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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

For the fiscal year ended December 31, 2003

OR

For the transition period from                                to                               

Commission File No.: 0-9409

MERCER INTERNATIONAL INC.

Exact name of Registrant as specified in its charter

14900 Interurban Avenue South, Suite 282, Seattle, Washington, 98168
Address of Office

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

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

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

Shares of beneficial interest, $1.00 par value
Preferred Stock Purchase Rights
Title of Class

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

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

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

        The aggregate market value of the Registrant's voting stock held by non-affiliates of the Registrant as of June 30, 2003, 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 $75,093,300.

        As of March 10, 2004, the Registrant had 17,174,566 common shares of beneficial interest, $1.00 par value, outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

        Certain information that will be contained in the definitive proxy statement for the Registrant's annual meeting to be held in 2004 is incorporated by reference into Part III of this Form 10-K.

TABLE OF CONTENTS

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FORWARD-LOOKING STATEMENTS

        This annual report contains "forward-looking statements". They can be identified by words such as "estimates", "projects", "scheduled", "anticipates", "expects", "intends", "plans", "will", "should", "believes", or their negatives or other comparable words. These statements are subject to a number of risks and uncertainties including the risks and uncertainties outlined under "Cautionary Statement Regarding Forward-Looking Information" in "Management's Discussion and Analysis of Financial Condition and Results of Operations", many of which are beyond our control. We wish to caution the reader that these forward-looking statements are only estimates or predictions, such as statements regarding:

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development of our business;



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demand and prices for our products; and



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future capital expenditures.

        We do not undertake any obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise. Although we believe that our plans, intentions and expectations reflected in or suggested by the forward-looking statements we make in this annual report are reasonable, we can give no assurance that such plans, intentions or expectations will be achieved. Actual events or results may differ materially due to risks facing us or due to actual facts differing from the assumptions underlying our predictions. Some of these risks and assumptions include:

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our level of indebtedness;



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the cyclical nature of our business;



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our ability to fully implement our business plan with relation to the development and expansion of our operations as planned, including our Stendal mill under construction;



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our exposure to interest rate and currency exchange rate fluctuations;



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our use of derivatives;



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fluctuations in the price and supply of our raw materials;



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our ability to respond to increasing competition;



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environmental legislation;



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our ability to negotiate acceptable agreements with our employees;



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our dependence upon key personnel; and



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other regulatory, legislative and judicial developments,

any of which could cause actual results to vary materially from anticipated results.

        We advise the reader that these cautionary remarks expressly qualify in their entirety all forward-looking statements attributable to us or persons acting on our behalf. Important factors that you should also consider, include, but are not limited to, the factors discussed below under "Cautionary Statement Regarding Forward-Looking Information" in "Management's Discussion and Analysis of Financial Condition and Results of Operations".

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EXCHANGE RATES

        As of January 1, 2002, we changed our reporting currency from the U.S. dollar to the Euro, as a significant majority of our business transactions are originally denominated in Euros. Accordingly, our financial statements for the years ended December 31, 2002 and 2003 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 (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:

        On March 10, 2004, the Noon Buying Rate for the conversion of U.S. dollars to Euros was €0.8179 per U.S. dollar.

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PART I

ITEM 1.    BUSINESS

        In this document, please note the following:

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



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



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information is provided as of December 31, 2003, unless otherwise stated;



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



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"€" refers to Euros; "CDN" refers to Canadian dollars; 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 1,022 people.

        We own and operate a modern, efficient ISO 9002 certified pulp mill (the "Rosenthal mill") that produces northern bleached softwood kraft ("NBSK") pulp. It has an annual production capacity of approximately 300,000 tonnes. Located near Blankenstein, the mill is currently the only producer of market kraft pulp in Germany. Our existing pulp operations are conducted through Zellstoff-und Papierfabrik Rosenthal GmbH & Co., KG and its affiliates ("Rosenthal"), which are our wholly-owned subsidiaries.

        Our 63.6% owned project subsidiary, Zellstoff Stendal GmbH ("Stendal"), is implementing a "greenfield" project (the "Stendal project") to construct a new state-of-the-art single-line NBSK kraft pulp mill (the "Stendal mill"). The Stendal mill is designed to have an annual production capacity of approximately 552,000 tonnes and is under construction near the town of Stendal, Germany, approximately 300 kilometers north of the Rosenthal mill.

        We also own and operate two paper mills located at Heidenau and Fährbrücke, Germany (the "paper mills") that produce specialty papers and printing and writing papers. The paper mills, based upon their current product mix, have an aggregate annual production capacity of approximately 70,000 tonnes. Our paper operations are conducted through Dresden Papier GmbH and its affiliates ("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 pulp and paper operations beginning in 1993.

        Over the last five years, we have expended an aggregate of approximately €337.0 million on capital investments at our pulp and paper mills, not including the Stendal project, to increase production capacities, improve efficiencies, reduce effluent discharges and emissions and modernize the mills. Such capital investments were financed in large part through government guaranteed term financing and government grants of approximately €94.2 million. For more information about these grants, see "Business — Government Financing".

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        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 €361.0 million.

        We completed financing arrangements and commenced construction of the Stendal mill in August 2002. We estimate that the Stendal project will cost approximately €1.0 billion and the Stendal mill 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".

        Commencing in 1998, we 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 €17.9 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 Fährbrücke paper mills as they principally produce niche products.

        We reorganized our interest in Landqart AG ("Landqart"), which owns a specialty paper mill in Switzerland, at the end of 2002 by transferring 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. See "Business — Our Products — Paper" and "Certain Relationships".

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:

(1)

The Stendal mill is under construction.

(2)

Managed and operated by Dresden.

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Corporate Strategy

        Our corporate strategy is to create shareholder value within the context of a long-term, inclusive stakeholder approach. We expect to pursue focused expansion of our asset and earnings base through acquisitions primarily in Europe and North America and through organic growth. We seek to acquire interests in companies and assets in the pulp and paper industry and related businesses where we can leverage our experience and expertise in adding value through a focused management approach. We pursue organic growth through focused capital expenditures designed to produce a high return by increasing production, reducing costs and improving quality.

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 species of hardwood contain shorter fibers which lend bulk and opacity. NBSK pulp, which is kraft pulp manufactured using species of northern softwood, is a premium grade because of its relative strength. It generally obtains the highest price relative to other kraft pulps. Southern bleached softwood kraft pulp is kraft pulp manufactured using southern softwood species and does not possess the strength found in NBSK pulp. NBSK pulp is the 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. Generally, 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. Although demand is cyclical and has weakened during the recent global economic slowdown, demand for bleached market pulp has been growing over the long-term at an average rate of approximately 3% annually worldwide and approximately 2% annually in Europe. The growth rate for demand for NBSK pulp reflects similar trends.

        Approximately 14 million tonnes of market pulp is consumed in Europe annually, of which approximately 6.3 million tonnes is comprised of NBSK pulp. Within Europe, Germany is the largest pulp market and consumes approximately five million tonnes of market pulp annually relying largely on imports from North America and Scandinavia. 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

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"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 was approximately 93% in 2003, 92% in 2002 and 90% in 2001. 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 list pulp prices. Kraft list pulp prices are quoted in U.S. dollars. Historically, kraft list pulp prices have been cyclical in nature. The average annual list prices for NBSK pulp between 1990 and 2003 ranged 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 ("Norscan") producers grew to over 2.5 million tonnes by early 1996. Norscan producers currently produce a majority of the market NBSK pulp sold in North America and Europe and inventory levels held by Norscan producers are considered an industry benchmark in determining industry inventory levels. Between 1996 and 1999, list pulp prices remained relatively low due in part to the Asian financial crisis which began in late 1997.

        Prices started to recover in 1999 due to a combination of factors including a recovery in the Asian economy, the shutdown of unprofitable mills or older mills in need of environmental upgrades and a decline in capacity expansion. This contributed to tightening inventory levels among Norscan producers, which fell to approximately 1.1 million tonnes in June 2000, resulting in list 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 list price levels eroded to an average of approximately $460 per tonne in late 2001. Norscan inventory levels ranged between approximately 1.3 million and 1.9 million tonnes in 2002, and list prices averaged approximately $463 per tonne in 2002. Although Norscan inventory levels remained relatively high in 2003, the weakening of the U.S. dollar against the Euro and other major currencies and increased demand resulting from improving American and major European economies lead to higher list prices for kraft pulp. Norscan inventory levels were approximately 1.8 million tonnes in December 2003 and list prices for kraft pulp in Europe increased to approximately $560 per tonne in December 2003. A continued recovery in the global economy in early 2004 and the weak U.S. dollar resulted in producers increasing list prices for kraft pulp to approximately $590 per tonne in February 2004. A further price increase of $10 to $20 per tonne has been announced by various pulp producers for March 2004. There can be no assurance that any such increase will be implemented or, if implemented, that prices will not fall in ensuing months.

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The Manufacturing Process

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

        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.

