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MERC > SEC Filings for MERC > Form 10-Q on 2-Nov-2012All Recent SEC Filings

Show all filings for MERCER INTERNATIONAL INC.

Form 10-Q for MERCER INTERNATIONAL INC.


2-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

In this document: (i) unless the context otherwise requires, references to "we", "our", "us", the "Company" or "Mercer" mean Mercer International Inc. and its subsidiaries; (ii) references to "Mercer Inc." mean the Company excluding its subsidiaries; (iii) information is provided as of September 30, 2012, unless otherwise stated; (iv) all references to monetary amounts are to "Euros", the lawful currency adopted by most members of the European Union, unless otherwise stated; (v) "" refers to Euros, "$" refers to U.S. dollars and "C$" refers to Canadian dollars; (vi) "ADMTs" refers to air-dried metric tonnes; (vii) "MW" refers to megawatts; and (viii) "MWh" refers to megawatt hours.

Results of Operations

General

We operate three northern bleached softwood kraft ("NBSK") pulp mills through our wholly owned subsidiaries, Rosenthal and Celgar, and our 74.9% owned subsidiary, Stendal, which have a consolidated annual production capacity of approximately 1.5 million ADMTs.

The following discussion and analysis of our results of operations and financial condition for the three and nine months ended September 30, 2012 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, 2011 filed with the Securities and Exchange Commission (the "SEC").

Current Market Environment

During the three months ended September 30, 2012, NBSK pulp prices decreased due to global economic uncertainty and the traditionally low pulp demand of the summer period. We believe that the market is bottoming and we currently anticipate that NBSK pulp prices will begin to gradually increase in the medium term as a result of improving demand and the relatively low level of NBSK inventories globally.

FORM 10-Q

QUARTERLY REPORT - PAGE 29

--------------------------------------------------------------------------------
Third Quarter Operational Snapshot

Selected production, sales and exchange rate data for the three and nine months
ended September 30, 2012 and 2011 is as follows:



                                                  Three Months Ended            Nine Months Ended
                                                    September 30,                 September 30,
                                                  2012           2011          2012           2011
Pulp production ('000 ADMTs)                        373.4         362.3        1,118.8        1,088.8
Scheduled production downtime ('000 ADMTs)           10.2           8.3           32.8           24.5
Pulp sales ('000 ADMTs)                             404.3         321.3        1,138.3        1,027.9
Pulp revenues (in millions)                        205.1        190.4         590.6         618.2
Average NBSK pulp list prices in Europe
($/ADMT)(1)                                    $      777      $    980      $     817      $     986
Average NBSK pulp list prices in Europe
(/ADMT)                                             620          694           637           701
Average pulp sales realizations (/ADMT)(2)          501          584           512           592

Energy production ('000 MWh)                        436.5         402.5        1,298.2        1,230.9
Energy sales ('000 MWh)                             181.3         149.3          546.4          483.1
Energy revenue (in millions)                        15.2         14.4          46.2          42.0
Average energy sales realizations (/MWh)             84           96            85            87
Chemical sales revenue (in millions)                 2.9          2.3           8.9           7.8
Total energy and chemical sales revenue (in
millions)                                           18.2         16.6          55.1          49.7

Average spot currency exchange rates
 / $(3)                                           0.7999        0.7084         0.7807         0.7110
C$ / $(3)                                          0.9954        0.9803         1.0022         0.9778
C$ / (4)                                          1.2452        1.3835         1.2847         1.3752

(1) Source: RISI pricing report.

(2) Sales realizations after discounts. Incorporates the effect of pulp price variations occurring between the order and shipment dates.

(3) Average Federal Reserve Bank of New York noon spot rate over the reporting period.

(4) Average Bank of Canada noon spot rates over the reporting period.

