Verso Corporation (VRS) Q1 2019 Results - Earnings Call Transcript

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About: Verso Corporation (VRS)
by: SA Transcripts
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Earning Call Audio

Verso Corporation (NYSE:VRS) Q1 2019 Results Earnings Conference Call May 8, 2019 9:00 AM ET

Company Participants

Tim Nusbaum - Treasurer

Les Lederer - Interim CEO

Allen Campbell - SVP and CFO

Mike Weinhold - President of Graphic and Specialty Papers

Conference Call Participants

Jeff Van Sinderen - B. Riley FBR

Salvator Tiano - Vertical Research

Hamed Khorsand - BWS Financials

Adam Richter - Private Investor

Operator

Good morning, and welcome to Verso Corporation First Quarter 2019 Earnings Conference Call. [Operator Instructions] Please note, the conference is being recorded. A replay of this call will be available on the investor page of Verso's website after 11 PM Eastern Time today.

At this time, I would like to turn the presentation over to Verso's Treasurer, Tim Nusbaum. Please go ahead.

Tim Nusbaum

Thank you, and good afternoon. The first quarter 2019 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 web page of Verso’s website, www.versoco.com.

Joining me for today’s call is Les Lederer, Interim Chief Executive Officer; Allen Campbell, Senior Vice President and Chief Financial Officer; and Mike Weinhold, President of Graphic and Specialty 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 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 SEC filings, which are posted on our website, versoco.com, under the Investor tab.

At this point, I’d like to turn the call over to Les Lederer.

Les Lederer

Thank you, Tim. Good morning everyone, and thank you for joining us on the call this morning.

As you all know, I was appointed Interim CEO by the Verso Board of Directors in early April, and this is my first opportunity to participate in a Verso earnings call. As Tim indicated, with me today is Allen Campbell who will walk through the financial slides and more fully explain our quarterly results, and also with me is Mike Weinhold, who is available to respond the questions on our commercial efforts.

Since I joined the company, I have spent significant time with our senior leadership team getting acquainted with Verso's business and the people who work with Verso. I've been impressed with everyone's efforts to position the company for future success.

Beginning next week and over the next few weeks, I will be traveling to our mill locations with Adam St. John our Senior Vice President of Manufacturing to meet with the mill teams to better understand our operating capabilities.

As described in the earnings press release and the presentation this morning, we still face continuing challenges through the continuing decline in the demand for graphic papers. In my review the business for the leadership team, I believe we are positioned in the company to overcome these challenges through product development and capital projects to be less reliant on graphic papers. However, despite all our efforts we have unfortunately announced that we will permanently shut down our paper mill in Luke, Maryland in response to continuing decline in customer demand for the grade the coated freesheet paper produced at the mill.

The declining demand along the rising input costs has significant influx of imports from Europe and Asia and rising compliance costs and infrastructure challenges associated with recent environmental and regulatory changes also add to the issues that we have at Luke. We expect to completely shut down and close the Luke mill by June 30, 2019. We undertook this difficult decision because we could not overcome the operating costs obstacles the Luke facility has faced which caused the continuing losses.

The company has studied the possibility of producing all from the grades of paper at Luke that could possibly provide better results but the conclusions remain the same. We could not achieve profitability at the mill in today's market environment.

On Page 4 of the presentation slides, we have outlined the impacts to Verso as a result of the closure. First it is important to note that the closure will have minimal disruption to our target markets as the majority of the coated freesheet and C1S specialty products produced at Luke can be later or maybe mills. The closer will reduce the company's annual production capacity of coated freesheet by 450,000 tons. Our first quarter production at Luke was 110,000 tons.

The company’s major maintenance spend otherwise planned for Luke will be reduced by $6 million to $7 million in the second half of 2019. Capital expenditures of $4 million planned for the remainder of 2019 at Luke will not be made. The closer of the Luke mill result and pretax cash charges or severance benefits and other shutdown activities of approximately $25 million to $35 million. These estimated cash charges consist of approximately $15 million to $20 million in severance and benefit costs that will be reflected in our second quarter 2019 results. And approximately $10 million to $15 million and other shutdown costs to be recorded in 2019.

