Mercer International Inc (MERC) 2007 Q2 法說會逐字稿

Good morning. My name is Tia and I will be the conference operator today. At this time, I would like to welcome everyone to the Mercer International Second Quarter Earnings conference call. (OPERATOR INSTRUCTIONS)

At this time, I would like to turn the conference over to Ms. Alexandra Tramont. Please go ahead, ma'am.

Thank you. Good morning, and welcome to the Mercer International 2007 Second 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 the Company's filings 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.

Thanks, Alex. I welcome everyone to Mercer International's Second Quarter Earnings conference call. As usual, I will begin by making a few prepared remarks regarding the results of the quarter, followed by a question and answer period.

We're generally pleased with the Company's performance in the quarter. All of our mills run well, and we completed the majority of our annual maintenance, leaving us well-provisioned to run full for the balance of the year. Pulp markets remain strong, and as expected our fiber pricing in Germany has begun to moderate.

Reported net income from continuing operations for the second quarter of 3.3 million Euros, or 9 Euro cents per basic and diluted share, compared to 18.3 million Euros, or 55 Euro cents per basic and 45 Euro cents per diluted share in the same quarter a year ago. Net earnings in the quarter included a pre-tax, non-cash gain of 18.1 million Euros before minority interests and our outstanding interest rate derivatives. This compares to the same quarter in 2006 when we recorded total gains of 44.7 million, and our then outstanding currency of interest rate derivatives.

Our operating EBITDA in the quarter was virtually unchanged from a year prior at 25 million Euros, and slightly lower than the 28 million we recorded in Quarter 1. Sequentially, our EBITDA was positively influenced by stronger pulp prices, higher productivity and moderately lower fiber prices in Germany. These improvements were more than offset by the production and cost impact of the annual maintenance shuts, and a weaker U.S. dollar compared to the Euro.

During the quarter, we completed our annual maintenance program at our Stendal and Celgar mills, that shut -- idled the mills for an aggregate of 24 days. And we took advantage of the time to complete some productivity capital projects, including the final phase of our Blue Goose project at Celgar. Both mills started up well and achieved near record production in June.

We also made considerable progress during the quarter in working with our Stendal construction partners, to conclude a final settlement of outstanding matters on the BPC contract. We expect to be able to finalize these matters in or about the third quarter of this year.

In Rosenthal, we are pleased to have concluded a new labor agreement with the union representing the majority of our employees. Their agreement contains provisions to lengthen the work week to more closely match industry practices, and provides for a 3% wage increase over the next 18 months.

Fiber costs continue to be high when compared to prior periods, approximately 39% higher in the quarter when compared to the same quarter of 2006. However, the wood situation in Germany is much better in recent months, due to the combination of increased lumber production activity, as well as increases in overall harvesting of the wind-damaged trees. And we should see further reductions in our wood cost for the balance of the year.

In Canada, we expect that the wood cost will remain steady at these elevated levels. The market for NBSK pulp continues to be very strong, and we are very optimistic this will continue for the balance of the year. Inventory levels for both the producers and consumers are at historic low levels, at a time when there is significant risk for further sudden supply disruptions, especially with the recent announced workers' strike in coastal BC Canada.

List prices for NBSK pulp in Europe increased in the quarter by $26 U.S. per ton to $783. This compared to $665 U.S. per ton in the second quarter of 2006. Although from a U.S. dollar perspective, NBSK prices are at historic high levels -- from the Canadian and European producers' perspective -- the prices are still at what would be trough prices. The bulk of the price increased to date have been due to the weak U.S. dollar, as well as the increase in input cost such as wood fiber, and not really reflecting the supply-demand balance that presently exists.

We believe with continued demand growth that prices will continue to increase. There has been no indication that the wide price gap between NBSK and eucalyptus pulps will diminish. The fact that capacity for eucalyptus pulp will significantly increase this year has not resulted in any reduction in the demand growth for softwood pulp. It is a clear indicator of our belief in the continued demand growth for NBSK.

Looking forward with the bulk of our downtime taken at our operations for maintenance, and strategic capital investments behind us, we are now well positioned to capitalize in the developments in the second half of the year. We had indicated on our earlier communications that the first half of this year would likely be our weakest, due to the wood cost developments at the end of the prior year, as well as the scheduled downtime in the second quarter. We remain focused on increasing margins by reducing costs, as well as increasing the mill availability at all operations, and improving the results on our by-products such as excess power.

That concludes my prepared remarks. So on that note, I would like to now open this call to questions.

(OPERATOR INSTRUCTIONS)

Your first question is from Kevin Cohen with Banc of America Securities.

Good morning. Thanks. I was wondering if you guys could comment a little bit in terms of your outlook on NBSK pricing, in the context of your FX comments and pricing being kind of at trough type levels. Where do you think pulp pricing can go over the next couple of years?

Oh I think pulp prices potentially -- as long the U.S. dollar remain at the type of weak type of levels -- could increase significantly higher in U.S. dollar terms from here. If you look at present pricing at around $800 U.S. level, clearly this kind of represents equivalent prices in U.S. dollar terms probably will about $600 in the prior periods. So you're looking at potentially anywhere between another $200 to another $400 type of potential U.S. dollar increases, if you look at prior historic type of peak conditions.

Great. And then can you guys quantify maybe the cost of fiber, in terms of the hit in the quarter sequentially? Or year over year as well as FX?