Three Months Ended September 30, 2012 Compared to Three Months Ended September 30, 2011

Total revenues for the three months ended September 30, 2012 increased to 223.3 million ($279.6 million) from 207.1 million ($292.4 million) in the same period in 2011, due to higher pulp and energy sales volumes and a stronger U.S. dollar relative to the Euro, partially offset by lower average pulp realizations.

Pulp revenues for the three months ended September 30, 2012 increased to 205.1 million from 190.4 million in the comparative quarter of 2011, primarily due to record pulp sales volumes and a stronger U.S. dollar relative to the Euro, partially offset by lower average pulp realizations. The U.S. dollar was approximately 13% stronger versus the Euro in the current quarter compared to the same quarter of last year.

Energy and chemical revenues increased by approximately 10% to 18.2 million in the third quarter from 16.6 million in the same quarter last year, primarily as a result of strong production at all of our mills. Energy and chemical revenues in the quarter included 15.2 million from the sale of electricity and 2.9 million of revenue from the sale of a biochemical called tall oil. Tall oil had previously been classified as an offset to operating costs and has been included with revenues as we currently expect proceeds from the sale of tall oil to remain stable in future periods.

FORM 10-Q

QUARTERLY REPORT - PAGE 30


List prices for NBSK pulp in Europe were approximately 620 ($777) per ADMT in the current quarter, compared to 694 ($980) per ADMT in the same quarter last year. In the third quarter of 2012, average pulp sales realizations decreased by 14% to 501 ($627) per ADMT from 584 ($824) per ADMT in the same quarter last year, primarily due to lower pulp prices, partially offset by a stronger U.S. dollar relative to the Euro.

Pulp production increased to 373,369 ADMTs in the current quarter from 362,330 ADMTs in the same quarter of 2011, due to increased production at our Rosenthal and Stendal mills. We took seven days (approximately 10,200 ADMTs) of scheduled maintenance downtime at our Celgar mill in the third quarter of 2012.

Pulp sales volumes increased by approximately 26% and 16% to a record 404,301 ADMTs in the current quarter from 321,338 ADMTs and 349,177 ADMTs in the comparative and prior quarters, respectively, primarily as a result of increased sales to China. During the current quarter, our Celgar and Stendal mills ramped up sales volumes to realize upon increased demand from China in the latter part of the quarter and re-balanced their inventory levels.

Costs and expenses in the third quarter of 2012 increased by 26% to 216.1 million from 171.8 million in the comparative period of 2011, primarily due to a 26% increase in sales volumes.

In the third quarter of 2012, operating depreciation and amortization increased to 15.0 million from 13.8 million in the same quarter last year. Selling, general and administrative expenses were 10.0 million in the third quarter of 2012, compared to 8.8 million in the third quarter of 2011, primarily as a result of higher stock compensation and selling costs.

Transportation costs increased to 21.1 million in the third quarter of 2012 from 15.3 million in the third quarter of 2011, primarily due to higher sales volumes, including significantly higher sales to China.

On average, our per unit fiber costs in the current quarter decreased by approximately 9% from the same period in 2011, due to lower fiber costs in Germany caused by reduced demand for fiber by other residual fiber users. Fiber costs at our Celgar mill were slightly higher, primarily due to increased demand for fiber. As we move into the fourth quarter, we currently expect fiber prices for our German mills to increase slightly as a result of seasonal demand and to decline slightly at our Celgar mill due to increased regional sawmill activity.

For the third quarter of 2012, operating income decreased to 7.2 million from 35.3 million in the comparative quarter of 2011, primarily due to lower average pulp realizations, partially offset by a stronger U.S. dollar relative to the Euro and lower fiber costs.

Interest expense in the third quarter of 2012 and 2011 was unchanged at 14.1 million.

We recorded a derivative loss of 0.9 million, which includes an approximately 0.3 million gain related to a fixed price pulp swap contract entered into in the second quarter of 2012 and an unrealized loss of 1.2 million on the mark to market adjustment of our Stendal mill's interest rate derivative, compared to an unrealized derivative loss of 10.5 million in the same quarter of last year. We did not incur any foreign exchange gain or loss on our foreign currency denominated debt in the third quarter of 2012, compared to a loss of 0.2 million in the same period of 2011.

