Resolute Forest Products Inc (RFP) 2006 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Bowater second quarter 2006 earnings conference call. [OPERATOR INSTRUCTIONS] As a reminder, this conference is being recorded today, Thursday, July 27, 2006. I would now like to turn the conference over to our host, Mr. Duane Owens, Director of Investor Relations. Please go ahead, sir.

Thank you, Andrew and good morning, everyone. Welcome to our second quarter call. With me on the call today are David Paterson, our President and Chief Executive Officer; and Bill Harvey, our Chief Financial Officer. Before we begin, I will cover a few preliminary items, following our prepared remarks we will take questions. The call is scheduled for about 45 minutes. I need to call your attention to the cautionary forward-looking statement language that is contained in the press release and on our website. If you haven't read it, please do so.

We will be discussing such forward-looking matters on the call today and you should be aware due to the uncertainties inherent in such statements actual results will differ and any such statements are not guarantees of future performance. Additional financial information as well as reconciliations of non-GAAP financial measures used on the call can be found on our website. In addition, note 6 to the financials contained in today's news release provides a reconciliation between the reported loss and the loss net of special items. The call is available to all shareholders via live webcast and replay on our website at bowater.com. The call is also open to the press. Please note that while any member who attends our call is free to quote the Company speakers, other participants on the call should not be quoted without their permission. I will now turn the call over to Dave Paterson.

Thanks, Duane. And good morning and thank you for joining us. On the call today we will talk about second-quarter results. Then I want to focus on our markets and the steps we are taking as a company towards improved operational excellence and financial results.

Our second quarter reported loss was 10.6 million or $0.18 per share. Our timberland sales program allowed our total debt net of cash to be reduced by 148 million during the quarter. Excluding special items, the loss for the quarter was 17.6 million or $0.31 per share. Special items net of tax included a $46 million gain on the sale of over 470,000 acres of timberlands in the U.S. and Canada. A $20 million charge due to translating our foreign denominated balance sheet items into U.S. currencies. And a $19 million tax charge related to the valuation allowance recorded during the quarter due to operating losses in Canada.

For the rest of the year, we expect any income tax benefits generated at our Canadian operations be offset by tax charges. We expect these tax charges to diminish over time and reverse as our Canadian financial results improve and generate taxable income. This is likely to result in significant volatility related to our effective tax rate. Our statutory rate remains at 35%.

Our financial results for the quarter were influenced by a number of key factors. First, scheduled maintenance outages at a number of our facilities resulted in lost production and higher repair spending. Fortunately, this work is now behind us. Maintenance is inevitable and while the extended work completed during the quarter was significant, I believe our third quarter will benefit greatly from reduced repair spending and improved asset performance. Second, we successfully completed the machine conversion at our Calhoun Mill from newsprint to a freesheet hybrid grade. This conversion reduced our profitability in the specialty product line for the quarter by approximately $10 million.

Third, we completed the closer of the Thunder Bay A pulp line during May. This closure negatively impacted our results by approximately $10 million in the quarter. We expect to be impacted by an additional $5 million in the third quarter as we continued to remove additional fixed costs associated with the closure. Finally, the Canadian dollar was up $0.025 from the first quarter to an average of $0.89. This was the highest quarterly average in almost 30 years. While our hedging programs offset a portion of this increase, the impact on the quarter was $16 million. Due to increased volatility and exchange rate, we have started to hedge the Canadian dollar on a short-term basis.

Last fall, Bowater announced an $80 million cost reduction program tied largely to a reduction in energy usage. We are achieving our operational goals. However, the strong Canadian dollar and other cost pressures are muting some of the benefit. We achieved a reduction in costs of 11 million in the second quarter, our current run rate is at about 55% of our $80 million target. We continue to make substantial progress towards our goal.

