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Edited Transcript of MERC earnings conference call or presentation 28-Apr-17 2:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Mercer International Inc Earnings Call

Vancouver May 3, 2017 (Thomson StreetEvents) -- Edited Transcript of Mercer International Inc earnings conference call or presentation Friday, April 28, 2017 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 and Secretary

* David M. Gandossi

Mercer International Inc. - CEO, President and Director

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Conference Call Participants

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* Adam Zirkin

Knighthead Capital Management, LLC - Partner

* Andrew Evan Shapiro

Lawndale Capital Management - Founder, Chairman, President, Portfolio Manager, and Managing Member

* Daniel Andres Jacome

Sidoti & Company, LLC - Research Analyst

* DeForest R. Hinman

Walthausen & Co., LLC - Research Analyst

* Hamir Patel

CIBC World Markets Inc., Research Division - Research Analyst

* Samuel Thomas McGovern

Crédit Suisse AG, Research Division - Research Analyst

* Sean Steuart

TD Securities Equity Research - Research Analyst

* Tom Bandurowski

Brown Investment Advisory & Trust Co. - Credit Analyst

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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 2017 Earnings Conference Call. On the call today is David Gandossi, President and Chief Executive Officer of Mercer International; and David Ure, 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 and Secretary [2]

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Good morning, everyone. I will begin by taking a few minutes to speak about the financial highlights of the quarter. And then I'll pass the call to David to discuss the markets, our operational performance 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.

Our Q1 financial results reflect solid operational performance, strong sales and the early impact of NBSK pricing improvements, which took hold late in the quarter. Our financial statements also reflect refinancing activities completed during the quarter in anticipation of our German sawmill and power plant acquisitions. In Q1, we achieved EBITDA of $60.2 million, compared to $57.8 million in Q4 of 2016. When compared to Q4, our Q1 results reflect higher sales volume, lower scheduled annual maintenance, partially offset by the absence of the wastewater fee reversal and favorable foreign exchange movements that occurred in Q4.

Our pulp sales totaled about 375,000 tonnes, which is up 30,000 tonnes compared to Q4, and electricity sales were up almost 23 gigawatt-hours relative to Q4 due to solid pulp production and the absence of scheduled maintenance downtime in Q1. We reported net income of $9.7 million for the quarter or $0.15 per basic share, compared to net income of $18.5 million or $0.29 per basic share in Q4.

As you know, early in the quarter, we issued $225 million of new senior notes that are due in 2024 and carry a coupon rate of 6.5%. These funds were used to redeem our higher cost 7% senior notes that were due in 2019 and extend the termination date beyond our existing 2022 notes. In connection with the redemption of our 2019 notes, we incurred an accounting loss of $10.7 million or $0.16 per share comprised of the $7.9 million call premium along with certain unamortized issuance costs. Subsequent to the initial issuance, we tacked on an additional $25.0 million to that same issue to help finance our recent sawmill and power plant acquisition in Germany. Our Q1 interest expense was $13.9 million, which is a little higher than normal due to a bit of an overlap in the timing of the issuance of our new senior notes and the redemption of our old 2019 senior notes in the quarter.

Income tax expense in the quarter was $7.5 million, of which approximately $3.3 million was current. Current taxes reflect our continued use of tax assets to shield cash taxes.

Turning to cash flow. Our cash balance increased by about $47 million in Q1 compared to a decrease in cash during Q4 of $8.5 million. Our Q1 operating results were comparable to Q4, but positive working capital movements and lower capital spending in Q1 compared to Q4 contributed to our cash build. In addition, there was a slight timing difference between when we completed a $25 million tack on to our new 2024 notes, which occurred in March, and the timing of the sawmill acquisition, which did not close until April. Overall, our operating cash flow was about $53 million in Q1 compared to $30 million in Q4, when working capital movements were significantly less favorable.

In addition, our 12 months rolling operating cash flow was $130 million. Capital expenditures grew approximately $8.4 million during the quarter. Some of the more notable projects include the completion of Rosenthal's whole log delivery system and work done to upgrade Celgar's bleach plant.

Our cash outflows in the quarter also included our quarterly $7.4 million dividend payment. And in early April, just after the quarter end, we also secured a new 5-year revolving credit facility for our German sawmill and power plant operations. The EUR 70 million facility will be shared with Rosenthal and replaces the existing EUR 25 million facility we had supporting that mill. The new facility has substantially similar terms to the terminated Rosenthal facility.

Our liquidity remains strong. Our consolidated cash balance was approximately $188 million at March 31, 2017, and we had about $134 million of undrawn revolvers between our 3 mills, putting our total liquidity at almost $322 million. This liquidity was used to finance the German sawmill and power plant acquisition and working capital requirements during Q2. The cash balance at the end of the quarter includes approximately $4 million of restricted cash. These are funds that have been set aside to act as collateral for our Stendal interest rate swap. The collateral amount is contractually based, and as the interest rate swap balance declines, so does the collateral amount, subject to certain minimum requirements. At the end of Q1, there were 2 settlement payments remaining, one in April and the final one in October of this year.

