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Edited Transcript of MERC earnings conference call or presentation 3-May-19 2:00pm GMT

Q1 2019 Mercer International Inc Earnings Call

Vancouver May 11, 2019 (Thomson StreetEvents) -- Edited Transcript of Mercer International Inc earnings conference call or presentation Friday, May 3, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David K. Ure

Mercer International Inc. - CFO & Secretary

* David M. Gandossi

Mercer International Inc. - President, CEO & Director

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Conference Call Participants

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* Adam Zirkin

Knighthead Capital Management, LLC - Partner

* Daniel Andres Jacome

Sidoti & Company, LLC - Equity Research Analyst

* DeForest R. Hinman

Walthausen & Co., LLC - Research Analyst

* Frank Duplak

PGIM Fixed Income, Research Division - Head of High Yield Credit Research

* Hamir Patel

CIBC Capital Markets, Research Division - Director of Institutional Equity Research & Paper and Forest Products Analyst

* Paul C. Quinn

RBC Capital Markets, LLC, Research Division - Analyst

* Sean Steuart

TD Securities Equity Research - Research Analyst

* Graeme Witts

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Presentation

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Operator [1]

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Good morning, and welcome to Mercer International's First Quarter 2019 Earnings Conference Call. On the call today is David Gandossi, President and Chief Executive Officer of Mercer International; and David Ure, the Senior Vice President, Finance, Chief Financial Officer and Secretary.

I will now hand the call over to David Ure.

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David K. Ure, Mercer International Inc. - CFO & Secretary [2]

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Good morning, everyone. I'll begin by reviewing the first quarter's financial highlights. Following my remarks, I'll pass the call to David. He will comment on our key markets, operational performance, the integration of our new assets, progress on our strategies and our outlook into Q2.

Please note that in this morning's conference call, we will make forward-looking statements. And according to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, I'd like to call your attention to the risks related to these statements, which are more fully described in our press release and in the company's filings with the Securities and Exchange Commission.

We're very pleased with our financial and operating performance and how they are beginning to reflect the benefits of our long-term value creation strategy and our operational priorities. We achieved record EBITDA in Q1 as a result of strong operational performance, which was a result of solid pulp and energy production, a full quarter of our new pulp assets from the DMI acquisition and was despite lower prices for both pulp and lumber compared to Q4. If we excluded the results from the recent acquisitions, this quarter would have still been our second highest quarterly EBITDA result in our history. Q1 consolidated EBITDA was $123.8 million compared to $118.1 million in Q4. When compared to Q4, our Q1 results were also positively impacted by higher pulp and lumber sales volumes, lower annual maintenance spending and moderating fiber costs. We did not have any planned maintenance in Q1. While in Q4, Stendal had a 3-day shut, which resulted in lost production and direct costs impacting Q4 EBITDA by about $3 million.

Our pulp segment contributed $121.5 million of EBITDA, and our wood products segment contributed EBITDA of $3.5 million. As usual, you can find additional segment disclosures in our 10-Q. In Q1, the average NBSK European pulp list price was down $100 a tonne relative to Q4, while the average list price in China was down $95 a tonne quarter-over-quarter. NBSK pricing in the U.S. market was down $50. Hardwood prices were also down but more modestly than those of NBSK. Compared to Q4, our average realizations negatively impacted EBITDA by about $30 million. Our pulp sales volume totaled about 555,000 tonnes, which was up 139,000 tonnes from Q4, primarily due to the full quarter's inclusion of the Peace River and Cariboo operations. In addition, our pulp sales volumes reflected early signs of a recovery in China, and we were able to make a modest finished goods inventory reduction.

Electricity sales totaled 234 gigawatt hours in the quarter and was essentially flat relative to Q4. Our Q1 electricity sales benefited from strong pulp production and a full quarter's contribution from the Peace River mill. I remind everyone that the energy sales and related statistics from our Cariboo pulp joint venture are not included in these figures because our joint venture is accounted for using the equity method of accounting. Inclusion of the Cariboo statistics would add another 12 gigawatt hours of sales.

On the wood products side of our business, we sold the equivalent of about 109 million board feet of lumber in the quarter with about 28% of this volume being sold to the U.S. market. Our lumber sales were up 8 million board feet from Q4 due to slightly higher production levels as we continue to see the benefit of our phase -- of Phase 1 of our Friesau mill expansion project.

We reported net income of $51.6 million in the quarter or $0.78 per diluted share compared to net income of $45 million or $0.68 per diluted share in Q4. Our strong EBITDA performance led to the generation of about $42 million of cash from operations in the quarter compared to $64 million in Q4. The slightly lower level of cash generation reflects a high level of accounts receivable at the end of Q1 as much of our business was transacted late in the quarter. Our expectation is that this timing anomaly will reverse in Q2 and we will begin to see a corresponding working capital reduction. We also invested about $20 million in our mills in this quarter. As noted in previous calls, we have got a fairly heavy capital expenditure plan in 2019, and David will talk more about this in a moment. Our leverage remains at an efficient level. And on a trailing 12-month basis, our net debt is down to 2x EBITDA.

