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MERCER INTERNATIONAL INC. - Quarter Report: 2011 March (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 March 31, 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
(State or other jurisdiction
of incorporation or organization)
  47-0956945
(I.R.S. Employer
Identification No.)
Suite 2840, 650 West Georgia Street, Vancouver, British Columbia, Canada, V6B 4N8
(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 o 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 45,790,343 shares of common stock outstanding as at May 6, 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


Table of Contents

PART I. FINANCIAL INFORMATION
ITEM 1.  
FINANCIAL STATEMENTS
MERCER INTERNATIONAL INC.
INTERIM CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2011
(Unaudited)
FORM 10-Q
QUARTERLY REPORT — PAGE 2

 

 


Table of Contents

MERCER INTERNATIONAL INC.
INTERIM CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands of Euros)
                 
    March 31,     December 31,  
    2011     2010  
ASSETS
               
Current assets
               
Cash and cash equivalents
  123,241     99,022  
Receivables
    112,991       121,709  
Inventories (Note 4)
    96,408       102,219  
Prepaid expenses and other
    10,787       11,360  
Deferred income tax
    22,414       22,570  
 
           
Total current assets
    365,841       356,880  
 
           
 
Long-term assets
               
Property, plant and equipment
    830,095       846,767  
Deferred note issuance and other
    10,461       11,082  
Note receivable
    890       1,346  
 
           
 
    841,446       859,195  
 
           
Total assets
  1,207,287     1,216,075  
 
           
 
               
LIABILITIES
               
Current liabilities
               
Accounts payable and accrued expenses
  108,765     84,873  
Pension and other post-retirement benefit obligations (Note 7)
    703       728  
Debt (Note 5)
    45,393       39,596  
 
           
Total current liabilities
    154,861       125,197  
 
           
 
Long-term liabilities
               
Debt (Note 5)
    713,422       782,328  
Unrealized interest rate derivative losses (Notes 6 and 9)
    38,730       50,973  
Pension and other post-retirement benefit obligations (Note 7)
    23,412       24,236  
Capital leases and other
    11,607       12,010  
Deferred income tax
    7,947       7,768  
 
           
 
    795,118       877,315  
 
           
Total liabilities
  949,979     1,002,512  
 
           
 
               
EQUITY
               
Shareholders’ equity
               
Share capital (Note 8)
    227,588       219,211  
Paid-in capital
    (5,877 )     (3,899 )
Retained earnings (deficit)
    18,097       (10,956 )
Accumulated other comprehensive income
    35,458       31,712  
 
           
Total shareholders’ equity
    275,266       236,068  
 
           
 
               
Noncontrolling interest (deficit)
    (17,958 )     (22,505 )
 
           
Total equity
    257,308       213,563  
 
           
Total liabilities and equity
  1,207,287     1,216,075  
 
           
Commitments and contingencies (Note 10)
Subsequent Events (Note 11)
The accompanying notes are an integral part of these interim consolidated financial statements.
FORM 10-Q
QUARTERLY REPORT — PAGE 3

 

 


Table of Contents

MERCER INTERNATIONAL INC.
INTERIM CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands of Euros, except per share data)
                 
    Three Months Ended  
    March 31,  
    2011     2010  
 
Revenues
               
Pulp
  210,458     171,121  
Energy
    13,677       9,131  
 
           
 
    224,135       180,252  
Costs and expenses
               
Operating costs
    163,355       140,409  
Operating depreciation and amortization
    14,076       13,724  
 
           
 
    46,704       26,119  
Selling, general and administrative expenses
    10,230       8,095  
Purchase (sale) of emission allowances
    (170 )      
 
           
Operating income (loss)
    36,644       18,024  
 
           
 
               
Other income (expense)
               
Interest expense
    (15,906 )     (16,423 )
Investment income (loss)
    327       94  
Foreign exchange gain (loss) on debt
    1,111       (5,231 )
Gain (loss) on extinguishment of debt (Note 5)
          (929 )
Gain (loss) on derivative instruments (Note 6)
    12,243       (6,546 )
 
           
Total other income (expense)
    (2,225 )     (29,035 )
 
           
Income (loss) before income taxes
    34,419       (11,011 )
Income tax benefit (provision) – current
    (819 )     (204 )
– deferred
           
 
           
Net income (loss)
    33,600       (11,215 )
Less: net loss (income) attributable to noncontrolling interest
    (4,547 )     3,669  
 
           
Net income (loss) attributable to common shareholders
  29,053     (7,546 )
 
           
 
               
Net income (loss) per share attributable to common shareholders (Note 3)
               
Basic
  0.66     (0.21 )
 
           
Diluted
  0.52     (0.21 )
 
           
The accompanying notes are an integral part of these interim consolidated financial statements.
FORM 10-Q
QUARTERLY REPORT — PAGE 4

 

 


Table of Contents

MERCER INTERNATIONAL INC.
INTERIM CONSOLIDATED STATEMENTS OF RETAINED EARNINGS (DEFICIT)
(Unaudited)
(In thousands of Euros)
                 
    Three Months Ended  
    March 31,  
    2011     2010  
 
               
Net income (loss) attributable to common shareholders
  29,053     (7,546 )
Retained earnings (deficit), beginning of period
    (10,956 )     (97,235 )
 
           
 
               
Retained earnings (deficit), end of period
  18,097     (104,781 )
 
           
 
               
INTERIM CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
(In thousands of Euros)
                 
    Three Months Ended  
    March 31,  
    2011     2010  
 
               
Net income (loss)
  33,600     (11,215 )
 
               
Other comprehensive income (loss), net of taxes
               
Foreign currency translation adjustment
    3,464       7,632  
Pension income (expense)
    276       (366 )
Unrealized gains (losses) on securities arising during the period
    6       6  
 
           
Other comprehensive income (loss), net of taxes
    3,746       7,272  
 
           
 
               
Total comprehensive income (loss)
    37,346       (3,943 )
Comprehensive (income) loss attributable to noncontrolling interest
    (4,547 )     3,669  
 
           
 
               
Comprehensive income (loss) attributable to common shareholders
  32,799     (274 )
 