Since joining Bowater in May, I have visited most of our North American paper mills. I have come to the conclusion that in addition to the previously discussed cost reduction program, we can achieve additional cost savings with minimal capital investment. I think of these improvements as the basic blocking and tackling needed to improve our operating performance. As a company, we need to focus on operating our mills as efficiently as possible to drive costs out of the system. In addition, we need to further reduce debt and improve operating results at a sustainable basis through better cost controls and cash management. We will intensely focusing on these improvements along with overall operational excellence and wise use of our capital in the weeks and months ahead.

For example, earlier this month we announced our decision to indefinitely suspend the Thunder Bay conversion project. Although this project is worthwhile long term for Thunder Bay, current conditions in Ontario, such as soaring energy costs, not to mention the exchange rate, prohibit an investment of this magnitude today. We continue to evaluate options for the future of Thunder Bay. However, I believe there are presently better places in our company to spend our capital and achieve superior returns for our shareholders. I am committed to wisely spending capital only on the right projects at the right time.

Our capital spending for the second quarter was 53 million. Including the completion of the machine conversion at Calhoun. Our target for the year remains at 220 million. During the quarter, we established a new credit facility for our U.S. and Canadian operations. The five-year U.S. facility is $415 million and the 364-day renewable Canadian facility's 165 million. As of the end of the quarter, we had no drawings on either facility using 101 million of the capacity for letters of credit. Covenants consist of an interest coverage test and a secured debt to EBITDA test and we are in compliance under both tests.

Turning now to our markets. North American newsprint consumption is on a negative trend, down 5.7% year-to-date as of June. Operating rates were at 94%. On a worldwide basis, newsprint demand is growing, up 1.1% through May, including the negative North American figures. Many analysts have written about the impending threat from Chinese capacity additions. However, given current worldwide growth rates, we believe this capacity can be absorbed into the marketplace.

Our domestic price of newsprint was improved by $25 per ton since December. We informed our customers of a price increase of $40 per ton effective August 1. Our inventories of newsprint at the end of the second quarter were the lowest they've been in five years. We expect this level to be sustainable going forward. Total coated mechanical remains the weak spot in our paper grades, although our -- their are signs of market return as operating rates in North America improved to 96% last month. North American demand is down 3% year-to-date as of June, but we have experienced a notable uptick in orders and inquiry for coated papers for July. Prices have fallen due to inventory levels which are now showing signs of decreasing. Our average price is down $21 per ton in the second quarter. Printers are beginning to report increasing demand as we prepare for the second half of the year, which is traditionally when the catalogue and retail markets improve.

Reported demand in operating rates for North American super calendar papers are statistically weak down 8% through June. However, our order book and operating rates are strong and our inventories are low. We have announced a price increase of $40 per ton effective July 1. North American Book and Superbright uncoated mechanical shipments were up 24% and 13% year to date respectively. We've produced these grades and machines that formerly produced newsprint. Our order book is in excellent condition as customers continue to demand products that offer innovative features to reduce their total costs.

As I mentioned earlier, the calendar conversion was completed in the second quarter. This new freesheet hybrid product is being produced, trialed, and sold to a variety of customers, including direct mailers and commercial printers. This high bulk and light-weight product sells in the end cutter freesheet market but offers the customer several advantages. At a low basis weight our product will provide the customer with 15% more printing area per ton than our traditional uncoated freesheet providing a cost savings for paper and postage. The sheet is lightly coated to offer excellent printing characteristics. I am optimistic about the success of this new product and the characteristics it offers our customers. Shifting to market fault -- world market pulp shipments were robust in June. They rose by more than 4% year over year and up almost 16% year to date. Excuse me, 6% year to date. The shipments to capacity ratio was 97% in June. Producers inventories declined at the end of June to 28 days of supply. This is the lowest level in over two years.

As a result of strong demand, our price has improved significantly, our price for all grades is up $41 per ton in the second quarter. In addition, we have announced a $20 per ton increase across all softwood and hardwood grades effective in July. Lumber markets trended lower in the quarter as housing starts weakened. To better manage our operating results we reduced our production volume at a certain of our lumber operations in Canada.

