Mercer International Inc (MERC) 2009 Q2 法說會逐字稿

Good morning, ladies and gentlemen. My name is Tina and I will be your conference operator today. At this time I would like to welcome everyone to the Mercer International second quarter 2009 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.) Thank you. Ms. Tramont, you may begin your conference.

Thank you. Good morning and welcome to the Mercer International 2009 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 with 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 Gandossi, Executive Vice President, Chief Financial Officer and Secretary. I will now turn the call over to David Gandossi. David, please go ahead.

Thanks, Alex, and welcome, everyone, to Mercer International's second quarter earnings conference call. As always, I will begin with some prepared comments on the key financial aspects of the quarter and then I'll pass the call to Jimmy who will speak about the particulars of the market, our operating performance, and some of our strategic initiatives. As always, we will be pleased to answer any questions you may have following our remarks. If there are any questions related to our exchange offer, we would ask that you save those until after the earnings and market related questions so we don't get bogged down.

Let me begin with few comments about our financial results. As we expected, the pulp markets tightened up nicely during the quarter. And while our production is not yet back to the record levels of 2008, we nonetheless had an acceptable production result in the quarter. But while the upward pressure on pulp pricing is returning, the volatility of currency markets has been punishing. As you will have seen in our press release, we reported a net loss of EUR 11.5 million in the quarter or EUR 0.32 per share compared to net income of EUR 0.9 million or EUR 0.02 per share in the same quarter in 2008. And as you know, our earnings are sometimes heavily influenced by the mark to market gains and losses on our interest rate swap held by our 75% owned Stendal operation. The swap is designed to fix the interest rate on the Stendal debt at 5.28%. Our earnings in the quarter included a pretax accounting gain of EUR 7.5 million on this instrument compared to a gain of EUR 2.06 million in the same quarter in 2008.

Often one of the accounting indicators that the bottom of the pulp market has passed is when there are no further reductions in inventory valuations. After downward adjustments totaling EUR 4.6 million in Q1, we're pleased to report we're pleased to report there were no further write-downs in the current quarter.

We recorded EBITDA of EUR 3.9 million in the quarter compared to EUR 1.1 million in the first quarter. For those of you interested in US dollar equivalents, this is about $5.3 million of EBITDA in the current quarter compared to $1.4 million in Q1. The largest contributors to the improvement were improved fiber costs, higher pulp realizations and the absence of inventory adjustments that occurred in Q1. The improvement is also despite a significantly weaker US dollar which we estimate had an EUR 11 million impact on our EBITDA in the quarter.

If I could switch to cash flow for a moment, we generated about EUR 21 million of cash in the quarter. The increase reflects EUR 4 million of cash flow from EBITDA and about EUR 41 million of inflows due to reductions in working capital. We're generally pleased with our working capital improvements in the quarter which included significant reductions in pulp and wood inventories. Offsetting these cash inflows were about EUR 8 million of high return capital spending and our EUR 16 million of interest expense.

We currently have cash liquidity of about EUR 66 million which is comprised of approximately EUR 34 million for the restricted group and EUR 32 million at Stendal. Currently we have approximately 30 million of undrawn revolver primarily at Rosenthal. We have recently concluded a new EUR 25 million revolving facility for Rosenthal that expires at the end of 2012. The facility is accompanied by a new EUR 4.4 million facility dedicated to financing a washer upgrade at the mill.

Regarding the Celgar green energy project, last week we announced changes to the project, particularly in light of the Canadian federal pulp and paper transformation program. Despite all our efforts, we were not able to conclude stand-alone loan financing for the project on acceptable terms. So while we were disappointed about this setback, we plan to continue working on our options and in particular we are staying close to federal government officials who are designing the regulations for the CAD 1 billion green energy transformation fund. We are confident that, failing efficient financing, the project will be an ideal candidate for the program, the rules of which should be announced shortly.

And as you know, we've been preparing to address the convertible debentures which expire in October of 2010. We commenced an exchange offer on July 13 wherein debenture holders who tender will get shares of Mercer common stock as per the debenture's conversion price of 70.75 per share plus a new note at $200.00 with a strike price of $275.00. The offer will remain open until August 11 and you can find more details on the exchange offering in our circular filed with the SEC.

So with that quick overview of the financials let me turn the call over to Jimmy to talk about our operational market and strategic developments.

Thank you, David. Good morning, everyone. As David mentioned, after a pretty discouraging quarter of bad economic news in Q1, there's some good reason for optimism as we go into Q3. While we clearly have some considerable difficult times ahead, there are indications that the worst has passed. I know the comfort is limited here and the past four quarters have been punishing on our earnings and our share price. I can tell you that it is much easier to move forward knowing that the bottom has indeed been reached.