On a trailing 12-month basis, our net debt is about 2.3x EBITDA, which has improved over Q4 as a result of strong operating cash flow in Q1. And you will have seen from our press release yesterday, our board has approved an $0.115 dividend for shareholders of record on June 27, for which payment will be made on July 6.

That is my overview of the financial results. I'll now turn the call over to David Gandossi to discuss market conditions, our operational performance and strategic activities.

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

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Thanks, Dave, and good morning, everyone. As Dave noted, effective April 12, we acquired a significant sawmill and energy generation complex in Friesau, Germany. The Friesau sawmill has an annual capacity of 550 million board feet of lumber, 13 megawatts of electricity and 49.5 megawatts of thermal energy. It is a flexible production facility that produces over 200 products with multiple package sizes capable to meet customer requirements around the world. This acquisition is in line with our longer term growth strategy, as it leverages some of our core competencies, including wood procurement, production optimization and green energy production. We believe the Friesau sawmill provides potential operating synergies and other margin enhancement opportunities, including synergies in the range of $4 million to $7 million, primarily relating to the procurement and sharing of wood and biomass fuel resources, the optimization of logistics and staffing and services with our Rosenthal mill. We also believe we have the opportunity to materially increase lumber production in 2018 and to reduce costs and improve sales realizations through targeted capital upgrades. We're optimistic about the potential for this acquisition, however, due to the nature of the German wood markets, we believe it will take between 4 and 6 months before this mill begins to contribute to our earnings.

Looking ahead to our entry into the lumber business, we are, obviously, watching with great interest the development of lumber markets and the potential impact of the Softwood Lumber Agreement between the United States and Canada. The Random Lengths Composite Index has surpassed the $430 per thousand mark in the recent weeks, and we're seeing steady improvement in European markets as well. As we develop our marketing plans for a product that will be branded Mercer Timber, we will take full advantage of our mill and logistics flexibility to optimize our global customer base and to maximize margins.

Turning to our Q1 performance. Overall, we had strong operating results this quarter as a result of strong pulp sales volumes, higher production volumes and continued cost discipline. In terms of the pulp markets, demand has been strong through April. Prices have risen steadily in China in Q1 to the point that our March list price was $670 per tonne, up $70 since September or up $100 since November of 2016. Demand is also strong in Europe, and although prices haven't risen as dramatically as they have in China, prices are up $30 per tonne since December. And an April price announcement will put the May list price to $890 per tonne. The quarterly average RISI list price in Europe increased to $822 per tonne compared to $810 in Q4. Similarly, the quarterly average RISI list price in China increased to $645 per tonne compared to $595 in Q4.

Overall, our pulp sales realizations were up only slightly compared to Q4. While the widening of industry list price discounts in Europe and the U.S. markets that took effect in January dampened the impact of the list 1 price improvements in Q1, we expect price improvements to be more apparent in Q2. It's important to note that these increases have been implemented or announced even as incremental NBSK capacity came online in Europe in 2016 and has been ramping up. Consistent with increasing NBSK pulp prices in Q1, NBSK producer inventories were down 3 days to 29 days from the end of 2016. At the same time, hardwood inventories were essentially flat since December. We believe inventories at this level are well balanced. Consistent with the upward pricing pressure on NBSK, demand through Q1 has been strong. Global NBSK shipments were up over 2% compared to the same period last year.

We continue to believe China's strong demand is consumer driven and being supported by increased tissue and paper capacity. We're also seeing the supply side impacting demand for wood pulp as highly polluting, old China agricultural-based pulp facilities are being closed.

Moving to operations. Overall, our Q1 production was up relative to Q4. The increase of almost 24,000 tonnes was due in part to both the timing of our scheduled maintenance shuts and increased productivity. In Q4, we took 12 days of scheduled downtime at our Stendal mill compared to no scheduled downtime in Q1. Our 2017 annual maintenance shuts are as follows. In Q2, Celgar has an 18-day shut, and it will include the completion of a number of capital projects that are designed to improve the mill's reliability. Stendal will also have a short 3-day shut in Q2. In Q3, Rosenthal will have its 12-day shut. And in Q4, Stendal will be down for another short 3-day period.

In total, we produced approximately 374,000 tonnes of pulp this quarter compared to approximately 350,000 tonnes in the fourth quarter of last year and approximately 378,000 tonnes in the first quarter of 2016. Strong market demand allowed us to sell all of our Q1 production. Consequently, our pulp sales volumes were also up in Q1 and totaled approximately 375,000 tonnes compared to 345,000 tonnes in Q4 of '16 and 393,000 tonnes in Q1 of 2016.

Similarly, our strong pulp production led to high energy sales. The mills sold approximately 203 gigawatt-hours of electricity in the quarter compared to 180 in Q4 and 207 gigawatt-hours in Q1 of 2016.