           
The accompanying notes are an integral part of these interim consolidated financial statements.
FORM 10-Q
QUARTERLY REPORT — PAGE 5

 

 


Table of Contents

MERCER INTERNATIONAL INC.
INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands of Euros)
                 
    Three Months Ended  
    March 31,  
    2011     2010  
Cash flows from (used in) operating activities
               
Net income (loss) attributable to common shareholders
  29,053     (7,546 )
Adjustments to reconcile net income (loss) attributable to common shareholders to cash flows from operating activities
               
Loss (gain) on derivative instruments
    (12,243 )     6,546  
Foreign exchange (gain) loss on debt
    (1,111 )     5,231  
Loss (gain) on extinguishment of debt
          929  
Depreciation and amortization
    14,138       13,821  
Accretion expense (income)
    470       431  
Noncontrolling interest
    4,547       (3,669 )
Stock compensation expense
    2,068       506  
Pension and other post-retirement expense, net of funding
    (14 )     194  
Other
    684       1,003  
Changes in current assets and liabilities
               
Receivables
    7,177       (17,144 )
Inventories
    4,313       (5,259 )
Accounts payable and accrued expenses
    25,388       7,955  
Other
    359       (1,281 )
 
           
Net cash from (used in) operating activities
    74,829       1,717  
 
           
 
               
Cash flows from (used in) investing activities
               
Purchase of property, plant and equipment
    (8,069 )     (5,850 )
Proceeds on sale of property, plant and equipment
    353       387  
Note receivable
    396       (84 )
 
           
Net cash from (used in) investing activities
    (7,320 )     (5,547 )
 
           
 
               
Cash flows from (used in) financing activities
               
Repayment of notes payable and debt
    (30,351 )     (8,250 )
Repayment of capital lease obligations
    (855 )     (1,004 )
Proceeds from (repayment of) credit facilities, net
    (14,652 )      
Proceeds from government grants
    4,112       9,415  
 
           
Net cash from (used in) financing activities
    (41,746 )     161  
 
           
 
               
Effect of exchange rate changes on cash and cash equivalents
    (1,544 )     1,070  
 
           
 
               
Net increase (decrease) in cash and cash equivalents
    24,219       (2,599 )
Cash and cash equivalents, beginning of period
    99,022       51,291  
 
           
Cash and cash equivalents, end of period
  123,241     48,692  
 
           
Supplemental disclosure of cash flow information
               
Cash paid during the period for
               
Interest
  6,514     14,429  
Income taxes
    301       102  
Supplemental schedule of non-cash investing and financing activities
               
Acquisition of production and other equipment under capital lease obligations
  310     212  
Decrease (increase) in accounts payable relating to investing activities
    55       (983 )
The accompanying notes are an integral part of these interim consolidated financial statements.
FORM 10-Q
QUARTERLY REPORT — PAGE 6

 

 


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”). The Company’s shares of common stock 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.
FORM 10-Q
QUARTERLY REPORT — PAGE 7

 

 


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)
Recently Implemented Accounting Standards
There were no recently implemented accounting standards that had an impact on the Company’s financial statements.
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 stock, performance shares, performance share units and stock appreciation rights to be awarded to employees, consultants and non-employee directors. As at March 31, 2011, after factoring in all allocated stock, there remain approximately 1.2 million common shares available for grant pursuant to the 2010 Plan.
Performance Stock
Grants of performance stock comprise rights to receive stock at a future date that are contingent on the Company and the grantee achieving certain performance objectives.
In February 2011, the Company awarded a total of 812,573 potential stock based performance awards 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 stock which had vested, forfeited, or been cancelled during the three months ended March 31, 2011. Expense recognized for the three month period ended March 31, 2011 was €521. Performance stock 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 stock is determined based upon the targeted number of shares awarded and the quoted price of the Company’s stock 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 determined by the Board of Directors.
Between February and March 2011, the Company granted and issued a total of 474,728 shares of common stock for stock based performance awards, which were originally awarded in 2008 and had 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 units 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 stock at the grant date. As a result, the Company recognized approximately €1,420 associated with the final determination of these performance shares. The fair value of these performance shares was determined based upon the number of shares granted and the quoted price of the Company’s stock at the grant date.
FORM 10-Q
QUARTERLY REPORT — PAGE 8

 

 


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)
Restricted Stock
The fair value of restricted stock is determined based upon the number of shares granted and the quoted price of the Company’s stock on the date of grant. Restricted stock generally vests 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 March 31, 2011, 200,000 restricted stock awards were granted to the Chief Executive Officer of the Company, which vest in equal amounts over a five-year period commencing in 2012.
There were no restricted stock awards cancelled or forfeited during the three-month period ended March 31, 2011. As at March 31, 2011, the total number of unvested restricted stock was 256,000 (2010 – 21,000).
Expense recognized for the three-month period ended March 31, 2011 was €127 (2010 – €3). As at March 31, 2011, the total remaining unrecognized compensation cost related to restricted stock amounted to approximately €1,781 (2010 – €4), which will be amortized over the remaining vesting periods.
Stock Options
During the three-month periods ended March 31, 2011 and 2010, no options were granted, exercised or cancelled and 15,000 options expired (2010 – 738,334). The aggregate intrinsic value of options outstanding and currently exercisable as at March 31, 2011 was $7.03 per option.
Stock compensation expense recognized for stock options for the three-month period ended March 31, 2011 was €nil (2010 – €nil). All stock options have fully vested.
FORM 10-Q
QUARTERLY REPORT — PAGE 9

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 3. Net Income (Loss) Per Share Attributable to Common Shareholders
                 
    Three Months Ended  
    March 31,  
    2011     2010  
Net income (loss) attributable to common shareholders – basic
  29,053     (7,546 )
Interest on convertible notes, net of tax
    403        
 
           
Net income (loss) attributable to common shareholders – diluted
  29,456     (7,546 )
 
           
Net income (loss) per share attributable to common shareholders
               
Basic
  0.66     (0.21 )
 
           
Diluted
  0.52     (0.21 )
 
