Mercer International Inc (MERC) 2013 Q2 法說會逐字稿

Good morning, and welcome to Mercer International's second quarter 2013 earnings conference call. On the call today are Jimmy Lee, President and Chief Executive Officer of Mercer International, and David Gandossi, Executive Vice President, Chief Financial Officer and Secretary. I will now hand the call over to David Gandossi.

Thank you Jay. As usual, we will begin with formal remarks, after which we will take your questions. For Safe Harbor, please note that in this morning's conference call we will make forward-looking statements according to Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. I would like to call your attention to the risks related to these statements, which are more fully described in our press release and with the Company's filings with the Securities and Exchange Commission. I will start by covering some of the key financial aspects of the quarter, and then I will pass the call to Jimmy.

Relative to the first quarter, average NBSK pricing was up marginally in all markets, demand was steady overall, with a slight increase in European demand. Relative to Q1, sales were up approximately 12,000 tons, however, our Q2 results were negatively impacted by Celgar's annual maintenance shut, which was planned for eleven days but took 15 days due to a lightning strike at the mill, and other equipment and execution related issues. The shutdown and the slow start-up resulted in a loss of approximately 30,000 tons, roughly 14,000 tons of which were unplanned. Apart from the Celgar restart, the Mills ran reasonably well in the quarter, and our sales outpaced production resulting in finished good inventory being down approximately 19,000 tons relative to Q1.

Pulp prices remained lower than expected, when current market metrics are considered, but we did see some positive pricing momentum in Q2 with quarterly average prices up over USD$20 per ton in Europe and China. List prices ended the quarter at USD$860 per ton in Europe, USD$690 per ton in China. German fiber prices rose this quarter due to strong demand from pellet and board producers and saw mills, while harvesting has been impaired by adverse weather conditions. As you will have seen in our press release, we reported a net loss of EUR9.9 million for the quarter, or a loss of EUR0.18 per basic share, compared to a net loss of EUR0.4 million, or a loss of EUR0.01 per basic share in Q1. Our Q2 2013 net loss includes a gain of approximately EUR5.3 million related to non-cash gains on the mark to market valuation of our fixedfixed interest rate swap, offset by a small loss on our pulp swaps. Before these items, basic earnings per share was a loss of EUR0.28 per share.

We recorded quarterly EBITDA of EUR14 million or approximately USD$18.3 million. This compares to EUR24.3 million, or about USD$32.1 million in Q1. The most significant impacts on our EBITDA this quarter was Celgar's annual maintenance shut, and subsequent slow start-up and higher German fiber costs. Partially offsetting these negative impacts were slightly improved pricing, and increased sales volumes. The US GAAP IFRS differences relating to major maintenance have an important impact on our quarter when comparing our results to those of many of our competitors. In Q2 we expensed approximately EUR8 million for major maintenance, the majority of which would have been eligible for capital treatment under IFRS.

Switching to cash flow, overall our cash position is almost EUR24 million higher than at the end of Q1, sitting at approximately EUR134 million, or approximately USD$174 million. Quarterly working capital movements increased cash by EUR16.6 million an a net basis, primarily due to decreases in receivables and finished goods inventories. Capital expenditures drew approximately EUR11 million during the quarter, of this total approximately EUR8 million were spent on the Stendal's Blue Mill project, while the remaining EUR3 million was spent on high return capital projects at Rosenthal and Celgar.

On the financing side, the Blue Mill facility is now fully drawn with the last EUR7 million drawn in the quarter. Stendal also received EUR3.4 million of government grants for the Blue Mill project in Q2, bring the total grants received to date to EUR4.1 million. The Mill expects to receive approximately EUR8 million of additional grants for this project. Finally we drew almost EUR7 million on our revolvers this quarter, these revolvers were fully repaid in July. Our working capital movements in the 12-month period ended June 30, excluding cash and short-term debt decreased by approximately EUR9 million, with working capital down from EUR134 million at the end of Q2 2012. The decrease was primarily due to lower inventory and receivables, partially offset by lower payables.

In terms of our liquidity, at June 30, we had approximately EUR17.7 million of undrawn revolvers available at Rosenthal, and approximately CAD17.6 available at Celgar. Subsequent to the quarter, we added to our liquidity by issuing a USD$50 million principal amount of our senior notes. These notes were priced at 104.5 plus accrued interest from June 1st. The net proceeds from this offering were used to pay our revolving credit facilities in July and for general corporate purposes.

