Resolute Forest Products Inc (RFP) 2012 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the Resolute Forest Products second quarter 2012 earnings call. I would now like to turn the meeting over to Mr. Remi Lalonde, Vice President for Investor Relations. Please go ahead, Mr. Lalonde.

Good morning. Thank you, Valerie. Welcome to Resolute's second quarter earnings call. My name is Remi Lalonde, Vice President for Investor Relations. I'm joined by Richard Garneau, President and Chief Executive Officer, and Jo-Ann Longworth, Senior Vice President and Chief Financial Officer.

We'll be using slides during today's presentation. You can follow along by logging onto the webcast using the link in the Presentations and Webcasts page under the Investor Relations section of our website. The slides are also available for download on the website.

Before we begin, let me direct your attention to the note on forward-looking statements in this morning's press release and the slides accompanying this presentation. We'll be discussing forward-looking matters on the call today. You should note that, due to uncertainties inherent in these statements, actual results may differ. Our statements are not guarantees of future performance. You can find additional financial and statistical information, including a reconciliation of non-GAAP financial measures we will use today, in the press release and the slides.

We'll take questions from analysts and investors following our prepared remarks. We ask that media and others please direct their questions to our communications department following today's call.

Richard?

Good morning, everyone. Thank you for joining us today.

Today we reported adjusted EBITDA of $120 million in the quarter, a $49 million improvement, or 69% improvement, over the first quarter. This is due in part to seasonal variation, but also to our relentless focus on reducing costs and our continued effort to optimize our diversified asset base to improve overall profitability. As such, we more than compensated for the difficult market conditions in market pulp and coated papers, with strong results in newsprint, specialty papers and the wood products. I will add that adjusted EBITDA was $10 million higher, or 9%, than the same quarter in 2011.

Adjusted EBITDA was up across all segments compared to the first quarter by $11 million in newsprint, $4 million in coated, $12 million in specialty, $16 million in pulp and $18 million in wood products. When compared to the second quarter of 2011, adjusted EBITDA was up in newsprint $7 million; specialty, $15 million; and in wood products, $25 million; but, lower in market pulp and coated paper segments by each down by $18 million.

We also generated significant cash flow in the quarter, as Jo-Ann will describe in a few moments. Seasonal demand improvement led to higher overall shipments. We remain committed (inaudible) only profitable tons and to manage our production and inventory levels very prudently to avoid any unnecessary buildup. We therefore took about [74,000] liquid tons of market downtime in the paper grades, including 70,000 liquid tons in newsprint and 18,000 tons in pulp. This is 102,000 liquid tons less market downtime in pulp and paper compared to the first quarter.

Before I review the segments, I am pleased to note that, as of yesterday, Resolute owns 100% of Fibrek and its Saint-Felicien Quebec softwood kraft mill and the two US-based recycle kraft mills. Though overall poor market conditions are challenging, we are confident that this acquisition will generate attractive value for our shareholders over the long term.

Total North American newsprint demand declined a modest 1.6% in the first half of the year compared to a 7.3% drop in all of 2011. The modest decline this year was largely the product of a 20% increase in demand of end users, other than newspaper as retailers are shifting the grade spectrum to cut costs. With a steep decrease in production following a number of announced closures, industry operating rates in North America on a production to capacity basis averaged 92.4% in the first half of the year. Pricing in North America has been stable in the mid 600s for over two years and mill inventories remain at manageable levels.

World newsprint demand declined only by 2.1% in the first six months of 2012 as the steep 11.3% decline in Western Europe was partially offset by a 3% increase in Asia.

First quarter Latin America and Indian demand growth has turned into 3% and 7% contractions over the first half of this year, largely due to currency-driven net cost increases to publishers. As such, exports to Asia and Latin America from North American producers has fallen 30% and 8%, respectively. It is interesting to know on the other hand that shipments to Asia from Western European producers are up 43% as a result of the weak euro and lower [OMP] pricing. In response to these challenging conditions, we announced the closure of our export-focused personnel in Nova Scotia.

