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Mercer International (NASDAQ:MERC)

Q2 2010 Earnings Call

August 4, 2010 10:00 a.m. ET

Executives

Alexandra Tramont – Financial Dynamics (FD)

David Gandossi – Executive Vice President and Chief Financial Officer and Secretary

Jimmy Lee – President and Chairman

Analysts

Bill Hoffman – RBC Capital Markets

Amil Schiaffino – Cantor Fitzgerald

Richard Kus - Jefferies

Andrew Shapiro – Lawndale Capital

Peter Ehret - Invesco

DeForest Hinman – Walthausen & Company

Jonathan [unintelligible] - CIVC

Christopher S. Dechiario - ISI Capital

Rick Sherman – Oppenheimer

Phillip Wirtz – Odeon Capital Group

[unintelligible] Goldman - Catalyst

David Shapiro – Aegis Financial

Paul Quinn - RBC Capital Markets

Sven Karlen - Wells Fargo Advisors

Scott [unintelligible] - Lawndale Capital

Operator

At this time I would like to welcome everyone to the Mercer International second quarter 2010 earnings conference call. [Operator instructions.] I would now like to turn the call over to Ms. Alexandra Tramont of FD. Ma’am, you may begin your conference.

Alexandra Tramont – Financial Dynamics (FD)

Good morning and welcome to the Mercer International 2010 second quarter earnings conference call. Management will begin with formal remarks after which we will take your questions.

Please note that in this morning’s conference call, management will make forward looking statements that were made in the press release. According to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, I would like to call your attention to the risks related to these statements, which are more fully described in the press release and with the company’s filings with the Securities and Exchange Commission.

Joining us from management on today’s call are Jimmy Lee, President and Chairman; and David Gandossi, Executive Vice President and Chief Financial Officer and Secretary. Now I will turn the call over to David Gandossi. Please go ahead.

David Gandossi

Thanks Alex, and welcome everyone to Mercer’s second quarter earnings conference call. I’ll begin with some prepared comments on the key financial aspects of the quarter and then I’ll pass the call to Jimmy, who will speak about the particulars of the markets, our operating performance, and some of our strategic initiatives. As always, we’ll be pleased to answer any questions you may have following our remarks.

Let me begin with a few comments about our financial performance. As expected, our second quarter was very strong, both financially and operationally. The pulp market tightened nicely and operationally all our mills ran at or near record production levels, after giving consideration for the scheduled maintenance shut at Celgar in the quarter. We also benefitted from both significant price increases, driven by the tightness of the market, and the euro’s considerable weakness relative to the U.S. dollar.

As you will have seen in our press release, we reported a net income of EUR12.4 million for the quarter, or EUR.34 per share, compared to a net loss of EUR11.5 million or EUR.32 per share in the same quarter in 2009. The net income includes EUR13.8 million of expenses related to our mark-to-market valuations on our fixed interest rate swap and U.S. dollar-denominated debt. Were it not for these non-cash items, EPS would have been EUR.72 per share.

We recorded our highest quarterly EBDA in the company’s history, at EUR62.1 million. This compares to EUR31.8 million in the first quarter of 2010. In U.S. dollar equivalents, this is about $79 million of EBDA in the current quarter, compared to about $44 million in Q1. The most significant contributors to the increase in EBDA were the improvement in pulp pricing and a weaker euro, which were partially offset by the impact of higher fiber prices in Germany.

We also completed a planned maintenance shut at Celgar during the quarter. The shut itself lasted 12 days and positions the mill to run full for about 12 months before its next major maintenance shut.

Switching to cash flow, overall our cash position is EUR13 million higher than that at the end of Q1. Inflows were dominated by EUR62 million from EBDA, EUR6 million of additional borrowing at Celgar to manage timing differences between payments for the green energy project and receipt of the Canadian government’s Green Transformation Fund grants.

The strong EBDA, however, does not immediately translate into cash flow, since some of our higher sales funds higher levels of accounts receivable and wood inventories. Working capital increases drew on cash by about EUR30 million, and capital expenditures drew about EUR15 million.

It’s important to note that about EUR13 million of the EUR15 million in capital expenditures is in respect to the green energy project. We have pre-funded a portion of this amount and funding from the Canadian government will come in accordance with the Green Transformation program in Q4. We have EUR26 million of undrawn revolvers available at Rosenthal and EUR6 million available at Celgar. We currently have cash of about EUR62 million, which is comprised of approximately EUR39 million for the restricted group, and EUR23 million at Stendal.

So with that quick overview of the financials, let me turn the call over to Jimmy to talk about our operational market and strategic developments.

Jimmy Lee

Thanks David. Good morning everyone. As David mentioned, we are very pleased with our second quarter results. We are especially satisfied with the mills’ productivities this quarter, after considering our annual maintenance program at Celgar. The expected impact of the tightening European fiber markets was really the only negative in the otherwise positive quarter.

In addition the green energy project is progressing as planned, and we continue to expect to be producing electricity early in the fourth quarter. We’re happy with the pulp market’s ability to support price increases in light of the low inventory levels in the first half of this year. And the NBSK market remains tight, with a historic low 21 days of inventory available.

We are also pleased with the progress of our high-return strategic projects, most notably Celgar’s green energy project. I’ll talk more about this in a moment, but let me first comment about the mills.

Our two mills in Germany ran extremely well in the quarter, with Stendal posting its highest production quarter ever and Rosenthal with near-record production. These results were particularly satisfying after we were forced to slow these mills down in the first quarter to manage our fiber inventories.

I continue to be pleased to see our vision and investments resulting in our people raising the bar in terms of what we are capable of producing, though we are continuing to believe that there is more untapped potential.

Although it is not immediately obvious in the numbers, due to its recent maintenance shut, Celgar performed particularly well. Productivity there continues to improve, and we achieve daily, weekly, and monthly production records during the quarter.

Although our return to full production was slower than we would have hoped coming out of the April shut, the mill followed up with a record month in June. In total, we produced 360,000 tons of pulp, compared to 330,000 tons in the first quarter of this year, and 349,000 tons in the second quarter of 2009. In addition the German mills’ strong productivity allowed us to sell 144 gigawatt hours of electricity in the quarter, compared to 107 gigawatt hours in Q1 and 129 in the same quarter last year.

As a reminder, we have a fairly significant planned maintenance shutdown at our Rosenthal mill in Q3. In addition to the regular 12-day shut that occurs annually for the prescribed maintenance we will also be performing a more thorough rebuild of our turbine and generator. The turbine work will not impact pulp production beyond the 12-day schedule, but it will limit our ability to generate electricity for about 51 days extra after the pulp shut.

If I could turn to the pulp markets for a moment, I would characterize it as tight, but a little confused. As you know current NBSK pulp inventory statistics remain positive, with producers’ global soft wood inventory standing at 21 days, which is among the lowest levels in nine years.

We continue to believe that the market tightness will continue to put pressure on prices in the longer term, but as you know the momentum we have experienced in the past year has stalled at the moment, as certain markets are resisting further price increases and some suppliers have lowered pricing to accommodate.

