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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2004

OR

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

For the transition period from                  to                 

Commission File No.: 000-09409

MERCER INTERNATIONAL INC.
(Exact name of Registrant as specified in its charter)

14900 Interurban Avenue South, Suite 282, Seattle, WA 98168
(Address of office)

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

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                     NOo

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES  ý                     NOo

The Registrant had 17,324,229 shares of beneficial interest outstanding as at August 6, 2004.

PART I.    FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS

MERCER INTERNATIONAL INC.

CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2004

(Unaudited)

2

MERCER INTERNATIONAL INC.

CONSOLIDATED BALANCE SHEETS

As at June 30, 2004 and December 31, 2003
(Unaudited)
(Euros in thousands)

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

3

MERCER INTERNATIONAL INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

For Six Months Ended June 30, 2004 and 2003
(Unaudited)
(Euros in thousands, except for earnings per share)

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

4

MERCER INTERNATIONAL INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

For Three Months Ended June 30, 2004 and 2003
(Unaudited)
(Euros in thousands, except for earnings per share)

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

5

MERCER INTERNATIONAL INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

For Six Months Ended June 30, 2004 and 2003
(Unaudited)
(Euros in thousands)

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

6

MERCER INTERNATIONAL INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

For Three Months Ended June 30, 2004 and 2003
(Unaudited)
(Euros in thousands)

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

7

MERCER INTERNATIONAL INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

For Six Months Ended June 30, 2004 and 2003
(Unaudited)
(Euros in thousands)

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

8

MERCER INTERNATIONAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR SIX MONTHS ENDED JUNE 30, 2004

(Unaudited)
(Euros in thousands, except for shares and loss per share)

Note 1.    Basis of Presentation

The interim period consolidated financial statements contained herein include the accounts of Mercer International Inc. and its wholly-owned and majority-owned subsidiaries (the "Company").

The interim period consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (the "SEC"). Certain information and footnote disclosure normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such SEC rules and regulations. The interim period consolidated financial statements should be read together with the audited consolidated financial statements and accompanying notes included in the Company's latest annual report on Form 10-K for the fiscal year ended December 31, 2003. In the opinion of the Company, the unaudited consolidated financial statements contained herein contain all adjustments necessary to present a fair statement of the results of the interim periods presented. The results for the periods presented herein may not be indicative of the results for the entire year.

Note 2.    Stock-Based Expenses

The Company has a stock-based employee compensation plan, which is described more fully in the Company's annual report on Form 10-K for the year ended December 31, 2003. The Company also has a 2004 Stock Incentive Plan, which is described more fully in the Form S-8 filed by the Company with the SEC on June 16, 2004. The Company accounts for the plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. The following tables illustrate the effect on net income (loss) and income (loss) per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation.

9

MERCER INTERNATIONAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR SIX MONTHS ENDED JUNE 30, 2004

(Unaudited)
(Euros in thousands, except for shares and loss per share)

In March 2004, 73,330 shares of beneficial interest were issued as a result of the cashless exercise of 150,000 stock options. This resulted in a total stock-based expense of €532, which was charged to net loss immediately.

In January 2004, 25,000 restricted shares of beneficial interest were issued to a trustee in connection with his role as Lead Trustee of the Board of Trustees. One-third of such shares vested on January 20, 2004, one-third will vest on November 11, 2004 and the remaining one-third on November 11, 2005. This resulted in a total expense of €161, one-third of which was charged to net loss immediately, while the remaining two-thirds is to be amortized over the period to November 2005 on a straight-line basis.

In June 2004, a total of 15,000 restricted shares of beneficial interest were issued to three trustees in connection with their roles as independent trustees of the Board of Trustees. These shares vest on June 18, 2005. This resulted in a total expense of €112, which will be amortized over the period to June 2005.

In June 2004, 21,000 shares of beneficial interest were issued as a result of the exercise of stock options by a former trustee.