FORM 10-Q

QUARTERLY REPORT - PAGE 31


During the current quarter, we recorded an income tax expense of 1.9 million, compared to an expense of 3.1 million in the same quarter of 2011, due to decreased taxable income.

In the third quarter of 2012, the noncontrolling shareholder's interest in the Stendal mill's income was 0.6 million, compared to a loss of 0.8 million in the same quarter last year.

We reported a net loss attributable to common shareholders of 9.7 million, or 0.17 per basic and diluted share, for the third quarter of 2012, which included a total non-cash unrealized loss of 1.3 million on the fixed price pulp swaps and Stendal interest rate derivative and a non-cash charge for stock compensation of 0.9 million. In the third quarter of 2011, net income attributable to common shareholders was 8.4 million, or 0.15 per basic and diluted share, which included a non-cash unrealized loss of 10.7 million, or 0.19 per basic share, on the Stendal interest rate derivative and foreign exchange losses on certain of our foreign currency denominated debt and a non-cash charge for stock compensation of 0.3 million.

Operating EBITDA in the third quarter of 2012 was 22.3 million, compared to 49.2 million in the third quarter of 2011. 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 (loss) 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 32

--------------------------------------------------------------------------------
The following table provides a reconciliation of net income (loss) attributable
to common shareholders to operating income and Operating EBITDA for the periods
indicated:



                                                               Three Months Ended
                                                                  September 30,
                                                               2012           2011
                                                                 (in thousands)
 Net income (loss) attributable to common shareholders         (9,712 )      8,440
 Net income (loss) attributable to noncontrolling interest         566          (838 )
 Income tax provision                                            1,910         3,124
 Interest expense                                               14,084        14,117
 Loss (gain) on derivative instruments                             883        10,484
 Foreign exchange loss on debt                                      -            181
 Other expense (income)                                           (517 )        (201 )

 Operating income                                                7,214        35,307
 Add: Depreciation and amortization                             15,054        13,893

 Operating EBITDA                                              22,268       49,200

Nine Months Ended September 30, 2012 Compared to Nine Months Ended September 30, 2011

Total revenues for the nine months ended September 30, 2012 decreased to 645.7 million ($827.9 million) from 667.9 million ($939.5 million) in the same period of 2011, primarily due to lower average pulp prices, partially offset by higher pulp and energy sales volumes and a stronger U.S. dollar relative to the Euro.

Pulp revenues for the nine months ended September 30, 2012 decreased to 590.6 million from 618.2 million in the comparative period of 2011, primarily due to lower pulp prices, partially offset by higher sales volumes and a stronger U.S. dollar compared to the Euro. The U.S. dollar was approximately 10% stronger versus the Euro in the nine months ended September 30, 2012 compared to the same period of 2011.

Energy and chemical revenues increased by approximately 11% to 55.1 million in the nine months ended September 30, 2012 from 49.7 million in the same period last year, primarily as a result of strong production at all of our mills. Energy and chemical revenues in the period include 46.2 million in revenues from the sale of electricity at our mills and 8.9 million from the sale of tall oil at our Stendal mill.

List prices for NBSK pulp in Europe were approximately 637 ($817) per ADMT in the nine months ended September 30, 2012, compared to 701 ($986) per ADMT in the same period of 2011. In the nine months ended September 30, 2012, average pulp sales realizations decreased by 14% to 512 ($656) per ADMT from 592 ($833) per ADMT in the same period last year, primarily due to lower pulp prices, partially offset by a stronger U.S. dollar relative to the Euro.

FORM 10-Q

QUARTERLY REPORT - PAGE 33


Pulp production increased to 1,118,758 ADMTs in the nine months ended September 30, 2012 from 1,088,801 ADMTs in the same period of 2011, due to increased pulp production at our Celgar and Stendal mills.