This development is somewhat puzzling to us, as there is no shortage of conflicting variables to consider. The inventory levels for NBSK are very positive; however the market is also considering the impact of a return to production of a small number of previously shut NBSK mills.

In addition to the restart, there is some uncertainty as to the impact in the market of certain recently sold mills - mills that previously supplied the market and which may, in the future, be dedicated to their new owners’ integrated paper production in China.

And in the background, there is the hardwood market, which has been softening despite relatively low inventories as well. As you know, the NBSK market appears to have settled on a $50 reduction for China in July and a $30 reduction in North America. So this will leave list prices in August at $990 per ton in North America, $980 in Northern Europe, and $840 in China. Despite the reduction our order books in China is much lighter than it has been in recent quarters. So we are cautiously optimistic on the strength of the continued low inventory levels.

We are also preparing for the likelihood of a slower period and higher Mercer pulp inventory levels than we have seen in the last year. Our sales volume was at normal levels for a quarter with a maintenance shut, sales volume totaled 365,000 tons, compared to 333,000 tons in the first quarter, and 395,000 in Q2 2009.

Let me now take a moment to discuss developments in the wood market. As we had discussed last quarter, after falling for most of 2009 wood prices in Europe have been rising in 2010. As we have expected, on average our wood costs were about EUR12 million higher than in Q1. We expect on average that our wood costs may increase slightly in the third quarter, but should flatten out for the remainder of 2010.

In Germany, wood prices was up for both whole logs and residual wood chips, primarily due to German wood board producers entering the market to take advantage of slightly improving board markets. The increase in German fiber prices has been as quick as the decline in 2009. After reaching cyclical lows in the summer of 2009, our fiber costs in Germany increased 17% in Q1 and 13% in Q2.

You will recall that in Q1 we eased production in Germany due to our tight fiber inventories, but as David noted, we have invested a significant amount of working capital to limit the risk of having to slow production again. We’re currently satisfied with our fiber inventories in Germany, but will continue to build our inventories in anticipation of the seasonally slow harvest in winter months.

In British Columbia, our fiber cost trend remains encouraging. The new supply chain for whole pulp log – pulp wood – we have developed has significantly addressed our delivery cost issues. As well we have begun to see a modest increase in saw milling activity in our area. This, combined with continued productivity improvements in our wood room, has us confident that Celgar’s wood costs will stay flat in the third quarter; however, even if a weak lumber market reduced the saw milling activity in our area, we believe that the impact on our costs will only be slightly negative.

If I can spend a moment talking about energy, our green energy project at Celgar is progressing nicely. The key machinery is now installed, and we’ll be progressing through the test phase shortly. We don’t anticipate any problems achieving our October startup for this important project, that we expected will add about CAN20 million to CAN25 million to our bottom line.

And as you know, the project will consume 40 million of our 58 million transformation fund grant. We’re in the final stages of preparing our submission for the use of the balance of the funds. Like the green energy project, these final few projects will be highly accretive, with quick paybacks of three years or less.

So to make a few closing observations, we continue to believe that the tightening market that was interrupted by the global crisis has returned. While we have some concern about pricing and our order book in the next few months, we believe that the upward pricing pressure will eventually return. There is much speculation about softening as capacity restarts and the new capacity, but our view is that this will be more evident on the hardwood side.

The fundamentals for NBSK supply and demand remain favorable, and we are optimistic with continued global economic growth. The supply-demand balance for softwood pulp should remain favorable for the next several years. We believe that there has been a significant and continued adjustment in global production capacity for softwood pulp. We also believe that because of the pre-existing inventory levels, the impact of this lost volume is only now becoming apparent. We remain focused on increasing margins by reducing costs, as well as increasing the mill availability at all operations, and improving the returns on our byproducts, such as excess power.

So with the conclusion of my prepared remarks, perhaps I can now turn the call back to the operator, where we can now open the call up for questions. Thank you.

Question-and-Answer Session

Operator

[Operator instructions.] Your first question comes from Bill Hoffman with RBC Capital Markets.

Bill Hoffman – RBC Capital Markets

Jimmy, I wonder if you could talk a little about the Rosenthal shut here in the third quarter. I want to get a sense of what the extended power cost differential might be for you in the quarter, and just whether there’ll be any difference than the impact on cost of the Celgar shut in the second quarter.

Jimmy Lee

I think the Rosenthal maintenance shut has been extended because of preventive maintenance programs that we attempt to do on the generator. We have found that generators of a similar vintage have experienced certain winding, or wire winding, problems, and as a preventative measure we have decided to increase the original expected additional downtime from 38 days to 51 days. And also it will involve additional costs. Those additional days will impact around 1.5 million. The original budget was somewhere on the order of 4 million in terms of the electricity sales lost in additional sales purchases.

So the total together, as we’ve announced on the press release, roughly, is about 6 million extra in regards to the additional power purchases and power sales loss for that period. The Celgar startup issues in the second quarter actually were quite difficult in the first month, so the impact actually at Celgar in Q2,

I would say in terms of the impact we’re comparable if not slightly higher in terms of lost in additional margins as a result of the startup difficulty that we experienced at Celgar. And a lot of that actually was due to certain unexpected problems related to outside contractors tripping the equipment accidentally, and as result there was some difficulty restarting the mill because of that disturbance. So hopefully that answers your question?

Bill Hoffman

It does. And a question for Dave, sort of housekeeping. One, can we get the production volumes at Rosenthal and Celgar and Stendal as well, as well as the restricted group cap ex?

David Gandossi

Okay, for production volumes, Rosenthal for the quarter 84.8. Stendal was 166, and Celgar was 108.9. And for sales volumes, Rosenthal was 82.8, Stendal was 164.3, and Celgar was 117.9. For cap ex, it’s a little bit complicated because we’ve got that transformation money coming in and out and we had funds received last quarter that are being applied this quarter, so you can’t really pick it out through the statement of changes. But most of the spending is, well 13 of the 15, is covered by government transformation money, and the spending at the other mills is pretty light, like on the order of a couple million.

Bill Hoffman

Right, but - so that - in the current quarter you actually charged the cap ex and in the third quarter that gets offset? Is that how it’s working, so I understand?

David Gandossi

It’s a little of both, so we had money received in advance last quarter, so some of the cap ex that was spent this period was money that was received and we were holding from the previous period, and some of the cap ex that was spent this period will be received next quarter.

Bill Hoffman

Okay. And if I could just get a final question and I’ll pass it along. The power project up at Celgar, obviously it’s a very important project. Could you just tell us what some of the – I want to call them gating – issues are from a timing to get that thing ramped up? Any risks of it getting delayed, etc.?

Jimmy Lee

I would say the risks are extremely low at this point, because pretty much all the equipment is present. It’s installed. There’s a lot of tie-in of pipes, etc. There is no delay in terms of the anticipated startup time. There will be testing before, of course. There is the handover and then the actual fixing of the contractual arrangement with BC Hydro. But in terms of the actual startup date, the test procedure, etc., we’re pretty much on schedule. In terms of the – I expect that steam volume, etc., availability of bark and other residuals, all of that is going along very well in terms of availability of the steam, so – that’s required – so there’s really no issue there as far as we can see.

