Mercer International Inc.

Good morning and welcome to Mercer International's second quarter 2023 earnings conference call. On the call today is Juan Carlos Bueno, Mercer's President and Chief Executive Officer, and Richard Short, Mercer's Chief Financial Officer and Secretary. I will now hand the call over to Richard.

Thank you. Good morning, everyone. Thanks for joining us today. I will begin by touching on the financial and operating highlights of the second quarter before turning the call over to Juan Carlos to provide further color into the markets, our capital plan, and our strategic initiatives. Also, for those of you that have joined today's call by telephone, there is presentation material that has been attached to the investor section of our website. Before turning to our results, I would like to remind you that we will make forward-looking statements in this morning's call. 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, our EBITDA was negative $69 million compared to Q1's positive EBITDA of $27 million. After adjusting for a $51 million non-cash inventory impairment, EBITDA in Q2 was roughly negative $17 million. The EBITDA decrease in Q2 from Q1 is primarily due to the significantly weaker pulp prices in all of our markets caused by weak demand created by global economic uncertainty. We also had more scheduled downtime at our pulp mills compared to Q1. In Q2, we had 60 days of scheduled downtime compared to 10 days in Q1. Our pulp segment had negative quarterly EBITDA of $56 million, which, after adjusting for the $51 million non-cash inventory impairment, leaves a negative $5 million result. Our solid wood segment EBITDA was negative $10 million and was driven by poor lumber prices. You can find additional segment disclosures in our Form 10-Q, which can be found on our website and that of the SEC. In addition to the $51 million non-cash impairment charge, lower pulp prices resulted in a negative EBITDA impact of about $81 million in Q2 compared to Q1. In Q2, average NBSK and MBHK list prices were down in all our markets compared to Q1 as economic uncertainty continued to negatively impact paper demand and was compounded by the impact of new South American hardwood capacity. In China, the Q2 average NBSK net price was $668 per tonne, down $223 relative to Q1. European NBSK list prices averaged $1,247 per tonne in the current quarter, a decrease of $130 per tonne. The market price gap between MBSK and MBHK in China widened slightly to about $85 per ton this quarter as the market struggled to digest new eucalyptus hardwood capacity from South America. In China, the Q2 average MBHK net price was $483 per ton, down $227, or 32%, compared to Q1. And the North American Q2 price was $1,277 per ton, down $246. As mentioned, lower pulp prices resulted in the recording of a $51 million non-cash inventory impairment in Q2, about $31 million of which was against hardwood pulp and fiber inventories at the Peace River Mill, and the remainder was against softwood pulp and fiber inventories at our Canadian pulp mills. The large hardwood component was the result of the mill having a significant volume of fiber in front of the mill in preparation for the startup of Peace River's new woodroom. Certain pulp buyers took advantage of the low prices this quarter, resulting in a strong pulp sales volume in Q2. Sales volumes increased roughly 100,000 tons or 23% in Q2 relative to Q1. All our mills ran well this quarter, but we had significantly more scheduled downtime in Q2 compared to Q1. In Q2, we had a total of 60 days of downtime at our mills, which consisted of 25 days of planned maintenance and 35 days for market curtailment. In Q1, we had only 10 days of planned maintenance downtime. The increased scheduled maintenance downtime negatively impacted EBITDA by about $17 million in Q2 when compared to Q1, and the market curtailments impact was a negative $21 million. After adjusting for the planned shuts and curtailments, pulp production was up almost 19,000 tons from the first quarter. In Q2, the Rosenthal Mill recognized almost $17 million to settle the business interruption insurance claim for its 2021 turbine downtime. This cash was subsequently received in July. The Stendahl Mill received $5 million worth of insurance proceeds related to its fire damaged wood yard insurance claim. The final repairs are scheduled to be completed in Q3. And I'll also point out that US GAAP requires these insurance proceeds be recorded in operating results. For our solid wood segment, lumber pricing was modestly up in both the US and European markets due to steady demand. The Random Links US benchmark for Western SPF number two and better was $380 per thousand board feet at the end of Q2 compared to $361 at the end of Q1. Overall, lumber prices positively impact EBITDA by approximately $2 million compared