During the quarter, Celgar extended its credit facility to May 2016 on more favorable terms. Our EUR134 million of cash at June 30, is compromised of approximately EUR69 million for the Restricted Group, and EUR65 million for Stendal. Net debt to equity on a consolidated basis at June 30 is up slightly from Q1 at approximately 2.3 times equity, while the Restricted Group's net debt to equity is essentially unchanged at approximately 0.5 times equity.

In July we also announced a workforce reduction at the Celgar Mill. We will reduce the workforce by approximately 85 employees, with the majority leaving over the next twelve months. We estimate we will incur pretax charges of between $6 million and $8 million. We have not recognized any restructuring costs in Q2, but we expect to recognize the majority of these charges by the end of 2013. We currently estimate that this workforce reduction will realize between $8 million and $10 million annually, with about 80% of those annual savings being realized in 2014.

Finally, as reported in our press release, we have had discussions with the agent bank for the lenders under Stendal's loan facilities for the purpose of obtaining a satisfactory amendment of the leverage and debt coverage rations. We have agreed with the bank on a nonbinding term sheet, which will provide the Mill with greater covenant flexibility, and the agent back has been engaged to seek lender approved for this term sheet. Pursuant to the term sheet, we have agreed to invest USD$20 million as additional capital in Stendal.

Subsequent to entering into the term sheet, the agent bank has confirmed that the lenders have agreed to have the two ratios covering the training 12-month period ending September 30, 2013, instead of June 30, 2013, and the Stendal Mill must now report on its compliance with the September 30 ratios on November 15, 2013. The change in the covenant measurement date has been put into place to allow the various lenders enough time to properly review the term sheet, and as such, we will continue to pursue the term sheet with the lenders. We believe we will be able to conclude a satisfactory amendment in the third quarter.

That ends my overview of the financial side, and I will turn the call over to Jimmy.

Thanks David. Good morning everyone. Overall, our second quarter results were disappointing, driven primarily by unplanned downtime, which led to higher costs and also negatively affected our electricity and chemical sales. However, we are encouraged by the modest pricing momentum experienced in the second quarter. Despite lower energy and chemical sales, our by-product revenue exceeded our interest expense on a consolidated basis by approximately EUR3 million in Q2. Our quarterly by-product sales continue to exceed quarterly debt carrying charges in both the restricted and unrestricted groups.

In the second quarter, average NBSK list prices rose in all markets, with the European quarterly average list price rising USD$25 to USD$857 per to, and the Chinese quarterly average list price rising USD$22 to USD$700 per ton. June NBSK producer inventories are at 28 days, down one day from March. At these inventory levels, the NBSK market is considered to be in balance, and has historically led to price increases. June hardwood pulp inventories are also down one day from March at 40 days, which is also considered to in balance.

We believe these inventory levels highlight the continuing improvement of the NBSK pulp market, currently the pulp markets are heading into a traditionally slow summer period. We believe customer inventories however remain low, and with producer inventories in balance, there should be enough upward pricing pressure to offset reduced demand in the short-term. In addition, one of our competitors recently announced the permanent closure of approximately 400,000 tons of NBSK mills scheduled for August 2013. While on the demand side, approximately 1 million tons of incremental tissue capacity is scheduled to be commissioned in second half of 2013, with a further 1.9 million tons in 2014. Consequently, we are optimistic that NBSK prices will not fall significantly, and should begin to increase late in the third quarter and through Q4.

Turning to our production. Celgar and Stendal both experienced some unplanned downtime this quarter. However Rosenthal continued to benefit from its 2012 recovery boiler upgrade, achieving near record production this quarter. In total, we produced approximately 350,000 tons of pulp this quarter, compared to approximately 361,000 tons in the first quarter, and approximately 365,000 tons in the second quarter of 2012. Our Q production was broken down as follows. Stendal produced 158,000 tons, Celgar produced 100,000 tons, and Rosenthal produced 92,000 tons. In addition, the Mills produced approximately 406 gigawatt hours of electricity in the quarter, compared to 424 gigawatts in Q1, and 425 gigawatt hours in Q2 of 2012. Our pulp sales volume totaled approximately 368,000 tons in Q2, compared to 357,000 tons in the first quarter of last year, and 349,000 tons in Q2 2012.

