10-Q 1 doc1.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001 OR [ ] 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.: 000-09409 MERCER INTERNATIONAL INC. (Exact name of Registrant as specified in its charter) WASHINGTON 91-6087550 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) GIESSHUBELSTRASSE 15, ZURICH, SWITZERLAND CH 8045 (Address of principal executive offices) (Zip Code) 41(1) 201 7710 (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 X NO ---- ---- The Registrant had 16,794,899 shares of beneficial interest outstanding as at November 12, 2001. PART I. FINANCIAL INFORMATION --------------------- ITEM 1. FINANCIAL STATEMENTS MERCER INTERNATIONAL INC. CONSOLIDATED FINANCIAL STATEMENTS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001 (UNAUDITED) MERCER INTERNATIONAL INC. CONSOLIDATED BALANCE SHEETS AS AT SEPTEMBER 30, 2001 AND DECEMBER 31, 2000 (UNAUDITED) (DOLLARS IN THOUSANDS)

SEPTEMBER 30, DECEMBER 31, 2001 2000 --------------- -------------- ASSETS Current Assets Cash and cash equivalents $ 18,393 $ 18,496 Investments 5,285 5,320 Receivables 39,916 46,088 Inventories 14,550 19,977 Prepaid and other 2,497 3,000 -------------- ------------- Total current assets 80,641 92,881 Long-Term Assets Cash restricted 22,498 25,150 Properties 246,712 265,607 Investments 7,713 6,101 Notes receivable - 4,296 Deferred income tax 9,353 9,624 -------------- ------------- 286,276 310,778 -------------- ------------- $ 366,917 $ 403,659 ============== ============= LIABILITIES Current Liabilities Accounts payable and accrued expenses $ 33,099 $ 37,058 Pulp mill renovation costs payable 193 1,146 Note payable 782 839 Debt 10,380 27,173 -------------- ------------- Total current liabilities 44,454 66,216 Long-Term Liabilities Debt 191,533 208,315 Other 3,339 3,721 -------------- ------------- 194,872 212,036 -------------- ------------- Total liabilities 239,326 278,252 SHAREHOLDERS' EQUITY Shares of beneficial interest 99,995 99,995 Retained earnings 93,371 88,698 Accumulated other comprehensive loss (65,775) (63,286) -------------- ------------- 127,591 125,407 -------------- ------------- $ 366,917 $ 403,659 ============== =============

The accompanying notes are an integral part of these financial statements. MERCER INTERNATIONAL INC. CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS FOR NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 (UNAUDITED) (DOLLARS IN THOUSANDS, EXCEPT FOR EARNINGS PER SHARE)

2001 2000 -------- -------- Revenues Sales $143,513 $175,597 Other 12,069 5,572 -------- -------- 155,582 181,169 Expenses Cost of sales 125,115 142,871 General and administrative 13,216 8,591 Interest expense 10,895 10,560 Loss on foreign currency derivative contracts 731 - Litigation claim 918 - -------- -------- 150,875 162,022 -------- -------- Income before income taxes 4,707 19,147 Income taxes 34 6 -------- -------- Net income 4,673 19,141 Retained earnings, beginning of period 88,698 59,224 -------- -------- Retained earnings, end of period $ 93,371 $ 78,365 ======== ======== Earnings per share Basic $ 0.28 $ 1.14 ======== ======== Diluted $ 0.27 $ 1.11 ======== ========

The accompanying notes are an integral part of these financial statements. MERCER INTERNATIONAL INC. CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS FOR THREE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 (UNAUDITED) (DOLLARS IN THOUSANDS, EXCEPT FOR EARNINGS PER SHARE)

2001 2000 -------- -------- Revenues Sales $42,693 $60,779 Other 4,583 915 ------- ------- 47,276 61,694 Expenses Cost of sales 39,874 45,795 General and administrative 4,738 3,340 Interest expense 3,391 3,450 Gain on foreign currency derivative contracts (1,822) - Litigation claim 918 - ------- ------- 47,099 52,585 ------- ------- Income before income taxes 177 9,109 Income taxes 8 15 ------- ------- Net income 169 9,094 Retained earnings, beginning of period 93,202 69,271 ------- ------- Retained earnings, end of period $93,371 $78,365 ======= ======= Earnings per share Basic $ 0.01 $ 0.54 ======= ======= Diluted $ 0.01 $ 0.52 ======= =======

