Mercer International Inc (MERC) 2010 Q2 法說會逐字稿

Good morning. My name is Chelsea and I'll be your conference operator today. At this time I would like to welcome everyone to the Mercer International second quarter 2010 earnings conference call. (Operator Instructions.) Thank you. I would now like to turn the call over to Ms. Alexandra Tramont of FD. Ma'am, you may begin your conference.

Thank you. Good morning and welcome to the Mercer International 2010 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 Security 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 and Chief Financial Officer and Secretary.

Now, I will turn the call over to David Gandossi. Please go ahead.

Thanks, Alex. And welcome, everyone, to Mercer's second quarter earnings conference call. I'll 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 markets, our operating performance, and some of our strategic initiatives. As always, we'll be pleased to answer any questions you may have following our remarks.

Let me begin with a few comments about our financial performance. As expected, our second quarter was very strong, both financially and operationally. The pulp market tightened nicely. And operationally, all our mills ran at or near record production levels after getting consideration for the scheduled maintenance shut at Celgar in the quarter.

We also benefited from both significant price increases, driven by the tightness of the market and the euro's considerable weakness relative to the US dollar.

As you will have seen in our press release, we reported a net income of EUR12.4 million for the quarter, or EUR0.34 per share, compared to a net loss of EUR11.5 million, or EUR0.32 per share, in the same quarter in 2009. The net income includes EUR13.8 million of expenses related to our mark-to-market valuations on our fixed interest rate swap and US dollar denominated debt. Were it not for these non-cash items, EPS would have been EUR0.72 per share.

We recorded our highest quarterly EBITDA in the Company's history at EUR62.1 million. This compares to EUR31.8 million in the first quarter of 2010. In US dollar equivalents, this is about $79 million of EBITDA in the current quarter, compared to about $44 million in Q1.

The most significant contributors to the increase in EBITDA were the improvement in pulp pricing and a weaker euro, which were partially offset by the impact of higher fiber prices in Germany.

We also completed a planned maintenance shut at Celgar during the quarter. The shut itself lasted 12 days and positions the mill to run full for about 12 months before its next major maintenance shut.

Switching to cash flow, overall our cash position is EUR13 million higher than that at the end of Q1. Inflows were dominated by EUR62 million from EBITDA, EUR6 million of additional borrowing at Celgar to manage timing differences between payments for the Green Energy Project and receipt of the Canadian government's Green Transformation Fund grants. The strong EBITDA, however, does not immediately translate into cash flow since some of our higher sales funds higher levels of accounts receivable and wood inventories.

Working capital increases drew on cash by about EUR30 million, and capital expenditures drew about EUR15 million. It's important to note that about EUR13 million of the EUR15 million in capital expenditures is in respect to the Green Energy Project. We have prefunded a portion of this amount, and funding from the Canadian government will come in accordance with the Green Transformation Program in Q4.

We have EUR26 million of undrawn revolvers available at Rosenthal, and EUR6 million available at Celgar. We currently have cash of about EUR62 million, which is comprised of approximately EUR39 million for the restricted group and EUR23 million at Stendal.

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.

Thanks, David. Good morning, everyone. As David mentioned, we are very pleased with our second quarter results. We are especially satisfied with the mills' productivities this quarter after considering our annual maintenance program at Celgar.

The expected impact of the tightening European fiber markets was really the only negative in the otherwise positive quarter. In addition, the Green Energy Project is progressing as planned and we continue to expect to be producing electricity early in the fourth quarter.

We're happy with the pulp market's ability to support price increases in light of the low inventory levels in the first half of this year. And the NBSK market remains tight with the historic low 21 days of inventory available.

We are also pleased with the progress of our high-return, strategic projects, most notably Celgar's Green Energy Project. I'll talk more about this in a moment, but let me first comment about the mills.

Our two mills in Germany ran extremely well in the quarter, with Stendal posting its highest production quarter ever, and Rosenthal with near record production. These results were particularly satisfying after we were forced to slow these mills down in the first quarter to manage our fiber inventories. I continue to be pleased to see our vision and investments resulting in our people raising the bar in terms of what we are capable of producing. So, we are continuing to believe that there is more untapped potential.

Although it is not immediately obvious in the numbers due to its recent maintenance shut, Celgar performed particularly well. Productivity there continues to improve and we achieved daily, weekly and monthly production records during the quarter. Although our return to full production was slower than we would have hoped coming out of the April shut, the mill followed up with record month in June.

In total, we produced 360,000 tonnes of pulp compared to 330,000 tonnes in the first quarter of this year, and 349,000 tonnes in the second quarter of 2009. In addition, the German mills' strong productivity allowed us to sell 144 gigawatt hours of electricity in the quarter, compared to 107 gigawatt hours in Q1 and 129 in the same quarter last year.

As a reminder, we have a fairly significant planned maintenance shutdown at our Rosenthal mill in Q3. In addition to the regular 12-day shut that occurs annually for the prescribed maintenance, we will also be performing a more thorough rebuild of our turbine and generator. The turbine work will not impact pulp production beyond the 12-day schedule, but it will limit our ability to generate electricity for about 51 days extra after the pulp shut.

If I could turn to the pulp market for a moment, I would characterize it as tight, but a little confused. As you know, current NBSK pulp inventory statistics remain positive with producers' global soft wood inventories standing at 21 days, which is amongst the lowest levels in nine years.

We continue to believe that the market tightness will continue to put pressure on prices in the longer term. But as you know, the momentum we have experienced in the past year has stalled at the moment as certain markets are resisting further price increases and some suppliers have lowered pricing to accommodate. This development is somewhat puzzling to us as there is no shortage of conflicting variables to consider.

The inventory levels for NBSK are very positive; however, the market is also considering the impact of a return to production of a small number of previously shut NBSK mills. In addition to the restarts, there is some uncertainty as to the impact in the market of certain recently sold mills, mills that previously supplied the market and which may in the future be dedicated to their own new owners, Integrated Paper Production in China. And of course, in the background, there is the hardwood market which has been softening despite relatively low inventories as well.

AS you know, the NBSK market appears to have settled on a $50 reduction for China in July and a $30 reduction North America. So, this will leave list prices in August at $990 per tonne in North America and $980 in Northern Europe, and $840 in China.

Despite the reduction, our order book in China is much lighter than it has been in recent quarters. So, we are cautiously optimistic on the strength of the continued low inventory levels. We are also prepared for the likelihood of a slower period and higher Mercer pulp inventory levels than we have seen in the last year.

Our sales volume was at normal levels for the quarter with a maintenance shut. Sales volume totaled 365,000 tonnes compared to 333,000 tonnes in the first quarter and 395,000 tonnes in Q2 2009.