Total North American demand for coated mechanical paper was down 4.1% in the first half of the year, but even lower in June, down more than 9%. Industry capacity reduction of 6.9% through end of June more than compensated for the drop in demand.

Our shipment-to-capacity ratio was 91% through the end of the second quarter, but it is climbing as a result of the capacity closures which occurred more recently and includes, as publicly reported, the intermediate idling of paper machine number 1 at our low-cost Catawba facility. We are not satisfied with the extent of increasing costs at this mill. We believe that the path to higher overall profitability at Catawba will come from reduced manning of the mechanical pulp production, fiber optimization and better overall mill efficiency.

Total North American demand for uncoated mechanical papers fell 17% in the first half of the year, including a 25% drop in high-gloss grade, 17% in lightweight and about 9% in standard grades. As a result of produced capacity adjustments, industry production across these grades, however, was lower by a corresponding 17% over the same period, leading to an average operating rate of 91%.

As I mentioned in my earlier comments, grade switching into newsprint is one of the main reasons for the decline in uncoated mechanical paper consumption. But, as a supplier of diversified products, we have adapted to our customer requests and we benefited in the newsprint segment. This diversity of products enables us to maintain overall margins and preserve our economics of scale.

Before moving away from the paper grades, I know that we expect a modest improvement in the coated, specialty and newsprint segments as a result of seasonal demand increases in the third quarter. But, the impact of recent newsprint and specialty paper mill restart announcements is creating uncertainty.

Overall demand for chemical market pulp was up 1.6% year to date through June, including a 15% increase in China and a 5.2% increase in Latin America, offset in part by a 5.2% reduction in North America and a 6.1% in Western Europe. The up-year statistics within the (inaudible) component rates or has fragmented as the geographic demand breakdown.

Overall, softwood pulp shipments, which represent about 45% of the total world demand, are up 1% and the overall hardwood pulp shipments are up 2.4%. Growth has been in the (inaudible) of this pulp, which increased 3.6% at the expense of northern and southern hardwood pulp, which together are down 2.9%. Northern and southern hardwood pulp together represent about 25% of our hardwood pulp demand.

The integration of Fibrek into Resolute has increased our relative exposure to high quality northern softwood pulp. Our softwood capacity is 80% of our virgin fiber pulp capacity, which puts us in a better position for the expected long-term growth in softwood pulp demand. Percent of (inaudible) high-quality black spruce softwood is particularly attractive. In addition, we now also have about 320,000 tons of recycles kraft pulp production after our acquisition of Fibrek.

There was a slight uptick in the recent pricing benchmark leading into the second quarter, but it has not held because of weak market fundamentals, including reports of rising inventory. Accordingly, we do not expect any meaningful improvement to market conditions for the balance of the year.

We expect to take an extended maintenance outage at the Saint-Felicien mill in the third quarter in order to carry out repairs on the electrostatic precipitator. The shutdown is now expected to last about five weeks. We want to ensure that Fibrek's operation meet the same environmental standards as the five other pulp mills in our network.

The positive momentum in the US building starts led to a $21 million adjusted EBITDA contribution from our wood products segment in the quarter. In June housing starts were at an annualized rate of over 760,000 units, a 24% increase over the same period last year. According to Random Lengths, pricing in our benchmark lumber grade is at such level not seen since 2006.

I want to close by saying that the results we reported today are not an accident. They are the direct result of our strategies to compete as the leading lower-cost North American producer through aggressive cost reduction, asset optimization and mill rationalization. Every incremental change is important. We will continue to push and to maximize our efficient operations through economies of scale and access to competitive sources of energy and fiber to succeed in the future. For the first time in years each of our paper segments generated EBITDA margins above 10% as did wood products.

Our strategy remains the same, guided by our values of safety, profitability and sustainability. We seek to build value for our shareholders through, on the one hand, a gradual but profitable retreat from certain paper grades and, on the other, using our strong financial position to act on opportunities to acquire competitive assets that lead to product diversification and synergies or provide growth into markets where the longer-term prospects are more favorable, such as pulp, wood products and other fiber-based products.