Last quarter, we put a new EUR 200 million revolving credit facility in place in Germany. This unsecured facility replaced all the previous existing secured German mill revolvers and has a much lower margin. As an extension of this facility, in Q1, we implemented a cash pooling mechanism for our German entities that will reduce our borrowing slightly, and as a result, moderately reduce our interest expense. For those of you that follow our balance sheet closely, you will have noticed that we've implemented the new U.S. GAAP leasing standard. This new standard does not change our financial results, but we now have an operating lease assets and a corresponding operating lease liabilities elements on our balance sheet, each totaling $14.6 million at the end of Q1. The vast majority of these relate to land leases used for sandalwood plantations as part of our Santanol sandalwood oil business. And you will have seen from our press release yesterday, our Board has approved a 10% increase in our quarterly dividend bringing it to $0.1375 per share for shareholders of record on June 24 for which payment will be made on July 3, 2019. In addition, yesterday, our Board has approved a share buyback program for up to $50 million that we expect to begin to implement in Q2. That ends my overview of the financial results. I'll now turn the call over to David.

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David M. Gandossi, Mercer International Inc. - President, CEO & Director [3]

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Thanks, Dave, and good morning, everyone. As Dave mentioned at the beginning, we're very pleased with our record Q1 performance. It's very gratifying to see the benefits of our long-term value-adding strategy taking shape. And as a reminder, the key pillars of that strategy are maintenance of modern world-class assets, acquisitions and organic growth in adjacent businesses and spaces where we have core competencies, prudent management of the balance sheet, all while maintaining the highest standard of safety and sustainability.

Our strategic focus on our assets has allowed us to achieve solid production and record quarterly EBITDA and is driving our enhanced capital expenditure plan in 2019. We will continue to invest in our mills with more than half of our investment being in high-return projects with the remainder focused on asset maintenance supporting mill reliability. Some of the projects planned include Phase 2 of our Friesau Santanol upgrade. The second phase includes a new planer mill, more efficient kilns and improved lumber sorting, which will allow us to increase volumes and significantly improve product values. Celgar will see productivity improvements through a debottlenecking project on its pulp packaging line. We'll also build a turpentine extraction plant at Celgar that generates turpentine sales and chemical cost savings.

In Germany, we have commenced construction through long-term capital use arrangements of another 300 high-efficiency rail cars, the majority of which will be operational this year as well as many smaller targeted strategic investments. Many of our capital projects also have benefits that reduce our environmental footprint. We are completing projects at both Stendal and Rosenthal that had their origins in the wastewater offset program. And I'll remind listeners that, in 3-year cycles, we can benefit from approximately EUR 18 million of wastewater fee offsets through strategic capital projects that lower wastewater emissions. We've also applied for and received $6 million in grant money from the Alberta provincial government to support several emission-reducing projects at our Peace River mill. Our ambitious capital program will be financed with cash from operations, leaving our strong balance sheet intact and a firm foundation for further growth.

Our mills ran very well in Q1. We produced a record 539,000 tonnes of pulp and a record 583 gigawatt hours of power. We're also pleased with our wood product segment performance this quarter. We produced almost 111 million board feet of lumber in the quarter. In addition to the $3.5 million of EBITDA generated from our wood products segment in Q1, the Friesau sawmill allowed us to achieve roughly $3 million of synergies this quarter, the majority of which resulted from reduced wood chip costs for the Rosenthal pulp mill.

Turning to our markets. European NBSK pulp market demand was fairly steady through Q1, but weak paper demand and weakness in China resulted in price erosion in Europe and the U.S. European list prices in Q1 averaged $1,105 per tonne compared to $1,205 in Q4. April's European list price is about $1,070 per tonne. In China, the Q1 average NBSK price was $710 per tonne, which was down from $805 per tonne in Q4. We believe the Chinese market price is near the bottom. The average Q1 hardwood list price in China was $687 per tonne, down $76 from Q4 and the hardwood list price in the U.S. market averaged $1,180 per tonne in Q1 compared to $1,213 in Q4.

During Q1, many factors, including macroeconomic indicators, the U.S.-China trade dispute and pulp inventory levels created uncertainty and negatively affected pulp prices in all markets. NBSK demand benefited from the unusually small premium against hardwood grades, but buyers in Europe and the U.S. have had some success leveraging down prices due to the low prices in China. On the hardwood side, significant producer inventories created an incentive for buyers to limit purchases in hope of future pricing concessions. However, that situation is beginning to reverse as we're now seeing larger paper purchasers starting to restock late in the quarter.

Looking ahead to Q2, we expect markets to remain essentially flat to slightly negative as inventories continue to shift. We expect pricing momentum to improve in the second half of 2019 as the result of economic growth in China being spurred on by government stimulus and the fall pulp producer maintenance schedule, which will take large amounts of production off-line. Looking further ahead, we continue to believe that steady demand combined with the absence of new capacity will exert upward pressure on prices.

Lumber markets in the U.S. started to rebound late in Q4, as many British Columbian suppliers announced curtailments as a result of [world] markets and limited sawlog supply. However, general economic uncertainty and weak housing data have stalled that momentum. The Random Lengths U.S. benchmark for Western S-P-F #2 and Better averaged $373 per 1,000 board feet in Q1 compared to $327 in Q4. Today, the benchmark is close to the Q4 average price.

It's clear that today's low prices are not sustainable especially considering recent supply curtailments announced coming out of Western Canada. We believe the curtailment announcements along with expected demand from the spring building season has yet to materialize due to poor weather and will eventually create upward pricing momentum in Q2.

