<PAGE>   1

================================================================================

                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                      ------------------------------------

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

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

                For the fiscal year ended December 31, 1996, or

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

          For the transition period from ____________ to ____________

                          Commission File No.: 0-9409

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

<TABLE>
<S>                                             <C>
                 WASHINGTON                                      91-6087550
        State or other jurisdiction                   IRS Employer Identification No.
              of incorporation
</TABLE>

                BRANDSCHENKE STR. 64, ZURICH, SWITZERLAND, 8002
             Address of principal executive office        Zip Code

       Registrant's telephone number including area code: 41(1) 201 7710

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

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

                      ------------------------------------
                 SHARES OF BENEFICIAL INTEREST, $1.00 PAR VALUE
                        PREFERRED STOCK PURCHASE RIGHTS
                                (Title of Class)
                          ---------------------------

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

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

     The aggregate market value of the Registrant's voting stock held by
non-affiliates of the Registrant as of March 21, 1997 was approximately
$143,444,927. The last reported sale price of the common shares of beneficial
interest on the NASDAQ Stock Market's National Market on March 21, 1997 was
$9.63 per share.

     As of March 21, 1997, the Registrant had 14,917,369 common shares of
beneficial interest, $1.00 par value, outstanding.

                      DOCUMENTS INCORPORATED BY REFERENCE

     The Proxy Statement for the Annual Meeting of Shareholders to be held June
30, 1997 is incorporated by reference in Part III hereof. Certain exhibits in
Part IV of this Form 10-K are incorporated by reference from prior filings made
by the Registrant under the Securities Act of 1933, as amended, and the
Securities Exchange Act of 1934, as amended.
================================================================================
<PAGE>   2

                       SECURITIES AND EXCHANGE COMMISSION
                                   FORM 10-K

                               TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                                          PAGE
                                                                                          ----
<S>        <C>                                                                            <C>
                                              PART I
Item 1.    BUSINESS.....................................................................    3
           The Company..................................................................    3
           Spun-off Operations..........................................................    3
           Products.....................................................................    4
           Sales, Marketing and Distribution............................................    4
           Fibre........................................................................    6
           Capital Expenditures and Government Financing................................    6
           Pulp Mill Conversion Project.................................................    7
           Environmental................................................................    8
           Human Resources..............................................................    9
           Acquisitions.................................................................   10
Item 2.    PROPERTIES...................................................................   10
Item 3.    LEGAL PROCEEDINGS............................................................   11
Item 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS..........................   11
                                             PART II
Item 5.    MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
             STOCKHOLDER MATTERS........................................................   12
Item 6.    SELECTED FINANCIAL DATA......................................................   13
Item 7.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
             OPERATION..................................................................   13
           Results of Operations........................................................   14
           Year Ended December 31, 1996 Compared to the Year Ended December 31, 1995....   14
           Year Ended December 31, 1995 Compared to the Year Ended December 31, 1994....   15
           Liquidity and Capital Resources..............................................   17
           Foreign Currency.............................................................   19
           Cyclical Nature of Business; Competitive Position............................   20
           Inflation....................................................................   20
Item 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA..................................   20
Item 9.    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
             ACCOUNTING AND FINANCIAL DISCLOSURE........................................   20
                                           PART III
Item 10.   DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT...........................   21
Item 11.   EXECUTIVE COMPENSATION.......................................................   21
Item 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT...............   21
Item 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS...............................   21
                                            PART IV
Item 14.   EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.............   22
           Financial Statements.........................................................   24
           Supplementary Financial Information..........................................   41
           SIGNATURES...................................................................   42
</TABLE>

                                        2
<PAGE>   3

                                     PART I

ITEM 1.  BUSINESS

THE COMPANY

     Mercer International Inc. is a Massachusetts trust organized under the laws
of the State of Washington in 1968. Under Washington law, shareholders of a
Massachusetts trust have the same limited liability as shareholders of a
corporation. In this document: (i) unless the context otherwise requires, the
"Company" or "Mercer" refers to Mercer International Inc. and its subsidiaries;
and (ii) a "tonne" is one metric ton or 2,204.6 pounds.

     Mercer is a pulp and paper company headquartered in Zurich, Switzerland,
with operations primarily located in Germany. The Company's pulp, paper and
sales operations are conducted through its indirectly wholly-owned subsidiaries,
Zellstoff-und Papierfabrik Rosenthal GmbH ("ZPR") and Dresden Paper AG ("DPAG").
The Company initially acquired its paper operations in 1993 and its pulp
operations in 1994 from Bundesanstalt fur Vereinigungsbedingte Sonderaufgaben
("BVS"), the German government agency responsible for the privatization of
government owned companies.

     The Company currently employs 873 people and its manufacturing plants
consist of five paper mills (the "Paper mills") and a pulp mill (the "Pulp
mill") with aggregate annual production capacities of approximately 220,000
tonnes and 160,000 tonnes, respectively. The Paper mills produce three primary
classes of paper products, being packaging, printing and specialty, and the Pulp
mill produces sulphite pulp.

     During the last three and a half years, the Company has focused upon
implementing operational changes and plant upgrades to improve efficiency,
reduce effluent discharges and emissions and modernize its manufacturing plants.
In aggregate, the Company has expended approximately $89.3 million on capital
investments at the Company's mills, of which $27.9 million was financed through
non-refundable government grants.

     The markets for pulp and paper are highly competitive and sensitive to
cyclical changes in industry capacity, the economy, interest rates and
fluctuations in foreign currency exchange, all of which can have a significant
influence on the Company's selling prices and overall profitability. The Company
competes with European and international pulp and paper firms ranging from very
large integrated firms to smaller specialty firms. Areas of competition include
price, innovation, quality and service. The Company's competitive position is
influenced by the availability and cost of its raw materials, energy and labour,
and its plant efficiencies and productivity in relation to its competitors.

     The Company previously also operated in the financial services segment. On
December 28, 1995, the Company announced that it would spin-off its financial
services business to its shareholders and the same was completed in June 1996.

     The corporate strategy of the Company is to expand its asset and earnings
base both in Europe and internationally through the acquisition of interests in
companies and assets in the pulp and paper and related businesses.

SPUN-OFF OPERATIONS

     Effective June 3, 1996, the Company completed the spin-off of its financial
services segment in a one for two stock dividend (the "Distribution") of
approximately 83% of its previously held 92% interest in Arbatax International
Inc., now called MFC Bancorp Ltd. ("Arbatax"). The Distribution was recorded as
a stock dividend from shareholders' equity at the carrying amount of the net
assets of the spun-off operations. As a result, the Company's total assets and
shareholders' equity were each reduced by approximately $50.7 million after the
Distribution. The operations of Arbatax have been classified separately within
the Company's financial statements and herein as "spun-off operations" and are
excluded from the amounts of revenues and expenses of the Company's continuing
operations. In addition, Arbatax's assets and liabilities are not consolidated
into the Company's continuing operations. Previously reported financial
statements for all periods and certain amounts in the Company's financial
statements have been restated to conform to this presentation.

                                        3
<PAGE>   4

     The Distribution has permitted the Company to concentrate its management
and financial resources on its core business and pursue new opportunities in the
pulp and paper and related industries.

PRODUCTS

     The Company manufactures and sells sulphite pulp and three primary classes
of paper products. The Company's products are produced from both virgin fibre,
being wood chips and pulpwood, and recycled fibre, being waste paper. The
Company's manufacturing plants are all located in Germany in the States of
Saxony and Thuringia. The Paper mills are located at Heidenau, Hainsberg,
Fahrbrucke, Trebsen and Greiz and have an aggregate annual production capacity
of approximately 220,000 tonnes. The Pulp mill is situated near the town of
Blankenstein and has an annual production capacity of approximately 160,000
tonnes. The following table sets out the Company's primary classes of paper
products and the mills at which they are produced:

<TABLE>
<CAPTION>
PAPER PRODUCT CLASS       MILL                         PRODUCT DESCRIPTION
-------------------       ----                         -------------------
<S>                       <C>                          <C>
Packaging Paper.......... Greiz and Trebsen            Corrugated medium and testliner used in
                                                       the production of boxes and corrugated
                                                       shipping containers.
Specialty Paper.......... Heidenau and Fahrbrucke      Greaseproof paper and coated and
                                                       uncoated wallpaper.
Printing Paper........... Hainsberg and Fahrbrucke     Recycled and woodfree printing, writing
                                                       and copy paper.
</TABLE>

     Pulp is generally classified according to fibre type, the process used and
the degree to which it is bleached. The sulphite pulp produced by the Pulp mill
is a chemical wood pulp manufactured by a magnesium bisulphite acid cooking
process. The majority of the production of the mill is used to make paper grade
pulp. The dissolving sulphite pulp produced by the mill is a specialty pulp used
in the production of synthetic textile fibre such as viscose staple fibre
(rayon). A number of factors beyond economic supply and demand have an impact on
the market for chemical pulp, including an emerging requirement, particularly in
the European market, for pulp bleached without any chlorine compounds or without
the use of chlorine gas. The Pulp mill has the capability of producing both
"totally chlorine free" ("TCF") and "elemental-chlorine free" ("ECF") pulp. TCF
pulp is bleached to a high brightness using oxygen and hydrogen peroxide as
bleaching agents, whereas ECF 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. Ethanol, a
by-product of pulp production, is also sold by the Company to industrial
producers and used in making paints, lacquers, films and printing colours. The
Company plans to convert the Pulp mill from the production of sulphite pulp to
kraft (sulphate) pulp. See "Business -- Pulp Mill Conversion Project."

