Hello and welcome to Mercer International’s Third Quarter 2022 Earnings Conference Call. My name is Sarah and I will be your coordinator for today’s event. Please note this conference is being recorded and for the duration of the call, your lines will be on listen-only. [Operator Instructions] On the call today is Juan Carlos Beuno, Mercer’s President and CEO; and David Ure, Mercer’s Senior Vice President, Finance, Chief Financial Officer and Secretary. I will now hand the call over to David Ure. 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 returning the call to Juan Carlos to provide further color on the markets, a strategy update and of course, our recently announced acquisition. Also, for those of you that have joined today’s call by telephone, there is a presentation material that we have attached to the Investors section of our website. But before turning to our results, I would 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 $141 million compared to Q2 EBITDA of roughly $145 million, which takes our year-to-date EBITDA to a record level of $440 million. This solid result was principally a consequence of improved pricing for energy and pulp, a reduced level of major maintenance, along with the positive impact of a stronger U.S. dollar being offset by lower lumber pricing and cost associated with the chip pile fire at our Stendal mill and lower pulp sales volume. 50,000 tons of which was a consequence of the Stendal fire. We are currently planning for the necessary permanent repairs to Stendal’s fire damaged chip pile infrastructure. The loss is covered by our insurance program and we expect that it will be settled in the first half of 2023 once permanent repairs are complete. To-date, we have received advance payments from our insurer totaling roughly $9 million. The energy situation in…

Thanks, Dave. I am pleased with our third quarter operating results. Strong energy and pulp prices combined with favorable foreign exchange movements were the main factors behind our solid results. I am particularly proud of our team’s ability to quickly find an effective temporary solution to the chip pile fire in Stendal to mitigate the impact on our Q3 results. Partially offsetting these positive effects was the impact high European energy prices are having on our business in the form of higher fiber and chemical costs. I am also excited about the recent addition of the Torgau mill. Mercer’s lumber capacity is now almost 1 billion board feet as a result of the addition of this business and our product mix has been broadened to include shipping pallets, wood pallets and briquettes, along with additional green energy capacity. Torgau 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 pallets over 400 million board feet of lumber and 85,000 metric tons of wood briquettes and 90 gigawatt hours of electricity. Our teams are now focused on integrating the Torgau mill and realizing the estimated $16 million worth of annual synergies we have identified. These synergies will come from the optimization of lumber production, drying, cleaning and grading between Torgau and Friesau. And on the input cost side we see opportunities to optimize wood chip and wood residual deliveries between Torgau, Rosenthal and Friesau. I will have more to say about our progress maximizing these synergies in the coming quarters. We are also making progress in developing our cross-laminated timber business. During the quarter, we completed the build-out of our design and engineering teams and are…

[Operator Instructions]

It’s Dave here. Just before we turn into questions, just – it’s been pointed out to me that there might have been some callers that we are having problems getting into the call today. So I just wanted to let folks know that I think it’s sorted out now, but if you miss part of the call, don’t hesitate to ask your questions. Juan Carlos and I have lots of time here today. And just to remind folks too if you did miss part of it, so the call is being recorded and you could pick it up at a later date. Sorry, Sara I will turn it back to you now for Q&A.

That’s no problem. [Operator Instructions] Our first question comes from the line of Sean Stewart from TD securities. Please go ahead.

Thank you. Good morning. Couple of questions. Now, that Torgau is in your portfolio, wondering if you can give any updated thoughts on potential repositioning of that mills product mix at the margin pallets versus standard lumber. I think that was an initial thought when you announced the acquisition. But are there any updated thoughts on that front?

Thank you, Sean, for the question. Yes, we are very pleased with the work that we are doing now in Torgau and the performance of the mill. As we have mentioned before, they are heavily weighted on the dependence on the pallet business. We believe that it’s a solid business to carry forward. And we will continue to explore because we know that there are opportunities to increase the lumber production out of that facility without necessarily sacrificing pallet production. So we believe we can carry both business forward and that is our intent.