Our fiber costs continued to trend down this quarter, if only slightly, as lower winter harvesting rates have marginally tightened our fiber markets. Our German fiber prices were down slightly in Q1. Looking forward, we expect German wood prices to increase slightly through Q2, as we expect strong demand to put some upward pressure on prices. In British Columbia, our Q1 fiber prices were also down slightly this quarter relative to Q4. We are currently forecasting that Celgar's Canadian dollar fiber prices will stay essentially flat in Q2. However, the Softwood Lumber Agreement dispute that is looming between Canada and the U.S. could push fiber prices up, but we currently believe that our Celgar mill will not be significantly impacted. As planned, our fiber inventory levels have come down in Q1, and we remain satisfied with our mills' wood markets and with our fiber inventory levels.

Regarding our CapEx plans, we expect to invest approximately $50 million in our mills in 2017. The focus of our CapEx program continues to be a balance of maintaining our mills while improving reliability and reducing costs. This spending will be spread evenly over all quarter -- over all 3 mills. With respect to our NAFTA claim, we do not have any updates at this time, but we continue to expect a decision this year.

And so that's the conclusion of my prepared remarks, and we'll turn the call now back to the operator so that we can open up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And your first question comes from the line of Hamir Patel with CIBC Capital Markets.

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Hamir Patel, CIBC World Markets Inc., Research Division - Research Analyst [2]

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David, your press release mentioned a short- to medium-term target of placing 25% of Friesau's volumes into the U.S. If prices are strong enough in the U.S., what do you think is sort of maximum that you'd feel comfortable moving into the U.S.?

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

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Yes, we'll be -- we're targeting 25%, Hamir. And we -- I think we'll push that as hard as we can. The mill's got a lot of flexibility. Got a big planer with 2 lines in it, 800,000 cubic meters a year of drying capacity in the kiln. So we're just ramping the mill up and working hard to put wood in front of it. And obviously, we'll push the U.S. market as hard as we can at this stage.

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Hamir Patel, CIBC World Markets Inc., Research Division - Research Analyst [4]

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Right. And we don't have much visibility on prices in Europe. So you could maybe help us understand how the economics for a typical European sawmill compare right now for selling in Europe versus selling to the U.S.?

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

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Yes, the prices have been improving in Europe. And the margins are -- have been pretty steady, sort of where they've been in the last several years even. So 12% to 15% EBITDA margins are quite normal for a modern sawmill running well over here.

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Hamir Patel, CIBC World Markets Inc., Research Division - Research Analyst [6]

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And would you -- are there any sort of infrastructure that you have to develop in the U.S. for distributing the products?

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

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Well, there's a number of different ways to approach that market, obviously. And we haven't finalized on how we're going to do that. There won't be any physical assets that we need to -- from an infrastructure point of view, we need to invest in. It's really just a matter of producing some product and getting it over onto the U.S. warehouses, probably Atlanta, and then starting to market it. But we have lots of optionality at this stage in terms of how we're going to approach that market.

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Hamir Patel, CIBC World Markets Inc., Research Division - Research Analyst [8]

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And just final question I had for David Ure. Can we get the mill production and shipments in Q1?

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David K. Ure, Mercer International Inc. - CFO and Secretary [9]

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Yes. Okay. I'll start with production. So this is in thousands of -- I'll quote these in thousands of air-dried tonnes. So in Q1, our Rosenthal mill produced 88.8, our Stendal mill produced 171.2 and Celgar produced 113.8. And sales volumes, again in thousands of tonnes, Rosenthal sold 91.4, Stendal 184.1 and Celgar 99.7.

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Operator [10]

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And your next question comes from the line of Dan Jacome with Sidoti & Company.

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Daniel Andres Jacome, Sidoti & Company, LLC - Research Analyst [11]

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Just following up on the sawmill acquisition. It looks like U.S. prices have obviously been very robust. But do you guys see that as sustainable going forward? I'm just trying to have a better understanding of, kind of like, your visibility into it once you start, kind of, getting to further capacity.

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

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Yes, so that's a good question. At this stage, the countervail, first estimate is out there. It's averaging 20%. Then in a few months, it will be a duty determination and then months following that, there will be, like, a settlement determination, like a sort of relook and final settlement of the countervail. So you go through, what's that, 3 quarters by the time you get through all that possibly. And then you have to have a negotiation between Canada and the U.S. And I don't know where that's going to land, but a lot of the -- the things we read imply that there's going to be a strong push for quotas against Canada, which was strongly resisted the last time they went through this thing. But if the American push for trade issues is for quota, then this could carry on for a very long time. We don't have to rely on that. We've got a really great mill in the middle of the European market, but right now with these kind of conditions, there's, obviously, premiums to be had in the U.S. market. So...

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Daniel Andres Jacome, Sidoti & Company, LLC - Research Analyst [13]

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Okay. I'm trying to understand -- if I understand you correctly, if the tariffs go into play, it could help the lumber pricing for you in the U.S.?