In Q1, about 28% of our lumber sales volume was sold in the U.S. market with the majority of the remainder of our sales in the European market. Despite the recent price softening in the U.S., the European lumber market has continued to experience steady demand with pricing down roughly 15% on average from the peaks in 2018. Q1 compared to Q4, our average realized sales price dropped slightly to $359 per 1,000 board feet to -- in Q1 compared to $369 in Q4. In Germany, storm- and beetle-damaged wood remains plentiful and is resulting in lower log costs generally. In Western Canada, pulp wood supply continues to be tight as saw mills had been curtailing production, which is limiting the volume of sawmill chips that are available. Looking forward, we expect our overall wood cost to continue to trend down as a result of the lower European costs.

In 2019, we expect to have 115 planned shut days, with the majority planned for the second half of 2019. At Rosenthal, we'll take a 10-day shut in Q3. At Stendal, we'll take a 13-day shut in Q4. At Celgar, we'll take a 22-day shut in Q4 not only for annual maintenance but also to do some important productivity improvements throughout the mill including a packaging line upgrade. At Peace River, we will take an extended 2-month shut that will straddle Q3 and Q4 to complete the rebuild of our recovery boiler. All of the capital costs of the rebuild will be covered by our property insurance, and about half of the lost production will be covered by our business interruption insurance. And our Cariboo joint venture mill will take a 12-day annual maintenance shut in Q2. We expect this shut will reduce our portion of the mills production by about 6,000 tonnes.

The integration of Peace River and Cariboo pulp mills is progressing well. I'm very pleased with how our Mercer safety program is being received and we're progressing well on our identified synergies. We still expect between $15 million and $20 million of annual synergies. In Q1, we achieved about $2 million, but we expect them to ramp up over the next 1.5 years. In addition, we've had further growth aspirations, but we will continue to take a disciplined approach. Any opportunity we consider will be framed by Mercer's core competencies in pulp and lumber production, wood derivatives and bio-extractives as well as in green energy. Our core competencies will continue to drive long-term value creation for shareholders.

Now, as Dave mentioned yesterday, we announced our Board has approved a 10% increase in our quarterly dividend. This increase reflects our deep commitment to the dividend and is well supported by the strength of our balance sheet and our steady cash flow generation. Also as previously mentioned, our Board has approved a $50 million share buyback program that we expect to begin to implement in Q2. I want to talk about this now. Considering our previous hesitancy to implement share buybacks, underpinning our decision are 2 main points. One, we are very confident that our long-term value creation strategy that focuses on high-performing people and assets will deliver significant value to shareholders; and two, our confidence in the medium and long-term market fundamentals for pulp, lumber and extractives. These have led us to the conclusion that we could accelerate shareholder value creation by making an opportunistic investment in ourselves. And I should also be clear, this targeted investment will not impact our future growth or CapEx plans in any way. Thanks for listening, and I'm looking forward to your questions. We'll now turn the call back to the operator so she can open the call. Thanks again.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Hamir Patel from CIBC Capital Markets.

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Hamir Patel, CIBC Capital Markets, Research Division - Director of Institutional Equity Research & Paper and Forest Products Analyst [2]

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David, how much beetle and storm wood is there to still get worked through in Germany? And I'm just trying to get a sense as to how long your fiber costs could stay low in Europe?

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David M. Gandossi, Mercer International Inc. - President, CEO & Director [3]

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Yes. Well, I mean, it's going to be all of this year, for sure, possibly well into next year. Part of the answer will depend on what happens this summer. But expectations are that -- and experience to date are such that there's a lot less water that's a lot less rainfall than there traditionally is. So I think there's a fair degree of alignment among the foresters that we could have another summer like last summer. So it's -- yes, the spruce log costs are down a lot and are expected to stay down and probably continue to decline further.

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Hamir Patel, CIBC Capital Markets, Research Division - Director of Institutional Equity Research & Paper and Forest Products Analyst [4]

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And Dave, you mentioned that the lumber prices in Europe are down 15% on average from the peak. How does that maybe differ within some of the regional markets? I imagine that Germany will be down even more with the low fiber costs, but how does maybe markets like Scandinavia share?

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David M. Gandossi, Mercer International Inc. - President, CEO & Director [5]

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Yes, boy, not really -- can't really take the time to go through market-by-market. What's behind my comment, I look at the -- sort of the 3 main products that we produce outside of the dimensional markets, that's KVH, [glue ram] and packaging grades, quite a bit of it green. And the -- each market really has its own dynamic in a lot of ways. The German market, as you say, is really heavily influenced by log costs. If the guys buying lumber see log costs going down, they expect the lumber prices to go down a bit. To this point in time, log costs have fallen further than lumber prices. But we also -- we have that grade -- the value -- well, there's more off-grade with the type of logs that we're able to get. So net-net, it's a little -- I mean it's a weaker situation from a profitably point of view but, as you saw in our results, not terrible.

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Hamir Patel, CIBC Capital Markets, Research Division - Director of Institutional Equity Research & Paper and Forest Products Analyst [6]

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That's helpful. And David, one of your Canadian peers has recently indicated they're going to switch back to 12-month maintenance cycles from 18 months. Can you remind us what are the major maintenance cycles at your various mills? And how do you think about the timing of those?