10

MERCER INTERNATIONAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR SIX MONTHS ENDED JUNE 30, 2004

(Unaudited)
(Euros in thousands, except for shares and loss per share)

Note 3.    Earnings Per Share

Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of shares outstanding during a period. Diluted earnings per share takes into consideration shares outstanding (computed under basic earnings per share) and potentially dilutive shares. The following table sets out the computation of basic and diluted earnings per share for the six months and three months ended June 30, 2004 and 2003, respectively:

For the six months ended June 30, 2004 and the six months and three months ended June 30, 2003, warrants, options and convertible notes were not included in the computation of diluted earnings per share because they were anti-dilutive.

11

MERCER INTERNATIONAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR SIX MONTHS ENDED JUNE 30, 2004

(Unaudited)
(Euros in thousands, except for shares and loss per share)

Note 4.    Stendal Pulp Mill Project

In August 2002, the Company completed financing arrangements for the design, development, financing, construction and operation of a "greenfield" project to construct and operate a 552,000-tonne softwood kraft pulp mill to be located near Stendal, Germany (the "Stendal Project"). The Stendal Project is being implemented through Zellstoff Stendal GmbH ("Stendal"), an approximately 63.6% owned subsidiary of the Company. Two minority shareholders own approximately 29.4% and 7%, respectively, of the project company. Accordingly, the results of the subsidiary are consolidated into the results of the Company. The Company currently capitalizes the majority of the expenses and the interest related to the Stendal Project as it is classified as construction in progress. Certain personnel and other supervisory expenses in respect of staffing and preparing for the start-up and operation of the Stendal mill are expensed. Construction of the Stendal Project was completed in late July 2004. The Stendal mill will commence to be depreciated when it commences its commercial production. Minority interest on the balance sheet represents the share capital contribution from the minority shareholders, adjusted for their proportionate share of income and loss.

12

MERCER INTERNATIONAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR SIX MONTHS ENDED JUNE 30, 2004

(Unaudited)
(Euros in thousands, except for shares and loss per share)

Note 5.    Business Segment Information

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

Summarized financial information concerning the segments is shown in the following table:

13

MERCER INTERNATIONAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR SIX MONTHS ENDED JUNE 30, 2004

(Unaudited)
(Euros in thousands, except for shares and loss per share)

The total assets for the Stendal pulp mill under construction were €683,834 and €555,966 as at June 30, 2004 and December 31, 2003, respectively.

14

MERCER INTERNATIONAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR SIX MONTHS ENDED JUNE 30, 2004

(Unaudited)
(Euros in thousands, except for shares and loss per share)

Note 6.    Derivatives Transactions

In addition to the derivatives reported in the Company's annual report on Form 10-K for the year ended December 31, 2003, the Company entered into certain new derivative transactions in the first six months of 2004.

The Company's wholly-owned subsidiary, Zellstoff-und Papierfabrik Rosenthal GmbH & Co., KG ("Rosenthal"), entered into two currency swaps in the aggregate principal amount of approximately €184,500 to convert all of its long-term indebtedness under its bank loan facility into U.S. dollars. The swaps mature in September 2008 and September 2013, respectively. In addition, in the first six months of 2004, Rosenthal entered into a currency forward in the notional amount of approximately €40,700 which matures in March 2005. A marked to market non-cash holding loss of approximately €5,272 and €382 was recognized in respect of these derivatives and certain interest rate derivatives previously entered by Rosenthal in the six months and three months ended June 30, 2004, respectively.

In the first six months of 2004, Stendal entered into a currency swap in the principal amount of approximately €306,300 which matures in April 2011 and a currency forward in the notional amount of approximately €20,600 which matures in March 2005. A net non-cash holding gain of approximately €13,866 and €14,028 was recognized in respect of these derivatives in the six months and three months ended June 30, 2004, respectively.