Bill Hoffman

Great, thank you.

Operator

Your next question comes from Amil Schiaffino with Cantor Fitzgerald.

Amil Schiaffino – Cantor Fitzgerald

I was just wondering, you referred to the accounts receivable increase. Is that exclusively due to the higher prices that you realized in the quarter, or is there a timing difference in any of the markets or customers that you’ve experienced.

David Gandossi

It’s primarily price related.

Amil Schiaffino

Okay. And the days outstanding is pretty much constant. Am I correct on that?

David Gandossi

Yep, it’s totally constant.

Amil Schiaffino

Okay. And forgive me if I missed that in your previous answer, but are you quantifying the cost of the downtime in the second quarter?

Jimmy Lee

No, what I basically have stated that the increase in terms of, let’s say, the cost in addition to what we normally would expect from regular maintenance downtime, for Rosenthal, was that additional 6 million. And in terms of the impact of the Celgar maintenance downtime, the additional costs related to the startup difficulty after that was slightly higher than the 6 million that we are likely to experience at Rosenthal. So that’s basically what my statement was.

Amil Schiaffino

And finally, could you just break down the debt by where it is? Or do I need to wait for the Q for that?

David Gandossi

That’s pretty simple, and while maybe the Q might help you, but we just have the three components: the senior notes, 310, that converts at 66, and the 506 for the Stendal [unintelligible].

Amil Schiaffino

Okay. Yeah, well, was there an effect of a weaker euro on how you’re - what you’re carrying?

David Gandossi

Oh I see what - yeah, so you’re looking at the – the debt looks like it increased but mostly that’s the impact of the U.S. dollar – euro exchange rate on the U.S. denominated debt reported in euros. So the only additional borrowing we had was CAN7 million on the Celgar revolver, which was just a temporary borrowing to match timing of the transformation funds. Everything else is just exchange related.

Amil Schiaffino

It is? Okay. Thank you.

Operator

Your next question comes from Richard Kus with Jefferies.

Richard Kus - Jefferies

Can you talk a little bit about what you’re hearing as far as inventories on the ground in China?

Jimmy Lee

Well, you know, we believe that the inventory levels in China are low, primarily because we know that even the trading organizations were liquidating the inventory before this, I guess, buyer strike. So my expectation is that there’s really not a lot of slack there. Now the problem is when you have a buying strike the question is how much, I guess, both sides are prepared to play this game of chicken. And it’s difficult to estimate. But clearly we know that they have to come back into the market fairly soon. Inventory levels as far as we could see in terms of the European markets, North American markets, on the consumer side, still is quite low, and producers’ side, as you’ve seen, extremely low. And we don’t think that the Chinese situation in fact is any better, probably is a lot worse.

Richard Kus

Thanks. And what about some – we’re hearing about some pulp production coming online over there in China. How do you think that might affect you?

Jimmy Lee

That’s really more the hardwood. There is a very large hardwood mill, which is in the startup phase, and so that should probably have an impact on the hardwood side. But certainly not on – you know, there’s no reason why it should have an impact on the softwood side.

Operator

Your next question comes from Andrew Shapiro with Lawndale Capital Management

Andrew Shapiro – Lawndale Capital Management

So with the substantial Stendal debt completely non-recourse to Mercer and its restricted group subsidiary, what are some of the strategic alternatives you and the board have considered to retain a more appropriate equity valuation and lower cost of capital financing for Mercer than what the market continues to undervalue the company for on a consolidated basis? Because as you know, the yield rates are – and your cost of financing has been so high and the equity valuation so low.

Jimmy Lee

Yeah, I mean if you look at the Stendal debt side, I would say that the debt carry cost is extremely low. At this point on the restricted group and the unrestricted group if you go through the financials I think you get to see the real financial performance and debt levels of both sides. On a consolidated basis it tends to confuse some of the readers because just on the surface it looks like the debt equity ratio seems to be quite high. Also, the fact that the subsidies and grants are not taken into account under U.S. GAAP. So there is a lot of confusion.

The interest rate valuation issue, again, undermines the balance sheet, primarily because, oddly enough, interest rates have been headed only in one direction for the last six-plus years, which is unbelievable. But that has a significant impact in terms of the consolidated balance sheet.

But if you strip that away and you just look at the restricted and unrestricted group I think you see the strength of both sides. Stendal gives significant leverage to the pulp cycle because of the financial structures that it had been originally built under. In terms of the restricted group, I think you’re going to see now the great performance that Celgar is starting to kick into, which was kind of delayed as a result of the downturn in the lumber market.

As you know, the fiber cost increase has been significant at Celgar as a result of the slowdown in lumber production. We have now addressed those issues, so the difference in wood costs are huge, and therefore you’re finally seeing in the quarter the true capability of Celgar and with the fourth quarter you’ll see even more of that where Celgar EBDA margins are comparable now to our German mills because of power production.

Now in terms of how we present our financials, the board is looking at the impact of the issues which cloud the easy transparency of understanding our financials. So we are looking and trying to address how do we present our financials in a more transparent manner, although we do believe, because of the way we have the restricted and unrestricted, if you do dig into the details I think a lot of that becomes apparent, but on the surface if you just use your computer scanning, or type of selection, it’s not as easy to see that, and we don’t come out as attractive because of a lot of the ratios not being comparable to our peers because of our structure in terms of how we built our facilities.

I would say that the board is very cognizant of it. There is no simple answer to those issues, because as you know the structure of the financing at Stendal certainly gives it huge leverage to the pulp cycle and at the same time does present certain complexities. And on the other side, the restricted group, though more conservative in nature, doesn’t give as comparable leverage to the pulp cycle earnings.

Andrew Shapiro

Yet it is your restricted group’s financing that actually is the more costly of the financing, and Stendal is in effect a call option giving a huge upside in good markets and without recourses if one’s made it a zero the restricted group still survives quite nicely.

Jimmy Lee

Yeah, I think if you look at the restricted group the fact that it is non-recourse from the Stendal debt, now with Celgar finally meeting its EBDA margin capabilities you’ll see the cash generative nature of that, and so I think clearly if you separate out the two I think you see the strength of both sides. Now how do you make it more transparent? That’s something that we are looking at. What is the structure that properly addresses the strength of both sides and gives the best potential advantage to an investor or an owner of the company?

Andrew Shapiro

Would a spin out or a public market valuation on the equity in Stendal be an option that is allowed under the various debt covenants?

Jimmy Lee

Well, everything is possible if done properly, clearly. The board is considering a lot of different ideas, and as I said earlier, there is no exact answer. There is no simple answer to this because as I said, the combination of the two gives you that huge leverage and at the same time the restricted group gives you also that conservative, more traditional finance type of structure.

Andrew Shapiro

So you deconsolidate it, you get the debt off, you get the Stendal debt off the balance sheet.

