MERCER INTERNATIONAL INC - 10-K Annual Report

Back to GetFilings.com

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

--------------------------

FORM 10-K
----------

/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2002

OR

/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________________ to ________________

COMMISSION FILE NO.: 0-9409

MERCER INTERNATIONAL INC.
EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER

WASHINGTON 91-6087550
STATE OR OTHER JURISDICTION IRS EMPLOYER IDENTIFICATION NO.
OF INCORPORATION OR ORGANIZATION

ONE RENTON PLACE, 555 S. RENTON VILLAGE PLACE, SUITE 700, RENTON, WA 98055
ADDRESS OF OFFICE

Registrant's telephone number including area code: (425) 687-4229

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 /X/ No / /

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. /X/

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

The aggregate market value of the Registrant's voting stock held by
non-affiliates of the Registrant as of June 28, 2002, 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 $133,287,192.

As of March 21, 2003, the Registrant had 16,874,899 common shares of
beneficial interest, $1.00 par value, outstanding.

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

TABLE OF CONTENTS

2

FORWARD-LOOKING STATEMENTS

The statements in this report that are not based on historical facts are
called "forward-looking statements" within the meaning of the United States
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. These statements appear in a
number of different places in this report and can be identified by words such as
"estimates", "projects", "expects", "intends", "believes", "plans", or their
negatives or other comparable words. Also look for discussions of strategy that
involve risks and uncertainties. Forward-looking statements include statements
regarding the outlook for our future operations, forecasts of future costs and
expenditures, the evaluation of market conditions, the outcome of legal
proceedings, the adequacy of reserves, or other business plans. You are
cautioned that any such forward-looking statements are not guarantees and may
involve risks and uncertainties. Our actual results may differ materially from
those in the forward-looking statements due to risks facing us or due to actual
facts differing from the assumptions underlying our estimates. Some of these
risks and assumptions include those set forth under the sub-heading "Cautionary
Statement Regarding Forward-Looking Information" in "Management's Discussion and
Analysis of Financial Condition and Results of Operations". We advise you that
these cautionary remarks expressly qualify in their entirety all forward-looking
statements attributable to us or persons acting on our behalf. Unless required
by law, we do not assume any obligation to update forward-looking statements
based on unanticipated events or changed expectations. However, you should
carefully review the reports and documents we file from time to time with the
SEC, particularly our quarterly reports on Form 10-Q and current reports on
Form 8-K.

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 year ended December 31, 2002 included in this annual report are stated in
Euros and our financial statements and other financial information for prior
periods included in this annual report have 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, referred to as the
"Noon Buying Rate", for the conversion of U.S. dollars to Euros 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:

- ------------------------

(1) As the Euro was introduced as of January 1, 1999, the exchange rates for
1998 are based upon the conversion of U.S. dollars to Deutschmarks and
Deutschmarks to Euros. The Noon Buying Rate for the conversion of
U.S. dollars to Deutschmarks at December 31, 1998 was $1.00 = DM1.6665. The
average rate of exchange (based on daily Noon Buying Rates) for the
conversion of U.S. dollars to Deutschmarks during 1998 was $1.00 = DM1.7667.
The rate established by the European Union for the conversion of
Deutschmarks to Euros is E1.00 = DM1.95583.

On March 21, 2003, the Noon Buying Rate for the conversion of U.S. dollars
to Euros was E0.9483 per U.S. dollar.

3

PART I

ITEM 1. BUSINESS

In this document, please note the following:

- references to "we", "our", "us", the "Company" or "Mercer" mean Mercer
International Inc. and its subsidiaries, unless the context clearly
suggests otherwise;

- a "tonne" is one metric ton or 2,204.6 pounds;

- information is provided as of December 31, 2002, unless otherwise stated;

- all references to monetary amounts are to "Euros", the lawful currency
adopted by most members of the European Union, unless otherwise stated;
and

- "E" refers to Euros; and "DM" refers to Deutschmarks, the lawful currency
of Germany prior to the formal introduction of the Euro in 2002.

THE COMPANY

GENERAL

Mercer 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. Our operations are located
primarily in Germany and we currently employ approximately 736 people.

We operate a modern, efficient pulp mill, referred to as the "Rosenthal
mill", that produces softwood kraft pulp. It has an annual production capacity
of approximately 300,000 tonnes. The Rosenthal mill is the only producer of
market kraft pulp in Germany. Our current pulp operations are conducted through
Zellstoff-und Papierfabrik Rosenthal GmbH & Co. KG and its affiliates, or
"Rosenthal", which are our wholly-owned subsidiaries.

Our 63.6% owned project subsidiary, Zellstoff Stendal GmbH, or "Stendal", is
implementing a "greenfield" project, referred to as the "Stendal project", to
construct a new state-of-the-art softwood kraft pulp mill. The mill, referred to
as the "Stendal mill", will have an annual production capacity of approximately
552,000 tonnes and will be located near the town of Stendal, Germany,
approximately 300 kilometers north of the Rosenthal mill.

We also operate two paper mills located at Heidenau and Fahrbrucke, Germany,
collectively referred to as the "Paper mills", that produce specialty papers and
printing and writing papers and have an aggregate annual production capacity of
approximately 85,000 tonnes. Our paper operations are conducted through Dresden
Papier GmbH and its affiliates, or "Dresden", which are our wholly-owned
subsidiaries.

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 operations beginning in 1993.

Over the last five years, we have expended an aggregate of approximately
E399.6 million on capital investments at our pulp and paper mills, not including
the Stendal project, to increase production capacity, improve efficiency, 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 E105.3 million. For more
information about these grants, see "Business--Government Financing".

4

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 tonnes to approximately
300,000 tonnes and reduced emissions and energy costs. The aggregate cost of the
project was approximately E361.0 million.

We completed financing arrangements and commenced construction of the
Stendal mill in August 2002. The Stendal project is currently estimated to cost
approximately E1.0 billion and is scheduled to be producing saleable kraft pulp
in the third quarter of 2004. For more information about the Stendal project,
see "Business -- Stendal Pulp Mill Project and Financing".

Since 1998, we have also implemented a strategy to focus on our core
operations and rationalize assets that either were not part of our core
operations or did not provide the desired level of return. As a result, between
1998 and 2000, we took a charge of E17.9 million relating to our paper
operations and sold four paper mills that produced packaging, carton and
printing papers located at Greiz, Raschau, Trebsen and Hainsberg, Germany.

The sale of these paper mills was the result of a strategic decision to
withdraw from commodity paper grades produced principally from waste paper where
we had little market share and, we believed, limited potential for long-term
profitability. We continue to operate and upgrade the Heidenau and Fahrbrucke
paper mills as they principally produce niche products and hold a significant
market share in their respective markets. In December 2001, we acquired Landqart
AG, or "Landqart", for approximately $2.7 million which operates a paper mill in
Graubunden, Switzerland that produces specialty paper. At the end of 2002, we
sold 20% of our interest in Landqart and reorganized our remaining interest into
an indirect 39% minority interest through a limited partnership.

ORGANIZATIONAL CHART

The following chart sets out our directly and indirectly owned principal
operating subsidiaries, all of which are organized under the laws of Germany,
and their principal activities:

[GRAPHIC]

- ------------------------

(1) The Stendal mill is under construction.

(2) Managed and operated by Dresden.

5

CORPORATE STRATEGY

Our corporate strategy is to create shareholder value within the context of
an inclusive, stakeholder approach. We expect to pursue the expansion of our
asset and earnings base globally through acquisitions and organic growth. We
seek to acquire interests in companies and assets in the pulp and paper industry
and related businesses where we can add value through focused management. We
pursue organic growth through high return capital expenditures at our operating
facilities to increase production, reduce costs and improve quality.

The markets for pulp and paper are highly competitive and sensitive to
cyclical changes in industry capacity, the economy, interest rates and
fluctuations in foreign currency exchange rates, all of which can have a
significant influence on our selling prices and overall profitability. Customers
in most markets in which we sell our products have a choice of suppliers. We
compete with European and international pulp and paper firms ranging from very
large integrated firms to smaller specialty firms. Many of these firms are
larger than us and have greater financial resources, longer operating histories
and larger sales organizations. The primary areas of competition include price,
quality and service. Our competitive position is influenced by the availability
and cost of our raw materials, energy and labor, and our plant efficiencies and
productivity in relation to our competitors. We believe that the quality of our
assets and the location of the Rosenthal mill and the Stendal mill provide us
with a competitive advantage in terms of our products, transportation costs and
ability to service our customers.

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 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 pulp depends in part on the raw materials, or 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 hardwood species contain
shorter fibers which lend bulk and opacity. Northern bleached softwood kraft, or
"NBSK", pulp, which is kraft pulp manufactured using northern softwood species,
is a premium grade because of its relative strength. It generally obtains the
highest price relative to other kraft pulps. NBSK pulp is the Rosenthal mill's,
and will be the Stendal mill's, sole product.

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. More than 100 million tonnes annually of
bleached pulp is converted into printing and writing papers, tissues,
cartonboards and other white grades of paper and paperboard around the world.
Approximately 55% of this pulp is produced for internal purposes by integrated
paper and paperboard manufacturers, and approximately 45% is produced for sale
on the open market, referred to as "market pulp". Although demand is cyclical
and has weakened during the recent global economic slowdown,

6

demand for bleached market pulp has been growing at approximately 3% annually
worldwide and approximately 2% annually in Europe.

Approximately 14 million tonnes of market pulp is consumed in Europe
annually, of which approximately 6.3 million tonnes is comprised of NBSK pulp.
Germany is the largest pulp market in Europe and consumes approximately five
million tonnes of market pulp annually. Approximately 35% of the market pulp
consumed in Germany is NBSK grade.

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 89% in 2001 and approximately 91% in 2002. 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.

KRAFT PULP PRICING

Global economic conditions, changes in production capacity and inventory
levels are the primary factors affecting kraft pulp prices. Kraft pulp prices
are quoted in U.S. dollars. Historically, kraft pulp prices have been cyclical
in nature. NBSK pulp prices between 1990 and 2002 ranged on average from a low
of approximately $444 per tonne in 1993 to a high of approximately $875 per
tonne 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 tonnes by early 1996. Between 1996 and 1999, 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 tonnes in June 2000, resulting in prices
increasing to an average of approximately $710 per tonne 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 tonnes in early 2001 and
price levels eroded to an average of approximately $460 per tonne in late 2001.
Inventory levels ranged between approximately 1.3 million and 1.9 million tonnes
in 2002, and prices averaged approximately $463 per tonne in 2002. Lower
producer inventories in early 2003 resulted in producers increasing list prices
for kraft pulp in Europe to approximately $520 per tonne in March 2003.

7

THE MANUFACTURING PROCESS

The following diagram provides a simplified description of the Rosenthal
mill's manufacturing process:

[GRAPHIC]

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 continuous digester where
they are heated and cooked with chemicals. This process softens and eventually
dissolves the phenolic material called lignin that binds the fibers to each
other in the wood.

Cooked pulp continuously 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.

8

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

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.

Specialty papers that we produce are comprised of coated and uncoated
wallpaper, non-woven wallpaper base, pre-impregnated decor paper 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. The non-woven wallpaper market is in a period of
capacity shortage and demand is primarily driven by quality rather than price.
Non-woven wallpaper is generally sold at a premium to woven wallpaper and we
expect premiums and higher margins to persist as long as capacity shortages
continue.

Decor papers are used in laminate flooring, interior panels, furniture and
other applications to provide a decorative surface. Decor papers can be
pre-impregnated with an agent to provide extra strength. Demand for decor paper
is related to activity in the construction and refurbishing industries. In
periods when prices increase, consumers often substitute less expensive
alternatives for more expensive wood-based material. Historically, markets for
pre-impregnated decor paper have grown faster than the decor paper market. The
main markets for decor paper are in Europe. In 2001, the market for decor paper
in Germany was approximately 154,000 tonnes. The pre-impregnated decor paper
market is in a period of capacity shortage and demand is primarily driven by
quality rather than price. Growth in the pre-impregnated decor market has been
steady in recent years.

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 include 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. The global demand for printing and writing paper increased by
approximately 2.5% from approximately 91.4 million tonnes in 2001 to
approximately 93.7 million tonnes in 2002, including approximately 28.5 million
tonnes in western Europe. The global demand for uncoated woodfree paper in 2002
was approximately 42.6 million tonnes.

RAW MATERIALS

The Rosenthal mill is situated in a region which offers an ample and stable
supply of fiber. The fiber consumed by the Rosenthal mill consists of wood chips
produced by local sawmills and pulpwood, 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 pulpwood processed, or chipped, especially
for this purpose. Pulpwood consists of lower quality logs not used in the
production of lumber. The costs of wood chips and

9

pulpwood in Germany are primarily affected by the supply and demand for lumber.
In 2002, the Rosenthal mill consumed approximately 1.6 million cubic meters of
fiber. Approximately 69%, or approximately 1.1 million cubic meters, of such
consumption was in the form of sawmill wood chips. The balance of approximately
31%, or approximately 0.5 million cubic meters, was in the form of pulpwood.
Approximately 85 to 90% of the fiber consumed by the Rosenthal mill is spruce
and the remainder is pine.

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. 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 51 trucks, handled approximately 61% of our wood chip
deliveries to the mill in 2002. 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 are normally sourced from sawmills under one year or quarterly
supply contracts with fixed volumes, which provide for price adjustments.
Pulpwood is 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 pulpwood sourced from the state forest agency in
Thuringia after discussions with the agency regarding the quantities of pulpwood
that we require.

The Rosenthal mill's fiber requirements were historically procured
principally by SCA Holz, a large wood supply company. In 2002, SCA Holz procured
approximately 25% of the fiber for the Rosenthal mill. Our agreement with SCA
Holz expires in April 2003 and will not be renewed. We have organized our own
internal wood procurement department to handle and source the fiber requirements
for the Rosenthal mill. Four people are employed in the department currently and
we expect to hire an additional four to five people. The department will
continue to procure fiber for the Rosenthal mill from many of the same sources
and under similar terms as under our agreement with SCA Holz. 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.

The Stendal mill will be situated in a region which offers an ample and
stable supply of fiber. The fiber consumed by the Stendal mill will consist of
wood chips and pulpwood. When fully operational, the Stendal mill is expected to
consume approximately 2.8 to 3 million cubic meters of fiber annually. The core
wood supply region for the Stendal mill will include 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 80% of all of the fiber needed by the mill. We
expect to obtain the balance primarily from southwestern and southern Germany.
The fiber base in the planned wood supply area for the Stendal mill consists of
approximately 80% pine and 20% spruce and fir. We expect approximately 25% of
the fiber consumed by the Stendal mill to be in the form of sawmill wood chips
and approximately 75% in the form of pulpwood. The Stendal mill will have
sufficient chipping capacity to fully operate using solely pulpwood, if
required. We expect to source wood chips from sawmills within an approximately
360 kilometer radius of the mill. We expect to source pulpwood partly from
private forest holders and partly from state forest agencies in Thuringia,
Sachsen-Anhalt and Brandenburg. In 2002, Stendal, in part to demonstrate to its
senior lenders the availability of its required fiber, obtained non-binding
letters of intent from potential wood chip and pulplog suppliers to supply fiber
well in excess of its needs. In 2003 and 2004, Stendal expects to put into place
definitive supply arrangements similar to those of the Rosenthal mill. The
Stendal mill is expected to be the largest consumer of wood chips in Germany
and, together with the Rosenthal mill, provide the best economic outlet for the
sale of wood chips in eastern Germany.

10

Stendal is establishing its own wood procurement organization to handle the
fiber requirements for the Stendal mill. This division would focus on three
principal activities, being wood procurement and sales, harvesting, and
transportation. The procurement and sales main activity will be to procure the
required wood chip and pulplog 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. We expect these
activities to employ up to 17 people. The harvesting activities will focus on
acquiring up to approximately 800,000 cubic meters per annum of harvestable
timber, of which approximately 75% would be pulpwood and the balance would be
higher quality logs to be sold or traded to third parties for wood chips. We
expect that approximately half of this volume may be harvested directly by us
and the other half would be contracted out to third parties. When fully
operational, we expect to engage up to 60 people in this division.
Transportation activities would focus on managing, controlling and optimizing
shipping and flows of pulpwood to the mill. When fully operational, we expect
that the transportation activities may employ up to 36 people.

When the Stendal mill commences production, we expect to be the largest
consumer of wood chips and pulplogs in Germany. We intend to coordinate and
integrate 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.

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 2002,
approximately 76%, or approximately 45,184 tonnes, 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 24%, or approximately 14,135
tonnes, 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.