The long running soft wood lumber dispute between the U.S. and Canada appears to be coming to a conclusion. An agreement has been reached between the two governments, but is awaiting final approval by the Canadian Parliament. Although there is some opposition to the terms and we recognize the agreement is not perfect, we expect agreement to be signed in the fourth quarter. To date we have deposited approximately 110 million. With the terms of this agreement, we expect to receive a refund in excess of $90 million.

Looking ahead to the third quarter, I expect the Company to benefit from stronger markets, limited scheduled maintenance, downtime, the continued ramp up of the Calhoun machine, and additional cost reduction realizations. With these improvements, I expect income from operations to be possibly -- positively impacted by over $30 million in the third quarter. Our first priority is to reduce debt. As I mentioned, we are making progress in that goal.

I would like to see our total debt reduced to about 1.8 billion. I believe this is the level where we can gain financial flexibility not only in the peaks of the cycles, but also in the troughs. Throughout this quarter, and the quarters ahead we're going to take actions we believe necessary to achieve greater efficiencies that will drive shareholder returns. There's a lot to be done, we are strongly committed to do it and it takes -- and do what it takes to achieve better performance overall. With that, we will take calls.

[OPERATOR INSTRUCTIONS] And our first question will come from the line of Chip Dillon with Citigroup. Please go ahead.

Yes. Good morning.

Food morning, Chip.

The first question is, you've redone your bank lines and could you just review for us what your debt maturity schedule looks like now for the next five years?

Okay. I'll ask Bill to answer that one.

Sure, Chip. We have a very light maturities until 2009. We have a sinking funds of about $15 million in 2007 and 2008. In 2009 is our first major maturity of about $200 million -- $250 million. And then we have a major maturity of the same size in 2010.

Got you. Okay. So basically your revolver right now more or less equals what's coming due through 2010?

That's correct.

Is a way of looking at it. Okay. And then, secondly, you mentioned that -- Dave mentioned that you all were looking for a $30 million -- I guess income from operation improvement in the third quarter versus the second. Does that include the impact of pricing, or is that just merely the stuff that you control, for example, the Calhoun conversion being behind you and the maintenance being less?

It primarily is maintenance, there's some small carryover of pricing, but it basically includes -- on the pricing side it's what's in hand right now and on most of it almost entirely is due to the -- getting the maintenance behind us.

Okay. And then the -- I had a question about the hedging. You mentioned that you're starting to do some short-term hedging of the Canadian dollar. How big is that? In other words, let's say for sake of argument if the Canadian dollar were to fall, let's say, to $0.85, would we not see any of that benefit because of the hedging, or would we only -- or would it be a partial -- we'd see at least some of that benefit?

Well, Chip, let me just start by saying as we looked at the daily volatility or the weekly volatility in the Canadian dollar we said on a short-term basis we should be taking advantage of that. And Bill started a program during the quarter and I'll let him talk of the details, but I think it's in our best interests when we see that volatility or the dollar spike down on a daily basis we take advantage of it. So Bill?

Yes. In effect, Chip, we are trying to just take advantage of the -- of the volatility. When you look at what we have in place right now, including hedges that have been done a couple years ago for the third quarter we're about 30% hedged.

Yes.

Our average rate -- and this includes some of the older hedges, is about $0.84.

Yes.

We typically have not done any hedges in the 90s and we have done our hedges at or below where the market is right now.

Yes. Yes. And then last question is--It's fascinating when you look and you see that prices are generally going up on either side of coated groundwood. Whether it's coated freesheet or uncoated freesheet or some of the specialty groundwood grades and we see that the -- UPM to shut down a massive 400,000 ton machine. Do you have any theories as to why in the sea of all this great news, coated groundwood is bucking the trend and having done so poorly up until -- in the last few months?

