SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

Commission File No.: 0-9409

MERCER INTERNATIONAL INC.

Exact name of Registrant as specified in its charter

14900 Interurban Avenue South, Suite 282, Seattle, Washington, 98168

Address of Office

Registrant’s telephone number including area code: (206) 674-4639

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Shares of beneficial interest, $1.00 par value

Preferred Stock Purchase Rights

Title of Class

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

         Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    þ

         Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    Yes þ         No o

         The aggregate market value of the Registrant’s voting stock held by non-affiliates of the Registrant as of June 30, 2004, the last business day of the Registrant’s most recently completed second fiscal quarter, based on the closing price of the voting stock on the Nasdaq National Market on such date, was approximately $166,401,116.

         As of March 11, 2005, the Registrant had 33,053,455 common shares of beneficial interest, $1.00 par value, outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

          Certain information that will be contained in the definitive proxy statement for the Registrant’s annual meeting to be held in 2005 is incorporated by reference into Part III of this Form 10-K.

TABLE OF CONTENTS

EXCHANGE RATES

      As of January 1, 2002, we changed our reporting currency from the U.S. dollar to the Euro, as a significant majority of our business transactions are originally denominated in Euros. Accordingly, our financial statements for the years ended December 31, 2002, 2003 and 2004 included in this annual report are stated in Euros while certain of our financial information for periods prior to the year ended December 31, 2002 included in this annual report has been restated in Euros. We translate non-euro denominated assets and liabilities at the rate of exchange on the balance sheet date. Revenues and expenses are translated at the average rate of exchange prevailing during the period.

      The following table sets out exchange rates, based on the noon buying rates in New York City for cable transfers in foreign currencies as certified for customs purposes by the Federal Reserve Bank of New York (the “Noon Buying Rate”) for the conversion of Euros and Canadian dollars to U.S. dollars in effect at the end of the following periods, the average exchange rates during these periods (based on daily Noon Buying Rates) and the range of high and low exchange rates for these periods:

      On March 11, 2005, the Noon Buying Rate for the conversion of Euros and Canadian dollars to U.S. dollars was €0.7427 per U.S. dollar and C$1.2041 per U.S. dollar.

      In addition, certain financial information relating to the Celgar pulp mill, which our subsidiary, Zellstoff Celgar Limited (formerly known as 0706906 B.C. Ltd.), acquired in February 2005, included in this annual report is stated in Canadian dollars while we report our financial results in Euros. The following table sets out exchange rates, based on the noon rates as provided by the Bank of Canada, for the conversion of Canadian dollars to Euros in effect at the end of the following periods, the average exchange rates during these periods (based on daily noon rates) and the range of high and low exchange rates for these periods:

      On March 11, 2005, the noon rate for the conversion of Canadian dollars to Euros was C$1.6217 per Euro.

PART I

ITEM 1.  BUSINESS

      In this document, please note the following:

The Company

General

      Mercer Inc. is a business trust organized under the laws of the State of Washington in 1968. Under Washington law, shareholders of a business trust have the same limited liability as shareholders of a corporation.

      We operate in the pulp and paper business. We are one of the largest producers of market northern bleached softwood kraft, or “NBSK”, pulp in the world. We are the sole kraft pulp producer, and the only producer of pulp for resale, known as “market pulp”, in Germany, which is the largest pulp import market in Europe. Our operations are currently located primarily in eastern Germany and, since our acquisition, referred to as the “Acquisition”, of the Celgar NBSK pulp mill in February 2005, in western Canada. We currently employ approximately 1,258 people at our German operations, approximately 409 people are employed at our Celgar mill and seven people at our office in Vancouver, British Columbia, Canada. We operate three NBSK pulp mills with a consolidated annual production capacity of approximately 1.3 million ADMTs:

      We also own and operate two paper mills located at Heidenau and Fährbrücke, Germany, which produce specialty papers and printing and writing papers and, based upon their current product mix, have an aggregate annual production capacity of approximately 70,000 ADMTs.

History and Development of Business

      We originally invested in various real estate assets with the intention of becoming a real estate investment trust, but in 1985 changed our operational direction to acquiring controlling interests in operating companies. We acquired our current pulp and paper operations beginning in 1993.

      Since 1999, we have expended an aggregate of approximately €345.6 million on capital investments at our pulp and paper mills, not including the Stendal mill or the Celgar mill, to increase production capacities, improve efficiencies, reduce effluent discharges and emissions and modernize the mills. Such capital investments were financed in large part through government guaranteed term financing and government grants of approximately €95.0 million. For more information about these grants, see “— Government Financing”.

      In late 1999, we completed a major capital project which converted the Rosenthal mill to the production of kraft pulp from sulphite pulp, increased its annual production capacity from approximately 160,000 ADMTs to approximately 280,000 ADMTs. Subsequent minor capital investments and efficiency improvements increased the Rosenthal mill’s annual production capacity to approximately 310,000 ADMTs, and reduced emissions and energy costs. The aggregate cost of the project was approximately €361.0 million. The project was financed through a combination of a project loan, referred to as the “Rosenthal Loan Facility”, supported by government guarantees, government grants totaling approximately €101.7 million and an equity investment made by us. We repaid the Rosenthal Loan Facility in February 2005 with a portion of the proceeds of the share and senior note offerings in connection with the Acquisition. See “— The Financings”.

      We completed financing arrangements and commenced construction of the Stendal mill in August 2002. The aggregate cost of the Stendal mill is approximately €1.0 billion. Construction of the Stendal mill was completed substantially on its planned schedule and budget in the third quarter of 2004 and the mill is currently in the start-up phase. For more information about the Stendal mill, see “— Stendal Pulp Mill Project and Financing”.

      In February 2005, we completed the Acquisition of substantially all of the assets of Stone Venepal (Celgar) Pulp Inc., or “Celgar”, comprised primarily of the Celgar mill. The aggregate cost of the Acquisition including defined working capital (excluding fees and expenses) was approximately $226 million. See “— Acquisition of Celgar Pulp Mill” below for more information relating to the Acquisition.

      We have also continually made upgrades to the Heidenau and Fährbrücke paper mills, which currently principally produce niche products.

Organizational Chart

      The following chart sets out our directly and indirectly owned principal operating subsidiaries, their jurisdictions of organization and their principal activities:

Acquisition of Celgar Pulp Mill

Overview

      On February 14, 2005, we completed the Acquisition of substantially all of the assets of Celgar for $210 million, of which $170 million was paid in cash and $40 million was paid in our shares, plus $16 million for the defined working capital at the Celgar mill on closing of the Acquisition. Our shares issued as part of the consideration for the Acquisition were issued at a price of $9.50 per share.

      The assets acquired are substantially all of the operating assets of Celgar, including real property, plant and equipment, personal property, leaseholds, contractual interests and intellectual property. We did not acquire certain assets of Celgar comprised principally of finished goods inventory, receivables, cash on hand and certain insurance claims. We assumed various employment, pension and benefit, asset retirement and contractual obligations of Celgar. We did not assume any obligations for any current liabilities of Celgar as at the date of closing, except for certain accrued employee liabilities, or any indebtedness of Celgar, whether incurred pre- or post-bankruptcy.

      On closing of the Acquisition, we added approximately 420 employees to our operations who were previously employees of Celgar. The initial positions, base salaries and benefits of such employees are comparable to the positions, salaries and benefits in place immediately prior to closing. The terms of employment, salaries and benefits applicable to such employees are comparable to other similarly situated employees in the pulp business in British Columbia, Canada.

      The acquisition agreement contains customary representations and warranties of the vendor covering various matters, many of which are qualified by the vendor’s knowledge after reasonable investigation and some of which are limited in scope to the receivership period extending from July 23, 1998 to the closing date. Additionally, the vendor’s environmental compliance representation and warranty in the acquisition agreement is limited in scope to the compliance period of November 15, 2003 to the closing date and certain specified environmental statutes, regulations and rules. The vendor’s environmental representations and warranties survive the closing for a period of 12 months after the closing date and all other representations and warranties made by the parties survive the closing for a period of 15 months after the closing date.

      In the case of misrepresentations or breaches of warranty by a party other than the vendor’s environmental representations and warranties, the claiming party must incur aggregate damages in excess of $0.5 million, in which event all such damages up to a maximum of $30 million may be claimed by the claiming party. In the case of a misrepresentation or breach of warranty in respect of the vendor’s environmental representations and

warranties, we must incur aggregate damages in excess of $1 million, in which event all such damages up to a maximum of $20 million may be claimed by us.

      Pursuant to the terms of the Acquisition, the vendor also entered into a lock-up agreement. Subject to certain exceptions, the lock-up agreement generally prohibits the vendor and its transferees, without the prior written consent of the underwriters of our recent $91 million public offering of our shares completed in February 2005, from selling, offering or agreeing to sell, hypothecating, pledging, granting an option to purchase or otherwise disposing of any of our shares of beneficial interest or securities convertible into or exchangeable or exercisable for our shares of beneficial interest or any warrants or other rights to purchase our shares of beneficial interest or such securities. These restrictions are in effect until August 13, 2005, being 180 days after the closing date of the Acquisition. In addition, pursuant to the terms of the acquisition agreement, we entered into a registration rights agreement dated November 22, 2004 with the vendor pursuant to which we agreed to file a registration statement under the Securities Act of 1933, as amended, or the “Securities Act”, to register our shares of beneficial interest issued to the vendor as part of the consideration of the Acquisition on or before May 14, 2005 and to use our commercially reasonable efforts to have the registration statement declared effective by August 12, 2005, being 180 days after the closing date of the Acquisition. The registration rights agreement also provides piggy-back registration rights for future equity offerings.

      The Celgar mill is a modern NBSK pulp mill that produces high quality NBSK pulp. It has an annual production capacity of approximately 430,000 ADMTs, and is located near the city of Castlegar, British Columbia, Canada. Completely rebuilt in the 1990s through an C$850 million modernization and expansion project, the Celgar mill was transformed into a low cost producer of high quality NBSK pulp. In 1998, primarily as a result of the indebtedness incurred by Celgar during the modernization process, its directors assigned it into bankruptcy and KPMG Inc. was appointed trustee in bankruptcy. Immediately thereafter, two senior secured bank lenders of Celgar appointed KPMG Inc. as the receiver for all of the assets and undertakings of Celgar under their security. KPMG Inc. had operated the Celgar mill as trustee in bankruptcy since that time.

      The Celgar mill has a secure supply of high quality wood chips and pulp logs that are purchased from a diverse group of Canadian and U.S. suppliers. The supply of fiber is characterized by a mix of a variety of species (whitewoods and cedar) which allows for production flexibility, custom blending and varied pulp grade mix.

      We believe that the pulp produced at the Celgar mill has excellent product characteristics and the mill is a long-established supplier to paper producers in Asia. We also believe that Celgar’s NBSK pulp is well recognized in China, having been sold there for over 20 years. The Asian markets currently show the highest rate of growth in demand for softwood pulp and, with the Celgar mill’s history in the region, we believe that Mercer will be well placed to exploit such growth.

      Although the Celgar mill is a modern facility that has generally been well maintained, it has been operated by a trustee in bankruptcy since 1998. As a result, we believe the Celgar mill has not performed at its full potential and that there are a number of opportunities to enhance its performance. See “— Acquisition Opportunities” below, “— Sales, Marketing and Distribution” and “— Capital Expenditures”.

Acquisition Rationale

      The Acquisition of the Celgar mill reflects our strategy of acquiring world-class market NBSK pulp production capacity on terms below comparable replacement cost where we can use our management focus to enhance operations, improve profitability and create value for our stakeholders. It provides us with several strategic benefits and synergies, including the following:

      Given our management team’s experience in converting and optimizing the Rosenthal mill, constructing the Stendal mill and starting up these large scale NBSK pulp mills, we believe we are well positioned to integrate the Celgar mill into our operations and to improve its operating and financial performance over time.

Acquisition Opportunities

      Although the Celgar mill is a modern facility that has generally been well maintained, it has been operated by a trustee in bankruptcy since 1998. As a result, we believe the Celgar mill has not performed at its full potential and that there are a number of opportunities to enhance its performance. We are currently targeting C$25 million in annual operating margin improvements over a three-year period, based on current pricing levels. This is expected to be achieved by capitalizing on the following opportunities:

      We estimate the aggregate amount to be spent on the foregoing capital projects to be approximately C$25 million over a three-year period.

The Financings

      In conjunction with the Acquisition, we sold $310 million in principal amount of 9.25% senior notes maturing in 2013 and an aggregate of approximately $91 million of our shares of beneficial interest (including those issued upon the exercise of the underwriters’ over-allotment option) by way of separate public offerings.

We issued our shares of beneficial interest at a price of $8.50 per share. The net proceeds from the offering of the senior notes and our shares of beneficial interest and cash on hand were utilized to pay the cash portion of the purchase price of the Acquisition, including defined working capital, transaction costs and to refinance all of the bank indebtedness of our Rosenthal mill and for working capital.

      Effective upon the completion of the Acquisition, we also established a new revolving working capital facility for the Rosenthal mill in the amount of € 40 million with an initial term of five years and for the Celgar mill in the amount of $30 million, with an initial term of one year which, if not renewed, will convert to a one year term loan. See “— Description of Certain Indebtedness” for more information relating to our senior notes and the new working capital facilities.

Corporate Strategy

      Our corporate strategy is to create shareholder value by focusing on the expansion of 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 designed to produce a high return by increasing production, reducing costs and improving quality. We seek to acquire interests in companies and assets in the pulp and paper industry and related businesses where we can leverage our experience and expertise in adding value through a focused management approach. Key features of our strategy include:

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 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 treated pulp allows the wood’s fiber to retain its length and flexibility, resulting in stronger paper products. Kraft pulp can be bleached to increase its brightness. 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 paper related products.

      The market value of kraft pulp depends in part on the fiber used in the production process. There are two primary species of wood used as fiber: softwood and hardwood. 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. Prices for softwood pulp are generally much higher than for hardwood pulp. Currently, the kraft pulp market is roughly evenly split between softwood and hardwood grades. Most uses of market kraft pulp, including fine printing papers, coated and uncoated magazine papers and various tissue products, utilize a mix of softwood and hardwood grades to optimize production and product qualities. In recent 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 that have longer growth cycles. As a result of the growth in supply and lower costs, kraft pulp customers in recent years have substituted some of the pulp content in their products to hardwood pulp. Counteracting customers’ increased proportionate usage of hardwood pulp has been the requirement for strength characteristics in finished goods and paper and tissue makers focus on higher machine speeds and lower basis weights for publishing papers which also require the strength characteristics of softwood pulp. We believe that the ability of kraft pulp users to further substitute hardwood for softwood pulp is limited by such requirements.

      NBSK pulp, which is a bleached kraft pulp manufactured using species of northern softwood, 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 species and does not possess the strength found in NBSK pulp. NBSK pulp is the sole product of the Rosenthal, Stendal and Celgar mills.

      Kraft pulp can be made in different grades, with varying technical specifications, for different end uses. High quality kraft pulp is valued for its reinforcing role in mechanical printing papers, while other grades of kraft pulp are used to produce lower priced grades of paper, including tissues and paper related products.

Pulp Markets

      Producers ranging from small independent manufacturers to large integrated companies produce pulp worldwide. In 2003, more than 130 million ADMTs of kraft pulp were converted into printing and writing papers, tissues, cartonboards and other white grades of paper and paperboard around the world. Approximately 65% of this pulp was produced for internal purposes by integrated paper and paperboard manufacturers, and approximately 35% was produced for sale on the open market.

      Although demand is cyclical, worldwide demand for kraft market pulp has grown at an average rate of approximately 3% annually over the last ten years. The growth rate for NBSK pulp reflects this continuing demand, with growth rates higher than the general softwood kraft group.

      Western Europe accounts for approximately 40% of global market pulp demand with a growth rate of approximately 2% annually over the past ten years. Within Europe, Germany, with its large economy and sizable paper industry, has been the largest pulp market historically relying largely on imports from North America and Scandinavia.

      Demand for market pulp in Asia (excluding Japan) has been growing at approximately 9% annually over the past ten years and currently accounts for approximately 30% of global demand. This demand growth has been driven by increasing per capita consumption combined with the mandated closure of numerous small, often non-wood based, pulp facilities in China. Canada is the largest exporter to this region.

      We expect Europe and Asia to continue to be significant net importers of pulp in the foreseeable future. The markets for kraft pulp are cyclical in nature and demand for kraft pulp is related to global and regional levels of economic activity. A measure of demand for kraft pulp is the ratio obtained by dividing the worldwide

consumption of kraft pulp by the worldwide capacity for the production of kraft pulp, or the “consumption/ capacity ratio”. An increase in this ratio generally occurs when there is an increase in global and regional levels of economic activity and low inventories of kraft pulp. An increase in this ratio generally indicates greater demand as consumption increases, which generally results in rising kraft pulp prices and a build-up of inventories by buyers and a reduction by producers. 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 to a high level of inventory build-up by buyers. As demand falls, buyers generally reduce their purchases and rely on inventories of kraft pulp and many producers will run at lower operating rates by taking downtime to limit the build-up of their own inventories.

      The consumption/ capacity ratio, excluding Indonesian and eastern European pulp producers, was approximately 91% in 2002, approximately 93% in 2003 and approximately 96% in 2004. We expect the long lead time and significant capital investment required to bring new pulp mills on stream to limit growth in industry capacity in the next few years.

NBSK Pulp Pricing

      Global economic conditions, changes in production capacity, inventory levels, and currency exchange rates are the primary factors affecting NBSK pulp list prices. The average annual European list prices for NBSK pulp between 1990 and 2004 ranged from a low of approximately $444 per ADMT in 1993 to a high of approximately $875 per ADMT in 1995.

      The 1995 price peak was followed by a steep decline as inventory levels for North American and Scandinavian, or “Norscan”, producers grew to over 2.5 million ADMTs by early 1996. Norscan producers currently produce a majority of the market NBSK pulp sold in North America and Europe and inventory levels held by Norscan producers are considered an industry benchmark in determining industry inventory levels. Between 1996 and 1999, list pulp prices remained relatively low due in part to the Asian financial crisis which began in late 1997.