Okay, thanks for that detail. And the question on pulp markets, you touched on generally tight conditions and less prices in Europe have held steady to this point. But it does sound like there is some cracks forming in the foundation. Can you give us any update on order file activity as we head into the fourth quarter, any signs of weakness in your business in Europe at this point?

Absolutely. Yes, when it comes to the order file, we haven’t seen any dramatic changes on that regard. So we are well positioned into the fourth quarter with the orders that we have incoming. We do see that even though there is obviously some pressure from a situation that is more complicated on the paper producers in Europe with the high costs that they are enduring, the truth of the matter is that we also have a situation where China is not present in the market today as it has been in the past. And we know that as those lockdown measures related with COVID ease down in China and China comes back into the market, that’s going to be a significant push going forward. So for the fourth quarter, we expect that it’s going to be very similar to what we have experienced in the last quarter, no major change on that end, again, our order book is healthy and we still have to see some forward pressure, positive pressure with the China situation going forward into the beginning of next year.

Okay. Thanks for that context. I will get back into queue.

Thanks.

The next question comes from the line of Hamir Patel from CIBC Capital Markets. Please go ahead.

Hey, good morning. Juan Carlos, could you give us a sense as to what you are seeing in terms of lumber demand across various end markets in Europe, specifically, repair renovation?

Sure. Basically, it’s kind of a similar situation that what we have seen with the pulp developments in terms of the order file and how things are moving. The only thing that we see differently is obviously the logistics are quite a bit complicated at this point in time. So there is significant delays in shipments and product that is sitting in the ports, longer time than what is expected or planned, but we do see that the price development for fourth quarter in both European and North American markets is fairly similar to what we are experiencing right now. We are not seeing a further deterioration of those markets. We are seeing a market that is fairly stable over the fourth quarter versus where we are right now. So, no major changes there.

Great. Thanks. That’s helpful. And just I wanted to ask about the lignin plant, assuming you eventually pursued commercialization now, what are the biggest potential end markets that you see and how big could the potential market be?

Lignin is clearly a very attractive opportunity that we still need to dimension properly. We know that there is a big potential for it as a substitute of fossil-based products, the markets in which it can be applied to our various. I’ll mention a few epoxy resins being one of them, probably the low hanging fruit, if I can put it somehow. But there is also opportunities in the carbon black space, there is opportunity in the asphalt space, this opportunity in battery replacement than in some of the components. There is opportunity in carbon fiber. We believe that most likely, the epoxy resins, the carbon black maybe a very attractive market, but it’s way too soon for us to have already that narrowed down to which market in particular we would be able to participate. That would also depend on the quality and specs of the lignin that we will be able to produce. All mills are different in terms of their setups and therefore the qualities of the lignins that can be extracted from them can vary. So, there is still questions to be asked as we push this exciting project forward and we should know more by the end of the year of next year.

Okay, fair enough. And just the last question I had for Dave Ure, just given the price cap on energy from December, based on maybe what you see in saw pricing in October and expect for November, what kind of pricing level would you expect for your electricity sales in Q4?

For electricity, Hamir, is that what you mean?

Yes.

Well, yes, it looks like the cap – looks like the cap will be around €180 per megawatt hour. So, the regulation, this particular regulation is still being still being drafted, but it looks like we are expecting that there will be – the capital will go in and it will be effective December 1. So in Q3, our average electricity price in Germany was in the order of €388 per megawatt hour. And we even expect that for two-thirds of the quarter. If the regulation rolls out the way it’s the narrative is describing, we would have two-thirds of the quarter would be at a lower rate, like €180 and one-third would be at a higher rate.

Okay. And where would that higher rate be based on what you have seen so far?

Yes, currently it’s still in the range of €300, €375 to – sorry. I said €300 I meant €400, €375 to €400.

Okay, great. Thanks, Dave. That’s all I had. I’ll turn it over.

The next question comes from the line of Richard Stevens from [indiscernible]. Please go ahead.

Hi, thank you. I am fairly new to the story. So I did want to follow-up on a couple of things if I could. Just in terms of overall cost, I assume most of your costs are dominated in euro or Canadian dollars, whereas the pulp and wood products is sold in dollars. And I don’t know whether you said something about it earlier, but overall, what was the impact of the strong dollar on the Q3 results? And I did have a follow-up.