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David M. Gandossi, Mercer International Inc. - President, CEO & Director [7]

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Yes. Well, we still do 18 at Stendal, and that works fine for us. But at our other mills, we're on 12s, and I think we're going to stay there. Yes, you just -- you need to -- on the older mills, you need to get in and do your inspections and make sure you're staying on top of everything. And we just -- we don't like the risk of going too long with -- on some of the older pieces of equipment. We have modern mills, but they're -- once you start getting up over 10 or 15 years, you -- I think an annual shut is the way to go.

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Operator [8]

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Your next question comes from Sean Steuart with TD Securities.

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Sean Steuart, TD Securities Equity Research - Research Analyst [9]

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A few questions. Pulp markets, to start with. You mentioned that it feels like the market in China is settling out. And David, I'm just hoping you can reconcile that with what look to be still relatively high mill inventories. And I know the buyer inventories in Europe are still elevated as well. What are you seeing in -- what are your guys seeing on the ground in China in terms of inventories there that gives you confidence that, that market is settling?

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David M. Gandossi, Mercer International Inc. - President, CEO & Director [10]

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Well, it's -- I mean, pulp is really starting to move in China. The mood in China is a lot better than it was 3 or 4 months ago. There's economic stimulus programs going on, things like 3% reduction in the VAT rate, income tax reductions going down, lots of positive messaging around small, medium enterprise organizations being supported. So the mood is better. There's on the hard -- there's a lot of -- the big chunk of inventory's on the hardwood side, but the majors are holding the line on price, it seems. So it doesn't look like that price is going to crack further. And if that's the case, then softwood will hold pretty steady. And if buyers think the price is going to be lower, then they hold off. If they think they've hit the floor, then they start to buy. And that's what they're doing. I mean, everybody's getting normal volumes, and we're working our way through the inventory. And I see generally this condition continuing through to the end of the summer. Sean, I don't see a catalyst for a big upsurge, obviously, with the inventory there. But we're seeing the inventory coming down, and consumption is happening at a good pace. So I think we'll work it. And then, in the back half of the year, there's a -- I mean, particularly in Europe, there's a lot of maintenance. It's all back-end loaded this year in Europe. There's spring maintenance in Canada. But for Europe, it's almost all back end, second half of the year. If you combine that with some of the conversions that are going on, like Valdivia, Enocell, a couple of Stora Enso mills, and we're going to -- I think we'll see things tighten up fairly quickly following the summer.

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Sean Steuart, TD Securities Equity Research - Research Analyst [11]

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Does it -- by your math, does it look like we'll see net capacity reductions globally in NBSK next year with these conversions?

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David M. Gandossi, Mercer International Inc. - President, CEO & Director [12]

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Yes. Yes, for sure.

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Sean Steuart, TD Securities Equity Research - Research Analyst [13]

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The second question is capital allocation, I suppose. I mean, it seems like the midterm priority is returning more capital to shareholders and the various discretionary CapEx initiatives you've laid out. Is there a point at which you guys start to refocus on potential M&A opportunities? What scale, over the longer term, would you be comfortable looking at? And when does your mind maybe get around those types of larger initiatives again?

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David M. Gandossi, Mercer International Inc. - President, CEO & Director [14]

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Yes. Well, I mean there's a lot of different things to think about that in all that. One of the -- I mean, what's driving us, I think, is recognition that there is some liquidity discount in our stock. We feel it would be really important to be bigger. But having said that, we want to always maintain our culture and our execution excellence and all those kind of things. So we're going to take it a step at a time and be disciplined. Sometimes value expectations of others are too high for us. We won't make any -- won't create any value by paying too much for things. And we've been trading at a fairly low EBITDA multiple relative to what we consider to be our inherent value. So we're not prepared to use our equity as consideration on acquisitions. So that's a limiting factor. But I think, as the market starts to appreciate more our platform and the fundamentals in pulp and lumber for the medium and longer term, those conditions could change, and we'll have more opportunity to execute on M&A. But we always have lots we're working on and looking at and thinking about. But we have to be balanced and keep all these factors in our mind.

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Operator [15]

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Your next question comes from DeForest Hinman from Walthausen & Co.

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DeForest R. Hinman, Walthausen & Co., LLC - Research Analyst [16]

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As a person in a firm that's been involved with the company for a long time, I think the share repurchase authorization is a good decision from the Board. It would be appreciated by shareholders as well. And I think as part of your toolbox in terms of capital deployment, it's something good to have, and hopefully we can execute on it. Digging a little further into capital deployment, can you help us think about how you're looking at your bonds? Some of them are callable, I believe, not at huge premiums. And any other thoughts you have on that cash balance?

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David M. Gandossi, Mercer International Inc. - President, CEO & Director [17]

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Yes, well, I think the -- yes, we're always thinking about what's the right timing on the bonds. And we've got the $100 million of 2022s out there, so that's obviously on our radar screen. And we don't want to pay too much of a premium to get them back, so there's no rush. There's also -- as interest rates, the environment changes over time and there may be an opportunity to refi some of our bonds with some M&A activity that we might do in the future. And so that would be on the table as well. So we're just -- no specific strategy to enunciate here other than maintaining a strong balance sheet and good duration on our debt is important, and we'll always keep that in mind.

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DeForest R. Hinman, Walthausen & Co., LLC - Research Analyst [18]

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And then in terms of the M&A front, can help us understand the focus area there? Is it pulp? Is it lumber? Derivative chemicals? Where is the focus right now?

