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Mercer International (NASDAQ:MERC)

Q2 2013 Earnings Call

August 02, 2013 10:00 am ET

Executives

David M. Gandossi - Chief Financial Officer, Principal Accounting Officer, Executive Vice President of Finance and Secretary

Jimmy S. H. Lee - Chairman, Chief Executive Officer, President, Member of Environmental, Health & Safety Committee and President of Merc Acquisition

Analysts

Bruce Klein - Crédit Suisse AG, Research Division

Bill Hoffman - RBC Capital Markets, LLC, Research Division

Andrew Evan Shapiro - Lawndale Capital Management

Mark Kennedy - CIBC World Markets Inc., Research Division

George Berman

Paul C. Quinn - RBC Capital Markets, LLC, Research Division

Operator

Good morning, and welcome to Mercer International's Second Quarter 2013 Earnings Conference Call. On the call today are Jimmy Lee, President and Chief Executive Officer of Mercer International; and David Gandossi, Executive Vice President, Chief Financial Officer and Secretary. I will now hand the call over to David Gandossi.

David M. Gandossi

Thank you, Jay. As usual, we'll begin with formal remarks, after which we'll take questions. For Safe Harbor, please note that in this morning's conference call, we will make forward-looking statements 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 with the company's filings with the Securities and Exchange Commission.

I'll start by covering some of the financial key aspects of the quarter and then I'll pass the call to Jimmy. Relative to the first quarter, average NBSK pricing was up marginally in all markets. Demand was steady overall, with a slight increase in European demand. Relative to Q1, sales were up approximately 12,000 tonnes. However, our Q2 results were negatively impacted by Celgar's annual maintenance shut which was planned for 11 days, but took 15 days due to a lightning strike at the mill, and other equipment and execution related issues. The shutdown and the slow start-up resulted in a loss of approximately 30,000 tonnes, roughly 14,000 tonnes of which were unplanned.

Apart from the Celgar restart, the mills ran recently well in the quarter and our sales outpaced production, resulting in finished goods inventory of being down approximately 19,000 tonnes relative to Q1. Pulp prices remained lower than expected when current market metrics are considered. We did see some positive pricing momentum in Q2, with quarterly average prices up over USD 20 per tonne in Europe and China. List prices at the end of the quarter at USD 860 per tonne in Europe, USD 690 per tonne in China. German fiber prices rose this quarter due to strong demand from pellet and board producers in sawmills while harvesting has been impaired by adverse weather conditions.

As you will have seen in our press release, we reported a net loss of EUR 9.9 million for the quarter, or a loss of EUR 0.18 per basic share, compared to a net loss of EUR 0.4 million or a loss of EUR 0.01 per basic share in Q1. For Q2 2013, net loss includes a gain of approximately EUR 5.3 million related to noncash gains on the mark-to-market valuation of our fixed interest rate swap, offset by a small loss in our pulp swaps. Before these items, basic earnings per share was a loss of EUR 0.28 per share.

We recorded quarterly EBITDA of EUR 14 million, or approximately USD 18.3 million. This compares to EUR 24.3 million or about USD 32.1 million in Q1. The most significant impacts on our EBITDA this quarter were Celgar's annual maintenance shut and subsequent slow startup and higher German fiber costs. Partially offsetting these negative impacts were slightly improved pricing and increased sales volumes. The US GAAP-IFRS differences relating to major maintenance have an important impact on our quarter when comparing our results to those of many of our competitors. In Q2, we expensed approximately EUR 8 million for major maintenance, the majority of which would've been eligible for capital treatment under IFRS.