OUR PRODUCTS

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

PULP

In early 2000, we completed the conversion of the Rosenthal mill to the
production of kraft pulp. The kraft pulp produced at the Rosenthal mill is a
long-fibred softwood pulp produced by a sulphate cooking process and
manufactured primarily from wood chips and pulpwood. 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

11

the highest price. Through a focused technical and marketing effort, we have
changed the mix of the kraft pulp that we produce to substantially increase our
relative amount of reinforcement fibers from approximately 16% at the beginning
of 2000 to approximately 39% at the end of 2002.

We produce pulp for reinforcement fibers to the specifications of certain of
our customers. We believe that a number of our customers consider us their
supplier of choice.

The Rosenthal mill is located in the State of Thuringia and has an annual
production capacity of approximately 300,000 tonnes. For more information about
the facilities at the Rosenthal mill, see "Business -- Rosenthal Conversion
Project and Financing" and "Properties".

The kraft pulp that will be produced at the Stendal mill will be of a
slightly different grade than the kraft pulp produced at the Rosenthal mill as
the mix of softwood fiber used will be slightly different. The Stendal mill will
also have the capability of producing both totally chlorine free and elemental
chlorine free pulp. The Stendal mill, being constructed in the State of
Sachsen-Anhalt, is scheduled to begin producing saleable kraft pulp in the third
quarter of 2004, with an overall design capacity of approximately
552,000 tonnes per annum. For more information about the facilities at the
Stendal mill, see "Business -- Stendal Pulp Mill Project and Financing"
and "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 pre-impregnated decor paper primarily to specialist converters serving
furniture and flooring producers. It is used primarily for furniture coverings.
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 from two facilities located in Germany. For more
information about the facilities at the Paper mills, see "Properties". In
addition to these two wholly-owned mills, we have an equity interest in the
Landqart mill in Switzerland, which also produces specialty papers.

12

SALES, MARKETING AND DISTRIBUTION

The distribution of our pulp and paper sales volume and revenues by product
class, and revenues by geographic area is set out in the following table for the
periods indicated:

EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC

EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC

EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC

- ------------------------

(1) Not including Germany.

A large proportion of our kraft pulp sales in western Europe were
historically handled through a sales agency agreement with Oy Metsa Botnia Ab,
or "Metsa", a member of the M-Real Group of Finland which operates a number of
different paper mills. These sales comprised approximately 41%, 37% and 42% of
our total pulp sales in 2002, 2001 and 2000, respectively. Sales and marketing
in other countries were conducted by our own sales staff and through independent
agents. We chose not to renew our sales agency agreement with Metsa when it
expired in December 2002. As a result, the M-Real Group is not expected to be a
significant customer in the future. We have successfully placed with other
customers all of the volumes formerly sold to the M-Real Group. We are now
conducting all sales and marketing of our kraft pulp internally through our
sales staff and through independent 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. When
the Stendal mill is fully operational, we expect to sell substantially all of
its kraft pulp production in continental Europe.

14

The Rosenthal mill is the only market kraft pulp producer 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
North American and Scandinavian pulp producers. 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 7% of the Rosenthal mill's pulp deliveries in
2002. Approximately 53% of our pulp sales in 2002 were to customers or
destinations located within a 500 kilometer radius of the Rosenthal mill. As a
result, we can generally supply our pulp customers 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 a day of it being ordered. This permits us to be a "just in time"
supplier to our customers. When operational, 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, 2002, we had
no material payment delinquencies. In 2002 one customer accounted for
approximately 12%, in 2001 two customers accounted for approximately 22% and in
2000 one customer accounted for approximately 27% of our pulp sales. As our pulp
was delivered to a number of different paper mills of the M-Real Group and its
affiliates, pulp sales have not been dependent upon the activities of any single
paper operation.

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 27% of total paper sales in 2002, compared to approximately 30% in
2001 and 29% in 2000. 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, 2002,
we had no material payment delinquencies. No single customer accounted for more
than 10% of our paper sales in 2002, 2001 or 2000. Our paper sales are not
dependent upon a single customer or upon a concentrated group of
major customers.

CAPITAL EXPENDITURES

In 2002, 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.

Our capital investments at the Rosenthal mill were approximately
E3.4 million, E7.4 million and E23.8 million in 2002, 2001 and 2000,
respectively, and we estimate them to be approximately E4.1 million for 2003. In
addition, in 2002 we commenced a strategic capital project to reconstruct the
landfill at the Rosenthal mill so that it will be useable for an additional
15 years. We estimate the total cost of this reconstruction to be approximately
E7.6 million, which Rosenthal is fully funding through a bank loan. Of this
amount, we incurred E5.0 million in 2002 and we will incur the remainder in
2003, which is when the reconstruction is expected to be completed. We estimate
this project to have an approximately three-year payback period and the project
requires no equity investment on our part.

Construction of the Stendal mill commenced in August 2002. Total capital
costs in respect of the project in 2002 were approximately E186.9 million. For
more information about the Stendal project, see "Business -- Stendal Pulp Mill
Project and Financing".

Our capital investments at our paper operations were approximately
E5.4 million, E2.7 million and E3.3 million in 2002, 2001 and 2000,
respectively. In 2003, we estimate capital investments to be approximately
E13.2 million relating primarily to quality and productivity upgrades of the
paper machines

15

at the Paper mills, replacement of a turbine at the Heidenau mill and the
completion of a wastewater treatment plant at the Fahrbrucke mill. Our capital
investments at our Paper mills in 2002 included the replacement of a gas turbine
and construction of the first stage of a wastewater treatment plant at the
Fahrbrucke mill, at a cost of approximately E0.9 million and E0.7 million,
respectively. We also adjusted the paper machine at the Fahrbrucke mill to
produce pre-impregnated decor paper at a cost of approximately E0.6 million. We
continue to review strategic initiatives designed to upgrade the product mix at
our Paper mills and enhance returns.

Over the last five years we have invested an aggregate of approximately
E399.6 million in gross capital improvements at our facilities, not including
the Stendal project. Our significant level of capital investment has largely
been facilitated by government financing and assistance initiatives in Germany.

Our capital investments to reduce effluent discharges have offset wastewater
fees that we would otherwise be required to pay. We estimate the aggregate
wastewater fees we saved over the last five fiscal years as a result of
environmental capital expenditures to be approximately E18.2 million. For more
information about our environmental capital expenditures, see
"Business -- Environmental".

GOVERNMENT FINANCING

GRANTS

Our capital investment programs 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 E500,000 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
project, we have agreed to maintain stipulated job levels at each operation for
the specified five-year period. For more information, see "Business -- Human
Resources". We believe that we are in compliance with all of the terms and
conditions governing the government grants we have received.

Such government grants are not reported in our income but instead reduce the
cost basis of the assets purchased with these grants.

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

- ------------------------

(1) Not including the Stendal project.

16

(2) The total cost of the conversion of the Rosenthal mill to produce kraft pulp
was approximately E361.0 million. We also received government grants
totaling approximately E101.7 million in connection with such capital
investments. For more information about the Rosenthal mill, see
"Business -- Rosenthal Conversion Project and Financing".

In addition, the Stendal project qualifies for approximately E274.5 million
of government grants. For more information about the Stendal project, see
"Business -- 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:

17

LOAN GUARANTEES

Loan guarantees are available from German federal and state governments for
up to 80% of the borrowed amount for qualifying capital investments made in
certain parts of Germany. 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.

ROSENTHAL CONVERSION PROJECT AND FINANCING

In late 1999, we completed a major capital project to convert the Rosenthal
mill to the production of kraft pulp and increase its annual production capacity
to approximately 280,000 tonnes. Through subsequent minor capital investments
and efficiency improvements, the annual production capacity at the Rosenthal
mill has been increased to approximately 300,000 tonnes. The project has also
substantially reduced effluent and sulphur dioxide emissions and has reduced
energy costs, with natural gas consumption decreasing by approximately 46.9%
during the period from the beginning of 2000 to the end of 2002 as a result of
operating efficiencies.

The aggregate cost of the project, including project financing, capitalized
interest of approximately E14.1 million and related costs and an amount for
contingencies, was approximately E361.0 million. The project was financed
through a combination of a project loan supported by government guarantees,
government grants and an equity investment made by us.

The following summary of the material provisions of the project loan
agreement is not complete and these provisions, including definitions of certain
terms, are qualified by reference to the project loan agreement and the
applicable amendment agreements on file with the SEC.

In 1998, Rosenthal entered into a project loan agreement, as amended, having
a 15 year term with a German bank and other syndicated lenders in the aggregate
amount of E259.7 million (DM508.0 million), referred to as the "Rosenthal Loan
Facility", to finance the project. The Rosenthal Loan Facility is secured by
liens on all of the assets of Rosenthal and the German federal government and
the state government of Thuringia provided a guarantee for 80% of the facility.
We have agreed with the lenders under the Rosenthal Loan Facility that, so long
as Rosenthal has liability thereunder, to retain control over at least 51% of
the voting shares of Rosenthal.

The rate of interest under the Rosenthal Loan Facility, other than for
amounts drawn as special credits, is an amount equal to the three or six month
Euribor rates plus a margin of between 60 and 75 basis points. The amounts drawn
as special credits, under programs established by certain German public banks
for projects which enhance environmental performance, are part of the overall
Rosenthal Loan Facility and repayment structure. The rates of interest for the
special credits are set for the first 10 years at an annual amount equal to the
lenders' variable costs of such funds. The rates of interest will be adjusted
and reset after 10 years for the balance of the term. These special credits
permit qualifying borrowers to borrow money at favorable rates of interest.

As part of the Rosenthal Loan Facility, there is a credit line which allows
for derivative transactions, subject to certain controls, including certain
maximum notional and at-risk amounts, to manage risk. Rosenthal has entered into
derivative instruments with the lead bank under the Rosenthal Loan Facility to
manage its risk exposure with respect to certain amounts outstanding thereunder.
For more information

17

about these derivative instruments, see "Quantitative and Qualitative
Disclosures About Market Risk -- Derivative Instruments".

Repayment of the Rosenthal Loan Facility commenced on March 31, 2001. During
2002, we repaid E12.5 million of the principal amount of the Rosenthal Loan
Facility and at year end E204.9 million was outstanding. Of this amount, an
aggregate of E130.4 million was drawn by Rosenthal pursuant to special
credit programs.

In addition to the government guarantee, the state government of Thuringia
provided government grants of E73.6 million (DM144.0 million) in respect of the
project. The German federal government also provided, under existing programs,
government grants totaling E27.1 million (DM53.0 million) in respect of the
project. As of December 31, 2002, Rosenthal had received government grants
totaling approximately E101.7 million for the Rosenthal mill conversion.

The sulphite pulp production at the Rosenthal mill was shut-down in
July 1999 to implement the conversion to kraft pulp. The mill was successfully
started-up to produce kraft pulp in December 1999. The Rosenthal mill was
producing at approximately 89% of its original planned conversion capacity in
the first year and was producing at full capacity by the end of 2000.

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-Losungen GmbH, or "RWE", as to a 29.4% interest and
AIG Altmark-Industrie AG, or "AIG", 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. AIG is a German real estate company which owns
1,050 acres of a 1,250 acre industrial park on which the Stendal mill will be
situated.

The Stendal mill is a "greenfield" softwood kraft pulp mill that is being
constructed at a total cost of approximately E1.0 billion near the town of
Stendal, in the German State of Sachsen-Anhalt. The mill will be a modern,
state-of-the-art single line mill with an anticipated annual production capacity
of approximately 552,000 tonnes. The overall mill design is based on proven or
existing processes and technologies. The process and mill operations will be
highly automated to ensure stable operation and pulp quality. The mill process
will be a modern but ordinary kraft pulping process that emphasizes
environmentally sound operational principles. The Stendal mill will use 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. The Stendal
mill will be 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
material costs, production engineering, maintenance and marketing.

The Stendal mill will be 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 AIG, which is seeking to develop the park. Although
no assurances can be provided that any development will occur and we are not
directly a party to these discussions, we are aware of third party proposals to
build manufacturing facilities on the balance of the industrial park that would
be complementary to our pulp operations. These include a sawmill and a
tissue mill.

When completed, the Stendal mill will be the largest market kraft pulp
facility 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 will produce slightly different grades of
softwood kraft pulp.

18

When the Stendal mill is fully operational, we anticipate that we will have
an aggregate annual production capacity of approximately 852,000 tonnes of NBSK
pulp from our two mills.

The summaries of certain material provisions of agreements entered into in
connection with the Stendal project 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, RWE and AIG, 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. 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 unified sales organization to
conduct the sales and marketing of the pulp produced by both mills. Mercer
currently coordinates the pulp sales of the Rosenthal mill pursuant to a sales
agency agreement with Rosenthal whereby we receive a commission on overall
sales. We intend to establish a similar arrangement for the Stendal mill when it
is operational. 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 is to be constructed under a E716.0 million fixed-price
turn-key engineering, procurement and construction, or "EPC", contract between
Stendal and RWE. 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 to be
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 will construct approximately
E23.5 million of the site infrastructure and additional general site
infrastructure connections will be constructed by the local government. The
costs of such infrastructure construction are 90%

19

subsidized and co-financed by us, among others. Our co-financing obligations
amount to approximately E3.0 million and are funded out of the project
loan facility.

Construction of the mill is scheduled to be completed in June 2004. Start-up
of the mill is to occur in July 2004, with production of saleable kraft pulp to
begin in the third quarter of 2004. Our acceptance of the mill and related works
is to occur by December 2004. Between July and December 2004, the mill will
undergo extensive testing and evaluation to determine whether mechanical
completion has occurred and whether certain performance requirements have been
met, referred to as the "Acceptance Test". The Acceptance Test requires that the
mill continuously produce pulp for a 72-hour period. If acceptance of the mill
has not occurred prior to December 2004, RWE has agreed to pay liquidated
damages equal to 0.4% of the contract price per week of delay, up to a 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.

Following completion of testing, if the requisite minimum performance
requirements are met, 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 Test. Such testing is scheduled to be completed within the six-month
period after the Acceptance Test. 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.

We have the right under the EPC contract to temporarily suspend construction
of the mill for a period of up to 150 days should we choose to do so, subject to
certain conditions. In addition, 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.

PROJECT FINANCING

In August 2002, referred to as the "Closing Date", we completed financing
arrangements for the Stendal project. Total investment costs in connection with
the project are approximately E1.0 billion, the majority of which is to be
provided under a senior project finance facility, referred to as the "Stendal
Loan Facility", arranged by Bayerische Hypo-und Vereinsbank AG, or "BHV",
pursuant to a project finance loan agreement, referred to as the "Project
Finance Loan Agreement", entered into between Stendal and BHV. We also
contributed financing to Stendal of approximately E63.5 million from cash on
hand and through bridge loans, referred to as the "Bridge Loans", from a
U.S. investment partnership and a bank.

20

As the site of the Stendal project is located in eastern Germany, it
qualifies for approximately E274.5 million of government grants, which are
applied to reduce the cost basis of the assets acquired with such grants. As of
December 31, 2002, we have applied for E38.0 million of such grants in
connection with the Stendal project, which we expect to receive in the second
half of 2003. In accordance with our accounting policies, these grants are not
recorded by us until they are received.

The Stendal Loan Facility is in the aggregate amount of E828.0 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 in the amount of E160 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 until final
payment in October 2017. For more information, see "Quantitative and Qualitative
Disclosures About Market Risk -- Derivative Instruments". In March 2003, as part
of its loan syndication, BHV 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 E599.0 million, from a maximum original amount of E638.0 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 will be
guaranteed by German federal and state governments in respect 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
E101.0 million was drawn under the Stendal Loan Facility as of December 31,
2002.

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.

21

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, AIG and BHV in order to finance the shareholders'
contribution to the Stendal project. Pursuant to the terms of the Undertaking,
on the Closing Date the shareholders of Stendal, on a pro rata basis, subscribed
for E15 million of share capital of Stendal and advanced to it E55 million in
subordinated loans. In addition, on a pro rata basis, the shareholders of
Stendal agreed to advance to it E30 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 Closing Date, we provided BHV with a cash deposit for our pro rata
portion of such equity reserve account. Our total funding commitment under the
Undertaking was E63.5 million, all of which was effected on August 2002.
Pursuant to the Undertaking, we have agreed, for as long as Stendal has any
liability under the Stendal Loan Facility to BHV, to retain control over at
least 51% of the voting shares of Stendal.

On the Closing Date, we entered into and completed funding under two bridge
financing loan agreements and used the net proceeds from such Bridge Loans to
fund, in part, our contribution to the Stendal project and commitment pursuant
to the Undertaking.