As you'd expect, the condition of the financial markets and its impact on our customers and us has dominated our focus during the quarter. But we are also growing more confident in the pulp market's ability to return to normal and support price increases. So marketing has returned to the forefront on our strategy as well. And like our marketing efforts, we remain committed to bringing our high-return strategic projects to conclusion. The most prominent of these of course is the Celgar green energy project. I'll talk about this in a moment but let me first comment about the mills.

While improved from the first quarter, productivity at our mills has not yet returned to the record levels of 2008. Rosenthal had a strong quarter with production within a few hundred tons of record levels. The two larger mills both had less than perfect quarters. At Celgar we were forced to take the mill down for almost five days when we experienced the unusual failure of a very critical valve. At Stendal we also lost several thousand tons due to upset conditions. In total we produced 349,000 tons of pulp compared to 346,000 tons in Q1, and almost 357,000 tons in the second quarter of 2008.

Just as a reminder, after a thorough shut late last year, we're now expecting to complete the entire year in 2009 without a shut at Stendal, a maintenance practice that can only be achieved under a highly proactive maintenance program. And as for our other mills, the annual shuts are currently scheduled for the third and fourth quarters. We expect these 2009 shuts to be somewhat longer than in the recent past, and will be performing a thorough maintenance of the recovery boiler at Rosenthal and will be conducting our annual shut at Celgar.

If I could turn to the pulp markets for a moment, I would characterize it as stable and tightening. Most of our large markets in Europe, the US, and China reached the bottom in February and March. Both our sales volumes were solid and we were not forced to participate in the heavily discounted spot markets like we experienced in December. June pulp inventory statistics were positive with inventories falling to 29 days for producers for market pulp as a whole, and 26 days for MBSK, levels that are widely seen as conductive for price increases. And while there remain some concern about China's ability to continue buying at the rate we have experienced during the past six months, as the global economy improves, we believe that the sudden collapse of Chinese buying is less likely.

Our sales volumes reached record levels in the quarter. Sales volumes totaled about 395,000 tons compared to 337,000 tons in the first quarter. Since the Chinese New Year, the volumes have been steady which has allowed us to keep our inventories at very manageable levels.

On Tuesday we announced a further USD 30 increase for America effective August 1. The price increases by us and certain competitors will take the price to USD 730 per ton in the North American market, USD 700 per ton in northern Europe and USD 600 per ton in China for August. We believe that the upward pressure on prices will remain and that the momentum will increase particularly since the value of the US dollars continues to erode. The euro equivalent for the US dollar today is about $1.42 compared to $1.3 just three months ago.

Let me now take a moment to discuss developments in the wood markets. As we discussed last quarter, the markets have continued to settle and the downward pressure on pricing was quite notable in this quarter's results. When compared to the fourth quarter, our fiber costs were on average about 6% lower than quarter one. In Germany, wood prices fell for both whole logs and residual woodchips and our average wood cost remained significantly lower than the same quarter one year ago.

The deterioration of the global housing construction has had a dramatic impact on board producers, continues to reduce our competition for fiber. And our ability to consume wood in either whole logs form or as residual chips has meant that we've been able to shift away from less abundant residual chips and focus more heavily on the whole log supplies that were previously the target of board manufacturers.

But we are now reaching price levels that are low enough to begin restricting supply. In recent weeks we have noticed reductions in whole logs being brought to market by landowners who are holding off for better pricing. In addition, residual chips are in short supply as sawmills' productivity in light of the poor new housing market continues to fall. This is happening at a time when we're beginning to build inventories for the winter.

As a result, we now expect that fiber prices in Germany are likely to begin rising for the next few quarters as we begin sourcing supplies from further afield. In British Columbia the overall fiber cost trend is more stable. We've been very successful in developing new supplies of whole log pulpwood for Celgar and we believe that we have addressed the delivery cost issues that we were faced with when the Arrow Lakes towing operation ceased after the Pope and Talbot's bankruptcy. While sawmill residuals have been harder to come by, our new woodroom will take some pressure off a reduced sawmill supply.

If I can spend a moment to talk about energy, we're pleased to have completed our second quarter in Germany's green energy program. As you know our admittance to the program gives us access to tariff rates that we expected to be significantly higher over the longer term. Our energy revenues in the quarter were about EUR 5 million higher than a year ago primarily as a result of this program. As David mentioned, we're disappointed to have deferred our activities on the Celgar green energy project but the financing challenges became too great and we're considering ourselves very fortunate that the Canadian government's green energy transformation program was announced. And while we're very disappointed in the delay, the green energy transformation program has the potential to turn a good project into an outstanding one.