Switching to cash flow. Overall, our cash position is almost EUR 24 million higher than at the end of Q1, sitting at approximately EUR 134 million or approximately USD 174 million. Quarterly working capital movements increased cash by EUR 16.6 million on a net basis, primarily due to decreases in receivables and finished goods inventories. Capital expenditures drew approximately EUR 11 million during the quarter. Of this total, approximately EUR 8 million was spent on Stendal's Blue Mill Project, while the remaining EUR 3 million was spent on high return capital projects at Rosenthal and Celgar. On the financing side, the Blue Mill facility is now fully drawn, with the last EUR 7 million drawn in the quarter. Stendal also received EUR 3.4 million of government grants for the Blue Mill Project in Q2, bringing the total grants received to date to EUR 4.1 million. The mill expects to receive approximately EUR 8 million of additional grants for this project.

Finally, we drew almost EUR 7 million on our revolvers this quarter. These revolvers were fully repaid in July. Our working capital movements in the 12-month period ended June 30, excluding cash and short-term debt, decreased by approximately EUR 9 million, with working capital down from EUR 134 million at the end of Q2 2012. The decrease was primarily due to lower inventory and receivables, partially offset by lower payables.

In terms of our liquidity, at June 30 we had approximately EUR 17.7 million of undrawn revolvers available at Rosenthal, and approximately CAD 17.6 million available at Celgar. Subsequent to the quarter, we added to our liquidity by issuing a USD 50 million principal amount of our senior notes. These notes were priced at USD 104.5 plus accrued interest from June 1st. The net proceeds from this offering were used to repay our revolving credit facilities in July and for general corporate purposes.

During the quarter, Celgar extended its credit facility to May 2016 on more favorable terms to EUR 134 million of cash at June 30. It is comprised of approximately EUR 69 million for the restricted group, and EUR 65 million for Stendal. Net debt to equity on a consolidated basis at June 30 is up slightly from Q1 at approximately 2.3x equity, while the restricted group's net debt to equity was essentially unchanged at approximately 0.5x equity.

In July, we also announced the workforce reduction at the Celgar Mill. We will reduce the workforce by approximately 85 employees, with the majority leaving over the next 12 months. We estimate we will incur pre-tax charges of between USD 6 million and USD 8 million. We have not recognized any restructuring costs in Q2, but we expect to recognize a majority of these charges by the end of 2013. We currently estimate that this workforce reduction will realize between USD 8 million and USD 10 million annually, with about 80% of those annual savings being realized in 2017 -- 2014, rather.

Finally, as reported in our press release, we've had discussions with the agent bank for the lenders under Stendal's loan facilities for the purpose of obtaining a satisfactory amendment of the leverage and debt coverage ratios. We have agreed with the agent bank on a non-binding term sheet, which will provide the mill with greater covenant flexibility. And the agent bank has been engaged to seek lender approval for this term sheet. Pursuant to the term sheet, we have agreed to invest USD 20 million as additional capital in Stendal. Subsequent to entering into the term sheet, the agent bank has confirmed that the lenders have agreed to have the 2 ratios covering the trailing 12-month period ending September 30, 2013 instead of June 30, 2013, and the Stendal mill must now report on its compliance with the September 30 ratios on November 15, 2013. The change in the covenant measurement date has been put in place to allow the various lenders enough time to properly review the term sheet, and as such, we will continue to pursue the term sheet with the lenders. We believe we will be able to include a -- conclude a satisfactory amendment in the third quarter.

So then, that ends my overview of the financial side. And I'll turn the call over to Jimmy.

Jimmy S. H. Lee

Thanks, David. Good morning, everyone. Overall, our second quarter results were disappointing, driven primarily by unplanned downtime, which led to higher costs and also negatively affected our electricity and chemicals sales. However, we're encouraged by the modest pricing momentum experienced in the second quarter.

Despite lower energy and chemical sales, our byproduct revenue exceeded our interest expense on a consolidated basis by approximately EUR 3 million in Q2. Our quarterly byproduct sales continued to exceed quarterly debt carrying charges in both the restricted and unrestricted groups. In the second quarter, average NBSK list prices rose in all markets, with the European quarterly average list price rising USD 25 to USD 857 per tonne, and the Chinese quarterly average list price rising USD 22 to USD 700 per tonne. June NBSK produced inventories are at 28 days, down 1 day from March. At these inventory levels, the NBSK market is considered to be imbalanced and historically led to price increases. June hardwood pulp inventories are also down 1 day from March, at 40 days, which is also considered to be imbalanced. We believe these inventory levels highlight the continuing improvement of the NBSK pulp market.

