Mercer International Inc (MERC) 2011 Q1 法說會逐字稿

Good morning. My name is Stephanie and I will be your conference operator today. At this time, I would like to welcome everyone to the quarterly earnings conference call. All lines have been placed on mute to avoid any background noise. After the speaker's remarks, there will be a question and answer session. (Operator instructions.) Thank you.

David Gandossi, you may begin your conference.

Thank you. Good morning and welcome to the Mercer International 2011 first quarter earnings conference call. As mentioned, my name is David Gandossi and I am Mercer's Executive Vice President, Chief Financial Officer, and Secretary. Joining me on today's call is Jimmy Lee, Mercer's President, Chief Executive Officer, and Chairman.

As usual, we'll begin with formal remarks, after which we will take your questions. Please note that in this morning's conference call we will make forward-looking statements similar to those that were made in the press release. According to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, I'd 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.

Okay. 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.

Our first quarter was strong and we are pleased to report a solid EBITDA quarter. The demand for pulp in all our markets was robust throughout the quarter. Our mills ran reasonably well with Rosenthal setting a quarterly production record. But, our overall production was lower than expected, primarily due to mechanical issues at our Celgar mill.

As you will have seen in our press release, we reported net income of EUR29.1 million for the quarter, or EUR0.66 per share, compared to a net loss of EUR7.5 million, or EUR0.21 per share, in the same quarter in 2010.

The net income includes approximately EUR13 million of non-cash gains related to mark to market valuations of the fixed interest rate swap, and foreign exchange related to the intercompany US dollar denominated debt. Before these non-cash items, basic earnings per share was EUR0.36 per share.

We recorded quarterly EBITDA of EUR50.8 million, or approximately $70 million. This compared to EUR64.6 million, or about $88 million, in the fourth quarter last year, which remains our second best quarterly EBITDA total in Company history.

The differences in EBITDA compared to Q4 were, one, the absence of the wastewater fee accrual that was reversed in Q4 following the German government's approval of our project, lower sales volumes, negative movement of foreign exchange rates, and slightly higher fiber prices in Germany, and higher stock compensation costs.

These negative impacts were partially offset by slightly higher sales prices in all our markets, higher energy sales volume, lower non-shut maintenance costs, and lower energy costs.

The lower sales volume requires some explanation. In Q1 2011, we sold 37,000 tonnes less than Q4 2010. Some of that was due to the higher than usual inventory carryover from Q3 2010 which we sold in Q4, and some of it related to shipping delays in Canada caused by weather. The production figures in Q1 were similar to Q4, which we feel could have been a bit better in both quarters. And Jimmy will talk about that a bit later.

Switching to cash flow, overall our cash position is EUR24 million higher than at the end of Q4, sitting at EUR123 million, or approximately $174 million. Inflow in Q1 were dominated by over EUR50 million from EBITDA and large working capital decreases.

Overall, the quarterly working capital movements increased cash by about EUR37 million on a net basis, primarily due to a large increase in accounts payable, which was at a low level at the end of Q4, and decreases in both receivables and raw material inventories.

Capital expenditures grew about EUR8 million. We also paid about EUR45 million in debt repayments, which we'll speak about in more detail in a moment.

In addition, we received EUR4 million of government grants in the quarter. When thinking about our cash build, it's also worth noting that we have a receivable of about CAD8.5 of Green Transformation Fund grants from 2010 and first quarter of 2011 capital spending that we expect to receive during the next several months.

In addition, we have a receivable of about CAD1.4 million due from another Canadian government program called the Transformative Technologies Program that Jimmy will speak about shortly.

Looking at the components of working capital in the quarter, finished goods are up approximately EUR4 million from Q4. Our year-end finished goods inventories were at 63,000 tonnes, while Q1 finished inventories are up to 73,000 tonnes. Offsetting this increase is an approximate EUR11 million decrease in our raw material inventories as the mills worked through their high winter inventory levels.

Receivables are down in the quarter by about EUR9 million to EUR113 million, primarily due to lower sales volumes. Accounts payables and accruals are up about EUR24 million quarter-over-quarter, primarily due to the timing of payments and the receipt of EUR10 million at Stendal as part of an ongoing arbitration with the general construction contractor of the Stendal mill.

Stendal was compelled to act on a bank guarantee for civil work claims because it was about to expire, and received the cash in the quarter. So, we have recorded that with an offsetting payable until the funds are spent on remediation. And Stendal continues to work through the arbitration process, as our claims exceed the amounts that we have received.