In the first half of 2013, NBSK demand from China was down approximately 10% compared to the same period last year. However, we believe that the Chinese markets will continue to grow, at or near its historical rates, and that additional demand also come from other growing economies in the medium to long-term as users increase their use of tissue-based products. To meet this expected demand, many of our customers have announced significant investments in new paper and tissue capacity. For example, two large tissue producers have publicly announced investment plans that when combined will add another total of 50 tissue machines at various sites by the end of 2015. These announced machines equate to approximately 2.3 million tons of incremental tissue capacity. As I noted earlier, some of these new tissue machines are scheduled to come online in the second half of 2013.

Let me take a moment to discuss the developments in the wood markets. Despite harvesting rates returning to traditional levels during the quarter, the European fiber market remained tight in Q2, driven by strong demand from board producers, unusually strong demand from pellet producers, and a shortage of saw logs, forcing saw mills to use higher quality pulp wood. This has forced our Mills to secure large volumes of wood outside of our traditional fiber baskets, resulting in higher transportation costs. We anticipate wood costs will increase marginally in Q3, but will begin to stabilize late in the quarter and into Q4. We expect that we will be able to continue to source the fiber that we need, but we will continue to monitor the market and our inventory levels closely.

In British Columbia, our fiber costs were down slightly in Q2 relative to the first quarter, primarily due to strong saw milling capacity in Celgar's fiber basket. We expect that Celgar's fiber costs will continue to decrease moderately through Q3 and Q4. We are currently satisfied with Celgar's fiber inventories, but we will also monitor them closely. I am pleased to meet that our Blue Mill project remains on schedule, and on budget. We are looking forward to getting the incremental 30,000 tons of pulp capacity, and new 40-megawatt turbine online at the end of Q3. Our total investment in this project will be approximately EUR40 million, with EUR12 million of that coming in the form of non-refundable government grants. Overall, we are anticipating that this project will pay for itself in about two years.

We regularly get questions about the timing of our annual maintenance shuts, so I would like to highlight that our remaining 2013 shuts will be Rosenthal in Q3, and Stendal in Q4. With respect to our NAFTA claim, we continue to work with our advisors to move this process forward. Based on our current schedule, we expect our case to be heard in mid to late-2014, with a decision several months after that. We will continue to provide updates as we move through this process.

As David noted, Stendal is currently working with its lending banks to amend its debt covenants. I wanted to stress that Stendal is not facing a liquidity issue. At June 30, they had roughly EUR65 million liquidity, and fully expect to meet all of their obligations. We have presented the lenders with an amendment proposal for the covenants, that will give Stendal more flexibility, but we believe will also provide the lenders the tools that they need to monitor their investment. We expect that we will be able to conclude a satisfactory amendment in the third quarter.

David also mentioned our decision to restructure our Celgar Mill. This restructuring is designed to reduce the Mill's fixed costs, and make it more efficient and productive, while also maintaining our high safety standards. We are confident that this restructuring will be successful in meeting its productivity and cost saving goals.

In July we closed on the issuance of USD$50 million in principal amount of our senior notes. We are pleased at the market's reception of this issue, which was priced and sold at a premium of 104.5. Adding to our existing senior notes was an efficient way to shore up our short term liquidity, and puts us in a strong financial position to continue to execute our strategic objectives.

If I can close with a few observations. The NBSK market continues to be sluggish relative to market matrix. Statistically speaking, the market is in good balance based on producer inventory levels, and consumer inventory levels are also low, so we remain optimistic that the pulp market will continue to strengthen despite the incremental rush in production that was new to the market in Q2. We believe that NBSK prices may decline slightly in the short-term, but by the end of Q3 will begin to slowly climb, and we expect that we will continue to gain positive momentum through Q4. We also continue to be very optimistic about 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 will turn the call back to the operator, so that we can open up the call for questions. Thank you.

(Operator Instructions). Our first question comes from the line of Bruce Klein with Credit Suisse. Your line is open.

Hi, good morning. The pulp markets, in terms of your latest take on the hardwood capacity in South America. I know that has been a recurring issue. It is coming in, in a lumpy way, in a larger way, and I was wondering if you have any thoughts on how that impacts on NBSK?