Note 7.    Reclassifications

Certain prior period amounts in the interim period consolidated financial statements contained herein have been reclassified to conform to the current period's presentation.

15

ITEM 2.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

In this document: (i) unless the context otherwise requires, "we", "our", "us", the "Company" or "Mercer" mean Mercer International Inc. and its subsidiaries; (ii) information is provided as of June 30, 2004, unless otherwise stated; (iii) all references to monetary amounts are to "Euros", the lawful currency adopted by most members of the European Union, unless otherwise stated; (iv) "€" refers to Euros; and (v) a "tonne" is one metric ton or 2,204.6 pounds.

The following discussion and analysis of our results of operations and financial condition for the six and three months ended June 30, 2004 should be read in conjunction with our consolidated financial statements and related notes included in this quarterly report, as well as our most recent annual report on Form 10-K for the fiscal year ended December 31, 2003 filed with the Securities and Exchange Commission (the "SEC"). Certain reclassifications have been made to the prior period financial statements to conform with the current period presentation.

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) a northern bleached softwood kraft ("NBSK") pulp mill operated by our wholly-owned subsidiary, Zellstoff-und Papierfabrik Rosenthal GmbH & Co., KG ("Rosenthal"), which has an annual production capacity of approximately 300,000 tonnes; (b) a newly constructed, state-of-the-art NBSK pulp mill, with a design production capacity of approximately 552,000 tonnes, near Stendal, Germany (the "Stendal project") built and being started up by our 63.6% owned subsidiary, Zellstoff Stendal GmbH ("Stendal"); and (c) two paper mills located at Heidenau and Fährbrücke, Germany (the "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.

We completed construction of the Stendal mill substantially on its planned schedule and budget in late July 2004. Total investment costs in respect of the Stendal project are approximately €1.0 billion, the majority of which is being financed under a senior project finance facility (the "Stendal Loan Facility") in the amount of €828 million and arranged with Bayerische Hypo-und Vereinsbank AG. The Stendal mill is currently in the start-up phase and will be undergoing extensive testing and evaluation. Costs, including interest, relating to and during the construction of the Stendal mill were generally capitalized. Costs comprised principally of personnel and other supervisory expenses in respect of staffing and the start-up and operation of the mill are expensed. See " — Stendal Project Status" below.

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.

16

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 declined from a high of approximately $710 per tonne in late 2000 to an average of approximately $460 per tonne in late 2001 and most of 2002 as the decline of North American and European economies caused a sharp reduction in paper demand and a build-up of producer inventories. The weakening of the U.S. dollar against the Euro and other major currencies and an increase in demand resulting from improving American and major European economies in 2003 resulted in list prices for kraft pulp in Europe increasing to approximately $560 per tonne in December 2003 despite relatively high inventory levels. List prices for kraft pulp in Europe continued to strengthen in the first half of 2004 due to the relatively weak U.S. dollar and improving world economies. List prices increased to approximately $600 per tonne in March 2004 and approximately $645 per tonne in June 2004. However, there can be no assurance 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 operating results because the price for our principal product, NBSK pulp, is generally based on a global industry benchmark that is priced 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 operating results 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 also impact certain foreign currency and interest rate derivatives Rosenthal and Stendal use to partially protect against the effect of such changes. Gains or losses on such derivatives are included in our earnings, either as they are settled or as they are marked to market for each reporting period. See "Quantitative and Qualitative Disclosures about Market Risk".

Stendal, as required under its project financing, entered into variable-to-fixed rate interest swaps (the "Stendal Interest Rate Swaps") in August 2002 to fix the interest rate on approximately €612.6 million of indebtedness for the full term of the Stendal Loan Facility. Rosenthal has also entered into forward interest rate and interest cap contracts (the "Rosenthal Interest Rate Contracts" and, together with the Stendal Interest Rate Swaps, the "Interest Rate Contracts") in respect of a portion of its long-term indebtedness under its bank loan facility (the "Rosenthal Loan Facility").