to the first quarter. Lumber prices have noticeably improved since the end of the quarter. Today, the benchmark price for Western SPF No. 2 and better 2x4s in the U.S. is $427 per thousand board feet, an increase of $47 from the end of the quarter. Lumber production was 122 million board feet in the quarter, down almost 10% from our record first quarter production due to minor production upsets early in Q2. Lumber sales volumes were also approximately 134 million board feet, down 4% from the prior quarter. Electricity sales totaled 250 gigawatt hours in the quarter, which is up 12 gigawatt hours from Q1 due to strong production in the current quarter. Pricing in Q2 fell to about $106 per megawatt hour from $130 in Q1 due to reduced energy supply concerns in Europe. Our mass timber business continues to ramp up operations, resulting in revenue of $14 million in Q2 compared to $6 million in Q1. This business also has a growing order book that we expect to fulfill over the coming months. We reported a consolidated net loss of $98 million for the second quarter or $1.48 per share, compared to a net loss of $31 million or $0.46 per share in Q1. After removing the impact of the non-cash inventory impairment charge, the Q2 net loss is about $0.71 per share. We used about $87 million of cash in Q2 compared to using $53 million in Q1. Our cash usage in Q2 was primarily due to our acquisition of structure lambs cross-laminated timber and glue lamb assets for about $82 million. The cash impact of our negative Q2 EBITDA was more than offset by reduced working capital in the form of lower inventory balances at our Canadian mills due to strong pulp sales and working capital management activities. We invested about $39 billion of capital in our mills in Q2 Looking ahead, we have reduced our expected capex spend to be about $130 million in 2023. At the end of the quarter, our liquidity position totaled $446 million, comprised of $213 million of cash and $233 million of undrawn revolvers. And as you have noted in our press release, our board has approved a quarterly dividend of 7.5 cents per share for shareholders of record on September 27th. for which payment will be made on October 4th, 2023. That ends my overview of the financial results. I'll now turn the call over to Juan Carlos.

Thanks, Rich. Q2 was a disappointing quarter for us as the market fall prices deteriorated sharply across the world and in a very short period of time. As Rich mentioned, prices in China fell by more than $200 per ton for both hardwood and softwood. The rapid decline in pulp prices was led by hardwood pricing in China due to weaker economic recovery than expected with large pulp producer inventories and compounded with a ramp-up of the new and large South American eucalyptus mills. Softwood, on the other hand, its supply is gradually tightening due to the various curtailments and mill closure announcements around the world. Several pulp producers are extending their annual maintenance shuts similar to what we did at Peace River in Q2. In addition to this, the recent British Columbia port strike as well as Canadian forest fires are also contributing to this tightening supply. On the demand side, European paper producers are still running at reduced capacity rates as the European economy continues to be burdened by the effects of the Ukraine war. And in China, while stimulus measures are being implemented, economic growth to date has been modest. Looking forward, We expect pulp prices to continue to be under pressure in Q3 as the traditionally weak summer months take hold. While hardwood and softwood pulp prices in China appear to have bottomed out in Q2, softwood is currently lagging behind in Europe, and we expect to hit its floor price in Q3. This weak pulp pricing outlook for Q3 drove us to book the large non-cash inventory impairment charge this quarter that Rich described earlier. As a result of the logistical issues created by the recent British Columbia port strike, we were forced to take a temporary 30-day curtailment at our Selgar Mill during the month of August. This is not a decision we made lightly, but we're optimistic the mill will clear its pulp inventory backlog and be able to run full by the end of this curtailment. Notwithstanding the port strike, we are seeing decreasing pricing pressure on freight costs, most notably container rates. As a result of uncertain market conditions, we have taken proactive actions to reduce our planned capex by roughly 40%, as we now expect to land at around $130 million for the full year. At the same time, we have focused on reducing our inventories aggressively over the second quarter of the year, and will continue to enforce discretionary spending cuts and cost-cutting measures across the company. Our mills ran very well in the quarter, although some plant maintenance downtime