The Bridge Loans were negotiated at the same time and the agreements in
respect of the Bridge Loans were entered into upon substantially the same terms.
The Bridge Loans are in the principal amounts of E15.0 million and
E30.0 million. The Bridge Loan for E15.0 million matures in October 2003, but
can be extended for a further four months if agreed to by the lender. The lender
in connection with the Bridge Loan for E30.0 million has consented to the
extension of the maturity date of the loan to February 2004.

The Bridge Loans accrue interest at rates equal to Euribor plus 6.5% per
year until April 2003, Euribor plus 9.0% per year thereafter until October 2003
and Euribor plus 11.5% per year thereafter until February 2004, in each case
calculated semi-annually, not in advance, and payable upon maturity or default.
In addition, in the event that a Bridge Loan is not repaid upon maturity, the
loan accrues interest at the rate of Euribor plus 15% per year.

Each Bridge Loan is secured by assignment agreements, under which we and
certain of our subsidiaries assign our respective interests in intercompany
loans, and securities pledge agreements, under which we pledge our interest in
all of the share capital of certain of our wholly-owned subsidiaries.

Under European Union rules, the Commission of the European Communities (the
"Commission") was formally notified in March 2002 by Germany of plans to provide
support to the Stendal project 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 project. 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 project. 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. 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. On December 23, 2002, Kronoply and Kronotex, two
related manufacturers of, inter alia, OSB and MDF boards that do not compete
with the Stendal project by selling pulp or paper, filed an appeal with the
Court of First Instance of the European Communities (Luxemburg) against the
Commission decision of June 19, 2002. Although no assurance can be provided, we
believe that the complainants are unlikely to have standing under the applicable
rules to proceed with the appeal and that their appeal is without merit.

22

PROJECT DEVELOPMENT

Beginning in February 2002, approximately three months of pre-construction
activity was carried out in respect of the Stendal project. This was comprised
of, among other things, pre-engineering, planning and reviewing and sourcing
procurement requirements. Construction activity commenced on the Stendal project
upon the effectiveness of the EPC contract on the Closing Date.

As at December 31, 2002, progress on the Stendal project was substantially
on schedule and there were no significant deviations from the project budget. At
December 31, 2002, the project was approximately 22% completed and approximately
50% of the total engineering was finished. Progress was made in all areas
including with respect to setting the foundations for the recovery boiler
system, recausticizing system and evaporation system. In addition, progress was
made in connection with the construction of the infrastructure of the mill site
and contractors had been approved for the electrical power supply and
distribution system, natural gas supply system, railway infrastructure and roads
and harbor facilities. The public awareness and project acceptance by the local
community has been very positive and the project has received good cooperation
from all governmental authorities. At December 31, 2002, no insurance claims had
been filed in respect of the project and there had been no casualties or severe
injuries on the site.

At the end of 2002, Stendal employed 14 people, of whom 11 were part of the
management organization charged with supervising the implementation and
completion of the Stendal project. The members of the management team are
experienced in large capital projects, including those related to pulp mills,
and several are former senior members of Jaako Poyry Consulting. The management
team at Stendal is charged with ensuring the project is effectively implemented
in accordance with the EPC contract and planned schedules and budgets. They meet
regularly with the main contractor and sub-contractors to, among other things,
coordinate site activities, review progress, review and approve engineering and
equipment specifications, and review any necessary work changes or permit
amendments. Payments are made to contractors against defined milestones set
forth in the EPC contract. Such milestone payments are due within 30 days of
receipt of an approved invoice by Stendal. As at December 31, 2002, Stendal had
approved invoices representing milestone payments equal to approximately 16% of
the total value of the EPC contract.

As at December 31, 2002, Stendal had applied for investment grants totaling
E38 million with respect to the project which are expected to be received in the
second half of 2003. In accordance with our accounting policies, these grants
are not recorded by us until they are received.

At the end of 2002, there were approximately 253 people working at the site.
This number is expected to increase to over 1,200 third party construction
workers in the latter part of 2003.

Our organization build-up and staff recruitment for the Stendal mill are on
schedule. We anticipate having approximately 230 employees at Stendal by the end
of 2003, to be at the required level for the commissioning of the mill and
start-up in mid-2004. We have developed a detailed manning and organizational
plan which we will start implementing in the second quarter of 2003. Hiring will
be coordinated through the Stendal management team and we will also use a
recruitment firm. We have hired a new human resources manager and co-managing
director (production) for the Stendal mill who will start in mid-2003. As part
of the hiring, we will be setting up training schedules for the bulk of the
mill's operating and maintenance staff. Such training will consist of both
fundamental classroom training, as well as on-job sessions at our Rosenthal mill
and courses and training sessions provided by equipment and other suppliers to
the project.

START-UP

Pursuant to the EPC contract, construction of the Stendal mill is scheduled
to be completed by June 26, 2004. Such completion means that the construction
and installation of all equipment and works are essentially finished and the
final checks are occurring so that continuous production from the mill can

23

commence. Upon such completion, the mill will be supervised by RWE, the EPC
contractor, using Stendal's personnel to operate the mill. The mill must then
pass the Acceptance Test prior to being accepted by Stendal. During the period
that RWE is commissioning the mill and supervising its operations in connection
with the Acceptance Test, the mill is expected to have a low capacity
utilization. Upon passing the Acceptance Test, the mill will be operated by
Stendal and we plan to ramp up production at the Stendal mill to approximately
76% of the rated capacity of the mill during the first year thereafter and in
excess of 90% of rated capacity in the following year.

PROJECT RISKS

The Stendal project is subject to customary risks and uncertainties inherent
for large capital projects which could result in the construction of the Stendal
mill not occurring on schedule or as budgeted. Delays or amendments to Stendal's
operating permits or governmental grants could result in construction delays,
operational deficiencies or funding shortfalls. Further, the Stendal mill could
experience operating difficulties or delays during the start-up period when
production is being ramped up. Also, the Stendal mill may not achieve our
planned production, quality or cost projections. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Cautionary
Statement Regarding Forward-Looking Information".

ENVIRONMENTAL

Our operations are subject to a wide range of German federal, state 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. Our total capital expenditures on environmental projects, excluding
those incurred in connection with the conversion of the Rosenthal mill to the
production of kraft pulp, were approximately E6.2 million in 2002 and are
expected to be approximately E3.2 million in 2003.

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.

The Rosenthal mill has a relatively modern biological wastewater treatment
and oxygen bleaching facility. We have significantly reduced our levels of AOX
(Adsorbable Organic Halogen) 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 COD (Chemical Oxygen Demand) discharge at the
Rosenthal mill below 25 kilograms per tonne 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 2002 we commenced 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 is approximately E7.6 million and the project is
scheduled to be completed in 2003.

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 2002 as a
result of environmental capital expenditures made at our manufacturing plants
were approximately E3.0 million. We expect that capital investment programs for
our manufacturing plants will fully offset the wastewater fees that may be
payable for 2003 and 2004 and will ensure that our operations continue in
substantial compliance with prescribed standards.

24

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.

In 2002, an ammonia scrubber was installed to reduce levels of NOx emissions
from the Rosenthal mill's gas burner. The installation of the ammonia scrubber
was made pursuant to a claim under a warranty provided by a supplier in
connection with the gas burner to reduce levels of NOx emitted by this gas
burner. We believe we are in compliance with NOx emission standards applicable
to the gas burner.

We have until the end of 2005 to begin biologically treating the wastewater
at the Fahrbrucke mill. We are in the process of constructing a wastewater
treatment plant at the Fahrbrucke 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 E2.0 million, of which
E0.9 million was incurred in 2002. 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 early 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 736 people,
including:

- approximately 231 salaried and 273 hourly employees working in our pulp
operations, including our transportation subsidiary; and

- approximately 80 salaried and 136 hourly employees working in our paper
operations.

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 completed, Stendal and its subsidiaries are
expected to employ approximately 580 people. Pursuant to the government grants
and financing arranged in connection with the Stendal project, 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
Industriegewerkschaft Bergbau-Chemie-Energie, or "IG-BCE", on behalf of pulp and
paper workers in Germany. In February 2003, we entered into a new labor
agreement with IG-BCE for our pulp workers which, among other things, has a
one-year term and provides for a 2% wage increase effective March 1, 2003 and
that the parties will negotiate in respect of a further wage increase for August
2003 depending upon the general economic conditions. The agreement has no fixed
term, but can be terminated by either party before February 28, 2004.

In 1998, the labor agreement with workers at our Paper mills was renewed
until the end of 1999, upon terms which provided for wage increases of 1.2% in
October 1998, 1.3% in July 1999 and 1.3% in December 1999. A new agreement was
reached in 1999 upon terms which provided for wage increases of

25

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%. A new agreement is expected to be
negotiated in 2003.

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

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 an office in Renton, Washington and in Germany. We own the Paper
mills and the Rosenthal mill and the underlying property. The Stendal mill will
be 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 300,000 tonnes 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:

- an approximately 723,000 square feet fiber storage area;

- barking and chipping facilities for pulpwood;

- a fiber line, which includes a Kamyer continuous digester and bleaching
facilities;

- a pulp machine, which includes a dryer and a cutter;

- an approximately 63,000 square foot finished goods storage area;

- a chemical recovery system, which includes a recovery boiler, evaporation
plant and recausticizing plant;

- a fresh water plant;

- a wastewater treatment plant; and

- a power station with a turbine capable of producing 45 megawatts of
electric power from steam produced by the recovery boiler and a
power boiler.

The Stendal mill will be 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 will be
adjacent to the Elbe river and have access to harbor facilities for water
transportation. Construction of the Stendal mill commenced in 2002 and is
scheduled to be completed by

26

the end of 2004. The mill will be a single line mill with an annual production
capacity of approximately 552,000 tonnes 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 will include:

- an approximately 920,000 square feet fiber storage area;

- barking and chipping facilities for pulpwood;

- a fiber line, which includes eight Superbatch digester and bleaching
facilities;

- a pulp machine, which includes a dryer and a cutter;

- an approximately 108,000 square foot finished goods storage area;

- a recovery line, which includes a recovery boiler, evaporation plant,
recausticizing plant and lime kiln;

- a fresh water plant;

- a wastewater treatment plant; and

- a power station with a turbine capable of producing approximately
100 megawatts of electric power from steam produced by the recovery boiler
and a power boiler.

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
Fahrbrucke mill and 12 kilometers south of the city of Dresden. The mill was
constructed in 1956 and has been continually upgraded. The mill has an annual
production capacity of approximately 45,000 tonnes of specialty papers. The
facilities at the mill include:

- an approximately 34,200 square feet fiber storage area;

- an approximately 57,600 square foot paper machine building, which houses a
Pama paper machine with a 339 centimeter trim width, processing speed of
300 meters per minute and including, among other things, a stock
preparation unit, approach system, press section and dryer section;

- a fresh water plant, which consists of 15 wells;

- a wastewater treatment plant; and

- a power plant, which includes a gas turbine capable of producing
approximately 4,200 kilowatts of electric power, a waste heat boiler
capable of producing 17 tonnes per hour of steam generated power and an
auxiliary boiler capable of producing five tonnes per hour of steam
generated power.

The Fahrbrucke mill is situated on a 27 acre site near the town of
Fahrbrucke in the State of Saxony, in the western part of the Erzebirge
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 an annual production capacity for
approximately 40,000 tonnes 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:

- an approximately 69,300 square feet fiber storage area;

- an approximately 60,300 square foot paper machine building, which houses a
Voith paper machine with a 276 centimeter trim width, processing speed of
540 meters per minute and including, among other things, a pulper unit,
paper chemical preparation unit, refiner system, stock blending system,
approach system, press section and dryer section;

- a fresh water plant;

27

- a power plant, which consists of, among other things, a waste heat boiler
which can produce 22 tonnes per hour of steam generated power and a heavy
duty boiler which can produce 3.2 tonnes per hour of steam generated
power, as well as a cogeneration plant with a gas turbine which can
produce approximately 4,280 kilowatts of electric power; and

- a wastewater treatment plant is currently being constructed, the first
stage of which was completed at the end of 2002 and brought on line at the
beginning of 2003.

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

- ------------------------

(1) Capacity is the rated capacity of the plants for the year ended
December 31, 2002, which is based upon production for 365 days a year.
Actual production is generally based upon 353 days per year for the
Rosenthal mill and 340 days per year for the Paper mills.

(2) Upon completion, the Stendal mill will increase our annual production
capacity by approximately 552,000 tonnes to approximately 852,000 tonnes,
for a total annual production capacity from our pulp and paper operations of
approximately 937,000 tonnes.

(3) We sold our packaging paper mill located in Trebsen effective June 2000.
This amount includes approximately 28,762 tonnes from the Trebsen mill.

(4) As we reorganized our interest in Landqart at the end of 2002, we no longer
have a direct interest in the Landqart mill. The Landqart mill had an annual
production capacity of approximately 20,500 tonnes, which is included in the
calculation of our annual production capacity for specialty papers. The
Landqart mill produced approximately 20,422 tonnes in 2002.

(5) We sold our printing paper mill located in Hainsberg effective
November 2000. This amount includes production of approximately
25,463 tonnes from the Hainsberg mill.

We own a substantial amount of real estate adjacent to the Paper mills,
which is in excess of our production requirements and may be divested.

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.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

28

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

(a) MARKET INFORMATION. Our shares of beneficial interest are quoted for
trading on the NASDAQ National Market under the symbol "MERCS" and on NASDAQ
Europe under the symbol "MERC". The following table sets forth the high and low
sale prices of our shares on the NASDAQ National Market for each quarter in the
two-year period ended December 31, 2002, and for the period ended
March 21, 2003:

(b) SHAREHOLDER INFORMATION. As at March 21, 2003, there were approximately
549 holders of record of our shares and a total of 16,874,899 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. For information about our equity
compensation plans, see "Security Ownership of Certain Beneficial Owners and
Management".

(e) PRIVATE PLACEMENT. 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 of 1933, as amended provided under Section 4(2) of the act.

29

ITEM 6. SELECTED FINANCIAL DATA

The following table sets forth selected financial information for each of
our last five fiscal years. Effective January 1, 2002, we changed our reporting
currency from the U.S. dollar to the Euro. The following selected financial
information 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, the more detailed financial statements and
related notes contained in this annual report and "Management's Discussion and
Analysis of Financial Condition and Results of Operations".

- ------------------------

(1) We acquired the specialty paper mill in Landqart effective December 2001 and
we reorganized our interest in Landqart at the end of 2002. Results from the
Landqart mill are not included in our results for 2001, but are included for
2002. The Landqart mill sold approximately 18,613 tonnes for approximately
E43.2 million in 2001 and approximately 18,222 tonnes for approximately
E39.7 million in 2002.

30

(2) The Rosenthal mill was shut-down from July to December 1999 in connection
with its conversion from sulphite to kraft pulp production.

(3) The exchange rates for 1998 are based upon the conversion of U.S. dollars to
Deutschmarks and Deutschmarks to Euros.

(4) Net loss before a special charge was E15.0 million, or E0.91 per share.

(5) Includes approximately E186.9 million related to properties construction in
progress at the site of the Stendal mill.

(6) Includes approximately E176.6 million related to construction in progress at
the site of the Stendal mill.

(7) Excluding intercompany sales.

31

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following discussion and analysis of our financial condition and results
of operations as of and for the three years ended December 31, 2002 should be
read in conjunction with the consolidated financial statements and related notes
included in this annual report. Effective January 1, 2002, we changed our
reporting currency from the U.S. dollar to the Euro. Accordingly, our financial
statements for the year ended December 31, 2002 included in this annual report
are stated in Euros. Our financial statements for periods prior to the year
ended December 31, 2002 included in this annual report have been restated in
Euros and reclassified to conform to the current presentation. The following
management discussion and analysis of our financial condition and results of
operations is based upon the restated financial statements for all prior
periods.

RESULTS OF OPERATIONS

OVERVIEW

We operate in the pulp and paper business and our operations are located
primarily in Germany. Our manufacturing facilities are comprised of: (a) the
Rosenthal mill which produces softwood kraft pulp and has an annual production
capacity of approximately 300,000 tonnes; (b) the Stendal project, a
"greenfield" project to construct a new, state-of-the-art softwood kraft pulp
mill, which will have an annual production capacity of approximately 552,000
tonnes; and (c) the Paper mills which produce specialty papers and printing and
writing papers and have an aggregate annual production capacity of approximately
85,000 tonnes.