Summarizing our working capital movements relative to our cash build in the 12 month period ended March 31st, our working capital, excluding cash and short term debt, grew by about EUR59 million, up from EUR74 million at the end of Q1 2010 to EUR133 million, which is down EUR39 million from the end of 2010 for the reasons I previously mentioned.

During the quarter, we fully paid down the Celgar revolver. At March 31st, 2011, we had EUR26 million of undrawn revolvers available at Rosenthal and about EUR35 million available at Celgar. Our EUR123 million of cash at March 31st is comprised of approximately EUR57 million for the Restricted Group and EUR66 million at Stendal.

In addition to our strong results, Q1 2011 was significant in terms of debt reduction. Overall, we repaid almost EUR45 million of debt this quarter. As I noted on our year end call, we redeemed the remaining $21 million of senior notes due in 2013 at 100% of the principal amount plus accrued and unpaid interest during Q1, which was the last step in our refinancing of the 2013 maturity with the new offering of our $300 million 9.5% senior notes due in 2017.

As I mentioned, we also paid down approximately EUR15 million of the Celgar revolving facility and made our scheduled principal payment of approximately EUR15 million on the Stendal facility. With that in mind, on April 1st, 2011 Stendal's debt service reserve account increased to over EUR28 million.

Finally, during Q1, roughly $6 million of convertible notes were converted into almost two million shares, putting the total conversion of notes at almost $27.5 million, or about 8.3 million shares.

Now, that's quite a bit of information, but I wanted to make the point that we are rapidly transforming our Company and our balance sheet. While we had been considered highly levered following the construction and acquisitions of our mills, that is changing.

Net debt to equity on a consolidated basis is currently at 2.3 times. And for the Restricted Group, net debt is well less than one times equity. The fixed charge coverage ratio for the current quarter on a consolidated basis is 3.2 times coverage. And for the Restricted Group, we are at four times coverage.

With the continuation of strong cash flows and the prospect of converting the debentures into equity, our balance sheet improvements should continue to impress.

So, that ends my overview of the financial position and developments. So, let me turn the call over to Jimmy now to talk about our operational market and strategic developments.

Thanks, David. Good morning, everyone.

As David mentioned, we're pleased with our first quarter results. Overall, our productivity was good this quarter and up slightly from our fourth quarter results.

Rosenthal achieved its best production quarter ever, but unfortunately Celgar struggled with some mechanical issues. The weakening of the US dollar and a tight European fiber market continues to be the negative factors in Q1.

However, demand for NBSK remained strong, and we have successfully implemented our announced April price increases. And we are confident demand will continue to be strong through Q2.

In the first quarter, average list prices in Europe rose about $30.00, while the list price in China rose by about $50.00 per tonne. Overall, the NBSK market remains well balanced. I'll talk more about this in a moment, but first let me comment about the mills.

Rosenthal continues to run very well, setting a quarterly production record in Q1. Unfortunately, we experienced some downtime in Q1, most of which came at Celgar where mechanical issues caused several days of lost production followed by several more days of operating below capacity.

Stendal struggled with some weather related issues, but still had a strong production quarter. Overall, we had a solid production quarter, but we are looking forward to even better production in Q2.

In total, we produced approximately 359,000 tonnes of pulp compared to 356,000 tonnes in the fourth quarter of 2010 and 329,000 tonnes in the first quarter of 2010. In addition, the mills sold approximately 158 gigawatt hours of electricity in the quarter compared to 150 gigawatt hours in Q4. This increase was primarily due to Stendal's gigawatt production increase in Q1 more than offsetting Celgar's gigawatt decrease during the quarter.

Turning back to the pulp markets for the moment, I'd continue to characterize the NBSK market as well balanced, if not slightly tight. As you know, current NBSK pulp inventory statistics continue to be very positive with producers globally soft with inventories falling to 24 days at the end of March, which is at historic low levels.

We continue to believe that the market tightness will continue to put pressure on prices in the longer term, and we are optimistic that any reduced demand this summer will be offset by reduced NBSK supply as a result of the heavier than usual maintenance downtime expected this summer in the Canadian pulp industry.

As David mentioned, we have successfully implemented a $30.00 price increase in all markets in April, bringing the European, North American, and China list prices to $1,010, $1,020, and $920 respectively. We believe that the continued growth of the Chinese paper and tissue producers is driving today's market tightness along with some new demand from users of dissolving pulp and producers of cotton linter dissolving pulp that are substituting with the NBSK as a cost saving measure and due to the shortage of cotton linter.

Although we believe the dissolving pulp market will eventually become rebalanced, we continue to believe that the growth of the Chinese paper and tissue producers will continue, given the demographic shifts that are currently underway in China.