SALES, MARKETING AND DISTRIBUTION

     The Company's sales and marketing operations focus primarily on western
European countries and are responsible for the majority of the paper sales. In
1996, the Company increased the amount of paper sales conducted through agents
to approximately 35% of total paper sales from approximately 30% in 1995 and 5%
in 1994, in order to expand its sales in markets outside of Germany. The
majority of the Company's paper products are sold to printers, wallpaper
manufacturers, corrugators and converters. Sales of sulphite pulp within Germany
are conducted primarily by the Company's own sales staff, while sales outside of
Germany are carried out primarily through agents. The Company's sulphite pulp is
sold principally to tissue and paper mills and rayon producers. Pulp and paper
sales are made on terms customary to the industry. At December 31, 1996, there
were no material payment delinquencies. The Company's products are delivered to
market by truck, rail and ship.

                                        4
<PAGE>   5

     The distribution of the Company's sales by volume, product class and
geographic area are set out in the following table for the periods indicated:

<TABLE>
<CAPTION>
                                                                  YEARS ENDED DECEMBER 31,
                                                             ----------------------------------
                                                               1996       1995(1)      1994(1)(2)
                                                             --------     --------     --------
                                                                          (tonnes)
<S>                                                          <C>          <C>          <C>
SALES BY VOLUME
Packaging Papers.........................................     110,179      121,145       98,387
Specialty Papers.........................................      26,548       29,813       28,371
Printing Papers..........................................      46,416       47,089       40,893
Pulp.....................................................     133,005      126,562       64,167
                                                             --------     --------     --------
Total(3).................................................     316,148      324,609      231,818
                                                             ========     ========     ========
                                                                       (in thousands)
SALES BY PRODUCT CLASS
Packaging Papers.........................................    $ 33,165     $ 66,776     $ 42,239
Specialty Papers.........................................      27,012       34,370       28,342
Printing Papers..........................................      36,469       50,960       29,536
Pulp.....................................................      72,456      115,934       40,512
Other....................................................       4,995        7,292        7,142
                                                             --------     --------     --------
Total....................................................    $174,097     $275,332     $147,771
                                                             ========     ========     ========
SALES BY GEOGRAPHIC AREA
Germany..................................................    $101,351     $171,876     $104,170
European Union(4)........................................      48,795       72,485       34,797
Other....................................................      23,951       30,971        8,804
                                                             --------     --------     --------
Total....................................................    $174,097     $275,332     $147,771
                                                             ========     ========     ========
</TABLE>

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

(1) In 1995, the Company divested the corrugating box plant at Heidenau and the
    Raschau paper mill. These plants had combined sales of $17.2 million or
    22,123 tonnes of packaging papers in 1995 and sales of $15.2 million or
    24,540 tonnes of packaging papers in 1994.

(2) The Company acquired its pulp operations effective July 1, 1994.

(3) Excluding intercompany sales of 3,609, 3,545 and 1,774 tonnes of pulp in
    1996, 1995 and 1994, respectively.

(4) Not including Germany.

     The following charts illustrate the geographic distribution of the
Company's sales for the periods indicated:

<TABLE>
<CAPTION>
                                                               YEAR ENDED          YEAR ENDED            YEAR ENDED
                                                            DECEMBER 31, 1996    DECEMBER 31, 1995    DECEMBER 31, 1994(1)
                                                                    %                    %                     %
                                                            -----------------    -----------------    --------------------
<S>                                                         <C>                  <C>                 <C>
Germany..................................................         58.2                 62.4                   70.5
European Union(2)........................................         28.0                 26.3                   23.5
Other....................................................         13.8                 11.3                    6.0
</TABLE>

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

(1) The Company acquired its pulp operations effective July 1, 1994.

(2) Not including Germany.

     In 1996 and 1995, no single customer accounted for more than 10% of the
Company's pulp and paper sales. The Company's sales are not dependent upon a
single customer or upon a concentrated group of major customers. The loss of any
one customer would not have a material adverse effect on the Company.

                                        5
<PAGE>   6

FIBRE

     The fibre used by the Company's manufacturing plants consists of waste
paper and pulp used to produce paper products and wood chips and pulpwood used
to produce sulphite pulp. Approximately 80% of the fibre used in the Company's
paper operations consists 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 fibre. The remaining 20% of the fibre is made up of market pulps and
chemical additives, both of which are available at market prices from suppliers
throughout Europe. In 1996, the Paper mills consumed approximately 167,802
tonnes of waste paper. Prices for fibre were relatively low in 1996 as a result
of weak paper markets and weakened pulp markets. Changes in market prices for
fibre in 1996 were generally reflected in the lower prices for the Company's
paper products.

     The Company's pulp operations are situated in a region which offers a
stable fibre supply. Its fibre requirements are met from wood chips produced by
local sawmills or pulpwood. Wood chips are small pieces of wood used to make
pulp and are a product of either wood waste from sawmills or pulpwood processed
especially for this purpose. Pulpwood consists of lower quality logs not used in
the production of lumber. The wood chips are procured from approximately 60
sawmills located in the States of Bavaria and Thuringia within a 150 kilometre
radius of the Pulp mill. Within this radius, the Pulp mill is by far the largest
consumer of wood chips. Wood chips are normally procured from sawmills pursuant
to one year supply contracts, which provide for quarterly price adjustments.
Pulpwood is partly procured from the state forest agency in Thuringia on a
contract basis and partly from private holders. The Pulp mill's fibre
requirements are handled and procured primarily by PWA Holz, which is the
largest wood procurement company in Germany and handles a total volume of
approximately four million cubic metres per year. In 1996, the Pulp mill
consumed approximately 656,109 cubic metres of fibre comprised of approximately
530,650 cubic metres of wood chips and 125,459 cubic metres of pulpwood.

     The cost of fibre for pulp producers in Europe decreased significantly
during 1996 due to low demand for pulp and a build-up in pulpwood supply. While
fibre costs remained relatively low in the last quarter of 1996, there can be no
assurance that they will not escalate in the future. During the early part of
1997, there were signs of upward price pressure for pulpwood in Europe. Overall,
in 1996, reduced fibre prices were reflected in significantly lower pulp prices.
While fibre costs are subject to cyclical changes based upon demand, the Company
expects that it will be able to obtain an adequate and stable supply of fibre on
satisfactory terms due to the favourable location of the Pulp mill and its
long-term relationship with suppliers.

CAPITAL EXPENDITURES AND GOVERNMENT FINANCING

     In 1996, the Company continued with its capital investment programs
designed to improve efficiency and profitability, reduce effluent discharges and
emissions and increase production capacity. Such capital investments were
partially financed through non-refundable grants made available by German
federal and state governments and were used to offset certain wastewater fees.

     Under legislation adopted by the federal and certain state governments of
Germany, non-refundable 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 terms of such grants,
state governments will provide funding ranging between 15% and 23% of the cost
of qualified investments. Additional non-refundable grants, equal to 5% of
qualified investments, are available from the federal government. These grants
are not refundable or repayable by the recipient, unless the proceeds are used
for a non-specified purpose. Such grants are available generally to qualifying
businesses in Germany, and are unrelated to BVS or other amounts due to the
Company from BVS. These non-refundable grants are not recorded in the income of
the Company, but instead reduce the cost basis of the assets purchased by the
proceeds thereof.

     Loan guarantees are also available from German state government agencies
for up to 80% of the cost of qualifying investments. These guarantees are
provided by state governments to assist qualifying businesses with financing
capital investments. The guarantees permit such businesses to obtain term loans
at below market interest rates. To date, the Company has not utilized any such
state government guarantees.

                                        6
<PAGE>   7

     The capital investments made by the Company to reduce effluent discharges
have been applied to offset wastewater fees that would otherwise be payable. At
December 31, 1996, the aggregate wastewater fees saved by the Company over the
last four years as a result of environmental capital expenditures were $10.3
million.

