Mercer International Inc (MERC) 2017 Q2 法說會逐字稿

Good morning, and welcome to Mercer International's Second Quarter 2017 Earnings Conference Call. On the call today is David Gandossi, President and Chief Executive Officer of Mercer International; and David Ure, Senior Vice President, Finance, Chief Financial Officer and Secretary.

I will now hand the call over to David Ure.

Good morning, everyone. I will begin by taking a few minutes to speak about the financial highlights of the quarter. And then I'll pass the call to David to discuss the markets, our operational performance, strategic activities and our outlook into Q3. Please note that in this morning's conference call, we will make forward-looking statements. And according to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, I'd like to call your attention to the risks related to these statements, which are more fully described in our press release and in the company's filings with the Securities and Exchange Commission.

Our Q2 financial results reflect strong operational performance, robust sales, heavy pulp mill maintenance spending and the acquisition of the Friesau sawmill. In Q2, we achieved consolidated EBITDA of $39.1 million, compared to $60.2 million in Q1 2017. When compared to Q1, our Q2 results reflect higher pulp production and sales volume, along with higher pulp prices, which were offset by the negative impacts of 22 days of scheduled annual maintenance and a weaker U.S. dollar. Our new sawmill operations also contributed small positive earnings. Our 22 days of scheduled major maintenance negatively impacted EBITDA by about $27.5 million, included in these costs were about $21 million of direct costs, the majority of which our IFRS reporting competitors can capitalize. David will have more to say on this topic, but the shut at Celgar was ambitious and successful, and Stendal's mini-shut was completed a day early, lasting only 2 days. We took the opportunity to lengthen Celgar's shut by 2 days, to add several projects to the schedule, some of which were scheduled to be completed later in the year; a decision that increased the costs beyond what would we would normally realize.

Our Q2 results also included higher regular maintenance costs, associated with an asbestos abatement project in an old power boiler building as well as temporary -- temporarily higher cost for dewatering logs, while we complete a rebuild of the foundation of our dewatering crane. Both of these projects are at Celgar. Our results also reflected the impact of a U.S. dollar that weakened sharply at the end of the quarter. In addition to the impact of the translation of our foreign currency denominated costs, we also held considerable balances of nonfunctional currency cash and receivables at the end of the quarter. Both of which are mark-to-market at the spot rate on the final day of the quarter, which in the case of June 30, was about 7 -- down 7% from Q1. On April 12, Mercer entered the solid wood products business with the acquisition of one of Germany's largest sawmills at Friesau. From a financial reporting perspective, the acquisitions resulted in us having 2 business segments, and as such, our financial reporting going forward will reflect this change. In Q2, we generated $20.7 million of operating income from our pulp segment and $0.1 million from our new wood product segment. While not meeting the definition of a segment, we have electricity revenues in both of these segments which totaled $19.8 million, of which $2.6 million came from the wood product segment. For those of you that are looking for a few more details on our segmented results, we've got some new disclosure in our 10-Q.

Our pulp sales totaled about 389,000 tonnes, which is up 14,000 tonnes compared to Q1, and electricity sales were up almost 15 gigawatt-hours relative to Q1, due to the solid pulp production and the addition of our Friesau mills electricity sales. In addition, with virtually no wood inventory on-site when we took over the mill in mid-April, we were able to sell about 41.5 million board feet of lumber in the quarter.

We reported a net loss of $2.1 million for the quarter or $0.03 per basic share, compared to net income of $9.7 million or $0.15 per share in Q1. Income tax expense in the quarter was $7.8 million, of which approximately $3.6 million was current. Current taxes reflect our continued use of tax assets to shield cash taxes. Our high quarterly effective tax rate reflects that certain of our companies generated text losses this quarter, but the accounting rules do not allow us to recognize the tax assets associated with some of those losses. The longer-term effective tax rate will return to more normal levels in Q3.

