Mercer International - 10-Q quarterly report FY2011 Q3

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES þ NO o

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months or for such shorter period that the registrant was required to submit and post such files). YES þ NO o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO þ

The Registrant had 55,779,204 shares of common stock outstanding as at November 4, 2011.

 

Commitments and contingencies (Note 11)
Subsequent event (Note 12)

The interim consolidated financial statements contained herein include the accounts of Mercer International Inc. (“Mercer Inc.”) and its wholly-owned and majority-owned subsidiaries (collectively the “Company”). Mercer Inc.’s common shares are quoted and listed for trading on both the NASDAQ Global Market and the Toronto Stock Exchange.

The interim consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (the “SEC”). The year-end consolidated balance sheet data was derived from audited financial statements. The footnote disclosure included herein has been prepared in accordance with accounting principles generally accepted for interim financial statements in the United States (“GAAP”). The interim consolidated financial statements should be read together with the audited consolidated financial statements and accompanying notes included in the Company’s latest annual report on Form 10-K for the fiscal year ended December 31, 2010. In the opinion of the Company, the unaudited interim consolidated financial statements contained herein contain all adjustments necessary to fairly present the results of the interim periods included. The results for the periods included herein may not be indicative of the results for the entire year.

The Company has three pulp mills that are aggregated into one reportable business segment, market pulp. Accordingly, the results presented are those of the reportable business segment.

Certain prior year amounts in the interim consolidated financial statements have been reclassified to conform to the current year presentation.

In these interim consolidated financial statements, unless otherwise indicated, all amounts are expressed in Euros (“€”). The term “U.S. dollars” and the symbol “$” refer to United States dollars. The symbol “C$” refers to Canadian dollars.

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.

In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2011-04, Fair Value Measurements (“ASU 2011-04”), which expands the existing disclosure requirements for fair value measurements (particularly for Level 3 inputs) defined under Accounting Standards Codification No. 820, Fair Value Measurement (“ASC 820”), and makes other amendments. Many of the amendments to ASC 820 are being made to eliminate wording differences between GAAP and International Financial Reporting Standards and are not intended to result in a change in the application of the requirements of ASC 820. However, some of the amendments clarify the application of existing fair value measurement requirements and others change certain requirements for measuring fair value and could change how the fair value measurement guidance in ASC 820 is applied. The measurement and disclosure requirements of ASU 2011-04 are effective for reporting periods beginning after December 15, 2011 and are to be applied prospectively. The Company does not expect that the adoption of this new guidance will have a material impact on the consolidated financial statements or related note disclosures.

In June 2011, the FASB issued Accounting Standards Update 2011-05, Presentation of Comprehensive Income (“ASU 2011-05”), which revises the manner in which entities present comprehensive income in their financial statements. The new guidance amends Accounting Standards Codification No. 220,Comprehensive Income, and gives reporting entities the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income in either a continuous statement of comprehensive income or two separate but consecutive statements. Under the two-statement approach, which the Company currently uses, the first statement includes components of net income, and the second statement includes components of other comprehensive income. ASU 2011-05 does not change the items that must be reported in other comprehensive income. This new guidance is effective for reporting periods beginning after December 15, 2011 and is to be applied retrospectively. The Company does not expect the adoption of this guidance to have an impact on the consolidated financial statements or related note disclosures.

In June 2010, the Company adopted a new stock incentive plan (the “2010 Plan”) which provides for options, restricted stock rights, restricted shares, performance shares, performance share units and stock appreciation rights to be awarded to employees, consultants and non-employee directors. As at September 30, 2011, after factoring in all allocated shares, there remain approximately 1.1 million common shares available for grant pursuant to the 2010 Plan.

Grants of performance shares comprise rights to receive shares at a future date that are contingent on the Company and the grantee achieving certain performance objectives.