Let me now take a moment to discuss developments in the wood markets. As we have discussed last quarter, after falling for most of 2009, wood prices in Europe have been rising in 2010. As we have expected, on average our wood costs were about EUR12 million higher than in Q1. We expect on average that our wood costs may increase slightly in the third quarter, but should flatten out for the remainder of 2010.

In Germany, wood prices was up for both whole logs and residual woodchips, primarily due to German wood board producers entering the market to take advantage of slightly improving board markets. The increase in German fiber prices has been as quick as the decline in 2009. After reaching cyclical lows in the summer of 2009, our fiber costs in Germany increased 17% in Q1 and 13% in Q2.

You will recall in Q1 we eased production in Germany due to our tight fiber inventories. But as David noted, we have invested a significant amount of working capital to limit the risk of having to slow production again. We are currently satisfied with our fiber inventories in Germany, but will continue to build our inventories in anticipation of the seasonally slow harvesting winter months.

In British Columbia, our fiber cost trend remains encouraging. The new supply chain for whole log pulp wood we have developed has significantly addressed our delivery cost issues. As well, we have begun to see a modest increase in sawmilling activity in our area. This, combined with continued productivity improvements in our wood room has us confident that Celgar's wood costs will stay flat in the third quarter. However, even if a weak lumber market reduces sawmilling activity in our area, we believe that the impact in our costs will only be slightly negative.

If I can spend a moment talking about energy, our Green Energy Project at Celgar is progressing nicely. The key machinery is now installed and we will be progressing through the test phase shortly. We don't anticipate any problems achieving our October start-up for this important project that we expected will add about CAD20 million to CAD25 million to our bottom line.

And as you know, the project will consume CAD40 million of our CAD58 million Green Transformation Fund grant. We're in the final stages of preparing our submission for the use of the balance of the funds. Like the Green Energy Project, these final few projects will be highly accretive with quick paybacks of three years or less.

So, to make a few closing observations, we continue to believe that the tightening market that was interrupted by the global crisis has returned. While we have some concern about pricing and our order book in the next few months, we believe that the upward pricing pressure will eventually return.

There is much speculation about softening as capacity restarts and the new capacity, but our view is that this will be more evident on the hardwood side. The fundamentals for NBSK supply and demand remain favorable, and we're optimistic with continued global economic growth. The supply/demand balance for soft wood pulp should remain favorable for the next several years.

We believe that there has been a significant and continuing adjustment in global production capacity for soft wood pulp. We also believe that, because of the pre-existing inventory levels, the impact of this lost volume is only now becoming apparent.

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.

So, with the conclusion of my prepared remarks, perhaps I can now turn the call back to the operator where we can open the call up for questions. Thank you.

(Operator Instructions.) Your first question comes from Bill Hoffmann with RBC Capital Markets.

Yes, good morning. Jimmy, I wonder if you could talk a little bit about the Rosenthal shut here in the third quarter. I want to get a sense of what the extended power cost differential might be for you in the quarter, and just whether it would be any different than sort of the impact of the cost of the Celgar shut in the second quarter.

Yes. I think the Rosenthal maintenance shut, of course, has been extended because of preventive maintenance program that we intend to do on the generator. We have found that generators of a similar vintage have experienced certain winding or wire winding problems. And of course, as a preventive measure, we have decided to increase the original expected additional down time from 38 days to 51 days.

And also, it will involve additional costs. Those additional days will impact around EUR1.5 million. The original budget was somewhere in the order of about EUR 4million in terms of electricity sales loss and additional sales purchases. So, the total together, as we've announced in the press release, roughly is about EUR6 million extra in regards to the additional power purchases and power sales loss for that period.

The Celgar start-up issues in the second quarter actually were quite difficult in the first month. So, the impact actually at Celgar in Q2, I would say in terms of the impact, is probable, if not slightly higher, in terms of loss in additional margins as a result of the start-up difficulty that we experienced at Celgar. And a lot of that actually was due to certain unexpected problems related to outside contractors tripping the equipment accidentally. And as a result, there was some difficulty restarting the mill because of that disturbance. So hopefully, that answers your question.

It does. And a question for Dave, sort of a housekeeping one. Can we get the production volumes at Rosenthal and Celgar and Stendal, as well as the restricted group CapEx?

Okay. For production volumes, Rosenthal for the quarter, 84.8; Stendal was 166; and Celgar was 108.9. And for sales volumes, Rosenthal was 82.8, Stendal was 164.3, and Celgar was 117.9.

For CapEx, it's a little bit complicated because we've got that transformation money coming in and out, and we had funds received last quarter that are being applied this quarter. So, you can't really pick it out through the statement changes. But most of the spending is -- well, 13 of the 15 is covered by government transformation money. And the spending at the other mills is pretty light, on the order of a couple of million.

Right. But -- so that -- in the current quarter you actually charged the CapEx and then in the third quarter that gets offset? Is that's how it's working--?

Well, it's a little of both. So, we had money received in advance last quarter. So, some of the CapEx that was spent this period was money that was received and we were holding from the previous period. And some of the CapEx that was spent this period will be received next quarter.

Okay. And then just like a final question and then I'll pass it on. Can you just talk -- the power project up at Celgar obviously is a very important project. Can you just tell us what some of the -- I don't want to call them gating -- issues are from a timing to get that thing ramped up? Any risks of it getting delayed, etc.?

I would say the risks are extremely low at this point because pretty much all the equipment is present. It's installed. There's a lot of, of course, tie-in of pipes, etc. There is no delay in terms of the anticipated start-up time. There will be testing before, of course, there is the handover and then the actual fixing of the contractual arrangement with BC Hydro.

But in terms of the actual start-up date, the test procedure, etc., we're pretty much on schedule. And in terms of the expected steam volume, etc., availability of bark and other residuals, all of that is going along very well in terms of availability of the steam source that's required. So, there's really no issue there as far as we can see.

Great. Thank you.

Your next question comes from Emil Schiffino with Cantor Fitzgerald.

Good morning. I was just wondering, you referred to the accounts receivable increase. Is that exclusively due to the higher prices that you realized in the quarter, or is there a timing difference in any of the markets or customers that you've experienced?

Yes, Emil, it's primarily price related.

Okay. And the days outstanding is pretty much constant, am I correct on that?

Yes. It's holding constant, yes.

Okay. And forgive me if I missed that in your previous answers, but are you quantifying the cost of the downtime in the second quarter?

No. What I basically have stated, that the increase in terms of let's say the costs in addition to what we normally would expect from a regular maintenance downtime for Rosenthal was that additional EUR6 million. And in terms of the impact of the Celgar maintenance downtime, the additional costs related to the start-up difficulty after that was slightly higher than the EUR6 million that we are likely to experience at Rosenthal. So, that's basically what my statement was.

What you're seeing.

Yes.