           
Weighted average number of common shares outstanding:
               
Basic(1)
    44,076,427       36,320,190  
Effect of dilutive instruments:
               
Performance rights
    330,977        
Restricted stock
    76,979        
Stock options and awards
    72,197        
Convertible notes
    12,440,562        
 
           
Diluted
    56,997,142       36,320,190  
 
           
     
(1)  
The basic weighted average number of shares excludes performance and restricted stock which have been issued, but have not vested as at March 31, 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.
Performance stock, restricted stock, stock options and awards, and shares associated with the convertible notes excluded from the calculation of diluted income (loss) per share attributable to common shareholders because they were anti-dilutive represented 375,586, 21,000, 190,000 and 20,227,893 shares, respectively, for the three-month period ended March 31, 2010.
Note 4. Inventories
                 
    March 31, 2011     December 31, 2010  
Raw materials
  36,392     47,179  
Finished goods
    31,052       27,127  
Work in process and other
    28,964       27,913  
 
           
 
  96,408     102,219  
 
           
FORM 10-Q
QUARTERLY REPORT — PAGE 10

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 5. Debt
Debt consists of the following:
                 
    March 31, 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)
  486,074     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)
    211,536       224,031  
Subordinated convertible notes due January 2012, interest at 8.5% accrued and payable semi-annually (d)
    26,138       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)
    31,804       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)
    3,263       3,807  
Credit agreement with a bank with respect to a revolving credit facility of €3,500 (i)
           
 
           
 
    758,815       821,924  
Less: current portion
    (45,393 )     (39,596 )
 
           
Debt, less current portion
  713,422     782,328  
 
           
The Company made principal repayments under these facilities of €30,351 during the three months ended March 31, 2011 (2010 — €8,250). As of March 31, 2011, the principal maturities of debt are as follows:
         
Matures   Amount  
 
       
2011
  9,126  
2012(1)
    51,810  
2013
    41,088  
2014
    40,544  
2015
    44,000  
Thereafter
    572,247  
 
     
 
  758,815  
 
     
 
     
(1)  
Including subordinated convertible notes due 2012 of €26,138 recorded as current debt as at March 31, 2011.
Certain of the Company’s debt instruments were issued under an indenture which, among other things, restricts its ability and the ability of its restricted subsidiaries to make certain payments. These limitations are subject to other important qualifications and exceptions. As at March 31, 2011, the Company was in compliance with the terms of the indenture.
FORM 10-Q
QUARTERLY REPORT — PAGE 11

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 5. Debt (continued)
(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 1.58% (rates on amounts of borrowing at March 31, 2011 range from 2.43% to 3.22%), 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 €433,573 of outstanding principal, subject to a debt service reserve account 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.
   
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 described in Note 10, held by Stendal which will be used first to fund the debt service reserve account to a level sufficient to service the amounts due and payable under the Stendal Loan Facility during the then following 12 months, or “Fully Funded”, and second to prepay the deferred principal amounts. As at March 31, 2011, the debt service reserve balance was approximately €7,000. Effective April 1, 2011, the debt service reserve balance was increased to approximately €28,300.
(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 5(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 approximately €7,500 to the loss on extinguishment of debt line in the Consolidated Statement of Operations which included the tender premium paid and the write-off of unamortized debt issue costs.
FORM 10-Q
QUARTERLY REPORT — PAGE 12

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 5. 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 5(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 9.5% which is accrued and payable semi-annually.
   
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 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.
(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 will be accreted to income through to January 2012 through interest expense yielding an effective interest rate of approximately 3% on the January 22, 2010 exchange.
FORM 10-Q
QUARTERLY REPORT — PAGE 13

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 5. Debt (continued)
   
The 2012 Notes bear interest at 8.50%, accrued and payable semi-annually, are convertible at any time by the holder into common shares of the Company at $3.30 per share and are unsecured. The Company may redeem for cash all or a portion of the notes on or after July 15, 2011 at 100% of the principal amount of the notes plus accrued interest up to the redemption date. During the three months ended March 31, 2011, approximately $6.0 million of Subordinated Convertible Notes due January 2012 were converted into 1,828,178 shares, respectively. The Company recorded a debt conversion expense of approximately €0.1 million during the three months ended March 31, 2011, as a result of the conversions, which is included within interest expense in the Interim Consolidated Statements of Operations.
(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%. During the three months ended March 31, 2011, the Company fully repaid this facility. As at March 31, 2011, approximately C$2.1 million of this facility was supporting letters of credit, leaving approximately C$35.0 million undrawn.
(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 March 31, 2011, approximately €2,200 of this facility was supporting bank guarantees leaving approximately €22,800 undrawn.
(h)  
On August 19, 2009 the Company finalized an investment loan agreement with a lender relating to the new wash press at the Rosenthal mill. The four-year amortizing investment loan was completed with a total facility of €4,351 bearing interest at the rate of Euribor plus 2.75%. Borrowings under this agreement are secured by the new wash press equipment. As at March 31, 2011, this facility was drawn by €3,263 and was accruing interest at a rate of 4.07%.
(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 will 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 March 31, 2011, this facility was undrawn.
FORM 10-Q
QUARTERLY REPORT — PAGE 14

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 6. 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 interest rate swaps, the Company pays a fixed rate and receives a floating rate with the interest payments being calculated on a notional amount. Currently, the contracts have an aggregate notional amount of €447,763 at a fixed interest rate of 5.28% and they mature 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 gain of €12,243 with respect to these interest rate swaps for the three months ended March 31, 2011 (2010 — a loss of €6,546), 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 “Unrealized interest rate derivative losses” within the long-term liabilities section in the Interim Consolidated Balance Sheets, which currently amounts to a cumulative unrealized loss of €38,730 (2010 — €50,973).
The interest rate derivative contracts are with the same banks that hold the Stendal Loan Facility and the Company does not anticipate non-performance by the banks.
Note 7. 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-month period ended March 31, 2011 totaled €465 (2010 — €156).
FORM 10-Q
QUARTERLY REPORT — PAGE 15