In the quarter Resolute became the largest manager of Forest Stewardship Council, what we call FSC, Certified Forest in the world as a result of the certification of an additional 7.9 million acres of forest land in the Lac-Saint-Jean region of Quebec. We have now passed the halfway point in delivering on our commitment to increase our overall FSC certification to 80% by 2015.

I will now turn the meeting over to Jo-Ann to review the results in greater detail.

Thank you, Richard. Good morning, everyone.

Today we reported net income of $30 million for the second quarter, or $0.30 per share, excluding $50 million of special items; that on sales of $1.2 billion. On adjusted we reported a net loss of $20 million, or $0.20 per share.

Special items in the second quarter net of tax included a $45 million charge related to closure costs, impairments and other related charges, as well as a $4 million non-cash charge for inventory writedowns, both associated with the closure of our Mersey newsprint mill; a $13 million non-cash gain related to reorganization tax adjustments; a $10 million non-cash charge on translation of Canadian dollar net monetary assets; and finally, $3 million of transaction costs related to the acquisition of Fibrek.

Total sales of $1.2 billion were up 11% in the second quarter, reflecting a seasonal increase in overall shipments, better pricing conditions in the wood products and pulp segments, and the integration of Fibrek's results for 2 months. Improving US housing starts pulled average transaction prices up by 13% in wood products and there was a 14% increase in pulp prices. Average transaction prices in paper grades trended slightly lower. Compared to the second quarter of 2011, average transaction prices improved in specialty paper and wood products, but were down slightly in newsprint, 5% in coated and 14% in pulp.

Cost of sales were 6% higher than in the first quarter, primarily as a result of the acquisition of Fibrek which accounted for $51 million of the increase, and also on higher volume. However, lower input costs, including lower OMP pricing and power costs, bill level restructuring initiatives at several newsprint and specialty mills, as well as the timing of annual outages helped reduce our cost base. Distribution costs increased 10% on higher shipments.

The factors I just mentioned helped push our operating costs per unit down in each grade compared to the first quarter, including a 4% decrease in each of newsprint and specialty, and 2% in wood products.

Operating costs per unit were also significantly lower than the second quarter of 2011 across all grades, with the exception of coated, which was up partly as a result of carryover maintenance in the first quarter and on higher input costs. Operating costs in the coated segment have trended higher, largely because of higher pricing for power and coating chemicals and increased usage of those chemicals.

Second quarter selling, general and administrative expenses were $41 million. They included a $2 million group benefit premium refund compared to a $9 million refund in the first quarter. The second quarter SG&A also included $3 million of transaction costs associated with the acquisition of Fibrek, compared to $4 million in the first quarter. It also included Fibrek's SG&A and incurred expenses of a closure of our Greenville office and Fibrek's head office in Montreal. A $2 million increase in interest expense to $18 million reflected the consolidation of Fibrek's debt, which I will address in a minute.

The decision to close the Mersey newsprint mill led to inventory writedowns and closure cost, impairments and other related charges of $95 million in the quarter. These included severance and other termination benefits of $18 million and asset impairment charges of $77 million to reduce the carrying value of the built asset. These charges were reduced by $46 million related to our partner's non-controlling interest.

Included in the $1 million income tax provision was a valuation allowance increase of the closure costs for Mersey, partially offset by the $13 million non-cash credit related to a reorganization tax adjustment that I mentioned in special items. We expect our effective accounting tax rate to be approximately 30% on a normalized basis, excluding currency translation impacts and other adjustments. We do not expect to pay meaningful cash taxes in the near term.

Turning to the balance sheet, cash and cash equivalents increased by $100 million in the quarter, closing at $510 million. The increase in cash was driven by strong cash flow from operating activities, notwithstanding the $41 million net spent for the acquisition of Fibrek and the $12 million used to purchase -- repurchase shares.