Turning to cash flow. Our cash balance decreased by about $43 million in Q2 compared to an increase in cash in Q1 of $47 million. The cash draw in the quarter was dominated by the $62 million Friesau sawmill acquisition and the spending associated with our annual shuts. We also drew $26.5 million on our sawmill credit facility to fund working capital, mostly in the form of inventory, as we prepared to enter the U.S. lumber market. Capital expenditures drew approximately $20 million during the quarter, about half of which were in connection with the Celgar shut, and it included some reliability improving initiatives, such as improvements to our washing equipment in our bleach plant, a new digester flash tank and a new energy-conserving condensate collection system. Our cash flows in the quarter also included our quarterly $7.5 million dividend payment. And even after the sawmill acquisition and our extensive maintenance spending this quarter, our liquidity remains strong. Our consolidated cash balance was approximately $145 million at June 30, and we had about $165 million of undrawn mill revolvers, putting our total liquidity at almost $310 million. On a trailing 12-month basis, our net debt is about 2.6x EBITDA, which has increased relative to Q1 due to our slightly higher debt levels at the end of Q2. And you will have seen from our press release yesterday that our Board has approved an $0.115 dividend for shareholders of record on September 27, for which payment will be made on October 4, 2017.

That ends my overview of the financial results. And I'll now turn the call over to David Gandossi to discuss market conditions, our operational performance and strategic activities.

Thanks, Dave, and good morning, everyone. I want to start by saying there were several positive developments from Mercer in the quarter. First of all, our pulp mills had strong, steady productions, with our Rosenthal mill setting a quarterly production record. We completed 22 days of maintenance with excellent execution, cooperation from labor and strong cost control, and we acquired the Friesau sawmill complex, which is just down the road from our Rosenthal mill. And finally, demand for both pulp and lumber continues to be strong and steady. Now, although Dave has already mentioned this, I want to emphasize the differing impacts of maintenance shuts on the pulp company results, and in particular, the impacts of different accounting treatments. Mercer, being a U.S. public company, is required to expense all direct annual maintenance costs in the quarter they are incurred, which means maintenance costs are a straight deduction from EBITDA. Conversely, most of our peers follow International Financial Reporting Standards, which allow them to capitalize their annual direct maintenance costs, and later expense them through the depreciation and amortization line of the income statement. This has the effect of excluding maintenance costs from our peers' EBITDA.

In this quarter, our direct maintenance costs, the majority of which would be eligible for capital treatment under IFRS, were approximately $21 million. So we have a practice of reporting our maintenance schedule and costs each quarter to assist investors and analysts understand the timing and quantums of those outages. So although we've missed the Street's earnings target this quarter, I don't want this to overshadow what in my view was a strong quarter. And in the results, I see clear evidence of the quality of our assets, and of our very capable and dedicated employees at all our locations.

Now getting back to some of the activities for the quarter. As Dave noted, we closed on our Friesau sawmill acquisition on April 12. The mill has an annual capacity of 465 million board feet of lumber and 13 megawatts of electricity. I'm pleased with the progress of the ramp-up of our new mill, which has progressed faster than we initially planned, and the mill is already generating positive earnings. In addition, the Friesau mill is on track to meeting our operating synergy objectives. At June 3, the mill had generated approximately $2 million worth of savings. These earnings -- savings relate to the sharing of fiber with our Rosenthal mill. In addition, our teams are actively working on a project to maximize the sawmill's energy revenues, which we hope to begin to realize within the next year. We still expect annual synergies to be in the range of $4 million to $7 million.

Friesau produced 67.5 million board feet of lumber, with strong European sales. We also staged about 20 million board feet for shipment to the U.S., and we're expecting our first U.S. market sales this quarter, Q3. As mentioned, our strong Q2 operating results included 22 days of pulp mill annual maintenance downtime. Stendal had an efficient 2-day shut, and Celgar has successfully completed the largest and most complex annual shut in its history. While the shut was initially scheduled for 18 days, we chose to extend it to 20 days to complete some extra projects, some of which were scheduled to be done later in the year. The shut was completed safely, with a seamless startup, and also included a number of important capital improvements. We're already seeing the benefits in many areas, and we intend to continue our efforts, focusing on high-return debottlenecking opportunities, which we've identified for the mill. Looking forward, we continue to monitor the development of the lumber markets and the potential impact of the Softwood Lumber Agreement on the U.S. lumber market. The random links U.S. benchmark for Western SBF #2 and better average $386 per thousand board feet in Q2, which is above its historical average. Similarly, we continue to see steady demand for lumber in European markets. We're continuing to develop our marketing plans for our lumber product, which is branded as Mercer Timber, and we are confident that our mills' production flexibility will allow us to maximize our lumber margins.