There are also non-cash charges of $95 million to $115 million in accelerated depreciation and impairment charges for property, plant and equipment at Luke. The costs to maintain the Luke facility until disposition are projected to be $4 million to $5 million per year.

In spite of the issues we face both results at Luke in the market generally as shown in Slide 3 of the presentation, the company had a strong quarter and reported 2019 first quarter net income of $36 million versus a net loss of $2 million in the corresponding quarter of 2018.

Our adjusted first quarter 2019 EBITDA was $69 million and increase of $28 million over the corresponding quarter in 2018. Sales for the quarter were $639 million and were flat compared to the corresponding quarter of 2018 with volume declining by 57,000 tons. All this was offset with better pricing and mix. The 12 month trailing EBITDA for the company totaled $324 million.

Notwithstanding the favorable quarterly results, we believe that the impact of our first quarter decreased order volume was the result of both the unusual high level of inventory stocking by our customers at year end along with the continued decline in demand for graphic paper products. We believe that with the closure of Luke, we'll be able to more effectively balance the demand with available supply.

While Verso was the industry leader in production and sales of graphic papers and we intend to remain the leader, we will continue to decrease our dependence on graphic related products and grow our business in specialty papers and other paper products. These efforts have met with success. In 2017, 72% of Verso’s revenue was in graphic products. That percentage is now 61%.

Our success in decreasing our dependence on graphic products is the result of significant efforts made by our product development and commercial teams, working together with the operations team, the trial and then commercially produce value added ultimate products. In addition to the product development and specialty grades, the company's efforts to reduce our graphic focus was the efficient use of capital to convert and restart the number three machine at our Androscoggin Mill.

The flexibility of this machine now allows us the ability to manufacture containerboard, unbleach and bleach pulp with the ability to swing between products as the market shifts which optimizes the results from this machine. This was the case in our first quarter.

One other important note before I turn over the presentation to Allen, Kenny Sawyer our Senior Vice President of Human Resources led the company's negotiating team to a successful conclusion in the lengthy negotiation process whereby the United Steelworkers of select trade unions ratified a two year master agreement with Verso in March. This resulted in an agreement which more closely aligns Verso with current industry labor practices can support the long-term interest of both the company and the employees covered by the contract. As a result of the agreement the company incurred a cash charge of $6 million for the first quarter.

I will now ask Allen, our CFO to provide a further financial update.

Allen Campbell

Thank you, Les.

Turning to Page 6 as Les mentioned prices were strong despite volume pressures. Paper prices were up $16 a ton from the fourth quarter and 9% versus prior year. Shipments were down 8% for the first quarter versus last year, the pulp up slightly and paper down.

Inventory was up in the first quarter $75 million versus the same quarter last year, as well as industry demand and strong production by our mills drove the increase. The mix of business in the first quarter as shown on the top right is fairly consistent with the fourth quarter that's important to note the increase is specially pulp and packaging for the first quarter of 2018 was only 29% where now we've moved it to 39% in the first quarter of 2019, 2018 versus 2019.

On Page 7 we show key financial highlights, sales came in towards the high end of our guidance at $639 million with double-digit percent of sales adjusted EBITDA in the first quarter which is normally weak quarter for us as our prices overcame volume declines and inflationary hits. Net income continue with of our positive quarter in a row earnings were $1.3 per diluted share.

Continuing to Page 8, the $28 million improvement in adjusted EBITDA that’s highlighted in our bridge walking $41 million adjusted EBITDA in quarter one 2018 to the $69 million we achieved in the first quarter of 2019. Price mix has been strong for us contributing $50 million in improvement to help offset $5 million of negative volume contribution. Price mix is favorable across our product lines.

The first quarter was relatively low in major maintenance projects which contributed$4 million improvement year-over-year. Input costs were up $13 million, primarily due to higher chemical and fiber prices.

Included in the line $7 million other costs and freight with the $6 million of union ratification expense that sold our master agreement with representing mails and also allow for improved operating arrangements going forward. Pension costs were $2 million unfavorable for 2019 versus 2018.

Boarding to Page 9, liquidity remained strong despite as mentioned in our year end call, the fact that we have seasonal use of cash in the first quarter as we incurred seasonal build-up inventory, employee compensation such as 401(k) and bonus payments and customer rebates.

