Mercer International Inc (MERC) 2007 Q3 法說會逐字稿

Good morning. My name is Kimberly, and I will be the conference operator today. At this time, I would like to welcome everyone to the Mercer International third quarter 2007 earnings conference call. (OPERATOR INSTRUCTIONS)

I would now like to turn the call over to Ms. Alexandra Tramont. Please go ahead, ma'am

Thank you. Good morning, and welcome to the Mercer International 2007 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 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 like to turn the call over to Jimmy Lee. Jimmy, please go ahead.

Thanks, Alex. And welcome everyone to Mercer International's third 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 pleased with the Company's performance in the quarter. Our company ran at record production levels and we completed the final component of our annual maintenance program, leaving us well positioned to run full through the fourth quarter.

Pulp markets remain strong, and as expected we saw some moderation in fiber pricing during the quarter. We do, however, continue to face considerable pressure from a weak US dollar.

Reported net income from continuing operations for the third quarter of 10.7 million Euros, or 30 Euro cents per basic share, compared to 6.1 million Euros, or 18 Euro cents per basic share in the same quarter a year prior. Our earnings in the quarter included pre-tax, non-cash losses totaling 1.1 million Euros for the mark to market value of our foreign denominated debt and our derivative instruments. This compares to the same quarter in 2006, when we recorded losses of 15.2 million on our then outstanding debt and hedged instruments.

Despite the currency headwinds we posted considerable improvement to our operating EBITDA in the quarter. Our quarter 3 operating EBITDA of 35.8 million Euros compared to approximately 25 million Euros in the prior quarter. Sequentially, our EBITDA was positively influenced by a lighter maintenance program, stronger pulp prices, lower fiber costs and higher productivity. These improvements were reduced somewhat by a weaker US dollar, which reached record lows against the Euro and a [30] Euro low against the Canadian dollar.

During the quarter, we completed our annual maintenance program at our Rosenthal mill. The shut idled the mill for just under nine days and restarted ahead of schedule. As I noted last quarter, we settled the final outstanding matters under the Stendal EPC contract with our construction partners during the quarter. The settlement provides funds to allow us to complete remediation of a small list of deficiencies, but maintains our future warranty position with the underlying equipment manufacturers. This settlement is a final step in what has been a very successful project.

We remain very focused on fiber supply in both Europe and British Columbia. Our wood source optimization efforts have had a noticeable impact on our mill fiber costs and while they remain relatively high when compared to a year ago, as we expected, our costs have fallen in the third quarter at all three mills.

In Europe, this effort has been assisted by a relatively active sawmilling industry and an abundance of wood from last year's storms. There are, however, a number of fiber market influences that we are closely monitoring. In recent months, European lumber prices and as result some mill activity has fallen, which may place pricing pressure on our residual supply in Germany.

In British Columbia sawmill operations remain under increasing pressure, so we have been actively developing alternative suppliers of fiber to reduce our exposure to supply disruptions from any particular sawmill operations. We are pleased that our fiber inventories are healthy and we are well positioned to run full through the winter.

We have also been dedicating considerable effort to energy optimization. As significant producers and consumers of energy, we are well suited to participate in the growth of alternative energy supplies and are working on possible projects to advance these objectives. We hope to have more to report on this in the near future.

The market for NBSK pulp continues to be quite strong and we are optimistic that this will continue. Inventory levels for both the producers and consumers remain at historic lows, at a time when higher cost producers are under pressure from fluctuations in currency as well as fiber costs.

The list prices for NBSK pulp in Europe increased during the quarter by $30 US per ton and currently sits at $830. This compares to $710 US per ton one year ago. While an additional price increase in the fourth quarter is not certain, we believe that there is enough foreign exchange in cost pressures to support further increases in the next six months.

Although from a US 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 increases to date have been due to weak US dollar as well as the increase in input costs such as wood fiber and not really reflecting the supply/demand balance that presently exists. We believe that with continued demand growth, prices will continue to increase.