Pulp sales volumes increased by approximately 11% to 1,138,304 ADMTs in the nine months ended September 30, 2012 from 1,027,918 ADMTs in the comparative period of 2011, primarily as a result of a significant increase in sales to China. During the third quarter of 2012, our Celgar and Stendal mills ramped up sales volumes to take advantage of increased demand from China in the latter part of the third quarter and re-balanced their inventory levels.

Costs and expenses in the nine months ended September 30, 2012 increased by approximately 8% to 603.9 million from 559.7 million in the same period of 2011, primarily due to an 11% increase in sales volumes, partially offset by lower fiber costs.

In the nine months ended September 30, 2012, operating depreciation and amortization increased to 43.8 million from 41.8 million in the same period last year. Selling, general and administrative expenses were 28.7 million in the nine months ended September 30, 2012, compared to 27.4 million in the same period of 2011.

Transportation costs increased to 56.5 million in the nine months ended September 30, 2012 from 47.5 million in the same period of 2011, primarily due to increased shipments to China and higher container costs.

On average, our per unit fiber costs in the nine months ended September 30, 2012 decreased by approximately 6% from the same period in 2011, primarily due to lower fiber costs in Germany caused by decreased demand from other residual fiber users. Fiber costs at our Celgar mill were higher, primarily due to increased demand for fiber. As we move into the fourth quarter, we currently expect fiber prices for our German mills to increase slightly as a result of seasonal demand and to decline slightly at our Celgar mill due to increased regional sawmill activity.

For the nine months ended September 30, 2012, operating income decreased to 41.8 million from 108.2 million in the same period of 2011, primarily due to lower pulp prices, partially offset by a stronger U.S. dollar relative to the Euro and lower fiber costs.

Interest expense in the nine months ended September 30, 2012 decreased to 42.1 million from 44.9 million in the comparative period of 2011, primarily due to reduced debt levels associated with the Stendal mill and the conversion of our remaining convertible notes in 2011.

We recorded a derivative gain of 1.3 million which included an approximately 1.9 million gain related to a fixed price pulp swap contract entered into in the second quarter of 2012, partially offset by an unrealized loss of 0.6 million on the mark to market adjustment of our Stendal mill's interest rate derivative during the nine months ended September 30, 2012, compared to an unrealized derivative loss of 0.6 million in the same period of 2011. We did not incur a foreign exchange gain or loss on our foreign currency denominated debt in the nine months ended September 30, 2012, compared to a gain of 1.3 million in the same period of 2011.

Our current tax expense increased to 7.2 million, compared to 3.9 million in the same period of 2011, primarily relating to changes in uncertain positions as a result of certain ongoing tax audits during the current period. Accordingly, we also reversed certain valuation allowances during the nine months ended September 30, 2012, resulting in a deferred tax recovery of 2.3 million, compared to a deferred tax provision of 3.7 million for the comparative period of 2011.

FORM 10-Q

QUARTERLY REPORT - PAGE 34


In the nine months ended September 30, 2012, the noncontrolling shareholder's interest in the Stendal mill's income was 2.9 million, compared to 5.2 million in the same period last year.

We reported net loss attributable to common shareholders of 7.0 million, or 0.13 per basic and diluted share, for the nine months ended September 30, 2012, which included a total non-cash unrealized gain of 0.8 million on the fixed price pulp swaps and Stendal interest rate derivative, more than offset by a non-cash charge for stock compensation of 1.8 million. In the nine months ended September 30, 2011, net income attributable to common shareholders was 51.9 million, or 1.07 per basic and 0.92 per diluted share, which included a non-cash unrealized loss of 0.6 million on the Stendal interest rate derivative, a 1.3 million non-cash foreign exchange gain on certain of our foreign currency denominated debt and a non-cash charge for stock compensation of 2.8 million.