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

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Well, the Canadian shipping into the U.S. market have a cost in countervail and dumping duties to get it there. So the price in the U.S. market has to go up to compensate for that. If there is a quota imposed, then there will be a restriction on the amount of Canadian lumber that can feed the U.S. demand. So Europeans and others possibly will look to service that market.

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Daniel Andres Jacome, Sidoti & Company, LLC - Research Analyst [15]

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Okay, that makes sense. So probably a positive, but looks like it's too early to tell. And then I just had a question about the sawmill in Germany. Were you guys buying sawmill residuals from it already before the acquisition, just out of curiosity?

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David M. Gandossi, Mercer International Inc. - CEO, President and Director [16]

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Yes. That's an absolutely important point. I mean, this mill was kind of a foundation of the Klausner Group back when he was starting to build his mills over here in Germany. Now this is a big mill. In the day when this mill was servicing almost completely the U.S. market pre-2008, it serviced -- it provided about 40% of Rosenthal's fiber, and it's 14 miles west of the pulp mill. So it's from a synergy point of view and a lot of respects, it's an important mill for us to control.

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Daniel Andres Jacome, Sidoti & Company, LLC - Research Analyst [17]

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Did you say 30%?

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David M. Gandossi, Mercer International Inc. - CEO, President and Director [18]

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It was 40% at its peak.

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Daniel Andres Jacome, Sidoti & Company, LLC - Research Analyst [19]

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40%, got you. And then, my favorite topic, wood procurement, fiber, logistics. You guys have been doing a pretty stellar job, especially in '16, with the railcar optimization. Just out of curiosity, I mean, where do you guys think we are on that? Like -- and I hate to use a cliche baseball analogy, but the fifth inning or the bottom of the ninth? How would you look at it?

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David M. Gandossi, Mercer International Inc. - CEO, President and Director [20]

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Well, I like to think we're just getting going. There's a lot of moving parts, obviously, in logistics and procurement. Having sawmill capacity just gives us even more levers. We've got the railcars, which gives us the ability to really optimize. We can bring more wood in from further away. We can backhaul out lumber. We have our wood2M joint venture with Mondi. So the import markets, we optimize there as well and can improve the volumes and lower the costs. So it's -- there's lots of that kind of creative thinking and work going on, and it's -- we're definitely having an impact. There's other bigger factors we can't control. So prices may go up or down, but on top of whatever happens, we optimize and do our best to make sure that we don't ever get behind the 8 ball.

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Operator [21]

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And your next question comes from the line of Sean Steuart with TD Securities.

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Sean Steuart, TD Securities Equity Research - Research Analyst [22]

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Couple of follow-ups on Friesau. Just coming at it another way, with respect to the 25% shipment targets in North America, how much of that's motivated just by the price spike we've seen since late January? And what would the inflection point be for pricing that makes it a viable market for the sawmill to ship into?

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David M. Gandossi, Mercer International Inc. - CEO, President and Director [23]

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It's -- I mean, I don't have the number in my head. I mean, right now, it's very attractive, obviously. It can fall back quite a bit and still be quite attractive, but the core European market is good too. It's just not as good as what the U.S. is offering today.

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Sean Steuart, TD Securities Equity Research - Research Analyst [24]

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Okay. And you indicated it's maybe 4 to 6 months of time to ramp the mill up to the 90% operating rate. Will you guys lose a little bit of EBITDA through that ramp-up period? Or does that stuff gets capitalized as you bring the operating rates up?

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David M. Gandossi, Mercer International Inc. - CEO, President and Director [25]

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Yes. We can't capitalize anything, Sean. This really can't -- there's nothing to capitalize in terms of operating start-up things or optimization severances or any of that kind of stuff. It won't -- there won't be big numbers. Really what's -- it'll be a moderate operating loss as we -- what we need to do in for the mill is to get the volume of wood in front of the mill up. The previous owner didn't -- wasn't really running the mill very much at all at the end. And it was really sort of a restructuring thing. So it's taking -- it'll take a little time to purchase the wood that we need to run the mill hard. And once we're running the mill hard, we will make money.

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Sean Steuart, TD Securities Equity Research - Research Analyst [26]

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Okay. And lastly on this asset, when you announced it -- and based on what you're saying today, I mean, it sounds like a very opportunistic tuck-in for you guys. Is there opportunity for other growth in the sawmill business in Europe? What's the opportunity set look like for further bolt-ons?

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David M. Gandossi, Mercer International Inc. - CEO, President and Director [27]

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Yes, we think there is. It fits our -- it's just a logical, good fit for us. We're big wood procurement guys in this central European market, and we're dominant in a lot of ways. And we don't have a lot of competition from guys that don't understand this market or wouldn't really be capable of competing with us in this market. So we see a potential for more growth, but we'll be opportunistic about that. We're not going to go crazy. We'll look for the right synergies and the right situation. But it's -- we are intending to keep -- to continue this path.