     The following table sets out the Company's capital expenditures and
non-refundable grants recorded for the periods indicated:

<TABLE>
<CAPTION>
                                                            YEARS ENDED              SIX MONTHS ENDED
                                                           DECEMBER 31,                DECEMBER 31,
                                                  -------------------------------    ----------------
                                       TOTAL       1996        1995       1994(1)        1993(2)
                                      -------     -------     -------     -------    ----------------
                                                           (in thousands)
<S>                                   <C>         <C>         <C>         <C>        <C>
Capital Expenditures................  $89,319(3)  $23,865     $18,968     $25,145        $ 21,341
                                      =======     =======     =======     =======        ========
Non-refundable grants...............  $27,952     $ 5,328     $ 7,291     $12,882        $  2,451
                                      =======     =======     =======     =======        ========
</TABLE>

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

(1) The Company acquired its pulp operations effective July 1, 1994.

(2) The Company acquired its paper operations effective July 1, 1993.

(3) To December 31, 1996, capital expenditures have offset $10.3 million in
    wastewater fees.

     In 1993, the Company initiated a four year capital investment program at an
anticipated cost of approximately $57.9 million to modernize and upgrade the
Paper mills. As at December 31, 1996, the Company had substantially completed
this capital investment program and spent in total approximately $58.8 million
thereon. Expenditures under this program in 1996 totalled approximately $9.7
million, of which $1.6 million was financed by non-refundable grants. The
principal investments at the Paper mills under this program consisted of: (i)
approximately $3.9 million for the installation of effluent treatment equipment
to improve environmental compliance; (ii) approximately $12.2 million for the
installation of power plants at two of the Paper mills; (iii) approximately $6.6
million to add a coating facility to the Heidenau mill; (iv) approximately $5.9
million to add a de-inking plant at the Hainsberg mill; and (v) approximately
$8.1 million to upgrade the paper machine at the Trebsen mill to increase its
annual production capacity by 25,000 tonnes. These investments are also expected
to improve the efficiencies of the Paper mills. As the capital investment
program has been substantially completed, the level of capital expenditures at
the Paper mills is expected to be lower in the next two years. The Company
anticipates that capital investments at its Paper mills will total approximately
$2.8 million in 1997.

     In 1994, the Company initiated a capital investment program to reduce
effluent discharges and emissions and upgrade the Pulp mill. The program was
estimated to cost approximately $48.4 million and be completed by December 31,
1998. As at December 31, 1996, approximately $33.8 million had been expended on
this program. Expenditures under this program in 1996 totalled $13.6 million, of
which $3.7 million was funded by non-refundable grants. These investments
included the installation of new screens at the Pulp mill at an approximate cost
of $2.7 million which decreased losses of dissolved material and resulted in
reduced effluent discharges and cleaner pulp. In 1996, the Company also
increased the evaporation capacity of the Pulp mill to reduce effluent
discharges at an approximate cost of $1.5 million. The balance of this
investment program has been modified as a result of the Company's plans to
convert the Pulp mill to produce kraft pulp.

PULP MILL CONVERSION PROJECT

     The Company plans to convert the Pulp mill from the production of sulphite
pulp to kraft pulp. Kraft pulp is a fibrous material produced by chemically
reducing wood into its component parts using a sulphate cooking process and is
primarily used in the production of paper, tissues and paper related products.
This grade of pulp is noted for its strength, whiteness and absorption
properties and is the main type of pulp imported and sold in the European
market. Germany is one of the most significant pulp markets in Europe and the
Company is the only non-integrated pulp producer in the country. As a result,
most of the Company's kraft pulp production will be sold on the domestic German
market.

     The conversion of the Pulp mill to produce kraft pulp is expected to
increase its annual production capacity from 160,000 tonnes to 280,000 tonnes,
substantially reduce effluent and sulphur dioxide emissions and reduce energy
costs.

                                        7
<PAGE>   8

     The estimated cost for the conversion is approximately $325 million, which
will be financed through a combination of non-refundable governmental grants of
approximately $97.5 million, governmental assistance and guarantees for
long-term project financing and cash flow from operations.

     The conversion will be subject to, among other things, the Company settling
all financing and governmental grants on satisfactory terms and obtaining all
necessary environmental and operating permits and approvals for the conversion.
The Company has conducted extensive studies and held extensive discussions with
the State Government of Thuringia in connection with the conversion project. To
date, the State Government of Thuringia has been supportive of the Company's
proposal and is assisting it in reducing the permitting period for a project of
this nature, from three years to approximately nine months. The Company is
finalizing its detailed reviews and anticipates making its formal application
for approval of the project in mid-1997. A final decision to proceed with the
conversion would be made upon receipt of all necessary permits and approvals
which are currently expected to be received at the end of 1997. The Company
estimates that its costs in respect of the project in 1997 will be approximately
$3.3 million. The actual conversion of the Pulp mill is expected to commence in
1998 and to be completed at or about the end of 1999. The majority of
expenditures on the project will occur in 1998 and 1999. The conversion of the
Pulp mill will result in it taking approximately three months downtime prior to
the switch over from sulphite to sulphate pulp production. The Finnish
engineering firm Jaakko Poyry has been appointed as the project engineer for the
conversion project. The fibre supply for the converted mill will primarily come
from the abundant source of long fibre spruce wood located in the region
surrounding the mill.

     Although the Company's plan to convert the Pulp mill to the production of
kraft pulp has received favourable support from German governmental and
regulatory bodies to date, the same is subject to receiving substantial
governmental financial assistance under existing programs and receipt of complex
environmental and operating permits. There can be no assurance that current
governmental assistance programs will not be amended in the future or that
financial assistance will be provided to the Company on terms satisfactory to
it, if at all, or that all necessary environmental and operating permits will be
received on satisfactory terms, if at all, or in time to permit the Company to
proceed with and complete the project as currently planned.

ENVIRONMENTAL

     The Company's operations are subject to a broad range of German federal,
state and local environmental laws and regulations, dealing primarily with
water, air and land pollution control. In recent years, the Company has devoted
significant financial and management resources to complying with all applicable
environmental laws and regulations. The Company's total capital expenditures on
environmental projects were approximately $13.7 million in 1996 and are expected
to be approximately $6.0 million in 1997.

     The Company's operations are currently in substantial compliance with the
requirements of all applicable environmental legislation and regulations and its
respective operating permits.

     In 1996, the Company completed the installation of a flue gas dust remover
at the Hainsberg paper mill and converted the Trebsen power plant to fire with
heating oil instead of coal, which reduced particulates in air emissions to
comply with prescribed levels effective on November 1, 1996 and January 1, 1997,
respectively. New wastewater treatment plants at the Greiz and Trebsen paper
mills were also completed in 1996 and are substantially in operation. The
municipality of Heidenau in co-operation with the Company is planning to build a
community wastewater treatment plant on land owned by the Company, which will
provide the Heidenau mill with the services of a new treatment facility.

     The Pulp mill, which has a relatively modern biological wastewater
treatment and oxygen bleaching facility, will have to gradually satisfy more
stringent state regulations with respect to both air emissions and effluent
discharges. In 1996, the Company installed new screens for the Pulp mill which
reduced the losses of dissolved material and resulted in reduced effluent
discharges and cleaner pulp. Additional upgrades to the Pulp mill were also
being implemented to recover more dissolved substances from the process and to
decrease the effluent load. In 1995, the Company modified the recovery boiler at
the Pulp mill to reduce certain levels of particulates in air emissions to
prescribed levels which became effective on January 1, 1996. As well, the
Company has reduced its levels of AOX (Adsorbable Organic Halogen) discharge to
0.6 kilograms per tonne,

                                        8
<PAGE>   9

in order to comply with new effluent discharge levels. A further reduction to
0.4 kilograms per tonne must be made by January 1, 1998. In addition, the
Company must reduce its levels of COD (Chemical Oxygen Demand) discharge at the
Pulp mill to 50 kilograms per tonne by July 1, 1997. The Company has and will
continue to modify its wastewater and bleaching facilities at the Pulp mill to
meet or exceed these prescribed regulations. Such modifications are also
expected to improve the operational efficiency of the Pulp mill and are part of
the Company's capital investment program for the mill.

     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 such expenditures
against the wastewater fees that would otherwise be payable. As a result, the
Company has offset the amount of environmental capital expenditures made at the
Pulp mill against wastewater fees for the period of 1993 to 1996, which totalled
approximately $10.3 million. The Company expects that its capital investment
programs for its manufacturing plants will offset the full amount of wastewater
charges that may be payable in 1997 and will ensure that its operations continue
in substantial compliance with prescribed standards.