      Prices started to recover in 1999 due to a combination of factors including a recovery in the Asian economy, the shutdown of unprofitable mills or older mills in need of environmental upgrades and a decline in capacity expansion. This contributed to tightening inventory levels among Norscan producers, which fell to approximately 1.1 million ADMTs in June 2000, resulting in list prices increasing to an average of approximately $710 per ADMT in the fourth quarter of 2000. However, the decline of the American and major European economies in 2001 caused a sharp reduction in paper demand. As a result, Norscan pulp inventories rose to a high of approximately two million ADMTs in early 2001 and list price levels eroded to an average of approximately $460 per ADMT in late 2001. Inventory levels ranged between approximately 1.3 million and 1.9 million ADMTs in 2002, and list prices averaged approximately $463 per ADMT in 2002. The weakening of the U.S. dollar against the Euro and other major currencies and an increase in demand resulting from improving American and major European economies in 2003 resulted in list prices for kraft pulp in Europe increasing to approximately $560 per ADMT in December 2003 despite relatively high inventory levels. List prices for kraft pulp in Europe continued to strengthen in 2004 and early 2005 due to the relatively weak U.S. dollar and improving world economies, and were approximately $625 per ADMT in December 2004 and approximately $635 per ADMT in January 2005. A producer’s sales realizations will reflect customer discounts, commissions and other items and it is likely that prices will continue to fluctuate in the future.

The Manufacturing Process

      The following diagram provides a simplified description of the kraft pulp manufacturing process at the Rosenthal, Stendal and Celgar mills:

      In order to transform wood chips into kraft pulp, wood chips undergo a multi-step process involving the following principal stages: chip screening, digesting, pulp washing, and screening, bleaching and drying.

      In the initial processing stage, wood chips are screened to remove oversized chips and sawdust and are conveyed to a pressurized digester where they are heated and cooked with chemicals. This occurs in a continuous process at the Celgar and Rosenthal mills and in a batch process at the Stendal mill. This process softens and eventually dissolves the phenolic material called lignin that binds the fibers to each other in the wood.

      Cooked pulp flows out of the digester and is washed and screened to remove most of the residual spent chemicals, called black liquor, and partially cooked wood chips. The pulp then undergoes a series of bleaching stages where the brightness of the pulp is gradually increased. Finally, the bleached pulp is sent to the pulp machine where it is dried to achieve a dryness level of more than 90%. The pulp is then ready to be baled for shipment to customers.

      A significant feature of kraft pulping technology is the recovery system, whereby chemicals used in the cooking process are captured and extracted for re-use, which reduces chemical costs and improves environmental performance. During the cooking stage, dissolved organic wood materials and black liquor are extracted from the digester. After undergoing an evaporation process, black liquor is burned in a recovery boiler. The chemical compounds of the black liquor are collected from the recovery boiler and are reconstituted into cooking chemicals used in the digesting stage through additional processing in the recausticizing plant.

      The heat produced by the recovery boiler is used to generate high-pressure steam. Additional steam is generated by a power boiler through the combustion of biomass consisting of bark and other wood residues from sawmills, residue generated by the effluent treatment system and natural gas. The steam produced by the recovery and power boilers is used to power a turbogenerator to generate electricity, as well as to provide heat for the digesting and pulp drying processes.

The Paper Industry

      The paper industry is global in nature with many international, national and regional producers competing over many different product lines. Prices and profitability in the paper industry are driven primarily by global supply and demand. Demand is strongly influenced by global and regional levels of economic activity. Supply is determined by industry capacity and operating rates. In general, the paper industry has experienced periods of supply and demand imbalance. When demand increases, prices rise, which leads producers to increase their capacity and operating rates. As supply increases in response, price competition increases, driving prices lower.

      We produce principally specialty papers and printing and writing papers. The specialty papers that we produce are comprised of coated and uncoated wallpaper base, non-woven wallpaper base and greaseproof paper.

      Wallpaper can be coated with an agent to enhance its appearance and printing capability. In addition, non-woven wallpaper contains a certain proportion of synthetic fibers so that it does not expand when wet, paste can be applied to the wall instead of the wallpaper and it can be easily torn from the wall, or drystripped. Demand for wallpaper is related to activity in the construction and refurbishing industries, which have been relatively strong due to low interest rates in most industrialized countries. Non-woven wallpapers are the fastest growing category of wallpaper.

      Greaseproof paper is a consumer oriented product that can be used for, among other things, baking and the packaging of food products such as fast foods.

      Printing and writing papers which we produce consist of only uncoated woodfree papers. Woodfree papers generally contain less than 10% mechanical pulp. Uncoated woodfree papers can be finished to enhance their surface and are often used to print less costly products.

Raw Materials

      Our mills are situated in regions which offer an ample and stable supply of fiber. The fiber consumed by our pulp mills consists of wood chips produced by sawmills and pulp logs, which are cyclical in both price and supply. Wood chips are small pieces of wood used to make pulp and are a product of either wood waste from sawmills or pulp logs processed, or chipped, especially for this purpose. Pulp logs consist of lower quality logs not used in the production of lumber. The costs of wood chips and pulp logs are primarily affected by the supply and demand for lumber.

Rosenthal mill

      The wood chips for the Rosenthal mill are sourced from approximately 60 sawmills located in the States of Bavaria and Thuringia within a 150 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 the best economic outlet for the sale of wood chips in the area. In 2004, the Rosenthal mill consumed approximately 1.7 million cubic meters of fiber. Approximately 71%, or approximately 1.2 million cubic meters, of such consumption was in the form of sawmill wood chips. The balance of approximately 29%, or approximately 0.5 million cubic meters, was in the form of pulp logs. Approximately 85% to 90% of the fiber consumed by the Rosenthal mill is spruce and the remainder is pine. We believe the Rosenthal mill’s fiber costs have historically been among the lowest for European pulp producers. The Rosenthal mill’s transportation division, which operates approximately 50 trucks, handled approximately 55% of our wood chip deliveries to the mill in 2004. 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 fiber supply interruptions at the Rosenthal mill.

      Wood chips for the Rosenthal mill are normally sourced from sawmills under one year or quarterly supply contracts with fixed volumes, which provide for price adjustments. In 2003, we entered into a three-year agreement with one of our existing wood chip suppliers for the supply for the Rosenthal mill of approximately 500,000 cubic meters of wood chips annually until 2006. Pulp logs are partly sourced from the state forest agency in Thuringia on a contract basis and partly from private holders, on the same basis as wood chips. We organize the harvesting of pulp logs sourced from the state forest agency in Thuringia after discussions with the agency regarding the quantities of pulp logs that we require.

      We organized our own internal wood procurement department in April 2003 to handle and source the fiber requirements for the Rosenthal mill. Five people are employed in the department currently. The department also assisted in sourcing fiber for the start-up of the Stendal mill. We have commenced coordinating the fiber procurement for the Rosenthal and Stendal mills. We believe that handling our own fiber procurement will reduce our operating costs over the long-term due to the elimination of third party fees paid for sourcing fiber.

Stendal mill

      The fiber consumed by the Stendal mill consists of wood chips and pulp logs. When operating at capacity, the Stendal mill will consume approximately 2.8 to 3.0 million cubic meters of fiber annually. The core wood supply region for the Stendal mill includes most of the northern part of Germany within an approximately 240 kilometer radius of the mill. The wood supply potential in this core region is not yet fully utilized and we expect that it should be able to supply all of the fiber needed by the mill. We also expect to purchase wood chips from southwestern and southern Germany. The fiber base in the planned wood supply area for the Stendal mill consists of approximately 65% pine and 35% spruce and fir in 2005. We expect approximately 20% of the fiber consumed by the Stendal mill to be in the form of sawmill wood chips and approximately 80% in the form of pulp logs. The Stendal mill has sufficient chipping capacity to fully operate using solely pulp logs, if required. We intend to source wood chips from sawmills within an approximately 600 kilometer radius of the Stendal mill. We intend to source pulp logs partly from private forest holders and partly from state forest agencies in Thuringia, Sachsen-Anhalt, Mecklenburg-Vorpommern, Sachsen, Niedersachsen, Nordrhein-Westfalen, Hessen and Brandenburg. In 2003, Stendal commenced putting into place definitive supply arrangements similar to those of the Rosenthal mill. We have currently arranged for approximately 66% of the fiber requirements for the Stendal mill for 2005.

      Stendal has established its own wood procurement organization to handle the fiber requirements for the Stendal mill. Currently, there are approximately 98 people employed in this division. This division focuses on three principal activities, being wood procurement and sales, harvesting, and transportation. The procurement and sales main activity is to procure the required wood chip and pulp log assortments for the mill’s annual production. In conjunction with this activity, it may also procure higher quality sawlogs, either through harvesting or through purchases that it can sell or trade with others for wood chips in order to optimize the fiber mix. When operating at capacity, we expect these trading activities to employ up to 15 people. The harvesting activities in 2005 will focus on acquiring up to approximately 300,000 cubic meters per annum of harvestable timber, of which approximately 85% is expected to be pulp logs and the balance likely to be higher quality logs that could be sold or traded to third parties for wood chips. We expect that approximately 90% of this volume may be harvested directly by us and the other 10% would be contracted out to third parties. When operating at capacity, we expect to engage up to 55 people in this division. Transportation activities focus on managing, controlling and optimizing shipping and flows of pulp logs to the mill. When operating at capacity, we expect that the transportation activities may employ up to 40 people.

      With the start up of the Stendal mill, we believe we are the largest consumer of wood chips and pulp logs in Germany and, together with the Rosenthal mill, provide the best economic outlet for the sale of wood chips in eastern Germany. We have commenced coordinating and integrating the wood procurement activities for the Rosenthal mill and the Stendal mill to realize on a number of potential synergies between them. These

include reduced overall personnel and administrative costs, greater purchasing power and coordinated buying and trading activities. We also believe such coordination and integration of fiber flows will allow us to optimize transportation costs, and the species and fiber mix for both mills.

Celgar mill

      The Celgar mill has a secure supply of high quality fiber that it purchases from a number of Canadian and U.S. suppliers. When operating at full capacity, the Celgar mill’s annual fiber requirements are approximately 2.4 million cubic meters. Two sources of fiber are used to meet this demand: chips purchased from nearby sawmills and chipping facilities, and roundwood pulp logs purchased from local logging contractors. All of the Celgar mill’s fiber is sourced externally with approximately 90% covered under chip contracts and the remaining 10% coming from the pulp logs processed through its woodroom.

      The Celgar mill has entered into long and short-term chip supply agreements with approximately 30 different suppliers from British Columbia, Canada and the U.S. for a total of approximately 2.2 million cubic meters (excluding chips from its own woodroom). This represents approximately 90% of total annual fiber requirements at the mill. The woodroom supplies the remaining chips to meet the Celgar mill’s requirements. The Canadian chip supply agreements contain terms that index the price of the chips to NBSK pulp pricing and therefore the chip costs are correlated with the Celgar mill’s net sales. The majority of the agreements are for periods ranging between two and six years. Several of the longer-term contracts are so-called “evergreen” agreements, where the contract remains in effect until one of the parties elects to terminate. Termination requires a minimum of two, and in some cases, five years written notice. Certain non-evergreen long-term agreements provide for renewal negotiations prior to expiry. The Celgar mill has contracts with three sawmills, which are all owned by the same parent. These sawmills comprise approximately 25% of the Celgar mill’s total fiber supply. Two of these chip agreements each remain in effect until December 31, 2008 and thereafter, if not extended, continue, subject to volume reductions, indefinitely, subject to termination by either party upon two years’ prior notice. The third agreement is an evergreen agreement that remains in effect until terminated upon five years’ prior notice. The chip agreements each contain provisions that may vary chip volume delivery commitments upon the happening of certain events.

      Except for occasional minor purchases from smaller suppliers, the balance of the Celgar mill’s fiber requirements is met by the production of chips from its own woodroom. Currently the woodroom is effectively operating a 40 hour per week schedule to supply chips to the Celgar mill. To secure the volume of pulp logs required to meet its requirements, the Celgar mill has entered into annual pulp log supply agreements with 20 to 30 different suppliers, many of whom are also contract chip suppliers to the mill. The woodroom is capable of running additional shifts and has historically operated in this fashion. Additional volumes of pulp logs are available to ramp up woodroom operations by up to 50%. All of the pulp log agreements can be terminated by either party for any reason, upon seven days’ written notice.

      In addition to existing agreements, opportunities exist for the Celgar mill to secure additional fiber from mills in both Canada and the U.S. The Celgar mill has flexibility in the selection and choice of suppliers, thus assuring continuity of supply as well as the ability to mix species when needed.

Paper mills

      The fiber used by the paper mills consists of pulp and waste paper (recycled paper), which are cyclical in both price and supply. The cost of this fiber is primarily affected by the supply and demand for paper and pulp. In 2004, approximately 83%, or approximately 63,114 ADMTs, of the fiber consumed by our paper mills was in the form of market pulp and chemical additives. Market pulp and chemical additives are available at market prices from various suppliers throughout Europe. The balance of approximately 17%, or approximately 12,986 ADMTs, of the fiber consumed by our paper mills was in the form of waste paper. Germany has extensive waste paper recycling and collection laws which result in a readily available supply. The cost of lower

grade waste paper is currently relatively low in comparison to virgin pulp. We have not historically experienced any fiber supply interruptions at our paper mills.

Pulp Cash Production Costs

      The Rosenthal mill commenced kraft pulp operations in late 1999. As production and sales ramped-up and increased, efficiencies were achieved within the mill operations, resulting in lower per unit costs. Cash production costs for the Rosenthal mill for the periods indicated below are as follows:

     Construction of the Stendal mill was completed in the third quarter of 2004. Although the Stendal mill has been in operation since mid-September 2004, it is currently in the start-up phase. As a result, we believe that cash production costs for pulp produced at the Stendal mill in 2004 are not meaningful as they do not provide an accurate representation of the mill’s future operating performance. Accordingly, they are not included herein. The Stendal mill is designed to have even lower production costs than the Rosenthal mill.

      Cash production costs for the Celgar mill for the periods indicated below are as follows:

Our Products

      We manufacture and sell NBSK pulp and two primary classes of paper products. Our products are produced from both virgin fiber, being wood chips, pulp logs and chemical woodfree pulp, and recycled fiber, being waste paper.

Pulp

      The kraft 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 chemical 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 mill effluent.

      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. Kraft pulp produced for reinforcement fibers is considered the highest grade of kraft pulp and generally obtains the highest price. Through a focused technical and marketing effort, we have changed the mix of the kraft pulp that we produce at the Rosenthal mill to substantially increase our relative amount of reinforcement fibers from approximately 16% at the beginning of 2000 to approximately 47% at the end of 2004.

      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. For more information about the facilities at the Rosenthal mill, see “Properties”.

      The kraft 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 will result 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. For more information about the facilities at the Stendal mill, see “— Stendal Pulp Mill Project and Financing” and “Properties”.

      The Celgar mill produces high quality kraft 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 products. The Celgar mill currently produces the following two grades of elemental chlorine free pulp:

      We believe the Celgar mill’s 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 producers in Asia. For more information about the facilities at the Celgar mill, see “Properties”.

Paper

      Our paper manufacturing strategy has focused on utilizing our existing machines, with certain modifications, in combination with our skilled workforce, to principally produce niche products. As a result, we have divested certain paper mills which focused on packaging, carton and recycled printing and writing papers, and shifted our production away from woodfree printing and writing papers.

      The following table sets out the primary classes of paper products that we produce and the mills at which they are produced:

      We sell our wallpaper and non-woven wallpaper base primarily to specialty paper converters and printers. It is used primarily in new construction and in the renovation industry in residential housing and commercial buildings. We sell our greaseproof paper to paper converters supplying the food industry. It is used primarily

for wrapping and baking food. We sell our printing and writing papers primarily to traders, converter suppliers and paper wholesalers.

      We currently manufacture specialty and printing paper at two facilities located in Germany. For more information about the facilities at the paper mills, see “Properties”.

      In December 2001, we acquired Landqart AG, or “Landqart”, for approximately $2.7 million, which operates a paper mill in Switzerland that produces specialty paper such as banknote and security paper. We reorganized our interest in Landqart at the end of 2002 by selling a 20% interest to a Swiss bank and exchanging the other 80% interest for a 49% interest in a limited partnership on a non-cash basis. This resulted in our having a 39% indirect interest in Landqart. We reduced our Landqart stake to prioritize our available capital and resources on Stendal including because of, among other things, our obligation to refinance the two bridge loans obtained in connection with the financing arrangements for Stendal.

Sales, Marketing and Distribution

      The distribution of Mercer’s pulp and paper sales volume and revenues by product class and geographic area are set out in the following table for the periods indicated:

     The following charts illustrate the geographic distribution of our revenues for the periods indicated:

     Since 2003, we have been conducting all sales and marketing of the kraft pulp from the Rosenthal mill internally through sales staff and through agents. We believe that this allows us to better coordinate our pulp sales and results in reduced sales and marketing costs due to reduced third party fees in the distribution of our products. In addition, the Stendal mill has established a sales and marketing division that is responsible for conducting all sales and marketing of the kraft pulp produced at the mill. When operating at capacity, we expect approximately 8 people to be employed in this division. We intend to co-ordinate and integrate the sales and marketing activities at the Rosenthal mill and Stendal mill to realize on a number of synergies between them. These include reduced overall administrative and personnel costs and co-ordinated selling, marketing and transportation activities. We expect to coordinate sales from the Celgar mill with our Rosenthal and Stendal mills on a global basis, thereby providing our larger customers with seamless service across all major geographies.

      The Rosenthal and Stendal mills are currently the only market kraft pulp producers in Germany, which is one of the leading import markets for kraft pulp in western Europe. We therefore have a material competitive transportation cost advantage compared to Norscan pulp producers when shipping to customers in Europe. Due to the Rosenthal mill’s central location, it delivers pulp to customers primarily by truck. Most trucks that deliver goods into eastern Germany generally do not also haul goods out of the region as eastern Germany is primarily an importer of goods. We are therefore able to obtain relatively low freight rates for the delivery of our products to many of our customers. Further, the Rosenthal mill’s transportation division handled approximately 9% of the Rosenthal mill’s pulp deliveries in 2004. Approximately 32% of pulp sales from the Rosenthal mill in 2004 were to customers or destinations located within a 500 kilometer radius of the Rosenthal mill. As a result, we can generally supply pulp to customers of Rosenthal faster than our competitors because of the short distances between the Rosenthal mill and our customers. For our customers in western Europe, we can, if requested, often supply them with pulp within one day of it being ordered. This permits us to be a “just in time” supplier to these customers. The Stendal mill should also have similar advantages over Norscan producers based upon its location.