Just looking it up here, but you are right typically you are exactly right, most of our cost structure is in euros or Canadian dollars if we can get a rough number for you.

Thank you.

14. And we – so sequentially, just to give you a sense sequentially, Q2 to Q3, we estimate the impact of foreign exchange was about $13 million this quarter compared to last quarter.

$13 million in revenue.

Yes, it depends how you think about because we are a US dollar reporter, the way it comes and the products are U.S. dollar denominated products. It’s actually the conversion of the cost structure, the euro cost and the Canadian dollar cost, it gives rise to the improvement, yes.

Got it. Okay, got it. Got it. Okay. And then I wanted to spend a couple of seconds on the energy business, my sense is the energy generated is a byproduct of your production process and that there really is not a ton of cost associated with that business and it’s sold directly back into the grid. And please correct me if I am wrong, so would it be fair to say that if the cap basically for lack of a better term kind of cuts rate in half that, that would impact that segment by roughly half as well, is that fair? It’s pretty hard…

Yes, all other things being equal, yes, that’s right.

Okay, perfect. Those are the two questions I have.

Richard, just to give you some context here, these are still very – these are really solid rates for us. It sounds like a big reduction coming from €400 down to €180 or €200, but if you go back a year ago, our average was probably closer to €80 that we were selling to the grid. So these are still pretty, pretty solid rates in our mind.

Got it. Alright. That’s very helpful. I appreciate it. Thank you. That’s all I had.

The next question comes from the line of [indiscernible] from Baird. Please go ahead.

Good morning. Before I begin, I was one that had trouble logging in, but just so you are aware too, the webcast just had the whole music on it, so you probably get some people let you know about that later.

Yes, sorry about that. Ryan. Yes, we are aware of that, if we don’t get you what you need today, don’t hesitate to give us a call after we will make sure you get everything you need.

No, no, appreciate it. Just a few for me, given the projects that you were just mentioning that you want to work on, you have any guidance that we should think about 2023 CapEx?

Absolutely. Ryan, we are looking at a 2023 very much in the ballpark of what we have in 2022. So we are focusing on our growth projects and ESG initiatives and we are maintaining that as what we are doing this year.

Okay, that’s helpful. And just on the new energy rules, is there any expectation that, that will go beyond June of next year or is it just unclear at this time?

This is still very volatile. What we see so far in the drafts of the documents that have been circulated by the German authorities, they are considering up until June. But at the same time, they have also looked into setting us, setting cap for gas. And for example, in the case of gas, they are thinking about the entire year. So again, electricity maybe until June and gas maybe the full year whether that’s going to be maintained that way or they are going to decide otherwise is yet to be seen. But that should be known hopefully in the next month or so as at the latest.

Understood. Just maybe broadly speaking, as for the investment you are going to make in the business, how should we think about capital allocation, some of your bonds are trading the low-80s. But there are also going to be some distressed companies out there just to look to get your thought process on how you are thinking about using some of the excess cash flow and you are facing your balance sheet too over the next year or so as these opportunities are presented?

We discuss these kinds of things regularly with our Board – with our Board, just as we do all the policies around dividends. And we still believe that since we have quite a bit of CapEx growth projects in the pipeline, we believe the better use for that cash is to fund those growth projects before we start buying back some of those loans.

Understood. Appreciate all the responses. Thank you.

Thank you.

The next question comes from the line of Andrew Kuske from Credit Suisse. Please go ahead.

Thanks. Good morning. I think the first question is really for Juan Carlos. I think you mentioned on the mass timber business, you have got 30 bids out in the market already. Maybe if you could just give us a bit of flavor on the projects you are targeting? Are they just dedicated to mass timber? Are they looking potentially to go mass timber? And then how do you see the competitive landscape for you in that business?

Absolutely, Andrew. Yes. It’s exciting times, because we just finished setting up or building the team actually the marketing team that is working on these bids. And as you might know, this is a pretty intensive piece of work just to get a bid together for any such project. The projects that we are looking at are above all different sizes. You have large buildings and complexes that would carry several buildings altogether. And also you would have individual construction units. So, you have an array of different size projects within those 30. And obviously, our expectation and as such, some of those projects are all CLT. Others are a combination of CLT together with steel. So, there is a bit of both, but obviously, heavy weight towards CLT as a replacement of concrete. But it’s looking very attractive as I mentioned before. And we are eager to see those bids come to closure, as the team is now advancing successfully into those.

That’s helpful. And then maybe just as a follow-up to that, how would you roughly and other all different shapes and sizes as far as the projects go, but how would you just conceptually think of the average project? How many average projects do you need over the course of the year to effectively fill the utilization of the facility?

It’s probably as much as I would like to give you a straight answer and know that it would be the right answer. I don’t think we are in a capacity right now to be able to say that the 30 projects that we have right now. When we have barely entered the market, we just launched our website. We haven’t done any mass work to spread the word out for ourselves. We are getting – we are about to be part of the San Francisco conference in the first week of November. That’s going to be really the first time that we go out there and our presence in a very significant way with a significant amount of developers and architects. So, the 30 projects that we are bidding for, I don’t know that they would be representative share of what we would expect to see in the future. If those 30 projects are in the tens of hundreds of millions of dollars – in the tens of millions of dollars, so it’s – they are significant in essence. But again, I don’t think those are necessarily representative of what we see once people really know that we are out there.

Okay. Thank you. Appreciate that. If I could sneak one more in and it really just changing geographies into Europe, you clearly have an advantage from a power standpoint, on the portfolio there the pulp mills. Are you seeing signs of stress, or do you think there are signs of stress for some of the other pulp producers? So, I guess we are asking a different way, are we seeing elevated pulp prices in part because input prices have gone up? But even with that, are we seeing margin compression for some of the competitors? And does that distress potentially create opportunity for you?

I think we do enjoy a significant advantage, because we have made a conscious effort to be able to extract as much energy as we can from our facilities. And that obviously has played positively for us in our strategy. I cannot say the same of other competitors that may have different positions that retains – reflects to energy. So, I think we are positively positioned versus others on the energy equation. Now, whether it’s something that it is hitting some more than others, I am sure there is. For us, it’s obviously positive, very positive. And we still are very bullish about this for Q4.

Okay. Appreciate it. Thank you.

Thank you.

The next question comes from the line of [indiscernible] Private Investor. Please go ahead.

Hey. Thanks for taking the question. Just so I was looking through the 10-Q, it’s kind of interesting to see the pro forma numbers with the MIT. I don’t have a lot of experience with pallet manufacturing. So, could you just give us kind of a quick education on the call in terms of like how that business works from a pricing perspective, is it your contracts, is it all spot, is there any seasonality with that business? And I will pause there.

Absolutely. Yes, we are also in the process of learning more and more about the pallet business. But I can anticipate already that yes, this is a – even though it’s a very dynamic market and we know it follows very much how the – it’s kind of a leading indicator of the economy as such. We do have long-term contracts with customers as well as some reserved spot business. We are by far the largest manufacturer of European or the e-power pallets. So, we have a kind of a very significant presence in Europe with our product. There are other geographies that are important. Ukraine is being one of them. And which is not suffering, as you would imagine, because it’s the Eastern part of Ukraine that – it’s the Western part of Ukraine, excuse me, the one where the production is held. So, they are pretty much active in the market still. So, it’s an active market, very competitive market. But what we enjoy probably the fact that by being the largest, we are also probably the most competitive – we are not probably we are the most cost competitive out there with the volumes that we are able to produce and how we manage inventory for our customers. It’s quite a unique competitive advantage. So, we will see how, again, economy determines a little bit of how this market oscillates in terms of price. And there is some softness, obviously in the price right now. But nothing that is out of the ordinary for this point of view.

Okay. That’s helpful. And then just our expectations, it looks like based on that performance disclosure, it was a profitably operating business year-to-date in 2022. Is that still a reasonable expectation for 2023?

Absolutely. It will be a profitable business in 2023. I would say more since we are reconfirming the fact that we have the synergies that were identified early on in the project. We are materializing those synergies. If you remember, and I believe we have mentioned it during the call earlier, today that we had identified $16 million worth of synergies by running HIT. The synergies being spread between hardwood chips and lumber. And we believe that we are in very good track towards achieving those, that level of synergies that we had identified. Just for the first month, we are on target and we are just beginning. So, there is a clear value in how we integrate the benefits of having the different setup mills close to each other, whether it’s Friesau, or whether it’s Rosenthal, or now HIT. And us being able to move around chips, wherever they are needed, and move sawdust where it’s needed. And so with that flow of product back and forth between mills, rather than each mill looking what to do with those excess products, brings a very significant benefit and we are capitalizing on it.

Okay. That’s helpful. And then on the sawmill side on Friesau, it’s very dynamic market last couple of years, prices up, prices down. We are seeing fiber costs higher in Europe. Is that facility able to run profitably with just say right now in terms of where all the metrics are? Do we have the ability to flex some of the labor shifts there? Is that business profitable in the current state?

It is it is very profitable. And I would say more Friesau was most likely the most profitable or cost competitive sawmill in Europe. So, we have a structure that allows us to navigate through these moments where lumber prices are not as high as we would like them to be, or some of the costs are higher than we would like them to be. It still generates quite a bit of earnings. So, it is still profitable.

Okay. And then just last question on, I think you alluded to this in the prepared comments. But just the normalization – maybe the normalization of trade flows as it relates to shipping costs coming down. I think within the European region, we were kind of a little bit of captive trade flows. We had the disruption in BC from the flooding. We are getting further away from that. And we are also seeing shipping prices coming down. Is it going to be going forward more dynamic and more competitive market as it relates to pulp with shipping costs falling?

Yes. I think you have – you are absolutely correct, there is. We see falling shipping rates, especially out of China. Now, out of China either to the U.S. or to Europe, you are basically getting fantastic rates. So, you can move products out of there, with not too much costs. So as and – again as a lockdown seas and those things are – and China starts to wake up, I think we expect to see a lot more movement and then taking advantage of those or being able to ship at lower costs. I think that’s absolutely true. I wish we could say the same about railways, railcar situation in Canada, where we still suffer the consequences of not having enough, even though there might have been a slight improvement where we were a couple of quarters ago. But it’s still far from where we would like it to be. So, I think there is a bit of mixed signals depending on where you bill, where you are going at, where you come from. That in some cases, it’s still advantageous and some others we still don’t see the benefit that you would expect to see.

Okay. Thank you for taking the questions.

Thank you.

[Operator Instructions] The next question comes from the line of Matthew McKellar from RBS Capital Markets. Please go ahead.

Hi. Thanks. First just on German fiber costs, you mentioned that you expect per unit fiber costs to increase in the fourth quarter, with continued strong demand for wood for energy purposes. Are you able to provide a little bit more color or a sense of magnitude here on how fiber costs will trends from Q3 into Q4 and how you might expect fiber costs to trend into next year, including once we are through winter?

Sure, Matthew, when we look at pulpwood costs, just looking at Q3, when we look at Q3 versus Q2, they went up almost 20%, give or take 17% or so. So, it’s – and we see that that escalation has not stopped. That escalation will continue in Q4, whether it’s going to be at that same level or not, we yet have to see. As I mentioned earlier, the wood chip is the one that is having the highest impact as people are now seeing the possibility of using those wood chips for the production of pallets and going into energy. And that’s a market that as we know is booming. But the saw logs are more or less another saw logs that the pulp word is more or less – the roundwood is more or less stable or relatively stable. Just a little bit up, but no to that affect. Nothing in comparison to what we have seen in the wood chips. So, we believe that trend will continue still in Q4, where there is still – until we see this energy cap impact and how that will materialize and what impact it would have on the overall situation of the biofuels and whether they will be maintained at the record levels that they are or whether they will recede a little bit and go back to more normal levels, we yet have to – we have to see. I think the gas cap and the electricity cap that Germany is about to implement all those measures will help bring things a bit more into a more reasonable level, not at a cheaper level that we used to before, but not low, but at least not increasing at the rate that we have seen from Q2 to Q3.

Okay. Thanks for that. And then just one other following up on John’s question earlier on Torgau, I know it’s early days. They are just under a month since you closed. But could you talk about the opportunities that you see to expand whether those are kind of opportunities we are looking at in the near-term that we should expect to see in your capital program for ‘23, or is your focus at this point still working toward the synergies you have targeted? Thanks.

Sure. Right now we are focusing primarily on the synergies that we targeted. At the same time, we are looking at what would be the capital plan for taking that mill to a higher level. We know that that mill can perform at higher levels and it will require some cash in order to do that, some CapEx to do that. But we don’t know at this point exactly what would we be looking at in terms of investments into the mill. We know the potential is large, but it’s too soon for us to already put a number out there of how much we think we will be investing into that facility. There are things that we can do that are not very costly. We have planar capacity, excess capacity in Friesau that we can simply move to Torgau, so that that would be – those would be kind of investments that are not material in terms of CapEx. But can bring already a significant improvement in the lumber output capacity of Torgau. So, they are things that we can do without necessarily adding a significant amount of CapEx. But we know that that if we were aggressive on CapEx there is a lot more that we can extract from that facility.

Thanks very much. That’s all for me. I will turn it back.

Thank you.

Our next question comes from the line of Dennis Collins from Stifel. Please go ahead.

Hi Carlos. Good morning. Good morning David. Thanks for taking the call. So, gentlemen, as of September 30th, company has looking at the Q2 $87 million in cash and estimated that the cash position will be as high as $430 million to $440 million end of ‘23. So, just looking at that, looking at, obviously, the bond offering that’s due in 3 years and 3 months, I am guessing that the Board has spoken about a buyback of stock. And I am sure there is opportunities that the company is looking in terms of acquisitions, but the stock has been volatile at times. Isn’t it advisable to have a $50 million to $80 million buyback that would be about 11% of the cash position at the end of the next year in place for volatile times? Is the Board considering a buyback announcement? If not, can you explain why not? Thank you.

Yes. Thanks Dennis. No, I can tell you the Board is considering this is a regular every meeting that the Board has. This is a regular topic. So, you can imagine they think about other ways of giving back to shareholders a buyback, a dividend, a special dividend. Those are all on the table. But ultimately they get weighed against alternatives and the alternatives that they are looking at the cap, the high return capital program that we have, not only the one that Juan Carlos talked about guiding for next year, but the portfolio of other projects that we have behind that. And many of these projects have got considerable returns better than 3 years. And then of course, on top of that, we have got a lot of resources that we are applying to trying to grow the company still. So, folks that are looking for new opportunities to buy something to grow in spaces where we have got competence and having a bit of dry powder has been – we have been rewarded for that several times in the last few years, including the Torgau acquisition, including the Spokane, MIT acquisition that we probably wouldn’t have been able to do if we weren’t able to – if we didn’t have the agility that we do and have the cash available that we do. So, these are all considerations, including debt reduction, that’s also a topic, particularly at the moment, since the bonds are trading at a bit of a discount today. These are all topics. And at the moment, we feel the right thing to do and the Board thinks the right thing to do is push ahead with the high return CapEx and give ourselves a little bit of a dry powder to make sure that we can take advantage of some of the M&A opportunities that we are currently looking at. So, not the answer you are looking at, but I can I can tell you it’s a – these are elements that the Board considers quite considerably.

Okay. Thank you.

We currently have no questions coming through. [Operator Instructions] Okay. There are no further questions, so I will now hand you back to your host. End of Q&A:

Okay. Thank you, Sarah. And thanks to all of you for joining our call. Dave and I are available to talk more at any time. So, don’t hesitate to call one of us. Otherwise, we look forward to speaking to you again on our next earnings call in February. Bye for now.

Thank you for joining today’s call. You may now disconnect your lines.