     The Company periodically performs environmental audits of operational sites
and procedures both with Company personnel and outside consultants.

HUMAN RESOURCES

     The Company currently employs a total of 873 employees, of which 487 are
engaged in paper operations, 381 in pulp operations and the balance at the
Company's head office. In 1996, the Company reduced the number of employees by
65 as part of its continuing operational changes. The Company expects to further
reduce employment levels to those permitted under the terms of acquisition,
which require the Company to employ 360 workers in its pulp operations in 1997
and 350 in 1998. At the end of 1996, there were no further contractual
obligations of the Company to BVS to maintain prescribed employment levels at
its paper operations. The terms of acquisition required BVS to reimburse the
Company, subject to certain maximum limits, for all severance payments and costs
incurred to reduce the number of employees in its pulp and paper operations to
the aforesaid permitted levels. To date, the Company has been reimbursed
approximately $5.7 million for such expenses.

     The majority of the Company's employees are represented by the
Industriegewerkschaft Chemie-Papier-Keramik (the "ICPK"), a national union which
represents pulp and paper workers in Germany. The Company was previously a
member of an employers' association, now called the Arbeitgeberverband
ostdeutsche Papierindustrie (the "AGOP"), which represents pulp and paper
producers in Germany and negotiates collectively on their behalf with the ICPK.
In April 1996, the AGOP reached an industry-wide collective agreement with pulp
and paper workers in Germany with respect to wages (the "National Agreement")
which provided for a 4% wage increase retroactive to March 1, 1996 and further
wage increases of 3%, 3% and 2.5% on September 1, 1996, January 1, 1997 and
March 1, 1997, respectively.

     In 1996, the Company gave notice to the AGOP that it was withdrawing from
the association and wished to negotiate independently with its workers with
respect to wages. In April 1996, the Company independently established a
separate wage agreement for its own workers, pursuant to which its employees
received a 4% wage increase retroactive to March 1, 1996. The Company is not
subject to the additional wage increases reached under the National Agreement,
but instead it has entered into separate labour negotiations with the Worker's
Council for each of its manufacturing plants. The Company has settled a labour
agreement for its pulp workers that expires at the end of June 1997 and is in
the process of negotiating agreements with its paper workers.

     Although the Company cannot predict with any certainty the results of such
labour negotiations or provide any assurances, it expects that new labour
agreements will eventually be successfully concluded without material work
stoppages.

                                        9
<PAGE>   10

ACQUISITIONS

     Effective April 1, 1995, the Company acquired the 30% minority interest and
related assets in its pulp and paper operations, including shareholder loans of
$6.4 million, held by the Shin Ho Group, a Korean industrial and paper
manufacturer, in consideration of two million common shares in the capital of
the Company at an issue price of $21.00 per share. The total acquisition price
was $42 million, of which $22.4 million was allocated to ZPR and $19.6 million
to DPAG.

     The Company acquired its 70% interest in its pulp operations from BVS,
effective July 1, 1994. Under the terms of acquisition: (i) the Company was
responsible for 70% of the total purchase price of $0.6 million and a loan of
$12.9 million to ZPR; and (ii) the pulp operations were to receive a total of
$40.3 million in non-refundable privatization supplements from BVS, of which
$27.3 million and $6.7 million was received by December 31, 1995 and 1996,
respectively, and the further amounts of $3.2 million and $3.2 million due in
1997 and 1998 will be set off against the acquisition cost of the tax losses.
These supplements were recorded by the Company as revenue in 1994 at a
discounted value of $38.8 million. In addition, ZPR undertook to make
approximately $48.4 million in capital investments during the period ending
December 31, 1998 and to maintain certain annual employment levels through
December 31, 1998.

     Pursuant to the terms of acquisition, BVS: (i) paid ZPR for the cost to
replace a boiler drum and to partially compensate it for downtime resulting from
the drum replacement; (ii) agreed to compensate ZPR for certain employee
termination costs; (iii) agreed to indemnify ZPR for 90% of remediation costs
for environmental liabilities of up to a maximum of $11.9 million; (iv) forgave
indebtedness of $47.4 million; and (v) agreed to reimburse ZPR for certain
interest, fees and charges relating to its bank credit facilities in 1994. ZPR
is restricted from making distributions to its owners prior to January 1, 1999,
however, the Company may expand or invest through ZPR.

     In 1996, the Company acquired the net operating tax losses of its pulp
operations of approximately $97.0 million for the fixed amount of $6.3 million,
which will be deducted from the government supplements due from BVS to ZPR in
1997 and 1998. Under German tax laws the tax losses may be carried forward
indefinitely to offset future taxable income.

     In 1994, the Company agreed to include the Trebsen paper mill in its
ongoing operations and BVS agreed to fund new investments at the mill of up to a
maximum of $11.4 million. This funding consisted of a subordinated loan in the
amount of $6.0 million with repayment beginning in 10 years, pre-financing of
certain non-refundable government grants and payment of $1.8 million. The
Company is permitted to sell the excess real estate located at the Trebsen mill
and apply the proceeds to repay the foregoing loan.

     The Company acquired its paper operations from BVS effective July 1, 1993.
Under the terms of acquisition: (i) the Company was responsible for 70% of the
total purchase price of $0.6 million for the shares of DPAG and related
receivables and a loan of $11.5 million to DPAG; (ii) DPAG undertook to make
approximately $57.9 million in capital investments during the period ending
December 31, 1996; and (iii) DPAG agreed to maintain certain average annual
employment levels and was restricted from making any distributions to its owners
until December 31, 1996. At December 31, 1996, DPAG had expended a total of
$58.8 million on capital investments and its obligations with respect to
maintaining certain employment levels and restrictions on distributions to its
owners had expired.

     In connection with the acquisition, BVS: (i) forgave $45.4 million of
indebtedness owed by DPAG, which was contributed to the capital of DPAG; (ii)
paid $39.2 million in non-refundable privatization supplements to DPAG; (iii)
paid $6.9 million to compensate for losses and closure costs at certain
previously operated mills; and (iv) provided an indemnity for 90% of the
remediation costs for environmental liabilities at the Paper mills, up to a
maximum of $7.2 million.

ITEM 2.  PROPERTIES

     The Company's corporate head office is located in Zurich, Switzerland and
it also maintains offices in Germany and Hong Kong. All of these offices are
leased, except for those in Germany which are owned.

                                       10
<PAGE>   11

     The Company's Paper mills and the Pulp mill are located in Germany in the
States of Saxony and Thuringia. All of the mills are situated on property owned
by the Company.

     The Heidenau paper mill serves as headquarters for the Company's pulp and
paper operations. It produces specialty papers and has an annual production
capacity of 35,000 tonnes. In October 1995, the Company closed the corrugating
box plant at this location. The Fahrbrucke mill produces both specialty and
printing papers and the Hainsberg mill produces printing papers and each has an
annual production capacity of 30,000 tonnes. The de-inking plant at the
Hainsberg mill improves paper brightness and general product quality and allows
for the increased usage of lower priced waste paper. Both mills use virgin and
recycled fibre in producing various grades of printing papers.

     The Greiz and the Trebsen mills produce packaging papers and have an annual
production capacity of 50,000 and 75,000 tonnes, respectively. The fibre supply
for these mills is almost entirely from waste paper. In November 1995, the
Company leased the Raschau paper mill, with an option to purchase, to third
parties. All of the Paper mills operate their own power plants to produce
electricity. A new power plant was completed at the Trebsen mill in 1996.

     The Pulp mill has an annual production capacity of 160,000 tonnes and is
situated on a 220 acre site in close proximity to the Saale River and the town
of Blankenstein in the State of Thuringia. The Pulp mill was constructed between
1973 and 1977 and has been upgraded in several stages. Its facilities include a
complete wood fibre processing line with an oxygen bleaching plant, chemical
recovery systems, power plant, a biological wastewater treatment facility and a
waste disposal site.

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

<TABLE>
<CAPTION>
                                                                               PRODUCTION
                                                                     -------------------------------
                                                                        YEARS ENDED DECEMBER 31,
                                               ANNUAL PRODUCTION     -------------------------------
PRODUCT CLASS                                     CAPACITY(1)         1996        1995        1994
-------------                                  -----------------     -------     -------     -------
                                                                     (tonnes)
<S>                                            <C>                   <C>         <C>         <C>
Packaging Papers...........................         120,000(2)       110,304     138,591      98,387
Specialty Papers...........................          40,000           26,179      34,069      28,371
Printing Papers............................          60,000           45,568      50,245      40,893
Pulp.......................................         160,000          134,950     139,409      67,810(3)
                                                    -------          -------     -------     -------
     Total.................................         380,000          317,001     362,314     235,461
                                                    =======          =======     =======     =======
</TABLE>

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

(1) Capacity is stated upon the rated capacity of the plants, which is based
    upon production for 365 days a year. Actual production is generally based
    upon 340 days per year.