Okay. And finally, could you just break down the debt by where it is, or do I need to wait for the Q for that?

That's pretty simple, Emil. Maybe the Q might help you, but we just have the three components -- the senior notes at 310, the converts at 66, and the 506 for the Stendal, and that's in euros.

Okay. Thank -- yes, well, was there an effect of a weaker euro on how you're -- what you're carrying--.

Oh, I see what -- yes. So you're looking at the -- the debt looks like an increase, but mostly that's the impact of the US dollar/euro exchange rate on the US-denominated debt reported in euros. So, the only additional borrowing we had was CAD7 million on the Celgar revolver, which was just a temporary borrowing to match timing of the transformation funds, but everything else is just exchange related.

It is. Okay. Thank you.

You're welcome.

Your next question comes from Richard Kus with Jefferies.

Hey, guys, good morning.

Good morning.

Can you talk a little bit about what you're hearing as far as inventories on the ground in China?

Well, we believe that the inventory levels in China are low, primarily because we know that even the trading organizations were liquidating the inventory before this, I guess, buyers' strike. So, my expectation is that there's really not a lot of slack there.

Now, the problem, of course, is when you have a buying strike, the question is how much I guess both sides are prepared to play this game of chicken, and it's difficult to estimate. But clearly, we know that they have to come back into the market fairly soon. Inventory levels, as far as we can see in terms of the European markets, North American markets on the consumer side still is quite low. And the producers side, as you've seen, is extremely low. And we don't think that the Chinese situation in fact is any better; probably, it's a lot worse.

Okay. And then what about some -- we're hearing about some pulp production coming online over there in China. How do you think that might affect you?

That's really more of the hardwood. There is a very large hardwood mill which, of course, is in the start-up phase. And so, that should probably have an impact on the hardwood side, but certainly not -- there's no reason why it should have an impact on the softwood side.

Right. Alright. Thank you.

Your next question comes from Andrew Shapiro with Lawndale Capital Management.

Hi. I'm calling in from overseas so I hope I have a good connection. And I might get disconnected, so I have a few questions. Can you hear me okay?

We're fine.

Great. So, with the substantial Stendal debt completely non-recoursed to Mercer and its restricted group subsidiary, what are some of the strategic alternatives you and the Board have considered to obtain a more appropriate equity valuation and lower cost of capital financing for Mercer than what the market continues to undervalue the Company for on a consolidated basis? Because as you know, the yield rates and your cost of financing have been so high and the equity valuation so low.

Yes. I mean, if you look at the Stendal debt side, I would say that the debt carrying cost is extremely low at this point on the restricted group. And the unrestricted group, of course, if you go through the financials, I think you get to see the real financial performance and debt levels of both sides. Of course, on a consolidated basis it tends to confuse some of the readers because, of course, just on the surface it looks like the debt/equity ratio seems to be quite high. Also, the fact that the subsidies and grants of course are not taken into account under US GAAP. So, there is a lot of confusion.

The interest rate valuation issue again undermines the balance sheet, primarily because, oddly enough, interest rates have been headed only in one direction for the last six-plus years, which is unbelievable. But that has a significant impact in terms of the consolidated balance sheet. But if you strip that away and you just look at the restricted and unrestricted group, I think you see the strength of both sides. I mean, Stendal of course gives significant leverage through the pulp cycle because of the financial structure that it had been originally built under.

In terms of the restricted group, I think you're going to see now the great performance that Celgar is starting to kick into, which was kind of delayed as a result of the downturn in the lumber market. As you know, the fiber cost increase have been significant at Celgar as a result of the slowdown in lumber production. We have now addressed those issues, so the difference in wood costs are huge and, therefore, you're finally seeing in the quarter the true capability of Celgar. And with the fourth quarter you'll see even more of that, where Celgar's EBITDA margins are comparable now to our German mills because of the power production.

Now, in terms of how we present our financials, I mean, the Board is looking of course at the impact of the issues which of course cloud the easy transparency of understanding our financials. So, we are looking and trying to address how do we present our financials in a more transparent manner. Although, we do believe because of the way we have the restricted and unrestricted, if you do, like, dig into the details, I think a lot of that becomes apparent. But of course, on the surface, if you just use your computer, I guess, scanning or a type of selection, it's not as easy to see that. And of course, we don't come out as attractive because of a lot of the ratios not being comparable to our peers because of our structure in terms of how we build our facilities.

I would say that the Board is very cognizant of it. There is no simple answer to those issues because, as you know, the structure of the financing at Stendal certainly gives it huge leverage to the pulp cycle and, at the same time, does present certain complexities. And on the other side, the restricted group, though more conservative in nature, doesn't give as comparable leverage to the pulp cycle earnings.

Yet, it is your restricted group's financing that actually is the more costly of the financing, and Stendal is in effect a call option, giving a huge upside in good markets. And without recourses, if one's made it a zero on the -- the restricted group still survives quite nicely.

Yes. I mean, I think if you look at the restricted group, the fact that it is nonrecourse from the Stendal debt, now with Celgar finally meeting its EBITDA margin capabilities, you'll see the cash generative nature of that. And so, I think clearly -- if you separate out the two, I think you see the strength of both sides. Now, how do you make it more transparent, that's something that we are looking at. What is the structure that properly addresses the strength of both sides and gives the best kind of potential advantage to an investor or an owner of the Company.

Would a spinout or a public market valuation on the equity in Stendal be an option that is allowed under the various debt covenants?

Well, I mean, everything is possible if done properly, clearly. I mean, the Board is considering a lot of different ideas. And as I said earlier, there is no exact answer. There is no simple answer to this. Because of course, as I said, the combination of the two gives you that huge leverage and, at the same time, the restricted group gives you also that conservative, more traditional finance type of structure.

Right. Because if you deconsolidated, you'd get that debt off, you'd get the Stendal debt off the balance sheet.

Yes. And of course, prior to this economic crisis, debt was -- and leverage wasn't as feared. And certainly, this structure was very attractive to the pulp cycle. Today, debt seems to be more of an issue to many of the investors. And so, we have to see what there may be in terms of a solution to address the new financial environment that we're living in. How do we look at making the investment in our company more attractive to a more risk adverse type of investment climate today.

Okay. Since I might get disconnected, I want to get another question in here or two, if you wouldn't mind. Based on your cash balances and working capital forecasts, which obviously you have huge receivables this quarter from a fabulous quarter, and the present pricing expectations, what do you feel is the range of where your debt net of cash should be at at the end of this year for both the consolidated and the restricted group levels? Do you have a range?

David, you want to take a shot at that?

No, I'd rather not put numbers out there, Andy, to be honest. As Jimmy and I have said on many calls, our objective is to delever. We have to pay attention to the converts. While they're in the money today, and we expect they'll stay there, we have to be prepared in case something terrible happens in the world.