Our build-up inventory saw in the first quarter results softer industry demand, seasonally build of wood inventories and strong operations performance as mentioned earlier. With our little closure we will service customer orders and trim down the inventory levels throughout the second half of the year.

Cash from operations was down $38 million in the first quarter, the result of the $106 million of working capital usage. Cash interest was down $4 million versus same quarter last year, maintenance and CapEx were both up slightly.

Page 10 shows our major maintenance outage cost estimates for 2019 versus the prior year's by two years by quarter. Note that we will step up spending in quarter two, and so we have a major boiler outage at our Wisconsin Rapids Mill. Spending will continue high in the quarter three and then drop significantly in the fourth quarter.

Moving forward toward guidance for the second quarter, we expect sales to be in the range of $618 million to $640 million. Capital spending to be in the $32 million to $35 million range, major maintenance,$21 million for the year and cash pension funding to $7 million to $9 million.

For the year, we expect cash pension expense to be equal to 2018. As mentioned earlier, look more closure costs being $25 million to $35 million range on cash basis. And we expect finish goods inventory decline back to last year's level by year end.

With that we conclude our prepared presentation and now return to operator to open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Jeff Van Sinderen of B. Riley FBR. Please go ahead.

Jeff Van Sinderen

I know you've only been there a short time but as the new CEO, albeit interim, how are you thinking about changing the approach to pursuing strategic alternatives versus the prior attempt than how are you changing your courage to operating the company or modifying it to make more - make it more attractive to a potential buyer?

Les Lederer

The issue of our strategy, I've been asked by the board to guide the company through a strategic or alternative review. And as you said I've been here a very short time, so that’s not anywhere near to be completed and operating the company we will - as I said in my opening remarks continue to diversify away from graphic products and get into specialty grades.

I think it's important that we continue operating the business and try to get the most optimal mix of products from the machines we have remaining at the company. As to your question about the former strategy possibly selling the company, there is no specific design at this point to go in any direction but to seek out the best alternatives and at this point we still studying the issues and I will report back to the board when we more news.

Jeff Van Sinderen

And then any more color that you can give us on what you are seeing in terms of prices for the legacy paper business. I know the pricing was up year-over-year, just wondering if you’ve seen anyone reduce prices on legacy maybe on CFS and then what do you think the outlook is for pricing as far as you can see?

Mike Weinhold

Obviously, you’re seeing some of the statements as to data that were leading the market environment and demand is certainly change from exceeding 2018 demand decline continues. With that said, and as reported in our quarterly earnings, pricing for us has been positive as we move sequentially from Q4 and Q1 and we are basically seeing a stable price environment.

From our standpoint with the little closure, we expect pricing fervor so to remain stable. I can’t speak though what I pretend to speak from the market price and we don’t give forward looking guidance on pricing but current environment I would characterize as demand is certainly challenging the graphic side and spot prices have seeing some deterioration but in general our pricing has been stable.

Jeff Van Sinderen

And then just one more, just wondering on liner board, if you’re seeing demand slow it all there overall if you are hearing about that given kind of the increased capacity that’s sitting in the marketplace and just maybe you can speak to the outlook for your liner board business on specialty paper this year?

Mike Weinhold

So I’ll take the liner board question first, and that’s really specific to our A3 conversion. We had a very successful conversion in startup, design for that machine initially was lightweight liner version kraft, primarily targeting export markets and we definitely have seen a slowdown in demand and a deterioration in pricing in the export market.

While we’ve also been able to produce other products on A3 and the design for flexibility was inherent in the conversion and so we’ve been able to offset some of the dependency quite a bit of the dependency quite honestly of export liner board into the domestic market.

So today on A3, as Les, had mentioned in his opening, the flexibility of that asset allow us to produce NBS K pulp U.K P pulp, liner board and we are knee deep in the development and successful trials of Kraft bag markets both leads to non leads. So there is a tremendous amount of flexibility.

So while we have certainly seeing a slowdown in demand and a little bit of deterioration even domestically in pricing on, container board side our dependence is less and our intention is continue to develop products on net asset to lessen our dependence on export.