In terms of the pulp markets, demand has been steady through July. Prices averaged about $670 per tonne in China in Q2, compared to $645 per tonne in Q1. The Chinese list prices come off about $50 per tonne in July, as traders who entered the market last year, particularly as prices were running up in Q4, have been selling out their precisions to capture profits. However, already in late July, we're already, again, seeing some upward pricing momentum due to the strong demand pull. NBSK demand also remained steady in Europe, with Q2 prices averaging $880 per tonne compared to $823 in Q1. Prices closed the quarter at $890, with efforts still underway to push the price to $910. Consistent with increasing NBSK pulp prices in Q2, NBSK producer inventories were relatively flat, ending June 30 -- June at 31 days. At the same time, hardwood inventories were also essentially flat since December. We believe inventories at these levels are well balanced. Contributing to the demand picture, global pulp shipments were up over 3.6% through the first 5 months of 2017 and softwood pulp shipments to China were up 4.4%. This demand is coming from paper producers, and we believe it is consumer-driven. Chinese paper and tissue capacity continues to grow, and we believe this and the diminishing supply and quality of recycled fiber will help mitigate any negative pricing impact that new NBSK capacity may have in late 2017 or 2018.

Looking forward, we have 2 annual maintenance shuts planned for the remainder of the year, 12-day shut at Rosenthal in Q3. In Q4, Stendal will be down for a short 3-day shut. In total, we produced approximately 363,000 tonnes of pulp this quarter compared to approximately 374,000 tonnes in Q1, and approximately 338,000 tonnes in the second quarter of 2016. We also produced 67.5 million board feet of lumber in the quarter. Strong market demand allowed us to sell all of our Q2 pulp production. Consequently, our pulp sales volumes were also up in Q2 and totaled approximately 389,000 tonnes compared to 375,000 tonnes in Q1, and 330,000 tonnes in Q2 of 2016. We also sold 41.5 million board feet of lumber in Q2, and we expect this volume to grow in Q3 as we build our U.S. market supply chain. The addition of our sawmill and our strong pulp and lumber production led to higher energy sales. The mills sold approximately 217 gigawatt-hours of electricity in the quarter, compared to 203 gigawatt-hours in Q1 and 190 gigawatt-hours in Q2 of 2016.

Relative to Q1, our fiber costs were up marginally this quarter, as our German mills purchased additional fiber to support the mill's strong production and to begin building their winter stocks. Looking forward, we expect German pulp wood prices to stay essentially flat through Q3, as we expect the German fiber market to stay balanced, with a potential for some moderate upward pricing -- pressure on prices into Q4. In British Colombia, our Q2 fiber prices were relatively flat compared to Q1. We are currently forecasting that Celgar's Canadian dollar fiber prices will increase marginally in Q3, due to weather-related factors. And while we're watching the development of the Canada-U. S. Softwood Lumber Agreement negotiations, currently we do not expect them to materially impact our fiber prices in the future. In addition, the forest fires that have been prominent in many parts of British Columbia have not been a factor in our forest region. As planned, our pulp mill fiber inventory levels have increased slightly in Q2 due to our scheduled maintenance downtime, and we remain satisfied with our mills, wood markets, and with our fiber inventory levels. We expect the sawmills fiber cost to be flat through Q3, as we rationalize the mills fiber logistics. We're also very comfortable with our sawmill fiber inventories and supply. Regarding our CapEx plans, we expect to invest between $45 million and $50 million in our mills this year. The focus of our CapEx program continues to be a balance of maintaining our mills, while improving reliability and reducing costs.

With respect to our NAFTA claim, unfortunately we still do not have any updates at this time, but we continue to expect a decision in the near future. As I noted earlier, we are pleased with how our new sawmill's operating and the solid wood business in general. The Friesau acquisition was consistent with our growth strategy, as it levers some of our core competencies. Looking forward, we continue to look to grow Mercer through similar opportunities allow us to -- that allow us to maximize the value of our core competencies.

So that's the conclusion of my prepared remarks, and I'll now turn the call back to the operator so we can open it up for questions.

(Operator Instructions) Our first question comes from Sean Steuart, TD Securities.