Yes. In terms of the increase, as you know, the increase in fiber cost probably from the prior year was probably more than over 50%. And I think if you look at the prior year--

I meant in dollar terms if you have that roughly.

You mean in terms of how much it cost us in a quarter?

Yes, in terms of dollar terms because we've dropped (inaudible) year over year just for fiber, and also for currency to the adverse affect there year over year -- or sequentially.

Well if you look at one of the mills -- if you look at Stendal, the impact in the quarter in terms of the foreign currency to the -- let's say to the budgeted type of numbers -- would have been about a $4 million difference. And the wood represents almost more than an $18 million difference.

Do you have it for the restrictive group?

On the Rosenthal -- well if you look at on a budget type of number for the first half of the year -- from the budgeted type of numbers versus -- on the foreign currency for Rosenthal would be about $2.6 million, and the wood impact was almost $7 million. And on the Celgar the impact was -- second quarter wood cost would have been about $3 million -- about $4 million, and the currency about $3 million.

And that was the second quarter at Celgar? Not the first half, just the second quarter?

Yes. So you can pretty much double that.

Right. And then just lastly -- what kind of export activity are you guys seeing to Asia, given the fiber situation and the ongoing labor strike? How do you see that situation resolve?

Well the labor situation doesn't really impact us, in terms of our wood supply, etc. So our export markets, of course, are to long term customers. So there's -- it hasn't really impacted directly, other than of course you're getting a larger type of purchasing just recently, or a pick-up in terms of purchasing, because of the potentials here that there will be closures on the coast. But it hasn't really had a big impact to date.

There has been inquiries in Europe from people who normally would buy from some of the coastal mills here, because of course the planned -- let's say closures or indefinite closures of some capacity. So you're getting interest from people who would not be buying from us in the past, as well as pick-up in terms of volume in anticipation that there may be potential supply disruptions. But nothing significant to date.

Okay. Great. Thanks a lot. Appreciate your thoughts.

Your next question is from Ben Carlin with A. G. Edwards.

Good morning, Jimmy.

Good morning.

Interest costs were down substantially in the quarter. Obviously the balance sheet is improving modestly as you're paying off debt on a scheduled basis. But that doesn't account for the big ponded interest costs. Can you give me run through how that works, please?

Hi, Ben. David here. Well there's a few things. In the first quarter we still had our currency swaps, and that had an interest carry associated with them. So in the second quarter you're seeing the absence of that. And then the rest of it's really just generally principal reductions.

So you'll recall we -- in the fourth quarter we converted a portion of our convertible debt. So we've got lower interest costs there. We've had some principal reductions on the Stendal debt. And princ -- really that's what you see in the second quarter, is really the moving forward with general declines as we decline principal going forward.

And you're coming up on the window in the fall of '08 -- a year out basically -- on the potential for forced conversion of the convertible fir. Is that correct?

Yes.

How much of that is still remaining outstanding?

Well that'd be 49 million Euro.

Fine, 49 million Euro. Okay. And then the last question is -- the Pope and Talbot situation -- they've got about 850 -- I think 830,000 tons of capacity.

Yes, that's right.

Are you anticipating there's a reasonable likelihood that that capacity could shut down?

Well you have -- they're a high cost producer. We can't really speculate as to whether they will shut down or not. But clearly the wood situation on the coast -- because of the strike -- could impair their fiber supply to a level where they will have to take closures. The other aspect of course is their weak financial condition.

So there is many issues which surround Pope and Talbot presently. But we are not necessarily anticipating that this capacity will shut down in the near future. But certainly it's a capacity or a volume that's -- is presently questionable. There's no question about that.

Any other -- I guess a million tons of capacity was announced to be shut down last year. Is all million tons shut at this point? Or is there still some to come?

Well there was over a million tons which were shut down, and of those approximately 1.4 million announced and closed. The Thunder Bay operation did come back. So there was about a million tons which were shut and remain shut. Our guesstimate moving forward -- we've always said there was probably more than 2 million tons of NBSK kraft which is likely to close in the coming years. We still believe that to be the case.

So we still believe there is at least another million tons which is likely to close in the coming years, as a result of age of the facilities, fiber availability, as well as the high cost related to the currency issues.

Thank you, Jimmy.

Okay.

Your next question is from Mark Bishop with RBC Capital Markets.

Good morning, Jimmy. A couple questions -- first just wanted to follow-up on your comment on the potential upside for pulp pricing, and I don't want to put you in a position of forecasting prices, but first -- I assume that was in dollars, not Euros -- the $200 to $400?

Right, right.

Just wondered how you see that in terms of how it might jive with your paper price outlook, and what your customers might need to support that kind of growth in pricing, or what you could effectively pass on to them without a whole lot more upside from their own end prices.

Yes. Clearly right now if you look at the European paper makers -- although the paper demand seems reasonable -- their pricing power has been quite weak. But if you look at the cost of their raw materials -- although they've been going up slightly -- they haven't really come up because of the real strength of the Euro.

And if you also factor in the fact that the bulk of their cost is going to be on the hardwood side, their raw material increases have not been as significant to the European paper producers, as compared to the dollar denominated producers. So clearly for us, our immediate customers need to have more pricing power. I think the demand side is reasonably good.