We continue to believe that the market fundamentals favor producers. And as a result, we believe that NBSK prices will remain at historically high levels through 2011. NBSK inventory matrixes continue to be very positive with market uncertainty coming from a projected seasonal summer slowdown.

However, we believe that the continued demand from the users of dissolving pulp and an unusual large number of planned maintenance shutdowns in Canada will keep market fundamentals in the producers' favor through the summer and into 2012.

In addition, there continues to be 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 new owners' integrated paper production in China.

Overall, we continue to believe that the increasing demand from NBSK customers will allow any market alignment changes to be absorbed without any disruption in the market significantly.

Our sales volume was lower than Q4 due to the reasons David mentioned. Sales volume totaled 349,000 tonnes compared to 386,000 tonnes in the fourth quarter of 2010 and almost 333,000 tonnes in Q1 2010.

Let me now take a moment to discuss developments in the wood markets. As we discussed last quarter, after rising through 2010, wood prices in Europe appear to have leveled off, albeit at elevated levels. We are seeing increased sawmilling activity which is starting to have a positive impact on chip prices.

But, the demand for fiber remains strong as the board industry is also slowly increasing its output. As a result, we currently expect fiber prices in Germany to remain relatively flat for the remainder of the year.

As expected, our German mills are working through the fiber that was stockpiled for the winter. And although fiber is expensive, we are not restricted in our abilities to source it. As a result, we're satisfied with our current fiber inventories in Germany, but we will continue to monitor them closely as supply remains tight.

In British Columbia, our fiber cost continues to trend positively. Although we have see modest increases in sawmill activity in our area, the main reason for the positive trend remains our improved wood room. Similar to the German mills, we expect Celgar to reduce its fiber inventories in the coming months before seeing them rebuild again in the fall.

We are confident that Celgar's fiber costs will remain flat in 2011. However, we continue to investigate other initiatives that will help us further reduce these costs further.

Turning to energy for a moment, Celgar continues to optimize its steam flow to the turbine. However, production issues negatively affected their steam production and consequently their energy output in Q1. Overall, we continue to be satisfied with our strategic decision to invest in our energy production assets, and will continue to look for additional accretive energy projects.

Last quarter I noted that we are in the process of negotiating a contribution agreement with the Canadian government under the Green Transformation Program for a second stage oxygen delignification project at Celgar. I am pleased to note that the contribution agreement has now been finalized and we are now finalizing the design and the equipment orders.

This project is expected to be highly accretive due to its many benefits, including reduced chemical usage, improved fiber yield, and reduced levels of effluent requirements for treatment. We will have more to report next quarter on this project.

As well, we are proud to note that Celgar qualified for a grant under the Canadian government's Transformative Technologies Program. These funds, totaling approximately CAD1.6 million, are directed towards a new technology for an acid wash project that is expected to be very accretive due to the benefits it will bring to Celgar, including reduced chemical usage and further reducing effluent levels.

We regularly get questions about the timing of our annual maintenance shuts. So, I would like to highlight that our 2011 shuts will line up as follows. Celgar will have its annual shut in Q2, Rosenthal in Q3, and Stendal in Q4.

If I can close for a few observations, we continue to believe that the tight NBSK market will remain for at least the short term, and are even more optimistic about 2011, given the recent price increase announcements, since it appears the markets are adjusting well to mill restarts and the realignment of producers and customers as a result of the recent acquisition of NBSK mills by a large paper producer.

We also believe that the supply-demand relationship for soft wood pulp should remain favorable for the next several years.

I'm also very pleased with the debt reduction this quarter, and we look forward to the continuation of that trend. We remain focused on increasing margins by reducing costs as well as increasing the mill availability at all operations, and improving the returns on our byproducts such as excess power.

Currently, our biggest challenge is the European fiber market, but we remain optimistic that supply and demand will come back into balance. And we continue to pursue projects to help us manage these costs.

So, with this conclusion of my prepared remarks, perhaps I can 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.

Good morning, guys. Jimmy, I wondered if you could talk a little bit more about this -- Celgar's energy operations in the first quarter and what you might expect to see in the second quarter just from the power sales, because normally you would expect, obviously, to see more power being able to sell versus being used internally.

Yes. I mean, clearly Celgar's operating issues in the first quarter were such that the mill ran quite unstable. And when you have these unstable conditions, of course you consume a lot of steam, as well as the fact that the overall power generation, as a result, is significantly lower.