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

Turning to our production, Celgar and Stendal both experienced some unplanned downtime this quarter. However, Rosenthal continued to benefit from its 2012 recovery boiler upgrade, achieving near record production this quarter. In total, we produced approximately 350,000 tonnes of pulp this quarter, compared to approximately 361,000 tonnes in the first quarter and approximately 365,000 tonnes in the second quarter of 2012. Our queue production was broken down as follows: Stendhal produced 158,000 tonnes; Celgar produced 100,000 tonnes; and Rosenthal produced 92,000 tonnes. In addition, the mills produced approximately 406 gigawatt hours of electricity in the quarter, compared to 424 gigawatt hours in Q1 and 425 gigawatt hours in Q2 of 2012. Our pulp sales volume totaled approximately 368,000 tonnes in Q2 compared to 357,000 tonnes in the first quarter of last year and 349,000 tonnes in Q2 of 2012. In the first half of 2013, NBSK demand from China was down approximately 10% compared to the same period last year. However, we believe that the Chinese markets will continue to grow at or near its historic rates. And that additional demand will come from other growing economies in the medium- to long-term as consumers increase their use of tissue-based products. To meet this expected demand, many of our customers have announced significant investments in new paper and tissue capacity. For example, 2 large tissue producers have publicly announced investment plans, that when combined will add another total of 50 tissue machines at various sites by the end of 2015. These announced machines equate to approximately 2.3 million tonnes of incremental tissue capacity. As I noted earlier, some of these new tissue machines are scheduled to come online in the second half of 2013.

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

In British Columbia, our fiber costs were down slightly in Q2 relative to the first quarter, primarily due to strong saw milling activity in Celgar's fiber basket. We expect that Celgar's fiber cost will continue to decrease moderately through Q3 and Q4. We're currently satisfied with Celgar's fiber inventories, but of course, we'll also monitor them closely. I'm pleased to note that our Blue Mill Project remains on schedule and on budget. We're looking forward to getting the incremental 30,000 tonnes of pulp capacity and new 40-megawatt turbine online at the end of Q3.

Our total investment in this project will be approximately EUR 40 million, both with EUR 12 million that is coming in the form of nonrefundable government grants. Overall, we're anticipating this project will pay for itself in about 12 -- in about 2 months -- 2 years. We regularly get questions about the timing of our annual maintenance shuts, so I'd like to highlight that our remaining 2013 shuts will be Rosenthal in Q3 and Stendal in Q4.

With respect to our NAFTA claim, we continue to work with our advisors to move this process forward. Based on our current schedule, we expect our case to be heard in mid to late 2014, with a decision several months after that. We'll continue to provide updates as we move through this process.

As David noted, Stendal's currently working with its lending banks to amend its debt covenants. I want to stress that Stendal is not facing a liquidity issue. At June 30, they had roughly EUR 65 million liquidity and fully expect to meet all of their obligations. We have presented to lenders with an amendment proposal for the covenant that will give Stendal more flexibility, but we believe will also provide the lenders the tools that they need to monitor their investment. We expect we'll be able to conclude a satisfactory amendment in the third quarter.

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

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

If I can close with a few observations. NBSK market continues to be sluggish relative to market matrix. Statistically speaking, the market is in good balance, based on producer inventory levels. And consumer inventory levels are also low. So we remain optimistic that the pulp market will continue to strengthen despite the incremental Russian production that was new to the market in Q2.