There has been a lot written up in terms of forecasted, because of the significant amount of hardwood capacity coming online this year and next year in South America, that this will have a big impact in terms of softwood prices, but if you look back historically, and this was and there were some studies done by the some of research firms, there clearly seems to no correlation between large start-ups that have occurred in prior years in South America with actual NBSK price developments. Although I see the psychological reasons, or inferred reasons why there should be maybe some softening in terms of NBSK prices, but statistically, historic data does not actually correlate to that.

So if you are looking at really what history teaches us, really there is nothing that kind of directly correlates, in fact hardwood prices or NBSK price gaps have been significant over extended periods of time. Today, of course, that gap is very small, in fact, in some areas it probably doesn't exist, and so we still very optimistic that we will continue to see maybe a disconnect between hardwood and softwood prices, although capacity clearly is increasing in South America.

The substitutability, I know historically it hasn't had a big impact, but is there something that has changed in the business or the technology that might make the substitutability easier than harder in prior cycles, that you are aware of?

There has always been incremental technology advancements that of course has reduced the amount of softwood in more the traditional areas, but this has been an ongoing development, so there is no new technology that I am aware of that suddenly everybody is using that will have such a significant impact, to change what we have seen historically. In fact, the trend is for more softwood usingcapacity come online, in terms of tissue than in the past. The expansions in the past has beenprimarily more publishing grades, which of course, there have been a lot of old machines, which of course have been taken out, and new machines which use left softwood, so that has been of course a big influence in terms of the development of the softwood, but the developments in terms of paper capacity moving forward tends to be a little bit more favorable I think, to softwood consumption than in the past.

That is why, clearly, I don't necessarily buy in really to the analysts projections. I feel what is happening today is a more of an inventory led sluggishness. You do have credit pressures clearly in Europe, credit pressures in China. We didn't see this kind of speculative type of buying out of China in the early part of this year, which traditionally happens and this kind of kicks up the price developments. You are not getting really a large speculative component of the buying that traditionally influenced the early development of the recovery, and that is why it is kind of muted. Yes, it is disappointing, but I guess it is really driven more financial reasons rather than supply and demand kind of reasons.

Bruce, it is Dave here. I just want to pick up on a point Jimmy made earlier. If you look at hardwood capacity additions, you just need to look back to 2010. There were two large Mills that came online, [Rijal] was one of them. There was hardwood prices were under pressure and softwood prices kept going up. For a period of time there, for five or six quarters, softwood prices were $200 north of hardwood, so that really is clear evidence in our minds that the substitution reversal sort of maxed out, and the paper makers were purchasing the softwood for the strength characteristics, and they really didn't have an option to default to the cheaper, overly abundant hardwood.

I haven't seen anything from a technological development point of view that is going to change that, so when the prices of hardwood and softwood are the same as they are today, there is some substitution in the opposite direction obviously. Guys will use more softwood because they can run up their machines faster, they get a better sheet, stronger, better performance, and all of that, I get it. But as soon as that softwood supply continues to fall short of the new demand that is coming, 1 million tons of tissue in the back half of this year, guys are going have to chase it, and I don't see any reason why the price wouldn't start to separate relative to hardwood.

Thanks for the color. Lastly, Celgar, how is it running? I know it had a tough quarter, but how is the performance and all of the metrics now?

The pricing at Celgar is running very, very well. In fact, it is probably running much better than it has in the last recent quarters, so we are very pleased with that development.

Okay, thanks, guys.

The next question comes from the line of Bill Hoffmann with RBC Capital Markets. Your line is open.

Thanks, good morning. Jimmy, before you had looked at Celgar as potentially converting to having some additional flexibility there to make specialty grades of pulp, do you want to talk about where your thoughts are on that right now?

Our studies clearly indicated that strategy for us didn't really make a lot of sense. I think there was inherent risks from what we felt moving forward, in terms of the developments of not just the demand side, but also the potential supply side with recent technologies that clearly were available, and as these recent developments in terms of technology advances further, as you know, traditionally it is very difficult to convert a continuous digester into a dissolving grade, because of the inherent problem of going from an acidic type of media to an alkaline type of media, and the inherent problems with that. We know that there have been several technologies which seems to have dealt with that problem, and of course, as certain facilities who have adopted that, continue to of course iron out those problems that are presently experiencing, I think that this technology will have a significant impact in terms the potential developments on the supply side.