We also decreased restricted cash by $72 million on the release of a tax indemnity given in connection with the sale of our MPCo hydroelectric assets in 2009.

On the working capital side, other accounts receivable dropped by $26 million from the first quarter, $25 million of which was the collection of 2010 road construction credits.

At concluding Fibrek and Mersey, inventories were down $27 million, a seasonal fluctuation of raw materials, mainly logs.

Following our announcement of Mersey's closure, we began the process of selling off all of our assets in Nova Scotia, including the private timberland, the paper mill, the saw mill and the Brooklyn power facility. As a result, assets held for sale increased by $75 million in the quarter. It is worth noting that there have been numerous indications of interest from international parties, particularly for the over 0.5 million acres of private timberland.

As you're reviewing the balance sheet, please keep in mind that the acquisition of Fibrek and the transfer of Mersey assets to assets held for sale resulted in a number of changes and adjustments to several individual balances.

We generated $116 million of cash from operating activity, which is $59 million higher than in the previous quarter and $159 million higher than a year ago. The improved cash from operating activities included a further $33 million improvement in working capital, compared to $16 million in the first quarter, reflecting the changes I mentioned earlier.

Capital expenditures were lower than the first quarter, reflecting the benefit of a $20 million grant for the installation of equipment to produce renewable, green electricity at our Thunder Bay mill. We continue to expect maintenance of business capital spending to be 55% to 65% of depreciation and amortization on an annualized basis.

As of June 30th we have acquired 75% of Fibrek for a consideration of 2.8 million shares at $53 million. As Richard mentioned, yesterday we completed the second-step transaction for the remaining 25% for additional consideration of 940,000 shares and $18 million, subject to dissent. We started to consolidate Fibrek's results within our market pulp segment on May 2nd.

During the quarter we advanced funds to Fibrek in order for it to repay $15 million of its credit facility. And on July 18th, we advanced additional funds to repay almost all of its remaining $103 million of outstanding debt. In both cases, we funded the repayment from cash on hand.

We spent $12 million to repurchase 1.1 million shares of our common stock during the quarter as part of the $100 million program our Board authorized on May 22nd. Total shares outstanding at the end of the quarter were 98.8 million. As I mentioned a moment ago, we have since distributed an additional 940,000 shares completing the Fibrek transaction.

Consistent with the first quarter, we made $24 million of pension contributions in the second quarter. This compares to a correspondent expense of $7 million. The difference of $17 million is re reflected as net pension contribution in the cash flow statement. Contributions would have been $12.5 million higher in the quarter, $25 million year to date, had we not prepaid into 2011 contributions otherwise payable in 2012 for the first half. This relates to the Canadian plan covered by the Quebec and Ontario Funding Relief Regulations. With this prepayment behind us, we expect contributions to those plans to be $25 million higher for the balance of the year, which is consistent with the basic contribution of $50 million per year under the funding relief regulations.

I will close by expanding on our pension liability; specifically, the Canadian plans subject to the funding relief regulation. On a balance sheet basis, these plants represent around 80% of our total unfunded pension liability. I note that the pension plan performed well, generating a 5.4% investment return in 2011 as we adjusted the plan in equities and fixed income components. The failure to meet certain annual solvency levels in the funding relief regulations triggers a requirement to implement corrective measures. These measures are to be developed in collaboration with other plan stakeholders and are meant to regain a target solvency ratio within 5 years.

In light of the significant decline in yields on government securities in Canada, we indicated last year that we expected that the plan would not meet the minimum levels (inaudible). Having completed and submitted an actuarial report, we confirmed that the solvency ratio in the plan, again, those subject to funding relief regulations, did not meet the prescribed solvency levels.

The portion of the solvency deficit that is subject to corrective measures is approximately CAD500 million. As Richard will describe in a moment, we will work in collaboration with our employees, retirees and union partners to address the issue. Solvency deficits can be reduced in a number of ways and we will review all of them over the coming months. But, it is critical that those measures be consistent with the principles of our original agreement with the provinces.