Operator

Our next question comes from Salvator Tiano of Vertical Research. Please go ahead.

Salvator Tiano

So first, I would like to follow up a little bit on the container board. You didn’t highlight also in the slides the flexibility and I think there are a lot of companies that are focusing more on the pulp, especially on pulp. Just can you talk a little bit how much you know, firstly, how your volumes trending in terms of actual container board versus pulp from the - even the PM3 [indiscernible] whether you can provide an absolute number for container board production or at least how things are being trending since the start up in the third quarter?

Les Lederer

We really don’t breakdown that type of detail in our disclosures. So all we can really say is repeat what Mike and I have said already is that we have proxibility in machine can make container board unbleached and bleach kraft products and as Mike mentioned we are trying to enter into some other product categories such as bleach and unbleach craft bag. So that’s the only type of disclosure we make at this point.

Salvator Tiano

And you mentioned the export markets, I think a few months ago you had your Investor Day and I think the idea but then was most of the product was initially exported, but I don't think that was the plan for the long-term necessarily just to be on exports. But then probably we're talking I think at least 80% or 90%. As we look now into your container board volumes, have you made more inroads into the domestic market or is it still mainly exported?

Les Lederer

Yes, we've had success with the domestic market and even during that investor presentation and you characterized it correctly, and this will start up certainly with target. And it's a desirable product from an export standpoint but we always intended to migrate into the domestic markets as well as develop alternative product and certainly we've accelerated that with the success of our domestic penetration and also with the deterioration we seen in the export market.

Salvator Tiano

And just one last one on - actually coated free sheet with pricing there not just holding out for white paper but actually increasing recently. There has been a lot of reports about companies the listing especially their cultures making white paper. Can you talk a little bit about your white paper volume how much perhaps you normally used to produce and if there has been any material change in the past few months because of that?

Les Lederer

Yes, I won't give absolute numbers, but I would tell you by enlarge uncoated free sheet production for Verso is a very small percentage of what we do. We've been focused on value added products, you can focus on growing our specialty. And as indicated by the Q1 earnings, the margins and the pricing for our coated free sheet products are holding up quite well. And so uncoated free sheet is not a big part of what Verso does.

Operator

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

Hamed Khorsand

So first off just given Luke and the commentary around it about the profitability of that mill. Are you had the stage to provide what kind of benefit you could see from aggregate standpoint on to the bottom line later this year?

Les Lederer

Well let me make sure I understand, can you repeat that one more time of the last part I didn’t quite get the last part?

Hamed Khorsand

I mean after it shutdown in June - just backing up the one-time events expenses won’t there be some sort of benefits to the bottom line as far as margin are concerned?

Les Lederer

Well what we hope to do is to balance the supply and demand and the issues of. We will have some charges as we explain we hope that we can maintain price stability but we don't have any expectation of the total effect at this point in time. We expect to maintain a balance in our supply and demand.

Hamed Khorsand

And then just from an inventory standpoint the build that you had in Q1 will there be a further build in Q2 are you managing that more appropriately?

Les Lederer

Well we’ll balance with what we need to do with Luke. The thought is with that now closing we taken out 450,000 tons of capacity. We have sales for that product in the last half of the year. So we may build slightly in quarter two. And then when production ceases, we’ll be selling down that value throughout this last half.

Hamed Khorsand

And then as far as the - your Q1 performance is concerned, could that be repeated in Q2 given the current market environments that you're seeing in your end markets?

Les Lederer

The one difference you need to look at closely is the maintenance we have heavy maintenance in the second quarter. We did not have in the first that will be a headwind for us in Q2.

Hamed Khorsand

Will it still be a free cash flow positive quarter?

Les Lederer

We haven't forecasted what the cash flow will be for the quarter.

Hamed Khorsand

And my last question is, any plans or expectations as to what to do with - versus capital structure. I mean if you're generating free cash flow we’re going to be ideal to start looking at allocating for stock buyback?

Allen Campbell

But again as I said in the original question the vast has through our strategic direction. We're still working on that strategy for the long-term growth and performance of the company. So that issue has not been addressed as a final conclusion I mean we are not going in any one specific direction with our free cash flow we are looking at all strategic alternatives.

Hamed Khorsand

But I mean this has been an ongoing discussion for over a year now right. I mean I brought it up last quarter as well. I mean the Board it started to listen to this call, they got to be making a decision here?

Allen Campbell

Well again the Board is fully aware of the questions that have been asking the last few quarters and they are trying to make sure that the direction the company goes is in the best direction for all constituents and. And there has been no decision made on the specific question you're asking but we are measuring and looking at all strategic alternatives.

Hamed Khorsand

You have a stock trading below book value generating free cash flow and you can't make a decision on the capital allocation?

Allen Campbell

Hameed we're not try to avoid your question, again we are trying to look at the long-term growth of the companies and if it requires additional liquidity in cash flow to achieve those objectives maybe stock buyback or dividend is in the best solution. I'm not saying we've reached a conclusion, but we have to measure all alternatives and have the Board make a decision. We have not made a decision on your question.

Operator

Our next question comes from Adam Richter a Private. Please go ahead.

Adam Richter

I guess my main question has to do with the supply demand situation in the industry. How much of a supply do you think Luke is going to take out of the overall coated free sheet market right now?

Allen Campbell

So the 450,000 tons as a percent of capacity if you look at 2018 it's roughly 12%.

Adam Richter

So its 12% there and what's the status right now with the catalyst nine dragon sale conversion I know made Les to probably answer that where does that stand currently do you think?

Les Lederer

We’re at in probably nine dragons plans at all I mean we've seen the public disclosure and their plans. And if that was the purpose of their acquisition from catalyst they didn't disclose it to us at the time. What we see is a public disclosure we don't know what the status is, what the progress is so we can’t answer that question.

Adam Richter

But your understanding is ultimately they're closing converting but I guess what you're saying is you don't know timing right now and you haven't heard that’s officially closed is that the best way to look at it?

Les Lederer

All I can say again is that we are subject to the same information that you get its public disclosure to the extent they want to make public disclosure. There are private companies in the U.S. and I don't have any more insight than that.

Adam Richter

And what about the Somerset mill closure by Sappi any information on that?

Les Lederer

That’s not a closure that’s a conversion that's not a closure it’s a conversion.

Allen Campbell

Yes, they continue through their conversion and of that machine up at Somerset Main which was C2 to us primarily coated free sheet being converted into SBS grades and we are seeing that in the marketplace somewhat.

Adam Richter

And also what do you guys think about the story and so European closures. I know last quarter you talked a little bit about the inventories, challenges in the industry, looks like Q1 was pretty good. What about the import the structure of that I know you talked about imports maybe hurting pricing a little bit but do you think that will help and what do you think the timing is on that closures?

Les Lederer

Yes, and so again we see what everyone sees for public disclosure standpoint. I believe you're specifically referring to the store Luke conversion which I've certainly would have an impact on coated free sheet. A lot of coated free sheets are produced at that facility.

So I don't think it's unusual to assume that that also would have an impact on trade flows of those products and specifically product coming into the U.S. We have seen imports and it has been mentioned import increasing gaining share both in the coated free sheet and coated groundwood segment and certainly gaining in coated free sheets.

Korea absolutely leading the charge and gains our coated free sheet imports. So you could summarize that that should have a simple the positive impact on the global trade flows and potentially on imports in the U.S. should that machine confirm or machine convert.

Adam Richter

Do you have any more specific data on how much imports were coming in right now, any idea?

Les Lederer

Yes, and so again if you look at just the imports as the percent of U.S. demand in coated free sheet its roughly 24% in coated groundwood, now its 45%. Canada is roughly 40% of that coated groundwood be in the imported in the U.S. So we’ve always import, have a certain percentage share both free sheet and coated groundwood it is increasing in the coated free sheet side.

Adam Richter

So that could be pretty impactful. And then my other question has to do with your cash flows in the quarter. It looks like that your EBITDA less your pension contribution CapEx and so some small interest payments. You guys generated a pretty decent amount of cash flow. You talked about the inventory builds or you understand that but you also – your cash was down $20 million and debt was $45 million. Could you discuss why is that recurring plus the inventory builds, seems like a big draw down on all aspects of cash?

