Mercer International Inc.: Form 10-Q for the period ended Sep 30, 2023

In this document: (i) unless the context otherwise requires, references to “we”, “our”, “us”, the “Company” or “Mercer” mean Mercer International Inc. and its subsidiaries; (ii) references to “Mercer Inc.” mean the Company excluding its subsidiaries; (iii) information is provided as of September 30, 2023, unless otherwise stated; (iv) our reporting currency is dollars and references to “€” mean euros and “C$” mean Canadian dollars; (v) “ADMTs” refers to air-dried metric tonnes; (vi) “m3” means cubic meters; (vii) “NBSK” refers to northern bleached softwood kraft; (viii) “NBHK” refers to northern bleached hardwood kraft; (ix) “MW” refers to megawatts and “MWh” refers to megawatt hours; (x) “Mfbm” refers to thousand board feet of lumber and “MMfbm” mean million board feet of lumber; and (xi) our lumber metrics are converted from cubic meters to Mfbm using a conversion ratio of 1.6 cubic meters to one Mfbm, which is the ratio commonly used in the industry.

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 figure.

The following discussion and analysis of our results of operations and financial condition for the three and nine months ended September 30, 2023 should be read in conjunction with our Interim Consolidated Financial Statements and related notes included in this quarterly report, as well as our most recent annual report on Form 10-K for the fiscal year ended December 31, 2022 filed with the Securities and Exchange Commission, referred to as the “SEC”.

Results of Operations

General

On June 15, 2023, we acquired substantially all of the assets of Structurlam Mass Timber Corporation and its subsidiaries (“Structurlam”), including a mass timber production facility located in Conway, Arkansas and mass timber production facilities in British Columbia, Canada, for cash consideration of $82.1 million.

We have two reportable operating segments:

• Pulp – consists of the manufacture, sale and distribution of pulp, electricity and chemicals at our pulp mills.
• Solid Wood – consists of the manufacture, sale and distribution of lumber, manufactured products (including cross-laminated timber, referred to as “CLT”, glulam and finger joint lumber), wood pallets, electricity, biofuels and wood residuals at our sawmills and other facilities in Germany and our mass timber facilities in North America which include the recently acquired U.S. and Canadian facilities from the Structurlam group of companies.

Each segment offers primarily different products and requires different manufacturing processes, technology and sales and marketing.

Commencing in the third quarter of 2022 and after our acquisition of the Torgau facility, we have included the mass timber results within our solid wood segment, which has been reflected retroactively. Previously they were included in our corporate and other segment.

Current Market Environment

In the third quarter of 2023, overall both pulp and lumber markets were generally weak. We saw modest pulp price improvements in China due to low customer inventory levels but prices in Europe and North America decreased compared to the second quarter of 2023 as a result of inflationary pressures negatively impacting demand. Our lumber sales realizations were flat compared to the second quarter of 2023 as higher realizations in North America were offset by lower realizations in Europe.

As we move into the fourth quarter, we currently expect modest improvements for pulp sales realizations as a result of increasing demand in China and reduced supply due to curtailments.

As of September 30, 2023, third party industry quoted NBSK list prices in Europe and North America were approximately $1,160 per ADMT and $1,270 per ADMT, respectively and NBSK net prices in China were approximately $715 per ADMT. Prices for China are net of discounts, allowances and rebates.

In our solid wood segment, we currently expect generally flat lumber prices in the fourth quarter due to high interest rates and we also currently expect continued growth in our mass timber operations.

Per unit fiber costs for the pulp segment decreased in the third quarter of 2023 compared to the second quarter of 2023 primarily due to realizing the benefits of the upgraded wood room at the Peace River mill and improved supply. For the fourth quarter of 2023, we currently expect a modest decrease to the per unit fiber costs for our pulp segment as a result of improved supply.

Per unit fiber costs for our solid wood segment decreased in the third quarter of 2023 compared to the second quarter of 2023 due to the increased supply of beetle damaged wood in Germany. For the fourth quarter of 2023, we currently expect modestly lower per unit fiber costs as a result of the continued availability of beetle damaged wood.

Summary Financial Highlights

(in thousands, other than per share amounts)

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

(in thousands)

FORM 10-Q

Selected Production, Sales and Other Data

(1) Source: RISI pricing report. Europe and North America are list prices. China are net prices which include discounts, allowances and rebates.

(2) Sales realizations after customer discounts, rebates and other selling concessions. Incorporates the effect of pulp price variations occurring between the order and shipment dates.

(3) Does not include our 50% joint venture interest in the Cariboo mill, which is accounted for using the equity method.

(4) Manufactured products primarily includes CLT, glulam, and finger joint lumber.

(5) Biofuels includes pellets and briquettes.

(6) Average Federal Reserve Bank of New York Noon Buying Rates over the reporting period.

Consolidated – Three Months Ended September 30, 2023 Compared to Three Months Ended September 30, 2022

Total revenues in the third quarter of 2023 decreased by approximately 12% to $470.8 million from $532.8 million in the same quarter of 2022 primarily due to lower pulp, energy and lumber sales realizations partially offset by higher sales volumes, the inclusion of Torgau and higher manufactured product sales realizations.