Jimmy Lee

Yeah, and prior to this economic crisis debt and leverage wasn’t as feared, and certainly the structure was very attractive to the pulp cycle. Today debt seems to be more of an issue to many of the investors, and so we have to see what there may be in terms of a solution to address the new financial environment that we’re living in. How do we look at making the investment in our company more attractive to a more risk-averse type of investment climate today.

Andrew Shapiro

Okay. Since I might get disconnected, want to get another question in here, or two if you wouldn’t mind. Based on your cash balances and working capital forecasts, which obviously you have huge receivables this quarter from a fabulous quarter, and the present pricing expectations, what do you feel is the range of where your debt net of cash should be at at the end of this year for both the consolidated and the restricted group levels? Do you have a range?

Jimmy Lee

David, do you want to take a shot at that?

David Gandossi

No, I’d rather not put numbers out there, Andy, to be honest. As Jimmy and I have said on many calls, our objective is to de-lever. We have to pay attention to the converts that are in the money today, and we expect they’ll stay there. We have to be prepared in case something terrible happens in the world and [inaudible] declines, so for now we’re just – and we’re in a bit of a choppy market here this summer, it’s a slow period – so we’re not setting perimeter hard targets for ourselves. We’d be quite comfortable accumulating more cash on the balance sheet, which is what’s going to happen in the third quarter, and then we’ll address it as we have a better feeling for what the future looks like.

Andrew Shapiro

I guess what I was trying to get at is, given what month we’re in here now, we’re in the beginning of August, so one month of the current third quarter is in the bag. You probably have orders going on that are giving you some visibility, and then you have Celgar energy kicking in. Are we in the range of having at least cash flows similar to Q1 for the rest of the year, if not higher?

David Gandossi

Yeah, we’ve signaled that we expect third quarter cash flows to be quite significant - accumulation of cash quite significant.

Andrew Shapiro

Okay. That’s what I was trying to get at. And on what type of projects, and when are you thinking, that you’re investing the extra Celgar money would begin and came in - what kind of enhancements would you be able to invest in with that money?

Jimmy Lee

Many of the projects that have been identified, in fact all the projects have been identified. We are now in the process of putting together the necessary documentation. Some of it, as you know, because of the nature of the program, we have to have input from all the stakeholders, which includes the native community, and all of those things take time. So we’re well in the process of doing the formal documentation, which is needed. And all of those projects, based on the modeling, etc. - all very high, or rapid payback type of projects, as I said, with three years or less, and therefore the balance of the money is going to have significant additional contribution to the EBDA margins at Celgar moving forward.

Andrew Shapiro

And your German, your government grants you have in your press release aggregate to EUR291 million at June 30. Is that consolidated figure net of amortization, and for the June quarter can you provide the grant figures net of amortization for the three plants, or at least between the restricted group and the non-restricted Stendal?

David Gandossi

Yeah we don’t – that’s getting into [unintelligible] there Andy. We don’t disclose that.

Andrew Shapiro

That’s why we’re asking on the call, which -

David Gandossi

Well I don’t have the numbers here and I’m not prepared to share all that. But yes it is net of amortization.

Andrew Shapiro

Okay, but you can’t break it out between restricted group and Stendal right now?

David Gandossi

Well maybe I can help you. It’s primarily Stendal. There’s some remaining un-amortized amounts for Rosenthal. I would guess Rosenthal’s maybe in the 40 million range, and that’s - I’m just – in a range, and then we’re starting to accumulate similar accounting treatment for the Celgar green energy transformation program. So we’ve probably got CAN30 million in there so far. So an order of magnitude. Maybe that will help.

Andrew Shapiro

Okay, last question, which is on the pulp pricing environment. You’ve discussed a bunch of it, but in the last price correction, which came at a time of above equilibrium industry inventory levels, there was the black liquor boondoggle that kept inefficient plants producing full tilt, right, and exacerbated the problem. Are there any programs going on now to incentivize producers to keep their pulp making operating longer than what is economically feasible should prices continue to drop?

Jimmy Lee

We’re not aware of any programs in Europe or North America this year in terms of any subsidy for black liquor, etc. There is that open question in terms of tax credits for last year, but that’s really a non-cash issue as you know. But in terms of this year, there’s no particular programs that we’re aware of. Also, the last downturn, as you’ve said, of the inventory levels at the producer side were at normal type of levels going into the downturn. And also the currency levels were way different. I think we’re faced - as well as wood costs. As you know the saw milling activity globally is very weak, and therefore the wood cost issue is a global issue. This is not just a European issue. In fact, even for the Canadian producers wood residuals coming out of the lumber production is very very weak. And so [unintelligible] pressures are certainly different. Currency pressures are different. So we do not expect that this downturn, if it does come, will be in any way comparable to what we saw last year.

Operator

Your next question comes from Peter Ehret at Invesco.

Peter Ehret - Invesco

Just a question really about the cap structure and plans to refinance. Obviously you don’t want to lose the company to bondholders here in a couple of years. Can you talk about your plans to refinance the bonds coming due now in just two and a half years. And it seems like you do now realize the need to de-lever and to respect what the markets are saying about lowering risk. How far do you plan to let that go before you have a hard date to target for cleaning that up?

Jimmy Lee

Well, you know, a lot of this is dependent on the markets.

Peter Ehret

Markets are really good right now.

Jimmy Lee

Well, I think, you know, there’s a period where the market is good and there’s an opportunity, whether it’s in the debt, or the equity side. We’re not overly, let’s say, anxious. There is enough time, and I think our earnings generative nature as you’ve seen at Celgar is such that in the past we kind of ran the restricted group with our smallest mill, essentially supporting that payment. What’s different today is the fact that both the mills are now running at the level that it’s supposed to and now supporting the debt levels. So I think you cannot take historic cash generative numbers out of Celgar in any way indicative of the cash generative potential of this mill moving forward. So if you look at both mills now running reasonably well, with the power project also completed in the fourth quarter, I think the EBDA type of generation out of the restricted group compared to its overall debt level isn’t that high. So I think there’s going to be opportunities for us to address that debt at good, attractive type of cost levels, and that’s of course dependent to a large degree on the market conditions, but if it’s right then we’ll address it both on the equity and the debt side.

Peter Ehret

Okay, but do you have any sort of hard date? How far up the line are you going to walk? I know you’re thinking that the numbers get a lot better and it reveals a carrying capacity in the company with regard to leverage, but at some point don’t you just have to just take down the risk, where you just can’t walk up to the line that close?

Jimmy Lee

As we move forward, and as we generate cash flow, which you’ll see, and we see the market’s very choppy in the second half of the – well, you know, after the first quarter you have the issue of the European issue making conditions very choppy. So it really is dependent on how the overall market kind of stabilizes out. There’s very short periods of attractive type of conditions and then all of a sudden they’re no longer available, so we have to look at where the window is going to be. That equity, why isn’t – we’ll see how it plays out. I cannot give you a time frame because even if I told you that the market conditions, as you know, are completely volatile.

Peter Ehret

Right, and that’s part of what the risk perception is all about, that they are volatile and as that window closes that the ultimate window is maturity. That’s the window that can close.