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

The Paper Industry

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

        We produce principally specialty papers and printing and writing papers. The specialty papers that we produce are comprised of coated and uncoated wallpaper base, non-woven wallpaper base, pre-impregnated décor 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. Non-woven wallpapers are the fastest growing category of wallpaper and are generally sold at a premium to standard wallpaper. Demand for non-woven wallpaper in Europe in 2003 generally increased while demand for standard wallpaper generally decreased due to overcapacity in western Europe.

        Décor papers are used in laminate flooring, interior panels, furniture and other applications to provide a decorative surface. Décor papers can be pre-impregnated with an agent to provide extra strength. Demand for décor 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 décor paper have grown faster than the décor paper market. The main markets for décor paper are in Europe. Demand for décor papers in Europe, and Germany in particular, in 2003 generally remained at 2002 levels.

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

        Printing and writing papers which we produce consist of only uncoated woodfree papers. Woodfree papers generally contain less than 10% mechanical pulp. Uncoated woodfree papers can be finished to enhance their surface and are often used to print less costly products. In 2003, while markets in western Europe for printing and writing papers, including for uncoated woodfree papers, improved marginally over 2002, they remained at historically low levels.

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 pulpwood in Germany are primarily affected by the supply and demand for lumber. In 2003, the Rosenthal mill consumed approximately 1.7 million cubic meters of fiber. Approximately 66%, or approximately 1.1 million cubic meters, of such consumption was in the form of sawmill wood chips. The balance of approximately 34%, or approximately 0.6 million cubic meters, was in the form of pulpwood.

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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 50 trucks, handled approximately 50% of our wood chip deliveries to the mill in 2003. 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. In 2003, we entered into a three-year agreement with one of our existing wood chip suppliers for the supply of approximately 500,000 cubic meters of wood chips annually until 2006. 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 principally procured by SCA Holz, a large wood supply company. Our agreement with SCA Holz expired in April 2003 and was not renewed. We have organized our own internal wood procurement department to handle and source the fiber requirements for the Rosenthal mill. Five people are employed in the department. The department also assisted in sourcing fiber for the start-up of the Stendal mill. We expect to coordinate the fiber procurement for the Rosenthal and Stendal mills in the future. Handling our own fiber procurement slightly reduced our operating costs in 2003 due to the elimination of fees paid to the previous supplier.

        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 3.0 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 2003, Stendal commenced putting into place definitive fiber supply arrangements similar to those of the Rosenthal mill. We have arranged for almost all of the fiber requirements for the Stendal mill for 2004.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.

        Stendal has established its own wood procurement organization to handle the fiber requirements for the Stendal mill. Currently, there are approximately 43 people employed in this division. This division focuses on three principal activities, being wood procurement and sales, harvesting, and transportation. The procurement and sales main activity is to procure the required wood chip and 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

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to optimize the fiber mix. We expect these activities to employ up to 17 people. The harvesting activities focus on acquiring up to approximately 800,000 cubic meters per annum of harvestable timber, of which approximately 75% is expected to be pulpwood and the balance likely to be higher quality logs that could be sold or traded to third parties for wood chips. We expect that approximately 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 57 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 39 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 2003, approximately 84.6%, or approximately 64,036 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 15.4%, or approximately 11,621 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 Pulp Cash Production Costs

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

(1)

Pulp segment cost of sales less depreciation, shipping and handling costs.

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-fibered softwood pulp produced by a sulphate cooking

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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 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 41% at the end of 2003.

        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 is scheduled to 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. This will result in a complementary product more suitable for different end uses. The Stendal mill is also designed to 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 décor paper primarily to specialist converters serving furniture and interior accessories, such as doors and panels, 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.

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

        We reorganized our interest in the Landqart specialty paper mill at the end of 2002 by transferring a 20% interest to a Swiss bank and exchanging the other 80% interest for a 49% interest in a limited partnership on a non-cash basis. This resulted in our having a 39% indirect interest in Landqart. We reduced our Landqart stake to prioritize our available capital and resources on Stendal because of our obligation to repay or refinance the two bridge loans obtained in connection with the financing arrangements for Stendal, and poor capital market conditions. The reorganization has allowed the management of Landqart to focus on its operations and financial requirements without regard to our other operations. The Swiss bank had agreed to reduce and refinance a portion of Landqart's debt in consideration of the equity stake, and was in a better position to assist Landqart in securing the funds necessary to make the required capital investment in the Landqart mill. See "Certain Relationships".

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:

(1)

Excluding intercompany sales volumes of 5,527, 10,768 and 10,447 tonnes of pulp and intercompany net sales revenues of €2.3 million, €4.9 million and €5.8 million for the years ended December 31, 2003, 2002 and 2001, respectively.

(2)

In December 2001, we acquired Landqart for approximately $2.7 million. Sales from the Landqart mill are not included in our results for 2001, but are included for 2002. The Landqart mill sold approximately 18,222 tonnes for €39.7 million in 2002. At the end of 2002, we transferred 20% of our interest in Landqart and reorganized our remaining interest into an indirect 39%

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minority interest through a limited partnership without recognizing a gain or loss. As of December 31, 2002, our interest in the Landqart mill is no longer consolidated and is included in our financial results on an equity basis in 2003.

(3)

Not including Germany or Italy.

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

Year Ended December 31, 2003		Year Ended December 31, 2002		Year Ended December 31, 2001

(1)

Sales from the Landqart mill, which were made predominantly in the Swiss market, which is not part of the European Union, are not included for 2003 or 2001, but are included for 2002.

(2)

Not including Germany or Italy.

        A large proportion of our kraft pulp sales in western Europe were historically handled through a sales agency agreement with Oy Metsä Botnia Ab ("Metsä"), a member of the M-Real Group of Finland which operates a number of different paper mills. 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 Metsä when it expired in December 2002. In 2003, we 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. In addition, the Stendal mill is establishing a sales and marketing division that will be responsible for conducting all sales and marketing of the kraft pulp produced at the mill. We expect approximately eight people to be employed in this division. We intend to coordinate and integrate the sales and marketing activities at the Rosenthal mill and Stendal mill to realize on a number of synergies between them. These include reduced overall administrative and personnel costs and coordinated selling, marketing and transportation activities. When the Stendal mill is fully operational, we expect to sell substantially all of its kraft pulp production in continental Europe.

        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 9% of the Rosenthal mill's pulp deliveries in 2003. Approximately 37% of our pulp sales in 2003 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 one day of it being ordered. This permits us to be a "just in

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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, 2003, we had no material payment delinquencies. In 2003 one customer, which operates a number of paper mills, accounted for approximately 11% of our pulp sales. In 2002 one customer accounted for approximately 12% and in 2001 two customers accounted for approximately 22% of our pulp sales. Our pulp sales are not dependent upon a single customer or upon a concentrated group of major customers.

        Our paper sales operations focus primarily on Europe and are responsible for the majority of our paper sales. Our paper sales conducted through agents were approximately 26% of total paper sales in 2003, compared to approximately 27% in 2002 and 30% in 2001. 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, 2003, we had no material payment delinquencies. No single customer accounted for more than 10% of our paper sales in 2003, 2002 or 2001. Our paper sales are not dependent upon a single customer or upon a concentrated group of major customers.

Capital Expenditures

        In 2003, 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 €4.3 million, €3.4 million and €7.4 million in 2003, 2002 and 2001, respectively. We estimate capital expenditures at the Rosenthal mill to be approximately €5.2 million for 2004 relating primarily to maintaining the quality and efficiency of the mill and the reconstruction of the wastewater reservoirs at the mill. In addition, in 2003, we completed a strategic capital project to reconstruct the landfill related to the Rosenthal mill so that it will be useable for an additional 15 years. The total cost of this reconstruction was approximately €7.6 million, which Rosenthal is fully funding through a bank loan. Of this amount, we incurred €2.6 million in 2003 and €5.0 million in 2002. We estimate this project to have an approximately three-year payback period and the project required no equity investment on our part. We installed a reboiler at the Rosenthal mill in 2003 at a cost of approximately €1.9 million which we expect will reduce energy costs at the mill.

        Construction of the Stendal mill commenced in August 2002. Total capital costs incurred in respect of the project in 2003 were approximately €399.4 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 €7.8 million, €5.4 million and €2.7 million in 2003, 2002 and 2001, respectively. As a result of flooding in parts of Germany and other eastern European countries during the third quarter of 2002, our paper mills had to replace certain damaged equipment at an aggregate cost of approximately €3.3 million. We have applied for reimbursement for these costs under German government grants and for assistance under special credit programs instituted by the German government for flooding victims. In 2004, we estimate capital investments to be approximately €4.0 million relating primarily to quality and productivity upgrades of the paper machines at the paper mills and the completion of a wastewater treatment plant at the Fährbrücke mill. Our capital investments at the Heidenau mill in 2003 included a new waste paper storage building, replacement of a gas turbine and the installation of a head box top wire on the paper machine at the mill at an aggregate cost of approximately €3.8 million. Our capital expenditures at the Fährbrücke mill in 2003 included the addition of a reel packing machine to the paper machine and the continued construction of a wastewater treatment plant at the mill at an aggregate cost of approximately €1.1 million. We also continued with the adjustment to the paper machine at the Fährbrücke mill to produce pre-impregnated décor paper and the adjustment to the paper machine at the Heidenau mill to produce non-woven

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wallpaper base in 2003 at a cost of approximately €0.9 million and €0.3 million, respectively. 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 €337.0 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 €18.7 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 €500,000 of capital investment eligible for such grants and that such jobs be maintained for a period of five years from the completion of the capital investment project. Such government grants are not repayable by a recipient unless it fails to complete the proposed capital investment or fails to create or maintain the requisite amount of jobs. In the case of such failure, the government is entitled to revoke the grants and seek repayment unless such failure resulted from material unforeseen market developments beyond the control of the recipient, wherein the government may refrain from reclaiming previous grants. Pursuant to such grants provided in respect of our Rosenthal mill and being provided in respect of the Stendal 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. These grants reduce the cost basis of the assets purchased when the grants are received.