Costs and expenses in the third quarter of 2023 increased by approximately 12% to $474.2 million from $424.1 million in the third quarter of 2022 primarily due to the inclusion of Torgau and higher sales volumes partially offset by lower per unit fiber, freight and other production costs. In the third quarter of 2023, we received an aggregate of $8.2 million of insurance proceeds relating to the fire last year at our Stendal mill compared to $3.1 million of insurance proceeds in the comparative quarter.

In the third quarter of 2023, cost of sales depreciation and amortization increased by approximately 27% to $40.9 million from $32.1 million in the same quarter of 2022 primarily caused by the inclusion of Torgau.

Selling, general and administrative expenses increased by approximately 24% to $30.1 million in the third quarter of 2023 from $24.3 million in the same quarter of 2022 primarily because of the inclusion of Torgau.

In the third quarter of 2023, operating loss was $3.4 million compared to operating income of $108.7 million in the same quarter of 2022 primarily due to lower pulp, energy and lumber sales realizations partially offset by lower per unit fiber and other production costs, higher sales volumes and the receipt of insurance proceeds.

Interest expense in the third quarter of 2023 increased to $21.9 million from $17.9 million in the same quarter of 2022 caused by higher borrowings on our revolving credit facilities and higher interest rates.

In the third quarter of 2023, other income was $3.3 million compared to $7.3 million in the same quarter of 2022. Other income in the third quarter of 2023 primarily consisted of interest earned on cash and in the third quarter of 2022 other income primarily consisted of foreign exchange gains on dollar denominated cash held at our operations, as the dollar strengthened in the quarter.

During the third quarter of 2023, we had an income tax provision of $4.0 million on a loss before income taxes as we do not recognize a tax recovery for certain entities for which we do not currently expect to realize a tax benefit. In the comparative quarter of 2022, we had an income tax provision of $31.3 million or an effective tax rate of 32%.

For the third quarter of 2023, net loss was $26.0 million, or $0.39 per share, compared to net income of $66.7 million, or $1.01 per basic share and $1.00 per diluted share in the same quarter of the prior year.

In the third quarter of 2023, Operating EBITDA was $37.5 million compared to $140.9 million in the same quarter of 2022 primarily due to lower pulp, energy and lumber sales realizations partially offset by lower per unit fiber, freight and other production costs and higher sales volumes.

Operating Results by Business Segment

None of the income or loss items following operating income (loss) in our Interim Consolidated Statements of Operations are allocated to our segments, since those items are reviewed separately by management.

Pulp Segment – Three Months Ended September 30, 2023 Compared to Three Months Ended September 30, 2022

Selected Financial Information

(in thousands)

FORM 10-Q

Our pulp segment revenues decreased by approximately 24% to $348.9 million from $456.7 million in the same quarter of 2022 primarily because of the overall weak pulp market and lower energy revenues.

Pulp revenues in the third quarter of 2023 decreased by approximately 20% to $318.1 million from $395.5 million in the same quarter of 2022 due to lower sales realizations only partially offset by higher sales volumes.

Energy and chemical revenues decreased by approximately 50% to $30.8 million in the third quarter of 2023 from $61.2 million in the same quarter of 2022 as a result of lower energy sales realizations partially offset by higher sales volumes.

Total pulp production increased by approximately 8% to 479,924 ADMTs in the third quarter of 2023 from 444,970 ADMTs in the same quarter of 2022 primarily due to overall stable production at all of our mills and higher production at the Stendal mill compared to the same quarter of 2022 because of a fire which occurred in July 2022.

In the third quarter of 2023, our pulp mills had 39 days of downtime (approximately 48,400 ADMTs) which included 13 days for annual maintenance downtime and 26 days for market curtailment at the Celgar mill. In the comparative quarter of 2022, our pulp mills had 17 days of annual maintenance downtime (approximately 17,300 ADMTs).

In the fourth quarter of 2023, at our pulp mills we currently expect a total of 29 days for annual maintenance downtime (approximately 41,200 ADMTs).

We estimate that annual maintenance downtime in the third quarter of 2023 adversely impacted our operating income by approximately $12.2 million, comprised of approximately $9.4 million in direct out-of-pocket expenses and the balance in reduced production.

Total pulp sales volumes increased by approximately 14% to 487,199 ADMTs in the third quarter of 2023 from 425,854 ADMTs in the same quarter of 2022 primarily because of higher production and the timing of sales.

In the third quarter of 2023, third party industry quoted average list prices for NBSK pulp decreased in Europe and North America and net prices decreased in China from the same quarter of 2022. Average third party industry quoted list prices for NBSK pulp in Europe and North America were approximately $1,160 per ADMT and $1,293 per ADMT, respectively, in the third quarter of 2023 compared to approximately $1,500 per ADMT and $1,800 per ADMT, respectively, in the same quarter of 2022. Average third party industry quoted NBSK net prices in China were approximately $680 per ADMT in the third quarter of 2023 compared to approximately $969 per ADMT in the same quarter of 2022. Prices quoted for China are net of discounts, allowances and rebates whereas quoted prices for Europe and North America are before applicable discounts, allowances and rebates.

Our average NBSK pulp sales realizations decreased by approximately 27% to $666 per ADMT in the third quarter of 2023 from approximately $911 per ADMT in the same quarter of 2022. In the third quarter of 2023, our average NBHK pulp sales realizations decreased by approximately 46% compared to the same quarter of 2022.