So the question is is there going to be really the strong will to take the closures -- which will rebalance the supply and demand situation -- that they are now in a position to have better type of prices which I think are needed. I don't think if you look at the pulp producers, many of them are still operating at very low margins. Some are still losing money, even though we have such high U.S. dollar denominated prices for NBSK.

So I think that there is a need on all sides for better pricing, as long as these foreign -- the currency remains strong for both the European as well as the Canadians. And I think that's the reality. It's not that we think that we have lots of price increases just because we can push it. It's just the reality of the business right now. The costs have come up for everyone to a level where nobody's really making a lot of money.

So is that the principal reason why the pulp producers have not pushed prices faster and harder -- is they appreciate the pricing and their customer situation?

No, I think that it has -- if you look at this year, we've increased prices quarter after quarter. The problem is also the currency have moved quite significantly quarter at a quarter. So although we've gotten some increases, the currency movement has been quite significant. And I think that has taken away a lot of that price impact. At the same time, I think there is some hesitancy on some of the other producers, in regards to the rate of increase in prices. So that has (inaudible) for that.

And I think there is positives and negatives to that, in the sense that it gives, of course, our customers time to adjust. But if you look at the reality, we have not -- the paper guys have not been able to take that opportunity to really get any increases. So I'm not sure whether it's really having the effect that I guess we would like to have, which is to buy them time to get the prices.

Okay. In Northern Europe, are you seeing some evidence now of the fiber shortage -- particularly in Scandinavia -- impact run rates and impact closures of pulp mills up there?

Yes. Clearly some of the Northern European pulp mills are operating at levels which indicate clearly that there is some supply constraints on their raw material. And this is mainly on the hardwood side. The softwood of course -- there is attempts by many to try to produce as much softwood to compensate. But we're not talking about significant amount of volumes that are going to change.

We're also seeing certain customers which would not necessarily be buying from us, which has entered into long-term contractual arrangements, which clearly indicates that within these larger groups -- which also have pulp capacity for softwood -- there really isn't sufficient production. And that means that there must be supply of raw material constraints.

Okay. That was my next question. So you are seeing some inquiries and contracts driven by concerns of availability up there?

Yes. Well we're getting customers which who would not really be buying from the outside. So we're getting customers which clearly already had or have capacity that normally would be buying from their group. But we're getting pretty good type of volumes coming out of groups which typically would not buy from us.

Okay. Great. Question on the APC contract -- and I apologize if you mentioned this at the beginning of your remarks, but I missed the first couple of minutes. You did suggest that you're going to be seeing the settlement of -- or the final settlement of the contract. I'm just wondering what you expect to see out of that this quarter.

Well it will not have an impact in terms of the earnings or any other thing -- if any settlement of these type of discussions impacted the asset side. So even there -- even if there is a payment, what it happens is that it goes against the value of the equipment. So it doesn't have an earnings impact. It may of course improve our tax position.

But we're getting paid, or whatever proceeds we get from the settlement of course reflects some of the improvements that we need to make on the equipment. So I think it's the substituting one for the other, in the sense that in the long run of course we have to make certain investments and changes, which will take money. At the same time, we are getting equipment in lieu of funds.

We are getting other warranty extensions and other type of benefits, which clearly are positive but not necessarily quantifiable in terms of dollar values. But what I think is important is that now we are establishing very good -- or getting back to normal type of relationships with the equipment suppliers, and no longer stressing these type of relationships, which is very important moving forward.

And at the same time, we of course have major pieces of equipment that which now have reached a level where we believe that they're going to run more reliably going forward. And this of course makes a big difference.

Okay. So we shouldn't expect on a cash impact side much of an impact from that settlement?

No. I think that even as a combination of equipment, cash and warranties and stuff. So I don't think from a cash perspective it'll be really material.

Yes. Okay. That's great. And just finally on the Blue Goose project -- I'm just wondering if you can just remind us broadly what the impacts you expect to be, in terms of productivity at the mill, so overall capacity and perhaps sort of a run rate impact if you could on cost?

Yes. The purpose of the Blue Goose of course was to de-bottleneck the production equipment to a level where we expect to produce somewhere in the range above 470,000 to 480,000 tons. It's likely that this mill will in time reach probably 500,000 tons on an annual basis. It should improve the overall chemical costs, in terms of the actual bleaching process.

So it's a combination of increased margins from the production volume. It hits of course the fixed cost and also reduced chemicals. So moving forward, I think when we had budgeted this particular project, I think that the EBITDA contribution I think when we modeled it was slightly above $30 Canadian per ton type of range. We think probably in the long run it will be better than that.

Okay. So you'd still be in that $30 range. And that is essentially starting this quarter, and that would be effectively a $30 per ton variance over -- say the run rate (inaudible)?

Yes. I think you'll have the improvements as you move forward, as the production volumes will increase. And so I think as we move forward, you'll see those margin improvements. And I think further there's probably potential to have better margin improvements than that that we budgeted originally.

Okay. And so just to clarify that was $30, not 30 Euro per ton?

Right, right, right.

Okay.

$30 Canadian.

Okay. Great. That's all I had, Jimmy. Thanks very much.

Great.

Your next question is from Herve Carreau with CIBC World Markets.

Yes, thanks. Just a few questions -- just to follow-up on the cost -- the upside for cost on a cost structure. Can you quantify the what was the impact of the downtime at Stendal in the quarter?

Yes. I think the total downtime costs for all of our sort of (inaudible). Stendal and Celgar was about 6.9 million Euro.