So to make a few closing observations, we continue to believe that the tightening market that was interrupted by the global economic crisis is now returning, not quickly, but is returning nonetheless. We're pleased with the market stability in recent weeks and expect significant improvements through the quarter. We're forging ahead with our various strategic projects so that when the markets return we're ready to take advantage of the demand for MBSK and energy.

We believe that there's been a significant and continuing improvement in global production capacity for softwood pulp. We also believe that because of the preexisting inventory levels of some of the shut mills, the impact of this loss volume is only now becoming apparent and the supply and demand balance has returned for market MBSK based on the recent inventory levels at both the consumer and producer. We remain focused on increasing margins by reducing costs as well as increasing the mill availability at all operations and improving the returns in our byproducts such as excess power.

That concludes my prepared remarks. So, on that note, perhaps I can turn the call back to the operator where we can open the call for questions.

(Operator instructions.) Our first question will come from the line of Paul Quinn with RBC Capital Markets.

Yes, thanks very much. Good morning, guys. Mentioned fiber prices up in Germany in the upcoming quarters. Maybe you can try to quantify what we're going to see in terms of costs increase there?

Yes. Well, we're not going to be able to say in terms of euros per cubic meter exactly, but it's just an upward pressure we're feeling, maybe having to procure logs from a little further away, as supply tightens up with our buying pressure. We might look in Poland, Czech, the Baltics, those kind of areas. So it could add a few euros to the transportation costs. So it's not significant but it is just general upward pressure as a result of the volumes.

So like year over year it's something like 5% kind of number?

Don't know yet. That order of magnitude, 5 to 10% I would guess.

But it was trending down last year so if you compare it to last year's wood prices versus what our expectations for this, it's still going to be lower cost. But I think what we're seeing clearly is that the continued reduction in wood prices in Germany has stopped because of the withdrawal of the wood from the forest owners. Because, of course, the demand from the sawmilling side is such that it doesn't make sense for them to continue to harvest at the rate that they were in the past. And this is restricting the volume and therefore we have to look towards the other Eastern European markets where, as you know, because of the global economic crisis, of course, the wood activity there has been impacted a lot. Their currencies have dropped a lot and therefore, there is room for us to be able to source wood from areas which clearly were not our traditional sourcing grounds.

In terms of the Canadian green transformation program, has that gone through Treasury Board approval yet?

Our information is that it is expected to go through Treasury Board this week, and the industry has been invited to a conference call on August 6 where we'll learn more about it. In the invitation they indicated there'd be an active website that would have the methodologies for measuring black liquor and its energy equivalence as well as the forms that are necessary to make the applications and notifications regarding black liquor usage and so on. So it's quite a positive signal I think. We'll know more within a very short period of time, I'm sure.

Your expectation of cash from that program would come at the earliest at the end of the year or -- ?

Well the government has said and left the door open for money to flow in December and that was some time ago when the last industry conference call occurred. That was their review of timing. There's been a lot of discussion and pressure to speed that up. So we should expect them to move as quickly as they can but so far their committed timeline is by December.

Okay. And in terms of your Celgar project, is there a penalty coming from BC, either you've a signed contract with them for not delivering the project on time or what happens there?

Well the contract had some wiggle room in it for what we call our COD date which was May 1 and so we're in discussions with hydro to move that COD date out a few months, possibly mid to late summer. And I wouldn't expect there to be a penalty. These are the kind of things that power projects get delayed fairly regularly and ours is a good project for them so. Further discussion yet to come but we're optimistic we won't have penalties and if there are penalties they won't be overly material.

Okay and just lastly, possibly, I guess you've got commitments up there with equipment suppliers for that project. Are you in negotiations with them to delay or what's the status of that?

Yes, I mean we're in discussions with them because of course our expectations are that the amount of funds available under the green energy transformation program is significantly higher than what we had originally envisioned in terms of power generation at the Celgar mill. So because of the clearly more available funding as a result of this, we have undertaken a significant amount of studies to further increase the amount of energy efficiency as well as energy production. And of course, when you have more money available there's a lot more things you clearly can do and make a more efficient project. And so as part of that process, it is going to expand over the given time, more work which -- as well as more equipment purchases from the suppliers which are presently involved.

So I think it isn't just a discussion which is limited clearly to the green energy project that was initially envisioned, but really an expansion for the future which will provide additional revenue and income to our suppliers. So I don't think this is a -- how you would call a limited discussion, Paul, where we're just talking about the delay of the project, but really an expansion of additional potential work. And clearly that results in delays because we would be looking to further improve the overall economics based on the larger available pool of money.

