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MERCER INTERNATIONAL INC. - Quarter Report: 2011 September (Form 10-Q)

Form 10-Q
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2011
OR
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File No.: 000-51826
MERCER INTERNATIONAL INC.
(Exact name of Registrant as specified in its charter)
     
Washington   47-0956945
(State or other jurisdiction   (I.R.S. Employer
of incorporation or organization)   Identification No.)
Suite 1120, 700 West Pender Street, Vancouver, British Columbia, Canada, V6C 1G8
(Address of office)
(604) 684-1099
(Registrant’s telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES þ NO o
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months or for such shorter period that the registrant was required to submit and post such files). YES þ NO o
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large Accelerated Filer o   Accelerated Filer þ  Non-Accelerated Filer o  Smaller Reporting Company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO þ
The Registrant had 55,779,204 shares of common stock outstanding as at November 4, 2011.
 
 

 

 


TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INTERIM CONSOLIDATED BALANCE SHEETS
INTERIM CONSOLIDATED STATEMENTS OF OPERATIONS
INTERIM CONSOLIDATED STATEMENTS OF RETAINED EARNINGS (DEFICIT)
INTERIM CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 4. CONTROLS AND PROCEDURES
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
ITEM 1A. RISK FACTORS
ITEM 2. UNREGISTERED SALE OF EQUITY SECURITIES AND USE OF PROCEEDS
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS
SIGNATURES
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT


Table of Contents

PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MERCER INTERNATIONAL INC.
INTERIM CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2011
(Unaudited)

 

 


Table of Contents

MERCER INTERNATIONAL INC.
INTERIM CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands of Euros)
                 
    September 30,     December 31,  
    2011     2010  
ASSETS
               
Current assets
               
Cash and cash equivalents
  127,758     99,022  
Marketable securities (Note 4)
    4,013        
Receivables
    110,296       121,709  
Inventories (Note 5)
    128,041       102,219  
Prepaid expenses and other
    9,907       11,360  
Deferred income tax
    24,951       22,570  
 
           
Total current assets
    404,966       356,880  
 
           
Long-term assets
               
Property, plant and equipment
    815,727       846,767  
Deferred note issuance and other
    9,943       11,082  
Note receivable
          1,346  
 
           
 
    825,670       859,195  
 
           
Total assets
  1,230,636     1,216,075  
 
           
 
               
LIABILITIES
               
Current liabilities
               
Accounts payable and accrued expenses
  109,845     84,873  
Pension and other post-retirement benefit obligations (Note 8)
    694       728  
Debt (Note 6)
    25,671       39,596  
 
           
Total current liabilities
    136,210       125,197  
 
           
Long-term liabilities
               
Debt (Note 6)
    707,040       782,328  
Unrealized interest rate derivative losses (Notes 7 and 10)
    51,553       50,973  
Pension and other post-retirement benefit obligations (Note 8)
    23,010       24,236  
Capital leases and other
    11,857       12,010  
Deferred income tax
    14,413       7,768  
 
           
 
    807,873       877,315  
 
           
Total liabilities
  944,083     1,002,512  
 
           
 
               
EQUITY
               
Shareholders’ equity
               
Share capital (Note 9)
    247,642       219,211  
Paid-in capital
    (5,308 )     (3,899 )
Retained earnings (deficit)
    39,786       (10,956 )
Accumulated other comprehensive income (loss)
    21,762       31,712  
 
           
Total shareholders’ equity
    303,882       236,068  
 
           
 
               
Noncontrolling interest (deficit)
    (17,329 )     (22,505 )
 
           
Total equity
    286,553       213,563  
 
           
Total liabilities and equity
  1,230,636     1,216,075  
 
           
Commitments and contingencies (Note 11)
Subsequent event (Note 12)
The accompanying notes are an integral part of these interim consolidated financial statements.

 

 


Table of Contents

MERCER INTERNATIONAL INC.
INTERIM CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands of Euros, except per share data)
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2011     2010     2011     2010  
 
                               
Revenues
                               
Pulp
  190,426     224,697     618,158     624,111  
Energy
    14,352       9,721       41,970       30,783  
 
                       
 
    204,778       234,418       660,128       654,894  
 
                               
Costs and expenses
                               
Operating costs
    146,885       162,293       482,775       470,977  
Operating depreciation and amortization
    13,832       13,987       41,777       41,817  
 
                       
 
    44,061       58,138       135,576       142,100  
Selling, general and administrative expenses
    8,754       6,894       27,616       24,944  
Purchase (sale) of emission allowances
          (167 )     (202 )     (167 )
 
                       
Operating income (loss)
    35,307       51,411       108,162       117,323  
 
                       
 
                               
Other income (expense)
                               
Interest expense
    (14,117 )     (17,820 )     (44,906 )     (51,141 )
Investment income (loss)
    270       93       733       304  
Foreign exchange gain (loss) on debt
    (181 )     9,927       1,272       (4,675 )
Gain (loss) on extinguishment of debt (Note 6)
    (69 )           (69 )     (929 )
Gain (loss) on derivative instruments (Note 7)
    (10,484 )     485       (580 )     (10,523 )
 
                       
Total other income (expense)
    (24,581 )     (7,315 )     (43,550 )     (66,964 )
 
                       
Income (loss) before income taxes
    10,726       44,096       64,612       50,359  
Income tax benefit (provision) — current
    (1,557 )     (2,227 )     (3,854 )     (3,750 )
— deferred
    (1,567 )     9,382       (3,707 )     9,382  
 
                       
Net income (loss)
    7,602       51,251       57,051       55,991  
Less: net loss (income) attributable to noncontrolling interest
    838       (5,116 )     (5,175 )     (5,001 )
 
                       
Net income (loss) attributable to common shareholders
  8,440     46,135     51,876     50,990  
 
                       
 
                               
Net income (loss) per share attributable to common shareholders (Note 3)
                               
Basic
  0.15     1.17     1.07     1.36  
 
                       
Diluted
  0.15     0.82     0.92     0.93  
 
                       
The accompanying notes are an integral part of these interim consolidated financial statements.

 

 


Table of Contents

MERCER INTERNATIONAL INC.
INTERIM CONSOLIDATED STATEMENTS OF RETAINED EARNINGS (DEFICIT)
(Unaudited)
(In thousands of Euros)
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2011     2010     2011     2010  
 
               
Net income (loss) attributable to common shareholders
  8,440     46,135     51,876     50,990  
Retained earnings (deficit), beginning of period
    32,480       (92,380 )     (10,956 )     (97,235 )
 
                       
 
    40,920       (46,245 )     40,920       (46,245 )
Retirement of treasury shares
    (1,134 )           (1,134 )      
 
                       
 
                               
Retained earnings (deficit), end of period
  39,786     (46,245 )   39,786     (46,245 )
 
                       
INTERIM CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
(In thousands of Euros)
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2011     2010     2011     2010  
 
               
Net income (loss)
  7,602     51,251     57,051     55,991  
 
                               
Other comprehensive income (loss), net of taxes
                               
Foreign currency translation adjustment
    (12,913 )     (134 )     (10,313 )     2,809  
Pension income (expense)
    (20 )     317       383       (282 )
Unrealized gains (losses) on securities arising during the period
    (20 )     (29 )     (20 )     (11 )
 
                       
 
                               
Other comprehensive income (loss), net of taxes
    (12,953 )     154       (9,950 )     2,516  
 
                       
 
                               
Total comprehensive income (loss)
    (5,351 )     51,405       47,101       58,507  
 
                       
 
                               
Comprehensive loss (income) attributable to noncontrolling interest
    838       (5,116 )     (5,175 )     (5,001 )
 
                       
 
                               
Comprehensive income (loss) attributable to common shareholders
  (4,513 )   46,289     41,926     53,506  
 
                       
The accompanying notes are an integral part of these interim consolidated financial statements.

 

 


Table of Contents

MERCER INTERNATIONAL INC.
INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands of Euros)
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2011     2010     2011     2010  
Cash flows from (used in) operating activities
                               
Net income (loss) attributable to common shareholders
  8,440     46,135     51,876     50,990  
Adjustments to reconcile net income (loss) attributable to common shareholders to cash flows from operating activities
                               
Loss (gain) on derivative instruments
    10,484       (485 )     580       10,523  
Foreign exchange loss (gain) on debt
    181       (9,927 )     (1,272 )     4,675  
Loss (gain) on extinguishment of debt
    69             69       929  
Depreciation and amortization
    13,893       14,055       41,960       42,052  
Accretion expense (income)
    (168 )     1,111       591       2,056  
Noncontrolling interest
    (838 )     5,116       5,175       5,001  
Deferred income taxes
    1,567       (9,382 )     3,707       (9,382 )
Stock compensation expense
    305       540       2,844       1,273  
Pension and other post-retirement expense, net of funding
    (95 )     96       (102 )     428  
Other
    359       989       1,962       2,836  
Changes in current assets and liabilities
                               
Receivables
    (9,452 )     19,591       3,248       (26,351 )
Inventories
    (23,776 )     (26,005 )     (27,862 )     (36,988 )
Accounts payable and accrued expenses
    318       1,814       24,873       15,146  
Other
    (752 )     (4,883 )     92       (5,477 )
 
                       
Net cash from (used in) operating activities
    535       38,765       107,741       57,711  
 
                       
 
                               
Cash flows from (used in) investing activities
                               
Purchase of property, plant and equipment
    (10,297 )     (8,484 )     (26,122 )     (28,876 )
Proceeds on sale of property, plant and equipment
    1,564       28       1,944       577  
Note receivable
    2,064       216       2,835       711  
Purchase of marketable securities
    (4,018 )           (4,018 )      
 
                       
Net cash from (used in) investing activities
    (10,687 )     (8,240 )     (25,361 )     (27,588 )
 
                       
 
                               
Cash flows from (used in) financing activities
                               
Repayment of notes payable and debt
    (12,160 )     (6,211 )     (42,511 )     (14,461 )
Repayment of capital lease obligations
    (776 )     (638 )     (2,269 )     (2,245 )
Proceeds from borrowings of notes payable and debt
                      840  
Proceeds from (repayment of) credit facilities, net
          (4,057 )     (14,652 )     1,493  
Proceeds from government grants
    4,470       6,778       13,419       17,337  
Purchase of treasury shares
    (7,477 )           (7,477 )      
 
                       
Net cash from (used in) financing activities
    (15,943 )     (4,128 )     (53,490 )     2,964  
 
                       
 
                               
Effect of exchange rate changes on cash and cash equivalents
    2,058       (3,416 )     (154 )     748  
 
                       
 
                               
Net increase (decrease) in cash and cash equivalents
    (24,037 )     22,981       28,736       33,835  
Cash and cash equivalents, beginning of period
    151,795       62,145       99,022       51,291  
 
                       
Cash and cash equivalents, end of period
  127,758     85,126     127,758     85,126  
 
                       
The accompanying notes are an integral part of these interim consolidated financial statements.

 

 


Table of Contents

MERCER INTERNATIONAL INC.
INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Unaudited)
(In thousands of Euros)
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2011     2010     2011     2010  
 
               
Supplemental disclosure of cash flow information
                               
Cash paid during the period for
                               
Interest
  5,822     17,402     35,742     46,435  
Income taxes
    1,389       412       1,725       441  
Supplemental schedule of non-cash investing and financing activities
                               
Acquisition of production and other equipment under capital lease obligations
  973     429     1,246     959  
Decrease in accounts payable relating to investing activities
    1,530       4,986       7,906       1,283  
The accompanying notes are an integral part of these interim consolidated financial statements.

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 1. The Company and Summary of Significant Accounting Policies
Basis of Presentation
The interim consolidated financial statements contained herein include the accounts of Mercer International Inc. (“Mercer Inc.”) and its wholly-owned and majority-owned subsidiaries (collectively the “Company”). Mercer Inc.’s common shares are quoted and listed for trading on both the NASDAQ Global Market and the Toronto Stock Exchange.
The interim consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (the “SEC”). The year-end consolidated balance sheet data was derived from audited financial statements. The footnote disclosure included herein has been prepared in accordance with accounting principles generally accepted for interim financial statements in the United States (“GAAP”). The interim consolidated financial statements should be read together with the audited consolidated financial statements and accompanying notes included in the Company’s latest annual report on Form 10-K for the fiscal year ended December 31, 2010. In the opinion of the Company, the unaudited interim consolidated financial statements contained herein contain all adjustments necessary to fairly present the results of the interim periods included. The results for the periods included herein may not be indicative of the results for the entire year.
The Company has three pulp mills that are aggregated into one reportable business segment, market pulp. Accordingly, the results presented are those of the reportable business segment.
Certain prior year amounts in the interim consolidated financial statements have been reclassified to conform to the current year presentation.
In these interim consolidated financial statements, unless otherwise indicated, all amounts are expressed in Euros (“€”). The term “U.S. dollars” and the symbol “$” refer to United States dollars. The symbol “C$” refers to Canadian dollars.
Use of Estimates
Preparation of financial statements and related disclosures in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Significant management judgment is required in determining the accounting for, among other things, doubtful accounts and reserves, depreciation and amortization, future cash flows associated with impairment testing for long-lived assets, derivative financial instruments, environmental conservation and legal liabilities, asset retirement obligations, pensions and post-retirement benefit obligations, income taxes, contingencies, and inventory obsolescence and provisions. Actual results could differ from these estimates, and changes in these estimates are recorded when known.