negatively impacted production relatively to the first quarter. In addition, we saw a modest decline in both fiber and chemical costs. Our remaining 2023 annual mill maintenance schedule includes Rosenthal being down for 14 days in Q3, reducing production by about 14,000 tons. Stendhal will have a short three-day shut, and Selgar will have a 26-day major maintenance shut in Q4, or roughly 41,000 tons of production in total. Our second quarter lumber results reflected mixed markets. But on average, both the U.S. and European markets were up slightly compared to Q1. While high interest rates continue to weigh on housing starts, we have witnessed a positive partial recovery of lumber prices in the U.S., with SPF benchmark prices recovering about 30 percent of lost value since early June through mid-July, although they have corrected slightly over the last two weeks. We continue to believe that low lumber channel inventories, the large number of sawmill curtailments, relatively low housing stock, recent Canadian forest fires, and constructive homeowner demographics will put positive pressure on the supply-demand fundamentals of this market in the midterm. We will continue to match our mix of lumber products and customers to current market conditions. As such, in Q2, our lumber sales volumes were weighted slightly more towards the U.S. relative to the European markets. The integration of Torgao continues to progress well. Although shipping pallet markets remain weak, prices and demand for heating pallets are growing strong. Once the European economy shows strong signs of recovery, we expect pallet prices to return to normal levels, allowing this asset to deliver significant shareholder value, not only backed by improved business conditions for pallets, but also by increased lumber production capabilities. As we have previously reported, we recently closed on the acquisition of StructureLamb. We're very pleased to have added its assets to our mass timber portfolio. We now have roughly 35% of North American mass timber production capacity and a much larger geographic footprint, which gives us competitive access to the entire North American market. The integration of this business is ongoing. Since the addition of the structural M assets, we have seen a noticeable escalation of customer interest in our mass timber offerings, with inquiries doubling over the previous month's average. Included in these inquiries are some marquee projects, and we will have more to say about this in the coming months. Moving on to Popwood, in Q2, we saw prices decrease overall. In Germany, we worked through our high-cost inventory while demand for fiber remains strong for our Canadian mills. Looking ahead, we expect further modest declines in pulpwood at our German mills, though we are seeing early signs of increased demand from the energy market, which could negatively impact our fiber costs for chips. Similarly, we are expecting the fiber costs at our Canadian mills to decline modestly in Q3. During the quarter, we commissioned our new lignin extraction pilot plant which is a large step towards being able to begin commercialization of lignin. We're excited about the future prospects of this product, a sustainable alternative to fossil fuel-based products, such as in adhesives and advanced battery elements, to only name a few. This aligns perfectly with our strategy, which involves expanding into green chemicals and products that are compatible with the circular carbon economy. As our world becomes more sensitive to reducing carbon emissions, we believe that products like lignin, mass timber, green energy, lumber, and pulp are all products that will play an increasingly important role in displacing carbon-intensive products, products like concrete and steel for construction or plastic for packaging. Furthermore, the potential demand for sustainable fossil fuel substitutes is very significant and has the potential to be transformative to the wood products industry. We're committed to our 2030 carbon reduction targets and believe our products form part of the climate change solution. In fact, we believe that in the fullness of time, demand for low carbon products will dramatically increase as the world looks for solutions to reduce its carbon emissions. We remain bullish on the long-term value of pulp, but to bring more balance to our business, lumber and mass timber will grow more quickly over time. In closing, looking forward to Q3, We will be laser focused on the continuous reduction of cost, capex, and working capital while we navigate this period of low pulp prices. We will also work on rebalancing our assets in line with the execution of our strategic plan, and we'll continue to manage our cash and liquidity prudently. Thanks for listening, and now I will turn the call back to the operator for questions. Thank you.