Okay, but in terms of the size of the generation is it still going to be limited to 48 megawatts?

At this time for the turbine, but it gives us an opportunity to look at tying in and doing work which would allow us to further expand potential power generation.

Just to add for you, Paul, the -- we're buying a 48 megawatt turbo generator and our commitment in our power purchase agreement is, depending on whether you're in the winter or the summer, 30 to 35 megawatts of power. So it was sized for the mill to grow. You know, we've got incremental capacity we're working to achieve. So there are things within the mill that we can do that will speed up our ability to deliver more megawatts than the 30 or 35. And that's what's Jimmy's talking about. There's -- it's a scope review of the entire project because several of the contracts that are in place will be expanded for additional work that will produce more power.

And just so I'm clear, any additional power generated over the 30-35 BC hydro is taken in [at] the same rate?

There is a certain percentage which would allow us to sell at the same rate.

Yes. The contract allows us to upsize by 10% within the first year and beyond that we'll be in discussions with.

Okay. That's all I have. Thanks, guys.

Thanks.

Our next question will come from the line of Bruce Klein with Credit Suisse.

Hi, good morning.

Good morning.

Just on the Celgar project, could you just remind me of the -- what was going to be the CapEx dollars associated with that? And then I thought at some point there was a number for potential benefits or cost benefits each year. Are those numbers -- maybe you could remind us of those numbers and are those numbers still relevant in your view? Or how -- I guess they might change with the scope of the project but maybe you can talk on that.

Yes, the original capital investment was expected to be CAD 55 million. Of course, with the change in, let's say, the scope which would be available based on what we think is going to happen under the green energy transformation program, that could expand. But the original project was CAD 55 million and there's really no change expected based on those equipment and the services that we expect to be provided. And the income or the additional revenue that we expected was something in or about CAD 25 million.

That was annual?

Yes, it was annual.

Okay. And then the new Rosenthal bank facility, are there any bank covenants in that facility?

Yes, there is covenants, things like debt to interest.

That was maintenance, Dave?

Yes, yes there are.

Could you share what the tightest one is or you don't --

Yes, we don't normally disclose our covenants, Bruce. We're comfortable with them. They're -- we had similar covenants in the previous Rosenthal revolver as well.

Okay. Okay. Thank you.

Our next question will come from the line of Andrew Shapiro with Lawndale Capital.

Hi. A few questions. Regarding the Celgar project and the prospective financing, how much has the Company invested so far in the project that could be subject to reimbursement from the governmental grant program? And based on Celgar's black liquor production and the proposed rate to be paid for black liquor, and the scope of the program, do you have a range for how much in grant money Celgar would be qualified to receive if you have the appropriate reimbursable projects to get the grant money for?

Sure, Andy. The first question, how much have we invested in the project, so up to June 30 it was about CAD 16.5 million. And the answer to the second ques --oh, and just further on that -- so the conditions of a grant are that money spent prior to the announcement date typically is not covered. So it's got to be incremental spending from the announcement. But they are expecting to allow certain soft costs. So we're -- don't have a number on that but I think it could be our engineering, a bit of site development, some of the legal work on preparing documents with vendors and those kind of things. So it could be a few million, CAD 2 million or CAD 3 million of soft costs on the project that would qualify. But we're waiting for the final rules on August 6 to make our determination of that number.

The range -- a bit hesitant to put numbers out on the market. What we've said on our press release is that we expect our entitlement to be -- I think we used the word "significantly" in excess of the cost of the existing project. So, maybe I could just leave that with you there.

You can't give a wide range? In other words, you produced a certain amount of black liquor. There's CAD 1 billion dollars they're going to give out. The industry has already produced enough black liquor year to date to chew up that full billion. You know, you're going to be entitled to between 50 and 80 or maybe even 100?

We've decided with our board we just didn't want to throw numbers around. There's some calculations that need to be done and verified in terms of liquor intensity and all sorts of issues. So we've got a view internally but we're comfortable enough to say it's in excess of the size of the project as it's designed.

Yes. (Inaudible - multiple speakers.)

(Inaudible - multiple speakers) of the project as it's designed is how much?

CAD 55 million.

Okay. So in excess of CAD 55 million?

That we're comfortable with, yes.

Okay. That at least gives us a decent handle on materiality of all this.

Okay.

Can you tell us, it looks like the due from unrestricted group, money downstream from the parent company into Stendal, is up at 68.465 --a million. I think that's -- I don't know if it was euro or dollars, but -- I think it was euro. That's a little bit higher than the prior quarter. Is this an incremental capital injection that's gone down from the holding company into Stendal or can you discuss what has caused that increase or potential future increases?