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 1. The Company and Summary of Significant Accounting Policies (continued)
Recent Accounting Pronouncements
In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2011-04, Fair Value Measurements (“ASU 2011-04”), which expands the existing disclosure requirements for fair value measurements (particularly for Level 3 inputs) defined under Accounting Standards Codification No. 820, Fair Value Measurement (“ASC 820”), and makes other amendments. Many of the amendments to ASC 820 are being made to eliminate wording differences between GAAP and International Financial Reporting Standards and are not intended to result in a change in the application of the requirements of ASC 820. However, some of the amendments clarify the application of existing fair value measurement requirements and others change certain requirements for measuring fair value and could change how the fair value measurement guidance in ASC 820 is applied. The measurement and disclosure requirements of ASU 2011-04 are effective for reporting periods beginning after December 15, 2011 and are to be applied prospectively. The Company does not expect that the adoption of this new guidance will have a material impact on the consolidated financial statements or related note disclosures.
In June 2011, the FASB issued Accounting Standards Update 2011-05, Presentation of Comprehensive Income (“ASU 2011-05”), which revises the manner in which entities present comprehensive income in their financial statements. The new guidance amends Accounting Standards Codification No. 220, Comprehensive Income, and gives reporting entities the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income in either a continuous statement of comprehensive income or two separate but consecutive statements. Under the two-statement approach, which the Company currently uses, the first statement includes components of net income, and the second statement includes components of other comprehensive income. ASU 2011-05 does not change the items that must be reported in other comprehensive income. This new guidance is effective for reporting periods beginning after December 15, 2011 and is to be applied retrospectively. The Company does not expect the adoption of this guidance to have an impact on the consolidated financial statements or related note disclosures.
Note 2. Stock-Based Compensation
In June 2010, the Company adopted a new stock incentive plan (the “2010 Plan”) which provides for options, restricted stock rights, restricted shares, performance shares, performance share units and stock appreciation rights to be awarded to employees, consultants and non-employee directors. As at September 30, 2011, after factoring in all allocated shares, there remain approximately 1.1 million common shares available for grant pursuant to the 2010 Plan.
Performance Shares
Grants of performance shares comprise rights to receive shares at a future date that are contingent on the Company and the grantee achieving certain performance objectives.

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 2. Stock-Based Compensation (continued)
In February 2011, the Company awarded a total of 812,573 performance shares to employees of the Company, the majority of which vest using a partial vesting schedule between 2014 and 2016; 50% are scheduled to vest on January 1, 2014, 25% are scheduled to vest on January 1, 2015, and the remaining 25% are scheduled to vest on January 1, 2016. There were nil performance shares which had vested, been forfeited, or been cancelled during the three and nine months ended September 30, 2011. Expense recognized for the three and nine month periods ended September 30, 2011 was €13 and €771, respectively. Performance shares are expensed each reporting period based on their fair value, which is then amortized to reflect the time elapsed in the vesting period. The fair value of the performance shares is determined based upon the targeted number of shares awarded and the quoted price of the Company’s shares at the reporting date. The target number of shares is determined using management’s best estimate. The final determination of the number of shares to be granted will be made by the Board of Directors.
Between February and March 2011, the Company granted and issued a total of 474,728 common shares under its performance share plan, which were originally awarded in 2008 and vested on December 31, 2010. Pursuant to the accounting guidance in FASB’s Accounting Standards Codification No. 718, Compensation — Stock Compensation, the Company adjusted the number of performance shares awarded to employees to the number granted by the Board of Directors, and accordingly adjusted compensation cost based on the fair value of Mercer’s common shares at the grant date. As a result, the Company recognized approximately €1,420 of stock compensation expense associated with the final determination of these performance shares in the three months ended March 31, 2011.
Restricted Shares
The fair value of restricted shares is determined based upon the number of shares granted and the quoted price of the Company’s shares on the date of grant. Restricted shares generally vest over a one year period, except as noted below. Expense is recognized on a straight-line basis over the vesting period.
During the three months ended June 30, 2011, 38,000 restricted shares were granted and issued to directors of the Company (2010 — 56,000). During the three months ended March 31, 2011, 200,000 (2010 — nil) restricted shares were granted and issued to the Chief Executive Officer of the Company, which vest in equal amounts over a five year period commencing in 2012.
During the three and nine months ended September 30, 2011, no restricted shares were cancelled or forfeited (2010 — nil and nil), and nil and 56,000 restricted shares had vested, respectively (2010 — 21,000 and 21,000). As at September 30, 2011, the total number of unvested restricted shares was 238,000 (2010 — 56,000).

 

 


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MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 2. Stock-Based Compensation (continued)
Expense recognized for the three and nine month periods ended September 30, 2011 was €295 and €691, respectively (2010 — €60 and €83). As at September 30, 2011, the total remaining unrecognized compensation cost related to restricted shares amounted to approximately €1,642 (2010 — €148), which will be amortized over the remaining vesting periods.
Stock Options
During the three and nine month periods ended September 30, 2011 and 2010, no options were granted, exercised or cancelled, and nil and 15,000 options expired, respectively (2010 — nil and 738,334). The aggregate intrinsic value of options outstanding and currently exercisable as at September 30, 2011 was $0.28 per option.
Stock compensation expense recognized for stock options for the three and nine month periods ended September 30, 2011 was €nil (2010 — €nil). All stock options have fully vested.
Note 3. Net Income (Loss) Per Share Attributable to Common Shareholders
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2011     2010     2011     2010  
Net income (loss) attributable to common shareholders — basic
  8,440     46,135     51,876     50,990  
Interest on convertible notes, net of tax
    40       571       789       2,011  
 
                       
Net income (loss) attributable to common shareholders — diluted
  8,480     46,706     52,665     53,001  
 
                       
Net income (loss) per share attributable to common shareholders
                               
Basic
  0.15     1.17     1.07     1.36  
 
                       
Diluted
  0.15     0.82     0.92     0.93  
 
                       
Weighted average number of common shares outstanding:
                               
Basic(1)
    55,141,780       39,446,447       48,289,039       37,383,444  
Effect of dilutive instruments:
                               
Performance shares
    158,023       455,609       543,383       453,780  
Restricted shares
          7,220       65,917       15,232  
Stock options and awards
    46,953             69,602        
Convertible notes
    1,219,468       17,113,010       8,260,848       19,167,690  
 
                       
Diluted
    56,566,224       57,022,286       57,228,789       57,020,146  
 
                       
     
(1)  
The basic weighted average number of shares excludes performance shares and restricted shares which have been issued, but have not vested as at September 30, 2011 and 2010.
The calculation of diluted net income (loss) per share attributable to common shareholders does not assume the exercise of any instruments that would have an anti-dilutive effect on earnings per share.
Restricted shares excluded from the calculation of diluted income (loss) per share attributable to common shareholders because they are anti-dilutive represented 238,000 shares for the three month period ended September 30, 2011.
The diluted net income (loss) per share calculation for the three and nine month periods ended September 30, 2010 excluded 190,000 shares related to stock options, as the exercise price of these options was greater than their average market value, which would result in an anti-dilutive effect on diluted earnings per share.

 

 


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MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 4. Marketable Securities
The Company’s marketable securities at September 30, 2011 and December 31, 2010 are summarized as follows:
                                 
            Gross   Gross        
    Amortized     Unrealized   Unrealized     Fair  
September 30, 2011   Cost     Gains   Losses     Value  
Current
                             
0.5% German federal government bonds due June 2012
  2,008       (2 )   2,006  
0.75% German federal government bonds due September 2012
    2,010           (3 )     2,007  
 
                     
 
  4,018       (5 )   4,013  
 
                     
 
                             
Long-term
                             
Equity securities
  63     130   (15 )   178  
 
                     
                                 
            Gross     Gross        
    Amortized     Unrealized     Unrealized     Fair  
December 31, 2010   Cost     Gains     Losses     Value  
Long-term
                               
Equity securities
  63     213     (1 )   275  
 
                       
In order to maintain the Company’s liquidity requirements and manage risk while ensuring a reasonable return, the Company invests in low risk and highly liquid marketable securities that are classified as available-for-sale investments and accordingly carried at fair value.
The Company recognizes any gross unrealized gains or losses through the “Accumulated other comprehensive income (loss)” line, and records investments in long-term marketable securities within the “Deferred note issuance and other” line in the Interim Consolidated Balance Sheet.
As at September 30, 2011, the Company had invested in German federal government bonds, with contractual maturities of less than one year. These bonds are highly liquid and are considered low risk debt securities. The Company also had nominal amounts invested in equity securities.
The Company reviews for other-than-temporary losses on a regular basis and has considered the gross unrealized losses indicated above to be temporary in nature.

 

 


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MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 5. Inventories
                 
    September 30, 2011     December 31, 2010  
Raw materials
  41,023     47,179  
Finished goods
    55,334       27,127  
Work in process and other
    31,684       27,913  
 
           
 
  128,041     102,219  
 
           
Note 6. Debt
Debt consists of the following:
                 
    September 30, 2011     December 31, 2010  
Note payable to bank, included in a total loan credit facility of €827,950 to finance the construction related to the Stendal mill (a)
  477,490     500,657  
Senior notes due February 2013, interest at 9.25% accrued and payable semi-annually, unsecured (b)
          15,341  
Senior notes due December 2017, interest at 9.50% accrued and payable semi-annually, unsecured (c)
    219,818       224,031  
Subordinated convertible notes due January 2012, interest at 8.5% accrued and payable semi-annually (d)
          31,707  
Credit agreement with a lender with respect to a revolving credit facility of C$40 million (e)
          15,016  
Loan payable to the noncontrolling shareholder of the Stendal mill (f)
    32,684       31,365  
Credit agreement with a bank with respect to a revolving credit facility of €25,000 (g)
           
Investment loan agreement with a lender with respect to the wash press project at the Rosenthal mill of €4,351 (h)
    2,719       3,807  
Credit agreement with a bank with respect to a revolving credit facility of €3,500 (i)
           
 
           
 
    732,711       821,924  
Less: current portion
    (25,671 )     (39,596 )
 
           
Debt, less current portion
  707,040     782,328  
 
           
The Company made principal repayments under these facilities of €42,511 during the nine months ended September 30, 2011 (2010 — €14,461). As of September 30, 2011, the principal maturities of debt are as follows:
         
Matures   Amount  
 
     
2011
   
2012
    25,671  
2013
    41,088  
2014
    40,543  
2015
    44,000  
Thereafter
    581,409  
 
     
 
  732,711  
 
     

 

 


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MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 6. Debt (continued)
Certain of the Company’s debt instruments were issued under an indenture which, among other things, restricts Mercer Inc.’s ability and the ability of its restricted subsidiaries to make certain payments. These limitations are subject to other important qualifications and exceptions. As at September 30, 2011, the Company was in compliance with the terms of the indenture.
(a)  
Note payable to bank, included in a total loan facility of €827,950 to finance the construction related to the Stendal mill (“Stendal Loan Facility”), interest at rates varying from Euribor plus 0.90% to Euribor plus 1.69% (rates on amounts of borrowing at September 30, 2011 range from 2.65% to 3.55%), principal due in required installments beginning September 30, 2006 until September 30, 2017, collateralized by the assets of the Stendal mill, with 48% and 32% guaranteed by the Federal Republic of Germany and the State of Saxony-Anhalt, respectively, of up to €417,490 of outstanding principal, subject to a debt service reserve account (“DSRA”) required to pay amounts due in the following twelve months under the terms of the Stendal Loan Facility; payment of dividends is only permitted if certain cash flow requirements are met. See Note 7 — Derivative Transactions for a discussion of the Company’s variable-to-fixed interest rate swaps.
   
On March 13, 2009, the Company finalized an agreement with its lenders to amend its Stendal Loan Facility. The amendment deferred approximately €164,000 of scheduled principal payments until the maturity date, September 30, 2017. The amendment also provided for a 100% cash sweep, referred to as the “Cash Sweep”, of any cash, in excess of a €15,000 working capital reserve and the guarantee amount, as discussed in Note 11, held by Stendal which will be used first to fund the DSRA to a level sufficient to service the amounts due and payable under the Stendal Loan Facility during the then following 12 months, which means the DSRA is “Fully Funded”, and second to prepay the deferred principal amounts. As at September 30, 2011, the DSRA balance was approximately €28,400 and increased to approximately €31,700 in October 2011.
(b)  
In February 2005, the Company issued $310 million of senior notes due February 2013 (“2013 Notes”), which bore interest at 9.25%, accrued and payable semi-annually, and were unsecured.
   
On November 17, 2010, the Company used the proceeds from a private offering of $300 million senior notes due 2017, described in Note 6(c) below, and cash on hand to complete a tender offer to repurchase approximately $289 million aggregate principal amount of its 2013 Notes. Pursuant to the FASB’s Accounting Standards Codification No. 405, Liabilities — Extinguishment of Liabilities (“ASC 405-20”), the Company concluded that the tendering of the 2013 Notes met the definition of a debt extinguishment. In connection with this tender offer and pursuant to FASB’s Accounting Standards Codification No. 470-50, Debt-Modifications and Extinguishments (“ASC 470-50”), the Company recorded a loss of approximately €7,500 to the “Gain (loss) on extinguishment of debt” line in the Interim Consolidated Statement of Operations which included the tender premium paid and the write-off of unamortized debt issue costs.

 

 


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MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 6. Debt (continued)
   
On February 15, 2011, the Company redeemed for cash all of its outstanding 2013 Notes, for a price equal to 100% of the principal amount of $20.5 million, plus accrued and unpaid interest to, but not including February 15, 2011. In total, the Company paid approximately $21.5 million (€15,900) in connection with the redemption of the 2013 Notes.
(c)  
On November 17, 2010, the Company completed a private offering of $300 million in aggregate principal amount of senior notes due 2017 (“2017 Notes”). The proceeds from this offering were used to finance the tender offer and consent solicitation for approximately $289 million of the Company’s 2013 Notes (see Note 6(b)). The 2017 Notes were issued at a price of 100% of their principal amount. The 2017 Notes will mature on December 1, 2017 and bear interest at 9.50% which is accrued and payable semi-annually.
   
In August 2011, the Company’s Board of Directors authorized the purchase of up to $25.0 million of the Company’s 2017 Notes from time to time, over a period ending August 2012. During August 2011, the Company purchased approximately $4.4 million of its outstanding 2017 Notes, which in aggregate, were purchased at a nominal discount to the principal amount thereof, plus accrued and unpaid interest to, but not including the repurchase date. Pursuant to ASC 470-50, the Company recognized a loss of approximately €69 on the extinguishment of these notes, in the “Gain (loss) on extinguishment of debt” line in the Interim Consolidated Statement of Operations, mainly relating to the write-off of unamortized debt issuance costs. (See Note 12 — Subsequent Event).
   