In February 2011, the Company awarded a total of 812,573 performance shares to employees of the Company, the majority of which vest using a partial vesting schedule between 2014 and 2016; 50% are scheduled to vest on January 1, 2014, 25% are scheduled to vest on January 1, 2015, and the remaining 25% are scheduled to vest on January 1, 2016. There were nil performance shares which had vested, been forfeited, or been cancelled during the three and nine months ended September 30, 2011. Expense recognized for the three and nine month periods ended September 30, 2011 was €13 and €771, respectively. Performance shares are expensed each reporting period based on their fair value, which is then amortized to reflect the time elapsed in the vesting period. The fair value of the performance shares is determined based upon the targeted number of shares awarded and the quoted price of the Company’s shares at the reporting date. The target number of shares is determined using management’s best estimate. The final determination of the number of shares to be granted will be made by the Board of Directors.

Between February and March 2011, the Company granted and issued a total of 474,728 common shares under its performance share plan, which were originally awarded in 2008 and vested on December 31, 2010. Pursuant to the accounting guidance in FASB’s Accounting Standards Codification No. 718,Compensation — Stock Compensation, the Company adjusted the number of performance shares awarded to employees to the number granted by the Board of Directors, and accordingly adjusted compensation cost based on the fair value of Mercer’s common shares at the grant date. As a result, the Company recognized approximately €1,420 of stock compensation expense associated with the final determination of these performance shares in the three months ended March 31, 2011.

The fair value of restricted shares is determined based upon the number of shares granted and the quoted price of the Company’s shares on the date of grant. Restricted shares generally vest over a one year period, except as noted below. Expense is recognized on a straight-line basis over the vesting period.

During the three months ended June 30, 2011, 38,000 restricted shares were granted and issued to directors of the Company (2010 — 56,000). During the three months ended March 31, 2011, 200,000 (2010 — nil) restricted shares were granted and issued to the Chief Executive Officer of the Company, which vest in equal amounts over a five year period commencing in 2012.

During the three and nine months ended September 30, 2011, no restricted shares were cancelled or forfeited (2010 — nil and nil), and nil and 56,000 restricted shares had vested, respectively (2010 — 21,000 and 21,000). As at September 30, 2011, the total number of unvested restricted shares was 238,000 (2010 — 56,000).

Expense recognized for the three and nine month periods ended September 30, 2011 was €295 and €691, respectively (2010 — €60 and €83). As at September 30, 2011, the total remaining unrecognized compensation cost related to restricted shares amounted to approximately €1,642 (2010 — €148), which will be amortized over the remaining vesting periods.

During the three and nine month periods ended September 30, 2011 and 2010, no options were granted, exercised or cancelled, and nil and 15,000 options expired, respectively (2010 — nil and 738,334). The aggregate intrinsic value of options outstanding and currently exercisable as at September 30, 2011 was $0.28 per option.

Stock compensation expense recognized for stock options for the three and nine month periods ended September 30, 2011 was €nil (2010 — €nil). All stock options have fully vested.

The calculation of diluted net income (loss) per share attributable to common shareholders does not assume the exercise of any instruments that would have an anti-dilutive effect on earnings per share.

Restricted shares excluded from the calculation of diluted income (loss) per share attributable to common shareholders because they are anti-dilutive represented 238,000 shares for the three month period ended September 30, 2011.

The diluted net income (loss) per share calculation for the three and nine month periods ended September 30, 2010 excluded 190,000 shares related to stock options, as the exercise price of these options was greater than their average market value, which would result in an anti-dilutive effect on diluted earnings per share.

The Company’s marketable securities at September 30, 2011 and December 31, 2010 are summarized as follows:

In order to maintain the Company’s liquidity requirements and manage risk while ensuring a reasonable return, the Company invests in low risk and highly liquid marketable securities that are classified as available-for-sale investments and accordingly carried at fair value.

The Company recognizes any gross unrealized gains or losses through the “Accumulated other comprehensive income (loss)” line, and records investments in long-term marketable securities within the “Deferred note issuance and other” line in the Interim Consolidated Balance Sheet.

As at September 30, 2011, the Company had invested in German federal government bonds, with contractual maturities of less than one year. These bonds are highly liquid and are considered low risk debt securities. The Company also had nominal amounts invested in equity securities.

The Company reviews for other-than-temporary losses on a regular basis and has considered the gross unrealized losses indicated above to be temporary in nature.