So, we believe those technical issues are now behind us. Certainly, the indications in the last few weeks is very positive in terms of the power production levels. So, clearly we think as long as the mill is running stable, we don't have any, any doubt that this mill will produce the power production levels that we envisioned as well as what we are obligated under the BC Hydro contract to deliver.

So, I think it is ramping up very nicely, albeit on the first quarter unfortunately we had a lot more problems, which really does not reflect, I think, the underlying power generation capacity and capability of the mill.

I'm trying to get some numbers on it. Can you help us? Was it a $3 million loss of power sales in the quarter, or some way to quantify that?

No. I think, as I said earlier, that we're coming out of the winter months, which typically, of course, you have more steam consumption. And also what you have is the issues related to finishing up all of the projects. And we are doing that.

And we said that we are going to essentially get closer to that full kind of run rate towards the second half of this year. And we're starting to get up to those levels.

So, rather than say what did we lose in the quarter, what I would say is that our ramp up, unfortunately there was a bit of a speed bump in the first quarter. But, the second quarter numbers, based on recent weeks, clearly indicates we're probably ahead of the plan when the mill runs properly.

And so, our outlook in terms of being able to reach kind of full production levels on the electricity side, certainly in the second half of the year, we'll accomplish that.

Bill, I could just add a little bit to that, put it in a purely numbers perspective. In euros, if we were sort of shooting for like on a trend of EUR3.5 million to EUR3.7 million a quarter, we hit about EUR2.6 million at Celgar.

Okay. Thanks on that. And then, just, Jimmy, as a further clarification on these government funds, this CAD9.7 million and the CAD1.6 million, this is incremental funding on top of what you had already done, correct?

Yes. The larger number is for oxygen delignification, which is part of the Green Transformation Program, which we qualified for CAD58 million. So, it's in excess of what the Green Energy Project was, but it's coming from that same program.

The Transformative Technologies grant is different. It's something we applied for during the year and qualified for for a transformative technology, this acid wash system that's a new technology. Only ourselves are implementing it in Canada so far.

And so, for the oxygen delignification, the CAD9.7 million, will that completely fund the dollar cost of that project, or do you also have to put some investment in?

Yes, that is to fund the full cost of that project.

And will you do that --?

We will have still a little bit of money left over under the Green Transformation Program, which will be spent on smaller also, again, very accretive type of projects.

Okay. And will you do that investment in the second quarter here when you have the shutdown?

Some of it will be essentially done. But, it will take the balance, because one of the major pieces of equipment is a big kind of a tube type of structure which will be transported to the mill in the second quarter, and then it'll be tied in sometime. But really, it's not going to finish in the second quarter.

Okay. Thanks. And then, just the last question. David, I wonder if you'd just give us the production by mill.

Sure, Bill. So, Rosenthal for the quarter was 87.6, Stendal was 154.3, Celgar was 116.7 for a total of 358.6. And sales volumes, Rosenthal were 87.5, Stendal 155.8, Celgar 105.7 for a total of 349.0.

Great. Thanks very much.

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

Hi. Thank you. A lot of your script as well as the financial statements last night show that Mercer debt levels have come down quite a bit, and your debt to equity levels will substantially drop on the upcoming conversion of your 2012 debt that you said you're going to do this quarter, or at the end of this quarter, into equity. So, what is -- what are management and the Board thinking as to the optimal debt to equity range and the use of cash flow when you reach that level? Is it the institution of a dividend, a stock buyback, an acquisition? What are your thoughts as we're getting closer to that point?

Well, I think really all I can say on this call, Andy, is that we're looking forward to continue our trend of debt reduction. As you know, Stendal has a cash sweep, and it also has a debt service reserve account which allows us to accumulate cash on the balance sheet to protect the Company in periods of economic weakness globally.

So, we're feeling much better about that whole situation. And on a net debt basis, it's obviously going to decline automatically. And then, as soon as we get the debt service reserve account filled up, it's going to sweep and accelerate the debt reduction.

On the senior note side, on the balance sheet on the restricted side, we've -- by the time we've paid off the convertible debentures, we're really down simply to our 300 million 2017 senior note maturity, which we're pleased with. It's got a nice run rate on it. Net debt will be reducing, obviously, as we accumulate cash.

And then, excess cash flow beyond that is obviously something I can't talk about today. But, it's on our minds, but it's still a ways out.

And regarding --.

We are reviewing all of the different options, clearly. And once certain decisions are made, certainly those would be announced. But, we are, of course, focused in terms of rebalancing our balance sheet. And we made substantial progress in that direction.