David Gandossi

Yes, so we’re very aware of what’s possible for us right now. And we have some opinions about what the future looks like to some extent. We know what we could do, and for now we’re just prepared to be a little bit patient. But we won’t take on undue risk. There will be a little bit of time.

Jimmy Lee

I think if you look at what we’ve been able to address prior to last year, even in terms of the Stendal debt restructuring, and all these other issues, we have taken on these things before the crisis hit. It was unfortunate that because of the crisis we were not able to address the energy project itself, however. I think that was the biggest concern for us, because it did drain us of a significant amount of liquidity at the worst time. It had potential litigation issues which could have resulted in issues related to not just our senior but also the convert. And so those were the concerns that were completely unexpected, because we went into the financial crisis with a commitment from a very large institution to fund that project and it was only at the very last minute that commitment essentially disappeared, which then created issues for us. But if you look at our normal type of issues, like the Stendal site, we were aware of the problems that were likely to develop and we took on that restructuring way before the problem happened. If we had taken that to the last minute, believe me it would have been a very different situation all together. So I think we are cognizant of the time issues, and so we will address them way before those become critical.

Peter Ehret

That’s good. It’s a good company, and the results are certainly there now, and you had a close scrape before but you got through it and of course you and all of us don’t want to get that close ever again. But good quarter. Thank you.

Operator

Your next question comes from DeForest Hinman with Walthausen & Company.

DeForest Hinman – Walthausen & Company

I had a few questions, the first of which is can you just walk me through the cost increase on the operating expense side within the restricted group from a sequential perspective? And I guess my questioning is around you disclosed the pulp sales on a quarterly basis on the conference call, but when I plug those numbers in, and kind of look at the operating expenses per tons sold, there’s a pretty material increase sequentially in the cost of goods sold per ton, I guess from the operating expense perspective. And it seems to be more so than what you had disclosed from the fiber price increase year over year.

David Gandossi

Yeah, I think what – the piece you might need to see is Celgar’s maintenance shut in the quarter. So during that timeframe all of the maintenance dollars get expensed directly. That’s consistent – everybody does it that way now. There’s no smoothing. So in a period when you’ve got a maintenance shut you’ve got higher operating costs spread over whatever tons were produced in the period. None of it goes into inventory. It all goes straight to the bottom line. So that’s the difference. There was – in the first quarter it was the Stendal shut, which is outside of the restricted group.

DeForest Hinman

Okay, but how about that same question on the Stendal group, because if I do the math that way it looks like the operating expenses per ton sold decrease sequentially, but you said German fiber costs are up.

David Gandossi

Yeah, in the first quarter, though, Stendal had a maintenance shut, and also had some down time for fiber preservation, so it’s the exact same situation, just in reverse.

DeForest Hinman

Okay. And I think in the past you had talked about some of the German mills being on some of those – I think it’s the short week program? Are we still getting a benefit from that or is that not the case?

David Gandossi

Yeah, Rosenthal is still on it and in fact I think they’re going to go on to something similar to that on a permanent basis – a negotiated permanent basis not government support for shorter work hours. They figured out how to man the mill with the shorter work week and it’s a better format. Guys are liking it. So we may stick with it.

DeForest Hinman

Okay, and then on the Celgar sales front, there’s been some issues with shipping container availability with this inventory restocking in the U.S. Are we seeing any issues on either the cost side, which would impact this on realizations, or then also availability?

Jimmy Lee

I don’t think that the container side, as well as the road freight cost issues in the European side will be significantly different in the third and fourth quarters. I think we’ve seen pretty much the difficulty in the second quarter, so we’re not anticipating any additional type of cost issues beyond what we’ve already seen.

DeForest Hinman

I was more – trying to be more specific on the Celgar. Is that the case as well?

Jimmy Lee

Well, Celgar mainly it’s the container issue, because of the fact that there’s been restrictions, restricted number of containers being available, so that has created certain shipment delays, but all of those have been addressed and we look at alternative types of methods. As you know we have the ability to ship a lot to bulk and so we’re doing that. So I don’t see the issues being any more difficult than we’ve already seen. In fact it should be easier moving in through the second half of the year.

Operator

Your next question comes from the line of Jonathan [unintelligible] with CIVC.

Jonathan [unintelligible] - CIVC

I just want to get back to the pulp pricing and focus on Europe. Pricing seems to be holding out there a little bit better than other regions. I was wondering if you could just talk about the market dynamics there, especially given the weaker euro.

Jimmy Lee

The weaker euro certainly would play in but of course in the last few days you’ve seen the euro strengthening. So on the European side the market conditions certainly are more stable, although typically the summer months, as you know, tend to be seasonally weak. But the inventory levels at the port, at the consumer/producer levels are such that there’s been less of a pressure being put. But because of the issues in China, of course, our end users are looking for similar types of discounts. Some of the producers in Canada have also announced discounts in North America. So all of the European producers as well as shippers into Europe are facing the same question mark from our end users.

And it’s difficult to know what the end results will be until the summer is over, because it’s not the price that determines the volume. Right now just because you’re reducing prices you’re not necessarily getting a significant volume increase, so it’s almost like pushing on a string. There will be a point where the Chinese buyers have to come back into the market because the inventory levels will be low, extremely low, and as I said it’s a game of chicken right now. But we do believe that the inventory within the system today is at historic lows, and that’s why we are reasonably optimistic that this kind of volatility through the summer months will probably lead to a more stable market coming out of the summer and without a significant deterioration in pricing.

Operator

Your next question comes from Christopher S. Dechiario with ISI Capital.

Christopher S. Dechiario - ISI Capital

My questions have been asked already, but I did want add [unintelligible] to a couple of the questions that a lot of people have been asking here. I guess to follow up on what you were just speaking about, is it really the low inventories that gives you confidence that the buyer strike or the slower demand from China isn’t going to be more permanent, or is – do you have any evidence that overall demand in China is at a lower level now, just from the paper mills there, from paper plants, or anything else more secular, or long term going on there?

Jimmy Lee

Well, if you look at North America and Europe the paper demand growth is still recently good coming out of very weak conditions albeit, but still positive. In terms of the China market, yes there has been certain sectors which have experienced inventory build in terms of their paper product and there has been certain closures to correct for that. But at the same time, as you know, there’s significant amount of capacity increases in terms of new machines being installed there on all grades of paper, and therefore these machines require a continued steady type of diet of predictable type of qualities and therefore they cannot really stay out of the market too long. When you have large machines which require certain quality standards you cannot really be too restrictive in terms of your buying because you need that inventory no matter what. And to have these machines stopped for an extended period of time is way costly.

Christopher S. Dechiario

So there hasn’t been any slowdown that you can tell in the installation of these new machines in conjunction with China’s cutting back on stimulus?