Debt consists of the following:

The Company made principal repayments under these facilities of €42,511 during the nine months ended September 30, 2011 (2010 — €14,461). As of September 30, 2011, the principal maturities of debt are as follows:

Certain of the Company’s debt instruments were issued under an indenture which, among other things, restricts Mercer Inc.’s ability and the ability of its restricted subsidiaries to make certain payments. These limitations are subject to other important qualifications and exceptions. As at September 30, 2011, the Company was in compliance with the terms of the indenture.

The Company is exposed to certain market risks relating to its ongoing business. The Company seeks to manage these risks through internal risk management policies as well as, from time to time, the use of derivatives. Currently, the only risk managed using derivative instruments is interest rate risk.

During 2004, the Company entered into certain variable-to-fixed interest rate swaps in connection with the Stendal Loan Facility with respect to an aggregate maximum principal amount of approximately €612,600 of the total indebtedness under the Stendal Loan Facility. Under the remaining interest rate swap, the Company pays a fixed rate and receives a floating rate with the interest payments being calculated on a notional amount. Currently, the contract has an aggregate notional amount of €426,518 at a fixed interest rate of 5.28% and it matures October 2017 (generally matching the maturity of the Stendal Loan Facility). The Company substantially converted the Stendal Loan Facility from a variable interest rate loan into a fixed interest rate loan, thereby reducing interest rate uncertainty.

The Company recognized an unrealized loss of €10,484 and a loss of €580 on the interest rate swap for the three and nine months ended September 30, 2011, respectively (2010 — a gain of €485 and loss of €10,523), in the “Gain (loss) on derivative instruments” line in the Interim Consolidated Statements of Operations and Interim Consolidated Statements of Cash Flows. Derivative instruments are required to be measured at their fair value. Accordingly, the fair value of the interest rate swap is presented in the “Unrealized interest rate derivative losses” line in the Interim Consolidated Balance Sheets, which currently amounts to a cumulative unrealized loss of €51,553 (2010 — €50,973).

The interest rate derivative contract is with the same bank that holds the Stendal Loan Facility and the Company does not anticipate non-performance by the bank.

Included in pension and other post-retirement benefit obligations are amounts related to the Company’s Celgar and Rosenthal mills. The largest component of this obligation is with respect to the Celgar mill which maintains a defined benefit pension plan and post-retirement benefit plans for certain employees (“Celgar Plans”).

Pension benefits are based on employees’ earnings and years of service. The Celgar Plans are funded by contributions from the Company based on actuarial estimates and statutory requirements. Pension contributions during the three and nine month periods ended September 30, 2011 totaled €534 and €1,429, respectively (2010 — €280 and €677).

Effective December 31, 2008, the defined benefit plan was closed to new members. In addition, the defined benefit service accrual ceased on December 31, 2008, and members began to receive pension benefits, at a fixed contractual rate, under a new defined contribution plan effective January 1, 2009.

The Company has authorized 200,000,000 common shares (2010 — 200,000,000) with a par value of $1 per share.

During the nine months ended September 30, 2011, 13,446,679 common shares were issued as a result of certain holders of the 2012 Notes exercising their conversion option (see Note 6(d) — Debt). In addition, 358,268 shares were issued to employees of the Company as part of the stock based performance awards and 238,000 restricted shares were issued to the Chief Executive Officer and directors of the Company.

During the three months ended September 30, 2011, the Company repurchased and retired 1,263,401 common shares. These retired shares are now included in the Company’s pool of authorized but unissued common shares.

As at September 30, 2011 and December 31, 2010, the Company had 55,779,204 and 42,999,658 common shares issued and outstanding, respectively.

In August 2011, the Company’s Board of Directors authorized a share and debt repurchase program (the “Program”) to repurchase up to $25.0 million worth of the Company’s outstanding common shares and up to $25.0 million in aggregate principal amount of the Company’s 2017 Notes from time to time over a period ending August 2012. During the three months ended September 30, 2011, the Company repurchased 1,263,401 of its common shares at an aggregate cost of approximately $10.6 million. The Company recorded these as treasury shares, and accounted for the repurchase using the Cost Method as outlined in FASB’s Accounting Standards Codification No. 505-30, Equity —Treasury Stock (“ASC 505-30”).

