In this document, please note the following:
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references to we, our, us, the Company or Mercer
mean Mercer International Inc. and its subsidiaries, unless the context clearly suggests otherwise, and references to Mercer Inc. mean Mercer International Inc. excluding its subsidiaries;
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references to net income (loss) mean net income (loss) attributable to common shareholders;
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references to NBSK mean northern bleached softwood kraft;
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references to ADMTs mean air-dried metric tonnes;
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references to MW mean megawatts and MWh mean megawatt hours; and
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all references to $ or dollars shall mean U.S. dollars, which is our reporting
currency, unless otherwise stated; refers to euros; and C$ refers to Canadian dollars.
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Due to rounding, numbers presented throughout this report may not add up precisely to totals we provide and percentages may
not precisely reflect the absolute figures.
Mercer
General
Mercer Inc. is a corporation organized under the laws of the State of Washington. Its common stock is quoted and listed for
trading on the NASDAQ Global Select Market (MERC) and the Toronto Stock Exchange (MERC.U).
We are one of the
worlds largest producers of market NBSK pulp, which is pulp that is sold on the open market. Our size provides us increased presence, better industry information in our markets and close customer relationships with many large pulp
consumers. We operate two modern and highly efficient mills in Eastern Germany and one mill in Western Canada and have our headquarters in Vancouver, Canada. We are the sole NBSK pulp producer, and the only significant market pulp producer in
Germany, which is the largest pulp import market in Europe. We are able to supply the growing pulp demand in China both through our Canadian mills ready access to the Port of Vancouver and through our Stendal mills existing logistics
arrangements. In addition, as a result of the significant investments we have made in co-generation equipment, all of our mills generate and sell a significant amount of surplus green energy to regional utilities. We also produce and
sell tall oil, a by-product of our production process, which is used as both a chemical additive and as a green energy source.
We currently employ approximately 1,486 people. Our three NBSK pulp mills have consolidated annual production capacity of
approximately 1.5 million ADMTs of NBSK pulp and are capable of generating 305 MW of electricity. Key operating details for each of our mills are as follows:
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Rosenthal mill
. Our Rosenthal mill is a modern, efficient ISO 9001, 14001 and 50001
certified NBSK pulp mill that has an annual production capacity of approximately 360,000 ADMTs and 57 MW of electrical generation. The Rosenthal mill is located in the town of Blankenstein, Germany, approximately 300 kilometers south of Berlin.
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Stendal mill
. Our Stendal mill is a state-of-the-art, single-line, ISO 9001, 14001 and 50001
certified NBSK pulp mill that has an annual production capacity of approximately 660,000 ADMTs and 148 MW of electrical generation. The Stendal mill is one of the largest NBSK mills in Europe. The Stendal mill is located near the town of Stendal,
Germany, approximately 130 kilometers west of Berlin.
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Celgar mill
. Our Celgar mill is a modern, efficient ISO 9001 and 14001 certified NBSK pulp
mill with an annual production capacity of approximately 520,000 ADMTs and 100 MW of electrical generation. The Celgar mill is located near the city of Castlegar, British Columbia, Canada, approximately 600 kilometers east of Vancouver.
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Our mills are some of the most modern and newest NBSK pulp mills in Europe and North America. We
believe the relative age, production capacity and electrical generation capacity of our mills provide us with certain manufacturing cost and other advantages over many of our competitors. We believe our competitors older mills do not have the
equipment or capacity to produce or sell surplus power or chemicals in a meaningful amount. In addition, since our mills are relatively new, they benefit from lower maintenance capital requirements and higher efficiency relative to many of our
competitors mills.
The following table sets out our pulp production and pulp revenues for the periods indicated:
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Year Ended December 31,
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2016
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2015
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2014
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Pulp production (000 ADMTs)
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1,428.4
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1,458.0
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1,485.0
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Pulp sales (000 ADMTs)
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1,428.7
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1,463.1
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1,486.4
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Pulp revenues (in thousands)
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$
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847,328
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$
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946,237
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$
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1,073,632
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Our modern mills generate electricity, which is surplus to their operating requirements,
providing our mills with a stable revenue source unrelated to pulp prices. Additionally, our German mills generate tall oil from black liquor, which is sold to third parties for use in numerous applications including bio-fuels. Since our energy and
chemical production are by-products of our pulp production process, there are minimal incremental costs and our surplus energy and chemical sales are highly profitable. All of our mills generate and sell surplus energy to regional utilities. Our
German mills benefit from special tariffs under Germanys
Renewable Energy Sources Act
, referred to as the Renewable Energy Act, which provides for premium pricing on green energy. Our Celgar mill is party to a
fixed electricity purchase agreement with the regional public utility provider for the sale of surplus power through 2020.
The following table sets out the amount of surplus energy produced and sold and revenues from the sale of surplus energy and
chemicals for the periods indicated:
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Year Ended December 31,
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2016
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2015
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2014
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(MWh)
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($)
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(MWh)
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($)
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(MWh)
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($)
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(thousands)
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(thousands)
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(thousands)
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Surplus electricity
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785,845
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71,539
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814,966
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74,736
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807,758
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88,758
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Chemicals
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12,756
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12,231
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12,722
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Total
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84,295
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86,967
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101,480
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Our strategic mill locations position us well to serve customers in Europe, Asia, and North
America. We primarily work directly with customers to capitalize on our geographic diversity, coordinate sales and enhance customer relationships. We believe our ability to deliver high quality pulp on a timely basis and our customer service make us
a preferred supplier for many customers.
4
Fiber is the largest production cost in manufacturing NBSK pulp. Although fiber
is cyclical in both price and supply, there is a significant amount of high-quality fiber within a close radius of each of our mills. This fiber supply, combined with our purchasing power and our ability to switch between whole logs chipped at our
mills and sawmill residual chips, enables us to enter into contracts and arrangements which have generally provided us with sufficient fiber supply.
Corporate Structure, History and Development of Business
The following simplified chart sets out our principal operating subsidiaries, their jurisdictions of organization, their
principal activities and their annual pulp production and electrical generation capacity:
We acquired our Rosenthal mill in 1994. In 1999, we completed a major capital project to
convert it to the production of kraft pulp, increase production and improve efficiencies at a cost of approximately $385.7 million, of which approximately $100.8 million was financed through government grants. Subsequent capital investments and
efficiency improvements have reduced emissions and energy costs, increased the mills annual production capacity and enabled the production of tall oil.
In September 2004, we completed construction of the Stendal mill at a cost of approximately $1.1 billion, which was financed
through a combination of government grants of approximately $332.0 million, low-cost, long-term project debt, which was largely severally guaranteed by governments in Germany, and equity. Subsequent capital investments and efficiency improvements
have increased the mills annual production capacity and its generation of green energy. We initially had a 63.6% interest in Stendal which increased over time through acquisitions and/or further investments until September 2014,
when we acquired all of the economic interest in Stendal.
In February 2005, we acquired the Celgar mill for
$210.0 million plus defined working capital. Since its acquisition, we have effected several capital projects and other initiatives at the Celgar mill to increase its annual production capacity and its generation of green energy.
Corporate Strategy
Our corporate strategy is to expand our asset and earnings base through organic growth and acquisitions, primarily in Europe
and North America. We pursue organic growth through active management and targeted capital expenditures to generate a high return by improving efficiency, reducing
5
costs and increasing production of pulp and energy and by-products such as chemicals. We are also leveraging our fiber and process expertise to develop innovative new products based on other
derivatives of the kraft pulping process. We seek to acquire interests in companies and assets in the pulp industry and related wood and wood extractive businesses where we can leverage our experience and expertise in adding value through a focused
management approach. Key elements of our strategy include:
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Focus on Premium Grade Market NBSK Pulp.
We produce market NBSK pulp because it is a premium
grade kraft pulp and generally obtains the highest price relative to other kraft pulps. Although demand is cyclical, between 2007 and 2016 overall worldwide demand for bleached softwood kraft market pulp grew at an average of approximately
1% per annum. We focus on customers that produce tissue, specialty papers and high-quality printing and writing paper grades. We believe the growth in demand from tissue and specialty paper customers, which utilize a significant proportion of
NBSK pulp, has more than offset the secular decline in demand from printing and writing paper customers. This allows us to benefit from our long-term relationships with tissue and specialty paper manufacturers in Europe and participate in higher
growth markets in emerging countries such as China where there has been strong growth in tissue demand.
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Increasing Stable Revenues from Renewable Energy and Chemical Sales and Leveraging our Fiber and
Process Expertise to Expand Growth.
We focus on enhancing our generation and sales of surplus renewable energy and chemicals and, because there are minimal associated incremental costs, such sales are highly profitable. These sales provide
us with a stable income source unrelated to cyclical changes in pulp prices. Additionally, we seek to capitalize on our fiber and process expertise to expand our commercialization and sales of new products and into new growth areas.
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Targeted Capital Expenditures to Enhance Production Capacity and Efficiency.
We operate three
large modern pulp mills which provide us with a platform to be an efficient and competitive producer of high-quality NBSK pulp without the need for significant sustaining capital. We seek to make targeted capital expenditures to increase production
and operational efficiency, reduce costs and increase electricity and chemical sales. Over the last five years, we have invested approximately $159.1 million (including $24.2 million in associated government grants) in growth capital expenditures
for capacity expansions, operational efficiencies and renewable energy and chemical production.
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Achieving Operational Excellence.
Operating our mills reliably and at a competitive cost is
important for our financial performance. In addition to capital expenditures, we continuously strive to develop maintenance systems and procedures that will improve the throughput of our products by increasing the reliability of our manufacturing
processes. We also seek to reduce operating costs by better managing certain operating activities such as fiber procurement, sales, marketing and logistics activities. We believe that our continued focus on operational excellence should allow us to
achieve improved profitability and cash flows.
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Strategic Opportunities.
We believe there will be continuing change and consolidation in pulp
and related wood harvesting, processing and extractive businesses as industry participants continually seek to lower costs, refocus their product lines and react to ever changing global market conditions. We take an opportunistic approach to
potential investments or acquisitions that can grow our business and expand our earnings.
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6
The Pulp Industry
General
Pulp is used in the production of paper, tissues and paper-related products. Pulp is generally classified according to fiber
type, the process used in its production and the degree to which it is bleached. Kraft pulp, a type of chemical pulp, is produced through a sulphate chemical process in which lignin, the component of wood which binds individual fibers, is dissolved
in a chemical reaction. Chemically prepared pulp allows the woods fiber to retain its length and flexibility, resulting in stronger paper products. Kraft pulp can be bleached to increase its brightness. Softwood kraft pulp is noted for its
strength, brightness and absorption properties and is used to produce a variety of products, including lightweight publication grades of paper, tissues and other paper-related products.
There are two main types of bleached kraft pulp, being softwood kraft made from coniferous trees and hardwood kraft made
from deciduous trees. Softwood species generally have long, flexible fibers which add strength to paper while fibers from species of hardwood contain shorter fibers which lend bulk and opacity.
We produce and sell NBSK pulp, which is a bleached kraft pulp manufactured using northern softwood and is considered a
premium grade because of its strength. It generally obtains the highest price relative to other kraft pulps. Southern bleached softwood kraft pulp is kraft pulp manufactured using southern softwood and does not possess the strength found in NBSK
pulp. NBSK pulp is the sole pulp product of our mills.
Most paper users of market kraft pulp use a mix of softwood and
hardwood grades to optimize production and product qualities. In 2016, market kraft pulp consumption was approximately 54% hardwood bleached kraft and 42% softwood bleached kraft, with the remainder comprised of unbleached pulp. Over the last
several years, production of hardwood pulp, based on fast growing plantation fiber primarily from Asia and South America, has increased much more rapidly than that of softwood grades, based on fiber that has longer growth cycles. Hardwood kraft
generally has a cost advantage over softwood kraft as a result of lower fiber costs, higher wood yields and, for newer hardwood mills, economies of scale. As a result of this growth in supply and lower costs, kraft pulp customers have substituted
some of the pulp content in their products to hardwood pulp.
Counteracting customers ability to substitute lower
priced hardwood pulp for NBSK pulp is the requirement for strength and formation characteristics in finished goods. Paper and tissue makers focus on larger paper machines with higher speeds and lower basis weights for certain papers which require
the strength characteristics of softwood pulp. Additionally, where paper products are lightweight or specialized, like direct mail, magazine paper or premium tissue, or where strength or absorbency are important, softwood kraft forms a significant
proportion of the fiber used. As a result, we believe that the ability of kraft pulp users to further substitute hardwood for softwood pulp is limited by such requirements.
Kraft pulp can be made in different grades, with varying technical specifications, for different end uses. Softwood kraft
pulp is valued for its reinforcing role in mechanical printing papers and is sought after by producers of paper for the publishing industry, primarily for magazines and advertising materials. Softwood kraft pulp is also an important ingredient for
tissue manufacturing and tissue demand tends to increase with living standards in developing countries. NBSK pulp produced for reinforcement fibers is considered the highest grade of kraft pulp and generally obtains the highest price.
7
Markets
We believe that over 130 million ADMTs of chemical pulp are converted annually into tissues, printing and writing
papers, carton boards and other specialty grades of paper and paperboard around the world. We also believe that over one third of this pulp is sold on the open market as market pulp, while the remainder is produced for internal purposes by
integrated paper and paperboard manufacturers.
The pulp business is highly cyclical in nature and markets are
characterized by periods of supply and demand imbalance, which in turn affect prices. Pulp markets are highly competitive and are sensitive to cyclical changes in the global economy, industry capacity and foreign exchange rates, all of which can
have a significant influence on selling prices and our operating results. The length and magnitude of industry cycles have varied over time but generally reflect changes in macro-economic conditions and levels of industry capacity. Pulp is a
commodity that is generally available from other producers. Because commodity products have few distinguishing qualities from producer to producer, competition is generally based upon price, which is generally determined by supply relative to
demand.
Between 2007 and 2016, worldwide demand for chemical market pulp grew at an average rate of approximately 2%
annually, with worldwide demand for bleached softwood kraft market pulp having grown at an average of approximately 1% per annum.
The following chart illustrates the global demand for chemical market pulp for the periods indicated:
Estimated Global Chemical Market Pulp Demand
Two key macro-economic trends in worldwide NBSK pulp demand over the last several years
have been:
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a significant increase in demand from emerging markets, and in particular China, which has more than offset
a decline in demand in the mature markets of Europe, North America and Japan; and
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a significant shift in demand by end use, as demand from tissue and specialty producers has increased
markedly and offset the secular decline in demand for printing and writing paper resulting from the rapid growth in digital media.
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Since 2007, demand for chemical softwood market pulp has grown in the emerging
markets of Asia, Eastern Europe and Latin America. China in particular has experienced substantial growth and its imports of chemical softwood market pulp grew by approximately 11% per annum between 2007 and 2016. We believe the emerging
markets now account for approximately 54% of total world demand for bleached softwood kraft market pulp. China now accounts for approximately 31% of global bleached softwood kraft market pulp demand, compared to only 15% in 2007. Western Europe
currently accounts for approximately 25% of global bleached softwood kraft market pulp demand, compared to approximately 35% in 2007. The demand in the mature markets of Europe, North America and Japan in 2016 declined by approximately
2.8 million ADMTs from 2007.
The following chart sets forth industry-wide bleached softwood kraft deliveries to
China for the periods indicated:
12 Month Rolling Bleached Softwood Kraft Pulp Deliveries to China
Growth in NBSK pulp demand in China and other emerging markets has, to a large extent,
been driven by increased demand from tissue and specialty paper producers, as a result of economic growth and rising income levels and living standards in such markets. These factors generally contribute to a greater demand for personal hygiene
products in such regions. In China alone, tissue producers have publicly announced plans to increase their annual tissue capacity by approximately 0.6 million ADMTs during 2017. At this time there can be no assurance as to when and how much of
such capacity expansion will be implemented.
This has also led to an overall shift in demand for NBSK pulp, as demand
from tissue producers has increased, while demand from printing and writing end uses has decreased. Between 2003 and 2015, NBSK pulp demand for tissue production increased by approximately 206%, an approximate 10% compound annual growth rate. From
2003 to 2015, a period very affected by digital substitution of traditional paper grades, total NBSK demand grew by 15%.
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The following chart compares NBSK pulp demand by end use in each of 2003 and
2015 (the latest year for which figures are currently available):
NBSK Pulp Demand by End Use
We believe 2016 NBSK demand by end use was generally consistent with the trend in the
chart above.
A measure of demand for kraft pulp is the ratio obtained by dividing the worldwide demand of kraft pulp by
the worldwide capacity for the production of kraft pulp, or the demand/capacity ratio. An increase in this ratio generally occurs when there is an increase in global and regional levels of economic activity. An increase in this ratio
also generally indicates greater demand as consumption increases, which often results in rising kraft pulp prices and a reduction of inventories by producers and buyers. As prices continue to rise, producers continue to run at higher operating
rates. However, an adverse change in global and regional levels of economic activity generally negatively affects demand for kraft pulp, often leading buyers to reduce their purchases and rely on existing pulp inventories. As a result, producers run
at lower operating rates by taking downtime to limit the build-up of their own inventories. The demand/capacity ratio for bleached softwood kraft pulp was approximately 92%, 92% and 93% in 2016, 2015 and 2014, respectively.
Between 2012 and 2016, we believe approximately 0.8 million ADMTs of pulp capacity was idled or shut down through mill
closures or curtailments. Further, in efforts to improve environmental and safety standards, China has publicly stated that it will be reducing existing pulp and paper capacity in the near term by closing old mills, targeting a removal
of 3.4 million ADMTs by the end of 2015. At this time, there can be no certainty as to the actual amount and timing of any such closures.
Currently, there have been publicly announced significant increases to expand chemical pulp capacity worldwide. Producers
have announced projects to increase hardwood kraft pulp capacity by an aggregate of about 3.2 million ADMTs in 2017 and 2018, primarily in South America and Asia. Further capacity increases of about 0.7 million ADMTs have been announced
for 2019. This increase in bleached hardwood kraft pulp is largely targeted at the growing demand for pulp in developing markets, particularly in China, by producers of tissues, specialty papers and packaging. Although not a direct competitor to
NBSK pulp, if such additional bleached hardwood kraft pulp supply is not absorbed by such demand growth, as a result of generally lower prices for bleached hardwood kraft pulp, this supply increase could
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put downward pressure on NBSK pulp prices. However, we believe customers ability to further substitute lower priced bleached hardwood kraft pulp for NBSK pulp is limited by the strength
characteristic of NBSK pulp which is required by large modern paper machines to run lower basis-weight paper products efficiently.
Producers have also publicly announced modernization and expansion projects for NBSK mills in Europe, including Russia, to
be implemented in 2017 and 2018, ranging from small expansions of existing mills to potential greenfield mills. We estimate that if all of these projects were completed, they would increase NBSK pulp capacity by about 1.9 million
ADMTs per annum. Further capacity increases of about 0.5 million ADMTs of NBSK pulp have been announced for 2019. We currently believe a number of such projects will be implemented while others are currently subject to various conditions
including financing and further development. We believe that, because of fiber constraints, such a significant expansion of NBSK capacity in the region would likely require the closure of older mills. However, at this time, we cannot predict which
of the publicly announced expansion projects will be completed or how much additional NBSK pulp production capacity may come online and when. As pulp prices are highly cyclical, there can be no assurance that NBSK pulp prices will not decline in the
future as a result of increases to the supply of kraft pulp.
In addition, certain integrated pulp and paper producers
have the ability to discontinue paper production by idling their paper machines and selling their NBSK pulp production on the market, if market conditions, prices and trends warrant such actions.
NBSK Pulp Pricing
Kraft pulp is a globally traded commodity and prices are highly cyclical and volatile. Kraft pulp prices are generally
quoted in dollars. Pricing is primarily influenced by the balance between supply and demand, as affected by global macro-economic conditions, changes in consumption and capacity, the level of customer and producer inventories and fluctuations in
exchange rates. Generally, we and other producers consider global NBSK pulp supply and demand to be evenly balanced when world inventory levels are at about 30 days supply.
General macro-economic conditions are closely tied to overall global business activity, which helps determine pulp demand
and, in turn, impacts pricing.
As the majority of market NBSK pulp is produced and sold by Canadian and Northern
European producers, while the price of NBSK pulp is generally quoted in dollars, pricing is often affected by fluctuations in the currency exchange rates for the dollar versus the euro and the Canadian dollar. As NBSK pulp producers generally incur
costs in their local currency, while pulp is quoted in dollars, a dollar strengthening generally benefits producers businesses and operating margins. Conversely, a weakening of the dollar versus the local currency of producers generally
adversely affects producers businesses and operating margins.
As a corollary to changes in exchange rates between
the dollar and the euro and Canadian dollar, a stronger dollar generally increases costs to customers of NBSK pulp producers and results in downward pressure on prices. Conversely, a weakening dollar generally supports higher pulp pricing. However,
there is invariably a time lag between changes in currency exchange rates and pulp prices. This lag can vary and is not predictable with any certainty.
As Northern Europe has historically been the worlds largest market and NBSK pulp is the premium grade, the European
market NBSK price is generally used as a benchmark price by the industry. The average European list prices for NBSK pulp since 2007 have fluctuated between a low of approximately $575 per ADMT in 2009 and a high of $1,030 per ADMT in 2011.
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The following chart sets out the changes in list prices for NBSK pulp in
Europe, as stated in dollars, Canadian dollars and euros for the periods indicated:
NBSK Pulp Price History (European Delivery)
In 2016 and 2015, demand was generally stable. However, the strength of the dollar
resulted in lower pulp prices. In 2014, demand from both Europe and China was stable, while supply was slightly under-balanced throughout the year which kept prices relatively high.
The following table sets out list prices for NBSK pulp in the regions indicated at the dates indicated:
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December 31,
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2016
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2015
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2014
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(in $/ADMT)
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Europe
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810
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800
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935
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China
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605
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595
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700
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North America
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990
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940
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1,020
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A producers net sales realizations are list prices, net of customer discounts, rebates
and other selling concessions. Over the last three years, these have increased as producers compete for customers and sales. The nature of the pricing structure in Asia is different in that, while quoted list prices tend to be lower than Europe,
customer discounts and rebates are much lower, resulting in net sales realizations that are generally similar to other markets.
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The following chart sets forth changes in FOEX PIX Pulp Index prices for NBSK
pulp in Europe and global bleached softwood kraft inventory levels between 2003 and 2016:
Pulp Price and Global Inventory History
Seasonality
We are exposed to fluctuations in quarterly sales volumes and expenses due to seasonal factors. These factors are common in
the NBSK pulp industry. We generally have weaker pulp demand in Europe during the summer holiday months and in China in the period relating to its lunar new year. We typically have a seasonal build-up in raw material inventories in the early winter
months as our mills build up their fiber supply for the winter when there is reduced availability.
Competition
Pulp markets are large and highly competitive. Producers ranging from small independent manufacturers to large integrated
companies produce pulp worldwide. Our pulp and customer services compete with similar products manufactured and distributed by others. While many factors influence our competitive position, particularly in weak economic times, a key factor is price.
Other factors include service, quality and convenience of location. Some of our competitors are larger than we are in certain markets and have substantially greater financial resources. These resources may afford those competitors more purchasing
power, increased financial flexibility, more capital resources for expansion and improvement and enable them to compete more effectively. Our key NBSK pulp competitors are principally located in Northern Europe and Canada and include Canfor Pulp,
Stora Enso, Metsä Fibre, Ilim, Södra Cell and Asia Pulp and Paper.
13
Pulp Production
Our pulp production capacity and actual production by mill for the periods indicated is set out below:
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Annual
Production
Capacity
(1)
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Year Ended December 31,
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2016
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2015
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2014
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Pulp Production by Mill
:
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(ADMTs)
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Rosenthal
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360,000
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353,486
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353,099
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360,463
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Celgar
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520,000
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426,317
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453,215
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453,104
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Stendal
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660,000
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648,581
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651,659
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671,444
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Total pulp production
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1,540,000
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1,428,384
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1,457,973
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1,485,011
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(1)
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Capacity is the rated capacity of the plants for the year ended December 31, 2016.
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Softwood kraft pulp is valued for its reinforcing role in mechanical printing papers and is sought after by producers of
paper for the publishing industry, primarily for magazines and advertising materials. Softwood kraft pulp is also an important ingredient for tissue manufacturing, and tissue demand tends to increase with living standards in developing countries.
NBSK pulp produced for reinforcement fibers is considered the highest grade of kraft pulp and generally obtains the highest price.
The NBSK pulp produced at the Rosenthal mill is a long-fibered softwood pulp produced by a sulphate cooking process and
manufactured primarily from wood chips and pulp logs. A number of factors beyond economic supply and demand have an impact on the market for NBSK pulp, including requirements for pulp bleached without any chlorine compounds or without the use of
chlorine gas. The Rosenthal mill has the capability of producing both totally chlorine free and elemental chlorine free pulp. Totally chlorine free pulp is bleached to a high brightness using oxygen, ozone and hydrogen
peroxide as bleaching agents, whereas elemental chlorine free pulp is produced by substituting chlorine dioxide for chlorine gas in the bleaching process. This substitution virtually eliminates complex chloro-organic compounds from the mills
effluent. The Rosenthal mill produces pulp for reinforcement fibers to the specifications of certain of our customers. We believe that a number of our customers consider us their supplier of choice.
The NBSK pulp produced at the Stendal mill is of a slightly different grade than the pulp produced at the Rosenthal mill as
the mix of softwood fiber used is slightly different. This results in a complementary product more suitable for different end uses. The Stendal mill is capable of producing both totally chlorine free and elemental chlorine free pulp.
The Celgar mill produces high-quality NBSK pulp that is made from a unique blend of slow growing/long-fiber Western Canadian
tree species. It is used in the manufacture of high-quality paper and tissue products. We believe the Celgar mills pulp is known for its excellent product characteristics, including tensile strength, wet strength and brightness. The Celgar
mill is a long-established supplier to paper and tissue producers in Asia.
Generation and Sales of Green
Energy and Chemicals at our Mills
Our pulp mills are large scale bio-refineries that, in addition to pulp, also
produce surplus carbon neutral or green energy. As part of the pulp production process our mills generate green energy using carbon-neutral bio-fuels such as black liquor and wood waste. Through the incineration
of bio-fuels in the
14
recovery and power boilers, our mills produce sufficient steam to cover all of our steam requirements and allow us to produce surplus electricity which we sell to third party utilities. As a
result, we have benefited from green energy legislation, incentives and commercialization that have developed over the last decade in Europe and Canada. In addition, in recent years we have applied considerable resources to increasing
our capacity to produce and sell chemicals, primarily tall oil for use in numerous applications including bio-fuels.
Our surplus energy and chemical sales provide our mills with a stable revenue source unrelated to pulp prices. Since our
energy and chemical production are by-products of our pulp production process, there are minimal incremental costs and our surplus energy and chemical sales are highly profitable. We believe that this revenue source gives our mills a competitive
advantage over other older mills which do not have the equipment or capacity to produce and/or sell surplus power and/or chemicals in a meaningful amount.
The following table sets out our electricity generation and surplus electricity sales for the five years ended
December 31, 2016:
Electricity Generation and Exports
15
The following chart sets forth our consolidated revenues from electricity and
chemical sales for the five years ended December 31, 2016:
Energy and Chemical Revenue
German Mills
Our German mills participate in a program established pursuant to the Renewable Energy Act, which requires that public
electric utilities give priority to electricity produced from renewable energy sources by independent power producers and pay a fixed tariff for such electricity for a period of 20 years. Such tariff expires December 31, 2019 for our Rosenthal
mill and December 31, 2024 for our Stendal mill. Recent amendments to the Renewable Energy Act will extend their initial terms for a further 10-year period, based upon the price received in the last year prior to renewal regressing at a rate of
8% per annum. Such amendments are subject to compliance with EU state aid rules. While we expect them to be effective, we can provide no assurance of the same.
Since 2005, our German mills have received emission allowances under the European Union Carbon Emissions Trading Scheme,
referred to as the EU ETS. However, our eligibility for special tariffs under the Renewable Energy Act has reduced the amount of emissions allowances granted to our German mills under the EU ETS.
In 2016, our Rosenthal and Stendal mills sold approximately 169,249 MWh and 479,310 MWh of electricity, respectively, for
proceeds of $17.1 million and $45.0 million, respectively.
In 2016, our Rosenthal and Stendal mills generated $1.5
million and $10.6 million, respectively, from the sale of tall oil, a by-product of our production process. In 2014, our Rosenthal mill completed a capital project which allowed it to process and sell tall oil.
Celgar Mill
The Celgar mill has an electricity sales agreement with British Columbia Hydro and Power Authority, referred to as
B.C. Hydro, for the sale of power generated, pursuant to which the mill agreed to supply a minimum of approximately 238,000 MWh of surplus electrical energy annually to the utility over a ten-year term. The agreement expires in
2020.
16
In 2016, our Celgar mill sold approximately 137,286 MWh of renewable
electricity for proceeds of approximately $9.4 million.
In 2012, we initiated a claim against the Government of Canada
under the North American Free Trade Agreement, referred to as NAFTA, relating to our investment in Celgar and unfair and discriminatory treatment regarding its ability to purchase and sell energy. See Item 3. Legal
Proceedings.
Cash Production Costs
Consolidated cash production costs per ADMT for our pulp mills are set out in the following table for the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2016
|
|
|
2015
|
|
|
2014
|
|
Cash Production Costs
|
|
(per ADMT)
|
|
|
(%)
|
|
|
(per ADMT)
|
|
|
(%)
|
|
|
(per ADMT)
|
|
|
(%)
|
|
Fiber
|
|
$
|
264
|
|
|
|
60
|
|
|
$
|
286
|
|
|
|
62
|
|
|
$
|
332
|
|
|
|
62
|
|
Labor
|
|
|
52
|
|
|
|
12
|
|
|
|
51
|
|
|
|
11
|
|
|
|
58
|
|
|
|
11
|
|
Chemicals
|
|
|
51
|
|
|
|
12
|
|
|
|
51
|
|
|
|
11
|
|
|
|
59
|
|
|
|
11
|
|
Energy
|
|
|
20
|
|
|
|
5
|
|
|
|
18
|
|
|
|
4
|
|
|
|
29
|
|
|
|
5
|
|
Other
|
|
|
54
|
|
|
|
11
|
|
|
|
59
|
|
|
|
12
|
|
|
|
57
|
|
|
|
11
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cash production costs
(1)
|
|
$
|
441
|
|
|
|
100
|
|
|
$
|
465
|
|
|
|
100
|
|
|
$
|
535
|
|
|
|
100
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Cash production costs per ADMT excludes depreciation and amortization.
|
Production Costs
Our major costs of production are fiber, labor, chemicals and energy. Fiber, comprised of wood chips and pulp logs, is our
most significant operating expense, representing about 60% of our cash production costs in 2016. Given the significance of fiber to our total operating expenses and our limited ability to control its costs, compared with our other operating costs,
volatility in fiber costs can materially affect our margins and results of operations.
Fiber
Our mills are situated in regions which generally provide a relatively stable supply of fiber. The fiber consumed by our
mills consists of wood chips produced by sawmills as a by-product of the sawmilling process and pulp logs. Wood chips are small pieces of wood used to make pulp and are either wood residuals from the sawmilling process or pulp logs chipped
especially for this purpose. Pulp logs consist of lower quality logs not used in the production of lumber. Wood chips and pulp logs are cyclical in both price and supply.
Generally, the cost of wood chips and pulp logs is primarily affected by the supply and demand for lumber. Additionally,
regional factors such as harvesting levels and weather conditions can also have a material effect on the supply, demand and price for fiber.
In Germany, the price and supply of wood chips has been affected by increasing demand from alternative or renewable energy
producers and government initiatives for carbon neutral energy. Declining energy prices, weaker economies or warm winters such as in 2014, 2015 and 2016 tempered the demand for wood chips resulting from initiatives by European governments to promote
the use of wood as a carbon neutral energy. Over the long-term, we expect this non-traditional demand for fiber is likely to continue to remain strong.
17
During the past few years, certain customers have endeavored to purchase pulp
that is produced using fiber that meets certain recognized wood certification requirements from forest certification agencies like FSC, PEFC, SFI-CSA. If the fiber we purchase does not meet certain wood certifications required by customers, it may
make it more difficult or prevent us from selling our pulp to such customers. The chain of custody wood certification process is a voluntary process which allows a company to demonstrate that they use forest resources in accordance with strict
principles and standards in the areas of sustainable forest management practices and environmental management. In an effort to procure wood only from sustainably managed sources, we employ an FSC Chain of Custody protocol for controlled wood and
PEFC certification, which requires tracking of fiber origins and preparing risk based assessments regarding the region and operator. In the areas where we operate, we are actively engaged in the further development of certification processes.
Although wood certification requirements continue to evolve and are not consistent from jurisdiction to jurisdiction, we currently do not expect certification requirements to have a material adverse impact on our fiber procurement and pulp sales.
Offsetting some of the increases in demand for wood fiber have been initiatives to increase harvest levels in Germany,
particularly from small private forest owners. We believe that Germany has the highest availability of softwood forests in Europe suitable for harvesting and manufacturing. We believe private ownership of such forests is approximately 48%. Many of
these forest ownership stakes are very small and have been harvested at rates much lower than their rate of growth.
In
2016, our per unit fiber costs in Germany were 9% lower than in 2015, primarily as a result of a balanced wood market in Germany. In 2015, our per unit fiber costs in Germany decreased by approximately 17% due to the strength of the dollar and as a
result of a generally balanced wood market. In 2014, our per unit fiber costs in Germany decreased by approximately 6% due to sawmills running at high rates, a stronger supply of logs and lower demand from pellet producers and board manufacturers.
We believe we are the largest consumer of wood chips and pulp logs in Germany and often provide the best long-term
economic outlet for the sale of wood chips in Eastern Germany. We coordinate the wood procurement activities for our German mills to reduce overall personnel and administrative costs, provide greater purchasing power and coordinate buying and
trading activities. This coordination and integration of fiber flows also allows us to optimize transportation costs, and the species and fiber mix for both mills. In addition, in 2016, we entered into a joint wood purchasing arrangement with
another significant wood consumer in Europe, being the Mondi Group.
In 2016, the Rosenthal mill consumed approximately
1.8 million cubic meters of fiber. Approximately 66% of such consumption was in the form of sawmill wood chips and approximately 34% was in the form of pulp logs. The wood chips for the Rosenthal mill are sourced from approximately 33 sawmills
located primarily in the states of Bavaria, Baden-Württemberg and Thüringia and primarily within a 300 kilometer radius of the Rosenthal mill. Within this radius, the Rosenthal mill is the largest consumer of wood chips. Given its location
and size, the Rosenthal mill is often the best economic outlet for the sale of wood chips in the area. In 2016, approximately 67% of the fiber consumed by the Rosenthal mill was spruce and the remainder was pine. While fiber costs and supply
are subject to cyclical changes largely in the sawmill industry, we expect that we will be able to continue to obtain an adequate supply of fiber on reasonably satisfactory terms for the Rosenthal mill due to its location and our long-term
relationships with suppliers. We have not historically experienced any significant fiber supply interruptions at the Rosenthal mill.
Wood chips for the Rosenthal mill are normally sourced from sawmills under one-year contracts with quarterly adjustments for
market pricing. Substantially all of our chip supply is sourced from suppliers with which we have long-standing relationships. Pulp logs are sourced from the state forest agencies in Thüringia, Saxony and Bavaria and from private and municipal
forest owners. In addition, the Rosenthal mill buys relevant volumes from traders and via imports from the Czech Republic and Poland.
18
In 2016, the Stendal mill consumed approximately 3.3 million cubic meters
of fiber. Approximately 29% of such fiber was in the form of sawmill wood chips and approximately 71% was in the form of pulp logs. The core wood supply region for the Stendal mill includes most of the Northern and Western part of Germany primarily
within an approximate 300 kilometer radius of the mill. We also purchase wood chips from Southwestern and Southern Germany. The fiber consumed by the Stendal mill consisted of approximately 53% pine, 46% spruce and 1% other species in 2016. The
Stendal mill has sufficient chipping capacity to fully operate solely using pulp logs, if required. We source pulp logs from private forest holders, municipal forest owners and from state forest agencies in
Saxony-Anhalt,
Mecklenburg-Western Pomerania, Saxony, Lower Saxony, North Rhine-Westphalia, Hesse, Brandenburg, Schleswig-Holstein, Rhineland Palatinate and the City of Berlin. The volumes are distributed at
optimal costs between the mills. In addition, over the last three years, the Stendal mill also imported fiber from Poland and the Baltic Sea region.
The availability of fiber for the Celgar mill is in large part influenced by the strength of the lumber market. Lumber
markets are primarily driven by U.S. housing starts and, to a lesser degree, demand from China.
In 2016, our Celgar
mills per unit fiber costs were 6% lower than in 2015, due to strong sawmilling activity in the Celgar mills fiber basket. In 2015, our Celgar mills per unit fiber costs were flat compared to 2014, as the strengthening of the
dollar largely offset higher prices in local currency terms. In 2014, our Celgar mills per unit fiber costs were 11% lower than in 2013, as a result of strong sawmill activity in the region.
In 2016, the Celgar mill consumed approximately 2.3 million cubic meters of fiber. Approximately 78% of such fiber was
in the form of sawmill wood chips and the remaining 22% came from pulp logs processed through its woodroom or chipped by a third party. Celgars woodroom is able to process about 40% of the mills fiber needs. The source of fiber at the
mill is characterized by a mixture of species (pine, douglas fir, hemlock, cedar and spruce) and the mill sources fiber from a number of Canadian and U.S. suppliers.
In 2016, the Celgar mill had access to approximately 27 different chip suppliers from Canada and the United States,
representing approximately 78% of its total annual fiber requirements. The Celgar mills woodroom and third party chippers supplied the remaining 22% of the mills fiber requirements in 2016. Chips are purchased in Canada and the United
States in accordance with chip purchase agreements. Generally, pricing is reviewed and adjusted periodically to reflect market prices. One of the longer-term contracts is a so-called evergreen agreement, where the contract remains in
effect until one of the parties elects to terminate after providing the stipulated notice. All other contracts are generally for one year with quarterly adjustments or on three-month terms.
To secure the volume of pulp logs required by its woodroom, the Celgar mill has entered into pulp log supply agreements,
which can range from three-month to one-year terms, with a number of different suppliers, many of whom are also contract chip suppliers to the mill. All of the pulp log agreements can be terminated by either party for any reason, upon seven
days written notice. The Celgar mill also purchased two non-renewable licenses at a cost of $1.3 million, which will provide saw logs to sawmills in the area and pulp logs for the Celgar mill to use. The Celgar mill also bids on British
Columbia timber sales from time to time. The Celgar mill has also commenced second pass harvesting in certain locales to increase harvesting of pulp logs that have traditionally been left as waste after harvesting operations.
19
Labor
Our labor costs are generally steady, with small overall increases due to inflation in wages and health care costs. Over the
last three years, we have been able to largely offset such increases by increasing our efficiencies and production and streamlining operations.
Energy
Our energy is primarily generated from renewable carbon neutral sources, such as black liquor and wood waste. Our mills
produce all of our energy requirements and generate excess energy which we sell to third party utilities. In 2016, we generated 1,812,646 MWh and sold 785,845 MWh of surplus energy. See also Generation and Sales of Green
Energy and Chemicals at our Mills. We utilize fossil fuels, such as natural gas, primarily in our lime kilns and we use a limited amount for start-up and shut-down operations. Additionally, from time to time, mill process disruptions occur and
we consume small quantities of purchased electricity and fossil fuels to maintain operations. As a result, all of our mills are subject to fluctuations in the prices for fossil fuels.
Chemicals
Our mills use certain chemicals which are generally available from several suppliers and sourcing is primarily based upon
pricing and location. Our chemical costs have generally declined over the last three years through improved efficiencies and capital expenditures and the strength of the dollar.
In connection with our focus on the growing bio-energy market, we sell tall oil, a by-product of our production process
which is used as both a chemical additive and as a green energy source. In 2016, we generated $12.8 million from the sale of tall oil and other chemicals.
Sales, Marketing and Distribution
Our pulp revenues by geographic area are set out in the following table for the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2016
|
|
|
2015
|
|
|
2014
|
|
Revenues by Geographic Area
|
|
(in thousands)
|
|
Germany
|
|
$
|
326,898
|
|
|
$
|
344,843
|
|
|
$
|
346,879
|
|
Italy
|
|
|
53,702
|
|
|
|
53,919
|
|
|
|
80,730
|
|
Other European Union countries
(1)
|
|
|
173,585
|
|
|
|
210,218
|
|
|
|
250,952
|
|
United States
|
|
|
26,985
|
|
|
|
15,453
|
|
|
|
39,146
|
|
China
|
|
|
221,773
|
|
|
|
266,632
|
|
|
|
276,848
|
|
Other Asia
|
|
|
31,897
|
|
|
|
43,981
|
|
|
|
69,711
|
|
Other countries
|
|
|
12,488
|
|
|
|
11,191
|
|
|
|
9,366
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
(2)
|
|
$
|
847,328
|
|
|
$
|
946,237
|
|
|
$
|
1,073,632
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Excluding Germany and Italy.
|
(2)
|
Excluding intercompany sales.
|
20
The following charts illustrate the geographic distribution of our pulp
revenues as a percentage of our total pulp revenues for the periods indicated:
|
|
|
|
|
2016 Geographically Segmented Pulp Sales
|
|
2015 Geographically Segmented Pulp Sales
|
|
2014 Geographically Segmented Pulp Sales
|
|
|
|
|
|
|
|
|
*Excluding Germany and Italy.
The distribution of our pulp sales by end use are set out in the following table for the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2016
|
|
|
2015
|
|
|
2014
|
|
|
|
(in thousands of ADMTs)
|
|
Tissue
|
|
|
503
|
|
|
|
501
|
|
|
|
542
|
|
Specialty
|
|
|
209
|
|
|
|
227
|
|
|
|
205
|
|
Printing & Writing
|
|
|
663
|
|
|
|
716
|
|
|
|
705
|
|
Other
|
|
|
54
|
|
|
|
19
|
|
|
|
34
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,429
|
|
|
|
1,463
|
|
|
|
1,486
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Our global sales and marketing group is responsible for conducting all sales and marketing
of the pulp produced at our mills and currently has approximately 15 employees. This group largely handles all European and North American sales directly. Sales to Asia are made directly or through commission agents overseen by our sales group. The
global sales and marketing group handles sales to approximately 190 customers. We coordinate and integrate the sales and marketing activities of our German mills to realize on a number of synergies between them. These include reduced overall
administrative and personnel costs and coordinated selling, marketing and transportation activities. We also coordinate sales from the Celgar mill with our German mills on a global basis, thereby providing our larger customers with seamless service
across all major geographies. In marketing our pulp, we seek to establish long-term relationships by providing a competitively priced, high-quality, consistent product and excellent service. In accordance with customary practice, we maintain
long-standing relationships with our customers, pursuant to which we periodically reach agreements on specific volumes and prices.
Our pulp sales are on customary industry terms. At December 31, 2016, we had no material payment delinquencies. In
2016, two customers through several of their operations accounted for 19% and 10%, respectively, of our pulp sales. In 2015, one customer through several of its operations accounted for 16% of our pulp sales. In 2014, one customer through several of
its operations accounted for 13% of our pulp sales. We do not believe our pulp sales are dependent upon the activities of any single customer and the loss of any single customer would not have a material adverse effect on us.
21
Our sales to tissue and specialty paper product manufacturers were
approximately 50% of our pulp sales in 2016, 2015 and 2014. Generally tissue producer customers are not as sensitive to cyclical declines in demand caused by downturns in economic activity. The balance of our sales was to other paper product
manufacturers.
Transportation
We transport our NBSK pulp generally by truck, rail and ocean carriers through third-party carriers. We have a small fleet
of trucks in Germany that deliver some of our German mills pulp.
Our German mills are currently the only
significant market kraft pulp producers in Germany, which is the largest import market for kraft pulp in Europe. We therefore have a competitive transportation cost advantage compared to Canadian and Northern European pulp producers when shipping to
customers in Europe. Due to the location of our German mills, we are able to deliver pulp to many of our customers primarily by truck and rail. Most trucks that deliver goods into Eastern Germany generally do not have significant backhaul
opportunities as the region is primarily an importer of goods. We are therefore frequently able to obtain relatively low backhaul freight rates for the delivery of our products to many of our customers.
The Celgar mills pulp is transported to customers by rail, truck and ocean carrier to ensure timely delivery. The
majority of Celgars pulp for overseas markets is initially delivered primarily by rail to the Port of Vancouver for shipment overseas by ocean carrier. Based in Western Canada, the Celgar mill is well positioned to service Asian customers. The
majority of the Celgar mills pulp for domestic markets is shipped by rail directly to the customer or to third party warehouses in the United States. In 2015, we established a logistics and reload center near Trail, British Columbia. The
center provides us with additional warehouse space for our Celgar mill and greater transportation flexibility in terms of access to rail and trucking options.
In each of 2016, 2015 and 2014, outbound transportation costs comprised approximately 8%, 9% and 9%, respectively, of our
total consolidated cost of sales. Generally, in recent years, our transportation costs have decreased due to the positive impact of a stronger dollar, decreases in fuel costs and higher shipping capacity. We have also taken initiatives to target
sales to the most freight logical customers.
Capital Expenditures
We have continued to make capital investments designed to increase pulp, green energy and chemical generation,
reduce costs and improve efficiency and environmental performance at our mills. The improvements made at our mills over the years have increased the competitive position of our facilities.
Total capital expenditures at our mills (excluding any related governmental grants) are set out in the following table for
the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2016
|
|
|
2015
|
|
|
2014
|
|
|
|
(in thousands of dollars)
|
|
Rosenthal
|
|
$
|
15,167
|
|
|
$
|
15,690
|
|
|
$
|
16,624
|
|
Stendal
|
|
|
7,801
|
|
|
|
18,490
|
|
|
|
8,700
|
|
Celgar
|
|
|
19,558
|
|
|
|
12,356
|
|
|
|
9,288
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
42,526
|
|
|
$
|
46,536
|
|
|
$
|
34,612
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital investments at the Rosenthal mill in 2016 related to a railcar acceptance system for
logs and a lime kiln retrofit. In 2015, they related to a wastewater reduction project consisting of an evaporation plant upgrade and completion of an automated chip storage project and, in 2014, they related primarily to the automated chip storage
project and a tall oil project.
22
Capital investments at the Stendal mill in 2016 related to a wastewater
reduction project consisting of an evaporation plant upgrade and a project to reduce chloride levels in the process water. In 2015 and 2014, they related primarily to the evaporation plant upgrade.
Certain of our capital investment programs in Germany were partially financed through government grants made available by
German federal and state governments. Under legislation adopted by the federal and certain state governments of Germany, government grants are provided to qualifying businesses operating in Eastern Germany to finance capital investments. The grants
are made to encourage investment and job creation. For example, the government grants received in connection with our main capital project completed at the Stendal mill in 2013 require us to maintain the employment of core employees for five years
after completion of the project, among certain other terms. Previously, government grants were available for up to 35% of the cost of qualified investments. These grants at the 35% of cost level required that at least one permanent job be created
for each 0.5 million ($0.5 million) of capital investment eligible for such grants and that such jobs be maintained for a period of five years from the completion of the capital investment project. Generally, government grants are not
repayable by a recipient unless such recipient fails to complete the proposed capital investment or, if applicable, fails to create or maintain the requisite amount of jobs or comply with other applicable terms. In the case of such failure, the
government is entitled to revoke the grants and seek repayment unless such failure resulted from material unforeseen market developments beyond the control of the recipient, in which case the government may refrain from reclaiming previous grants.
Pursuant to legislation in effect at the time, the Stendal mill recorded approximately $350.0 million of government grants. We believe that we are currently in compliance in all material respects with all of the terms and conditions governing the
government grants we have received in Germany. See Item 3. Legal Proceedings.
The following table sets
out, as at the dates indicated, the effect of government grants on the recorded value of such assets in our Consolidated Balance Sheets:
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As at December 31,
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|
|
2016
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|
|
2015
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|
|
2014
|
|
|
|
(in thousands)
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|
Property, plant and equipment, gross amount less amortization
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|
$
|
971,462
|
|
|
$
|
1,015,569
|
|
|
$
|
1,188,195
|
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Less: government grants less amortization
|
|
|
(233,186
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)
|
|
|
(253,178
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)
|
|
|
(305,045
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)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property, plant and equipment, net (as shown on the Consolidated Balance Sheet)
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|
$
|
738,276
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|
|
$
|
762,391
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|
|
$
|
883,150
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|
|
|
|
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|
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The following table sets forth, as at the dates indicated, the gross amount of all
government grants we have received and capitalized in our balance sheet, the associated amortization and the resulting net balance we include in our property, plant and equipment:
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|
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|
|
|
|
|
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As at December 31,
|
|
|
|
2016
|
|
|
2015
|
|
|
2014
|
|
|
|
(in thousands)
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|
Government grants gross
(1)
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|
$
|
467,260
|
|
|
$
|
475,142
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|
|
$
|
532,696
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Less: Accumulated amortization
|
|
|
(234,074
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)
|
|
|
(221,964
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)
|
|
|
(227,651
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)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Government grants less accumulated amortization
|
|
$
|
233,186
|
|
|
$
|
253,178
|
|
|
$
|
305,045
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
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Grants were received in euros and Canadian dollars and amounts change when translated into dollars as a result
of changes in currency exchange rates.
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23
Qualifying capital investments at industrial facilities in Germany that reduce
effluent discharges offset wastewater fees that would otherwise be required to be paid. For more information about our environmental capital expenditures, see Environmental.
In 2016, capital investments at the Celgar mill included new wood harvesting equipment, a logistics and reload center and
other maintenance projects. In 2015, they included the logistics and reload center and other maintenance projects and, in 2014, they included a new chip screening project, the logistics and reload center and maintenance projects.
In January 2014, we commenced the implementation of a new enterprise resource planning, or ERP, system to
replace our existing business software applications at an estimated cost of $12.0 million. The project was designed to be completed in stages and is expected to be substantially completed in 2017. The ERP system installation will replace a suite of
existing legacy systems which, while functional, will begin becoming obsolete in the near future. The ERP solution introduces state-of-the-art, end-to-end business solutions that will provide automation for most aspects of our business.
Excluding costs for projects financed through government grants, capital expenditures, including ERP expenditures, in 2017
are expected to be approximately $48.0 million, comprised principally of approximately:
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$13.0 million at the Rosenthal mill for a project to reduce wastewater fees and other projects;
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$17.0 million at the Stendal mill for a project to reduce wastewater fees and other projects; and
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$18.0 million at the Celgar mill for maintenance and other projects.
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Innovation
We are well positioned to capitalize on our expertise with fiber and its processing to expand our product mix and into new
markets. Accordingly, we have a number of initiatives focused on developing innovative new products that are based on derivatives of the kraft pulping process. Currently these derivatives are focused in two broad categories:
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the further refinement of materials contained in black liquor, the extractive chemical and lignin containing
compounds that are a result of the kraft pulping process; and
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the further refinement of cellulose materials that are currently the basis of NBSK pulp.
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We are working on some of these initiatives on our own and some with industry associations and others
with joint venture partners. Currently, one of the better-developed of these projects is a cellulose derivative generally referred to in the industry as cellulose filaments. Cellulose filaments are the result of a new process that
unbinds the individual filaments that make up a cellulose fiber. In northern softwoods, there are approximately 1,000 filaments making up a single fiber. The filaments resulting from this patented process are long, ribbon-like structures that have
unique strength characteristics similar to other chemical derivatives, such as aramids. We believe that this material may have commercial potential in many applications, including strength enhancers, solution stabilizers and specialty solutions for
numerous other industries.
We are part of an industry association that has made considerable progress in developing a
particular manufacturing process. We, along with other member companies, including certain other NBSK producers, have license rights to further develop and market existing intellectual property registered under patent to our industry association.
The association and one of its member companies have constructed a
24
pilot production facility and we have access to its product for development purposes. While there remains much work to be done, we continue to be encouraged with the results to date and intend to
continue to expend resources to develop this technology, both individually and in joint development arrangements with third parties. We currently estimate expenditures totaling approximately $1.0 million in 2017.
Such research and development is still at an early stage and there has been no commercialization of any products to date. We
currently estimate it may take about three years before we can determine if product applications can be commercialized. However, there can be no assurance that such research and development will ever result in commercialization or the production or
sales of any products by us at a profit or at all.
We have also worked with suppliers to develop new customized forms
of railcars in Germany designed to better handle the transportation of logs and chips to our German mills. These customized cars are larger than existing ones and are designed to reduce transportation and handling costs at our German mills. In 2016,
we leased and received about 200 such railcars.
We have also worked with equipment suppliers to develop innovative
logging equipment to permit us to effect second pass harvesting in the fiber procurement area for the Celgar mill. Such equipment includes customized processing and chipping equipment and trailers for haulage.
Environmental
Our operations are subject to a wide range of environmental laws and regulations, dealing primarily with water, air and land
pollution control. We devote significant management and financial resources to comply with all applicable environmental laws and regulations. In particular, the operation of our plants is subject to permits, authorizations and approvals and we have
to comply with certain emission limits. Compliance with these requirements is monitored by local authorities and non-compliance may result in administrative orders, fines or closures of the non-compliant mill. Our total capital expenditures on
environmental projects at our mills were approximately $2.9 million in 2016, approximately $19.4 million in 2015 and approximately $6.1 million in 2014. In 2017, capital expenditures for environmental projects, principally comprised of projects to
reduce wastewater fees and upgrade the effluent system at our German mills, are expected to be approximately $21.0 million.
We believe we have obtained all required environmental permits, authorizations and approvals for our operations. We believe
our operations are currently in material compliance with the requirements of all applicable environmental laws and regulations and our respective operating permits.
Under German state environmental rules relating to effluent discharges, industrial users are required to pay wastewater fees
based upon the amount of their effluent discharge. These rules also provide that an industrial user which undertakes environmental capital expenditures and lowers certain effluent discharges to prescribed levels may offset the amount of these
expenditures against the wastewater fees that they would otherwise be required to pay. We expect capital investment programs and other environmental initiatives at our German mills will continue to offset the wastewater fees that are payable and we
believe they will ensure that our operations continue in substantial compliance with prescribed standards.
Environmental compliance is a priority for our operations. To ensure compliance with environmental laws and regulations, we
regularly monitor emissions at our mills and periodically perform environmental audits of operational sites and procedures both with our internal personnel and outside consultants. These audits identify opportunities for improvement and allow us to
take proactive measures at the mills as considered appropriate.
25
The Rosenthal mill has a relatively modern biological wastewater treatment and
oxygen bleaching facility. We have significantly reduced our levels of absorbable organic halogen discharge at the Rosenthal mill and we believe the Rosenthal mills absorbable organic halogen and chemical oxygen discharges are in compliance
with the standards currently mandated by the German government.
Management believes that, as the Stendal mill is a
state-of-the-art facility, it will be able to continue to operate in compliance with the applicable environmental requirements.
Management further believes that Celgar will continue to operate in substantial compliance with the requirements of all
applicable environmental laws and regulations. However, on September 16, 2016, our Celgar mill had a valve issue at its sewage treatment plant which was promptly notified to environmental authorities and was resolved on the same day. Prior to
such resolution, the mill discharged effluent into a river which was toxic to fish. After investigation, our Celgar mill received a written warning from the federal environmental authority under the
Fisheries Act
. While we believe the issue
is resolved and completed, we can provide no assurance that a governmental authority will not take any further actions regarding the same, including monetary penalties.
Future regulations or permits may place lower limits on allowable types of emissions, including air, water, waste and
hazardous materials, and may increase the financial consequences of maintaining compliance with environmental laws and regulations or conducting remediation. Our ongoing monitoring and policies have enabled us to develop and implement effective
measures to maintain emissions in substantial compliance with environmental laws and regulations to date in a cost-effective manner. However, there can be no assurances that this will be the case in the future.
Climate Change
Over the past several years, changing weather patterns and climatic conditions due to natural and man-made causes have added
to the unpredictability and frequency of natural disasters, such as hurricanes, earthquakes, hail storms, wildfires, snow storms and ice storms, which could also affect our operations, including variations in the cost and availability of raw
materials, such as fiber. However, as there are differing scientific studies relating to the severity, extent and speed at which climate change is occurring, we cannot identify and predict all of the consequences of climate change on our business
and operations.
The effects and perceived effects of climate change and social and governmental responses have created
both opportunities and negative consequences for our business.
The focus on climate change has generated a substantial
increase in demand and in legislative requirements for carbon neutral or green energy in both Europe and, increasingly, in North America. Pulp mills consume wood residuals, being wood chips and pulp logs, as the base raw
material for their production process. Wood chips are residuals left over from lumber production and pulp logs are generally lower quality logs left over from logging that are unsuitable for the production of lumber.
As part of their production process, our mills take wood residuals and process them through a digester where cellulose is
separated from the wood to be used in pulp production and the remaining residuals, called black liquor, are used for green energy production. As a result of their use of wood residuals and because our mills generate combined
heat and power in a process known as cogeneration, they are efficient producers of energy. This energy is carbon neutral and produced from a renewable source. Our relatively modern mills generate a substantial amount of energy that is surplus to
their operational requirements.
These factors, along with governmental initiatives in respect of renewable or
green energy legislation, have provided business opportunities for us to enhance our generation and sales of green energy to regional utilities.
26
We are constantly exploring other initiatives to enhance our generation and
sales of surplus green energy and chemical by-products. Other potential opportunities that may result from climate change include:
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the expansion of softwood forests and increased growth rates for such forests;
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more intensive forestry practices and timber salvaging versus harvesting standing timber;
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greater demand for sustainable energy and cellulosic biomass fuels; and
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additional governmental incentives and/or legislative requirements to enhance biomass energy production.
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At this time, we cannot predict which, if any, of these potential opportunities will be realized by
us or their economic effect on our business.
While all of the specific consequences to our business from climate change
are not predictable, the most visible adverse consequence to date is that the focus on renewable energy has created greater demand and competition for wood residuals or fiber from renewable energy producers like the pellet industry in Germany.
In Germany, the price and supply of wood residuals have been affected by an increasing demand from alternative or renewable
energy producers and governmental initiatives for carbon neutral energy. Declining energy prices, weaker economies or warm winters such as in 2016, 2015 and 2014 temper the demand for wood chips resulting from initiatives by European governments to
promote the use of wood as a carbon neutral energy. Over the long term, this non-traditional demand for fiber is expected to remain strong in Europe. Additionally, the growing interest and focus in British Columbia for renewable green
energy is also expected to create additional competition for such fiber in that region over time. Such additional demand for wood residuals may increase the competition and prices for wood residuals over time.
Governmental action or legislation may also have an important effect on the demand and prices for wood residuals. As
governments pursue green energy initiatives, they risk creating incentives and demand for wood residuals from renewable energy producers that cannibalizes or adversely affects traditional users, such as lumber and pulp and
paper producers. We are continually engaged in dialogue with governments to educate and try to ensure potential initiatives recognize the traditional and continuing role of our mills in the overall usage of forestry resources and the economies of
local communities.
Other potential negative consequences from climate change that over time may affect our business
include:
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a greater susceptibility of northern softwood forests to disease, fire and insect infestation;
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the disruption of transportation systems and power supply lines due to more severe storms;
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the loss of fresh water transportation for logs and pulp due to lower water levels;
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decreases in the quantity and quality of processed water for our mill operations;
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the loss of northern softwood forests in areas in sufficient proximity to our mills to competitively acquire
fiber; and
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lower harvest levels decreasing the supply of harvestable timber and, as a consequence, wood residuals.
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27
Human Resources
We currently employ approximately 1,486 people. We have approximately 1,025 employees working in our German operations,
including our wood procurement, transportation and sales subsidiaries. In Canada, we have approximately 461 employees, of which 21 are employed at our Vancouver, British Columbia, office.
Rosenthal employs approximately 439 people, the majority of whom are bound by a collective agreement. In July 2015, the
Rosenthal mill revised its collective agreement for a two-year period until June 2017. The agreement provided for an initial 2.4% wage increase and a subsequent increase of 2.4% in September 2016.
Stendal employs approximately 579 people, the majority of which are bound by a collective agreement. In 2011, Stendal
entered into a seven-year collective agreement, effective July 2011 and expiring in 2018. Since, prior to entering into this collective agreement, Stendals employees had relatively lower wages compared to their peers at other German pulp
mills, this agreement provided for an approximately 5.5% wage increase in 2012 and a further 2.5% minimum annual wage increase from 2013 to 2015, with no wage increases from 2016 to the agreements expiry in 2018.
Celgar employs approximately 440 people, the majority of which are bound by a collective agreement. Celgar entered into a
five-year collective agreement with its hourly workers in 2012, which expires in April 2017. The agreement provided for lump sum payments of C$3,750 for all active employees in 2012 and 2013 and wage increases of 2.0%, 2.5% and 3.0% in each of 2014,
2015 and 2016, respectively.
We consider the relationships with our employees to be good. Although no assurances can be
provided, we have not had any significant work stoppages at any of our operations and we would therefore expect to enter into new labor agreements with our workers when the current labor agreements expire without any significant work stoppages.
Our directors and senior managers have extensive experience in the pulp and forestry industries, along with experienced
managers at all of our mills. Our management has a proven track record of implementing new initiatives and capital projects in order to reduce costs throughout our operations as well as identifying and harnessing new revenue opportunities.
Description of Certain Indebtedness
The following summarizes certain material provisions of: (i) our 2019, 2022 and 2024 Senior Notes; (ii) our
Stendal Revolving Credit Facility; (iii) our credit facilities related to our Rosenthal mill; and (iv) the Celgar Working Capital Facility. The summaries are not complete and are qualified by reference to the applicable documents and the
applicable amendments to such documents on file with the SEC and incorporated by reference herein.
2019, 2022 and 2024 Senior
Notes
In November 2014, we issued $250.0 million in aggregate principal amount of 7.000% Senior Notes due 2019,
referred to as the 2019 Senior Notes, and $400.0 million in aggregate principal amount of 7.750% Senior Notes due 2022, referred to as the 2022 Senior Notes, to refinance our previously outstanding 9.50% Senior Notes due 2017
and Stendals two senior project finance facilities.
28
In 2016, we repurchased and cancelled $23.0 million in aggregate principal
amount of our 2019 Senior Notes and, in January 2017, we announced the redemption of all of our remaining 2019 Senior Notes, being $227.0 million in aggregate principal amount, with the net proceeds of an issuance of $225.0 million in aggregate
principal amount of 6.500% senior notes due 2024, referred to as the 2024 Senior Notes and, together with the 2019 Senior Notes and the 2022 Senior Notes, the 2019, 2022 and 2024 Senior Notes, and cash on hand. The 2024
Senior Notes were issued on February 3, 2017 and our outstanding 2019 Notes will be redeemed on March 1, 2017, subject to our deposit with the paying agent of sufficient funds to pay the redemption price, being $1,035.00 per $1,000.00 of
principal amount redeemed, plus accrued and unpaid interest to, but not including the redemption date.
The 2019 Senior
Notes were to mature on December 1, 2019 and interest on the 2019 Senior Notes is payable semi-annually in arrears on each June 1 and December 1. The 2022 Senior Notes mature on December 1, 2022 and interest on the 2022 Senior
Notes is payable semi-annually in arrears on each June 1 and December 1. Interest is payable to holders of record of the 2022 Senior Notes on the immediately preceding May 15 and November 15 and is computed on the basis of a
360-day year consisting of twelve 30-day months. The 2024 Senior Notes mature on February 1, 2024 and interest on the 2024 Senior Notes is payable semi-annually in arrears on each February 1 and August 1. Interest is payable to
holders of record of the 2024 Senior Notes on the immediately preceding January 15 and July 15 and is computed on the basis of a 360-day year consisting of twelve 30-day months.
Commencing December 1, 2017, the 2022 Senior Notes will become redeemable at our option at a price equal to 105.813% of
the principal amount redeemed and declining ratably on December 1 of each year thereafter to 100.000% on or after December 1, 2020. Commencing February 1, 2020, the 2024 Senior Notes will become redeemable at our option at a price
equal to 103.250% of the principal amount redeemed and declining ratably on December 1 of each year thereafter to 100.000% on or after February 1, 2022.
The indentures governing the 2019, 2022 and 2024 Senior Notes contain covenants limiting, among other things, our ability
and the ability of our restricted subsidiaries to: incur additional indebtedness or issue preferred stock; pay dividends or make other distributions to our shareholders; purchase or redeem capital stock or subordinated indebtedness; make
investments; create liens; incur restrictions on the ability of our restricted subsidiaries to pay dividends or make other payments to us; sell assets; consolidate or merge with or into other companies or transfer all or substantially all of our
assets; and engage in transactions with affiliates. As of December 31, 2016, all of our subsidiaries were restricted subsidiaries.
The 2019, 2022 and 2024 Senior Notes are unsecured and are not guaranteed by any of our operating subsidiaries, all of which
are located outside the United States. Our obligations under the 2019, 2022 and 2024 Senior Notes rank: effectively junior in right of payment to all of our existing and future secured indebtedness, to the extent of the assets securing such
indebtedness, and all indebtedness and liabilities of our subsidiaries; equal in right of payment with all of our existing and future unsecured senior indebtedness; and senior in right of payment to any of our future subordinated indebtedness.
As at December 31, 2016, $227.0 million in aggregate principal amount of 2019 Senior Notes and $400.0 million in
aggregate principal amount of 2022 Senior Notes were outstanding. Upon completion of the redemption of the 2019 Senior Notes and as a result of the issuance of the 2024 Notes, $400.0 million in aggregate principal amount of 2022 Senior Notes and
$225.0 million in aggregate principal amount of 2024 Senior Notes will be outstanding.
29
Stendal Revolving Credit Facility
Our Stendal mills 75.0 million revolving credit facility, referred to as the Stendal Revolving Credit
Facility, with a syndicate of four banks as original lenders matures in October 2019. The principal terms of the Stendal Revolving Credit Facility are as follows:
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The total availability under the facility is 75.0 million.
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The facility matures on the earlier of October 31, 2019 and one month prior to the stated maturity of
the 2019 Senior Notes.
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The facility may be utilized in the form of cash advances or advances by letters of credit or bank
guarantees of up to 5.0 million. Borrowings accrue interest at a rate of Euribor plus a 3.50% margin. Fees of 2.25% per annum are payable on issued but undrawn letters of credit and bank guarantees. There is a commitment fee of
1.10% per annum payable on unused availability.
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The facility is secured by a first ranking registered security interest on the inventories and receivables
of Stendal. All shareholder loans made by Mercer Inc. to Stendal are subordinated to the indebtedness under the facility.
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The facility contains financial maintenance covenants which are tested semi-annually on June 30 and
December 31, which require Stendal to maintain (i) a leverage ratio of net debt (excluding shareholder loans) to EBITDA of not greater than 2.50:1.00, (ii) an interest coverage ratio (EBITDA to interest expense) of not
less than 1.20:1.00 and (iii) a current ratio (current assets to current liabilities) of at least 1.10:1.00.
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Stendal is permitted under the facility to make (i) distributions for regularly scheduled interest
payments on its shareholder loans from Mercer Inc. in an amount of up to $23.0 million per year, provided it maintains pro forma liquidity (availability under the facility plus unencumbered cash) of at least 20.0 million and no event of
default is occurring and (ii) other distributions to Mercer Inc. semi-annually, provided it maintains pro forma liquidity of at least 20.0 million, no event of default is occurring and it has (A) a leverage ratio (excluding
shareholder loans) of not greater than 2.50:1.00, (B) a trailing six-month interest coverage ratio of at least 1.40:1.00 and (C) a current ratio of at least 1.25:1.00.
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Pursuant to the facility, Stendal has provided 4.1 million as at December 31, 2016 as
partial cash collateral for variable-to-fixed interest rate swaps, referred to as the Stendal Interest Rate Swap Contract, and such contract shares
pari passu
in the security for the Stendal Revolving Credit Facility. For further
information related to the Stendal Interest Rate Swap Contract, see Item 7A. Quantitative and Qualitative Disclosures About Market Risk and the notes to our consolidated financials included herein.
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The facility contains other customary restrictive covenants which, among other things, govern the ability of
Stendal to incur liens, sell assets, incur indebtedness, make investments, enter into joint ventures, change its business and issue, repurchase or redeem shares. The facility also contains customary events of default.
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As at December 31, 2016, the total amount of funds available under the Stendal Revolving Credit Facility was 75.0
million.
30
Rosenthal Credit Facilities
Our Rosenthal mill has the following credit facilities:
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a 25.0 million revolving working capital facility which we extended in 2016 to mature in October
2019, referred to as the Rosenthal Loan Facility. The Rosenthal Loan Facility consists of a revolving credit facility which may be utilized by way of cash advances or advances by way of letter of credit or bank guarantees. The interest
payable on cash advances is Euribor plus 2.95%, plus certain other costs incurred by the lenders in connection with the facility. Each cash advance is to be repaid on the last day of the respective interest period and in full on the termination date
and each advance by way of a letter of credit or bank guarantee shall be repaid on the applicable expiry date of such letter of credit or bank guarantee. An interest period for cash advances shall be one, three or six months or any other period as
Rosenthal and the lenders may determine. There is also a 0.90% per annum commitment fee on the unused and uncancelled amount of the revolving facility which is payable semi-annually in arrears. This facility is secured by a first ranking
security interest on the inventories and receivables of Rosenthal. It also provides Rosenthal with a hedging facility relating to the hedging of the interest, currency and pulp prices as they affect Rosenthal pursuant to a strategy agreed to by
Rosenthal and the lender from time to time. As at December 31, 2016, 3.1 million was supporting bank guarantees, leaving approximately 21.9 million available under this facility; and
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a 5.0 million revolving credit facility for our Rosenthal mill which bears interest at the rate
of the three-month Euribor plus 2.5%. Borrowings under this agreement are secured by certain land at the Rosenthal mill. The facility matures in December 2018. As at December 31, 2016, 3.2 million was supporting bank guarantees.
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As at December 31, 2016, the total amount of funds available under the Rosenthal credit
facilities was 23.7 million.
Celgar Working Capital Facility
Our Celgar mills C$40.0 million revolving credit facility with a Canadian bank, referred to as the Celgar
Working Capital Facility, matures in May 2019. The facility is available by way of: (i) Canadian and U.S. denominated advances, which bear interest at a designated prime rate per annum, (ii) bankers acceptance equivalent loans,
which bear interest at the applicable Canadian dollar bankers acceptance plus 1.50% per annum and (iii) dollar LIBOR advances, which bear interest at LIBOR plus 1.50% per annum. The facility includes a C$3.0 million sub-limit
for letters of credit. Celgar is required to pay 0.25% per annum on unused availability under the facility and 1.25% per annum on issued but undrawn letters of credit. The availability of the facility is subject to a borrowing base limit
that is based on the Celgar mills eligible receivable and inventory levels from time to time. The Celgar Working Capital Facility is secured by, among other things, a first priority charge on the inventories and receivables of Celgar. The
facility is guaranteed by Mercer Inc. and all material subsidiaries of Celgar. The facility includes a springing financial covenant, which is measured when excess availability under the facility is less than C$5.0 million and which requires Celgar
to comply with a 1.10:1.00 fixed charge coverage ratio. The facility also contains restrictive covenants which, among other things, restrict the ability of Celgar to declare and pay dividends, incur indebtedness, incur liens and make payments on
subordinated debt. The facility contains customary events of default.
As at December 31, 2016, the total amount of
funds available under the Celgar Working Capital Facility was C$38.3 million.
31
Internet Availability and Additional Information
We make available free of charge on or through our website at www.mercerint.com annual reports on Form 10-K, quarterly
reports on Form 10-Q and current reports on Form 8-K, and all amendments to these reports, as soon as reasonably practicable after we file these materials with, or furnish these materials to, the SEC. The public may read and copy any material we
file with the SEC at the SECs Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may also obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an
internet site at www.sec.gov that also contains our current and periodic reports, including our proxy and information statements.
All websites referred to herein are inactive textual references only, meaning that the information contained on such
websites is not incorporated by reference herein and you should not consider information contained on such websites as part of this document unless expressly specified.
32
ITEM 1A. RISK FACTORS
The statements in this Risk Factors section describe material risks to our business and should be considered
carefully. You should review carefully the risk factors listed below, as well as those factors listed in other documents we file with the SEC. In addition, these statements constitute our cautionary statements under the Private Securities Litigation
Reform Act of 1995. Our disclosure and analysis in this annual report on Form 10-K and in our annual report to shareholders contain some forward-looking statements that set forth anticipated results based on managements current plans and
assumptions.
There are a number of important factors, many of which are beyond our control that could cause actual
conditions, events or results to differ significantly from those described in the forward-looking statements. These factors include, but are not limited to, the following:
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our business is highly cyclical;
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a weakening of the global economy, including capital and credit markets, could adversely affect our business
and financial results and have a material adverse effect on our liquidity and capital resources;
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our level of indebtedness could negatively impact our financial condition, results of operations and
liquidity;
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cyclical fluctuations in the price and supply of our raw materials, particularly fiber, could adversely
affect our business;
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we face intense competition in our markets;
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we are exposed to currency exchange rate fluctuations;
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we are subject to extensive environmental regulation and we could incur substantial costs as a result of
compliance with, violations of or liabilities under applicable environmental laws and regulations;
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our business is subject to risks associated with climate change and social and government responses thereto;
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our operations require substantial capital and we may be unable to maintain adequate capital resources to
provide for such capital requirements;
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future acquisitions may result in additional risks and uncertainties in our business;
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changes in credit ratings issued by nationally recognized statistical rating organizations could adversely
affect our cost of financing and have an adverse effect on the market price of our securities;
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we rely on government grants and participate in German statutory energy programs;
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we are subject to risks related to our employees;
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we are dependent on key personnel;
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we may experience material disruptions to our production (including as a result of, among other things,
planned and unplanned maintenance downtime);
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if our long-lived assets become impaired, we may be required to record non-cash impairment charges that
could have a material impact on our results of operations;
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we may incur losses as a result of unforeseen or catastrophic events, including the emergence of a pandemic,
terrorist attacks or natural disasters;
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our insurance coverage may not be adequate;
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we rely on third parties for transportation services;
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our new ERP system may cost more than expected, be delayed, fail to perform as planned and interrupt
operational transactions during and following the implementation, which could adversely affect our operations and results of operations;
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we periodically use derivatives to manage certain risks which has caused significant fluctuations in our
operating results;
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failures or security breaches of our information technology systems could disrupt our operations and
negatively impact our business;
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the price of our common stock may be volatile;
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a small number of our shareholders could significantly influence our business;
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our international sales and operations are subject to applicable laws relating to trade, export controls and
foreign corrupt practices, the violation of which could adversely affect our operations; and
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we are exposed to interest rate fluctuations.
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From time to time, we also provide forward-looking statements in other materials we release as well as oral forward-looking
statements. Such statements give our current expectations or forecasts of future events; they do not relate strictly to historical or current facts.
Statements in the future tense, and all statements accompanied by terms such as may, will,
believe, project, expect, estimate, assume, intend, design, anticipate, plan, should and variations thereof and similar terms are
intended to be forward-looking statements as defined by federal securities law. You can find examples of these statements throughout this annual report on Form 10-K, including in the description of business in Item 1. Business and
Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. While these forward-looking statements reflect our best estimates when made, the following risk factors could cause actual results
to differ materially from estimates or projections.
We intend that all forward-looking statements we make will be
subject to safe harbor protection of the federal securities laws pursuant to Section 27A of the
Securities Act of 1933
, as amended and Section 21E of the
Securities Exchange Act of 1934
, as amended.
You should consider the limitations on, and risks associated with, forward-looking statements and not unduly rely on the
accuracy of predictions contained in such forward-looking statements. As noted above, these forward-looking statements speak only as of the date when they are made. We do not undertake any obligation to update forward-looking statements to reflect
events, circumstances, changes in expectations, or the occurrence of unanticipated events after the date of those statements. Moreover, in the future, we may make forward-looking statements that involve the risk factors and other matters described
in this document as well as other risk factors subsequently identified.
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Our business is highly cyclical in nature.
The pulp business is highly cyclical in nature and markets are characterized by periods of supply and demand imbalance,
which in turn can materially affect prices. Pulp markets are sensitive to cyclical changes in the global economy, industry capacity and foreign exchange rates, all of which can have a significant influence on selling prices and our operating
results. The length and magnitude of industry cycles have varied over time but generally reflect changes in macro-economic conditions and levels of industry capacity. Pulp is a commodity that is generally available from other producers. Because
commodity products have few distinguishing qualities from producer to producer, competition is generally based upon price, which is generally determined by supply relative to demand.
Industry capacity can fluctuate as changing industry conditions can influence producers to idle production capacity or
permanently close mills. In addition, to avoid substantial cash costs in idling or closing a mill, some producers will choose to operate at a loss, sometimes even a cash loss, which can prolong weak pricing environments due to oversupply. Oversupply
of our products can also result from producers introducing new capacity in response to favorable pricing trends. Certain integrated pulp and paper producers have the ability to discontinue paper production by idling their paper machines and selling
their NBSK pulp production on the market, if market conditions, prices and trends warrant such actions.
Currently,
there have been publicly announced significant increases to expand chemical pulp capacity worldwide. Producers have announced projects to increase hardwood kraft pulp capacity by an aggregate of about 3.2 million ADMTs in 2017 and 2018,
primarily in South America and Asia. Further capacity increases of about 0.7 million ADMTs have been announced for 2019. This increase in bleached hardwood kraft pulp is largely targeted at the growing demand for pulp in developing markets,
particularly in China, by producers of tissues, specialty papers and packaging. If such additional bleached hardwood kraft pulp supply is not absorbed by such demand growth, as a result of generally lower prices for bleached hardwood kraft pulp,
this supply increase could put downward pressure on NBSK pulp prices.
Producers have also announced increases to NBSK
pulp capacity in 2017 and 2018 of an estimated 1.9 million ADMTs, along with another 0.6 million ADMTs of southern softwood and fluff pulp capacity. Further net capacity increases of NBSK and southern and fluff pulp capacity of about
0.3 million ADMTs have been announced for 2019. At this time, we cannot predict how much of the publicly announced capacity will come on line and when. If such new capacity, particularly for NBSK pulp, is not absorbed in the market or offset by
curtailments or closures of older, high-cost NBSK pulp mills, the increase could put downward pressure on NBSK pulp prices and materially adversely affect our results of operations, margin, and profitability.
Demand for pulp has historically been determined primarily by general global macro-economic conditions and has been closely
tied to overall business activity. NBSK pulp prices have been and are likely to continue to be volatile and can fluctuate widely over time. Between 2007 and 2016, European list prices for NBSK pulp have fluctuated between a low of approximately $575
per ADMT in 2009 to a high of $1,030 per ADMT in 2011.
A producers actual sales price realizations are list
prices net of customer discounts, rebates and other selling concessions. Over the last three years, these have increased as producers compete for customers and sales. Our sales price realizations may also be affected by NBSK price movements between
the order and shipment dates.
Accordingly, prices for pulp are driven by many factors outside our control, and we have
little influence over the timing and extent of price changes, which are often volatile. Because market conditions beyond our control determine the price for pulp, prices may fall below our cash production costs, requiring us to either incur
short-term losses on product sales or cease production at one or more of our mills.
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Therefore, our profitability depends on managing our cost structure, particularly raw materials which represent a significant component of our operating costs and can fluctuate based upon factors
beyond our control. If the prices of our products decline, or if prices for our raw materials increase, or both, our results of operations and cash flows could be materially adversely affected.
A weakening of the global economy, including capital and credit markets, could adversely affect our business and financial results and
have a material adverse effect on our liquidity and capital resources.
As demand for pulp has principally
historically been determined by general global macro-economic activities, demand and prices for our product have historically decreased substantially during economic slowdowns. A significant economic downturn may affect our sales and profitability.
Further, our suppliers and customers may also be adversely affected by an economic downturn. Additionally, restricted credit and capital availability restrains our customers ability or willingness to purchase our products resulting in lower
revenues. Depending on their severity and duration, the effects and consequences of a global economic downturn could have a material adverse effect on our liquidity and capital resources, including our ability to raise capital, if needed, and
otherwise negatively impact our business and financial results.
Our level of indebtedness could negatively impact our financial
condition, results of operations and liquidity.
As of December 31, 2016, we had an aggregate principal
amount of $627.0 million of indebtedness outstanding. We may also incur additional indebtedness in the future. Our high debt levels may have important consequences for us, including, but not limited to the following:
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our ability to obtain additional financing for working capital, capital expenditures, general corporate and
other purposes or to fund future operations may not be available on terms favorable to us or at all;
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a significant amount of our operating cash flow is dedicated to the payment of interest and principal on our
indebtedness, thereby diminishing funds that would otherwise be available for our operations and for other purposes;
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increasing our vulnerability to current and future adverse economic and industry conditions;
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a substantial decrease in net operating cash flows or increase in our expenses could make it more difficult
for us to meet our debt service requirements, which could force us to modify our operations;
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our leveraged capital structure may place us at a competitive disadvantage by hindering our ability to
adjust rapidly to changing market conditions or by making us vulnerable to a downturn in our business or the economy in general;
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causing us to offer debt or equity securities on terms that may not be favorable to us or our shareholders;
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limiting our flexibility in planning for, or reacting to, changes and opportunities in our business and our
industry; and
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our level of indebtedness increases the possibility that we may be unable to generate cash sufficient to pay
the principal or interest due in respect of our indebtedness.
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The indentures that govern our 2019, 2022 and 2024 Senior Notes and our bank
credit facilities contain restrictive covenants which impose operating and other restrictions on us and our subsidiaries. These restrictions will affect, and in many respects will limit or prohibit, our ability to, among other things, incur or
guarantee additional indebtedness, pay dividends or make distributions on capital stock or redeem or repurchase capital stock, make investments or acquisitions, create liens and enter into mergers, consolidations or transactions with affiliates. The
terms of our indebtedness also restrict our ability to sell certain assets, apply the proceeds of such sales and reinvest in our business.
Certain of the agreements governing our indebtedness have covenants that require us to maintain prescribed financial ratios
and tests. Failure to comply with such covenants could result in events of default and could have a material adverse effect on our liquidity, results of operations and financial condition.
Our ability to repay or refinance our indebtedness will depend on our future financial and operating performance. Our
performance, in turn, will be subject to prevailing economic and competitive conditions, as well as financial, business, legislative, regulatory, industry and other factors, many of which are beyond our control. Our ability to meet our future debt
service and other obligations may depend in significant part on the extent to which we can successfully implement our business strategy. We cannot assure you that we will be able to implement our strategy fully or that the anticipated results of our
strategy will be realized. Over the next several years, we will require financing to refinance maturing debt obligations (unless extended), and such refinancing may not be available on favorable terms or at all.
Cyclical fluctuations in the price and supply of our raw materials, particularly fiber, could adversely affect our business.
Our main raw material is fiber in the form of wood chips and pulp logs and represented approximately 60% of our
cash production costs in 2016. Fiber is a commodity and both prices and supply are cyclical. Fiber pricing is subject to regional market influences and our costs of fiber may increase in a region as a result of local market shifts. The cost of wood
chips and pulp logs is primarily affected by the supply and demand for lumber. Demand for these raw materials is generally determined by the volume of pulp and paper products produced globally and regionally. Governmental regulations related to the
environment, forest stewardship and green or renewable energy can also affect the supply of fiber. In Germany, governmental initiatives to increase the supply of renewable energy have led to more renewable energy projects in Europe,
including Germany. Demand for wood residuals from such energy producers, combined with lower harvesting rates, has generally put upward pressure on prices for wood residuals, such as wood chips, in Germany and its neighboring countries. This has
resulted in higher fiber costs for our German mills and such trend could continue to put further upward pressure on wood chip prices. Wood chip supply in Germany was stable during the course of 2015 and 2016 due to stable sawmill production and
lower demand from pellet producers and board manufacturers; however, there is no assurance that wood chip supply will continue to be stable or that supply will not be reduced or that fiber costs will not increase in the future.
Similarly, North American sawmill activity declined significantly during the recession, reducing the supply of chips and
availability of pulp logs to our Celgar mill. Additionally, North American energy producers are exploring the viability of renewable energy initiatives and governmental initiatives in this field are increasing, all of which could lead to higher
demand for sawmill residual fiber, including chips. A recovery in U.S. housing starts, which commenced in the latter part of 2012 and has continued through 2016, resulted in increased sawmill activity. This increased the supply of wood chips for the
Celgar mill and reduced its need for pulp logs, which are generally a higher cost for the mill than wood chips. Sawmill activity was stable in Canada during 2015 and 2016; however, there is no assurance that sawmill activity will continue to remain
stable or that fiber prices will not increase in the future.
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The 2006 Softwood Lumber Agreement which governed softwood lumber exports from
Canada to the United States expired in 2015 and a one-year post-expiration period during which the United States agreed not to impose trade sanctions expired in October 2016. In December 2016, the U.S. Department of Commerce initiated
investigations, which could result in countervailing and anti-dumping duties on Canadian softwood lumber exports to the United States commencing in the second and third quarters of 2017, respectively. Canada may appeal any such duties to the World
Trade Organization. It is uncertain when or if the United States and Canada may settle a new agreement and what terms or restrictions it may contain. Any duties or other restrictions imposed on Canadian softwood lumber exports by the United States
could negatively impact Canadian sawmill production in our Celgar mills supply area and result in reduced availability and increased costs for wood chips for the mill. While we believe this may be partially offset by increased wood chip supply
from U.S. sawmills and pulp log availability, we cannot currently predict the overall effect on our Celgar mills overall fiber costs.
Availability of fiber may be further limited by adverse responses to and prevention of wildfires, weather, insect
infestation, disease, ice storms, wind storms, flooding and other natural causes. In addition, the quantity, quality and price of fiber we receive could be affected by man-made causes such as those resulting from industrial disputes, material
curtailments or shut-down of operations by suppliers, government orders and legislation (including new taxes or tariffs). Any or a combination of these can affect fiber prices in a region.
The cyclical nature of pricing for fiber represents a potential risk to our profit margins if pulp producers are unable to
pass along price increases to their customers or we cannot offset such costs through higher prices for our surplus energy.
We do not own any timberlands or have any material long-term governmental timber concessions and we currently have few
long-term fiber contracts at our German operations. Fiber is available from a number of suppliers and we have not historically experienced material supply interruptions or substantial sustained price increases. However, our requirements have
increased and may continue to do so as we expand capacity through capital projects or other efficiency measures at our mills. As a result, we may not be able to purchase sufficient quantities of these raw materials to meet our production
requirements at prices acceptable to us during times of tight supply. An insufficient supply of fiber or reduction in the quality of fiber we receive would materially adversely affect our business, financial condition, results of operations and cash
flow.
In addition to the supply of fiber, we are, to a lesser extent, dependent on the supply of certain chemicals and
other inputs used in our production facilities. Any disruption in the supply of these chemicals or other inputs could affect our ability to meet customer demand in a timely manner and could harm our reputation. Any material increase in the cost of
these chemicals or other inputs could have a material adverse effect on our business, results of operations, financial condition and cash flows.
We face intense competition in our markets.
We sell our pulp globally, with a large percentage sold in Europe, Asia and North America. The markets for pulp are highly
competitive. A number of other global companies compete in each of these markets and no company holds a dominant position. Our pulp is considered a commodity because many companies produce similar and largely standardized products. As a result, the
primary basis for competition in our markets has been price. Many of our competitors have greater resources and lower leverage than we do and may be able to adapt more quickly to industry or market changes or devote greater resources to the sale of
products than we can. There can be no assurance that we will continue to be competitive in the future. Prices for our products are affected by many factors outside of our control and we have no influence over the timing and extent of price changes,
which are often volatile. Our ability to maintain satisfactory
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margins depends, in large part, on managing our costs, particularly raw material and energy costs which represent significant components of our operating costs and can fluctuate based upon
factors beyond our control.
The global pulp market has historically been characterized by considerable swings in prices
which have and will result in variability in our earnings.
We are exposed to currency exchange rate fluctuations.
We have manufacturing operations in Germany and Canada. Most of the operating costs and expenses of our German mills are
incurred in euros and those of our Celgar mill in Canadian dollars. However, the majority of our sales are in products quoted in dollars. Our results of operations and financial condition are reported in dollars. As a result, our costs generally
benefit from a strengthening dollar but are adversely affected by a decrease in the value of the dollar relative to the euro and to the Canadian dollar. Such declines in the dollar relative to the euro and the Canadian dollar reduce our operating
margins and the cash flow available to fund our operations and to service our debt. This could have a material adverse effect on our business, financial condition, results of operations and cash flows.
Further, while a strengthening dollar generally lowers our costs and expenses, it increases the cost of NBSK pulp to our
customers and generally puts downward pressure on pulp prices and reduces our energy and chemical sales revenues as they are sold in euros and Canadian dollars.
Although we report in dollars, we hold certain assets and liabilities, including our mills, in euros and Canadian dollars.
We translate foreign denominated assets and liabilities into dollars at the rate of exchange on the balance sheet date. Equity accounts are translated using historical exchange rates. Unrealized gains or losses from these translations are recorded
in our other comprehensive income (loss) and do not affect our net earnings, operating income or Operating EBITDA.
Certain intercompany dollar advances between Mercer Inc. and its foreign subsidiaries are held in euros and Canadian
dollars. When such advances are translated by the subsidiaries into dollars at the end of each reporting period, the gains or losses thereon are reflected in net earnings.
We are subject to extensive environmental regulation and we could incur substantial costs as a result of compliance with, violations
of or liabilities under applicable environmental laws and regulations.
Our operations are subject to numerous
environmental laws and regulations as well as permits, guidelines and policies relating to the protection of the environment. These laws, regulations, permits, guidelines and policies govern, among other things:
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unlawful discharges to land, air, water and sewers;
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waste collection, storage, transportation and disposal;
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dangerous goods and hazardous materials and the collection, storage, transportation and disposal of such
substances;
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the clean-up of unlawful discharges;
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employee health and safety.
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In addition, as a result of our operations, we may be subject to remediation,
clean-up or other administrative orders or amendments to our operating permits, and we may be involved from time to time in administrative and judicial proceedings or inquiries. Future orders, proceedings or inquiries could have a material adverse
effect on our business, financial condition and results of operations. Environmental laws and land use laws and regulations are constantly changing. New regulations or the increased enforcement of existing laws could have a material adverse effect
on our business and financial condition. In addition, compliance with regulatory requirements is expensive, at times requiring the replacement, enhancement or modification of equipment, facilities or operations. There can be no assurance that we
will be able to maintain our profitability by offsetting any increased costs of complying with future regulatory requirements.
We are subject to liability for environmental damage at the facilities that we own or operate, including damage to
neighboring landowners, residents or employees, particularly as a result of the contamination of soil, groundwater or surface water and especially drinking water. The costs of such liabilities can be substantial. Our potential liability may include
damages resulting from conditions existing before we purchased or operated these facilities. We may also be subject to liability for any offsite environmental contamination caused by pollutants or hazardous substances that we or our predecessors
arranged to transport, treat or dispose of at other locations. In addition, we may be held legally responsible for liabilities as a successor owner of businesses that we acquire or have acquired. Except for Stendal, our facilities have been
operating for decades and we have not done invasive testing to determine whether or to what extent any such environmental contamination exists. As a result, these businesses may have liabilities for conditions that we discover or that become
apparent, including liabilities arising from non-compliance with environmental laws by prior owners. Because of the limited availability of insurance coverage for environmental liability, any substantial liability for environmental damage could
materially adversely affect our results of operations and financial condition.
We have incurred, and we expect to
continue to incur, significant capital, operating and other expenditures as a result of complying with applicable environmental laws and regulations.
Further, enactment of new environmental laws or regulations, changes in existing laws or regulations or the interpretation
of these laws and regulations might require significant capital expenditures. We may be unable to generate sufficient funds or access other sources of capital to fund unforeseen environmental liabilities or expenditures.
Our business is subject to risks associated with climate change and social and government responses thereto.
Our operations and those of our suppliers are subject to climate change variations which can impact the productivity of
forests, the abundance of species, harvest levels and lumber. Further, over the last few years, changing weather patterns and climate conditions due to natural and man-made causes have added to the frequency and unpredictability of natural disasters
like earthquakes, storms, wildfires and snow and ice storms. One or a combination of these factors could adversely affect our fiber supply which is our largest cash production cost. There are differing scientific studies and opinions relating to the
severity, extent and speed at which climate change is or may be occurring around the world. As a result, we are currently unable to identify and predict all of the specific consequences of climate change on our business and operations.
Further, governmental initiatives in response to climate change also have an impact on operations.
In Germany, government and social focus on and demand for carbon neutral or green energy has created
greater demand and competition for the wood residuals or fiber that is consumed by our pulp mills as part of their production process. This has helped drive up the cost of fiber for German mills. In
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addition, further or new governmental initiatives or legislation may also increase both the demand and prices for wood residuals. As governments pursue green energy initiatives, they
may implement financial, tax, pricing or other legislated incentives for renewable energy producers that cannibalize or materially adversely affect fiber supplies for existing traditional users, such as lumber and pulp and paper
producers.
Such additional demand for wood residuals and/or governmental initiatives may materially increase the
competition and prices for wood residuals over time. This could increase our fiber costs and/or restrict our ability to acquire fiber at competitive prices or at all during times of shortages. If our fiber costs increase and we cannot pass on these
costs to our customers or offset them through higher prices for our sales of surplus energy, it will negatively affect our operating margins, results of operations and financial position. If we cannot obtain the fiber required to operate our mills,
we may have to curtail and/or shut down production. This could have a material adverse effect on operations, financial results and financial position.
Other potential risks to our business from climate change include:
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a greater susceptibility of northern softwood forests to disease, fire and insect infestation, which could
diminish fiber availability;
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the disruption of transportation systems and power supply lines due to more severe storms;
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the loss of fresh water transportation for logs and pulp due to lower water levels;
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decreases in the quantity and quality of processed water for our mill operations;
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the loss of northern softwood forests in areas in sufficient proximity to our mills to competitively acquire
fiber; and
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lower harvest levels decreasing the supply of harvestable timber and, as a consequence, wood residuals.
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The occurrence of any or a combination of these events could have a material adverse effect on our
operations and/or financial results.
Our operations require substantial capital and we may be unable to maintain adequate capital
resources to provide for such capital requirements.
Our business is capital intensive and requires that we
regularly incur capital expenditures to maintain our equipment, improve efficiencies and, as a result of changes to environmental regulations that require capital expenditures, bring our operations into compliance with such regulations. In addition,
we may approve projects in the future that will require significant capital expenditures. Increased capital expenditures could have a material adverse effect on our cash flow and our ability to satisfy our debt obligations. If our available cash
resources and cash generated from operations are not sufficient to fund our operating needs and capital expenditures, we would have to obtain additional funds from borrowings or other available sources or reduce or delay our capital expenditures.
Our indebtedness could adversely affect our financial health, limit our operations or impair our ability to raise additional capital. If this occurs, we may not be able to obtain additional funds on favorable terms or at all. If we cannot maintain
or upgrade our equipment as may be required from time to time, we may become unable to manufacture products that compete effectively. An inability to make required capital expenditures in a timely fashion could have a material adverse effect on our
growth, business, financial condition or results of operations.
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Future acquisitions may result in additional risks and uncertainties in our business.
In order to grow our business, we may seek to acquire additional assets or companies. Our ability to pursue
selective and accretive acquisitions will be dependent on managements ability to identify, acquire, and develop suitable acquisition targets in both new and existing markets. In pursuing acquisition and investment opportunities, we face
competition from other companies having similar growth strategies, many of which may have substantially greater resources than us. Competition for these acquisitions or investment targets could result in increased acquisition or investment prices,
higher risks and a diminished pool of businesses or assets available for acquisition.
Acquisitions also frequently
result in recording of goodwill and other intangible assets, which are subject to potential impairments in the future that could have a material adverse effect on our operating results. Furthermore, the costs of integrating acquired businesses
(including restructuring charges associated with the acquisitions, as well as other acquisition costs, such as accounting fees, legal fees and investment banking fees) could significantly impact our operating results.
Although we perform diligence on the businesses we purchase, in light of the circumstances of each transaction, an
unavoidable level of risk remains regarding the actual condition of these businesses. We may not be able to ascertain the value or understand the potential liabilities of the acquired businesses and their operations until we assume operating control
of the assets and operations of these businesses.