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Operator [28]

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And your next question comes from the line of Sam McGovern with Crédit Suisse.

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Samuel Thomas McGovern, Crédit Suisse AG, Research Division - Research Analyst [29]

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I apologize; you may have touched on this and I may have missed it. But just in terms of fiber costs with -- at the Celgar mill with regard to the Softwood Lumber Agreement, I mean, can you talk a little bit about the impact there? Should we expect fiber costs to go up if there is less sawmills operating in the area? Or what would be the impact there?

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

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Yes, Sam, the -- 2 of the big mills that are in our region are really modern mills. Interfor has put a lot of money into Grand Forks and the Castlegar mill over the recent years. And they do have options to the U.S. market. My feeling is that they will run where others in other regions may have more difficulty to do that. So I think the Eastern Canadian mills are going to be harder hit than the guys in the West. Our -- and our guys, in our region, in the specialty lumber production and the well-invested nature -- low-cost nature of the mills, I'm not really that worried about it at this stage.

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David K. Ure, Mercer International Inc. - CFO and Secretary [31]

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And I would just add that the -- our number 2 supplier is a U.S. supplier as well.

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Operator [32]

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And your next question comes from the line of Adam Zirkin with Knighthead.

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Adam Zirkin, Knighthead Capital Management, LLC - Partner [33]

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Just a couple of questions for you. First of all, just on the production rate at Celgar. David, on the last call, you talked about some of the initiatives there, and you talked about even potentially getting to more than a 1.5 million tonne number for the total year. Curious how you feel about that now going into the 18-day shut in the second quarter.

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David M. Gandossi, Mercer International Inc. - CEO, President and Director [34]

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Yes, so -- yes, Celgar has been putting on some good runs. And a lot of the work that the guys have been doing is really starting to pay off. And -- but having said that, we've -- you're very right, this is a big shut. And I've got all my fingers crossed hoping that they -- they executed really well last year, but they had, as you will all remember, 3 completely unrelated upsets that were not really related to the performance of the work and the shut. It had more to do with just unusual conditions of -- just a bunch of unusual, unrelated situations. So I really -- we're doing everything we can to perform all the quality checks that need to be performed for all -- just an enormous amount of work, obviously, in these kind of shuts. But I think we've got good systems and processes and barring any unforeseen disasters, I'm optimistic for that mill this year. And -- but the most important thing is to come out of that shut and get it up and running and no upsets in that process. That's...

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Adam Zirkin, Knighthead Capital Management, LLC - Partner [35]

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And David, assuming that all goes as planned, what would you anticipate the production for that mill would be in this year?

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David M. Gandossi, Mercer International Inc. - CEO, President and Director [36]

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Yes, I think we would count on between 475,000 to 480,000 tonnes for this year, if everything goes well.

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Adam Zirkin, Knighthead Capital Management, LLC - Partner [37]

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Got it. Okay. That's very helpful. Moving over to pricing. Perhaps you could put a -- you mentioned expanding discounts and having an impact on the realizations. Perhaps you could put a little more color around that. By how much did discounts widen? And also I know that -- or I believe that some of your pricing is done on sort of a 1-month lag basis. So perhaps you could talk about the impact of that because it would help to get a better sense as to what the sort of sequential improvement in price would be from the first quarter into the second.

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David M. Gandossi, Mercer International Inc. - CEO, President and Director [38]

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Yes, okay. Well, I'll do my best, Adam. I'm not going to give you the discount number because that's something that we just can't do. Just -- it's part of the competitive tension in the market, and producers don't disclose those numbers. But -- so generally, it's the European and the U.S. markets that -- where discounts have been widening historically for the last 10 years. And they creep up a little bit every year. And they typically get established as part of the annual contracts at the end of the year. So that was the case again this year. And then the price increases in Europe starting December, remember, was around $810. And then in January, we announced $20 up for new orders taken in January. So that's orders in January that get shipped in February. And then in February, we implemented up to $650 for orders taken in February but most of those not delivered until March. And then in March, we're up $20 to $670 and then again up to $690. So there is -- I'm sorry, I'm sorry, Adam, I took you between 2 things. So let me finish Europe. So $810, then to $830; January we announced $830. And then in February we announced $20 up to $840. And then in March, $20 to $860. And all of those, when you announce, it's for the orders taken, effectively, almost immediately after that point, and then there's another month before it gets shipped. In China, which I just went back and forth in answers. China started at $590, up $20 to $610, then up $40 to $650, and then up $20 to $670. China -- when we announced prices in China, we're always net. So there's no incremental discounting here, but it's a slightly longer supply chain. So it's even more delayed from when you announce to when the customer sale is recorded. So in China, the price increases were more dramatic, but China business is 1/3 of our business, and Germany is a much bigger piece. And so the 2 more or less offset each other in the quarter. But these price increases when you get into the second quarter, you really start getting some rubber on the road because they -- they're -- we're starting to ship at these higher prices right now.