The accompanying notes are an integral part of these financial statements. MERCER INTERNATIONAL INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME FOR NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 (UNAUDITED) (DOLLARS IN THOUSANDS)

2001 2000 -------- --------- Net income $ 4,673 $19,141 Other comprehensive income (loss): Foreign currency translation adjustments (3,992) (13,771) Unrealized gain (loss) on securities 1,503 (1,037) ------- -------- Other comprehensive loss (2,489) (14,808) ------- ------- Total comprehensive income $ 2,184 $ 4,333 ======= =======

The accompanying notes are an integral part of these financial statements. MERCER INTERNATIONAL INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME FOR THREE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 (UNAUDITED) (DOLLARS IN THOUSANDS)

2001 2000 ------- -------- Net income $ 169 $ 9,094 Other comprehensive income (loss): Foreign currency translation adjustments 9,012 (7,723) Unrealized loss on securities (15) (415) ------ ------- Other comprehensive income (loss) 8,997 (8,138) ------ ------- Total comprehensive income $9,166 $ 956 ====== =======

The accompanying notes are an integral part of these financial statements. MERCER INTERNATIONAL INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 (UNAUDITED) (DOLLARS IN THOUSANDS)

2001 2000 -------- -------- Cash Flows from Operating Activities: Net income $ 4,673 $ 19,141 Adjustments to reconcile net income from operations to cash Depreciation and amortization 15,506 19,753 Changes in current assets and liabilities Investments (789) (28,964) Inventories 4,723 858 Receivables 6,248 (2,195) Accounts payable and accrued expenses (4,051) 1,456 Other 369 (611) -------- -------- Net cash provided by operating activities 26,679 9,438 Cash Flows from Investing Activities: Decrease in notes receivable, net 4,296 11 Purchase of available-for-sale investments (569) (859) Purchase of fixed assets, net of investment grants (5,058) 30,972 Proceeds from sale of properties - 8,892 Other 58 - -------- -------- Net cash provided by (used in) investing activities (1,273) 39,016 Cash Flows from Financing Activities: Cash restricted 1,834 - Increase in indebtedness - 5,768 Decrease in indebtedness (25,923) (5,682) Net proceeds on issuance of shares of beneficial interest - 957 Decrease in pulp mill conversion costs payable (902) (48,792) -------- -------- Net cash used in financing activities (24,991) (47,749) Effect of exchange rate changes on cash and cash equivalents (518) (542) -------- -------- Net increase (decrease) in cash and cash equivalents (103) 163 Cash and cash equivalents, beginning of period 18,496 1,722 -------- -------- Cash and cash equivalents, end of period $ 18,393 $ 1,885 ========= =========