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

(1)

Not including the Stendal project.

(2)

The total cost of the conversion of the Rosenthal mill to produce kraft pulp was approximately €361.0 million. We also received government grants totaling approximately €101.7 million in connection with such capital investments. For more information, see "Business — Rosenthal Conversion Project and Financing".

        In addition, the Stendal project qualifies for approximately €274.5 million of government grants, of which €82.7 million has been received as at December 31, 2003. For more information about the Stendal project, see "Business — Stendal Pulp Mill Project and Financing".

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

Loan Guarantees

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

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

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 45% during the period from the beginning of 2000 to the end of 2003 as a result of operating efficiencies.

        The aggregate cost of the project, including project financing, capitalized interest of approximately €14.1 million and related costs and an amount for contingencies, was approximately €361.0 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.

        In 1998, Rosenthal entered into a project loan agreement (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 severally guaranteed an aggregate of 80% of the facility. For a brief summary of the Rosenthal Loan Facility, see "Business — Description of Certain Indebtedness — Rosenthal Project Financing".

        In addition to the government guarantee, the state government of Thuringia also provided government grants of €73.6 million (DM144.0 million) in respect of the project. The German federal government also provided, under existing programs, government grants totaling €27.1 million (DM53.0 million) in respect of the project. As of December 31, 2003, Rosenthal had received government grants totaling approximately €101.7 million for the Rosenthal mill conversion.

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        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 planned production 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 — Lösungen GmbH ("RWE") as to a 29.4% interest, and AIG Altmark-Industrie AG ("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 cost we estimate will be approximately €1.0 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 a planned 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.

        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 suitable for different end uses.

        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 Securities and Exchange Commission ("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

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

        In addition to integrating the wood procurement activities at the Rosenthal and Stendal mills, we plan to coordinate other activities and operations between the two mills to realize efficiencies and optimize the cost structure of each mill. Such activities include establishing a 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 being constructed under a €716.0 million fixed-price turn-key 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 €23.5 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% subsidized and co-financed by us, among others. Our co-financing obligations amount to approximately €3.0 million and are funded out of the project loan facility.

        Construction of the mill is scheduled to be completed in mid- 2004. Start-up of the mill is scheduled to occur and production of saleable kraft pulp is expected to begin in the third quarter of 2004. Our acceptance of the mill and related works is to occur by December 2004. Between completion of construction and our acceptance of the mill scheduled for 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 (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

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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 (the "Closing Date"), we completed financing arrangements for the Stendal project. Total investment costs in connection with the project are approximately €1.0 billion, the majority of which is to be provided under a senior project finance facility (the "Stendal Loan Facility") arranged by Bayerische Hypo-und Vereinsbank AG ("HVB"), pursuant to a project finance loan agreement (the "Project Finance Loan Agreement") entered into between Stendal and HVB. We also contributed financing to Stendal of approximately €63.5 million from cash on hand and through bridge loans from a U.S. investment partnership and a bank. For a brief summary of the Stendal Loan Facility, see "Business — Description of Certain Indebtedness — Stendal Pulp Mill Project Financing".

        As the site of the Stendal project is located in eastern Germany, it qualifies for approximately €274.5 million of government grants, which are applied to reduce the cost basis of the assets acquired with such grants. As of December 31, 2003, we have claims for €82.1 million of such grants in connection with the Stendal project, of which we have received €8.1 million and we expect to receive the remainder in 2004. In accordance with our accounting policies, these grants are not recorded by us until they are received.

        Under European Union rules, the Commission of the European Communities (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

21

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, among other things, 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 (Luxembourg) 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.

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, 2003, progress on the Stendal project was substantially on schedule and there were no significant deviations from the project budget. As at December 31, 2003, the project was approximately 92% completed. Approximately 99% of the total engineering and approximately 93% of the civil works were completed. Progress was made in a number of areas including the erection of the recovery boiler, which was also successfully hydro tested. In addition, most storage tanks have been completed and insulated, construction of the steam distribution system is in progress with the delivery of the steam turbine, and all of the main equipment for the evaporator and the recausticizing plant has been installed. Progress was also made in connection with the construction of the infrastructure of the mill site, including with respect to the gas system which we started using in February 2004. In addition, power was switched on at the site and construction of a road to the site was completed in December 2003. 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, 2003, no major insurance claims had been filed in respect of the project and there had been no casualties or severe injuries on the site.

        Stendal currently employs approximately 291 people, approximately 59 of whom 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 Jaakko Pöyry 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, 2003, Stendal had approved invoices representing milestone payments equal to approximately 66% of the total value of the EPC contract.

        As at December 31, 2003, Stendal had applied for investment grants and had claims totaling €82.1 million with respect to the project, of which we have received €8.1 million and we expect to receive the remainder in 2004. In accordance with our accounting policies, these grants are not recorded by us until they are received.

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        At the end of 2003, there were over 1,500 people working at the site. This number is expected to increase to over 2000 third party construction workers in the first half of 2004.

        Our organization build-up and staff recruitment for the Stendal mill are on schedule. We anticipate having approximately 460 employees at Stendal by the end of the second quarter of 2004, to be at the required level for the commissioning and start-up of the mill. We have developed a detailed manning and organizational plan which we started implementing in 2003. Hiring is coordinated through the Stendal management team and we also use a recruitment firm. We have hired a new transportation and logistics manager and central purchase manager for the Stendal mill. We have also started training the bulk of the mill's operating and maintenance staff. Such training consists of fundamental classroom training, 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 around the end of June 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 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 "Cautionary Statement Regarding Forward-Looking Information" in "Management's Discussion and Analysis of Financial Condition and Results of Operations".

Description of Certain Indebtedness

Rosenthal Project Financing

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

        In 1998, Rosenthal entered into the Rosenthal Loan Facility, as amended, having a 15 year term with a German bank and other syndicated lenders in the aggregate amount of €259.7 million (DM508.0 million) to finance the conversion 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 severally guaranteed an aggregate of 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.

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        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 derivatives with the lead bank under the Rosenthal Loan Facility to manage its risk exposure with respect to certain amounts outstanding thereunder.

        Repayment of the Rosenthal Loan Facility commenced on March 31, 2001. During 2003, we repaid €13.2 million of the principal amount of the Rosenthal Loan Facility and at year end €191.7 million was outstanding. Of this amount, an aggregate of €118.0 million was drawn by Rosenthal pursuant to special credit programs.

        Rosenthal also has a €7.6 million bank facility in connection with the reconstruction of the landfill at the Rosenthal mill. See "Business — Capital Expenditures" and "Business — Environmental".

Stendal Pulp Mill Project Financing

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

        In August 2002, we completed financing arrangements for the Stendal project. Total investment costs in connection with the project are estimated to be €1.0 billion, the majority of which is to be provided under the Stendal Loan Facility pursuant to the Project Finance Loan Agreement entered into between Stendal and HVB. We also contributed financing to Stendal of approximately €63.5 million from cash on hand and through the bridge loans from a U.S. investment partnership and a bank.

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

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

24

its right under the Stendal Loan Facility to increase its up-front arrangement fee by 20 basis points and the rate of interest under the facility by 30 basis points.

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

        The tranches under the Stendal Loan Facility for project construction and development costs, financing costs, start-up costs and working capital are severally guaranteed by German federal and state governments in respect of an aggregate of 80% of the principal amount of these tranches, but the tranche under the Stendal Loan Facility for financing and start-up costs, working capital and certain of the project construction and development costs benefiting from these guarantees will be reduced semi-annually by 12.5% per year beginning on the first repayment date following the fourth anniversary of the first advance under the Stendal Loan Facility for each of these costs. Under the guarantees, the German federal and state governments that provide the guarantees are responsible for the performance of our payment obligations for the guaranteed amounts. Approximately €394.4 million was drawn under the Stendal Loan Facility as of December 31, 2003.

        On December 12, 2003, Stendal entered into agreements with Nord Deutsche Landesbank ("Nord LB") and the European Investment Bank ("EIB"). Pursuant to the agreements, EIB will provide a refinancing credit facility to Nord LB at preferred interest rates for up to €495.0 million. Such refinancing loan is made to Nord LB for the benefit of the Stendal project. Instead of actually refinancing the Stendal Loan Facility through Nord LB, and Stendal benefiting from lower interest rates over time, the agreements provide for the disbursement to Stendal of the net present value of the interest rate differential offered to Nord LB by EIB (less a portion retained by Nord LB).