Well, I think, there are a couple issues there, one I think inventories are a little high in that sector. And I also think [Maramashe] operating -- they came backed up in the first half and put considerable tonnage back in the market. Having said all that, I think we're optimistic about coated in the second half of the year. We get a normal seasonal pickup and you're absolutely right, the grades around it and the overall demand structure I think will be fine. So we may be conservative on coated papers in the second half. We need to see that lift first before we get excited.

Okay. Thank you.

Thank you.

And our next question comes from the line of Mark Connelly with Credit Suisse. Please go ahead with your question, sir.

Thank you. Just looking at the new paper. I'm reminded of what happened with New Way during the testing period. It got off to a good start and then it ran into consumer acceptance issues later. Can you give us a sense of how this process is different or whether you're far enough along that you can be confident that you don't have those kind of issues that bogged us down last time?

Well, I guess specifically to the New Way process. I think New Way was built around trying to take a newsprint base sheet and coat it and sell it as a light-weight coated sheet and ran into a number of issues. In regards to the hybrid grade, it is a sheet that I believe will find its place in the marketplace, particularly with commercial printers and direct mailers, given the fact that it has bulk opacity and brightness with less basis weight and ultimately we certainly, in the early test and the early feedback is it's printing and running on the presses at comparable or better speeds with better performance than the substitute grade which have been uncoated freesheet grade. So I think it's really looking at an on machine mill coating process versus off machine converting process and the leap from newsprint to light-weight coated through a New Way process was much bigger than going from a a newsprint machine with P&P and recycled and some market pulp to a Kraft content hybrid grade with TMP and some recycled with a coating on it. And I think based on our successful conversion at Catawba and some of the coating technologies we transferred from Catawba to Calhoun, it's gone very, very well. The Catawba people were instrumental in helping the Calhoun people make that happen.

How much opportunity have customers had to play around with this paper to this point?

Well, we have essentially made our first shipments the early part of July. We are getting repeat orders in the certain press rooms. We're expanding the number of presses and press rooms it's operating on. We're getting direct feedback that it is performing very well and that the customers are going to start converting some lines over to it. So that in combination with the fact the machine is running very well, we're feeling very positive about this introduction and hope to be able to report good things to you at the end of the third quarter.

Okay. That's helpful. Just one more question. That 94% operating rate you gave us on newsprint. Is that you or industry?

Industry.

Industry.

Industry. And are you more or less in that same ballpark, or?

We probably would have been less in the quarter due to our downtime. I mean we had a number of -- as we talked about, downtimes.

Okay. Very helpful. Thank you.

Thank you.

And our next question comes from the line of Edings Thibault with Morgan Stanley. Please go ahead with your question.

Thanks very much and good morning, gentlemen. Good morning, gentlemen. A question for you. As you begin to ramp up the Calhoun machine, what are your targets in terms of perhaps cost per ton and sort of over when the machine is fully up and running and how long do you think it'll take you to hit those targets?

Well, I think our goal in the conversion was to create a first quartile machine in terms of the grade -- the machines it's going to compete against which would be uncoated freesheet machines and we feel confident we can do that. As I mentioned on a tonnage basis, the machine has come up very well. It is running a combination of uncoated and coated grades at this time but it -- production rate's well ahead of pro forma. We've been there almost a month now, so again at the end of the third quarter we'll have much more to report. I would say given the progress today and we stay on track that we'll be well ahead of our pro forma, very pleased with the project.

Got it. And did you think about the impact on the specialty papers business as that volume ramps? Would you expect that we would see a -- and obviously as you get over the start-up costs, we'll see reduction costs, but relative to perhaps to where you were in the first quarter, would you expect to see a reduction in your total costs, or would the cause of impact of the machine come more on the absolute mix in the impact of selling a higher priced product?

Well, I think it -- the immediate impact's going to be in the cost side.

Right.

I mean you are going to get the tons back in the system, for one, without the expense of the closure or the maintenance downtime and replacement. And then the product that it's -- the market it's selling into is very robust at this time. It's, again, going into the -- against the uncoated freesheet market, which is strong. And what is basically a new product entry for ourselves, so, yes, I think you would see both kick in during the quarter.