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David M. Gandossi, Mercer International Inc. - President, CEO & Director [19]

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Well, DeForest, they are all open for us. We're delighted with the DMI acquisition, the 2 pulp mills, both hardwood and softwood, Peace River being a swing mill. We're delighted with our Friesau acquisition and the value we're able to create by implementing some strategic capital investments there. Similarly, very pleased with our investment in Western Australia in sandalwood in expanding our extractives business and tying into that our investments in our own mills for things like methanol extraction and turpentine extraction and so on. So we look at all these areas and we expand in a disciplined way, targeting investments that won't tax the balance sheet, don't require us to pay too much for them, create a way for us to create shareholder value. And so it's -- so we're digging around in all the areas and looking at different opportunities all the time. And could be -- next step could be any one of them.

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DeForest R. Hinman, Walthausen & Co., LLC - Research Analyst [20]

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Okay. And then on the SG&A number, I'm just trying to get my math right. It was a little bit higher in the fourth quarter, actually stepped down sequentially, and we had a full quarter of DMI expense load. Is that some of the synergy gains? Is that FX movement? Is that the new run rate going forward? Is it a $17 million to $18 million range for the remainder of the year?

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David K. Ure, Mercer International Inc. - CFO & Secretary [21]

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Yes. I think that's going to be pretty close, DeForest. So we get a little bit of bumpiness in there so in Q -- and some of it has to do with stock compensation. So part of our compensation is stock, and it has a relationship to the price. So there's adjustments to the stock comp expense when there's a price change in the stock. So if it moves quite a bit, you'll see a little bit of bumpiness in the G&A. So quarter-over-quarter, it was broadly putting in the DMI -- adding the DMI G&A, and then there was a reduction because the stock price was a little bit lower through the period.

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DeForest R. Hinman, Walthausen & Co., LLC - Research Analyst [22]

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Okay. And then just to help my understanding on the moving parts. With pricing down, whether it sounds like costs coming down and then realizing there's some work in process and there's some chip and log inventory on the balance sheet, is the margin outlook, anyway you want to describe it, gross margin or operating profit or EBITDA margin, is that outlook better or worse in the second quarter than the first quarter?

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David K. Ure, Mercer International Inc. - CFO & Secretary [23]

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Well I think the only material change in the margin is going to be the price -- pricing, so the mill net. So depending on your view of pulp pricing, that will be the biggest contributor to the change in margin. The rest of the cost structure is -- should be -- that should be pretty quiet. Although, as David mentioned, we're still -- we're seeing -- still seeing a little bit of a -- getting a bit of downward pressure on fiber costs in Europe. But other than that, the margin is about price -- whatever your view on price and foreign exchange is.

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Operator [24]

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Your next question comes from Adam Zirkin from Knighthead.

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Adam Zirkin, Knighthead Capital Management, LLC - Partner [25]

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So first of all, just congratulations on a really exceptional quarter in a tough environment. Frankly, I think this will go down -- I've been following this for probably a decade, and this will go down as one of the more significant ones. So really great job. A couple of questions for you. Number one, what's your sense of how your pulp competitors are faring right now? You spoke about the lumber guys. And I ask because if you have told me that the inventories were at 37 days and asked me what the price was, I would have thought it would be lower than it was a today, right? So what do you see is the fundamental sort of cost curve base supports at these levels? And how are they functioning?

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David M. Gandossi, Mercer International Inc. - President, CEO & Director [26]

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Yes. Well, I think we've still got a pretty steep cost curve in both grades. We've got quite a bit more consolidation on the hardwood side, which I think is a contributing factor to what we're experiencing today. It seems to be a higher floor than what would traditionally be the case. So for our peers, it's hard to generalize. We have competitive peers and we have a lot of peers that have a much higher cost structure than we do. And you also have to take into account the timing of maintenance shuts between all the different companies as well, so. But look, the -- prices at these levels are, they're not what they were a year ago, but they're still healthy prices for us. And when you take all of our competitive advantage into consideration, we'll continue to do quite well, I believe. And that's really what was behind our thinking on the share buyback and increasing the dividend. And we wanted to express our confidence in that view.

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Adam Zirkin, Knighthead Capital Management, LLC - Partner [27]

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I think that makes a lot of sense. I guess, I'm wondering, do you believe that there are guys out there, at these prices, who are struggling?

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David M. Gandossi, Mercer International Inc. - President, CEO & Director [28]

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Well, some are but for different reasons. I think, some don't have access to fiber the way we do and maybe having to make heroic decisions to keep their mills running even despite -- they just haven't -- not everybody's got the logistics and the innovative activities necessary to do it -- to make it happen. So I think there's some mills that are really, really struggling. And I also know that some of the mills are getting to an age where their issues are pretty big. And it gets harder and harder for them to address those issues as time goes on. So I also -- we haven't really seen any big supply disruptions yet this year. I think, the first quarter, everybody ran successfully. Unlike last year or the year before, where we started to see some fairly significant upsets, we -- that hasn't happened yet, but I'm kind of the view that we will see some more of that as time goes on.

