Verso Corporation
Q2 2017 Earnings Call Transcript

Published: 9 Aug 2017

[Operator:]

Good day and welcome to the Verso Corporation Second Quarter 2017 Earnings Conference Call. All participants will be in listen-only-mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Tim Nusbaum, Treasurer. Please go ahead.

[Tim Nusbaum:]

Thank you and good morning. Second quarter 2017 financial results for Verso Corporation were announced this morning before the market opened. The earnings release, as well as the set of slides that we'll refer to during the call, are available on the Investors page of Verso's Web-site, www.versoco.com. Joining me today is Chris DiSantis, Chief Executive Officer; Allen Campbell, Senior Vice President and Chief Financial Officer; and Mike Weinhold, President of Graphic Papers. I'd like to remind everyone that in the course of the call in order to give you a better understanding of our performance, we'll make certain forward-looking statements. These forward-looking statements are subject to risks and uncertainties. Should one or more of these uncertainties or risks 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 SEC filings, which are posted on our Web-site, versoco.com, under the Investors tab. At this point, I'd like to hand the presentation over to Chris DiSantis.

[Christopher DiSantis:]

Thank you, Tim. Good morning everybody. I'll start with a high level sort of macro update on the business. So, the first point I'll make is that the treadmill effect continues in terms of the demand destruction in the graphic space pulling down the top line, the same phenomenon we have talked about many times before. So, it's digitization that's impacting magazines and catalog distribution and the continuation of the upward trends in e-commerce. You could see some of the data on Slide 3 here, particularly look at magazine ad pages off over 15%, catalog mailings off almost 6%. Those are both big drivers of ad spending and demand drivers for our business. The second quarter net sales finished up with down 7% versus the second quarter of 2016. However, I'll note a couple of important comparatives. First, this is less than the 11% decline in revenue that was experienced in the first quarter of 2017 versus the prior year, and of the 7 point decline in net sales, 4 points, so 4% of the 7% decline, is the idling and also shutdown of the A3 line at the Androscoggin Mill. Offsetting some of the decline in most of the graphic paper lines, we did achieve growth in digital, in Productolith Points which is used in high-end print, lightweight packaging applications, and some growth in other areas as well, and continue to build a robust new product development pipeline. There was substantial downward price pressure in the quarter. So the market pressure took 3% off the price versus the second quarter of 2016. And in response to this, we've announced $40 per ton price increases. The realization on that price increase is still to be determined, but we have got good traction there. We have also seen a reversal in the trends in the euro 1.19 in euro exchange certainly changes the landscape, effectively lowering the net prices that are received by some key competitors. Pricing on pulp has been strong in the second quarter. So we announced successive price increases that cumulatively totaled $118 per ton. And with that, let's go to the next slide, Slide 4, the specialty products came in at 23% versus year-to-date revenue. That's up from 21% of revenue in the prior year. This product line and business continues to perform very well. We're talking about Stevens Point and Androscoggin Mills here primarily. The coated machine-glazed products hit an all-time record level in sales in the second quarter. We continue to do very well in uncoated machine-glazed products as well. So we've just given you a couple of examples here. Since we launched the natural grades in late January on the A5 line at Androscoggin, those have grown from 5% of the volume there to 40% in July, and the utilization of the A5 line, which is primarily a specialty line, ended the quarter at around 70% utilized, and is all the way up to 78% here at the end of July. We expect that rate to keep growing as the year continues. Continuing to gain share in roll release liner, we are on pace for 20% growth there year-over-year. Product development pipeline is strong. We think there is going to be a lot of new SKUs added as we expand the A5 portfolio, add more release liner products and expand the face paper offering. The mix dynamics are better for specialty products, were up 2% in price per ton, versus the prior year. We are currently evaluating the Androscoggin Mill for additional capital investment opportunities there to expand the product line offering and invest more in our co-generative capabilities. So, on to the next slide, Slide 5 in the deck, overall it was a challenging quarter for Verso and it's really three things. It's price, input costs, and it's downtime. So, first comment I'll make on pricing, as the fall in pricing is just not sustainable, and that's a trend that has to reverse. So, if you break it down, we lost $12 million in pricing versus the prior quarter sequentially, so relative to 1Q 2017, and we lost $19 million comparatively versus the second quarter of the prior year. And if you break it down, take it one level further, so of the $12 million in pricing that was lost versus the prior quarter, sequentially $5 million of that is real price deflation on prime grade. So we could call that a competitive dynamic. But the $7 million of that hit, so the $7 million in addition to $5 million gets you $12 million, the other $7 million of that hit is really a hit that was taken is for the inventory reduction program, which hit second and it's slow moving, obsolete. So, it's really self-inflicted, if you will, as far as the $7 million of the $12 million is concerned. But deflationary prices, they just don't work, given the economic profile of the Company and when you consider all the costs, from the manufacturing of product, you consider the necessary investment to maintain and grow future capabilities, deflationary prices just don't work. The second big problem in the quarter were input costs. So we made a lot of good progress in productivity and SG&A and other cost reduction areas, but we experienced $11 million in net inflation, which was primarily driven by chemicals, so latex, other additives like titanium dioxide were inflationary, natural gas prices were up, that overshadowed any of the gains that we made on the cost side of the equation, like in wood cost where we were very effective in reducing the wood cost in the second quarter. And the third thing that was a problem in the quarter was downtime. So, our mills are the large scale economic machines that are built to run 24/7, they are built to run wide-open, they have high fixed costs associated with them, and downtimes are real impediment to making any kind of profit. So, if you look at the downtime numbers for the quarter, downtime costs, $16 million in the quarter versus Q1 and $19 million in the quarter versus the prior year. Most of that was intentional as we did a couple of things. We had a very aggressive inventory reduction program. We also pulled forward an outage, Wisconsin Rapids. But if