We believe that NBSK prices may decline slightly in the short term. But by the end of Q3, will begin to slowly climb and we expect that we'll continue to gain positive momentum through Q4. We're also continued to be very optimistic about the medium- to long-term NBSK supply demand fundamentals, which we foresee as being driven by the increasing economic standards of the emerging markets. That is the conclusion of my prepared remarks. And I will turn the call back to the operator so we can open up the call for questions. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Bruce Klein with Crédit Suisse.

Bruce Klein - Crédit Suisse AG, Research Division

Can you just -- the pulp markets in terms of your latest take on the harbor capacity in South America. I know that it's been a recurring issue, but it's kind of coming in a lumpy way and a larger way. And I'm wondering if you have any additional thoughts on how that impacts NBSK.

Jimmy S. H. Lee

Well, of course, there's been a lot written up in terms of forecast because of the significant amount of hardwood. Of course, capacity coming online this year and next year in South America, that this will have a big impact in terms of softwood prices. But if you look back historically, and this was some studies which were done by some of the research firms, there seems to be clearly no correlation between large startups that have occurred in prior years in South America with actual NBSK price developments. Although I see the psychological kind of reasons or kind of inferred reasons why there should be maybe some softening in terms of NBSK prices but statistically, historic data does not actually correlate to that. And so, if you're looking at, really, what history teaches us, really, there is nothing that kind of directly correlates. In fact, hardwood price to softwood or NBSK priced gaps have been significant over extended periods of time. Today of course, that gap is very small. In fact, in some areas it probably doesn't exist. And so, we still feel very optimistic that we will continue seeing maybe a disconnect between hardwood and softwood prices, although capacity, clearly, is increasing in South America.

Bruce Klein - Crédit Suisse AG, Research Division

Is the substitutability, has that -- I know, historically, I guess, it hasn't had a big impact, but there is something in the change in the efficiency or technology that might make the substitutability easier than harder in prior cycles that you're aware of?

Jimmy S. H. Lee

Well, I mean, there's always been incremental technology advancements that, of course, has reduced amount of softwood in more of the traditional areas. But this has been an ongoing development. So it's not -- there's no new technology that I'm aware of that suddenly everybody is using that will have such a significant impact to change what we've seen historically. In fact, the trend is for more softwood using capacity come online in terms of tissue. But then in the past, the expansions in the past has been primarily more publishing grades which, of course, there's been a lot of old machines which, of course, have been taken out, and new machines which use less softwood. So that has been, of course, a big influence in terms of the development of the softwood. But the developments in terms of paper capacity, moving forward, tends to be a little bit more favorable, I think, to softwood consumption than in the past. So that's why, clearly, I don't necessarily buy in, really, to the analysts' projections. I feel what's happening today is really more of an inventory-led sluggishness. You do have credit pressures, clearly, in Europe. Credit pressures in China. We didn't see this kind of speculator type of buying coming out of China early part of this year which traditionally happens and this kind of kicks up really the price developments. You're not getting really a large speculative component of the buying that traditionally kind of influence the early development of the recovery. And that's why it's kind of muted. Yes, it's disappointing. But I guess it's really driven more financial reasons rather than supply and demand kind of reasons.

David M. Gandossi

And Bruce, this is Dave here. I just want to pick up on a point Jimmy made earlier. If you look at hardwood capacity additions, you just need to look back to 2010. There were 2 large mills that came online. Rizhao [ph] was one of them. There was -- hardwood prices were under pressure and softwood prices kept going up. And for a period of time there, for 5 or 6 quarters, spot softwood prices were USD 200 north of hardwood. So that's really clear evidence, in our minds, that the substitution reversal sort of maxed out, and the paper makers were purchasing the softwood for its strength characteristics. And they really didn't have an option to default to the cheaper, overly abundant hardwood. And I haven't seen anything from a technological development point of view that's going to change that. So it's -- when the prices of hardwood and softwood are the same as they are today, there's some substitution in the opposite direction. Obviously, guys will use more softwood because they can run their machines faster, they get a better sheet, stronger, better performance and all that. I get it. But as soon as that softwood supply continues to fall short of the new demand that's coming, that 1 million tonnes of tissue in the back half of this year, guys are going to have to chase it. And I don't see any reason why the price wouldn't start to separate relative to hardwood.