The 2017 Notes are general unsecured senior obligations of the Company. The 2017 Notes rank equal in right of payment with all existing and future indebtedness of the Company and senior in right of payment to any current or future subordinated indebtedness of the Company. The 2017 Notes are effectively junior in right of payment to all borrowings of the Company’s restricted subsidiaries, including borrowings under the Company’s credit agreements which are secured by certain assets of its restricted subsidiaries.
   
The Company may redeem all or a part of the 2017 Notes, upon not less than 30 days or more than 60 days’ notice, at the redemption prices (expressed as percentages of principal amount) equal to 104.75% for the twelve-month period beginning on December 1, 2014, 102.38% for the twelve-month period beginning on December 1, 2015, and 100.00% beginning on December 1, 2016, and at any time thereafter, plus accrued and unpaid interest.

 

 


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MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 6. Debt (continued)
(d)  
In December 2009, the Company exchanged approximately $43.3 million of Subordinated Convertible Notes due October 2010 (the “2010 Notes”) through two private exchange agreements with the holders thereof for approximately $43.8 million of Subordinated Convertible Notes due January 2012 (the “2012 Notes”). On January 22, 2010, through an exchange offer with the remaining holders of the 2010 Notes, the Company exchanged a further $21.7 million of 2010 Notes for approximately $22.0 million of the Company’s 2012 Notes. The Company recognized both exchange transactions of the Subordinated Convertible Notes as extinguishments of debt in accordance with ASC 470-50, because the fair value of the embedded conversion option changed by more than 10% in both transactions. During 2010, the Company recognized a loss of €929 as a result of the January 22, 2010 exchange. The loss was determined using the fair market value prevailing at the time of the transaction, and yielded an effective interest rate of approximately 3% on the January 22, 2010 exchange.
   
The 2012 Notes bore interest at 8.50%, accrued and payable semi-annually, were convertible at any time by the holder into common shares of the Company at $3.30 per share and were unsecured. The Company could redeem for cash all or a portion of the 2012 Notes on or after July 15, 2011 at 100% of the principal amount plus accrued interest up to the redemption date. During the nine months ended September 30, 2011, approximately $44.4 million of 2012 Notes were converted into 13,446,679 common shares and the Company paid approximately $1.5 million of accrued and unpaid interest. Pursuant to the 2012 Notes indenture, on July 15, 2011, the nominal amount of remaining 2012 Notes were redeemed by the Company on July 15, 2011 at par plus accrued and unpaid interest to, but not including, July 15, 2011. In accordance with FASB’s Accounting Standards Codification No. 470-20, Debt — Debt with Conversions and Other Options (“ASC 470-20”), the Company recorded the carrying amount of the converted 2012 Notes, which included approximately €800 of unamortized discount, as an increase to share capital.
(e)  
Credit agreement with respect to a revolving credit facility of C$40.0 million for the Celgar mill. The credit agreement matures May 2013. Borrowings under the credit agreement are collateralized by the mill’s inventory and receivables and are restricted by a borrowing base calculated on the mill’s inventory and receivables. Canadian dollar denominated amounts bear interest at bankers acceptance plus 3.75% or Canadian prime plus 2.00%. U.S. dollar denominated amounts bear interest at LIBOR plus 3.75% or U.S. base plus 2.00%. The Company fully repaid this facility on March 30, 2011. As at September 30, 2011, approximately C$2.1 million of this facility was supporting letters of credit, leaving approximately C$37.9 million available.
(f)  
A loan payable by the Stendal mill to its noncontrolling shareholder bears interest at 7.00%, and is accrued semi-annually. The loan payable is unsecured, subordinated to all liabilities of the Stendal mill, non-recourse to the Company and its restricted subsidiaries, and is due in 2017. The balance includes principal and accrued interest. During the first quarter of 2010, the noncontrolling shareholder converted €6,275 of accrued interest into a capital contribution.
(g)  
A €25,000 working capital facility at the Rosenthal mill that matures in December 2012. Borrowings under the facility are collateralized by the mill’s inventory and receivables and bear interest at Euribor plus 3.50%. As at September 30, 2011, approximately €2,200 of this facility was supporting bank guarantees leaving approximately €22,800 available.

 

 


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MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 6. Debt (continued)
(h)  
A four-year amortizing investment loan agreement with a lender relating to the new wash press at the Rosenthal mill with a total facility of €4,351 bearing interest at the rate of Euribor plus 2.75% that matures August 2013. Borrowings under this agreement are secured by the new wash press equipment. As at September 30, 2011, this facility was drawn by €2,719 and was accruing interest at a rate of 4.57%.
(i)  
On February 8, 2010 the Rosenthal mill finalized a credit agreement with a lender for a €3,500 facility maturing in December 2012. Borrowings under this facility bear interest at the rate of the 3-month Euribor plus 3.50% and are secured by certain land at the Rosenthal mill. As at September 30, 2011, this facility was undrawn.
Note 7. Derivative Transactions
The Company is exposed to certain market risks relating to its ongoing business. The Company seeks to manage these risks through internal risk management policies as well as, from time to time, the use of derivatives. Currently, the only risk managed using derivative instruments is interest rate risk.
During 2004, the Company entered into certain variable-to-fixed interest rate swaps in connection with the Stendal Loan Facility with respect to an aggregate maximum principal amount of approximately €612,600 of the total indebtedness under the Stendal Loan Facility. Under the remaining interest rate swap, the Company pays a fixed rate and receives a floating rate with the interest payments being calculated on a notional amount. Currently, the contract has an aggregate notional amount of €426,518 at a fixed interest rate of 5.28% and it matures October 2017 (generally matching the maturity of the Stendal Loan Facility). The Company substantially converted the Stendal Loan Facility from a variable interest rate loan into a fixed interest rate loan, thereby reducing interest rate uncertainty.
The Company recognized an unrealized loss of €10,484 and a loss of €580 on the interest rate swap for the three and nine months ended September 30, 2011, respectively (2010 — a gain of €485 and loss of €10,523), in the “Gain (loss) on derivative instruments” line in the Interim Consolidated Statements of Operations and Interim Consolidated Statements of Cash Flows. Derivative instruments are required to be measured at their fair value. Accordingly, the fair value of the interest rate swap is presented in the “Unrealized interest rate derivative losses” line in the Interim Consolidated Balance Sheets, which currently amounts to a cumulative unrealized loss of €51,553 (2010 — €50,973).
The interest rate derivative contract is with the same bank that holds the Stendal Loan Facility and the Company does not anticipate non-performance by the bank.

 

 


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MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 8. Pension and Other Post-Retirement Benefit Obligations
Included in pension and other post-retirement benefit obligations are amounts related to the Company’s Celgar and Rosenthal mills. The largest component of this obligation is with respect to the Celgar mill which maintains a defined benefit pension plan and post-retirement benefit plans for certain employees (“Celgar Plans”).
Pension benefits are based on employees’ earnings and years of service. The Celgar Plans are funded by contributions from the Company based on actuarial estimates and statutory requirements. Pension contributions during the three and nine month periods ended September 30, 2011 totaled €534 and €1,429, respectively (2010 — €280 and €677).
Effective December 31, 2008, the defined benefit plan was closed to new members. In addition, the defined benefit service accrual ceased on December 31, 2008, and members began to receive pension benefits, at a fixed contractual rate, under a new defined contribution plan effective January 1, 2009.
                                 
    Three Months Ended September 30,  
    2011     2010  
            Post-             Post-  
    Pension     Retirement     Pension     Retirement  
    Benefits     Benefits     Benefits     Benefits  
 
                               
Service cost
  22     117     21     100  
Interest cost
    376       203       425       196  
Expected return on plan assets
    (385 )           (398 )      
Recognized net loss (gain)
    127       (17 )     111       (79 )
 
                       
Net periodic benefit cost
  140     303     159     217  
 
                       
                                 
    Nine Months Ended September 30,  
    2011     2010  
            Post-             Post-  
    Pension     Retirement     Pension     Retirement  
    Benefits     Benefits     Benefits     Benefits  
 
                               
Service cost
  65     352     61     294  
Interest cost
    1,134       612       1,257       580  
Expected return on plan assets
    (1,163 )           (1,175 )      
Recognized net loss (gain)
    383       (52 )     329       (233 )
 
                       
Net periodic benefit cost
  419     912     472     641  
 
                       

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 9. Share Capital
Common shares
The Company has authorized 200,000,000 common shares (2010 — 200,000,000) with a par value of $1 per share.
During the nine months ended September 30, 2011, 13,446,679 common shares were issued as a result of certain holders of the 2012 Notes exercising their conversion option (see Note 6(d) — Debt). In addition, 358,268 shares were issued to employees of the Company as part of the stock based performance awards and 238,000 restricted shares were issued to the Chief Executive Officer and directors of the Company.
During the three months ended September 30, 2011, the Company repurchased and retired 1,263,401 common shares. These retired shares are now included in the Company’s pool of authorized but unissued common shares.
As at September 30, 2011 and December 31, 2010, the Company had 55,779,204 and 42,999,658 common shares issued and outstanding, respectively.
Share Repurchase Program
In August 2011, the Company’s Board of Directors authorized a share and debt repurchase program (the “Program”) to repurchase up to $25.0 million worth of the Company’s outstanding common shares and up to $25.0 million in aggregate principal amount of the Company’s 2017 Notes from time to time over a period ending August 2012. During the three months ended September 30, 2011, the Company repurchased 1,263,401 of its common shares at an aggregate cost of approximately $10.6 million. The Company recorded these as treasury shares, and accounted for the repurchase using the Cost Method as outlined in FASB’s Accounting Standards Codification No. 505-30, Equity —Treasury Stock (“ASC 505-30”).
The Company retired all such purchased shares prior to September 30, 2011. The retired shares had a carrying value of approximately €6,342. Upon the formal retirement of such shares and in accordance with ASC 505-30, the Company reduced its share capital based on the average cost of the common shares and reduced the treasury share account based on the repurchase price. The difference between the repurchase price and the original issue value was recorded as a reduction to retained earnings.
The Company may make additional repurchases of common shares under its Program, depending on prevailing market conditions, alternate uses of capital, and other factors. Whether and when to initiate a purchase of common shares and the amount of common shares purchased is at the Company’s discretion. As at September 30, 2011, the Company has an authorized amount of approximately $14.4 million left to repurchase its common shares, and has no treasury shares outstanding.

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 9. Share Capital (continued)
Preferred shares
The Company has authorized 50,000,000 preferred shares (2010 — 50,000,000) with $1 par value issuable in series, of which 2,000,000 shares have been designated as Series A. The preferred shares may be issued in one or more series and with such designations and preferences for each series as shall be stated in the resolutions providing for the designation and issue of each such series adopted by the Board of Directors of the Company. The Board of Directors is authorized by the Company’s articles of incorporation to determine the voting, dividend, redemption and liquidation preferences pertaining to each such series. As at September 30, 2011, no preferred shares had been issued by the Company.
Note 10. Financial Instruments
The fair value of financial instruments at September 30, 2011 and December 31, 2010 is summarized as follows:
                                 
    September 30, 2011     December 31, 2010  
    Carrying     Fair     Carrying     Fair  
    Amount     Value     Amount     Value  
 
                               
Cash and cash equivalents
  127,758     127,758     99,022     99,022  
Marketable securities
    4,191       4,191       275       275  
Receivables
    110,296       110,296       121,709       121,709  
Note receivable
                2,978       2,978  
Accounts payable and accrued expenses
    109,845       109,845       84,873       84,873  
Debt
    732,711       707,620       821,924       847,875  
Interest rate derivative contract liability
    51,553       51,553       50,973       50,973  
The carrying value of cash and cash equivalents, notes receivable and accounts payable and accrued expenses approximates the fair value due to the immediate or short-term maturity of these financial instruments. The carrying value of receivables approximates the fair value due to their short-term nature and historical collectability. The fair value of debt reflects recent market transactions and discounted cash flow estimates. The fair value of the interest rate derivative is calculated by discounting the future interest rate payments using a yield curve derived by a recognized financial institution. Marketable securities are recorded at fair value based on recent transactions.

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 10. Financial Instruments (continued)
The fair value methodologies and, as a result, the fair value of the Company’s investments and derivative instruments are determined based on the fair value hierarchy provided in FASB’s Accounting Standards Codification No. 820, Fair Value Measurements (“ASC 820”). The fair value hierarchy per ASC 820 is as follows:
Level 1 — Valuations based on quoted prices in active markets for identical assets and liabilities.
Level 2 — Valuations based on observable inputs in active markets for similar assets and liabilities, other than Level 1 prices, such as quoted interest or currency exchange rates.
Level 3 — Valuations based on significant unobservable inputs that are supported by little or no market activity, such as discounted cash flow methodologies based on internal cash flow forecasts.
The Company classified its marketable securities within Level 1 of the valuation hierarchy where quoted prices are available in an active market. Level 1 investments include exchange-traded equities and German federal government bonds. The Company classified the German federal government bonds as available for sale as it is not certain these investments will be held until maturity, nor does the Company intend to actually trade these investments.
The Company’s derivatives are classified within Level 2 of the valuation hierarchy, as they are traded on the over-the-counter market and are valued using internal models that use as their basis readily observable market inputs, such as forward interest rates.

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 10. Financial Instruments (continued)
The valuation techniques used by the Company are based upon observable inputs. Observable inputs reflect market data obtained from independent sources. In addition, the Company considered the risk of non-performance of the obligor, which in some cases reflects the Company’s own credit risk, in determining the fair value of the derivative instruments. The counterparty to our interest rate swap derivative is a multi-national financial institution.
The following table presents a summary of the Company’s outstanding financial instruments and their estimated fair values under the hierarchy defined in ASC 820:
                                 
    Fair value measurements at September 30, 2011 using:  
    Quoted prices                    
    in active markets     Significant other     Significant        
    for identical assets     observable inputs     unobservable inputs        
Description   (Level 1)     (Level 2)     (Level 3)     Total  
 
               
Assets
                               
Marketable securities (a)
                               
German federal government bonds
  4,013             4,013  
Exchange traded equities
    178                   178  
 
                       
Total
  4,191             4,191  
 
                       
 
                               
Liabilities
                               
Derivatives (b)
                               
Interest rate swap
      51,553         51,553  
 
                       
     
(a)  
Based on observable market data.
 