In the six months ended June 30, 2004, we recorded a net non-cash holding loss of €1.7 million before minority interests on the marked to market valuation of the Interest Rate Contracts versus a net loss of €28.8 million before minority interests thereon in the prior period of 2003. In the quarter ended June 30, 2004, we recorded a net non-cash holding gain of €15.8 million before minority interests on the marked to market valuation of the Interest Rate Contracts versus a net loss of €18.1 million before minority interests thereon in the prior period of 2003.

17

In March 2004, to protect against a weakening U.S. dollar, Rosenthal entered into two currency swaps in the aggregate principal amount of €184.5 million to convert all of its long-term indebtedness under the Rosenthal Loan Facility into U.S. dollars and a currency forward in the notional amount of €40.7 million (the "Rosenthal Currency Derivatives"). In the same month, Stendal entered into a currency swap in the principal amount of €306.3 million to convert approximately one-half of its indebtedness under the Stendal Loan Facility into U.S. dollars and a currency forward in the notional amount of €20.6 million (the "Stendal Currency Derivatives" and, together with the Rosenthal Currency Derivatives, the "Currency Derivatives"). Primarily as a result of a weakening of the U.S. dollar versus the Euro and changes in interest rates related to such currencies, in the six and three months ended June 30, 2004, we recognized a net non-cash holding gain of approximately €8.7 million and €13.7 million, respectively, before minority interests on the Currency Derivatives. In the six and three months ended June 30, 2003, we recognized a net non-cash holding gain of approximately €15.4 million and €13.3 million, respectively, before minority interests on the then outstanding currency derivatives of Rosenthal. During the prior periods, Stendal did not have any currency derivatives outstanding. See "Quantitative and Qualitative Disclosures about Market Risk".

Since mid-2003, the U.S. dollar has generally weakened versus the Euro and other major currencies. The weak U.S. dollar has effectively reduced pulp sales realizations in Europe. However, improving pulp demand resulting from improving American and major European economies and the weak U.S. dollar has led to higher list prices for kraft pulp in Europe. If the U.S. dollar continues to weaken versus the Euro, we could record marked to market non-cash holding gains on the Currency Derivatives in future periods, although our pulp sales realizations would decrease. A strengthening of the U.S. dollar versus the Euro could result in our recording marked to market non-cash holding losses on the Currency Derivatives in future periods, although we would expect to achieve higher pulp sales realizations. Improving world economies resulted in an increase in interest rates in the second quarter of 2004. If world economies continue to strengthen, we would expect interest rates to continue to rise from their historically low levels. Higher interest rates could result in our recording marked to market non-cash holding gains on the Stendal Interest Rate Swaps in future periods, which may be offset in part by higher interest rates payable on Rosenthal's debt obligations. However, a fall in interest rates could result in our recording non-cash holding losses on the Stendal Interest Rate Swaps in future periods when they are marked to market. See "Quantitative and Qualitative Disclosures about Market Risk".

18

Six Months Ended June 30, 2004 Compared to Six Months Ended June 30, 2003

Selected sales data for the six months ended June 30, 2004 and 2003 is as follows:

(1)

Excluding intercompany sales volumes of 2,549 tonnes and 3,611 tonnes of pulp and intercompany net sales revenues of approximately €1.2 million and €1.5 million in the six months ended June 30, 2004 and 2003, respectively.

Total revenues for the six months ended June 30, 2004 increased to €104.8 million from €98.3 million in the comparative period of 2003, primarily because of higher pulp sales. Pulp and paper revenues were €97.8 million in the first half of 2004, versus €91.3 million in the comparative period of 2003.

Costs of pulp and paper sales in the six months ended June 30, 2004 increased to €90.7 million from €86.5 million in the comparative period of 2003, primarily as a result of increased pulp sales volumes.

