Mercer International Inc.

You are currently on hold for the conference call. Today's call will be recorded. At this time, we are assembling today's audience and plan to be underway shortly. We appreciate your patience and please remain on the line. Good morning and welcome to Mercer International's second quarter 2022 earnings conference call. On the call today is Juan Carlos Bueno, President and Chief Executive Officer of Mercer International, and David Yor, Senior Vice President, Finance, Chief Financial Officer, and Secretary. I will now hand the call over to David Yor.

Good morning, everyone. Thanks for joining us today to discuss what has been an eventful few months for us. I will begin by touching on the financial and operating highlights of the second quarter before turning the call to Juan Carlos to provide further color on the markets, a strategy update, and of course, our recently announced acquisition. Juan Carlos was appointed President and CEO effective May 1st, and I'm delighted to introduce him to you on his first analyst conference call with Mercer. As many of you know, Juan Carlos is a globally recognized leader in the wood products and biomaterial space and brings to our company leadership qualities and expertise that will help us drive our growth in the years to come. We are excited for his appointment. Also, for those of you that have joined today's call by telephone, there is a presentation material that we've attached to the investor section of our website. But before turning to our results, I'd like to remind you 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. This quarter, we achieved EBITDA of approximately $145 million, compared to Q1 EBITDA of roughly $155 million. This solid result was principally a consequence of strong demand for all our products, leading to sequentially higher pulp and lumber prices, along with the positive impact of a stronger U.S. dollar being offset by the costs and lost volume associated with our planned major maintenance downtime. In Europe, the natural gas shortages that are providing us record electricity revenues are also creating conditions for inflationary pressure on energy-dependent input costs such as pulpwood fiber, chemicals, and to some extent freight. The quarter results also included a $13 million positive adjustment reflecting the reversal of a payable relating to three years' worth of wastewater effluent fees. The reversal is a result of German authorities waiving the fees after we demonstrated certain reductions in effluent load in connection with recent environmental capital expenditures. After giving consideration to our planned shuts at Selgar and Peace River, our mills ran well this quarter when compared to Q1, when we had no scheduled maintenance. Going forward into the second half of the year, we will complete 14-day planned shuts at both Rosenthal in Q3 and also Stendhal in Q4. Our pulp segment contributed quarterly EBITDA of roughly $102 million, and our wood product segment contributed record quarterly EBITDA of $49 million. You can find additional segment disclosures in our Form 10-Q, which can be found on our website and that of the SEC. Demand for pulp was stable in Q2, and supply constraints pushed prices higher than Q1 in all of our major markets. In China, the Q2 average NBSK net price was $1,008 per ton, up $109 from Q1. European list prices averaged $1,437 per ton in the current quarter, compared to $1,330 per ton in Q1. The price gap between NBSK and hardwood narrowed this quarter due to strong upward pricing pressure on hardwood with the average Q2 net eucalyptus hardwood price in China at $815 per ton up $147 from Q1. In total, average pulp sales realization movements positively impacted our EBITDA by about $39 million compared to the prior quarter. Overall, Our average lumber realizations also increased in Q2, despite the US market weakening significantly late in the quarter, in part due to strong European prices. In the US, we experienced excellent pricing in the first two months of the quarter before prices decreased significantly in the final month. The random lengths U.S. benchmark for Western SPF 2 and better averaged $866 per thousand board feet in Q2, which was down $408 from last quarter. Our average European sales realizations were up approximately $112 per thousand board feet compared to Q1. Since the end of the quarter, U.S. pricing fell further but appears to have hit a floor and has since been slowly moving up. Today, the benchmark lumber price in the U.S. is currently $670 per thousand board feet. Our electricity sales reflect strong generation along with elevated prices in Europe, where prices continue to be in the range of $200 per megawatt hour. Exports to the grid totaled about 225 gigawatt hours in the quarter, which was up modestly relative to Q1. We reported consolidated net income of $71 million for the quarter, or $1.08 per basic share, compared to net income of $89 million, or $1.35 per basic share in Q1. Cash generated in the quarter totaled approximately $84 million compared to cash generated of $65 million in Q1. Our strong cash generation in Q2 was primarily the result of working capital movements in the form of lower accounts receivable balances, a consequence of lower sales volumes. Capital spending in the quarter totaled about $47 million and we remain on target to invest about $175 to $200 million in our operations this year. Juan Carlos will provide an update on our CapEx program in a moment. At the end of the quarter, our strong liquidity position totaled about $771 million, comprised of $495 million of cash and $276 million of undrawn revolvers. Our quarter end liquidity position will support our recently announced acquisition of Holtz Industry Torgau, along with our planned working capital movements and 2022 high return capital spending program. In connection with the Torgau acquisition, we have obtained a bank commitment for our German revolver that will expand it from 200 million euros to 300 million euros. we can draw up to 100 million euros from this facility upon closing of the HIT transaction. And as most of you have noted from our press release, our board has approved a quarterly dividend of seven and a half cents per share for shareholders of record on September 28th, 2022, for which payment will be made on October 5th. That ends my overview of the financial results and I'll turn the call over to Juan Carlos.

