Mercer International Inc (MERC) 2012 Q2 法說會逐字稿

Good morning. My name is Kirk, and I will be your conference operator today. At this time, I'd like to welcome everyone to the Q2 2012 conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions).

Mr. David Gandossi, you may begin your conference.

Thank you Kirk. Good morning and welcome to the Mercer International Q2 2012 quarter earnings conference call. My name is David Gandossi. I am Mercer's Executive Vice President, Chief Financial Officer and Secretary. And on the call with me today is Jimmy Lee, President and Chief Executive Officer. As usual, we'll begin with formal remarks, after which we will take your questions.

Please note this morning's conference call, we will make forward-looking statements similar to those that were made in the press release according to 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 both more fully described in the press release and with the Company's filings with the Securities and Exchange Commission.

As you have seen from our press release, our second-quarter results were generally positive, given the current market conditions. Relative to the first quarter of 2011, average NBSK pricing was flat. However, we saw pricing fall off noticeably in China in June.

Our mills ran well at near record levels during the quarter, despite a couple of days of unplanned down time and the costs of key inputs such as fiber and energy were down this quarter. In addition, foreign exchange movements, most notably the weakening euro, created a positive movement relative to Q1. Consequently, given the lower pulp prices in Q2, we are satisfied with the overall operating results.

Beginning in Q2, we have decided to reclassify certain by-product chemical sales out of operating costs and into revenue. We made this decision because chemical sales have grown to the point where they are now material. Energy & Chemicals by-product revenues are a distinguishing feature for Mercer and we believe our focus on various bio-economy related initiatives will continue to develop further margin-enhancing opportunities. All comparative figures have been adjusted to conform to this current presentation.

I'll be going over our financial results in more detail in a few moments, but first I want to highlight that, in the three months ended June 30, 2012, we repurchased $2 million worth of our senior notes. Our Board has authorized the purchase of up to EUR50 million worth our senior notes and $25 million worth of our common shares. To date, we have opportunistically repurchased approximately $15.6 million worth of our senior notes and $10.6 million worth of common shares, or almost 1.3 million shares. The senior note repurchase program expires in June of 2013 and the common share repurchase program expires in August 2013. We will continue to balance our approach of purchasing senior notes or common shares with our high return capital project opportunities and our general liquidity requirements considering the global economy.

During the quarter, cash has increased by approximately EUR4.7 million, despite spending almost EUR10 million and repaying EUR3.8 million of Celgar's working capital revolver. Operationally, our mills ran well in the quarter. However, pulp sales volumes were down approximately 36,000 tons relative to Q1, and as a result, we have seen our finished goods inventory rise relative to Q1. However, despite our lower sales volumes and debt principal repayments, our liquidity is up 7% almost EUR196 million.

Pulp prices dropped late in the quarter primarily driven by China as producers and traders worked through inventories in anticipation of lower pricing. European pricing also fell off at the end of the quarter as they continue to struggle with weak paper demand and sluggish economic growth. Overall average list prices were flat but we estimate the June price reductions in sales mix impacts reduced our EBITDA by almost EUR7 million relative to Q4.

Also in Q2, we entered into fixed-price pulp swap contract that will effectively hedge 40,000 tons of pulp sales at $915 spread evenly over the remainder of the year at 5000 tons per month. Jimmy will update you about our short-term outlook for the pulp markets in a moment.

As you will have seen in our press release, we reported net income of EUR1.5 million for the quarter or EUR0.03 per basic share, compared to net income of EUR1.2 million or EUR0.02 per basic share in Q1. Our Q2 2012 net income includes approximately EUR1.3 million of a net non-cash gain primarily related to the mark-to-market valuation of our pulp price swap which was partially offset by a small non-cash loss on the mark-to-market valuation of our fixed interest rate swap. Before these non-cash items, basic EPS was EUR0.01 per basic share.

We recorded quarterly EBITDA of EUR32.9 million or approximately $42.2 million. This compares to EUR30.6 million in the first quarter this year.

As I highlighted earlier, there were a number of positive influences on EBITDA when compared to Q1 after allowing for the negative impact of lower prices. The most notable were the weaker euro, lower fiber and lower energy costs.

However, Rosenthal had a large maintenance shut in Q2 compared to no maintenance shuts in Q1, which created a negative variance when comparing the two periods. And as I've highlighted on previous calls, many of our competitors report using IFRS, and that type of negative would not be reflected in their reporting.

Switching to cash flow, overall, our cash position is about EUR4.7 million higher than at the end of Q1, sitting at EUR141 million or approximately $179 million. Overall, the quarterly working capital movement increased cash by approximately EUR5 million on a net basis, primarily due to a decrease in receivables partially offset by an increase in finished goods inventory.