Jimmy Lee

We’re seeing certain weakness in certain paper grades in China there’s no question, but at the same time there’s new machines going in and these have to run. Certainly on the hygiene area we haven’t seen any real weakness globally. So it’s really dependent on the paper grade but it’s really driven as I said by this huge amount of new paper machine capacity being installed in China and the fact that they have announced that the intent is to close another 4.5 million tons of old polluting pulp and paper capacity in conjunction with that. Now the timing of that is difficult to know, but that’s going to have an impact in terms of local production, which has been kind of dirty and highly polluting. That’s going to be substituted by the new production which is dependent to a large degree on quality imported fiber furnish, and that is why we are reasonably optimistic that in the medium term, that these developments will support the continued strength within the market pulp sector.

Christopher S. Dechiario

Okay. And then on the – also back on the question of your future use of cash balances as you believe you’ll continue to build them here. Just based on your answers to a previous question, should I be thinking along the lines that your first priority is probably more the converts and then you’ll deal with the [unintelligible] after that or am I mistaken? You haven’t really made that decision yet, or -

David Gandossi

Well, we would expect the converts will become equity. That’s our view today and therefore the cash that we’re accumulating lines up to deal with other leverage. So the senior notes would be next in line from a maturity point of view. So that’s directionally the way we think. We just don’t want to ride the line on cash on the balance sheet, buying back debt, when we haven’t got a clear window through to seeing the converts convert into equity. We’ve been through one crisis already. If the whole equity market takes a dive then we need to be able to address the converts to save ourselves. So we just – we need to have that insurance on the balance sheet in case. At some point in time we’ll be comfortable that risk is reduced enough that we’ll deal with the other restructuring that might be possible for us. So we’re paying lots of attention to it, discussing it with the board. We’re very clear view of what the market is on the high yield and we know what’s possible today and our view is that it will be more opportunistic for the company to wait a bit.

Christopher S. Dechiario

Okay. And then my last question is on a previous call you discussed the level of discounts – I guess discounts to list – that you were receiving. I think at that point they were in the 12% to 14% range and you were saying that typically in a tight market they’d be more in the 7% to 8% range and I was wondering if those have tightened at all, where they are today?

Jimmy Lee

I wouldn’t say that it’s tightened any more, but I think the discount issue is a crazy one, but as you know the industry uses this list price and a discount to list, which unfortunately makes it very complicated and non-transparent. I think it would be a lot easier if we basically just had a transaction price that we would announce rather than just list price because in reality this discounting tends to be pretty much the same for everybody, so it doesn’t hide the fact that the list is not necessarily what the transaction price is. So no, there has been no narrowing, but I think this use of discounts certainly is something that the industry needs to question in the future.

Christopher S. Dechiario

Yeah, I was wondering about that. So really what you’re saying, which is what I was thinking, is that nobody really gets list.

Jimmy Lee

Yeah, nobody gets list. [Laughter.]

Christopher S. Dechiario

Right, okay. And the discounts are pretty similar across the board.

Jimmy Lee

Right, everybody gives the same level of discounts. It’s kind of silly. We should just have a standard transaction price.

Operator

Your next question comes from the line of Rick Sherman with Oppenheimer

Rick Sherman – Oppenheimer

My question is just on the foreign exchange loss having risen a bit because of, I assume, the strengthening of the dollar. Is there some metric to where x number of movement of the euro versus the dollar moves that non-cash number by a certain amount that I could figure out a way to model that?

David Gandossi

Maybe the easiest way to think about it is the amount that goes through P&L is generated by intercompany borrowings within Mercer, so it’s Mercer’s – Mercer has loan money down to Rosenthal. It’s in the order of $125 million. It’s part of our capital structure in fact. So the movements there are what go through P&L, so you can just model that. The principal is $125 million.

Rick Sherman

Is it - the foreign exchange loss, though is it – I assume it has to be affected by movements of the – also of the currency itself? The euro and the dollar?

David Gandossi

That’s what drives it. Because we report in euros and we have a U.S. dollar debt down to Rosenthal, the value of that receivable to the parent goes up and down based on exchange rates.

Rick Sherman

All right, so it’s – like for each cent you use approximately $125 million times that movement in the euro?

David Gandossi

That’s right. And if you’re struggling with it you can call me offline and I’ll walk you through it.

Rick Sherman

Okay great. Thanks a lot. Good quarter.

Operator

Your next question comes from Phillip Wirtz with Odeon Capital Group.

Phillip Wirtz – Odeon Capital Group

I just had a couple quick questions. The first is on the cash sweep. I was kind of wondering, hoping to understand it a little better. I understand it applies at Stendal, so at what point does cash from Stendal become available for general corporate purposes, and can it ever be applied to something like restricted group debt service. Is it all being swept right now as per the requirements of that 2017 loan?

David Gandossi

Okay, I’ll try to address that. So essentially excess cash has established priorities under the facility agreement, so first of all we’re entitled to retain $15 million of cash on the balance sheet at all times. The next priority would be to build up a thing called a debt service reserve account. So this is a cash balance on Stendal’s balance sheet, and it’s intended to accumulate one year’s principal plus interest requirements, and so it – as it fills up it becomes a safety valve for the cycle that the mill has to work within. So then the third priority after that is fully satisfied and that’s about, call it EUR70 million. Then the third priority would be excess cash gets swept to the bank syndicate to the extent that there’s been deferrals of principal from the original amortization schedule, so it’s an amortizing loan. It had a pre-established amortizing schedule and then a year and a half ago we negotiated with the syndicate to lighten up those principal payments with a bigger bullet at the end and so before we can get any cash out of Stendal we need to build up that – that cash sweep has to catch up with the amounts that have been deferred since the amendment.

Phillip Wirtz

Okay.

David Gandossi

So we’ve got a little ways to go here obviously, but from an enterprise value point of view it all is essentially helping us de-lever, creating shareholder value. And it’s nice to have the big chunk of the cash stays on our balance sheet and our debt service reserve account for a rainy day. It takes risk out of the equation for everybody.

Phillip Wirtz

Okay. And so the debt service account is just reported on a consolidated basis –

David Gandossi

Yeah. In prior years you’d see it. It sits as restricted cash. It’s a separate line in there.

Phillip Wirtz

I see. Okay. And then finally, on the European wood prices, I’m just a little curious. If we’re looking back, like over the last business cycle, and I know that perhaps last summer they reached a bottom and then they’ve climbed quite dramatically since then. Are there any structural reasons that we should be looking forward to or looking for across the next business cycle? Are there additional buyers that didn’t exist before, such as mills in Scandinavia or anything else, that are going to put structural pressure moving forward on European wood prices? Or should we plan on a cycle similar to the last?

Jimmy Lee

The issue really is all related to the harvesting activity globally, because of course when you go into the forest you don’t just cut pulp logs, you basically cut the highest value logs and part of that process is a lot of waste, which really goes to the particle board manufacturers, the pulp industry, and paper industry, etc. So when overall harvesting activity is slowed because of the overall lumber activity being slow, and that’s a global issue, then wood availability gets limited for everyone and that’s why we have to go to a wider radius to be able to source the same amount of volume. And this pressure, essentially, is the same for everybody, even on the Canadian side, because some milling activity is less than half of what it used to be. Essentially the wood flow is less than half of what it normally would be. And the wood residual creation is less than half of what it would be. So as you can see this is really the issue. It’s not, you’re all of a sudden getting third party competition for a significant amount of your wood.