In the third quarter of 2023 compared to the same quarter of 2022, primarily as a result of the effect of the weakening dollar on our euro denominated costs and expenses, we had a negative impact of approximately $17.7 million in operating income due to foreign exchange.

Costs and expenses in the third quarter of 2023 decreased by approximately 5% to $327.9 million from $346.7 million in the third quarter of 2022 primarily due to lower per unit fiber, freight and other production costs and the receipt of insurance proceeds in 2023 partially offset by a higher sales volume.

In the third quarter of 2023 per unit fiber costs decreased by approximately 12% from the same quarter of 2022 due to the sale and revaluation in the current quarter of inventory for which we took an impairment charge in the prior quarter. After giving effect to such impairment, per unit fiber costs increased as a result of strong demand in the mills' fiber baskets and lower wood chip availability for our Celgar mill because of regional sawmill curtailments. We currently expect per unit fiber costs to decrease in the fourth quarter of 2023 driven by improved supply.

Transportation costs decreased by approximately 20% to $34.3 million in the third quarter of 2023 from $42.7 million in the same quarter of 2022 driven by lower freight rates.

In the third quarter of 2023, depreciation and amortization was flat at $28.2 million compared to the same quarter of 2022.

In the third quarter of 2023, pulp segment operating income was $21.2 million compared to $110.0 million in the same quarter of 2022 primarily as a result of lower pulp and energy sales realizations and the negative impact of a weaker dollar partially offset by lower per unit fiber, freight and other production costs, higher sales volumes and the receipt of insurance proceeds of $8.2 million.

Solid Wood Segment – Three Months Ended September 30, 2023 Compared to Three Months Ended September 30, 2022

Selected Financial Information

(in thousands)

(1) Manufactured products primarily includes CLT, glulam, and finger joint lumber.

(2) Biofuels includes pellets and briquettes.

In the third quarter of 2023, solid wood segment revenues increased by approximately 61% to $119.5 million from $74.3 million in the same quarter of 2022 primarily as a result of the inclusion of Torgau and the ramping up of our mass timber operations partially offset by lower lumber and energy revenues.

In the third quarter of 2023, lumber revenues decreased by approximately 6% to $50.8 million from $54.3 million in the same quarter of 2022 due to lower sales realizations partially offset by higher sales volumes. In the third quarter of 2023, both U.S. and European realized lumber prices were lower because of decreased demand as a result of higher interest rates and an uncertain economic outlook compared to the same quarter of 2022. The U.S. market accounted for approximately 57% of our lumber revenues and approximately 49% of our lumber sales volumes in the third quarter of 2023. The majority of the balance of our lumber sales were to Europe.

In the third quarter of 2023, our mass timber operations continued the ramp up of their operations and manufactured products revenue increased to $20.9 million from $7.1 million in the comparative quarter of 2022 as a result of both higher sales volumes and realizations.

Energy and wood residuals revenues in the third quarter of 2023 decreased by approximately 40% to $7.7 million from $12.8 million in the same quarter of 2022 primarily caused by lower sales realizations.

Pallet revenues of $28.8 million and biofuels revenues of $11.4 million in the third quarter of 2023 are from the inclusion of Torgau.

In the third quarter of 2023, lumber production modestly decreased to 94.4 MMfbm from 97.1 MMfbm in the same quarter of 2022 as a result of maintenance downtime and the overall weak lumber market, partially offset by the inclusion of Torgau.

Lumber sales volumes increased by approximately 28% to 114.7 MMfbm in the third quarter of 2023 from 89.8 MMfbm in the same quarter of 2022 primarily due to the timing of sales.

Average lumber sales realizations decreased by approximately 27% to $443 per Mfbm in the third quarter of 2023 from approximately $605 per Mfbm in the same quarter of 2022 as a result of lower demand in both the U.S. and

European markets.

Manufactured products sales realizations increased to $1,752 per m3 in the third quarter of 2023 from $677 per m3 in the third quarter of 2022 as a result of higher CLT sales volumes.

Fiber costs were approximately 70% of our lumber cash production costs in the third quarter of 2023. In the third quarter of 2023, per unit fiber costs for lumber production modestly decreased compared to the same quarter of 2022 due to an increased supply of beetle damaged wood. We currently expect modestly lower per unit fiber costs in the fourth quarter of 2023 as a result of continuing availability of beetle damaged wood.

In the third quarter of 2023, depreciation and amortization increased to $12.5 million compared to $3.7 million in the same quarter of 2022 primarily due to the inclusion of Torgau.

Transportation costs in the third quarter of 2023 increased by approximately 46% to $13.9 million from $9.5 million in the same quarter of 2022 primarily as a result of a higher sales volume.

In the third quarter of 2023, operating loss was $19.7 million compared to operating income of $2.9 million in the same quarter of 2022 primarily due to lower lumber and energy sales realizations partially offset by higher manufactured products sales realizations.

Consolidated ‑ Nine Months Ended September 30, 2023 Compared to Nine Months Ended September 30, 2022

Total revenues for the nine months ended September 30, 2023 decreased by approximately 10% to $1,523.4 million from $1,697.9 million in the same period of 2022 primarily due to lower pulp, lumber and energy sales realizations partially offset by the inclusion of Torgau and higher sales volumes.