Capital expenditures drew nearly EUR10 million which was higher than Q1 by about EUR2 million, the bulk of which was spent on Rosenthal's recovery boiler project.

Summarizing our working capital movements relative to our cash build, in the twelve-month period ended June 30, our working capital, excluding cash and short-term debt, increased by about EUR3 million, up from EUR131 million at the end of Q2 2011. At June 30, 2012, we had approximately EUR26.4 million of undrawn revolvers available at Rosenthal and approximately CAD36.3 million available to Celgar. Our EUR141 million of cash at June 30 is comprised of approximately EUR60 million for the restricted group at EUR81 million at Stendal.

Net debt to equity on a consolidated basis at June 30 is essentially unchanged from Q1 at approximately 2 times equity while the restricted group net debt is also unchanged at about 0.5 times equity.

As I noted earlier, many of our competitors now report using IFRS. An implication of this change is that many of our competitors that we benchmark ourselves against now account for major maintenance using a different method than us. Currently, in accordance with US GAAP, we expense all major capital in the period in which it's incurred, while for those reporting under IFRS noncapital major maintenance costs are capitalized as property, plant, and equipment and then amortized to the next major maintenance shut through, depreciation and amortization expense. So, I wanted to remind everyone that financial performance comparisons to many of our competitors using metrics such as EBITDA are no longer on apples-to-apples basis. So to give you the number, I'll just highlight that we expensed approximately EUR4.2 million of major maintenance costs in the quarter, the majority of which would have been held for capital treatment under IFRS.

So that ends my overview of the financial position and developments, so I'll turn the call now over to Jimmy.

Thanks David. Good morning to everyone.

As David mentioned, we are satisfied with our second-quarter results given the current recent market turmoil. We increased our cash balance this quarter despite making a significant capital investment in Rosenthal's recovery boiler and repurchasing a small amount of our senior notes. I'm also pleased that our continuing focus on reliability has resulted in another strong production quarter. We still have work to do in this area, but I'm satisfied that we are moving in the right direction.

We also achieved our highest quarterly energy sales volume this quarter, suppressing the previous record set last quarter. This marks the third quarter in a row where we have set an energy sales volume record. And this record was set despite Rosenthal being down for 23 days for its annual maintenance and recovery boiler rebuild.

Although Q2 energy sales volume was only slightly higher than Q1, we are very pleased with this trend. Another way of looking at our energy and chemical revenues is that, in Q2, it exceeded our interest expense by over EUR4 million, which is significant given current pulp prices. That is our by-product sales surpassed our debt-carrying charges.

In the second quarter, average NBSK list prices were essentially flat in all markets, with the European Q2 average list price remaining at $837. In North America, the average list price rose $30 to $900, while in China the quarterly average list price rose slightly to $690 per ton.

Despite the quarterly averages, we saw prices come off late in the quarter and producers selling at spot prices well below list. I'll talk a little bit more about recent pricing developments in a moment, but first let me comment on the mills. All three mills ran at near record levels after adjusting for Rosenthal's annual maintenance shut this quarter. Celgar lost some production due to a lime kiln issue, but overall we are pleased with all three of the mills' performance.

In total, we produced 365,000 tons of pulp this quarter, compared to 380,000 tons in the first quarter, and 368,000 tons in the second quarter of 2011. In addition, the mills produced 425 gigawatt hours of electricity in the quarter compared to 436 in Q1.

Turning back to the pulp market for a moment, we are optimistic that the NBSK pulp market is near the bottom, since even at current prices we believe some producers are selling at prices that are below cost. Despite the fact that there is a significant amount of global economic uncertainty, current pulp statistics have the NBSK market in a range that is considered to be in balance. Consequently, it is not clear what is motivating certain producers to sell at deeply discounted spot prices. However, it may be an indicator that certain high-cost producers are operating below cash cost and could be curtailed.

Producer inventories were at 29 days at the end of June, though we believe that number will increase slightly when the July numbers are released. In addition, hardwood pulp inventories are up four days to 40 days. The price spread between hardwood and softwood continues to narrow, which we believe is another positive NBSK indicator since we believe that NBSK demand will grow as paper producers take advantage of our low NBSK prices to reduce their costs.

Europe is continuing to struggle with its sovereign debt issues, which is severely limiting economic growth. And as a result, European paper demand continues to be weak. As I noted last quarter, the current dynamic in Europe has resulted in previously integrated pulp being sold as market pulp. Consequently, we continue to believe that a supply-side reduction is required in the short-term to bring this market more balance.