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Adam Zirkin, Knighthead Capital Management, LLC - Partner [29]

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Got it. Can you talk a little bit about the scope of the fiber opportunity in Europe? You mentioned in the capital plan that you're taking on another 300 railcars. Perhaps I should know this, but can you just sort of let me know the total anticipated size of that opportunity? And sort of, for lack of a better phrase, what inning of that you're in?

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David M. Gandossi, Mercer International Inc. - President, CEO & Director [30]

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Well, we're well into it. It's not just, though, cost reduction. We can move roughly 40% more wood on the same length of train if you have modern [reserve] railcars compared to what you would otherwise rent or lease from Deutsche Bahn or other entities. So there's a cost saving, but there's also the strategic potential that they create for us. So we can bring wood in from a long way away. We can go east in Poland, east in Czech, we've got all the Baltics that can feed into ports in Northern Germany. We have what we call satellite yards. So we're accumulating more and more rail holding places. These are sidings where you can locally buy wood from markets that we wouldn't have previously tapped into and then have the local operators bring their wood to that location, it's a storage facility, and then we load it on a railcar on a train when we're ready. So we've just got lots of different strategic advantages to having that kind of horsepower around. And the net result is we -- there's less pressure on the fiber basket in our traditional procurement areas because we're able to import into our operating region wood that we wouldn't have otherwise been able to do economically. So I think it's a really big strategic advantage for us and something we're continuing to further develop.

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Adam Zirkin, Knighthead Capital Management, LLC - Partner [31]

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Got it. And then lastly, just on the capital return. Obviously, we've been talking about it for a long time, so I'm thrilled to see it. I think it's the right decision. But I'm curious, was that decision made to the exclusion of anything, any large capital projects or other stuff that you guys sort of had on the drawing board for the short term? Or is it something that you sort of intend to just weave into the longer-term capital allocation strategy of the company?

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David M. Gandossi, Mercer International Inc. - President, CEO & Director [32]

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Yes, as I said in my comments, it doesn't -- it in no way changes our enthusiasm for the organic or external growth opportunities. It's something we can afford comfortably and it's -- I just think it's a really important statement for us to make that -- pay attention to the changing conditions in this world. Fiber scarcity is going to come. And Mercer has access to tremendous fiber baskets with great mills and all of the strategic wherewithal to make it happen in a profitable way for ourselves. So we just wanted to make that statement that we're here to create shareholder value. And this is something we can do, and it doesn't really change anything else for us operationally.

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Operator [33]

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

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Paul C. Quinn, RBC Capital Markets, LLC, Research Division - Analyst [34]

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I understand wood costs are coming down in 2019 here, but maybe you can just talk a little bit about wood availability in BC given that we expect some sawmills to be rationalized over time? And then in terms of -- give us an idea of percent whole log chipping shipping versus percent residual and what you see with those relative percentages going forward?

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David M. Gandossi, Mercer International Inc. - President, CEO & Director [35]

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Okay. Well, you're right, in BC there -- maybe for some of the listeners to think about what's happened is -- so there's this been a pine beetle issue. And there's been a lot of saw milling capacity built up to process that incremental volume that is going to be available for a period of time. And now that, that incremental volume is starting to diminish, everybody's expecting and has been and there will continue to be some rationalization of that capacity that was put in place to deal with it. We're also in a short-term period here where the weather has just been so rough for builders. And I think there's been some, maybe, confidence issues, perhaps, and increased costs that have -- impact housing starts and a bunch of issues that have just resulted in a much slower building season so far this year. So there's -- sawmills around British Columbia are curtailing for market reasons. Log costs are still high, lumber prices are low. So the whole dynamic is pretty challenging for everybody. Where we are in the Kootenays, we're in a green forest. We really don't have much pine in our region. We've tended to opportunistically go after the pine. We could go north up past Revelstoke, buy in the Okanagan and float it down the Arrow Lakes, which is a 160-mile highway to the mill, if you like, at the Columbia River. We've been very innovative over all these years, focusing on roundwood programs because we see a lot of waste in the BC processing. There's -- just the way the forest management regime has been there, there's -- these saw millers have tended to leave quite a bit of roundwood behind when they're harvesting for sawlogs. And we've participated in a lot of the policy development and demonstrated that, economically, we can bring it out. And it's economic fiber for us. So you're not going to see much fiber cost inflation from us. I think we've got access to lots of wood. And it's a little bit higher than it would be if it was sawmill residuals just flooding at the mill from a healthy lumber market. But we're in pretty good shape relative to perhaps some others. I think, if you were to look at Coastal British Columbia, the fiber cost there would be a lot higher than what we are dealing with in the Kootenays. I think up north, their costs have risen from the point -- perspective that they're having to move into roundwood programs maybe more heavily than they're used to doing, and they haven't fully rationalized it, at least, that's my view. They haven't really figured out how the bring in roundwood in a really cost-competitive way. You have to put some energy into it and put some capital in place. And so I think the guys up north can do a lot better. And they probably will as time goes on. So summarizing it all, I'd say, we're at a point in time where some mills are struggling. We're paying more for fiber than we would like to, but it's not terrible and it's pretty well contained and I'm not expecting it to increase a whole bunch. And over time, there's lots of wood in British Columbia. I don't see pulp mills curtailing for lack of fiber. I just think some of the guys in the industry need to put a little more effort into innovation, but there's lots of wood around.