      Our pulp sales are on customary industry terms. At December 31, 2004, we had no material payment delinquencies. In 2004, one customer accounted for approximately 10% of our pulp sales. In 2003, one customer, which operates a number of paper mills, accounted for approximately 11% of our pulp sales. In 2002, one customer accounted for approximately 12% of our pulp sales. Our pulp sales are not dependent upon the activities of any single customer or upon a concentrated group of major customers.

      The distribution of Celgar’s pulp sales volume and revenues by pulp product is set out in the following table for the periods indicated:

     Historically, Celgar sold all of its pulp through sales agents. We intend for our sales force to take over responsibility for supervising and managing all Celgar’s sales agents and to perform some of its sales functions directly over time. We believe such changes will result in reduced agents’ commissions and fees, increased contract sales and improved pulp price realizations.

      Recently, the Celgar mill’s price realizations have been adversely affected by the amount of pulp that was considered and sold as “off-grade” caused primarily by a combination of technical production issues relating to variations in brightness and high quantities of pitch and talc deposits in the pulp and the mill’s sales structure. We expect to address the amount of off-grade production and sales by adding a new EOP washer to the mill at a cost of approximately C$8.5 million and making other capital improvements as well as supervising and coordinating its sales with our Rosenthal and Stendal mills.

      The Celgar mill’s pulp production is transported to customers by rail, truck and ocean carrier using strategically located third party warehouses to ensure timely delivery. All overseas exports are shipped through warehouse facilities in the Vancouver, British Columbia area. The majority of Celgar’s pulp for overseas markets is initially delivered primarily by rail to the port of Vancouver for shipment overseas by ocean carrier. As a western Canada based pulp mill, the Celgar mill enjoys a transportation advantage in sales to Asian customers, in comparison to certain other NBSK pulp producers.

      The majority of the Celgar mill’s pulp for domestic markets is shipped by rail to third party warehouses in the U.S. midwest or directly to the customer.

      Our paper sales operations focus primarily on Europe and are responsible for the majority of our paper sales. Our paper sales conducted through agents were approximately 26% of total paper sales in 2004 and 2003, compared to approximately 27% in 2002. We sell the majority of our paper products to paper converters, printers and wallpaper manufacturers.

      Our paper sales are also on customary industry terms. At December 31, 2004, we had no material payment delinquencies. No single customer accounted for more than 10% of our paper sales in 2004, 2003 or 2002. Our paper sales are not dependent upon a single customer or upon a concentrated group of major customers.

Capital Expenditures

      In 2004, we continued with our capital investment programs designed to increase production capacity, improve efficiency and reduce effluent discharges and emissions at our manufacturing facilities. The improvements made at our mills over the past five years have reduced operating costs and increased the competitive position of our facilities.

      Capital investments at the Rosenthal mill were approximately €3.9 million, €6.9 million and €8.4 million in 2004, 2003 and 2002, respectively. Capital investments at the Rosenthal mill in 2004 related mainly to maintaining the quality and efficiency of the mill and we also completed the reconstruction of the wastewater

reservoirs at the mill at the end of 2004 at a cost of approximately €1.0 million. We estimate capital expenditures at the Rosenthal mill to be approximately €8.8 million for 2005 relating primarily to a project to upgrade the chip yard at the mill and a new wash press project for the mill and other smaller projects relating to maintaining the quality and efficiency of the mill.

      Construction of the Stendal mill commenced in August 2002. Total capital costs incurred in respect of the project in 2004 were approximately €396.6 million. For more information about the Stendal mill, see “— Stendal Pulp Mill Project and Financing”.

      In June 1993, an extensive modernization and expansion of the Celgar mill was completed at an aggregate cost of approximately C$850 million, which resulted in the Celgar mill becoming a low cost producer of high quality NBSK pulp with a significantly increased production capacity. Since the modernization of the Celgar mill in 1993, Celgar has made other capital expenditures to improve the efficiency of the mill and reduce operating costs. We expect to invest approximately C$25 million in high return strategic capital projects at the Celgar mill over the next three years to reduce operating costs and increase production capacity and enhance operating efficiency and reliability at the mill, the largest of which is the addition of a new EOP washer at the mill at a cost of approximately C$8.5 million.

      Capital investments at our paper operations were approximately €4.7 million, €7.8 million and €5.4 million in 2004, 2003 and 2002, respectively. As a result of flooding in parts of Germany and other eastern European countries during the third quarter of 2002, our paper mills had to replace certain damaged equipment at an aggregate cost of approximately €3.3 million. We have applied for reimbursement for these costs under German government grants and for assistance under special credit programs instituted by the German government for flooding victims. In 2005, we estimate capital investments to be approximately €4.3 million relating primarily to quality and productivity upgrades of the paper machines at the paper mills and the completion of a wastewater treatment plant at the Fährbrücke mill. Capital investments at the Heidenau mill in 2004 included upgrades to the hood pre-drying section of the paper machine at the mill and construction of a raw material storage area and related upgrades at an aggregate cost of approximately €1.8 million. Capital expenditures at the Fährbrücke mill in 2004 included upgrades to the reel packing machine to the paper machine and the continued construction of a wastewater treatment plant at the mill at an aggregate cost of approximately €0.5 million. We continue to review strategic initiatives designed to enhance returns at our paper mills.

      Capital investments at our facilities in Germany to reduce effluent discharges have largely offset wastewater fees that would otherwise be required to be paid. We estimate the aggregate wastewater fees we saved over the last five fiscal years as a result of these environmental capital expenditures at our facilities in Germany to be approximately €16.8 million. For more information about our environmental capital expenditures, see “— Environmental”.

Government Financing

Grants

      Our capital investment programs in Germany are 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. Pursuant to the current terms of these grants, federal and state governments will provide funding for up to 35% of the cost of qualified investments. The terms of such government grants also require that at least one permanent job be created for each €500,000 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. Such government grants are not repayable by a recipient unless it fails to complete the proposed capital investment or fails to create or maintain the requisite amount of jobs. 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, wherein the government may refrain from reclaiming previous grants. Pursuant to such grants provided in respect of our Rosenthal mill and being provided in

respect of the Stendal mill, we have agreed to maintain stipulated job levels at each operation for the specified five-year period. For more information, see “— Human Resources”. We believe that we are in compliance in all material respects with all of the terms and conditions governing the government grants we have received in Germany.

      Such government grants are not reported in our income. These grants reduce the cost basis of the assets purchased when the grants are received.

      The following table sets out the capital expenditures and government grants recorded by Mercer for the periods indicated:

     In addition, the Stendal mill qualifies for approximately €274.5 million of government grants, of which we have received €185.7 million as at December 31, 2004. For more information about the Stendal mill, see “— Stendal Pulp Mill Project and Financing”.

      The following table sets out for the periods indicated the effect of these government grants on the recorded value of such assets in our consolidated balance sheets:

Loan Guarantees

      Loan guarantees are available from German federal and state governments for up to an aggregate of 80% of the borrowed amount for qualifying capital investments made in certain parts of Germany. The federal and state governments are each severally committed to a portion of the guaranteed amount. These guarantees are provided by German federal and state governments to assist any qualifying businesses with financing capital investments. The guarantees permit qualifying businesses to obtain term loans for such capital investments on terms and at interest rates that are more favorable than available in the general market. In addition, subsidized interest rate loans are available from public financial institutions in Germany, which provide loans at below market interest rates for qualified investments.

      These loan guarantees have permitted us to obtain a significantly greater amount of financing for the project to convert the Rosenthal mill to the production of kraft pulp, as well as the construction of the Stendal mill, at substantially more favorable rates and upon substantially more favorable terms than would otherwise have been available.

Stendal Pulp Mill Project and Financing

The Project

      Our 63.6% owned subsidiary, Stendal, is the project company formed to develop, construct and operate the Stendal mill. The other shareholders of Stendal are RWE Industrie-Lösungen GmbH, or “RWE”, as to a 29.4% interest, and MFC Industrial Holdings AG (formerly AIG Altmark-Industrie AG), or “MIH”, as to a 7.0% interest. RWE is a subsidiary of the second largest utility company in Germany and is experienced in the construction of pulp mills.

      The Stendal mill is a “greenfield” softwood kraft pulp mill that was constructed at an aggregate cost of approximately €1.0 billion near the town of Stendal, in the German State of Sachsen-Anhalt. The mill is a modern, state-of-the-art single line mill with a designed annual production capacity of approximately 552,000 ADMTs. The overall mill design is based on proven or existing processes and technologies. The process and mill operations are highly automated to ensure stable operation and pulp quality. The mill process is a modern but ordinary kraft pulping process that emphasizes environmentally sound operational principles. The Stendal mill uses a batch pulp cooking process. Batch cooking allows for different grades to be batch produced for different end uses.

      Construction of the Stendal mill commenced on August 26, 2002 and was completed in the third quarter of 2004. The Stendal mill is located approximately 300 kilometers north of the Rosenthal mill. As a result of the proximity of the Stendal mill to the Rosenthal mill and the use of similar equipment at both mills, we believe we will be able to realize operating synergies between the two operations, particularly in the areas of raw materials and supplies procurement, production engineering, maintenance and marketing.

      The Stendal mill is situated on an approximately 200 acre site owned by Stendal that is part of a larger 1,250 acre industrial park. The balance of the industrial park is owned by MIH, which is seeking to develop the park.

      The Stendal mill is the largest market kraft pulp mill in Germany, the only other being our Rosenthal mill. We anticipate that the addition of production from the Stendal mill will allow us to expand our customer base, as our two pulp mills produce slightly different grades of softwood kraft pulp suitable for different end uses.

      The summaries of certain material provisions of agreements entered into in connection with the Stendal mill set forth herein are not complete and such summaries, including definitions of certain terms, are qualified in their entirety by reference to such agreements on file with the SEC.

Control and Management

      We, Stendal and its other shareholders entered into a shareholders’ agreement dated August 26, 2002 to govern our respective interests in Stendal. The agreement contains terms and conditions customary for these types of agreements, including restrictions on transfers of share capital and shareholder loans other than to affiliates, rights of first refusal on share and shareholder loan transfers, pre-emptive rights and piggyback rights on dispositions of our interest. The shareholders are not obligated to fund any further equity capital contributions to the project. Pursuant to the shareholders’ agreement, we are entitled to transfer up to 12.5% of our interest in Stendal without the prior consent of the other shareholders. The shareholders’ agreement provides that Stendal’s managing directors may be appointed by holders of a simple majority of its share capital. Further, shareholder decisions, other than those mandated by law or for the provision of financial assistance to a shareholder, are determined by a simple majority of Stendal’s share capital. If a shareholder is in default under the shareholders’ agreement or commits certain acts of insolvency or bankruptcy, it shall be considered to be a defaulting shareholder and must offer to sell its share capital and shareholder loans to the remaining shareholders on a pro rata basis, to a third party nominated by the other shareholders or permit them to be redeemed by Stendal. Other than in circumstances where a shareholder is considered to be a defaulting shareholder, the shareholders’ agreement does not provide for any mandatory or forced purchases and sales of a shareholder’s interest in Stendal.

      In addition to integrating the wood procurement activities at the Rosenthal and Stendal mills, we plan to coordinate other activities and operations between the two mills to realize efficiencies and optimize the cost structure of each mill. Such activities include establishing a sales organization to coordinate and handle the sales and marketing of the pulp produced by both mills. We currently coordinate the pulp sales of the Rosenthal mill pursuant to a sales agency agreement with Rosenthal whereby we receive a commission on overall sales. Other activities that we intend to coordinate between the two mills include purchases of supplies and stores, maintenance activities, workforce and management training and transportation.

EPC Contract

      The Stendal mill was constructed under a €716.0 million fixed-price turn-key engineering, procurement and construction, or “EPC”, contract between Stendal and RWE, referred to as the “principal” or “EPC contractor”. RWE’s obligations under the EPC contract are guaranteed by its parent company.

      The contract price for the completion of the project is fixed, taking into account all risks associated with the project and is subject only to certain changes that we cause or agree to, changes that arise due to changes in the law and specified events of force majeure. Payments under the EPC contract are made periodically against milestones as and when achieved by RWE.

      Under the EPC contract, RWE is responsible for all planning, design, engineering, procurement, construction and testing in connection with the build-out and start-up of the mill. We are responsible for obtaining legal title and possession of the site and providing the site and certain equipment, materials and services, as well as personnel, raw materials and other items in connection with the start-up of the mill. RWE is also primarily responsible for obtaining construction and operating permits. We constructed approximately €23.5 million of the site infrastructure and additional general site infrastructure connections were constructed by the local government. The costs of such infrastructure construction are 90% subsidized and co-financed by us, among others. Our co-financing obligations amounted to approximately €3.0 million and were funded out of the project loan facility.

      Subject to certain conditions, we have the right to terminate the EPC contract if, among other things, RWE becomes insolvent, assigns or transfers its interest in the agreement in violation of the provisions of the agreement or fails, without valid reason, to perform any of its material obligations.

      The EPC contract also contains reciprocal indemnities between us and RWE pursuant to which we each agree to indemnify the other in respect of losses or claims arising from negligent, illegal or other wrongful acts in connection with the agreement or arising out of any violation of applicable laws or permits.

Stendal Mill Completion

      Pursuant to the EPC contract, construction of the Stendal mill was completed substantially on its planned schedule and budget in the third quarter of 2004 and the mill is currently in the start-up phase. Such completion means that the construction and installation of all equipment and works were essentially finished and final checks occurred so that continuous production from the mill could commence. The mill underwent extensive testing and evaluation in December 2004 to determine whether certain performance requirements have been met, referred to as the “Acceptance Test”. The mill must pass the Acceptance Test prior to being accepted by Stendal. See “— Acceptance of the Stendal Mill” below. The mill is being supervised by RWE using Stendal’s personnel to operate the mill. Upon passing the Acceptance Test, the mill will be operated by Stendal. Production at the Stendal mill is expected to reach in excess of 90% of rated capacity in 2005. In the fourth quarter of 2004, production at the mill reached approximately 86% of the rated capacity of the mill.

      The mill has all of its requisite permits in place in connection with the commencement of operations and has currently arranged for approximately 66% of its fiber requirements for 2005. The mill has also currently filled approximately 91% of its overall staffing requirements. The balance of the hiring will occur in affiliated activities such as harvesting and transportation and will be completed through 2005 as the mill ramps up operations.

      Stendal commenced the initial production of pulp in mid-September 2004. The initial pulp produced was off-grade pulp which was primarily sold into the recycled fiber, corrugated board and similar markets. The prices realized on the sale of off-grade pulp are lower than the selling price for on-grade NBSK pulp. Pursuant to our current start-up plan, we have been ramping up pulp production and quality at the Stendal mill and the mill is now producing a significant proportion of saleable kraft pulp. As the NBSK pulp from the Stendal mill is further accepted in the market, we expect to eliminate its price discount relative to our Rosenthal mill in 2005.

      In conjunction with the start-up of the Stendal mill, we built up the fiber and finished goods inventory at the mill. These inventory levels at the Stendal mill have decreased to more normalized levels as the mill has ramped up operations.

      Pursuant to the current start-up plan, the contractor shut down the mill for approximately one week in the fourth quarter of 2004 for the completion of adjustments, installations and the replacement of equipment that was required in order to fulfill its obligations under the construction contract, as well as for a few days in December 2004 for fine tuning and cleaning so that the contractor could commence trials for the Acceptance Test.

Acceptance of the Stendal Mill

      The Stendal mill underwent extensive testing and evaluation in December 2004 in connection with its mechanical completion and the Acceptance Test. The Acceptance Test required that the mill continuously produce pulp for a 72-hour period in compliance with specified operational, quality and environmental requirements. When acceptance of the mill has occurred, we are required to provide the contractor with an acceptance certificate. Once we deliver the acceptance certificate, we assume responsibility for the operation of the mill, subject to the contractor’s warranty obligations.

      The test was generally successful and we were pleased with both the quantitative and qualitative aspects of the test. We have reviewed the results of the test with the lenders under the project finance facility related to the Stendal mill and certain suppliers. RWE and certain suppliers have agreed to implement certain measures at the mill, prior to Stendal accepting delivery of the mill. These include the installation of two additional digesters and related equipment, improvements to the NCG boiler and water treatment plant, reimbursement to Stendal of certain costs and the provision of certain warranties. The mill is currently operating well and product sales continue to be for the benefit of Mercer.

      The installation of the two additional digesters will increase the number of digesters at the Stendal mill from eight to ten and is planned to be completed by November 30, 2005. Once installed and fully operational, we believe the additional digesters should increase the annual production capacity of the Stendal mill to in excess of 600,000 ADMTs. We and our consultants believe that the design and capacity of the rest of the mill and fiber availability will, over time, permit the Stendal mill to achieve such increased production volumes. These digesters are also expected to enhance the reliability and overall operating performance of the Stendal mill. The two additional digesters have a capital cost of approximately €8 million, of which we will only pay €2 million and the balance shall be paid by RWE and certain suppliers.

      The acceptance of the 72-hour test and the mill and the implementation of these remedial measures are subject to, among other things, the settlement and execution of a definitive settlement agreement among the parties. Although no assurance can be provided, we currently believe the parties will conclude a definitive agreement around the end of the first quarter of 2005.

      If it is determined that the mill has not satisfied the Acceptance Test, RWE would be required to pay liquidated damages equal to 0.4% of the contract price per week of delay up to the maximum of 12% of the contract price. If certain performance requirements are not met within the terms of the agreement, subject to certain conditions, RWE has agreed to pay liquidated damages totaling up to a maximum of 10% of the contract price. The combined amounts that may become payable to us by RWE as a result of delays in completion and failure to meet performance requirements are capped at 17% of the contract price. Payment of

such amounts will not relieve RWE of its obligations to complete the project, attain minimum performance requirements or cure deficiencies.