As you know, there is a significant amount of large capacity with continuous digesters on the hardwood side, which are very modern, and so it doesn't require a lot of new capital investments to shift it to the commodity end of the dissolving. Now the specialty end is different, but of course that is a much smaller market, it is technically very difficult. It take a long time before you can get customer acceptance, so for us that didn't really make a lot of sense. Of course, we would love to be in the specialty grade, but there are a lot of challenges as you know from a strict kraft base pulping, to the more premium grade of dissolving. All-in-all, those kind of assessments made us feel less confident in terms of the potential strategy, and that is why we decided that this didn't make sense for us.

Thanks. Sort of the other angle, the question you just raised obviously a little bit of incremental liquidity here. I am just wondering if there are any other capital projects that you see that are attractive here from a cost standpoint?

I think that you will see further progress in terms of our by-product income stream, there are a few areas that we believe there is potentially better margin capture, so we will be focusing on those areas, on areas that we already produce, but we can get incremental margins benefits from upgrading those, without significant investments. There are some additional efficiencies, clearly, we can also obtain for some other small investments, so those are really more the programs.

Thanks. Just a question for David. You obviously drew down some more of your inventory in the quarter. Do you feel like you are at a good inventory level, or do you have to try to rebuild here in the back half of the year?

We don't really need to rebuild. We produce and we sell. There is a minimum inventory level that each Mill needs to keep an eye on, so that you can continue to service your customers reliably. I don't think we have sunk below that, so we will just keep trucking along here.

I guess we can be a little bit more discriminating in terms of our order acceptance probably more than anybody else.

Right. Okay. Thank you.

The next question come from Andrew Shapiro with Lawndale. Your line is open.

Good morning. Regarding the loss of the EBITDA from the Celgar maintenance shut and complications, can you clarify was the 11 million Euro reduction for a total shut, or just the unexpected portion?

That is in total.

Okay. Of the 11 million; this pulp only or is it lost energy in chemical revenue this that number as well?

We are talking the costs of maintenance and the impact on fixed cost absorption.

Okay. So arguably it cost more because of the lost energy production, et cetera?

That is true.

Okay. Any thought or estimate on incremental costs?

We haven't disclosed those numbers, Andy. I don't have something I can share with you at the moment.

Okay. But it is more than just the number that you gave then, in terms we will call it the non-recurring hit?

Yes, but in order of magnitude, it is not huge. If I was going put a number out there, you could say the impact on energy revenues would be about $500,000, possibly incremental chemical costs on start-up and shutdown it would be $500,000, that kind of thing. And then there would be some incremental energy usage as well when you are starting up, but not material.

Right. Okay, so it is not as meaningful. What month has or will Rosenthal do the maintenances this quarter?

In September.

Okay, so it hasn't started yet, alright.

I should just point out, Andy, thanks for raising the question. It is a significantly lower maintenance cost at that Mill than it is as the Canadian Mill, so it is almost a quarter of the direct maintenance dollars to do a revision at Rosenthal compared to Celgar.

Is that always, or just this particular year's schedule?

Typically that is the way, yes.

Okay. Great. Now, you provided production by Mill. Did you provide sales by Mill in your script, and if, so I can pick it up later?

I can give it to you now. I think other listeners like to get that. The sales by Mill for the quarter, Rosenthal was 92,000, Stendal was 165,800, Celgar was 110,500, for a total of 368,300.

Okay. Now when your sales were up here, I was a little surprised to see your receivables drop in the quarter, rather than being up or stable, and similarly because the production issues. I was wondering why your inventory wasn't down even more, when your sales were up but the production from the maintenance shutdown was a lot lower than expected. Can you give some more color on both of those?

There are a lot of moving parts obviously in that question. A lot of it has to do with timing. You would have to look at the sales pattern in the first quarter as well, which was we had a very high level of receivables at the end of the first quarter that flowed through, and we are increasing production in the second quarter.

The working capital movement will depend a lot in terms of the shipments out of Celgar, because it relies a lot on bulk carriers, so there are major shipments that go out, kind of lumpy unlike the German Mills, which of course are more closer customers, and go out by truck so it is more regular. Quarter by quarter, it is difficult to estimate because of course you are going to get timing of the bulk carrier going out in different periods within that quarter.