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

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

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

        In connection with the Stendal Loan Facility, we entered into a shareholders' undertaking agreement (the "Undertaking") dated August 26, 2002 with RWE, AIG and HVB 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 €15 million of share capital of Stendal and advanced to it €55 million in subordinated loans. In addition, on a pro rata basis, the shareholders of

25

Stendal agreed to advance to it €30 million of stand-by equity to, among other things, cover approved cost overruns, fund the equity reserve account and partially fund the debt service reserve account under the Stendal Loan Facility. On the Closing Date, we provided HVB with a cash deposit for our pro rata portion of such equity reserve account. Our total funding commitment under the Undertaking was €63.5 million, all of which was effected in August 2002. Pursuant to the Undertaking, we have agreed, for as long as Stendal has any liability under the Stendal Loan Facility to HVB, to retain control over at least 51% of the voting shares of Stendal.

        On the Closing Date, we entered into and completed funding under two bridge financing loan agreements and used the net proceeds from the two bridge loans (the "Bridge Loans") in the principal amounts of €15.0 million and €30.0 million 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 accrued interest at rates equal to Euribor plus 6.5% per year until April 2003 and Euribor plus 9.0% per year thereafter until October 2003.

        In October 2003, we completed the sale of $82.5 million in aggregate principal amount of convertible senior subordinated notes due 2010. The notes bear interest at a rate of 8.5% per annum and are convertible into our shares of beneficial interest at a conversion price of $7.75 per share. The net proceeds from the offering of approximately $78.4 million were used to repay in full our indebtedness, including fees and accrued interest, under the Bridge Loans aggregating approximately $66.9 million and the balance was used for general corporate purposes, including working capital. For more information, see "Market for Registrant's Common Equity and Related Stockholder Matters".

Paper Mill Project Facilities

        In 2003, our paper operations secured two long-term credit facilities aggregating approximately €2.5 million, which facilities along with certain government grants are being utilized to repair flooding damage suffered by the mills in 2002. One facility totaling approximately €1.0 million matures on June 30, 2009, bears interest at a rate of 2.65% per annum and is repayable in ten equal semi-annual installments. The other facility in the amount of approximately €1.5 million matures on June 30, 2013, bears interest at a rate of 2.65% per annum and is repayable in 15 equal semi-annual installments. Both facilities are guaranteed as to 80% thereof by a German governmental agency.

        In addition, in 2003, our Fährbrücke paper mill secured three credit facilities aggregating €5.5 million, which facilities along with certain government grants will be utilized to finance equipment and construction costs associated with expanding and adapting the paper machine at the mill for the production of pre-impregnated décor paper. Two of the facilities aggregating €3.5 million mature on December 30, 2012 and bear interest at rates between 4.15% and 4.3% per annum and are repayable in 16 equal semi-annual installments. The other facility in the amount of €2.0 million matures on March 31, 2009 and bears interest at a rate equal to the three-month Euribor rate plus 1.75% per annum and is repayable in 16 equal quarterly installments. All three facilities are guaranteed as to 80% thereof by a German state government. As at December 31, 2003, we had utilized an aggregate of approximately €6.0 million of €8.0 million available under these five credit facilities relating to the paper operations.

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 €3.7 million in 2003 and are expected to be approximately €3.2 million in 2004.

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        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 Adsorbable Organic Halogen, or "AOX", discharge at the Rosenthal mill and we believe the Rosenthal mill's AOX discharges are substantially below those currently mandated by the German government. Effective January 1, 2001, the Rosenthal mill is required to maintain levels of Chemical Oxygen Demand, or "COD" discharge at the Rosenthal mill below 25 kilograms per 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 2003 we completed a strategic capital project to reconstruct the landfill at the Rosenthal mill so that it will be useable for an additional 15 years. The aggregate cost of the project was approximately €7.6 million.

        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 2003 as a result of environmental capital expenditures made at our manufacturing plants were approximately €3.0 million. We expect that capital investment programs for our manufacturing plants will fully offset the wastewater fees that may be payable for 2004 and 2005 and will ensure that our operations continue in substantial compliance with prescribed standards.

        Environmental compliance is a priority for our operations. To ensure compliance with environmental laws and regulations, we regularly monitor emissions at our mills and periodically perform environmental audits of operational sites and procedures both with our internal personnel and outside consultants. These audits identify opportunities for improvement and allow us to take proactive measures at the mills as considered appropriate.

        Although the Rosenthal mill's overall emission levels for nitric oxide and nitrogen oxide, collectively referred to as "NOx", are substantially below prescribed levels, NOx emissions from one gas burner have recently exceeded its permitted emission level. We made a claim on the warranty from the supplier of the gas burner who installed an ammonia scrubber to reduce NOx emissions. Due to a technical issue, emission levels from the gas burner were not reduced to permitted levels. Pursuant to our agreement with the gas burner supplier, the supplier is responsible for installing a new burner that reduces NOx emission levels to prescribed standards. We estimate the aggregate cost of the new burner to be approximately €750,000, approximately half of which is expected to be borne by the supplier and the balance by us. We have advised German environmental authorities of the technical issue relating to the burner and the proposal to replace the same. Although there can be no assurance, we do not expect any regulatory action in respect thereof as a result of the Rosenthal mill's plans to install a new burner and that its overall NOx emissions are well below permitted standards.

        We have until the end of 2005 to begin biologically treating the wastewater at the Fährbrücke mill. We are in the process of constructing a wastewater treatment plant at the Fährbrücke mill, the first stage of which was completed in 2002 and brought into operation at the beginning of 2003. The cost of the treatment plant is expected to be approximately €2.0 million, of which €0.2 million was incurred in 2003. The project is being funded by government grants as to 28%, a bank loan as to 45% and the remainder from our funds. 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

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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 approximately 1,022 people. Approximately 677 salaried and 125 hourly employees work in our pulp operations, including our transportation subsidiary, and approximately 84 salaried and 136 hourly employees work 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 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, had a one-year term and provided for a 2% wage increase effective March 1, 2003 and that the parties would negotiate in respect of a further wage increase for August 2003 depending upon general economic conditions. Our pulp workers agreed to defer negotiations in respect of a further wage increase as a result of current general economic conditions. The agreement has no fixed term, but could not be terminated by either party before February 28, 2004. A new agreement is expected to be negotiated in the first half of 2004.

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

        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 implemented 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

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the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site at www.sec.gov that contains reports, proxy and information statements, and other information regarding us.

ITEM 2.    PROPERTIES

        We lease offices in Seattle, Washington, Vancouver, British Columbia and in Germany. We own the 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 Kamyr 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 the third quarter of 2004. The mill will be a single line mill with a planned annual production capacity of approximately 552,000 tonnes of kraft pulp. The Stendal mill is designed to 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 are designed to 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

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•

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 Fährbrücke mill and 12 kilometers south of the city of Dresden. The mill was constructed in 1956 and has been continually upgraded. The mill has 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 4,250 kilowatts of electric power, a waste heat boiler capable of producing 17 tonnes per hour of steam and an auxiliary boiler capable of producing five tonnes per hour of steam.

        The Fährbrücke mill is situated on a 27 acre site near the town of Langenweissbach 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;



•

a power plant, which consists of, among other things, a waste heat boiler which can produce 22 tonnes per hour of steam, a heavy duty boiler which can produce 3.2 tonnes per hour of steam, and a gas turbine which can produce approximately 4,250 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.

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        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, 2003, 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 is designed to increase our annual aggregate production capacity by approximately 552,000 tonnes to approximately 852,000 tonnes for our pulp operations, for a total rated annual production capacity from our pulp and paper operations of approximately 937,000 tonnes.

(3)

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 not included in the calculation of our annual production capacity for specialty papers. Actual production of specialty papers at the Landqart mill is not included for 2001, but is included for 2002. The Landqart mill produced approximately 20,422 tonnes in the year ended December 31, 2002. As of December 31, 2002, our interest in the Landqart mill is no longer consolidated and is included in our financial results on an equity basis in 2003.

(4)

See footnote 5 below.

(5)

Based upon the current product mix at the paper mills, the aggregate annual production capacity of the paper mills is approximately 70,000 tonnes. The rated aggregate annual production capacity of the paper mills is approximately 85,000 tonnes.

        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. Substantially all of our pulp related assets, including our pulp facilities, are pledged to secure the Rosenthal Loan Facility and the Stendal Loan Facility.

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

        We held a special meeting of shareholders on October 2, 2003 at which we obtained approval for the issuance of up to 10,750,000 shares of beneficial interest upon the conversion of convertible senior subordinated notes that we sold in a private offering on October 10, 2003. For more information, see "Submission of Matters to a Vote of Securityholders" in our quarterly report on Form 10-Q for the third quarter of 2003 on file with the SEC.

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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 listed in U.S. dollars on the Toronto Stock Exchange under the symbol "MRI.U". The following table sets forth the high and low reported sale prices of our shares on the Nasdaq National Market for each quarter in the two year period ended December 31, 2003, and for the period ended March 10, 2004:

        (b)   Shareholder Information.    As at March 10, 2004, there were approximately 507 holders of record of our shares and a total of 17,174,566 shares were outstanding.