I want to stress that this issue is a product of one thing, the significant reduction in discount rates. Government monetary policy and the flight to safety we experienced in 2011 have pushed interest rates of Canadian treasury securities to historic lows. The source of the problem for us, like many other companies with defined benefit plans in Canada, is the very conservative manner in which the solvency ratio is calculated. Both discount rates decreased 0.6% on an accounting basis in 2011. Under Canadian solvency rules the mandatory discount rate dropped by 1.2% or doubled. This is a harsh result.

To put it in perspective, a 1% decrease in the discount rate will increase the solvency deficit by approximately $450 million for the Canadian plans covered by the funding relief regulations.

I note with interest that, while it will have a limited impact of Resolute, US lawmakers were suspiciously concerned about the discount rate issue that they recently adopted legislation that would significantly reduce companies' pension funding requirements over the short term in light of the new -- the low interest rate environment. But, like many other companies with Canadian defined benefit pension plans, we will have to work through this situation as long as low interest rates prevail, a situation that negatively affects the Canadian forest product industry's ability to compete.

Richard?

It is very important to keep the pension deficit situation in context in the negotiations leading to the Company's emergence from credit protection in 2010 we chose to protect 100% of pension benefits of all retirees, leaving them essentially unaffected by the further credit protection proceedings in exchange for manageable funding obligations over the next 10 years. Otherwise, the plan would have been treated, as any other bankruptcy claim, would likely have been wound up and the retirees would have lost up to 25% of their benefits in 2010. All employee retirees and any of the partners should this in mind, particularly when we see developments like employees and retirees elsewhere in the industry losing a significant portion of their benefits frequently without (inaudible).

From our perspective, the dramatic decline in interest rates that we are facing today was not reasonably foreseeable when we agreed to the pension funding relief plan in the fall of 2010. And (inaudible), we likely would have made different choices in light of today's prevailing interest rates.

Jo-Ann talked about a 1.2% drop in the discount rates between 2010 and 2011. The 2011 rate was 1.6% below the 10-year average before 2010. And Jo-Ann mentioned a 1% increase in the discount rate would reduce the solvency in the Canadian plan by about $450 million. Remember that our agreement with the province is based on the principle that the free emergence (inaudible) would be restored over 10 years.

Applying the rule rigidly in this never seen -- never before seen interest rate environment is inconsistent with the spirit of our negotiation with the providential governments and our employees, retirees and the unions and what we feel is the ultimate risk going forward. And all of you, by measuring a single frozen debt in the claim, the rules create unrealistic and unnecessary burdens that ignore historical trends. If we (inaudible) and ignore the facts that the true solvency conditions will rise and fall over the life of the funding obligation. Interest rates are currently at historical lows and they are likely to recover up to higher levels in the next few years.

Going forward, we will be working actively with all employee retirees, senior partners and the providential governments of Quebec and Ontario to find a reasonable solution that will ensure we need undertaking to retirees while giving us the pension funding ability we need to manage our business. As such, we will use all means and efforts available with key cash funding obligations, consistent with the principle of our agreement. And I mean a reasonable basic contribution of $50 million per year, plus up to $15 million based on free cash flow.

And with that, Operator, we would like to open the call for questions.

Thank you, Mr. Garneau. (Operator Instructions). Our first question is from Tarek Hamid of JPMorgan. Please go ahead.

Good morning. Could you talk a little bit more about the price increases in progress in coated paper and specialty papers? Sort of any color on the progress on those and should we expect to see some realization in the third quarter?

Well, there is some indication that here is some trends into the market and (inaudible) that it's only a part of the price increase announcement is going to be implemented. Generally, with the seasonal demand that is generally stronger in the third quarter, there is certainly reason to be optimistic on this side.

Thanks. Then I guess, just on the same segments, the cost performance was very impressive during the quarter, especially relative to the first quarter. Of the $40 a ton in coated, how much of that was just maintenance rolling off from the first quarter and how much of that was just lower raw materials?