Bruce Klein - Crédit Suisse AG, Research Division

Thanks for the color. And lastly, just Celgar, how's it running -- I know everyone had a tough quarter but how's the performance in there or the metrics there?

Jimmy S. H. Lee

Surprisingly, Celgar is running very, very well. In fact, it's probably running much better than it has in the last recent quarters. So we're very pleased with that development.

Operator

Next question comes from the line of Bill Hoffman with RBC Capital Markets.

Bill Hoffman - RBC Capital Markets, LLC, Research Division

Jimmy, before you had looked at Celgar as potentially converting to -- having some additional flexibility there to make specialty grades of pulp, do you want to -- are you going to talk about sort of where your thoughts are in that right now?

Jimmy S. H. Lee

Yes, I mean our studies clearly indicated that, that strategy for us didn't really make a lot of sense. I think there was inherent risks from what we felt, moving forward, in terms of the developments of not just the demand side but also the potential supply-side with recent technologies that clearly were available. And as these recent developments, in terms of technology, advances further, as you know, traditionally it's very difficult to convert a continuous digester into dissolving grade because of this -- the inherent problem of going from an acidic type of media to an alkali type of media, and the inherent problems with that. We know that there's been several technologies which, of course, seems to have dealt with that problem. And of course, as certain facilities which have adopted that continue to, of course, iron out those problems that they're presently experiencing. I think that this technology will have a significant impact in terms of potential developments from the supply side. As you know, there's a significant amount of large capacity with continuous digesters on the hardwood side, which are very modern. And so it doesn't really require a lot of new capital investments to ship some of that into the commodity and the dissolving. Now, the specialty end is different. But of course, that's a much smaller market. It's technically very difficult. It takes a long time before you can get customer acceptance. So for us, that didn't really make a lot of sense. I mean, of course, we'd love to be in the specialty grade. But there's a lot of challenges as you know from a strict kraft-based pulping to the more premium grade of the dissolving. So, all in all, those kind of assessments made us feel less confident in terms of the potential strategy. And that's why we decided that didn't make sense for us.

Bill Hoffman - RBC Capital Markets, LLC, Research Division

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

Jimmy S. H. Lee

I think you'll see further progress in terms of our byproduct income strength. There's a few areas that, of course, we believe there's potentially better margin capture. So we will be focusing on those areas, on areas that we already produced but we can get incremental margin benefits from upgrading those. And without significant investment, there's some additional efficiencies. Clearly, we can also obtain from some other smaller investments. So those are really more of the programs.

Bill Hoffman - RBC Capital Markets, LLC, Research Division

Thanks. And then just a question for David. You obviously drew down some more of your inventory in the quarter. Do you feel like they're a good inventory level, or do you have to try to rebuild here a little bit in the back half of the year?

David M. Gandossi

Well, we really don't need to rebuild, Bill. It's -- we produce and we sell. And there's a minimum inventory level that each mill needs to keep an eye on so that you could continue to service your customers reliably. I don't think we've sunk below that. So I -- we'll just keep trucking along here.

Jimmy S. H. Lee

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

Operator

The next question comes from Andrew Shapiro with Lawndale.

Andrew Evan Shapiro - Lawndale Capital Management

Regarding the lost EBITDA from the Celgar maintenance shut and complications, could you clarify, was the EUR 11 million reduction for a total shut or just the unexpected portion?

David M. Gandossi

That's in total.

Andrew Evan Shapiro - Lawndale Capital Management

Okay. And of the EUR 11 million, is this pulp only or is it lost energy and chemical revenue in that number as well?

David M. Gandossi

We're talking the cost of maintenance and the impact on fixed cost absorption.

Andrew Evan Shapiro - Lawndale Capital Management

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

David M. Gandossi

That's true.