For the first half of 2004, pulp sales increased to €69.2 million from €62.4 million in the same period a year ago. List prices for NBSK pulp in Europe were approximately €535 ($645) per tonne at the end of the first half of 2004, compared to approximately €484 ($550) per tonne at the end of the first half of last year. The increase in NBSK pulp prices was partially offset by the weakness of the U.S. dollar versus the Euro in the current period. Increased production volumes due to enhanced operational efficiency lead to higher pulp revenues. In the current period, pulp sales by volume were 156,334 tonnes, compared to 148,179 tonnes in the comparative period of 2003.

Pulp sales realizations were €443 per tonne on average in the current period, compared to €421 per tonne in the first half of 2003.

Transportation and other revenues for the pulp operations were €7.8 million in the period ended June 30, 2004, compared to €6.3 million in the comparative period of last year.

Cost of sales and general, administrative and other expenses for the pulp operations increased to €75.4 million in the six months ended June 30, 2004 from €69.3 million in the comparative period of 2003, primarily as a result of the inclusion of certain non-capitalized expenses of approximately €5.4 million related to the Stendal mill. Such costs are comprised principally of personnel and other supervisory expenses in respect of staffing and the start-up and operation of the Stendal mill. As such costs are not directly related to the construction of the Stendal mill, they are not capitalized. We expect the amount of costs relating to the Stendal project that are expensed to markedly increase as the mill is started up in the third quarter of 2004. On average, per tonne fiber costs for pulp production decreased by approximately 4.2% compared to the first half of last year. Depreciation for the pulp operations was €11.1 million in the current period, versus €10.9 million in the year ago period.

19

For the first half of 2004, our pulp operations generated operating income of €2.8 million, versus operating income of €0.9 million in the year ago period.

Paper sales in the first half of 2004 were €28.5 million, compared with €28.9 million in the same period of last year. Sales of specialty papers in the first half of 2004 were €19.4 million versus €21.6 million in the first half of 2003, primarily as a result of a shift in the product mix. For the current period, total paper sales volumes were 32,789 tonnes, versus 31,009 tonnes in the first half of last year. On average, prices for specialty papers realized in the current period decreased slightly, reflecting a shift in the product mix. Average prices for our printing papers decreased by approximately 11.0% reflecting generally weak demand.

Cost of sales and general, administrative and other expenses for the paper operations in the first half of 2004 increased to €30.9 million from €28.1 million in the comparative period of 2003, primarily as a result of higher paper sales volumes. Depreciation for the paper operations was €1.1 million in the first half of 2004, compared to €1.0 million in the same period last year.

For the first half of 2004, our paper operations generated an operating loss of €2.6 million, compared to operating income of €2.7 million in the same period of last year.

For the first half of 2004, consolidated general and administrative expenses increased to €14.4 million from €8.7 million in the year ago period, primarily as a result of the inclusion of certain non-capitalized expenses related to the Stendal mill.

In the first half of 2004, we reported a loss from operations of €2.5 million, compared to income from operations of €2.6 million in the same period last year. Interest expense (excluding capitalized interest of €17.5 million relating to the Stendal pulp mill) in the first half of 2004 increased to €5.4 million from €4.7 million a year ago, due to higher borrowings resulting primarily from our convertible note issue in October 2003.

In the first half of 2004, we recorded a net non-cash holding loss of €1.7 million before minority interests on the marked to market valuation of the Interest Rate Contracts versus a net loss of €28.8 million before minority interests thereon in the prior period of 2003. In addition, in the six months ended June 30, 2004, we recorded a net non-cash holding gain of approximately €8.7 million before minority interests on the valuation of the Currency Derivatives as a result of the weakening of the U.S. dollar versus the Euro and changes in interest rates related to such currencies. In the prior period of 2003, we recorded a net non-cash holding gain of €15.4 million before minority interests on the then outstanding currency derivatives of Rosenthal. Stendal did not have any currency derivatives outstanding in the prior period of 2003.