      When acceptance of the mill has occurred, we are required to provide RWE with an acceptance certificate. Once we deliver the acceptance certificate to RWE, we assume responsibility for the operation of the mill, subject to RWE’s warranty obligations. Furthermore, each department of the mill will be tested on a stand-alone basis for compliance with its design specifications after the acceptance of the mill has occurred. Such testing is scheduled to be completed within the six-month period after acceptance of the mill has occurred. Under the EPC contract, RWE warrants conformity to specifications, compliance with permits and laws, suitability for intended use, compliance with performance requirements and warrants against defects in construction, in each case for a period of 18 months after acceptance, subject to extension in certain circumstances. RWE is required under the EPC contract to provide irrevocable bank guarantees in our favor, in agreed upon amounts, as security for an initial advance payment and for any deficiencies arising during the warranty period. In July 2006, RWE is required to provide an additional guarantee in the same form, in respect of the same matters, in an amount not less than 5% of the contract price which shall remain in effect until January 1, 2009.

Stendal Mill Construction and Start-up Risks

      Our start-up of the Stendal mill is subject to risks commonly associated with the start-up of large greenfield industrial projects which could result in the Stendal mill experiencing operating difficulties or delays in the start-up period and the Stendal mill may not achieve our planned production, timing, quality or cost projections. These risks include, without limitation, equipment failures or damage, errors or miscalculations in engineering, design specifications or equipment manufacturing, faulty construction or workmanship, defective equipment or installation, human error, industrial accidents, weather conditions, failure to comply with environmental and other permits, and complex integration of processes and equipment. See “Cautionary Statement Regarding Forward-Looking Information” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.

Stendal Pulp Mill Financing

      In August 2002, we completed financing arrangements for the Stendal mill. Total investment costs in connection with the project are approximately €1.0 billion, the majority of which was provided under a senior project finance facility, referred to as the “Stendal Loan Facility”, arranged by Bayerische Hypo-und Vereinsbank AG, referred to as “HVB”, pursuant to a project finance loan agreement, referred to as the “Project Finance Loan Agreement”, entered into between Stendal and HVB. See “— Description of Certain Indebtedness — Stendal Loan Facility”.

      We also contributed financing to Stendal of approximately €63.5 million from cash on hand and through two bridge loans aggregating €45 million from a U.S. investment partnership and a bank. We repaid these bridge loans in October 2003 from our issuance of convertible notes. See “— Description of Certain Indebtedness — Convertible Notes”.

      As the site of the Stendal mill is located in eastern Germany, it qualifies for approximately €274.5 million of government grants, which are applied to reduce the cost basis of the assets acquired with such grants. As of December 31, 2004, we had outstanding claim expenditures of €65.9 million of such grants in connection with the Stendal mill, which we expect to receive in 2005. In accordance with our accounting policies, these grants are not recorded by us until they are received.

      Under European Union rules, the Commission of the European Communities, referred to as the “Commission”, was formally notified in March 2002 by Germany of plans to provide support to the Stendal mill through grants and guarantees. The Commission considered these plans and, on June 19, 2002, decided not to raise any objection against such support being provided by the German federal and state governments in respect of the Stendal mill. In its decision, the Commission was not called upon to determine whether the governmental aid schemes, on which the support is based, were acceptable, but was limited to a determination as to whether a reduction of the pre-approved aid level for investment in the German State of Sachsen-Anhalt

under the previously approved schemes was required under European Union law in the case of the Stendal mill. In coming to its decision, the Commission generally has a wide margin of discretion in its assessment of facts and data. Under European Union law, member states, competitors or trade associations directly affected by a decision of the Commission may appeal such decision within a period of two months and twenty-four days after publication of the Commission decision. On December 23, 2002, Kronoply and Kronotex, two related manufacturers of, among other things, OSB and MDF boards that do not compete with the Stendal mill by selling pulp or paper, filed an appeal with the Court of First Instance of the European Communities (Luxembourg), referred to as the “Court”, against the Commission decision of June 19, 2002. Generally to be successful, an appeal must show that the Commission failed to comply with procedural requirements or committed a manifest error in assessing facts and data in adopting its decision.

      Recently, the Court in an unrelated case determined that the Commission committed a procedural error in determining the amount of state aid that could be granted by Germany to a recipient in a different business. The Court found the Commission erred when reviewing the effect of state aid on competition by only considering capacity utilization and not also considering product demand trends prior to providing its approval. As a result, in that case the Court set aside the Commission approval and remanded the matter back to the Commission to redetermine. The Court’s decision is being appealed by the aid recipient and the government of Germany. If such appeal is unsuccessful, the Commission will have to redetermine the matter based upon its mandated criteria and may come to the same determination as before. The procedure followed by the Commission in this remanded decision was similar to that it used in determining not to reduce the amount of state aid available to the Stendal mill. The remanded case does not affect Stendal’s current entitlement to receive grants, the balance of which are expected to be received in 2005.

      Although no assurance can be provided, we continue to believe that the appellant does not have any standing to bring the appeal as it is not a competitor of Stendal and, in any event, that the appeal is without merit. Further, the procedural error found by the Court in the remanded case was not raised in the Stendal appeal and we do not believe the Court should permit the appellant to amend its appeal at this stage.

      Subject to the Court’s schedule, we believe a hearing as to whether the appellant has standing to bring the appeal would be heard in 2005. If the Court determined the appellant had standing, such decision was upheld on appeal and the matter is not otherwise settled, we believe that a hearing on the merits of the appeal would occur in late 2006 or 2007. In the event the appellant was then successful on the merits and such decision was again upheld on appeal, the issue of whether the amount of state aid granted to the Stendal mill should be reduced would be remanded back to the Commission for reconsideration. Although we cannot assure you as to the outcome of any such redetermination, we believe that, given the Commission’s criteria and the factual circumstances related to the Stendal mill including demand trends in the pulp business, there would be no basis for the Commission to reduce the level of state aid. If the Commission determined to reduce the level of state aid available to the Stendal mill and such decision was upheld on appeal, Stendal would be required to repay a portion of the previously received state aid back to the German government. While we do not expect an adverse outcome, litigation is inherently uncertain and there can be no assurance of the final outcome.

Description of Certain Indebtedness

      The following summaries of certain material provisions of: (i) the Rosenthal Loan Facility; (ii) the Stendal Loan Facility; (iii) our convertible notes; (iv) our senior notes; (v) the Rosenthal working capital facility; and (vi) the Celgar working capital facility, are not complete and these provisions, including definitions of certain terms, are qualified by reference to the applicable documents and the applicable amendments to such documents on file with the SEC.

Rosenthal Loan Facility

      In 1998, Rosenthal entered into the Rosenthal Loan Facility, as amended, having a 15 year term with a German bank and other syndicated lenders in the aggregate amount of €259.7 million to finance the conversion project. Repayment of the Rosenthal Loan Facility commenced on March 31, 2001. During 2004, €20.1 million of the Rosenthal Loan Facility was repaid and, net of cash in a restricted account, €143.1 million

remained outstanding as at December 31, 2004. The outstanding amount under the Rosenthal Loan Facility and under the Rosenthal landfill facility of €7.6 million was repaid in February 2005 with a portion of the proceeds of the share and senior note offerings in connection with the Acquisition. See “— The Financings”.

Stendal Loan Facility

      In August 2002, referred to as the “Stendal Financing Closing Date”, we completed financing arrangements for the Stendal mill. Total investment costs in connection with the project are approximately €1.0 billion, the majority of which was provided under the Stendal Loan Facility pursuant to the Project Finance Loan Agreement entered into between Stendal and HVB. We also contributed financing to Stendal of approximately €63.5 million.

      The Stendal Loan Facility is in the aggregate amount of €828.0 million and is divided into tranches which cover, among other things, project construction and development costs, financing and start-up costs and working capital, as well as the financing of a debt service reserve account, approved cost overruns and a revolving loan facility to cover any time lag for receipt of grant funding and value-added tax refunds in the amount of €160 million, referred to as “Tranche E”. The Stendal Loan Facility is available for disbursement from August 2002 until the earlier of the issuance by us of a final acceptance certificate for the project and December 2005, except that financing under the Stendal Loan Facility for approved cost overruns will be available for up to one month prior to the first repayment.

      Pursuant to the Project Finance Loan Agreement, interest on the credit facilities was to accrue at variable rates between Euribor plus 0.60% and Euribor plus 1.55% per year. The Project Finance Loan Agreement provides for facilities to allow us to manage our risk exposure to interest rate risk, currency risk and pulp price risk by way of interest rate swaps, Euro and U.S. dollar swaps and pulp hedging transactions, subject to certain controls, including certain maximum notional and at-risk amounts. Pursuant to the terms of the Project Finance Loan Agreement, in 2002 Stendal entered into interest rate swap agreements in respect of borrowings under the Stendal Loan Facility to fix most of the interest costs under the Stendal Loan Facility at a rate of 3.795% per year until April 2004 and at a rate of 5.28% commencing May 2004, plus margin, until final payment in October 2017. For more information, see “Quantitative and Qualitative Disclosures about Market Risk”. In March 2003, as part of its loan syndication, HVB exercised its right under the Stendal Loan Facility to increase its up-front arrangement fee by 20 basis points and the rate of interest under the facility by 30 basis points.

      Stendal has agreed to initially reduce the aggregate advances outstanding under the Stendal Loan Facility, other than in respect of Tranche E, to a maximum of €599.0 million, from a maximum original amount of €638.0 million (assuming no draws for approved cost overruns), on or before the first March 31 or September 30 following the fourth anniversary of the first advance under the Stendal Loan Facility for project construction and development costs. The tranches are generally repayable in installments and mature between the fifth and 15th anniversary of the first advance under the Stendal Loan Facility for project construction and development costs. Subject to various conditions, including a minimum debt service coverage test, Stendal may make distributions, in the form of interest and capital payments on shareholder debt or dividends on equity invested, to its shareholders, including us.

      The tranches under the Stendal Loan Facility for project construction and development costs, financing costs, start-up costs and working capital are severally guaranteed by German federal and state governments in respect of an aggregate of 80% of the principal amount of these tranches, but the tranche under the Stendal Loan Facility for financing and start-up costs, working capital and certain of the project construction and development costs benefiting from these guarantees will be reduced semi-annually by 12.5% per year beginning on the first repayment date following the fourth anniversary of the first advance under the Stendal Loan Facility for each of these costs. Under the guarantees, the German federal and state governments that provide the guarantees are responsible for the performance of our payment obligations for the guaranteed amounts. Approximately €631.4 million was drawn under the Stendal Loan Facility as of December 31, 2004.

      On December 12, 2003, Stendal entered into agreements with Nord Deutsche Landesbank, referred to as “Nord LB”, and the European Investment Bank, referred to as “EIB”. Pursuant to the agreements, EIB will

provide a refinancing credit facility to Nord LB at preferred interest rates for up to €495.0 million. Such refinancing loan is made to Nord LB for the benefit of the Stendal mill. Instead of actually refinancing the Stendal Loan Facility through Nord LB, and Stendal benefiting from lower interest rates over time, the agreements provide for the disbursement to Stendal of the net present value of the interest rate differential offered to Nord LB by EIB (less a portion retained by Nord LB).

      A first draw down refinancing of €250.0 million was completed in December 2003 which resulted in a net present value of the interest rate differential of approximately €2.1 million being disbursed to Stendal. A second draw down refinancing in the amount of up to €245.0 million was completed in the first quarter of 2004 which resulted in a net present value interest rate differential credit of approximately €2.0 million being disbursed to Stendal.

      The proceeds received from the interest rate differential arrangement with EIB were transferred to the Stendal mill’s disbursement account. These EIB proceeds are considered additional cash flow in the period between the Stendal mill’s start-up and acceptance.

      The Stendal Loan Facility is secured by all of the assets of Stendal. In addition, the Project Finance Loan Agreement provides for the establishment of an equity reserve account into which excess start-up cash flows may be deposited. The account will be used to secure claims and amounts owing to the lenders in priority to the funding of the debt service reserve account under the Stendal Loan Facility. The Project Finance Loan Agreement also provides that revenues held by Stendal after certain payments may be paid to a shareholders’ account.

      In connection with the Stendal Loan Facility, we entered into a shareholders’ undertaking agreement, referred to as the “Undertaking”, dated August 26, 2002 with RWE, MIH and HVB in order to finance the shareholders’ contribution to the Stendal mill. Pursuant to the terms of the Undertaking, on the Stendal Financing Closing Date the shareholders of Stendal, on a pro rata basis, subscribed for €15 million of share capital of Stendal and advanced to it €55 million in subordinated loans. In addition, on a pro rata basis, the shareholders of Stendal agreed to advance to it €30 million of stand-by equity to, among other things, cover approved cost overruns, fund the equity reserve account and partially fund the debt service reserve account under the Stendal Loan Facility. On the Stendal Financing Closing Date, we provided HVB with a cash deposit for our pro rata portion of such equity reserve account. Our total funding commitment under the Undertaking was €63.5 million, all of which was effected in August 2002. Pursuant to the Undertaking, we have agreed, for as long as Stendal has any liability under the Stendal Loan Facility to HVB, to retain control over at least 51% of the voting shares of Stendal. We have no further capital commitments with relation to the Stendal mill.

      On the Stendal Financing Closing Date, we entered into and completed funding under two bridge financing loan agreements and used the net proceeds from the two bridge loans in the principal amounts of €15.0 million and €30.0 million to fund, in part, our contribution to the Stendal mill and commitment pursuant to the Undertaking. We repaid these bridge loans in October 2003 with the net proceeds from our offering of 8.5% convertible notes.

Convertible Notes

      In October 2003, we issued $82.5 million in aggregate principal amount of 8.5% convertible senior subordinated notes due 2010, referred to as the “convertible notes”.

      We pay interest semi-annually on the convertible notes on April 15 and October 15 of each year, beginning on April 15, 2004. The convertible notes mature on October 15, 2010. The convertible notes are redeemable on and after October 15, 2008, at any time in whole or in part, at our option on not less than 20 and not more than 60 days’ prior notice at a redemption price equal to 100% of the principal amount thereof plus accrued and unpaid interest, if any, to, but not including, the date of redemption, subject to the restrictions in the indenture governing the notes.

      The convertible notes are convertible, at the option of the holder, unless previously redeemed, at any time on or prior to maturity into our shares of beneficial interest at a conversion price of $7.75 per share, which is

equal to a conversion rate of approximately 129 shares per $1,000 principal amount of convertible notes, subject to adjustment. Holders of the convertible notes have the right to require us to purchase all or any part of the convertible notes 30 business days after the occurrence of a change of control with respect to us at a purchase price equal to the principal amount thereof plus accrued and unpaid interest, if any, to the date of purchase.

      The convertible notes are unsecured obligations of Mercer Inc. and are subordinated in right of payment to existing and future senior indebtedness (including our 9.25% senior notes described below) and are effectively subordinated to all of the indebtedness and liabilities of our subsidiaries. The indenture governing the convertible notes limits the incurrence by us, but not our subsidiaries, of senior indebtedness.

      The convertible notes are eligible for trading in the Private Offerings, Resales and Trading through Automated Linkages (PORTAL) systems of the National Association of Securities Dealers, Inc. In addition, we have registered the convertible notes and underlying shares with the SEC for resale by the holders thereof.

Senior Notes

      In conjunction with the Acquisition of the Celgar mill and the repayment of Rosenthal’s bank indebtedness, in February 2005, we issued $310 million in principal amount of senior notes. The senior notes bear interest at the rate of 9.25% per annum and mature on February 15, 2013. Interest on such notes is payable in arrears on February 15 and August 15 of each year the notes are outstanding, beginning on August 15, 2005. The notes are our senior unsecured obligations and, accordingly, will rank junior in right of payment to all existing and future secured indebtedness and all indebtedness and liabilities of our subsidiaries, equal in right of payment with all existing and future unsecured senior indebtedness and senior in right of payment to the 8.5% convertible senior subordinated notes due 2010 and any future subordinated indebtedness. We may redeem the notes on or after February 15, 2009, in whole or in part, at the applicable redemption prices plus accrued and unpaid interest, if any, to the redemption date. In certain circumstances, we may also redeem up to 35% of the aggregate principal amount of the notes at any time prior to February 15, 2008 at a redemption price of 109.35% of the principal amount, plus accrued and unpaid interest, if any, to the redemption date with the net cash proceeds of certain equity offerings. The notes were issued under an indenture which, among other things, restricts our ability and the ability of our restricted subsidiaries under the indenture to: (i) incur additional indebtedness or issue preferred stock; (ii) pay dividends or make other distributions to our stockholders; (iii) purchase or redeem capital stock or subordinated indebtedness; (iv) make investments; (v) create liens and enter into sale and lease back transactions; (vi) incur restrictions on the ability of our restricted subsidiaries to pay dividends or make other payments to us; (vii) sell assets; (viii) consolidate or merge with or into other companies or transfer all or substantially all of our assets; and (ix) engage in transactions with affiliates. These limitations are subject to other important qualifications and exceptions.

Rosenthal Working Capital Facility

      In conjunction with the Acquisition and the repayment of Rosenthal’s bank indebtedness, in February 2005, we established a new revolving working capital facility for the Rosenthal mill. The €40 million revolving working capital facility for the Rosenthal mill, arranged by HVB, 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 facility matures in February 2010. The interest payable on cash advances is LIBOR or EURIBOR plus 1.55%, 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 three, six or 12 months or any other period as Rosenthal and the lenders may determine. There is also a 0.375% per annum commitment fee on the unused and uncancelled amount of the revolving facility which is payable quarterly in arrears. This facility is secured by a first fixed charge on the inventories, receivables and accounts 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 HVB from time to time.