Okay. Then I didn't catch the detail. You started here in your script. I know you talked about the severance charges over the next 12 months, and I think you commented on what the amount was, if any for the second quarter, if you could recap that one line again? And also what is or are the line items, or will be the line items in your income statement that these charges are going to come through? Is it all going to be done in SG&A? Is it going to be a separated line item, or some of it in costs of goods sold?

In the second quarter we didn't have any charges, Andy. It will come in the third and fourth quarter, and under US GAAP you need to identify the names of the individuals, and have communicated before you can make your accruals. We think we will have most of those accruals done in 2013.

Okay. When you accrue and it goes through the income statement, again will it be in the cost of goods sold, and SG&A line in general, or a specific broken out one?

It will be a separate line.

Okay, so we will see it there. Great. A few follow-ups here. Was there any new incremental grants awarded this quarter outside of the release of funds for Blue Mill, and are there any future grant opportunities that either of the countries have put in front of you?

Well, we have got the wastewater feed program which continues, so that is a German program where wastewater feeds on affluent or a crude over a 3-year period, and then if one can identify a capital project that improves the performance of the affluent treatment facilities which result in a reduction of the permit levels, then you can avoid the wastewater fees, so it is like getting a grant for the full capital spend of the project. We have done that twice successfully with Rosenthal. For Stendal, it is going into its first 3-year program on that, so we are hopeful that we will identify a successful project there. We have got some good ideas, but that will be several years before we really actually do the work.

Okay. What the timing of your expected receipt of the remaining grant money for Stendal?

It will be coming in pretty heavily in the third quarter, with a trickle in the fourth, would be my estimate.

Okay. You mentioned in the last quarter and I think in your annual disclosures as well that you were exploring opportunities for tall oil production. What is the status of that kind of CapEx expense? I think it was for Rosenthal. Can you give more color and clarify?

As you may know, tall oil prices have gone up dramatically over the years, and we have always had a program where we have produced the crude tall oil at a plant at Stendal, and in fact, we used to ship Rosenthal's soap to Stendal where it was processed. As we got better at recovering soap out of the liquor, the Stendal tall oil plant is at capacity, so the Board has approved a higher return project to install another plant at Rosenthal. It is not a huge capital spend. It is something in the order of EUR2.5 million, but pretty good payback. It is one of these chemical by-product opportunities that Jimmy was referring to earlier.

And what is the timing of this investment, and the expected payback once you have got it up and running?

Well, the engineering is just nearing completion, so I don't have a construction schedule for you yet.

Likely second half of 2014, so it will be next year.

Right. When you looked at this, what is your expected payback on the 2.5 million Euro investment?

At today's pricing, it would be 2.5 to 3 years.

Good, high return. Okay, two other general industry questions. Do you have any better visibility or comments on the paper producers deintegration? Are you seeing more paper capacity come out and create further headwinds? Is a status quo situation, or is there a tailwind yet, or do you have visibility on a tailwind where some paper facilities may--?

All I can point to is if you look at really the shipping data that we get from the Pulp and Paper Council, Pulp Counsel, basically what you get is the shipments coming out of the different regions. If you look at the shipments from the Scandinavian countries, which of course is the major deintegration supplier, the development there has clearly indicated moderating type of increases. In fact, it looks like it is pretty close to being flat for this year versus last year, that kind of gives you an indication that this deintegration stuff essentially, we have done that last year.

Okay, so that is done. And the dissolving market, is it improving to cause some capacity that was planning to convert to actually finally convert?

What was that again, Andy, I didn't quite understand.

There was some softwood, like Terrace Bay, and there are others where--?

No, no, Terrace Bay is at least two to three years away from converting into dissolving grade. They announced closures of the smaller ones. Yes, there has been one of the lines that dumped our Kamloops Mill which shut down, which is a sawdust based facility, I think it was around 150,000 tons or so that shut down. There was another very small one in the eastern part of Canada I think shut down.

From an incremental decline, I think there was something like in the order of about 300,000 tons of small line closures, offset by the incremental increase of about roughly 500,000 tons at Elam. Of course, that is at full capacity like any start-up, it is going through the incremental kind of start-up curve, so it is nowhere close to its full capacity at this stage, and likely won't be at least for another year or so, if it follows a traditional kind of path.