Couple of questions. Your overall downtime of 22 days was just 1 day longer than what you guys guided to last quarter. And I guess I'm just wondering, David, about the nature of the maintenance you took. Specifically the incremental, I guess, pull forward of activity you had at Celgar. What was the incremental expense associated with pulling that forward?

Yes. Hard to say exactly. It's not a huge number. It just it's really -- we highlight it more as a reflection of how well the mill executed on their maintenance shut, that they got -- they were getting things done on schedule. All of the quality work was evidenced as things are -- were going to start up well, and we had some capacity to do a bit more work, because, as you know, we got all the contractors in the mill at that time. And -- so it's just a big improvement over last year's performance. And that's why we highlighted it. So in terms of dollars, it might be a few million. Clearly, not all that material compared to what the normal cost of a maintenance shut is, but, again, highlighting the good performance of the crews up there.

And further your comments on the currency moving really quickly at quarter-end, and, the reevaluation of the working cap items. Can you put a dollar figure on how much that would've fit into earnings as well, quarter-over-quarter?

Yes, quarter-over-quarter, through a bridging number, you could say FX impacted us almost $7 million.

Okay. And with respect to the Friesau facility, good progress out of the gate there. You noted the volume you've held back for shipments to North America. Is that delta representative of how much volume from that facility you expect to ship to North America going forward?

Yes. Not really. It's just that -- that's just logistics. That's sending the mill to a port in Germany and then you've got to ship it on the water. And then it sits in a warehouse and it gets sold out of a warehouse in Eastern Seaboard. So as I guided on our acquisition announcement, we're thinking around 25% of that mills production will find its way into the U.S. markets. This is the way we're currently thinking about it. Roughly 50% will stay in Central Europe, around the chimneys. We are planning to have a J-grade program. Up to 8%, possibly 10% of Friesau's product is a very high-quality J grade. And then the remainder would be Middle East, North Africa.

Our next question comes from Hamir Patel, CIBC.

David, you mentioned the diminishing supply of recycled fiber. Just curious, if you had a sense as to maybe how much recycle capacity may come out this year and then similarly in 2018?

Yes. We're pretty curious about that, and we're still digging into it. But on the surface if you look at the PPPC data, it could be around 5 million to 6 million tonnes of mixed office waste that's going to be blocked from the China market. And so what's going on there is we've been hearing these rumors. There's recently been like a public announcement come out of China, sort of a press release type of thing that says, "Mixed office waste has been finding its way into China, to be processed into pulp and paper, is going to be restricted because China doesn't want to import everybody else's garbage," essentially is what they're saying. So that's going to impact some deliveries from the U.S., some from Japan and some from the U.K.

In order that order, 5 million to 6 million tonnes this year. A lot of the guys that use that kind of product, I mean there is some tensile properties in that mixed office waste. So it's a positive development for virgin softwood pulp producers, in the sense that there'll be a substitution or an increased demand for virgin fiber to fill the hole that's going to be left by this.

Okay. And then I was kind of under the impression that a lot of that mixed paper was getting used to make containerboard, but I mean give us a sense where does that go?

Yes, well, there's a little bit that goes all over the place. They're not restricting old corrugated box recycling and that kind of stuff. This is the dirty, mixed recycling office waste, comes in with a bunch of other garbage. And I -- it depends on who you are in China, but it's going into all sorts of different paper products.

Okay. And then in terms of the -- I know you've spoken over the years about some of the higher costs pollutive capacity situated in China itself. Any updated thoughts on how much of that's going to come out?

Yes. No, it's -- I mean, I think it's possible that they've done a lot of the heavy lifting now. And we don't -- we're not seeing the regular announcements that we've had over the last 3 or 4 years, which, as you know, have been very sizeable. So our sense is they worked through the list. Our feeling is that the bigger mills were the ones that were done the latest. And I think also the Chinese government is very serious about keeping these things down once they make the announcement, which is -- in sort of previous years that was not the case. I think it's becoming a very serious issue over there for them with both water and air pollution. So what's down I'm sure will stay down. There may be some small incremental amounts still to come, but they're not as vocal about it. So...

And just a final question out for Dave Ure. Could you give us the shipments and production by mill in Q2?