Okay. So we can add that to the -- well redo the cost structure by that amount, plus the improvement at Celgar?

Right.

But when going forward. Okay. And just another question on -- can you provide some numbers in terms of shipments and sales figure for Stendal in the quarter as well?

For Stendal or Celgar?

For Stendal.

Okay. The Stendal operations basically for the quarter -- the production volume in total tons was approximately 140,000 tons.

Yes.

And the dollar volume was $140 million for the quarter.

Okay. Great. Thank you.

So good today?

Yes. That's it. Thank you.

Okay.

The next question is from Steve Chercover with D. A. Davidson.

Thank you and good morning. My first question was going back to the wood costs and supply in Germany. Jimmy, you indicated that salvage of wind-blown timber should help in the second half of the year. But is there any concern that the demand from biomass will creep up again in the winter and impact costs? And also has there been any impact from the Russian logging -- the tax on Russian logs?

Yes. In terms of the present situation, the wind-blown lumber or the wood, including the present sub-milling activity, clearly indicates that we will not have any real fiber issues moving forward into the big part of next year. The lumber activity until very recently in Germany has been very positive because of housing construction based on wood.

At the same time, there is projected to be further sawmill expansions, both of existing as well as new projects moving forward. This will mean that availability of sawmill chips will increase. At the same time, the pellet sector has of course suffered a lot, as a result of the very warm winter conditions at the end of last year. And so they are sitting on a fair amount of inventory which needs to be cleared.

At the same time you've had new production of pellets now coming on in North America, which of course will tend to temper any potential price increases as a result of any real harsh winter. So I think the situation moving forward is different than what we faced last year, when you had really limited pellet production capacity in a rising demand market. But that's different today.

You got inventory in the system. You got new capacity, which also has lower cost because of lower fiber availability, both in northern as well as southern hemisphere. So I think that you'll see that the impact of the pellet or the bio side is going to be quite mute moving forward. The biomass -- the liquid type technologies are still quite far out in terms of potential competition for supply. So that's probably not likely.

But of course there is growing overall demand for biomass to energy. And I think that will continue. But it's not something that will have quite the impact that we've seen in the prior year. That was a bit of an anomaly.

And has the Russian tax had any impact on your procurement?

Well we're seeing some increase in procurement activity around the Baltic area, which we would have expected. So that had some limited impact. But it is very expensive to move wood from the interior of Germany to Northern Europe. So I don't think that the big impact is going to felt.

You're getting some limited purchasing around the Baltic coastal areas, and of course the northern part of Germany. Clearly it is part of that. But overall I don't think the wood prices will be highly influenced -- certainly in the German area as a result of the Russian timber taxes.

Okay. Switching gears a bit -- it's been a year now since you've exited the paper business. And I believe those assets are now traded as Fortress Paper. Do you have any kind of earn-out? Or is there just zero relationship financial or otherwise between you and those former paper mills?

No, we do have still a debt which is convertible in through the equity at our option.

And how much is that, please?

I think it's about 10 million.

Do you have any intent to convert it?

I think we'll have to face that decision when we are allowed to convert and sell. So at this point we have a lockup for six months. And at the same time of course, we have to examine what the situation will be when we face it later on.

Great. Final question -- with respect to your treatment of derivatives, it seems like it's getting a little bit less complicated. But it still seems to always cloud the numbers. Do you have any plans to change either the use of derivatives? Or maybe how you present your financials so that a cleaner number was easier to come by?

Yes. I think you can actually look at our derivatives. It's really not let's say -- the word derivatives kind of makes it look like we're doing some very complicated type of financial structures. But it's not. All we did was -- on the interest rate we fixed it at around 5.2%. So because the underlying debt facility was a floating -- if the floating interest rates of course will move against whatever the fixed rate will be.

And that's really the valuation difference against the life of the loan. And because it's a fairly large facility, you're going to have significant type of movements. That was entered into at the time we actually drew the first dollar out of the project finance. So it wasn't really something that we chose to do. But it was part of what was needed to be done because of the situation after September 11, which had impacted the insurance premium market and other type of events as a result of that event.

And so we of course now have come to a level in terms of interest rates and the loan rates, which now are closer to when we originally entered into the swaps. If we now have a profit, the Company may unwind that. But we'll have to face that decision when we get there. In terms of the currencies, we felt that the U.S. dollar was vulnerable, and that's why we had swapped our debt facility into U.S. dollars.

But because of the change in the interest rate curves between the U.S. and the Euro, well what we found was that the currency exchange rates have to move a lot more significantly for us to actually get any realized values. And so in the first quarter of this year, we chose to unwind those swaps because the higher interest rates that we are paying, in combination with the potential risk certainly offset any benefit that we would have been able to get, because the impact of the movements weren't as big recently as in the past.

And that's why we've basically unwound that. And unless the situation changes, we're not likely to enter into those currency swaps, because the impact doesn't seem to really mirror the short term movements in currency. And it's not giving us the true hedging or any potential hedging that we used to have in the prior years. And that's really what happened.

In terms of reporting, it's just basically what the market valuation is against whatever we had already swapped into. So there's really not much we can do in regards to how we report those numbers.

Yes, but I suppose if you look at some of your -- and it's -- you guys are a bit of a hybrid with European operations, and Canadian headquarters in the U.S. stock. But the way some of your Canadian counterparts express their financial results, they will say GAAP of 9 Euro pennies, and then operating number I think in your case would have been a loss this quarter. And I think it would help perhaps to -- for the street to have it as transparent as possible.

