Mercer International Inc (MERC) 2006 Q3 法說會逐字稿

Good morning. My name is Casey and I will be your conference operator today. At this time, I would like to welcome everyone to the Mercer International third-quarter 2006 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (OPERATOR INSTRUCTIONS)

Ms. [Saymont], you may begin your conference.

Thank you. Good morning and welcome to the Mercer International 2006 third-quarter earnings conference call. Management will begin with formal remarks, after which we will take your questions.

Please note that in this morning's conference call, management will make forward-looking statements that were made in the press release. According to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, I would like to call your attention to the risks related to these statements, which are more fully described in the press release and in the Company's filing with the Securities and Exchange Commission.

Joining us from management on today's call are Jimmy Lee, President and Chairman, and David M. Gandossi, Executive Vice President, Chief Financial Officer, and secretary. I would now like to turn the call over to Jimmy Lee. Jimmy, please go ahead.

Thank you. I would like to welcome everyone to Mercer International's third quarter nine-months' year 2006 earnings conference call. We are very pleased to report record operating EBITDA for the third quarter, as well as for the nine months.

This was the first quarter when all three pulp mills operated without major production losses due to scheduled maintenance downtime, unexpected technical difficulties, or weather-related shortages in raw materials. Our sales operations are starting to show the results of the initiatives we have undertaken. The mill availability is gradually improving, as we catch up on the maintenance work that had been lacking under the prior ownership. With the capital investments which will be completed in the first half of 2007, Celgar's operating costs should show further improvements.

Revenue for the three months ended September 30, 2006 increased to EUR175.2 million from EUR148.9 million in the comparative period of 2005. This was primarily due to the higher pulp prices. Pulp sales by volume increased slightly to 338,201 tons from 332,282 tons. List prices for NBSK pulp in Europe were approximately EUR556 or [US$708] in the third quarter compared to EUR476 or US$580 per ton in the 2005 period. Mill net pulp sales realizations increased to EUR482 per ton on average from EUR398 per ton in the prior-year period.

Fiber costs at our German pulp mills increased by approximately 10% versus the same period of 2005, and at the Celgar, increased by approximately 6%. Our pulp operations generated an operating income of EUR33.8 million versus operating income of EUR9.2 million due to higher prices.

Due to the disposition of our Heidenau paper mill in August of this year, paper mill revenues were EUR10.3 million versus EUR15.5 million in the prior-year period. For the third quarter, the paper operations generated a smaller operating loss of EUR300,000 from EUR1.5 million for the third quarter of 2005.

The slight weakening of the long-term interest rates in the quarter resulted in a net unrealized non-cash holding loss of EUR14.5 million before minority interests, upon the mark-to-market valuation of the currency and interest rate derivatives that were outstanding at the end of the third quarter, compared to a net non-cash holding gain of EUR3.3 million before minority interest in the prior-year period.

We generated operating EBITDA of EUR48 million versus EUR21.9 million in the prior-year period. For the quarter, we had a net income of EUR6.7 million or EUR0.20 per basic and EUR0.19 per diluted share, which included an aggregate of EUR15.2 million unrealized losses on our outstanding derivatives and our foreign exchange loss on our long-term debt. Last year, we reported a net loss of EUR5.6 million, or EUR0.17 per share, which included a net realized and unrealized gain of EUR3.1 million, and our derivatives had an unrealized non-cash foreign exchange gain on our long-term debt of EUR5.9 million.

For the nine months ended September 30, 2006, revenues increased to EUR501 million from EUR376.4 million due to the higher pulp prices as well as increased sales. Pulp sales by volume increased by 22.7% to 994,567 tons from 810,258 tons in the nine-month period 2005. List prices for NBSK pulp in Europe were approximately EUR533, or US$663 per ton, in the nine-month period, as compared to approximately EUR484, or US$611 per ton in 2005's nine-month period. Mill net pulp sales realizations increased by 12.9% to EUR454 per ton from EUR402 per ton in 2005's nine-month period.

For the nine months, our pulp mills took an aggregate of 50 days' scheduled maintenance and strategic capital expenditure downtime versus approximately 44 days in 2005's nine-month period. Fiber costs at our German pulp mills increased by approximately 7% versus the same period of 2005. At Celgar, fiber costs decreased by approximately 10%.

Our pulp operations generated operating income of EUR57.5 million versus EUR22.9 million in the prior-year period. Revenue from our paper operations decreased slightly from EUR47 million to EUR43.8 million, mainly due to the disposition of the Heidenau paper mill. The paper operations generated operating income of EUR600,000 as compared to an operating loss of EUR0.2 million in the 2005 nine-month period. Income from operations increased to EUR56.8 million from EUR16.2 million due to higher pulp sales as well as prices.

Due to the increase in long-term interest rates and the weakening of the U.S. dollar, we recorded a net unrealized non-cash holding gain of EUR76.3 million before minority interest upon the mark-to-market valuation of the currency and interest rate derivatives that were outstanding at the end of the nine-month period. This compared to a non-cash holding loss of EUR67.8 million before minority interest for the 2005 nine-month period.

For the nine months, we generated operating EBITDA of EUR99.1 million as compared to EUR55.1 million in 2005. Net income was EUR41.7 million, or EUR1.26 per basic and EUR1.05 per diluted share, which included a net realized and unrealized gain of EUR71 million in our long-term interest rate and currency derivatives, and an unrealized non-cash foreign exchange gain of EUR11.5 million on our long-term debt.

In the 2005 nine-month period, we reported a net loss of EUR87.4 million, or EUR2.86 per share, which included a net realized and unrealized non-cash foreign exchange loss on our currency and interest rate derivative of EUR70.1 million, and unrealized non-cash foreign exchange loss of EUR1.6 million on our long-term debt.

Although the quarter was very good, the overall pulp mill net realizations could have been much higher if not for the weaker European market as compared to North America or Asia. List prices in Europe continued to lag due to weak market conditions for paper as a result of overcapacity in certain paper grades. As a large proportion of our sales was in Europe, we had on average lower middle net realizations as compared to those producers whose main markets are North America or Asia.

We believe that moving forward, the paper markets in Europe should improve as a result of capacity closures, as well as continuing improvements in the European economy. Overall, we have made significant progress in all of our pulp operations. Gross margins moving forward will be impacted by higher-than-expected fiber costs. Fiber costs are increasing in North America as well as Germany for different reasons, and in the short-term, this trend will continue.