Yes. Okay. In thousands of tonnes, the shipments, Rosenthal was 90.3 tonnes, Stendhal 169.6 tonnes, Celgar 128.9 tonnes. And as far as production, again in thousands, Rosenthal, 97.3; Stendhal 168.1 and Celgar 97.3.

Our next question comes from David (sic) [Daniel] Jacome from Sidoti & Company.

Dan. I don't know what happened. I guess they changed my name. So look, pulp seems to be in really good shape. So I'm just going to focus on the new lumber assets, which I'm excited about. So 4 quick ones. You know if I annualize the production you did in this quarter, you'd be about half, if I'm not mistaken, of your total capacity. So can you just remind us again what your target is for 2018? Do you expect to be maybe at 75% or producing 100% of that 550 million capacity, I think, you guys have?

Yes. Well, it would be just -- maybe I can just do it by annualizing how we run in -- ran in June. When we bought the mill, there was no wood in front of it. There was no wood-buying program in front of it. And as I've always said, our wood procurement logistics strength is one of the reasons we are moving in that direction. So within -- from April 12 to the end of the quarter. In June, we were processing about 5000 cubic meters of logs a day, with a yield of around 60%. And when you convert that into board feet, produces about almost 37 million board feet a month. Annualize that to look at a run rate of around 440 million to 445 million board feet a year, running 2 shifts.

Okay. Excellent. That's very helpful. And then I think you said -- I know you touched on it, but your sawlog costs in the quarter were a little bit higher than you expected, just because probably you're buying so much on a short-time basis. Is that what drove it? And then do you expect it to improve in 2018? Could you just you give a little bit more color on that?

Yes, exactly. Yes, so the -- we just had to hit the market. And our -- we knew we were going to have some inflationary impact on the market when you buy that much wood really quickly. So I mean the increase was not really a big number. It's like -- it will be less than 6%, say. But we did influence the sawlog prices in that region. But our strategy was just to hit it. We wanted to get that mill up and running. And now that we've got a big chunk of wood in front of the mill, now we're starting to optimize and rationalize, and turning back and pushing down prices where we -- wherever we can. So it's -- so what we're signaling is we got over the hump, stabilized and now we're going to start to do what we do, which is start to push the prices down again.

Great. Terrific. And then the U.S. market you're, obviously, targeting. That should be exciting too. I mean just -- can you just give us very high-level view of how this conversations are going thus far? And then internally, what are you guys assuming for lumber prices? Because the $390, I think, the current spot market is. Is that what you're assuming going forward? Or some pullback? I think -- I know they've gone as high as like $410 recently. So what are you guys assuming?

Yes. So first of all -- like it's hard to talk about benchmark pricing and our product mix. I mean what's -- what we're going to bring to the U.S. market is a very high-quality product. It's great lumber. It's going to be all the different sorts, including up to the 16-foot. We'll get premium pricing because of the quality and some of the features of it. The demand in the U.S. market right now for that kind of product is very strong. From a margin perspective, maybe this will help answer your second question. It is a slightly better margin than the European. It's further away, in terms of -- the freight cost is greater to the U.S. market compared to Europe. Europe's a strong market, good margin, very efficient freight cost for us. It is slightly better today in the U.S. market.

You said overall margins in the U.S. will be better for you than Europe?

Slightly better, yes.

And our next question comes from Charan Sanghera of RBC Capital Markets.

Just a quick question on Celgar. With a lot of the annual maintenance now behind you guys, any additional color on the kind of the uptick in production performance?

Well, it's been running really well since the shut, which is great. I think for the year, considering the size of this shut, we're expecting to finish off somewhere in the 470,000, 475,000 range. And as I've mentioned several times, what we're -- the work we're doing at Celgar is to get it up from sort of the 440,000 tonne average over the last 3 years, up more into the 480,000, 490,000 range. And those incremental tonnes are actually quite valuable when you consider the fixed cost coverage equation in a pulp mill. So for 2018, that's our goal. And so far it looks like things are on -- really on track, going well for that mill.

Okay. And just shifting gears back to the GAAP (inaudible), EBITDA. You said that $21 million in maintenance, most of it, potentially, under IFRS could be eligible for expensing. So you could say, on a more apples to apples basis, your EBITDA was $55 million to $60 million or closer to $60 million? What's -- would you give some additional color there?