The Company retired all such purchased shares prior to September 30, 2011. The retired shares had a carrying value of approximately €6,342. Upon the formal retirement of such shares and in accordance with ASC 505-30, the Company reduced its share capital based on the average cost of the common shares and reduced the treasury share account based on the repurchase price. The difference between the repurchase price and the original issue value was recorded as a reduction to retained earnings.

The Company may make additional repurchases of common shares under its Program, depending on prevailing market conditions, alternate uses of capital, and other factors. Whether and when to initiate a purchase of common shares and the amount of common shares purchased is at the Company’s discretion. As at September 30, 2011, the Company has an authorized amount of approximately $14.4 million left to repurchase its common shares, and has no treasury shares outstanding.

The Company has authorized 50,000,000 preferred shares (2010 — 50,000,000) with $1 par value issuable in series, of which 2,000,000 shares have been designated as Series A. The preferred shares may be issued in one or more series and with such designations and preferences for each series as shall be stated in the resolutions providing for the designation and issue of each such series adopted by the Board of Directors of the Company. The Board of Directors is authorized by the Company’s articles of incorporation to determine the voting, dividend, redemption and liquidation preferences pertaining to each such series. As at September 30, 2011, no preferred shares had been issued by the Company.

The fair value of financial instruments at September 30, 2011 and December 31, 2010 is summarized as follows:

The carrying value of cash and cash equivalents, notes receivable and accounts payable and accrued expenses approximates the fair value due to the immediate or short-term maturity of these financial instruments. The carrying value of receivables approximates the fair value due to their short-term nature and historical collectability. The fair value of debt reflects recent market transactions and discounted cash flow estimates. The fair value of the interest rate derivative is calculated by discounting the future interest rate payments using a yield curve derived by a recognized financial institution. Marketable securities are recorded at fair value based on recent transactions.

The fair value methodologies and, as a result, the fair value of the Company’s investments and derivative instruments are determined based on the fair value hierarchy provided in FASB’s Accounting Standards Codification No. 820, Fair Value Measurements (“ASC 820”). The fair value hierarchy per ASC 820 is as follows:

Level 1 — Valuations based on quoted prices in active markets for identical assets and liabilities.

Level 2 — Valuations based on observable inputs in active markets for similar assets and liabilities, other than Level 1 prices, such as quoted interest or currency exchange rates.

Level 3 — Valuations based on significant unobservable inputs that are supported by little or no market activity, such as discounted cash flow methodologies based on internal cash flow forecasts.

The Company classified its marketable securities within Level 1 of the valuation hierarchy where quoted prices are available in an active market. Level 1 investments include exchange-traded equities and German federal government bonds. The Company classified the German federal government bonds as available for sale as it is not certain these investments will be held until maturity, nor does the Company intend to actually trade these investments.

The Company’s derivatives are classified within Level 2 of the valuation hierarchy, as they are traded on the over-the-counter market and are valued using internal models that use as their basis readily observable market inputs, such as forward interest rates.

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:

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 intended to compensate the Company for remediation work that is required at the Stendal mill, but it is less than the amount claimed by the Company under the arbitration. The Guarantee Amount was recognized as an increase in cash, and a corresponding increase in accounts payable. Since receiving the €10,000 Guarantee Amount, the Company has recorded approximately €1,400 of costs for remediation work at the Stendal mill, which leaves approximately €8,600 remaining for future remediation work. As the arbitration proceeding remains ongoing, there is no certainty that the Company will be successful with its claims or whether the costs recorded to date will qualify as eligible expenditures.

In October 2011, the Company purchased approximately $9.3 million of the outstanding 2017 Notes, at a nominal discount to the principal amount thereof, plus accrued and unpaid interest to, but not including the repurchase date.

The terms of the indenture governing our 9.5% senior unsecured notes require that we provide the results of operations and financial condition of Mercer International Inc. and our restricted subsidiaries under the indenture, collectively referred to as the “Restricted Group”. As at and during the three and nine months ended September 30, 2011 and 2010, the Restricted Group was comprised of Mercer International Inc., certain holding subsidiaries and our Rosenthal and Celgar mills. The Restricted Group excludes the Stendal mill.