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 7. Pension and Other Post-Retirement Benefit Obligations (continued)
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 March 31,  
    2011     2010  
            Post-             Post-  
    Pension     Retirement     Pension     Retirement  
    Benefits     Benefits     Benefits     Benefits  
 
                               
Service cost
  22     120     19     93  
Interest cost
    385       208       397       183  
Expected return on plan assets
    (395 )           (371 )      
Recognized net loss (gain)
    130       (18 )     104       (74 )
 
                       
Net periodic benefit cost
  142     310     149     202  
 
                       
Note 8. 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 three months ended March 31, 2011, 1,828,178 shares were issued as a result of certain holders of the 2012 Notes exercising their conversion option (see Note 5(d) – Debt). In addition, 358,268 shares were issued to employees of the Company as part of the stock based performance awards and 200,000 shares of restricted stock were issued to the Chief Executive Officer of the Company.
As at March 31, 2011 and December 31, 2010, the Company had 45,386,104 and 42,999,658 common shares issued and outstanding, respectively.
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 March 31, 2011, no preferred shares had been issued by the Company.
FORM 10-Q
QUARTERLY REPORT — PAGE 16

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 9. Financial Instruments
The fair value of financial instruments at March 31, 2011 and December 31, 2010 is summarized as follows:
                                 
    March 31, 2011     December 31, 2010  
    Carrying     Fair     Carrying     Fair  
    Amount     Value     Amount     Value  
 
                               
Cash and cash equivalents
  123,241     123,241     99,022     99,022  
Investments
    258       258       275       275  
Receivables
    112,991       112,991       121,709       121,709  
Note receivable
    2,428       2,428       2,978       2,978  
Accounts payable and accrued expenses
    108,765       108,765       84,873       84,873  
Debt
    758,815       839,528       821,924       847,875  
Interest rate derivative contracts liability
    38,730       38,730       50,973       50,973  
The carrying value of cash and cash equivalents 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 notes receivable was estimated using discounted cash flows at prevailing market rates. The fair value of debt reflects recent market transactions and discounted cash flow estimates. The fair value of the interest rate derivatives is based on observable inputs including applicable yield curves. Investments are recorded at fair value based on recent transactions.
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 and Disclosures (“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 investments within Level 1 of the valuation hierarchy where quoted prices are available in an active market. Level 1 investments include exchange-traded equities.
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.
FORM 10-Q
QUARTERLY REPORT — PAGE 17

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 9. 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 March 31, 2011 using:  
    Quoted prices in                    
    active markets for     Significant other     Significant        
    identical assets     observable inputs     unobservable inputs        
Description   (Level 1)     (Level 2)     (Level 3)     Total  
 
                               
Assets
                               
Investments (a)
  258             258  
 
                       
 
                               
Liabilities
                               
Derivatives (b)
                               
— Interest rate swaps
      38,730         38,730  
 
                       
     
(a)  
Based on observable market data.
 
(b)  
Based on observable inputs for the liability (yield curves observable at specific intervals).
Note 10. 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.
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 designed 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. Consequently, the arbitration proceeding is ongoing, and there is no certainty that the Company will be successful with its claims. As at March 31, 2011, the Guarantee Amount was recognized as an increase in cash, and a corresponding increase in accounts payable until such funds are spent on remediation.
FORM 10-Q
QUARTERLY REPORT — PAGE 18

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 11. Subsequent Events
In January 2011, the Company finalized a contribution agreement with Natural Resources Canada (“NRCan”) for approximately C$9.7 million of Mercer’s allocated Green Transformation Program funding towards improving the fiber line and oxygen delignification process at the Celgar mill, referred to as the “Oxygen Delignification Project”. On April 12, 2011, the Company received approximately C$3.8 million from NRCan pursuant to the terms of the contribution agreement, which was accrued in the Interim Consolidated Balance Sheet at March 31, 2011.
FORM 10-Q
QUARTERLY REPORT — PAGE 19

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 12. 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 months ended March 31, 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
                                 
    March 31, 2011  
    Restricted     Unrestricted             Consolidated  
    Group     Subsidiaries     Eliminations     Group  
ASSETS
                               
Current assets
                               
Cash and cash equivalents
  57,202     66,039         123,241  
Receivables
    63,063       49,928             112,991  
Inventories
    59,663       36,745             96,408  
Prepaid expenses and other
    6,582       4,205             10,787  
Deferred income tax
    22,414                   22,414  
 
                       
Total current assets
    208,924       156,917             365,841  
 
                               
Long-term assets
                               
Property, plant and equipment
    350,034       480,061             830,095  
Deferred note issuance and other
    6,437       4,024             10,461  
Due from unrestricted group
    82,303             (82,303 )      
Note receivable
    890                   890  
 
                       
Total assets
  648,588     641,002     (82,303 )   1,207,287  
 
                       
 
                               
LIABILITIES
                               
Current liabilities
                               
Accounts payable and accrued expenses
  53,444     55,321         108,765  
Pension and other post-retirement benefit obligations
    703                   703  
Debt
    27,226       18,167             45,393  
 
                       
Total current liabilities
    81,373       73,488             154,861  
 
                               
Long-term liabilities
                               
Debt
    213,711       499,711             713,422  
Due to restricted group
          82,303       (82,303 )      
Unrealized interest rate derivative losses
          38,730             38,730  
Pension and other post-retirement benefit obligations
    23,412                   23,412  
Capital leases and other
    6,990       4,617             11,607  
Deferred income tax
    7,947                   7,947  
 
                       
Total liabilities
    333,433       698,849       (82,303 )     949,979  
 
                       
 
                               
EQUITY
                               
Total shareholders’ equity (deficit)
    315,155       (39,889 )           275,266  
Noncontrolling interest (deficit)
          (17,958 )           (17,958 )
 
                       
Total liabilities and equity
  648,588     641,002     (82,303 )   1,207,287  
 
                       
FORM 10-Q
QUARTERLY REPORT — PAGE 20

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 12. 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  
 
                       
FORM 10-Q
QUARTERLY REPORT — PAGE 21

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 12. Restricted Group Supplemental Disclosure (continued)
Combined Condensed Statements of Operations
                                 