In the first half of 2004, minority interest, representing the two minority shareholders' proportionate interest in the Stendal project, was €(2.8) million, compared to €10.4 million in the comparative period of 2003.

20

Our results for the current period include an adjustment of €0.4 million relating primarily to the valuation of certain assets at the paper operations made obsolete as a result of a change in the product mix. Our results for the prior period of 2003 included an adjustment of €5.5 million for the non-cash impact of other-than-temporary impairment losses of our available-for-sale securities.

We reported a net loss for the first half of 2004 of €2.7 million, or €0.16 per diluted share, versus a net loss of €10.0 million, or €0.60 per diluted share, a year ago.

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 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 six months ended June 30, 2004, we reported a net loss of €2.7 million or €0.16 per share on a diluted basis. If we had excluded items relating to the Stendal project by adding the loss of €1.6 million on the Stendal Interest Rate Swaps, general and administrative expenses of €5.5 million related to the Stendal mill and minority interest of €2.8 million to, and subtracting the gain of €13.9 million on the Stendal Currency Derivatives and other income of €0.4 million related to the Stendal mill from, the reported net loss of €2.7 million, we would have reported a net loss of €7.2 million or €0.42 per share on a diluted basis. For the six months ended June 30, 2003, we reported a net loss of €10.0 million or €0.60 per share on a diluted basis. If we had excluded items relating to the Stendal project by adding the loss of €27.9 million on the Stendal Interest Rate Swaps and general and administrative expenses of €0.8 million related to the Stendal mill to, and subtracting minority interests of €10.4 million and other income related to the Stendal mill of €0.4 million from, the reported net loss of €10.0 million, we would have reported net income of €8.0 million or €0.47 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 €10.1 million in the current period, compared to Operating EBITDA of €14.5 million in the comparative period of 2003. The decrease from the prior period results is primarily as a result of the inclusion of certain non-capitalized expenses of €5.4 million related to the Stendal mill in the current period. Operating EBITDA is defined as income (loss) from operations plus depreciation and amortization. Operating EBITDA is calculated by adding depreciation and amortization of €12.6 million and €11.9 million to the loss from operations of €2.5 million and income from operations of €2.6 million for the six-month periods ended June 30, 2004 and 2003, respectively.

Management uses Operating EBITDA as a benchmark measurement of its own operating results, and as a benchmark relative to its competitors. Management considers it to be a meaningful supplement to operating income as a performance measure primarily because depreciation expense 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.

21

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.

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

22

Three Months Ended June 30, 2004 Compared to Three Months Ended June 30, 2003

Selected sales data for the three months ended June 30, 2004 and 2003 is as follows:

(1)

Excluding intercompany sales volumes of 1,540 tonnes and 1,482 tonnes of pulp and intercompany net sales revenues of approximately €0.8 million and €0.6 million in the three months ended June 30, 2004 and 2003, respectively.

Total revenues for the three months ended June 30, 2004 increased to €51.8 million from €47.9 million in the comparative period of 2003, primarily because of higher pulp sales. Pulp and paper revenues were €48.5 million in the second quarter of 2004, versus €45.0 million in the comparative period of 2003.

Costs of pulp and paper sales in the three months ended June 30, 2004 increased to €44.0 million from €41.5 million in the comparative period of 2003, primarily a result of increased pulp sales volumes.

For the three months ended June 30, 2004, pulp sales increased to €35.3 million from €31.0 million in the same period a year ago. List prices for NBSK pulp in Europe were approximately €535 ($645) per tonne in the second quarter of 2004, approximately €464 ($580) per tonne in the first quarter of 2004 and approximately €484 ($550) per tonne in the second quarter of last year. The increase in NBSK pulp prices was partially offset by the weakness of the U.S. dollar versus the Euro in the current period. Increased production volumes due to enhanced operational efficiency lead to higher pulp revenues. In the current quarter, pulp sales by volume were 74,841 tonnes, compared to 69,700 tonnes in the comparative period of 2003.