While in North America, the high-cost mills that are down need to stay down or risk further damage to a still fragile global market. Unfortunately, we currently learned that at least one curtailed high-cost producer is planning to restart as early as Q3 and new production in Russia is scheduled to come online in 2012, though we believe this incremental production will be partially offset by tons lost as a result of mills undergoing their annual maintenance and capital upgrade down time.

Previously, China was absorbing the majority of the world's excess tons. However, we believe -- we don't believe their inventories are high enough to allow them to stay out of the market for a substantial period. We are anticipating the traditional summer slowdown, but we believe we will have upward pricing pressure near the end of Q3. We also continue to believe that the Chinese market will continue to grow despite some predictions that production will outpace demand in the near future. This is because the Chinese government is targeting the closure of inefficient and highly polluting pulp and paper capacity. Many of these older machines use recovered or non-wood fiber, and when this capacity is replaced with modern facilities, the demand for high-quality pulp will grow. This replacement process has been ongoing and it is worth noting that they're currently targeting the closure of an additional approximate 9 million tons of pulp and paper annual capacity by the end of this year.

In the medium to long-term, we continue to believe that the growth in China and similar growing economies will increase market tightness as consumers increase their use of tissue-based products. Indeed, our customers are investing heavily in new paper and tissue capacity in anticipation of this expected demand. Our pulp sales volume totaled 349,000 tons in Q1 compared to 385,000 tons in the first quarter, and 358,000 tons in Q2 2011.

Let me now take a moment to discuss developments in the wood markets. The European fiber prices remain at historically levels, but we continue to have downward trends in Q2. Demand for fiber remains low from board and particle industries, but we are also beginning to see reduced harvesting levels. We anticipate that we will see further price declines in Q3, but expect that reduced harvesting levels will begin to negatively affect prices near the end of Q3.

We continue to be able to source the fiber we need and as a result we are satisfied with our current fiber inventories in Germany, but we will continue to monitor them of course closely. In British Columbia, our fiber costs were flat in Q2 relative to Q1, primarily due to lower whole log prices being off -- lower whole log prices being offset by higher chip costs. We currently expect Celgar's fiber costs to decrease in Q3 as we anticipate chip prices falling, as well as being able to drop certain high-cost suppliers. We are currently satisfied with Celgar's fiber inventories but will continue of course to monetize them closely.

In addition, we are currently working with the provincial government and suppliers as we look to develop greater efficiencies in processing residual fiber harvest waste, otherwise known as burn piles. We are hopeful that we will be able to find both technical and procedural solutions that will allow us to more efficiently process this potential resource. I hope to have more to share on this topic in the future.

In January, we announced our Blue mill project at Stendal. We are very excited about this project because it will create an additional 30,000 tons of pulp production capacity and includes the installation of the new 40 megawatt turbine. We expect to invest approximately EUR40 million in this project with EUR12 million of that coming in the form of nonrefundable government grants. Overall, we are anticipating this project will pay for itself in about two years.

We also expect to benefit from excess generating capacity going forward as well as incremental investment in pulp production will also increase our energy output. Although construction has not begun, this project is on schedule and we anticipate being able to commission the new equipment either late in Q3 or early Q4 2013.

We have received almost all of the grants allocated to us by the Canadian government under the Green Transformation Program. At June 30, 2012, we have about CAD200,000 left that we expect to receive in Q3. This Canadian government-sponsored program has been extremely helpful to our Celgar mill. By far, the biggest project was the installation of the new 48 megawatt turbine which has made Celgar much more competitive, but we have also been able to reduce our fluid levels and chemical costs through other smaller but highly accretive projects.

Ultimately, we feel all of our mills are well positioned to deal with the market downturns as well as provide excellent platforms as we look to the future projects that will allow us to take advantage of the emerging bio-economy.

As David noted earlier, we have moved our chemical revenues out of operating costs to the revenue line, although the size of those revenues weren't to change, it also highlights to our investors that we understand the need to maximize the value of our fiber beyond producing pulp and green energy. We are constantly looking at new technologies and processes that will allow us to do that.

We regularly get questions about the timing of our annual maintenance shuts, so I would like to highlight that our remaining 2012 shuts will line up as follows. Celgar's shut will be in Q3, and will be approximately 5 days long. Stendal's will be Q4 and is scheduled to be approximately 10 days long. I would also like to mention that Celgar's label agreement expired on April 30, Camphor Pulp has been selected as the target for negotiating a pattern agreement in British Columbia, and certainly there is some ongoing discussions. It may be some time before we have an agreement with our local unions. At this point, we are not anticipating any significant labor disruptions as a result of this negotiating process.