Right.

-- (multiple speakers) and equity values decline. So, for now, we're just -- and we're in a bit of a choppy market here this summer. It's a slow period. So, we're not setting firm or hard targets for ourselves. Be quite comfortable accumulating more cash on the balance sheet, which is what's going to happen in the third quarter, and then we'll address it as we have a better feeling for what the future looks like.

I guess what I was trying to get at is, given what month we're in here now, we're in the beginning of August. So, one month of the current third quarter is in the bag. You probably have orders going on that are giving you some visibility, and then you have Celgar Energy kicking in. Are we in the range of having at least cash flows similar to Q1 for the rest of the year, if not higher?

We've signaled that we expect third quarter cash flows to be quite significant.

Okay.

Accumulation of cash to be significant, yes.

Okay, yes. That's what I was trying to get at.

Yes.

And on what type of projects, and when are you thinking that your investing in the extra Celgar money would begin and kick in, and what kind of I guess enhancements would you be able to invest in with that money?

I mean, many of the projects have been identified. In fact, all of the projects have been identified. We are now in the process of putting together the necessary documentation. Some of it, as you know, because of the nature of the program, we have to have input from all the stakeholders, which includes of course the native community and those -- all of those things take time. So, we're well in the process of doing the formal documentation which is needed. And all of those projects, based on the modeling, etc., all very high pay -- or rapid payback type of projects, as I said, with three years or less. And therefore, the balance of the money is going to have significant additional contribution to the EBITDA margins at Celgar moving forward.

Okay. And your German -- your government grants you have in your press release aggregate to EUR290 million -- EUR291 million at June 30th. Is that consolidated figure net of amortization? And for the June quarter, can you provide the grant figures net of amortization for the three plants, or at least between the restricted group and the non-restricted Stendal?

Yes. We don't -- that's getting into Reg FD a bit there, Andy. We don't disclose that--.

That's why--.

(Inaudible.)

That's why we're asking on the call, which--.

Yes. Well, I don't have the numbers here and I'm not prepared to share all that.

Okay.

But yes, it is net of amortization.

Okay. But you can't break it out between restricted group and Stendal right now?

Well, maybe I can help you. I mean, it's primarily Stendal. There's some remaining unamortized announced for Rosenthal. I would guess Rosenthal's probably in the EUR40 million range. And that's -- I'm just -- in a range. And then we're starting to accumulate similar accounting treatment for the Celgar Green Energy Transformation Program. So, we've probably got CAD30 million in there so far. So, order of magnitude, maybe that will help.

Okay. Last question, which is on the pulp pricing environment. You've discussed a bunch of it. But in the last price correction, which came at a time of above equilibrium industry inventory levels, there was the black liquor boondoggle that kept inefficient plants producing full tilt, right, and exacerbated the problem. Are there any programs going on now to incentivize producers to keep their pulp-making operating longer than what is economically feasible should prices continue to drop?

We're not aware of any programs in Europe or North America in this year in terms of any subsidies for black liquor, etc. There is that open question in terms of tax credits for last year, but that's really a non-cash issue, as you know. But in terms of this year, there's no particular programs that we're aware of.

Also, the last downturn, as you've said, the inventory levels at the producer side were, of course, at normal type of levels going into the downturn. And also, the currency levels were way different. I think we're faced -- as well as wood costs. As you know, the sawmilling activity globally is very weak and, therefore, the wood cost issue is a global issue. This is not just a European issue; in fact, even for the Canadian producers. Wood residuals coming out of the lumber production is very, very weak. And so, pulp pressures are certainly different. Currency pressures are different. So, we do not expect that this downturn, if it does come, will be in any way comparable to what we saw last year.

Okay. Well, thank you very much. I'll go back in the question queue.

Okay.

Your next question comes from Peter Ehret with Invesco.

Hi. Good morning. Just a question related about the cap structure and plans to refinance. Obviously, you don't want to lose the Company to bondholders here in a couple of years. Can you talk about your plans to refinance? The bonds come due now in just two and a half years. And it seems like you do now realize the need to delver and to respect what the markets are saying about lowering risk. How far do you plan to let that go before you have a hard date to -- a target for cleaning that up?

Well, a lot of this, of course, is dependent on the markets.

The markets are really good right now.

Well, I think there's a period where the market is good and there's an opportunity, whether it's on the debt or the equity side. We're not overly, let's say, anxious or -- there is enough time. And I think our earnings generative nature, as you've seen at Celgar, is such that -- in the past we kind of ran the restricted group with our smallest mill essentially supporting that payment.

What's different today is the fact that both the mills are now running at the levels that it's supposed to and now supporting the debt level. So, I think you cannot take historic type of cash generative numbers out of Celgar in any way indicative of the cash generative potential of this mill moving forward. So, if you look at both mills now running reasonably well, with the power project also completed in the fourth quarter, I think the EBITDA type of generation out of the restricted group compared to its overall debt level isn't that high.

So, I think there's going to be opportunities for us to address that debt at good, attractive type of cost levels. And that's, of course, dependent to a large degree on the market conditions. But if it's right, then we'll address it both on the equity and the debt side.

Okay. But do you have any sort of hard date? How far up to the line are you going to walk? I know you're thinking that the numbers get a lot better and it reveals the carrying capacity of the Company with regard to leverage, but at some point don't you just have to just take down the risk where you just can't walk up to the line that close?

Well, as we move forward and as we generate cash flow, which you'll see -- and we see the market is very choppy in the second half of the -- well, after the first quarter you had the issue of the European issue, of course, making conditions very choppy. So, it really is dependent on how the overall market kind of stabilizes out. There's period -- very short periods of attractive type of conditions and then, all of a sudden, they're no longer available. So, we have to look at where the window is going to be debt/equity-wise and we'll see how it plays out. I cannot give you a timeframe because, even if I told you that, the market conditions, as you know, are completely volatile.

Right. And that's part of what the risk perception's all about, that they are volatile and, as that window closes -- the ultimate window is maturity. That's the window that can close.

Yes. So, we're very aware of what's possible for us right now. And we have some opinions about what the future looks like to some extent. We know what we could do and, for now, we're just prepared to be a little bit patient. But we won't take on undue risk. We'll deal with it at the appropriate time.

I think if you look at what we've been able to address prior to last year, even, in terms of the Stendal debt restructuring and all these other issues, I think we have taken on these things before the crisis hit. I mean, it was unfortunate that because of the crisis we were not able to address the energy project at Celgar. And I think that was the biggest concern for us because it did drain us of a significant amount of liquidity at the worst time. It had potential litigation issues, which could have resulted in issues related to not just our senior, but also the converts, etc., etc.