Yes. We tried to make it out as much as we can. I think the number that we tried to use of course is the operating EBITDA. There is a difference in terms of the requirements under the U.S. GAAP versus Canadian GAAP. So there's not much we can do about that. But we try to filter out the noise by giving you a number which is more representative of the operating cash flow, which you can also compare against the Canadian competitors, which have a similar type of operating EBITDA type of announcement.

And I think that's fairly apples to apple type of comparison. I think, too, the Canadians also have this influence of the U.S. dollar denominated debt, which tends to skew the reported numbers. Theirs is simpler because of course they just have the facility in U.S. dollars. We have more complex structures that we can deploy. And that's why at some points, clearly we have much more complicated type of swaps, because we have better facilities. Many of our competitors have no facilities to enter into any of these. And that's what has made us fairly competitive in the past.

Sure. Well that's great. Thanks so much. And good luck in the quarter to come.

Thank you.

Your next question is from Aaron Rickles with CIBC.

Hey, good morning. Thanks. I was hoping we can get back a little bit to the maintenance discussion. You talked about 24 days of shuts between Celgar and Stendal. Is it possible to I guess to start off by splitting the days between the two? And then you also mentioned 6.9 million Euro impact on a cost basis. Can you split that between Stendal and Celgar? And then when you mentioned 6.9, is that just the cost of maintenance? Or is that the cost of maintenance and the impact of spreading the fixed cost over a smaller production base?

No, that's just basically the maintenance cost, in terms of the actual dollars spent.

Okay.

So if you look at the maintenance shutdown, we had ten days at Stendal scheduled, and we had roughly the 14 days scheduled at Celgar. And if you looked at the shutdown dollars of that 6.9, about 2.7 was Stendal and 4.2 was Celgar.

And then of course there's the impact of the fixed cost. Is it possible to ballpark the amount of cost (inaudible). What's that? I lost him. Hello?

Yes. Of course we had lost a certain amount of tons. If you looked at our average between the two mills, what you've got to factor it into 24 days of tonnage.

There was 36,000 tons that was lost roughly? Is that--?

Roughly.

And should we -- can we look at the ten day and the 14 day on a pro rata basis for those, so it'll apply that? Is that fair?

Well I guess what you would use is our average EBITDA margin.

Right.

And just factor the 34,000 tons as being a reasonable kind of guesstimate.

Okay. Okay. We can go back to that. Can you -- would you mind disclosing the CapEx for the quarter on a mill by mill basis?

Dave?

Okay. For the quarter there on Rosenthal was .9, Stendal was .7 and Celgar was 3.1.

Okay. And then the expected downtime for maintenance in the back half of the year -- is nothing or is there a little bit for Rosenthal remaining?

It's Rosenthal.

In Q4, right, isn't it?

No, Q3.

Oh, Q3? Okay.

Our estimate and our budget for maintenance for that is 1.6.

(inaudible) as well as shut. The production levels currently -- or I guess the capacity levels currently at -- you mentioned Celgar at Stendal and Rosenthal. Have they changed materially? Can you just remind us what those are at?

Yes, I think Stendal will be close the 600,000 tons, Celgar approximately the 470,000, and then 315 for Rosenthal.

Okay. Could you talk a little bit about the fiber cost? We went over to Germany and aced the commentary on Canada. So far is that you expected to sort of remain elevated but not continue to increase. You think there is going to be any impact from this coastal strike on your fiber cost? How do you foresee that playing out?

I don't think it's going to have really any impact, in terms of our fiber cost, because of the coastal strike. It'll be prohibitively expensive really for the coastal guys to source the type of volumes that they need from the interior. So any volume (inaudible) talking about which would be sourced, in excess of what they normally would take from (inaudible) here, would be just for that small percentage that they need to cough up.

You can't run these mills by bringing in the bulk of their supply from that area. So we don't see an impact because they'll either shut because they don't get the fiber, or they'll be losing way too much money to try to source fiber from the interior. It's the freight cost and other logistics costs which creates the barrier.

So we don't expect any real impact, in terms of people trying to source additional material from our region certainly. And at the same time, I think some of the interior sawmills will probably benefit from the fact that it does eliminate the inventory, and probably makes the interior mills in a better position. So all in all, it's probably more positive unbalanced than negative.

Okay. That sounds like to be good. Can you give us a sense, or just remind us really, what your costs per ton of pulp production is for fiber currently? Is it sort of in the $200 per ton Euro range?

Yes, it ranges. In terms of the fiber for the first quarter, it was about 270 Euro. And in the second quarter it was around 240.

And that's across the--?

Yes, across the--

And if we were looking at Celgar -- Celgar would be (inaudible) the Celgar versus Stendal, versus Rosenthal. Is there a material difference that we should be thinking about there? Can you sort of go mill by mill and give us a sense of where those are at?

No, I think what you got is that you do have certain differences in terms of the supply. If you look at Rosenthal and Celgar, they're primarily reliant on sawmill residuals. So clearly their fiber costs will be lower. If you look at Stendal, the bulk of their supply is from pine logs -- and because of course pulp logs are always more expensive to process, and so Stendal will have a structural higher cost.