If I can close with a few observations, we continue of course to watch the NBSK market very closely. Currently, there seems to be a strong negative sentiment over our markets, but statistically speaking the market is still in very good balance. The anticipated restart of the curtailed mill and new incremental production in Russia will make probably Q3 a little challenging, but we believe that maintenance and capital investment shutdowns will help the market absorbed these tons and we expect that these inventories will be well-positioned in late Q3 and Q4 when demand is expected to strengthen. We believe that the NBSK prices is close to the bottom and that we will see prices beginning to slowly climb late in Q3. We remain strong believers in the medium to long-term NBSK supply demand fundamentals, which we foresee as being driven by the increasing economic standards of the emerging markets.

That is the conclusion of my prepared remarks, and I would like to turn the call back to the operator so we can open the call up for questions. Thank you.

(Operator Instructions). Bill Hoffmann.

Good morning Jimmy and David. I wonder if you could talk a little bit about the pulp market buying patterns. Obviously, the Chinese come and go from the markets. Can you give any sense of where they are right now, inventory-wise? And we are assuming they would've depleted inventory at this point. But I'm also wondering if you are seeing different buying patterns by other buyers in the markets.

I mean, you know, the demand side, if you look at the shipment volume rate, certainly year-over-year you're seeing double-digit type of percentage increases in terms of overall pulp importations into China. So in that trend, things haven't really changed.

I think if you look at it on a monthly basis, of course they being very opportunistic in the sense that when they believe that prices of course are very close to where many of the high-cost producers are operating at a loss, they seem to be opportunistically buying fairly large volumes, and then withhold the buying for a period to see if they can keep the prices at those levels. We know that of course a certain number of trading firms had purchased earlier on, so they have been in the process of liquidating their inventories as well. So, I think that there is a general feeling certainly from the markets that we are close to bottom, and therefore there will probably be additional volumes to speculate on the fact that prices will start to move upwards. These are very difficult to monitor, but all we can say is that as we can see from the port levels, inventory-wise and producer levels, inventories are in fact reasonably low. So, we don't expect any particular reason why all of a sudden the dynamics will turn more negative. I think you know it's probably near what we would call a turning point.

And what about just other buyers? European market, North American market? Any change in the buying patterns?

No, not really. Clearly, the European paper demand is continuing to be fairly soft, so you are seeing the continued trend of let's say prior integrated pulp making its way, so you are seeing that certainly shipment rates out of north Europe, primarily from the Scandinavian countries, have increased, of course assisted like we have been. If you look at it, a primary benefactor has been Finland, of course, like we have, because of the euro. I think [Sadra] of course because of the strengthening of the kroner is having probably more desires for higher pricing overall. I think the euro certainly is helping us; it's helping the Finns,. So you're seeing increased volume into China year-over-year from the Finnish kind of areas. And so no, we haven't seen anything in particular that really changes that. You're getting good growth in China, weakness in Europe, and a kind of flat type of situation in the US.

Thanks. Just one question on the wood costs. You said I guess up in Celgar you're pretty comfortable with where the situation is. Any thoughts on the incremental cost pressure in Europe from the reduced harvest over there?

No, I mean we are getting the benefit of the fact that our competitors are certainly in a much weaker position, and the sawmill activity seems to have stabilized, albeit at a much lower level. These sawmills are producing primarily for the domestic European market, and in particular the Germans are mainly for the German type of do-it-yourself type of business. So they have stabilized, and so we don't really expect any real change in terms of availability of sawmill residuals. Of course, the forest owner is motivated to see if they can get better pricing, but I think everybody is aware that the economic conditions are not conducive to that type of focus. So yes, we are not expecting any real increase in fiber costs. In fact, to the contrary, we think we can continue to do the job better, and hopefully we can further reduce our overall fiber costs.

Thank you.

Andrew Shapiro.

Yes, a few items here. On the NAFTA claim on the arbitration, can you update us on the status and what the next steps and milestones are since our last call?

Sure. I guess it's a pretty formal process, Andy. We are at the stage of picking arbitrators. So we've picked ours. I think Canada has picked one for themselves and now there's a process where those to get together and they pick the third, which is the President of the Council. So that's on the administrative side.

There's lots of information that's been pushed across to Canada, so they are going through their learning curve process. We have been -- we've had some minor engagement with the province, but they don't seem all that interested in having a discussion at this point in time. I think it might have something to do with timing of elections and so on. So really not a lot else (inaudible). It's moving forward, and we believe very strongly in our position, and just wish we could get the provincial government to wake up and realize how --

In terms of milestones, when are the elections?

It's May of next year.

Okay. And in terms of any deadline for the arbitrators to be picked by all sides, is there a deadline?

The schedule floats depending on how certain things develop. Ultimately, there will be a deadline, but I can't really indicate what that would be. But it will be within a couple of months I would assume.

Okay. Regarding the industry, are you yet seeing any high-cost producers going off-line due to the NBSK price declines? I know you've mentioned frustration that some you think should go off-line haven't yet. But are you seeing anyone go off-line yet?