And so, those were the concerns that were complexly unexpected, because we went into the financial crisis with a commitment from a very large institution to fund that project. And it was only at the very last minute that that commitment essentially disappeared, which then created issues for us.

But if you look at our normal type of issues, like the Stendal side, we were aware of the problems that were likely to develop and we took on that restructuring way before the problem happened. If we'd have taken that to the last minute, believe me, it would have been a very different situation altogether. So, I think we are cognizant of the time issues. And so, we will address them way before those become critical.

Well, that's good. It's a good company and the results are certainly there now and you had a close scrape before but you got through it. And of course, (inaudible) want to get that close ever again but, good quarter. Thank you.

Thank you.

Your next question comes from DeForest Hinman with Walthausen & Company.

Hi. I had a few questions, the first of which is can you just walk me through the cost increase on the operating expense side within the restricted group, from a sequential perspective? And I guess my questioning is around you disclosed the pulp sales on a quarterly basis on the conference call, but when I plug those numbers in and kind of look at the operating expenses per tonnes sold, there's a pretty material increase sequentially in the cost of goods sold per tonne, I guess, from that operating expense perspective. And it seems to be more so than what you've disclosed from the fiber price increase year-over-year.

Yes. I think what -- the piece you might need to see is Celgar's maintenance shut in the quarter. So during that timeframe, all of the maintenance dollars get expensed directly. That's consistent -- everybody does it that way now. There's no smoothing. So, in a period where you've got a maintenance shut, you've got higher operating costs spread over whatever tonnes were produced in the period. None of it goes into inventory. It all goes straight to the bottom line. So, that's the difference. There was -- in the first quarter it was the Stendal shut, which is outside of the restricted group.

Okay. But what -- how about that same question on the Stendal group because, if I do the math that way, it looks like the operating expenses per tonnes sold decreased sequentially. But you said German fiber costs are up.

Yes. In the first quarter, though, Stendal had a maintenance shut and also had some down time for fiber preservation. So, it's the exact same situation, just in reverse.

Okay. And I think in the past you had talked about some of the German mills being on some of those -- I think it's the short-week program. Are we still getting a benefit from that, or is that not the case?

Yes. Rosenthal is still on it. And in fact, I think they're going to go onto something similar to that on a permanent basis. But a negotiated permanent basis, not government supported, but shorter work hours. They've figured out how to man the mill with the shorter work week and it's a better format. The guys are liking it so we may stick with it.

Okay. And then on the Celgar sales front, there's been some issues with the shipping container availability with this kind of inventory restocking in the US. Are we seeing any issues on either the cost side, which would impact us on realizations, or -- then also availability?

I don't think that the container side, as well as the road freight cost issues in the European side, will be significantly different in the third and fourth quarters. I think we've seen pretty much the difficulty in the second quarter. So, we're not anticipating any additional type of cost issues beyond what we've already seen.

And I was more -- trying to be more specific on the Celgar. Is that the case as well?

Well Celgar, mainly it's the container issue because of the fact that there's been restrictions -- restricted number of containers being available. So, that has created certain shipment delays, but all of those have been addressed and we look at alternative type of methods. As you know, we have the ability to ship a lot to bulk and so we're doing that. So, I don't see the issues being any more difficult than we've already seen. In fact, it should be easier moving into the second half of the year.

Alright. Thank you.

Your next question comes from Jonathan Lethbridge with CIBC.

Thanks. Good morning. I just want to get back to pulp pricing and focus on Europe, that pricing seems to be holding out there a little bit better than other regions. I was wondering if you can just talk about the market dynamics there, especially given the weaker euro.

Yes. I mean, the weaker euro certainly would play in, but of course in the last few days you've seen the euro strengthening. So, on the European side the market conditions certainly are more stable, although typically the summer months, as you know, tend to be seasonally weak. But the inventory levels at the port, at the consumer, producer levels are such that there has been less of a pressure being put. But because of the issues in China, of course, our end users are looking for of course similar type of discounts.

Some of the producers in Canada, as you know, have also announced discounts in North America. So, all of the European producers, as well as shippers into Europe, are facing the same question mark from our end users. And it's difficult to know what the end results will be until the summer is over, because it's not the price that determines the volume.

Right now, just because you're reducing prices, you're not necessarily getting significant volume increase. So, it's almost like pushing on a string. There will be a point where the Chinese buyers have to come back into the market because the inventory levels will be low, extremely low.

And as I said, it's a game of chicken right now. But we do believe that the inventory within the system today is at historic lows. And that's why we are reasonably optimistic that this kind of volatility through the summer months will probably lead to a more stable market coming out of the summer, and without a significant deterioration in pricing.

Thanks, Jimmy.

Okay.

Your next question comes from Chris Dechiario with ISI Capital.

Good morning. Just -- most of my questions have been answered, but I did want to just ask then to -- a couple of the questions that a lot of people was asking here. And I guess to follow up on what you were just speaking about, is it really the low inventories that gives you confidence that the buyers' strike or the slower demand from China isn't going to be more permanent, or is it--? I mean, what -- do you have any evidence that just overall demand in China is a lower level now, just from the paper mills there or from paper plants, or anything else sort of more secular or long term going on there?

Well, I mean, if you look at North America and Europe, the paper demand growth is still reasonably good. Coming out of very weak conditions, albeit, but still very positive. In terms of the China market, yes, there has been certain sectors which have experienced inventory build in terms of their paper product. And there has been, of course, certain closures to correct for that.

But at the same time, as you know, there's a significant amount of capacity increases in terms of new machines being installed there on all grades of paper. And therefore, these machines require a continued steady type of diet of predictable type of qualities and, therefore, they cannot really stay out of the market too long. When you have large machines which require certain quality standards, you cannot really be too restrictive in terms of your buying because you need that inventory no matter what. And to have these machines stopped for an extended period of time is way costly.

So, there hasn't been any slowdown that you can tell in the installation of these new machines in conjunction with sort of China's sort of cutting back on the stimulus?

Well, I mean, we're seeing certain weakness in certain paper grades in China, there's no question. But at the same time, there's new machines going in and these have to run. Certainly on the hygiene area we haven't seen any real weakness globally. So, it's really dependent on the paper grade, but it's really driven, as I said, by these huge amount of new paper machine capacity being installed in China, and the fact that they have announced that they intend to close another 4 and 4.5 million tonnes of old polluting pulp and paper capacity in conjunction with that.

Now, the timing of that is difficult to know, but that's going to have an impact in terms of local production, which has been kind of dirty and highly polluting. That's going to be substituted by the new production which is dependent to a large degree on quality imported fiber furnish. And that is why we are reasonably optimistic that in the medium term that these developments will support the continued strength within the pulp -- market pulp sector.