In North America, the housing market slowdown, together with the softwood lumber settlement, has resulted in a sudden shift in the supply/demand balance, leading to production curtailments of lumber as well as some closures of sawmills. Thus, availability of sawmill residuals and pulp logs in many areas has been constrained, leading to higher prices and lower inventory levels of raw materials for most of the pulp producers. It is difficult to estimate the full impact of recent developments, as the lumber markets are just at the start of the readjustment phase.

In Germany, the impact of the severe winter conditions at the beginning of this year is still being felt. Overall inventory level for most wood residual consumers is lower than normal, with further competition for lower grade of wood waste coming from the expanding biomass energy industry, especially for the production of wood pellets. There has been a lot of speculative investment in the biomass energy sector, as well as speculative buying of materials. And there are now indications that maybe adjustments may be occurring due to the rapid rise of prices to the retail and user for wood pellets.

Unfortunately, in the short-term, we will continue to suffer from further price increases, and thus operating margins will be reduced in the short-term. The extent and duration of the bio-energy-led price increases will be dependent on energy prices, winter conditions in Germany, and governmental policies, in addition to the normal supply and demand relationships.

We are more optimistic as to the NBSK price developments in the next quarter as well as the coming year due to the raw material situation, as well as the continued growth in demand with limited increase in production capacity for the near future. It is more likely that further pulp mill closures will occur, as well as constrained production levels, due to the raw material availability.

On that note, I would like to open this call to questions.

(OPERATOR INSTRUCTIONS) Mark Bishop, RBC Capital Markets.

Good morning and congratulations, Jimmy, on a very good quarter. A couple of questions. First, could you repeat -- I think I may have missed the downtime comment with respect to third quarter, how many days were taken at each mill. And I don't think it was very much. But also what you're looking at for the fourth quarter downtime.

In terms of the maintenance downtime for the quarter, we just basically had very minor downtimes in regards to Rosenthal as well as Stendal. We had probably two days for Rosenthal and seven days for Stendal.

And coming in the fourth quarter?

Fourth quarter, we're going to have the tie-in, of course, with the new washers at Celgar. So there will be a minor downtime for the tie-in somewhere in the range of about two to three days.

Has that already taken place?

That has taken place.

Okay. So nothing else at the other two mills?

Nothing in regards to scheduled maintenance or capital investment downtime. Next year, it is projected that there will be fewer downtimes related to maintenance and capital expenditures overall.

What would be a good run rate to be using for Stendal for 2007 in terms of overall [punch]? Is the third-quarter run rate more or less what we should be looking at as a good base level for '07?

I think we will be running probably close to the 600,000 ton type of production levels.

Again with Stendal, it looked like the discount to list at Stendal had increased from last quarter. Was there an mix change quarter-over-quarter in terms of the markets served, or what might have caused that?

No, basically it is a question of the currency, as well as the market timing lag in regards to increases to certain customers. It is really the timing of the price increases that we have. As you know, certain European markets tend to be a lot more resistant to price increases, and that typically tends to lag the others, and therefore, it is a reflection really of timing and certain currency movements in that quarter.

Okay. Just a question on the carbon credit allowances. Obviously, you did not report any for the quarter. Your earlier guidance was for EUR17 million for the year. I see that carbon pricing has come down about 30%, and I think you had hedged earlier some additional volume. But is the EUR17 million still reasonable number to be looking at for this year and do you have any guidance for next year?

Yes, for this year I think our basic assumptions are still valid. As you know, we did hedge certain volume, so I think we will be very close to those. Moving forward into next year, I think our expectations are, of course based on today's pricing, a little bit lower in terms of revenue derived from those allowances.

Okay. Just a final question. Looking at the transactions in the quarter, and I guess post-quarter, with the sale of paper assets and the pickup of 7% in Stendal -- and I realize these are relatively small amounts and the value for the 7% was certainly attractive. But going back to when you were looking at a new issue, you certainly at that point were not contemplating acquiring any additional portion of Stendal. I'm just wondering what has changed or what did change in the course of several months here, and why we just did not see that applied to debt reduction.

Basically, I think it was more motivated by the part of the seller rather than our part. So of course, you know we can never expect when someone may be motivated to sell their position. And as you know, it is structured as a debt, which could be converted into equity at our option. So it is our choice whether we choose to pay it in cash or pay it in equity.

Okay, and are there potential additional opportunities like that going forward in the next 12 months?

As I said, it really depend on the motivation of the seller and the willingness of the seller and whether we feel that price expectations are reasonable. At this point, we do not have any indications from, let's say, our existing minority shareholder in Stendal. So there's certainly nothing we can really give you further information on, and certainly nothing in terms of any potential acquisitions that we have -- I can really comment on. There is nothing that certainly is on the table or that we are presently engaged in.

Right. Okay. Thanks very much. I will turn it over.

Don Roberts, CIBC World Markets.

Thanks very much. You mentioned about the bio sector or the bioenergy sector as sort of the [thread side of the companies for fiber. But we're seeing other folks out there, like UPM, putting a fair bit of emphasis on this as a potential new product line. Is there anything that you would see as an opportunity for Mercer out there, whether it seems like black liquor gasification or different concepts of biorefiners that you could explore?

I think bioenergy certainly is a very interesting field for a pulp producer, because, as you know, of course we're in the business of turning woodwaste or lower-value wood into a much higher value product. We already do that in the sense that we sell electricity, which of course is produced from essentially a recycling of our chemicals. So it is an industry that we are examining quite closely.

As you know, I think the best opportunities really are still in the area where you can utilize species which are the most efficient in converting sunlight into biomass. Certainly, the Northern Hemisphere species are not the best in that regard. So although I see UPM's announcement, I do not quite understand, I guess, their strategy.

We are aware of the biomass, the liquid fuel type of developments, which are quite interesting. But certainly, in terms of the raw materials source for the biomass, I think there is much cheaper alternatives type of raw materials than the Northern softwood or even Northern hardwood species, as you know.

And you see that in regards to the eucalyptus plantation in the Southern Hemisphere, where -- and, of course, the biomass to energy is less dependent on the quality. It is really more dependent on more density and BTU value, rather than anything else, and how rapidly it will convert sunlight into biomass.