(b)  
Based on observable inputs for the liability (yield curves observable at specific intervals).
Note 11. Commitments and Contingencies
The Company is involved in certain legal actions and claims arising in the ordinary course of business. While the outcome of these legal actions and claims cannot be predicted with certainty, it is the opinion of management that the outcome of any such claim which is pending or threatened, either individually or on a combined basis, will not have a material adverse effect on the consolidated financial condition, results of operations or liquidity of the Company.

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 11. Commitments and Contingencies (continued)
Pursuant to an arbitration proceeding with the general construction contractor of the Stendal mill regarding certain warranty claims, the Company acted upon a bank guarantee for defect liability on civil works that was about to expire as provided in the engineering, procurement, and construction contract. On January 28, 2011, the Company received approximately €10,000 (the “Guarantee Amount”), which is intended to compensate the Company for remediation work that is required at the Stendal mill, but it is less than the amount claimed by the Company under the arbitration. The Guarantee Amount was recognized as an increase in cash, and a corresponding increase in accounts payable. Since receiving the €10,000 Guarantee Amount, the Company has recorded approximately €1,400 of costs for remediation work at the Stendal mill, which leaves approximately €8,600 remaining for future remediation work. As the arbitration proceeding remains ongoing, there is no certainty that the Company will be successful with its claims or whether the costs recorded to date will qualify as eligible expenditures.
Note 12. Subsequent Event
In October 2011, the Company purchased approximately $9.3 million of the outstanding 2017 Notes, at a nominal discount to the principal amount thereof, plus accrued and unpaid interest to, but not including the repurchase date.

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 13. Restricted Group Supplemental Disclosure
The terms of the indenture governing our 9.5% senior unsecured notes require that we provide the results of operations and financial condition of Mercer International Inc. and our restricted subsidiaries under the indenture, collectively referred to as the “Restricted Group”. As at and during the three and nine months ended September 30, 2011 and 2010, the Restricted Group was comprised of Mercer International Inc., certain holding subsidiaries and our Rosenthal and Celgar mills. The Restricted Group excludes the Stendal mill.
Combined Condensed Balance Sheets
                                 
    September 30, 2011  
    Restricted     Unrestricted             Consolidated  
    Group     Subsidiaries     Eliminations     Group  
ASSETS
                               
Current assets
                               
Cash and cash equivalents
  60,426     67,332         127,758  
Marketable securities
    4,013                   4,013  
Receivables
    60,639       49,657             110,296  
Inventories
    71,404       56,637             128,041  
Prepaid expenses and other
    6,309       3,598             9,907  
Deferred income tax
    24,951                   24,951  
 
                       
Total current assets
    227,742       177,224             404,966  
 
                               
Long-term assets
                               
Property, plant and equipment
    345,077       470,650             815,727  
Deferred note issuance and other
    6,229       3,714             9,943  
Due from unrestricted group
    86,623             (86,623 )      
 
                       
Total assets
  665,671     651,588     (86,623 )   1,230,636  
 
                       
 
                               
LIABILITIES
                               
Current liabilities
                               
Accounts payable and accrued expenses
  56,258     53,587         109,845  
Pension and other post-retirement benefit obligations
    694                   694  
Debt
    1,088       24,583             25,671  
 
                       
Total current liabilities
    58,040       78,170             136,210  
 
                               
Long-term liabilities
                               
Debt
    221,449       485,591             707,040  
Due to restricted group
          86,623       (86,623 )      
Unrealized interest rate derivative losses
          51,553             51,553  
Pension and other post-retirement benefit obligations
    23,010                   23,010  
Capital leases and other
    6,557       5,300             11,857  
Deferred income tax
    14,413                   14,413  
 
                       
Total liabilities
    323,469       707,237       (86,623 )     944,083  
 
                       
 
                               
EQUITY
                               
Total shareholders’ equity (deficit)
    342,202       (38,320 )           303,882  
Noncontrolling interest (deficit)
          (17,329 )           (17,329 )
 
                       
Total liabilities and equity
  665,671     651,588     (86,623 )   1,230,636  
 
                       

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 13. Restricted Group Supplemental Disclosure (continued)
Combined Condensed Balance Sheets
                                 
    December 31, 2010  
    Restricted     Unrestricted             Consolidated  
    Group     Subsidiaries     Eliminations     Group  
ASSETS
                               
Current assets
                               
Cash and cash equivalents
  50,654     48,368         99,022  
Receivables
    70,865       50,844             121,709  
Inventories
    60,910       41,309             102,219  
Prepaid expenses and other
    6,840       4,520             11,360  
Deferred income tax
    22,570                   22,570  
 
                       
Total current assets
    211,839       145,041             356,880  
 
                               
Long-term assets
                               
Property, plant and equipment
    362,274       484,493             846,767  
Deferred note issuance and other
    6,903       4,179             11,082  
Due from unrestricted group
    80,582             (80,582 )      
Note receivable
    1,346                   1,346  
 
                       
Total assets
  662,944     633,713     (80,582 )   1,216,075  
 
                       
 
                               
LIABILITIES
                               
Current liabilities
                               
Accounts payable and accrued expenses
  44,015     40,858         84,873  
Pension and other post-retirement benefit obligations
    728                   728  
Debt
    16,429       23,167             39,596  
 
                       
Total current liabilities
    61,172       64,025             125,197  
 
                               
Long-term liabilities
                               
Debt
    273,473       508,855             782,328  
Due to restricted group
          80,582       (80,582 )      
Unrealized interest rate derivative losses
          50,973             50,973  
Pension and other post-retirement benefit obligations
    24,236                   24,236  
Capital leases and other
    7,154       4,856             12,010  
Deferred income tax
    7,768                   7,768  
 
                       
Total liabilities
    373,803       709,291       (80,582 )     1,002,512  
 
                       
 
                               
EQUITY
                               
Total shareholders’ equity (deficit)
    289,141       (53,073 )           236,068  
Noncontrolling interest (deficit)
          (22,505 )           (22,505 )
 
                       
Total liabilities and equity
  662,944     633,713     (80,582 )   1,216,075  
 
                       

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 13. Restricted Group Supplemental Disclosure (continued)
Combined Condensed Statements of Operations
                                 
    Three Months Ended September 30, 2011  
    Restricted     Unrestricted             Consolidated  
    Group     Subsidiaries     Eliminations     Group  
 
                               
Revenues
                               
Pulp
  111,634     78,792         190,426  
Energy
    6,121       8,231             14,352  
 
                       
 
    117,755       87,023             204,778  
 
                       
 
                               
Operating costs
    85,962       60,923             146,885  
Operating depreciation and amortization
    7,364       6,468             13,832  
Selling, general and administrative expenses and other
    6,080       2,674             8,754  
 
                       
 
    99,406       70,065             169,471  
 
                       
Operating income (loss)
    18,349       16,958             35,307  
 
                       
 
                               
Other income (expense)
                               
Interest expense
    (5,496 )     (9,869 )     1,248       (14,117 )
Investment income (loss)
    1,334       184       (1,248 )     270  
Foreign exchange gain (loss) on debt
    (181 )                 (181 )
Gain (loss) on extinguishment of debt
    (69 )                 (69 )
Gain (loss) on derivative instruments
          (10,484 )           (10,484 )
 
                       
Total other income (expense)
    (4,412 )     (20,169 )           (24,581 )
 
                       
Income (loss) before income taxes
    13,937       (3,211 )           10,726  
Income tax benefit (provision)
    (2,566 )     (558 )           (3,124 )
 
                       
Net income (loss)
    11,371       (3,769 )           7,602  
Less: net loss (income) attributable to noncontrolling interest
          838             838  
 
                       
Net income (loss) attributable to common shareholders
  11,371     (2,931 )       8,440  
 
                       
                                 
    Three Months Ended September 30, 2010  
    Restricted     Unrestricted             Consolidated  
    Group     Subsidiaries     Eliminations     Group  
 
                               
Revenues
                               
Pulp
  123,518     101,179         224,697  
Energy
    1,535       8,186             9,721  
 
                       
 
    125,053       109,365             234,418  
 
                       
 
                               
Operating costs
    91,528       70,765             162,293  
Operating depreciation and amortization
    7,514       6,473             13,987  
Selling, general and administrative expenses and other
    3,221       3,506             6,727  
 
                       
 
    102,263       80,744             183,007  
 
                       
Operating income (loss)
    22,790       28,621             51,411  
 
                       
 
                               
Other income (expense)
                               
Interest expense
    (8,796 )     (10,213 )     1,189       (17,820 )
Investment income (loss)
    1,246       36       (1,189 )     93  
Foreign exchange gain (loss) on debt
    9,927                   9,927  
Gain (loss) on derivative instruments
          485             485  
 
                       
Total other income (expense)
    2,377       (9,692 )           (7,315 )
 
                       
Income (loss) before income taxes
    25,167       18,929             44,096  
Income tax benefit (provision)
    8,849       (1,694 )           7,155  
 
                       
Net income (loss)
    34,016       17,235             51,251  
Less: net loss (income) attributable to noncontrolling interest
          (5,116 )           (5,116 )
 
                       
Net income (loss) attributable to common shareholders
  34,016     12,119         46,135  
 
                       

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 13. Restricted Group Supplemental Disclosure (continued)
Combined Condensed Statements of Operations
                                 
    Nine Months Ended September 30, 2011  
    Restricted     Unrestricted             Consolidated  
    Group     Subsidiaries     Eliminations     Group  
 
                               
Revenues
                               
Pulp
  352,098     266,060         618,158  
Energy
    17,668       24,302             41,970  
 
                       
 
    369,766       290,362             660,128  
 
                       
 
                               
Operating costs
    272,162       210,613             482,775  
Operating depreciation and amortization
    22,379       19,398             41,777  
Selling, general and administrative expenses and other
    17,572       9,842             27,414  
 
                       
 
    312,113       239,853             551,966  
 
                       
Operating income (loss)
    57,653       50,509             108,162  
 
                       
 
                               
Other income (expense)
                               
Interest expense
    (19,202 )     (29,404 )     3,700       (44,906 )
Investment income (loss)
    3,918       515       (3,700 )     733  
Foreign exchange gain (loss) on debt
    1,272                   1,272  
Gain (loss) on extinguishment of debt
    (69 )                 (69 )
Gain (loss) on derivative instruments
          (580 )           (580 )
 
                       
Total other income (expense)
    (14,081 )     (29,469 )           (43,550 )
 
                       
Income (loss) before income taxes
    43,572       21,040             64,612  
Income tax benefit (provision)
    (5,941 )     (1,620 )           (7,561 )
 
                       
Net income (loss)
    37,631       19,420             57,051  
Less: net loss (income) attributable to noncontrolling interest
          (5,175 )           (5,175 )
 
                       
Net income (loss) attributable to common shareholders
  37,631     14,245         51,876  
 
                       
                                 
    Nine Months Ended September 30, 2010  
    Restricted     Unrestricted             Consolidated  
    Group     Subsidiaries     Eliminations     Group  
 
                               
Revenues
                               
Pulp
  354,775     269,336         624,111  
Energy
    8,750       22,033             30,783  
 
                       
 
    363,525       291,369             654,894  
 
                       
 
                               
Operating costs
    269,063       201,914             470,977  
Operating depreciation and amortization
    22,355       19,462             41,817  
Selling, general and administrative expenses and other
    14,792       9,985             24,777  
 
                       
 
    306,210       231,361             537,571  
 
                       
Operating income (loss)
    57,315       60,008             117,323  
 
                       
 
                               
Other income (expense)
                               
Interest expense
    (24,073 )     (30,593 )     3,525       (51,141 )
Investment income (loss)
    3,770       59       (3,525 )     304  
Foreign exchange gain (loss) on debt
    (4,675 )                 (4,675 )
Gain (loss) on extinguishment of debt
    (929 )                 (929 )
Gain (loss) on derivative instruments
          (10,523 )           (10,523 )
 
                       
Total other income (expense)
    (25,907 )     (41,057 )           (66,964 )
 
                       
Income (loss) before income taxes
    31,408       18,951             50,359  
Income tax benefit (provision)
    8,354       (2,722 )           5,632  
 
                       
Net income (loss)
    39,762       16,229             55,991  
Less: net loss (income) attributable to noncontrolling interest
          (5,001 )           (5,001 )
 
                       
Net income (loss) attributable to common shareholders
  39,762     11,228         50,990  
 
                       

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 13. Restricted Group Supplemental Disclosure (continued)
Combined Condensed Statements of Cash Flows
                         
    Three Months Ended September 30, 2011  
    Restricted     Unrestricted     Consolidated  
    Group     Group     Group  
Cash flows from (used in) operating activities
                       
Net income (loss) attributable to common shareholders
  11,371     (2,931 )   8,440  
Adjustments to reconcile net income (loss) attributable to common shareholders to cash flows from operating activities
                       
Loss (gain) on derivative instruments
          10,484       10,484  
Foreign exchange loss (gain) on debt
    181             181  
Loss (gain) on extinguishment of debt
    69             69  
Depreciation and amortization
    7,425       6,468       13,893  
Accretion expense (income)
    (168 )           (168 )
Noncontrolling interest
          (838 )     (838 )
Deferred income taxes
    1,567             1,567  
Stock compensation expense
    305             305  
Pension and other post-retirement expense, net of funding
    (95 )           (95 )
Other
    209       150       359  
Changes in current assets and liabilities
                       
Receivables
    (12,224 )     2,772       (9,452 )
Inventories
    (14,899 )     (8,877 )     (23,776 )
Accounts payable and accrued expenses
    (1,704 )     2,022       318  
Other(1)
    (4,020 )     3,268       (752 )
 
                 
Net cash from (used in) operating activities
    (11,983 )     12,518       535  
 
                 
 
                       
Cash flows from (used in) investing activities
                       
Purchase of property, plant and equipment
    (7,859 )     (2,438 )     (10,297 )
Proceeds on sale of property, plant and equipment
    76       1,488       1,564  
Note receivable
    2,064             2,064  
Purchase of marketable securities
    (4,018 )           (4,018 )
 
                 
Net cash from (used in) investing activities
    (9,737 )     (950 )     (10,687 )
 
                 
 
                       
Cash flows from (used in) financing activities
                       
Repayment of notes payable and debt
    (3,576 )     (8,584 )     (12,160 )
Repayment of capital lease obligations
    (270 )     (506 )     (776 )
Proceeds from government grants
    4,470             4,470  
Purchase of treasury shares
    (7,477 )           (7,477 )
 
                 
Net cash from (used in) financing activities
    (6,853 )     (9,090 )     (15,943 )
 
                 
 
                       
Effect of exchange rate changes on cash and cash equivalents
    2,058             2,058  
 
                 
 
                       
Net increase (decrease) in cash and cash equivalents
    (26,515 )     2,478       (24,037 )
Cash and cash equivalents, beginning of period
    86,941       64,854       151,795  
 
                 
Cash and cash equivalents, end of period
  60,426     67,332     127,758  
 
                 
 
     
(1)  
Includes intercompany working capital related transactions.