There has been no indication that the wide price gap between NBSK and eucalyptus pulp will diminish. The fact that recent capacity increases for eucalyptus pulp have not resulted in any reduction in the demand growth for softwood pulp is a clear indicator of our belief in the continued demand for NBSK.

Looking forward with our 2007 scheduled maintenance now completed and healthy fiber supplies in front of our mills, we will be well positioned to take advantage of further price increases in the fourth quarter. We remain focused on increasing margins by reducing costs as well as increasing the mill availability at all operations and improving the returns on our byproducts such as excess power.

That concludes my prepared remarks. So on that note, I would be pleased to open the call up for questions.

(OPERATOR INSTRUCTIONS) Patrick Wang with SCM Advisors.

Question, you have cash, almost 50 million Euros. What's your plan for the cash?

We will be having a reasonable cash buildup as we move forward. Certainly the fourth quarter will be better. And with the present price situation as well as the fiber costs, we expect that things will again improve into next year. We are studying really what the best use of the cash right now is, because we do have a little bit more flexibility. As you know, the senior notes had certain restrictions. With the present EBITDA generation those restrictions -- certainly we have a lot more flexibility and therefore, we are in a position to now focus on what would be the best use of that cash moving forward. So I would say that is being studied. There is a combination of many things, clearly, share buyback is possible, dividend is possible. So all of those things will be looked into and discussed.

Could you disclose the restricted group's CapEx for the quarter?

It's in the order of 3 million.

And that's down from last year, I assume?

Yes, because of course, the Blue Goose project at Celgar would have certainly skewed the investment, last year versus this year. So with the Blue Goose project finished, of course we're now more into the regular type of investment program at both Rosenthal and Celgar.

Right, so for the year it will something like 17-18 million?

Yes. But moving forward, as we said, in terms of the mills investments for all three mills, we think that will average between 4 and 5 million Euro each.

Herve Carreau with CIBC World Markets.

Now that the upgrade at Celgar has been completed, would you say that most of the cost savings were in place in the third quarter or are you expecting us to see some of these savings in the next few quarters, given the ramp-up of the project?

I think you'll see the gradual improvements continue throughout this year as well into next year in regards to the increased productivity as well as the quality issues. The quality, of course, is much more stable and better, which of course, means that we have less off-spec, which of course has to be sold at a reduced price. So you'll see both an improvement in the actual production levels, but also in terms of the quality should benefit us at Celgar.

Okay. Can you say how much is left in dollars per ton or too difficult to quantify at this time?

Difficult to quantify, but I think we're looking to produce next year, somewhere around 480,000 tons, which is slightly up from this year.

David Gonzales of DA Davidson.

I'd just like to ask you about your general and administrative expenses. They've gone down a little bit, by 3 or 4 million. Is that going to be kind of typical or what was the cause of that?

The G&A, unfortunately, has certain other components other than strictly G&A. There's some foreign currency adjustments, etc. So maybe David, you could?

I think the run rate that you see this quarter is what you could expect going forward.

All right, great. And then secondly, recently reading about the Rosenthal 400 project bringing the capacity from 310,000 to 400,000 tons per year. What's the cost and the timeline of that?

That basically is under study at this particular time. There has been really no decision formally made. It will involve certain understandings in regards to what availability and what costs, as well as the type of energy revenue contribution. The ballpark figure in terms of the cap, the total size of the project in terms of the equipment is somewhere in the range of about 100 million Euro. But that is essentially a project that is under study and it is something that is clearly, very much dependent on many factors.

Eric Seeve of GoldenTree.

I have two questions. The first is, may I trouble you for production and sales by mill?

Okay, in the third quarter, Rosenthal 76.9, Stendal 158.7 and Celgar 125.4. So those are production volumes in thousands of tons. Sales at Rosenthal were 80.3, Stendal was 162.3 and Celgar was 120.9.

Thanks very much. My second question is regarding, you talked about potentially looking at free cash flow for potentially stock buybacks or dividends or other things. Can I trouble you to remind us of where the restricted payment basket stands right now?

The restricted basket basically has a condition that -- I think it's the 12-month EBITDA has to be greater than 2 times the interest serviced and anything above that is available for us to do with whatever we wish.