Celgar Working Capital Facility

      In conjunction with the Acquisition, in February 2005, we also established a new revolving working capital facility for the Celgar mill. The $30 million revolving working capital facility for the Celgar mill consists of a 364 day revolving credit facility convertible to a one year non-revolving term loan at the election of the borrower. The revolving facility has a term of 364 days and the term facility will mature on the first anniversary of the conversion date. The borrower is Zellstoff Celgar Limited, which is our wholly owned acquisition subsidiary that acquired the Celgar mill. Availability of drawdowns under the facility is subject to a borrowing base limit, that is based upon the Celgar mill’s eligible accounts receivable and inventory levels from time to time. The borrower can request a 364 day extension, not more than 90 days or less than 60 days prior to the maturity date of the revolving facility, and the lenders, in their sole discretion, shall decide whether or not to extend such facility not later than 30 days prior to the maturity date of the revolving facility. The revolving facility shall be available by way of: (i) Canadian and U.S. denominated advances which bear interest at the agent’s prime rate for Canadian advances and designated base rate for U.S. advances plus, in each case, between 1.5% and 2% per annum depending upon the debt coverage ratio of the borrower in effect at the time; (ii) banker’s acceptances which will be issued at a specified discount rate and will be subject to annualized stamping fees of between 2.5% and 3%, depending upon the debt coverage ratio of the borrower in effect at the time; and/or (iii) LIBOR advances, which will be made available for periods of one, two, three or six months duration and which will bear interest at LIBOR plus between 2.5% and 3%, depending upon the debt coverage ratio of the borrower in effect at the time. Letters of credit and/or letters of guarantee will also be available under the facility up to a maximum of $10 million. There is also a commitment fee payable monthly in arrears on any unutilized and uncancelled amount of the revolving facility. The amount of the fee varies from 0.625% to 0.9% of such amount depending upon the amount drawn under the facility and the borrower’s debt coverage ratio in effect at the time. This facility is secured by a first charge on the current assets of the borrower and a guarantee and postponement of claim delivered by Mercer Inc.

Paper Mill Loan Facilities

      In 2003, our paper operations secured two long-term credit facilities aggregating approximately €2.5 million, which facilities along with certain government grants are being utilized to repair flooding damage suffered by the mills in 2002. One facility totaling approximately €1.0 million matures on June 30, 2009, bears interest at a rate of 2.65% per annum and is repayable in ten equal semi-annual installments. The other facility in the amount of approximately €1.5 million matures on June 30, 2013, bears interest at a rate of 2.65% per annum and is repayable in 16 equal semi-annual installments. Both facilities are guaranteed by Mercer Inc.

      In addition, in 2003, our Fährbrücke paper mill secured three credit facilities aggregating €5.5 million, which facilities along with certain government grants were utilized to finance equipment and construction costs associated with expanding and adapting the paper machine at the mill. In September 2004, we repaid the majority of the outstanding amounts under these credit facilities and permanently reduced the aggregate amount available thereunder to €2.2 million. Two of the facilities aggregating approximately €1.4 million mature on December 30, 2012 and bear interest at rates between 4.15% and 4.3% per annum and are repayable in 16 equal semi-annual installments. The other facility in the amount of approximately €0.8 million matures on March 31, 2009 and bears interest at a rate equal to the three-month Euribor rate plus 1.75% per annum and is repayable in 16 equal quarterly installments. All three facilities are guaranteed by Mercer Inc. as well as to 80% thereof by a German state government.

      As at December 31, 2004, we had utilized the entire €4.7 million available under the five credit facilities relating to the paper operations.

Environmental

      Our operations are subject to a wide range of environmental laws and regulations, dealing primarily with water, air and land pollution control. In recent years, we have devoted significant financial and management resources to comply with all applicable environmental laws and regulations. Our total capital expenditures on

environmental projects at our facilities in Germany were approximately €2.4 million in 2004 and are expected to be approximately €2.4 million in 2005.

      We believe we have obtained all required environmental permits, authorizations and approvals for our operations. We believe our operations are currently in substantial 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. As a result, we estimate that the aggregate wastewater fees we saved in 2004 as a result of environmental capital expenditures made at our manufacturing plants in Germany were approximately €2.9 million. We expect that capital investment programs for our manufacturing plants in Germany will fully offset the wastewater fees that may be payable for 2005 and 2006 and 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.

      The Rosenthal mill has a relatively modern biological wastewater treatment and oxygen bleaching facility. We have significantly reduced our levels of Adsorbable Organic Halogen, or “AOX”, discharge at the Rosenthal mill and we believe the Rosenthal mill’s AOX discharges are substantially below those currently mandated by the German government. Effective January 1, 2001, the Rosenthal mill is required to maintain levels of Chemical Oxygen Demand, or “COD” discharge at the Rosenthal mill below 25 kilograms per ADMT of pulp. The Rosenthal mill is currently in compliance with these levels of COD discharge. We will continue to modify our wastewater and bleaching facilities at the Rosenthal mill, which have been further enhanced as a result of the conversion of the mill to the production of kraft pulp, to meet or exceed prescribed regulations. In addition, in 2003 we completed a strategic capital project to reconstruct the landfill at the Rosenthal mill so that it will be useable for an additional 15 years. The aggregate cost of the project was approximately €7.6 million.

      Although the Rosenthal mill’s overall emission levels for nitric oxide and nitrogen oxide, collectively referred to as “NOx”, are substantially below prescribed levels, NOx emissions from one gas burner have recently exceeded its permitted emission level. We made a claim on the warranty from the supplier of the gas burner who installed an ammonia scrubber to reduce NOx emissions. Due to a technical issue, emission levels from the gas burner were not reduced to permitted levels. Pursuant to our agreement with the gas burner supplier, the supplier is responsible for installing a new burner that reduces NOx emission levels to prescribed standards. The supplier completed the installation of a new gas burner at the Rosenthal mill in the third quarter of 2004 at an aggregate cost of €0.9 million, of which € 0.5 million was borne by the supplier and the remainder by us.

      The Stendal mill, which commenced operations in September 2004, has been in substantial compliance with applicable environmental laws, regulations and permits, but has experienced certain minor exceedances from time to time which are typical for a mill in the start-up phase of its operations. Management believes that, as the Stendal mill is a state-of-the-art facility, once the start-up phase has been completed and all necessary adjustments have been made, the mill will operate in compliance with the applicable environmental requirements. Under the terms of the EPC contract, the contractor has provided various representations and warranties as to compliance with permits and laws and will be responsible for ensuring such compliance for a period of 18 months after acceptance.

      In September 2003, during a shut down, the Celgar mill inadvertently discharged approximately 1,500 m³ of diluted process chemicals through its effluent treatment system and, as a result, released semi-treated

effluent into a nearby river. An independent report concluded that there were no measurable adverse effects from the spill. Upon investigation, the British Columbia Ministry of Water, Lands and Air Protection, referred to as “MWLAP”, issued a pollution prevention order that required the Celgar mill to adopt certain requirements including operator training, reporting requirements, development of contingency plans and the dredging of spill ponds. The mill has complied with all of the requirements of the order. The MWLAP has not imposed any fines or sanctions as a result of the spill.

      The Celgar mill has a number of permits regulating air emissions, including those with respect to sulphur dioxide, referred to as “SO₂”. While the mill’s overall SO₂ emissions are generally below one-third of the total SO₂ emissions permitted to be discharged under its air permits, the mill’s lime kiln SO₂ emissions periodically exceed emissions allowed under its individual SO₂ air permit. The mill is investigating the level of SO₂ emissions from the lime kiln and the ability to amend its air permits to lower overall SO₂ emissions for the mill while increasing the SO₂ emission discharge limit on its lime kiln permit. In the event that such permit amendments are not available, our consulting engineers have preliminarily estimated the capital cost to correct the SO₂ emissions at the lime kiln to be in the range of C$1.5 million to C$2 million. MWLAP has been advised of the level of SO₂ emissions at the lime kiln and apprised of the mill’s efforts to correct the same. Although the MWLAP has not taken actions or imposed any fines to date, there can be no assurance that any permit amendment will be successful, that MWLAP may not take action in the future or that the capital requirements to address the same will not exceed the preliminary estimates.

      The Celgar mill operates two landfills, a newly commissioned site and an older site. The Celgar mill intends to decommission the old landfill and is developing a closure plan and reviewing such plan with the MWLAP. The Celgar mill currently believes it may receive regulatory approval for such closure plan in 2005 and would commence closure activities in 2006. Our consulting engineers have estimated that the closure program will cost up to C$3 million, which would incorporate a clay or synthetic hydraulic cap. Potential savings may accrue should effluent treatment sludge be approved for use as a cap. As the closure program for the old landfill has not been finalized or approved, there can be no assurance that the decommissioning of the old landfill will not exceed such cost estimate.

      We have until the end of 2005 to begin biologically treating the wastewater at the Fährbrücke mill. We are in the process of constructing a wastewater treatment plant at the Fährbrücke mill, the first stage of which was completed in 2002 and brought into operation at the beginning of 2003. The cost of the treatment plant is expected to be approximately €1.8 million, of which €0.3 million was incurred in 2004. The project is being funded by government grants as to 28%, a bank loan as to 45% and the remainder from our funds, and we expect construction of the plant to be completed in 2005.

      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 material 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.

Human Resources

      We currently employ or hold positions for approximately 1,674 people. Our German operations have approximately 1,031 employees working in our pulp operations, including our transportation subsidiary, and approximately 227 employees working in our paper operations. In addition, there are approximately seven people working at the office we maintain in Vancouver, British Columbia, Canada. The Celgar mill currently employs approximately 409 people in its operations, the vast majority of which are unionized.

      Pursuant to the government grants and financing arranged in connection with the conversion of the Rosenthal mill to the production of kraft pulp, we have agreed with state government authorities in Germany to maintain at least 504 jobs at our Rosenthal pulp operations until June 30, 2005. This includes the employees of the Rosenthal mill’s transportation operations which deliver raw materials to the mill and pulp to our customers.

      When the Stendal mill is operating at capacity, Stendal and its subsidiaries are expected to employ approximately 580 people. Pursuant to the government grants and financing arranged in connection with the Stendal mill, we have agreed with German state authorities to maintain this number of jobs until 2010.

      Rosenthal and Dresden are bound by collective agreements negotiated with Bergbau-Chemie Energie, or “IG-BCE”, a national union that represents pulp and paper workers. In February 2003, we entered into a new labor agreement with IG-BCE for our pulp workers which, among other things, had a one-year term and provided for a 2% wage increase effective March 1, 2003 and that the parties would negotiate in respect of a further wage increase for August 2003 depending upon general economic conditions. Our pulp workers agreed to defer negotiations in respect of a further wage increase for 2003 as a result of current general economic conditions. In February 2004, a new agreement was reached which provides for a 2% wage increase. The agreement expired at the end of February 2005 and a new agreement is expected to be negotiated in the first half of 2005.

      Stendal has not yet entered into any collective agreements with IG-BCE, although it may do so in 2005. We anticipate that any such agreement would reflect wage levels in accordance with industry standards in this part of Germany. In January 2005, Stendal’s wage levels approximated 90% of the lowest eastern German wage level for a 40 hour work week for similar industrial companies. We expect that, over time, as the Stendal mill ramps up production and subject to general economic conditions, wage levels at the Stendal mill will correspond with those for similarly situated producers in Germany.

      A labor agreement was reached with the workers at our paper mills in 1999 upon terms which provided for wage increases of 1.5% in July 2000 and January 2001. A further agreement was reached in May 2001 upon terms which provided for wage increases of 2.0% in each of July 2001 and January 2002. In December 2002, a new agreement was reached for 2003 which provided for a wage increase of 2.5%. In February 2004, a new agreement was reached which provides for a 1.5% wage increase on each of February 1, 2004, July 1, 2004, January 1, 2005 and July 1, 2005. This agreement cannot be terminated prior to August 31, 2005 and a new agreement is expected to be negotiated in the fourth quarter of 2005.

      Over 90% of the employees at our German pulp and paper operations have post-secondary education or are trained tradespersons. We consider the relationships with these employees to be good. We have implemented profit sharing plans, training programs and early retirement schemes for the benefit of our German employees. Although no assurances can be provided, we have not had any significant work stoppages at any of our German operations and we would therefore expect to enter into labor agreements with our pulp and paper workers in Germany without any significant work stoppages at our German mills.

      A collective agreement was reached with the union hourly workers at the Celgar mill in January 2003 which has a term of five years. The agreement provides for wage increases effective May 2003 of 2.5% in each of 2003 and 2004, and 2% in each of the following three years. We consider relations with these workers to be good.

Additional Information

      We make available free of charge on or through our website at www.mercerinternational.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 the SEC. The public may read and copy any material we file with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, NW, 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 contains reports, proxy and information statements, and other information regarding us.

ITEM 2.  PROPERTIES

      We lease offices in Seattle, Washington, Vancouver, British Columbia, and in Germany. We own the Rosenthal mill, the Celgar mill and the paper mills and the underlying property. The Stendal mill is situated on property owned by Stendal, our 63.6% owned subsidiary.

      The Rosenthal mill is situated on a 220 acre site near the town of Blankenstein in the State of Thuringia, approximately 300 kilometers south of the Stendal mill. The Saale river flows through the site of the mill. In late 1999, we completed a major capital project which converted the Rosenthal mill to the production of kraft pulp. It is a single line mill with an annual production capacity of approximately 310,000 ADMTs of kraft pulp. The mill is self-sufficient in steam and electrical power. Some excess electrical power which is constantly generated is sold to the regional power grid. The facilities at the mill include:

      The Stendal mill is situated on a 200 acre site near the town of Stendal in the State of Sachsen-Anhalt, approximately 300 kilometers north of the Rosenthal mill and 130 kilometers from the city of Berlin. The mill is adjacent to the Elbe river and has access to harbor facilities for water transportation. Construction of the Stendal mill was completed in the third quarter of 2004. The mill is a single line mill with a designed annual production capacity of approximately 552,000 ADMTs of kraft pulp. The Stendal mill will be self-sufficient in steam and electrical power. Some excess electrical power which is constantly being generated will be sold to the regional power grid. The facilities at the mill include:

      The Celgar mill is situated on a 400 acre site near the city of Castlegar, British Columbia in Canada. The mill is located on the south bank of the Columbia River, approximately 600 kilometers east of the port city of Vancouver, British Columbia, and approximately 32 kilometers north of the Canada-United States border. The city of Seattle, Washington is approximately 650 kilometers southwest of Castlegar. It is a single line mill with a current annual production capacity of approximately 430,000 ADMTs of NBSK pulp. Internal power

generating capacity could, with certain capital improvements, enable the Celgar mill to be self-sufficient in electrical power and at times to sell surplus electricity. The facilities at the Celgar mill include:

      The Heidenau mill is situated on a 26 acre site in the town of Heidenau in the State of Saxony at the Elbe river, approximately 120 kilometers east of the Fährbrücke mill and 12 kilometers south of the city of Dresden. The mill was constructed in 1956 and has been continually upgraded. The mill has a rated annual production capacity of approximately 45,000 ADMTs of specialty papers. The facilities at the mill include:

      The Fährbrücke mill is situated on a 27 acre site near the town of Fährbrücke in the State of Saxony, in the western part of the Erzgebirge mountains at the Zwickauer Mulde river. The mill is approximately 100 kilometers east of the Rosenthal mill and approximately 120 kilometers west of the Heidenau mill. The mill was constructed between 1972 and 1973 and has been continually upgraded. The mill has a rated annual production capacity for approximately 40,000 ADMTs of printing and writing papers and specialty papers. The mill uses virgin fiber in producing various grades of printing and writing papers and specialty papers. The facilities at the mill include:

      The following table sets out, by primary product class, our production capacity and actual production for the periods indicated:

     At the end of 2004, substantially all of our German pulp related assets, including our German pulp facilities, were pledged to secure the Rosenthal Loan Facility and the Stendal Loan Facility. The Rosenthal Loan Facility was repaid and discharged in February 2005.

ITEM 3.  LEGAL PROCEEDINGS

      We are subject to routine litigation incidental to our business. We do not believe that the outcome of such litigation will have a material adverse effect on our business or financial condition.

      Not applicable.

PART II

      (a) Market Information. Our shares of beneficial interest are quoted for trading on the Nasdaq National Market under the symbol “MERCS” and listed in U.S. dollars on the Toronto Stock Exchange under the symbol “MRI.U”. The following table sets forth the high and low reported sale prices of our shares on the Nasdaq National Market for each quarter in the two year period ended December 31, 2004, and for the period ended March 11, 2005:

      (b) Shareholder Information. As at March 11, 2005, there were approximately 489 holders of record of our shares and a total of 33,053,455 shares were outstanding.

      (c) Dividend Information. The declaration and payment of dividends is at the discretion of our board of trustees. Our board of trustees has not declared or paid any dividends on our shares in the past two years and does not anticipate declaring or paying dividends in the foreseeable future.

      (d) Equity Compensation Plans. The following table sets forth information as at December 31, 2004 regarding: (i) our 1992 amended and restated stock option plan under which options to acquire an aggregate of 3,600,000 of our shares may be granted; and (ii) our 2004 Stock Incentive Plan pursuant to which 1,000,000 of our shares may be issued pursuant to options, stock appreciation rights and restricted shares:

     (e) Private Placements. In October 2002, we sold 200,000 of our shares to an accredited investor for gross proceeds of $900,000 by way of private placement in reliance on the exemption from the registration provisions of the Securities Act provided under Section 4(2) of the Securities Act.

      In October 2003, we completed the sale of $82.5 million in aggregate principal amount of convertible senior subordinated notes due October 15, 2010. The notes bear interest at a rate of 8.5% per annum and are convertible into our shares of beneficial interest at a conversion price of $7.75 per share, which is equal to a conversion rate of approximately 129 shares per $1,000 principal amount of the notes, subject to adjustment for certain customary anti-dilution matters. The notes were offered only to qualified institutional buyers in reliance on Rule 144A and to certain buyers outside of the United States in reliance on Regulation S under

the Securities Act. The notes were sold to RBC Dain Rauscher Inc., as the initial purchaser. The aggregate initial purchaser’s discounts of the offering were approximately $3.4 million.

      In connection with the offering of the notes, we filed a shelf registration statement on Form S-3 (File No. 33-111118) with the SEC in December 2003 to register for resale the notes and shares of beneficial interest into which the notes are convertible on behalf of the purchasers of the notes. The shelf registration statement was declared effective by the SEC on January 29, 2004. We will not receive any proceeds from the sale of the notes or shares of beneficial interest into which the notes are convertible under the shelf registration statement.