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 13. Restricted Group Supplemental Disclosure (continued)
Combined Condensed Statements of Cash Flows
                         
    Three Months Ended September 30, 2010  
    Restricted     Unrestricted     Consolidated  
    Group     Group     Group  
Cash flows from (used in) operating activities
                       
Net income (loss) attributable to common shareholders
  34,016     12,119     46,135  
Adjustments to reconcile net income (loss) attributable to common shareholders to cash flows from operating activities
                       
Loss (gain) on derivative instruments
          (485 )     (485 )
Foreign exchange loss (gain) on debt
    (9,927 )           (9,927 )
Depreciation and amortization
    7,582       6,473       14,055  
Accretion expense (income)
    1,111             1,111  
Noncontrolling interest
          5,116       5,116  
Deferred income taxes
    (9,382 )           (9,382 )
Stock compensation expense
    540             540  
Pension and other post-retirement expense, net of funding
    96             96  
Other
    286       703       989  
Changes in current assets and liabilities
                       
Receivables
    13,790       5,801       19,591  
Inventories
    (13,209 )     (12,796 )     (26,005 )
Accounts payable and accrued expenses
    (2,127 )     3,941       1,814  
Other(1)
    (4,242 )     (641 )     (4,883 )
 
                 
Net cash from (used in) operating activities
    18,534       20,231       38,765  
 
                 
 
                       
Cash flows from (used in) investing activities
                       
Purchase of property, plant and equipment
    (8,392 )     (92 )     (8,484 )
Proceeds on sale of property, plant and equipment
    27       1       28  
Notes receivable
    216             216  
 
                 
Net cash from (used in) investing activities
    (8,149 )     (91 )     (8,240 )
 
                 
 
                       
Cash flows from (used in) financing activities
                       
Repayment of notes payable and debt
    (544 )     (5,667 )     (6,211 )
Repayment of capital lease obligations
    (220 )     (418 )     (638 )
Proceeds from (repayment of) credit facilities, net
    (4,057 )           (4,057 )
Proceeds from government grants
    6,778             6,778  
 
                 
Net cash from (used in) financing activities
    1,957       (6,085 )     (4,128 )
 
                 
 
                       
Effect of exchange rate changes on cash and cash equivalents
    (3,416 )           (3,416 )
 
                 
 
                       
Net increase (decrease) in cash and cash equivalents
    8,926       14,055       22,981  
Cash and cash equivalents, beginning of period
    39,485       22,660       62,145  
 
                 
Cash and cash equivalents, end of period
  48,411     36,715     85,126  
 
                 
 
     
(1)  
Includes intercompany working capital related transactions.

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 13. Restricted Group Supplemental Disclosure (continued)
Combined Condensed Statements of Cash Flows
                         
    Nine Months Ended September 30, 2011  
    Restricted     Unrestricted     Consolidated  
    Group     Group     Group  
Cash flows from (used in) operating activities
                       
Net income (loss) attributable to common shareholders
  37,631     14,245     51,876  
Adjustments to reconcile net income (loss) attributable to common shareholders to cash flows from operating activities
                       
Loss (gain) on derivative instruments
          580       580  
Foreign exchange loss (gain) on debt
    (1,272 )           (1,272 )
Loss (gain) on extinguishment of debt
    69             69  
Depreciation and amortization
    22,562       19,398       41,960  
Accretion expense (income)
    591             591  
Noncontrolling interest
          5,175       5,175  
Deferred income taxes
    3,707             3,707  
Stock compensation expense
    2,844             2,844  
Pension and other post-retirement expense, net of funding
    (102 )           (102 )
Other
    574       1,388       1,962  
Changes in current assets and liabilities
                       
Receivables
    2,007       1,241       3,248  
Inventories
    (12,534 )     (15,328 )     (27,862 )
Accounts payable and accrued expenses
    11,979       12,894       24,873  
Other(1)
    (7,889 )     7,981       92  
 
                 
Net cash from (used in) operating activities
    60,167       47,574       107,741  
 
                 
 
                       
Cash flows from (used in) investing activities
                       
Purchase of property, plant and equipment
    (19,860 )     (6,262 )     (26,122 )
Proceeds on sale of property, plant and equipment
    95       1,849       1,944  
Note receivable
    2,835             2,835  
Purchase of marketable securities
    (4,018 )           (4,018 )
 
                 
Net cash from (used in) investing activities
    (20,948 )     (4,413 )     (25,361 )
 
                 
 
                       
Cash flows from (used in) financing activities
                       
Repayment of notes payable and debt
    (19,344 )     (23,167 )     (42,511 )
Repayment of capital lease obligations
    (1,131 )     (1,138 )     (2,269 )
Proceeds from (repayment of) credit facilities, net
    (14,652 )           (14,652 )
Proceeds from government grants
    13,311       108       13,419  
Purchase of treasury shares
    (7,477 )           (7,477 )
 
                 
Net cash from (used in) financing activities
    (29,293 )     (24,197 )     (53,490 )
 
                 
 
                       
Effect of exchange rate changes on cash and cash equivalents
    (154 )           (154 )
 
                 
 
                       
Net increase (decrease) in cash and cash equivalents
    9,772       18,964       28,736  
Cash and cash equivalents, beginning of period
    50,654       48,368       99,022  
 
                 
Cash and cash equivalents, end of period
  60,426     67,332     127,758  
 
                 
 
     
(1)  
Includes intercompany working capital related transactions.

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 13. Restricted Group Supplemental Disclosure (continued)
Combined Condensed Statement of Cash Flows
                         
    Nine Months Ended September 30, 2010  
    Restricted     Unrestricted     Consolidated  
    Group     Group     Group  
Cash flows from (used in) operating activities
                       
Net income (loss) attributable to common shareholders
  39,762     11,228     50,990  
Adjustments to reconcile net income (loss) attributable to common shareholders to cash flows from operating activities
                       
Loss (gain) on derivative instruments
          10,523       10,523  
Foreign exchange loss (gain) on debt
    4,675             4,675  
Loss (gain) on extinguishment of debt
    929             929  
Depreciation and amortization
    22,590       19,462       42,052  
Accretion expense (income)
    2,056             2,056  
Noncontrolling interest
          5,001       5,001  
Deferred income taxes
    (9,382 )           (9,382 )
Stock compensation expense
    1,273             1,273  
Pension and other post-retirement expense, net of funding
    428             428  
Other
    856       1,980       2,836  
Changes in current assets and liabilities
                       
Receivables
    (12,778 )     (13,573 )     (26,351 )
Inventories
    (12,592 )     (24,396 )     (36,988 )
Accounts payable and accrued expenses
    5,595       9,551       15,146  
Other(1)
    (8,040 )     2,563       (5,477 )
 
                 
Net cash from (used in) operating activities
    35,372       22,339       57,711  
 
                 
 
                       
Cash flows from (used in) investing activities
                       
Purchase of property, plant and equipment
    (27,467 )     (1,409 )     (28,876 )
Proceeds on sale of property, plant and equipment
    90       487       577  
Note receivable
    711             711  
 
                 
Net cash from (used in) investing activities
    (26,666 )     (922 )     (27,588 )
 
                 
 
                       
Cash flows from (used in) financing activities
                       
Repayment of notes payable and debt
    (544 )     (13,917 )     (14,461 )
Repayment of capital lease obligations
    (804 )     (1,441 )     (2,245 )
Proceeds from borrowings of notes payable and debt
    840             840  
Proceeds from (repayment of) credit facilities, net
    1,493             1,493  
Proceeds from government grants
    17,337             17,337  
 
                 
Net cash from (used in) financing activities
    18,322       (15,358 )     2,964  
 
                 
 
                       
Effect of exchange rate changes on cash and cash equivalents
    748             748  
 
                 
 
                       
Net increase (decrease) in cash and cash equivalents
    27,776       6,059       33,835  
Cash and cash equivalents, beginning of period
    20,635       30,656       51,291  
 
                 
Cash and cash equivalents, end of period
  48,411     36,715     85,126  
 
                 
 
     
(1)  
Includes intercompany working capital related transactions.

 

 


Table of Contents

ITEM 2.  
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In this document: (i) unless the context otherwise requires, references to “we”, “our”, “us”, the “Company” or “Mercer” mean Mercer International Inc. and its subsidiaries; (ii) references to “Mercer Inc.” mean the Company excluding its subsidiaries; (iii) information is provided as of September 30, 2011, unless otherwise stated; (iv) all references to monetary amounts are to “Euros”, the lawful currency adopted by most members of the European Union, unless otherwise stated; (v) “€” refers to Euros, “$” refers to U.S. dollars and “C$” refers to Canadian dollars; (vi) “ADMTs” refers to air-dried metric tonnes; (vii) “MW” refers to megawatts and (viii) “MWh” refers to megawatt hours.
Results of Operations
General
We operate three northern bleached softwood kraft (“NBSK”) pulp mills through our wholly owned subsidiaries, Rosenthal and Celgar, and our 74.9% owned subsidiary, Stendal, which have a consolidated annual production capacity of approximately 1.5 million ADMTs.
The following discussion and analysis of our results of operations and financial condition for the three and nine months ended September 30, 2011 should be read in conjunction with our interim consolidated financial statements and related notes included in this quarterly report, as well as our most recent annual report on Form 10-K for the fiscal year ended December 31, 2010 filed with the Securities and Exchange Commission (the “SEC”).
Current Market Environment
Although uncertainties concerning the economic situation in Europe and credit tightening in China have caused pulp prices to come off their record levels from earlier this year, NBSK list prices remained generally strong in the third quarter. While we currently anticipate further downward price pressure in the fourth quarter, the recent strengthening of the U.S. dollar against both the Euro and the Canadian dollar is helping to partially offset such decreases.

 

 


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Third Quarter Operational Snapshot
Selected production, sales and exchange rate data for the three and nine months ended September 30, 2011 and 2010 is as follows:
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2011     2010     2011     2010  
Pulp Production (‘000 ADMTs)
    362.3       380.9       1,088.8       1,070.0  
Scheduled Production Downtime (‘000 ADMTs)
    8.3       8.3       24.5       43.5  
Pulp Sales (‘000 ADMTs)
    321.3       344.8       1,027.9       1,042.6  
Pulp Revenues (in millions)
  190.4     224.7     618.2     624.1  
Average NBSK pulp list prices in Europe ($/ADMT)
  $ 980     $ 980     $ 986     $ 932  
Average NBSK pulp list prices in Europe (€/ADMT)
  694     758     701     708  
Average pulp sales realizations (€/ADMT)(1)
  584     642     592     590  
 
                               
Energy Production (‘000 MWh)
    402.5       330.8       1,230.9       1,051.1  
Energy Sales (‘000 MWh)
    149.3       119.1       483.1       370.3  
Energy Revenue (in millions)
  14.4     9.7     42.0     30.8  
Average energy sales realizations (€/MWh)
  96     82     87     83  
 
                               
Average Spot Currency Exchange Rates
                               
€ / $(2)
    0.7084       0.7729       0.7110       0.7608  
C$ / $(2)
    0.9803       1.0385       0.9778       1.0358  
C$ / €(3)
    1.3835       1.3438       1.3752       1.3639  
 
     
(1)  
Average realized pulp prices for the periods indicated reflect customer discounts and pulp price movements between the order and shipment date.
 
(2)  
Average Federal Reserve Bank of New York noon spot rate over the reporting period.
 
(3)  
Average Bank of Canada noon spot rates over the reporting period.
Three Months Ended September 30, 2011 Compared to Three Months Ended September 30, 2010
Total revenues for the three months ended September 30, 2011 decreased to €204.8 million ($289.1 million) from €234.4 million ($303.1 million) in the same period in 2010, primarily due to lower pulp revenues, partially offset by higher energy revenues.
Pulp revenues for the three months ended September 30, 2011 decreased to €190.4 million from €224.7 million in the comparative quarter of 2010, primarily due to a weaker U.S. dollar and lower sales volumes. The U.S. dollar was approximately 8% weaker versus the Euro in the current quarter compared to the same quarter of last year. Energy revenues increased by approximately 48% to a record €14.4 million in the third quarter from €9.7 million in the same quarter last year, primarily as a result of increased energy production at our Rosenthal mill and increased energy sales at our Celgar mill.
List prices for NBSK pulp in Europe were approximately $980 (€694) per ADMT in the current quarter, compared to $980 (€758) per ADMT in the same quarter last year and $950 (€709) per ADMT at the end of 2010. In the third quarter of 2011, average pulp sales realizations decreased to €584 ($824) per ADMT from €642 ($831) per ADMT in the same quarter last year, primarily due to a weaker U.S. dollar relative to the Euro.

