Mercer International Inc. (MERC) Earnings Call Transcript

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.

Thanks, Lisa. Good morning, everyone. Thanks for joining us today. I will begin by touching on the financial and operating highlights of the third quarter before turning the call to Juan Carlos to provide further color into the markets, our operations, and our strategic initiatives. Also, for those of you that have joined today's call by telephone, there is presentation material that we've 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 conference 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. As many of you have already seen in response to persistent economic uncertainty and challenging market conditions, on November 2nd, we entered into a restructuring support agreement with holders of more than 87% of our senior notes and with the majority of our common shareholders. This agreement will provide Mercer with a significantly stronger balance sheet as approximately $1.1 billion of our senior notes are exchanged for equity, reducing existing senior note debt by approximately 88%, with minimal cash interest requirements over the next 2 years following this transaction, and no senior note maturities until 2031. In addition, we will have substantial liquidity to support our operations post-emergence as a result of a $400 million new money rights offering of new senior secured notes which will be 100% backstopped by certain members of the ad hoc group. The recapitalization is being implemented through a prepackaged joint Chapter 11 plan of reorganization. I want to be clear to all our stakeholders that only Mercer International, the parent company and a Texas subsidiary are filing Chapter 11 under this prepackaged plan. For all our operating subsidiaries, it is business as usual. We will meet all customer, supplier, and employee obligations without interruption. In addition, we expect this plan to be confirmed by the court within about 45 days of filing, with the recapitalization completed by the end of 2026. Additional information on the recapitalization can be found in our 8-K filed on the SEC website on November 2nd. With the recapitalization requiring court approval, we have kept the going concern disclosure in our third quarter financial statements. This disclosure stems from the classification of our Canadian and German revolving credit facilities as current liabilities. Turning to our third quarter financial results, our operating EBITDA was negative $3 million, an improvement from negative $21 million in the second quarter. Third quarter results included 44 days of planned maintenance downtime, which had a negative EBITDA impact of approximately $34 million, compared to no days of planned maintenance downtime in the second quarter. Our improved results were largely due to a lower non-cash inventory impairment of $8 million in the third quarter, down from $29 million in the second quarter. This reduction was driven by modestly lower forecasted fiber costs at our Canadian pulp mills and German sawmills, with forecasted improvements in pulp pricing. Additionally, during the third quarter, our Peace River mill received $13 million in non-repayable government grants. These grants were designed to support our efforts to implement productivity improvements in light of ongoing trade tensions and evolving tariff pressures. In the third quarter, our pulp segment reported positive quarterly EBITDA of $6 million, and our solid wood segment reported negative quarterly EBITDA of $7 million. Additional segment disclosures are available in our Form 10-Q, which can be found on our website and that of the SEC. Pulp markets continued to be impacted by the ongoing global economic headwinds through the third quarter. As a result, our pulp realizations were essentially flat in the third quarter compared to the second quarter. Our softwood pulp sales realizations were $671 per ton in the third quarter compared to $682 per ton in the second quarter. In the third quarter, the NBSK net price in China decreased to $645 per ton, a modest $13 decrease from the second quarter. In Europe, the average NBSK list price was $1,625 per ton, a $30 decrease from the second quarter. In North America, the average price was $1,570 per ton, or a $7 decrease. Our hardwood pulp sales realizations were $601 per ton in the third quarter compared to $607 per ton in the second quarter. In the third quarter, the average price gap in China between softwood and hardwood pulp increased to approximately $73 per ton. The average net price for eucalyptus hardwood pulp in China in the third quarter was $572 per ton, down $30 from the second quarter. In North America, the average hardwood list price was $1,535 per ton, up $40 per ton from the second quarter. Third quarter production decreased to about 407,000 tons from 456,000 tons in the second quarter. After adjusting for planned maintenance downtime, third quarter pulp production was about the same as in the second quarter. Pulp sales volumes in the third quarter decreased to about 421,000 