you look at the $16 million of downtime costs in the quarter, $12 million of that was caused by the inventory reduction program where we set about making the right decisions with regard to synchronizing supply and demand and right-sizing the inventory in the Company. It's very important to get that synchronized because mills cannot run effectively with holes in the schedules. So this was an important rebalancing effort for us and it's one where we're going to be ambitious in managing those links between supply and demand going forward. I'll turn to Slide 6. There is a very strong emphasis at Verso on driving cash flow and reducing debt. So the inventory progress was quite sizable in the quarter and we reduced $54 million in inventory. There is certainly additional upside there in the years to come, but I would say that that's the bulk of the reduction expected for the year. We also continue to partner with our suppliers to extend payment terms and reduce costs. We made good progress so far this year with $13 million in accounts payable gains in the second quarter. There's certainly much to be done there. We have efforts right now to dual-source, multi-source resource, phase out any material supplier that's not showing flexibility. So, I'm going to say that twice to make sure that it gets clearly heard, which is if you are a service provider to Verso, you provide us with any kind of service, if you are a supplier to Verso in any way, if you aren't in active discussions with us to proactively lower price and extend payment terms, you are being phased out as I speak. We also expect on the cash side of the business to generate some proceeds through the sale of the Wickliffe Mill in the third quarter and use those proceeds to reduce debt. We're very close on that. The attack on cost continuous within the companies, we have taken a lot of, call it, austerity measures. We announced $25 million in SG&A overhead reduction goal for the year. We will exceed that. I think if you're thinking about, what the SG&A cost for Verso is going to look like, if I imagine go forward, roughly 4%, honesty above that, it's really a pretty good number to think about for the cost structure of the business going forward. The first phase of cost reductions are well underway and a lot of good stuff has been completed. So we have formally closed the headquarters in Memphis. So that office is now dark and consolidated into Miamisburg, Ohio. We reduced 100 positions across Verso. We restructured a lot of reporting relationships and we also redesigned the compensation plans for the Company. We hired a new CIO to lead the IT effort, and we think there is some considerable cost reduction to get in that area. We made a lot of progress with harmonizing benefits. There is a medical standardization program that's going on across the Company that's got some cost savings. And before the end of the year, as for the budget planning process for 2018, we're going to be very ambitious about the next phase of cost reduction, putting a prime focus on the supply chain, on energy and other purchased input costs. Turning to Slide 7, there has been a lot of good work done reviewing the landscape of conversion opportunities across the mill system and it's a wide range of things. It's low dollar conversion opportunities, the short/quick payback, it's larger dollar conversion opportunities that fundamentally reposition the paper machines into product lines like SBS, carton, containerboard liner, bag, all that's still under review. And we have engaged a pretty broad and deep pool of outside advisors to help us with these evaluation efforts. These are all people who have successfully converted graphic mills in the past into other product lines. We announced in our press release today that we have formally engaged Houlihan Lokey to consider strategic alternatives for the business. So there's a whole M&A evaluation that's going to be undertaken as part of our strategy. And we are also really starting to develop very clear mill by mill strategies for the business. So, different strategies can apply to different mills. So, one strategy for one of our mills might be to continue to exploit its low-cost position in graphics. Another strategy might be, this one has got a lot of opportunity for new business and new product development, and we are going to focus on that. For another mill, it could be repositioning that mill completely. And for other mills, it could be downsizing and reducing the amount of production coming out of those based on their cost position or what have you. We certainly don't have to have the same strategy for all the products, all the businesses, all the mills in the system. Moving on to Slide 8, the good news is that we are building pretty considerable momentum going into the third quarter. So, we have increased prices that will yield results. Pulling forward the Wisconsin Rapids outage in hindsight is a right decision. It's going to allow us to capitalize on the stronger part of the season. The cost profile of the business is improving with structurally lower costs and SG&A. We are going to see the benefits of that going forward. We are fighting back against short accounts payable terms and rising input costs. And the reduction of inventory has a lot of other benefits besides the obvious cash flow benefit. It improves the cost position of the business. So, the less inventory we have, the less warehouses, the less storage cost, the less logistics, less insurance, obsolescence damage, moving the product around, that kind of thing. So, a leaner system is a better system. We expect less downtime going forward to the back half of the year, and the likely sale of the Wickliffe Mill is going to generate cash that's going to be used for debt reduction. So, bottom line, second half expected to be much better than the first. In closing, on Slide 9, I'll make some additional sort of final comments on the business. So we've made very good progress. We're viewing the strategic options for the business. We have started to narrow the field of alternatives. We announced a formal process that we have engaged Houlihan Lokey to help us with. We are going to continue to leverage the growth in the specialty business by ambitiously managing the mix at the Andro Mill and the 4 Line, rapidly filling up the A5 Line, continuing to push new product development at the Stevens Point Mill. So we expect the specialty business to continue to be an important growth engine for us. And we also are going to maintain our leadership position in graphics. So we have true supply chain partnerships with our customers and those relationships, they are very forward, they are very valuable to us. There is going to be an extreme intense focus on cash flow management to increase liquidity and rapidly pay down the term loan balance and we are well positioned and I think on much better footing going into the back half of the year than the first half and we expect better results as a result of that. So, despite what was a pretty tough quarter, our team is working tirelessly and relentlessly to pursue every opportunity that we can think of for value creation. I think they have acted like real owners of the business. So with that, I'm going to turn it over to Allen Campbell, our CFO, to talk more about the numbers.