Okay. And then on the -- also back on the question of your sort of future use of cash balances as you -- as we believe you -- obviously current -- you'll continue to build them here. Just based on your answer to a previous question, should I be thinking sort of along the lines that your first priority is probably more the converts and then you'll deal with the 9.25's after that, or am I mistaken? Have you even really made that decision yet, or--?

Well, we would expect the converts will become equity. That's our view today. And therefore, the cash that we're accumulating sort of lines up to deal with other leverage. So, the senior notes would be next in line from a maturity point of view. So, that's directionally the way we think. We just don't want to ride the line on cash on the balance sheet buying back debt when we haven't got a clear window through to seeing the converts convert into equity. We've been through one crisis already. If the whole equity market takes a dive, then we need to be able to address the converts to save ourselves.

So, we just -- we need to have that insurance on the balance sheet in case. At some point in time we'll be comfortable that risk is reduced enough that we'll deal with the other restructuring that might be possible for us. So, we're paying lots of attention to it, discussing it with the Board. We're very -- a very clear view of what the market is on the high yield and we know what's possible today and our view is that it'll be more opportunistic for the Company to wait a bit.

Okay. And then my last question is, on a previous call you discussed somewhat sort of the level of discounts, I guess discounts to list, that you were receiving -- I think at that point they were in the 12% to 14% range and you were saying that typically in a tight market they'd be more like in the 7% to 8% range. And I was wondering if those have tightened at all or sort of where they are today.

I wouldn't say that it's tightened anymore, but I think the discount issue I think is a crazy one because the industry uses this list price and a discount to list, which unfortunately makes it very complicated and non-transparent. I think it would be a lot easier if we just basically had a transaction price that we would announce, rather than this list price. Because in reality, the discounting tends to be pretty much the same for everybody. So, it doesn't hide the fact that list is not necessarily what the transaction price is. So no, there has been no narrowing, but I think this use of discounts certainly is something that the industry needs to question in the future.

Yes, I was wondering about that. So really, what you're saying, which is what I was thinking, is that nobody really gets list.

Yes, nobody gets list.

Right. Okay. And the discounts are pretty similar across the board.

Right. Everybody gives the same level of discounts so it's kind of silly. We should just have a standard transaction price.

Right.

Yes.

Okay. Thank you.

Okay.

Your next question comes from Rick Sherman with Oppenheimer.

Yes. Hi, guys. My question is just on the foreign exchange loss having risen a bit because of, I assume, the strengthening of the dollar. Is there some metric to where an X number of movement of the euro versus the dollar moves that noncash number by a certain amount, that I could figure out a way to model that?

Well, maybe the easiest way to think about it is, is that -- the amount that goes through P&L is generated by intercompany borrowings within Mercer. So, it's Mercer's -- Mercer has loaned money down to Rosenthal. It's in the order of $125 million US. It's part of our capital structure, in fact. So, the movements there are what go through P&L. So, you can just model that. The principal is $125 million.

Is it -- the foreign exchange loss, though, is it -- I assume it has to be affected by movements of the -- also of the currency itself?

Well, that's what--.

Between the euro and the dollar?

That's what drives it is the -- because we report in euros and we have a US dollar debt down to Rosenthal, the value of that receivable to the parent goes up or down based on exchange rates.

Alright. So, it's a -- like for each cent you use approximately $125 million times that movement in the euro?

That's right--.

Or is it the--?

Yes.

Okay.

I mean, if you're struggling with it, you can call me offline and I'll walk you through it.

Okay, great. Thanks a lot. Good quarter.

Okay. Thanks, Rick.

Your next question comes from Phillip Wirtz with Odeon Capital Group.

Hi. I just had a couple quick questions. The first is on the cash sweep. I was kind of wondering, hoping to understand it a little better. I understand it applies to Stendal. So, at what point does cash from Stendal become available for general corporate purposes, and can it ever be applied to something like restricted group debt service? Is it all being swept right now as per the requirements of that 2017 loan?

Okay. I'll try to address that. So essentially, excess cash has established priorities under the facility agreement. So, the -- first of all, we're entitled to remain -- retain EUR15 million of cash on the balance sheet at all times.

The next priority would be to build up a thing called a debt service reserve account. So, this is the cash balance on Stendal's balance sheet. And it's intended to accumulate one year's principal plus interest requirements. And so, it's -- as it fills up it becomes the safety value for the cycle that the mill has to work within. So then, the third priority after that is fully satisfied -- and that's about -- call it EUR70 million.

Then the third priority would be excess cash gets swept to the bank syndicate to the extent that there's been deferrals of principal from the original amortization schedule. So, it's an amortizing loan. It had a pre-established amortizing schedule. And then, a year and a half ago we negotiated with the syndicate to lighten up those principal payments with a bigger bullet at the end. And so, before we can get any cash out of Stendal, we need to build up that -- the cash sweep has to catch up with the amounts that have been deferred since the amendment.

Okay.

So, we've got a little ways to go here, obviously. But from an enterprise value point of view, it all is essentially helping us de-lever, creating shareholder value. And it's nice to have -- the big chunk of the cash stays on our balance sheet in our debt serve reserve account for a rainy day. It just makes it all the -- it takes risk out of the equation for everybody.

Okay. And so, the debt service account is just reported on a consolidated basis the cash--.

Yes. In--.

Okay.

Yes. In prior years you'd see it. It sits as a restricted cash. It's a separate line item.

I see. Okay.

Yes.

Okay. And then finally, on the European wood prices, I'm just a little curious. If you look -- if we're looking back, like, over the last business cycle -- and I know that perhaps last summer they reached a bottom and then they've climbed quite dramatically since then. Are there any structural reasons that we should be looking forward to or looking for across the next business cycle? Are there additional buyers that didn't exist before, such as mills in Scandinavia or anything else that are going to put structural pressure moving forward on European wood prices? Or should we plan on a cycle similar to the last?

Well, the issue really is all related to the harvesting activity globally. Because, of course, when you go into the forest you don't just cut pulp logs, you basically cut the highest value logs. And part of that process is a lot of waste, which really goes to the particle board manufacturers, the pulp industry and paper industry, etc., etc.

So, when overall harvesting activities slowed because of the overall lumber activity being slow, and that's a global issue, then wood availability gets limited for everyone. And that's why we have to go to a wider radius to be able to source the same amount of volume. And this pressure essentially is the same for everybody. Even on the Canadian side because sawmilling activity is less than half of what it used to be. Essentially, the wood flow is less than half of what it normally would be, and the wood residual creation is less than half of what it would be. So, as you can see, this is really the issue. It's not you're getting all of a sudden third-party competition.

Okay.

Versus the amount of your wood.

I see. And so does increased energy usage of wood play any role in this, or not really?