Thank you. And just lastly, can you give a little bit more color on the situation in terms of fiber supply in terms of Canada? Obviously a lot of the lumber mills in the area are struggling. It sounds like you expect things to be fine for the remainder of the year. Can you give your thoughts as we look into 2008 at what opportunities you have to address it?

I think because we are, of course, a low-cost producer, we've been able to continue to have I guess a reasonable EBITDA margin in terms of our present production. Of course, we continue to focus in regards to reducing those costs and that's the primary focus. At the same time trying to of course move the price for pulp upwards to compensate for many of the currency movements we've seen, as well as the fact that certain inputs have gone up and are likely to continue to go up. The freight rates for next year are likely to go up as well as other costs, so these are some things which clearly we're focusing a lot of attention.

In terms of the Canadian situation, as you know, many of the producers certainly are under pressure. We don't necessarily think that will change, as long as the currency continues to be at these type of levels. The lumber industry certainly looks like it is going to be very depressed and may be even more depressed next year, so that means fiber costs, etc., are going to continue to pressure many of the producers and at the same time, the coastal mills will also have a significant potential increase in regards to the freight rates, because of bulk carrier availability as well as the rates themselves. So, I think there's a lot of issues which certainly makes the Canadian situation difficult.

Celgar has been fortunate in the sense that we do have the economies of scale. It is the single largest -- it's the largest single line mill and therefore we do have the efficiencies which come with that. We've been able to change the mix of our customer base to really hone-in in regards to reducing the freight cost, etc. So, I think that our profile certainly is a lot different than the profile of the average Canadian pulp mill.

Brian Doyle of RBC Capital Markets.

Just a quick question. The availability under the Celgar and the Rosenthal revolver?

The Rosenthal revolver has 40 million Euro of availability. There's nothing drawn on it. The Celgar has 22 million Canadian drawn on a 40 million Canadian facility.

Chris Jones of Morgan Asset Management.

Can you explain to me exactly what the largest impact of the weakening dollar is on the business and can you quantify maybe a metric as far as the change in the US dollar, how that affects your operating earnings?

The US dollar, of course, directly impacts the pricing. So the list price -- like all commodities, pulp is essentially priced in US dollars, so any weakness in Canadian, you know, the strength in Canadian or Euro translates to a lower price for our European customers and that's an immediate impact. So unless we can raise the US dollar list price to compensate for that, you will always have a lag. So, as just a ballpark type of indicators, the Euro 0.01 change in Euro to US dollar on a consolidated basis may have an impact somewhere between 3.5 to 4 million, so you know, turnover.

Okay. Well, if that's the case, do you not receive some type of offsetting benefit with your fiber costs?

Yes, I mean, you've got fiber basically is sourced domestically, so you don't get any benefit of the fiber cost, because of course, the local wood is sourced in Canadian dollars and Euros, so you don't get any compensating reduction in your input costs. So on an EBITDA basis, as I said, like a US dollar Canadian 0.01 impact on a consolidated basis is about a 2 million Euro impact on EBITDA.

William Thomas of AG Edwards.

It's Ben Carlin. Two questions. One, your EBITDA margin looked like it was about 18.5% overall for the quarter. Are you still thinking that 25% over time is realistic here?

I think that of course, the German mills were all over the 20%. What impacted the overall margins was of course Celgar continues to be under that and of course, Rosenthal had a maintenance shutdown. So I think that the objective of moving it over the 20% is still our goal in the short-term. I think we can do even better than that, but that's really the short-term goal.

Some of it is going to require investments. I think the electricity area is, of course, very important for Celgar, because unlike our German mill, the amount of excess electricity that Celgar sells to the grid of course is far less. And that's one of the primary reasons that it continues to lag the other mills in EBITDA margin. So, I think that's a big focus. So yes, I think that 20-25 certainly is, on an overall basis, certainly very realistic in the short-term.

And then the second question would be, your interest expense moved up about a million Euros in the quarter, even though your debt balances are coming down. What was the reason for that?

A little bit of increased borrowing under the Celgar revolver.