[Allen J. Campbell:]

Thank you, Chris. As Chris mentioned, we had a tough quarter, but we made significant progress on value creation initiatives, on items we can control, and we highlighted those on Page 11. Victories in the second quarter, when we look back at that versus the first, we were able to improve our accounts payable terms by $13 million. We decreased inventory by $54 million and we reduced net debt by $28 million. We paid down $4 million on the term loan, at the same time increasing liquidity by $30 million. We did complete our outage at Wisconsin Rapids. We are well-positioned for the second half. We continue to reduce SG&A. It was down $9 million versus the first quarter. Chris mentioned our price increases that we have launched into the third quarter. And we are at a below 1x TIR, 1.0 to 0.93. So we are very happy with our safety performance as a company. We did have our challenges obviously in the quarter. We lost $12 million in pricing and $20 million in volume. Adjusted EBITDA was off $30 million versus the first quarter. Trailing leverage crept up to 1.99, but still very manageable at under 2. And we had several items that impacted our gross margin. We had a downtime cost of $16 million. We had a major outage that we had planned at Wisconsin Rapids. We had some other outage issues and some issues related to rolling downtime across the system as we cut inventory. We saw input cost inflation of $11 million versus the prior year. And we had some reliability and productivity issues. Some other items in the quarter on Page 12; we did announce significant price increase, as Chris mentioned, on pulp. We announced price increases for coated grades, digital, and specialty products during the rest of the year. SG&A savings were achieved through position elimination, organizational changes, and we are on track to achieve our yearly targets. Our working capital initiatives continue to yield strong results. We significantly improved liquidity which allowed for additional $20 million payment on our term loan in July, which will yield significant rate arbitrage savings. We are happy with our progress in natural kraft products on our No. 5 machine at Andro. Turning to Slide 13, you see our mix of products on the top right; graphic papers, 72% of our business; specialty papers at 23%; and pulp at 5%. Shipments for the quarter were down 5% or 32,000 tons. Remember that we did close our No. 3 machine at Andro. That had about 34,000 tons on it. We did recover some of those at other mills though. We saw volume less at coated groundwood web, coated freesheet and supercalendered, causing the declines. Pulp down 8%, as we did adjust some customers from last year. Pricing, as Chris mentioned, off 3% on paper, up 1% year-over-year since the pricing in pulp declined in the last part of 2016, and now we have recovered to be ahead of 2016, so going forward we are happy about that. Inventory, you see a significant decline. We had $498 million on our balance sheet at June of last year. This year, that's dropped to $408 million. We have saved $90 million in inventory during this time period. Slide 14, we show our income statement for the quarter compared to the predecessor period, same period in 2016. You see our net sales were off 7%. There is one thing I just want to highlight on this page, is our classification. Post emergence, we have a different methodology of putting costs between cost of goods sold and SG&A. There is a $7 million difference in the way we account for cost in 2017 versus 2016. So if we did 2016 the way we did 2017, it would be $7 million lower SG&A and $7 million higher of cost of products sold. Page 15 walks down our adjustments, the standard adjustments for the second quarter. Restructuring charges related to our headquarter consolidation, severance cost related to the reduction of force and the 100 positions that we eliminated amounts to cost of $5 million, and miscellaneous of $1 million. So, that shows our walk down to a minus $4 million EBITDA for the quarter, gross margins obviously the biggest swing in that period. I do want to note, to try to do an apples-to-apples comparison, SG&A, if you take out the adjustments in EBITDA to SG&A in 2016, you would have $37 million of SG&A. Take $7 million that comes out and goes to cost of goods sold this year, comparable basis we have $30 million SG&A in 2016. We'll spend to get $19 million this year. So that was the $11 million swing year-over-year in SG&A. There were some true-ups in the quarter, so you need to look at the first half not just the quarter standalone in SG&A. On Slide 16, we show the traditional income statement for the year. I'll concentrate on next couple of pages primarily upon the year basis. Page 17 again walks down from our reported EBITDA to our adjusted EBITDA. Recall that in 2016 it was our last full quarter in our reorganization process. So there's a lot of noise in there related to the restructuring and rework, lot of changes in our income statement. So if you look at the year to date right-hand side, you see standard effects for restructuring and severance, and some other items which about half of that is non-cash items. So, it shows our 1.8% adjusted EBITDA for the first six months. Our bridge on Slide 18 walks the key reasons and what drove that; $19 million of price, along with $4 million of volume, offset somewhat by a $2 million of favorable mix. We are seeing improvement in premium product, digital and specialty grades. This helps offset some of the lower margin business that we exited. If you look at our downtime, we had $19 million of downtime in 2017 versus 2016. $15 million of that is related to reducing inventory, came with the outage of Wisconsin Rapids plus rolling outage of other mills, and then we took $4 million for what we call traditional market downtime. Because of the outrage, because of the rolling downtime, because of some reliability issues also, our production mix was unfavorable in the second quarter. Our operations were down year-over-year by about $9 million. Input cost, as I had mentioned earlier, of $11 million, and then we started to see some improvement in the logistics. Our run rate was much higher than in the first quarter. We tempered the cost of logistics in the second, so it's just $1 million calendar year-over-year, and you see the $11 million improvement in SG&A that I talked about earlier. Going to Page 19, we want to highlight our cash flow in the second quarter. Adjusted EBITDA was minus $4 million and CapEx was $11 million, so we net it from operations, minus $15 million, but we made significant progress on our working capital. As you can see, it improved by $65 million in the quarter and we're $30 million favorable for the first part of the year, first half of the year. Pension contributions were $5 million in the quarter, which was very difficult. Ccash interest of $7 million. And we made some other payments in the quarter, we had severance cost going out, the main driver of the $10 million that you see, so net cash flow of $28 million even after those one-time payments. We then reduced our revolver by $25 million and we paid $4.4 million down on our term loan. Page 20 highlights our progress we've made on working capital. We moved our payables days getting closer to what you would expect on a traditional company. We were held pretty tight in the reorganization but we are trying to continue to improve that to get it to more normal terms and we made significant progress in the first six months. Our cash conversion cycle has been reduced from 77 days to 72 during the first six. You see significant reduction in inventory. As we talked about, it was our major goal in the second quarter. And accounts receivable is fairly close to what we would expect. Highlighting on Slide 21 our liquidity, you see the increase from $141 million at the end of first quarter to $171 million at the second quarter, an increase of $30 million. Our debt is at net of $322 million. Term loan of $195 million as of June and revolving credit facilities of $133 million, plus cash on hand of $6 million, gives you our $322 million. Our leverage ratio as I mentioned earlier is just under 2, at 1.99, covenant is at 2.5x. Fixed cost coverage is 1.2-to-1 versus the covenant minimum 1-to-1. And some progress we also made in helping this liquidity was we were able to eliminate a letter of credit requirement in the amount of $21 million in the second quarter. We used that freeing up of liquidity and we made a voluntary term loan payment in July that wasn't reflected in the above balance, but we made a voluntary term loan payment of $20 million. Turning to Slide 22, our guidance, this is how we see the third quarter versus the second quarter. We expect a significant increase in sales. We expect sales to be in the range of $625 million to $640 million. We have announced price increases for the period. We expect gross profit to be up significantly through improved operational performance and less downtime. We believe we will be able to operate our mills where they should be operating in the third quarter. That will help significantly. SG&A, we're continuing to manage that down. We expect the full year to be in the $100 million to $110 million range and we have opportunities. Input cost, we anticipate some flattening of the increases that we saw in the first half. We expect energy to be favorable in the third and we continue to work on the other inputs. Inventory, which can be flat to slightly down as we go through significant improvement in our sales and we don't expect any other major activities in that area in the third quarter. CapEx will be in the normal rate. We expect to spend $16 million to $20 million. It's fairly expected in difficult time period. Full year we expect to be in the $55 million to $60 million range. That's down from what we spent in 2016 of $73 million. So that concludes our presentation. I'd like to turn to the operator for question and answer period.