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

        (d)   Equity Compensation Plans.    The following table sets forth information as at December 31, 2003 regarding: (i) 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; and (ii) a non-qualified stock option plan to acquire up to 375,000 of our shares:

(1)

On August 22, 2003, we issued an aggregate of 375,000 options to purchase our shares of beneficial interest at a price of $4.53 per share to Guy W. Adams, GWA Investments, LLC, of which Mr. Adams is the managing member, and Saul E. Diamond under our 2003 non-qualified stock option plan in accordance with the terms of the settlement agreement with Greenlight Capital. Options to acquire up to: (i) 225,000 shares exercisable on or before September 22, 2003 were granted to GWA; (ii) 100,000 shares exercisable on or before June 20, 2004 were granted to Mr. Adams; and (iii) 50,000 shares exercisable on or before June 20, 2004 were granted to Mr. Diamond. GWA exercised its options and acquired 225,000 shares on September 16, 2003.

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

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provisions of the Securities Act of 1933, as amended (the "Securities Act") provided under Section 4(2) of the act.

        In October 2003, we completed the sale of $82.5 million in aggregate principal amount of convertible senior subordinated notes due October 15, 2010. The notes bear interest at a rate of 8.5% per annum and are convertible into our shares of beneficial interest at a conversion price of $7.75 per share, which is equal to a conversion rate of approximately 129 shares per $1,000 principal amount of the notes, subject to adjustment for certain customary anti-dilution matters. The notes were offered only to qualified institutional buyers in reliance on Rule 144A and to certain buyers outside of the United States in reliance on Regulation S under the Securities Act. The notes were sold to RBC Dain Rauscher Inc., as the initial purchaser. The aggregate initial purchaser's discounts of the offering were approximately $3.4 million.

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

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ITEM 6.    SELECTED FINANCIAL DATA

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

        Selected historical financial data as at and for the period ended December 31, 1999 is set out below. Management believes that the financial data relating to 1999 does not provide a meaningful comparison of financial and operating data to the other periods shown below. In 1999, the Rosenthal mill was shut down from July to December while we completed a major capital project which converted the Rosenthal mill to the production of kraft pulp from sulphite pulp and increased its annual production capacity from approximately 160,000 tonnes to approximately 300,000 tonnes. Between 1998 and 2000, we owned and operated an additional four paper mills that produced packaging, carton and printing papers which have been divested pursuant to our strategy to focus on our core operations.

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(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 €43.2 million in 2001 and approximately 18,222 tonnes for approximately €39.7 million in 2002. As of December 31, 2002, our interest in the Landqart mill is no longer consolidated and is included in our financial results on an equity basis in 2003.

(2)

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

(3)

Net loss before a special charge was €15.0 million, or €0.91 per share.

(4)

We have applied for investment grants from the federal and state governments of Germany and had claims of €82.1 million outstanding at December 31, 2003, which we expect to receive in 2004. However, in accordance with our accounting policies, we do not record these grants until they are received.

(5)

Includes approximately €503.2 million and €186.6 million related to properties construction in progress at the site of the Stendal mill for 2003 and 2002, respectively.

(6)

Includes approximately €367.4 million and €176.6 million related to construction in progress at the site of the Stendal mill for 2003 and 2002, respectively.

(7)

Excluding intercompany sales.

(8)

Cash production costs per tonne sold are determined by subtracting depreciation and shipping and handling costs from cost of sales for the pulp segment divided by sales volume.

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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, 2003 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 years ended December 31, 2002 and 2003 included in this annual report are stated in Euros and 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 periods.

Results of Operations

        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 is designed to have an annual production capacity of approximately 552,000 tonnes, being implemented by Stendal, our 63.6% owned project subsidiary; and (c) two paper mills which produce specialty papers and printing and writing papers and, based upon their current product mix, have an aggregate annual production capacity of approximately 70,000 tonnes.

        Total investment costs in respect of the Stendal project are estimated to be approximately €1.0 billion, the majority of which is being financed under the Stendal Loan Facility in the amount of €828 million and arranged with HVB. 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.

        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 and list prices 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, producer inventories increased markedly and list price levels eroded to an average of approximately $460 per tonne in late 2001. List prices for kraft pulp averaged approximately

36

$463 per tonne in 2002. The weakening of the U.S. dollar against the Euro and other major currencies and an increase in demand resulting from improving American and major European economies in 2003 resulted in producers increasing list prices for kraft pulp in Europe to approximately $560 per tonne in December 2003 despite relatively high inventory levels. Most producers, including ourselves, announced a price increase for NBSK pulp for February 2004 to approximately $590 per tonne, which was largely implemented. Further price increases of $10 to $20 per tonne have been announced by various pulp producers for March 2004. However, there can be no assurance that any such increase will be implemented or, if implemented, that prices will not fall in ensuing months.

        Our financial performance for any reporting period is also impacted by changes in the U.S. dollar to Euro exchange rate and in interest rates. Changes in currency rates affect our performance because the price for our principal product, NBSK pulp, is generally based on a global industry benchmark that is quoted in U.S. dollars, even though our sales are invoiced in Euros. Therefore, a weakening of the U.S. dollar against the Euro will generally reduce the amount of Euro revenues of our pulp operations. Most of our costs, including our debt obligations, are incurred in Euros. These do not fluctuate with the U.S. dollar to Euro exchange rate. Thus, a weakening of the U.S. dollar against the Euro tends to reduce our sales revenue, gross profit and income from operations.

        Changes in interest rates can impact our performance because the indebtedness we incurred under the credit facilities for establishing the Rosenthal and Stendal pulp mills provide for floating rates of interest.

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

        In order to partially protect against a weakening U.S. dollar, Rosenthal uses derivatives to swap its Euro denominated debt obligations to U.S. dollars (the "Currency Swaps") under the Rosenthal Loan Facility. Such derivatives effectively converted Rosenthal's loan obligations from Euros into U.S. dollars. Rosenthal's use of U.S. dollar currency derivatives ("Currency Forwards") had provided additional protection and augmented earnings and cash flow during a weakening U.S. dollar environment. We settled these Currency Swaps and Currency Forwards in December 2003. Primarily as a result of the substantial weakening of the U.S. dollar versus the Euro in 2003, we recognized a net gain of approximately €28.5 million on these Rosenthal foreign currency derivatives and certain interest rate derivatives of Rosenthal in the year ended December 31, 2003.

        Stendal, as required under its project financing, entered into variable-to-fixed rate swaps (the "Stendal Interest Rate Swap Agreements") to fix the interest rate for the full term of the Stendal Loan Facility. While such swaps effectively fix the interest cost on the Stendal Loan Facility and provide stability with respect to future interest payments, they have kept Stendal from benefiting from the general decline in interest rates in the later part of 2002 and in 2003. These swaps are marked to market on a quarterly basis taking into account, among other things, all future payments and the yield curve. Declining interest rates resulted in a non-cash holding loss of approximately €13.0 million on these swaps in 2003, compared to a non-cash holding loss of approximately €30.1 million in 2002. Stendal also entered into a currency forward contract in connection with the Stendal Loan Facility in the third quarter of 2003. This derivative instrument is also marked to market on a quarterly basis. Primarily as a result of the weakening of the U.S. dollar versus the Euro, a non-cash holding gain of €0.7 million on such currency forward contract was recognized for the year ended December 31, 2003.

        Since mid-2003, general trends with respect to interest rates have partially reversed and long-term European interest rates have risen somewhat, while the U.S. dollar has continued to weaken versus the Euro and other major currencies. The weak U.S. dollar has effectively reduced pulp selling prices in

37

Europe. However, the weak U.S. dollar and increased pulp demand resulting from improving American and major European economies has led to higher list prices for kraft pulp in Europe. We would expect the U.S. dollar to remain relatively weak against the Euro in the near term, although generally we would expect our operations to benefit from higher pulp pricing. If higher interest rates continue, the Stendal variable-to-fixed rate swaps may have a mark to market non-cash holding gain in future periods, which may be offset in part by higher interest rates payable on Rosenthal's debt obligations. If the Euro continued to materially strengthen against the U.S. dollar, it could, among other things, result in lower European interest rates. If European interest rates were to so decline, the Stendal variable-to-fixed rate interest swaps would result in further non-cash holding losses in future periods when they were marked to market. See "Quantitative and Qualitative Disclosures about Market Risk".

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

(1)

Excluding intercompany sales volumes of 5,527, 10,768 and 10,447 tonnes of pulp and intercompany net sales revenues of approximately €2.3 million, €4.9 million and €5.8 million in 2003, 2002 and 2001, respectively.

(2)

We acquired Landqart, which operates a specialty paper mill, in December 2001 for approximately $2.7 million. As of December 31, 2002, our interest in Landqart is no longer consolidated and is included in our financial results on an equity basis in 2003. Accordingly, sales from the Landqart specialty paper mill are not included in our results for 2001, but are included for 2002. The Landqart mill sold approximately 18,222 tonnes for approximately €39.7 million in 2002.