Got it. And then one detail -- or note question. You mentioned what grade is it that you're seeking a $40 per ton increase? Is that on the coated mechanical side?

Supercalender.

Supercalender. Got it.

Right.

Thanks very much.

You're welcome, thank you.

And our next question comes from the line of Mark Weintraub of Buckingham Research. Please go ahead with your question.

First, Dave, congratulations on your new post. I don't think we've spoken since.

Well, thank you.

The first question I had was, you talk about a $1.8 billion goal on the debt side, which if my math's right is about 5 or $600 million below where it is today. Can you give us a sense of how much of -- to get there how much of that you expect to come from asset sales and also in that context just your thought on dividend policy as you're working to get to the debt goal.

Okay. Well, let me start and then Bill can jump in. I think the key of course we're doing very well on the land sales, which is a big part of it. Another component will be the settlement and their return of $90 million plus against the softwood lumber settlements. But the real key for us going forward and really my charge to the management team is to get operational earnings and cash flows to a sustainable level that we can reduce debt through generating earnings rather than asset sales. So that's my primary focus. I will turn it over to Bill and he can talk about the land sales and other issues.

Yes. And as you -- what we have left at the end of the quarter, of course, in the U.S. owned and leased is about 220,000 acres and we will be moving ahead to monetize that. And when you add that component, operations and the resolution of softwood lumber dispute that gets us well on our way and -- with respect to the dividend policy, it remains as is. We've -- we certainly have monetized 200 million in the second quarter and at this point with the upswing we see in the market -- in our financial results over the third and fourth quarter and our movement towards and to profitability we feel it's policy -- our dividend policy's sound.

We see no change in the dividend policy. The real key for us going forward again and I can't reiterate this enough is to get to operational earnings and generate sufficient cash flows, particularly in '07 and '08 to reduce debt repayment without having to depend on asset sales. So that's the charge. That's my message internally every day.

Yes. And understanding there are lots of moving parts, but is it end of '08, is that timing-wise roughly where you're hoping to get to?

I would -- I would hope to be there earlier than that.

Yes.

I think '08 is too late. We have to be at a higher operating level before then and I would like to see us there by the end of '07 or certainly early '08.

Okay. And based on the elements that you talked about, that would not -- there had been some talk or consideration on the -- where is your thought process on your Korean assets at this point?

Well, the Korean asset is -- you're referring to our mill Mokpo in Korea. I view Mokpo in a strategic sense. I think if we execute all the things we talked about then it becomes a strategic decision on Mokpo in terms of do we retain it or do we market the Company? My belief is that at the right price, based on its performance, which is improving, that we would strongly consider it. There's -- having one mill in Korea, and it is a good mill, and we've had operational improvement this year and we're back where we want to be, to me it becomes a strategic decision and we would look at a transaction if it made sense for us.

Thank you.

You're welcome.

And our next question comes from the line of Peter Ruschmeier with Lehman Brothers. Please go ahead with your question.

Thanks. Good morning.

Good morning, Peter.

Just a couple questions. The $200 million of timber sold in the quarter, can you help us to break down some of the key parcels and where they're located?

Sure, Bill.

Sure. The -- two components, Pete, we had about -- the Canadian component was about 370,000 acres on a dollar per acre basis that would be about $340 Canadian per acre. The U.S. component was about approximately 100,000 acres at about $950 an acre.

Okay. Very good. And just a clarification. On the 10 million hit you took at Calhoun, that, I believe was entirely included in the uncoated groundwood specialty segment?

Where we post the loss in terms of product goods, it was in the specialty segment.

Yes, it was.

So 10 million goes away there going into 3Q and then the pulp segment had a 10 million hit as you mentioned from Thunder Bay and 5 million of that goes away. And so that's 15 of the 30 million improvement and the remaining 15 million is split between maintenance and price, is that correct?

