can do to change that? And we just got done with that project and we’re already seeing the benefits of that, in terms of water usage, energy usage, chemical usage, and really that’s where our focus will continue to be. It’s certainly not going to be in trying to put in certainly a new head box for increased production. So that’s kind of where we are.

Operator

Your next question comes from Bruce Klein with Credit Suisse.

Bruce Klein – Credit Suisse

I know you don’t speak for the rest of the industry regarding pricing and capacity but do you suspect, in your view, that they’re doing or preparing to do the kinds of things necessary regarding shuts and down time to hold pricing? Do they share your view on that?

Michael A. Jackson

Obviously we just take care of what we do, Bruce, and what our competitors do, that’s their deal. We really can’t comment on what they’re doing. They make public announcements and we read them just like you do. There’s been a fairly large recent announcement by one of our competitors but I read that as that’s pretty much what they said they would do when they made their acquisition and to me they’re following right in line with what they announced as far as their synergy opportunities.

Bruce Klein – Credit Suisse

And the cost inflation, I think you have a year-over-year, but what was the sort of cost inflation in Q2 versus Q1 and the R-GAP delta, also, Q2 versus Q1.

Robert P. Mundy

Versus the first quarter cost inflation was about $12.0 million, Bruce, quarter-over-quarter. The R-GAP was about $6.0 million is what I think I said earlier. Because we had outages and so forth during the quarter, which are a little bit distracting when you have three of your mills down with planned major outages, so the R-GAP was a bit lower than what we normally see, but we knew that because of all the activity in the outages.

Bruce Klein – Credit Suisse

And what was the volume figure in the Q2? 490, all in?

Robert P. Mundy

In the second quarter, all in, it was 502.

Bruce Klein – Credit Suisse

Just demand again, you touched on it. So it sounds like Q3 usually sees a pretty good increase, sequentially. So it sounds like you’re going to see some but given demand in inventory it’s not going to be the 10% or 15% sequential that you typically might see because of slower markets. Is that fair?

Robert P. Mundy

Yes, right now I think it will be up. And we will see, obviously with the economy and where the slight pass [inaudible], probably not, but I think it will be up and as we talked about we might expect some of that to sort of bleed over into the fourth quarter as well.

Operator

Your next question comes from Ross Gilardi with Merrill Lynch.

Ross Gilardi - Merrill Lynch

I just had a couple of questions. Could you guys just talk a little bit more about your volumes during the second quarter? I mean, when you look at the 3.8% increase in coated paper volumes, did any of that borrow from the third quarter? Are you taking share? Obviously you’ve talked about the bigger emphasis on light weight grades and the fact that you don’t produce sheets. But could you just talk a little bit more about the volume that you did see in the quarter, just in relation to the industry statistics which would have shown clearly not as strong results?

Michael A. Jackson

Let me comment on a grade-by-grade perspective. Coated free sheet, we were compared to Q2 2007, and remember Q2 2007 was not a strong quarter so I want to keep this in perspective. Our coated free sheet volume was up year-over-year about 6,500 tons. You go to coated ground wood, I believe that Q2 2007 we shipped about 242,000 tons of coated ground wood and then Q2 2008 we shipped about 253,000, so another 10,000 tons. So, that’s kind of the differential. But coming off of a very weak Q2 2007.

In terms of your comment about market share, I think the key thing there is that, I think Mark had asked the question, is that our light-weight strategy continues to really work because of what we’ve seen relative to postal increases and other reasons. So that’s part of why our volume grew.

And, honestly, I think our pricing realization, if you go back to 2007 and track through the end of 2008 June, we’ve done a great job in terms of price. So we certainly haven’t bought market share. I think it has to do with the products we make.

And I’ll just throw one last thing in there, that we have some very good data and very good feedback from the printers where the products that we make and the web breaks that we have per run of paper for the printers is a very good product. And that’s extremely important to the printers as they think about their cost structure, because when they’re down that’s money and so I think overall, that’s how I would answer your question.

Ross Gilardi - Merrill Lynch

Do you have available capacity to continue ramping up even more light weight papers as customers continue?

Michael A. Jackson

Well, the capacity comes where we would take it from the heavier weight products. And by the way, that’s a coated ground wood comment, it’s not a coated free sheet comment.

Ross Gilardi - Merrill Lynch

And then could you just talk a little bit more about your free cash flow and debt reduction expectations for the second half of the year?

Robert P. Mundy

Well, obviously we expect to have a strong free cash flow second half, Ross. We expect results to continue to increase in the second half and our goal is to use that cash to reduce debt. We sort of got through our heavy capital-spend quarter with all the outages and I think that’s certainly where we’ll be focused in the second half.

Ross Gilardi - Merrill Lynch

And just remind me, it’s the fourth quarter that’s usually your strongest free-cash-flow quarter?

Robert P. Mundy

Sort of in the third, in the fourth. In there, it’s about right timing-wise.