Total investment costs in respect of the Stendal project are estimated to be
approximately E1.0 billion, the majority of which is being financed under the
Stendal Loan Facility in the amount of E828 million. The construction of the
Stendal mill commenced in August 2002 and is scheduled to be completed in the
third quarter of 2004. Costs, including interest, in respect of the Stendal
project are capitalized. A variable-to-fixed rate interest rate swap entered
into by Stendal to fix the interest rate for the full term of the Stendal Loan
Facility is marked to market on a quarterly and annual basis and gains or losses
are recognized in our earnings for the period.

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 kraft 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 pulplogs 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. 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. Kraft
pulp prices, which had been at historically low levels between 1996 and 1999,
rebounded in 2000 as a result of recoveries in Asian economies and a decline in
capacity resulting from the shut-down of unprofitable or older mills requiring
environmental upgrades. This contributed to tightening inventory levels among
Norscan producers, which fell to approximately 1.1 million tonnes in mid-2000
and prices

32

increasing to an average of approximately $710 per tonne in the fourth quarter
of 2000. However, the decline of North American and 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 tonnes in early 2001 and price
levels eroded to an average of approximately $460 per tonne in late 2001.
Inventory levels ranged between 1.3 and 1.9 million tonnes in 2002 and prices
averaged approximately $463 per tonne in 2002. Low producer inventories in early
2003 resulted in producers increasing list prices for kraft pulp in Europe to
approximately $520 per tonne in March 2003.

As kraft pulp is quoted in dollars and Rosenthal's debt facilities and costs
are in Euros, Rosenthal enters into currency swaps to help manage its exposure
to exchange fluctuations between the dollar and the Euro. Gains or losses on
such swaps are recorded in our earnings either as they are settled or as they
are marked to market for each reporting period.

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

- ------------------------

(1) Excluding intercompany sales volumes of 10,768, 10,447 and 1,893 tonnes of
pulp and intercompany net sales revenues of approximately E4.9 million,
E5.8 million and E1.4 million in 2002, 2001 and 2000, respectively.

(2) We sold our packaging paper mill in Trebsen effective June 2000 and no
longer produce packaging papers. Sales of approximately 29,111 tonnes for
approximately E9.5 million from the Trebsen mill are included in our results
for 2000.

(3) We acquired the specialty paper mill in Landqart effective December 2001 and
we reorganized our interest in Landqart at the end of 2002. Sales from the
Landqart mill are not included in our results for 2001, but are included for
2002. The Landqart mill sold approximately 18,613 tonnes for

33

approximately E43.2 million in 2001 and approximately 18,222 tonnes for
approximately E39.7 million in 2002. As of December 31, 2002, our interest
in the Landqart mill will no longer be consolidated and will be included in
our financial results on an equity basis.

(4) We sold our printing paper mill in Hainsberg effective November 2000. Sales
of approximately 24,964 tonnes for approximately E16.8 million from the
Hainsberg mill are included in our results for 2000.

YEAR ENDED DECEMBER 31, 2002 COMPARED TO THE YEAR ENDED DECEMBER 31, 2001

In 2002, total revenues increased by approximately 10.5% to E239.1 million
from E216.4 million in 2001, primarily as a result of increased sales of
specialty papers resulting from the acquisition of the Landqart mill in
December 2001. In 2002, pulp and paper revenues increased by approximately 11.2%
to E227.9 million from E205 million in 2001, on a 66.3% increase in paper sales
partially offset by an 11.0% decrease in pulp sales.

Costs of sales in 2002 increased to E213.5 million from E184.7 million in
2001, primarily as a result of higher revenues.

Pulp sales in 2002 decreased to E130.2 million from E146.2 million in 2001,
as global economic weakness and high producer inventory levels lead to lower
prices. List prices for kraft pulp in Europe decreased from approximately E528
($470) per tonne at the end of 2001 to approximately E420 ($440) per tonne at
the end of the fourth quarter of 2002, before improving in early 2003 due
primarily to supply disruptions. Our pulp sales realizations in 2002 decreased
to E443 per tonne from E512 per tonne in 2001 as a result of such lower sales
prices and the weaker dollar versus the Euro during 2002 compared to the prior
period. Pulp sales by volume increased to 293,607 tonnes in 2002 from 285,654
tonnes in 2001, when we had 19 days of unscheduled technical downtime at the
Rosenthal mill.

Cost of sales and general, administrative and other expenses for our pulp
operations decreased to E125.4 million in 2002 from E126.4 million in 2001
despite higher production and sales volumes. On average, our per tonne fiber
costs for pulp production decreased by approximately 5.8% in 2002 compared to
2001 primarily because of lower fiber costs. Additionally, efficiency
improvements at the Rosenthal mill also reduced energy and chemical costs
relative to 2001. Depreciation was E21.6 million in 2002 compared to
E21.4 million in 2001. In 2002, our average per tonne production costs
(excluding depreciation) were reduced by approximately 9% compared to 2001.

Our pulp operations generated E4.8 million of income from operations in
2002, compared to E19.9 million in 2001.

Paper sales in 2002 increased to E97.7 million from E58.8 million in 2001.
Sales of specialty papers in 2002 increased to E79.4 million from E36.0 million
in 2001 as a result of the inclusion of the results of the Landqart mill, which
contributed sales volumes of 18,222 tonnes in 2002. Excluding Landqart, our
sales volumes for these grades increased to 43,505 tonnes in 2002 from 40,437
tonnes in 2001. This increase in specialty paper sales is largely the result of
our strategy to focus on niche products. In response to market conditions, we
adjusted our product mix to more specialty products at our Heidenau mill where
volumes of printing papers decreased to 23,195 tonnes in 2002 from 26,815 in the
prior period. On average, prices for specialty papers realized in 2002 increased
by approximately 44.6% and for printing papers decreased by approximately 6.9%,
compared to 2001.

Cost of sales and general, administrative and other expenses for our paper
operations increased to E99.5 million in 2002 from E62.0 million in 2001 as a
result of the inclusion of Landqart. This increase was partially offset by lower
raw material prices, particularly for virgin pulp and waste paper as compared to
2001. Furthermore, the flooding experienced at our Heidenau and Fahrbrucke Paper
mills in August 2002 resulted in a period of reduced production and increased
costs. Depreciation increased to E4.0 million in 2002 from E1.5 million in the
prior year, as a result of the inclusion of Landqart.

34

A loss from operations of E1.8 million was recorded by our paper operations
in 2002 relative to a E2.5 million loss from operations in 2001.

General and administrative expenses increased to E25.0 million in 2002 from
E18.4 million in 2001, primarily as a result of the inclusion of the results of
the Landqart mill and a foreign exchange transaction loss of E3.0 million in
2002. In 2001, we recorded a foreign exchange transaction gain of $3.4 million.

We had income from operations of E0.7 million in 2002, compared to
E13.3 million in 2001. Interest expense (excluding capitalized interest of
E3.1 million in respect of the Stendal project) in 2002 decreased to
E13.8 million from E16.2 million in 2001, primarily as a result of repayments
made on outstanding indebtedness.

Pursuant to the Stendal Loan Facility, Stendal entered into
variable-to-fixed rate interest swaps for the full term of the facility to
manage the risk exposure with respect to an aggregate maximum amount of
approximately E612.6 million of the principal amount of the Stendal Loan
Facility, referred to as the "Stendal Interest Rate Swap Agreements". Under
these swaps, Stendal pays a fixed rate and receives a floating rate with respect
to interest payments calculated on a notional amount. These swaps manage the
exposure to variable cash flow risk from the variable interest payments under
the Stendal Loan Facility. The swaps are marked to market at the end of each
reporting period and all unrealized gains and losses are recognized in earnings
for a reporting period. We recognized a holding loss of E30.1 million before
minority interests in respect of these swaps for the year ended December 31,
2002. For more information about these swaps, see "Quantitative and Qualitative
Disclosures About Market Risk -- Derivative Instruments".

In 2002, we also entered into currency swaps, referred to as the "Rosenthal
Currency Swaps", to manage our exposure with respect to an aggregate amount of
approximately E223.3 million of the principal long-term indebtedness under the
Rosenthal Loan Facility. During 2002, we settled two Rosenthal Currency Swaps to
realize gains. We then subsequently re-entered into two Rosenthal Currency Swaps
and one of them was settled and a gain was realized in December 2002. In
addition, we have entered into currency forward contracts, referred to as
"Currency Forwards", and forward interest rate and interest cap contracts,
referred to as the "Interest Rate Contracts", in connection with certain
indebtedness relating to the Rosenthal mill. These derivative instruments are
also marked to market at the end of each reporting period and all gains and
losses are recognized in earnings for a reporting period. In 2002, we realized a
total gain of E23.4 million from these derivative contracts. For more
information about these derivatives, see "Quantitative and Qualitative
Disclosures About Market Risk -- Derivative Instruments".

Income tax impacts were negligible in both 2002 and 2001 given the pre-tax
losses sustained in both years. Minority interest in 2002 amounted to
E11 million and represented the minority shareholders' interest in the losses of
Stendal. There was no minority interest in 2001.

For 2002, we reported a net loss of E6.3 million, or E0.38 per share on a
basic and diluted basis, compared to a net loss of E2.8 million, or E0.17 per
share on a basic and diluted basis, in 2001.

For 2002, excluding items related to the Stendal project, net income would
have been E12.8 million, or E0.76 per share on a diluted basis, which was
determined by adding the loss on derivative financial instruments of
E30.1 million to, and subtracting minority interest of E11.0 million from, the
reported net loss of E6.3 million. As the Stendal project is currently under
construction and because of its overall size relative to our other facilities,
management uses our consolidated operating results excluding items relating to
the Stendal project to measure the performance and results of our operating
units. Management believes this measure provides meaningful information on the
performance of our operating facilities for a reporting period.

35

YEAR ENDED DECEMBER 31, 2001 COMPARED TO THE YEAR ENDED DECEMBER 31, 2000

In 2001, revenues decreased by E42.4 million to E216.4 million from
E258.9 million in 2000, primarily as a result of lower pulp prices and lower
paper sales. We completed construction of the capital project at the Rosenthal
mill in late 1999 to convert the Rosenthal mill's production to kraft pulp and
increase its annual production capacity. The Rosenthal mill ramped up production
in early 2000 and operated in excess of 90% of capacity after the first quarter
of 2000.

Cost of sales decreased to E184.7 million in 2001 from E193.7 million in
2000, primarily as a result of lower paper sales volumes.

In 2001, our pulp and paper sales decreased by approximately 16.3% to
E205.0 million from E245.1 million in 2000 on an 8.4% decrease in pulp sales and
a 31.2% decrease in paper sales. In 2001, pulp sales were lower than in 2000 as
a result of weakening demand due to global economic weakness and high producer
inventory levels that lead to a decline in prices. Overall, in 2001, paper
markets were generally stable with prices increasing marginally.

On average, pulp prices realized by us in 2001 decreased by approximately
23.2% compared to 2000. Pulp sales decreased to E146.2 million in 2001 from
E159.7 million in 2000, primarily as a result of a decrease in pulp prices. Pulp
sales volumes increased in 2001 as a result of increased production. List prices
for kraft pulp in Europe decreased from approximately E756 ($710) per tonne at
the end of 2000 to approximately E705 ($650) per tonne during the first quarter
of 2001, approximately E591 ($530) per tonne during the second quarter of 2001,
approximately E514 ($460) per tonne during the third quarter of 2001 and
approximately E525 ($470) per tonne during the fourth quarter of 2001. Kraft
pulp prices continued to weaken at the end of 2001 as a result of high product
inventories and weakening prices continued in the early part of 2002. We
undertook a planned eight-day maintenance and modification shutdown at the
Rosenthal mill in August 2001, and it was shutdown for an additional 19 days
over the year to correct technical difficulties.

On average, our per tonne fiber costs for pulp production increased by
approximately 6.3% in 2001 compared to 2000 and remained among the lowest in
Europe.

Paper prices realized by us increased by approximately 27.0% on average in
2001, compared to 2000, primarily as a result of the disposition of lower priced
product lines. Paper sales in 2001 decreased to E58.8 million from
E85.3 million in 2000, on a volume decrease of 45.8%. In 2001, sales volumes for
printing papers decreased by approximately 49.9%, primarily due to the sale of
the printing paper mill in Hainsberg effective November 2000. Sales volumes for
specialty papers decreased by 2.4% compared to 2000. We did not sell any
packaging paper in 2001 as a result of the sale of our packaging paper mill
in 2000.

While prices for waste paper, which comprises approximately 25% of the fiber
for the Paper mills, increased by approximately 30.0% in 2001 compared to 2000,
they remained relatively low compared to the cost of virgin fiber.

General and administrative expenses increased to E18.4 million in 2001, from
E15.5 million in 2000, primarily as a result of payments made in connection with
profit sharing bonuses for the prior year and costs related to specific
projects.

We had income from operations of E13.3 million in 2001, compared to
E49.7 million in 2000. Interest expense in 2001 increased to E16.2 million from
E15.2 million in 2000.

We sold our printing paper mill located in Hainsberg, Germany effective
November 2000 for approximately E5.0 million plus an amount equal to the net
working capital associated with the Hainsberg mill from the sale. We also sold
our packaging paper mill located in Trebsen, Germany effective June 2000 for
approximately E9.5 million plus an amount equal to the net working capital
associated with the Trebsen mill from the sale. As a result, we no longer
produce packaging papers.

36

In 2001, we reported a net loss of E2.8 million, or E0.17 per share on a
basic and diluted basis, compared to net income of E32.0 million, or E1.91 per
share on a basic basis and E1.87 per share on a diluted basis, in 2000.

LIQUIDITY AND CAPITAL RESOURCES

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

- ------------------------

(1) Includes approximately E186.9 million related to properties construction in
progress at the site of the Stendal mill.

(2) Includes approximately E146.5 million related to construction in progress at
the site of the Stendal mill.

At December 31, 2002, our cash and cash equivalents was E30.3 million, a net
increase of E18.5 million from E11.7 million at the end of 2001. We also had
E9.5 million of cash restricted to pay construction in progress costs payable
and E19.1 million of cash restricted in a debt service account, both relating to
the construction in progress at the site of the Stendal mill. In addition, we
had E19.7 million of cash restricted in a debt service account relating to the
Rosenthal mill. At December 31, 2002, short-term trading securities decreased to
E0.3 million from E4.5 million at December 31, 2001.

OPERATING ACTIVITIES

Operating activities in 2002 provided cash of E39.7 million, compared to
E29.8 million in 2001. Net changes in trading securities provided cash of
E4.4 million in 2002, compared to E0.5 million in 2001. Decreases in receivables
and inventories provided cash of E14.9 million and E1.7 million, respectively,
in the current period, compared to E7.8 million and E2.6 million, respectively,
in 2001. A decrease in accounts payable and accrued expenses used cash of
E13.4 million in 2002, compared to E0.9 million in 2001. We expect to continue
to generate sufficient cash flow from operations to pay our interest expense and
meet the working capital requirements for our operations.

INVESTING ACTIVITIES

Investing activities in 2002 used cash of E196.0 million, primarily as a
result of the acquisition of properties, net of investment grants, in connection
with the Stendal project, compared to E10.3 million in 2001. The acquisition of
properties in connection with the Stendal project used cash of E186.9 million in
2002. The acquisition of properties, net of investment grants, in 2001 used cash
of E7.6 million. The sale of properties in 2002 provided cash of E4.4 million.
Purchases of available-for-sale securities used cash of E0.6 million in 2002 and
2001, respectively. The disposition of a subsidiary in 2002 used cash of
E1.2 million, net of cash disposed, compared to the purchase of a subsidiary,
net of cash acquired, using cash of E2.1 million in 2001.

37

In 2002, we applied for investment grants totaling E38.0 million with
respect to the Stendal project, which we expect to receive in the second half of
2003. In accordance with our accounting policies, we do not record these grants
until they are received.

Our Paper mills have or will have to replace certain equipment that was
damaged as a result of flooding in parts of Germany and other eastern European
countries during the third quarter of 2002. The aggregate equipment costs are
estimated to be approximately E3.3 million, of which approximately E0.2 million
was incurred in 2002. We have applied for German government grants and for
assistance under special credit programs instituted by the German government for
flooding victims in connection with these costs. Although we have received
approval for certain of these grants, there can be no assurance that we will
receive such grants and assistance in the amounts applied for, or at all.

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 an indirect
39% minority interest through a limited partnership on a non-cash basis. We
effected the reorganization as the markets for the specialty papers produced by
Landqart are significantly different from the markets for the more consumer
oriented types of specialty papers produced by us. The reorganization will allow
the management of Landqart to focus on its operations and financial requirements
without regard to our other operations. Further, to develop the business of
Landqart will require a substantial amount of capital investment in the Landqart
mill. The Swiss bank has agreed to reduce and refinance a portion of Landqart's
debt and may be able to assist Landqart in securing the funds necessary to make
the required capital investment in the Landqart mill.