tons from 450,000 tons in the second quarter, reflecting the lower production. For our solid wood segment, lumber sales realizations modestly increased in the third quarter as improved prices in the U.S. were driven by low customer inventory levels and reduced supply resulting from sawmill curtailments. In Europe, demand remained weak but prices were stable due to reduced supply. The Random Lengths U.S. benchmark price for Western SPF #2 and Better averaged $487 per 1,000 board feet in the third quarter, about the same as the second quarter. Today, the benchmark price for Western SPF #2 and Better is around $439 per 1,000 board feet, a $37 increase from the end of 2025. In the third quarter, lumber production decreased to 109 million board feet compared to 124 million board feet in the second quarter due to planned maintenance. While production was down, sales volumes increased to 116 million board feet in the third quarter from 100 million board feet in the second quarter, reflecting the timing of sales. Electricity sales in the third quarter totaled 193 GWh, which is about 13 GWh less than the second quarter due to lower production at our pulp mills. Pricing increased to about EUR 155 per megawatt hour from EUR 117 in the second quarter, primarily due to higher spot prices in Germany. Fiber costs for both our pulp and solid wood segments modestly decreased in the third quarter compared to the second quarter. This was driven by improved fiber availability at our Celgar mill and lower costs at our German sawmills due to weak demand for sawlogs. As mentioned previously, the third quarter included an $8 million non-cash inventory impairment primarily driven by historically high fiber costs and low pulp prices for our German pulp mills. Of this amount, approximately $7 million was against inventory at our pulp mills, and the remainder was against inventory at our Friesau and Torgau mills. Our mass timber operations within our solid wood segment had lower revenues in the third quarter compared to the second quarter due to production issues at our Conway facility and project construction delays. Our order book remains strong and is expected to provide stable production for our facilities through 2027. We continue to make progress on our One Goal 100 program and are on track to achieve our target of improving our profitability by $100 million by the end of 2026, using 2024 as a baseline. In the third quarter, our aggregate liquidity decreased by about $48 million to about $144 million, comprising $71 million of cash and $73 million of undrawn revolvers. The decrease was caused by our weak operating results. Excluding the impact of the $8 million non-cash inventory impairment, our change in working capital was flat when compared to the second quarter. In the third quarter, we invested a total of $13 million of capital across our facilities, the majority of which was maintenance capital. We reported a consolidated net loss of $59 million for the third quarter, or $0.88 per share, which includes the non-cash inventory impairment of $8 million, or $0.12 per share. In the second quarter, we reported a net loss of $76 million, or $1.13 per share, which includes the non-cash inventory impairment of $29 million, or $0.43 per share. That ends my overview of the financial results. I'll now turn the call over to Juan Carlos.

Thanks, Rich. As Rich noted, we are very pleased to have reached our restructuring support agreement with the majority of our bondholders and shareholders. This agreement is a critical step in our comprehensive balance sheet restructuring that will equitize approximately $1.1 billion of debt and inject up to $400 million of new money. I want to emphasize that this is a balance sheet recapitalization. All our mills will continue to operate as usual with no interruptions in meeting our commitments to customers, suppliers, and employees. The completion of this transaction will create a much stronger balance sheet and improve liquidity, which will be critical for us to navigate the market headwinds in this geopolitically convoluted environment. In addition, it allows our management team to focus fully on running our business without the distraction of the balance sheet restructuring. Turning to our third quarter results, industry-wide downtime helped balance out pulp supply this quarter, keeping our pulp sales realizations stable despite soft market demand. However, our results were negatively impacted by the significant planned maintenance downtime. Overall, our fiber costs were down modestly due to lower costs for our pulp mills in Canada and for our sawmills in Germany, which were partially offset by higher wood costs at our German pulp mills. In the third quarter, we successfully secured $26 million in government support for Peace River mill, consisting of $13 million in non-repayable grants, as Rich already mentioned, plus an additional $13 million in repayable contributions. This funding is designed to support projects that improve productivity and modernize the mill as we navigate current macroeconomic and