Ross Gilardi - Merrill Lynch

And then you commented before that you coated, I think you’re talking coated paper, in total, I’m not sure, or coated magazine, you think operating rates for the year will still flesh out in the high-90s despite this demand softness that we’re seeing now. What are you assuming in terms of fourth quarter volumes in sort of making that prediction?

Michael A. Jackson

It’s really not just taking a look at our own, Ross, it’s really taking a look at the industry and saying capacity in both ground wood and free sheet are going to be in that 5 million, 5.1 million in number, which is down significantly from 2007 levels. And then you look at the projected demand fall off and if you just kind of look through the map on that it still puts you in that above 95%, which is a very, very good operating rate.

I think the thing some folks do is they look at these swings, and if you remember, if you go back to January, February, the demand rates were in the teens. They were well above 10%, 11%, 12%. And then, of course, in June they fell the other way. So I think we have to look at this fairly long term and look at it from a trend perspective and say, look, it’s down but it’s not down 12%. Again, you do the math with the capacity shut downs and I think it puts you right in those mid-to-high 90s.

Operator

Your next question comes from Mark Wilde with Deutsche Bank.

Mark Wilde – Deutsche Bank

Mike, to start off, can we just talk a little bit about what you might be seeing over in your pulp business right now?

Michael A. Jackson

Well, we’ve had a very good year in pulp. Obviously we’ve had continued price appreciation and we have continued, by the way, to broaden our customer base as it relates to the selling of pulp. It’s kind of interesting, Mark, because in the past that really wasn’t a “true” business for IP but we’ve really made it a true business.

And put a lot of effort in that and we feel very good about our Quinnesec pulp. It’s well respected in the market place, it’s got high value to the folks that buy it and we feel good about our cost structure.

Mark Wilde – Deutsche Bank

What has pricing been doing recently in pulp? The hardwood pulp there?

Michael A. Jackson

We’ve continued to see price appreciation. And I think we actually had an announcement sometime in May, and we’ve had nice appreciation throughout the year and actually going back from the low point, the low point was May 2007, and it’s gone up steadily since then.

Mark Wilde – Deutsche Bank

Then turning to costs, there were some real big cost [inaudible] increases that were proposed for August this year. And I know other inputs, particularly petrochemical related probably, like latex, had been going up as well. With energy prices moderating, are you seeing any less resolve in the chemical producer determination to raise price?

Robert P. Mundy

Not yet. I think we still expect those prices to remain at high levels and hopefully that’s to come, Mark, but maybe we’ll be surprised here as we get more into the quarter, into the second half but right now we’re expecting those prices to stay high.

Mark Wilde – Deutsche Bank

So like the cost increase that was out here for I think August, at this point it looks like that’s going through?

Robert P. Mundy

From what we see, yes.

Mark Wilde – Deutsche Bank

There have been some things in your space, some assets, that have been pretty widely rumored to be in play right now. I think some SC and LWC assets. Do you think that the current market conditions, the slow down in the market, has backed any of those asset sales off? Any way for you to assess that?

Michael A. Jackson

It’s hard to say. You can’t make strategic decisions based on maybe short-term market dynamics. I think that you’ve got a, folks are looking at these facilities longer term than that. And I think either it fits in their portfolio or it doesn’t. And really the same with us. How does it fit strategically, what’s the work force like, what’s the opportunity to return value to our shareholders, which is critical? I mean, how does all that fit? And I think, as importantly, what is, whoever is selling the asset, what’s their view of value versus the potential purchaser’s view. And perhaps therein lies maybe a dilemma.

Mark Wilde – Deutsche Bank

Another thing, on kind of a similar vein. I wondered if you could kind of weight for us, in your mind, kind of pluses and minuses of continuing to focus on taking costs out of some of your existing operations versus maybe the opportunity to say, you know, buy a fairly large newsprint machine at a distressed price, and then do a conversion to light-weight coated paper, some other people have done. And at the end of the day have a bigger, possibly faster, machine with maybe a longer investment life on it.

Michael A. Jackson

I would say that our strategy has been very consistent, including when we went out on the road show. You know, we’ve got some assets that we continue to improve. We look at these assets and say we have done that and we see a lot of opportunity to continue to improve our cost structure. And right now, certainly with our debt level, I think that’s the proper way for us to go. And certainly we’ve not had any discussions about a newsprint machine. And obviously some folks are thinking about that but that’s something that I can you that I’m not interested in.

Mark Wilde – Deutsche Bank

Last question, Mike. There’s been a little bit of press about these do-not-send registries for the catalogue orders. Are you customers telling you that those are having any impact at all?

Michael A. Jackson

No, certainly not yet. But I can tell you, Mark, that we’re heavily involved with that relative to AF&PA. We have feet on the street dealing with that, from a state level and we certainly made some visits to our friends in Washington. I can say that maybe, and I could have this number wrong, there may be a million people that have signed up for that but relative to the scale of who gets mail, it’s certainly not had any impact at all.