Andrew Evan Shapiro - Lawndale Capital Management

Okay. Any thought or estimate on incremental costs?

David M. Gandossi

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

Andrew Evan Shapiro - Lawndale Capital Management

Okay. But it's more than just the number you gave them in terms of this, we'll call it, nonrecurring hit?

David M. Gandossi

Yes, but in order of magnitude, it's not huge. Like, I mean, if I was going to put a number out there, you could say the impact on energy revenue, it should be above EUR 500,000. Possibly incremental chemical costs on start up and shutdown would be EUR 0.5 million, that kind of thing. And then there's -- there would be some incremental energy usage as well, when you're not -- when you're starting up but it's not material.

Andrew Evan Shapiro - Lawndale Capital Management

Okay, so it's not as meaningful. In what month has -- or will Rosenthal do the maintenance this quarter?

David M. Gandossi

In September.

Andrew Evan Shapiro - Lawndale Capital Management

Okay, so it hasn't started yet. All right.

David M. Gandossi

I should just point out, Andy, and thanks for raising the question. I know you didn't -- It is a significantly lower maintenance cost at that mill than it is at the Canadian mill. So it's almost a quarter of the direct maintenance dollars to do a revision at Rosenthal compared to Celgar.

Andrew Evan Shapiro - Lawndale Capital Management

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

Jimmy S. H. Lee

Yes, I know it does.

David M. Gandossi

Typically, that's the way. Yes.

Andrew Evan Shapiro - Lawndale Capital Management

Great. Now did you provide -- you provided production by mill. Did you provide sales by mill as well in your script? And if so, I can pick it up later.

David M. Gandossi

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

Andrew Evan Shapiro - Lawndale Capital Management

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

Jimmy S. H. Lee

We're increasing our production.

David M. Gandossi

Yes, well, there's a lot of moving parts, obviously, in that question. But a lot of it has a to do with timing. You have to look at the sales pattern in the first quarter as well, which was, we had a very high level of receivables just at the end of the first quarter that flowed through. And we're increasing production in the second quarter. So I mean...

Jimmy S. H. Lee

The working capital movement will depend a lot in terms of the shipments out of Celgar, because it relies a lot on both carriers. And so, of course, there's major shipments that go out kind of lumpy unlike the German mills which, of course, are more closer customers and go out by trucks. So it's more regular. So quarter by quarter, it's difficult to estimate because, of course, you're going to get timing of the both carrier going out at different periods within the quarter.

Andrew Evan Shapiro - Lawndale Capital Management

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

David M. Gandossi

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

Andrew Evan Shapiro - Lawndale Capital Management

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

David M. Gandossi

It will be a separate line.

Andrew Evan Shapiro - Lawndale Capital Management

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

David M. Gandossi

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

Andrew Evan Shapiro - Lawndale Capital Management

Okay. And how much -- what is the timing of your expected receipt of the remaining grant money for Stendal?

Jimmy S. H. Lee

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

Andrew Evan Shapiro - Lawndale Capital Management

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

David M. Gandossi

Yes, that's right. Yes. As you may know, tall oil prices have gone up dramatically over the years. And we have always had a program where we produce the crude tall oil in a plant at Stendal. And in fact, we used to ship Rosenthal's soap to Stendal where it was processed. As we got better at recovering soap out of the liquor, the Stendal tall oil plant's at capacity. So the board has approved a high return project to install another plant at Rosenthal. It's not a huge capital spend. It's something in the order of EUR 2.5 million, but pretty good payback. It's one of these chemical byproduct opportunities that Jimmy was referring to earlier.

Andrew Evan Shapiro - Lawndale Capital Management

And what's the timing of this investment, and the expected payback once you've got it up and running?

David M. Gandossi

Well, the engineering is just nearing completion. So I don't have a construction schedule for you yet. But it will be...