Sorry, Jo-Ann. Most of it was as a result of the impact of the maintenance costs in Q1 versus (inaudible).

And then one last one for me. Just on the pension, assuming that legislation stayed the same and remains sort of unfairly punitive, what do you estimate the 2013 pension contribution would look like under that scenario?

Again, we are going to be working with our partners in Quebec and Ontario to keep our pension contribution a little bit higher in 2013, because I will reiterate we prepaid part of the 2012 contribution last year. That's worth $25 million. So, you'll see a $25 million increase in 2013 due to that. There is also potentially another $15 million based on solvency rates that will kick in under those plans in Canada with funding relief. And then, there'll be probably similar or slightly lower funding on the US plans based on the new legislation.

So, right there we're talking about $25 million because of the prefunding and $15 million due to other solvency issues on those plans. However, I'll reiterate, we have to negotiate with our partners to keep them at those levels based on the solvency ratio for 2011.

And what I would like to add, as I said, I think that the intent and the negotiation that we've had with the two providences, Quebec and Ontario, was a $50 million a year contribution plus another $15 million.

So, in our mind there is the -- really, we're going to work on it, on the assumption that it's a contribution that we're going to make and we believe that the interest rate eventually is going to go up. And as we mentioned during the call, that 1% is $450 million. So, it's -- the interest rate is at the level that is -- we believe is going to correct itself and we see no need to make a special contribution at this point. But obviously, with the agreement that we have, we have to talk to our partners and address the issues.

And I think that the other factor in this is that, as you have seen, there is companies that we compete with that have seen a reduction, a significant reduction of benefits and we believe that this also has to be taken into account. So, this agreement is over a 10-year period, but now we have to compete with a reduced obligation by a company in our segment that would have a -- what I would quantify as the kind of undue advantage on the cash side.

I appreciate the comments on a complex issue. Thank you.

Thank you. Our next question is from Stephen Atkinson of BMO Capital Markets. Please go ahead.

Thank you and good morning. Great results.

This may be a bit unfair question but, as you know, International Paper, for instance, took their contribution for next year's pension from $500 million down to $100 million and the reason is the passing of the highway bill in the US, which takes, should we say, a more realistic view of, should we say the -- calculating the solvency ratio. Do you know what your deficit would be using the new US standard?

Yes, we do. If we were to use the new US standard discount rate, the deficit for these same Canadian plans would be around zero.

Okay. Okay, I can calculate that one.

The second thing, I know that you've been doing a lot of work at Catawba shutting down the machine, the one machine included. Are you able to give me an idea of benefits or what was the impact last quarter?

On -- well, the machine was closed at the end of June, so we have no impact on the closure of the machine.

And I would like to comment on Canada. I think that, certainly, the decision to close or to stop the production, and we haven't decided what we're going to do with that, is an indication of our -- we're not satisfied -- even though the mill is a lower-cost mill, we're not satisfied with the EBITDA structure that we presently have. We're going, as I said, to work on manning reduction. We're going to seek the advantage of producing more mechanical pulp using (inaudible) power. But, the power rate is now 11% higher than last year. And because we now have the reservoir and storage capacity to produce the pulp, (inaudible) advantage.

The machine efficiency is also lower than our expectation. It's probably lower by 3 to 5 points. And I think that, focusing on the two machines, we're considering that we're going to be able to recapture a significant portion of the lost production on this machine. And overall, I think that by running with one machine less, we're going to be able to use more energy or more steam that is generated by the pulp mill and use less fossil fuel or coal or (inaudible) to generate steam. So overall, we expect that our costs are going to come down and that this mill is going to be more cost competitive going forward.

Okay. Oh, that's great. In terms of the share buyback where you acquired the, I guess, $11 million out of your $100 million program, is there any restriction in terms of timing or how many -- how much -- how many shares you can buy back?