We are in the process of constructing a wastewater treatment plant at the
Fahrbrucke mill and reconstructing the landfill at the Rosenthal mill. For more
information, see "Business -- Environmental" and "Business -- Capital
Expenditures", respectively.

In August 2002, we completed financing arrangements for the Stendal project.
Total investment cost in connection with the project are approximately
E1.0 billion, the majority of which is to be provided under the Stendal Loan
Facility. We also contributed approximately E63.5 million to Stendal from cash
on hand and through the Bridge Loans. For more information about the Stendal
project, see "Business -- Stendal Pulp Mill Project and Financing".

FINANCING ACTIVITIES

Financing activities provided cash of E175.8 million in 2002, primarily as a
result of a net increase in indebtedness of E166.2 million relating to the
Stendal project. An increase in restricted cash, including in connection with
the Stendal project, used cash of E14.9 million in the current period. An
increase in construction in progress costs in connection with the Stendal
project provided cash of E24.9 million in 2002. Equity invested by minority
shareholders in connection with the Stendal project provided cash of
E6.3 million in 2002. We made a repayment of E12.5 million in connection with
the Rosenthal Loan Facility in 2002. Financing activities used cash of
E30.1 million in 2001, primarily as a result of the reduction of indebtedness
during the period.

Our pulp and paper operations were reorganized in 2002 which resulted in a
reduction of tax losses being carried forward from December 31, 2001 and these
tax losses were fully utilized. For more information, see Note 9 of our
consolidated financial statements included in this annual report.

Other than the agreements entered into by Stendal relating to the Stendal
project, we had no material commitments to acquire assets or operating
businesses at December 31, 2002. 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 will be generated from cash flow from operations, cash on
hand, borrowing against our assets, the sale of debt

38

and/or equity securities and/or asset sales. In addition, in connection with our
obligation to repay or refinance the Bridge Loans, we may in 2003 issue debt,
equity or convertible securities.

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 E130.2 million, or approximately 54.4%, of our revenues
in 2002 were from pulp sales. The following table illustrates the effect on our
net operating results in 2002 of a $20 change in our average selling price per
tonne for NBSK pulp in 2002, based upon our pulp sales during the year:

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, to a lesser extent, 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 as shareholders' equity on the balance sheet and
do not affect our net earnings.

In the year ended December 31, 2002, we reported a net E2.2 million foreign
exchange translation gain and, as a result, the cumulative foreign exchange
translation gain increased to E3.5 million at December 31, 2002 from
E1.3 million at December 31, 2001.

Based upon the exchange rate at December 31, 2002, the U.S. dollar decreased
by approximately 15.1% in value against the Euro since December 31, 2001. See
"Quantitative and Qualitative Disclosures about Market Risk -- Derivative
Instruments".

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements in conformity with generally
accepted accounting principles requires our management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods.

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
consolidated financial statements included in this annual report.

39

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.

Retroactive application of this standard was not allowed. There is no
cumulative effect in our financial statements as a result of adopting this
standard. We reported a holding loss of E30.1 million before minority interests
in respect of the Stendal Interest Rate Swap Agreements and a realized gain of
E23.4 million in respect of the Rosenthal Currency Swaps and Interest Rate
Contracts in our loss for the year ended December 31, 2002.

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:

- the history of the tax loss carryforwards and their expiry dates;

- our projected earnings; and

- tax planning opportunities.

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, 2002, we had E53.9 million in deferred tax assets and
E43.7 million in valuation allowances, resulting in a net deferred tax asset of
E10.1 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 German
federal, state 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.

40

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 government
agencies. As a result, we believe that our capital investment programs for our
manufacturing plants will fully offset the wastewater fees that would have been
payable for the past three years, subject to environmental audits. We estimate
the aggregate wastewater fees for the past three years to be approximately
E11.2 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, 2002, we recorded a liability for environmental conservation
expenditures of E2.3 million, based on environmental studies that we conducted.
We believe that the liability amount recorded is sufficient, subject to future
changes in German environmental regulations.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

Statements in this report that are not reported financial results or other
historical information are "forward-looking statements" within the meaning of
the United States PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. 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:

INDEBTEDNESS. We have incurred a significant amount of debt. Our high debt
levels may have important consequences for us, including, but not limited to the
following:

- our ability to obtain additional financing to fund future operations or
meet our working capital needs or any such financing may not be available
on terms favorable to us;

- a certain amount of our operating cash flow is dedicated to the payment of
principal and interest on our indebtedness, thereby diminishing funds that
would otherwise be available for our operations and for other purposes;

- a substantial decrease in net operating cash flows or increase in our
expenses could make it more difficult for us to meet our debt service
requirements, which could force us to modify our operations; and

- our leveraged capital structure may place us at a competitive disadvantage
by hindering our ability to adjust rapidly to changing market conditions
or by making us vulnerable to a downturn in our business or the economy in
general.

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
and the extent to which we can implement successfully our business and growth
strategy. We cannot assure you that we will be able to implement our strategy
fully or that the anticipated results of our strategy will be realized.

41

CYCLICAL NATURE OF BUSINESS; COMPETITIVE POSITION. 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 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 the past three years, pulp prices have fallen significantly.
Our competitive position is influenced by the availability and quality of raw
materials and our experience in relation to other producers with respect to
inflation, energy, transportation, labor costs, productivity and currency
exchange rates. There can be no assurance that we will continue to be
competitive in the future, as a result of new technological advancements or
otherwise.

RAW MATERIALS. Wood chips and pulpwood comprise the fiber used by the
Rosenthal mill and which will be used by the Stendal mill. The fiber used by our
Paper mills consists of waste paper and pulp. Such fiber is cyclical in terms of
both price and supply. The cost of wood chips and pulplogs is primarily affected
by the supply and demand for lumber. The cost of fiber for our Paper mills is
primarily affected by the supply and demand for paper and pulp. Demand for these
raw materials is determined by the volume of pulp and paper products produced
globally. The markets for pulp and paper products, including our products, are
highly variable and are characterized by periods of excess product supply due to
many factors, including periods of insufficient demand due to weak general
economic activity or other causes. The cyclical nature of pricing for these raw
materials represents a potential risk to our profit margins if we are unable to
pass along price increases to our customers. Although these materials are
available from a number of suppliers, we may not be able to purchase sufficient
quantities of these raw materials to meet our production requirements at prices
acceptable to us during times of tight supply. In addition, the quality of fiber
we receive could be reduced as a result of industrial disputes, material
curtailments or shut-down of operations by suppliers for market or other
reasons, government orders and legislation, acts of god and other events beyond
our control. Historically, the fiber requirements for the Rosenthal mill were
procured by a third party. The agreement with this party will expire shortly and
will not be renewed as we have organized our own internal wood procurement
department. There can be no assurance that this department will be able to
procure our fiber requirements on terms as favorable as those procured by the
third party. An insufficient supply of fiber or reduction in the quality of
fiber we receive would materially adversely affect our business, financial
condition and results of operations.

ENVIRONMENTAL REGULATION. We are subject to extensive environmental laws
and regulations. These laws and regulations impose stringent standards on us
regarding, among other things, air emissions, effluent discharges and
remediation of environmental contamination. We may incur substantial costs to
comply with current requirements or new environmental laws that might be
adopted. In addition, we may discover currently unknown environmental problems
or conditions in the future and may incur substantial costs in correcting such
problems or conditions.

STENDAL PULP MILL PROJECT UNCERTAINTIES. The Stendal project is subject to
various risks and uncertainties customary to large "greenfield" projects of this
nature which may result in the Stendal project not being completed as currently
scheduled or budgeted. Such delays and/or cost overruns may result from:

- the availability and cost of materials and labor;

- construction delays;

- equipment failures or damage;

- weather conditions;

- industrial accidents;

- government regulations;

42

- changes to government assistance;

- delays in obtaining or amending our permits;

- errors or miscalculations in engineering, design specifications or
equipment manufacturing;

- faulty construction or workmanship; or

- defective equipment or installation.

The Stendal project will also be subject to extensive and complex
regulations and environmental compliance which may result in delays, in Stendal
and/or its shareholders, including us, incurring substantial costs, or in the
Stendal project being changed or not being completed at all.

The implementation of the Stendal project commenced in 2002 and is scheduled
to be completed in the third quarter of 2004. However, there can be no assurance
that the Stendal project will be completed or start-up will occur as currently
planned or that, if completed, the mill will perform as currently planned. For
more information about the Stendal project, see "Business -- Stendal Pulp Mill
Project and Financing".

COMPETITIVE MARKETS. We sell our products primarily in Europe and the
markets for our products are highly competitive. A number of global companies
compete in each of our markets and no company holds a dominant position. For
both pulp and paper, a large number of companies produce products that are
reasonably standardized. As a result, the traditional basis for competition in
our markets has been price. Many of our competitors have greater resources than
we do and may be able to adapt more quickly to industrial changes or devote
greater resources to the sale of products than we can. We cannot assure you that
we will be able to compete successfully against these competitors.

DERIVATIVES. We use derivative instruments in regard to our exposure to
interest rate and currency fluctuations and may in the future use derivative
instruments to mitigate pulp price risks. The derivative instruments may not be
designated as hedging instruments for accounting purposes. The purpose of the
derivative activity may be speculative in nature, as our management uses these
derivative instruments either to augment our potential gains or reduce our
potential losses, depending on our management's perception of future economic
events and developments. If any of the variety of instruments and strategies we
utilize are not effective, we may incur losses, which may have a materially
adverse effect on our results of operations and financial condition. See
"Quantitative and Qualitative Disclosures about Market Risk -- Derivative
Instruments".

LABOR AGREEMENTS. The majority of our employees in Germany are represented
by the IG-BCE, a national union that represents pulp and paper workers in
Germany. The collective agreement relating to employees at our Paper mills
expires at the end of 2003. We expect to negotiate a new collective agreement
for employees at our Paper mills in 2003. For our pulp workers, we have agreed
to negotiate in respect of an additional wage increase for August 2003 depending
upon the general economic conditions. Although we have not experienced any
significant work stoppages in the past, there can be no assurance that we will
be able to negotiate an acceptable collective agreement with our employees upon
expiration of the existing collective agreement with our employees at the Paper
mills. This could result in a strike or work stoppage by the affected workers.
The renewal of the collective agreements could result in higher wages or
benefits paid to union members. Accordingly, we could experience a significant
disruption of our operations or higher on-going labor costs, which could have a
material adverse effect on our business, financial condition, results of
operations and cash flow.

INSURANCE. We have obtained insurance coverage that we believe would
ordinarily be maintained by an operator of facilities similar to our pulp and
paper mills. Our insurance is subject to various limits and exclusions. Damage
or destruction to our facilities could result in claims that are excluded by, or
exceed the limits of, our insurance coverage.

43

LEGAL PROCEEDINGS. Although we are not currently subject to any material
legal proceedings, should legal proceedings be initiated against us in the
future, whether in connection with environmental matters or otherwise, pursuant
to which we are required to pay significant amounts under an order issued in or
to settle such a proceeding, our results of operations and financial condition
would be materially adversely affected.

OTHER RISKS. Our future results could be adversely affected by a variety of
other factors beyond our control, including, but not limited to:

- general economic and business conditions, including changes in interest
rates;

- prices and other economic conditions;

- natural phenomena;

- actions by government authorities, including changes in government
regulation;

- uncertainties associated with legal proceedings;

- technological development;

- future decisions by management in response to changing conditions;

- our ability to execute prospective business plans; and

- misjudgments in the course of preparing forward-looking statements.

INFLATION

We do not believe that inflation has had a material impact on revenues or
income during 2002.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risks from changes in interest rates, foreign
currency exchange rates and equity prices which may affect our results of
operations and financial condition and, consequently, our fair value. We manage
these risks through internal risk management policies as well as the use of
derivative instruments. We use derivative instruments to reduce or limit our
exposure to interest rate and currency risks. We may in the future use
derivative instruments to reduce or limit our exposure to fluctuations in pulp
prices. We also use derivative instruments either to augment our potential gains
or to reduce our potential losses, depending on our management's perception of
future economic events and developments. These types of derivative instruments
are generally highly speculative in nature. They are also very volatile as they
are highly leveraged given that margin requirements are relatively low in
proportion to notional amounts.

Many of our strategies, including the use of derivative instruments, and the
types of derivative instruments selected by us, are based on historical trading
patterns and correlations and our management's expectations of future events.
However, these strategies may not be fully effective in all market environments
or against all types of risks. Unexpected market developments may affect our
risk management strategies during this time, and unanticipated developments
could impact our risk management strategies in the future. If any of the variety
of instruments and strategies we utilize are not effective, we may incur losses.

DERIVATIVE INSTRUMENTS

Rosenthal has entered into the Rosenthal Currency Swaps in connection with
our long-term indebtedness relating to the conversion of the Rosenthal mill to
the production of kraft pulp. These derivatives have been contracted by
Rosenthal using a dedicated credit line within the Rosenthal Loan Facility and
assigned for this purpose, and are subject to prescribed controls, including
certain maximum

44

amounts for notional and at-risk amounts. As NBSK pulp prices are quoted in
U.S. dollars and the majority of our business transactions are denominated in
Euros, Rosenthal has entered into the Rosenthal Currency Swaps to reduce the
effects of exchange rate fluctuations between the U.S. dollar and the Euro on
notional amounts under the Rosenthal Loan Facility. Under the Rosenthal Currency
Swap, Rosenthal effectively pays the principal and interest in U.S. dollars and
at U.S. dollar borrowing rates.

In December 2000, Rosenthal entered into U.S. dollar/Euro Rosenthal Currency
Swaps to manage its risk exposure with respect to in aggregate approximately
E223.3 million of the principal amount under the Rosenthal Loan Facility. These
swaps were subsequently settled and realized in July 2002. A currency gain was
recognized when loan repayments were made under the currency swap contracts
during the current period. As a consequence of the settlement of these Rosenthal
Currency Swaps, commencing from April 1, 2002, interest was paid at the
six-month Euribor plus bank margin rate and 4.5% fixed rate including bank
margin, as applicable, in accordance with the terms of the original underlying
loans.

Subsequently in July 2002, Rosenthal re-entered the Rosenthal Currency Swaps
for the principal amounts of E74.5 million and E130.4 million. In
December 2002, the swap relating to the principal amount of E130.4 million under
the Rosenthal Loan Facility was settled. In January 2003, Rosenthal re-entered
the Rosenthal Currency Swap for the principal amount of E130.4 million.

In addition, Rosenthal entered into the Interest Rate Contracts in the
fourth quarter of 2002 to either fix or limit the interest rates in connection
with certain of its indebtedness. Rosenthal also has entered into various
Currency Forwards to reduce or limit its exposure to currency risks and to
augment its potential gains or to reduce its potential losses.

In August 2002, Stendal entered into the Stendal Interest Rate Swap
Agreements in connection with its long-term indebtedness relating to the Stendal
project to fix the interest rate under the Stendal Loan Facility at the then low
level, relative to its historical trend and projected variable interest rate.
These contracts were entered into under a specific credit line under the Stendal
Loan Facility and are subject to prescribed controls, including certain maximum
amounts for notional and at-risk amounts. Under the Stendal Interest Rate Swap
Agreement, Stendal pays a fixed rate and receives a floating rate with the
interest payments being calculated on a notional amount. The interest rates
payable under the Stendal Loan Facility were swapped into fixed rates based on
the Eur-Euribor rate for the repayment periods of the tranches under the Stendal
Loan Facility. Stendal effectively converted the Stendal Loan Facility from a
variable interest rate loan into a fixed interest rate loan, thereby reducing
interest rate uncertainty. As at December 31, 2002, the aggregated notional
amount outstanding was E1.1 billion.

In addition, pursuant to the Bridge Loan which related to our investment in
the Stendal project, the bank has an option to demand that the E30.0 million
loan be repaid in Euros or U.S. dollars at an exchange rate of E1.00 = $0.9731,
which was the exchange rate prevailing at the date of the loan, if the Euro
falls below this exchange rate on the repayment date of the loan. At
December 31, 2002, the Euro had appreciated to exceed this rate. Such an option
is considered an embedded derivative.

The Rosenthal Currency Swaps, Interest Rate Contracts, Currency Forwards,
the Stendal Interest Rate Swap Agreements and embedded derivative are marked to
market at the end of each reporting period, and all unrealized gains and losses
are recognized in earnings for a reporting period.