The accrued interest on the loan, Andy.

So no new cash, it's just the buildup of the loan?

That's right. That's the money that we pushed into Stendal to buy our interest in it initially. That was -- that's what the convertible debenture was for.

Okay.

And it accrues interest.

All right. And as this accrual occurs, and the minority partner in Stendal has not made a similar type of injection, each quarter, does their pro rata ownership interest then further diminish and what percentage are they down to now in Stendal?

No, Andy, because there was original capital injected into Stendal based on shareholders' equity plus the shareholders' loan. So what we're talking about is this accrual in terms of the interest on the shareholders' loan that existed and that will continue to accumulate and that accumulates for both parties, the minority and us. There was of course a dilution because of the -- when we amended the Stendal facility last year, we contributed EUR 10 million that the minority partner did not contribute and there was of course some dilution up to the 75% which allowed us then to keep the relationship and that's basically it. So there's no further dilution at this point that we're expecting of the minority.

Okay. In terms of your Celgar and Rosenthal debt pieces, the Celgar -- remind us again when the Celgar line matures, and also the Rosenthal line, when you would expect this new line and its new maturity dates and all that to be locked down? And also, if you could tell us anything in particular about the differences in the new loan from the prior facility. Because it seems like the availability on the new loan is a bit reduced and I don't know if there's a rate change or not.

Yes, so the Canadian one expires May of next year. The Rosenthal line expires October of next year but the extension carries it out into 2012. The reduction on the Rosenthal revolver is standard practice for European banks today. If you want to renew, their starting position is, "Well, why don't we talk about 75% of your original loan?" And I guess considering that we've never drawn on the Rosenthal revolver in its original state in the four years that we had it, at 40 million, we thought 25 was okay. We also, at the same time, are getting a government supported 4.4 million equipment loan which is not a working capital base thing but it's just a recovery of capital we've been spending on a washer project at Rosenthal. So that, kind of in our minds, allowed us to be comfortable with the 25.

And how much is drawn on each of the Celgar and Rosenthal lines against how much is available?

Yeah, so the Canadian is drawing CAD 22 million out of CAD 40 million, but with where our inventory levels are now and this is similar to the disclosure of last quarter, we really are at the limit of our borrowing base on the Canadian one. And on the existing EUR 40 million revolver for Rosenthal we had EUR 10 million drawn at the end of the year and we since paid that EUR 10 million back in mid-July. I'm sorry -- at the end of June we had EUR 10 million outstanding and we repaid that in the middle of July.

Okay. So it's at zero out of 40, and when does it drop down to 25? When does the new line likely go effective?

I think it will be two weeks when we sign all the documentation. We've been through -- we've got -- we've had our commitment letter obviously. We've announced that and we've finished turning the documents so it's just the legal department's finishing off the security agreements and then we're done.

And is it a similar interest rate margin, no change in that?

Slight increase in the margin but it's a great rate compared to anything you'd ever expect to find in North America. And the covenants are a little bit easier than the previous one.

Okay. I have a few more questions but we've asked a few here, so we'll back out in the question queue, but come back to us, please.

Our next question will come from the line of Bill Hoffman with RBC Capital Markets.

Hey, yes, good morning. Just to follow up on the last questions, Dave, the -- you said you paid down 10 of the revolver after the quarter end. I'm assuming that pulls your cash down then from 33 to 23?

In the restricted group, that's right. Yes.

Yes, in the restricted group. So, I guess the next question is, is that cash available to either entity, Celgar and Rosenthal? And I guess to follow on with that, if you have the availability over at Rosenthal and need it over at Celgar, can you move that if you have -- are you restricted from moving cash back and forth?

Well, there's no tax reasons or legal impediments to moving money within our structure. The -- where we have to be careful though is if we draw too much out of Rosenthal and pushed it up to Mercer or to Celgar, we have to think about the bank's perceptions. Like they just don't want us draining the liquidity out of their facility and moving it to the parent.

So there are some structural restrictions depending on how well that mill is doing. For example, if you do an EBITDA to interest expense test, included in interest expense needs to be payments to the parent so that you have some natural restriction from moving liquidity at a time when the mill was doing poorly. If the mill is doing better from an EBITDA perspective, that opens up the availability. So today we have room to move some amount of money, not all of it. Some amount of money, but having said that, we don't have a need so we're not intending to do that in the near future.

And then just to follow on that, with regards to the Celgar side of the equation, could you just talk about your liquidity strategy there, especially as you go into the back half of the year and are planning some -- your annual maintenance shut?