If you look at the combination of cash, working capital, and the debt levels that we are now having, I mean, the Company is way different than a year ago.

Oh, yes. And I was wondering what your optimal level is as to how low you take it, because once you convert the converts into equity, that's going to materially turn the ratio. And at some point, you get to a level that's low enough for this cyclical industry, you're then looking for alternatives as to what to do with the built up cash and --.

Yes. And clearly we are examining all of those alternatives from share buybacks to dividend and all of these other factors. What we can say is right now we don't have any particular acquisition, as you know. We've stated that we're focused in terms of rebuilding our balance sheet and focusing in terms debt reduction, etc. So, clearly acquisitions is not something high in our mind.

Also, we stated earlier that we're not interested in the sake of buying something for the sake of growing revenue. It has to meet the type of profile of our existing mills and be complementary to our overall type of quality of assets.

So, I think we are going through all of the different scenarios. And in time we'll see what that conclusion will mean.

So, just to press the point, I don't think you're purposely evading the question, has there been discussed a range of the optimal debt to equity ratio that you and the Board feel is a kind of a target area to get to? And so, I can figure out what your debt to equity is going to be on the conversion, but I'm wondering how much lower you're going to want to take it, if at all, before this issue of alternatives for cash start becoming a higher agenda item.

Yes. Well, I'll take a shot at it and try not to get myself in too much trouble here with regulation FD and other things.

Well, that's what this call is about.

Well, yes. In fairness, we haven't announced any kind of policy decisions, Andy, so we have to be careful.

But, I guess management thinks about a couple of things. One is we have a structured finance on the Stendal side which is geared to -- it's an autopilot, if you like. It's going to happen. It's going to de-lever automatically once we have the DSRA filled up. That's going to happen.

So, there's no decision to be made there. We're not looking to amend that or -- it's just going to be what it is, and that'll be a determinant of the pulp prices and exchange rates and everything else.

On the Restricted Group side, $300 million of debt with a couple of assets like Celgar and Rosenthal, we're not feeling highly levered on the Restricted Group side. And we also don't see huge value in buying back senior notes in the market for a 7% or 7.3% return, which is what it would be today.

So, we're going to be much more opportunistic about that kind of opportunity. We recognize we're in a cyclical business, so we're going to be opportunistic, keep our powder dry, accumulate cash on the balance sheet so that all our investors feel safe and all of our investors understand we have options.

Now, in terms of whether we pay a dividend or we do a share buyback, that's a discussion for some quarters out. I don't want to signal anything today that we're close to thinking about that, because we're not. But, we understand what impact it can have on share value, and we are shareholder centric here. We're all about generating shareholder value.

So, at the appropriate time, it will be on the table. It will be discussed and we'll be able to communicate it in due course.

So, the answer is up at the Restricted Group you're comfortable with the debt to equity ratio, will be on the conversion already, and Stendal, of course, is still got to build up its specifically defined reserves. Is that correct?

Yes. And if there was an opportunity to buy back restricted senior notes at a screaming deal, we're obviously a buyer. But, not when it's trading at 110.

Yeah. Again, I'm not asking what you're going to do with the cash. What I was trying to get at is at what kind of debt to equity ratio range will it be that you're starting to look at those options and if we're there or how many quarters we might take to get there, because we're on a (multiple speakers).

Well, I think we've talked around it as much as we can, to be honest.

Yes. I think you've got to look at it this way. If you look at the build up of working capital cash, and the EBITDA kind of generative capabilities now at Celgar because it's addressed its problem, are such that in view of the transformation of Celgar in the last year, really this debt level of $300 million based on today's liquidity at the Restricted Group clearly is not something that we feel uncomfortable with.

Now, there is every room to certainly further reduce that. But, at the same time, we're having cash as well as working capital build ups to offsetting any of that long-term debt. So, on a net debt net-net basis, we are making a reduction in terms of the overall debt at the restricted level.

So, we feel comfortable that the present situation is very good. The issue, then, is okay, is there accretive further improvements that we can derive from the use of that cash. Clearly, a lot of them are on the table, and then we have to decide what is really the amount that we want to dedicate.

And these are things that are being discussed and modeled. And we'll have to see what is the best alternatives for the cash build up, assuming, now, the pulp markets stay at the levels that we believe are there. And so, those discussions are occurring. We're comfortable with the debt levels now we have been able to reach. And certainly we're dealing with a completely different profile.

Okay. Thank you.

Okay.

Your next question comes from Gary Madia with Gleacher & Company.

Thank you. Good morning. Just a couple questions. Can you give us a sense -- I know you announced what the maintenance closures were going to be for the coming quarters. Can you quantify that in terms of expected maintenance expense?