[Operator:]

[Operator Instructions] Our first question comes from Kevin Cohen of Imperial Capital. Please go ahead.

[Kevin Cohen:]

Thanks for taking the questions and all the helpful commentary and the slides. Just a quick question, just thinking about the industry price hikes of about $40 a ton on coated and SC grades, just trying to think apples to apples what that means relative to the starting point given I think you guys mentioned in the quarter organic price pressure year-over-year of 3%, so just kind of thinking apples to apples does that imply maybe only 1% or 2% organic increase in price for you guys versus 2Q, or maybe if you can just kind of clarify that a bit?

[Allen J. Campbell:]

I just want to make sure I do follow. We were down in the second quarter. Some of this price increase, yes, would be a recovery of the second quarter decline. Is that what the question is?

[Christopher DiSantis:]

I think he's asking on a net basis relative to the start of the year, do you think it will be up or down.

[Kevin Cohen:]

Yes, just given the indications from where I see it, I think we are kind of more flatfish from what we had seen, so just kind of want to taking into account the product mix and all the moving parts, sort of organically relative to sort of the headline from [indiscernible], what kind of potential price increases you guys might see excluding any product mix changes?

[Christopher DiSantis:]

I mean we can't guide specifically to how the increases will turn out, but I would tell you that we have very good traction.

[Kevin Cohen:]

Got it. And then thinking about the term loan repayment post quarter end, I guess is that to proactively get ahead of the annual excess cash flow sweep or was there something else that was driving that, just kind of thinking about the need or desire to hold on to liquidity, all else being the same, to part ways with liquidity, maybe a little more color on that?

[Christopher DiSantis:]

So we have ample liquidity and the cost of the term loan, there is a considerable amount of interest rate arbitrage between the revolver and the term. So our view on it is holding the term loan as we do, continuing to make those payments. It's a very expensive piece of paper. So it was done strictly out of savings and just out of the need to -- eventually that paper has to be replaced. I mean it's not long-term paper. So, we are going to keep chunking away at that aggressively.

[Kevin Cohen:]

And then just the last question before getting into the queue, in terms of the midpoint of the 3Q revenue guidance versus 2Q, seasonally it's a better quarter. Just wondering what percentage of any of the industry price hikes might be baked into that 3Q guidance, just trying to parse that out a bit?

[Christopher DiSantis:]

We are not including that in our guidance. You mean is it reflected in the revenue or you are asking what the [indiscernible] is going to be?

[Kevin Cohen:]

Is the revenue guidance in the quarter, does that reflect any flow-through from the price hikes on which there is some traction?

[Christopher DiSantis:]

Yes, so we have a projection built into the revenue for the price hike, but we are not guiding specifically to what we think the increase will be other than say it's got traction.

[Kevin Cohen:]

Got it, okay, thank you very much. Appreciate all your patience with the questions.

[Operator:]

Our next question comes from Hamed Khorsand of BWS Financial. Please go ahead.

[Hamed Khorsand:]

So first question I had was, what are your expectations for the Kentucky facility being sold as far as dollar amount goes?

[Christopher DiSantis:]

We haven't disclosed that yet, but we expect within weeks we will be making an announcement for what the proceeds will be from that sale and then how it will be used.

[Hamed Khorsand:]

Okay, can't you even just give a ballpark in rough sense?

[Christopher DiSantis:]

No, I don't want to give a ballpark number.

[Hamed Khorsand:]

Okay. And then just given your reducing inventory as well in Q2, it sounds like – are you improving your run rate as well as far as how much are you producing in Q3?

[Allen J. Campbell:]

Yes, we will be running…

[Christopher DiSantis:]

[Indiscernible] operationally to be higher [indiscernible], yes.

[Hamed Khorsand:]

So what I'm trying to get to is if you are running at a higher rate and if you are keeping inventories flat to maybe even down sequentially, are you discounting inventory more or are you just not able to sell a lot more given – or is there maintenance, there is downtime in the quarter? I'm just trying to understand where the sales guidance is coming from.

[Christopher DiSantis:]

Okay. No, there is no discounting built into the third quarter revenue guidance. There was some hit on prices. We right-sized the inventory in the second quarter, but no, I think you can think of the third quarter as a more typical quarter as far as operating the business at high operating rates. And keep in mind, [indiscernible], that Q3 is typically one of our stronger quarters during the year. So we expect a seasonality jump from Q2, which historically we've seen and every indication is we'll see that this year.