geopolitical uncertainty. In the second quarter, we launched our restructuring plan for Torgau mill. I am pleased to highlight that we're beginning to see the benefit of these changes. We have more work to do on this initiative to continue refining our product portfolio with market demand and further fixed cost reductions. We anticipate all changes will be fully implemented near the end of the second quarter of 2027. We expect to reduce headcount by almost 400 positions when this is all said and done, out of which 63% have already been completed, with the remainder scheduled to happen over the next 6 months, a difficult but necessary step to make Torgau mill cash positive. We also continue to make progress on the One Goal 100 program that we launched in the second quarter of 2025. This initiative delivered about $30 million of concrete savings in 2025, with an additional $46 million achieved through the third quarter of 2026. We remain on track to achieve our $100 million target by the end of 2026. And while achieving this milestone is significant, we continue to aggressively pursue additional operational improvements across the business to help offset the increasing macroeconomic pressures. Trade uncertainty, combined with inflationary pressures brought on by high energy prices, are expected to continue to negatively impact our pulp business. Furthermore, until these macroeconomic factors stabilize, the supply side will heavily influence the supply-demand dynamic. As a reminder, the only direct tariff we are facing is the 10% tariff on our European lumber imports into the U.S. This positions us favorably against Canadian lumber imports into the U.S., which, despite recent decreases in anti-dumping and countervailing duties, are subject to a significantly higher average combined tariff and duty rate of about 35%. Although the direct tariff impacts are very limited, we continue to monitor tariff-related events as they have indirect impacts on our customers and our supply chain, creating significant headwinds for businesses. Relative to the second quarter, pulp and sawmill fiber costs were down slightly overall, with slight increases in German pulpwood costs and decreases in Canadian pulpwood and German sawlog prices. Our German fiber costs are at historically high levels, driven by tight supply and strong demand. These market dynamics are a direct result of the war in Ukraine, which stopped the inflow of Russian wood into Europe and caused energy costs to reach record levels. High energy prices, coupled with legislation that allows wood burning for energy purposes and German government subsidies for home wood-burning heating solutions, have resulted in a high demand for wood pellets. As a result, our German pulp mills are now in direct competition with pellet producers for pulp fiber. This higher demand from pellet producers, coupled with reduced sawmilling output across the country, ends up limiting the amount of residuals available, thus creating increased price pressure for the fiber that we use to feed our pulp mills. In contrast, we're seeing pulp fiber costs coming down meaningfully in Canada as we renegotiate contracts with our suppliers, taking advantage of the reduced chip demand resulting from pulp mill curtailments. We expect German sawlog prices to be flat in the fourth quarter due to weak European lumber demand offsetting ongoing supply constraints. Overall, NBSK pulp markets were mostly flat in the third quarter when compared to the second quarter. While demand was soft in China and Europe, compounded by high port inventory levels in China, supply constraints helped balance the markets. North America list prices were stable. Today, the softwood-hardwood price differential in China has come down to about $30 per ton. Hardwood markets remained flat in the third quarter when compared to the second quarter. And although hardwood prices in North America increased about 3% in the third quarter, this was offset by a decrease of roughly 5% in China. Looking ahead, we expect low pulp demand to be more than offset by reduced supply levels, pushing NBSK pricing modestly higher before the end of the year. NBSK supply is tightening as a consequence of the heavy maintenance season in the Northern Hemisphere, coupled with announced mill closures. Similarly, we are seeing market supply constraints for NBHK and expect slight pricing improvements in the fourth quarter. Our pulp production was down 11% in the third quarter compared to the second quarter. In total, we produced 407,000 tons in the third quarter compared to 456,000 tons in the second quarter. We took 44 days of planned maintenance downtime in the third quarter compared to no shut days in the second quarter. Planned downtime and the impact of strategic reductions due to fiber constraints at our German pulp mills resulted in approximately 71,000 lost tons in the quarter. Our German pulp mills will continue to operate at a reduced rate in the fourth quarter. As well, our Rosenthal mill experienced 24 days of unplanned downtime in October due to problems with the effluent