The accompanying notes are an integral part of these financial statements. MERCER INTERNATIONAL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR NINE MONTHS ENDED SEPTEMBER 30, 2001 (UNAUDITED) NOTE 1. BASIS OF PRESENTATION The interim period consolidated financial statements contained herein include the accounts of Mercer International Inc. and its subsidiaries (the "Company"). The interim period 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"). Certain information and footnote disclosure normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such SEC rules and regulations. The interim period 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, 2000. In the opinion of the Company, the unaudited consolidated financial statements contained herein contain all adjustments necessary to present a fair statement of the results of the interim periods presented. NOTE 2. EARNINGS PER SHARE Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of shares outstanding during a period. Diluted earnings per share takes into consideration shares outstanding (computed under basic earnings per share) and potentially dilutive shares. The weighted average number of shares outstanding for the purposes of calculating basic earnings per share was 16,874,899 and 16,763,538 for the nine months ended September 30, 2001 and 2000, respectively, and 16,874,899 and 16,808,769 for the three months ended September 30, 2001 and 2000, respectively. The weighted average number of shares outstanding for the purposes of calculating diluted earnings per share was 17,181,616 and 17,207,610 for the nine months ended September 30, 2001 and 2000, respectively, and 17,236,295 and 17,368,786 for the three months ended September 30, 2001 and 2000, respectively. NOTE 3. ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities", established accounting and reporting standards for derivative instruments and hedging activities. SFAS No. 133 was amended by SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133", which deferred the implementation date of SFAS 133 to fiscal years beginning after June 15, 2000. Retroactive application is prohibited. The Company adopted SFAS No. 133 effective from January 1, 2001. All derivative instruments are measured at fair value and reported in the balance sheet as assets or liabilities. Accounting for gains and losses depends on the intended use of the derivative instrument. Gains and losses on derivative instruments not designated as hedging instruments are recognized in earnings in the period of the change in fair value. Accounting for gains and losses on derivative instruments designated as hedging instruments depends on the type of hedge, and such gains and losses are recognized in either earnings or other comprehensive income. NOTE 4. BUSINESS SEGMENT INFORMATION The Company operates in two reportable business segments: pulp and paper. The segments are managed separately because each business requires different production and marketing strategies. Summarized financial information concerning the segments is shown in the following tables:

PULP PAPER TOTAL ---- ----- ----- NINE MONTHS ENDED SEPTEMBER 30, 2001 Sales to external customers $102,157 $41,356 $143,513 Intersegment net sales 4,277 - 4,277 Segment profit 7,937 1,162 9,099 Reconciliation of profit: Total profit for reportable segments $ 9,099 Elimination of intersegment profits 602 Unallocated amounts, other corporate expenses (4,994) -------- Consolidated income before income taxes $ 4,707 ======== NINE MONTHS ENDED SEPTEMBER 30, 2000 Sales to external customers $110,766 $64,831 $175,597 Intersegment net sales 712 - 712 Segment profit 18,713 1,894 20,607 Reconciliation of profit: Total profit for reportable segments $ 20,607 Elimination of intersegment profits 908 Unallocated amounts, other corporate expenses (2,368) --------- Consolidated income before income taxes $ 19,147 ========

PULP PAPER TOTAL ---- ----- ----- THREE MONTHS ENDED SEPTEMBER 30, 2001 Sales to external customers $29,999 $12,694 $42,693 Intersegment net sales 1,041 - 1,041 Segment profit 1,433 376 1,809 Reconciliation of profit: Total profit for reportable segments $ 1,809 Elimination of intersegment profits - Unallocated amounts, other corporate expenses (1,632) ------- Consolidated income before income taxes $ 177 ======= THREE MONTHS ENDED SEPTEMBER 30, 2000 Sales to external customers $40,666 $20,113 $60,779 Intersegment net sales 360 - 360 Segment profit 8,099 664 8,763 Reconciliation of profit: Total profit for reportable segments $ 8,763 Elimination of intersegment profits 908 Unallocated amounts, other corporate expenses (562) ------- Consolidated income before income taxes $9,109 ========

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Mercer International Inc. is a pulp and paper company and its operations are primarily located in Germany. The following discussion and analysis of the results of operations and financial condition of the Company for the nine months and three months ended September 30, 2001 should be read in conjunction with the consolidated financial statements and related notes included elsewhere herein. In this document: (i) unless the context otherwise requires, the "Company" refers to Mercer International Inc. and its subsidiaries; and (ii) a "tonne" is one metric ton or 2,204.6 pounds. Based upon period average exchange rates, the U.S. dollar appreciated by approximately 5.0% and 1.3% against the deutschmark in the nine months and three months, respectively, ended September 30, 2001, compared to the same periods of 2000. RESULTS OF OPERATIONS - NINE MONTHS ENDED SEPTEMBER 30, 2001 The following table sets forth selected sales data for the Company for the periods indicated:

NINE MONTHS ENDED SEPTEMBER 30, ------------------------------- 2001 2000 ---------- ---------- (UNAUDITED) (IN THOUSANDS) SALES BY PRODUCT CLASS Packaging papers(1) $ - $ 8,758 Specialty papers 25,075 25,374 Printing papers(2) 16,281 30,699 Pulp 102,157 110,766 -------- -------- Total(3) $143,513 $175,597 ======== ======== SALES BY GEOGRAPHIC AREA Germany $ 66,439 $ 71,108 European Union(4) 49,736 61,906 Eastern Europe and other 27,338 42,583 -------- -------- Total(3) $143,513 $175,597 ======== ======== SALES BY VOLUME (TONNES) Packaging papers(1) - 29,111 Specialty papers 30,320 31,255 Printing papers(2) 20,666 44,427 Pulp 216,019 183,027 -------- -------- Total(3) 267,005 287,820 ======== ======== ------------------- (1) The Company sold its packaging paper mill in Trebsen, Germany effective June 2000. (2) The Company sold its printing paper mill in Hainsberg, Germany effective November 2000. (3) Excluding intercompany sales. (4) Not including Germany.

In the nine months ended September 30, 2001, revenues decreased by approximately 14.1% to $155.6 million from $181.2 million in the nine months ended September 30, 2000, primarily as a result of lower pulp prices and lower paper sales in the current period. The decrease in revenues in the current period was partially offset by higher pulp volumes. In the current period, pulp and paper revenues decreased by approximately 18.3% from the comparable period of 2000, on a 7.8% decrease in pulp sales and a 36.2% decrease in paper sales resulting primarily from the sale of the Company's packaging paper mill in Trebsen, Germany effective June 2000 and printing paper mill in Hainsberg, Germany effective November 2000. Pulp sales in the nine months ended September 30, 2001 decreased to $102.2 million from $110.8 million in the comparable period of 2000, as weakening demand and high producer inventory levels lead to a marked decline in prices. List prices for kraft pulp in Europe decreased from approximately $710 per tonne at the end of 2000 to approximately $650 per tonne during the first quarter of 2001, approximately $530 per tonne during the second quarter of 2001 and approximately $460 per tonne during the third quarter of 2001. Primarily as a result of producer downtime, the continuing erosion in kraft pulp prices steadied in the third quarter of 2001 and producers have announced a marginal price increase for the fourth quarter of 2001. Paper sales in the nine months ended September 30, 2001 decreased to $41.4 million from $64.8 million in the comparable period of 2000. Sales of specialty papers decreased slightly in the nine months ended September 30, 2001 compared to the nine months ended September 30, 2000 as a result of lower sales volumes, while sales of printing papers declined primarily as a result of the sale of one of the Company's printing paper mills effective November 2000. The Company did not sell any packaging papers during the nine months ended September 30, 2001 as a result of the divestiture of its packaging paper mill effective June 2000. On average, prices for specialty and printing papers realized by the Company in the nine months ended September 30, 2001 increased by approximately 1.9% and 14.0%, respectively, compared to the same period in 2000. Expenses decreased to $150.9 million in the nine months ended September 30, 2001 from $162.0 million in the comparable period of 2000, primarily as a result of lower paper sales and an improvement in pulp production efficiency due to the ramping-up of pulp production in early 2000. On average, the Company's unit fibre costs for pulp production in the nine months ended September 30, 2001 increased by approximately 8.6% compared to the same period in 2000. Prices for waste paper, which currently comprises approximately 25% of the fibre for the Company's paper mills, also increased in the nine months ended September 30, 2001, compared to the same period of 2000. General and administrative expenses increased to $13.2 million in the nine months ended September 30, 2001 from $8.6 million in the nine months ended September 30, 2000, primarily due to higher professional fees in the current period and an exchange gain in the comparative period. Interest expense in the current period increased to $10.9 million from $10.6 million in the comparable period of 2000, primarily as a result of the payment of government guarantee fees and higher interest rates in connection with the entering into of foreign currency forward rate swaps relating to the Company's bank loans. The Company recorded a loss of $0.7 million on its foreign currency derivative contracts in the nine months ended September 30, 2001. See "Item 3. Quantitative and Qualitative Disclosures About Market Risk" for information with respect to foreign currency derivatives. For the nine months ended September 30, 2001, the Company reported net income of $4.7 million, or $0.27 per share on a diluted basis, compared to $19.1 million, or $1.11 per share, in the comparable period of 2000. RESULTS OF OPERATIONS - THREE MONTHS ENDED SEPTEMBER 30, 2001 The following table sets forth selected sales data for the Company for the periods indicated:

THREE MONTHS ENDED SEPTEMBER 30, -------------------------------- 2001 2000 --------- -------- (UNAUDITED) (IN THOUSANDS) SALES BY PRODUCT CLASS Specialty papers $ 7,496 $ 8,514 Printing papers(1) 5,198 11,599 Pulp 29,999 40,666 -------- -------- Total(2) $ 42,693 $ 60,779 ======== ======== SALES BY GEOGRAPHIC AREA Germany $ 18,882 $ 24,156 European Union(3) 14,136 20,611 Eastern Europe and other 9,675 16,012 -------- -------- Total(2) $ 42,693 $ 60,779 ======== ======== SALES BY VOLUME (TONNES) Specialty papers 9,411 10,199 Printing papers(1) 6,818 16,574 Pulp 73,937 63,775 -------- -------- Total(2) 90,166 90,548 ======== ======== ------------- (1) The Company sold its printing paper mill in Hainsberg, Germany effective November 2000. (2) Excluding intercompany sales. (3) Not including Germany.

In the three months ended September 30, 2001, revenues decreased by approximately 23.4% to $47.3 million from $61.7 million in the three months ended September 30, 2000, primarily as a result of lower pulp prices and lower paper sales in the current period. In the current quarter, pulp and paper revenues decreased by approximately 29.8% from the comparable period of 2000, on a 26.2% decrease in pulp sales and a 36.9% decrease in paper sales. Pulp sales in the three months ended September 30, 2001 decreased to $30.0 million from $40.7 million in the comparable period of 2000 as a result of lower prices. Weak demand and high producer inventories resulted in list prices for kraft pulp in Europe decreasing from approximately $500 per tonne at June 30, 2001 to approximately $450 per tonne at September 30, 2001. In order to balance pulp inventory levels, many pulp producers took market downtime in the third quarter of 2001. Such downtime resulted in a steadying of the continuing price erosion facing producers during 2001, and certain producers have announced a marginal price increase for the fourth quarter of 2001. Whether pulp prices have steadied and whether any short-term price increases are achieved by producers will depend primarily on producers reducing inventory levels through downtime as required and the timing and strength of any recovery to the current global economic slowdown. The timing and strength of any such recovery is currently uncertain. Paper sales in the three months ended September 30, 2001 decreased to $12.7 million from $20.1 million in the comparative period of 2000. Sales of specialty papers declined in the three months ended September 30, 2001 compared to the three months ended September 30, 2000 as a result of lower sales prices and volumes, while sales of printing papers declined primarily as a result of the sale of one of the Company's printing paper mills effective November 2000. On average, prices for specialty papers realized by the Company in the three months ended September 30, 2001 decreased by approximately 4.6% compared to the same period in 2000, while prices for printing papers increased by approximately 8.9%. Expenses decreased to $47.1 million in the three months ended September 30, 2001 from $52.6 million in the comparable period of 2000, primarily as a result of lower paper production and sales and a gain on foreign currency derivative contracts. On average, the Company's unit fibre costs for pulp production in the three months ended September 30, 2001 increased by approximately 0.6% compared to the same period in 2000. Prices for waste paper, which currently comprises approximately 25% of the fibre for the Company's paper mills, decreased in the three months ended September 30, 2001, compared to the same period of 2000. General and administrative expenses increased to $4.7 million in the current quarter from $3.3 million in the three months ended September 30, 2000 primarily due to higher professional fees. Interest expense in the three months ended September 30, 2001 decreased slightly to $3.4 million from $3.5 million in the comparable period of 2000, reflecting lower interest payments resulting from the decrease in the principal of the Company's bank indebtedness, partially offset by the payment of government guarantee fees and higher interest rates in connection with the entering into of foreign currency forward rate swaps. The Company recorded a gain of $1.8 million on its foreign currency derivative contracts in the three months ended September 30, 2001. See "Item 3. Quantitative and Qualitative Disclosures About Market Risk" for information with respect to foreign currency derivatives. For the three months ended September 30, 2001, the Company reported net income of $169,000, or $0.01 per share on a diluted basis, compared to $9.1 million, or $0.52 per share, in the comparable period of 2000. LIQUIDITY AND CAPITAL RESOURCES The following table is a summary of selected financial information concerning the Company for the periods indicated:

AS AT AS AT SEPTEMBER 30, 2001 DECEMBER 31, 2000 -------------------- ------------------ (UNAUDITED) (IN THOUSANDS) FINANCIAL POSITION Working capital $ 36,187 $ 26,665 Property, plant and equipment (net) 246,712 265,607 Total assets 366,917 403,659 Long-term debt 191,533 208,315 Shareholders' equity 127,591 125,407

At September 30, 2001, the Company's cash and cash equivalents totalled $18.4 million, compared to $18.5 million at December 31, 2000. At September 30, 2001 and December 31, 2000, the Company had short-term trading securities totalling approximately $5.3 million. OPERATING ACTIVITIES Operating activities provided cash of $26.7 million in the nine months ended September 30, 2001, compared to $9.4 million in the same period in 2000. A decrease in receivables provided cash of $6.2 million in the current period, compared to an increase in receivables using cash of $2.2 million in the comparative period of 2000. Lower inventories provided cash of $4.7 million in the current period, compared to $0.9 million in the comparative period. A decrease in accounts payable and accrued expenses used cash of $4.1 million in the nine months ended September 30, 2001, compared to an increase in accounts payable and accrued expenses providing cash of $1.5 million in the nine months ended September 30, 2000. Net purchases of investment securities used cash of $0.8 million in the nine months ended September 30, 2001, compared to $29.0 million in the comparative period of 2000. INVESTING ACTIVITIES Investing activities in the nine months ended September 30, 2001 used cash of $1.3 million, consisting primarily of capital expenditures on properties and partially offset by a reduction in notes receivable, compared to providing cash of $39.0 million in the nine months ended September 30, 2000. The Company completed a major capital project to convert its Rosenthal pulp mill from the production of sulphite to kraft pulp, increase capacity and improve operations (the "Conversion Project") in late 1999. The Conversion Project was financed through a combination of borrowings under a project loan, non-refundable governmental grants, governmental assistance and guarantees for long-term project financing and an equity investment by the Company. The Company is continuing to review its paper operations to define a long-term core competency in respect of products produced in order that future investment may be directed towards that segment. FINANCING ACTIVITIES Financing activities used cash of $25.0 million in the nine months ended September 30, 2001, primarily as a result of lower indebtedness, including the repayment of $25.6 million in indebtedness relating to the Conversion Project. Financing activities used cash of $47.7 million in the nine months ended September 30, 2000. The depreciation of the deutschmark against the U.S. dollar in the nine months ended September 30, 2001 resulted in an unrealized foreign exchange translation loss of $0.5 million on cash and cash equivalents, which is included in the Company's statement of comprehensive income and does not affect the Company's net earnings. See "Foreign Currency". Effective January 2000, the Company agreed, subject to certain conditions, to acquire a controlling interest in a "greenfield" project to construct and operate a 550,000-tonne softwood kraft pulp mill to be located at Stendal, Germany (the "Stendal Project"). In 2001, the Company agreed to increase its ultimate ownership position in the Stendal Project to 57.5%. The Company's participation in the Stendal Project is subject to, among other things, completion of due diligence and the Stendal Project itself is subject to, among other things, financing, final permit amendments and approval of government investment incentives. The Stendal Project is currently estimated to cost approximately euro 1.0 billion (or $0.9 billion) and to be completed by the end of 2004. Financing for the Stendal Project is expected to come from the project partners, long-term bank credit facilities and government investment incentives. In July 2001, Bayerische Hypo- und Vereinsbank AG agreed to act as the lead financial arranger and underwriter for committed project financing for the Stendal Project in the amount of euro 891.4 million (or $811.1 million). Such financing is subject to terms and conditions customary for project financings of such nature. See "Stendal Pulp Mill Project Uncertainties". Other than the agreement relating to the Stendal Project, the Company had no material commitments to acquire assets or operating businesses as at September 30, 2001, although it is considering a number of initiatives relating to potential acquisitions and joint ventures both in Europe and North America. In November 2001, the Company entered into an exclusive arrangement to restructure and acquire Skeena Cellulose Inc., an insolvent Canadian pulp and forest products company that is currently under court-ordered protection from creditors. The proposed transaction is subject to various conditions, customary for transactions of this nature, including entering into a definitive agreement by mid-December 2001 and receipt of all necessary creditor, regulatory and court approvals. The Company anticipates that there will be acquisitions of businesses or commitments to projects in the future. To achieve its long-term goals of expanding its asset and earnings base through mergers and acquisitions, the Company will require substantial capital resources. The necessary resources will be generated from cash flow from operations, cash on hand, borrowing against its assets and/or the sale of assets. FOREIGN CURRENCY Substantially all of the Company's operations are conducted in international markets and its consolidated financial results are subject to foreign currency exchange rate fluctuations, in particular, those in Germany. The Company's pulp and paper products are principally sold in deutschmarks and euros and approximately 99% of the Company's revenues are denominated in deutschmarks and euros. The value of the euro is fixed at 1.95583 deutschmarks. The Company translates foreign assets and liabilities into U.S. dollars at the rate of exchange on the balance sheet date. Revenues and expenses are translated at the average rate of exchange prevailing during the period. Unrealized gains or losses from these translations are recorded as shareholders' equity on the Company's balance sheet and do not affect the net earnings of the Company. Since substantially all of the Company's revenues are received in deutschmarks and euros, the financial position of the Company for any given period, when reported in U.S. dollars, can be significantly affected by the exchange rates for deutschmarks prevailing during that period. In the nine months ended September 30, 2001, the depreciation of the deutschmark against the U.S. dollar resulted in a net $4.0 million foreign exchange translation loss and, as a result, the cumulative foreign exchange translation loss increased from $56.3 million at December 31, 2000 to $60.3 million at September 30, 2001. See "Item 3. Quantitative and Qualitative Disclosures About Market Risk" for information with respect to foreign currency derivatives. The average and period end exchange rates for the deutschmark to the U.S. dollar for the periods indicated are as follows:

QUARTER ENDED QUARTER ENDED SEPTEMBER 30, 2001 SEPTEMBER 30, 2000 ------------------------------ ------------------------------ PERIOD END PERIOD AVERAGE PERIOD END PERIOD AVERAGE ---------- -------------- ---------- -------------- RATE OF EXCHANGE Deutschmark 2.1495 2.1940 2.2119 2.1653

Based upon the period average exchange rate in the nine months ended September 30, 2001, the U.S. dollar increased by approximately 4.9% in value against the deutschmark since December 31, 2000. CYCLICAL NATURE OF BUSINESS; COMPETITIVE POSITION The pulp and paper business is cyclical in nature and markets for the Company's principal products are characterized by periods of supply and demand imbalance, which in turn affects product prices. The markets for pulp and paper are highly competitive and sensitive to cyclical changes in industry capacity and in the economy, both of which can have a significant influence on selling prices and the earnings of the Company. Demand for pulp and paper products has historically been determined by the level of economic growth and has been closely tied to overall business activity. The competitive position of the Company is influenced by the availability and quality of raw materials (fibre) and its experience in relation to other producers with respect to inflation, energy, transportation, labour costs and productivity. STENDAL PULP MILL PROJECT UNCERTAINTIES The Company's participation in the Stendal Project is subject to certain conditions, including completion of its due diligence. In addition, the Stendal Project itself is subject to various risks and uncertainties customary to large "greenfield" projects of this nature which may result in the Stendal Project not proceeding as currently planned, or at all, such as availability and cost of materials and labour, construction delays, cost overruns, weather conditions, governmental regulations, availability of adequate financing, increases in long-term interest rates and increases in taxes and other governmental fees. The Stendal Project will also be subject to extensive and complex regulations and environmental compliance which may result in delays, in the project company and/or its shareholders, including the Company, incurring substantial costs in relation thereto or in the Stendal Project being amended or not proceeding at all. The implementation of the Stendal Project is currently expected to commence in 2002 and be completed by the end of 2004. However, there can be no assurance that the Stendal Project will proceed as currently planned, or at all. FORWARD-LOOKING STATEMENTS Statements in this report, to the extent they are not based on historical events, constitute forward-looking statements. Forward-looking statements include, without limitation, statements regarding the outlook for future operations, forecasts of future costs and expenditures, the evaluation of market conditions, the outcome of legal proceedings, the adequacy of reserves, or other business plans. Investors are cautioned that forward-looking statements are subject to an inherent risk that actual results may vary materially from those described herein. Factors that may result in such variance, in addition to those accompanying the forward-looking statements, include changes in interest rates, commodity prices, and other economic conditions; actions by competitors; changing weather conditions and other natural phenomena; actions by government authorities; uncertainties associated with legal proceedings; technological development; future decisions by management in response to changing conditions; and misjudgments in the course of preparing forward-looking statements. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to market risks from changes in interest rates, foreign currency exchange rates and equity prices which may affect its results of operations and financial condition. The Company manages these risks through internal risk management policies. The Company also uses derivative instruments in regard to its exposure to interest rate, currency and pulp price risks. The derivative instruments are not designated as hedging instruments and the purpose of the derivative activity is speculative in nature, as management uses such tools either to augment the Company's potential gains or to reduce the Company's potential losses, depending on management's perception of future economic events and developments. If any of the variety of instruments and strategies the Company utilizes are not effective, the Company may incur losses. Many of the Company's strategies are based on historical trading patterns and correlations. However, these strategies may not be fully effective in all market environments or against all types of risks. Unexpected market developments may affect the Company's risk management strategies during this time, and unanticipated developments could impact the Company's risk management strategies in the future. In December 2000, the Company entered into U.S. dollar/euro foreign currency forward rate swaps to manage its risk exposure with respect to in aggregate approximately euro 223.3 million of the principal amount of its long-term indebtedness. The current nominal amount at September 30, 2001 was euro 217.4 million and a fair value gain of $1.3 million on these contracts was recognized in the nine months ended September 30, 2001. During the first quarter of 2001, the Company entered into a U.S. dollar/euro forward contract in the amount of approximately euro 35.0 million, which was settled in March 2001. The contract resulted in a $2.3 million loss. During the second quarter of 2001, the Company entered into two U.S. dollar/euro forward contracts in the aggregate amount of approximately euro 22.4 million, maturing in the second quarter of 2002. A fair value gain of $0.3 million on these contracts was recognized in the nine months ended September 30, 2001. As at September 30, 2001, no derivative contract had been executed with respect to pulp prices. Any change in the fair value of derivative instruments is included in the determination of earnings. Reference is made to the Company's annual report on Form 10-K for the year ended December 31, 2000 for additional information concerning market risk. PART II. OTHER INFORMATION ----------------- ITEM 1. LEGAL PROCEEDINGS The Company is subject to routine litigation incidental to its business. The Company does not believe that the outcome of such litigation will have a material adverse effect on its business or financial condition. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Company held its annual meeting of shareholders on July 10, 2001. At the meeting, C.S. Moon and Maarten Reidel were elected Class I Trustees of the Company for a three year term as follows:

ABSTENTIONS AND VOTES FOR VOTES WITHHELD BROKER NON-VOTES --------- -------------- ---------------- C.S. Moon 15,082,168 5,576 - Maarten Reidel 15,082,168 5,576 -

Jimmy S.H. Lee, Michel Arnulphy and R. Ian Rigg continued their respective terms as Trustees of the Company. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS None. (b) REPORTS ON FORM 8-K None. 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/ R. Ian Rigg ------------------ R. Ian Rigg Vice President and Chief Financial Officer Date: November 13, 2001