[Hamed Khorsand:]

No, I get that, and that's why I'm asking this question, because seasonality is supposed to be great for Q3 and you're seeing this price increases coming in and operations are running back to normal, your guidance for sales is still below what you achieved in Q4 of last year, which is not your peak quarter of the year...

[Christopher DiSantis:]

But there was production taken off-line that would have been in Q4, that's not in our Q3 of this year, so to adjust for the shutdown at Androscoggin.

[Hamed Khorsand:]

Got you, okay. All right, that's it for me. Thank you.

[Operator:]

Our next question comes from Andrew D'Silva of B. Riley. Please go ahead.

[Andrew D'Silva:]

Just a few quick questions here. If we look at maintenance expenses, number one, is that analogous to you guys with downtime, and then if you could just thinking about it over the course of the whole year, if you were just to have had a more normal maintenance expense during the quarter, do you know what Q2 gross margins would have been like in the ballpark?

[Christopher DiSantis:]

So let me make sure I understand the question. I'll restate it and then I'll let Allen answer it. So, in the second quarter there were outages or some maintenance expense associated with the outages, but when we talk about a downtime expense related to inventory, that is more of a call it inventory fixed overhead absorption cost, not a maintenance cost for the quarter. So there's really two different phenomena that are going on. One is on outage and the cost associated with that outage and we call that maintenance expense. Then the second is when you shut the mill down to drain out inventory, there is a standard cost accounting gap absorption effect where you take a hit for doing that. So, is that what you're asking, what's one vis-a-vis the other?

[Andrew D'Silva:]

Yes. So, I actually just thought of those as the same thing, but let's just I guess strip those out and make them more normalized as they would be typically, do you have an idea where your gross margin would have been for the quarter? Obviously, this is one of the lowest gross margin periods there is but there are some external factors that were maybe self-inflicted that caused that. So I'm just trying to get a sense of what a more normalized gross margin should be as we move forward.

[Christopher DiSantis:]

So Allen, why don't you probably explain two things, one is what was the – just highlight again the impact of the inventory reduction in the quarter, the hit that that had to gross margin, and then I would highlight from a maintenance cost standpoint associated with outages and that sort of thing, how did that vary in the quarter from what a normalized [indiscernible]?

[Allen J. Campbell:]

Sure. I'll take the last one. On maintenance, if we look at major maintenance, that was $5 million hit in 2017 versus 2016, so if you want to look at it that way. The other way is on Slide 18, we talk about the inventory market downtime. That was a $15 million hit. That's in addition to the maintenance that I talked about. So you could look at it as $15 million plus $5 million, or $20 million. But there is a piece of the $9 million operations unfavorable that I would say is related to these less than favorable way to take down some inventory since we took rolling outages. So I would say a piece of our operations we [indiscernible] them with some of it. But I would take the $15 million on inventory management downtime on Page 18. I would give you a number of $5 million of major maintenance that was higher in 2017 versus 2016. That's $20 million. And then I would say a piece of that operation's red box is also related.

[Andrew D'Silva:]

So in a normalized scenario, you should have been closer to the probably 8% mark roughly with the dynamics that we are seeing during the period?

[Allen J. Campbell:]

I think that's the math.

[Andrew D'Silva:]

Okay. And then how about from the A5 Line at Andro from a utilization standpoint, you said you were 78%, is that line achieving profitability yet or what percentage is that going to start contributing? I think you have mentioned in the past that adequate utilization could generate about $10 million in annual EBITDA?

[Christopher DiSantis:]

That's correct. So at a full run rate it's $10 million. As we have got about 50%, we are making money. So we are into making money now on that line.

[Andrew D'Silva:]

Okay, and you crossed over in the second quarter from not making to making money essentially or was that…?

[Allen J. Campbell:]

It was on a run rate basis.

[Andrew D'Silva:]

Okay, thank you. And then how about imports, obviously you are going up in benefit to you guys, are you seeing decline in at least the markets that you are playing with relative to previous quarters as the euro has gone up or have international producers still really been taking bigger price hits just to continue to stay in the market?

[Christopher DiSantis:]

I think it's too soon to tell, kind of given where we are at, how quickly the reps gone in the other direction. So I think we won't know for another quarter or two. But again, I mean we can't speculate as to what others will do. I mean it's an independent decision that companies make. If you are going to run the mill full and take the price that the market gives you or if you're going to be more disciplined, that individual companies make those decisions, we can't speculate on them.

[Andrew D'Silva:]

Right. And just moving over to Wickliffe Mill, obviously you're selling it and can't disclose how much that's for at this point, but I believe previously you have mentioned that that mill out of the eight that you own was probably the least valuable in multiple aspects. Is that still accurate or was that an incorrect statement that I'm remembering?

[Christopher DiSantis:]

I don't remember making that. If someone made that statement…

[Allen J. Campbell:]

It's a reasonable assumption.

[Andrew D'Silva:]

Okay, all right. And just a final question, price increase in pulp is good for you, correct? Obviously it's an input cost, but you sell it. So increases in pulp we should view favorably generally as a market trend or negatively?

[Christopher DiSantis:]

Yes, because it's primarily an integrated business, favorable.

[Andrew D'Silva:]

Okay, thank you. That's all I had.

[Operator:]

Our next question comes from Nilay Mehta of KLS. Please go ahead.

[Nilay Mehta:]

Just looking at the core operations, trying to get a sense of what you guys think volume trends in the underlying business are. I mean I know it was down 8% I think in the first quarter, down 5% this quarter. Kind of what you see is the underlying trends in the market, is it similar to those numbers as we kind of look out in the second half of the year?