Certainly, the high-cost producers domestically in China, the software guys, I wouldn't rate them exactly NBSK, but clearly in competition to some of our customer base. I guess they've taken production down time as well as switching some of their production to dissolving if they've already implemented the conversions. So certainly in those areas, you are already seeing adjustments.

I think where we need to get further adjustments is of course what traditionally had been the guys in North America, and of course I do believe that there is going to be significant pressure. As you know, the Canadian dollar has been relatively strong against the euro. And therefore, really I think these producers are under pressure in terms of the production costs. I do believe that there is going to be further announcements, of course. In the last couple of years the market has been fairly attractive, and therefore there has been profitability, even to the marginal producers. And there is probably some anticipation that there may be some recovery because, of course, the inventory balances are pretty good. So, they are probably hanging on, expecting that the turn is going to happen soon. So, I do believe, if it doesn't turn, that they will take down time. And so if they do take down time, then of course the market will turn. So, I think in a way they are inducing their own pain because, without that kind of movement, things could be flatter for a longer period, and if they do go off, then things will recover. So it's kind of a perverse situation, if you may.

Now, with August price cuts already announced, I guess really bringing it down to where the spot was anyway.

Yes.

It looks, from prior cost estimate graphs you guys have put up on investor presentations, that maybe 10% to 12% of the overall industry capacity may be at loss levels. Does that sound about right?

It's very difficult to gauge, because you, know you're, taking a very static type of position. And all of those numbers adjust for currency and all that, so you know you can't -- I can't really give you a percentage.

All I can say is that, clearly, based on the fact that, in prior cycles, if you look at the mills that have closed, there were a handful of Canadian and European mills. Now, the European ones clearly have benefited this time around because the euro being significantly weaker, and it has disadvantaged the Canadian ones. So the likely scenario is that first you get the high-cost domestic Chinese production curtailing. Next would likely be the Canadian production because of the currency impact, and then if it continues further, the European type of high cost. So that's all I can say about that.

I'll ask one more question and then get back into the question queue. I have a few more, so please come back to us afterwards. But regarding the accumulated grants that the Company has received over the last several years from the German and the Canadian government for all your respective plants, I don't know if you want to answer this off-line or if you guys have it pretty available. You guys published at the end of the year the annual report -- approximately EUR292 million, or about EUR6.50 a share, of unamortized government grant value that is embedded in your plants that is not because accounting standards reflected in your PP&E. Are you able to provide a breakdown of this either by plants or preferably at least between the restricted group and Stendal as to those amounts? And also, is that EUR292 million, since it was in the annual report, it would seem like -- can you please confirm that's before the incremental EUR12 million of grants you've either booked or expect to book for the Blue Mill project on Stendal.

Yes. Great question. Today I can give some general guidance, and then I can help you in more detail off-line if you like. So general pictures, the Stendal mill first of all, the grant was EUR276 million. The mill was completed in September of 2004, and so that would have been capitalized at that point in time. It amortizes over 25 years.

There's been smaller trickling amounts for adjustments to close that agreement and so on. But that's the big chunk there.

For Rosenthal, which was completed in 1999, the number was about EUR102 million, again, 25 years. And Celgar -- and that was 1999. Celgar had about CAD58 million that it received over the course of the last year and a bit. All of them amortize at 25 years, and if you add them all up, you get pretty close to the EUR290. There's been other little trickle in things all over the place, but those are the big numbers.

So Celgar's starting date would be mid-2011 on average?

Sure.

Okay. And for Rosenthal, where in 1999 might that be? Same thing?

Yes.

Mid '99. Great. I have more questions, I'll back out into the queue. Thank you for answering my first set.

(Operator Instructions). Mark Kennedy.

Good morning. Just first question, just on this tall oil breakout, am I correct in assuming that most of this is coming from Stendal? And if it is, is there the possibility to grow this line from either your Rosenthal or Celgar mills?

The tall oil plant is at Stendal, but we transfer soap from Rosenthal down to Stendal for processing. So the only increases will be production improvements or pricing improvements --

And consumption of pine.

-- yes, or more consumption of time, as Jimmy mentioned, in the mix. Tall oil prices, having said that, have nicely doubled in the last two or three years, so it's a feedstock for a number of interesting chemical products, so I think that's a good sustainable business. The mix in the Celgar region really doesn't warrant putting in a tall oil plant. There just wouldn't be enough feedstock to justify it at this stage.

Okay. And then following your work here in this quarter on the Rosenthal recovery boiler, is there any capacity bump at Rosenthal you expect out of that?