And that's because, of course, we are sitting with more inventory of both the finished as well as raw materials. So in terms of Celgar you're producing more, so of course you end up with more inventory and in terms of the raw materials side, all the mills are sitting with a lot more wood.

Okay. And the last question would be, are you making any progress in your negotiations with the German government with regard to selling excess power into the grid at green prices, premium prices?

Well, I think that we are looking at a lot of the programs which are available in Europe as well as in Canada in regards to renewable energy and of course being properly compensated in regards to the green energy type of rates for that power. So I would say that we have undertaken a lot of education of the various governments in regards to the role of the pulp industry, as well as the fact that we are producing significant amounts of renewable green energy already, both in terms of [steams] as well as electricity. And I think we are optimistic that these efforts will have some success.

(OPERATOR INSTRUCTIONS) Andrew Shapiro of Lawndale Capital Management.

A few questions. First off, backing up to what David had said several callers ago, I just wanted to confirm this. David, you're confirming or projecting out that the SG&A run rates are likely to be at this quarter's run rates, which were about almost [4] million dollars lower than the prior three quarters? That's the new ongoing levels, around 6 million?

That's right, Andrew.

Okay. And what attributes to that kind of ongoing lower level? What expenses were in the prior quarters that won't be in there going forward?

It's the classification of the foreign exchange from G&A to cost of sales. Just too much variability creates problems for you guys to get the run rate.

Yes, it does. So thanks. And now, this quarter it looks like you have current and long-term cash and all that in aggregate went up by about 10 million Euro, maybe 9 million Euro, and more importantly, your debt levels dropped by almost 25 million -- over 25 million Euro just in the quarter. So we've had sizable pay down in accumulation just in this quarter alone. Of the 822 million Euro that sit on the balance sheet, can you breakout, there's a bunch that you never or the last you're going to pay down, because it's the German government subsidized rates. Then there's a quantity, if you could tell us what that is, that is the convertible sub debt that is in the money and you guys can force call on this when, less than a year from now?

The convertible debt is about 50 million Euro, 67 million US I guess. And it's callable October 2008.

Okay. And when that comes off, presumably the way things are you would force its conversion and call it in, about how much interest expense is attributed to that that would then come off the income statement?

I don't have it in front of me.

What's the rate on it?

8.25 I believe was the rate.

I mean, generalizing is fine. So 8.25 and that's off the US dollar balance of 67?

Yes.

Okay, so that's the 5.5 million. That's a decent chunk. And then the remaining outstanding debts are what, the senior notes?

Yes. 10 [Standard] million senior notes.

What kind of rates on that? Would that be something you'd want to more aggressively pay down?

It's at 9.25 I believe and I mean, we had looked at it in regards to prior periods when of course the senior notes were very very attractively priced. Presently I think they're trading around the 96 type of range. Certainly that's one of the areas that we will also look at in terms of the use of excess cash. But let's say it's certainly not something that -- at these levels, I mean it's attractive, but I wouldn't say it's significantly attractive.

Well relative -- I mean, if you paid down so much debt already and you have this conversion, etc. coming off, it's going to take down a bunch of interest expense, it would seem if your stock price doesn't move from these levels, that buying and retiring shares might be a much higher return use of capital.

Yes, well that's one of the things that clearly we are looking at seriously.

Are you allowed to buyback shares to the extent your interest coverage is above a certain level of restricted group--?

Yes. And that's basically what we will be looking at in terms of either share buyback or share dividend in regards to the excess cash above the restricted ratio.

Are you presently running at a rate that would allow some of that already?

Yes, we are.

Excellent. The settlement money you got from the contractor and previously the German government grants, which were hundreds of millions of dollars, were used as you described, to reduce the cost of the asset and the asset value?

Yes, that's correct, so the assets of course are -- I wouldn't call it understated, but clearly are after the reduction of the grants as well as the settlement of any EPC contract pursuant to the construction.

So how much in German government grants were provided, particularly I guess it was Stendal?

Stendal was 276, Rosenthal was 100.