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Adam Zirkin, Knighthead Capital Management, LLC - Partner [39]

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Right, I mean they look fairly meaningful, right? Because if, correct me if I'm wrong, but if the pricing you have as of today were to hold for the remainder of the second quarter, the average pricing in Europe would be up some $30, $40 above the first quarter average and a little more than that above the China average, right? So you'd, in theory, sort of weight that heavy toward Europe, right? And that would give you a sequential change, right? Am I thinking about that correctly?

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David M. Gandossi, Mercer International Inc. - CEO, President and Director [40]

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Yes, yes, you're thinking about it right. Just remember to take the discount off the increase in the list price.

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Adam Zirkin, Knighthead Capital Management, LLC - Partner [41]

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Of course. And then lastly, David, and -- so you get this question on every call, and it's a fair weather question. But once again, you did an excellent job of generating cash in the quarter. And certainly, you'll generate some next quarter and, winds willing, through the remainder of the year. How are you thinking about spending that cash, particularly given that you've done the first sawmill acquisition, you have the integration of that into the business in front of you? How would you hope to use the cash balance that just continues to fortunately build?

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

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Well, I guess my pitch would not be any different from what it was on our last call. It's -- debt reduction is always a priority. We intend to maintain our dividend. We intend to maintain a strong balance sheet. And we do like to keep optionality in for future growth. So I think it's stay the course, like, no real changes in our capital allocation approach.

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Operator [43]

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And your next question comes from the line of Andrew Shapiro with Lawndale Capital Management.

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Andrew Evan Shapiro, Lawndale Capital Management - Founder, Chairman, President, Portfolio Manager, and Managing Member [44]

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A few touch-ups from prior people's questions, and I have 1 or 2 of my own here. I just want to get like the big picture. In summary, on the sawmill acquisition, is the bulk of the integration activity simply the timing of rolling over to the new raw material contracts later in the year?

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David M. Gandossi, Mercer International Inc. - CEO, President and Director [45]

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Yes, that's -- primarily Andrew, it's -- the timing is -- was one of these things so that the previous -- the mill was not running normally for the last year or so. It really had mostly to do with liquidity issues for the -- of its owner. So it didn't have -- so the annual process of establishing fiber contracts didn't happen normally. So when we take over the business early in the new year, we've -- obviously, we're out there with all our suppliers that we know so well in our pulp business and saying, okay, now we need some sawlogs too. And they are all doing whatever they can to deliver sawlogs to us. But they're not sold out, but their allocations have been predetermined. So they're all sort of making adjustments and doing whatever they can to help us ramp the mill up. And I'm confident we will. It's happening very quickly, but we just -- we're just trying to signal that we just need that first couple of quarters to really get the mill up to the level where it's really humming.

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Andrew Evan Shapiro, Lawndale Capital Management - Founder, Chairman, President, Portfolio Manager, and Managing Member [46]

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And the big picture is, when the annual contracts then roll, your, obviously, much stronger balance sheet than the seller's enables you to then come in and lock in favorable spreads and rates?

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

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Yes, yes, exactly. We've got very strong logistics. The sawmill -- the typical sawmill has got a truck logistics in its region. We're pan-European with optimized railcars, our own railway stations, our own facilities at the port of Rostock. We've got a much bigger reach and wood costs, further east you go, obviously, the cheaper they are, and it's all about the transport cost to get it into our markets. So we've got all sorts of trading options. We've got leverage back and forth between pulp and sawlogs. We've got fuel optimization, so we can put the bark where it needs, to whichever boiler it makes the most sense to go to. We can push all of those boilers to their maximum capacities. We can sell the other byproducts like pins and fines to guys that will pay a little bit more than the energy value and trade products and that kind of thing.

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Andrew Evan Shapiro, Lawndale Capital Management - Founder, Chairman, President, Portfolio Manager, and Managing Member [48]

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Okay. On some of your past CapEx projects, the one I wanted to follow up on and just find out what -- if there are still decent amounts of improvements ahead of us is, you had a goal of increasing the power and the byproduct profitability at Celgar. And you had previously said there was still a lot of room for improvement on power generation at Celgar? Is that still the case? And what are the milestones and the timing for those improvements?

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

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So Celgar, I guess the way to think about it is the amount of fuel we have for power production is related to the amount of pulp that we produce. And if you look at the average in the last 3 years that mill has produced in the 440,000 to 450,000-tonne range. Earlier on this call, I expressed an aspiration to 475,000 to 480,000 this year. And with our -- and I said on previous calls that we're working hard to get that mill up to about 500,000. So that's -- that generates incremental electricity. And the other leg of the stool is to -- is the work we're doing to -- with BC Hydro and the province of British Colombia to ensure that we have fair power rates in front of the mill. And that also ties into the NAFTA situation as well. So yes, I think there is room for steady improvement and progress on the generation side. How we'll do in the long-term power rate side, I'm not -- really, I don't have a good clear line of sight on that, but I'm optimistic the province will do the right thing for us when renewal comes and also optimistic about NAFTA, but we don't have any visibility on -- we just don't get any input from the tribunal until they're finished making their decision. So I just don't know at this stage.