Jimmy S. H. Lee

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

Andrew Evan Shapiro - Lawndale Capital Management

Right. And then what you're -- when you looked that this, what's your expected payback on the EUR 2.5 million investment?

David M. Gandossi

Well, at today's pricing, it will be 2.5 years to 3 years.

Andrew Evan Shapiro - Lawndale Capital Management

Good high return, okay. One -- or 2 other general industry questions. Do you have any better visibility or comments on the paper producers' deintegration? Are you seeing more paper capacity come out and create further headwinds? Is it a status quo situation? Or is it a tailwind yet or visibility on the tailwind where some paper facility...

Jimmy S. H. Lee

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

Andrew Evan Shapiro - Lawndale Capital Management

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

Jimmy S. H. Lee

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

Andrew Evan Shapiro - Lawndale Capital Management

There was some -- there are some softwood like Terrace Bay, there's others where they're...

Jimmy S. H. Lee

No, no, no. Terrace Bay's plant is at least 2 to 3 years away from converting into dissolving grade. They announced closures of the smaller ones. Yes, there has been -- one of the lines, the Domtar's Kamloops mill, would shut down, which is a sawdust based facility. I think it was around 150,000 tonnes or so, that shut down. There was another very small one in the eastern part of Canada, I think, shut down. So, yes, I mean, from an incremental decline, I think, there was something like in the order of about 300,000 tonnes of small line closures, offset, of course, by the incremental increase of about roughly $0.5 million tonnes at Ilim. Of course, that is at full capacity. It's like any start up, it's going through the incremental kind of startup curve, so it's nowhere close to its full capacity at this stage, and likely won't be at least for another year or so if it follows the traditional kind of path.

Andrew Evan Shapiro - Lawndale Capital Management

Right. Now, you mentioned that fiber costs were expected to marginally increase in Germany and decrease moderately in Canada. Can you just clarify what you mean in the difference between those 2 words? Which is the greater adjective?

David M. Gandossi

It's a hard thing to quantify and we're looking in the future as well in your question so it's a bit of a guess. But, I mean, to put things in perspective, the increase in the fiber cost that we discussed here, the reason our queue, that if you compare the first 6 months of this year to the first 6 months of last year, fiber costs, on average, have gone up 2% in the 6-month period. So, I mean, it's -- we're directionally giving you an indication. And we're not expecting significant increases from this point forward like we've been through the lift that Jimmy mentioned, it has mostly to do with logistics. Getting through the winter and the floods and all that kind of stuff. And we're expecting that to moderate and stabilize. And then we're certainly focused on doing everything we can to push those down. And in Celgar, it's just generally a good story, in the sense that the lumber guys are running hard and they're making money. And there tends to be some abundance of fiber that gives us an opportunity to continue to put downward pressure on fiber costs.

Andrew Evan Shapiro - Lawndale Capital Management

What are your planned roadshows and conferences? And then I'm out of the queue here.

David M. Gandossi

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

Operator

[Operator Instructions] The next question comes from Mark Kennedy with CIBC.

Mark Kennedy - CIBC World Markets Inc., Research Division

Dave, just a question on the term sheet negotiations with your Stendal lenders. I'm just trying to understand what you're looking to accomplish there. Is it a change in your coverage ratios, or just a waiver of them? Like a one-time waiver?