Pulp sales realizations were €471 per tonne on average in the current quarter, compared to €416 per tonne in the first quarter of 2004 and €445 per tonne in the three months ended June 30, 2003.

Transportation and other revenues for the pulp operations were €4.4 million in the three months ended June 30, 2004, compared to €2.4 million in the comparative quarter of last year.

Cost of sales and general, administrative and other expenses for the pulp operations increased to €36.9 million in the three months ended June 30, 2004 from €31.8 million in the comparative period of 2003, primarily as a result of the inclusion of certain non-capitalized expenses of approximately €2.3 million related to the Stendal mill. On average, per tonne fiber costs for pulp production decreased by approximately 2.8% compared to the second quarter of last year. Depreciation for the pulp operations was €5.6 million in the current quarter, versus €5.5 million in the year ago period.

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For the three months ended June 30, 2004, our pulp operations generated operating income of €3.6 million, versus operating income of €2.3 million in the year ago period.

Paper sales in the three months ended June 30, 2004 were €13.2 million, compared with €14.0 million in the same period of last year. Sales of specialty papers in the three months ended June 30, 2004 were €8.6 million versus €10.5 million in the three months ended June 30, 2003, primarily as a result of a shift in the product mix. For the current quarter, total paper sales volumes were 15,383 tonnes, versus 15,302 tonnes in the comparative period of last year. On average, prices for specialty papers realized in the current quarter decreased slightly, reflecting a shift in the product mix. Average prices for our printing papers decreased by approximately 6.0% reflecting generally weak demand.

Cost of sales and general, administrative and other expenses for the paper operations in the three months ended June 30, 2004 increased to €15.1 million from €14.9 million in the comparative quarter of 2003, primarily as a result of higher paper sales volumes. Depreciation for the paper operations was €0.6 million in the three months ended June 30, 2004, compared to €0.5 million in the same period last year.

For the three months ended June 30, 2004, our paper operations generated an operating loss of €2.1 million, compared to €1.1 million in the same period of last year.

For the three months ended June 30, 2004, consolidated general and administrative expenses increased to €7.3 million from €3.9 million in the year ago period, primarily as a result of the inclusion of certain non-capitalized expenses related to the Stendal mill.

In the three months ended June 30, 2004, we reported a loss from operations of €0.6 million, compared to income from operations of €1.4 million in the same period last year. Interest expense (excluding capitalized interest of €10.4 million relating to the Stendal pulp mill) in the three months ended June 30, 2004 increased to €2.4 million from €2.2 million a year ago, due to higher borrowings resulting primarily from our convertible note issue in October 2003.

In the three months ended June 30, 2004, the marked to market valuation of the Interest Rate Contracts resulted in a net non-cash holding gain of approximately €15.8 million before minority interests, primarily as a result of an increase in long-term interest rates during the period. In the comparable period of 2003, we recorded a net loss of €18.1 million before minority interests on such Interest Rate Contracts. In addition, in the three months ended June 30, 2004, we recorded a net non-cash holding gain of approximately €13.7 million before minority interests on the valuation of the Currency Derivatives as a result of a weakening of the U.S. dollar versus the Euro and changes in interest rates related to such currencies, versus a net non-cash holding gain of €13.3 million before minority interests on Rosenthal's then outstanding currency derivatives in the year ago period.

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In the current quarter, minority interest, representing the two minority shareholders' proportionate interest in the Stendal project, was €(10.2) million, compared to €6.5 million in the comparative period of 2003.

Our results for the current period include an adjustment of €0.4 million relating primarily to the valuation of certain assets at the paper operations made obsolete as a result of a change in the product mix.

We reported net income for the three months ended June 30, 2004 of €16.2 million, or €0.94 per basic share and €0.57 per diluted share, versus net income of €0.9 million, or €0.05 per basic and diluted share, a year ago.