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Andrew Evan Shapiro, Lawndale Capital Management - Founder, Chairman, President, Portfolio Manager, and Managing Member [50]

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Is your feel on the decision by the judge or arbitrator, is your feel or feedback from your lawyers, etc., is that, that decision is completely independent of the new uncertainties that have been tossed into the interactions between the 3 governments with the new presidential administration?

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

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Yes, I really hope it is. Yes, I mean, I have every reason to believe it is, like an impartial tribunal under NAFTA. Remember we're on the American side of this argument. We're a U.S. public company, and we're fighting for fair treatment in Canada. So I don't think there'll be -- like the rhetoric, I don't think, will influence decisions.

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Andrew Evan Shapiro, Lawndale Capital Management - Founder, Chairman, President, Portfolio Manager, and Managing Member [52]

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And will it slow the decision down? Or you think it's on its own course?

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David M. Gandossi, Mercer International Inc. - CEO, President and Director [53]

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I don't think it has any impact at all, Andrew. I don't see why it would.

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Andrew Evan Shapiro, Lawndale Capital Management - Founder, Chairman, President, Portfolio Manager, and Managing Member [54]

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Okay. On capacity questions here. You talked about some producers with higher costs were at the tipping point for closure due to losses in a declining price environment. With a decent amount now of increased prices, does that terminate thought of these closures? Or are there other factors that make these closures inevitable regardless?

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David M. Gandossi, Mercer International Inc. - CEO, President and Director [55]

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That's a good question. Some of these -- it's -- some of the mills that are running are -- it just must -- they must be exceptionally difficult to run because of the age of the equipment, the end-of-life issues. And when you get into the big vessels and recovery boilers and power boiler rebuilds, these are really expensive things to do and they're really old mills, and you don't have that much margin enhancement. It's kind of like putting drain tiles around your house. So eventually these things will go away, regardless of what pulp prices are doing, is my view. But when you're in a pricing environment like we are right now, the owners of them are going to be trying to hang on because they can eke out a living until the big disaster happens where they're faced with a very expensive maintenance of business capital project (inaudible). So in the current environment, I'm not anticipating, meaning we can't -- we have no visibility on anything that might be happening in the near term.

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Andrew Evan Shapiro, Lawndale Capital Management - Founder, Chairman, President, Portfolio Manager, and Managing Member [56]

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Okay, and then in Canada, there was thought prior to the anti-dumping countervailing duties kicking in here now, that if that were to kick in, that -- on sawmills, that the cost for Eastern Canadian pulp producers would greatly rise. Is that still the visibility on the circumstance?

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

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With the countervail duty in? Is that what ...

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Andrew Evan Shapiro, Lawndale Capital Management - Founder, Chairman, President, Portfolio Manager, and Managing Member [58]

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Yes, with the -- I think they've come out now and they've proposed that they're going to have all these extra duties. I don't know when and if it will get implemented. But it's now a little more definitive that that's what's being assessed. Will that and how long does it take to get into the system to make the cost for the Eastern Canadian pulp producers to jump?

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

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Yes, it's a question that really relates to what's going to happen to the Eastern sawmills. And I can't answer that. It's -- lumber prices have been increasing to offset the increased cost of the duties, and as long as the sawmills run and the pulp mills get the fiber. If you have sawmill capacity reductions, then that impacts on the pulp mills' fiber availability. So I can't -- I don't know what's going to happen for those guys.

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Andrew Evan Shapiro, Lawndale Capital Management - Founder, Chairman, President, Portfolio Manager, and Managing Member [60]

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Okay. Last question since it wasn't in the script -- but last question. What are the plans for your investment presentations, nondeal roadshows in the coming months?

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David K. Ure, Mercer International Inc. - CFO and Secretary [61]

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Yes, so for the rest of the quarter, we'll be attending the Barclays high-yield conference in the second week of June. And then, we'll probably be doing a small nondeal roadshow in Europe, probably in the third week of June. And then looking further ahead, we'll be attending the Jefferies industrials conference in August as well.

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Operator [62]

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(Operator Instructions) Your next question comes from the line of Tom Bandurowski with Brown J Advisors (sic) [Brown Investment Advisory].

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Tom Bandurowski, Brown Investment Advisory & Trust Co. - Credit Analyst [63]

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This one is quick. In the press release, there's the 5% decline in pulp production due to a delayed shipment. So can we think about that as all of that moving into the second quarter? And does that imply sort of flat production in the second quarter? How do we think about that?