treatment that occurred when they were restarting the mill after the maintenance shutdown. This issue resulted in an emission exceedance that took time to investigate and correct and required a slower than normal startup to ensure all emissions stay within proper levels. The only remaining planned maintenance shutdown we have scheduled in the fourth quarter is at Celgar. This 18-day shut was successfully and safely completed in October and resulted in about 23,000 tons of lost production. Our lumber production was down 12% relative to the second quarter, primarily due to planned maintenance at our Friesau mill. We continue to be pleased with the performance of the new advanced scanning technology installed at Torgau. As expected in the third quarter, we achieved higher sales realizations on the mill's dimensional lumber sales. The stagnation of the European economy and high U.S. mortgage rates continue to dampen demand for wood products. This unfavorable business environment combined with high fiber costs were the primary drivers of the $7 million EBITDA loss of our solid wood segment in the third quarter. This segment's earnings were also held back this quarter by unplanned downtime at our Conway facility, incremental fixed costs associated with a transition to 2 shifts at that facility as well as construction project schedule delays. Looking ahead, we expect the full implementation of a second shift, which will create meaningful operating efficiencies. With regards to our mass timber business, we expect our production and sales to increase significantly in the fourth quarter due to the timing of projects. Today, our mass timber backlog of projects sits at about $151 million and we continue to see a steady volume of incoming project inquiries, including large data center projects sponsored by hyperscalers, which make up right now about 62% of our backlog. We feel our large production capacity and geographic footprint positions us well for these types of projects, and we remain bullish on this business as a growth engine for Mercer. Our lumber sales realizations improved in the third quarter compared to the second quarter, as lumber prices in the U.S. were pushed upwards due to the reduced supply of Canadian lumber. Given the many headwinds affecting U.S. construction activity, U.S. lumber pricing will likely continue to be volatile in the short term. Similar forces are expected to keep European prices flat in the fourth quarter. Any meaningful long-term improvement in either European or U.S. markets remains dependent on improved economic conditions and lower long-term interest rates, none of which we're expecting in the very short term. In the third quarter, 50% of our lumber volume was sold in the U.S. And looking forward, we believe the U.S. lumber market will be driven by favorable homeowner demographics, which combined with reduced North American lumber capacity will create supportive supply-demand dynamics in the midterm. Now, switching to other products in our portfolio, the European shipping pallet market remains weak with pallet prices staying generally flat due to the overhang of the European economy, particularly in Germany, and we don't expect this to change in the fourth quarter. Biofuel prices were flat in the third quarter relative to the second quarter, but we do expect biofuel prices to increase in the fourth quarter due to seasonably cooler weather. Thinking about Mercer overall, the headwinds facing our industry have proven to be both longer and more severe than many anticipated. The most recent war in the Middle East has only exacerbated global economic challenges and volatility. It's in this context of continuous business turbulence that we pursued a balance sheet restructuring transaction with the expectation to emerge as a financially stronger company by the end of 2026. In the meantime, we expect persistent market weakness in the fourth quarter, and as a result, we continue to focus on cost reductions, minimal capital expenditures, prudence on working capital, and improved operational efficiency at our mills. We continue to believe that the current market conditions validate our long-term strategy that focuses on transforming our pulp mills into biorefineries with additional revenue streams that will balance our product mix and make Mercer more resilient during market downturns. As we begin to look forward to 2027 with an improved balance sheet supporting the business, we will refocus on our long-term strategy. Thanks for listening and I will now return the call back to the operator for questions. Thank you.

[Operator Instructions] There are no questions in the queue. I would like to turn the call back to Juan Carlos. Please go ahead.

Hey, thank you, Lisa. And thanks to all of you for joining our call today. Rich and I are obviously available to talk more at any time, so don't hesitate to call either one of us. Otherwise, we look forward to speaking to you again in our next earnings call in February. Bye for now. This live transcript is auto-generated without human intervention or review.