If we had excluded items relating to the Stendal project by subtracting the gain on derivative financial instruments of €15.8 million on the Stendal Interest Rate Swaps, €14.0 million on the Stendal Currency Derivatives and other income of €0.3 million related to the Stendal mill from, and adding minority interest of €10.2 million and general and administrative expenses of €2.3 million relating to the Stendal mill to, the reported net income of €16.2 million, we would have reported a net loss of €1.4 million or €0.08 per share on a diluted basis. For the three months ended June 30, 2003, we reported net income of €0.9 million or €0.05 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 €17.6 million on the Stendal Interest Rate Swaps and general and administrative expenses of €0.8 million related to the Stendal mill to, and subtracting minority interests of €6.5 million and other income of €0.3 million related to the Stendal mill from, the reported net loss of €0.9 million, we would have reported net income of €12.4 million or €0.74 per share on a diluted basis. This measure has significant limitations as an analytical tool, and should not be considered in isolation, or as a substitute for analysis of our results as reported under GAAP.

We generated Operating EBITDA of €5.7 million in the current quarter, compared to Operating EBITDA of €7.3 million in the comparative period of 2003. The decrease from the prior period results is primarily as a result of the inclusion of certain non-capitalized expenses of €2.3 million related to the Stendal mill in the current period. Operating EBITDA has significant limitations as an analytical tool, and should not be considered in isolation, or as a substitute for analysis of our results as reported under GAAP. See the discussion of our results for the six months ended June 30, 2004 for additional information relating to Operating EBITDA.

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

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Stendal Project Status

Construction of the Stendal pulp mill was completed substantially on its planned schedule and budget in the last week of July 2004. Such completion means that the construction and installation of equipment and works are essentially finished and operational testing, checks and approvals are occurring so that continuous production from the mill can commence. At the end of July 2004, the mill had all of its requisite permits in place to commence operations and had secured sufficient fiber supplies for the balance of 2004 and into the first quarter of 2005. At July 31, 2004, the mill had filled in excess of 71% of its overall staffing requirements. The balance of the hiring will occur in affiliated activities such as harvesting and transportation and will be completed through 2004 and 2005 as the mill ramps up operations.

The Stendal mill is currently being supervised by the contractor using Stendal's personnel to operate the mill. Stendal commenced feeding wood chips to the digester at the end of July 2004 and commenced the initial production of pulp. The initial pulp produced was off-grade pulp which was primarily sold into the recycled fiber, corrugated board and similar markets. The mill is currently producing "start-up quality" pulp. The prices realized on the sale of off-grade and start-up quality pulp are lower than the selling price for on-grade NBSK pulp. Under our current start-up plan, we expect Stendal to commence ramping up pulp production and quality so that the Stendal mill will be producing a significant proportion of saleable kraft pulp by the end of the third quarter of 2004. Pursuant to our start up plan, we expect that the mill would be operating at approximately 80% of its design capacity by the end of 2004.

During the start-up period of the Stendal mill, the mill will undergo extensive testing and evaluation to determine whether mechanical completion has occurred and, following several months of start-up operations, whether certain performance requirements have been met, referred to as the "Acceptance Test". The Acceptance Test requires that the mill continuously produces pulp for a 72-hour period in compliance with specified operational, quality and environmental requirements. Following completion of such testing, if the requisite performance requirements are met, we are required to provide the contractor with an acceptance certificate. Once we deliver the acceptance certificate, we assume responsibility for the operation of the mill, subject to the contractor's warranty obligations.

Under the current start-up plan, we expect that the contractor will shut down the mill for a two or three-week period in October 2004 for the completion of any adjustments, installations and the replacement of any equipment that may be required in order to fulfill its obligations under the construction contract. We also expect that, in the latter part of 2004, the Stendal mill will be shut down for a few days for fine tuning and cleaning so that the contractor may commence trials for the Acceptance Test.

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

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Liquidity and Capital Resources

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