Costs and expenses in the nine months ended September 30, 2023 increased by approximately 22% to $1,655.7 million from $1,352.8 million in the same period of 2022 primarily caused by the inclusion of Torgau, higher per unit fiber costs, which includes the net inventory impairment charges at our Canadian pulp mills of $56.6 million, higher sales volumes and higher chemical costs. These increases were partially offset by the receipt of $37.7 million of insurance proceeds.

In the nine months ended September 30, 2023, cost of sales depreciation and amortization increased to $128.5 million from $95.2 million in the same period of 2022 primarily due to the inclusion of Torgau.

Selling, general and administrative expenses increased by approximately 38% to $96.4 million in the nine months ended September 30, 2023 from $70.1 million in the nine months ended September 30, 2022 primarily because of the inclusion of Torgau.

In the nine months ended September 30, 2023, our operating loss was $132.4 million compared to operating income of $345.1 million in the same period of 2022 primarily due to lower pulp, lumber and energy sales realizations, higher per unit fiber costs, which includes the net inventory impairment charges at our Canadian pulp mills, and higher chemical costs partially offset by insurance proceeds received in the nine months ended September 30, 2023 and higher sales volumes.

Interest expense in the nine months ended September 30, 2023 increased by approximately 16% to $61.0 million from $52.7 million in the same period of 2022 primarily caused by higher borrowings on our revolving credit facilities and higher interest rates.

In the nine months ended September 30, 2023, other income decreased to $9.7 million from $24.3 million in the same period of 2022. Other income in the nine months ended September 30, 2023 primarily consisted of interest earned on cash and in the nine months ended September 30, 2022 primarily consisted of foreign exchange gains on dollar denominated cash held at our operations, as the dollar strengthened in 2022.

During the nine months ended September 30, 2023, we had an income tax recovery of $28.9 million or an effective tax rate of 16% as we do not recognize a tax recovery for certain entities for which we do not currently expect to realize a tax benefit. In the same period of 2022, the provision for income taxes was $89.7 million or an effective tax rate of 28%.

In the nine months ended September 30, 2023, Operating EBITDA was negative $3.7 million compared to a positive $440.4 million in the same period of 2022 primarily due to lower pulp, lumber and energy sales realizations, higher per unit fiber costs which includes the net inventory impairment charges at our Canadian pulp mills, and higher chemical costs, partially offset by insurance proceeds received and higher sales volumes.

Operating Results by Business Segment

None of the income or loss items following operating income (loss) in our Interim Consolidated Statements of Operations are allocated to our segments, since those items are reviewed separately by management.

Pulp Segment ‑ Nine Months Ended September 30, 2023 Compared to Nine Months Ended September 30, 2022

Selected Financial Information

(in thousands)

In the nine months ended September 30, 2023, pulp segment revenues decreased by approximately 18% to $1,151.9 million from $1,402.9 million reflecting the overall weak pulp market and lower energy revenues.

Pulp revenues in the nine months ended September 30, 2023 decreased by approximately 16% to $1,061.9 million from $1,260.9 million in the same period of 2022 primarily due to lower sales realizations.

Energy and chemical revenues decreased by approximately 37% to $90.0 million in the nine months ended September 30, 2023 from $141.9 million in the same period of 2022 primarily due to lower energy sales realizations partially offset by higher sales volumes.

Pulp production was modestly higher at 1,457,911 ADMTs in the nine months ended September 30, 2023 compared with 1,407,103 ADMTs in the same period of 2022 primarily due to stable production. In the nine months ended September 30, 2023, our pulp mills had 109 days of downtime (approximately 120,900 ADMTs) which included a total of 48 days of annual maintenance downtime and 61 days for market curtailment at the Peace River, Cariboo and Celgar mills. In the nine months ended September 30, 2022, our pulp mills had 66 days of downtime (approximately 79,900 ADMTs) comprised of 60 days of annual maintenance downtime and an additional six days at our Celgar mill caused by slower than planned start up.

We estimate that annual maintenance downtime in the nine months ended September 30, 2023 adversely impacted our operating loss by approximately $38.6 million, comprised of approximately $31.0 million in direct out-of-pocket expenses and the balance in reduced production.

Pulp sales volumes remained generally flat at 1,460,050 ADMTs in the nine months ended September 30, 2023 from 1,452,426 ADMTs in the same period of 2022.

In the nine months ended September 30, 2023, prices for NBSK pulp decreased from the same period of 2022, largely as a result of weaker demand. Average list prices for NBSK pulp in Europe and North America were approximately $1,261 per ADMT and $1,493 per ADMT, respectively in the nine months ended September 30, 2023 compared to approximately $1,422 per ADMT and $1,690 per ADMT, respectively, in the same period of 2022. Average NBSK net prices in China were approximately $746 per ADMT in the nine months ended September 30, 2023 compared to approximately $959 per ADMT in the nine months ended September 30, 2022.

Average NBSK pulp sales realizations decreased by approximately 15% to $735 per ADMT in the nine months ended

September 30, 2023 from approximately $865 per ADMT in the same period of 2022. In the nine months ended September 30, 2023, average NBHK pulp sales realizations decreased by approximately 25% from the same period of 2022.

In the nine months ended September 30, 2023, we had a positive impact of approximately $2.0 million in operating loss due to foreign exchange.

In the nine months ended September 30, 2023, we recorded net inventory impairment charges at our Canadian pulp mills of $56.6 million.