    Three Months Ended March 31, 2011  
    Restricted     Unrestricted             Consolidated  
    Group     Subsidiaries     Eliminations     Group  
Revenues
                               
Pulp
  115,226     95,232         210,458  
Energy
    5,846       7,831             13,677  
 
                       
 
    121,072       103,063             224,135  
 
                       
Operating costs
    85,991       77,364             163,355  
Operating depreciation and amortization
    7,614       6,462             14,076  
Selling, general and administrative expenses and other
    6,191       3,869             10,060  
 
                       
 
    99,796       87,695             187,491  
 
                       
Operating income (loss)
    21,276       15,368             36,644  
 
                       
 
Other income (expense)
                               
Interest expense
    (7,273 )     (9,851 )     1,218       (15,906 )
Investment income (loss)
    1,279       266       (1,218 )     327  
Foreign exchange gain (loss) on debt
    1,111                   1,111  
Gain (loss) on derivative instruments
          12,243             12,243  
 
                       
Total other income (expense)
    (4,883 )     2,658             (2,225 )
 
                       
Income (loss) before income taxes
    16,393       18,026             34,419  
Income tax benefit (provision)
    (524 )     (295 )           (819 )
 
                       
Net income (loss)
    15,869       17,731             33,600  
Less: net (income) loss attributable to noncontrolling interest
          (4,547 )           (4,547 )
 
                       
Net income (loss) attributable to common shareholders
  15,869     13,184         29,053  
 
                       
                                 
    Three Months Ended March 31, 2010  
    Restricted     Unrestricted             Consolidated  
    Group     Subsidiaries     Eliminations     Group  
Revenues
                               
Pulp
  106,417     64,704         171,121  
Energy
    3,375       5,756             9,131  
 
                       
 
    109,792       70,460             180,252  
 
                       
Operating costs
    81,665       58,744             140,409  
Operating depreciation and amortization
    7,213       6,511             13,724  
Selling, general and administrative expenses and other
    4,841       3,254             8,095  
 
                       
 
    93,719       68,509             162,228  
 
                       
Operating income (loss)
    16,073       1,951             18,024  
 
                       
 
                               
Other income (expense)
                               
Interest expense
    (7,320 )     (10,264 )     1,161       (16,423 )
Investment income (loss)
    1,239       16       (1,161 )     94  
Foreign exchange gain (loss) on debt
    (5,231 )                 (5,231 )
Gain (loss) on extinguishment of debt
    (929 )                 (929 )
Gain (loss) on derivative instruments
          (6,546 )           (6,546 )
 
                       
Total other income (expense)
    (12,241 )     (16,794 )           (29,035 )
 
                       
Income (loss) before income taxes
    3,832       (14,843 )           (11,011 )
Income tax benefit (provision)
    (161 )     (43 )           (204 )
 
                       
Net income (loss)
    3,671       (14,886 )           (11,215 )
Less: net (income) loss attributable to noncontrolling interest
          3,669             3,669  
 
                       
Net income (loss) attributable to common shareholders
  3,671     (11,217 )       (7,546 )
 
                       
FORM 10-Q
QUARTERLY REPORT — PAGE 22

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 12. Restricted Group Supplemental Disclosure (continued)
Combined Condensed Statements of Cash Flows
                         
    Three Months Ended March 31, 2011  
    Restricted     Unrestricted     Consolidated  
    Group     Group     Group  
Cash flows from (used in) operating activities
                       
Net income (loss) attributable to common shareholders
  15,869     13,184     29,053  
Adjustments to reconcile net income (loss) attributable to common shareholders to cash flows from operating activities
                       
Loss (gain) on derivative instruments
          (12,243 )     (12,243 )
Foreign exchange (gain) loss on debt
    (1,111 )           (1,111 )
Depreciation and amortization
    7,676       6,462       14,138  
Accretion expense (income)
    470             470  
Noncontrolling interest
          4,547       4,547  
Stock compensation expense
    2,068             2,068  
Pension and other post-retirement expense, net of funding
    (14 )           (14 )
Other
    133       551       684  
Changes in current assets and liabilities
                       
Receivables
    6,259       918       7,177  
Inventories
    (251 )     4,564       4,313  
Accounts payable and accrued expenses
    10,962       14,426       25,388  
Other(1)
    (1,722 )     2,081       359  
 
                 
Net cash from (used in) operating activities
    40,339       34,490       74,829  
 
                 
 
                       
Cash flows from (used in) investing activities
                       
Purchase of property, plant and equipment
    (5,708 )     (2,361 )     (8,069 )
Proceeds on sale of property, plant and equipment
    3       350       353  
Notes receivable
    396             396  
 
                 
Net cash from (used in) investing activities
    (5,309 )     (2,011 )     (7,320 )
 
                 
 
                       
Cash flows from (used in) financing activities
                       
Repayment of notes payable and debt
    (15,768 )     (14,583 )     (30,351 )
Repayment of capital lease obligations
    (522 )     (333 )     (855 )
Proceeds from (repayment of) credit facilities, net
    (14,652 )           (14,652 )
Proceeds from government grants
    4,004       108       4,112  
 
                 
Net cash from (used in) financing activities
    (26,938 )     (14,808 )     (41,746 )
Effect of exchange rate changes on cash and cash equivalents
    (1,544 )           (1,544 )
 
                 
 
                       
Net increase (decrease) in cash and cash equivalents
    6,548       17,671       24,219  
Cash and cash equivalents, beginning of period
    50,654       48,368       99,022  
 
                 
Cash and cash equivalents, end of period
  57,202     66,039     123,241  
 
                 
 
     
(1)  
Includes intercompany working capital related transactions.
FORM 10-Q
QUARTERLY REPORT — PAGE 23

 

 


Table of Contents

MERCER INTERNATIONAL INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)
Note 12. Restricted Group Supplemental Disclosure (continued)
Combined Condensed Statements of Cash Flows
                         
    Three Months Ended March 31, 2010  
    Restricted     Unrestricted     Consolidated  
    Group     Group     Group  
Cash flows from (used in) operating activities
                       