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David M. Gandossi, Mercer International Inc. - CEO, President and Director [64]

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Yes, so it is -- so we -- so the background of that story is that our Canadian pulp goes to China in break bulk delivery systems that we control as what we're seeing -- as opposed to a lot of the other guys who ship over in containers. So break bulk is, all the stuff goes to the port, gets put on a ship and it all goes over in one big shot. And so sometimes we have a timing issue. So I think it's really about 10,000 tonnes of normalizing things that slip into the second quarter. We don't -- doesn't get recorded as a sale until the ship sails. And then another piece, things are really strong right now and the mills have been running pretty well. So it's inventories -- the Canadian mills' inventories are pretty close to 50,000 tonnes at the end of the quarter. So we're going to really push it in the second quarter. Like in April, shipments might be around 44,000 tonnes -- 44,000 to 45,000 tonnes for April and probably for May. So there's a good chance we'll get Celgar's inventory down well below the 40,000 sort of level by the end of the second quarter. So good volume and good prices in the second quarter for that though.

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Operator [65]

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And your next question comes from the line of DeForest Hinman with Walthausen & Co.

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DeForest R. Hinman, Walthausen & Co., LLC - Research Analyst [66]

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Just help me understand the fiber basket around Friesau. You talked about, we have to rebuild those wood supply relationships at that sawmill. And it sounds like it's a multiyear process, but we also have -- it sounds like lumber prices are relatively high. So maybe there's an increased desire for people who own that land to harvest. Is the allocation that we're going to get from that fiber, is it displacing other people? Or is it more a function of getting them to just harvest more?

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David M. Gandossi, Mercer International Inc. - CEO, President and Director [67]

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Yes, well, first, there's -- I mean, this is sawmill country. There is sawmills in the southern part of Germany that predominantly rely on spruce. There's some sawmills in the North that rely on the pine. And then there is Mercer, the only 2 kraft pulp mills in the country. And we buy chips from all those guys, and we buy roundwood that is the part of the harvest that isn't a sawlog. It's all the thinnings and the tops and the pieces that aren't appropriate for sawmills. So we're just expanding our activities with all of these suppliers that we have a long-term relationship with. And we're just -- we just -- now we want sawlogs as well. Their ability to meet the volumes that we're looking for -- I mean, they can't mobilize fast enough for us, is our -- like, we'll get the mill up to -- these numbers are like 75,000 cubic meters of wood a month for the first couple of months. And then in the next month, expecting to get up closer to 100,000 cubic meters. And then the month after that, if we can get to 110,000 or 115,000, then we're -- now we're cooking. Then we're going to be hitting that 300,000 to 330,000 cubic meters (inaudible). So it's not -- I mean, we're not that far behind. But a sawmill needs to run hard to make good margins. And it's going to take us several months to get there. But we're not talking years. We're talking several months. And then as we get -- as we approach the -- and we have import capabilities. We'll bring in wood from Czech. It's a big market for us, from Poland. We can bring wood in from all around Germany, bring it in port from the Baltics, that kind of thing. By the end of the year, I'm really optimistic that with our -- combining our wood procurement strategies with the pulp side, that the contracts for next year will be -- we'll get the volumes we want. We'll work hard on getting the good prices and optimize our logistics and we'll be away to the races. But it's just going to take a little while to get it going.

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David K. Ure, Mercer International Inc. - CFO and Secretary [68]

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Just to make one thing clear. It's not like we're building new relationships with new suppliers. These are people -- these are landowners and state forests that we have existing relationships through our pulp business. So we're harvesting sawlogs or obtaining sawlogs for the sawmill from the same sites as pulp log. So it's just a matter of reintroducing ourselves on the sawlog business. But these are folks that we've got ongoing relationships with already.

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DeForest R. Hinman, Walthausen & Co., LLC - Research Analyst [69]

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And then on the sales side, as we ramp that -- I mean, did the adequacy -- help us understand of our ability to get that product moved so we don't have a situation where we have too much inventory build on the balance sheet, because it's a pretty meaningful ramp. Is that something that we -- Friesau already had? Or is that something we need to add headcount to, build more relationships to make sure we can sell that product?

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David M. Gandossi, Mercer International Inc. - CEO, President and Director [70]

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Yes, so the -- one way -- I mean, that mill makes lumber to order. It's -- we're not going to be making inventory. We just -- we can expand the orders and make product for it depending on how much wood we think we have and the timing. So it's -- and logistics are not a problem for us between truck and rail out of the mill. So I don't -- I'm not anticipating any bottlenecks, and I'm not anticipating inventory building. We're going to increase -- we're going to invest in working capital on the raw material side. And there will be working capital in the finished goods since that's on its way to the customer. And then you've got receivables. And that's why we've started the new revolver for the mill. But, yes, we will take orders for everything we think we can produce.

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Operator [71]

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And I see no further questions over the phone at this time. I'll turn the call back over to David Gandossi for closing remarks.

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David M. Gandossi, Mercer International Inc. - CEO, President and Director [72]

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Okay. Well, thanks, everyone. Lots of interesting questions today. So thanks for joining the call. Dave and I are always available. If you have more questions, feel free to call us anytime. And we look forward to speaking to you all again on the next quarter. Bye for now.

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Operator [73]

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And this concludes today's conference call. You may now disconnect.