[Christopher DiSantis:]

I think on an annualized basis our outlook would be similar to what we have experienced so far, but you do have to sort of look at the seasonality of the business as you think about that quarter by quarter. But it's a very difficult industry to predict. So a lot of our modeling looks at extrapolation of the slopes and the curves in terms of actions what's supposed to be really happening.

[Nilay Mehta:]

You brought up the point of seasonality, what is the typical seasonality on volume basis for 3Q and 4Q?

[Allen J. Campbell:]

We gave you guidance of third quarter vis-a-vis second quarter. If you were to look at our last year's trend of third and fourth, that would give you a good indication of how you would look at 2017.

[Nilay Mehta:]

On a volume basis? I thought the guidance was just total revenue basis.

[Allen J. Campbell:]

I was using total revenue basis as a proxy for it, the volume.

[Nilay Mehta:]

Got it, okay. And then I know you were saying obviously that you have gotten or you have announced sort of these $48 price hikes across a lot of the grades across your mill set, and I know a couple of your customers sort of announced as well they see some paper price inflation, which suggest that you guys should be getting some of that price increase. I know you haven't disclosed how much you expect to get. But historically when you guys have announced price increases, like what's kind of the range of realization versus what you…?

[Christopher DiSantis:]

Yes, it's really been all over the place and that wouldn't be a good – I wouldn't look at the past as a proxy for what's going to happen now with pricing. But I would tell you this, I made this comment, I mean to reconcile [indiscernible] slides, but the whole deflationary model for price, it just doesn't work, it doesn't work. As a new person coming to the industry, coming from the outside, this is just sort of mathematical perspective you have to take early on, on these businesses and that just does not work. It's not sustainable.

[Nilay Mehta:]

Got it, okay. And then I know you guys have gotten a few questions on Wickliffe already. Could you remind us kind of what the capacity of that mill was? I think it's been idle since I think November 2015. So has that just been an EBITDA neutral or has there been sort of any costs associated to this mill that we may see some benefits as you get rid of it?

[Christopher DiSantis:]

There are costs associated with the maintenance of idling of the mill. I don't think we have disclosed I mean what those numbers are. Have we disclosed that?

[Allen J. Campbell:]

But you see it in other that we show on our adjusted EBITDA [indiscernible]

[Christopher DiSantis:]

There will be a cash benefit, a one-time cash benefit of the sale of the mill, and then there will be some ongoing cost savings associated with not having it in the portfolio any longer. And Mike Weinhold?

[Michael A. Weinhold:]

Yes just from historical capacity situation, Wickliffe was 270,000 tons and about 50,000 tons of flash dry pulp output.

[Nilay Mehta:]

Got it, thank you. Do you guys like to see any of the pension obligation travel with the sale of Wickliffe?

[Christopher DiSantis:]

No.

[Nilay Mehta:]

No, okay. And then I know already you've been asked about the, I think you paid $20 million on your term loan, does that come mostly from the ABL? So in the Q, that was from the ABL including the ABL.

[Christopher DiSantis:]

Yes, I mean it's funded debt, but if you go up, there were a lot of sources of cash and liquidity in the quarter. So we freed up some LCs and we worked a lot of money out of our capital. So there were a lot of contributors.

[Nilay Mehta:]

Got it, okay. And you said you expect the Wickliffe sale sometime in 3Q, right. Any chance on like early part or later part, I mean we are already in 3Q I guess technically, so any kind of broad timing-wise, any color there?

[Christopher DiSantis:]

We would expect it in weeks, not months.

[Nilay Mehta:]

Okay. Are you guys evaluating other mill/asset sales?

[Christopher DiSantis:]

We are evaluating everything. So we look at every single mill, we look at what's the opportunity for conversion of that mill if we make a considerable investment there, and whatever the products might be, what's the net present value, I mean those cash flows that come off of that mill. We also look at I mean does that mill have more value if it's contributing as a joint venture, does that mill have more value if it's sold, does that mill have more value if we ambitiously try to fill that mill with new product and upgrade the mix. So we really go – you are looking at a variety of ways. You're looking at holistically which is having to maximize the value of the whole system. You're also looking at it in terms of product, specialty graphic, and ultimately you have to get to a level of detail, which is mill by mill, like what's going to be the operating plan for this mill and what's the best way to maximize value. So we look at it like owners when we look at a portfolio of assets as opposed to just purely looking at it from an operating perspective of how do you get it to run better. We look at it in terms of what's the value creation strategy from this asset, what's the best thing for the shareholder.

[Nilay Mehta:]

Got it. I guess I mean it sounds like you guys are obviously evaluating some capital additions or deployment to some of the existing mills to maybe better enter growth markets, et cetera. I think you mentioned Andro in the deck. Given the guidance you have for CapEx, which we took down at the high end this year, is that including potential Andro investment or is that on top, would that be on top of that, or how should we think about that?

[Christopher DiSantis:]

I think that's the project that we had in mind which we are not ready to share yet, but the project that we have in mind, it could fit within that bucket. I mean I don't think there would be a considerable variance from it. But if we do anything large scale, we would likely I mean either announce that or just include that as an update in the future quarterly call. There is no large scale conversions in that capital number.

[Nilay Mehta:]

Got it, okay. And could you just give a sense of what the pricing difference is between your specialty versus coated?

[Christopher DiSantis:]

You mean in terms of like average price per ton?

[Nilay Mehta:]

Right.

[Christopher DiSantis:]

I mean it would really depend on the comparative…

[Nilay Mehta:]

Like a blended or something, just because given that specialty is now 20%, 25% of the total revenue?

[Christopher DiSantis:]

I mean I'm going to have to give you a wide range because it really depends on which products you are comparing to which because we have such a wide range of selling prices in our portfolio, but I mean graphic business could be $800 a ton business, specialty could be 50% or more than that, $1200 a ton. So it really depends on the product, depends on the application, depends on the quantity that's being ordered, and there are a lot of mix changes in the business, so you just have to be careful with those assumptions.