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

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

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

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        Pulp sales in the current period were €126.6 million, compared to €130.2 million in 2002. U.S. dollar denominated list pulp price increases were mostly offset by a 17% decline in the U.S. dollar against the Euro in 2003. Average list prices for NBSK pulp in Europe were approximately €420 ($440) per tonne at the end of 2002, approximately €441 ($480) per tonne in the first quarter of 2003, approximately €484 ($550) per tonne in the second quarter of 2003, approximately €444 ($500) per tonne in the third quarter of 2003 and approximately €444 ($560) per tonne in the fourth quarter of 2003. Prices further improved to approximately €464 ($590) per tonne in early 2004. Our pulp sales realizations were €417 per tonne on average in the current period, compared to €443 per tonne in 2002. Pulp sales by volume increased to 303,655 tonnes in the current period from 293,607 tonnes in 2002.

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

        Our pulp operations generated operating income of €0.1 million in the year ended December 31, 2003, compared to operating income of €1.8 million in 2002.

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

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

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

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

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

        Pursuant to the Stendal Loan Facility, Stendal entered into the Stendal Interest Rate Swap Agreements for the full term of the facility to manage the risk exposure with respect to an aggregate maximum amount of approximately €612.6 million of the principal amount of the Stendal Loan Facility. 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. Stendal also entered into a currency forward contract in connection with the Stendal Loan Facility in the third quarter of 2003. These derivatives are marked to market at the end of each reporting period and all unrealized gains and losses are recognized in

39

earnings for such period. In 2003, we recorded a non-cash holding loss of approximately €13.0 million when these swaps were marked to market at the end of the period, compared to a non-cash holding loss of approximately €30.1 million in 2002. A non-cash holding gain of €0.7 million before minority interests was recognized in respect of the currency forward in the year ended December 31, 2003. We determine market valuations based primarily upon values provided by our counterparties.

        In addition, Rosenthal had entered into Currency Swaps to manage its exposure with respect to an aggregate amount of approximately €198.4 million of the principal long-term indebtedness of the Rosenthal mill under the Rosenthal Loan Facility. Rosenthal had also entered into Currency Forwards and forward interest rate and interest cap contracts ("Interest Rate Contracts") in connection with certain indebtedness relating to the Rosenthal mill. The Currency Swaps and the Currency Forwards were settled in December 2003. These derivatives are also marked to market at the end of each reporting period, and all gains and losses are recognized in earnings for such period. Primarily as a result of the weakening of the U.S. dollar versus the Euro, in the current year we recognized a net gain of €28.5 million upon the settlement of the Currency Swaps and Currency Forwards and the mark to market valuation of the Interest Rate Contracts. In 2002, we recognized a net gain of €23.4 million from these derivative contracts.

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

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

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

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

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

40

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

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

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

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

        Operating EBITDA has significant limitations as an analytical tool, and should not be considered in isolation, or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are: (i) Operating EBITDA does not reflect our cash expenditures, or future requirements, for capital expenditures or contractual commitments; (ii) Operating EBITDA does not reflect changes in, or cash requirements for, working capital needs; and (iii) Operating EBITDA does not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments, on our outstanding debt. Because of these limitations, operating EBITDA should not be considered as a measure of liquidity or cash available to us to invest in the growth of our business. See the Statement of Cash Flows set out in our consolidated financial statements included herein. Because all companies do not calculate Operating EBITDA in the same manner, Operating EBITDA as calculated by us may differ from Operating EBITDA as calculated by other companies.

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

Year Ended December 31, 2002 Compared to the Year Ended December 31, 2001

        In 2002, total revenues increased by approximately 10.5% to €239.1 million from €216.4 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 €227.9 million from €205.0 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 €213.5 million from €184.7 million in 2001, primarily as a result of higher revenues.

        Pulp sales in 2002 decreased to €130.2 million from €146.2 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 €528 ($470) per tonne at the end of 2001 to approximately €420 ($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 €443 per tonne from €512 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 and administrative expenses for our pulp operations decreased to €138.9 million in 2002 from €140.4 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 €21.6 million in 2002 compared to €21.4 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 €1.8 million of income from operations in 2002, compared to €18.6 million in 2001.

        Paper sales in 2002 increased to €97.7 million from €58.8 million in 2001. Sales of specialty papers in 2002 increased to €79.4 million from €36.0 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

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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 and administrative expenses for our paper operations increased to €101.0 million in 2002 from €61.7 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 Fährbrücke paper mills in August 2002 resulted in a period of reduced production and increased costs. Depreciation increased to €4.0 million in 2002 from €1.5 million in the prior year, as a result of the inclusion of Landqart.

        A loss from operations of €4.5 million was recorded by our paper operations in 2002 relative to a €2.5 million loss from operations in 2001.

        General and administrative expenses increased to €25.0 million in 2002 from €18.4 million in 2001, primarily as a result of the inclusion of the results of the Landqart mill and a foreign exchange transaction loss of €3.0 million in 2002. In 2001, we recorded a foreign exchange transaction gain of €3.4 million.

        We had a loss from operations of €1.1 million in 2002, compared to income from operations of €13.3 million in 2001. Interest expense (excluding capitalized interest of €3.1 million in respect of the Stendal project) in 2002 decreased to €13.8 million from €16.2 million in 2001, primarily as a result of repayments made on outstanding indebtedness.

        We recognized a holding loss of €30.1 million before minority interests in respect of the Stendal Interest Rate Swap Agreements for the year ended December 31, 2002. See "Quantitative and Qualitative Disclosures about Market Risk".

        During 2002, we settled two Currency Swaps which were entered into earlier in the year to realize gains. We then subsequently re-entered into two Currency Swaps and one of them was settled and a gain was realized in December 2002. In addition, we have entered into Currency Forwards and Interest Rate Contracts in connection with certain indebtedness relating to the Rosenthal mill. These derivatives 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 €23.4 million from these derivative contracts. See "Quantitative and Qualitative Disclosures about Market Risk".

        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 €11.0 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 €6.3 million, or €0.38 per share on a basic and diluted basis, compared to a net loss of €2.8 million, or €0.17 per share on a basic and diluted basis, in 2001.

        For 2002, excluding items related to the Stendal project, net income would have been €12.8 million, or €0.76 per share on a diluted basis, which was determined by adding the loss on derivative financial instruments of €30.1 million to, and subtracting minority interest of €11.0 million from, the reported net loss of €6.3 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.

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Liquidity and Capital Resources

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

(1)

We have applied for investment grants from the federal and state governments of Germany and had claims of €82.1 million outstanding at December 31, 2003, which we expect to receive in 2004. However, in accordance with our accounting policies, we do not record these grants until they are received.

(2)

Includes approximately €503.2 million and €186.6 million as at December 31, 2003 and 2002, respectively, related to properties construction in progress at the site of the Stendal mill.

(3)

Includes approximately €324.2 million and €146.5 million as at December 31, 2003 and 2002, respectively, related to construction in progress at the site of the Stendal mill.

        At December 31, 2003, our cash and cash equivalents were €52.0 million, compared to €30.3 million at the end of 2002. We also had €15.2 million of cash restricted to pay construction in progress costs payable and €19.1 million of cash restricted in a debt service account, both related to the Stendal project. In addition, we had €25.1 million of cash restricted in a debt service account relating to the Rosenthal mill. At December 31, 2003, we had a working capital deficit of €48.9 million, primarily because we pre-finance certain governmental grants which we expect to receive under a dedicated tranche of the Stendal Loan Facility but, under our accounting policies, do not record these grants until they are received, as well as Stendal construction in progress costs payable for which we had not drawn down under such facility. At the end of 2003, we had applied for investment grants totaling approximately €82.1 million from the federal and state governments of Germany which we expect to receive in 2004. Approximately €74.0 million of these grants, when received, will be applied to repay the amounts drawn under the dedicated tranche of the Stendal Loan Facility. The grants are not reported in our income and reduce the cost basis of the assets purchased when they are received. At the end of 2003, we had Stendal construction in progress costs payable of €42.8 million which will be paid pursuant to the Stendal Loan Facility in the ordinary course.

        In October 2003, we completed the sale of $82.5 million in aggregate principal amount of convertible senior subordinated notes due October 2010. The notes bear interest at a rate of 8.5% per annum and are convertible into our shares of beneficial interest at a conversion price of $7.75 per share. The net proceeds from the offering of approximately $78.4 million were used to repay in full our indebtedness, including fees and accrued interest, under two bridge loan facilities aggregating approximately $66.9 million and the balance was used for general corporate purposes, including working capital.

        We expect to continue to generate sufficient cash flow from operations to pay our interest and debt service expenses and meet the working and maintenance capital requirements for our current operations. We currently do not have any revolving credit facilities. From time to time, we have entered into project specific credit facilities to finance capital projects and expect to continue to do so, subject to availability. We expect to meet the capital requirements for the Stendal mill, including working capital and potential losses during start-up, through shareholder advances already made to Stendal, the Stendal Loan Facility, which includes a revolving line of credit for the mill, the receipt of government grants and, when

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operational, cash flow from operations. See "Business — Stendal Pulp Mill Project and Financing" and "Business — Description of Certain Indebtedness — Stendal Pulp Mill Project Financing".