Costs and expenses in the nine months ended September 30, 2023 increased by approximately 6% to $1,202.2 million from $1,131.2 million in the nine months ended September 30, 2022 primarily due to higher per unit fiber, which includes the net inventory impairment at our Canadian mills, and chemical costs partially offset by the receipt of $37.7 million of insurance proceeds in the nine months ended September 30, 2023, relating to the 2021 turbine downtime at the Rosenthal mill and the July 2022 fire at the Stendal mill, and lower energy and freight costs.

On average, in the nine months ended September 30, 2023 overall per unit fiber costs increased by approximately 25% from the same period of 2022 due to higher per unit fiber costs for all of our mills. Our German mills had higher per unit fiber costs as a result of strong demand from other wood consumers such as heating pellet manufacturers in response to energy shortages caused by the war in Ukraine. For our Canadian pulp mills, per unit fiber costs increased as a result of strong demand in the mills' fiber baskets and for our Celgar mill a decrease in the availability of wood chips because of regional sawmill curtailments.

Transportation costs for our pulp segment decreased by approximately 12% to $118.0 million in the nine months ended September 30, 2023 from $133.8 million in the same period of 2022 driven by lower freight rates.

In the nine months ended September 30, 2023, depreciation and amortization remained relatively flat at $83.4 million from $82.9 million in the same period of 2022.

In the nine months ended September 30, 2023, the pulp segment had an operating loss of $49.5 million from operating income of $271.7 million in the same period of 2022 primarily as a result of lower pulp and energy sales realizations, higher per unit fiber costs, which includes the net inventory impairment at our Canadian pulp mills, partially offset by the receipt of insurance proceeds and lower energy and freight costs.

Solid Wood Segment ‑ Nine Months Ended September 30, 2023 Compared to Nine Months Ended September 30, 2022

Selected Financial Information

(in thousands)

(1) Manufactured products primarily includes CLT, glulam and finger joint lumber.

(2) Biofuels includes pellets and briquettes.

In the nine months ended September 30, 2023, solid wood segment revenues increased by approximately 26% to $366.6 million from $290.0 million in the same period of 2022 primarily because of the inclusion of Torgau and the ramping up of our mass timber operations partially offset by a decline in lumber revenues.

In the nine months ended September 30, 2023, lumber revenues decreased by approximately 30% to $170.1 million from $243.0 million in the same period of 2022 primarily caused by lower sales realizations partially offset by higher sales volumes. In the nine months ended September 30, 2023, both U.S. and European realized lumber prices were lower because of decreased demand as a result of higher interest rates and an uncertain economic outlook compared to the same period of 2022. The U.S. market accounted for approximately 56% of our lumber revenues and approximately 51% of our lumber sales volumes in the nine months ended September 30, 2023. The majority of the balance of our lumber sales were to Europe.

Energy and wood residuals revenues decreased by approximately 12% to $26.4 million in the nine months ended September 30, 2023 from $29.9 million in the same period of 2022 as a result of lower energy sales realizations.

In the nine months ended September 30, 2023, our mass timber business continued to ramp up operations and manufactured products revenues more than doubled to $42.6 million from $17.2 million in the same period of 2022.

Pallet revenues of $97.7 million and biofuels revenues of $29.8 million in the nine months ended September 30, 2023 are from the inclusion of Torgau.

Lumber production increased by approximately 8% to 350.7 MMfbm in the nine months ended September 30, 2023 from 324.8 MMfbm in the same period of 2022 as a result of the inclusion of Torgau and the upgrades at the Friesau mill.

Lumber sales volumes increased by approximately 25% to 388.4 MMfbm in the nine months ended September 30, 2023 from 310.7 MMfbm in the same period of 2022 primarily because of higher production and the timing of sales.

Average lumber sales realizations decreased by approximately 44% to $438 per Mfbm in the nine months ended September 30, 2023 from approximately $782 per Mfbm in the same period of 2022 caused by lower demand in both the U.S. and European markets. Demand was negatively impacted by rising interest rates, inflationary pressures and an uncertain economic outlook.

Manufactured products sales realizations increased to $1,672 per m3 in the nine months ended September 30, 2023 from $756 per m3 in the same period of 2022 as a result of higher CLT sales volumes.

Fiber costs were approximately 75% of our lumber cash production costs in the nine months ended September 30, 2023. In the nine months ended September 30, 2023, per unit fiber costs for lumber production increased compared to the same period of 2022, due to strong fiber demand in Germany.

In the nine months ended September 30, 2023, depreciation and amortization increased to $44.5 million from $11.7 million in the same period of 2022 primarily because of the inclusion of Torgau. Torgau’s amortization included $8.3 million for the order backlog intangible asset acquired, which is now fully amortized.

Transportation costs for our solid wood segment in the nine months ended September 30, 2023 increased by approximately 44% to $48.0 million from $33.4 million in the same period of 2022 primarily due to the inclusion of Torgau and higher lumber sales volumes.

In the nine months ended September 30, 2023, operating loss was $69.3 million compared to operating income of $84.9 million in the same period of 2022 primarily because of lower sales realizations.

Liquidity and Capital Resources

Summary of Cash Flows

(in thousands)

We operate in a cyclical industry and our operating cash flows vary accordingly. Our principal operating cash expenditures are for fiber, labor and chemicals. Working capital levels fluctuate throughout the year and are affected by maintenance downtime, changing sales patterns, seasonality and the timing of receivables and sales and the payment of payables and expenses.