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Paul C. Quinn, RBC Capital Markets, LLC, Research Division - Analyst [36]

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Great. Just on the share buyback, I mean, you guys have been hesitant to do that in the past. Part of that is related to just the liquidity of your shares in the marketplace. Is there stocks in place to make sure there's enough liquidity, i.e., how much you can buy? Is there a limit on that?

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David M. Gandossi, Mercer International Inc. - President, CEO & Director [37]

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We'll we sized it at $50 million, as you can see, and that's a level we're comfortable with. And we'll put in our tranches as normal work for us that we need to implement it. But I'm not worried about liquidity from the share buyback or we wouldn't be doing it, so.

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Paul C. Quinn, RBC Capital Markets, LLC, Research Division - Analyst [38]

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Okay. And then just -- new -- well, new-for-you mill up in Peace River area and there's saw millers and others that have been affected by the mitigation strategies around caribou. Just wondering if you could address that, whether there's any kind of long-term issues on the fiber supply for that facility?

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David M. Gandossi, Mercer International Inc. - President, CEO & Director [39]

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No, not -- I mean, caribou is a species at risk issue that is concerning for all of us. Our FMA, our forest management area is so large that we'll be fine. This is going to require some management attention obviously but it's not going to fundamentally change anything in terms of our access to wood or what we're going to have to pay for it. We have -- the size of the FMA gives us optionality. And we've always had an ecological-based forest management approach in that -- in Alberta. And I'd say that [while] we -- I mean, DMI before us, they had a really strong team and I think they did it right. They've been focusing on caribou corridors and managing the landscape in a way that replicates what nature would do. Like if you had a forest fire, for example, in the boreal, you'd have a patchwork of burned areas and green areas, and it'd look a bit like a mosaic, and that's the way we've always harvested. And we close off haul roads and create speed bumps for the wolves and thing like that. We've done all the things right. So I don't -- I just don't think that anything that we're doing is exacerbating the issue for the caribou. And -- but we will continue to do the right things. And as I say, if we just step away from one area and move to another, it's not a big deal. Like, we've just got lots of options.

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Operator [40]

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(Operator Instructions) And your next question comes from Dan Jacome from Sidoti & Company.

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Daniel Andres Jacome, Sidoti & Company, LLC - Equity Research Analyst [41]

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Kudos on the quarter, for sure. With the dividend, buyback and the earnings, it seems like almost a hat trick if this was a hockey game. Just one question sort of to satisfy my curiosity on the beauty of the timber and wood product coming out of Saalburg. In the last 6 months, have you guys seen any difference in the end market, EU versus U.S.? Just high-level, how lumber is customized? I think when you first entered the timber lumber business, you noted that the EU is a little bit more focused on kind of robust finishing. And then, in the U.S., if I'm not mistaken, the lumber tends to be more typically standardized. Have you seen any changes? And if you have, how is your capacity mix and production efficiencies adapting to this market? That was it for me really.

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David M. Gandossi, Mercer International Inc. - President, CEO & Director [42]

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Okay, Dan. Well, maybe just the character of the 2 markets, the European in the U.S. markets, are quite different. The European market tends to be much more stable, less volatile. Many, many different types of products, not -- whereas, the U.S. market tends to be a dimensional lumber market for construction. There are other products obviously but the big driver is the dimensional market. And that's similar to the U.K. market, also to (inaudible) obviously, and then Japan. But in Europe, we make many, many different products for lots of different reasons. Some of the big grades I mentioned earlier are KVH, which is a construction beam that's finger jointed, can be made into any length. So we're providing a product to somebody else who's adding value to it, and they've got their customers. And their view of our price is really informed mostly about what they think our log costs are. It's a really steady market, steady demand, steady supply and prices is really related to our cost structure. That's the same for CLT products, and it's the same for a lot of the packaging grades and other things. So no change to our strategy. I've always said that we'll commit about 25% of Friesau to the U.S. market. I think over a cycle, that market will perform very well for us. I really like the fundamentals of lumber. I mean, it doesn't feel like it just at the moment when you look at the curtailments and the some of the guys in Canada are suffering from higher log costs. So it's not a lot of good news coming out of the peers, but the medium and long-term fundamentals for lumber feel really good to me. And so we want to be in that U.S. market to capture those margins as they come. Also we're developing quite a successful following in Japan, which is a dimension product, but it's a very high quality lumber product and with higher margins. If you can make the grade and develop those relationships to service the market. So we're going to continue that strategy, 25% U.S., 10% Japan and the rest sticking to Europe and possibly bits to the other -- Europe is a lot of different markets, obviously. But just generally speaking, that would be how we break it down.

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Daniel Andres Jacome, Sidoti & Company, LLC - Equity Research Analyst [43]

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Yes, that was very helpful. I totally forgot that you were in the Japan market. What is it like over there? Is it closer to the U.S. market or more like the EU market in terms of standardized versus non -- more customized?

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David M. Gandossi, Mercer International Inc. - President, CEO & Director [44]

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It's not as volatile, simply because not everybody can service it. You have to -- and it's a relationship market as well. You have to earn your right to play there. You have to produce a high-quality product consistently, the service has to be right on point, and it takes a while to build up that relationship. And so it's a less volatile market than the U.S., which is lumber on a railcar down the track and guys taking positions on it, if you know what I mean.

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Operator [45]

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Your next question comes from Frank Duplak from Prudential.