Phillip Wirtz

I see, and so does increased energy usage of wood play any role in this, or not really?

Jimmy Lee

On the margins it does, because of course they’re competing for the wood waste that typically would have gone through the pulp mills, etc. But because if you look at the costs related to the energy side, it is very freight dependent. Because you’re taking sawdust or chips and then creating pellets, and you’re having to ship it long distances. So geographically, it is limiting in terms of the logistics issue, and as you know also the carbon credits have been quite weak. And the energy prices have been weaker than what used to be at the peak of the cycle. So all of these play in. Electricity prices in Europe are significantly lower than what it used to be a year ago. So the attractiveness and the competitive margin for the bio-energy sector certainly is less than what it used to be, so affordability is less. So everybody’s faced with the same type of cost pressure. So we’re not necessarily faced with an industry which, all of a sudden, can afford to pay a lot more than we can. In fact, our competitive structure probably has remained the same through that spectrum and we’re all kind of forced to pay more and of course we have to increase our product prices as a result. It’s easier for us than, let’s say, the power guys because of course the utility rates are not going to adjust as rapidly as what we’ve been able to push through.

Operator

Your next question comes from [unintelligible] Goldman with Catalyst.

Catalyst Representative

My questions have mostly been answered, but I just wanted to clarify on the build in accounts receivable, do you guys expect to convert that to cash in Q3, or what’s the timing on that and the order of magnitude of cash generation?

David Gandossi

The way to think about it is the build occurs because you have – we’ve had a period of steadily increasing pricing, so there’s always an element of increasing investment in receivables because the per-unit value is higher. Now that pulp prices are level or even possibly declining a little bit, just the natural flow will be no longer building into receivables but will tumble straight into the balance sheet. So our days sales and receivables I don’t think is going to change, but we won’t have this building effect. So you’ll see a very positive cash generation, cash produced on the balance sheet as a result.

Catalyst Representative

Gotcha. And then secondly on the press release it looked like the average sales realization price was EUR618 for Q2. Can you give us a sense of what it is today approximately?

David Gandossi

Well that would be difficult to do. I mean the only – you’ve seen a $50 reduction in China of July 1 and $30 in the U.S., so those are the only two metrics that I could go by, and it’s still early days. So I don’t have a number for you to be honest.

Catalyst Representative

Right, but I guess because Q2 is more of an average, I’m just trying to get a sense of, you know, today you’re realizing sort of higher or lower than that number.

Jimmy Lee

I think the difficulty right now is, as I said, we’re going through a period where, really, you’re not getting a lot of sales volume out of China. And therefore until we actually come out of August and into the September type of situation it’s going to be difficult to really know where the price development is going to be. So I would say it’s a little bit premature to discuss what third quarter will look like, but based on the numbers we’ve already seen, clearly they’re not going to be as strong, probably as the second quarter. But certainly better than the first quarter. So that’s all I can say based on the clarity of information right now. But, you know, we’ll see, and I mean maybe all of a sudden they turn around after September because inventory levels are low. It could surprise us all, and we could end up with even a stronger quarter than even Q2, but based on the discounts that people are giving, based on those numbers and the euro development etc. it’s likely a Q1, Q2 type of number, somewhere in between there.

Operator

Your next question comes from David Shapiro with Aegis Financial.

David Shapiro – Aegis Financial

Quick question on your discounts. You mentioned 12% to 15% is sort of where the market is right now. Yet when I take a look at your realization prices, versus the list prices, it’s somewhere closer to 17% or 18% discount. Is that just the lag effect from prices rising in the period, and then once – and we should expect that discount range to narrow? What’s going on there?

David Gandossi

Yeah, you got it exactly right. So you know, average list price the, you know, it’s the calendar list prices averaged. Realizations work differently so if a customer orders pulp one month and it ships the next month he’s still priced in the month that it was ordered, not in the month when it was shipped. So he’s behind a month, at least a month. And then the realization also has an exchange component where a European customer for example, when he orders his pulp, he wants to know what his exchange rate is involved in that transaction, so there’s a look back to the average exchange rate of the prior period applied at that time. And then the actual exchange rate in the month when the pulp is shipped is something different. So there’s some different drivers. But it’s just – I’ll summarize it by saying it’s the lag effect of the difference between the order date and the calendar when the list price is published.

David Shapiro

Okay, so since we were at about 18% down in this quarter, and since prices have more or less stabilized now, we’d expect this account maybe to be a lot closer to the 15%?

David Gandossi

Yeah, the pricing component will be the same, but then you’ve still got the exchange volatility, right?

Jimmy Lee

There’s really too many variables to work that discount number into the list price on any given month because you’ve got the exchange rate and then you’ve got the lag in terms of actual shipment. When we talk about list that’s the actual price that we actually price it at at that time, but you’re never going to see that on a month by month. It will go less, sometimes more.

David Shapiro

And then on your G&A there was some creep up in the G&A, especially in the restricted group. Where should we expect that to be running at on a normalized basis?

David Gandossi

Our G&A structure doesn’t change at all to be honest other than we just grind our cost a little bit down. So the volatility all comes out of foreign exchange.

David Shapiro

Okay, and then on the power issue, has there been any advancement on getting market power prices. I know there was an issue where the company was attempting to get better pricing, Canada especially. Has there been any progress on that? Or are we still sort of stuck at a reduced discounted rates for power?

David Gandossi

We’re still working on that. We’ve been through quite an extensive process in front of the BC Utilities Commission. Those filings are all public I believe. So we’re fighting for fairness. We’re fighting for something we believe we’re entitled to, but we can’t control the political process. We’re – the next milestone if you like of information will likely be the decision that the BCUC has on the process that we just went through. And we’re probably two or three months away from that at this stage.

Jimmy Lee

But if the decision is favorable it could be – it could have a material impact in terms of our power revenue coming out of Celgar.

David Shapiro

Okay, so maybe there’d be more details on the next quarter call.

Jimmy Lee

Well, it depends on the timing of the utility commission decision, so it’s difficult to estimate or guess as to when that may happen.

David Shapiro

Okay, and then finally on this debt issue everyone seems to be talking about on the call, given that you guys are playing the waiting game, which may be advisable, I would assume that building cash is really pretty much your main option and there’s no acquisition opportunities that are being planned at the moment?

Jimmy Lee

Yes, I would say that de-leveraging is a key component to our – or main component – to our strategy at this point.

David Shapiro

Are you seeing anything on the market, or any – or the market is just – everybody is holding on to their mills at this point?

Jimmy Lee

Well, you know we believe we have probably one of the most attractive profiles in this industry, and therefore we don’t want to do something that would change that profile. And so we’re not seeing any particular reason why we should be engaging in acquisitions, I mean aside from the fact that the financial markets and our balance sheet structure are such that unless it’s done in the right manner it doesn’t really make sense for us. But availability of comparable type of capacity, profile and age of machines, etc. and margin capability are such that we don’t really see anything that is out there.