Cash Flows from (used in) Operating Activities. Cash used in operating activities was $60.3 million in the nine months ended September 30, 2023 compared to cash provided of $310.0 million in the comparative period of 2022. A decrease in accounts receivable provided cash of $89.1 million in the nine months ended September 30, 2023 and an increase in accounts receivable used cash of $4.3 million in the same period of 2022. In the nine months ended September 30, 2023, adjusting for net inventory impairments of $56.6 million, an increase in inventories used cash of $19.0 million and $23.9 million in the same period of 2022. A decrease in accounts payable and accrued expenses used cash of $107.6 million in the nine months ended September 30, 2023 and an increase in accounts payable and accrued expenses provided cash of $37.6 million in the same period of 2022.

Cash Flows from (used in) Investing Activities. Investing activities in the nine months ended September 30, 2023 used cash of $179.7 million primarily related to capital expenditures of $110.3 million and acquisition costs of $82.1 million for mass timber assets in the United States and Canada. In the nine months ended September 30, 2023, capital expenditures primarily related to costs to complete the Rosenthal lignin plant, upgrades to the wood rooms at our Canadian mills and maintenance and optimization projects at our German mills. In the nine months ended September 30, 2023, we received $5.4 million of insurance proceeds for our property damage claim related to the fire in 2022 at our Stendal mill and we received $4.6 million of government grants for the Peace River wood room project. Investing activities in the nine months ended September 30, 2022 used cash of $451.6 million primarily related to the acquisition of Torgau for $257.4 million, capital expenditures of $128.9 million and our transferring of $75.0 million into a six month term deposit. In the nine months ended September 30, 2022, we received insurance proceeds of $7.6 million comprised of the initial payment of $1.2 million for our property damage claim related to the Stendal fire and the balance related to the final payment for our property damage claim related to the Peace River recovery boiler.

Cash Flows from (used in) Financing Activities. In the nine months ended September 30, 2023, financing activities provided cash of $230.6 million primarily from the proceeds of the issuance of $200.0 million of senior notes due 2028 and borrowing approximately $51.3 million under our revolving credit facilities. In the nine months ended September 30, 2023, we paid dividends of $10.0 million and incurred aggregate debt issuance costs of $4.6 million related to the issuance of the senior notes and to increase the maximum borrowing capacity under our German revolving credit facility by €70.1 million. In the nine months ended September 30, 2022, financing activities provided cash of $94.7 million. In such period we borrowed $116.5 million under our revolving credit facilities. In the nine months ended September 30, 2022, we paid dividends of $9.9 million and incurred aggregate debt issuance costs of $3.0 million for the amended €300.0 million German revolving credit facility and C$160.0 million Canadian revolving credit facility.

Balance Sheet Data

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

(in thousands)

Sources and Uses of Funds

Our principal sources of funds are cash flows from operations and cash and cash equivalents on hand. Our principal uses of funds consist of operating expenditures, capital expenditures and interest payments on our senior notes.

The following table sets out our total capital expenditures and interest expense for the periods indicated:

(in thousands)

(1) Amounts differ from interest expense, which includes non-cash items. See supplemental disclosure of cash flow information from our Interim Consolidated Statements of Cash Flows included in this report.

(2) Interest on our senior notes due 2026 is paid semi-annually in January and July of each year. Interest on our senior notes due 2029 is paid semi-annually in February and August of each year. Interest on our senior notes due 2028 is paid semi-annually in April and October of each year.

As of September 30, 2023, we had cash and cash equivalents of $343.7 million and approximately $304.7 million available under our revolving credit facilities and as a result aggregate liquidity of about $648.4 million.

We have reduced our planned capital expenditures for fiscal 2023 and expect them to be between $130 to $150 million.

We currently consider the majority of undistributed earnings of our foreign subsidiaries to be indefinitely reinvested and, accordingly, no U.S. income tax has been provided on such earnings. However, if we were required to repatriate funds to the United States, we believe that we currently could repatriate the majority thereof without incurring any material amount of taxes as a result of our shareholder advances and U.S. tax reform. However, it is currently not practical to estimate the income tax liability that might be incurred if such earnings were remitted to the United States. Substantially all of our undistributed earnings are held by our foreign subsidiaries outside of the United States.

Based upon the current level of operations and our current expectations for future periods in light of the current economic environment, and in particular, current and expected pulp and lumber pricing and foreign exchange rates, we believe that cash flow from operations and available cash, together with available borrowings under our revolving credit facilities, will be adequate to finance the capital requirements for our business including the payment of our quarterly dividend during the next 12 months.

In the future we may make acquisitions of businesses or assets or commitments to additional capital projects. To achieve the long-term goals of expanding our assets and earnings, including through acquisitions, capital resources will be required. Depending on the size of a transaction, the capital resources that will be required can be substantial. The necessary resources will be generated from cash flow from operations, cash on hand, borrowing against our assets or the issuance of securities.

Debt Covenants

Certain of our long-term obligations contain various financial tests and covenants customary to these types of arrangements. See our annual report on Form 10-K for the fiscal year ended December 31, 2022.

As of September 30, 2023, we were in full compliance with all of the covenants of our indebtedness.