      In February 2005, pursuant to the Acquisition of the Celgar mill, we issued 4,210,526 of our shares of beneficial interest at a price of $9.50 per share to the vendor of the Celgar mill for gross proceeds of $40 million in reliance on Regulation S under the Securities Act.

ITEM 6. SELECTED FINANCIAL DATA

      The following table sets forth selected historical financial and operating data as at and for the periods indicated. Effective January 1, 2002, we changed our reporting currency from the U.S. dollar to the Euro. Accordingly, the following selected financial data for periods prior to the year ended December 31, 2002 has been restated in Euros and reclassified to conform with the current year’s presentation. The following selected financial data is qualified in its entirety by, and should be read in conjunction with, our consolidated financial statements and related notes contained in this annual report and “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.

      We commenced construction of our Stendal mill in August 2002. Construction of our Stendal mill was completed in the third quarter of 2004 and the mill is currently in the start-up phase. The following selected financial data for 2004 includes the operating results of the Stendal mill from its start up in September 2004.

      The following selected financial data does not reflect the results of operations and financial condition of the Celgar mill that we acquired in February 2005, which will have a significant impact on our future results of operations and financial condition.

      The following discussion and analysis of our financial condition and results of operations as at and for the three years ended December 31, 2004 should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this annual report. The following management discussion and analysis of our financial condition and results of operations is based upon the financial statements as at and for the three years ended December 31, 2004.

      The following Management’s Discussion and Analysis of Financial Condition and Results of Operations does not reflect the results of operations and financial condition of the Celgar mill with an annual production capacity of approximately 430,000 ADMTs that we acquired in February 2005, which will have a significant impact on our future results of operations and financial condition. In addition, our Stendal mill with an annual production capacity of approximately 552,000 ADMTs only commenced production in mid-September 2004.

Results of Operations

      We operate in the pulp and paper business and our operations are located primarily in Germany and, since the Acquisition, in Western Canada. Our manufacturing facilities are comprised of: (a) an NBSK pulp mill operated by our wholly-owned subsidiary, Rosenthal, near Blankenstein, Germany, which has an annual production capacity of approximately 310,000 ADMTs; (b) a newly constructed, state-of-the-art NBSK pulp mill, with a design production capacity of approximately 552,000 ADMTs per year, near Stendal, Germany built and being started up by our 63.6% owned subsidiary, Stendal; (c) since the Acquisition in February 2005, the Celgar NBSK pulp mill with an annual production capacity of approximately 430,000 ADMTs located near Castlegar, British Columbia, Canada; and (d) two paper mills located at Heidenau and Fährbrücke, Germany, which produce specialty papers and printing and writing papers and, based upon their current product mix, have an aggregate annual production capacity of approximately 70,000 ADMTs.

      The Stendal mill was completed substantially on its planned schedule and budget in the third quarter of 2004. Total investment costs in respect of the Stendal mill are approximately €1.0 billion, the majority of which was financed under the Stendal Loan Facility in the amount of €828 million. The Stendal mill is currently in the start-up phase and underwent extensive testing and evaluation in December 2004. The test was generally successful and we were pleased with both the quantitative and qualitative aspects of the test. We are settling the terms under which we currently expect to issue an acceptance certificate for the Stendal mill. See “Business — Stendal Pulp Mill Project and Financing”.

      Effective September 18, 2004, we commenced expensing all of the costs, including interest, related to the Stendal mill. Prior to that date, most of the costs, including interest, relating thereto were capitalized. Our results for the year ended December 31, 2004 include revenues of €45.0 million and operating and interest costs of €76.6 million related to the Stendal mill.

      Our financial performance depends on a number of variables that impact sales and production costs. Sales and production results are influenced largely by the market price for products and raw materials, the mix of products produced and foreign currency exchange rates. Kraft pulp and paper markets are highly cyclical, with prices determined by supply and demand. Demand for kraft pulp and paper is influenced to a significant degree by global levels of economic activity and supply is driven by industry capacity and utilization rates. Our product mix is important because premium grades of NBSK pulp and specialty papers generally achieve higher prices and profit margins.

      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 and pulp logs for pulp production, and waste paper and pulp for paper production. Wood chip and pulp log costs are primarily affected by the supply of, and demand for, lumber and pulp, which are both highly cyclical. Production costs also depend on the total volume of production. High operating rates and production efficiencies permit us to lower our average cost by spreading fixed costs over more units.

      Global economic conditions, changes in production capacity and inventory levels are the primary factors affecting kraft pulp and paper prices. Historically kraft pulp and paper prices have been cyclical in nature. The average annual European list prices for NBSK pulp between 1990 and 2004 ranged from a low of $444 per ADMT in 1993 to a high of $875 per ADMT in 1995. Following a decline in demand in 2001, list prices for NBSK pulp also declined and averaged approximately $463 per ADMT in 2002. An increase in demand resulting from improving American and major European economies and the weakening of the U.S. dollar against the Euro and other major currencies in 2003 resulted in European list prices for NBSK pulp increasing to approximately $560 per ADMT in December 2003 despite relatively high inventory levels. List prices for NBSK pulp in Europe continued to strengthen overall in 2004 and early 2005 due to the relatively weak U.S. dollar and improving world economies, and were approximately $625 per ADMT in December 2004 and approximately $635 per ADMT in January 2005. A producer’s sales realizations will reflect customer discounts, commissions and other items and it is likely that NBSK pulp prices will continue to fluctuate in the future.

      Our financial performance for any reporting period is also impacted by changes in the U.S. dollar to Euro exchange rate and in interest rates. In addition, as a result of the Acquisition of the Celgar mill, we expect that our future financial performance will be impacted by changes in the Canadian dollar to U.S. dollar exchange rate. Changes in currency rates affect our operating results because the price for our principal product, NBSK pulp, is generally based on a global industry benchmark that is quoted in U.S. dollars, even though our sales are primarily invoiced in Euros. Therefore, a weakening of the U.S. dollar against the Euro and, since the Acquisition, the Canadian dollar will generally reduce the amount of revenues of our pulp operations. Most of our costs, including our debt obligations in 2004, are incurred in Euros and those of the Celgar mill are in Canadian dollars. These do not fluctuate with the U.S. dollar to Euro or Canadian dollar exchange rates. Thus, a weakening of the U.S. dollar against the Euro and the Canadian dollar tends to reduce our sales revenue, gross profit and income from operations. The effect of such weakening against the Euro has been partially offset by gains from time to time on foreign currency derivatives we put into place to protect against such currency movements.

      Changes in interest rates can impact our operating results because the indebtedness we incurred under the credit facilities established for our Rosenthal and Stendal pulp mills provided for floating rates of interest. In addition, changes in interest rates may impact our future operating results as the new revolving credit facilities we established for the Rosenthal and Celgar mills in February 2005 provide for floating rates of interest.

      Changes in currency exchange and interest rates also impact certain foreign currency and interest rate derivatives Rosenthal and Stendal use to partially protect against the effect of such changes. Gains or losses on such derivatives are included in our earnings, either as they are settled or as they are marked to market for each reporting period. See “Quantitative and Qualitative Disclosures about Market Risk”.

      In March 2004, to protect against a weakening U.S. dollar, Rosenthal entered into two currency swaps in the aggregate principal amount of €184.5 million to convert all of its long-term indebtedness under the Rosenthal Loan Facility into U.S. dollars and a currency forward in the notional amount of €40.7 million, referred to as the “Rosenthal Currency Derivatives”. In the same month, Stendal entered into a currency swap in the principal amount of €306.3 million to convert approximately one-half of its indebtedness under the Stendal Loan Facility into U.S. dollars and a currency forward in the notional amount of €20.6 million, referred to as the “Stendal Currency Derivatives” and, together with the Rosenthal Currency Derivatives, the “Currency Derivatives”. In December 2004, we settled the Currency Derivatives due to the substantial weakening of the U.S. dollar versus the Euro in 2004. We realized a gain of approximately €44.5 million upon the settlement of these derivatives, compared to a gain of €29.3 million before minority interests on the then outstanding currency derivatives of Rosenthal and Stendal in 2003. In February 2005, Stendal entered into a currency swap in the principal amount of €306 million to convert approximately one-half of its indebtedness under the Stendal Loan Facility into U.S. dollars and a currency forward in the notional amount of $50 million. See “Quantitative and Qualitative Disclosures about Market Risk”.

      Stendal, as required under its project financing, entered into variable-to-fixed rate interest swaps, referred to as the “Stendal Interest Rate Swaps”, in August 2002 to fix the interest rate on approximately

€612.6 million of indebtedness for the full term of the Stendal Loan Facility. Rosenthal had also entered into forward interest rate and interest cap contracts, referred to as the “Rosenthal Interest Rate Contracts” and, together with the Stendal Interest Rate Swaps, the “Interest Rate Contracts”, in respect of a portion of its long-term indebtedness under the Rosenthal Loan Facility. The Rosenthal Interest Rate Contracts were settled in February 2005 in connection with the repayment of the Rosenthal Loan Facility.

      In the year ended December 31, 2004, we recorded a net non-cash holding loss of €32.3 million before minority interests on the marked to market valuation of the Interest Rate Contracts versus a net loss of €13.2 million before minority interests thereon in the year ended December 31, 2003.

      Improving world economies resulted in an increase in interest rates in the first half of 2004. If world economies continue to strengthen, we would expect interest rates to continue to rise from their historically low levels. Higher interest rates could result in our recording marked to market non-cash holding gains on the Stendal Interest Rate Contracts in future periods, which may be offset in part by higher interest rates payable on the new working capital facilities we established in February 2005 for the Rosenthal and Celgar mills. However, a fall in interest rates could result in our recording non-cash holding losses on the Stendal Interest Rate Contracts in future periods when they are marked to market, which may be offset in part by lower interest rates payable on the new working capital facilities for the Rosenthal and Celgar mills. See “Quantitative and Qualitative Disclosures about Market Risk”.

      Selected sales data for each of our last three years is as follows:

Year Ended December 31, 2004 Compared to Year Ended December 31, 2003

      Total revenues for the year ended December 31, 2004 increased to €247.9 million from €194.6 million in the comparative period of 2003, primarily because of higher pulp sales resulting from the start up of production at our Stendal mill in mid-September 2004. Pulp and paper revenues were €233.1 million in the

current period, versus €182.5 million in the comparative period of 2003. In 2004, the Stendal mill produced 132,694 ADMTs of NBSK pulp and had sales of €41.2 million.

      Costs of pulp and paper sales in the year ended December 31, 2004 increased to €232.1 million from €179.7 million in the comparative period of 2003, primarily as a result of the inclusion of production from our Stendal mill.

      In the year ended December 31, 2004, pulp sales increased to €178.5 million from €126.6 million in 2003 as a result of higher prices and production from our Rosenthal mill and the inclusion of production from our Stendal mill. List prices for NBSK pulp in Europe were approximately €496 ($616) per ADMT in 2004, compared to approximately €453 ($523) per ADMT last year. The increase in NBSK pulp prices was partially offset by the weakness of the U.S. dollar versus the Euro in 2004. In 2004, pulp sales by volume increased to 421,716 ADMTs from 303,655 ADMTs in 2003.

      Pulp sales realizations increased to €423 per ADMT on average in the year ended December 31, 2004 from €417 per ADMT in 2003, primarily as a result of higher prices, partially offset by lower price realizations of the Stendal mill during its start up when it sold pulp at a discounted price. We expect that such discount will be eliminated in 2005.

      Transportation and other revenues for the pulp operations increased to €14.2 million in the year ended December 31, 2004 from €10.9 million last year, because of the start up of the Stendal mill.

      Cost of sales and general, administrative and other expenses for the pulp operations increased to €200.6 million in the year ended December 31, 2004 from €141.3 million in 2003, primarily as a result of the inclusion of €65.6 million of operating costs related to the Stendal mill.

      On average, fiber costs for pulp production at the Rosenthal mill decreased by approximately 3.9% compared to last year.

      Depreciation for the pulp operations increased to €26.8 million in the current period, from €21.9 million in 2003, primarily as a result of the inclusion of €9.0 million of depreciation from the Stendal mill. A change effective July 1, 2004 in our depreciation estimate in respect of our Rosenthal mill resulted in a decrease of €4.4 million in cost of sales.

      For the year ended December 31, 2004, the pulp operations generated an operating loss of €4.8 million, versus an operating loss of €1.5 million last year, primarily as a result of a loss from operations of €20.6 million from our Stendal mill. Such loss from our Stendal mill resulted primarily from expensing certain costs associated with the mill prior to its start up and the higher production costs and lower price realizations it incurred during its start up.

      Paper sales in the current period were €54.6 million, compared with €55.9 million in the same period of last year. Sales of specialty papers in the year ended December 31, 2004 were €37.5 million versus €40.1 million in 2003, primarily as a result of a shift in the product mix. For the year ended December 31, 2004, total paper sales volumes were 62,282 ADMTs, versus 62,018 ADMTs in the year ended December 31, 2003. On average, prices for specialty papers realized in 2004 increased slightly, reflecting a shift in the product mix. Average prices for our printing papers decreased by approximately 6.4% reflecting generally weak demand.

      Cost of sales and general, administrative and other expenses for the paper operations in the year ended December 31, 2004 increased to €65.2 million from €56.9 million in the year ended December 31, 2003, primarily as a result of a non-cash €6.0 million impairment charge relating to our paper operations. In November 2004, our management determined to record and our audit committee approved a non-cash impairment charge of €6.0 million to write-off the carrying value of our Fährbrücke paper mill assets. Based upon its current product mix, the mill has an annual production capacity of approximately 35,000 ADMTs and produces primarily printing and writing paper. We determined to take the impairment charge as the Fährbrücke mill has generated weaker than expected returns over a period of time despite changes to its product mix. We do not expect the impairment charge in and of itself to result in future cash expenditures as we intend to continue to operate the Fährbrücke mill.

      Depreciation for the paper operations was €2.4 million in the year ended December 31, 2004, compared to €2.0 million last year.

      For the year ended December 31, 2004, our paper operations generated an operating loss of €9.8 million, which included the non-cash impairment charge of €6.0 million, compared to operating income of €0.1 million in 2003.

      In 2004, we had a loss from operations of €18.0 million, compared to a loss of €4.5 million last year, primarily as a result of a loss from operations of €20.6 million from our Stendal mill and the €6.0 million non-cash impairment charge related to our Fährbrücke paper mill. Interest expense (excluding capitalized interest of €27.2 million relating to the Stendal pulp mill) in the year ended December 31, 2004 increased to €23.7 million from €11.5 million a year ago, due to higher borrowings resulting primarily from our $82.5 million convertible note issue in October 2003 and the inclusion of interest expense of €12.2 million relating to the Stendal mill after its start up in mid-September 2004.

      In the year ended December 31, 2004, we recorded a gain of €44.5 million before minority interests upon the settlement of the Currency Derivatives due to the weakening of the U.S. dollar versus the Euro in 2004. In 2003, we recorded a gain of €29.3 million before minority interests on our then outstanding currency derivatives. In the year ended December 31, 2004, we also recorded a non-cash holding loss of €32.3 million before minority interests on the marked to market valuation of the Interest Rate Contracts versus a net loss thereon of €13.2 million before minority interests in 2003.

      In the year ended December 31, 2004, minority interest, representing the two minority shareholders’ proportionate interest in the Stendal mill, was €2.5 million, compared to €5.6 million in 2003.

      Our results for 2003 included an adjustment of €5.6 million for the non-cash impact of other-than-temporary impairment losses on our available-for-sale securities.

      During the fourth quarter of 2004, we completed a reorganization of certain of our German subsidiary companies and tax field audits for years prior to 2001 of certain of our German subsidiaries were completed. As a result, we re-evaluated our income tax provision and deferred income tax asset valuation allowance and recorded an income tax benefit of €44.2 million for the year ended December 31, 2004.

      We reported net income for the year ended December 31, 2004 of €20.0 million, or €1.15 per basic and €0.89 per diluted share, which reflected the positive impact of the net gain on derivative instruments and the income tax benefit, partially offset by the loss from our Stendal mill. In 2003, we reported a net loss of €3.6 million, or €0.21 per basic and diluted share.

      We generated “Operating EBITDA” of €17.2 million and €19.6 million in the years ended December 31, 2004 and 2003, respectively. Operating EBITDA is defined as income (loss) from operations plus depreciation and amortization and non-recurring capital asset impairment charges. Operating EBITDA is calculated by adding depreciation and amortization and non-recurring capital asset impairment charges of €35.1 million and €24.1 million to the loss from operations of €18.0 million and €4.5 million for the years ended December 31, 2004 and 2003, respectively.

      Management uses Operating EBITDA as a benchmark measurement of its own operating results, and as a benchmark relative to its competitors. Management considers it to be a meaningful supplement to operating income as a performance measure primarily because depreciation expense and non-recurring capital asset impairment charges are not an actual cash cost, and depreciation expense varies widely from company to company in a manner that management considers largely independent of the underlying cost efficiency of their operating facilities. In addition, we believe Operating EBITDA is commonly used by securities analysts, investors and other interested parties to evaluate our financial performance.

      Operating EBITDA does not reflect the impact of a number of items that affect our net income (loss), including financing costs and the effect of derivative instruments. Operating EBITDA is not a measure of financial performance under GAAP, and should not be considered as an alternative to net income (loss) or income (loss) from operations as a measure of performance, nor as an alternative to net cash from operating activities as a measure of liquidity.

      Operating EBITDA has significant limitations as an analytical tool, and should not be considered in isolation, or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are that Operating EBITDA does not reflect: (i) our cash expenditures, or future requirements, for capital expenditures or contractual commitments; (ii) changes in, or cash requirements for, working capital needs; (iii) the significant interest expense, or the cash requirements necessary to service interest or principal payments, on our outstanding debt; (iv) minority interests on our Stendal NBSK pulp mill operations; (v) the impact of realized or marked to market changes in our derivative positions, which can be substantial; and (vi) the impact of impairment charges against our investments or assets. Because of these limitations, Operating EBITDA should only be considered as a supplemental performance measure and should not be considered as a measure of liquidity or cash available to us to invest in the growth of our business. See the Statement of Cash Flows set out in our consolidated financial statements included herein. Because all companies do not calculate Operating EBITDA in the same manner, Operating EBITDA as calculated by us may differ from Operating EBITDA or EBITDA as calculated by other companies. We compensate for these limitations by using Operating EBITDA as a supplemental measure of our performance and relying primarily on our GAAP financial statements.