(2) In 1995, the Company divested the corrugating box plant at Heidenau and the
    Raschau paper mill. These plants had a combined annual production capacity
    of 20,000 tonnes.

(3) The Company acquired the pulp operations effective July 1, 1994.

     The Company owns a substantial amount of real estate adjacent to its Paper
mills, which is excess to its production requirements and may be divested.

ITEM 3.  LEGAL PROCEEDINGS

     The Company is subject to routine litigation incidental to its business.
The Company does not believe that the outcome of such litigation will have a
material adverse effect on its business or financial condition.

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

     None.

                                       11
<PAGE>   12

                                    PART II

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

(a) Market Information.  The Company's shares of beneficial interest trade on
     the NASDAQ Stock Market's National Market under the symbol "MERCS" and on
     EASDAQ under the symbol "MERC". The following table sets forth the
     quarterly high and low closing prices on NASDAQ for the two years ended
     December 31, 1995 and 1996, and for the period ending March 21, 1997.

<TABLE>
<CAPTION>
    FISCAL QUARTER ENDED                                                      HIGH       LOW
    --------------------                                                     ------     ------
    <S>                                                                      <C>        <C>
    1995
    March 31.............................................................    $15.63     $12.00
    June 30..............................................................    $22.00     $13.00
    September 30.........................................................    $27.75     $19.63
    December 31..........................................................    $25.75     $19.00

    1996
    March 31.............................................................    $24.00     $18.50
    June 30..............................................................    $23.63     $13.13(1)
    September 30.........................................................    $15.38     $10.75
    December 31..........................................................    $13.63     $ 9.00

    1997
    Period ending March 21...............................................    $12.63     $ 8.63
</TABLE>

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

(1) Stock dividend paid.

(b) Shareholder Information.  As of March 21, 1997, there were approximately 927
     holders of record of the Company's shares and a total of 14,917,369 shares
     were outstanding.

(c) Dividend Information.  Effective June 3, 1996, the Company spun-off its
     financial services segment in a one for two stock dividend of 6,697,716
     shares of Arbatax. The Company did not pay any cash dividends on its shares
     of beneficial interest in 1996. In 1997, the Company resolved that subject
     to, among other things, the availability of earnings and its anticipated
     cash requirements, to pay regular dividends on its shares of beneficial
     interest. The first dividend will be $0.03 per share to be paid on May 9,
     1997 to shareholders of record as of April 30, 1997. The actual timing,
     payment and amount of future dividends paid by the Company will be
     determined by the board of trustees of the Company from time to time based
     upon, among other things, the cash flow, results of operations and
     financial condition of the Company, the need for funds to finance ongoing
     operations and such other business considerations as the board of trustees
     of the Company considers relevant.

(d) Recent Sales of Unregistered Securities.  In December 1996, the Company
     issued 2,461 shares of beneficial interest upon the conversion of $24,000
     of Series 1 convertible bonds initially issued in 1992. These securities
     were issued in reliance on the exemption from registration under Section
     3(a)(9) of the Securities Act of 1933, as amended (the "Act"), and the
     rules promulgated under the Act, as transactions not involving a public
     offering.

                                       12
<PAGE>   13

ITEM 6.  SELECTED FINANCIAL DATA

     The following table sets forth selected financial information for the
Company for each of the last five years ended December 31, 1996. The Company's
previous interest in the operating results and net assets of "spun-off
operations" are classified separately and excluded from the Company's revenues,
expenses and other amounts presented for continuing operations. The following
financial information has been restated to conform to this current presentation.

     The following selected financial data is qualified in its entirety by, and
should be read in conjunction with, the more detailed financial statements and
related notes contained elsewhere herein.

<TABLE>
<CAPTION>
                                                      YEARS ENDED DECEMBER 31,
                                 ------------------------------------------------------------------
                                   1996            1995          1994          1993          1992
                                 --------        --------      --------      --------      --------
                                            (in thousands, other than per share amounts)
<S>                              <C>             <C>           <C>           <C>           <C>
Revenues(1)....................  $186,729        $300,737      $197,359      $ 66,260      $  9,346
Net income from continuing
  operations...................  $ 15,557        $ 65,637      $ 41,499      $ 18,663      $  4,697
Net income from continuing
  operations, per common
  share........................  $   1.12        $   5.14      $   3.69      $   1.79      $   0.46
Current assets.................  $132,651        $140,618      $111,374      $ 71,460      $  6,561
Current liabilities............  $ 53,988        $ 49,915      $ 57,063      $ 54,456      $  8,048
Working capital................  $ 78,663        $ 90,703      $ 54,311      $ 17,004      $ (1,487)
Total assets...................  $279,839(1)     $328,750(2)   $245,326(2)   $165,102(2)   $ 69,638(2)
Long-term liabilities..........  $ 31,312        $ 51,820      $ 52,049      $ 33,501      $ 12,997
Shareholders' equity...........  $194,539(1)(3)  $227,015(2)   $111,540(2)   $ 77,120(2)   $ 48,593(2)
Cash dividends.................  $  --           $  --         $  --         $  --         $  --
</TABLE>

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

(1) Excludes spun-off operations.

(2) Includes net assets of spun-off operations.

(3) After stock dividend.

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

     The following discussion and analysis of the financial condition and
results of operations of the Company for the three years ended December 31, 1996
should be read in conjunction with the consolidated financial statements and
related notes included elsewhere in this annual report. The Company's previous
interest in the operating results and net assets of the financial services
segment, which were spun-off to shareholders of beneficial interest on June 3,
1996, are classified separately within the Company's financial statements as
"spun-off operations" and are excluded from the amounts of revenues and expenses
of the Company's continuing operations. Previously reported financial statements
for all periods and certain amounts in the Company's financial statements and
related notes have been restated to conform to the current presentation. The
following management discussion and analysis of financial condition and results
of operations are based upon the restated financial statements for all prior
years as aforesaid.

                                       13
<PAGE>   14

RESULTS OF OPERATIONS

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

<TABLE>
<CAPTION>
                                                                  YEARS ENDED DECEMBER 31,
                                                             ----------------------------------
                                                               1996       1995(1)      1994(2)
                                                             --------     --------     --------
                                                                       (in thousands)
<S>                                                          <C>          <C>          <C>
SALES BY PRODUCT CLASS
Packaging Papers.........................................    $ 33,165     $ 66,776     $ 42,239
Specialty Papers.........................................      27,012       34,370       28,342
Printing Papers..........................................      36,469       50,960       29,536
Pulp.....................................................      72,456      115,934       40,512
Other....................................................       4,995        7,292        7,142
                                                             --------     --------     --------
Total....................................................    $174,097     $275,332     $147,771
                                                             ========     ========     ========
                                                                          (tonnes)
SALES BY VOLUME
Packaging Papers.........................................     110,179      121,145       98,387
Specialty Papers.........................................      26,548       29,813       28,371
Printing Papers..........................................      46,416       47,089       40,893
Pulp.....................................................     133,005      126,562       64,167
                                                              -------      -------      -------
Total(3).................................................     316,148      324,609      231,818
                                                              =======      =======      =======
</TABLE>

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

(1) In 1995, the Company divested the corrugating box plant at Heidenau and the
    Raschau paper mill. These plants had combined sales of $17.2 million or
    22,123 tonnes of packaging papers in 1995 and sales of $15.2 million or
    24,540 tonnes of packaging papers in 1994.

(2) The Company acquired its pulp operations effective July 1, 1994.

(3) Excluding intercompany sales of 3,609, 3,545 and 1,774 tonnes of pulp in
    1996, 1995 and 1994, respectively.

YEAR ENDED DECEMBER 31, 1996 COMPARED TO THE YEAR ENDED DECEMBER 31, 1995

     In 1996, revenues decreased by 37.9% to $186.7 million from $300.7 million
in 1995, primarily as a result of decreased sales volumes, lower prices for pulp
and paper products, and the divesture of the Company's corrugated box plant at
Heidenau and the Raschau paper mill which occurred in the second half of 1995.
As the Company's products are principally sold in deutschmarks, the depreciation
of the deutschmark against the U.S. dollar in 1996 compared to 1995 also
contributed to lower revenues.