[Nilay Mehta:]

Would that 50% relative difference be like the high end of a relative difference between grades and applications and products or is that kind of in the middle or what?

[Christopher DiSantis:]

No, I mean I think that's – I mean you can call it $300 average differential, maybe $400, a little high, but maybe a $300 differential on average.

[Nilay Mehta:]

$300 to $400, okay, got it. All right guys, that's it for me. Thank you.

[Operator:]

Our next question comes from Ketan Mamtora of BMO Capital Markets. Please go ahead.

[Ketan Mamtora:]

I want to come back to the conversion opportunities that you have talked about, and among other things you have mentioned kind of SBS and containerboard. Can you obviously at a high level talk about relative attractiveness of both the markets and kind of as you think about it, kind of your preference for one over the other, and kind of how you think about size, capital investment and timeline?

[Christopher DiSantis:]

It really depends. So, all those evaluations are in process. And it's no surprise, you're not the only one looking at this. So the graphic business is in a difficult ecosystem and it's under a lot of pressure from demand destruction from digitization. So you have to look at the machines that you have and say, where could we potentially go with these things, from SBS to container and carton-board, liner, looking at – there is a range of products that you could look at, top liner, that kind of thing, given that asset setup. So we have very strong back-end and most of the mills in our system are pretty incredible. When you go and see them, I mean I'm talking about some wildly productive assets that can pay for the world. So it's really a question of what's the right product to put on that machine. So we look at all these different end markets, we look at all the probably a lot of the same data that you look at in terms of growth rates and attractiveness in that market, and we are making a determination of kind of what's the pros and cons of doing it. Some of these conversions we can do for low capital, others take higher capital. There's implications on where you wind up being in the cost curve. Some mills are better set up than others. There are challenges associated with location on these conversions. So, if you look at where the mills are located, up in the North and the access to wood basket and that sort of thing, their freight considerations, access to OCC and that sort of thing. So all of these things, we are working with some very qualified people who have done conversions for a living, and we are trying to figure out which is the best and most likely the ripest opportunities that have the best return on capital across that portfolio that fit within the liquidity profile of the business. And right now, we are just not prepared to talk about which of those segments we find most attractive, but there will definitely be something to announce. So whether we are going to do bag or we are going to do medium or we're going to do SBS or top line or whatever it is, we are going to figure that out in the months ahead and create a strategy around that.

[Ketan Mamtora:]

Got it, now that's very helpful color. And one additional question if I may, on the low conversion, low-cost conversion side, can you give us again at a high level what are you thinking, what kind of opportunities there may be on the low-cost side, is it more on the specialty side of things, any sense that you can provide?

[Christopher DiSantis:]

I mean, again, we are not ready to announce specifically what we want to do there, but there are, I would say that there are opportunities for relatively small amounts of capital where we can convert assets to make other products in Androscoggin in particular, that mill there where for instance we have already launched the natural kraft lines there, which is a business that's performing very well for us. That transition to natural kraft was done for a very low amount of capital. So just taking the Androscoggin Mill for instance, there is a lot you could do with that mill. There is small capital projects which you could do things like liner or other product there. And there is other big capital projects. I mean there is opportunity to do things like dissolving pulp and that kind of thing. So when I throw out that range of options, because we haven't narrowed down the list. The core takeaway from this is there is a lot to do with the assets at Verso on a low capital and a high capital basis. There are a lot of different directions we can go and we just haven't narrowed it down yet. But I do want to just give our investors assurance that we are actively and intensively evaluating all those opportunities to service the ones that have the best math associated with them.

[Ketan Mamtora:]

Got it, that's very helpful color. I appreciate it. I'll turn it over. Thank you.

[Operator:]

Our next question comes from Amer Tiwana of Cowen and Company. Please go ahead.

[Amer Tiwana:]

A couple of things I wanted to explore. One, when you think about the imports coming in, if you can tell us what is sort of the absolute tonnage that you estimate right now that's coming from imports, and obviously the exchange rate is starting to become more helpful, is there a point or a particular rate at which you would say, you know what, the margins of the importers will probably be squeezed to the point where we can start to take back market share and these price realizations that we are pushing through become much more of a certainty? I mean is there a magic number where you say, you know what, now the tide has shifted?

[Allen J. Campbell:]

I mean I could say this, I mean, again, it requires just speculation on what others will do, which we can't do, but I mean the euro goes from 1.06 to 1.19, you're importing product, you just took a considerable hit on products, I mean you just took a double-digit price hit. And in a business like this with the kinds of margins, the crack that paper companies have, that math just doesn't work. But they might choose to continue to keep the machines full anyway, just take whatever price the market gives them. So it's really hard to speculate.

[Amer Tiwana:]

And what percentage of the market is imports right now?

[Allen J. Campbell:]

It varies by product line. If you are looking coated freesheet kind of mechanicals, relative to the U.S. and imports into the U.S., it can be upwards of 18% to 20% market share. Supercalendered paper as an example has very high import percentage because we are the last U.S. producer of supercalendered papers. And I think Chris is spot on, just historically if you look at correlations between currency and imports, there is none. And so it is more in tune with supply and demand balance on a global basis. And if you have capacity overhang globally, that excess capacity will find a home and we are still a very attractive market here in North America and specifically in the U.S. And so Chris is right, currency, as it moves against them, it is positive, but I don't know if you can operate at that point as materially.

[Christopher DiSantis:]

It certainly helps, we just can't speculate on that.

[Amer Tiwana:]

Understood. And what's your capacity utilization of current portfolio as it stands today?

[Allen J. Campbell:]

Say that again, past utilization, you want to know where like our operating rates are for the…?

[Amer Tiwana:]

Yes.

[Allen J. Campbell:]

The current capacity utilization, again, it really varies by product line. So to give it as a general thinking, coupled with at least in Q2 was the downtime that we took to manage the inventory to potentially [indiscernible]. But I can tell you historically as we approach Q3, which we anticipate, we've got very high utilization rate across the system.