That's large amount. So if you wouldn't call it understated it sounds like it's understated to replacement costs for sure. What is the right side of the balance sheet entry that occurs when you're reducing the cost basis of the asset?

Well, you start with the cash and then you spend it.

Okay. So when you're reducing the balance it just doesn't go on the balance sheet as a cost basis?

No, it's basically reflected less the actual grants.

The two steps, Andrew, would be you'd get a [bag] to cash and you get a credit on your balance sheet against fixed assets and then you spend the cash reduces your payables.

Okay. The company has an IR program periodically. Are you set and scheduled to be going to particular paper or industry shows in the coming quarter or so or is there anything going on?

We don't have anything that's projected for the end of this year, but we are looking at certainly the first quarter of next year in regards to both the debt as well as the equity side.

Okay. The last question I have that comes to mind here is that with the Canadian dollar where it is, fiber cost not abating, you have in the past made presentations -- I think there was even one under an 8-K that's either on your website or up on Edgar, the talks about the age of boilers and other CapEx expenditure requirements of the industry. What are your expectations for further closures being announced in the near future in terms of capacity since you mentioned on a currency adjusted basis, frankly, pulp prices are at a trough, not what might appear to be a peak?

I think that we believe that further closures will happen. I mean, one of the mills on the list actually Frank Stora Enso has been announced to close for next year. That's already half a million tons. It's likely that there will be further casualties in Canada.

There are many mills, which even with today's prices, certainly are barely making any cash and not enough cash really for the maintenance and other capital requirements that are likely in those mills. So, I think there is going to be certainly casualties unless something fundamental changes. I would imagine that there would be one on the East and one on the West Coast, which could happen moving forward, just because of the wood issues being so constrained and likely to become more constrained as we move forward, because of the overall housing activity of the US, aside from just the currency related issues.

You guys bumped up your prices or announced price increases November 1, for another 20. Did that price increase take?

We announced the increase in Europe. That did take. We have not announced one in terms of the Asian and North American. There is for some reason, hesitancy on some of the other competitors in regards to translating the recent Canadian dollar strength into prices in those areas. I think that further increases will happen though, probably first part of next year.

What percent of your Celgar goes into Asia?

I would say about half of the production is going to go into Asia, a little bit more than that presently, so around 60-something percent presently, but I think next year about half will go into Asia.

Patrick Wang of SCM Advisors.

You mentioned that the [baskets] for the 9.25 senior notes are subject to 2 times interest coverage. I have a hard copy of it says 60% of net income.

It's two baskets.

Okay, which?

There's more than one basket, you're right.

So for dividend and share buyback there's a different basket?

You have to meet both.

Oh, you have to meet both. Okay, thank you.

At this time there are no further questions. I'll turn the call back over to Management for any closing remarks.

Well, I thank everyone, again, for coming to today's conference call. I think the situation certainly for us overall, I think is quite reasonable. I think moving forward we're still very optimistic that further pulp prices will happen, mainly because of really the continued pressure on the currency as well as the input costs. And the supply and demand situation certainly looks very healthy, which again is very supportive of that. We believe next year, certainly the situation should be quite reasonable, comparable to this year's type of numbers, assuming that we don't really have a significant change in the global economy.

Also, we do know that recent movements in China have been very positive for the paper as well as the pulp sector. They are starting to close many of the very small highly-polluting pulp operations in China. This has a benefit both in regards to the environment as well as the pricing of paper in China and they're actually doing this in a more prominent basis in the sense that they're actually going and taking out the equipment rather than just stopping the operations. So I think that this will continue into next year, so certainly there's a lot of tons in China which could be impacted which will have a benefit overall to both the paper operations as well as the hard and softwood pulp industry as a whole.

So again, as I said, we're optimistic about the current trends, but there will be significant pressures in between in the short-term which may have an impact. But I think on a longer-term basis the fundamentals really do look very very positive for us. So I think again, we have a very different profile than many of the others in the industry and that's why, of course, we are in a position to be a little bit more optimistic as to the longer-term.

So on that, again, thank you and I would conclude the call.

Ladies and gentlemen, this concludes today's conference. You may now disconnect.