     Costs and expenses decreased to $174.3 million in 1996 compared to $238.5
million in 1995, primarily as a result of lower sales revenues and decreased
fibre costs (raw materials). In 1995, cost and expenses included $7.0 million in
respect of a litigation settlement. General and administration expenses
decreased to $24.9 million in 1996 from $35.2 million in 1995. Interest expense
decreased to $4.0 million from $4.5 million in 1995 as a result of lower
interest rates. The acquisition of the Company's pulp and paper operations
resulted in a purchase credit, which was allocated to property and equipment.
See Note 3 to the financial statements included in this annual report.

     In 1996, net earnings from continuing operations were $15.6 million or
$1.12 per share, compared to $65.6 million or $5.14 per share in 1995. Net
earnings in 1996 reflected the acquisition of the 30% minority interest in the
Company's pulp and paper operations for the entire year, compared to nine months
in 1995 and a net deferred income tax benefit of $3.1 million.

     On June 3, 1996, the Company completed the spin-off of its financial
services business. As a result, these operations are classified separately
within the Company's financial statements as "spun-off" operations, are excluded
from the amounts of revenues and expenses of continuing operations and its
assets and liabilities are not consolidated into the Company's continuing
operations.

     In 1996, the Company's sales, operating income and net earnings were all
lower than in 1995. The primary factors contributing to the decrease in 1996
were the sudden and prolonged collapse in the pulp

                                       14
<PAGE>   15

market and weak paper market. Lower prices for pulp and paper were in sharp
contrast with the 1995 record levels, accounting for the decline in the
Company's 1996 earnings. In 1996, world pulp and paper markets were generally
weak throughout the year. List prices for pulp in 1996 were, on average,
approximately 40.5% lower than in 1995, primarily as a result of weak demand for
pulp and high world pulp inventories. Sulphite pulp prices were also negatively
impacted by price reductions implemented by a large Eastern European producer to
solidify its market position. The Company's pulp sales decreased by 37.5% to
$72.5 million in 1996 from $115.9 million in 1995 on a volume increase of 5% and
an average price decrease of 40.5%. The overall effect of weaker pulp demand
resulting from weaker paper markets was partially offset by the Company's
increased production and sales of dissolving sulphite pulp. Paper sales in 1996
decreased by 36.5% to $96.6 million from $152.1 million in 1995 on a volume
decrease of 7.5% and an average price decrease of 31.3%. The average price for
specialty papers remained relatively stable, while prices for packaging and
printing papers declined during 1996. Sales volumes for all papers declined in
1996, compared to 1995. The 1995 results included other revenue of $14.8 million
related to a pre-acquisition contingent asset.

     The deterioration in pulp and paper prices in 1996 was partially offset by
decreased fibre costs from lower prices for wood chips and pulpwood used to
produce pulp and lower prices for pulp and recycled fibre (waste paper) used to
produce paper. Weak pulp and paper markets resulted in manufacturing facilities
taking market-related downtime. Recycled fibre costs decreased dramatically in
1996 and were down approximately 61.0% compared to 1995, although there can be
no assurance that they will not escalate in the future. The price of wood for
pulp production also decreased in 1996, primarily due to weak pulp demand and a
build-up of wood inventories. By the end of 1996, the price of pulpwood began to
experience upward pressure in Europe. On average, the Company's fibre costs for
pulp production were down approximately 23% in 1996, compared to 1995 and remain
among the lowest in Europe. Decreased fibre costs in 1996 were generally
reflected in lower product prices.

     In the fourth quarter of 1996, pulp and paper markets remained weak as a
result of lower demand and a sharp increase in pulp inventories. Customers
generally reduced purchases to decrease their excess inventories. As a result,
prices for pulp and paper remained depressed in the last quarter of 1996 and
have remained weak in early 1997. This price weakness is expected to continue
until the excess inventory situation corrects itself.

     Since the acquisition of its pulp and paper operations, the Company has
been implementing operational changes to its operations to improve efficiency,
increase export sales to markets outside of Germany and upgrade its product mix.
In 1995, the Company centralized its pulp and paper administration in Heidenau.
It also closed the corrugated box plant at the Heidenau mill, sold the
corrugating machine for $2.6 million and eliminated 60 employee positions
thereat. The Company also leased the Raschau paper mill and its operations, with
an option to purchase, to third parties in 1995. The Raschau mill and Heidenau
corrugated box plant had a combined annual production capacity of 20,000 tonnes
and neither made a positive contribution to the Company or were considered to be
long-term strategic assets. In 1996, the Company increased its sales outside of
Germany by approximately 3.8%, increased its production of dissolving sulphite
pulp to 26.6% of total pulp production from 24.5% in 1995 and upgraded its paper
product mix. The implementation of operating changes resulted in downtime at
some of the Company's mills in 1996. In addition, the Pulp mill, like many other
pulp producers, took market-related downtime in 1996. Operating changes and
upgrades to the mills will continue in 1997 and may result in further downtime
at the Company's operations. In any given future reporting period, such downtime
may affect the Company's results of operation.

YEAR ENDED DECEMBER 31, 1995 COMPARED TO THE YEAR ENDED DECEMBER 31, 1994

     The Company's results of operation in 1995 did not include any government
supplements, whereas its results for 1994 reflected $44.4 million of government
supplements, including $38.8 million of one-time non-refundable government
supplements for its pulp operations (the "pulp supplement").

     In 1995, revenues increased by 52.4% to $300.7 million from $197.3 million
($158.5 million excluding the pulp supplement) in 1994, primarily as a result of
increased sales volumes, higher prices for pulp and paper products and the
inclusion of pulp sales for the entire year in 1995, compared to six months in
1994. As the

                                       15
<PAGE>   16

Company's products are principally sold in deutschmarks, the strength of the
deutschmark against the U.S. dollar in 1995 compared to 1994 also contributed to
higher revenues.

     Pulp and paper costs increased to $191.7 million in 1995 compared to $116.7
million in 1994, primarily as a result of increased sales revenues and higher
costs for fibre (raw materials). General and administration expenses increased
to $35.2 million in 1995 from $19.6 million in 1994. The increase in general and
administrative expenses is primarily a result of the inclusion of pulp
operations for the entire year in 1995, compared to six months in 1994. Interest
expense increased to $4.5 million from $3.5 million in 1994 as a result of
increases in the Company's borrowings. The acquisition of the Company's pulp and
paper operations resulted in a purchase credit, which was allocated to property
and equipment. See Note 3 to the Financial Statements included in this annual
report.

     In 1995, net earnings from continuing operations were $65.6 million or
$5.14 per share in 1995, compared to $41.5 million or $3.69 per share ($14.4
million or $1.28 per share excluding the pulp supplement) in 1994. Net earnings
in 1995 reflected the acquisition effective April 1995 of the 30% minority
interest in the Company's pulp and paper operations, included a deferred income
tax benefit of $9.1 million and a one-time expense of $7.0 million resulting
from the settlement of a securities class action suit filed in 1994 against the
Company.

     On December 28, 1995, the Company announced that it would distribute
approximately 83% of the issued shares of Arbatax to its shareholders as a
special dividend. As a result, the Company has accounted for Arbatax separately
within its financial statements as "spun-off operations" and it is excluded from
the amounts of revenues and expenses of the Company's continuing operations. In
the year ended December 31, 1995, the spin-off operations resulted in a loss of
$1.5 million or $0.11 per share, compared to earning of $4.6 million or $0.41
per share in 1994.

     In 1995, the Company's sales, operating income and net earnings were all
higher than in 1994. The improved results were due to higher pulp and paper
prices, increased sales volumes and operating changes implemented by the
Company. In 1995, world pulp and paper markets were generally strong. Strong
paper markets and a tight supply resulted in higher pulp prices, and in the
first three quarters of 1995 list prices for pulp were near historical highs. In
1995, list prices for pulp were, on average, approximately 45% higher than in
1994. Pulp sales increased to $115.9 million in 1995 from $40.5 million in 1994,
primarily as a result of the inclusion of pulp sales for the entire year in 1995
compared to six months in 1994 and improved prices. Paper sales in 1995
increased by 51.9% to $152.1 million from $100.1 million in 1994 on a volume
increase of 18.1% and an average price increase of 25%. The Pulp mill owns two
waste disposal sites. At the time of acquisition of the Company's pulp
operations, the extent of and conditions relating to the future use of such
sites were not determinable. In 1995, the Company clarified the conditions
relating to the use of such waste disposal sites and, pursuant to Statement of
Financial Accounting Standards No. 38, recorded the value thereof, being $14.8
million, as other revenue.