 

 


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Pulp production decreased to 362,330 ADMTs in the current quarter from 380,894 ADMTs in the same quarter of 2010, primarily due to 11 days (approximately 21,000 ADMTs) of unscheduled maintenance downtime at our Stendal mill to repair the mill’s recovery boiler.
Pulp sales volume decreased to 321,338 ADMTs in the current quarter from 344,777 ADMTs in the comparative period of 2010, primarily as a result of softer demand caused by economic uncertainty in Europe and credit tightening in China.
Costs and expenses in the third quarter of 2011 decreased to €169.5 million from €183.0 million in the comparative period of 2010, primarily due to lower sales volumes and foreign exchange gains on our U.S. dollar denominated balances, partially offset by higher fiber costs.
In the third quarter of 2011, operating depreciation and amortization decreased slightly to €13.8 million from €14.0 million in the same quarter last year. Selling, general and administrative expenses increased to €8.8 million from €6.9 million in the third quarter of 2010, primarily as a result of increased foreign exchange losses due to the weaker U.S. dollar relative to the Euro.
Transportation costs decreased to €15.3 million in the third quarter of 2011 from €16.3 million in the third quarter of 2010 primarily due to lower sales volumes.
On average, our per unit fiber costs in the current quarter increased by approximately 5% from the same period in 2010, primarily due to higher fiber costs at our Celgar mill caused by increased competition for fiber. Fiber costs at our German mills were higher due to lower harvesting rates in Germany. As we move into the fourth quarter, we currently expect fiber prices for our German mills to stabilize as the German fiber market remains well balanced. We expect fiber prices at our Celgar mill to increase slightly in the short term due to ongoing competition for fiber. However, we expect prices to flatten out towards the end of the year as the availability of pulp logs increases.
For the third quarter of 2011, operating income decreased to €35.3 million from €51.4 million in the comparative quarter of 2010, primarily due to lower pulp revenues resulting from lower sales volumes and a weaker U.S. dollar relative to the Euro.
Interest expense in the third quarter of 2011 decreased to €14.1 million from €17.8 million in the comparative quarter of 2010, primarily due to the conversion of the majority of our convertible notes and reduced levels of debt associated with the Stendal mill.
Our Stendal mill recorded an unrealized loss of €10.5 million on the mark to market adjustment of its interest rate derivative in the current quarter, compared to an unrealized gain of €0.5 million in the same quarter of last year. We recorded a foreign exchange loss of €0.2 million on our foreign currency denominated debt in the third quarter of 2011, compared to a foreign exchange gain of €9.9 million in the same period of 2010.
During the current quarter, we recorded €3.1 million of income tax expense, compared to net income tax recoveries of €7.2 million in the same period last year, primarily due to the recognition of additional deferred tax liabilities in the current quarter, compared to the reversal of certain valuation allowances during the same period last year.

 

 


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In the third quarter of 2011, the noncontrolling shareholder’s interest in the Stendal mill’s loss was €0.8 million, compared to income of €5.1 million in the same quarter last year.
We reported net income attributable to common shareholders of €8.4 million, or €0.15 per basic and diluted share for the third quarter of 2011, which included a non-cash unrealized loss of €10.7 million, or €0.20 per basic share, on the Stendal interest rate derivative and foreign exchange losses on our debt, and an income tax expense of €3.1 million, or €0.06 per basic share. In the third quarter of 2010, net income attributable to common shareholders was €46.1 million, or €1.17 per basic and €0.82 per diluted share, which included a non-cash unrealized gain of €10.4 million, or €0.26 per basic share, on the Stendal interest rate derivative and foreign exchange gains on our debt and a net income tax benefit of €7.2 million, or €0.18 per basic share.
Operating EBITDA in the third quarter of 2011 was €49.2 million, compared to €65.5 million in the third quarter of 2010. Operating EBITDA is defined as operating income (loss) plus depreciation and amortization and non-recurring capital asset impairment charges. Management uses Operating EBITDA as a benchmark measurement of its own operating results, and as a benchmark relative to its competitors. Management considers it to be a meaningful supplement to operating income as a performance measure primarily because depreciation expense and non-recurring capital asset impairment charges are not an actual cash cost, and depreciation expense varies widely from company to company in a manner that management considers largely independent of the underlying cost efficiency of their operating facilities. In addition, we believe Operating EBITDA is commonly used by securities analysts, investors and other interested parties to evaluate our financial performance.
Operating EBITDA does not reflect the impact of a number of items that affect our net income (loss) attributable to common shareholders, including financing costs and the effect of derivative instruments. Operating EBITDA is not a measure of financial performance under the accounting principles generally accepted in the United States of America (“GAAP”), and should not be considered as an alternative to net income (loss) or income (loss) from operations as a measure of performance, nor as an alternative to net cash from operating activities as a measure of liquidity.
Operating EBITDA has significant limitations as an analytical tool, and should not be considered in isolation, or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are that Operating EBITDA does not reflect: (i) our cash expenditures, or future requirements, for capital expenditures or contractual commitments; (ii) changes in, or cash requirements for, working capital needs; (iii) the significant interest expense, or the cash requirements necessary to service interest or principal payments, on our outstanding debt; (iv) noncontrolling interests on our Stendal mill operations; (v) the impact of realized or marked to market changes in our derivative positions, which can be substantial; and (vi) the impact of impairment charges against our investments or assets. Because of these limitations, Operating EBITDA should only be considered as a supplemental operational performance measure and should not be considered as a measure of liquidity or cash available to us to invest in the growth of our business. See the Statement of Cash Flows set out in our interim consolidated financial statements included herein. Because all companies do not calculate Operating EBITDA in the same manner, Operating EBITDA as calculated by us may differ from Operating EBITDA or EBITDA as calculated by other companies. We compensate for these limitations by using Operating EBITDA as a supplemental measure of our operational performance and relying primarily on our GAAP financial statements.

 

 


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The following table provides a reconciliation of net income (loss) attributable to common shareholders to operating income (loss) and Operating EBITDA for the periods indicated:
                 
    Three Months Ended  
    September 30,  
    2011     2010  
    (in thousands)  
Net income attributable to common shareholders
  8,440     46,135  
Net income (loss) attributable to noncontrolling interest
    (838 )     5,116  
Income taxes (benefits)
    3,124       (7,155 )
Interest expense
    14,117       17,820  
Investment income
    (270 )     (93 )
Foreign exchange (gain) loss on debt
    181       (9,927 )
Loss on extinguishment of debt
    69        
Loss (gain) on derivative financial instruments
    10,484       (485 )
 
           
Operating income
    35,307       51,411  
Add: Depreciation and amortization
    13,893       14,055  
 
           
Operating EBITDA
  49,200     65,466  
 
           
Nine Months Ended September 30, 2011 Compared to Nine Months Ended September 30, 2010
Total revenues for the nine months ended September 30, 2011 increased to €660.1 million ($928.5 million) from €654.9 million ($862.3 million) in the same period in 2010 due to higher energy revenues, partially offset by marginally lower pulp revenues.
Pulp revenues for the nine months ended September 30, 2011 decreased marginally to €618.2 million from €624.1 million in the comparative period of 2010, primarily due to higher pulp prices being more than offset by lower sales volumes and a weaker U.S. dollar relative to the Euro. The U.S. dollar was approximately 6% weaker versus the Euro in the nine months ended September 30, 2011, compared to the same period of 2010. Energy revenues increased by approximately 36% to a record €42.0 million in the nine months ended September 30, 2011 from €30.8 million in the comparative period last year, primarily as a result of increased energy production at our Rosenthal mill and increased energy sales from our Celgar mill.
Pulp prices in Europe for the nine months ended September 30, 2011 were approximately 6% higher than in the same period last year. List prices for NBSK pulp in Europe were approximately $986 (€701) per ADMT in the nine months ended September 30, 2011, compared to approximately $932 (€708) per ADMT in the comparative period of 2010. In the nine months ended September 30, 2011, average pulp sales realizations marginally increased to €592 per ADMT from €590 per ADMT in the comparative period of 2010, primarily due to higher pulp prices being mostly offset by a weaker U.S. dollar.
Pulp production increased to 1,088,801 ADMTs in the nine months ended September 30, 2011 from 1,070,043 ADMTs in the comparative period of 2010, primarily due to record levels of production at our German mills.
Pulp sales volume decreased slightly to 1,027,918 ADMTs in the nine months ended September 30, 2011 from 1,042,649 ADMTs in the comparative period of 2010, primarily as a result of softer demand caused by economic uncertainty in Europe and credit tightening in China during the third quarter of 2011.

 

 


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Costs and expenses in the nine months ended September 30, 2011 increased to €552.0 million from €537.6 million in the comparative period of 2010, primarily due to higher fiber costs.
Operating depreciation and amortization remained unchanged at €41.8 million in both the nine months ended September 30, 2011 and 2010. Selling, general and administrative expenses increased to €27.6 million in the nine months ended September 30, 2011 from €24.9 million in the comparative period of 2010, primarily due to foreign exchange losses as a result of a weaker U.S. dollar.
Transportation costs decreased marginally to €47.5 million in the nine months ended September 30, 2011 from €47.6 million in the comparative period of 2010.
On average, our per unit fiber costs in the nine months ended September 30, 2011 increased by approximately 9% from the same period in 2010, primarily due to higher fiber costs at our German mills during the first half of 2011, combined with higher fiber costs at our Celgar mill during the latter part of the period. As we move into the fourth quarter, we currently expect fiber prices for our German mills to continue to be stable as the German fiber market remains well balanced. We expect fiber prices at our Celgar mill to increase slightly in the short term due to ongoing competition for fiber. However, we expect prices to flatten out towards the end of the year as the availability of pulp logs increases.
For the nine months ended September 30, 2011, operating income decreased to €108.2 million from €117.3 million in the comparative period of 2010, primarily due to higher pulp prices being more than offset by a weaker U.S. dollar relative to the Euro.
Interest expense in the nine months ended September 30, 2011 decreased to €44.9 million from €51.1 million in the comparative period of 2010, primarily due to the conversion of the majority of our convertible notes and reduced levels of debt associated with the Stendal mill.
Our Stendal mill recorded an unrealized loss of €0.6 million on the mark to market adjustment of its interest rate derivative in the nine months ended September 30, 2011, compared to an unrealized loss of €10.5 million in the same period of last year. We recorded a foreign exchange gain of €1.3 million on our foreign currency denominated debt in the nine months ended September 30, 2011, compared to a foreign exchange loss of €4.7 million in the comparative period of 2010.
During the nine months ended September 30, 2011, we recorded €7.6 million of income tax expense, compared to net income tax recoveries of €5.6 million in the comparative period of 2010, primarily as a result of the recognition of additional deferred tax liabilities in the current period, compared to the reversal of certain valuation allowances during the same period last year.
In the nine months ended September 30, 2011, the noncontrolling shareholder’s interest in the Stendal mill’s income was €5.2 million, compared to €5.0 million in the same period last year.
We reported net income attributable to common shareholders of €51.9 million, or €1.07 per basic and €0.92 per diluted share for the nine months ended September 30, 2011, which included a non-cash unrealized loss of €0.6 million on the Stendal interest rate derivative, a €1.3 million non-cash foreign exchange gain on our debt, a non-cash charge for stock compensation of €2.8 million and an income tax expense of €7.6 million. In the nine months ended September 30, 2010, net income attributable to common shareholders was €51.0 million, or €1.36 per basic and €0.93 per diluted share, which included non-cash unrealized losses of €15.2 million on the Stendal interest rate derivative and foreign exchange effect on our debt, and a net income tax benefit of €5.6 million.

 

 


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Operating EBITDA in the nine months ended September 30, 2011 was €150.1 million, compared to €159.4 million in the comparative period of 2010. Operating EBITDA is defined as operating income (loss) plus depreciation and amortization and non-recurring capital asset impairment charges. Operating EBITDA has significant limitations as an analytical tool, and should not be considered in isolation, or as a substitute for analysis of our results as reported under GAAP. See the discussion of our results for the three months ended September 30, 2011 for additional information relating to such limitations and Operating EBITDA.
The following table provides a reconciliation of net income (loss) attributable to common shareholders to operating income (loss) and Operating EBITDA for the periods indicated:
                 
    Nine Months Ended  
    September 30,  
    2011     2010  
    (in thousands)  
Net income attributable to common shareholders
  51,876     50,990  
Net income attributable to noncontrolling interest
    5,175       5,001  
Income taxes (benefits)
    7,561       (5,632 )
Interest expense
    44,906       51,141  
Investment income
    (733 )     (304 )
Foreign exchange (gain) loss on debt
    (1,272 )     4,675  
Loss on extinguishment of debt
    69       929  
Loss on derivative instruments
    580       10,523  
 
           
Operating income
    108,162       117,323  
Add: Depreciation and amortization
    41,960       42,052  
 
           
Operating EBITDA
  150,122     159,375  
 
           
Liquidity and Capital Resources
The following table is a summary of selected financial information at the dates indicated:
                 
    As at     As at  
    September 30,     December 31,  
    2011     2010  
    (in thousands)  
Financial Position
               
Cash and cash equivalents
  127,758     99,022  
Marketable securities(1)
    4,191       275  
Working capital
    268,756       231,683  
Property, plant and equipment
    815,727       846,767  
Total assets
    1,230,636       1,216,075  
Long-term liabilities
    807,873       877,315  
Total equity
    286,553       213,563  
 
     
(1)  
Principally comprised of German federal government bonds with a maturity of less than one year.
As at September 30, 2011, our cash and cash equivalents had increased to €127.8 million from €99.0 million at the end of 2010, and working capital had increased to €268.8 million from €231.7 million at the end of 2010.