Yes, so we brought our liquidity out of working capital, we're continuing to do that. We're being very careful about fiber procurement, inventory management, those kind of things. And it's a difficult situation but we think it's manageable. And just carry on.

And then with regards to the annual shuts at both facilities in the back half of the year, can you give us an indication of what -- how many days you would expect to have them down?

Yes. Rosenthal is a longer one. It's going to be about 18 days because there's a bunch of recovery boiler work that needs to be done. It's scheduled. We've been planning this for a couple of years. And for Celgar, we're still not clear on the scope of it because we're pulling back from the amount of work we were going to do, because we did have a bunch of tie-in work originally scheduled for the green energy project which obviously is going to be moving forward into next year sometime. So, still working on the scope of that, but it will be at least 11 days which would be the normal, possibly a slight bit longer.

Okay. Thanks. And then finally, can you [just talk about] production volumes in Celgar and Rosenthal in the second quarter?

In the second quarter, I can do that. So production for Rosenthal was 79.9. Stendal was 160.9. Celgar was 108.3. Sales volumes for Rosenthal were 84.3. Stendal was 191.4. And Celgar was 119.6.

Thank you very much.

(Operator instructions.) Our next question will come from Andrew Shapiro with Lawndale Capital.

Follow ups to fill in some gaps. What type of fiber prices were embodied in the recently reduced drawn down inventory versus the current market environment for the fiber prices? I mean, higher? Lower? What are we moving out here?

Well, once we wrote down our inventory, we wrote it down to a level which is pretty similar to --

What it is.

-- what it is.

Okay. Great. And can you break out what the energy sales were from Rosenthal versus Stendal during the quarters to understand what type of higher German energy subsidies come into the restriction group versus what is outside of the restricted group?

Yeah, sorry, Andy, I just don't have the energy revenue breakdown here at the table.

Okay. We'll do that offline then?

Okay.

And can you describe under what scenarios and timing is the restricted group able to recoup back part or all of its capital investments down into Stendal?

Well it's going to take some much stronger operating conditions obviously. And the way to think about it is as Stendal earns -- earnings improve, the first place that free cash flow will go will be to top up the debt services reserve account to the point where it has one year's principal plus interest. And that's something we negotiated in so that it will always have muscle to weather the next downturn. So it's -- first liquidity goes into an insurance basket which is on our balance sheet but it's restricted.

How big of a basket is that?

One year principal plus interest. So it'll depend on -- the principal for the next year is going to be relatively small. Then it starts growing again and the interest is the -- it's roughly 35 million a year.

Okay.

Then beyond that, any amounts that had been deferred from the original principal retirement schedule will be swept to the bank up until the point in time where you've made up the deferral to that point in time and then beyond that, free cash flow is available for distribution to shareholders.

And what is the quantification of the amount that had been deferred?

Well, right now we deferred the March payment, so we'll call that 10 million.

So about 20 million a year?

Yes. For the first two years. For the first two years and then every year beyond that it's -- there is some deferral as well. We had almost a complete deferral in the first two years on the principal and then every year beyond that to 2017 it's some deferral every year. We just change the slope of the amortization curve out to the point where we've got a bullet at the end of --

Right.

The total deferral was around EUR 164 million.

Okay. Will your footnotes or could your footnotes in your financial statements provide or break out and quantify kind of these cumulative buckets of hurdle before money could flow up from Stendal into the restricted group? It would be useful to have (inaudible - multiple speakers) --

(Inaudible - multiple speakers)

-- in your footnote breakout.

We'll think about it. We didn't, obviously it wasn't an issue for December 31 because there hadn't been any deferrals, but we'll consider what disclosure will help you understand that.

Right, because we're trying to understand the distinction between the two and when money can flow up in the investment in Stendal can be recouped up by the parent co. You've really reduced inventory down, which created a lot of cash. Want to get a better feel for whether this is a sustainable level, there's even more room for improvement, or it's a level that you have to bring back up and costing a bit of cash in the current and future quarters.

Well I think the expectation should be that for fiber we will start to invest working capital in fiber again going into the second half of the year at all three mills. That would be typical of the seasonality. And for finished goods inventory we're going to work hard to keep them at the levels they're at right now. There's not a lot of room to take them down, maybe a little bit of room in Rosenthal. They're a little bit higher than they need to be. But the other two mills are down at pretty much what it takes to keep the flow going to the customers considering the order fulfillment process that pulp has to follow.

Okay, and I don't have any questions about the current proposed exchange offer. It is certainly an offer we as large convert holders will not be accepting. And hopefully there will be an improved discussions going forward.