Now, you mentioned that fiber costs were expected to marginally increase in Germany, and decrease moderately in Canada. Can you just clarify what you mean, and the difference between those two words? Which is the greater adjective?

It is a hard thing to quantify and we are looking in the future as well in your question, so it is a bit of a guess. To put things into perspective, the increase in fiber costs that we discussed here, you will read in our Q, that if you compare the first six months of this year to the first six months of last year, fiber costs on average have gone up 2% in the 6-month period, so we are directionally giving you an indication. We are not expecting significant increases from this point forward like we have been through the lift.

As Jimmy mentioned, it has mostly to do with the logistics, getting through the winter, and the floods and that kind of stuff, and we are expecting that to moderate and stabilize, and then we are certainly focused on doing everything that we can to push those down. In Celgar, it is just generally a good story in the sense that the lumber guys are running hard and they are making money, and there tends to be some abundance of finer that gives us an opportunity to continue to put downward pressure on fiber costs.

What are your planned road shows and conferences, and then I am out the queue here?

I will be at Jefferies here in the middle of August in New York, and then Jimmy and I will both be at RBC in September.

Great, thank you, guys.

Thanks.

(Operator Instructions). The next question comes from Mark Kennedy with CIBC. Your line is open.

Good morning. Dave, just a question on the term sheet negotiations with your Stendal lenders. Just trying to understand what you are looking to accomplish there. Is it a change in your coverage ratios, or just a waiver of them, like a one-time waiver?

We are really looking to make a change, Mark. These ratios were put in some time ago at a time when there was a global crisis happening in 2009, and today they don't make a lot of sense, so we always describe we have got a covenant problem, we don't have a liquidity problem. When you have a EBITDA covenant in a cyclical business, if you say total debt to EBITDA can't go above X, what does that mean? We have got EUR65 million of liquidity in the system. We don't have any default risks or any of that kind of stuff. We have got all of this cash on the balance sheet, so things like changing the definition of total debt to EBITDA to be net debt to EBITDA, for example, giving us credit for the cash that we have in the calculation.

So it is really just window dressing covenants to give us the flexibility and the headroom that we need so that we don't have to announce to the market every quarter that we have got a potential covenant default, and we fix it. We have done it three times now, but it also is a early warning signal for the banks which is what they need. Covenants are that middle ground where the Company is not at risk and has got flexibility, but the banks have an early warning signal. We have negotiated that with the lead bank. We have got a signed mandate letter with them. We have been engaged with the other banks through meetings, and the diligence, and so on. They have consented to changing the calculation timing to give us some more time. It is difficult to get these things done over the summer months as you might guess. All-in-all, it has been a very productive process, and we are confident that it is not going to impact things, other than take a month or two to get it resolved.

From a timing point of view, you are hoping by the time you report Q3 numbers, you will have it put to bed?

Yes, we will have a pretty good idea by then. Yes.

Okay. That is it for me. Thanks.

The next question comes from George Berman with J.P. Turner and Company. Your line is open.

Good morning, gentlemen, thanks for taking my call.

Hey, George.

Just one quick comment. I had occasion recently to visit your Rosenthal operation and to say the least, it was extremely impressive. You run a very, very good operation there, and I would highly recommend a visit any of your locations to any prospective or existing shareholders. Next question, actual question I had, is the discounts that the Chinese purchasers receive, have they shown any signs of abating a little bit?

These discounts unfortunately once they are set, they seem to only go one directions, so clearly it is negative in the sense list prices, of course, from a list pricing always has to go up as well. We are trying to get more to this kind of net pricing type of development, rather than this list price, and this kind of discount that is supposed to be opaque, but really is transparent, since everybody knows it seems to be going up. Traditionally we had no discounts in China, it was a net pricing. Now you are seeing small discounts and a push to increase that. What that means is that we have to look to offset that discount by increasing the list price. It is a crazy game, and sometimes the discounts can be so ridiculous that really the list price loses meaning.

Right. I remember a couple of years ago, coming out of the recession, you guys were almost printing money at 950, 980, 1,000, and now we are almost there again, and there s not much left.

That is because if you look at the US, the discounts have increased quite significantly, into the 20%. While in China, you look at discounts more like in the 3% type, but it used to be zero.