Yes. There is going to be an incremental capacity increase. The exact number kind of slips me, but really the benefit of that particular project was not just the capacity increase but also the fact that we had a significant amount of steam because the present turbine was limited. We basically had to of course look for productive use for that steam, and so this new turbine will allow us not just to consume the steam that previously we were not using, also we would be able to increase the of course steam production from the power boiler as well. So we think that's really the big potential there.

I think, in terms of pulp production, our target is to go move Rosenthal more to the 345, 350 type of range, and so really that's kind of the direction that we are trying to move towards in terms of overall capacity at Rosenthal.

Okay. Jimmy, you mentioned in your comments there as you look towards the end of the year, you think your German mills on the fiber side, there might be reduced harvest, harvesting levels? Can you just explain that thought further?

I mean, we believe that, in terms of the harvesting activity, only because of course prices have been under pressure because of the reduced consumption generally coming out of the board, as well as the saw millers. And so you know the private as well as the public forest owners of course are motivated to see if they can at least get better pricing. And so there has been a trend to see if they can get better pricing by reducing the harvesting activity. We do believe that it is not going to be that significant, so it's not going to be something where we are going to get an end result where prices are going to increase significantly. In fact, all we are seeing is that probably the trend will stabilize where prices stabilize at that these type of levels.

Yes, but I guess the important point is any reduction, that's the voluntary reduction. It isn't like they've been overcutting their harvest.

No, no, no, no, no. This is more of a voluntary, so it's not imposed in terms of availability of fiber or anything like that.

Right, okay. And then one last question, David. You had mentioned last quarter a comment in your reporting that the Stendal might be in violation of its debt-to-EBITDA covenant. Is there any update on that for us that you have at this point?

Yes, I do. Yes, so we were close to that line, so we applied for a waiver, which we received, but having said that, Stendal did make its covenant. So --

Okay, thank you.

Paul Quinn.

Yes, thanks very much. Just I wanted to ask a question about what you guys have been experiencing with discounts on list prices in the marketplace, and what levels those are increasing to, if they are.

I mean, you are seeing additional pressure for discounts to lift. They have of course now trended to the high double digits --

High teens.

Yes, in those high teens. We basically feel that prices are moving to reflect I guess the discounting. So, we are not going to see prices hold up with the discount increase. You are going to get essentially discounts widen and then ultimately the list prices adjust for the discounts.

Certainly, in terms of the China market, I think present prices, spot-wise, you are sharing somewhere around slightly under the EUR600 type of range. I think that's probably where things are going to stay. I can't see prices with current exchange rates going much lower because essentially a lot of producers are going to be losing money. So I think that discounts will stay kind of like at these high teens, and then the prices will drop to reflect any further pressure to widen that.

Okay, thanks Jimmy. Just a question on other cost inflation, you guys mentioned fiber. What other chemicals are? You seeing anything there, or other areas?

I think fiber for us of course is a very big focus. So we think we have certain programs both in our German as well as our Canadian mills, to further make very good progress in reducing fiber costs. So I think, moving forward, we are very confident that you're going to see fiber actually become a very good positive type of development, certainly we think at our Canadian situation.

In terms of chemical cost pressures, no. We are not seeing any real pressures from any chemical producers. I think the focus has been to reduce our chemical costs and I think they are trending in the right direction. So you know, we don't have any expectations that chemical costs will increase. In fact, it's more likely they will further decline.

Great, thanks. Good luck in Q3.

Andrew Shapiro.

Thank you. A few follow-up questions. I think you answered someone else's question on the maintenance and CapEx monies in Rosenthal that it was substantive improvements to Rosenthal that you did in addition to recurring maintenance. Was that correct? Did I hear that right?

Yes. Basically, it was not really a maintenance item. It was one. A big chunk of that investment offsets certain costs or expenses that we would've had to pay and were accrued. So --

Wastewater fees.

Which was the wastewater fees. And so in effect, that facility that we built and modernized didn't really cost us, from our own perspective, a lot of money. In fact, most of that came from offsetting expenses that we would've otherwise paid if we didn't make such investments. And at the same time, it provides not just incremental increase in pulp production, but really further growth in our electricity revenue, both from the incremental tonnages that we of course have out of pulp production, but also additional power generation from just earning biomass. I think, all in all, the project was an extremely attractive and very accretive one.

Yes, so internally analyzing this, or figuring this out, what would you then kind of say the payback period or return on investment was?

Because most of the costs you had offsetting expenses, your cost is very low. So the incremental benefit or the return on investment is -- yes, it's very high.

On your financials, I just want to understand what may be going on here. Am I correct in observing the minority interest allocation for this quarter increased from last quarter? It seems that a substantially greater rate than the income, so if that's correct, can you explain?