But, I will say that we need to continue to fight that fight and we will do that.

Mark Wilde – Deutsche Bank

And how exactly are you doing that?

Michael A. Jackson

Through our lobbyists. Through AF&PA and their organization. So, it’s some of the work that our people do but primarily we’re using Donna Harmon, who is the CEO of AF&PA, to really drive the on-the-street feet to deal with that.

Operator

Your next question comes from Joe Stivaletti with Goldman Sachs.

Joe Stivaletti – Goldman Sachs

Just a couple of things. So, when you look at cost inflation, $38.0 million in the second quarter year-over-year, do you have a rough idea on where you think that will shake out for your full year?

Robert P. Mundy

Well, Joe, we certainly expect it to stay at high levels. Obviously we’ve seen some moderation recently in gas and oil, and hopefully that will pay some dividends for us. But we’re expecting it to stay high. Whether it gets higher than it has been in the past, maybe in some of the chemical areas where there is a bit of a lag effect, you know, that could happen. But maybe it’s moderated by some of these things that are going down.

So, I can’t say specifically where I think it will be, but we certainly think it will, it’s not going to go down significantly any time soon.

Joe Stivaletti – Goldman Sachs

In the past you’ve made comments about cost inflation versus what you think you could get out of your productivity programs. When you look at R-GAP and then that other four-point program that you have outlined for us, that I think the eventual target was $60.0 million in savings, can you give us some feel for the benefits, overall, you expect to get out of those two programs in 2008.

Robert P. Mundy

Well, I can’t speak to, sort of the net effect of benefit, is impacted by the outages that we had this year. We said before that we expect to get this sort of 50+ type year-over-year improvement but when you have outages and some other things that were going on, you certainly will not be offsetting your inflation that we’re experiencing this year.

Joe Stivaletti – Goldman Sachs

And on those outages, just in terms of guidance, if you took out 19,000 tons in the second quarter and I believe you said the cost there was roughly $8.0 million and you’re looking at a 13,000 outage in the third quarter at Bucksport, on a per ton basis would that be a good guide. I mean, would the cost there be similar to what you experienced in the second quarter on a per ton basis?

Michael A. Jackson

Well, you sort of had apples and oranges there. The tons that went out in the second quarter, that $8.0 million and the tons involved were not just for the unabsorbed costs that you have with this down time we’ve been our for September. In that $8.0 million you have expenses and so forth, the money, the repairs you’re doing, the maintenance work you’re doing and so forth, it’s not just an unabsorbed cost of not producing those tons.

Joe Stivaletti – Goldman Sachs

So on a per ton basis it would be lower.

Michael A. Jackson

No, I think on a per ton basis, the 13, I think it’s 13.4, as far as time in September, and that will be around $3.0 million, a little over $3.0 million for us of unabsorbed costs.

Joe Stivaletti – Goldman Sachs

In terms of the outlook for pricing for coated paper, you guys announced price increases for July, a portion of that was reflected in the publications for the month of July. Are you still of a mindset that you will get the full announced price increases flowing through here as we see the publications for the remainder of the third quarter?

Michael A. Jackson

Well, I can just say we certainly, because we just finished July, we have seen price appreciate. And we will have to wait until the end of the quarter to see what the total impact of that will be. But I think we commented in the script that we expect to see continued price appreciation, both into the third quarter perhaps even a little bit into the fourth quarter.

Operator

Our last question today is from Matthew [Armitz] with Goldman Sachs.

Matthew [Armitz] – Goldman Sachs

Can you say what backlog and order book look like for July versus, say, June, and how far out it goes?

Michael A. Jackson

I think that as we go into the third quarter I would say it’s relatively stable. I think you saw that we announced the 13,000 tons of down time so that provided a gap there. So if you just kind of look at our normal bookings and you take that away, I think that kind of gives you a view of kind of where we are, which I think falls in line with what we’ve seen happen with demand.

Matthew [Armitz] – Goldman Sachs

And how does the FIFO inventory accounting pay impact the flow dat margin compression as we go forward. Does it accelerate the cost per ton? What’s the right way to think about that?

Robert P. Mundy

You said FIFO?

Matthew [Armitz] – Goldman Sachs

You guys are FIFO accounting, correct?

Robert P. Mundy

Right.

Matthew [Armitz] – Goldman Sachs

And how does that impact the timing of the flow through the cost increases?

Robert P. Mundy

The cost increases on our products?

Matthew [Armitz] – Goldman Sachs

Correct.

Robert P. Mundy

You know, that cost, we turn our inventories about every month or better so that cost is coming through in a virtually quick period.

Robert P. Mundy

We appreciate y our attending our call and we look forward to talking to you again in the next quarter and we hope to, as we said, have a continuing positive improvement as we move forward in the second half.

Michael A. Jackson

Thanks for the good questions.

Operator

This concludes today’s conference call.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Verso Paper Corp. Q2 2008 Earnings Call Transcript
This Transcript
All Transcripts