Yes. That's how it works. Like if you -- you read all the analyst reports of guys that use IFRS for accounting, I mean they had a shut, don't really talk much about the costs and there's your EBITDA and it just -- we look so different because there is this big focus on the variability of our EBITDA. But financially, it's exactly the same thing going on. Every pulp mill in the world has an annual maintenance shut. And it's just unfortunate that ours bumps up and down in the EBITDA line. So what we're trying to do is make sure that the Street can see it. That's why we disclose when the shuts are. And we always -- if you go back for the last 3 years, you can track what our shut costs -- direct maintenance costs typically are. And we do that to help everybody kind of dial-in to make the apples-to-apples comparison.

(Operator Instructions) Our next question comes from Andrew Shapiro, Lawndale Capitals.

Follow-up on the prior question and answer and then 1 or 2 more, if I could. So you have -- you gave guidance on an 18-day maintenance shut. You quantified somewhat on earlier questioners, cost inquiry about what the extra 4 days, et cetera, might have cost. But when these maintenance shuts are planned, is there visibility of the expensible costs that you have confidence in, that could be spelled out for investors? Or is it unknown until you get the equipment opened up, et cetera?

Yes. Well, our budgeting is pretty accurate, Andy. And we haven't really turned our minds to whether we would give forward-looking guidance on maintenance costs for a quarter. The other way to go is for investors just to look at the last couple of years to get a quantum of what the different mills do. And then we would always try to signal well 12 days as an average. If it's an 18-day, it means we are expecting to do more. And if it's like -- sort of go that logic. That's probably the better way to go.

I don't disagree, and it's certainly what we did. So we didn't necessarily get surprised, but unfortunately it looked like the analyst community on this one missed the boat on that one. So I was just wondering if there's another way. It's unfortunate you've got to spoon-feed it, but I was just wondering if that was something you're comfortable with doing. But that's okay. I mean we got it on that. So -- anyway, that was a follow-up on that. The currency effects during in the quarter, when you called them out for, I think, Mr. Steuart's question upfront, early on. Was that answer with respect to just the fall off in the last week or the last few days of the quarter, in terms of the spot price movement that you have to mark-to-market on? Or was that what -- I think it was 7% or so that David had mentioned was the quarterly move for the full currency effect? Can you just reconcile that?

It's the bridging calculation for the whole quarter, which would include the impact on pulp pricing and also on the revaluation of the monetary receivables, cash and receivables at the end of the period.

Would it also impact your COGS at all?

Yes.

And is there a quantification about what that might have been in the COGS in terms of your EBITDA?

Not off the top of my head, Andy. Sorry.

Okay. All right. And then last 2 questions here. I was late to the call. So I wasn't sure if your prepared comments provided any kind of update or insight on the status of the NAFTA claim? And I'm sorry to ask for a repeat on that, if you did, or I can go back to the transcript.

No, that's okay. Just briefly, there's, unfortunately, no update. It's -- we're approaching that 2-year time frame from the completion of the orals. So it's -- that's a long time. We do know that the President of our tribunal was involved in a very large case before ours and the results came out while we've been waiting. So that's part of it. But maybe it's a reflection of the combination of that, plus the complexity of the issues. So we don't really have any more insight from the last time we spoke. Although, we still expect a decision relatively soon.

I was going to say, could it happen like anytime? Or do you guys get a little bit of an advanced read on it because of certain milestones or activities that the tribunal goes through with respect to the petitioners?

No, there's no steps for us in the process. No milestones to monitor. It'll be what -- it'll just come when it comes.

Okay. And lastly, what are your plans for investment presentations, nondeal roadshows, et cetera in the coming months?

So we've got a couple of conferences we'll be attending in the next couple of months. On August 8, we'll be attending the Jefferies Industrials Conference in New York. And then in the second week -- pardon me, the third week of September, we'll be at the (inaudible) Institutional Conference in Toronto.

Our next question comes from DeForest Hinman, Walthausen & Co.

Couple of questions. The Celgar production numbers look encouraging. In the past, I think you identified that as a pretty meaningful opportunity. I think you had mentioned previously 480,000 tonnes, now you're saying 475,000, which would still be a good outcome. And you talked about the strength coming out of the shut, and if we take the 475,000 or the 480,000 divide that by 12, it's 40,000 tonnes a month. Are we hitting those types of numbers right now or higher than that? Can you help us understand how that mills running?