Net income (loss) attributable to common shareholders
  3,671     (11,217 )   (7,546 )
Adjustments to reconcile net income (loss) attributable to common shareholders to cash flows from operating activities
                       
Loss (gain) on derivative instruments
          6,546       6,546  
Foreign exchange loss (gain) on debt
    5,231             5,231  
Loss (gain) on extinguishment of debt
    929             929  
Depreciation and amortization
    7,310       6,511       13,821  
Accretion expense (income)
    431             431  
Noncontrolling interest
          (3,669 )     (3,669 )
Stock compensation expense
    506             506  
Pension and other post-retirement expense, net of funding
    194             194  
Other
    388       615       1,003  
Changes in current assets and liabilities
                       
Receivables
    (16,382 )     (762 )     (17,144 )
Inventories
    (193 )     (5,066 )     (5,259 )
Accounts payable and accrued expenses
    (2,845 )     10,800       7,955  
Other(1)
    1,062       (2,343 )     (1,281 )
 
                 
Net cash from (used in) operating activities
    302       1,415       1,717  
 
                       
Cash flows from (used in) investing activities
                       
Purchase of property, plant and equipment
    (4,927 )     (923 )     (5,850 )
Proceeds on sale of property, plant and equipment
    54       333       387  
Note receivable
    (84 )           (84 )
 
                 
Net cash from (used in) investing activities
    (4,957 )     (590 )     (5,547 )
 
                       
Cash flows from (used in) financing activities
                       
Repayment of notes payable and debt
          (8,250 )     (8,250 )
Repayment of capital lease obligations
    (382 )     (622 )     (1,004 )
Proceeds from government investment grants
    9,415             9,415  
 
                 
Net cash from (used in) financing activities
    9,033       (8,872 )     161  
Effect of exchange rate changes on cash and cash equivalents
    1,070             1,070  
 
                 
 
                       
Net increase (decrease) in cash and cash equivalents
    5,448       (8,047 )     (2,599 )
Cash and cash equivalents, beginning of period
    20,635       30,656       51,291  
 
                 
Cash and cash equivalents, end of period
  26,083     22,609     48,692  
 
                 
 
     
(1)  
Includes intercompany working capital related transactions.
FORM 10-Q
QUARTERLY REPORT — PAGE 24

 

 


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 March 31, 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; and (vii) “MW” refers to megawatts and “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 months ended March 31, 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
During the first quarter of 2011, the global market for NBSK pulp remained well balanced, and NBSK pulp prices remained at historically high levels. However, price increases in the quarter were largely offset by the weakening of the U.S. dollar. Looking ahead into 2011, we currently expect demand/supply conditions to result in a continued favorable outlook for our business.
FORM 10-Q
QUARTERLY REPORT — PAGE 25

 

 


Table of Contents

First Quarter Operational Snapshot
Selected production, sales and exchange rate data for the three months ended March 31, 2011 and 2010 is as follows:
                 
    Three Months Ended  
    March 31,  
    2011     2010  
Pulp Production (‘000 ADMTs)
    358.6       329.5  
Scheduled Production Downtime (‘000 ADMTs)
    3.7       18.2  
Pulp Sales (‘000 ADMTs)
    349.0       332.9  
Pulp Revenues (in millions)
  210.5     171.1  
NBSK pulp list prices in Europe ($/ADMT)
  $ 960     $ 860  
NBSK pulp list prices in Europe (€/ADMT)
  702     621  
Average pulp sales realizations (€/ADMT)(1)
  593     507  
 
               
Energy Production (‘000 MWh)
    407.8       337.7  
Energy Sales (‘000 MWh)
    157.9       107.1  
Energy Revenue (in millions)
  13.7     9.1  
Average energy sales realizations (€/MWh)
  87     85  
 
               
Average Spot Currency Exchange Rates
               
€ / $(2)
    0.7304       0.7240  
C$ / $(2)
    0.9856       1.0401  
C$ / €(3)
    1.3487       1.4406  
 
     
(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 March 31, 2011 Compared to Three Months Ended March 31, 2010
Total revenues for the three months ended March 31, 2011 increased to €224.1 million ($306.6 million) from €180.3 million ($249.5 million) in the same period in 2010.
Pulp revenues for the three months ended March 31, 2011 increased by approximately 23% to €210.5 million from €171.1 million in the comparative quarter of 2010, primarily due to higher pulp prices, being partially offset by a weaker U.S. dollar. Revenues from the sale of excess energy increased by approximately 51% to a record €13.7 million in the first quarter from €9.1 million in the same quarter last year, primarily as a result of energy sales from the Celgar Green Energy Project in 2011.
Pulp prices in the first quarter of 2011 were higher than in the same period last year due to the continued strengthening in global pulp markets. List prices for NBSK pulp in Europe were approximately $960 (€702) per ADMT in the current quarter compared to approximately $860 (€621) per ADMT in the first quarter of 2010 and $950 (€709) at the end of 2010. In the first quarter of 2011, average pulp sales realizations increased by approximately 17% to €593 per ADMT from €507 per ADMT in the same period last year, primarily due to higher pulp prices.
Pulp production increased to 358,557 ADMTs in the current quarter from 329,455 ADMTs in the same quarter of 2010, primarily due to only two days of scheduled maintenance downtime at our Stendal mill in the current quarter, compared to ten days at Stendal in the first quarter of 2010.
FORM 10-Q
QUARTERLY REPORT — PAGE 26

 

 