 

 


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Sources and Uses of Funds
Our principal sources of funds are cash flows from operations, cash on hand and the revolving working capital loan facilities for our Celgar and Rosenthal mills. Our principal uses of funds consist of operating expenditures, payments of principal and interest on the project loan facility relating to our Stendal mill (“Stendal Loan Facility”), capital expenditures and interest payments on our outstanding 9.5% senior notes due 2017 (the “Senior Notes”).
During the third quarter of 2011, all of our 8.5% Convertible Notes due 2012 were either converted into shares of our common stock or were redeemed by us. We also announced a share and debt repurchase program whereby we would have the discretion to make open-market purchases of up to $25.0 million in aggregate principal amount of our Senior Notes and up to $25.0 million of our outstanding shares of common stock over a twelve-month period. As of November 1, 2011, we had purchased approximately 1.3 million shares ($10.6 million) of our common stock and $13.6 million in aggregate principal amount of our Senior Notes.
During the quarter, our Celgar mill received approximately C$4.7 million of grant monies related to holdbacks from the Government of Canada in regard to the completion of the Celgar energy project. Additionally, in March 2011, the Company finalized a contribution agreement with Natural Resources Canada for approximately C$9.7 million of unallocated Green Transformation Program funds to be used towards improving the fiber line and oxygen delignification process at the Celgar mill. As of September 30, 2011, the Company had received approximately C$6.6 million of such funds, and expects to receive an additional C$1.8 million in the fourth quarter of 2011.
During the first quarter of 2011, the Company finalized a contribution agreement under the Government of Canada’s Transformative Technology Program to fund approximately 50% of the capital cost associated with the installation of a generator acid purification system at our Celgar mill. During this quarter, we received approximately C$1.6 million from the Canadian government related to this project.
Debt Covenants
Our long-term obligations contain various financial tests and covenants customary to these types of arrangements. As at September 30, 2011, we were in compliance with all of the covenants of our indebtedness.
Cash Flow Analysis
Cash Flows from Operating Activities. We operate in a cyclical industry and our operating cash flows vary accordingly. Our principal operating cash expenditures are for labor, fiber, chemicals and debt service.
Working capital levels fluctuate throughout the year and are affected by maintenance downtime, changing sales patterns, seasonality and the timing of receivables and the payment of payables and expenses.

 

 


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Cash provided by operating activities increased to €107.7 million in the nine months ended September 30, 2011 from €57.7 million in the comparative period of 2010, primarily due to a decrease in receivables, which provided cash of €3.2 million in the nine months ended September 30, 2011, compared to an increase in receivables using cash of €26.4 million in the same period of 2010. An increase in inventories used cash of €27.9 million in the nine months ended September 30, 2011, compared to an increase in inventories using cash of €37.0 million in the same period of 2010. An increase in accounts payable and accrued expenses provided cash of €24.9 million in the nine months ended September 30, 2011, compared to an increase in accounts payable and accrued expenses providing cash of €15.1 million, in the same period of 2010.
Cash Flows from Investing Activities. Investing activities in the nine months ended September 30, 2011 used cash of €25.4 million, compared to using cash of €27.6 million in the same period of 2010. Capital expenditures in the nine months ended September 30, 2011 used cash of €26.1 million, compared to €28.9 million in the same period of 2010. Capital expenditures in the nine months ended September 30, 2011 primarily related to improving the fiber line and oxygen delignification process at the Celgar mill. We also used cash of €4.0 million to purchase German federal government bonds with maturities of less than one year in the nine months ended September 30, 2011.
Cash Flows from Financing Activities. In the nine months ended September 30, 2011, financing activities used cash of €53.5 million, compared to providing cash of €3.0 million in the same period of 2010. In the nine months ended September 30, 2011, we used cash of €15.2 million to redeem our 9.25% senior notes due 2013, €23.2 million to repay the principal amount under the Stendal Loan Facility and €14.7 million to repay the balance of our Celgar revolving credit facility. We also used cash of €7.5 million to purchase shares of our common stock and €3.0 million to purchase our Senior Notes. In the comparative period of 2010, net repayment of debt and credit facilities used cash of €12.1 million. We received cash of €13.4 million from government grants in the nine months ended September 30, 2011, while receiving cash of €17.3 million from government grants in the comparative period of 2010.
Capital Resources
We have no material commitments to acquire assets or operating businesses.
Future Liquidity
Based upon the current level of operations and our current expectations for future periods in light of the current economic environment, and in particular, current and expected pulp pricing and foreign exchange rates, we believe that cash flow from operations and available cash, together with available borrowings will be adequate to meet our liquidity needs in the next 12 months.
Contractual Obligations and Commitments
There were no material changes outside the ordinary course to any of our material contractual obligations during the first nine months of 2011.
Foreign Currency
Our reporting currency is the Euro as the majority of our business transactions are denominated in Euros. However, we hold certain assets and liabilities in U.S. dollars and Canadian dollars. Accordingly, our consolidated financial results are subject to foreign currency exchange rate fluctuations.

 

 


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We translate foreign denominated assets and liabilities into Euros at the rate of exchange on the balance sheet date. Equity accounts are translated using historical exchange rates. Unrealized gains or losses from these translations are recorded in our consolidated statement of comprehensive income and impact shareholders’ equity on the balance sheet but do not affect our net income.
In the nine months ended September 30, 2011, accumulated other comprehensive income decreased by €10.0 million to €21.8 million, primarily due to the foreign currency translation adjustment.
Based upon the exchange rate at September 30, 2011, the U.S. dollar has marginally strengthened by approximately 1% in value against the Euro since September 30, 2010. See “Quantitative and Qualitative Disclosures about Market Risk”.
Results of Operations of the Restricted Group under our Senior Note Indenture
The indenture governing our Senior Notes requires that we also provide a discussion in annual and quarterly reports we file with the SEC under Management’s Discussion and Analysis of Financial Condition and Results of Operations of the results of operations and financial condition of Mercer Inc. and our restricted subsidiaries under the indenture, referred to as the “Restricted Group”. The Restricted Group is comprised of Mercer Inc., our Rosenthal and Celgar mills and certain holding subsidiaries. The Restricted Group excludes our Stendal mill.
The following is a discussion of the results of operations and financial condition of the Restricted Group. For further information regarding the Restricted Group including, without limitation, a reconciliation to our consolidated results of operations, see Note 13 of our Interim Consolidated Financial Statements included herein.
Restricted Group Results — Three Months Ended September 30, 2011 Compared to Three Months Ended September 30, 2010
Total revenues for the Restricted Group decreased to €117.8 million ($166.3 million) in the third quarter of 2011, compared to €125.1 million ($161.8 million) in the third quarter of 2010 due to higher energy revenues being more than offset by lower pulp revenues.
Pulp revenues for the Restricted Group for the three months ended September 30, 2011 decreased to €111.6 million from €123.5 million in the comparative period of 2010, primarily due to a weaker U.S. dollar. The U.S. dollar was approximately 8% weaker versus the Euro in the third quarter of 2011 compared to the third quarter of 2010. Energy revenues increased by approximately three fold in the current quarter to a record €6.1 million from €1.5 million in the same period last year, primarily due to increased energy production at our Rosenthal mill and increased energy sales at our Celgar mill.
List prices for NBSK pulp in Europe were approximately $980 (€694) per ADMT in the current quarter, compared to $980 (€758) per ADMT in the same quarter last year. In the third quarter of 2011, average pulp sales realizations for the Restricted Group decreased to €587 per ADMT from €643 per ADMT in the same period last year due to a weaker U.S. dollar.
Pulp production for the Restricted Group marginally decreased to 206,907 ADMTs in the third quarter of 2011 from 207,720 ADMTs in the same period of 2010.

 

 


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Pulp sales volume of the Restricted Group marginally decreased to 190,013 ADMTs in the third quarter of 2011 from 191,860 ADMTs in the comparative period of 2010, primarily due to softer demand caused by economic uncertainty in Europe and credit tightening in China.
Costs and expenses for the Restricted Group in the third quarter of 2011 decreased to €99.4 million from €102.3 million in the comparative period of 2010, primarily due to lower sales volumes and foreign exchange gains on our U.S. dollar denominated balances, partially offset by higher fiber costs.
In the third quarter of 2011, operating depreciation and amortization for the Restricted Group decreased marginally to €7.4 million from €7.5 million in the same period last year. Selling, general and administrative expenses and other for the Restricted Group increased to €6.1 million from €3.2 million in the comparative period of 2010, primarily as a result of a weaker U.S. dollar relative to the Euro.
Transportation costs for the Restricted Group decreased slightly to €11.6 million in the third quarter of 2011 from €12.3 million in the same quarter last year.
Overall, per unit fiber costs of the Restricted Group in the third quarter of 2011 increased by approximately 9% compared to the same period in 2010, primarily due to higher costs at our Celgar mill caused by increased competition for fiber and marginally higher fiber costs at our Rosenthal mill caused by lower harvesting rates in Germany.
In the third quarter of 2011, the Restricted Group reported operating income of €18.3 million compared to operating income of €22.8 million in the third quarter of 2010, primarily due to lower pulp price realizations resulting from a weaker U.S. dollar.
Interest expense for the Restricted Group decreased to €5.5 million in the third quarter of 2011 from €8.8 million in the same quarter last year, primarily due to lower debt levels and a weaker U.S. dollar relative to the Euro.
In the third quarter of 2011, the Restricted Group recorded a foreign exchange loss on foreign currency denominated debt of €0.2 million, compared to a gain on foreign currency denominated debt of €9.9 million in the third quarter of 2010.
During the third quarter of 2011, the Restricted Group recorded €2.6 million of net income tax expense, compared to net income tax recoveries of €8.8 million in the same period last year, primarily due to the recognition of additional deferred tax liabilities in the current quarter, compared to the reversal of certain valuation allowances during the same period last year.
The Restricted Group reported net income for the third quarter of 2011 of €11.4 million compared to net income of €34.0 million in the same period last year.
In the third quarter of 2011, the Restricted Group reported Operating EBITDA of €25.8 million compared to Operating EBITDA of €30.4 million in the comparative quarter of 2010. Operating EBITDA is defined as operating income (loss) plus depreciation and amortization and non-recurring capital asset impairment charges. Operating EBITDA has significant limitations as an analytical tool, and should not be considered in isolation, or as a substitute for analysis of our results as reported under GAAP. See the discussion of our results for the three months ended September 30, 2011 for additional information relating to such limitations and Operating EBITDA.

 

 


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The following table provides a reconciliation of net income (loss) to operating income (loss) and Operating EBITDA for the Restricted Group for the periods indicated:
                 
    Three Months Ended  
    September 30,  
    2011     2010  
    (in thousands)  
Restricted Group(1)
               
Net income
  11,371     34,016  
Income taxes (benefits)
    2,566       (8,849 )
Interest expense
    5,496       8,796  
Investment income
    (1,334 )     (1,246 )
Foreign exchange (gain) loss on debt
    181       (9,927 )
Loss on extinguishment of debt
    69        
 
           
Operating income
    18,349       22,790  
Add: Depreciation and amortization
    7,425       7,582  
 
           
Operating EBITDA
  25,774     30,372  
 
           
 
     
(1)  
See Note 13 of the interim consolidated financial statements included elsewhere herein for a reconciliation to our consolidated results.
Restricted Group Results — Nine Months Ended September 30, 2011 Compared to Nine Months Ended September 30, 2010
Total revenues for the Restricted Group increased to €369.8 million ($520.2 million) in the nine months ended September 30, 2011, compared to €363.5 million ($478.6 million) in the nine months ended September 30, 2010 due to higher energy revenues, partially offset by slightly lower pulp revenues.
Pulp revenues for the Restricted Group for the nine months ended September 30, 2011 marginally decreased to €352.1 million from €354.8 million in the comparative period of 2010, primarily due to a weaker U.S. dollar, partially offset by higher pulp prices. Energy revenues increased two fold in the nine months ended September 30, 2011 to a record €17.7 million from €8.8 million in the comparative period of 2010, primarily due to increased energy production at our Rosenthal mill and increased energy sales at our Celgar mill.
In the nine months ended September 30, 2011, pulp prices were higher than in the same period of 2010. List prices for NBSK pulp in Europe were approximately $986 (€701) per ADMT in the nine months ended September 30, 2011, compared to approximately $932 (€708) per ADMT in the same period last year. In the nine months ended September 30, 2011, average pulp sales realizations for the Restricted Group increased to €596 per ADMT from €591 per ADMT in the same period last year.
Pulp production for the Restricted Group marginally decreased to 611,139 ADMTs in the nine months ended September 30, 2011 from 611,753 ADMTs in the comparative period of 2010.
Pulp sales volume of the Restricted Group decreased to 590,448 ADMTs in the nine months ended September 30, 2011 from 599,971 ADMTs in the comparative period of 2010, primarily due to lower sales at our Celgar mill caused by reduced demand in China.

 

 


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Costs and expenses for the Restricted Group in the nine months ended September 30, 2011 increased slightly to €312.1 million from €306.2 million in the comparative period of 2010, primarily due to higher fiber costs.
In the nine months ended September 30, 2011, operating depreciation and amortization for the Restricted Group remained unchanged at €22.4 million in both the current period and the comparative period of 2010. Selling, general and administrative expenses and other for the Restricted Group increased to €17.6 million in the nine months ended September 30, 2011 from €14.8 million in the comparative period of 2010, primarily due to foreign exchange losses as a result of a weaker U.S. dollar.
Transportation costs for the Restricted Group decreased slightly to €35.1 million in the nine months ended September 30, 2011 from €36.1 million in the same period of 2010.
Overall, per unit fiber costs of the Restricted Group in the nine months ended September 30, 2011 increased by approximately 8% compared to the same period of 2010, primarily due to higher fiber costs at both our Rosenthal and Celgar mills caused by increased demand for fiber.
In the nine months ended September 30, 2011, the Restricted Group reported operating income of €57.7 million compared to operating income of €57.3 million in the same period of 2010, primarily due to higher pulp prices being mostly offset by a weaker U.S. dollar.
Interest expense for the Restricted Group decreased to approximately €19.2 million in the nine months ended September 30, 2011 from €24.1 million in the nine months ended September 30, 2010, primarily as a result of lower debt levels and a weaker U.S. dollar relative to the Euro.
In the nine months ended September 30, 2011, the Restricted Group recorded a foreign exchange gain on foreign currency denominated debt of €1.3 million, compared to a loss on foreign currency denominated debt of €4.7 million in the same period of 2010.
During the nine months ended September 30, 2011, the Restricted Group recorded €5.9 million of net income tax expense, compared to net income tax recoveries of €8.3 million in the same period of 2010, primarily as a result of the recognition of additional deferred tax liabilities in the current period, compared to the reversal of certain valuation allowances during the same period last year.
The Restricted Group reported net income for the nine months ended September 30, 2011 of €37.6 million, compared to net income of €39.8 million in the same period of 2010.
In the nine months ended September 30, 2011, the Restricted Group reported Operating EBITDA of €80.2 million, compared to Operating EBITDA of €79.9 million in the same period of 2010. Operating EBITDA is defined as operating income (loss) plus depreciation and amortization and non-recurring capital asset impairment charges. Operating EBITDA has significant limitations as an analytical tool, and should not be considered in isolation, or as a substitute for analysis of our results as reported under GAAP. See the discussion of our results for the three months ended September 30, 2011 for additional information relating to such limitations and Operating EBITDA.