Thanks, Dave. Our strong Q2 operating results were driven by increased pulp and lumber pricing, continued strong energy pricing, and a rising U.S. dollar. We completed a very ambitious maintenance program at both Selgar and Peace River, and as Dave mentioned, while we have experienced considerable inflation on natural gas, chemicals, and fiber in recent months, we continue to achieve record levels of electricity revenues that are helping to offset cost inflation. We have had a tough start to Q3 with the recent Woodyard fire at Stendhal, but we are today on the way to recovery, and I'll speak more to this in a moment. But before I speak about the fire and our HIT acquisition, I'll make a few comments about current market conditions and our capital expenditure program. In terms of pulp markets, global pulp supply-demand fundamentals remain tight through Q2, And as a result, relative to Q1, average pulp prices were up in all markets. Chinese demand continues to be negatively impacted by pandemic conditions, but we're beginning to see improvements as lockdowns are becoming less frequent and shipping channels slowly begin to recover. In other markets, demand has been steady and logistic bottlenecks and supply disruptions in certain regions continue to create extremely tight conditions. In addition, we're in the middle of the traditional major maintenance season, and on planned downtime, including our stand-up mill fire, continue to put upward pricing pressure on all markets. For lumber markets, pricing has been mixed, but on average, they were higher in the quarter when compared to Q1. While housing starts have begun to diminish, homebuilder sentiment remains positive, and we believe the midterm backdrop for U.S. lumber pricing conditions remains positive, with relatively low housing inventory, strong housing expectations supported by recent statistics, and constructive homeowner demographics, today market volatility is the result of rising borrowing costs, construction constraints from inflexible supply chains, labor and home construction supply shortages, and inconsistent lumber supply from Canada. We expect European lumber prices will moderate in Q3, while the US market hit a floor early in July and has since been modestly strengthening. We will continue to optimize our mix of lumber products and customers. In Q2, 46% of our lumber sales volumes were in the US market, with the majority of the remainder of our sales in the European market. We believe our logistics strategies give us a competitive advantage However, we experienced some freight cost increases in Q2. This is primarily the result of higher fuel costs, increased jobs of trucking, along with higher warehousing costs in North America due to the limited availability of rail cars. Railways are struggling with labor shortages caused by the pandemic. We're seeing improvements, but the lack of rail car availability will likely persist in the near term. as the railway continues to work through its shipping backlogs and labor issues. In Germany, we continue to see strong demand for both pulpwood and saw logs. Much of the increased demand for pulp logs is being driven by pellet manufacturers. Russia's war in the Ukraine is behind European energy concerns and is pushing energy prices up and creating more demand for wood-based heating solutions. Currently, solid demand and supply appear to be in balance, but we're expecting upward pricing pressure for pulpwood in Q3. In Western Canada, as expected, increased harvesting activity has helped ease pricing pressure, and as a result, we expect modest downward pricing pressure in Q3. We have an aggressive CAPEX program in 2022. The majority of these investments are focused on high return projects that will drive new product development, ESG advances, productivity improvements, and input cost reductions. Two of the larger projects, the new woodrooms at Selgar and Peace River are progressing, but have begun to slip from project schedules due to delays in delivery of key pieces of equipment. These projects will generate high returns for us and have considerable carbon reduction attributes, so we remain committed to them. and we will be pushing hard to have them commissioned this winter. We're making good progress on investments in our German wood procurement infrastructure that will add to our competitive advantage, and the new sorter at our freestyle mill is on schedule and will maximize the benefit of our new planer by allowing for even greater grade differentiation. And while most of the Stendahl 740 pulp expansion project was completed, in the spring and running as expected, we will complete the final element, some modest modifications to the pulp machine wrapping line in the fourth quarter. In keeping with our carbon reduction strategy, we're developing a lignin development center that will include a lignin