Predominantly maintenance.

Predominantly maintenance.

It's an operational -- we had maintenance other than the mills you just listed in the quarter that does not reoccur to the same degree in the third quarter.

Okay. Shifting gears to the lumber business. Understanding that the market's very tough at the moment. Could you comment on what kind of volumes you might expect going forward if we were not to see much of a change in the price from current depressed levels? I would think that you might be considering cutting back some volumes there?

Well, we've already -- we've already reduced some shifts in the late second quarter going into the third quarter. We will continue to match our capacity to the demand and where we think the right financial balance is for the Company. Of course, some of -- particularly in Canada some of it is related to the residual wood flow, chip flow to our paper mills but in general, I would think you would see a fairly slow third quarter in terms of our lumber business both in terms of financial performance as well as volumes.

Okay. And just lastly if I could. Back to Calhoun. Sorry if I missed this. Did you indicate what kind of utilization rate that new machine is running at today and kind of your expectation for the learning curve? I know it's both a manufacturing challenge and also a marketing issue, but can you comment on the expected learning curve?

Well, we're -- I did comment but we are ahead of our pro forma learning curve by a substantial amount. We are not operating the machine as at full design capacity yet, but we are very encouraged by the start-up. It's from an operating point of view it's been exceptional and the crews there have done a good job. It's a big change to go from making newsprint to making a coated hybrid sheet and the operating crews there have done a great job. I would say that we will be given the path we're on, we will be -- given the path we're on we'll be close to full design capacity by the fourth quarter.

Very good.

Which is a -- a pretty quick start-up.

Super. Thanks very much. And welcome aboard, Dave.

Thank you.

And our next question comes from the line of George Staphos with Banc of America Securities. Sir, please go ahead with your question.

Thanks, good morning everybody. Dave, thanks for all the color on the details. I guess the first thing I wanted to check with is to be clear the $30 million improvement that you see, the basis of comparison we should use would be the second-quarter operating profit this year, is that correct?

That's correct.

That's correct.

Okay. Fair enough. Now, back to coated paper. Why again do you think the market has been soft? I think you mentioned inventory levels, you think customers have now worked their inventory levels down such that these prices can stick, or do you think the pickup in demand here has been a little bit of prebuying ahead of knowledge that these price hikes are coming?

I don't see a lot of -- I mean I wouldn't call it prebuying. I think the consumer base was cautious in the first half of the year. And we're getting early indications that demand is picking up at their end and I think there's -- there was reference earlier I think to some capacity closures in Europe that are going to kick in in the second half and that will tighten things up.

Dave, are your customers saying that they're now more optimistic, too? In terms--.

Yes.

--of their outlook.

Our sales -- our salespeople are reporting that their customers are saying it looks like the seasonal factors are starting to kick in and they're feeling better.

Okay.

Which is great.

No, absolutely. No, that's helpful. You mentioned that you have seen a number of things in the operations that you think are opportunities for improving performance going forward.

Yes.

Can you give us a sense of some things that perhaps could have been done a bit more efficiently that will help your earnings going forward and what kind of target could this be on top of what you've already specified? $50 million opportunity two years from now, et cetera?

Well, I think, from my career experience I think a couple things happened to us here at Bowater. I think clearly we were on a constrained capital program for several years to conserve cash which was the right thing to do. And then with the conversion opportunities that were presented to the Company a lot of the capital was directed to conversions, which are now completed at Calhoun and we've suspended or indefinitely suspended the conversion opportunity at Thunder Bay. So it says now we get back to sort of fundamental let's go back and do the things here at Bowater that others in the industry have been doing to reduce energy consumption to reduce all sorts of raw material inputs and increase efficiencies with proven technologies across the mill system at Bowater.

Some of that I think is direction from corporate, some of it also is just a refocus on operational excellence and it's a key in a mill manufacturing company like ourselves. So part of that is also going to be to bring in some new talent and help supplement the manufacturing team here. I am actively recruiting that talent and hope to have some positive news to report fairly soon about bringing in some very experienced and successful manufacturing professionals into the Company.