Yes. Hi, Stephen, it's Jo-Ann. We are restricted during blackout periods or have been during this last blackout period. We're looking at ways so that we can continue to buy during blackout periods. Our plan cap is $100 million. So, whatever number of shares that we'll buy, that's our cap.

Okay. And a similar idea. On the debt retirement, yes, I've where you've basically retired the Fibrek debt. What about your debt? Are you -- how much can you do this year and next year without significant penalty?

We can do in October, starting October 4th, another $85 million for the next 12 months after October 4th.

Okay. And finally, on the lumber side, that shows really good result. Are you able to expand your lumber business? Do you have any opportunities to take advantage of, should we say better markets?

Well, I think that certainly we have this year the capacity to sell more, but I think that we also have to manage the chip, the residual chip size. So, I mentioned that the pulp mill in (inaudible) where we have a significant percentage of capacity, the fact that the pulp mill is going to have to take another five weeks of downtime to repair the (inaudible) there.

So, we'll have to monitor the situation. Not to avoid (inaudible), but chip advance rate is going to affect a production of 20 of our products going forward. So, it's unclear at this point how much that we'll be able to take advantage of it considering the situation that we have on the Saint-Felicien pulp mill.

How about the fiber deficit in Ontario, not that you have a big one, but can you do anything there like -- thinking of Thunder Bay?

Well, we are running at full capacity in Thunder Bay, so there is no -- in Ontario (inaudible) mill there was not much potential to increase production more. We're running already full.

Okay. Thanks a lot.

You're welcome.

Thank you. (Operator Instructions). Our next question is from Sean Steuart of TD Securities. Please go ahead.

Thanks. Good morning, everyone. A few questions.

Richard, I'm wondering if you can speak to North American uncoated ground wood markets. And I guess my question is, assuming Port Hawkesbury restarts, I guess either later this quarter or early in Q4, I know you don't have machines that compete in that SC grade specifically, but can you speak to expectations of substitution across the grade spectrum and how that might impact markets for some of the other uncoated ground wood grades you produce?

Well, I think that -- let's talk first, we have -- our machine at Kenogami produce the same grade as SC. And we're also using -- well, the SC plus and I would say SC minus at Laurentide. So obviously, the restart of Hawkesbury would certainly have an impact on the market.

When you look at the client demand at 24% compared to last year of 26%, obviously there is this grade shifting that we've seen in the first two quarters. But, I think that when you look at the third quarter it's seasonally stronger, as you know, and fourth quarter, also. So, we expect to see some improvement on this side. But, quite frankly, restart of the 350,000 or 400,000 tons machine, well, it's impossible not to have an impact on the market.

So, we're going to monitor the situation. And it is the reason that, frankly, that we're working on our costs to be really competitive on that side and we will continue to address it. And unfortunately, at this -- we don't know (inaudible) to restart it, but we're certainly going to continue to compete head on and continue to work on our costs and make sure that we're going to turn the -- I believe be able to serve our customers with the same dedication than let's say before the restart, if it happens.

Okay, thanks for that context. The next question, you mentioned that you don't expect to see any improvement in pulp markets, I guess, before year end. Can you give us a little bit of detail on what you're seeing in recycled fiber pulp markets for the two US Fibrek mills? And have we seen similar weakness there to what we've seen in softwood markets? And can you speak to, I guess, your intentions long term for those two assets?

So, those -- these two mills, I think that we were impressed by the asset quality. Obviously, the SOP, the paper that we use to feed the mills (inaudible) that supply is under pressure because of the decline in demand. But, we have decided to -- basically to apply the same strategy to sell only profitable tons, and have decided to slow down the production at these two mills to ensure that we supply the SOP that is closer to the mill and that we don't put undue pressure on SOP pricing.

So, I think that our intention going forward is to try to operate these two mills as efficiently as possible, to really -- to set the production level to -- set production level to be able to optimize the cost on SOP. And when you look at what could be done, I think that with this pulp, it's -- the demand for tissue user out there is very good and I think that it's going to continue to grow over time. So, as I said, our plan is to run them as efficiently as possible and apply the same approach on cost control that we have elsewhere in our network.