And the fact that you have to source from a larger geographic area, because it's 600,000 tons -- so it's almost double what Rosenthal's requirement is, and so is the fiber. So naturally the logistics costs will also increase. So structurally Stendal will always have a slightly higher cost of its fiber than Rosenthal. And Celgar will have, of course, lower mainly because the wood cost overall in Canada is lower.

Sure. And I guess if we think about the freight aspect of the fiber cost as a whole, versus just sort of the raw wood, to put it in kind of it was 50 Euros per ton of production, something like that -- and more or less that sort of the right magnitude?

Yes. But it also depends on really where you're sourcing, because chips can be very low in terms of freight cost. But of course pulp logs can be more expensive.

Right.

The other anomalies that we're seeing right now in Germany for some reason is that OSB markets in Germany is very good. And therefore you're getting prices of OSB, which are significantly higher than in North America. And as a result, their ability to pay for wood is much stronger.

And of course in the northern part for our pine pulp log, we are in competition with them. So we have this kind of competitor, which seems to have a fairly good ability to pay, which you would expect otherwise if you were just looking at the North American situation, where OSB prices are on the floor. So these are the things that we of course have to look at when we're looking at overall prices and our ability to reduce the cost for the wood.

It's essentially bringing up the European OSBs. This is something I've sort of been thinking about. What's the outlook? Obviously that's tied to European housing markets, and if it's the big competitor for wood and it's sort of relevant to you guys -- what's sort of your outlook there for European housing? And how do you think the OSB markets are going to do, and how that would affect you?

Well surprisingly the OSB market has been recently strong in Germany and continental Europe as a whole. I think the initial forecast -- because of the capacity increases in the last few years -- that this market would have been quite depressed. But actually the demand side has been quite positive. The consumers have been more receptive to this particular product.

Also, there seems to be still a reasonably good activity in terms of home construction using wood in Germany. So although the housing construction market has dropped recently, it seems that the housing construction market based on wood frame has kind of held up. So overall the demand seems to be quite strong.

Also, the OSB market, unlike North America, where it goes really more in terms of the new home type of use, I think the OSB market in Germany certainly is more in terms of the rental type of market as well as to the retail. So the retail component of the business is quite strong. And therefore they have different type of situation than North America.

But also at the same time, the product specifications are different on the continent than the U.S. And so that's probably some of the reasons why that there is this large pricing gap between the U.S. and continental Europe. I guess the qualities are a little bit more similar in the U.K. market, so that you're seeing some OSB coming into the U.K. from North America -- but to date not a lot of OSB coming in from North America to Germany and continent. And of course there's a much smaller market overall.

That's a pretty good call. And I don't want to take up too much more of them. Okay. I'll also ask one more question. In terms of sort of going forward -- I ask this a lot -- but obviously building up hopefully some cash at the restricted group, it seems like limited abilities to filter that out. Strategically, what are your thoughts there in terms of future acquisitions, future CapEx plans, what you want to do with that cash as you move forward?

Well I think right now we're focused on improving our margins, as I said, both from the operations as well as trying to improve margins on our by-products such as electricity. We expect in the second half of this year that conditions will be much stronger overall, both from an operating as well as a market perspective in terms of price. So we will have much better cash build-up in the second half than in the first half.

We are seeing some -- let's say pricing distortions on the debt market. So our debt has started to weaken. So we have to look at that clearly as a potential. So moving forward, what we will be looking at is building up the cash, and let's see what attractive opportunities there are in terms of a return.

And that could be our existing debt as an example, or it could be certain minor investments to improve our margins in certain areas, as well as new opportunities. But I would say that it's more likely that we'll be focusing in terms of our present operations.

Got you. All right. Very good. Thanks for the time.

Thanks.

The next question is from Eric Seeve with Golden Tree.

Hello. I have two questions. Firstly, with respect to SG&A within the restricted group, it had been running around 4 million the last couple of quarters, and it ticked steadily higher this quarter. I wanted to understand what was behind that and what to expect going forward. And then I have one additional question.

You want to take a shot at that, David?

Sure. Within the restricted group, we have a foreign exchange impact on the receivables for Celgar with the strengthening Canadian dollar. In both April and May, we had a foreign exchange valuation adjustment that goes through GNA according to U.S. gaps. So that's what that is. To quantify it, it's probably -- between the two months it's close to about 1.7 million Euro. So you can back that out on a run rate going forward.

Okay. Thank you. And the second question is -- can you disclose production and sales volumes for the Celgar and Rosenthal mills in the quarter?

Okay. Production volumes in the second quarter for Rosenthal were 82.4, Stendal 137.6 and Celgar 106.4.

I'm sorry. That was production or sales?

That's production.

Can I trouble you for sales as well?

For sales was -- Rosenthal was 81.1, Stendal was 140 and Celgar was 115.9.

Thank you.

Your next question is from Patrick Lang with Sim Advisors

Yes, that's me. Hi, Jimmy. The question is on margins. If you assume that there's no down time -- like you took down time in Celgar -- and you add back into the loss revenue, your margin is already pretty respectable, probably the highest in Canada. We're talking about 15% here. But if you assume that the pulp pricing is to go up like to $200 and hold everything else constant -- the input price and currency -- are we going to see theoretically a 35% peak margin back in year 2000?

Well I can't speculate in terms of the pricing movement of the currency. But what I tried to do is bring the EBITDA margins up to comparable levels of our German mills. Our German mills, before we had this upset in terms of the fiber cost, typically was in the high 20s, and I think that still can be improved.