 

 


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The following table provides a reconciliation of net income (loss) to operating income (loss) and Operating EBITDA for the Restricted Group for the periods indicated:
                 
    Nine Months Ended  
    September 30,  
    2011     2010  
    (in thousands)  
Restricted Group(1)
               
Net income
  37,631     39,762  
Income taxes (benefits)
    5,941       (8,354 )
Interest expense
    19,202       24,073  
Investment income
    (3,918 )     (3,770 )
Foreign exchange (gain) loss on debt
    (1,272 )     4,675  
Loss on extinguishment of debt
    69       929  
 
           
Operating income
    57,653       57,315  
Add: Depreciation and amortization
    22,562       22,590  
 
           
Operating EBITDA
  80,215     79,905  
 
           
 
     
(1)  
See Note 13 of the interim consolidated financial statements included elsewhere herein for a reconciliation to our consolidated results.
Liquidity and Capital Resources of the Restricted Group
The following table is a summary of selected financial information for the Restricted Group at the dates indicated:
                 
    As at     As at  
    September 30,     December 31,  
    2011     2010  
    (in thousands)  
Restricted Group Financial Position(1)
               
Cash and cash equivalents
  60,426     50,654  
Marketable securities(2)
    4,191       275  
Working capital
    169,702       150,667  
Property, plant and equipment
    345,077       362,274  
Total assets
    665,671       662,944  
Long-term liabilities
    265,429       312,631  
Total equity
    342,202       289,141  
 
     
(1)  
See Note 13 of the interim consolidated financial statements included elsewhere herein for a reconciliation to our consolidated results.
 
(2)  
Principally comprised of German federal government bonds with a maturity of less than one year.
At September 30, 2011, cash and cash equivalents for the Restricted Group increased to €60.4 million from €50.7 million at the end of 2010.
We currently expect the Restricted Group to meet its interest and debt service obligations and meet the working and maintenance capital requirements for its operations for the next 12 months with cash flow from operations, cash on hand and available borrowings.
Critical Accounting Policies
The preparation of financial statements and related disclosures in conformity with GAAP requires management to make estimates and assumptions that affect both the amount and the timing of the recording of assets, liabilities, revenues, and expenses in the consolidated financial statements and accompanying note disclosure. Our management routinely makes judgments and estimates about the effects of matters that are inherently uncertain. As the number of variables and assumptions affecting the probable future resolution of the uncertainties increase, these judgments become even more subjective and complex.

 

 


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Our significant accounting policies are disclosed in Note 1 to our annual report on Form 10-K for the fiscal year ended December 31, 2010. While all of the significant accounting policies are important to the consolidated financial statements, some of these policies may be viewed as having a high degree of judgment. On an ongoing basis, using currently available information, management reviews its estimates, including those related to the accounting for pensions and post-retirement benefits, provisions for bad debt and doubtful accounts, derivative instruments, impairment of long-lived assets, deferred taxes, inventory provisions and environmental conservation and legal liabilities. Actual results could differ from these estimates.
We have identified certain accounting policies that are the most important to the portrayal of our current financial condition and results of operations.
For information about both our significant and critical accounting policies, see our annual report on Form 10-K for the fiscal year ended December 31, 2010.
New Accounting Standards
See Note 1 to the Company’s interim consolidated financial statements included in Item 1.
Cautionary Statement Regarding Forward-Looking Information
The statements in this report that are not reported financial results or other historical information are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, as amended.
Generally, forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words such as “expects”, “anticipates”, “intends”, “plans”, “believes”, “seeks”, “estimates”, or words of similar meaning, or future or conditional verbs, such as “will”, “should”, “could”, or “may”, although not all forward-looking statements contain these identifying words. Forward-looking statements are based on expectations, forecasts and assumptions by our management and involve a number of risks, uncertainties and other factors, many of which are beyond our control, which could cause actual conditions, events or results to differ significantly from those described in the forward-looking statements. These factors include, but are not limited to, the following:
   
the highly cyclical nature of our business;
 
   
our level of indebtedness could negatively impact our financial condition and results of operations;
 
   
a weak global economy could adversely affect our business and financial results and have a material adverse effect on our liquidity and capital resources;
 
   
in a weak pulp price and demand environment there can be no assurance that we will be able to generate sufficient cash flows, to service, repay or refinance debt;
 
   
cyclical fluctuations in the price and supply of our raw materials could adversely affect our business;
 
   
we operate in highly competitive markets;
 
   
we are exposed to currency exchange rate and interest rate fluctuations;

 

 


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increases in our capital expenditures or maintenance costs could have a material adverse effect on our cash flow and our ability to satisfy our debt obligations;
 
   
we use derivatives to manage certain risks which has caused significant fluctuations in our operating results;
 
   
we are subject to extensive environmental regulation and we could have environmental liabilities at our facilities;
 
   
our business is subject to risks associated with climate change and social government responses thereto;
 
   
we are subject to risks related to our employees;
 
   
we rely on German federal and state government grants and guarantees;
 
   
risks relating to our participation in the European Union Emissions Trading Scheme and the application of Germany’s Renewable Energy Resources Act;
 
   
we are dependent on key personnel;
 
   
we may experience material disruptions to our production;
 
   
we may incur losses as a result of unforeseen or catastrophic events, including the emergence of a pandemic, terrorist attacks or natural disasters;
 
   
our insurance coverage may not be adequate; and
 
   
we rely on third parties for transportation services.
Given these uncertainties, you should not place undue reliance on our forward-looking statements. The forgoing review of important factors is not exhaustive or necessarily in order of importance and should be read in conjunction with the risks and assumptions including those set forth in reports and other documents we have filed with or furnished to the SEC, including in our annual report on Form 10-K for the fiscal year ended December 31, 2010. We advise you that these cautionary remarks expressly qualify in their entirety all forward-looking statements attributable to us or persons acting on our behalf. Unless required by law, we do not assume any obligation to update forward-looking statements based on unanticipated events or changed expectations. However, you should carefully review the reports and other documents we file from time to time with the SEC.
Cyclical Nature of Business
Revenues
The pulp business is highly cyclical in nature and markets for our principal products are characterized by periods of supply and demand imbalance, which in turn affects product prices. Pulp markets are highly competitive and are sensitive to cyclical changes in the global economy, industry capacity and foreign exchange rates, all of which can have a significant influence on selling prices and our operating results. The length and magnitude of industry cycles have varied over time but generally reflect changes in macro-economic conditions and levels of industry capacity.

 

 


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Industry capacity can fluctuate as changing industry conditions can influence producers to idle production or permanently close machines or entire mills. In addition, to avoid substantial cash costs in idling or closing a mill, some producers will choose to operate at a loss, sometimes even a cash loss, which can prolong weak pricing environments due to oversupply. Oversupply of our products can also result from producers introducing new capacity in response to favorable pricing trends.
Demand for pulp has historically been determined by the level of economic growth and has been closely tied to overall business activity. From 2006 to mid-2008, pulp prices in Europe steadily improved. However, in the latter half of 2008, a global economic crisis resulted in a sharp decline of European pulp prices from a high of $900 per ADMT to $635 per ADMT at the end of 2008. Beginning in the second quarter of 2009 prices began to improve, rising from a low of $575 per ADMT in March 2009 to $980 per ADMT at the end of the second quarter of 2010. Despite some softening in demand, European list pulp prices remained at generally high levels through the third quarter of 2011.
Prices for pulp are driven by many factors outside our control, and we have little influence over the timing and extent of price changes, which are often volatile. Because market conditions beyond our control determine the price for pulp, such pulp may fall below our cash production costs, requiring us to either incur short-term losses on product sales or cease production at one or more of our mills. Therefore, our profitability depends on managing our cost structure, particularly raw materials which represent a significant component of our operating costs and can fluctuate based upon factors beyond our control. If the prices of our products decline, or if prices for our raw materials increase, or both, our results of operations could be materially adversely affected.
Costs
Our production costs are influenced by the availability and cost of raw materials, energy and labor, and our plant efficiencies and productivity. Our main raw material is fiber in the form of wood chips and pulp logs. Fiber costs are primarily affected by the supply of, and demand for, lumber which is highly cyclical in nature and can vary significantly by location. The state of lumber markets affects both the amount of sawmill residuals, such as chips, produced as a by-product of lumber and the level of timber harvesting, which provides us with pulp logs. Production costs also depend on the total volume of production. Lower operating rates and production efficiencies during periods of cyclically low demand result in higher average production costs and lower margins.
Currency
The majority of our sales are in products quoted in U.S. dollars while most of our operating costs and expenses, other than those of the Celgar mill, are incurred in Euros. In addition, all of the products sold by the Celgar mill are quoted in U.S. dollars and the Celgar mill costs are primarily incurred in Canadian dollars. Our results of operations and financial condition are reported in Euros. As a result, our revenues are adversely affected by a decrease in the value of the U.S. dollar relative to the Euro and to the Canadian dollar. Such shifts in currencies relative to the Euro and the Canadian dollar reduce our operating margins and the cash flow available to fund our operations and to service our debt. Conversely, an increase in the U.S. dollar versus the Euro and the Canadian dollar positively impacts our revenues by increasing our operating margins and cash flow.

 

 


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ITEM 3.  
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risks from changes in interest rates and foreign currency exchange rates, particularly the exchange rate between the Euro and the U.S. dollar and the Canadian dollar versus the U.S. dollar and the Euro. Changes in these rates may affect our results of operations and financial condition and, consequently, our fair value. We seek to manage these risks through internal risk management policies, as well as the use of derivatives. We use derivatives to reduce or limit our exposure to interest rate and, from time to time, currency risks. We may in the future use derivatives to reduce or limit our exposure to fluctuations in pulp prices. We also use derivatives to reduce our potential losses or to augment our potential gains, depending on our management’s perception of future economic events and developments. These types of derivatives are generally highly speculative in nature. They are also very volatile as they are highly leveraged given that margin requirements are relatively low in proportion to notional amounts.
Many of our strategies, including the use of derivatives, and the types of derivatives selected by us, are based on historical trading patterns and correlations and our management’s expectations of future events. However, these strategies may not be effective in all market environments or against all types of risks. Unexpected market developments may affect our risk management strategies during this time, and unanticipated developments could impact our risk management strategies in the future. If any of the variety of instruments and strategies we utilize are not effective, we may incur significant losses.
All of our derivatives are marked to market at the end of each reporting period, and all unrealized gains and losses are recognized in earnings for a reporting period. We determine market valuations based primarily upon observable inputs including applicable yield curves.
During the nine months ended September 30, 2011, we recorded an unrealized loss of €0.6 million on our outstanding interest rate derivative compared to an unrealized loss of €10.5 million in the same period of 2010.
We are also subject to some energy price risk, primarily for the electricity that our operations purchase.

 

 


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ITEM 4.  
CONTROLS AND PROCEDURES
Disclosure Controls and Procedures. Our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of the end of the period covered by this report. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is accumulated and communicated to management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. Based on such evaluation, our principal executive officer and principal financial officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports that we file or submit under the Exchange Act.
It should be noted that any system of controls is based in part upon certain assumptions designed to obtain reasonable (and not absolute) assurance as to its effectiveness, and there can be no assurance that any design will succeed in achieving its stated goals.
Changes in Internal Controls. There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 


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PART II. OTHER INFORMATION
ITEM 1.  
LEGAL PROCEEDINGS
We are subject to routine litigation incidental to our business, including those described in our latest annual report on Form 10-K for the fiscal year ended December 31, 2010. We do not believe that the outcome of such litigation will have a material adverse effect on our business or financial condition.
ITEM 1A.  
RISK FACTORS
There have been no material changes to the factors disclosed in Item 1A. Risk Factors in our latest annual report on Form 10-K for the fiscal year ended December 31, 2010.
ITEM 2.  
UNREGISTERED SALE OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3.  
DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 5.  
OTHER INFORMATION
None.
ITEM 6.  
EXHIBITS
         
Exhibit    
No.   Description
       
 
  31.1    
Section 302 Certification of Chief Executive Officer
       
 
  31.2    
Section 302 Certification of Chief Financial Officer
       
 
  32.1 *  
Section 906 Certification of Chief Executive Officer
       
 
  32.2 *  
Section 906 Certification of Chief Financial Officer
 
     
*  
In accordance with Release 33-8212 of the Commission, these Certifications: (i) are “furnished” to the Commission and are not “filed” for the purposes of liability under the Securities Exchange Act of 1934, as amended; and (ii) are not to be subject to automatic incorporation by reference into any of the Company’s registration statements filed under the Securities Act of 1933, as amended for the purposes of liability thereunder or any offering memorandum, unless the Company specifically incorporates them by reference therein.

 

 


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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
         
  MERCER INTERNATIONAL INC.
 
 
  By:   /s/ David M. Gandossi    
    David M. Gandossi   
    Secretary and Chief Financial Officer   
Date: November 7, 2011