Well, I guess that's your opinion, Andy, so we'll certainly have discussions I'm sure. But the offer presently is outstanding and we'll have further discussions, I'm sure.

I just think you're wasting valuable time.

Well, we appreciate your comments.

Our final question will come from the line of Rick Sherman with Oppenheimer.

Yes, hi, guys. I'm a little confused about the program for the black liquor. I thought it was predicated on what was going on in the US. And that program was going to come to an end anyway by the end of the year. If this thing pa- -- the investments you make in this, do they extend beyond 2009? Are they predicated in any way on whatever's going on with the program in the US? Because I thought they were simply put forward by the government to try to mitigate the advantages that the US producers had.

I'll try to address that, Rick. So the US black liquor program has been in place -- companies in America have been benefitting since late third quarter of last year, benefitting throughout all of 2009. And some question as to whether it will end. The highway bill that it's embedded in is up for amendment or whatever they do at the end of this year. There's also a budget before Congress that would have this ended at September 30. So there's not real good clarity on where it's going.

But the Canadian government's response was to assist the Canadian industry to recover from the damage that's been done by that protectionist measure. But they want to do it in a way where they don't create softwood lumber risk. So it's a capital grant. It's to pulp producers only that produce black liquor. You can't spend it on a sawmill or in the forest or those kind of things. And it has to be -- it has to have an energy and environmental benefit to the mill, through the spending of capital.

They also didn't want to create an environment where Canadian operators start destroying their own market running hard to earn more black liquor. So they set it up in a way that's quite clever. They said it's -- you start measuring black liquor back at January 1st of 2009 and each company's entitlement is allocated starting with January 1. Every day they measure the black liquor until a full CAD 1million is allocated to the companies that operated in that timeframe. The math tells us we're pretty close to that line right now. So any future activity isn't -- any change in activity isn't going to change how much you're entitled to. So it takes gaming away from the system. And then because capital takes time to deploy, they've given us a three-year window to spend it.

Do you have to produce some form of biodiesel with it or anything like that?

No, it's strictly a benefit based on the black liquor generated and burned at the facility. We don't have to add diesel to it.

Yes, the project has to basically be in energy efficiency or environmental improvements.

So is the intention of the government right now as it currently is constituted that this is a three year pr- -- is there a timeline on this program -- is three years?

The CAD 1billion gets allocated and as I mentioned, it's probably allocated now. Our activities up to this point in time when you -- as a Canadian industry the CAD 1 billion dollar limit has been reached. It will be by mid-September we'll know how much we as a company are entitled to. And so every company will have a bucket of funding available, predefined and you've got three years to spend it.

Oh, three years to spend it. Okay. So, it's really not -- you have a grant to basically spend this money on a project that ultimately on a longer term basis will throw off additional EBITDA to you through energy production.

Yes. That's right.

Is that the way to think about it?

Exactly. So the government has a number of objectives. They're looking for energy efficiency in their industries. They're looking for environmental improvements in their industries. And they've got an economic development agenda. They want to preserve as much of this industry as they can in the wake of this recession that we're in, and some of the protectionist measures that the American mills have received which puts them in a much more advantageous competitive landscape. If you don't spend capital on these kind of facilities, eventually you become a dinosaur. And so that's part of the thinking behind the Canadian government's approach. They're doing what they can to help us compete in the face of existing competition.

Okay. Going over to your working line of capital, I think I, if I understood it correctly -- okay, I understand you're going from 40 to 25 million but your 40 million original line on Rosenthal was good until -- did I hear October of 2010? The original line?

Yes.

Okay and you're changing that to approximately a combination of 30 million, a combination of 25 plus the term loan?

Right.

Okay. Did I hear you say -- okay, is there a reason -- did I hear you say that you're -- in the next few weeks or whatever you would subsequently convert that down to the 20 -- you would put into place -- you'd go from the 40 million to the 25 million literally a year early?

Yes.

Would the situation -- and then on top (technical difficulty) pay down the line by 10 million. I'm just curious, if cash is -- if the situation is in the world right now is so unsettled, why negotiate that -- where you might need cash, you never know, based on market conditions. If we do a double swoon or something or other--

(Inaudible - multiple speakers.)

-- why would you put that into effect a year early and not wait until you got off --over the hump?

Yes, the way these things work, Rick, I think is as you approach them as you approach the maturity on a revolver and if you're -- particularly in challenging times -- if you're going to draw money on it, you need to demonstrate to the lender how you're going to pay them back through normal operations. And so just drawing down 40 without a forecast to support how you're going to pay it back or -- the lender's going to have an issue with that. So we felt that it was better to have the certainty and the security of a long-term facility. We don't think we're going to need that line of credit even, but it's a good thing to have and --

No, I'm not disputing that, but I mean, everything you just said about the lender wants to know when you draw it down, how you're going to pay it back, that doesn't change whether it's currently at 40 and you drew it down or whether you bring it down to 25 and suddenly you draw it down.