Operator

Your next question comes from Paul Quinn of RBC Capital Markets.

Paul Quinn - RBC Capital Markets.

Just a couple of cleanup questions here. Just on the green transformation program funding, it sounds like you got advanced some and then you’ve got receivables here. What’s net net at the end of Q2? How much money from the program do you expect to receive in Q3 out of what you spent? Rough orders of magnitude are fine.

David Gandossi

Yeah, there’s about EUR4 million that will come in Q3, and then there’s some hold docs that will come in Q4, and the chunk of the money that was spent in this quarter was received in the prior quarter.

Paul Quinn

Okay, so net the stuff that you received in the prior quarter? Am I still okay with the EUR4 million? Or is it less?

David Gandossi

EUR4 million is coming in in the third quarter from spending this quarter.

Paul Quinn

Okay, just on inventory – you talked about the 21 days globally. What are inventories at Mercer and how does that break out between Europe and North America?

Jimmy Lee

Well, on the European side we are at extremely low inventory levels, especially with Rosenthal going into its maintenance shut. At Celgar we were starting to see starting certainly building some inventory levels because of this buyer strike in China. So we are looking at corrective measures for that and we’ll have to see how that develops, but let’s say that at Celgar inventory levels are starting to creep up above what we originally expected and we’ll continue to do so unless we can redirect a significant amount to the more peripheral non-core type of markets.

Paul Quinn

Okay, and then in terms of the buyer strike, I mean I saw June shipments to China were basically unchanged, you know 538,000 in June from May. You talk about a buyer strike, is that certain buyers that have refused to purchase that historically were customers of yours?

Jimmy Lee

What’s happening basically is it started more in terms of July than June, so you’re not going to see a real big impact in June. What happened is in July with [Arelco] coming back into the market, they basically – initially held firm and then they basically offered to discount to get the volumes. And all of the other soft wood producers were approached and said okay, we want this particular pricing, which was extreme discount, or we’re going to stop buying. And of course the industry has such held firm because inventory levels as we know were low, and so far some of the producers have reduced the pricing to 50 in Canada, albeit generated really not significant volume. And it tends to be general in the sense you’re getting volume from certain groups which are higher margin type of producers, but the big guys who are Dakota etc., because of the pricing pressures for their product are resisting, let’s say, purchases. I wouldn’t say all of them, but unfortunately there’s a group of producers which have their own products under margin pressures, which are showing this kind of buyer strike.

Paul Quinn

Okay, that’s helpful, and just on maintenance, I guess because Stendal took a Q1 maintenance they’re not due until Q3 ’11 so we have Rosenthal in Q3, nothing in Q4, nothing in Q1 ’11 and then Celgar in Q2. Is that what we should look at going forward?

Jimmy Lee

Yeah.

Paul Quinn

Okay, and Rosenthal would be back and is it on a 12-month period, or is it moved to 18 like Stendal?

Jimmy Lee

No, it will be on a 12 month at this point

Operator

Your next question comes from Sven Karlen with Wells Fargo Advisors

Sven Karlen - Wells Fargo Advisors

You guys haven’t talked at all about the substitution issue given the price spread between hard and soft pulp prices. Can you address that a little bit? Is that spread widening, and is substation – has that been aggressively pursued by buyers of pulp and users of pulp as it could be, or is that potentially a bigger issue as this price spread widens?

Jimmy Lee

I think if you look actually at the historic spread between hard and soft wood over the last several years you’ve seen that spread actually widen, so clearly the substitution issue is one which is ongoing. I mean everybody wants to, of course, have the raw material price decline, so they’re going to substitute as much as they can with any cheaper type of input fibers, whether it’s hard wood or non-fiber coating or whatever it may be. But throughout this process what we’ve seen is clearly demand for softwood continues to grow, albeit at low rates, but at the same time the gap between hard and soft wood over those periods also has widened. So our expectation actually is that there’s no reason why that gap can’t continue to widen further. I mean we’ve seen it where we’ve had traditional of about 30 widen to 50. We’ve seen it now around 80. Clearly it may be sustainable at 100 for an extended period of time and maybe higher. So the issue is really the differential between hard wood production cost and soft wood. There is a structural change. The eucalyptus guys structurally have a much cheaper fiber cost, and while the soft wood, which is mainly in the northern hemisphere, has a different structural cost. And that is accounting for this kind of continued increase in the gap between hard and soft wood on average through the cycle. And we think that will continue to increase as we go forward, because there is a structural cost on both sides, and as more production of eucalyptus comes on from the southern hemisphere and you know capacity constraints on the soft wood from northern hemisphere there’s no reason why this gap essentially can’t widen and stay wide for an extended period of time. Because the end users of the fiber are different, and they use the fiber for different reasons.

Sven Karlen - Wells Fargo Advisors

Last question: Celgar’s been a very pleasant surprise in the last 12 months. You’ve stated many times that the EBDA margins are finally catching up significantly. I know you had the [unintelligible] energy capital spending project and then you had the wood room which you made into a big deal and it seems to have been very helpful. Are there any other factors at Celgar that you would point to that account for this dramatic turnaround in the EBDA margin there?

Jimmy Lee

I think we certainly are improving the performance of the people at the mill and this is ongoing. I was a little bit disappointed in terms of the startup after the maintenance, and that’s going to be addressed, so we’re not going to have those issues in the future. Because that cost us a fair amount of money. So I think the mill, once it’s up and running, actually is producing record volumes, and it’s unbelievable in terms of the actual daily records that we’re setting at Celgar. And the fiber costs now are finally under control, so the profitability certainly is improving very rapidly at Celgar. And so in terms of the labor performance, labor attitude, etc. I think that’s changing quite significantly as well and the procedures on some of the operations will mean that there will be continued efficiency gains moving forward. So I’m actually very optimistic that Celgar will live up to the potential that we saw when we first acquired this mill, albeit delayed by the impact of the market being so weak in the last three years.

Operator

Your final question comes from Scott [unintelligible] with Lawndale Capital.

Scott [unintelligible] - Lawndale Capital

I wanted to ask you from a marketing perspective what the company’s next steps are in terms of conferences and road shows and achieving an improvement in the market’s valuation and understanding of Mercer.

David Gandossi

We’re attending the Jefferies conference next week in New York and then the following week we’re doing a marketing – just a general marketing road show to tell the story. We’re going to be in Toronto, New York, I think San Francisco, and L.A., and Vancouver, and then at the end of the month we’re going to be doing the Midwest conference –Midwestern best ideas conference in Chicago. And then in September we’re going to attend the Credit Suisse conference – the high yield conference. And then we’re going to wait and see if there’s another window of opportunity for some further marketing following the third quarter.

Jimmy Lee

Okay. So I would like to thank everyone again for attending today’s call and we’re actually looking forward, at least to a reasonably good second half, so on that note I would like to call a stop to the call. Thank you.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

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Source: Mercer International Q2 2010 Earnings Call Transcript
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