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We have ten days (approximately 15,000 ADMTs) of scheduled maintenance downtime planned for our Celgar mill in the second quarter of 2011.
Pulp sales volume increased to 348,995 ADMTs in the current quarter from 332,869 ADMTs in the comparative period of 2010, primarily as a result of stronger demand.
Costs and expenses in the first quarter of 2011 increased to €187.5 million from €162.2 million in the comparative period of 2010, primarily due to higher fiber costs.
In the first quarter of 2011, operating depreciation and amortization increased slightly to €14.1 million from €13.7 million in the same quarter last year. Selling, general and administrative expenses increased to €10.2 million from €8.1 million in the first quarter of 2010, primarily as a result of a higher non-cash stock compensation expense resulting from a higher share price.
Transportation costs increased to €15.5 million in the first quarter of 2011 from €14.2 million in the first quarter of 2010, primarily due to higher container rates and fuel costs.
On average, our per unit fiber costs in the quarter increased by approximately 20% from the same period in 2010, primarily due to low harvesting activity in Germany as a result of the downturn in the lumber industry which has been compounded by demand for fiber from the European wood pellet and particle board industries. As a result, our German mills have been required to source fiber outside their traditional fiber baskets. We currently expect our overall fiber costs to remain stable at these levels in the short- to mid-term.
For the first quarter of 2011, operating income increased by approximately 103% to €36.6 million from €18.0 million in the comparative quarter of 2010, primarily due to significantly higher pulp prices.
Interest expense in the first quarter of 2011 decreased to €15.9 million from €16.4 million in the comparative quarter of 2010, primarily due to reduced levels of debt associated with the Stendal mill.
Our Stendal mill recorded an unrealized gain of €12.2 million on the mark to market of its interest rate derivatives in the current quarter, compared to an unrealized loss of €6.5 million in the same quarter of last year. We recorded a foreign exchange gain of €1.1 million on our foreign currency denominated debt in the first quarter of 2011 compared to a foreign exchange loss of €5.2 million in the same period of 2010.
During the current quarter, we recorded €0.8 million of net income tax expense, compared to net income tax expense of €0.2 million in the same period last year.
In the first quarter of 2011, the noncontrolling shareholder’s interest in the Stendal mill’s income was €4.5 million, compared to a loss of €3.7 million in the same quarter last year.
We reported net income attributable to common shareholders of €29.1 million, or €0.66 per basic and €0.52 per diluted share for the first quarter of 2011, which included aggregate non-cash unrealized gains of €12.2 million on the Stendal interest rate derivatives and a €1.1 million non-cash foreign exchange gain on our debt, partially offset by a non-cash charge for stock compensation of €2.1 million. In the first quarter of 2010, the net loss attributable to common shareholders was €7.5 million, or €0.21 per basic and diluted share, which included non-cash unrealized losses of €6.5 million on the Stendal interest rate derivatives and a non-cash foreign exchange loss of €5.2 million on our debt.
FORM 10-Q
QUARTERLY REPORT — PAGE 27

 

 


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Operating EBITDA in the first quarter of 2011 was €50.8 million, compared to €31.8 million in the first 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.
FORM 10-Q
QUARTERLY REPORT — PAGE 28

 

 


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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  
    March 31,  
    2011     2010  
    (in thousands)  
Net income (loss) attributable to common shareholders
  29,053     (7,546 )
Net income (loss) attributable to noncontrolling interest
    4,547       (3,669 )
Income taxes (benefits)
    819       204  
Interest expense
    15,906       16,423  
Investment (income) loss
    (327 )     (94 )
Foreign exchange (gain) loss on debt
    (1,111 )     5,231  
Loss (gain) on extinguishment of debt
          929  
Loss (gain) on derivative instruments
    (12,243 )     6,546  
 
           
Operating income (loss)
    36,644       18,024  
Add: Depreciation and amortization
    14,138       13,821  
 
           
Operating EBITDA
  50,782     31,845  
 
           
Liquidity and Capital Resources
The following table is a summary of selected financial information at the dates indicated:
                 
    March 31,     December 31,  
    2011     2010  
    (in thousands)  
Financial Position
               
Cash and cash equivalents
  123,241     99,022  
Working capital
    210,980       231,683  
Property, plant and equipment
    830,095       846,767  
Total assets
    1,207,287       1,216,075  
Long-term liabilities
    795,118       877,315  
Total equity
    257,308       213,563  
As at March 31, 2011, our cash and cash equivalents had increased to €123.2 million from €99.0 million at the end of 2010, and working capital had decreased to €211.0 million from €231.7 million at the end of 2010.
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”) and our 8.5% convertible senior subordinated notes due 2012.
During the first quarter of 2011, we redeemed all of our previously outstanding 9.25% senior notes due 2013 and repaid approximately C$20.0 million of principal under our Celgar loan facility.
At March 31, 2011, our Celgar mill had approximately C$4.7 million of grant monies related to holdbacks that we expect to receive in the second half of 2011 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, or “NRCan”, for approximately C$9.7 million of unallocated Green Transformation Program or “GTP” funds to be used towards improving the fiber line and oxygen delignification process at the Celgar mill. As of April 2011, the Company has received approximately C$3.8 million of such funds.
FORM 10-Q
QUARTERLY REPORT — PAGE 29

 

 