Operating Activities

        Operating activities in 2003 provided cash of €31.4 million, compared to €40.4 million in 2002. Net changes in trading securities provided cash of €0.3 million in 2003, compared to €4.4 million in 2002. An increase in receivables due primarily to higher sales in December 2003 used cash of €4.7 million in the current period, compared to a decrease in receivables providing cash of €18.2 million in 2002. An increase in inventories due primarily to the build up of fiber in connection with the start-up of the Stendal mill used cash of €7.5 million in 2003, compared to a decrease in inventories providing cash of €1.7 million in 2002. A decrease in cumulative unrealized gains on derivatives provided cash of €3.8 million in 2003, compared to an increase in the same using cash of €3.3 million in 2002. An increase in accounts payable and accrued expenses provided cash of €1.1 million in 2003, compared to a decrease in the same using cash of €12.7 million in 2002.

Investing Activities

        Investing activities in 2003 used cash of €318.5 million, primarily as a result of the acquisition of properties, net of investment grants, of which €316.7 million was attributable to the Stendal project, compared to €195.7 million in 2002, of which €186.6 million was attributable to the Stendal project. Sales of available-for-sale securities provided cash of €6.4 million in 2003.

        We have applied for investment grants from the federal and state governments of Germany and have claims of €82.1 million outstanding as of December 31, 2003. We expect to receive the full amount of our currently outstanding claims in 2004. We received investment grants totaling €82.7 million with respect to the Stendal project as at December 31, 2003. In accordance with our accounting policies, we do not record these grants until they are received. These grants reduce the cost basis of the assets purchased with them. See "Business — Government Financing".

        Our paper mills had 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 €3.3 million, of which approximately €3.0 million was incurred in 2003. 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 and for certain repairs required at the paper mills as a result of the flooding. As at December 31, 2003, we had received approximately €3.5 million of grants, of which €1.9 million was recognized as income in the current period and the balance has either been deferred or deducted from the cost of property acquired. Although we have received approval for the full amount of these grants and assistance applied for, there can be no assurance that we will receive any unpaid amounts of such grants and assistance.

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

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

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Financing Activities

        Financing activities provided cash of €307.1 million in the year ended December 31, 2003. A net increase in indebtedness, primarily related to the Stendal project, provided cash of €299.0 million. An increase in restricted cash used cash of €11.1 million in the current period. We made principal repayments of €13.2 million in connection with the Rosenthal Loan Facility in the year ended December 31, 2003. The issuance of shares in connection with the exercise of options provided cash of €0.9 million in the current period. Financing activities provided cash of €174.7 million in 2002, primarily as a result of a net increase in indebtedness relating to the Stendal project.

        In 2003, our paper operations secured two term credit facilities aggregating approximately €2.5 million, which facilities along with certain government grants are being utilized to repair flooding damage suffered by the mills in 2002. For information about these credit facilities, see "Business — Description of Certain Indebtedness — Paper Mill Project Facilities".

        In addition, in 2003, our Fährbrücke paper mill secured three credit facilities aggregating €5.5 million, which facilities along with certain government grants will be utilized to finance equipment and construction costs associated with expanding, adapting and improving the efficiency of the paper machine at the mill. This will also permit the mill to produce pre-impregnated décor paper. For information about these credit facilities, see "Business — Description of Certain Indebtedness — Paper Mill Project Facilities". As at December 31, 2003, we had utilized an aggregate of approximately €6.0 million of €8.0 million available under these five credit facilities relating to the paper operations.

        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 10 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, 2003. We anticipate that there will be acquisitions of businesses or commitments to projects in the future. To achieve our long-term goals of expanding our asset and earnings base through the acquisition of interests in companies and assets in the pulp and paper and related businesses, and organically through high return capital expenditures at our operating facilities, we will require substantial capital resources. The required necessary resources for such long-term goals will be generated from cash flow from operations, cash on hand, borrowing against our assets, the sale of debt and/or equity securities and/or asset sales.

46

Contractual Obligations and Commitments

        The following table sets out our contractual obligations and commitments as at December 31, 2003 in connection with our long-term liabilities:

(1)

This reflects principal only relating primarily to indebtedness under the Rosenthal Loan Facility and credit facilities relating to the paper mills, but does not reflect indebtedness relating to the Stendal project. See "Business — Description of Certain Indebtedness", footnote 2 below and Note 9 to our annual financial statements included herein for a description of such indebtedness. Does not include amounts associated with derivatives entered into in connection with indebtedness relating to the Rosenthal mill. See "Quantitative and Qualitative Disclosure about Market Risk" for information about our derivatives.

(2)

This reflects principal only in connection with indebtedness relating to the Stendal project, including under the Stendal Loan Facility and convertible notes. See "Business — Description of Certain Indebtedness" and Note 9 to our annual financial statements included herein for a description of such indebtedness. Does not include amounts associated with derivatives entered into in connection with the Stendal Loan Facility. See "Quantitative and Qualitative Disclosure about Market Risk" for information about our derivatives.

(3)

Capital lease obligations relate to transportation vehicles and production equipment. These amounts reflect principal and interest.

(4)

Operating lease obligations relate to transportation vehicles and other production and office equipment.

(5)

Purchase obligations relate primarily to take-or-pay contracts made in the ordinary course of business, of which purchases of raw materials and supplies totaled approximately €85.0 million.

(6)

Other long-term liabilities relate primarily to pension liability. Does not include obligations under employment agreements.

Capital Resources

        For a description of our credit facilities, see "Business — Description of Certain Indebtedness".

Sensitivity Analysis

        The pulp and paper business is cyclical in nature and markets for our principal products are characterized by periods of supply and demand imbalance, which in turn affects product prices. The markets for pulp and paper are highly competitive and sensitive to changes in industry capacity and in the economy, both of which can have a significant influence on our selling prices and earnings. Approximately €126.6 million, or approximately 69.4%, of our revenues in 2003 were from pulp sales. The following table illustrates the effect on our net operating results in 2003 and 2002 of a $20 change in our average selling

47

price per tonne for NBSK pulp in 2003 and 2002, based upon our pulp sales during each year and translated into Euros at the average exchange rate for the U.S. dollar to the Euro for 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, 2003, we reported a net €2.5 million foreign exchange translation gain and, as a result, the cumulative foreign exchange translation gain increased to €6.0 million at December 31, 2003 from €3.5 million at December 31, 2002.

        Based upon the exchange rate at December 31, 2003, the U.S. dollar decreased by approximately 17% in value against the Euro since December 31, 2002. See "Quantitative and Qualitative Disclosures about Market Risk".

Critical Accounting Policies

        The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Estimates are used for, but not limited to, the accounting for doubtful accounts, depreciation and amortization, asset impairments, income taxes, and contingencies. Actual results could differ from these estimates.

        Our management routinely makes judgments and estimates about the effects of matters that are inherently uncertain. As the number of variables and assumptions affecting the probable future resolution of the uncertainties increase, these judgments become even more subjective and complex. We have identified certain accounting policies, described below, that are the most important to the portrayal of our current financial condition and results of operations. Our significant accounting policies are disclosed in Note 1 to our consolidated financial statements included in this annual report.

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

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        We reported a non-cash holding loss of €13.0 million before minority interests in respect of the Stendal Interest Rate Swap Agreements, a non-cash holding gain of €0.7 million before minority interests in respect of the Stendal currency forward contract and a gain of €28.5 million in respect of the Rosenthal Interest Rate Contracts and settlement of the Currency Swaps and Currency Forwards in our loss for the year ended December 31, 2003.

        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, 2003, we had €84.5 million in deferred tax assets and €74.5 million in valuation allowances, resulting in a net deferred tax asset of €10.0 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.

        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

49

environmental audits. We estimate the aggregate wastewater fees for the past three years to be approximately €9.6 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, 2003, we recorded a liability for environmental conservation expenditures of €1.8 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 annual report that are not reported financial results or other historical information are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, as amended. These statements are based on present information we have related to our existing business circumstances and involve a number of risks and uncertainties, any of which could cause actual results to differ materially from these forward-looking statements. We caution you that we do not assume any obligation to update forward-looking statements based on unanticipated events or changed expectations. Factors that could cause actual results to differ materially include, but are not limited to:

        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 pulp 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.

        Cyclical Nature of Business.    The pulp and paper business is cyclical in nature and markets for our principal products are characterized by periods of supply and demand imbalance, which in turn affects product prices. The markets for pulp and paper are highly competitive and are sensitive to cyclical changes in industry capacity and in the global economy, all of which can have a significant influence on selling prices and our earnings. Demand for pulp and paper products has historically been determined by the level of economic growth and has been closely tied to overall business activity. During the past three calendar years, list pulp prices have fallen significantly. Although pulp prices have improved overall in 2003 and 2004, we cannot predict the impact of continued economic weakness in most world markets or the impact of war, terrorist activity or other events on our markets.

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        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 in nature. Production costs also depend on the total volume of production. Lower operating rates and production efficiencies during periods of cyclically low demand result in higher average production costs and lower margins.