Okay. Just switching gears here, what has been sort of the -- if you look at the geographic pattern of your shipments, what has the big picture level been, the major changes we've seen over the last couple quarters, and where do you see that moving in the next couple going forward?

We continue to focus, for our German mills, on our domestic markets. That means that we are continuing to increase our percentage of sales in Germany, as well as the rest of Western and Eastern Europe. We are reducing our shipments into Asia as a whole, as well as into China.

Of course, we will never be out of the China market. It is quite freight effective from our Stendal mill to the China market in particular. And therefore, we will always have a reasonable quantity which we will of course hope to sell in China. But again, those volumes will be lower than what we have shipped this year, even, and certainly much lower than the startup years.

In regards to Celgar, of course the focus is primarily North America and Asia. It is essentially out of the European side, because the freight did not really make any sense.

We will again be focusing more on the North American market, but to be honest, the China market right now is very attractive in regards to no net prices. So really there is no urgency on our part to be selling into North America for the sake of trying to get market share. We believe that the price realizations today and Asia and certainly even in China is very attractive for us.

Thanks very much, Jimmy.

Ted Wolff, U.S. Financial.

Congratulations on the quarter. The -- I wonder if you could broaden out your comments about pulp markets. In particular, I have in mind the question of capacity. Has the improvement that we've seen in prices resulted entirely from demand or has there been a reduction in capacity? And what is the outlook going forward?

I think of course that the improvement has been initiated by the fact that there have been significant amount of closures at the end of last year and throughout this year. We had, of course, a restart of the (indiscernible) Bay. But in the long run, this restart will probably mean that the fiber competition in that area will increase. And with the present lumber markets, the wood situation certainly will become even more constrained, and of course lead to higher prices. So clearly in the eastern part of Canada, we still believe that there will be further adjustments as a result of further raw material shortage issues.

And in terms of the West Coast, you are seeing also that fiber availability is quite constrained, because the sawmilling activity is of course much lower. There are certain policies which have been adopted by the government in regard to stumpage rates, etc., which has resulted in also lower availability of pulp logs because they are not really taken out of the forests. Which means that to really get them motivated to bring those pulp logs out, they expect higher prices.

So material prices as a whole for raw material, I think in Canada, even on the West Coast, will reflect the change in the environment. And therefore the marginal or the high-cost producer will continue to have margin pressures, and therefore, we think that there is certainly further room for capacity closures.

This will mean that pulp prices, certainly for NBSK, are not likely to really go down. It is more probable that it will go up rather than down. I know that of a lot of the projections moving forward based on eucalyptus pulp capacity increases is the other way around. But I do believe that there is a fundamental increase in the floor price for NBSK.

And therefore, I think we have to be cognizant of that in the sense that we don't really think that the price developments that I've seen are realistic in light of the fiber or the raw material development (indiscernible).

And demand certainly globally is continuing to increase for NBSK, as well as softwood. And the only capacity increases -- of course, Radiata in Chile, roughly just about 400 something thousand tons -- this really is not significant if you look at the fact that an annual increase in demand by China alone approximates that year-after-year.

So clearly, a very limited supply growth and, if not further closures, with continued demand growth for at least the foreseeable future.

Thank you, Jimmy. That's very helpful.

Steve Chercover, D.A. Davidson.

Some of my questions have been answered, but let me fire away anyhow. First of all, if we were to assume kind of a similar EBITDA number and yet no derivative impact, what would be an appropriate tax rates to use?

Tax rate? Right now, of course, you know with the loss carryforwards in our pulp operations in Germany, we do not expect to be paying taxes, at least for the short term. Certainly in terms of the Celgar operations, also, our expectations are at least in the immediate term it is not likely we will be paying taxes. (technical difficulty) of course chew up all these tax losses, than we will be paying corporate tax rates, which are the normal rates in Canada as well as in Germany.

Blended, would a 37, 38 be appropriate?

In the '30s. Yes.

Okay. Could you tell us what the fully-diluted share count should be, please?

I think it is about 42 million. There's 33 million shares out and there's probably about 10 or so million on the convertible.

Okay. And you did touch on the pulp price outlook, and it is good to see that the floor seems to be rising. You are playing some catch-up in Europe and Asia. Do you think it is possible that we could actually see another round of NBSK hikes early in the new year?

Yes, my expectation certainly is that the hikes are more probable in Europe than it is in North America, as well as less likely in Asia. I think that the gap that traditionally has been there between U.S. and European prices today seems to be quite extreme.

Typically, you expect about a $20 to $30 gap between U.S. and European list price. Right now, we have had more than $50 for a period of time, and we're starting to close that. There is a $10 increase, which means that probably there is potential for another $20 type of increase to bring it in line with more traditional type of gap between U.S. and European list price.

In terms of the Asian, as you know, there was a $10 increase, which bring the net prices to 700 from the 660. I think that is quite reasonable, and we do not think that there is any real reason to be accelerating further increases in Asia before there is some catch-up on the other areas, like Europe and such.

Great, thanks. I guess we should see the minority interest line go down, given the acquisition of that additional 7% in Stendal?

Yes, that is correct.

Great, thank you.

Daryl Swetlishoff, Raymond James.

Jimmy, just on your Celgar mill, the results were a lot better than we thought. And you've talked a bit about it. I was hoping you could give us just a bit more details on what exactly has been done to date and what you have planned for the future of that mill.

Celgar's operating performance improved only because the mill reliability improved. So it was not experiencing the type of unexpected downtime that it had in the past because of really more poor maintenance practices, as well as power [fees]. So we're finally starting to catch up on that, and we will be further catching up.

And as we improve the mill reliability as well as the Blue Goose project, which will improve chemical costs on the bleaching size, we think that Celgar's performance will further increase quite significantly from here.

Already, if you look at our third-quarter numbers and you compare us against the other type of producers, I think Celgar's performance is starting to reflect the capacity size that it has. It performed well. It really was strictly based on mill availability. I mean, raw material prices wasn't that significantly different. Electricity generation was better, because of course you had better mill reliability. We have now restructured the way we sell our electricity, so there has been some benefit in regards to better energy contributions.

But the balance really is strictly just cost benefits as a result of better mill reliability issues more than anything else.

Okay. Going forward with the addition of the washer, should we expect -- what sort of improvement should we expect and when exactly should we expect it to start hitting the bottom line there?

You know that we have the Blue Goose project, which we will complete in the first half of next year. I think we basically said that there is about a $28 million -- or $20-something million EBITDA improvement as a result of our investment program. And I think that is still quite realistic.

Okay, that's helpful. Thank you. Just a question, given your pulp outlook and the flexibility that you have, have you provided any thoughts around where you might feel on hedging pulp prices going forward or hedging a portion of your production?

Of course, at the list prices that we're seeing today, we are offered a lot of hedging opportunities. In the past, if it was not for the fact that I've seen that raw material cost clearly is rising in all different geographic areas, that I would be fairly excited about maybe selling some forward. But today, my excitement to do that certainly is far less, because I see that the floor prices moved a lot. So that means my expectation for further price increase certainly is there. So at these levels, I think my enthusiasm for hedging pulp right now probably is not very high.

Okay, that's helpful. Thanks so much.

Eva (indiscernible), [Independent United Capital].

It's Cheryl Van Winkle. First, a couple things on Celgar. Did you say that it was in a EUR20 million EBITDA improvement you expect, once the washer program is all in place?

When we basically went and did the financing for the bonds, we basically projected, with the capital investment that we would make, that there would be somewhere in the range of $20 million in EBITDA improvement, together with better, of course, operating efficiencies. And I think that the combination of lower chemical consumption, larger production qualities coming out, those types of numbers are still very, very realistic moving forward.

Okay, so that is $20 million on top of wherever you are, say, in the second half of this year at Celgar.

Well, you have to project out your raw material prices as well. You can't just make a straightforward type of increase on top of what we have today. I think what you are seeing today is a combination of better mill net pricing, lower discounts, lower commissions that we pay to agents, lower freight rates on average because we of course shipped more freight logical. And all of these are clearly falling to the bottom line, and those will stay.

The areas that will continue to have pressures, of course, is the fiber cost, which means that if price of pulp continues to be at these levels, you'll see some margin pressures coming out of the raw material price. Compensating that of course will be the improvement in chemical costs, because of course with the washer project now installed, chemical consumption should drop. As well as further improvements in terms of our energy sales through a combination of better pricing, as well as more energy that we would sell because of better mill reliability.

Okay, so excluding the issue of fiber, if we take away fiber, if we assume maybe prices go up as much as fiber costs go up, then would you expect another $20 million improvement over where you are right now?

Well, you know, the chemical savings probably alone will not be that. So it is a combination of capacity increase. Because of course the debottlenecking will mean that instead of, say, the 440,000 tons or 445,000 tons, will be probably more closer to the 470,000, 480,000 tons, moving closer again to just under 500,000 tons of total production. This will mean that all of the other incremental costs will come down.

Chemicals cost savings may be in the range of -- on a per ton basis -- of somewhere around 20 or so. But this will fluctuate, together with the production increase. So you have to factor these in -- when we talked about that $20 million plus in savings, we had lumped in the chemical savings, expected efficiency gains. But I think we're seeing better efficiency gains overall because of improvements in mill reliability, better pricing, that we get lower commissions etc., etc., and better location of our customers.

Okay, so since you have gotten some of it, you might -- but on the other hand, you are doing better than you thought. It sounds like maybe if you were going to (indiscernible) an incremental number, excluding the fiber cost issue, maybe you are more talking 15 plus rather than the 20.

I just look at it in terms of trying to compare ourselves against our German mills. Celgar, I think had a 21% [retail] margin. Our German operation had about a 29% EBITDA margin. So clearly, you can see that there is still room for improvement, somewhere in the range of about 6% to 7%.

There is no reason why Celgar for (technical difficulty) production, because it is exactly (technical difficulty), that Celgar's EBITDA margin should not really approach those of our other operating units with the same price type of development.

Okay, so that is something that potentially could happen -- or you would expect to happen after you've gotten the new CapEx in play.

I think it is a combination of the CapEx, the continued improvement in terms of the maintenance, which means that the mill reliability will further improve. There's other efficiency gains that we will make. There is certain advantages that Celgar always had. Of course, there's certain disadvantages, but that is true at our German mill.

So I think that you have to look at the overall operations and say, well, our German mills are having a 29% type of margin with today's prices, and we had much lower ones at Celgar. It is more realistic that we will improve Celgar's margins more closer to our German operations.

Okay. And then could you just quickly tell me, what was CapEx for the restricted group for the quarter?

For the restricted group -- David, do you have that number?

Yes, Rosenthal was 3.5 million and Celgar was 4.8.

Okay. And then finally, I just wanted to ask -- it looked like on Stendal, did costs increase in the quarter in that -- I have not really run closely through all the numbers, but it looks Stendal maybe did not do as well as the other mills. And was there a particular reason for that?

No, there was a slight increase in costs, but that was only related to, of course, the fiber cost increase. It did impact at both Rosenthal and Stendal, a little bit more at Stendal than Rosenthal. But also the combination of lag in terms of pushing sales prices.

Oh, maybe there was more of a lag at Stendal.

It was not really the cost side, but really it was a bit of a lag on the price as well.

And that's just because of the nature of Stendal -- it's a newer mill. There is the nothing else going on there.

It is a mix of the customers. Because Stendal has more customers, which are what I call located in a geographic area which is more resistant to price increases.

Okay, great. Thank you very much.

Aaron Rickles, CIBC.

Basically, was Celgar energy positive this quarter or were they net energy users?

They are still net energy users, but much improved from the previous quarter.

Do you think you could get to sort of a net flat or positive in Q4, or is that going to be more of '07 or '08? What do you think about that?

It really depends on how well we are able to get the mill reliability up. Once the mill reliability is on par with our German mills, then it should be pretty close to (indiscernible) in regards to net-net.

That's helpful. I was hoping we could drill down a little bit more on the fiber costs and maybe -- I don't know if it could be quantified a little bit. You have talked about, I think, the German mills were up about 10% in this quarter -- and that is year-over-year, right? 10% year-over-year. And I guess Celgar was up in the mid single digits. But in the first half of this year, Celgar had been reported down about 20% on fiber and I guess year-over-year.

So is it possible maybe to quantify that and say if we look out -- what you seeing now? How does that compare year-over-year, and maybe even how do these quarters that you have just reported compare sequentially to the second quarter of '06?

What you are seeing is that the price development for the raw materials, certainly from the start of the year, has been one where it has been increasing gradually over a quarter in Germany. In Canada, this development was really more sudden. It happened more as a result of the housing market downturn, where you are now experiencing certain curtailments in sawmill production.

So the Canadian situation is a little bit different. In Germany, it kicked off by the weather (indiscernible) shortage, and just increase has been going quarter-by-quarter continually. And it is likely that this will continue throughout the end of this year into next year. We are taking certain measures in regards to trying to get these prices probably back into line towards the second half of next year. So clearly, our expectation is continued increases, but towards the middle of next year, things will develop in the exact opposite, where demand and supply balances will come back more to the balanced situation that existed in the past.

In terms of the Celgar situation, it really is dependent on the overall sawmilling activity. But it's very difficult to project out whether these price increases will continue throughout all of next year or, similar to what we expect to happen in terms of the European, where there will be further increases, but towards the middle of the year, supply/demand situation would be rebalancing as a result of better sawmilling activity, etc., and prices then start to come down. So we are, let's say, less optimistic in the short-term, but a lot more optimistic in the longer-term.

That's helpful. Can you give us a sense of what you have seen for Celgar through October, maybe in terms of year-over-year price increases or even sequentially?

I think that there is further price increase development that we will see on average, because of course we have a lot of yearly contracts which will come up for renewal at the end of this year. So it is a rolling increase. It is not just an increase that happens month by month. It is a rolling one, because of course a certain amount of the wood is being purchased at higher levels, so on average, of course it is slightly higher.

And this will work its way through the system, all the way through into the first half of next year. Because as the cheap wood contracts come up for renewal, of course there will be higher-priced wood that we would have to contract, and this will be kind of rolling quarter-by-quarter. And as the supply/demand rebalances, then it will go the other way.

So it is not just we had a one-month increase in wood prices and it is reflected. It is not. It is really an averaging. And it is difficult to guesstimate as to what realistically we would get in terms of next quarter -- well, not next quarter, but let's say next year's type of average wood costs. We have a better idea in terms of quarter-by-quarter. But we think that right now, of course, we've been able to maintain the pulp price increases sufficiently to cover the pulp log -- let's say raw material price increase to date. But whether we can continue to do that, we are not certain.

Okay, thanks. Good quarter.

[Ben Carlin], AG Edwards.

Question is, you made several new hires and including attracting a new board member. Could you give us some background on those gentlemen and your thoughts are? That is question number one.

And question number two is, I know you were in China recently with your sales force. Can you give us a feel as to whether or not the large Chinese customers are going along with long-term price contract thinking as opposed to trying to buy cheap on the spot market?

I think of the new hires, of course, in terms of the COO position, which is a newly-created position. We have first Mr. Isacson come on board. He has very extensive experience in the pulp and paper sector from Scandinavia. He had several executive positions with Norske Skog, as an example. He is very knowledgeable in terms of the technical and production issues.

And really what we are looking for is to better coordinate mill activity, try to really learn from each mill in terms of the best performance and really nail down in terms of capital investments moving forward, so that we are expanding the dollars a lot more tighter or the dollar value certainly for the investments will be something that makes sense for us. I think this is something where, on an overall basis, Claes's contribution. I think, will go a long way, as well as coordinating a lot of the group activity as a single type of entity rather than individual mill activity, which has been really the way it has been because of the rapid growth to date.

Also is experienced in regards to wood and his knowledge of Asia. He was very much involved with Indonesian operations. So I think his broad base of experience certainly will go a long way in improving our overall performance for the future. And he is much more senior, which means that also at the same time, he will give our existing midlevel management the depth of his experience sharing that will further elevate their skill sets moving forward. And this will certainly aid in their own development as well.

In terms of the new board member, George Malpass, George actually comes from the solid wood part of the business. And we felt that his contribution, in light of the fact that of course we have now issued in terms of raw material in Canada as well as in Germany, his knowledge in terms of the solid wood business would be very, very useful, and a great contribution to the group.

He has been a good -- phenomenal entrepreneur in the past as well. He built up his own business, as well as a lot of public market experience in the forestry products type of industry. And overall, I think his contribution to the Board as an outside director clearly is going to be something which will strengthen our overall Company.

In terms of the China situation, I was just there. It is very clear that the Chinese recognize that the capacity for NBSK is quite constrained. They also recognize the fact that they need to develop relationships on a long-term basis because of course their capacity is increasing. Also, they are going to invest a lot of money in further capacity increases.

A large amount of that is going to be in the tissue area, which means that they will require anywhere between 30% to 40% of their fiber in softwood. And clearly, they are doubling and tripling of capacity in the next three to five years certainly means that there is really very little likelihood that there is going to be available supply to meet the expected growth ambitions that they have.

So they are very anxious to develop a really long-term relationship. They are aware that there is going to be less softwood producers in the future. And at the same time, they are very much aware of the raw material situation developing in Canada, because of the softwood lumber agreement, as well as the overall downturn in the housing market. So they were quite aware of that. They wanted to discuss that when I was there.

I discussed growing trend in regards to biomass energy, because of course this will have an impact in regards to potentially the Southern Hemisphere producers, because clearly the best plants in terms of efficiency to convert sunlight into biomass are the trees which are presently being you used for the hardwood production.

As an example, eucalyptus is very efficient. And in the past, there was different types of eucalyptus which were grown mainly for the coking requirements, and therefore really more as an energy type of source than really a fiber source. Now, the species have been more fiber requirements rather than energy, because there is no reason why that trend may not reverse the other way.

So it is affecting not just the Northern Hemisphere and users of wood, but really it could potentially have an impact in terms of the Southern Hemisphere producers of pulp as well. So I think this is a growing trend, as long as oil prices and energy prices remain at these levels, as well as the fact that there is a drive in regards to emission reduction overall for C02. As you know, biomass is viewed as C02 neutral.

I hope that kind of explains some of the stuff.

Thanks, Jimmy.

[Marty Kaplan], (indiscernible) Capital.

Most of my questions have been answered, but can you give us some visibility on CapEx going forward in '07?

David, do you want to maybe outline the CapEx program?

Yes, sure. I guess for Celgar, we will be finishing off the program in the early part of the year. And that will result in roughly 9 million for the year for Celgar. So 3 million or 4 million of regular, high-return capital and about 5 million, say, to finish off (indiscernible). Stendal, our projection is for EUR6 million and Rosenthal is for EUR5 million.

Okay, and then your SG&A number seemed to come down precipitously in this quarter. I was just wondering if that is something we can expect going forward or --.

I think the items that you saw previously were -- we had some onetime costs. Our equity issues, for example, we had some legal costs and mostly onetime stuff that has gone away.

Okay. So this quarter would be pretty representative of a run rate going forward.

I think so, running.

Okay. Then you pulled this equity offering a while back. Is that something that you're going to revisit, given market conditions, or are you happy to leave that on the sidelines for the time being?

I think it is not right now high on the priority list. We did feel that, based on the developments that we saw in terms of the wood as well as the logistics, that it would make sense for us to have a better liquidity, because of course there was potential use for investments in trying to improve the costs in those areas. We still believe that that is true.

But with the price developments in terms of pulp market and certainly (indiscernible) the performance to date, there is no urgency on our part to be going and trying to raise equity, unless it is done, of course, at very attractive type of conditions. So I would say it is not something that is high on the list right now.

Okay, great. Thank you very much.

[Pat Brown], Xylem Global Partners.

Thank you. Very good operations in the mills. A question on the derivatives. What calculations should we use to remove the effect of the derivatives to look at what the operating results were? Specifically, is there a tax rate that we should apply, marginal tax rate we should apply to the derivatives loss? And is there an adjustment that should be made in the minority interest to take out the derivatives effect?

I guess the derivatives are really like a long-term insurance against potential currency movements to the adverse, at least in the short-term, to operations. So on the interest rate side, it was fixed at the time we drilled the original tranche of the financing. So it was essentially mandated by the banks to go with a long-term interest rate. So if we would have actually just did it as a long-term borrowing at the 5.2%, you would not have this mark-to-market valuation, gains and losses.

Unfortunately after we fixed the interest rate, of course, long-term interest rates in Germany continued to go down. They have partially reversed, so they are now increasing, but still not to the levels that existed at the time of the financing. There may come a time where on a net-net basis, rather than having a fixed long-term interest rate just to go with the short-term floating rate, which is on the six-month type of float, which then would eliminate this valuation issue.

But unfortunately, the interest rates on the long end has not reached the levels. So it is not something that we can really control. All we look at and say, okay, we are paying 5 point something percent per year, and that is fixed.

On the currency side, really it is one where we have taken the original Euro-based debt that Stendal was financed and switched into U.S. dollar debt. Now what this means that is the full amount, which is roughly about 600 something million, of course over 15 years, based on fluctuations of the currency and interest rates, has a large impact. And that is why you see this movement in valuation. But really on a year by year basis, the actual cash payment on the interest as well as the principal amount is clearly 1/13 of that or 1/12 of that.

And it insulates us at the same time in the sense that if there is a sudden movement or a weakening of the U.S. dollar, we are able to monetize that value at one time, and this of course is a significant contribution in terms of an insurance against our margin losses as a result of a sudden currency change against the U.S. dollar. And that is why it is really an insurance premium that we are presently paying to insulate us against the sudden movement of the U.S. against the Euro.

There is a cost to it, clearly, because we are paying slightly higher interest rates. And of course, depending on what the exchange rates are between U.S. and Euro at the time we make the actual payments, there may be a slight increase in the amount that we have to pay. But clearly, in proportion to the overall risk, we feel that it is a valid insurance to date. And depending on what developments we have in the near future, we may monetize that, if we have a gain, and we may reenter or choose not to reenter it.

And, as you know, the projection by many of the analysts for next year is a significantly higher Euro against the U.S. dollar exchange rates. And this means that we will be insulated in regards to at least some of those margin losses if there is a shift in the exchange rate moving forward.

That is a very helpful answer to, I guess, what would have been my follow-up question, which is to understand better the philosophy behind the derivatives. But how would we make adjustments to the third-quarter results to look at what the underlying operating results would have been, excluding the unusual influence of the derivatives?

One of the clear issues is that operating EBITDA takes no account of any derivative movements So I think how you measure our operating performance is really to look at our operating EBITDA performance.

Is there a tax impact?

Jimmy, let me try to help [Ted] a little bit here. Ted, if you look on the balance sheet, there is an unrealized interest rate derivative loss and the unrealized foreign exchange derivative loss. So if those weren't there, the implications would be there would be an increase in after-tax retained earnings and there would also be a minority interest obligation on the balance sheet, because that loss effectively grinds down minority interest obligations. So you just have to reinstate the minority obligation and the after-tax benefit in retained earnings.

Okay, but on your accrual for taxes or the tax benefit, is that affected by the derivatives?

Yes, there is. There is a tax benefit and a deferred tax asset from the derivative part.

How large is that? What is the tax rate that would apply?

It is about 37% or 38%.

Okay. And is the minority interest affected by the derivatives also?

Yes, they are. Because in the Stendal system, if there are losses in operations they reduce the obligation to minority interest. They are not -- their shareholder-owned minority interest is not repaid until the entity is net income positive.

How much of the derivative loss is applicable to Stendal or to the minority interest?

It's part of the equation. You could see the size of them, because it's all the other factors as well. It's the net income of the Stendal system that drives that calculation.

Okay. Then let me just jump to another question. On the capacity, you are running above 100% on what you have been using as the capacity numbers. What should we think of as the current capacity for your three mills?

I think on the Rosenthal, you have to look at it pretty much at the limit of its capacity without fairly large investments.

Stendal we believe has further potential, but I think if you look at our monthly run rates to date, somewhere in the range of 600,000 tons is probably a good number. I'm not saying that is certainly the peak, but we believe that there is further improvement certainly moving forward on the 600,000. But 600,000 for now is clearly being demonstrated on a monthly type of performance basis.

Celgar, it is already up to -- we're seeing on a monthly type of basis run rates which would indicate that it is capable of probably around 470,000 plus, if not more closer to 500,000.

When could you get to the 475,000, 500,000 rate, do you think, at Celgar?

We have to complete out the necessary investments in the first half of next year, and we have to then fine tune all of those balances at least in terms of the equipment -- and go through the balance of the year. But certainly on a day-to-day type of run rate, even with existing equipment, the 470,000 type of run rate are there.

Another operational question. Have you seen any effect from the mountain pine beetle at Celgar? And what might you see in 2007?

Our forests really don't have a lot of pine, which are impacted, so we are not really seeing much impact in regards to the pine beetle. In the early part of this year, we did see fiber costs come down because of course there was the whole pine beetle issue. And of course the expectancy was that there would be flatter fiber. And so overall, it was kind of like a peripheral impact with reduced fiber costs.

In terms of the situation for us moving forward, clearly, our forests are going to be continuing to be healthy, and therefore we are not going to have the problem where you may have a sudden loss of raw materials because of a big fire or even the fact that these standing trees, which are dead already, will of course be too dry to consume.

At the rate that the pine beetle is moving, there's a lot of issues related whether these trees can be harvested in time to actually be commercially salvageable. So we don't have those problems in our area, and that is one of the long-term benefits, I think, that we have operating in the present locations at Celgar.

But short-term, you're paying more for fiber than the mills that are right around the Prince George area, where the impact is greater?

Well, Canfor certainly has an agreed arrangement with their pulp mills as part of their whole divestment. And it reflects, I think, the situation that existed for the Canfor Mills at that time. If you look at their announcements and what they have been saying, I think certainly even the interior sawmills are not insulted from the downturn in the housing market.

So fiber is not just the fact that we've got all these diseased trees, but it is also the result of a lot more activity. And if people are not cutting these trees because your sawmills are not operating, then your fiber availability is certainly going to change.

Is there any prospect of your going to whole-tree chipping at Celgar if the lumber (technical difficulty) proves to be --?

We have chipping capacity and we continue to, of course, use pulp log shipping, and we will continue to do that. And that is part of our overall, of course, --.

So you are there already, in other words?

(indiscernible)

Okay, thank you.

James (indiscernible).

Just one last housekeeping note. Could you give us the balances on each of the respective revolvers?

Yes. The Rosenthal revolver is completely undrawn at EUR40 million, and the Celgar revolver has 8.6 drawn against an availability of about double that, so 17.2.

All right, great. One last item. In terms of fiber cost, to touch on that again, as this moves up through the balance of the year -- and I don't know if you've commented on this in the past -- but could you provide guidance as to what percentage of cost of goods sold fiber costs are in the higher environment and kind of maybe where they were in the past?

Are you talking about the percentage of wood costs in our overall operating costs or--?

Percentage of total operating cost, actually. I realize fiber is a percentage of the raw materials and, just in particular, what is fiber? Is energy 20%, 30%? Is fiber 25%?

It depends -- big differences geographically.

Is there an overall figure that you could guide us to, say, for 2006?

I think if you just -- this is really rough-cut averaging, but if average fiber costs are somewhere in the EUR170, EUR180 range per ton, and operating costs for us are just a little bit south of EUR300 per ton. So, it's a big number, right (multiple speakers)?

Naturally. Thank you very much.

Jim (indiscernible), [EBS & Associates].

With the performance you had in the third quarter, and you extrapolate that forward, it appears you will be generating significant cash flow going into '07. Would you be using that to reduce debt? What would be your plan for that?

Of course, you have the restricted and nonrestricted group. The cash flow development certainly is quite strong at both levels. And on the restricted group, there is of course opportunity, depending on the price for our debt, to look at potential buybacks. We do not really have any revolvers to pay down at Rosenthal, and the revolvers that we have at Celgar are again quite small. So those will likely not be big issue. Of course they will fluctuate. But given the right moment, there may be opportunity for us to repurchase some of the debt, depending on the price.

Other than that, it would just go towards building the cash balance?

I mean, as I said, there is opportunity for us to try to improve our overall raw materials as well as logistics costs by having stronger working capital in certain of these areas. So maybe some of that cash will be used as working capital enhancements to improve our costs in procurement of wood as well as trading of wood, as well as how we ship our end products to reduce our costs.

But other than really more working capital type of investments, I don't think there's any specific use that we have in mind.

Great, thank you.

[Brian Doyle], RBC Capital Markets.

The revolver, you just went over it, but I was a bit confused. I thought the Celgar line was 40 million.

That's right. But it limits itself based on the (multiple speakers) available.

Okay, that's fine.

And we're talking Canadian versus Euro as well.

Thank you.

Andrew Shapiro, Lawndale Capital Management.

Since we are betting cleanup here, we have a few things we just want to touch on here. The first is, we talked about Celgar and the optimum reliability. On a scale of 1 to 10, you obviously have improved the reliability from prior levels, but you have also implied that there is more reliability enhancements to be done. So on a scale of 1 to 10, 10 being the most reliable, optimal reliability, where do you feel you are with Celgar?

I would say around 7.

Okay. And with Stendal, could you discuss where you are in the process of finalizing things with the contractors and to what extent you think we will collect financial refunds versus them, let's say, conducting further tweaks to the plant to expand its capacity even further?

We are in continued discussions. There's a lot of issues in regards to experts and also our discussions with the various members of our group, their group, etc. We do have an internal kind of guideline to try to come to some form of conclusion by the end of the year. But really, there is no particular reason as long as they continue to maintain the necessary guarantees that that should be a particular kill date.

So I think that moving forward, because of the complex nature of the discussions, it is very difficult to guess when they will conclude and what type of deal that we will end up essentially doing at the end. However, we do believe, based on an the performance as well as the tests that we have done, that we do have certainly some claim on quality and other issues, on the equipment that they delivered.

And therefore, we believe there will be some form of benefit that we can work out. Whether that is in cash or in equipment or some other form we will have to see. But it is very complicated and there's a lot of different issues that are on the table. So it's impossible to guess.

Okay. You realized a gain of about $360,000 on the sale of thee paper assets of Heidenau in Switzerland. How much, if anything, did those assets generate in cash flow or were they losers?

They were positive cash flow generated, but I think the biggest problem moving forward from our perspective was really the reinvestment that was needed. So the projection was that although there was cash generation, if you look at on the need to continue to invest moving forward, if you're going to remain as a paper operation, it was probably larger than the cash flow being generated.

Right. And the remaining assets to be sold, are they as equally positive cash flow generating or they are a little weaker or not as favorable assets?

No, that one is far less competitive. It has always been the weakest operation. And therefore, clearly, it is not something that is going to be easily controlled or dealt with.

And long will it take for you and the Board to come to the decision of what options you're going to do on that one?