Celgar has operated in the low teens, sometimes even under the 10%. My goal is to try to bring those EBITDA margins really to the levels of our German mills, which means in excess of 20 on a consistent basis, through a combination of various things -- including price, better operating efficiencies, better prices for our co-products or by-products.

So I think you'll see that Celgar will move continually upwards in terms of EBITDA margins on a more consistent basis, not necessarily reflecting just anomalies in terms of the supply and demand type of situation. I think we would like to keep these mills with an EBITDA type of margin on an average, which is in excess of the 20.

Right, right. If you compare the restricted group mills versus Stendal -- Stendal this quarter did as much EBITDA as the restricted group.

Yes.

So going forward, you think these two different groups will kind of contribute similar amount of EBITDA if everything else being equal? What I'm saying is that that we see the inflection point of that big mill back in 2006.

Yes, I think that moving forward you probably will have very similar type of EBITDA contributions between the two mills -- between the two groups -- Stendal and also the Celgar-Rosenthal combination.

Right. Great. And can you comment on the Chinese -- the buying pattern? I assume that they are driving up the marginal in the price in the world commodity pulp market. Do you see much of that coming out of China?

Yes. The demand growth in pulp, whether it's hard or softwood, is really driven by the emerging markets. And of course the most important market is China. Paper production has moved quite a bit into China. And therefore it's only natural that raw material demand will continue to increase. And we don't expect that to change.

It is really the growth market. So you're going to have further closures of paper capacity in the developed countries -- whether it's North America or Europe -- moving to the developing countries, which means that as a market pulp producer we're well positioned. Because that's really what we're supposed to do, which is supplying raw materials to the producers. I think the integrated producers have more of an issue, because clearly you're in direct competition with new equipment.

So for us the changes in China only reflect what is natural in the evolution of the paper business. The demand for softwood has been fairly consistent. In fact, the substitution question is kind of irrelevant, because if you look at overall softwood demand growth over last year, it has grown somewhere around 1.8, almost 2% -- which means that everybody knew in the paper business that the hardwood prices would be lower than softwood.

Everybody knew there was a capacity problem likely to happen at the end of this year, so one would expect that they would be doing everything possible to reduce hardwood consumption. Well the figures don't show that. The figures show that although everybody expected price gaps, the demand for softwood overall increased at the rate which was consistent with prior years -- so really no change.

So I don't see why we have this substitution question always popping up. Yes, there has been a lot of changes in the fiber mix. But demand for softwood continued to grow. That demand side was filled by the new capacity of radiata coming out of Chile. And so the ones which had the least discretionary need for the quality issues was filling it using radiata. But they were still buying softwood.

So that is why we feel very positive and optimistic that moving forward, that the situation will not radically change -- for China or the rest of the world for that matter.

Right. So the NBSK mills in North America should retain its value, given the supply and demand scenario you just described. And recently what I have heard talked -- told that my (inaudible) kind of financial trouble when the stock is trading below a dollar. So I think some kind of restructuring is imminent. And would you be interest some of the three mills -- I know they're a little high cost -- but there is one million interior BC, although it's small. But do you see any--?

I think one has to reflect on the fact that although we think that the future for softwood and NBSK is positive, presently the EBITDA margins on most of these operations are very low. So you're really not generating the cash which is needed for the significant investments that are needed in these older mills.

The other thing is just looking at overall tonnage production doesn't necessarily reflect the actual activities at the mill site. If you look at most of the Canadian mills -- although you may have 300,000, 400,000 tons of production -- you're looking at 304 actual pulp mills at one site. You're not really talking about one operation.

If you look at our mills, we have one line. We produce 600,000 tons on Stendal and one line. If you look at a Canadian mill with 400,000 tons -- they may be producing that on three lines, with three digestion lines, so three recovery lines. This is very expensive. It requires a lot of people. Also you've got a lot of hidden costs in regards to the prior issues, whether it's pension funds or such.

So I think that we have to reflect on that when you say, "Well the future is bright," and the prices or the value for NBSK mills will hold up. I think it will hold up for the good producers. But I think there's a big question mark as to whether there's any value for certain producers, because it's really a liability rather than an asset.

Right, right, right. Great. And what do you think of they happen those mills then? If it's in bankruptcy and there's going to be -- go for Chapter 7 liquidation, or do you keep them running?

I can't really speculate. All I know is that if you look at presently -- these mills really are no longer being sold for anything other than multiples to what they're able to produce in terms of cash flow. And if you look at the cash flow generated in many of these mills, there is none.

So what is the value of assets which presently don't make any money? At the same time, if you look at trend pricing -- we used to talk about trend EBITDA prices -- what, $640 U.S. Well at $640 U.S. everybody would be losing money with the present exchange rates and fiber costs. But it's typical to guesstimate what is a trend EBITDA price moving forward, because of this radical shift in fiber cost and exchange rates.

And then try to measure what is of reasonable value of an existing operation. And I think that fundamentally I think there is been a change in actual input costs, as well as currency, at least for the immediate future. That means that we have to look at probably a moving forward NBSK price, which is probably a lot different than what we used to think about in the past.

Right, right. Final question -- do you have any update on the minority owner of the Stendal mill? Any update on -- any extension negotiations of becoming a wholly owned subsidiary?