So I guess you would be looking at the page in our press release where we show you the restricted and the unrestricted groups, so investors should look at the net income before the net income attributable to controlling interest. And in this quarter, it was EUR5.7 million. If you multiply that by 25%, you get EUR1425 or something like that. And in our case, it was EUR1625. So the difference is only really accounted for by -- we have Stendal, which has a subsidiary parent company called Stendal Pulp Holdings. Then you've got (inaudible) the mill, so the minority interest is only on the mill level, so any activities at the parent level don't get picked up in miscalculations. So it's up by EUR100,000, EUR200,000, and it has everything to do with these parent company adjustments. There's and amortization element of capitalized startup costs and things like that.

I just was wondering if there was a policy. Now, when you state you expected the sales of tall oil to be stable in future periods, can you clarify whether this is stable in terms of euro amount in revenues or stable in terms of percentage of pulp production or some other thing?

It's -- we know what our fiber diet is. We know what the history of the tall oil plant is, and we know the trendline for the tall oil pricing and still the metrics are solid in our mind that this activity will continue.

So is this stable form of cash flow that one should look at, or look to like your power generation versus the volatility that goes on with your cash flows that come from the movements in pulp pricing?

Yes, I think so. For sure that's really one of the reasons we wanted to try to highlight it. It's a stable cash flow that is not susceptible to the cycles as pulp is.

Okay. And lastly, you had this unrealized gain on your pulp price swap that you entered into, which I think in all my years of following you might be the first time I've seen this, or -- I don't think I've ever seen it from you guys. Can you explain your thinking here? Obviously, it was a good move as prices move down -- what the breakout is between Stendal and Rosenthal or Stendal and restricted group as to where the gains fall, or if it's up at the corporate and spread out equally? How do you do that?

It was done at the corporate level, so it wasn't done at the mill level. This was essentially a financial hedge. What we believed is that if you look at presently what we do in terms of sales, sometimes depending on the customer, we may enter into a fixed-price contract for a year. And so of course the prices in our mind have to be reasonable, so this is really just a financial duplication of what we would do otherwise from a physical perspective. And so when we were essentially given this opportunity early on this year, and certainly from talking with our sales guys and the outlook, we felt that the pricing for the year period, because it was entered into in April, so from May to delivery to the end of the year, no shorter than a year but it represented for us essentially an opportunity where we felt that the pricing scenario for the year type of scenario was attractive in the sense we felt it was a fair price. So we didn't take --

Where did the gain go, then, if it's corporate? If it's --

It goes to the corporate level, of course.

No, is it in cost of goods sold? Does it come through as a reduction (multiple speakers)

It just comes to the bottom line.

Was it below the line amount?

Yes, it just comes through the bottom line.

Was it below -- in the income statement, is it found in the below the line area?

Yes, it does, yes, right below where it is right now, so it's a realized.

Okay.

It's a combination of the net between the interest rate swap at Stendal, and this forward sale.

Okay. It's netted with the interest rate.

So we think that, incrementally, we do believe that, also on the interest rate, things have to start to recover, unless interest rates in Europe go through further -- from a general perspective down and stays down. We have a situation where, as you know, German interest rates are at unbelievable historic lows. So the trend should be more in the other direction in the coming years. We have suffered in terms of valuation, but I think probably, moving forward, it's more likely that we should have some recovery of that valuation.

And I don't know if you broke it out as you've done in other calls, the sales and production numbers by mill?

Haven't been asked yet, but I'm happy to do it for you. Production volumes, starting with Rosenthal, was 65,900, Stendal was 171,000. Celgar was 128,200 for a total of 365,000. On the sales volumes, Rosenthal was 77.4, Stendal was 152.7, and Celgar was 119.3 for a total of 349.2.

And I think you bought back during this quarter some debt, but no stock yet. Have you announced the reauthorization of the buyback? And in terms of your cash needs for various projects, I know that some of this might've been on hold because you were looking at the sizable (inaudible) merger opportunity. Do you have strategic opportunities like that in front of you now that would impede with -- moving forward with the buyback? What are the factors that you'll be thinking about in terms of when and if to be buying back some shares?

We always have a lot of things on the go. Of course, it is a combination of accretive type of projects which of course are very high-return. We see a lot of potential there. There's a lot of things we are doing in terms of the fiber situation where we do believe that, given certain investments, that this will further strengthen our position. So the second half of this year, there is a lot of things in the air, not just in terms of what the market conditions are, but a lot of projects that we had initiated a couple of years ago not just for BRIC but also internally, there's a lot of things that we're working on, not necessarily external type of projects, but really a lot of internal things as well. And so we have to weigh all of these issues in terms of deployment of our cash resources.