        Stendal Pulp Mill Project Uncertainties.    We are the majority shareholder of a project company that is constructing a softwood kraft pulp mill near the town of Stendal, Germany. We estimate the overall cost of this project at about €1.0 billion, and the performance of this project will have a material impact on our financial condition and operating performance. The construction of the Stendal mill is subject to various risks and uncertainties customary to larger "greenfield" projects of this nature which may result in the Stendal project not proceeding or being completed as scheduled or budgeted. Such delays and cost overruns may result from the lack of availability and cost of materials and labor, construction delays, equipment failures or damage, weather conditions, industrial accidents, governmental regulations, 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. Further, the Stendal mill could experience operating difficulties or delays during the start-up period when production is being ramped up and the Stendal mill may not achieve our planned production, quality or cost projections.

        The Stendal project will also be subject to extensive and complex regulations and environmental compliance which may result in unanticipated delays, in substantial costs to Stendal and/or its shareholders, including us, or in the Stendal project being changed or not being completed at all. Any change in the foregoing could have a material adverse impact on our business, financial condition, results of operations and cash flow. The implementation of the Stendal project commenced in 2002 and is currently scheduled to be completed by the third quarter of 2004. However, there can be no assurance that the Stendal project will be completed 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".

        Currency Exchange Rate and Interest Rate Fluctuations.    Approximately 69% of our sales in 2003 were in products quoted and listed in U.S. dollars while most of our operating costs and expenses are incurred in Euros. Our results of operations and financial condition are reported in Euros. A significant increase in the value of the Euro relative to the U.S. dollar would reduce the amount of revenues in Euros realized by us from sales denominated or priced in U.S. dollars. This would reduce our operating margin and the cash flow available to fund our operations and to service our debt. This could have a material adverse effect on our business, financial condition, results of operation and cash flow.

        Stendal has entered into variable-to-fixed interest rate swaps to fix interest payments under the Stendal project financing facility, which has kept Stendal from benefiting from the general decline in interest rates in the latter part of 2002 and first half of 2003. In addition, Rosenthal has entered into interest rate contracts to limit the interest rate in connection with certain of its indebtedness. However, an increase in interest rates to such limit would require Rosenthal to make higher interest payments, which could adversely affect our results of operations and financial condition.

        Derivatives.    A significant amount of our sales revenue is based on pulp sales priced in U.S. dollars while our reporting currency is Euros and our costs are predominantly in Euros. We therefore use foreign currency derivative instruments primarily to manage against depreciation of the U.S. dollar against the Euro.

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        We also use derivative instruments to limit our exposure to interest rate fluctuations. Concurrently with entering into the Stendal financing, Stendal entered into variable-to-fixed rate interest swaps for the full term of the facility to manage its interest rate risk exposure with respect to a maximum aggregate amount of approximately $612.6 million of the principal amount of such facility. Stendal has also entered into a currency forward contract in connection with the Stendal financing. Rosenthal also entered into currency swap, currency forward, interest rate and interest cap derivative instruments in connection with its outstanding floating rate indebtedness. Our derivative instruments are marked to market and can materially impact our operating results. For example, our operating results for fiscal 2003 and 2002 included net gains of €28.5 million and €23.4 million, respectively, on the Rosenthal derivatives and unrealized losses of €13.0 million and €30.1 million, respectively, on the Stendal interest rate swaps.

        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 business, financial condition, results of operations and cash flow. The purpose of our derivative activity may also be considered speculative in nature; our management does not use these instruments with respect to any pre-set percentage of revenues or other formula, but to reduce our potential losses or augment potential gains depending on our management's perception of future economic events and developments. See "Management's Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations" and "Quantitative and Qualitative Disclosures about Market Risk".

        Raw Materials.    Wood chips and pulplogs 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 and regionally. 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.

        We do not own any timberlands, have any governmental timber concessions or have any long-term fiber contracts. Although raw materials are available from a number of suppliers, and we have not historically experienced supply interruptions or substantial price increases, our requirements will increase when the Stendal mill commences production and 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, government orders and legislation, acts of god and other events beyond our control. An insufficient supply of fiber or reduction in the quality of fiber we receive would materially adversely affect our business, financial condition, results of operations and cash flow.

        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.

        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

52

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.

        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 expired at the end of 2003. We expect to negotiate a new collective agreement with employees at our paper mills in the first half of 2004. Our pulp workers have agreed to defer negotiations in respect of an additional wage increase as a result of current 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 at the paper mills or in potential wage negotiations with our pulp workers. 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.

        Key Personnel.    Our future success depends, to a large extent, on the efforts and abilities of our executive and senior mill operating officers. Such officers are industry professionals many of whom have operated through multiple business cycles. Our officers play an integral role in, among other things:

•

sales and marketing;



•

reducing operating costs;



•

identifying capital projects which provide a high rate of return; and



•

prioritizing expenditures and maintaining employee relations.

        The loss of our officers or any one of them could make us less competitive in these areas which could materially adversely affect our business, financial condition, results of operations and cash flows. We do not maintain any key person life insurance on any of our executive or senior mill operating officers.

        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.

        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;

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•

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 2003.

ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

        We are exposed to market risks from changes in interest rates, foreign currency exchange rates, particularly the exchange rate between the U.S. dollar and the Euro, 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 derivatives. We use derivatives to reduce or limit our exposure to interest rate and currency risks. We may in the future use derivatives to reduce or limit our exposure to fluctuations in pulp prices. We also use derivatives to reduce our potential losses or to augment our potential gains, depending on our management's perception of future economic events and developments. These types of derivatives 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 derivatives, and the types of derivatives 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.

Derivatives

        Derivatives are contracts between two parties where payments between the parties are dependent upon movements in the price of an underlying asset, index or financial rate. Examples of derivatives include swaps, options and forward rate agreements. The notional amount of the derivatives is the contract amount used as a reference point to calculate the payments to be exchanged between the two parties and the notional amount itself is not generally exchanged by the parties.

        The principal derivatives we use are foreign exchange derivatives and interest rate derivatives.

        Foreign exchange derivatives include currency swaps which involve the exchange of fixed payments in one currency for the receipt of fixed payments in another currency. Such cross-currency swaps involve the exchange of both interest and principal amounts in two different currencies. They also include foreign exchange forwards which are contractual obligations in which two counterparties agree to exchange one currency for another at a specified price for settlement at a pre-determined future date. Forward contracts are effectively tailor-made agreements that are transacted between counterparties in the over-the-counter market.

        Interest rate derivatives include interest rate forwards (forward rate agreements) which are contractual obligations to buy or sell an interest-rate-sensitive financial instrument on a future date at a specified price. Forward contracts are effectively tailor-made agreements that are transacted between different counterparties in the over-the-counter market. They also include interest rate swaps which are over-the-counter contracts in which two counterparties exchange interest payments based upon rates applied to a notional amount.

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        We use foreign exchange derivatives to convert some of our costs (including currency swaps relating to our long-term indebtedness) from Euros to U.S. dollars. We use interest rate derivatives to fix the rate of interest on indebtedness under the Rosenthal Loan Facility and the Stendal Loan Facility.

        All of the derivatives we enter into are pursuant to the Rosenthal Loan Facility and the Stendal Loan Facility, each of which provide facilities for foreign exchange derivatives, interest rate derivatives and commodities derivatives, subject to prescribed controls, including maximum notional and at-risk amounts. These credit facilities are secured by substantially all of the assets of the Rosenthal and Stendal pulp mills, respectively, and have the benefit of certain German governmental guarantees. These credit facilities do not have any separate margin requirements when derivatives are entered into pursuant to the terms and conditions thereof and are subsequently marked to market.

        All of the derivatives of Rosenthal and Stendal 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.

        Rosenthal entered into the 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 had been contracted by Rosenthal using a dedicated credit line within the Rosenthal Loan Facility. As NBSK pulp prices are quoted in U.S. dollars and the majority of our business transactions are denominated in Euros, Rosenthal had entered into the 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 these Currency Swaps, 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 Currency Swaps to manage its risk exposure with respect to in aggregate approximately €223.3 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 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 Currency Swaps for the principal amounts of €74.5 million and €130.4 million. In December 2002, the swap relating to the principal amount of €130.4 million under the Rosenthal Loan Facility was settled. In 2003, Rosenthal re-entered the Currency Swap for the notional amount of €124.2 million, maturing on September 30, 2008. In December 2003, both Currency Swaps were settled as a result of the substantial weakening of the U.S. dollar against the Euro in 2003.

        In addition, Rosenthal entered into the Interest Rate Contracts in the fourth quarter of 2002 and in 2003 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. These Currency Forwards were also settled in 2003 as a result of the substantial weakening of the U.S. dollar against the Euro in 2003.

        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

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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.

        In the third quarter of 2003, Stendal also entered into a currency forward contract for the notional amount of $10.0 million maturing in August 2004 to reduce or limit its exposure to currency risks and to augment its potential gains or reduce its potential losses.

        The following table sets forth the maturity date, the notional amount and the recognized gain or loss, for derivatives that were transacted during 2002 and 2003: