Juan Carlos Bueno - President, Chief Executive Officer David Ure - Senior Vice President, Finance, Chief Financial Officer and Secretary

Good morning and welcome to Mercer International’s, Fourth Quarter 2022 Earnings Conference Call. On the call today is Juan Carlos Bueno, President and Chief Executive Officer of Mercer International with David Ure, 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 fourth quarter, before returning the call to Juan Carlos to provide further color on the markets, our capital plan as well as our strategic initiatives. 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 $96 million compared to Q3 EBITDA of roughly $141 million. This solid Q4 results was a consequence of improved pulp production of our Stendal mill, as we return the mill to near full production after the Q3 wood yard fire, along with higher pulp and energy sales volumes. This was more than offset by lower energy sales realizations in Europe due to the recently implemented energy price cap, along with considerably higher pulp fiber and chemical costs. In the 2022 fiscal year, we achieved record EBITDA of almost $537 million, driven by strong pricing for our products through most of 2022, a relatively strong U.S. dollar compared to the Euro and Canadian dollar, along with improved pulp sales volumes. Currently, Stendal is approaching 100% of capacity, and we expect the final repairs to the fire damaged wood yard infrastructure to be complete in Q2. The loss is covered by…

Thanks Dave. Overall, I'm pleased with our fourth quarter operating results, as it provided a solid conclusion to a record year for our company. Operationally we ran well, and our production and sales volume were up for all our products compared to Q3 and we return our Stendal mill to almost full capacity midway through the quarter. As we expected the pulp markets weakened, but only slightly. Lumber markets weakened more significantly in the quarter, but we are beginning to see signs that this market will improve. As Dave highlighted, there were significant changes in energy policy in Germany during the quarter, which reduced our electricity revenue compared to Q3, but while this top line reduction can quickly lower costs for natural gas, chemicals and pulpwood are now following and will materialize in our results in the next few quarters. We made good progress with the integration of the Torgau sawmill, coordinating the logistics for the various fiber and wood transfers we envisioned takes time, and I am excited with our progress to date with regards to our targeted synergies. On an annualized basis, we achieved approximately $6 million of synergies in Q4 and once we fully are integrated, we expect to achieve about $60 million per year of synergies. I'm also pleased with the progress we're making in developing our mass timber business. Our design and engineering teams are now actively bidding on numerous mass timber products, and we have currently over 50 projects in various stages of evaluation or bid, and many of our complex projects will take time to negotiate and finalize, but we expect a few of these already to be contracted in the coming days and weeks. As I mentioned, global pulp markets remained resilient through the fourth quarter with prices down only slightly. There…

[Operator Instructions]. The first question comes from the line of Kasia Kopytek from TD Securities. Please go ahead.

Hi, good morning! Apologies in advance. I think I have a bad connection. David, you mentioned $18 million in insurance proceeds to-date, how much was in Q4?

Yeah, it was about $6 Kasia.

Okay, so most of it had been revived in Q3 then I take it.

Yeah, that's right. That's right, so there'll be a little bit coming, but the insurance here has actually been quite efficient. So the insurers been providing us advances that sort of match our expenditures. So it's generally been coming in as the work has been done.

Got it. So maybe just a single digit few million coming in Q1, is that fair?

I think that's fair, yeah.

Great! And David, can you quantify the mark-to-market on the inventory? How much that impacted the EBITDA in the quarter.

Yeah, roughly $10 million.

And the Q4 depreciation rate, is that a good rate to use going forward as a run rate for modeling purposes.

Yeah, that should be, that should be all right.

And then, David, if you could just give a maintenance outlook for 2023. I know it’s in your 10-K, but if you could specify between the mills that would be great.

Sure, just one moment here. All right, okay, so in Q1 we will have the shut at Celgar, a small shut at Celgar. In Q2 we will have a larger shut, so a fairly substantial typical shut. Peace River for a couple of weeks. We also have a shut at Cariboo in Q2. Q3 we will have our typical two week shut at Rosenthal, and Celgar will have their major shut in Q4, sort of a two to three week shut in Q4.

Thanks, Dave. What do you think for paper maker demand right now? And what are your order books looking like?

It's Juan. Kasia, thanks for the question. In paper demand, what we're seeing is obviously a slowdown in Europe, in the European markets. Those have been the one that have suffered a bit the most since I would say almost end of Q3 and beginning of Q4. But now what we see compensating that is obviously the China coming back. So there's a little bit of a balance there in terms of how the paper market is moving.

Thanks for that context. So the last one for me, you had Torgau for a little over a quarter. How is that going relative to your expectations and any contacts you could provide there, any way on progress to-date?

Very good and very happy about the progress in Torgau, particularly with the synergies that we're already able to extract in very little time. When we think about this, we just took over, 1st of October. And looking at the progress that we made, moving all sorts of products around our mills in Germany, has been very, very - and as we unlock further capacity of Torgau, we expect those synergies just to increase. What we're aiming for obviously is to increase our lumber production over there, but at the same time we have benefits when it comes to the movement of wood chips or the movement of pines, sawdust and whatnot. So it's a very positive addition to our overall portfolio.

Thanks very much, everyone. I appreciate the context. I will get back in the queue.

Thank you.

Your next question comes from the line of Paul Quinn from RBC Capital Markets. Please go ahead.

Yeah, thanks very much and good morning, guys. I guess maybe this is for David. By David, if you could just give me a rough cost of the shut at Torgau and Celgar, how should we model that in?

For 2023, Paul?

Yes, just the sort of fiber related shuts that you're taking in both mills.

Okay, so not the maintenance shuts. You're talking about the curtailments?

Right, yeah.

Yes, I don't think we have. I don't think we have – I don't think we can disclose that. But I can tell you that the reason you do it is because that incremental fiber that is available to operate the mill is higher than what it would take to just to cover your fixed cost. So generally that's the call we make.

Okay, and just. Yes, you don't have the specifics, but what about overall fiber costs in general? I mean, you're obviously seeing a big price increase in Europe, but I suspect that's also affecting you in BC, Alberta, pretty flat?

Yes, Alberta – Paul, this is Juan. Alberta is – we have seen a bit of increase, but nothing too dramatic. Remember in Alberta two mills that we work with, we have quite a significant amount of wood at our disposal. So it's a very different situation from what we experienced in British Columbia. Now having said that, obviously also in Germany we had over the quarter of a very high increase in wood costs associated with all the energy crisis and all the scare that was going on during that period of time. But obviously that has now eased down significantly, and actually what we're seeing today is an important reduction of the cost of the wood chips in Germany, which obviously is very, very favorable to us. Not yet to the level that we would want it to be, but clearly heading in the right direction, and we expect that to continue going forward, so I think that's very positive overall. And in the case of BC, obviously with the curtailments of – continuous curtailments of saw mills, that is putting a significant strain in the whole system. And we'll see now that this other pulp mill has been shut down as was announced recently. Obviously that creates a little bit more balance, but yet we have to see how the development goes for the coming months.

Okay. And then just longer term on fiber availability, especially in BC, because it seems most constrained there. What do you think of the positioning of the mills that you've got in that jurisdiction? Are they going to be able to - you know, be able to be fibered up going “forward” or is it going to be rolling downtimes because of the lack of residuals?

There's a – if I talk about Celgar specifically, there's a couple of things that makes Celgar probably in a stronger position than other pulp mills that are in BC, and it's geographic location since we're close to the U.S. border. We have the advantage of being able to tap into the U.S. market for chips. We're actively pursuing that and now basically setting up the proper logistics that would allow us to flow, to have a good flow of chips from the U.S., in case the BC continues to put more and more pressure on this. So that way we can protect ourselves from further issues in British Columbia. I think that's something very positive for Celgar, number one. And number two, we have the woodroom, that is – that we've announced and that will be ready, not only in Peace River, but also in Celgar later in the year. We expect that woodroom to be up and running by the end of the year. And the fact that we are able to bring that woodroom in play, that basically reduces the dependence that we have on sawmill residuals. So that's another very important step to make sure that Celgar runs without interruptions once those things are in place. In Cariboo it's a little bit different situation. We don't have those options of the woodroom or the proximity to the U.S., but together with our partners, we're working very diligently in making sure that we secure the necessary wood that is required for the mill. And we'll see how the development of this year works, but we're actively pursuing options to see if we can reduce the 60 day short curtailments that we've announced before. So we are in the works on that.

All right. David maybe over to you. Just that $175 million or $200 million in CapEx, how do you split that between maintenance and then the amount that you're spending on high return projects?

Yes, that's always a tricky one, because one person's definition of MOB might be different than anothers. But it's probably a pretty good mix of – it's probably close to 50-50. So it's got some terrific projects like Juan Carlos had mentioned. This will be the year that we do the bulk of the work on the Spokane CLT plant, so we're looking for some expansion there. We're also doing some work at Torgau, some early optimization work to increase the lumber production at Torgau, and of course these - the woodroom that Juan Carlos talked about at Celgar. We’re also doing the same thing at Peace River, which is nearing completion, and both of these projects are extremely high, high return. But I would say it's probably roughly 50-50.

Okay and just lastly, and I didn't - sorry, I haven't been on these calls for a while just due to conflicts, but paper excellence is close to - from their acquisition resolute, resolute effort to best, both [inaudible] or any interest in those.

Not really to be honest Paul. I think we're happy with what we have and we’ll continue to focus on those.

Alrighty, that's all I had. Thanks. Best of luck!

Thanks.

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

Hi! And thank you for taking that question. I just had to – wanted to follow up on Juan’s statement. I thought I heard you guys say, just to make sure I fully understand. I think you had new capacity coming online in 2023 and that it would take some time to absorb this capacity. Is that capacity actually coming out of China, so while you're importing right now into China, as China opens up, that they will be a net exporter of product. And more than likely that product will end up into Europe. Is that fair to say?

When we were – I believe Richard what we were referring to in additional capacity was more on the NBHK market, so hardwood market that will see a very significant capacity coming through during the year. That capacity is coming basically from South America, with Brazil and Uruguay coming, and Chile coming to play, and that's something that we’ll – that during the course of this year and next year will add quite a significant amount of pulp, of hardwood pulp into the market. So the destination of that, obviously as you will say China is going to be a significant market for it. I would say that if not the most predominant one, the off taker of a large part of that, and that's why we made the statement that we believe that NBHK is going to be going through probably a bit tougher cycle as that amount of capacity is being absorbed by the market. One thing that I would comment though is, usually when those things happen, it's kind of phased in. It's not that you have 2 million tons of pulp dumped in the market from one day to another. So those things are usually phased in a way that it seems a little bit easy to go through it, and as they ramp up their production, but obviously it's an important factor for I think for the end of this year, when some of those things are fully up and running, and even more in 2024.

Got it, okay, that's very helpful. All right, I appreciate it. Thank you.

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

Thanks, good morning. I guess the first question, it's for Juan Carlos, and it’s really along the lines of balancing the business, and you mentioned this earlier on about – when you announced the business. How do you think about the business mix for Mercer on a longer term basis, whether we're talking five years out, 10 years out, how do you think about that?

Thank you, Andrew. Yes, we're very, very focused on that specific item that you just mentioned, on balancing better our company and diverse it, so that it's not so heavily dependent on pulp overall. We believe that there is still very good opportunities for us to grow in pulp, but we will pursue higher opportunities for growth in lumber and CLT, and not only that, but also in our biomaterials space with lignin, and as Dave mentioned and I think I mentioned as well. We have this – already this lignin investment going through in 2023. If you ask me looking 10 years ahead, I would hope to see a company that is much more balanced, and by that I wouldn't be surprised if pulp is anywhere below 40% and lumber is anywhere above a third of our company, and some of these biomaterials take – start taking some two digit space into this mix. So that would be how I would paint it for the future, with lumber and pulp almost at balance.

Okay, that's very helpful. And then I guess the second question and sort of thinking about the same kind of timeframe goes to Dave. You don't really have any near term matures at all. You've been very adept and this isn't to be patronizing, but you’ve been very adept over the years of sort of flexing things, levering up when appropriate and then paying down debt and being well positioned generally through the cycle. How do you think about the evolution of the balance sheet if the business mix changes? Do you move from high yield assure into investment grade and just have different market access points?

Yeah, no we do think about that a lot, even though we don't have any near term maturities, and I think we've been pretty fortunate to have kind of that core foundational unsecured, no covenant, very flexible financing structure in the past, but that may not be the place. Maybe as we get closer to the first maturity, which is in 2026, we'll have to see what the market conditions are for other sources of financing and a lot can change in the next year as well. As you know we've been generating – we've got a pretty good cash flow, pretty good operating cash flow, and so I think we're going to have the opportunities if the markets aren't there to roll those facilities over. We'll have the opportunity to do something else, and that may include shrinking the debt up, and it may include – we'll look at the other sources of financing at the time. And of course we're always balancing that with what we have in the pipeline for CapEx or M&A opportunities. As you know, we've been – we've had a little bit of extra cash on the balance sheet at times in the last couple of years, and we've deployed that to pick up a couple of assets in the Spokane facility and recently the Torgau facility. I think we've been – we may have struggled to get those assets if we didn't have a little bit of dry powder on the balance sheet. So I think you'll see us at times be a little bit conservative or what might look outwards to be a little bit conservative, to make sure that if we do come across an opportunity that aligns with the strategy that Juan Carlos was talking about, that we're able to jump on those opportunities quickly. Sorry Andrew, that's a bit of a ramble, but yes, there's a lot of moving parts, but we're paying a lot of attention to that, particularly over the next year or two.

Okay, I appreciate the color. Thank you.

[Operator Instructions] The next question comes from [inaudible] as a private investor. Please go ahead.

Hey! Thanks for taking my questions. Can you just give us an update on the woodrooms? I think you had spoken about these at length in the past and talked about the opportunity for grant proceeds tied to the completion of those. Is that still possible, and what would the quantity of the proceeds be?

Yes, the woodrooms are progressing well. One that is very, very close to completion is the one in Peace River. We expect that to be concluded and starting up already in the second quarter, early in the second quarter. So we're already halfway through the commissioning phase. So that is obviously of high expectations, and we've gotten good support from the government into that project. So that to us is very, very important as we mentioned before. [inaudible], that one we need to associate it with – there's some work that needs to be done, and we want to do it at the time of our shutdown. As Dave mentioned earlier, that shutdown is scheduled for the fourth quarter for October, so it is linked to the fourth quarter shutdown for us to be entering to that commissioning phase in Celgar. As far as the values, do you remember really how much is…

Yeah, round numbers. The peace river, the peace river woodroom is in the range of $50 million to $60 million, and we'll start up in the next few months here, and the Celgar one is about in the range of $30 million to $40 million.

And I think there was talk in the past that there would be some grants associated with that. Are there still grants tied to those?

Yes, there are, yes. So those numbers that I'm referring to, those are net of grants.

Okay, thank you. And then the second question on – can you just give everyone an update in terms of where we stand with the cross laminated timber. Obviously been on this asset out of bankruptcy. There was some commentary. It was a really nice facility, brand new, lots of equipment, lots of capacity. We started doing some finger joint work. We've added a pallet business in there as well. It's just a little confusing, you know given – how the mix of that segment has changed, and now you've talked about some investments to increase capacity. So you know taking a big step back. What is the profit outlook for that business going forward, either over the next one to two years, and what's the targeted return on investment for that Spokane facility. Just to help everyone understand you know what is that building, what’s it able to do in our minds?

Absolutely! As I mentioned earlier, we're very happy with the way things are evolving there, and when I say that, despite the fact that materially in our revenue it doesn't show up yet, what we see is a tremendous amount of project and bidding work that we're doing with the team that we have assembled in Vancouver, and that is what gives us an extremely high confidence about the future of this business. We have several projects as I mentioned earlier, and that are in the bidding process. Some of them in the very, very final stages and with very high confidence that we will close in a few that are very significant, and they we’ll make a mark for, let's say the full load of our CLT facility and that is very important. That's why as we were seeing already this unraveling, even though we've only been into this, as you well said, for a short period of time and this is coming out of bankruptcy. Almost considered – for us, it's considered as a startup. and that's why we decided to make the investment ahead of time, because we see the need for that facility to develop itself further, even though it's – it was state of the art technology, but obviously there's opportunities to do more. One of the things that we are adding is the capacity to put Glulam in there. Glulan and CLT, as we phase many of these projects that we're bidding on, we see more and more the need of those two going together in many of the construction projects that we’re working on. So having the facility, being capable to provide both offerings is obviously something that would be very attractive to our customers and hence are decided to go through with that investment. In terms of your question of how material it can be going forward, without getting into committing to numbers, I would say that we would be – by the end of ’24, we should be much closer to rounding values in – closer to the $100 million profit overall in this facility. So that is the rain, and we see a very strong likelihood that we will be able to achieve that growth. So it is important that we talk about how those projects materialize, and we will be sharing more of that as we go into the future.

Okay, that's some interesting color. In the past we've had some credit facilities tied to individual locations. If we're going to be doing type of profit number that you put out there for 2024 in that ballpark, I mean does that facility were in its own credit structure associated with it.

Yes, I think your question, will it be big enough to support its own facility, the diverse. Yeah, we'll have to wait and see at the moment. We'll take that as it comes, it possibly could, yeah, it possibly could. We'll see how it develops, and as Juan Carlos had mentioned, we're pretty bullish about it, and we'll probably if it goes away; we think it's going to go. We're going to invest more in that business, and it may need some financing and that might be appropriate to do. But at the moment, we're covering that with our existing finance structure and cash.

And just one thing to make sure that I – I don't know if I misspoke, but when we look at the value of this and the expectations for it for next year, 2024 that I mentioned closer to 100, I refer revenue more, not profitability.

Oh, okay, thank you for clarifying that. And then last question on free sale. Can you give us an update in terms of where we stand on capital expenditures there. I believe at one point there was a fair amount of pointer capacity, sort of capacity going in, and I think there was some thought of you know additional, either sorting or plaining capacity, I can't remember exactly which one. But can you just give us an update in terms of how we're looking at CapEx at that facility at this point in time?

Well, the majority of the CapEx that was intended for free sale after acquisition a few years back has now been concluded. So that has – we've made very good progress on it. So there's very little that is left, yet to be to be executed there. Now, the focus is now turning on the CapEx that we want to put into Torgau as we see a tremendous amount of potential in that facility. That is back to your original question about CLT. You mentioned that or made some comment associated with pallets, and just to be clear, our Spokane facility in Washington is not doing any of that. It is just focused on CLT, Glulam and finger joint. Now the acquisition of Torgau, that's where the palette and the pellet business comes in, and that's obviously something that we intend to maintain. But what we want to grow in that facility is the lumber output, and that's a facility that has four saw mills, saw lines and only two of them are being used in a proper way. So we know that there's a tremendous amount of potential to be extracted. That's why we want to divest – or excuse me, direct our investment more towards Torgau as we unlock the potential that that facility really has.

Okay, thank you.

As there are no further questions, I will now hand the call back to Juan Carlos for closing remarks.

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

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