      The following table provides a reconciliation of net loss to loss from operations and Operating EBITDA for the periods indicated:

Year Ended December 31, 2003 Compared to Year Ended December 31, 2002

      In the year ended December 31, 2003, total revenues decreased to €194.6 million from €239.1 million in the year ended December 31, 2002, primarily as the current period does not include the revenues of the Landqart AG, referred to as “Landqart”, specialty paper mill, which we reorganized in December 2002 and now account for under the equity method. Primarily as a result thereof, pulp and paper revenues decreased to €182.5 million in the current period from €227.9 million in 2002.

      Cost of pulp and paper sales in the year ended December 31, 2003 decreased to €179.7 million from €213.5 million in the year ended December 31, 2002, primarily as a result of the deconsolidation of Landqart.

      Pulp sales in the current period were €126.6 million, compared to €130.2 million in 2002. U.S. dollar denominated list pulp price increases were mostly offset by a 17% decline in the U.S. dollar against the Euro in 2003. Average list prices for NBSK pulp in Europe were approximately €420 ($440) per ADMT at the end of 2002, approximately €441 ($480) per ADMT in the first quarter of 2003, approximately €484 ($550) per ADMT in the second quarter of 2003, approximately €444 ($500) per ADMT in the third quarter of 2003 and approximately €444 ($560) per ADMT in the fourth quarter of 2003. Our pulp sales realizations were €417 per ADMT on average in the current period, compared to €443 per ADMT in 2002. Pulp sales by volume increased to 303,655 ADMTs in the current period from 293,607 ADMTs in 2002.

      Cost of sales and general and administrative expenses for the pulp operations were €136.6 million for the year ended December 31, 2003, compared to €138.9 million for the year ended December 31, 2002. On average, fiber costs for pulp production in the current period generally remained at the same level as in the year ended December 31, 2002. Depreciation within the pulp segment was €21.9 million in the current period, compared to €21.6 million in 2002.

      Our pulp operations generated an operating loss of €1.5 million in the year ended December 31, 2003, compared to operating income of €1.8 million in 2002.

      Results for our paper segment during the current period reflect the aforementioned exclusion of the results from the Landqart specialty paper mill, which were included in the results for the prior year. Paper sales in the current period decreased to €55.9 million from €97.7 million in 2002. Sales of specialty papers in the year ended December 31, 2003 decreased to €40.1 million from €79.4 million in the year ended December 31, 2002. Total paper sales volumes decreased to 62,018 ADMTs in the year ended December 31, 2003 from 84,922 ADMTs in the year ended December 31, 2002. On average, prices for specialty papers realized in the year ended December 31, 2003 decreased by approximately 23.3% as our product mix changed upon the deconsolidation of the Landqart mill, and for printing papers decreased by approximately 6.8%, compared to the year ended December 31, 2002.

      Cost of sales and general and administrative expenses for the paper operations decreased to €57.9 million in the current period from €101.0 million in 2002 as a result of lower paper sales. Paper segment depreciation decreased to €2.0 million in the year ended December 31, 2003 from €4.0 million in the prior period.

      Our paper operations generated operating income of €0.1 million in the year ended December 31, 2003, compared to an operating loss of €4.5 million in the year ended December 31, 2002.

      Consolidated general and administrative expenses decreased to €19.3 million in the year ended December 31, 2003 from €25.0 million in the year ended December 31, 2002, primarily as a result of the exclusion of the results of the Landqart mill and a decrease in professional fees in the current period.

      For the year ended December 31, 2003, we reported a loss from operations of €4.5 million, compared to €1.1 million in 2002. Interest expense (excluding capitalized interest of €17.4 million in respect of the Stendal mill) in the current period decreased to €11.5 million from €13.8 million in 2002, primarily as a result of lower borrowing costs and lower indebtedness for our operating units. During the current period, we made principal repayments of €13.2 million in respect of the indebtedness of the Rosenthal pulp mill.

      Pursuant to the Stendal Loan Facility, Stendal had entered into the Stendal Interest Rate Swaps. These swaps manage the exposure to variable cash flow risk from the variable interest payments under the Stendal Loan Facility. Stendal also entered into a currency forward contract in connection with the Stendal Loan Facility in the third quarter of 2003. In 2003, we recorded a non-cash holding loss of approximately €13.0 million when these swaps were marked to market at the end of the period, compared to a non-cash holding loss of approximately €30.1 million in 2002. A non-cash holding gain of €0.7 million before minority interests was recognized in respect of the currency forward in the year ended December 31, 2003. We determine market valuations based primarily upon values provided by our counterparties.

      In addition, Rosenthal had entered into currency swaps in connection with the long-term indebtedness of the Rosenthal mill under the Rosenthal Loan Facility. Rosenthal had also entered into currency forwards and forward interest rate and interest cap contracts in connection with certain indebtedness relating to the Rosenthal mill. The currency swaps and the currency forwards were settled in December 2003. Primarily as a result of the weakening of the U.S. dollar versus the Euro, in the current year we recognized a net gain of €28.5 million upon the settlement of the currency swaps and currency forwards and the marked to market valuation of the forward interest rate and interest cap contracts. In 2002, we recognized a net gain of €23.4 million from these derivative contracts.

      Minority interest in the year ended December 31, 2003 amounted to €5.6 million and represented the proportion of the loss of the Stendal mill allocated to the two minority shareholders of Stendal. Minority interest in the year ended December 31, 2002 amounted to €11.0 million.

      Our results for the year ended December 31, 2003 include an adjustment of €5.6 million for the non-cash aggregate pre-tax earnings impact of other-than-temporary impairment losses on certain of our available-for-sale securities. This adjustment was recorded in other income (expense) in our consolidated statement of operations. This adjustment did not affect our shareholders’ equity since all of our available-for-sale securities are marked to market on a quarterly basis and unrealized gains or losses are reported through the statement of comprehensive income in our financial statements and recorded in other comprehensive income (loss) within shareholders’ equity on our balance sheet. Such unrealized gains or losses, the cost base and the current marked to market value of our available-for-sale securities are further described in the notes to our annual financial statements. These were legacy investments and unrelated to our pulp and paper operations and were largely sold in December 2003.

      SFAS 115, Accounting for Certain Investments in Debt and Equity Securities, EITF 03-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments, and SEC Staff Accounting Bulletin 59, Accounting for Noncurrent Marketable Equity Securities, provide guidance on determining when an impairment is other-than-temporary, which requires judgment. In making this judgment, we evaluate, among other factors, the duration and extent to which the fair value of an investment is less than its cost; the financial health of and business outlook for the investee, including factors such as industry and sector performance, changes in technology, operational and financing cash flow, the investee’s financial position including its appraisal and net asset value, market prices, its business plan and investment strategy; and our intent and ability to hold the investment.

      During 2003, we recorded a reserve for potential tax obligations of €3.0 million and an asset write-down of €2.3 million related to the valuation of certain assets in which we have a non-controlling interest as a result of the Landqart reorganization in 2002. No similar reserves or write-downs were recorded in 2002. Our results for 2003 also include a one-time pre-tax charge of approximately €1.0 million for settlement expenses relating to a proxy solicitation and settlement agreement with respect to our 2003 annual meeting.

      For the year ended December 31, 2003, we reported a net loss of €3.6 million, or €0.21 per share on a basic and diluted basis, compared to a net loss of €6.3 million, or €0.38 per share on a basic and diluted basis, in the year ended December 31, 2002.

      As the Stendal mill was under construction and because of its overall size relative to our other facilities, management uses consolidated operating results excluding derivative items relating to the Stendal mill to measure the performance and results of our operating units. Management believes this measure provides meaningful information for it and securityholders on the performance of our operating facilities for a reporting period. Upon completion of the ramp-up phase for the Stendal mill, the Stendal mill will be evaluated with our other operating units. For the year ended December 31, 2003, we reported a net loss of €3.6 million or €0.21 per share on a diluted basis. If we had excluded items relating to the Stendal mill by adding the loss on derivative financial instruments of €13.0 million on the Stendal Interest Rate Swap Agreements to, and subtracting the gain on the currency forward relating to the Stendal Loan Facility of €0.7 million and minority interest of €5.6 million from, the reported net loss of €3.6 million, we would have reported net income of €3.1 million or €0.18 per share on a diluted basis. For the year ended December 31, 2002, we reported a net loss of €6.3 million or €0.38 per share on a diluted basis. If we had excluded items relating to the Stendal mill by adding the loss on derivative financial instruments of €30.1 million on the Stendal Interest Rate Swap Agreements to, and subtracting minority interests of €11.0 million from, the reported net loss of €6.3 million, we would have reported net income of €12.8 million or €0.76 per share on a diluted basis. This measure has significant limitations as an analytical tool, and should not be considered in isolation, or as a substitute for analysis of our results as reported under GAAP.

      We generated “Operating EBITDA” of €19.6 million in the current period, compared to Operating EBITDA of €24.5 million in 2002. Operating EBITDA is defined as income (loss) from operations plus depreciation and amortization and non-recurring capital asset impairment charges. Operating EBITDA is calculated by adding depreciation and amortization of €24.1 million and €25.6 million to the loss from operations of €4.5 million and €1.1 million for the years ended December 31, 2003 and 2002, respectively.

      Operating EBITDA has significant limitations as an analytical tool, and should not be considered in isolation, or as a substitute for analysis of our results as reported under GAAP. See the discussion of our results for the year ended December 31, 2004 for additional information relating to such limitations and Operating EBITDA.

      The following table provides a reconciliation of net loss to loss from operations and Operating EBITDA for the periods indicated:

Liquidity and Capital Resources

      The following table is a summary of selected financial information for the periods indicated:

     At December 31, 2004, our cash and cash equivalents were €49.6 million, compared to €52.0 million at the end of 2003. We also had €45.3 million of cash restricted to pay construction costs payable and €19.1 million of cash restricted in a debt service account, both related to the Stendal mill. In addition, we had €28.5 million of cash restricted in a debt service account relating to the Rosenthal Loan Facility, which facility was fully repaid in February 2005. At December 31, 2004, we had a working capital deficit of €21.7 million, primarily because we had Stendal construction costs payable of €65.4 million for which we had not yet drawn down under the Stendal Loan Facility and, under our accounting policies, we do not record certain government grants until they are received. The Stendal construction costs will be paid pursuant to the Stendal Loan Facility in the ordinary course. At December 31, 2004, we qualified for investment grants related to the Stendal mill totaling approximately €65.9 million from the federal and state governments of Germany, which

we expect to receive in 2005. These grants, when received, will be applied to repay the amounts drawn under the dedicated tranche of the Stendal Loan Facility. The grants are not reported in our income and reduce the cost basis of the assets purchased when they are received. We expect to qualify for additional investment grants totaling €22.6 million when such Stendal construction costs have been substantially paid.

      We expect to meet our interest and debt service expenses and the working and maintenance capital requirements for our operations (other than at Stendal) from cash flow from operations, cash on hand and the two new working capital facilities for the Rosenthal and Celgar mills in the amounts of €40 million and $30 million, respectively, established in February 2005. We expect to meet the capital requirements for the Stendal mill, including working capital and potential losses during start-up, through shareholder advances already made to Stendal, the Stendal Loan Facility (which includes a revolving working capital tranche), the receipt of government grants, cash on hand and cash flow from operations.

Operating Activities

      Operating activities in 2004 provided cash of €9.6 million, compared to €31.4 million in 2003. An increase in receivables due primarily to higher sales in December 2004 used cash of €21.7 million in 2004, compared to €1.7 million in 2003. An increase in inventories due primarily to the build up of fiber in connection with the start-up of the Stendal mill used cash of €29.0 million in 2004, compared to €7.5 million in 2003. An increase in accounts payable and accrued expenses provided cash of €17.3 million in 2004, compared to €1.1 million in 2003.

Investing Activities

      Investing activities in 2004 used cash of €220.2 million, primarily as a result of the acquisition of properties, net of investment grants, of which €210.9 million was attributable to the Stendal mill, compared to using cash of €318.5 million in 2003, of which €316.7 million was attributable to the Stendal mill. Sales of available-for-sale securities provided cash of €1.2 million in 2004, compared to €6.4 million in 2003.

      We qualify for investment grants from the federal and state governments of Germany and had claim expenditures of €65.9 million outstanding as of December 31, 2004. We expect to receive our currently outstanding claim expenditures in 2005. We received investment grants totaling €103.0 million with respect to the Stendal mill during 2004. In accordance with our accounting policies, we do not record these grants until they are received. These grants reduce the cost basis of the assets purchased with them. See “Business — Government Financing”.

      We are in the process of constructing a wastewater treatment plant at the Fährbrücke mill and have completed reconstructing the landfill at the Rosenthal mill. See “Business — Environmental” and “Business — Capital Expenditures”.

      In August 2002, we completed financing arrangements for the Stendal mill. Total investment costs in connection with the Stendal mill are approximately €1.0 billion, the majority of which was provided under the Stendal Loan Facility. We also contributed approximately €63.5 million to Stendal. For more information, see “Business — Stendal Pulp Mill Project and Financing” and “Business — Capital Expenditures”.

Financing Activities

      Financing activities provided cash of €206.5 million in the year ended December 31, 2004. A net increase in indebtedness, primarily related to the Stendal mill, provided cash of €215.0 million in 2004. An increase in restricted cash used cash of €33.5 million in 2004. We made principal repayments of €20.1 million in connection with the Rosenthal Loan Facility in the year ended December 31, 2004. We fully repaid the Rosenthal Loan Facility and indebtedness relating to the landfill at the Rosenthal mill in February 2005 from the proceeds of the share and senior note offerings in connection with the Acquisition. An increase in construction costs payable provided cash of €22.7 million in 2004. The issuance of shares in connection with the exercise of options provided cash of €4.2 million in 2004. Financing activities provided cash of €307.1 million in 2003, primarily as a result of a net increase in indebtedness relating to the Stendal mill.

      In 2004, we repaid the majority of the outstanding amounts under the three credit facilities relating to the Fährbrücke paper mill aggregating €5.5 million and permanently reduced the aggregate amount available thereunder to €2.2 million. As at December 31, 2004, we had utilized the entire €4.7 million available under the five credit facilities relating to the paper operations.

      We have no material commitments to acquire assets or operating businesses. We anticipate that there will be acquisitions of businesses or commitments to projects in the future. To achieve our long-term goals of expanding our asset and earnings base through the acquisition of interests in companies and assets in the pulp and paper and related businesses, and organically through high return capital expenditures at our operating facilities, we will require substantial capital resources. The required necessary resources for such long-term goals will be generated from cash flow from operations, cash on hand, the sale of securities and/or assets, and borrowing against our assets.

      In addition, we have amounts available under a revolving tranche of the Stendal Loan Facility, and the two new revolving working capital facilities established for the Rosenthal and Celgar mills in February 2005.

Contractual Obligations and Commitments

      The following table sets out our contractual obligations and commitments as at December 31, 2004 in connection with our long-term liabilities. These obligations and commitments are expected to increase in the future to reflect the ramp-up of production at the Stendal mill and the obligations and commitments incurred in connection with the Acquisition of the Celgar mill.

Capital Resources

      In addition to our new €40 million and $30 million revolving credit facilities for the Rosenthal and Celgar mills and the revolving working capital tranche of the Stendal Loan Facility, respectively, we may seek to raise future funding in the debt markets if our indenture relating to our 9.25% senior notes permits, subject to compliance with the indenture. The indenture governing the senior notes contains various restrictive covenants, including several that are based on a formulation of the financial measure EBITDA, which is net income (loss) adjusted to exclude interest, taxes, depreciation and amortization, certain non-cash charges and extraordinary or otherwise unusual gains or losses, and certain other items. We refer to this formulation of EBITDA as “Indenture EBITDA” which is defined in the senior note indenture as Consolidated EBITDA.

      The indenture governing the senior notes provides that, in order for Mercer Inc. and its restricted subsidiaries (as defined in the indenture) to enter into certain types of transactions, including the incurrence of additional indebtedness, the making of restricted payments and the completion of mergers and consolidations (other than, in each case, those specifically permitted by our senior note indenture), we must meet a minimum ratio of Indenture EBITDA to Fixed Charges as defined in the senior note indenture of 2.0 to 1.0 on a pro forma basis for the most recently ended four full fiscal quarters. This ratio is referred to and defined as the Fixed Charge Coverage Ratio in the senior note indenture.

      Our Acquisition of the Celgar mill in February 2005 was a significant transaction for us and will have a material impact on our future results of operations and financial condition. The Acquisition will impact the ability of Mercer Inc. and its restricted subsidiaries under the indenture governing the senior notes to make distributions and incur additional indebtedness in the future beyond our revolving credit facilities and certain permitted borrowings under the indenture, and, in that regard, we and our restricted subsidiaries will be required to meet the Fixed Charge Coverage Ratio. As at December 31, 2004, we do not believe that Mercer Inc. and our restricted subsidiaries under the indenture governing the senior notes met the Fixed Charge Coverage Ratio of 2.0 to 1.0 as set out in the senior note indenture.

      For a description of our senior notes and credit facilities, see “Business — Description of Certain Indebtedness”.

Sensitivity Analysis

      The pulp and paper business is cyclical in nature and markets for our principal products are characterized by periods of supply and demand imbalance, which in turn affects product prices. The markets for pulp and paper are highly competitive and sensitive to changes in industry capacity and in the economy, both of which can have a significant influence on our selling prices and earnings. Approximately €178.5 million, or approximately 76.6%, of our revenues in 2004 were from pulp sales and approximately €126.6 million, or approximately 69.4%, of our revenues in 2003 were from pulp sales. The following table illustrates the effect on our net operating results in 2004 and 2003 (which do not include the operating results of the Celgar pulp mill) of a $20 change in our average selling price per ADMT for NBSK pulp in 2004 and 2003, based upon our pulp sales during each period and translated into Euros at the average exchange rate for the U.S. dollar to the Euro for the period:

      As our Stendal mill only started production in mid-September of 2004 and we acquired the Celgar mill in February 2005, we expect our sensitivity to pulp prices to increase significantly both on an absolute and per share basis in the future.