What we've always found is that when you need the cash, no one seems to give it to you. And so we have been a little bit more cautious of course in terms of husbanding are cash, because as you know our prior experience hasn't been favorable when we have kind of been a little bit more aggressive in terms of our liquidity. And so I think there is a desire to be a lot more conservative so that everybody benefits from that. And so I think we will have to weigh all of these factors in determining which -- whether it's debt or equity, and the aggressiveness of such repurchases. That's all I can really say.

[Is] the other strategic projects are not in the way of the stock buyback, but you have these considerations if it would sound like that at least even more aggressive retirements of debt ought to be pursued to get that out of the way, since that seems to be in the way of many analysts, rightly or wrongly, when it comes to your equity anyway.

Yes. If you look at our debt repurchases, we try to find reasonable pricing scenarios so that we'd be opportunistically repurchasing stock. Right now, of course, the debt side seems to be certainly stronger than the equity side. So, you know, we have to monitor that closely moving forward, as well as the general markets, to see of course how aggressive we may be on the debt.

Is there another debt refinancing opportunity available at lower rates then?

Unfortunately, the way that the bond was structured, it would be expensive for us to be refinancing this existing debt. So it isn't of course interest rate but there's a lot of soft costs, as you know, related to these activities. So we think that there will be a time, if timing as well as the market conditions is right, that we may look towards a refi, where it's much more attractive, but right now we would have to pay fairly expensive type of premiums.

Right. And your equity is the cheapest of the options maybe in terms of returns on the underlying assets, because these assets are greatly being mispriced in the market right now.

Yes, we have to look at where the markets are and what the other use of proceeds, etc., and certainly we will take consideration in all of these factors in determining what should be kind of the actions that we take. I think, as I said, from the experience that we have had, I think we tend to of course lean more towards the conservative side, mindful of the fact that we are a small company, and it's a very cyclical business, as you know, and therefore we need to be very careful in terms of husbanding our resources.

Great, thank you.

Joe Licursi.

Good morning gentlemen. I just had a quick question. David, could you tell us what the capital expenditures will be for 2012?

Okay, hello. So, really, the majority of our capital spending I guess would be Rosenthal and Stendal. Rosenthal finishing off their capital project of EUR7 million to EUR8 million in the second half of the year. And Stendal is ramping up Blue mill, so that will be about EUR12 million to EUR13 million for the remainder of the year. And with the grant offsets on that coming in in a slightly lagged, one-quarter lag approach.

Okay. And so like, in total, in total for the year, net of grants, David, would you have that number?

Yes, about EUR38 million for the year.

Okay. That's net of grants, right?

Yes.

Jimmy, I had one question for you very quickly. We see this phenomenon of the BHK prices in China being higher than NBSK. How do you see that situation developing now?

I think, from a tissue manufacturer's perspective, there is certain benefits in substituting our softwood for hardwood if you got the same pricing. So I think what the trend will be is that they will consume certainly a lot more softwood in their furnace, and get the benefit of reduced costs and still have the same quality. So I think that it is going to benefit us to where softwood consumption of course will be a lot more at the expense of hardwood, and then hardwood prices either have to start to weaken, or software prices will go up to further establish that gap that normally exists.

Okay. A final question. What is your view on the wood costs in Europe and in British Columbia?

From our perspective, we believe that wood prices in British Columbia, if we don't take of course a lot of the same actions we are presently taking, will likely trend upwards -- but because of course the reduction in terms of harvesting availability. But from our perspective we do believe we have certain projects at hand that will actually allow us to further reduce our fiber costs.

In terms of the European situation, we really don't see any reason why we will see price of fiber increase, and we don't expect fiber prices really generally to reduce significantly. So, we think that fiber prices probably will stay similar to where we are now.

Even with the -- what we read like with the expected production in (inaudible) generally the demand from pulp producers in Germany?

yes. There has been a lot of talk of biomass, and of course there has been a lot of issues related to the environmental as well as the best use issues, and so you're not really seeing many of the projects that were originally on the drawing board really coming to reality yet. And so yes, there's going to be ongoing pressure for biomass, but I don't think it's going to be as extreme as one would've thought earlier on. And certainly the cost of the fossil fuels, of course natural gas being one of them, in Europe is such that it's not as attractive with the combination of the carbon credits. If you look at the carbon credit market, it's collapsed. So, the benefits that would have otherwise been there certainly isn't as attractive.

Okay, so basically you're saying flat in Germany, and slightly lower in BC, right?

Yes. We think we can make the right type of decisions to make a good dent in our fiber cost in Canada over time. It won't happen overnight.

Thank you very much. Good luck.

There are no further questions at this time. I will turn the call back over to the presenters.

We thank everyone for attending today's conference call, and I would like to end it. Thank you very much.

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