So the numbers could be significant, but at this juncture it seems like it's a little bit too early for you to give--?

I think -- I'm not -- I brought -- I operated with a lot of mills and had a lot of mills reporting to me. I don't think it's unreasonable to ask our manufacturing organization to put $10 a ton on the bottom line and do it with the next year.

Got it.

On a sustainable basis and given our capacities that's sort of the $50 million number you're talking about.

Okay. Two last questions. One related. Overall how do you feel about your mill network and newsprint as we go into next year? Are there any laggards that you may look to address even if you can't specify them here? And what's your macro outlook that's built into your planning process for next year? Thanks, guys.

Well, I will start with the second question first. I think, we have to assume a continued decline in newsprint demand until the market proves otherwise in terms of being prudent planners for the business, which then drives a lot of our thinking around mills for next year. Our markets are fine in terms of our custom base and we stay very close to our customers. We have -- on the newsprint specifically, I mean we ultimately have a number of first quartile machines in that sector and we have some that aren't and the ones that are -- the ones in Canada cause ourselves the most concern and it's really we've got to get a better handle both internally and in discussions with the government on issues around energy and what exchange rate policies are going to be in Canada. And that will help us determine what we do. But energy in the short run is probably our biggest challenge in Canada, particularly in the province of Ontario.

Okay. Thanks, Dave. Good luck.

Thank you. Thank you.

And our next question comes from the line of Paul Glen with Salomon Partners. Please go ahead with your question.

I just want to understand your new product coming out of Calhoun, how it differs from the [Abbot Tibey] offset grades, what you see in terms of your next conversion, whether that -- whether that opportunity's at Coosa Pines and what's the status of the number 3 machine at Thunder Bay?

Well, a lot of questions there, so I'll start.

Three easy ones.

Three. Okay. Well, the difference -- I mean the -- just if you look at the makeup of the sheet, we've got, Kraft pulp, we have an integrated Kraft mill at Calhoun, so we put kraft into our sheet, which gives us greater strength and brightness levels at lower chemical costs than our competitors' product. And the feedback -- our goal coming out and what we're producing is to produce a sheet that is comparable to an uncoated freesheet and all strength characteristics and printing characteristics. Admittedly some of the freesheet guys have gone up to a much higher brightness grade but in the mid 80s brightness that's the product we're producing. So it's really the kraft content -- or the integrated kraft content that we can produce at Calhoun that our competitors couldn't. In terms of other conversion opportunities, we certainly have options and we'll evaluate those. What was the third question?

Number three machine at--.

Number three machine. Bill, you want to?

Sure. Number three machine at Thunder Bay remains idle.

When do you make a decision on closing that machine?

Well, it's idle at this point. We are about -- we evaluate it but at this point, Paul, it's idle.

Okay, thanks.

Thank you.

And our next question comes from the line of Rich Schneider with UBS. Please go ahead with your question, sir.

When you look at the quarter.

Good morning, Rich.

Good morning. Sorry to start in like that. When you look at the maintenance expenditures and the conversion costs in the -- in both Thunder Bay and at Calhoun, I guess Thunder Bay's not conversion costs.

Right.

You add all that up you come out to about $34 million, 14 million for maintenance and 10 on each of the other two situations. That seemed to be quite a bit higher than what was the expectation going into this quarter. I was wondering if you can talk about why, those expenses seem to be, -- could have been as much as $15 million higher than what was led to believe was going to happen in the quarter?