Foreign Currency

      Effective January 1, 2002, we changed our reporting currency from the U.S. dollar to the Euro as a significant majority of our business transactions are originally denominated in Euros. By adopting the Euro, most cumulative foreign currency translation losses were eliminated. However, we hold certain assets and liabilities in U.S. dollars, Swiss francs and in Canadian dollars. Accordingly, our consolidated financial results are subject to foreign currency exchange rate fluctuations.

      We translate foreign denominated assets and liabilities into Euros at the rate of exchange on the balance sheet date. Unrealized gains or losses from these translations are recorded in our consolidated statement of comprehensive income and impact on shareholders’ equity on the balance sheet but do not affect our net earnings.

      In the year ended December 31, 2004, we reported a net €4.5 million foreign exchange translation gain and, as a result, the cumulative foreign exchange translation gain increased to €10.5 million at December 31, 2004 from €6.0 million at December 31, 2003.

      Based upon the exchange rate at December 31, 2004, the U.S. dollar decreased by approximately 7.5% in value against the Euro since December 31, 2003. See “Quantitative and Qualitative Disclosures about Market Risk”.

Results of Operations of the Restricted Group Under Our Senior Note Indenture

      The indenture governing our 9.25% senior notes requires that we also provide a discussion in annual and quarterly reports we file with the SEC under Management’s Discussion and Analysis of Financial Condition and Results of Operations of the results of operations and financial condition of Mercer Inc. and our restricted subsidiaries under the indenture, referred to as the “Restricted Group”. During the years ended December 31, 2004, 2003 and 2002, the Restricted Group was comprised of Mercer Inc., certain holding subsidiaries and Rosenthal, which was the only member of the Restricted Group with material operations during such periods. We acquired the Celgar pulp mill in February 2005 and, as a result, its results of operations and financial condition are not included in the following discussion. The Celgar mill will be included as part of the Restricted Group from the date of the Acquisition. The Restricted Group excludes our paper operations and our Stendal mill.

      The following is a discussion of the results of operations and financial condition of the Restricted Group. For further information regarding the operating results of Rosenthal, see Note 14 of our annual financial statements included herein. For further information regarding the Restricted Group including, without limitation, a reconciliation to our consolidated results of operations, see Note 20 of our annual financial statements included elsewhere herein.

Restricted Group Results — Year Ended December 31, 2004 Compared to Year Ended December 31, 2003

      Total revenues for the Restricted Group for the year ended December 31, 2004 increased to €150.6 million from €139.6 million in the comparative period of 2003, primarily because of higher pulp sales from the Rosenthal mill. Pulp sales realizations for the Rosenthal mill increased to €446 per ADMT on average in the year ended December 31, 2004 from €417 per ADMT in 2003, primarily as a result of higher prices. The increase in NBSK pulp prices was partially offset by the weakness of the U.S. dollar versus the Euro in 2004.

      Costs of sales for the Restricted Group in the year ended December 31, 2004 decreased to €124.3 million from €129.3 million in the comparative period of 2003, primarily as a result of lower production costs at the Rosenthal mill.

      General and administrative expenses for the Restricted Group increased to €13.8 million in the year ended December 31, 2004 from €10.5 million in 2003, primarily as a result of higher professional fees and corporate reorganization costs.

      Depreciation for the Restricted Group was €17.8 million in the current period, versus €21.9 million in 2003, relating primarily to the Rosenthal mill. A change effective July 1, 2004 in our depreciation estimate in respect of our Rosenthal mill resulted in a decrease of €4.4 million in cost of sales for the Restricted Group.

      In 2004, the Restricted Group reported income from operations of €12.4 million, compared to a loss from operations of €1.3 million last year. Interest expense for the Restricted Group in the year ended December 31, 2004 decreased to €10.9 million from €10.7 million a year ago.

      In the year ended December 31, 2004, the Restricted Group recorded a gain of approximately €13.3 million upon the settlement of the outstanding currency derivatives relating to the Rosenthal mill due to the weakening of the U.S. dollar versus the Euro in 2004. In 2003, the Restricted Group recorded a gain of €28.6 million upon the settlement of the then outstanding currency derivatives relating to the Rosenthal mill. In the year ended December 31, 2004, the Restricted Group also recorded a marginal non-cash holding loss on the marked to market valuation of the interest rate derivatives related to the Rosenthal mill versus a net loss of €0.1 million thereon in 2003.

      The results of the Restricted Group for 2003 included an adjustment of €4.5 million for the non-cash impact of other-than-temporary impairment losses on available-for-sale securities.

      During the fourth quarter of 2004, we completed a reorganization of certain of our German subsidiary companies and tax field audits for years prior to 2001 of certain of our German subsidiaries were also completed. As a result, we re-evaluated our income tax provision and deferred income tax asset valuation allowance and recorded an income tax benefit related to the Restricted Group of €17.2 million for the year ended December 31, 2004.

      Net income for the Restricted Group for the year ended December 31, 2004 was €35.1 million, which reflected improved NBSK pulp prices and the positive impact of the net gain on derivative instruments of the Rosenthal mill and the income tax benefit. In 2003, the Restricted Group reported net income of €11.5 million.

      The Restricted Group generated “Operating EBITDA” of €30.2 million and €20.6 million in the years ended December 31, 2004 and 2003, respectively. Operating EBITDA is defined as income (loss) from operations plus depreciation and amortization and non-recurring capital asset impairment charges. Operating EBITDA for the Restricted Group is calculated by adding depreciation and amortization and non-recurring capital asset impairment charges of €17.8 million and €21.9 million to the income from operations of €12.4 million and loss from operations of €1.3 million for the years ended December 31, 2004 and 2003, respectively.

      Operating EBITDA has significant limitations as an analytical tool, and should not be considered in isolation, or as a substitute for analysis of our results as reported under GAAP. See the discussion of Mercer’s results for the year ended December 31, 2004 for additional information relating to such limitations and Operating EBITDA.

      The following table provides a reconciliation of net loss to loss from operations and Operating EBITDA for the Restricted Group for the periods indicated:

Restricted Group Results — Year Ended December 31, 2003 Compared to Year Ended December 31, 2002

      Total revenues for the year ended December 31, 2003 for the Restricted Group were €139.6 million, compared to €145.5 million in the comparative period of 2002. Increases in NBSK pulp prices were largely offset by the weakness of the U.S. dollar versus the Euro in 2003. Pulp sales realizations for the Rosenthal mill decreased to €417 per ADMT on average in the year ended December 31, 2003 from €443 per ADMT in 2002, primarily as a result of the weakness of the U.S. dollar versus the Euro in 2003.

      Costs of sales for the Restricted Group in the year ended December 31, 2003 increased to €129.3 million from €128.0 million in the comparative period of 2002, primarily as a result of the higher production from the Rosenthal mill.

      General and administrative expenses for the Restricted Group decreased to €10.5 million in the year ended December 31, 2003 from €12.6 million in 2002.

      Depreciation for the Restricted Group was €21.9 million in the current period, versus €21.6 million in 2002, relating primarily to the Rosenthal mill.

      In 2003, the Restricted Group reported a loss from operations of €1.3 million, compared to income from operations of €4.9 million in 2002. Interest expense for the Restricted Group in the year ended December 31, 2003 decreased to €10.7 million from €12.5 million in 2002, due to repayments made under the Rosenthal Loan Facility.

      In the year ended December 31, 2003, the Restricted Group recorded a gain of approximately €28.6 million upon the settlement of the outstanding currency derivatives relating to the Rosenthal mill due to the weakening of the U.S. dollar versus the Euro in 2003. In 2002, the Restricted Group recorded a gain of €25.7 million on the then outstanding currency derivatives relating to the Rosenthal mill. In the year ended December 31, 2003, the Restricted Group also recorded a net non-cash holding loss of €0.1 million on the marked to market valuation of the interest rate derivatives related to the Rosenthal mill versus a net loss of €2.3 million thereon in 2002.

      The results of the Restricted Group for 2003 include an adjustment of €4.5 million for the non-cash impact of other-than-temporary impairment losses on available-for-sale securities. See our consolidated results of operations for the year ended December 31, 2003 for information relating thereto.

      The Restricted Group reported net income for the year ended December 31, 2003 of €11.5 million. In 2002, the net income for the Restricted Group was €13.5 million.

      The Restricted Group generated “Operating EBITDA” of €20.6 million and €26.5 million in the years ended December 31, 2003 and 2002, respectively. Operating EBITDA is defined as income (loss) from operations plus depreciation and amortization and non-recurring capital asset impairment charges. Operating EBITDA for the Restricted Group is calculated by adding depreciation and amortization and non-recurring capital asset impairment charges of €21.9 million and €21.6 million to the loss from operations of €1.3 million and income from operations of €4.9 million for the years ended December 31, 2003 and 2002, respectively.

      Operating EBITDA has significant limitations as an analytical tool, and should not be considered in isolation, or as a substitute for analysis of our results as reported under GAAP. See the discussion of Mercer’s results for the year ended December 31, 2004 for additional information relating to such limitations and Operating EBITDA.

      The following table provides a reconciliation of net loss to loss from operations and Operating EBITDA for the Restricted Group for the periods indicated:

Liquidity and Capital Resources of the Restricted Group

      The following table is a summary of selected financial information for the Restricted Group for the periods indicated:

     At December 31, 2004, the Restricted Group had cash and cash equivalents of €45.5 million, compared to €47.3 million at the end of 2003. In addition, there was €28.5 million of cash restricted in a debt service account relating to the Rosenthal Loan Facility, which facility was fully repaid in February 2005. At December 31, 2004, the Restricted Group had working capital of €48.5 million.

      We expect the Restricted Group to meet its interest and debt service expenses and meet the working and maintenance capital requirements for its current operations from cash flow from operations, cash on hand and two new working capital facilities for the Rosenthal and Celgar mills in the amounts of €40 million and $30 million, respectively, put into effect in February 2005.

Critical Accounting Policies

      The preparation of financial statements and related disclosures in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Estimates are used for, but not limited to, the accounting for doubtful accounts,

depreciation and amortization, asset impairments, income taxes, and contingencies. Actual results could differ from these estimates.

      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 increase, these judgments become even more subjective and complex. We have identified certain accounting policies, described below, that are the most important to the portrayal of our current financial condition and results of operations. Our significant accounting policies are disclosed in Note 1 to our annual audited consolidated financial statements included elsewhere in this annual report.

      Derivative Instruments. We adopted Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” effective January 1, 2001. Derivative instruments are measured at fair value and reported in the balance sheet as assets or liabilities. Accounting for gains or losses depends on the intended use of the derivative instruments. Gains or losses on derivative instruments which are not designated hedges are recognized in earnings in the period of the change in fair value. Accounting for gains or losses on derivative instruments designated as hedges depends on the type of hedge and these gains or losses are recognized in either earnings or other comprehensive income.

      We reported a non-cash holding loss of €32.3 million before minority interests in respect of the Interest Rate Contracts and a gain of €44.5 million before minority interests in respect of the Currency Derivatives in our loss for the year ended December 31, 2004.

      Impairment of Long-Lived Assets. We periodically evaluate long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In performing the review of recoverability, we estimate future cash flows expected to result from the use of the asset and its eventual disposition. The estimates of future cash flows, based on reasonable and supportable assumptions and projections, require our management to make subjective judgments. In addition, the time periods for estimating future cash flows is often lengthy, which increases the sensitivity of the assumptions made. Depending on the assumptions and estimates used, the estimated future cash flows projected in the evaluation of long-lived assets can vary within a wide range of outcomes. Our management considers the likelihood of possible outcomes in determining the best estimate of future cash flows.

      Deferred Taxes. We currently have deferred tax assets which are comprised primarily of tax loss carryforwards and deductible temporary differences, both of which will reduce taxable income in the future. We assess the realization of these deferred tax assets on a periodic basis to determine whether a valuation allowance is required. We determine whether it is more likely than not that all or a portion of the deferred tax assets will be realized, based on currently available information, including, but not limited to, the following:

      If we believe that it is more likely than not that some of these deferred tax assets will not be realized, based on currently available information, an income tax valuation allowance is recorded against these deferred tax assets. As at December 31, 2004, we had €91.1 million in deferred tax assets and €38.6 million in valuation allowances, resulting in a net deferred tax asset of €52.5 million.

      If market conditions improve or tax planning opportunities arise in the future, we will reduce our valuation allowances, resulting in future tax benefits. If market conditions deteriorate in the future, we will increase our valuation allowances, resulting in future tax expenses. Any change in tax laws, particularly in Germany, will change the valuation allowances in future periods.

      Environmental. Our operations are subject to a wide range of federal, state, provincial and local environmental laws and regulations, dealing primarily with water, air and land pollution control. In recent years, we have devoted significant financial and management resources to comply with all applicable

environmental laws and regulations. We believe our operations are currently in substantial 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 in a three-year period. The requirement and timing of capital expenditures and the amount of wastewater fee charges are subject to negotiation with German government agencies. As a result, we believe that our capital investment programs for our German manufacturing plants will largely offset the wastewater fees that would have been payable for the past three years, subject to environmental audits. We estimate the aggregate wastewater fees offset by capital expenditures for the past three years to be approximately €8.7 million.

      Other than wastewater fees, we accrue for environmental remediation liabilities on a site-by-site basis when it is probable that a loss can be reasonably estimated, or as a result of an environmental action or claim, environmental studies that we conduct or regulatory assessment. As at December 31, 2004, we recorded a liability for environmental conservation expenditures of €3.5 million, based on environmental studies that we conducted. We believe that the liability amount recorded is sufficient, subject to future changes in environmental regulations.

New Accounting Standards

      In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), Share-Based Payments (“SFAS 123R”). This statement eliminates the option to apply the intrinsic value measurement provisions of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, to stock compensation awards issued to employees. Rather, SFAS No. 123R requires companies to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide services in exchange for the award — the requisite service period (usually the vesting period). SFAS No. 123R will be effective for the Company from July 1, 2005.

      SFAS No. 123R permits public companies to account for share-based payments using one of two methods: the modified-prospective method or the modified-retrospective method. Under the modified-prospective method, SFAS No. 123R will be applied to all awards granted after the required effective date and to awards modified, repurchased, or cancelled after that date. Compensation cost will also be recognized at the effective date in respect of any unvested awards granted prior to the effective date in accordance with SFAS No. 123, as previously disclosed for pro-forma purposes.

      The requirements of the modified-retrospective method are as above, with the exception that companies are permitted to restate, based on the amounts previously recognized under SFAS 123 for pro forma disclosure purposes, either all prior periods presented or prior interim periods in the year of adoption.

      The Company is continuing to evaluate the transition method to be adopted.

      For a discussion of other new accounting standards see Note 1 to our annual audited consolidated financial statements included elsewhere in this annual report.

Cautionary Statement Regarding Forward-Looking Information

      Statements in this annual 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. These statements are based on present information we have related to our existing business circumstances and involve a number of risks and uncertainties, any of which could cause actual results to differ materially from these forward-looking statements. We caution you that we do not assume any obligation

to update forward-looking statements based on unanticipated events or changed expectations. Factors that could cause actual results to differ materially include, but are not limited to:

Our level of indebtedness could negatively impact our financial condition and results of operations.

      As of December 31, 2004, we had approximately €793.0 million of indebtedness outstanding, of which €548.8 million is project debt of Stendal. In February 2005, we sold $310 million in principal amount of 9.25% senior notes due 2013 as well as repaid all of the net bank indebtedness of our Rosenthal mill. 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:

      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 success of the Stendal mill, our ability to successfully integrate the Celgar mill into our operations and the extent to which we can implement successfully our business and growth strategy. We cannot assure you that the Stendal mill will be successful, that we will be able to successfully integrate the Celgar mill into our operations or that we will be able to implement our strategy fully or that the anticipated results of our strategy will be realized.

Our business is cyclical in nature.

      The pulp and paper business is cyclical in nature and markets for our principal products are characterized by periods of supply and demand imbalance, which in turn affects product prices. The markets for pulp and paper are highly competitive and are sensitive to cyclical changes in industry capacity and in the global economy, all of which can have a significant influence on selling prices and our earnings. Demand for pulp and paper products has historically been determined by the level of economic growth and has been closely tied to overall business activity. During 2001 and 2002, pulp list prices fell significantly. Although pulp prices have improved overall since then, we cannot predict the impact of continued economic weakness in certain world markets or the impact of war, terrorist activity or other events on our markets.

      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 and pulp logs for pulp production, and waste paper and pulp for paper production. Fiber costs are primarily affected by the supply of, and demand for, lumber and pulp, which are both highly cyclical in nature and can vary significantly by location. Production costs also depend on the total volume of production. Lower operating rates and production efficiencies during periods of cyclically low demand result in higher average production costs and lower margins.

Our Stendal mill is subject to risks commonly associated with the start-up of large greenfield industrial projects.

      Stendal has recently completed construction of the Stendal mill near the town of Stendal, Germany. The aggregate cost of the mill is approximately €1.0 billion. The performance of the Stendal mill will have a material impact on our financial condition and operating performance. The construction of the Stendal mill commenced in 2002 and was completed in the third quarter of 2004. Under our current start-up plan, the Stendal mill underwent operational testing so that continuous production from the mill can commence. Our ongoing start-up of the Stendal mill is subject to risks commonly associated with the start-up of large greenfield industrial projects which could result in the Stendal mill experiencing operating difficulties or delays in the start-up period and the Stendal mill may not achieve our planned production, timing, quality, environmental or cost projections, which could have a material adverse effect on our results of operations, financial condition and cash flows. These risks include, without limitation, equipment failures or damage, errors or miscalculations in engineering, design specifications or equipment manufacturing, faulty construction or workmanship, defective equipment or installation, human error, industrial accidents, weather conditions, failure to comply with environmental and other permits, and complex integration of processes and equipment.