     Improvements in pulp and paper prices in 1995 were partially offset by
increased fibre costs from higher prices for wood chips and pulpwood used to
produce pulp and higher prices for pulp and recycled fibre (waste paper) used to
produce paper. Strong pulp and paper markets resulted in manufacturing
facilities operating at or near full production capacity and contributed to
higher fibre costs. Recycled fibre costs were extremely volatile in 1995. Such
costs, which on a relative basis were extremely low at the beginning of 1995,
were on average 125% higher in 1995 compared to 1994. Recycled fibre costs
increased dramatically in the first half of 1995, and for the first six months
of 1995 were up approximately 416% over the corresponding period in 1994.
Recycled fibre costs stabilized in the third quarter of 1995 and certain grades
decreased markedly in the last quarter of 1995, although there can be no
assurance that they will not escalate in the future. Fibre costs for pulp
production were also up in the first half of 1995 and then stabilized and
decreased in the last quarter of 1995. On average, fibre costs for pulp
production were up 34% in 1995 compared to 1994. Increased fibre costs in 1995
were generally reflected in higher product prices and the Company has not
experienced any significant difficulty in obtaining fibre in the economic
proximity to its mills.

     In the fourth quarter of 1995, pulp and paper markets began to weaken as a
result of lower demand and a sharp increase in pulp inventories. Customers
generally reduced purchases to decrease their excess inventories.

                                       16
<PAGE>   17

As a result, prices for pulp and certain grades of paper began to decline in the
last quarter of 1995 and remained weak through 1996.

     Since acquisition, the Company has been implementing operational changes to
its operations to improve efficiency, increase export sales to markets outside
of Germany and upgrade its product mix. In 1995, the Company centralized its
pulp and paper administration in Heidenau. It also closed the corrugated box
plant at the Heidenau mill, sold the corrugating machine for $2.6 million and
eliminated 60 employee positions thereat. The Company also leased the Raschau
paper mill and its operations, with an option to purchase, to third parties in
1995. The Raschau mill employed 70 people and all ongoing employees were
transferred to the lessee. The Raschau mill and Heidenau corrugated box plant
had a combined annual production capacity of 20,000 tonnes and neither made a
positive contribution to the Company or were considered to be long-term
strategic assets. In 1995, the Company increased its sales outside of Germany by
approximately 8.1%, increased its production of dissolving sulphite pulp to
24.5% of total pulp production from 16.6% in 1994 and upgraded its paper product
mix. The implementation of operating changes resulted in downtime at some of the
Company's mills in 1995.

LIQUIDITY AND CAPITAL RESOURCES

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

<TABLE>
<CAPTION>
                                                           DECEMBER 31, 1996       DECEMBER 31, 1995
                                                           -----------------       -----------------
                                                          (in thousands, other than per share amounts)
<S>                                                        <C>                     <C>
FINANCIAL POSITION
Working capital...........................................     $  78,663               $  90,703
Property, plant and equipment (net).......................       125,116                 104,038
Total assets..............................................       279,839(1)              328,750(2)

Long-term government debt.................................         9,184                  10,522
Long-term debt -- other...................................        19,426                  12,238
Due to spun-off operations................................           368                  21,778

CAPITAL SOURCES
Shareholders' equity......................................     $ 194,539(1)(3)         $ 227,015(2)
Cash flow(4)..............................................         8,688                  45,480
Cash flow per share(4)....................................          0.62                    3.56
</TABLE>

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

(1) Excludes spun-off operations.

(2) Includes net assets of spun-off operations.

(3) After stock dividend.

(4) Cash flow provided by operations before net purchases of trading securities.

     At December 31, 1996, the Company's cash and cash equivalents totalled
$10.0 million, a net decrease of $19.2 million from $29.2 million at the end of
1995. At December 31, 1996, the Company had short-term trading securities
totalling $83.4 million, compared to $65.3 million at December 31, 1995.

     Effective June 3, 1996, the Company completed the spin-off of its financial
services segment in a one for two stock dividend of approximately 83% of its
previously held 92% interest in Arbatax. The Distribution was recorded as a
stock dividend from shareholders' equity at the carrying amount of the net
assets of the spin-off operations. As a result, the Company's total assets and
shareholders' equity were each reduced by approximately $50.7 million after the
Distribution. The stock distribution itself is a non-cash transaction which did
not affect the Company's cash flow statement.

OPERATING ACTIVITIES

     Net cash used by operating activities was $6.4 million in 1996, compared to
$16.5 million in 1995. Reductions in receivables and inventories accounted for
the majority of cash provided by operations. Net purchases of trading securities
used cash of $15.1 million in 1996, compared to $61.9 million in 1995. The
Company expects to generate sufficient cash flow from operations to meet its
working capital requirements.

                                       17
<PAGE>   18

INVESTING ACTIVITIES

     Investing activities in 1996 used cash of approximately $16.3 million,
consisting primarily of capital expenditures for upgrades to the Company's
manufacturing plants, compared to $11.0 million in 1995.

     The Company has undertaken significant capital investments to upgrade its
manufacturing plants including approximately $23.5 million in 1996, of which
$5.3 million was funded by non-refundable government grants. As a result of the
Company's plans to convert the production of the Pulp mill from sulphite to
kraft pulp, the Company's previous capital investment program has been modified
to reflect the conversion project.

     The Company expects capital investments in 1997 to be approximately $10.7
million, which will be funded from cash, cash flow from operations and
non-refundable government grants. Such non-refundable grants are made available
by German federal and state governments to qualifying businesses. At December
31, 1996, the Company has a receivable of non-refundable grants totalling $1.3
million. These non-refundable government grants are not recorded in the income
of the Company, but instead reduce the cost base of the assets purchased with
the proceeds thereof. In addition, loan guarantees are available to the Company
from state governments in Germany for up to 80% of the cost of qualified
investments. Such guarantees permit businesses to obtain term loans at below
market interest rates. The Company has not used such state guarantees to date,
but anticipates utilizing the same in connection with its conversion plans for
the Pulp mill. See "Business -- Capital Expenditures and Government Financing."

     The Company plans to convert the Pulp mill from the production of sulphite
pulp to kraft pulp. The conversion is, among other things, expected to increase
the capacity of the Pulp mill from 160,000 tonnes per annum to 280,000 tonnes
and reduce the mill's emissions of sulphur dioxides and effluent substantially.
The estimated cost for the conversion is approximately $325 million, which will
be financed through a combination of non-refundable governmental grants of
approximately $97.5 million and governmental assistance and guarantees for
long-term project financing. The conversion project is expected to commence in
1998 and to be completed at or about the end of 1999.

     The conversion project is subject to, among other things, the Company
settling all financing and governmental grants and obtaining all necessary
environmental and operating permits. Although the Company's plan to convert the
Pulp mill to produce kraft pulp has received favourable support from German
governmental and regulatory bodies to date, there can be no assurance that
current governmental financial assistance programs will not be amended in the
future or that financial assistance will be provided to the Company on
satisfactory terms or that all necessary environmental and operating permits
will be received on satisfactory terms or in time to permit the Company to
proceed and complete the project as currently planned. See "Business -- Pulp
Mill Conversion Project."

FINANCING ACTIVITIES

     Cash provided by financing activities was $5.8 million in 1996, primarily
as a result of increased bank indebtedness. Cash provided by financing
activities in 1995 was also $5.8 million. The overall depreciation of the
deutschmark against the U.S. dollar in 1996 resulted in an unrealized foreign
exchange translation loss of $1.0 million from cash and cash equivalents, which
is included as shareholders' equity in the Company's balance sheet and does not
affect the Company's net earnings. See "Foreign Currency."

     In 1996, the Company settled bank debt of $13.4 million through a partial
repayment, the issuance of 650,000 shares of beneficial interest and a
promissory note in the amount of $0.9 million due in July 1997. The Company also
settled its indebtedness to Arbatax in 1996 of $22.3 million through the
issuance of 700,000 shares of beneficial interest and a note in the amount of
$14.5 million due in January 1998.

     The Company's pulp and paper operations had net operating tax losses of
approximately $242.0 million at December 31, 1996, which under German tax laws
may be carried forward indefinitely. Pursuant to the terms of acquisition, if
the Company utilized the pre-acquisition tax losses of its pulp operations, it
was required to pay to BVS either a portion of all tax savings realized or a
one-time payment of approximately $6.3 million to be made on or before December
31, 1996. In 1996, the Company paid the $6.3 million which was deducted

                                       18
<PAGE>   19

from the long-term portion of government receivables due to the Company from
BVS. As a result, no payments are due to BVS if the Company utilizes any of its
tax losses. These tax losses may result in a substantial deferred tax benefit
being recognized by the Company, which under FASB Statement No. 109 may be
reflected in an increase to earnings. In 1996, the Company re-examined its
operations and ability to utilize its tax losses and reduced the valuation
allowance therefor, which resulted in a net deferred tax benefit of $3.1 million
being recognized. In 1995, the Company recognized a deferred tax benefit of $9.1
million.