Yes. That's a good reference number. The way to think about Celgar, so it's been averaging in the 440,000. At 475,000 -- 470,000 to 475,000, what it means is we've improved on the reliability of the mill. We've eliminated the variability that occurs when equipment fails for whatever reasons. So first step for that mill has been to fix or replace some of the older things that have the potential to break this because of their age and get that reliability back. That gets you to that 470,000 range. And then as I mentioned in my comments, there's -- then you get -- then there's debottlenecking exercise where you kind of systematically go through and it's -- these are high-return, low-capital type of capital projects within the mill to improve the rate. So you're actually getting more products through the various departments, to get to production up into that 490,000 -- 480,000, 490,000, call it 500,000 tonne range. And then the mill has potential to debottleneck further, but you do these things in stages. So over the next couple of years, the focus is going to be on just making sure that mill gets as close to 500,000 as we can.

Okay. And you touched on this briefly. The wildfires not impacting Celgar directly in the fiber basket, it sounds like. But in terms of getting product to the ports and moving it by rails, has there been any disruption there?

No, touching wood here, we've been very fortunate that we haven't had any impact to speak of on our logistics.

Okay. And then, can you help me understand the working capital needs for Friesau? And is the second quarter kind of reflective of a steady state working capital for that type of mill or would there be some seasonality with the winter, like with some of the pulp mills?

Yes. It's a good question. It's a little less seasonality actually because the wood that comes into the -- into a sawmill comes in fresh. Whereas in a pulp mill, we'll stock pretty significant volumes for the winter months. So the wood inventory, it flows, actually shape-scan the wood and you don't even -- you don't pay for it until it's been shape-scanned and debarked in the mill. And so where we are on raw material is where we're going to be. And maybe we're just a little bit high at the moment because we've been staging for the U.S. market. Once we get that thing flowing, then I think you'll see a little release coming out of working capital.

So just so I understand, if I see the 50.2 at the end of second quarter, that's reflective of the pulp mills normal type of operations? And then, we have wood at Friesau, but it's kind of on a consignment basis, is that correct? Until we...

It's not consignment. It's woods delivered. You don't pay for it until it's measured. And the way that sawmill in Germany does that is, we put it through your shape-scanner that gets all in a single line. It goes through a shape-scanner and gets debarked, and then it gets put in the yard. And we do that to sort the log by its diameter because this is a length mill that -- where wood is processed in batches by diameter. And just the way the commercial structure works is you don't pay for the log until you've measured it, until you've scanned it. So it's just a -- it's a nice feature for working capital that you don't have to pay for wood in the forest or wood on its way, and you pay for it once you analyze it at the mill.

And then the shipment, I guess dock staging to sell to the U.S. Is that somewhat reflected in finished goods? Or this work in process line we have on -- or spare parts and others? Where's that wood going to set up?

That would be in finished goods.

So the 33.5 that we're disclosing in the second quarter, that's reflective of the wood that's waiting on the dock right now?

Yes that's correct or on a train or a ship.

Yes. And then if we continue to increase shipments to the U.S., it would -- would that line go up because we own the wood until it's delivered to the U.S. or is it we remove by...?

Yes. I'm not going to give you an up or down because I don't know yet. Some of the variables are -- what is the time -- at what point in time does the wood gets sold. As you develop your programs, it's quite possible that customers can make orders while the wood's on its way to the market and be sold while it's on -- literally on its way. So right now, what's going to happen is it's got to the -- it's got to get into a warehouse in the U.S., where the development programs customers will come and look at it. That kind of thing, and it'll be -- we'll be developing a sales channel, initially. So it's a longer, longer supply chain today than it will be 6 months from now, for example.

Our next question comes from Adam Zirkin, Knighthead.

A couple of questions for you. The production looked awfully good, considering the Celgar shut. Can you talk about what's happening at the German mills? Did Rosenthal or Stendal run particularly well during the quarter?

They both did. Excellent performance with mills. Rosenthal, I mentioned in my comments, its best quarter ever from a production point of view. They also had -- one month was the highest -- highest production month ever, and another month was highest rate of production ever. So both mills really hitting their stride and it's just very gratifying to see that. What it means in the pulp world is that all the hard work around preventive maintenance programs, standard operating procedures, the centering efforts and so on and all effective, and we've got very, very solid workforce looking after those mills at the moment.

