MERC

Business Context and Reporting Period

Company: Mercer International Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2010
Reporting Currency: Euros (€)
Operations: The Company operates three northern bleached softwood kraft (NBSK) pulp mills (Rosenthal, Celgar, and Stendal) with a consolidated annual production capacity of approximately 1.5 million air-dried metric tonnes (ADMTs). The Company also generates revenue from the sale of excess energy.

Key Financial Metrics (Nine Months Ended Sept 30, 2010)

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 44% to €654.9 million from €454.7 million in the prior year period. Pulp revenues rose 48% to €624.1 million, driven by significantly higher pulp prices (average realization €590/ADMT vs. €380/ADMT) and a stronger U.S. dollar relative to the Euro.
• Profitability Turnaround: The Company reported an operating income of €117.3 million, a significant improvement from an operating loss of €22.6 million in the same period of 2009. Net income attributable to common shareholders was €51.0 million, compared to a net loss of €64.9 million in 2009.
• Cost Increases: Operating costs increased to €471.0 million from €417.6 million, primarily due to higher fiber costs (up 23% per unit) and energy costs related to turbine maintenance at the Rosenthal mill.
• Debt Reduction: Total debt decreased slightly to €816.7 million from €829.2 million at year-end 2009, aided by the conversion of approximately €15.4 million of 2010 Convertible Notes into 2012 Convertible Notes.
• Liquidity Improvement: Cash and cash equivalents increased by 66% to €85.1 million from €51.3 million at December 31, 2009. Working capital increased to €176.8 million from €99.2 million.

Guidance, Outlook, and Risks

• Market Outlook: Management expects a reasonably favorable outlook for the fourth quarter, citing improving Chinese demand and low NBSK pulp inventory levels, despite some softness in pricing due to new capacity coming online.
• Energy Project: The Celgar Energy Project was completed in September 2010, providing a new stable revenue source unrelated to pulp pricing.
• Credit Ratings: In May and June 2010, S&P and Moody's upgraded the Company's credit ratings (S&P to B, Moody's to B3) citing improved liquidity and favorable pulp prices.
• Key Risks:
  • Cyclicality: The pulp business is highly cyclical; prices are volatile and driven by global economic conditions and supply/demand imbalances.
  • Foreign Exchange: Results are sensitive to exchange rates, particularly the U.S. dollar and Canadian dollar against the Euro. A weaker dollar reduces operating margins.
  • Raw Materials: Fiber costs are volatile and dependent on lumber market conditions and timber harvesting rates.
  • Legal/Environmental: The Celgar mill is subject to a preliminary assessment regarding alleged historical discharges of chlorinated organic compounds into the Columbia River; costs cannot currently be quantified.

Investor Verification Checklist

• Pulp Price Sustainability: Verify if the record-high pulp prices (€708/ADMT average list price) are sustainable given the entry of new capacity and potential demand softness.
• Fiber Cost Exposure: Assess the impact of rising fiber costs in Germany on future margins, as these costs increased 23% year-over-year.
• Debt Service Capacity: Review the Company's ability to service its €816.7 million debt load, particularly the 9.25% Senior Notes due 2013 and the Stendal Loan Facility, given the cyclical nature of cash flows.
• Derivative Exposure: Note the €63.4 million unrealized loss on interest rate derivatives; verify the impact of interest rate fluctuations on future earnings.
• Environmental Liability: Monitor the outcome of the Upper Columbia River Natural Resources Trustee Council assessment regarding the Celgar mill.