Well the minority owner is RWE, or the prior subsidiary of RWE. Right now as you know, we're just finishing up the discussions in terms of the APC contracts. So clearly we are not really in a position to discuss other issues. And whether we undertake any other discussions we'll have to see. But right now we are engaged in trying to resolve the outstanding issues from the original construction. And once that is over then we'll have to see what further discussions we will have with them.

All right. Great. Thank you.

Okay.

Your next question is from Craig Kelleher with Regiment Capital.

Actually some of my questions were answered. But just back to the Pope and Talbot situation -- you mentioned that there are high costs for this. Are there any of those assets that you would be interested in, maybe like one of the mills or anything that could be a potential acquisition for you?

Well I don't let -- I can't speculate in terms of other people. For us if you look at the profile of the mills that we are interested in, clearly their mills and many other mills in North America don't quite fit that profile. So it's not likely that -- based on what we typically have bought -- that the Pope and Talbot mills would likely fit into that type of profiling.

Got you. And just looking at the outlook for the second half of the year, which obviously seems very positive -- if you look specifically at the restricted group where the bonds reside, you guys should be generating a pretty significant amount of cash over the next kind of six to 12 months. In terms of your intentions for that cash, can you talk about that?

Well the bonds have recently started to weaken. We think that it does not reflect the cash generation out of the restricted group. I think that moving forward clearly we think that the bonds are attractive. If they continue to weaken, then they are the type of -- or even weaken further. So we have to examine that in terms of our attractiveness, in terms of return on capital employ. So clearly we think that moving forward it could be a lot of avenue for the use of the cash.

Got you. Okay. Thanks, guys.

Your next is from David Kirkenberg with Cook Capital Asset Management.

Hello, Jimmy and David.

Hello.

Morning.

I see that the increase in cost of fiber and the negative effect of currency continued to represent some challenges. On the positive side, you're nearing record productivity. NBSK pricing is improving and margins are up, and operations appear to be on track. And it sounds like you're looking ahead to a good second half.

What's the Company's view as to why the stock has traded off so sharply in the last quarter?

I think there was a negative type of view on the sector as a whole. I think their expectations in some of the second quarter for most of the producers were certainly negative, because of the developments on the currency as well as the fiber cost. I think that we are probably lumped in with that.

I think there was also probably some fears, in terms of maybe that there could be even speculation of Pope and Talbot, in terms of they are a supplier of fiber to us. But we don't think that's a big issue. And it did go down on fairly low volume. I think the issue was there was uncertainty in terms of the numbers coming forward, although we did say that the second quarter will be close to the first quarter, and that it would represent the lowest quarter for the year.

But I guess because of the currency movements -- the Euro moved quite significantly that quarter. And there was probably not a clear view as to what the number may be coming out.

Do you think the market has a little better visibility looking ahead?

Well I think we stated that the second half is going to be very positive, based on what we think was developing, both price and demand side. The fiber situation now has stabilized in all areas. So I think that there is now a better understanding as to the numbers moving forward. So I think that hopefully the market will reflect that knowledge as we move into the second half of this year and beyond. I think the numbers developing are much better hopefully than most people's expectations.

Okay. Fair enough. Thank you.

Your final question is a follow-up question from Mark Bishop with RBC Capital Markets.

Thanks. Yes, Jimmy, just a follow-up on Stendal. Just as we've gone through the last several quarter, I guess we've been seeing the Stendal mill not to discount -- or discount to necessarily converge on Rosenthal. But do you think you've gone as far as you can there? Where do you think we should be--?

Yes, I think that there's going to be very little potential -- let's say further improvements between the Rosenthal and Stendal discounts, because there's a structural difference between the customer base of Stendal and Rosenthal. Rosenthal still has because of the smaller size, etc. -- it has shorter distances to the customer base. And so it has a freight advantage already.

So if you look at the discount on the mill map, overall it will have that structural advantage moving forward. The other advantage that Rosenthal has over Stendal is that some of Stendal's production is exported into China. Although it's that favorable rate, still in comparison to the domestic local area, of course you still have higher cost. So those are the things which influence a structural difference in the discount received at the two mills.

That was part of what I was getting at. So at this point you don't see the Stendal mix -- geographic mix changing a whole lot? You'll still have the China--?

No. I think we've continued to make significant change in the customer mix. We continue to filter out the weaker customers, both from a freight as well as a purchasing ability. We are increasing the amount of domestic sales, which in Germany as well as the percentage going into Europe as a whole.

So I think China will represent less and less moving forward of Stendal's production. I think we'll continue to be there. But I think you'll see that Stendal's volume into China will continue to inch down moving forward.

Okay. And Celgar -- I guess you've been pretty static on the China proportion of your shipments. Do you see that changing say over the next 18 months?

Well I think that you're seeing further increase in our penetration into North America. But at the same time our capacity for production is increasing. So you may not have really a change in terms of the actual volume going into China. But the percentage will be reduced in the coming years, because our role in North America is increasing and the volumes are increasing. So clearly China is important. But probably North America will become more and more important moving forward.

Okay. That's great. Thanks very much.

Thanks.

(inaudible) conference back over to me after any closing remarks.

Well I'd like to thank everyone for attending today's conference call. And we look forward very positively and optimistically to the second half. So on that note I'll again thank everyone and finish this call. Thank you.

Thank you for participating in today's conference. You may now disconnect.