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Frank Duplak, PGIM Fixed Income, Research Division - Head of High Yield Credit Research [46]

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I'm just curious, and maybe I missed it, have you guys sort of given a range of what CapEx might be for 2019? I know you said maybe a little more aggressive this year. Can you give us some range around that, please?

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David M. Gandossi, Mercer International Inc. - President, CEO & Director [47]

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Yes, sure. Including carryovers from last year and approvals from this year, we'll spend somewhere around $150 million to $170 million in the year on a whole variety of different things, half of which -- half of that would be high return and the other half would be what we call maintenance. But maintenance of business does include usually cost savings. It would be both on the maintenance side but also energy, chemical usage and other efficiency savings as well.

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Frank Duplak, PGIM Fixed Income, Research Division - Head of High Yield Credit Research [48]

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So will we see a material bump up in the rate next quarter? Because I mean, obviously, what you did in the first quarter wouldn't get you there if you annualize it. When do we expect to see really the pace of that pick up?

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David M. Gandossi, Mercer International Inc. - President, CEO & Director [49]

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Well, I would think it's going to be pretty steady through the rest of the year. And obviously, it will be higher than it was in the first quarter.

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Frank Duplak, PGIM Fixed Income, Research Division - Head of High Yield Credit Research [50]

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So maybe $40 million to $50 million a quarter for the rest of this year makes sense.

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David M. Gandossi, Mercer International Inc. - President, CEO & Director [51]

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Just let me have a look here.

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David K. Ure, Mercer International Inc. - CFO & Secretary [52]

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Might be heavier -- a little bit heavier to the second half because some of these projects are completed during the shut downs. And as David was mentioning, most of our maintenance shuts are in the second half of the year.

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Frank Duplak, PGIM Fixed Income, Research Division - Head of High Yield Credit Research [53]

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Okay. And then if you had to look out into 2020, is this kind of a 1-year event? Or do you think we'll be elevated CapEx now kind of for a longer period of time? Just curious.

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David M. Gandossi, Mercer International Inc. - President, CEO & Director [54]

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No. This is not run rate CapEx. This is strategic capital that we're putting in place to -- as part of our strategy to invest in our assets so that they're reliable and they can produce the results that we expect. We don't need to keep doing this every year. Once we get through this, there'll be opportunities to significantly reduce the amount we spend, but there's also -- there continues to be projects available to us that are very attractive that increase our volumes. I've talked about those in the past, and we're continuing to work on some of those, where, if we can increase in the productive capacity of the mill with a 3 or better year payback, we're hoping to have some project announcements down the road. That's in our organic growth strategy.

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Operator [55]

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Your next question comes from [Tony Graves].

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Unidentified Analyst, [56]

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Just 3 quick questions from me. Just a follow-up on CapEx guidance. Is that gross or net of insurance recoveries for the [NPR] project?

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David M. Gandossi, Mercer International Inc. - President, CEO & Director [57]

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Oh that's gross not net.

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Unidentified Analyst, [58]

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Okay. And then maybe shipments and production by mill, too?

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David M. Gandossi, Mercer International Inc. - President, CEO & Director [59]

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David, do you want to address that?

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David K. Ure, Mercer International Inc. - CFO & Secretary [60]

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Yes, sure. You'll recall we talked about this a little bit last quarter, and we made the determination that we wouldn't be disclosing those detailed shipments and production numbers by mill. We sort of looked at our -- what our peers are doing. And now that we've -- we're a much larger company than we were last year, we've made the decision to not do that disclosure. But I would say that I think, for us, you'd find that our production is pretty consistent as long as you have -- you understand what the shut schedule is. And that's why we go to considerable effort to make sure that we disclose when the mills are shutting down and the particular -- the number of days. And if you can understand the shut schedule, you'll generally get pretty close on our productivity numbers.

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Unidentified Analyst, [61]

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Okay, that's fair. Thanks for the clarification. And then last one from me. Could you maybe size the turpentine opportunity at Celgar? And is this something that you can do in addition to [frutalo] refining? Or are these processes mutually exclusive?

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David M. Gandossi, Mercer International Inc. - President, CEO & Director [62]

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Well, they're exclusive. So the 2 things -- well, first of all, the size -- so the capital investment for the turpentine plant will be about $3.5 million. The project itself will generate just around a 2-year payback. And there's 2 things that happen. We'll have turpentine to sell, but we'll also have reduced chemical costs by -- turpentine in the bleach plant require -- drives the chemical costs up. So by extracting it, pulling it out, we'll be -- we'll have more efficient chemical usage downstream. So it's not huge. We do this in the Rosenthal and Stendal. And it's a bolt-on technology that's well proven and generates roughly $2 million to $2.5 million -- well, maybe $2 million of sales a year on turpentine.

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Operator [63]

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I'll now turn the call back over to the speakers for further comment. We have a question from Graeme Witts, he's a private investor.

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Graeme Witts, [64]

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My question actually has been answered. It was to do with share buyback, share versus debt buyback and why share buyback, but you've covered it very well during the meeting.

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David M. Gandossi, Mercer International Inc. - President, CEO & Director [65]

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Thank you, Graeme. Okay. Well, thank you, everyone for joining on the call. As always, Dave and I are happy to take calls anytime, so don't hesitate to reach out to us. And failing that, we'll look forward to speaking to you again at our next earnings call in August. So bye for now.

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Operator [66]

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