45

The following table sets forth the maturity date, the notional amount and
the recognized gain or loss, for derivative instruments that were transacted
during the year 2002:

- ------------------------

(1) The interest component of the swaps is required under the terms of the
Rosenthal Loan Facility, and became effective for the period starting
September 30, 2002. For the outstanding principal amounts of E74.5 million
under the Rosenthal Loan Facility, all repayment installments from
September 30, 2002 until September 30, 2013, were swapped into U.S. dollar
amounts at a rate of Euro 1.0050. The interest rate was swapped into the
six-month U.S. dollar/Libor plus bank margin rate with a cap of 6.8% until
September 28, 2007.

(2) Rosenthal entered into two interest rate cap contracts with notional amounts
of $131.0 million and $74.9 million, both maturing on September 28, 2007
with a strike rate of 6.8%.

(3) Rosenthal entered into two forward interest rate contracts with notional
amounts of $74.5 million and $124.8 million both maturing on
September 30, 2003.

(4) In connection with the Stendal Loan Facility, in the third quarter of 2002
Stendal entered into the Stendal Interest Rate Swap Agreements, which are
variable-to-fixed interest rate swaps, for the term of the Stendal Loan
Facility, with respect to an aggregate maximum amount of approximately
E612.6 million of the principal amount of the long-term indebtedness under
the Stendal Loan Facility. The swaps took effect on October 1, 2002 and are
comprised of three contracts. The first contract commenced in October 2002
for a notional amount of E4.1 million, gradually increasing to
E464.9 million, with an interest rate of 3.795%, and matures in May 2004.
The second contract is to commence in May 2004 for a notional amount of
E464.9 million, gradually increasing to

46

E612.6 million, with an interest rate of 5.28%, and matures in April 2005.
The third contract is to commence in April 2005 for a notional amount of
E612.6 million, with an interest rate of 5.28%, and the notional amount
gradually decreases and the contract terminates upon the maturity of the
Stendal Loan Facility in October 2017. As at December 31, 2002, the notional
amount of these three contracts was E30.9 million, E464.9 million and
E612.6 million, respectively.

We are exposed to very modest credit-related risks in the event of
non-performance by counterparties to derivative contracts. However, we do not
expect that the counterparties, which are major financial institutions, will
fail to meet their obligations.

Other than the embedded derivative within the Bridge Loans, as of
December 31, 2002, we have not entered into any material financial derivatives
outside of our project companies, Rosenthal and Stendal, under their existing
lines of credit. As at December 31, 2002, no derivative contract had been
executed with respect to pulp prices.

INTEREST RATE RISK

Fluctuations in interest rates may affect the fair value of fixed interest
rate financial instruments which are sensitive to such fluctuations. A decrease
in interest rates may increase the fair value of such fixed interest rate
financial instrument assets and an increase in interest rates may decrease the
fair value of such fixed interest rate financial instrument liabilities, thereby
increasing our fair value. An increase in interest rates may decrease the fair
value of such fixed interest rate financial instrument assets and a decrease in
interest rates may increase the fair value of such fixed interest rate financial
instrument liabilities, thereby decreasing our fair value. The following tables
provide information about our exposure to interest rate fluctuations for the
carrying amount of financial instruments sensitive to such fluctuations as at
December 31, 2002 and 2001, respectively, and expected cash flows from these
instruments:

AS AT DECEMBER 31, 2002

- --------------------------

* Including dividends and interest where applicable.

(1) Debt obligations consist of our debt, including the gross amount of loans
payable to minority shareholders of Stendal.

AS AT DECEMBER 31, 2001

- --------------------------

* Including dividends and interest where applicable.

(1) Investments consist of debt securities.

(2) Debt obligations consist of our debt.

47

FOREIGN CURRENCY EXCHANGE RATE RISK

Our reporting currency is the Euro. However, we hold financial instruments
denominated in U.S. dollars, Swiss francs and, to a lesser extent, in Canadian
dollars, which are sensitive to foreign currency exchange rate fluctuations. A
depreciation of these currencies against the Euro will decrease the fair value
of such financial instrument assets and an appreciation of these currencies
against the Euro will increase the fair value of such financial instrument
liabilities, thereby decreasing our fair value. An appreciation of these
currencies against the Euro will increase the fair value of such financial
instrument assets and a depreciation of these currencies against the Euro will
decrease the fair value of financial instrument liabilities, thereby increasing
our fair value. As a result of the change in our reporting currency from the
U.S. dollar to the Euro, we re-calculated our financial instrument assets and
liabilities that are sensitive to foreign currency exchange rate risk to measure
their risk against the Euro, and cash restricted is no longer sensitive to
foreign currency exchange rate risk. The following tables provide information
about our exposure to foreign currency exchange rate fluctuations for the
carrying amount of financial instruments sensitive to such fluctuations as at
December 31, 2002 and 2001, respectively, and expected cash flows from these
instruments:

AS AT DECEMBER 31, 2002

- --------------------------

* Including dividends and interest where applicable.

(1) Investments consist of equity securities, which are denominated primarily in
U.S. dollars, and to a lesser extent, in Canadian dollars.

(2) Debt obligations consist of our debt, denominated in U.S. dollars.

AS AT DECEMBER 31, 2001

- --------------------------

* Including dividends and interest where applicable.

(1) Investments consist of debt and equity securities. Debt securities are
denominated in U.S. dollars. Equity securities are denominated primarily in
U.S. dollars, and to a lesser extent, in Canadian dollars and Swiss francs.

(2) Debt obligations consist of our debt, denominated in U.S. dollars and Swiss
francs.

EQUITY PRICE RISK

Changes in trading prices of equity securities may affect the fair value of
equity securities or the fair value of other securities convertible into equity
securities. An increase in trading prices will increase the fair value of equity
based financial instrument assets, thereby increasing our fair value. A decrease
in trading prices will decrease the fair value of equity based financial
instrument assets, thereby decreasing our fair value. The following tables
provide information about our exposure to fluctuations in trading

48

prices for the carrying amount of equity based financial instruments sensitive
to such fluctuations as at December 31, 2002 and 2001, respectively, and
expected cash flows from these instruments:

AS AT DECEMBER 31, 2002

- --------------------------

* Including dividends where applicable.

(1) Investments consist of equity securities.

AS AT DECEMBER 31, 2001

- --------------------------

* Including dividends where applicable.

(1) Investments consist of equity securities and debt securities convertible
into equity securities.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The consolidated financial statements and supplementary data required with
respect to this Item 8, and as listed in Item 15 of this annual report, are
included in this annual report commencing on page 59.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

Not applicable.

49

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

As a Massachusetts trust, we are managed by "trustees", who have comparable
duties and responsibilities as directors of corporations. Trustees are elected
by shareholders at annual meetings for staggered three-year terms. Each issued
and outstanding share of beneficial interest is entitled to one vote at such
meetings. Our trustees and executive officers are as follows:

J.S.H. LEE, age 45, has been a trustee since May 1985 and President and
Chief Executive Officer since 1992. Previously, Mr. Lee served with MFC
Bancorp Ltd. as a director from 1986, Chairman from 1987 and President from 1988
to December 1996, respectively.

C.S. MOON, age 56, has been a trustee since June 1994. Mr. Moon is an
independent consultant. He was formerly the Executive Director of Shin Ho Group
of Korea, an international paper manufacturer headquartered in Korea until 1998.
Mr. Moon joined Shin Ho Group in 1990 and previously served in managerial
positions with Moo Kim Paper Manufacturing Co., Ltd. and Sam Yung
Pulp Co., Ltd.

M. ARNULPHY, age 69, has been a trustee since June 1995. Mr. Arnulphy has
been the Managing Director of Electro Orient Ltd., a merchandise trading company
located in Hong Kong, since 1998. From 1975 to 1998, Mr. Arnulphy was the
Managing Director of J. Mortenson & Co., Ltd. in Hong Kong, a water treatment
equipment manufacturing company.

M. REIDEL, age 39, has been a trustee since December 1996, and Secretary and
Chief Financial Officer since November 2002. Mr. Reidel also acted as our
Secretary and Chief Financial Officer from December 1996 to October 1999.
Mr. Reidel was the Chief Financial Officer of Ision Internet AG from
August 1999 to February 2002. Mr. Reidel was a Managing Director of Rosenthal
from 1994 to 1999 and the Chairman of the Management Board of Dresden from 1995
to 1998. Previously, he was a member of the Supervisory Board of Dresden from
1992 to 1994, vice-president of Bundesanstalt fur Vereinigungsbedingte
Sonderaufgaben, the privatization agency of the German government, responsible
for portfolios of service industry and wood and paper industry companies from
1992 to 1994, and an accountant with Arthur Andersen & Co. from 1987 to 1992.

J. L. RYU, age 43, has been a trustee since May 2002. Mr. Ryu has been the
Managing Director of CSC Corporation of Korea, a general merchandise trading
company, since 1993. Mr. Ryu previously founded Sam Heung Trading Co. of Korea
in 1988 and subsequently merged it into CSC Corporation in 1993.

W. MCCARTNEY, age 47, has been a trustee since January 2003. Mr. McCartney
has been President and a director of Pemcorp Management Inc., a management
services company, since 1990. Mr. McCartney is a member of the Institute of
Chartered Accountants in Canada.

G. WITTS, age 64, has been a trustee since January 2003. Mr. Witts organized
Sanne Trust Company Limited, a trust company located in the Channel Islands, in
1988 and was managing director from 1988 to 2000, when he retired.

W. RIDDER, age 41, was appointed a managing director of Stendal in
September 2002. Mr. Ridder was the principal assistant to our chief executive
officer from November 1995 until September 2002.

The terms of Mr. Arnulphy, Mr. McCartney and Mr. Ryu as trustees expire at
the annual meeting of shareholders to be held in 2003. The terms of Mr. Moon and
Mr. Reidel as trustees expire at the annual meeting of shareholders to be held
in 2004. The terms of Mr. Lee and Mr. Witts as trustees expire at the annual
meeting of shareholders to be held in 2005.

50

SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Section 16(a) of the SECURITIES EXCHANGE ACT OF 1934, as amended, requires
that our officers and trustees and persons who own more than 10% of our shares
file reports of ownership and changes in ownership with the SEC and furnish us
with copies of all such reports that they file. Based solely upon a review of
the copies of these reports received by us, and upon written representations by
our trustees and officers regarding their compliance with the applicable
reporting requirements under Section 16(a) of the Exchange Act, we believe that
all of our trustees and officers filed all required reports under Section 16(a)
in a timely manner for the year ended December 31, 2002.

ITEM 11. EXECUTIVE COMPENSATION

SUMMARY COMPENSATION TABLE

The following table sets forth information on the annual compensation for
each of the last three years paid to our chief executive officer and those
executive officers that earned in excess of $100,000 during the most recently
completed fiscal year, referred to as the "Named Executive Officers":

- ------------------------

(1) Mr. Reidel was appointed Chief Financial Officer in November 2002. The
amounts presented for Mr. Reidel have been annualized.

(2) Mr. Ridder was appointed a managing director of Stendal effective
September 2002 for an indefinite term at a salary of E200,000 per annum,
increasing to E240,000 in April 2003, and a bonus of up to 25% of his annual
salary based upon performance targets. The amounts presented for Mr. Ridder
have been annualized.

STOCK OPTIONS

None of our Named Executive Officers were granted options to purchase our
shares during 2002. Pursuant to Mr. Reidel's employment agreement effective
July 1, 2002, in March 2003, we granted Mr. Reidel options to acquire up to
100,000 of our shares under our stock option plan at an exercise price of $6.375
per share, exercisable immediately as to one-third of the options granted and
one-third on each of the first and second anniversaries of the date of grant.

51

The table below provides information regarding the exercise of options
during 2002 by our Named Executive Officers and information with respect to
unexercised options held by them at December 31, 2002:

AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND
FISCAL YEAR-END OPTION VALUES

COMPENSATION OF TRUSTEES

Our non-management trustees receive $20,000 annually for their services and
$500 for each meeting of trustees that they attend. We also reimburse our
trustees and officers for expenses incurred in connection with their duties as
our trustees and officers. Trustees that are not also our officers or employees
and who are in office at the end of a fiscal year may receive options to acquire
up to 6,000 of our shares at an exercise price equal to the closing price of our
shares on the NASDAQ National Market on the last trading day of a fiscal year.

INDEMNITY AGREEMENTS

We have entered into a Trustee's Indemnity Agreement with each of our
trustees. We have agreed under each of these agreements to indemnify each of our
trustees against any and all claims and costs that are or may be brought against
him as a result of his being one of our trustees, officers or employees or that
of a company related to us. However, under the agreements, we are not obligated
to indemnify a trustee against any claims or costs in certain instances,
including if it is determined that the trustee failed to act honestly and in
good faith with a view to our best interests, if the trustee failed to disclose
his interest or conflicts as required under corporate legislation in Washington
or we are not permitted to indemnify the trustee under such legislation, or if
the trustee has violated any insider trading rules under United States federal
and state securities laws.

If there is a change in control (as defined in the agreement) of Mercer
other than a change in control which has been approved by a majority of our
trustees, we are required to seek legal advice as to whether and to what extent
a trustee would be permitted to be indemnified under applicable law. In
addition, the agreements allow us to defend any claim made against a trustee.

EMPLOYMENT AGREEMENTS

Mr. Lee is a party to an amended and restated employment agreement dated
November 20, 2000 with us. The agreement generally provides, subject to certain
termination provisions, for the continued employment of Mr. Lee as president and
chief executive officer for a period of 36 months with automatic one month
renewals, so that the contract at all times has a remaining term of 36 months.
The agreement provides for a base salary of $240,000 (which is paid in a foreign
currency) and other compensation as determined by the board of trustees. The
agreement contains change in control provisions pursuant to which, if a change
in control (as defined in the agreement) occurs, Mr. Lee may only be discharged
for cause. In the event Mr. Lee is terminated without cause or resigns for good
reason (as defined in the agreement) within eighteen months of the change in
control, he shall be entitled to a severance payment of

52

three times his annual salary under the agreement and all unvested rights in any
stock option or other benefit plans shall vest in full. If Mr. Lee is terminated
without cause or resigns for good reason within three years of the change in
control, he shall be entitled to a severance payment of three times the sum of
his then annual salary under the agreement plus the higher of his last annual
bonus and the highest bonus received during the preceding five years. In
addition, all unvested rights in any stock option or other benefit plans will
vest in full. Mr. Lee will also continue to receive equivalent benefits as were
provided at the date of termination for the remaining term of the agreement.
Mr. Lee may terminate his employment with us at any time for good reason (as
described in his employment agreement) within 180 days after the occurrence of
the good reason event.

Mr. Reidel is a party to an employment agreement effective July 1, 2002 with
us. The agreement is for an indefinite term, except that it automatically
terminates at the end of the month in which Mr. Reidel turns 65 years old. Under
the agreement, Mr. Reidel is to act as chief financial officer and is
responsible for, among other things, the strategic development of Mercer. In
consideration for services provided under the agreement, Mr. Reidel is entitled
to an annual gross salary of E300,000 and options to acquire up to a maximum of
100,000 of our shares, and is entitled to participate in our bonus program. The
agreement may be terminated by either party upon three months' prior written
notice, except that no notice period is required where such termination is for
cause.

INCENTIVE BONUS PLAN

We have adopted an employee incentive bonus plan which provides for the
award of interests in an incentive bonus pool established under the plan to our
trustees, officers and employees. The purpose of the plan is to attract and
retain the services of qualified people and to provide additional incentive to
them by granting them the opportunity to participate in our profits. Under the
plan, up to 5% of our Net Income (as defined in the plan) for each fiscal year
is set aside as a bonus pool. Units in the bonus pool may be granted by our
board of trustees at its discretion to eligible persons during a fiscal year.
The amount payable to a person from the bonus pool equals the percentage of the
total number of units granted during the fiscal year which are held by the
person at the end of the fiscal year.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

C.S. Moon and Michel Arnulphy served as members of the compensation
committee of our board of trustees during the year ended December 31, 2002.
Neither Mr. Moon nor Mr. Arnulphy was one of our officers or employees during
the year ended December 31, 2002, or has formerly been one of our officers.

53

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth information regarding the beneficial
ownership of our shares as of March 21, 2003 by each shareholder who is known by
us to own more than five percent of our outstanding shares. The following is
based solely on statements made in filings with the SEC or other information we
believe to be reliable.

- ------------------------

(1) Filed jointly with Edward C. Johnson III and Abigail P. Johnson.

The following table sets forth information regarding ownership of our shares
as of March 28, 2003 by each of our trustees and all of our trustees and
executive officers as a group. Unless otherwise indicated, each trustee has sole
voting and disposition power with respect to the shares set forth opposite
his name.

- ------------------------

* Less than 1%.

(1) Includes presently exercisable stock options to acquire up to 1,585,000
shares.