Operating EBITDA in the nine months ended September 30, 2012 was 85.7 million, compared to 150.1 million in the same period of 2011. Operating EBITDA is defined as operating income (loss) plus depreciation and amortization and non-recurring capital asset impairment charges. Operating EBITDA has significant limitations as an analytical tool, and should not be considered in isolation, or as a substitute for analysis of our results as reported under GAAP. See the discussion of our results for the three months ended September 30, 2012 for additional information relating to such limitations of Operating EBITDA.

The following table provides a reconciliation of net income (loss) attributable to common shareholders to operating income and Operating EBITDA for the periods indicated:

                                                              Nine Months Ended
                                                                September 30,
                                                             2012          2011
                                                               (in thousands)
   Net income (loss) attributable to common shareholders    (7,024 )      51,876
   Net income attributable to noncontrolling interest         2,865          5,175
   Income tax provision                                       4,907          7,561
   Interest expense                                          42,080         44,906
   Loss (gain) on derivative instruments                     (1,336 )          580
   Foreign exchange gain on debt                                 -          (1,272 )
   Other expense (income)                                       261           (664 )

   Operating income                                          41,753        108,162
   Add: Depreciation and amortization                        43,992         41,960

   Operating EBITDA                                         85,745       150,122

FORM 10-Q

QUARTERLY REPORT - PAGE 35

--------------------------------------------------------------------------------
Liquidity and Capital Resources

The following table is a summary of selected financial information at the dates
indicated:



                                             As at              As at
                                         September 30,       December 31,
                                             2012                2011
                                                  (in thousands)
        Financial Position
        Cash and cash equivalents              126,169           105,072
        Marketable securities                       190             12,372 (1)
        Working capital                         220,480            247,159
        Property, plant and equipment           815,661            820,974
        Total assets                          1,220,739          1,217,250
        Long-term liabilities                   775,041            807,641
        Total equity                            288,784            283,542

(1) Principally comprised of German federal government bonds with a maturity of less than one year.

As at September 30, 2012, our cash and cash equivalents and short-term German federal government bonds increased to 126.2 million from 117.3 million and working capital had decreased to 220.5 million from 247.2 million compared to the end of 2011.

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 facilities relating to our development of the Stendal mill ("Stendal Loan Facility") and for its Project Blue Mill, capital expenditures and interest payments on our outstanding 9.5% Senior Notes (the "Senior Notes").

In October 2012, we extended our 25.0 million Rosenthal revolving working capital facility to October 31, 2016.

Debt Covenants

Our long-term obligations contain various financial tests and covenants customary to these types of arrangements.

Our Stendal mill has established the Stendal Loan Facility and a project loan facility for Project Blue Mill (collectively the "Facilities") which require Stendal to maintain a similar leverage ratio of total debt thereunder to EBITDA (the "Stendal Ratio"). An aggregate of 80% of the principal amount of the tranches under the Facilities are severally guaranteed by German federal and state governments, and the Facilities are without recourse to the "Restricted Group" which is comprised of Mercer Inc., the Rosenthal and Celgar mills, and certain holding subsidiaries. Because of volatility in foreign exchange rates and pulp prices we can give no assurance that the Stendal mill will be in compliance with the Stendal Ratio as of December 31, 2012. We have entered into discussions with the Stendal mill's lenders and currently expect to receive, if required, a satisfactory amendment or waiver. Additionally, we have the right to cure any breach of the Stendal Ratio by providing additional equity to Stendal. In the event that the Stendal mill is not in compliance with the Stendal Ratio, we are not able to acquire a satisfactory amendment or waiver of such covenant, and we do not undertake to cure the breach by providing additional equity to Stendal, the Stendal mill would be in default under the Facilities and the Stendal mill's lenders would be entitled to pursue their remedies thereunder. This would have a material adverse effect on the Stendal mill, our business and our consolidated results of operations.

FORM 10-Q

QUARTERLY REPORT - PAGE 36


As at September 30, 2012, 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 . . .

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