David M. Gandossi

Yes. We're really looking to make a change, Mark. These ratios were put in some time ago at a time when there was a global crisis happening in 2009. And today, don't make a lot of sense. So we always described -- we got a covenant problem, we don't have a liquidity problem. When you have a EBITDA covenant in a cyclical business, if when you say total debt to EBITDA can't go above x, what does that mean? You got EUR 65 million of liquidity in the system. We don't have any default risks or any of that kind of stuff. We've got all this cash in the balance sheet. So things like changing the definition of total debt to EBITDA to be net debt to EBITDA, for example, giving us credit for cash that we have in the calculation. So it's just really, it's just window dressing covenants to give us the flexibility and the headroom that we need so that we don't have to announce to the market every quarter that we've got a potential covenant default then we've fixed it. And we've done it 3 times now. And -- but it also is an early warning signal for the banks, which is what they need. So it's covenants for that middle ground where the company is not at risk. And it's got flexibility but the banks have an early warning signal. So we've negotiated that with the lead bank. We've got a signed mandate letter with them. We've been engaged with the other banks through meetings and the diligence and so on. They've given us -- they've consented to changing the calculation timing to give us some more time. It's difficult to get these things done over the summer months, as you might guess. So all in all, it's been a very productive process. And we're confident that it's not going to impact things, other than take 1 month or 2 to get it resolved.

Mark Kennedy - CIBC World Markets Inc., Research Division

So from a timing point of view, you're hoping by the time you report Q3 numbers, you'll have it put to bed then?

David M. Gandossi

Yes. We'll have a pretty good idea by then. Yes.

Operator

Next question comes from George Berman with J.P. Turner and Company.

George Berman

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

Jimmy S. H. Lee

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

George Berman

Right. I remember a couple of years ago, coming out of recession, you guys were almost printing money at 950, 980 a thousand. And now we're almost there again and there's not much left.

Jimmy S. H. Lee

Yes, that's because if you look at the U.S., the discounts have increased quite significantly. You see the 20s percents. While in China, you're looking at discounts more on like the 3 type of percent, but used to be 0.

George Berman

And that's sort of the industry standard now and it just keeps on going, no?

Jimmy S. H. Lee

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

David M. Gandossi

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

George Berman

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

Jimmy S. H. Lee

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

David M. Gandossi

And then on the fixed cost rate production we're doing at Celgar is it links into the concept that as the older guys take their early retirement packages and you have the average age of the mill drops, this younger generation is much more open and their thinking flexible in terms of the way they approach things. So we're -- a big part of what we're doing at Celgar is trying to get to the root cause that prevent us from doing some of these more compressive things.

George Berman

Okay. And any thought of maybe changing the reporting from Euros to U.S.?

Jimmy S. H. Lee

Yes. I mean, there's been discussion on a topic with, of course, one of the biggest risk in the past was this kind of sudden kind of movement in currency essentially having a very adverse impact on the equity -- shareholders equity part. So, now with our equity position a little bit more built up and the likelihood of extreme volatility being a little bit less, I think there is clearly some thoughts as to changing the reported currency.

Operator

[Operator Instructions] The next question comes from Paul Quinn with RBC Capital Markets.

Paul C. Quinn - RBC Capital Markets, LLC, Research Division

I understand Celgar's shutting down your Tofte mill in the summer in August here and then -- but also increasing capacity at the rural mill. Would you expect that the -- the impact from pricing, specifically in Europe, will be on NBSK pulp?

Jimmy S. H. Lee

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

Paul C. Quinn - RBC Capital Markets, LLC, Research Division

Okay. And then my understanding is on the Ilim's start up, they're obviously commissioning and stirring up, ramping up the new line. But my understanding is the existing line is still running. Is your information the same?

Jimmy S. H. Lee

Yes. That's planned.

David M. Gandossi

Yes. I think they're planning to take it down in the fourth quarter, it's what we've heard.

Paul C. Quinn - RBC Capital Markets, LLC, Research Division

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

Jimmy S. H. Lee

Well, we have seen this in prior periods. We've had several of these kind of dislocations as a result of climate problems, especially in the winter. So if you look back, we've had prior kind of cycles where we had price increase of the fiber going up about where we are, or going to and then gradually again coming down as the seasons or the climate becomes more kind of normal. So if you do look at our fiber costs over the last 5 years, and you correlate that to adverse winter conditions and the impact to the balance of the year and then the subsequent years, you'll see that is the case. So that's -- we don't particularly believe there's any reason to believe otherwise in this case.

Operator

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

Jimmy S. H. Lee

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

Operator

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

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