Furthermore, any future acquisitions of businesses or facilities
could entail a number of risks, including:
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problems with the effective integration of operations;
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inability to maintain key pre-acquisition business relationships;
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increased operating costs;
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exposure to substantial unanticipated liabilities; and
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difficulties in realizing projected efficiencies, synergies and cost savings.
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In addition, geographic and other expansions, acquisitions or joint ventures may require significant managerial attention,
which may be diverted from our other operations. If we are unsuccessful in overcoming these risks, our business, financial condition or results of operations could be materially and adversely affected.
Changes in credit ratings issued by nationally recognized statistical rating organizations could adversely affect our cost of
financing and have an adverse effect on the market price of our securities.
Credit rating agencies rate our
debt securities on factors that include our operating results, actions that we take, their view of the general outlook for our industry and their view of the general outlook for the economy. Actions taken by the rating agencies can include
maintaining, upgrading or downgrading the current rating or placing the company on a watch list for possible future downgrading. Downgrading the credit rating of our debt securities or placing us on a watch list for possible future downgrading could
limit our access to the credit markets, increase our cost of financing and have an adverse effect on the market price of our securities, including the 2019, 2022 and 2024 Senior Notes.
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We rely on government grants and participate in German statutory energy programs.
We currently benefit from a subsidized capital expenditure program as a result of German federal and state
government grants. Should either the German federal or state governments be prohibited from honoring legislative grants, or should we be required to repay any such legislative grants, this may have a material adverse effect on our business,
financial condition, results of operations and cash flow.
Since 2005, our German mills have received emission
allowances under the EU ETS. Since our German mills receive stipulated special tariffs under the Renewable Energy Act, the amount of emissions allowances granted to our German mills under the EU ETS has been reduced and, as a result, from time to
time, we purchase emission allowances in order to meet statutory requirements. Additionally, such emission allowances are subject to statutory amendment or change in the future.
In 2014, in response to an investigation by the European Commission into whether portions of the Renewable Energy Act
constituted unpermitted state aid, the German government amended the Renewable Energy Act. After such amendment, our German mills continued to sell green energy into the market at stipulated prices or tariffs and were
exempted, as existing installations, from certain surcharges on the consumption of energy that they generate, or auto-generation. The German government further amended the Renewable Energy Act effective January 1, 2017,
so that funding for renewable energy is to be allocated through an auction system, primarily to create a competitive bidding process for new installations of wind, solar and biomass energy. However, the amendments provide that existing pulp mills,
including our German mills, are ineligible for such auction process and instead will have their tariffs renewed upon expiry of their initial 20-year terms for a further 10-year period, based upon the price received in the last year prior to renewal
regressing at a rate of 8% per annum. Our Rosenthal mills initial 20-year tariff expires on December 31, 2019 and our Stendal mills initial 20-year tariff expires on December 31, 2024. Such 10-year extensions for such
mills have been notified by the German government to the European Commission for review for compliance with applicable state aid rules. While we currently expect they will become effective, we can provide no assurance that they will be permitted
under EU rules. As a result, we cannot currently predict the effect of promulgated amendments to the Renewable Energy Act on our German mills sale or consumption of energy.
Our costs of energy for our operations in Germany could increase in the event that the auto-generation surcharge exemption
is removed or reduced in the future. Additionally, if the stipulated tariffs for energy sold by our German mills are reduced in the future, our energy sales in Germany may not be as profitable. Any of the foregoing situations or any combination of
them could have a material adverse effect on our results of operations.
We are subject to risks related to our employees.
The majority of our employees are unionized and we have collective agreements in place with our employees at
all of our mills. Although we have not experienced any material work stoppages in the past, there can be no assurance that we will be able to negotiate acceptable collective agreements or other satisfactory arrangements with our employees upon the
expiration of our collective agreements, including our collective agreement with hourly workers at the Celgar mill which expires in April 2017. This could result in a strike or work stoppage by the affected workers. The registration or renewal of
the collective agreements or the outcome of our wage negotiations could result in higher wages or benefits paid to union members. Additionally, changing demographics may make it more difficult for us to recruit skilled employees in the future.
Accordingly, we could experience a significant disruption of our operations or higher ongoing labor costs, which could have a material adverse effect on our business, financial condition, results of operations and cash flow. In addition, whenever we
seek to reduce workforce at any of our mills, the affected mills labor force could seek to hinder or delay such actions, we could incur material severance or other costs, and our operations could be disrupted.
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We are dependent on key personnel.
Our future success depends, to a large extent, on the efforts and abilities of our executive and senior mill operating
officers. Such officers are industry professionals many of whom have operated through multiple business cycles. Our officers play an integral role in, among other things:
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reducing operating costs;
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identifying capital projects which provide a high rate of return; and
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prioritizing expenditures and maintaining employee relations.
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The loss of one or more of our officers could make us less competitive in these areas, which could materially adversely
affect our business, financial condition, results of operations and cash flows. We do not maintain any key person life insurance for any of our executive or senior mill operating officers.
We may experience material disruptions to our production.
A material disruption at one of our manufacturing facilities could prevent us from meeting customer demand, reduce our pulp
and energy sales and/or negatively impact our results of operations. Any of our mills could cease operations unexpectedly due to a number of events, including:
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unscheduled maintenance outages;
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prolonged power failures;
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employee errors or failures;
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design error or employee or contractor error;
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chemical spill or release;
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disruptions in the transportation infrastructure, including roads, bridges, railway tracks, tunnels, canals
and ports;
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fires, floods, earthquakes or other natural catastrophes;
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prolonged supply disruption of major inputs;
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capital projects that require temporary cost increases or curtailment of production; and
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other operational problems.
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Any such downtime or facility damage could prevent us from meeting customer demand for our products and/or require us to
make unplanned capital expenditures. If any of our facilities were to incur significant downtime, our ability to meet our production capacity targets and satisfy customer requirements would be impaired and could have a material adverse effect on our
business, financial condition, results of operations and cash flows.
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If our long-lived assets become impaired, we may be required to record non-cash
impairment charges that could have a material impact on our results of operations.
We review the carrying value
of long-lived assets for impairment when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Should the markets for our products deteriorate or should we decide to invest capital differently or
should other cash flow assumptions change, it is possible that we will be required to record non-cash impairment charges in the future that could have a material adverse effect on our results of operations.
We may incur losses as a result of unforeseen or catastrophic events, including the emergence of a pandemic, terrorist attacks or
natural disasters.
The occurrence of unforeseen or catastrophic events, including the emergence of a pandemic
or other widespread health emergency (or concerns over the possibility of such an emergency), terrorist attacks or natural disasters, could create economic and financial disruptions and could lead to operational difficulties (including travel
limitations) that could impair our ability to manage or operate our business and adversely affect our results of operations.
Our
insurance coverage may not be adequate.
We have obtained insurance coverage that we believe would ordinarily be
maintained by an operator of facilities similar to our mills. Our insurance is subject to various limits and exclusions. Damage or destruction to our facilities could result in claims that are excluded by, or exceed the limits of, our insurance
coverage. Additionally, the weak global and financial markets have also reduced the availability and extent of credit insurance for our customers. If we cannot obtain adequate credit insurance for our customers, we may be forced to amend or curtail
our planned operations which could negatively impact our sales revenues, results of operations and financial position.
We rely on
third parties for transportation services.
Our business primarily relies upon third parties for the
transportation of pulp to our customers, as well as for the delivery of our raw materials to our mills. Our pulp and raw materials are principally transported by truck, barge, rail and sea-going vessels, all of which are highly regulated. Increases
in transportation rates can also materially adversely affect our results of operations.
Further, if our transportation
providers fail to deliver our pulp in a timely manner, it could negatively impact our customer relationships and we may be unable to manufacture pulp in response to customer orders or sell our pulp at full value. Also, if any of our transportation
providers were to cease operations, we may be unable to replace them at a reasonable cost. The occurrence of any of the foregoing events could materially adversely affect our results of operations.
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Our new ERP system may cost more than expected, be delayed, fail to perform as planned
and interrupt operational transactions during and following the implementation, which could adversely affect our operations and results of operations.
In January 2014, we commenced the implementation of a new ERP solution to replace our existing business software
applications at a total estimated cost of $12.0 million. The project was designed to be completed in stages and is expected to be substantially completed in 2017. Such projects are inherently complex, resource intensive and lengthy. As a result, we
could experience unplanned or unforeseen issues that could adversely affect the project, our business and/or our results of operations, including:
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costs of implementation that materially exceed our expectation;
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delays in the go-live of one or more of the stages of the project, resulting in additional costs or time for
completion;
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errors in implementation resulting in errors in the commencement or reporting of business transactions;
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failure in the deliverables of our key partners, suppliers and implementation advisors, resulting in an
inferior product, reduced business efficacy and the project not providing expected benefits;
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deficiencies in the training of employees in the use of the new solution, resulting in errors in the
recording of data or transactions, leading to delays in input deliveries and production impairment;
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a control failure during or post implementation, which may result in a material weakness in our internal
controls over financial reporting; and
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other implementation issues leading to delays and impacts on our business.
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We periodically use derivatives to manage certain risks which has caused significant fluctuations in our operating results.
In 2002, Stendal entered into the Stendal Interest Rate Swap Contract to fix interest payments under its
indebtedness until 2017, which prevented Stendal from benefiting from the general decline in interest rates that ensued. Because we effectively fixed the rate on Stendals indebtedness under such contract, the value of our derivative position
moves inversely to interest rates. The Stendal Interest Rate Swap Contract remains in place after we refinanced Stendals indebtedness in 2014.
We also periodically use other derivatives related to currency exchange rates, pulp prices and energy prices.
We record unrealized gains or losses on our derivative instruments when they are marked to market at the end of each
reporting period and realized gains or losses on them when they are settled. These unrealized and realized gains and losses can materially impact our operating results for any reporting period.
If any of the variety of instruments and strategies we utilize is not effective, we may incur losses which may have a
material adverse effect on our business, financial condition, results of operations and cash flow. The purpose of our derivative activity may also be considered speculative in nature; we do not use these instruments with respect to any pre-set
percentage of revenues or other formula, but either to augment our potential gains or reduce our potential losses depending on our perception of future economic events and developments.
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Failures or security breaches of our information technology systems could disrupt our
operations and negatively impact our business.
We use information technologies to securely manage our
operations and various business functions. We rely on various technologies to process, store and report on our business and to communicate electronically between our facilities, personnel, customers and suppliers. We also use information
technologies to process financial information and results of operations for internal reporting purposes and to comply with regulatory, legal and tax requirements. Despite our security design and controls, and those of our third party providers, our
information technology systems may be vulnerable to a variety of interruptions, including during the process of upgrading or replacing software, databases or components thereof, natural disasters, terrorist attacks, telecommunications failures,
computer viruses, cyber-attacks, hackers, unauthorized access attempts and other security issues or may be breached due to employee error, malfeasance or other disruptions. Any such interruption or breach could result in operational disruptions or
the misappropriation of sensitive data that could subject us to civil and criminal penalties, litigation or have a negative impact on our reputation. There can be no assurance that such disruptions or misappropriations and the resulting
repercussions will not negatively impact our cash flows and materially affect our results of operations or financial condition.
The price of our common stock may be volatile.
The market price of our common stock may be influenced by many factors, some of which are beyond our control, including
those described above and the following:
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actual or anticipated fluctuations in our operating results or our competitors operating results;
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announcements by us or our competitors of new products, capacity changes, significant contracts,
acquisitions or strategic investments;
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our growth rate and our competitors growth rates;
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the financial market and general economic conditions;
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changes in stock market analyst recommendations regarding us, our competitors or the forest products
industry generally or lack of analyst coverage of our common stock;
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sales of common stock by our executive officers, directors and significant shareholders;
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changes in accounting principles; and
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changes in laws and regulations.
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In addition, there has been significant volatility in the market price and trading volume of securities of companies
operating in the forest products industry that often has been unrelated to the operating performance of particular companies. Some companies that have had volatile market prices for their securities have had securities litigation brought against
them. If litigation of this type is brought against us, it could result in substantial costs and would divert managements attention and resources.
A small number of our shareholders could significantly influence our business.
There are a few significant shareholders of our common stock who own a substantial percentage of the outstanding shares of
our common stock. These few significant shareholders, either individually or acting together, may be able to exercise significant influence over matters requiring shareholder approval,
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including the election of directors and approval of significant corporate transactions, such as a merger or other sale of the company or our assets. This concentration of ownership may make it
more difficult for other shareholders to effect substantial changes in the company, may have the effect of delaying, preventing or expediting, as the case may be, a change in control of the company, and may adversely affect the market price of our
common stock. Further, the possibility that one or more of these significant shareholders may sell all or a large portion of their common stock in a short period of time could adversely affect the trading price of our common stock. Also, the
interests of these few shareholders may not be in the best interests of all shareholders.
Our international sales and operations
are subject to applicable laws relating to trade, export controls and foreign corrupt practices, the violation of which could adversely affect our operations.
As a result of our international sales and operations, we are subject to trade and economic sanctions and other restrictions
imposed by the United States, Canada and other governments or organizations, including prohibitions in the United States against foreign competitors (including our operating subsidiaries) receipt of certain unlawful foreign governmental
benefits. We are also subject to the U.S.
Foreign Corrupt Practices Act
, the Canadian
Corruption of Foreign Public Officials Act
and other anti-bribery laws that generally bar bribes or unreasonable gifts to foreign governments or
officials. Changes in trade sanctions laws could restrict our business practices, including cessation of business activities in sanctioned countries or with sanctioned entities, and may result in modifications to compliance programs. Violations of
these laws or regulations could result in sanctions including fines, loss of authorizations needed to conduct our international business, the imposition of tariffs or duties, and other penalties, which could adversely impact our business, operating
results and financial condition.
We are exposed to interest rate fluctuations.
Interest on borrowings under our revolving credit facilities are at floating rates. As a result, increases in
interest rates will increase our costs of borrowing and reduce our operating margins.
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