And even if you carved out -- if you took out the shut out of Celgar, if you took those days out, the productivity at Celgar was -- for the quarter, was among the best quarters we've had in the last 2 or 3 years. So...

Is this the sort of thing that causes you to reassess sort of your annual targets for production on the assets?

Well, I mean both Rosenthal and Stendal are pumping right up at there disclosed capacities. For Celgar, it's a little different. Many years ago, we defined that mill to be a 520,000-tonne mill. For the last 3 years, as you know, it's averaged more in the 440,000 tonnes. And that's just a combination of a number of factors that are, kind of, maybe too complicated to approach on this call. But getting the reliability up through the elimination of risk and equipment and also improvements in preventive maintenance processes, quality work done and all those sorts of things contribute to the mill today for 2017, including the shut being something in the 470,000 tonnes, 475,000 tonnes range, moving towards 500,000 tonnes as we do some of the rate work that I've been describing. So it's not -- we're still not at 520,000. The mill can get to 520,000. It's going to take a little bit of work, and as we say, we're doing it in stages. So I don't see a re -- a change in the capacity -- disclosed capacity numbers at this stage. But it's important to understand how significant the move is on Celgar, particularly.

That's helpful. One other -- I guess, a few other questions. Can you speak to perhaps in the real time what's happening in the fiber markets? The -- with maybe 1 or 2 exceptions, the year-over-year comps have been sort of down now, for a fairly consistent period. That's difficult to tell when you're lapping easier quarters or tougher quarters. So as you look out sequentially, what's happening in those markets, on both continents?

Yes. Well, you know I think, I see things pretty steady. I don't know -- I don't see any structural change that's going to materially increase our costs. We have seasonality impacts. As we all know, the -- in particular, the fourth quarter is when we push the market a bit to make sure we get a lot of wood close to the mill to cope with winter conditions. There's times in the winter where guys can't get into the woods to harvest or the logistics get challenging. So we have some upward inflation on costs, as we push the market to deliver more wood. And then we have that big release of working capital in the first and into the beginning of the second quarter. But beyond that, our focus is to continue to really work on the strategies that we've developed, which enable us to control the cost in the market, if you like. So things like importing more wood. When we're starting to feel price pressure in the market, we just turn up the dial and bring in a lot more wood. We can bring it in from further away and in Germany, when you go east, it's cheaper wood. You just have to compensate with logistics. And so as we bring more of that, and you might pay a little bit more in an import market, but you take the pressure off the domestic market. And so we're getting quite effective at kind of keeping our foot on it, and we'll expect to continue to do that more and more. The Board's just approved another tranche of railcars for us, as we've now got the sawmill business, and we're finding more synergies by, for example, shipping lumber up to the Port of Bremen, using the same railcars, do a triangle over to Port of Rostock and bring the roundwood back down to Rosenthal and Friesau and do that. So we're continuing to expand our -- the size of our fleet in Germany, as we grow the business, and that will help both control and possibly even kind of help us reduce some of our costs.

Got it. And then lastly, David, can you just speak to your inventory position? I know I'm assuming the sales out of inventory had more to do with the Celgar shut than anything else. But going into the third quarter, do you expect any inventory build or release on the pulp side? And then, I also noticed, it's small but in the wood product segment, you produced a fair amount more than you shipped. So what's happening there?

Yes. I think we'll -- that's a good thing you point that out. I think inventory will build a little bit in the third quarter. Celgar, it's just the timing of vessels and the strength of the market. We got right down to about 18,000 tonnes at the end of the quarter at that mill and that's lower than normal. So more in the 35,000 to 40,000 range is more normal. So we'll build maybe 15,000 to 20,000 tonnes of finished goods inventory by the end of the third quarter.

And there are no further questions in the queue at this time. We'll turn the call back over to the presenters.

Okay. Well thank you, everyone, for joining the call and as usual, if anybody has any further follow-ups, don't hesitate to reach out to either Dave or I. We're going to be around for the next week or so. So happy to take your calls. Thanks, again.

Thank you, very much, ladies and gentlemen. This concludes today's call. You may now disconnect.