And then, my second question is, is there any way that you can help us understand or quantify potentially what the currency impact was in the most recent quarter due to the weakness in the US dollar? Thanks.

Yes. Hi, Gary. On the -- the way we've often talked about our maintenance shuts in the past, typically they're about 10 days. So, you lose about 10 days production. That has some impact on fixed cost coverage during the quarter, those kind of things.

From a maintenance spend point of view, average would be about 4 million. And it's interesting. It's about EUR4 million if you're a German mill, maybe EUR3.5 million to EUR4 million, Stendal a little on the lower -- Rosenthal a little on the lower side, Stendal a little on the higher side. And if you're in Canada, the Celgar mill is about CAD4 million.

The Stendal shut this fourth quarter is going to be a little bit longer than usual because it only has its closures once every 18 months now. So, we've got a bit more work to do there. So, hopefully that answers that side.

What was the second part of your question?

The currency impact with the extraordinary -- the weak US dollar.

Yes. So, Gary, the only sensitivity we have in the market is really what we put in our 10-K. And in there we say EUR$0.01 impacts on revenues by about 11 million.

It's difficult for us to do it with EBITDA, because there's so many variables and there's the Canadian versus the euro versus the US. So, we don't put the sensitivity out in the market. It's easy to model an estimate. It's a pretty -- you're selling pulp in US dollars, and you know what the pulp prices in the US are. And you just convert to euros and you can sort of get a feeling for it.

Right. But, you did have commentary in the press release that basically said that the $30.00 that was garnered on the price increase in US dollar terms was basically eaten away with the current -- eaten away with the currency. Is that fair?

Yes.

Yes, that's the general rule of thumb.

Okay. Final question. Just as a reminder, obviously with additional price increases coming on down the road, and I know people like [Ricci] expect additional kind of towards the end of the year. Just remind us again in terms of the typical price lag in terms of implementation date and how long it takes this, based upon your contracts, to actually flow into the business.

I mean, the producers traditionally essentially announce the price increases for the upcoming month. So, as we essentially go into the -- towards the second half of the month prior, essentially there is going to be announcements for price increases, if that's the trend. And then, of course you're going to start to implement for the new orders that are coming in that month the new price increase.

So, you have a combination of two factors that play in here. One is that, because we price the euro price based on the average of the exchange rate of the prior month, although you may see a price increase for the next month, but if you translate the average exchange rate, there may be, in euro terms, actually either a flat or even a slightly lower price.

So, then you're going to get producers who are going to try to play the game where, instead of taking the full allotment of that month but actually wait to order in the next month. And that's very difficult to project because it's based on what the currency trend is happening in the month prior to you setting the order volume for the next month.

So, our implementation is such that we know what the average volume commitment is, and that's what we push for in terms of the price. The end users are going to try to arbitrage as much as possible in terms of those delivery schedules and order schedules to optimize their cost as much as possible. So, there is no simple rule in this.

Okay. All right. Well, thanks for that color. I appreciate it.

Okay.

That's all I have.

Yes. Thank you.

Your next question comes from Joe Galzerano from Muzinich.

Yes. Joe Galzerano from Muzinich. Could you -- a couple years ago, you somewhat solved the fiber basket issue for Celgar. Is there any option that you have in Germany?

The German wood purchasing type of situation is very different, and the ownership of the forest is very different. As you know, in Germany the way the harvesting occurs also is on the base that the wood itself is already segregated and then sold in segregated lots, while in Canada you do have the option of even tendering for certain cutting rights where you can go in and harvest it. You can basically take the wood that you want and sell the type of sortments that you may not need.

So, the flexibility, certainly, in Canada is much broader, and also because in our area a big chunk of the forest is owned by the government. The government forest department establishes the type of cutting rate volume that they wish based on the underlying demand. And so, if the underlying demand for lumber grade logs is low, clearly the amount of other sortments is going to be dropping as well, because they don't go into the forest to just cut down logs for pulp or particleboard or the lower end type of market.

So, what typically happens is that it is the lumber grade which determines overall wood availability. So, what we're seeing essentially is, because harvesting activity is lower, what we have to do is go further out and essentially source. So, the wood cost increase is really reflective of the transport and other logistics costs of having to go further afield. Not necessarily giving higher prices now for the wood, but really the transportation component of having to source wood from wider distances.

And we're not going to be able to change that because, of course, the forest structurally is owned differently. And the ownership sortment of the wood is also different in the sense that the owner of the forest essentially does the cutting, they sort through it and then market it based on those qualities.