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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 our generator acid purification system at our Celgar mill. We expect to receive approximately C$1.6 million (€1.2 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 March 31, 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.
Cash provided by operating activities increased to €74.8 million in the three months ended March 31, 2011 from €1.7 million in the same period of 2010, primarily due to significantly higher net income and an increase in accounts payable and accrued expenses. A decrease in receivables provided cash of €7.2 million in the first three months of 2011, compared to an increase in receivables using cash of €17.1 million in the first three months of 2010. A decrease in inventories provided cash of €4.3 million in the first three months of 2011, compared to an increase in inventories using cash of €5.3 million in the first three months of 2010. An increase in accounts payable and accrued expenses provided cash of €25.4 million in the first three months of 2011, compared to an increase in accounts payable and accrued expenses providing cash of €8.0 million, in the first three months of 2010.
Cash Flows from Investing Activities. Investing activities in the first three months of 2011 used cash of €7.3 million, compared to using cash of €5.5 million in the same period of 2010. Capital expenditures in the first three months of 2011 used cash of €8.1 million, compared to €5.9 million in the same period of 2010.
Cash Flows from Financing Activities. In the first three months of 2011, financing activities used cash of €41.7 million, compared to providing cash of €0.2 million in the same period last year, primarily as a result of cash used to redeem our 9.25% senior notes due 2013, to repay €14.6 million of the principal under the Stendal Loan Facility and to repay €14.7 million of borrowings under the revolving facility at our Celgar mill. Repayment of indebtedness used cash of €30.4 million in the three months ended March 31, 2011, compared to using cash of €8.3 million in the three months ended March 31, 2010.
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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 three 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.
We translate foreign denominated assets and liabilities into Euros at the rate of exchange on the balance sheet date. Unrealized gains or losses from these translations are recorded in our consolidated statement of comprehensive income and impact on shareholders’ equity on the balance sheet but do not affect our net earnings.
In the three months ended March 31, 2011, accumulated other comprehensive income increased by €3.7 million to €35.5 million, primarily due to the foreign exchange translation.
Based upon the exchange rate at March 31, 2011, the U.S. dollar has weakened by approximately 5% in value against the Euro since March 31, 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 12 of our Interim Consolidated Financial Statements included herein.
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Restricted Group Results — Three Months Ended March 31, 2011 Compared to Three Months Ended March 31, 2010
Total revenues for the Restricted Group increased to €121.1 million ($165.7 million) in the first quarter of 2011, compared to €109.8 million ($152.0 million) in the first quarter of 2010.
Pulp revenues for the Restricted Group for the three months ended March 31, 2011 increased by approximately 8% to €115.2 million from €106.4 million in the comparative period of 2010, primarily due to higher pulp prices, partially offset by a weaker U.S. dollar. Revenues from the sale of excess energy increased by approximately 71% in the current quarter to a record €5.8 million from €3.4 million in the same period last year, primarily due to energy sales from the Celgar energy project in 2011.
Pulp prices were higher in the first quarter of 2011 than in the same period last year due to continued strengthening in global pulp markets. List prices for NBSK pulp in Europe were approximately $960 (€702) per ADMT in the current quarter compared to approximately $860 (€621) per ADMT in the first quarter of 2010. In the first quarter of 2011, average pulp sales realizations for the Restricted Group increased by approximately 16% to €596 per ADMT from €513 per ADMT in the same period last year.
Pulp production for the Restricted Group decreased slightly to 204,306 ADMTs in the first quarter of 2011 from 210,336 ADMTs in the same period of 2010, primarily as a result of minor temporary equipment failures adversely affecting production at our Celgar mill.
Pulp sales volume of the Restricted Group decreased slightly to 193,236 ADMTs in the first quarter of 2011 from 207,431 ADMTs in the comparative period of 2010, primarily due to lower production levels at our Celgar mill.
Costs and expenses for the Restricted Group in the first quarter of 2011 increased to €99.8 million from €93.7 million in the comparative period of 2010, primarily due to higher fiber costs at our Rosenthal mill.
In the first quarter of 2011, operating depreciation and amortization for the Restricted Group increased to €7.6 million from €7.2 million in the same period last year. Selling, general and administrative expenses and other for the Restricted Group increased to €6.2 million from €4.8 million in the comparative period of 2010, primarily as a result of a higher non-cash stock compensation expense resulting from a higher share price.
Transportation costs for the Restricted Group were unchanged at €11.2 million in the first quarter of 2011 and the same quarter last year.
Overall, per unit fiber costs of the Restricted Group in the first quarter of 2011 increased by approximately 16% compared to the same period in 2010, primarily due to higher fiber costs at our Rosenthal mill, mainly due to continued low harvesting rates in Germany and high demand from both the European wood pellet and particle board industries.
In the first quarter of 2011, the Restricted Group reported operating income of €21.3 million compared to operating income of €16.1 million in the first quarter of 2010, primarily due to significantly higher pulp price realizations.
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Interest expense for the Restricted Group remained unchanged at approximately €7.3 million in the first quarter of this year and last year.
In the first quarter of 2011, the Restricted Group recorded a foreign exchange gain on foreign currency denominated debt of €1.1 million, compared to a loss on foreign currency denominated debt of €5.2 million in the comparative quarter of 2010.
During the first quarter of 2011, the Restricted Group recorded €0.5 million of net income tax expense, compared to net income tax expense of €0.2 million in the same period last year.
The Restricted Group reported net income for the first quarter of 2011 of €15.9 million compared to net income of €3.7 million in the same period last year.
In the first quarter of 2011, the Restricted Group reported Operating EBITDA of €29.0 million compared to Operating EBITDA of €23.4 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 March 31, 2011 for additional information relating to such limitations and Operating EBITDA.
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  
    March 31,  
    2011     2010  
    (in thousands)  
Restricted Group(1)
               
Net income (loss)
  15,869     3,671  
Income taxes (benefits)
    524       161  
Interest expense
    7,273       7,320  
Investment (income) loss
    (1,279 )     (1,239 )
Foreign exchange (gain) loss on debt
    (1,111 )     5,231  
Loss (gain) on extinguishment of debt
          929  
 
           
Operating income (loss)
    21,276       16,073  
Add: Depreciation and amortization
    7,676       7,310  
 
           
Operating EBITDA
  28,952     23,383  
 
           
 
     
(1)  
See Note 12 of the interim consolidated financial statements included elsewhere herein for a reconciliation to our consolidated results.
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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:
                 
    March 31,     December 31,  
    2011     2010  
    (in thousands)  
Restricted Group Financial Position(1)
               
Cash and cash equivalents
  57,202     50,654  
Working capital
    127,551       150,667  
Property, plant and equipment
    350,034       362,274  
Total assets
    648,588       662,944  
Long-term liabilities
    252,060       312,631  
Total equity
    315,155       289,141  
 
     
(1)  
See Note 12 of the interim consolidated financial statements included elsewhere herein for a reconciliation to our consolidated results.
At March 31, 2011, cash and cash equivalents for the Restricted Group increased to €57.2 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.
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.
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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, that 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;
   
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 Celgar energy project may not generate the results or benefits we expect;
   
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;
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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.
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. European list pulp prices remained at historically high levels through the first quarter of 2011, and reached a record of $1,010 per ADMT in April 2011.
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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 wood 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 first three months of 2011, we recorded an unrealized gain of €12.2 million on our outstanding interest rate derivatives compared to an unrealized loss of €6.5 million in the comparative 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: May 9, 2011
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