extraction pilot plant. The pilot plant will employ a leading-edge technology that would allow us to look at commercializing derivatives of lignin. We also commence construction on a $27 million expansion project at our Spokane mass timber plant, which I expect will be a first phase of investment as we look to grow this business. This phase one project will allow this state-of-the-art facility to fully utilize a more varied raw material mix and increase finger joint production. This is a first step in what will ultimately be an expansion of CLT capacity. a preparatory step we're making while we steadily increase our order book for mass timber elements, which we expect to materialize in sales in 2023. We remain satisfied with the pace of the ramp-up of this business, which we expect will continue for several more quarters. And now, a quick update on the Stendhal fire. As most of you know, we took the Stendhal mill down July 1st due to a fire in our woodyard, specifically the automated inventory and reclaimed bunker. While the fire was quickly and safely extinguished, it has taken us a number of weeks to assess the damage and determine the best approach to safely return the mill to full production. It now appears that there is considerable damage to certain overhead conveyor systems that will take several months to repair. However, we have developed a temporary solution to bypass damaged elements of the system and restarted the mill earlier this week on a reduced production level. Over the next few weeks, we expect to optimize this temporary process with an objective of returning the mill to as close to full capacity as possible. We're also currently working with suppliers to plan a permanent repair of our fully automated system. Our property damage and lost business damages are covered by insurance subject to normal deductibles, and we will be settled in due course. As we think about climate change and the rapid shifts occurring regarding carbon, products like lignin, mass timber, green energy, extractives, lumber, and pulp are all products that will play increasingly important roles in displacing plastics and carbon-intensive products. Products like concrete and steel for construction, plastic packaging, fossil fuel generated electricity, and synthetic fragrances and flavors, even synthetic textiles, all products that are releasing carbon or ending up in our oceans and our food chain. As you may have seen from our recent press release, we're pleased to have published our 2021 sustainability report. The report highlights not only our ESG performance and midterm objectives, but why we believe that our low-carbon, low-pollution products are part of a solution to the global carbon challenge facing our generation. Finally, I'm excited about the potential of our recently announced acquisition, Pulse Industry Torgau. This acquisition will be accurate immediately, and it advances our long-term strategy of growing our business in solid wood products and diversifying our revenue streams. We have entered into an agreement to acquire all the outstanding shares for 270 million euros, including working capital that we're estimating to be about 43 million euros. This facility has an annual lumber production capacity of about 410 million board feet, an addition that will push our total number capacity to almost 1 billion board feet. Most of the Torgao production today is being used as feedstock for highly automated pallet plant. The plant is the world's largest producer of European Pallet Associated, or EPAL, wood pallets, with the ability to produce 17 million pallets annually. In addition, the facility can produce up to 150,000 metric tons of wood pellets, 85,000 metric tons of wood briquettes, 136,000 million board feet of mill lumber products, and 90 gigawatts hours of electricity. The synergies of the business with our existing pot mills and saw mill are compelling, and we estimate to be in the range of $16 million annually, most of which will be in place within six to 12 months of closing. The synergies arise from our intent to optimize lumber production, drying, planing, and grading between Torgau and Friesau. And on the input cost side, we see opportunities to optimize wood chip and residual deliveries between Torgau, Rosenthal, and Friesau. According to the sellers, Torgau generated 68 million euros of adjusted EBITDA in 2021 on sales of 227 million euros. And for the three months ended in March 2022, the business had already generated 22 million euros of EBITDA. This acquisition is subject to a customary governmental competition review before we will be able to close on the purchase, which we expect to occur in about two months. We will have more to say about this business when we close in late Q3 or early Q4. Thanks for listening. And I will now turn the call back to the operator for questions. Thank you.