Thank you.

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

Hi. Good morning. My question is on the feasibility study for the dissolving pulp conversion. I realize that the decision -- certainly the decision hasn't been made yet. It's probably something that would appear in Q3 at the earliest. But, my question is, is that if you decide to go ahead with this, I just wanted to get a sense of what the business would look like.

I mean, would you be -- would you need to develop long-term supply agreements with customers, or would you be selling most of this into the spot market? And how much visibility would you really have on the timeline in terms of doing the conversion itself?

And then finally, how quickly can a swing facility -- let's say that you converted Stendal to be capable of running dissolving pulp. How quickly can you swing from one grade to the other? Is this something that would happen perhaps once a year for half a year production, or is this something that could swing on a quarterly basis? Just trying to understand this business a little better.

Yes. I mean, in terms of the estimate of our decision, we said that towards the end of the summer we will essentially have the various parameters for the two different mills to a level of conclusion that we would then decide which mill likely would move ahead in terms of implementing the project itself.

Now, from that decision on, it would take roughly about another 16 months or so, 16 to 18 months to implement it. And that is why we projected that if we make the decision at the end of the year that it would be the end of 2012, so really production only being -- occurring in 2013 in terms of dissolving grade.

Now, in terms of the flexibility of producing it, because really it's a process of treating the wood to take out this hemicellulose primarily -- there is additional stuff that has to do to extract more lignin and all these other things to bring it into the quality spectrum that you need.

But really, because the hemicellulose is not normally dissolved out in a kraft or alkali process, we have to essentially now have a process which will dissolve out that hemi. So, that's really the only difference.

And now, whether we can do it yearly, quarterly, it's really one of you can do it fairly quickly in terms of switching from one grade to the other grade. But, nobody's going to run one quality one day and then switch it to another quality the next day. One will run campaigns so you build inventory of that particular quality, very much like we presently run our paper grade.

Not everybody wants the same kind of quality spectrum. Some end users demand more rigid strength characteristics, as an example. And so, we make campaign production so that we produce a quality that our customers want. So, it's the campaigning that will happen.

The decision whether we switch from the paper grade to dissolving will be based on the enhanced margin available. So, it's not the price that determines whether we switch from paper grade to dissolving, but really it's the premium that is being paid for dissolving.

And we know that historic numbers indicate that there has been certainly more than half the time in terms of price where it's a attractive for us to produce dissolving grade, because the margin is certainly better. But, there is other times when that's not the case at all, in fact the margin doesn't justify the switchover. And then, of course we would continue to run purely paper grade.

Because we don't have any real requirements to produce dissolving, I think it's more opportune for us to be producing more as a spot player than a contract player, because it's only during these periods of in-balance that you're going to get extremely attractive prices. And it is determined, to a large degree, through a combination of fashion, cotton, availability, and many other factors.

And so, it's very complicated to know whether, just because cotton, there is a shortage, that all of a sudden you're going to get a price increase. A lot of the other variables play into it.

And to, the decision will be only made based on whether the margin or the premium given to dissolving is attractive enough at that time to essentially campaign to produce this particular grade. And the amount of quantity will be also based on why that market condition is prevailing at that time.

And if the market is healthy, we will continue to supply it. If it's not, we'll swing back to our main product. And because it's a much bigger market, the amount of swing capacity that is coming back into the paper grade market will have really no impact at all in terms of the pricing overall. So, this allows us to benefit from unusual market conditions in dissolving, and really participate only when the margins are attractive enough.

I hope that answers your questions.

Yes, that's extremely helpful. And just one follow up. So, in terms of the margin, what really does determine the difference in cost between the two grades? I mean, my understanding is that the dissolving pulp is, of course, more manufacturing intensive. Is there a considerable increase in the chemicals requirement there, or is it more of it takes longer and it's more energy intensive?

The biggest cause really is the fact that you're -- the amount of wood that you have to use to produce the same tonne is higher. So, naturally because you're dissolving out more lignin and hemicellulose, etc., what you have is a pure cellulose form.

So, the more purer of a cellulose product you want, the more impurities that you need to extract, and therefore you have a much large percentage of wood being consumed. So, the big component of the price difference is really based on the increase in raw materials that you need to consume.

Now, the rest of it, assuming you have a very modern mill, because you're extracting a lot more of this impurity, you got to burn it and then you got to be compensated for that. So, it depends on the type of facility you have presently as to whether you need to invest in a power production facility or you have the recovery boiler which is large enough to burn that.