Off-Balance Sheet Arrangements

As of September 30, 2023, we did not have any off-balance sheet arrangements (as defined in Item 303(a)(4)(ii) of Regulation S-K).

Contractual Obligations and Commitments

There were no material changes outside the ordinary course to any of our material contractual obligations during the nine months ended September 30, 2023.

Foreign Currency

As a majority of our assets, liabilities and expenditures are held or denominated in euros or Canadian dollars, our consolidated financial results are subject to foreign currency exchange rate fluctuations.

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 other comprehensive loss and do not affect our net earnings.

As a result of the strengthening of the dollar versus the euro as of September 30, 2023, we recorded a non-cash decrease of $7.6 million in the carrying value of our net assets denominated in euros, consisting primarily of our property, plant and equipment. This non-cash decrease does not affect our net loss, Operating EBITDA or cash but is reflected in our other comprehensive loss and as a decrease to our total equity. As a result, our accumulated other comprehensive loss increased to $187.4 million.

Based upon the exchange rate as of September 30, 2023, the dollar has strengthened by approximately 1% against the euro and was flat against the Canadian dollar since December 31, 2022. See "Quantitative and Qualitative Disclosures about Market Risk".

Credit Ratings of Senior Notes

We and our senior notes are rated by Standard & Poor's Rating Services, referred to as "S&P", and Moody's Investors Service, Inc., referred to as "Moody's". In September 2023, S&P lowered its outlook to negative from stable and downgraded its rating on our senior notes to B from B+. Its recovery rating decreased to “4” from “3”. Moody’s lowered its outlook to negative from stable and downgraded its rating on our senior notes to B2 from Ba3.

Credit ratings are not recommendations to buy, sell or hold securities and may be subject to revision or withdrawal by the assigning rating organization. Each rating should be evaluated independently of any other rating.

Critical Accounting Policies

The preparation of financial statements and related disclosures in conformity with GAAP requires management to make estimates and assumptions that affect both the amount and the timing of the recording of assets, liabilities, revenues, and expenses in the consolidated financial statements and accompanying note disclosures. Our management routinely makes judgments and estimates about the effects of matters that are inherently uncertain. As the number of variables and assumptions affecting the probable future resolution of the uncertainties increases, these judgments become even more subjective and complex.

Our significant accounting policies are disclosed in Note 1 to our audited annual financial statements included in our annual report on Form 10-K for the fiscal year ended December 31, 2022. While all of the significant accounting policies are important to the consolidated financial statements, some of these policies may be viewed as having a high degree of judgment. On an ongoing basis using currently available information, management reviews its estimates, including those related to accounting for, among other things, pension and other post-retirement benefit obligations, deferred income taxes (valuation allowance and permanent reinvestment), depreciation and amortization, future cash flows associated with impairment testing for long-lived assets and goodwill, the allocation of the purchase price in a business combination to the assets acquired and liabilities assumed, legal liabilities and contingencies. Actual results could differ materially from these estimates, and changes in these estimates are recorded when known.

We have identified certain accounting policies that are the most important to the portrayal of our current financial condition and results of operations.

For information about both our significant and critical accounting policies, see our annual report on Form 10-K for the fiscal year ended December 31, 2022.

Cautionary Statement Regarding Forward-Looking Information

The statements in this report that are not reported financial results or other historical information are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, as amended.

Generally, forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words such as "expects", "anticipates", "intends", "plans", "believes", "seeks", "estimates", or words of similar meaning, or future or conditional verbs, such as "will", "should", "could", or "may", although not all forward-looking statements contain these identifying words. Forward-looking statements are based on expectations, forecasts and assumptions by our management and involve a number of risks, uncertainties and other 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:

Risks Related to our Business

• Our business is highly cyclical in nature;
• cyclical fluctuations in the price and supply of our raw materials, particularly fiber, could adversely affect our business;
• our business, financial condition and results of operations could be adversely affected by disruptions in the global and European economies caused by Russia's invasion of Ukraine;
• inflation or a sustained increase in our key production and other costs would lead to higher manufacturing costs which could reduce our margins;
• the ongoing COVID-19 pandemic could materially adversely affect our business, financial position and results of operations;
• we face intense competition in the forest products industry;
• our business is subject to risks associated with climate change and social and government responses thereto;
• if we are unable to offer products certified to globally recognized forestry management and chain of custody standards or meet customers’ product specifications, it could adversely affect our ability to compete;
• our operations require substantial capital and we may be unable to maintain adequate capital resources to provide for such capital requirements;
• trends in non-print media and changes in consumer habits regarding the use of paper have and are expected to continue to adversely affect the demand for market pulp;
• fluctuations in prices and demand for lumber could adversely affect our business;
• our solid wood segment lumber products are vulnerable to declines in demand due to competing technologies or materials;
• we may experience material disruptions to our production;
• acquisitions may result in additional risks and uncertainties in our business;
• we are subject to risks related to our employees;
• we are dependent on key personnel;
• 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;
• our insurance coverage may not be adequate;
• we rely on third parties for transportation services;
• failures or security breaches of our information technology systems could disrupt our operations and negatively impact our business;
• we have limited control over the operations of the Cariboo mill;

Risks Related to our Debt

• our level of indebtedness could negatively impact our financial condition, results of operations and liquidity;
• 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;
• we are exposed to interest rate fluctuations;