(2) Represents presently exercisable stock options.

(3) Includes presently exercisable stock options to acquire up to
33,333 shares.

(4) Includes presently exercisable stock options to acquire up to 1,730,333
shares.

54

The following table sets forth information as at December 31, 2002 regarding
our stock option plan under which options to acquire an aggregate of 3,600,000
of our shares may be granted to our officers and employees, and to our trustees
who are not our officers or employees up to a maximum of 130,000 shares:

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Not applicable.

ITEM 14. CONTROLS AND PROCEDURES

Within 90 days prior to the date of this report, we carried out an
evaluation, under the supervision and with the participation of our principal
executive officer and principal financial officer, of the effectiveness of the
design and operation of our disclosure controls and procedures. Based on this
evaluation, our principal executive officer and principal financial officer
concluded that our disclosure controls and procedures are effective in timely
alerting them to material information required to be included in our periodic
reports on file with the SEC. It should be noted that the design of any system
of controls is based in part upon certain assumptions about the likelihood of
certain events, and there can be no assurance that any design will succeed in
achieving its stated goals under all future conditions, regardless of how
remote. In addition, we reviewed our internal controls, and there have been no
significant changes in our internal controls or in other factors that could
significantly affect those controls subsequent to the date of their
last evaluation.

55

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

56

(2) LIST OF EXHIBITS

3.1 (a) * Restated Declaration of Trust of the Company as filed with
the Secretary of State of Washington on June 11, 1990
together with an Amendment to Declaration of Trust dated
December 12, 1991.
(b) * Amendments to Declaration of Trust dated July 8, 1993;
August 17, 1993; and September 9, 1993.
3.2* Trustees' Regulations dated September 24, 1973.
4.1 Shareholder Rights Plan. Incorporated by reference from
Form 8-A dated August 17, 1993.
10.1 Acquisition Agreement among Treuhandanstalt, Dresden Papier
AG, Dresden Papier Holding GmbH, Mercer
International Inc., and Shin Ho Paper Mfg. Co., Ltd.
Incorporated by reference from Form 8-K dated
September 20, 1993.
10.2 Acquisition Agreement among Treuhandanstalt, Zellstoff-und
Papierfabrik Rosenthal GmbH, Raboisen
Einhundertsechsundfunfzigste Vermogensverwaltungs-
gesellschaft GmbH, to be renamed ZPR Zellstoff-und
Papierfabrik Rosenthal Holding GmbH, Mercer
International Inc. and 448380 B.C. Ltd. dated July 3,
1994. Incorporated by reference from Form 8-K dated
July 3, 1994.
10.3 Amended and Restated 1992 Stock Option Plan. Incorporated by
reference from Form S-8 dated March 2, 2000.
10.4 2002 Employee Incentive Bonus Plan.
10.5* Form of Separation Agreement between Mercer
International Inc. and Arbatax International Inc.
10.6 English Translation of a Loan Agreement in the amount of
DM508,000,000 between Zellstoff-und Papierfabrik
Rosenthal GmbH & Co. KG, Blankenstein on the one hand and
Bayerische Hypotheken-und Wechsel-Bank Aktiengesellschaft,
Munich and Bayerische Vereinsbank Aktiengesellschaft,
Munich on the other hand dated July 6, 1998. Incorporated
by reference from Form 8-K dated July 16, 1998.
10.7 English Translation of Agreement on the obligations of the
shareholders between Mercer International Inc.,
Spezialpapierfabrik Blankenstein GmbH and Zellstoff-und
Papierfabrik Rosenthal Verwaltungs GmbH and Bayerische
Hypo-und Vereinsbank Aktiengesellschaft dated
February 11, 1999.
10.8* Amended and Restated Employment Agreement between Mercer
International Inc. and Jimmy S.H. Lee dated
November 20, 2000.
10.9 English Translation of Amendment Agreement No. 4 dated
December 13, 2000 between Zellstoff-und Papierfabrik
Rosenthal GmbH & Co. KG and Bayerische Hypo-und
Vereinsbank Aktiengesellschaft to the Loan Agreement dated
July 6, 1998. Incorporated by reference from Form 8-K
dated January 23, 2001.
10.10* Purchase Agreement between Sihl and Mercer
International Inc. dated December 14, 2001 relating to
the acquisition of Landqart AG.
10.11 Project Financing Facility Agreement dated August 26, 2002
between Zellstoff Stendal GmbH and Bayerische Hypo-und
Vereinsbank AG. Incorporated by reference from Form 8-K
dated September 10, 2002.
10.12 Shareholders' Undertaking Agreement dated August 26, 2002
among Mercer International Inc., Stendal Pulp
Holdings GmbH, RWE Industrie-Losungen GmbH, AIG Altmark
Industrie AG and FAHR Beteiligungen AG and Zellstoff
Stendal GmbH and Bayerische Hypo-und Vereinsbank AG.
Incorporated by reference from Form 8-K dated
September 10, 2002.
10.13 Shareholders' Agreement dated August 26, 2002 among
Zellstoff Stendal GmbH, Stendal Pulp Holdings GmbH, RWE
Industrie- Losungen GmbH and FAHR Beteiligungen AG.

57

10.14 Loan Agreement dated August 26, 2002 among Babcock & Brown
Investment Management Partners LP, Babcock & Brown
Investment Management Partners LP et. al. and Mercer
International Inc. Incorporated by reference from
Form 8-K dated September 10, 2002.
10.15 Loan Agreement dated August 26, 2002 among MFC Merchant
Bank S.A., MFC Merchant Bank S.A. et. al. and Mercer
International Inc. Incorporated by reference from
Form 8-K dated September 10, 2002.
10.16 Contract for the Engineering, Design, Procurement,
Construction, Erection and Start-Up of a Kraft Pulp Mill
between Zellstoff Stendal GmbH and RWE Industrie-
Losungen GmbH dated August 26, 2002.
10.17 Purchase and Sale Agreement dated December 30, 2002 between
Equitable Industries Limited Partnership and Mercer
International Inc. relating to the sale of Landqart AG.
10.18 Employment Agreement effective July 1, 2002 between ZPR
Zellstoff-und Papierfabrik Rosenthal Holding GmbH and
Maarten Reidel.
10.19 Form of Trustee's Indemnity Agreement between Mercer
International Inc. and its Trustees.
10.20 English Translation of Agreement between Zellstoff-und
Papierfabrik Rosenthal GmbH & Co. KG, Blankenstein a.d.
Saale and Bayerische Hypo-und Vereinsbank AG dated
May 27, 2002.
21 List of Subsidiaries of Registrant.
23 Independent Auditors Consent.
99.1 Certification of Periodic Report.
99.2 Certification of Periodic Report.

-----------------------------

* Filed in Form 10-K for prior years.

(b) REPORTS ON FORM 8-K

The Registrant filed the following reports on Form 8-K with
respect to the indicated items during the fourth quarter of
the fiscal year:

Form 8-K/A dated October 4, 2002:
Item 7. Exhibits

58

INDEPENDENT AUDITORS' REPORT

To the Shareholders
Mercer International Inc.

We have audited the accompanying consolidated balance sheets of Mercer
International Inc. and Subsidiaries as of December 31, 2002 and 2001, and the
related consolidated statements of operations, comprehensive income, changes in
shareholders' equity, and cash flows for the years ended December 31, 2002, 2001
and 2000. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Mercer
International Inc. and Subsidiaries as of December 31, 2002 and 2001, and the
consolidated results of their operations and their cash flows for the years
ended December 31, 2002, 2001 and 2000, in conformity with accounting principles
generally accepted in the United States.

/s/ PETERSON SULLIVAN P.L.L.C.

Seattle, Washington
January 31, 2003

59

MERCER INTERNATIONAL INC.

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 2002 AND 2001
(IN THOUSANDS OF EUROS)

The accompanying notes are an integral part of these financial statements.

60

MERCER INTERNATIONAL INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(IN THOUSANDS OF EUROS, EXCEPT PER SHARE DATA)

The accompanying notes are an integral part of these financial statements.

61

MERCER INTERNATIONAL INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(IN THOUSANDS OF EUROS)

The accompanying notes are an integral part of these financial statements.

62

MERCER INTERNATIONAL INC.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(IN THOUSANDS OF EUROS)

The accompanying notes are an integral part of these financial statements.

63

MERCER INTERNATIONAL INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000

(IN THOUSANDS OF EUROS)

The accompanying notes are an integral part of these financial statements.

64

MERCER INTERNATIONAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Mercer International Inc. ("the Company") is a business trust organized
under the laws of the State of Washington, U.S. Under Washington law,
shareholders of a business trust have the same limited liability as shareholders
of a corporation. The Company produces and markets pulp and paper products. The
amounts in the notes are rounded to the nearest thousand except for the per
share amounts.

BASIS OF PRESENTATION

The consolidated financial statements include the accounts of the Company's
subsidiaries, Dresden Papier GmbH, Papierfabrik Fahrbrucke GmbH, Spezial
Papierfabrik Blankenstein GmbH, Zellstoff-und Papierfabrik
Rosenthal GmbH & Co., KG and Zellstoff Stendal GmbH. Investments in entities
where the Company owns at least a 20% voting interest, but does not have
control, are accounted for under the equity method. The amount of earnings from
equity investees was not material. Significant intercompany accounts and
transactions have been eliminated.

CASH AND CASH EQUIVALENTS

Cash and cash equivalents include highly liquid investments with original
maturities of three months or less. The Company maintains cash balances in
foreign financial institutions in excess of insured limits.

At December 31, 2002, E9,459 in cash was restricted by a lender to pay
construction in progress costs payable. In addition, the Company had E38,795 of
long-term restricted cash representing debt service reserve accounts required by
long-term debt agreements.

INVESTMENTS

The Company's available-for-sale and trading securities are stated at their
fair values. Realized gains or losses of investments are included in the results
of operations. Any unrealized holding gains or losses for trading securities are
included in the results of operations. Any unrealized gains or losses for
available-for-sale securities are reported as a separate component of
comprehensive income until realized. If a loss in value in available-for-sale
securities is considered to be other than temporary, it is recognized in the
determination of net income. Cost is based on the specific identification method
to determine realized gains or losses.

The Company uses the equity method to account for an investment when it has
the ability to significantly influence the investee's operating and financial
policies. Under the equity method, the investment is initially recorded at cost,
then reduced by dividends and increased or decreased by the Company's
proportionate share of the investee's net earnings or loss.

INVENTORIES

Inventories of pulp are stated at the lower of cost (average-cost method) or
market. Paper products are stated at the lower of cost (first-in, first-out
method) or market.

PROPERTIES

Properties are stated at cost less accumulated depreciation, unless the
estimated future undiscounted cash flows expected to result from either the use
of an asset or its eventual disposition is less than its

65

MERCER INTERNATIONAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
carrying amount in which case an impairment loss is recognized based on the fair
value of the asset. Grants received from a government reduce cost of property
improvements.

Depreciation of buildings and production equipment is based on the estimated
useful lives of the assets and is computed using the straight-line method.
Buildings are depreciated over 10 to 50 years and production equipment over 8 to
20 years. Repairs and maintenance are charged to expense as incurred.
Expenditures for new facilities and those expenditures that substantially
increase the useful lives of existing properties are capitalized, as well as
interest costs associated with major capital projects until ready for their
intended use.

FOREIGN OPERATIONS AND CURRENCY TRANSLATION

The Company translates foreign assets and liabilities of its subsidiaries,
other than those not denominated in Euros, at the rate of exchange at the
balance sheet date. Revenues and expenses are translated at the average rate of
exchange throughout the year. Gains or losses from these translations are
reported as a separate component of other comprehensive income (loss), until all
or a part of the investment in the subsidiaries is sold or liquidated. The
translation adjustments do not recognize the effect of income tax because the
Company expects to reinvest the amounts indefinitely in operations.

Transaction gains and losses that arise from exchange rate fluctuations on
transactions denominated in a currency other than the local functional currency
are included in "General, administrative and other" in the statement of
operations, which amounted to E(3,026), E3,361 and E(355) for the years ended
December 31, 2002, 2001 and 2000, respectively.

Effective January 1, 2002, the Company changed its reporting currency from
the U.S. dollar to the Euro (except for currency amounts as contractually
required). The reason for this change was because a significant majority of the
Company's assets and operations are located in Germany where the currency is the
Euro. The Company's functional currency and reporting currency are now the same.
Prior years' financial statements had been reported in U.S. dollars, but have
been restated into Euros using the guidance of Statement of Financial Accounting
Standards No. 52, "Foreign Currency Translation." Therefore, the financial
statements for prior years depict the same trends as the previous financial
statements presented in U.S. dollars.

The Euro was initially implemented by the European Union on January 1, 1999.
By adopting the Euro as the Company's reporting currency, most of the cumulative
foreign currency translation losses were eliminated from the Company's balance
sheets and most of the foreign currency translation losses were eliminated from
the Company's statements of comprehensive income. Prior to the restatement, at
December 31, 2001, there was a cumulative foreign currency translation loss of
$64,016 (in thousands of U.S. dollars) included as part of shareholders' equity
in the balance sheet. In conjunction with the restatement, the majority of this
amount was eliminated. During the years ended December 31, 2001 and 2000, there
were foreign currency translation losses of $7,687 and $6,400 (in thousands of
U.S. dollars), respectively, included as part of other comprehensive income
(loss). In conjunction with the restatement, the majority of these amounts were
eliminated.

REVENUE AND RELATED COST RECOGNITION

The Company recognized revenue from product sales when the sales price is
fixed or determinable, title of ownership and risk of loss have passed to the
customer and collectibility is reasonably assured. Sales

66

MERCER INTERNATIONAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
are reported net of discounts and allowances. Amounts charged to customers for
shipping and handling are recognized as revenue. Shipping and handling costs
incurred by the Company are included in cost of sales.

ENVIRONMENTAL CONSERVATION

Liabilities for environmental conservation are recorded when it is probable
that obligations have been incurred and the amounts can be reasonably estimated.
Any potential recoveries of such liabilities are recorded when there is an
agreement with the reimbursing entity.

STOCK-BASED COMPENSATION

The Company has a stock-based employee compensation plan, which is described
more fully in Note 11. The Company accounts for the plan under the recognition
and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued
to Employees," and related interpretations. No stock-based employee compensation
cost is reflected in net income, as all options granted under the plan had an
exercise price equal to or greater than the market value of the underlying
common stock on the date of grant. The following table illustrates the effect on
net income and earnings per share if the Company had applied the fair value
recognition provisions of Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation," to stock-based employee compensation.

TAXES ON INCOME

The Company accounts for income taxes under an asset and liability approach
that requires the recognition of deferred tax assets and liabilities for
expected future tax consequences of events that have been recognized in the
Company's financial statements or tax returns. In estimating future tax
consequences, the Company generally considers all expected future events other
than enactments of changes in the tax laws or rates.

67

MERCER INTERNATIONAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
DERIVATIVE FINANCIAL INSTRUMENTS

The Company 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 consolidated balance sheets as assets or liabilities. Accounting for
gains or losses depends on the Company's 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 such gains or losses are recognized in either
earnings or other comprehensive income.

EARNINGS PER SHARE

Basic earnings per share is computed by dividing income available to common
shareholders by the weighted average number of common shares outstanding in the
period. Diluted earnings per share takes into consideration common shares
outstanding (computed under basic earnings per share) and potentially dilutive
common shares.

RECLASSIFICATIONS

Certain prior year amounts in the consolidated financial statements have
been reclassified to conform to the current year presentation (primarily in the
consolidated statements of operations because management has determined that the
2002 presentation better portrays operating results).

ESTIMATES

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.

NEW ACCOUNTING STANDARDS

Statements of Financial Accounting Standards No. ("SFAS") 145 and 146 are
generally modifications to previously adopted standards. A part of SFAS 145 is
effective for years beginning after May 15, 2002, and SFAS 146 is effective for
years beginning after December 31, 2002. These new standards do not have an
effect on the Company's consolidated financial statements.

68

MERCER INTERNATIONAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 2. INVESTMENTS

Trading securities are classified as current investments and are summarized
as follows:

Included within trading securities at December 31, 2002, is an investment in
common shares of one company that represents 95% of the total value of trading
securities. Included within trading securities at December 31, 2001, are
investments in a bond and common shares of two companies that represent 53% of
the total value of trading securities. The change in net unrealized holding
gains (losses) on trading securities which has been included in earnings was
E(501), E1,383 and E(186) during 2002, 2001 and 2000, respectively.