[Amer Tiwana:]

Got it. One last question, and this is more to do with the regulatory and trade environment, a lot of industries, manufacturing industries in the areas that you operate in are being helped by the administration both from regulatory as well as trade front. Anything happening on the paper front?

[Christopher DiSantis:]

There are duties in some of our – certain regions in the world and to North America, some Canadian manufacturers have duties, Asian, significant duties in various countries. So there have been trade cases and trade hindrance on getting the products into the U.S. That exists. I think we are we believe the overall competitiveness in the environment, regulatory that we'll be working under seem to be much more positive than the trends were in the past. So I think that will be positive. So, I think what we are talking about from administration, what we are seeing, it will help U.S. manufacturers stay cost competitive, remain strong within their markets. And like we said, there are some duty issues that we have that we are facing in [indiscernible].

[Operator:]

Our next question comes from Hamir Patel of CIBC. Please go ahead.

[Hamir Patel:]

I just had one follow up on the containerboard potential. If you did decide to go down that road, do you think the open market or export opportunity is big enough to sell into or would you likely need to either build or acquire converting assets as well?

[Christopher DiSantis:]

It's a good question. That's being evaluated right now. So I would lean towards, yes, the market is big enough to handle it from an export, open market standpoint, but that's an important part of the evaluation, ultimately it depends on how much tonnage you wind up converting. So it's going to depend on the size of the machine that ultimately got converted and how many incremental tons that adds to the market. Whether it's couple of hundred thousand or 500,000 makes a heck of a difference.

[Hamir Patel:]

Right, okay. That's all I had. Thanks a lot.

[Operator:]

Our next question comes from Beth Lilly of [Verso] [ph]. Please go ahead.

[Unidentified Analyst:]

Chris, I wanted to ask you, can you talk about Houlihan and when you talk about strategic alternatives, I mean that's a very broad concept, so have you hired them to help you sell mills, have you hired them to help you with evaluate whether or not to sell the Company, can you give us a little more specific direction about what you have engaged them to do?

[Christopher DiSantis:]

Yes, I mean so they have been engaged to help us with everything. So, the view that we really take with the business is trying to figure out what's the best possible economic actions we can take for the shareholders. And when you take a very broad brush like that, you wind up looking at everything, what's the value of the Company, the whole value of the Company, value of the mills individually, value of its part, but you're also looking at the opposite perspective as what corporate development moves could we make to enhance value for shareholders that might entail volume/mix. So it's really looking at it I mean from every angle. So, I know that's certainly not specific in terms of answering your question, but they have got a lot of expertise in the space. So they have worked with a lot of big companies in the past on value creation moves and strategies, and we put a lot of value on their advice.

[Unidentified Analyst:]

Okay. And you have talked about figuring out, I mean you are in the process of putting together a plan in terms of what you want Verso to look like in the coming years. When do you think you'll be willing to share that with shareholders?

[Christopher DiSantis:]

That's a good question. I mean it's something that I would expect to evolve over time. So, what's likely is kind of every time we have an earnings call, I think there will be important pieces of the strategy that get revealed. So I understand an investor right now, it's a little bit of cloudy picture and you are wondering, okay, when is it going to be clear and kind of what the next steps are. And the only thing I could say is that next earnings call, next earnings call after that, it's going to become clearer and we are going to keep revealing I mean each step kind of as we go and as we solidify. But right now, we are still looking at a lot of different options and alternatives. So it would be premature to say specifically this is what we are going to do, until that conversion analysis is done or until that growth strategy is completed and so forth.

[Unidentified Analyst:]

And when do you hire Houlihan?

[Christopher DiSantis:]

So we've been engaged with Houlihan for some time. I don't recall the exact date of when they were officially engaged.

[Unidentified Analyst:]

Yes, okay. So it's fair to say that the plan, I just want to try to understand, so the plan in terms of what you want Verso to look like will be brought to the Board first and then from there it will be implemented and we will learn about it quarterly as things unfold?

[Christopher DiSantis:]

Yes, absolutely, absolutely. So we are presenting to the Board a variety of options and alternatives to consider along with recommendations and how to proceed, and like I said, there is a lot of different alternatives being considered right now. We are not ready to announce anything specifically, but the Board will be considering a variety of alternatives to do the right thing for shareholders.

[Unidentified Analyst:]

Yes, okay, great. Thank you very much.

[Operator:]

Our next question comes from Debbie Jones of Deutsche Bank. Please go ahead.

[Debbie Jones:]

I just had one follow-up, obviously a lot of questions on the strategic direction here, I would imagine just the comment you made about your liquidity profile that you have some sense of how much capital you might be willing to spend to shift gears a little bit with one of your mills, and I was wondering if you could just speak to that because some of the things that you mentioned would be I think classified in the high capital range that you were referring to earlier?

[Christopher DiSantis:]

No, and we are not willing to reveal a specific range yet on what that could potentially be, because it really comes down to risk adjusted return on investment profile characteristics for all of these conversion projects that we are looking at. So if there is a high capital project that's got exceptional return on it, when we talk about what that conversion investment is going to be, we need to talk about what kind of growth and earnings we expect from that. Same with the small capital one. So we are not ready to guide on potentially what those numbers could be. Obviously there is a preference for no-brainer small dollar, high return projects, because they have got the best return on capital, but that doesn't preclude us from looking at large-scale projects too. We have seven mills and a whole variety of machines and a variety of options. It's a lot of different alternatives to run down for the Company.

[Debbie Jones:]

Okay, great. Thank you very much. That's helpful.

[Operator:]

Our next question is a follow-up from Andrew D'Silva of B. Riley. Please go ahead. Andrew, your line is open. As we have no further questions, this does conclude our question-and-answer session and concludes the conference call. Thank you for attending today's presentation. You may now disconnect.