Rich, if you look at the numbers, the -- the Calhoun conversion we had talked about in the -- in our last press release and on the call, we had expected about $5 million impact and it came in at $10 million. So 5 million of it is just due to some -- through an extension of the period that we -- that was covered there. Secondly, the maintenance numbers we used is an estimate. We're about $5 million lower than -- and this is not Calhoun, this is across the Company. $5 million higher than we anticipated. So of the 15 million, 10 million is just simply due to those two factors. The five -- Thunder Bay we talked about it being out, it had about a $10 million impact on us. I think I covered that impact. What that really is is when we shut it down on May 1, we have not taken out the fixed costs as -- in the second quarter associated with that as we did training and other things and that will just diminish over time. So I can explain very quickly 10 million of the 15 I don't know if I -- what I missed on the other 5 or what information you had on the other 5.

Yes. I guess part of it was Thunder Bay. I didn't realize the hit was going to be that much. So getting back to the $30 million, that was thrown out there in terms of operating income improvement. If you take the 34 million and you look at the third quarter, you said there would be 5 million still remaining at Thunder Bay so that takes you down to 29 million. Is there -- is that 29 all going to be gone in the third quarter, or do you hope that will be all gone?

Should be, yes.

So that's the 30 that you are talking about, 30--?

That's the basis of the 30, yes.

Okay. So that means that 30 doesn't include anything for pricing or for potential cost reduction that you are working on.

I think that's a fair assumption.

That's a fair assumption, Rich.

Okay. And just staying on the cost reduction. Will we see any benefits at Thunder Bay, or is it still -- you said the 20 million you get at the beginning, 2007, but do we see any of that benefit earlier than the beginning of 2007?

Yes. It's the run rate will be there at 2007, but through the quarters, quarter by quarter that will be rolling in.

Okay. And then we get a big chunk of the 80 million in the second half of the year?

Yes.

Okay. And then some benefits from the start-up of hybrid sheet, right?

Right.

Okay. Great. Just on another matter. Dave, you had mentioned briefly the closures in Canada on coated groundwood and they are fairly substantial -- I'm sorry, in Europe in the second half and particularly in the third quarter by UPM and Stora. Are you starting to see any change, or is it a little too early in import patterns, are you hearing anything from your customers that would indicate that they are looking for more from you as a result of what's happening in Europe?

No. Well, I think -- the -- from the industry statistics we've seen imports down through the first half, we'll just have to see what happens in the second half. The real driver for the industry is demand. And, again, from -- based on our interactions with our customers in the month of July things are feeling better. Whether that's driven by an import issue or just general market demand, it's too early to tell, but it feels better.

We've been hearing reports from people coming out with -- that the catalog season looks like it's going to be pretty good with a number of new catalogs, even some of the on-line players like Amazon have been putting out catalogs. What are you hearing from that?

That's the sense we're getting from talking to our customers, that they're feeling a lot better.

Okay. And then just last question. Could you describe your order book in newsprint at this point?

Well, I mean it's fine. I mean I think, for us -- yes, it's fine. I think it's a matter of -- we've got a pretty good customer base and we have a nice export position so we're doing okay.

So would you describe it as pretty full order book right now?

We're able to run our mills.

Okay. Thank you.

Operator, we have time for one more question.

Certainly. And our next question will come from the line of Rick Skidmore with Goldman Sachs.

Thank you for taking the question and good morning. Two quick ones. First, on coated groundwood pricing. Have you seen that market stabilize or are you still seeing some weakness there? And then secondly, Dave, can you talk about how you might be doing things differently from the prospect of newsprint pricing and perhaps breaking the trend in the industry of announcing an increase and getting half. Is there anything that you're doing differently at Bowater going forward with regards to getting the full price increase in newsprint? Thanks.

Well, I would think on the first issue, yes, we're -- I think again as demand improves on the coated side and our customers start, placing more orders we'll see better pricing, we believe. And on the newsprint side I don't know enough about newsprint pricing yet to really answer that question so I'll beg off and -- but, yes, I mean it's our responsibility to price our products appropriately and we'll do that.

Thank you.

Thank you.

Gentlemen, please go ahead with any closing comments.

I'd just like to end the call by thanking each of you for your interests in Bowater. Thank you.

Thanks.

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