Les Lederer

Well, if you’ve looked at the balance sheet its somewhat little bit a noise in here because we’ve added lease accounting into our balance sheet. But our working capital usage was say, we made $69 million EBITDA we had $106 million roughly working capital usage and then you saw the pension either on that and you get to roughly the numbers you are talking about.

So the $106 million is working capital, $75 million was inventory and as we talked about that we have a decent build of wood that we do every year. We are buying in the first quarter and that we worked that down in second and third. The finished goods that we built and as we announced at the closure, we’ll that’s going to clean that up in the second half. So abnormally high working capital usage in the first quarter combined with the seasonal build of the wood drove about $106 million number.

Adam Richter

And the debt build up is because of the new accounting charges on having leases on the balance sheet, is that correct?

Les Lederer

No, it's definitely - if you look at $69 million EBITDA you see crack to $106 million for working capital that get you $31 million, $37 million of usage of cash there and then we have a few other payments throughout the first quarter.

Operator

Our next question is a follow up from Jeff Van Sinderen of B. Riley FBR. Please go ahead.

Jeff Van Sinderen

Yes, just wanted to ask in the light of closure of Luke and all the analysis what you’ve done over the last 18 months or so are there any other potential line closures that you might make this year and keeping in mind that the company is looking its strategic alternatives, are you planning to wait to do any major conversion projects or should we expect you to move forward with some of the projects that maybe you’ve looked at and seem they are good return projects, that might increase penetration specialty and other goods of paper that we’re on?

Les Lederer

Well, as we said we’re definitely want to increase our concentration in specialty papers to the extend it takes some conversion capital to get the machines to make those types of products. We’ll definitely look into it.

Again, the overall question of our strategic direction is under study and I don’t even hear a month or so and I am still gathering information talking to senior leadership team about a variety of topics, not trying to avoid the questions that have been asked this morning but asking everyone to give us time to have this appropriate studies undertaken and then we can come back and give the closure that’s necessary.

Operator

[Operator Instructions] Our next question is a follow up from Salvator Tiano of Vertical Research. Please go ahead.

Salvator Tiano

So couple of follow up questions. First one is you know, specifically about Luke obviously you now, you chose to shut down the mill. Now the way you’re undertaking this project, is there a potential that you know the mill could restart not obviously as a called for it should produce mill but as something else in the future, the same way you know shunning in both this mill in Kentucky and is there any - could there be any potential interest from any Chinese companies and why essentially are we going for a full closure instead of specifically again for this mill not to an entire company you know, considering any other alternatives like convergence, making pulp or client to see if Chinese player would be interested?

Les Lederer

Again, whether if someone is interested in purchasing the mill for other purposes we do not have an answer on that. The question of us, if you ask me yes, it will start of our conversion that mill we, is that the question?

Salvator Tiano

Yes, essentially why is it closed instead of doing something else?

Les Lederer

It’s closed because the products we make and the cost to make those products and the efficiencies and other compliance issues at that facility caused us to close the facility because we were losing money on the facility. We had negative cash flows on that facility.

If you know, we have not determined, we have not – we don’t have a direction how we can convert that mill and make it profitable and therefore we close the mill because of those reasons. If some buyer whether its Asian or otherwise wants to come and look at the mill, we’re more than happy to have them take a look and if they wish to purchase it and altar it to some other purpose we are more than happy to listen to them.

Salvator Tiano

And just one last question that towards trying to understand a little bit and if could provide a little bit more color on the management change took place last month, we’re actually very puzzled with the press release not mainly because at least on our annual world expecting to see your change but we’ve noted there was like a six day gap between when the information became public to the press release and when actually the change took place in April. So can you elaborate a little bit on the management change and provide a little bit some caller about why it happened and what happened during these six days?

Les Lederer

Well, again, this closure of the company made around the executive changes in early April and have been made and that’s the only disclosure we will talk about. We made our disclosures and the story that’s in the disclosures is what we have.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Allen Campbell for any closing remarks.

Allen Campbell

I’d like to thank each of you for your time. We appreciate your interest in Verso and this ends our call. Thank you.

Les Lederer

Thank you.

Operator

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.