Risks Related to Macro-economic Conditions

• 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;
• we are exposed to currency exchange rate fluctuations;
• globally, central banks have raised interest rates in response to high inflation rates which could dampen macroeconomic conditions and business activity which could reduce demand for our products;
• political uncertainty, an increase in trade protectionism or geo-political conflict could have a material adverse effect on global macro-economic activities and trade and adversely affect our business, results of operations and financial condition;
• we may incur losses as a result of unforeseen or catastrophic events, including the emergence of a new pandemic, terrorist attacks or natural disasters;

Legal and Regulatory Risks

• 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;
• we sell surplus green energy in Germany and are subject to changing energy legislation in response to high prices and energy shortages resulting from the war in Ukraine;
• our international sales and operations are subject to applicable laws relating to trade, export controls, foreign corrupt practices and competition laws, the violation of which could adversely affect our operations;

Risks Related to Ownership of our Shares

• the price of our common stock may be volatile; and
• a small number of our shareholders could significantly influence our business.

Given these uncertainties, you should not place undue reliance on our forward-looking statements. The foregoing review of important factors is not exhaustive or necessarily in order of importance and should be read in conjunction with the risks and assumptions including those set forth under "Part II. Other Information – Item 1A. Risk Factors" and in reports and other documents we have filed with or furnished to the SEC, including in our annual report on Form 10-K for the fiscal year ended December 31, 2022. We advise you that these cautionary remarks expressly qualify in their entirety all forward-looking statements attributable to us or persons acting on our behalf. Unless required by law, we do not assume any obligation to update forward-looking statements based on unanticipated events or changed expectations. However, you should carefully review the reports and other documents we file from time to time with the SEC.

Cyclical Nature of Business

Revenues

The pulp and lumber businesses are highly cyclical in nature and markets are characterized by periods of supply and demand imbalance, which in turn can materially affect prices. Pulp and lumber 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 and lumber are commodities that are 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 pulp production on the market, if market conditions, prices and trends warrant such actions.

Demand for each of pulp and lumber has historically been determined primarily by general global macro-economic conditions and has been closely tied to overall business activity. Pulp and lumber prices have been and are likely to continue to be volatile and can fluctuate widely over time.

The third party industry quoted average European list prices for NBSK pulp between 2013 and 2023 have fluctuated between a low of $790 per ADMT in 2016 to a high of $1,500 per ADMT in 2022. In the same period, third party industry quoted average North American list prices for NBHK pulp have fluctuated between a low of $770 per ADMT in 2013 to a high of $1,620 per ADMT in 2022.

As a key construction material, the pricing and demand for lumber is also significantly influenced by the number of housing starts, especially in the United States. In the U.S., third party industry quoted monthly average western spruce/pine/fir (WSPF) 2 x 4 #2&Btr prices between 2013 and 2023 have fluctuated between a low of $245 per Mfbm in 2015 to a high of $1,604 per Mfbm in 2021. Similarly, the demand for CLT is primarily driven by the wood construction market and increased government policies focused on a low-carbon economy.

Our mills and operations voluntarily subject themselves to third-party certification as to compliance with internationally recognized, sustainable management standards because end use paper and lumber customers have shown an increased interest in understanding the origin of products they purchase. Demand for our products could be adversely affected if we, or our suppliers, are unable to achieve compliance, or are perceived by the public as failing to comply, with these standards or if our customers require compliance with alternate standards for which our operations are not certified.

A pulp producer's actual sales price realizations are net of customer discounts, rebates and other selling concessions. Accordingly, prices for pulp and lumber 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 prices for pulp and lumber, 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. 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.

Costs

Our production costs are influenced by the availability and cost of raw materials, energy and labor, and our plant efficiencies and productivity. Our main raw material is fiber in the form of wood chips, pulp logs and sawlogs. Wood chip, pulp log and sawlog costs are primarily affected by the supply of, and demand for, lumber and pulp, which are both highly cyclical. Higher fiber prices could affect producer profit margins if they are unable to pass along price increases to pulp and lumber customers or purchasers of surplus energy.

Currency

We have manufacturing operations in Germany, Canada and the United States. Most of the operating costs and expenses of our German mills are incurred in euros and those of our Canadian mills 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.

We are exposed to market risks from changes in interest rates and foreign currency exchange rates, particularly the exchange rates between the dollar and the euro and Canadian dollar. Changes in these rates may affect our results of operations and financial condition and, consequently, our fair value. We seek to manage these risks through internal risk management policies as well as the periodic use of derivatives.

For additional information, please refer to Part II, Item 7A. Quantitative and Qualitative Disclosures about Market Risk included in our annual report on Form 10-K for the fiscal year ended December 31, 2022.

Disclosure Controls and Procedures

Our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, referred to as the "Exchange Act"), as of the end of the period covered by this report. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is accumulated and communicated to management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. Based on such evaluation, our principal executive officer and principal financial officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports that we file or submit under the Exchange Act.

It should be noted that any system of controls is based in part upon certain assumptions designed to obtain reasonable (and not absolute) assurance as to its effectiveness and there can be no assurance that any design will succeed in achieving its stated goals.

Changes in Internal Controls

There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

There have been no material changes to the factors disclosed in Item 1A. Risk Factors in our annual report on Form 10-K for the fiscal year ended December 31, 2022.