Available-for-sale securities consist of equity securities and have been
classified as long-term investments. Equity securities of two companies
represented 98% and 85% of the total available-for-sale securities at
December 31, 2002 and 2001, respectively. The proceeds from sales of these
securities amounted to E948, none and E205 which resulted in realized gains
(losses) of E66, none and E(84) during 2002, 2001 and 2000, respectively. The
fair value of available-for-sale securities included on the balance sheets at
December 31, 2002, 2001 and 2000, was E4,727, E8,202 and E5,585, respectively.
The cost of these securities was E13,033, E13,727 and E12,991 which resulted in
unrealized losses being recorded in comprehensive income of E(8,306), E(5,525)
and E(7,406) at December 31, 2002, 2001 and 2000, respectively. Also, included
in long-term investments were equity securities stated at cost of E865 and E396
at December 31, 2002 and 2001, respectively, which did not have a readily
determinable fair value. However, management believes that the estimated market
value is greater than the carrying value.

NOTE 3. RECEIVABLES

Receivables are stated at their outstanding principal balances. The Company
had a long-term note receivable at December 31, 2001, on which interest income
was accrued as earned. This note was used to reduce debt during 2002. Management
reviews the collectability of receivables on a periodic basis and determines the
appropriate amount of any allowance. Based on this review procedure, management
has determined that any allowance would not be material at either December 31,
2002 or 2001. The Company

69

MERCER INTERNATIONAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 3. RECEIVABLES (CONTINUED)
charges off receivables to any allowance when management determines that a
receivable is not collectible. The Company does not generally require collateral
for any of its receivables.

At December 31, 2001, the Company pledged E14,137 in securities trading
receivables as collateral, for amounts payable for securities.

NOTE 4. INVENTORIES

NOTE 5. PROPERTIES

Construction in progress represents the costs incurred (including E3,134 of
debt interest capitalized in 2002) to build a 552,000 tonne softwood kraft pulp
mill located in Stendal, Germany. A subsidiary that is owned 63.6% by the
Company is building the mill and will operate it on completion. Management
estimates the total cost of the mill will be E1,000,000. Under German
legislation, non-repayable grants are provided to qualifying businesses that
comply with the terms of the grants and are operating in eastern Germany to
finance capital investments. Management expects to receive these government
grants and when received, they will reduce the overall cost. The Company has
applied for approximately E38,000 in construction grants which are expected to
be received prior to the end of 2003.

70

MERCER INTERNATIONAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 6. NOTES PAYABLE

At December 31, 2002, the Company has a note payable to a financial
institution in the amount of E15,000 relating to the Company's investment in the
Stendal pulp mill project, interest rate at Euribor plus 6.5% in initial term
(9.75% at December 31, 2002), Euribor plus 9.0% in extended period and Euribor
plus 11.5% in second extended period; principal plus interest due April 26,
2003, or at the Company's option on October 26, 2003 (extended period) or at the
lender's option on February 26, 2004 (second extended period); secured by an
interest in the Company's operating pulp mill.

The Company also has notes payable to banks of E832 and E7,392 at
December 31, 2002 and 2001, respectively. The notes bear interest at rates
ranging from 6.75% to 7%.

NOTE 7. LONG-TERM DEBT

Long-term debt consists of the following:

71

MERCER INTERNATIONAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 7. LONG-TERM DEBT (CONTINUED)

The Company has entered into interest rate and foreign exchange derivative
contracts in connection with the first three notes payable in the table above.
The contracts were entered into consistent with the Company's policy to manage
interest rate and foreign currency exchange risks. The contracts are with the
same banks which hold the notes and the Company does not anticipate
nonperformance by the banks. At December 31, 2002 and 2001, the interest rate
contracts had a notional amount of E1,614,157 and none, and the foreign exchange
contracts had a notional amount of E101,413 and E225,723, respectively. The
change in the fair value of these contracts is included in net income (loss).

72

MERCER INTERNATIONAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 7. LONG-TERM DEBT (CONTINUED)
As of December 31, 2002, the principal maturities of long-term debt are as
follows:

Interest paid amounted to E13,894 (net of E922 capitalized) in 2002, E15,854
in 2001 and E12,451 in 2000.

NOTE 8. ACCOUNTS PAYABLE AND ACCRUED EXPENSES

73

MERCER INTERNATIONAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 9. INCOME TAXES

The provision for income taxes is current and consists of the following:

Differences between the U.S. Federal Statutory and the Company's effective
rates are as follows:

Deferred tax assets are composed of the following:

During 2002, the Company instituted a plan to reorganize its German
subsidiaries. As a part of the plan, the German tax basis of the Company's
operating pulp mill will be increased to the extent of available German tax loss
carryforwards. The reorganization together with other adjustments resulted in a
reduction of losses being carried forward from December 31, 2001. Further, the
Company is the subject of income tax audits in Germany on a continuing basis
which may result in changes to the amounts in the preceding table. Because of
this and other uncertainties regarding future amounts of taxable income in
Germany, the Company has provided a valuation reserve for much of the German
deferred tax assets. However, management believes that, while realization of the
net deferred tax asset in Germany is not assured, it is more likely than not
that it will be realized. At December 31, 2002, the Company has no significant
German tax loss carryforward amount.

74

MERCER INTERNATIONAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 9. INCOME TAXES (CONTINUED)
The Company's U.S. net operating losses amount to approximately E16,000 at
December 31, 2002, which will expire in years ending in 2021, if not used.
Management believes that these tax loss carryforwards are not likely to be
utilized under current circumstances and has fully reserved any resulting
potential tax benefit. Further, the Company fully reserved any tax benefit which
resulted from the Swiss tax loss carryforwards in 2001 because of uncertainties
as to their use. There were no Swiss tax loss carryforwards at
December 31, 2002.

Income (loss) from foreign source operations amounted to E(3,275), E2,366
and E32,749 for the years ended December 31, 2002, 2001 and 2000, respectively.
These amounts are intended to be indefinitely reinvested in operations. Since
available-for-sale securities are primarily securities held by foreign
subsidiaries and the proceeds are expected to be reinvested, no tax has been
provided in the determination of other comprehensive income for the years ended
December 31, 2002, 2001 and 2000.

NOTE 10. SHAREHOLDERS' EQUITY

In a prior year, the Company issued one attached preferred share purchase
right for each outstanding share of beneficial interest. A total of 11,958,993
rights were issued which allow the holder to acquire from the Company one
one-hundredth of a share of Series A Junior Participating Preferred Stock at a
price of U.S. $75 per one one-hundredth of a preferred share. The rights will
expire on December 31, 2003. The Company has the right to repurchase the rights
for U.S. $.01 each.

The Company has reserved 110,000 Series A Junior Participating Preferred
Shares in connection with the rights. The preferred shares are entitled to
quarterly dividends of U.S. $10 per share and have 100 votes per share. However,
the preferred shares will be entitled to an aggregate dividend of 100 times any
dividends declared on shares of beneficial interest and an aggregate of 100
times any payment to shares of beneficial interest on merger or liquidation.

Also, during a prior year, the Company authorized the issuance of
3.5 million shares of Cumulative Retractable Convertible Preferred Shares,
Series B at a price of U.S. $20 per share. These shares have a cumulative
dividend rate of up to 4%, a liquidation preference of $20 per share plus unpaid
dividends, a redemption right beginning January 1, 2004, at $20 per share plus
unpaid dividends, and may convert up to 10% of the issued and outstanding shares
into shares of beneficial interest based on dividing the issue price plus unpaid
dividends by $20 per share.

NOTE 11. STOCK-BASED COMPENSATION

The Company has a non-qualified stock option plan which provides for options
to be granted to officers and employees to acquire a maximum of 3,600,000 shares
of beneficial interest including options for 130,000 shares to trustees who are
not officers or employees.

During 2002, options to acquire 18,000 shares of beneficial interest at
U.S. $7.46 per share were granted to trustees of the Company which vest
one-third at the grant date and one-third each of the next two years. The
options expire in ten years. The weighted fair value of these options was
U.S. $2.07 each. The options granted to one trustee expired upon his resignation
in 2002.

During 2000, options to acquire 1,600,000 shares of beneficial interest at
U.S. $6.375 per share were granted to officers and employees of the Company
which vest one-third at grant date and one-third each

75

MERCER INTERNATIONAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 11. STOCK-BASED COMPENSATION (CONTINUED)
for the next two years. These options expire in ten years. The weighted fair
value of these options was U.S. $3.60 each.

Following is a summary of the status of the plan during 2002, 2001 and 2000:

Following is a summary of the status of options outstanding at December 31,
2002:

The fair value of each option granted is estimated on the grant date using
the Black Scholes Model. The assumptions used in calculating fair value are as
follows:

76

MERCER INTERNATIONAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 12. EARNINGS PER SHARE

Earnings per share data for years ended December 31 is summarized as
follows:

For 2002 and 2001, options and warrants were not included in the computation
of diluted earnings per share because they were anti-dilutive. Warrants were not
dilutive in 2000.

NOTE 13. BUSINESS SEGMENT INFORMATION

The Company operates in two reportable business segments: pulp and paper.
The segments are managed separately because each business requires different
production and marketing strategies.

The pulp segment consists of a single operating mill located in Germany
which produces and markets kraft pulp. The paper segment consists of two mills
located in Germany and one located in Switzerland. The Swiss mill was acquired
in December 2001, and its results of operations are included for 2002.

Both segments operate in industries which are cyclical in nature and their
markets are affected by fluctuations in supply and demand in each cycle. These
fluctuations have significant effect on the cost of materials and the eventual
sales prices of products.

77

MERCER INTERNATIONAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 13. BUSINESS SEGMENT INFORMATION (CONTINUED)
Summarized financial information concerning the segments is shown in the
following table:

78

MERCER INTERNATIONAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 13. BUSINESS SEGMENT INFORMATION (CONTINUED)

Income (loss) from operations stated above does not include any allocation
of corporate general, administrative and other expenses.

The following table presents net sales to external customers by geographic
area based on location of the customer.

79

MERCER INTERNATIONAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 13. BUSINESS SEGMENT INFORMATION (CONTINUED)
The following table presents total assets by geographic area based on
location of the asset.

The Company also had labor agreements which expired on December 31, 2002.
The Company is in negotiations with the employee union on a new labor agreement.
In 2002, pulp sales to one customer amounted to 12% of total pulp sales, pulp
sales to two customers amounted to 22% in 2001, and pulp sales to one customer
amounted to 27% in 2000.

NOTE 14. FAIR VALUE OF FINANCIAL INSTRUMENTS

The fair value of other financial instruments at December 31 is summarized
as follows:

The fair value of cash and cash equivalents is based on reported market
value. The fair value of cash restricted was equal to its carrying amount
because it is in an account which bears a market rate of interest. The value of
the note receivable is based on the value of similar long-term receivables. The
fair value of notes payable was based on the value of similar debt incurred in
the pulp industry. The fair value of long-term debt was determined using
discounted cash flows at prevailing market rates. The other long-term
liabilities which have a carrying value of E2,906 and E3,441 at December 31,
2002 and 2001, respectively, are primarily an accrued environmental liability at
the pulp mill. This liability may be partially reimbursable. Further, the
Company cannot estimate at this time when these amounts will be paid. Therefore,
the fair value of other long-term liabilities cannot be determined. The fair
values of the interest rate and foreign currency exchange contracts are obtained
from dealer quotes. These values represent the estimated amount the Company
would receive or pay to terminate agreements taking into consideration current
interest rates, the creditworthiness of the counterparties and current foreign
currency exchange rates.

80

MERCER INTERNATIONAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 15. COMMITMENTS AND CONTINGENCIES

At December 31, 2002 and 2001, the Company recorded a liability for
environmental conservation expenditures of E2,309 and E2,046, respectively.
Management believes the liability amount recorded is sufficient, however, future
regulations in Germany may result in additional liability.

The Company is required to pay certain charges based on water pollution
levels at its mills. Unpaid charges can be reduced by investing in qualifying
equipment that results in less water pollution. The Company believes that
equipment investments already made will offset most of these charges, but it has
not received final determination from the appropriate authorities. Accordingly,
a liability for these water charges has only been recognized to the extent that
equipment investments have not been made.

As provided in a purchase agreement for a subsidiary company in a prior
year, the Company may be required to pay up to an additional E2,241 based on
profitability criteria being met during the period January 1 through
September 30, 2003. The purchase agreement also requires additional payments
based on any sales of the subsidiary's real estate assets. At December 30, 2002,
the Company exchanged its 80% interest in this subsidiary for a 49% interest in
Equitable Industries Limited Partnership ("Equitable") (resulting in a 39%
indirect interest in the subsidiary) which represents the equity method
investments on the December 31, 2002, consolidated balance sheet. The Company
recorded this exchange based on the carrying value of the subsidiary resulting
in no gain or loss being recorded. The exchange agreement provides that the
Company is to be indemnified by Equitable if any of the contingent payments are
to be made. This was treated as a nonmonetary transaction in 2002; there were no
significant nonmonetary transactions in 2001 and 2000.

The Company is involved in various matters of litigation arising in the
ordinary course of business. In the opinion of management, the estimated outcome
of such issues will not have a material effect on the Company's financial
statements.

81

MERCER INTERNATIONAL INC.

SUPPLEMENTARY FINANCIAL INFORMATION (UNAUDITED)

QUARTERLY FINANCIAL DATA
(THOUSANDS, EXCEPT PER SHARE AMOUNTS)

- ------------------------

* on a diluted basis

(1) The Company acquired its specialty paper mill in Landqart, Switzerland
effective December 2001 and sold it effective December 2002. The amounts for
2002 include the results from the Landqart mill, while the amounts for 2001
do not include the results from the Landqart mill.

82

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the SECURITIES
EXCHANGE ACT OF 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

MERCER INTERNATIONAL INC.

By: /s/ JIMMY S.H. LEE
-----------------------------------------
Jimmy S.H. Lee
Dated: March 28, 2003 Chairman

Pursuant to the requirements of the SECURITIES EXCHANGE ACT OF 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

/s/ JIMMY S.H. LEE
-------------------------------------------
Jimmy S.H. Lee
Chairman, Chief Executive Officer and Trustee Date: March 28, 2003

/s/ MICHEL ARNULPHY
-------------------------------------------
Michel Arnulphy Date: March 28, 2003
Trustee

/s/ C.S. MOON
-------------------------------------------
C.S. Moon Date: March 28, 2003
Trustee

/s/ MAARTEN REIDEL
-------------------------------------------
Maarten Reidel Date: March 28, 2003
Chief Financial Officer and Trustee

/s/ WILLIAM MCCARTNEY
-------------------------------------------
William McCartney Date: March 28, 2003
Trustee

/s/ GRAEME WITTS
-------------------------------------------
Graeme Witts Date: March 28, 2003
Trustee

/s/ JONG L. RYU
-------------------------------------------
Jong L. Ryu Date: March 28, 2003
Trustee

83

CERTIFICATION OF PERIODIC REPORT

I, Jimmy S.H. Lee, certify that:

1. I have reviewed this annual report on Form 10-K of Mercer
International Inc. (the "Registrant");

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the Registrant as of, and for, the periods presented in this annual report;

4. The Registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and have:

(a) designed such disclosure controls and procedures to ensure that material
information relating to the Registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;

(b) evaluated the effectiveness of the Registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and

(c) presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of
the Evaluation Date;

5. The Registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the Registrant's auditors and the audit
committee of the Registrant's board of directors (or persons performing the
equivalent functions):

(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Registrant's ability to record,
process, summarize and report financial data and have identified for the
Registrant's auditors any material weaknesses in internal controls; and

(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the Registrant's internal
controls; and

6. The Registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.

/s/ JIMMY S.H. LEE
---------------------------------------------
Jimmy S.H. Lee
Date: March 28, 2003 Chief Executive Officer

84

CERTIFICATION OF PERIODIC REPORT

I, Maarten Reidel, certify that:

1. I have reviewed this annual report on Form 10-K of Mercer
International Inc. (the "Registrant");

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the Registrant as of, and for, the periods presented in this annual report;

4. The Registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and have:

(a) designed such disclosure controls and procedures to ensure that material
information relating to the Registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;

(b) evaluated the effectiveness of the Registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and

(c) presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of
the Evaluation Date;

5. The Registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the Registrant's auditors and the audit
committee of the Registrant's board of directors (or persons performing the
equivalent functions):

(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Registrant's ability to record,
process, summarize and report financial data and have identified for the
Registrant's auditors any material weaknesses in internal controls; and

(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the Registrant's internal
controls; and

6. The Registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.

/s/ MAARTEN REIDEL
---------------------------------------------
Maarten Reidel
Date: March 28, 2003 Chief Financial Officer

85

EXHIBIT INDEX

- ------------------------

* Filed in Form 10-K for prior years.