And so, each mill's characteristics and increased cost is going to be different. For us, because we have very modern, well equipped mills, certainly the investments and the additional type of cost is nominal in terms of chemicals and other things, because one increase here is kind of offset by income contribution, as an example. So, if I'm getting more wood out, I'm being compensated because of course I'd produce more steam and I get more electricity and comp at a particular level.

And again, it's dependent on whether you're getting proper compensation for the electricity. If you're getting very little value for the electricity, then you are not going to get the level of compensation for the increase in wood consumption.

So, our margin, the premium difference between dissolving and what we're presently producing, the attractiveness will be different versus some other mill, because their costs clearly will be different.

I see. Okay. Well, thank you very much.

Thank you.

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

Yes. Thanks very much. Just a question on European fiber. If I took a look at historical fiber costs for Rosenthal and Stendal and we went back five years or so, what is the price increase from that point? I mean, I can understand that 20% year-over-year, but isn't this materially up from a period like five years ago?

Yes, it's materially up, no question.

Any chance down the road that this materially falls back down?

Our assumption basically is of course there is room for wood prices to come down, mainly because, of course, this represents harvesting levels which are unusual because of the very depressed lumber markets as a whole globally. So, I think that they're -- if lumber activity increases, then harvesting activity overall will improve and therefore wood costs will come down.

Now, whether they will go back to levels pre 2006, I don't think so, because inherently there has been other competitors for wood, which is really the biomass to energy side. So, there's a lot of pellet production, as an example, as you know.

And so, we never will have wood prices probably drop to the levels that we saw pre 2006. But, certainly we expect that prices can drop meaningfully from our present levels.

Okay. And then, just on European pulp customers, I mean, we've seen this real strong move in the euro here which, for a lot of those pulp buyers, has reduced significantly their cost of pulp. In terms of their overall profitability, your major customers in Europe, are they doing pretty well? I mean, can we see further price increases in Europe, I guess, is the question.

Well, I think what you're seeing in Europe, of course, is different for the different paper grades. I would say that probably the most depressed are the coated grades because of course the margins are still quite low. The tissue grade margins have been okay.

But, of course I think with overall raw material prices having come up, they're motivated to push increases. They're getting resistance from the big retailers. And so, their margins probably aren't as good as they would have hoped, but certainly they are making money. And so, the well run ones and the bigger ones certainly are still doing quite well.

In terms of the price in euro terms, you're right. In fact, in most cases it's been a reduction in euro prices rather than an increase. At the same time, the dollar-based consumers like in China, etc., of course we are at historic highs for the dollar-based consumers.

And I think they're the ones which, of course, are having more of an issue in terms of trying to keep prices from increasing further. I think there's less of an issue in Europe other than really the general margins that exist because of competition and overcapacity.

Okay.

I hope that is --.

Yeah. No, that's great. Thanks, Jimmy. And just a question on your potential to convert to dissolving pulp. I mean, you've outlined Stendal, which has got that super vat. Seems pretty easy to be able to convert that.

Lots of questions from competitors whether you can convert Celgar, just because of the continuous digesting system there. But, I do note that under -- of all the dissolving pulp capacity additions that have been announced, there's a couple of them on the list that are also continuous digesters.

So, I guess the question comes, have you learned anything new since you put out the prefeasibility study on the ability to do a conversion at Celgar?

Yes, we did learn. And we know that a couple of guys have certainly continuous. And there seems to be certainly, from at least one supplier, the confidence level that they have solved the problem since they've accepted orders. And clearly, we need to understand further.

But, if you're the supplier and you're prepared to give guarantees, then I guess they feel comfortable that they solved the problem.

Okay, great. Good luck, guys. Thanks.

So, I guess that answers your question. I don't know yet because we haven't run it, and none of the other guys have. But, certainly from the suppliers' perspective, they feel comfortable and confident enough that they're prepared to accept orders and give guarantees based on their studies and whatever they've done.

Okay. Thanks very much.

Okay. Yes.

There are no further questions at this time.

Okay. Well, I'd like to thank everyone again. And as I said earlier, we are very pleased with the result.

Of course, we had some production problems, but a lot of the inefficiencies also was related to the weather. We had extreme weather conditions in Germany. So, we are very optimistic that the coming year will be even better.

And looks like the euro, looks like it may be now kind of more flattening. We were concerned that the euro would continue to increase very rapidly, but maybe there has been a switch now.

But, overall the balance between supply and demand looks very, very positive. And we think it's going to be, again, a good year unless something really unexpected happens in terms of the global economy.

So, looking forward again. And thank you again.

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