On the margins it does because, of course, they're competing for the wood waste that typically would have gone to the pulp mills, etc. But because -- if you look at the costs related to the energy side, it is very freight dependent because you're taking sawdust or chips and then creating pellets and you're having to ship it long distances. So geographically, it is limiting in terms of the logistics issue. And as you know also, the carbon credits have been quite weak so -- and the energy prices have been, of course, weaker than what used to be at the peak of the cycle. So, all of these play in.

Electricity prices in Europe are significantly lower than what it used to be a year ago. So, the attractiveness and the competitive margin for the bio-energy sector certainly is less than what it used to be so affordability is less. So, everybody's faced with the same type of cost pressures. So we're not necessary faced with an industry which all of a sudden can afford to pay a lot more than we can. In fact, our competitive structure probably has remained the same through that spectrum and we're all kind of forced to pay more. And of course we have to increase our product price as a result. It's easier for us than let's say the power guys because of course the utility rates are not going to adjust as rapidly as what we've been able to push through.

Right. Okay. That's very helpful. Thanks so much.

Okay.

Your next question comes from Bill Goldman with Catalyst.

Yes, hi. My questions have mostly been answered, but I just wanted to clarify. On the build in accounts receivable, do you guys expect to convert that to cash in Q3 or what's sort of the timing on that and the order of magnitude of cash generation?

Yes. The way to think about it is the build occurs because you have -- we've had a period of steadily increasing pricing. So, there's always an element of increasing investment in receivables because the per unit value is higher. Now that pulp prices are level, or even possibly declining a little bit, just the natural flow will be no longer building into receivables but will tumble straight into the balance sheet. So, our days sales and receivables I don't think is going to change, but we won't have this building effect, so you'll see a very positive cash generation, cash produced on the balance sheet as a result.

Gotcha. And then secondly, on the press release it looked like the average sales realization price was EUR 618 for Q2. Can you give us a sense of what it is today approximately?

Well, that's difficult to do. I mean, the only -- you've seen a EUR 50 reduction in China for July 1, and $30 in the US, so those are the only two metrics really that I could go by, and it's still early days. We just -- so, I don't have a number for you, to be honest.

Right. But I guess because Q2 is more of an average. I'm just trying to get a sense if today you're realizing sort of higher or lower than that number.

I think the difficult right now is, as I said, we're going through a period where really you're not getting a lot of sales volume out of China. And therefore, until we actually come out of August, I mean, into the September type of situation, it's going to be difficult to really know where the price development's going to be.

So, I would say it's a little bit premature to discuss what the third quarter will look like. But based on the numbers we've already seen, clearly they're not going to be strong probably as the second quarter, but certainly better than the first quarter. So, that's all I can say based on the clarity of information right now, but we'll see.

I mean, maybe all of a sudden the turnaround after September because inventory levels are low. It could surprise us all, that we could end up with even a stronger quarter than even Q2. But based on clearly the discounts that people are giving, based on those numbers, the third quarter based on those numbers and the euro development, etc., it's likely a Q1, Q2 type of number. Somewhere in-between there.

Got it. Thank you.

Your next question comes from David Shapiro with Aegis Financial.

Good morning, gentlemen. A quick question. On your discounts you mentioned 12% to 15% as sort of where the market is right now. Yet, when I take a look at your realization prices versus the list prices, it's somewhere closer to 17% or 185 discount. Is that just a lag effect from prices rising in the period and then once -- and we should expect that discount range to narrow, or what's going on there?

Yes, you got it exactly right. So, average list price is the -- it's the calendar list prices average realizations work differently. So if a customer orders pulp one month and it ships the next month, he's still priced in the month that it was ordered, not in the month that it was shipped. So, he's behind a month; at least a month.

And then, the realization also has an exchange component where a European customer, for example, when he orders his pulp, he wants to know what exchange rate is involved in that transaction. So there's a look-back to the average exchange rate of the prior period that's applied at that time. And then the actual exchange rate in the month when the pulp was shipped, again, is something different.

So, there's just -- there's some different drivers, but it's just -- summarize it by saying it's the lag effect of the difference between the order date and the calendar when the list price is published.

Okay. So, since we were at about 18% down from -- in this quarter, and since prices have more or less stabilized now, we'd expect this discount maybe to be a lot closer to the 15%?

Yes. The pricing component will be the same, but then you've still got the exchange volatility, right?

Right. Okay.

There's really too many variables to kind of work that discount number into the list price of any given month because you've got the exchange rate and then you've got the lag in terms of actual shipment. When we talk about list, that's the actual price that we actually price it at at that time, but you're never going to see that, really, on a month by month. It'll go less, sometimes more.

Okay. And then on your G&A there was some creep up in the G&A, especially in the restricted group. Where should we expect that to be running at on a normalized basis?

Our G&A structure doesn't change at all, to be honest, other than we just grind our costs a little bit down. So, the volatility all comes out of foreign exchange.

Okay. Okay. And then on the power issue, has there been any sort of advancement on getting sort of market power prices? I know there was an issue where the Company was attempting to get a better pricing, in Canada especially. Has there been any progress on that or we're still sort of stuck at the reduced discounted rates for power?

Well, we're still working on that. We've been through quite an extensive process in from of the VC Utilities Commission. Those filings are all public, I believe. So, we're fighting for fairness. We're fighting for something that we believe we're entitled to, but we can't control the political process. The next milestone, if you like, of information will likely be the decision that the VCUC has on the process that we just went through and we're probably two or three months away from that at this stage.

Okay.

But if the decision is favorable, it could be -- it could have a material impact in terms of our power revenue coming out Celgar.

Okay. So maybe there'd be more details on the next quarter call?

Well, it depends on the timing of the Utility Commission's decision. So, it's difficult to estimate it or guess as to when that may happen.

Okay. And then finally, on this debt issue everyone seems to be talking about on the call, given you guys are playing the waiting game, which may be advisable, I would assume that building cash is really pretty much your main option at this point and that there's no acquisition opportunities that are being planned at the moment?

Yes, I would say deleveraging is a key component to our -- or main component to our strategy at this point.

Are you seeing anything on the market or any -- or the market is just -- everybody's holding onto their mills at this point.

Well, we believe we have probably one of the most attractive profiles in this industry. And therefore, we don't want to do something that would certainly change that profile. And so, we're not seeing any particular reason why we should be engaging in acquisitions. I mean, aside from the fact that the financial markets and our balance sheet structure are such that, unless it's done in the right manner, it doesn't really make sense for us. But availability of comparable type of capacity, profile and age of machines, etc., and margin capability are such that we don't really see anything that is out there.

Sounds good, gentlemen. Thank you very much.

Okay.

Your next question comes from Paul Quinn with RBC Capital Markets.