Okay. That's all I have. I'll get back in the queue. Thank you.

Thank you. Our next question is from Paul Quinn of RBC Capital Markets. Please go ahead.

Yes, thanks. Good morning. Terrific results on the cost side especially. Congratulations. Just a question on maintenance, if you could quantify the outage at SFK for Q3. And I think there's another pulp mill that you've got maintenance on for that. If you could give us an idea of what that's going to cost as well.

Well, I think the big one is the Saint-Felicien mill. I think that's what we have discovered, is that the precipitator there didn't have any maintenance for a number of years. And we have -- what we have to do is to change the electrodes in the precip in the thick steel. So, it's pretty significant work that takes time. And we have now sourced the electrodes and they're going to be replaced by -- well, it's going to be at the end of August or September. So, I think that it is the one that's going to be the most significant.

The other mill that we have maintenance is at Thunder Bay. So, I --.

No, Fort Frances.

At Fort Frances. Excuse me, at Fort Frances. And I don't have any of the costs at this point to -- it's probably going to be less than $1 million. It's not going to be that significant.

Okay, thanks. That's all I had.

Thank you.

Thank you. Our next question is from Michael Marczak of UBS. Please go ahead.

Hi. Thanks for taking my question. I guess just a question on the newsprint side. How does the closure of the Mersey mill affect your cost per ton in your newsprint segment?

Well, the -- I don't think that it's -- it's only going to bring the costs down overall because we know that in Nova Scotia the power cost is quite high and also [private] costs, so it's going -- that's only to bring our costs down. I cannot say how much because -- on the percentages, but it's not going to be that significant overall. This mill had a capacity of about 250,000 tons on more than 3 million tons of capacity. So, on a weighted average it's going to be a few dollars.

Got it. And then maybe on your outlook on coated paper. I think last year you seemed a little more pessimistic on the seasonal recovery and, sure enough, second half was -- on a volume, I guess, basis -- unchanged from first. I guess can you compare and contrast what you are seeing from your kind of customers' order pattern this year versus last year? And then, when you talk about seasonal improvement, is it going to be a matter of better mix, an improvement in volumes or potentially both? Thank you.

Well, the third and fourth quarter, especially the third, normally what you see, you see the retailers spending more money on flyers and advertising material. So, I think that we're cautiously optimistic. I think that on coated and mechanical -- we're more optimistic on coated and mechanical. I think we've have -- (inaudible) is relatively strong. And the question is, are we going to see the continued grade shifting to newsprint.

So, I think that obviously there is the impact of consumer of spending less, of the impact of the US economy, well, seeming to be heading into a very, very, very small growth is having an impact. So, quite frankly, difficult, very difficult to forecast what's going to happen. We are certainly going to monitor the situation. I think that what we have been doing is really look at what we can control and hopefully continue to show a good result.

Thank you. And then, generally on inflation, do you think, given the run up in costs end of last year and beginning of this year across your various -- particularly in coated paper, I guess, but across the various segments, that the inflation will be a tailwind going into the second half for you guys?

Well, the -- on the chemical side, again, it's difficult. I think you have to look at the chemical (inaudible) and the titanium and you have to look at the (inaudible). So, the coated part of the cost increase that we've had, it's really on the chemical side and the change in [basis weight] where you had more chemical by weight, when your big sheet is -- you put less pulp and more of the costly chemical. I think that, certainly, when you look at energy, we should get -- should be better in the third quarter if gas is competitive. And I think that when you look at oil, it's coming down, it's more competitive. Again, it's because of the economy. So, there's probably some relief that we're going to see on this point, but very, very difficult to put that -- to forecast a trend on the cost side.

Got it. Thank you very much. Good luck in the quarter.

Thank you. There are no further questions registered at this time. I would like to turn the meeting back over to Mr. Lalonde.

Great. Well, thank you, everyone, for joining us today.

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