I think it will be reasonably quick, because, as you know, we are only now down to one mill. And it does not really make a lot of sense for us to be hanging onto one mill.

Okay. Are you taking the view on the emissions credits that they have gotten too cheap or that you'll need the ones that you have left, or what are your thoughts with respect to credits going forward?

You know, they have no value once basically the year is out. So clearly, if we have an access in terms of allowance, it only makes sense for us to be looking at disposing of those excesses.

Is that a calendar year type of cycle?

Yes.

So then there's some emission credit activity probably you have here for Q4 then?

Yes.

Can you give a range or an estimate as to kind of what it might be like?

Well, we said that basically the revenue on the income out of the emissions will be very close to the prior years, and it is a combination of some hedging and actual sales. So all I can say is that the yearly amount will be close to last year's. So it will be (multiple speakers) was crystallized in the fourth quarter.

So when you say comparable, you were not referring to fourth quarter versus fourth quarter, but more year-over-year.

No, year-to-year, year-over-year.

Why was the SG&A off -- reduced so much sequentially? How much was it onetime maintenance charges that were in there last quarter versus onetime factors in this quarter's SG&A?

I think most of the SG&A issue as it relates -- it is not to do with the maintenance. As David explained, the SG&A drop was because we did expense out certain costs of the financing that we of course were trying to do in the second quarter.

That's good -- okay. And that was a sizable drop. So was this more of an ongoing rate that we see now or are there onetime factors in this quarter's SG&A?

No, I think the third quarter is probably indicative of the type of expenses that would normally be there, unless we were doing something extraordinary.

Excellent. Just a few more here. What are your thoughts at this stage then on the use of the cash proceeds from operations? Does the Board and you have an optimal level or optimal ratio of debt you seek to get down to, and thereafter plug away, looking at other alternatives?

No, I think if you look at our interest rate costs, certainly on the Stendal side --

Yes, those are very good.

It is still very good. And therefore, if you look at other producers, we are able to maintain higher levels of debt and still -- although the ratio is high, it is not that high in proportion to the amount of interest that we're paying.

And that is why the ratio is a little bit skewed, because if you look at the restricted group, that debt to equity or debt coverage to cash flow certainly is quite reasonable. So I think you have to look at the company in two pots, one which is the unrestricted and the restricted group. And on the restricted group, clearly the debt ratios and the cash flow to interest payment etc. are quite in line with -- and it is fairly comfortable.

So within the restricted group, though, you do have some high stated rate borrowing costs. What are your thoughts on --?

And clearly those are going to be the ones which are the most attractive for us, because you know we do have debt out there, which, from our perspective, is expensive. And given the right opportunity, it makes sense for us to really buy those back. It is not because of the debt/equity ratio or anything else, but really, it's more the fact that it makes sense from an earnings as well as a cash flow perspective to be looking at potentially buying some of that high-cost debt, given the right time.

You also have some converts that are deep in the money. What are the Company's abilities to force or --?

We don't really have an ability until 2008 to really force anything, so we are a little bit limited in that regard. And of course, we would like to have the converts either converted or purchased. But unfortunately, the converts are trading at prices which are -- of course, from an interest rate perspective, the yield is not that -- it is a different type of the equation, as you know.

Yes. No, you take that out, you're removing dilution along with a lower-cost coupon.

Yes. We have to analyze exactly what is available, and it is not something that we can really go out in the market and try to. If, given the right opportunity, certainly we would women look at, both at the senior debt level as well as the convert.

Are you allowed to pay a dividend with the current debt instruments out, or which debt instruments have covenants precluding the cash dividend?

It is the senior notes which basically have the debt restrictions in terms of the dividend and etc.. But it is dependent on certain cash flow tests, etc.

Last question sort of got into the Stendal transaction. I think this puts you up at around 70%. But can you share who you bought this incremental interest from, and did you have a fixed-price call on acquiring this? Or how was the value determined at which you were to buy this percentage interest?

Basically, there was no call or any other type of option. The position came from the actual group which used to own the site. So they were the original party to the actual development of the pulp mill initially. And they contributed the equity in cash, like everyone else at the time the project financing was completed.

That company was later acquired in terms of the actual ownership, ultimately, by MFC -- or now I think it is called Humboldt, or something like that, which is (technical difficulty) company. The price determinant was really more based on the actual equity that had been contributed in the beginning.

So are you implying that it was -- you got to buy them at their cost? No.

Yes, essentially what their cost plus the accrued type of shareholders' loan.

So it was more like a debt takeout.

Well, it was a combination of equity and debt that we had contributed into the project companies. So what you have is the equity component for the investment and then you also have shareholders' loans.

I guess what I'm trying to get at is your takeout for EUR8.1 million for a 7% interest implies a $115 million equity value to Stendal.

Which is basically, if you look at the original investment that we made, which consisted of equity and subordinated loans to the project company, was EUR100 million. So basically, it was taken out very much at their cost.

Rather than some type of fair market arm's length valuation on the equity, based on the fact the plant is now up and running?

No, it was basically more related to the original investment. Although of course there was models in regards to the valuation (multiple speakers) 7% is not something where it is a big impact.

So arguably this could have been a -- this could be a really big, good deal for Mercer, in terms of 7% incremental ownership.

We think that moving forward that the investment made sense for us, because of the structure of the deal that we were able to do.

Right. What are the terms of the note rate, its duration, and the conversion terms that exist on this new note?

I forget the exact interest rate, but we have the right to essentially repay that note in equity, based on a trailing average price equation or to effectively pay it in cash.

I think the note is a one-year note.

Oh, it is a one-year note. So this -- you'll convert it to equity or it will get paid off fairly quickly. Excellent. Thank you very much. We're done.

We have no further questions at this time. Management, do you have any closing remarks?

No, I think I appreciate everyone attending today's call. I think that we -- as I said earlier, I am quite optimistic in regard to certainly the pulp price development for NBSK. Unlike many of the other published numbers out there, I am not pessimistic.

But at the same time, as I earlier indicated, I think the biggest challenges moving forward for us is going to be in our raw materials. This is not something that can be addressed short-term. It will be something that will occur throughout the year. We believe we have the right programs in place to deal with this.

But overall, we think moving forward certainly this year is going to be very positive and we think moving forward into next year, again, probably a very good year. On that, again, thank you very much.

This concludes today's Mercer International conference call. You may now disconnect.