And that is sort of the industry standard now, and it just keeps on going?

Well, unfortunately, we have been trying to push for this kind of net pricing, but still they want to continue this kind of list and a discount, and I don't see any particular reason. It makes the markets really not, it doesn't make a lot of sense.

I think one of the things, George, to sort of reflect on is Jimmy was saying earlier, the deintegration of some of that Scandinavian pulp capacity has been like a new slug of pulp, it is like somebody built a pulp mill in Scandinavia that now needs a new home. Whenever you have somebody buying market share like that, it has an impact on discounts, so I think there is a bit of that going on, and also just the fragmented nature of the industry, there has sort of been this prolonged period of balance it feels like, with some macro factors like China tightening credit, and other issues that have given the attention to the buyer's side, which allowed these discounts allow to expand. We just need a little bit of time to tighten the market up, and we will either whittle away on the discounts, or as Jimmy said, we will be pushing price because we can.

Right. I was introduced at the Rosenthal Mill, they have a very interesting and apparently very successful apprenticeship program going, that virtually assures successions in some key professions there. Do you guys have any sort of plans to maybe introduce that to the Canadian operations?

Well, that is really what we would love to achieve, but of course, the union situation in Canada, and in particular in BC,is such that this kind of clear cut apprenticeship type of program with much clearer defined lines of succession is very difficult to implement. Yes, but we are of course continuing with apprenticeship programs, and all of these other trainings, because it is important for us to train the generation of workers.

Okay.

And this production program we are doing at Celgar, links into that concept that as the older guys take the early retirement packages, and you have the average age of the mill drops, there is the younger generation is much more open in their thinking, and flexible in terms of the way they approach things. A big part of what we are doing at Celgar is trying to get to the root cause that prevent us from doing some of these more progressive things.

And any thought of maybe changing your reporting from Euros to US?

Yes, there has been discussion on that topic, with of course, one of the biggest risks in the past was the sudden movement in currency, essentially having a very adverse impact on the equity, the shareholders part. Now with our equity position more built up, and the likelihood of extreme volatility being a little bit less, I think there are clearly some thoughts as to changing that reported currency.

Okay, that is good to hear. Thank you.

(Operator Instructions). The next question comes from Paul Quinn with RBC Capital Markets. Your line is open.

Yes, thanks very much. I understand Sodra is shutting down their Tofte Mill in the summer in August here, but also increasing capacity at their Varo Mill. What do you expect the impacts on pricing specifically in Europe will be on NBSK pulp?

I think everybody is skeptical that Sodra will shut down that mill, so I think from a market and certainly from a buyer's prospective, I think everybody is skeptical and has probably discounted that, because as you know, there have been several announcements in the past about it being shut. It was originally April or May, then it began and later on. There seems to be significant scepticism that this is actually going to occur, but my thoughts are is that if this does occur, then certainly this would probably come more as a surprise, and therefore could be a catalyst in terms of our price developments, because of course it would have a significant impact in terms of the shorter term, in terms of supply availability offsetting any incremental increase coming out of Elam, and it will take at least a couple of years before the new capacity or expansion that Sodra is talking about will be online. In the short-term, it is potentially a very positive type of situation for us.

Okay. Then my understanding is that on Elam's start-up, they are obviously commissioning and starting up, they are ramping up the new line, but my understanding is that the existing line is still running. Is your information the same?

Yes.

They are planning to take it down in the fourth quarter is what we heard.

Same here. Okay. Just lastly on European fiber prices. I guess your expectation is that they come down over time. What gives you the confidence that they actually will?

We have seen this in prior periods. We have had several of these dislocations as a result of climate problems, especially in the winter. If you look back, we have had prior cycles where we had price increase of the fiber going up about where we are, or going to and then gradually again coming down, as the seasons or the climate becomes more normal, so if you do look at our fiber costs over the last five years, and you correlate that to adverse winter conditions, and the impacts through the balance of the year, and then the subsequent years, you will see that is the case. We don't particularly believe there is any reason to believe otherwise in this case.

Okay, that is helpful. Thanks very much. Best of luck.

There are no further questions in queue at this time. I turn the call back to our presenters.

Well, I appreciate everyone's time, and thank you very much. Bye bye.

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