Hi. Good morning. Just a couple of cleanup questions here. Just on the Green Transformation Program funding, it sounds like you got advanced and then you've got receivables here. What's net/net at the end of Q2? Like, how much money from the program is -- do you expect to receive in Q3 of what you've spent? Rough orders of magnitude are fine.

Yes, about four.

About EUR 4 million?

Yes, it's about EUR 4 million that'll come in in Q3. And then, there's some holdbacks that'll come in in Q4. And a chunk of the money that was spent in this quarter was received in the prior quarter.

Okay. So net the stuff that you received in the prior quarter, am I still okay with the EUR 4 million, or is it less?

EUR 4 million coming in in the third quarter from spending this quarter.

Okay. Just on inventories, you talked about at 21 days globally. What are inventories at Mercer and how does that break out between Europe and North America?

Well, I mean, on the European side we are at extremely low inventory levels, especially with Rosenthal going into its maintenance shut. At Celgar we were starting to -- see starting -- certainly building some inventory levels because of this buyers' strike in China. So, we are looking at corrective measures for that and we'll have to see how that develops. But, let's say the Celgar inventory levels are starting to creep up above what we originally expected, and will continue to do so unless we can redirect a significant amount to the more peripheral, non-core type of markets.

Okay. And then in terms of the buyers' strike, I mean, I saw June shipments to China were basically unchanged at 538,000 in June from May. When you talk about a buyers' strike, is that certain buyers that have refused to purchase that historically were customers of yours?

What's happening, basically, is it started more in terms of July and June. So, you're not going to see a real big impact in June. What happened is in July with [Arelco] coming back into the market, they basically initially held firm and then they basically offered to discount to get the volume. And all of the other softwood producers approached and said, okay, we want this particular pricing, which was extreme discount, or we're going to stop buying. And of course the industry as such held firm because the inventory levels, as we know, were low. And so far, some of the producers, as you know, have reduced the pricing to CAD 50 in Canada, albeit generated not really significant volume.

And it tends to be general in the sense -- you're getting volume from certain groups which are higher margin type of producers. But, the big guys, who are the coated, etc., because of the pricing pressures for their product are resisting, let's say, purchases. I wouldn't say all of them but, unfortunately, there's a group of producers which have their own products under margin pressures, which are showing this kind of buyers' strike.

Okay, that's helpful. And just on maintenance, I guess because Stendal took a Q1 maintenance, I guess they're not due until Q3 '11. So, we have Rosenthal in Q3, nothing in Q4, nothing in Q1 '11, and then Celgar in Q2. Is that what we should look at going forward?

Yes.

Yes.

Okay. And Rosenthal would be back on a -- is it on a 12-month period, or is it moved to 18 like Stendal?

No, it'll be on a 12-month at this point.

Great. That's all I had. Thanks, guys.

Okay, thanks.

Your next question comes from [Tim Carlin] with Wells Fargo Advisors.

Jimmy, you guys haven't talked at all about the substitution issue given the price spread between hard and soft pulp prices. Can you address that a little bit? Is that spread widening? And is the substitution, is that -- has that been as aggressively pursued by buyers of pulp and users of pulp as it could be, or is that potentially a bigger issue if this price spread widens?

Well, I think if you look actually at the historic spread between hard and soft wood, over the last several years you've seen that spread actually widen. So clearly, the substitution issue is one which is ongoing. I mean, everybody wants to, of course, have their raw material price decline. So, they're going to substitute as much as they can with any cheaper type of input fibers, whether it's hardwood or non-fiber coating, whatever it may be. But throughout this process, what' we've seen is clearly demand for softwood continues to grow, albeit at low rates. But at the same time, the gap between hard and softwood over those periods also has widened.

So our expectation, actually, is that there's no reason why that gap can't continue to widen further. I mean, we've seen it where we've had traditional about 30, widened to 50. We've seen it now around 80, has gone to -- clearly may be sustainable at 100 for an extended period of time and maybe higher.

So, the issue is really the differential between hardwood production costs and softwood. There is a structural change. The eucalyptus guys structurally have a much cheaper fiber cost. And while the softwood, which is mainly in the northern hemisphere, has a different structural cost. And that is accounting for this kind of continued increase in the gap between hard and softwood on average through the cycle.

And we think that will continue to increase as we go forward because there's a structural cost on both sides. And as more production of eucalyptus comes on from the southern hemisphere and capacity constraints on the softwood from northern hemisphere, there's no reason why this gap essentially can't widen and stay, wide for an extended period of time, because the end users of the fiber are different and they use the fiber for different reasons.

Okay. Last question. Celgar's been a very pleasant surprise in the last 12 months. You've stated many times that the EBITDA margins are finally catching up significantly. I know you had the Blue Goose energy -- or capital spending project, and then you had the wood room which you made into a big deal and it seems to have been very helpful. Are there any other factors at Celgar that you would point to that account for this dramatic turnaround in the EBITDA margin there?

Well, I think we certainly are improving the performance of the people at the mill. And this is ongoing. I mean, I was a little bit disappointed in terms of the startup after the maintenance, and that's going to be addressed so we're not going to have those issues in the future, because that, of course, cost us a fair amount of money.

So, I think the mill, once it's up and running, actually is producing record volumes. And it's unbelievable in terms of the actual daily records that we're setting at Celgar. And the fiber costs now are finally under control, so the profitability certainly is improving very rapidly at Celgar.

And so, in terms of the labor performance, labor attitude, etc., I think that's changing quite significantly as well. And the procedures on some of the operations will mean that there will be continued efficiency gains moving forward.

So, I'm actually very optimistic that Celgar will live up to the potentials that we saw when we first acquired this mill, albeit delayed by the impact of the lumbar market being so weak in the last three years.

Thank you.

Okay.

Your final question comes from the line of Scott Bieber with Lawndale Capital.

Hi, gentlemen.

Hi, Scott.

I wanted to ask you, from a marketing perspective, what the Company's next steps are in terms of conferences and road shows, and achieving an improvement in the market's valuation and understanding of Mercer?

Yes. We're attending the Jefferies conference next week, Scott, in New York. And then the following week we're doing a marketing -- just a general marketing road show to tell the story. We're going to be in Toronto, New York, I think San Francisco and L.A., and Vancouver. And then, at the end of the month, we're going to be doing the Midwest Conference, the Best Ideas -- Midwestern Best Ideas Conference in Chicago. And then in September we're going to attend the Credit Suisse Conference to -- the High Yield Conference. And then, we're going to wait and see if there's another window of opportunity for some further marketing following the third quarter.

Alright. So we'll have to see you when you come out our way.

Yes. Look forward to that.

Thank you very much.

Okay.

Okay. So, I would like to thank everyone again for attending today's call. And we're actually looking forward at least to a reasonably good second half. So on that note, I would like to call a stop to the call. Thank you.

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