It depends -- depending on when the maturity is of that line. So if you basically have to demonstrate that you've pulled down 40 and you've got to pay it back next month, then you better be able to justify you're going to do that versus a year or two years from now. Right?

Right.

There is a big difference in terms of how you can justify the amount that you have drawn and still have outstanding versus the forecast. And clearly certainty is better if you have a longer period of time than if you have such a short time where nobody's going to believe that, right?

And I also mentioned, Rick, that we did improve some of the features in the new facility which makes it more available to us under poor operating conditions than the previous --

I would imagine you would have, basically having done it so far in advance and having reduced the line in general. Yes.

Just to the point of -- not to harp on the exchange offer, but this has been an obviously maybe once in a generational type of downward move where probably the whole world was disrupted in a way that we haven't seen before. Obviously the concern was tremendous based on the damage done to your stock price, your bonds, and everything else -- was just the industry. And obviously it's starting to improve somewhat. But is there -- I don't know if you can share any of this, but is there anything you can share that's like a plan B if we come around to -- you've made this offer to the bondholders. The other caller obviously was quite -- made his opinion known.

Is -- first of all, the converts, are they primarily -- I recall in the past that a very large percentage of those converts were held by a very small amount of investors. Is that still the case where maybe 80% of those bonds are held by five entities or ten entities? And I guess my question would be first of all, do you -- can you take any percentage of those -- anybody who wants to do it, there's no minimums I believe. What's plan B if basically that doesn't fly and we come around another year from now or whatever? Is there any alternative planning being done relative to taking out those converts?

I think clearly the exchange offer is out there. I'm sure that the various holders will have their own opinions. Clearly the quarter was important so that everybody understands how we're performing in light of a very difficult early year period. And I think the global economy hopefully has now bottomed. And I think moving forward our expectations are that if the existing holders of the convertible notes, they're going to have to make up their own mind about the exchange offer. And we, based on the forecast that we have and the improvements of the global pulp market, we will continue to have adequate liquidity to continue the business and pay the -- and service the interest. So there's -- this is not something where there's an immediacy here.

Now clearly the liquidity issue is at low level so it's not like we're -- we've had a lot of safety but we do have adequate levels. So this is not an issue where we got to [solve] the convertible note or senior note or any other issues. So that's not a concern to us. I think the equity value clearly has reflected a significant downturn in the business. It's also had an impact in terms of the debt values as well. And there's a dislocation in terms of what market is perceiving asset values in this industry to be. And we've never seen enterprise values which are reflected today in terms of our business in the past because clearly we are in a completely different type of reality. And until we get to more normalized conditions we won't really know what the next period's going to be in terms of asset values.

So I think it's a little bit too early to say, "Oh do you have a plan B?" As we said -- I mean, we will always have plans to deal with the need of that time, but it also has to reflect the conditions that will exist at that particular period. And we're just transitioning out of a very abnormal period into one hopefully which is more normal. And so to make a decision and extend and setting up plans based on what we just went through is clearly not realistic. We believe we can service the existing debt so there's no urgency here. We've made an exchange offer. I'm sure we'll have further discussions. And if it's not successful, it's not successful. We will then have to deal with the situation at that time. But we felt based on the conditions that existed prior to us going out with that exchange offer that it was not something that was completely a waste of one's time. Now the conditions of course change subsequent to those but it may change again within a week. So no one knows. We have of course now another quarter finished, everyone has the benefit of seeing how we performed and then we can continue to move forward from there.

Okay. Are you able under the restricted group to, for example, sell just one of the mills and subsequently -- and if you did, use it to pay down or, you know, the debt that's related to the restricted group? What's the flexibility --

I don't think we want to get into restructuring scenarios on an open conference call. It's not an appropriate conversation at all. Sorry.

Okay. No problem. Thank you very much.

And we have no further questions at this time. I would now like to turn the call back over to management for closing remarks.

Well, again, we'd like to thank everyone for attending today's conference call and hopefully as we commented in our -- on our, I guess, presentation, that we have now reached at least a bottom and that we're going to return to a bit of normalcy moving forward. We're quite optimistic based on the inventory levels that we've seen that clearly further price increases may occur, and this is really dependent on how China moves forward in the coming months. On that, thank you very much.

This does conclude today's teleconference. You may all disconnect.