     The Company is continuing discussions with third parties to divest certain
redundant assets, including a substantial amount of real property which is
excess to its requirements. The Company has entered into certain lease
arrangements with respect to some of the redundant assets whereby the Company
has the right to "put" the assets to the tenant at a prearranged price
commencing in 1997.

     In 1996, net proceeds used to repurchase shares were $0.8 million. In 1995,
the Company received, net of share repurchases, proceeds of $7.1 million from
the issuance of shares.

     Other than the Company's plan to convert the production of the Pulp mill
from sulphite to kraft pulp, the Company had no material commitments to acquire
assets or operating businesses as at December 31, 1996. The Company anticipates
that there will be acquisitions of businesses or commitments to projects in the
future. To achieve its long-term goals of expanding the asset and earnings base
by mergers and acquisitions, the Company will require substantial capital
resources. The required necessary resources will be generated from cash flow
from operations, cash on hand, borrowing against its assets and/or the sale of
assets.

FOREIGN CURRENCY

     Substantially all of the Company's operations are conducted in
international markets and its consolidated financial results are subject to
foreign currency exchange rate fluctuations and in particular those in Germany.
The Company's pulp and paper products are principally sold in deutschmarks and
approximately 99% of the Company revenues were denominated in deutschmarks.

     The Company translates foreign assets and liabilities into U.S. dollars at
the rate of exchange on the balance sheet date. Revenues and expenses are
translated at the average rate of exchange prevailing during the year.
Unrealized gains or losses from these translations are recorded as shareholders'
equity on the balance sheet and do not affect the net earnings of the Company.

     Since substantially all of the Company's revenues are received in
deutschmarks, the financial position of the Company for any given period, when
reported in U.S. dollars, can be significantly affected by the exchange rate for
deutschmarks prevailing during that period. At December 31, 1996, the cumulative
foreign exchange translation resulted in a loss of $12.0 million. During 1996,
the overall depreciation of the deutschmark against the U.S. dollar resulted in
a net $10.3 million foreign exchange translation loss and as a result the
cumulative foreign exchange translation loss was increased from $1.7 million at
December 31, 1995 to $12.0 million at December 31, 1996.

     As both the Company's principal sources of revenues and expenses are in
deutschmarks, the Company does not currently enter into any currency hedging
arrangements for exchange rate fluctuations.

     The average and period ending exchange rates for the deutschmark to the
U.S. dollar for the periods indicated are as follows:

<TABLE>
<CAPTION>
                                                                         YEARS ENDED DECEMBER 31,
                            --------------------------   ---------------------------------------------------------

                                       1997                         1996                          1995
                            --------------------------   ---------------------------   ---------------------------
                                        PERIOD AVERAGE
                            MARCH 21,    TO MARCH 21,    PERIOD END   PERIOD AVERAGE   PERIOD END   PERIOD AVERAGE
                            ---------   --------------   ----------   --------------   ----------   --------------
<S>                         <C>         <C>              <C>          <C>              <C>          <C>
RATES OF EXCHANGE
Deutschmark................   1.6888        1.6707         1.5389         1.5075         1.4339         1.4209
</TABLE>

Based upon the period average exchange rate in 1996, the U.S. dollar increased
by approximately 5% in value against the deutschmark since December 31, 1995.

                                       19
<PAGE>   20

CYCLICAL NATURE OF BUSINESS; COMPETITIVE POSITION

     The pulp and paper business is cyclical in nature and markets for the
Company's principal products are affected by fluctuations in supply and demand
in each cycle, which in turn affects product prices. The markets for pulp and
paper are highly competitive and sensitive to cyclical changes in the industry
capacity and in the economy, both of which can have a significant influence on
selling prices and the earnings of the Company. 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. The competitive position of
the Company is influenced by the availability and quality of raw materials
(fibre) and its experience in relation to other producers with respect to
inflation, energy, labour costs and productivity.

INFLATION

     The Company does not believe that inflation has had a material impact on
revenues or income during 1996.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     The consolidated financial statements and supplementary data required with
respect to this Item 8, and as listed in Item 14 of this annual report, are
included in this annual report commencing on page 24.

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

     Not applicable.

                                       20
<PAGE>   21

                                    PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     As a Massachusetts trust, the Company is managed by "trustees", who have
comparable duties and responsibilities as directors of corporations.

     J.S.H. Lee, age 39, has been a Trustee since May 1985 and President and
Chief Executive Officer since 1992. Previously, Mr. Lee served with MFC Bancorp
Ltd. (formerly Arbatax International Inc.) as a director from 1986, Chairman
from 1987 and President from 1988 to December 1996, respectively.

     C.S. Moon, age 49, has been a Trustee since June 1994. Mr. Moon is
Executive Director of Shin Ho Group of Korea, an international paper
manufacturer headquartered in Korea. Mr. Moon joined Shin Ho in 1990 and
previously served in managerial positions with Moo Kim Paper Manufacturing Co.,
Ltd. and Sam Yung Pulp Co., Ltd.

     M. Arnulphy, age 62, has been a Trustee since June 1995. From 1975 to
present, Mr. Arnulphy has been Managing Director of J. Mortenson & Co., Ltd. in
Hong Kong. J. Mortenson & Co., Ltd. manufactures water treatment equipment.

     M. Reidel, age 33, has been a Trustee since December 1996, a Managing
Director of ZPR since November 1994 and the Chairman of the Management Board of
DPAG since 1995. Previously, he was a member of the Supervisory Board of DPAG
from 1992 to 1994, a member of BVS responsible for portfolios of service
industry and wood and paper industry companies from 1992 to 1994, and an
accountant with Arthur Andersen & Co. from 1987 to 1992.

     Dr. R. Aurell, age 61, has been a Managing Director of ZPR since November
1994. From November 1991 to 1994, Dr. Aurell served as an independent consultant
advising clients, including the Company, on the pulp and paper industry.
Previously, he held managerial positions with North British Newsprint Ltd.,
Jaakko Poyry OY, MoDo-Chemetics AG and Stora Forest Industries.

ITEM 11.  EXECUTIVE COMPENSATION

     Incorporated by reference from Registrant's definitive proxy statement to
be filed within 120 days of the end of Registrant's fiscal year.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     Incorporated by reference from Registrant's definitive proxy statement to
be filed within 120 days of the end of Registrant's fiscal year.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     Incorporated by reference from Registrant's definitive proxy statement to
be filed within 120 days of the end of Registrant's fiscal year.

                                       21
<PAGE>   22

                                    PART IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

                                     INDEX

(a)  (1)  FINANCIAL STATEMENTS

          Independent Auditors' Report
          Consolidated Balance Sheets
          Consolidated Statements of Operations
          Consolidated Statements of Changes in Shareholders' Equity
          Consolidated Statements of Cash Flows
          Notes to the Consolidated Financial Statements

     (2)  FINANCIAL STATEMENT SCHEDULES

          Independent Auditors' Report
          SCHEDULE I - Condensed Financial Information of Registrant

          All other schedules have been omitted because they are not applicable
          or the required information is shown in the financial statements or
          notes thereto.

     (3)  LIST OF EXHIBITS

<TABLE>
    <S>       <C>
      3.1(a)* Restated Declaration of Trust of the Company as filed with the Secretary of
              State of Washington on June 11, 1990 together with an Amendment to Declaration
              of Trust dated December 12, 1991.
             (b)* Amendments to Declaration of Trust dated July 8, 1993; August 17, 1993; and
              September 9, 1993.
      3.2*    Trustees' Regulations dated September 24, 1973.
      4.1     Shareholder Rights Plan. Incorporated by reference from Form 8-A dated August
              17, 1993.
      4.2     Trust Indenture for Convertible Subordinated Debentures between Mercer
              International Inc. and Montreal Trust Company of Canada dated as of September
              10, 1992. Incorporated by reference from Form 8-K of Mercer International Inc.
              dated October 31, 1992.
      4.3*    Trust Indenture for Subordinated Debentures between Mercer International Inc.
              and Montreal Trust Company of Canada as Trustee dated as of December 22, 1992.
     10.1     Acquisition Agreement among Treuhandanstalt, Dresden Papier AG, Dresden Papier
              Holding GmbH, Mercer International Inc., and Shin Ho Paper Mfg. Co., Ltd.
              Incorporated by reference from Form 8-K dated September 20, 1993.
     10.2     Acquisition Agreement among Treuhandanstalt, Zellstoff- und
              Papierfabrik Rosenthal GmbH, Raboisen Einhundertsechsundfunfzigste
              Vermogensverwaltungsgesellschaft GmbH, to be renamed ZPR
              Zellstoff- und Papierfabrik Rosenthal Holding GmbH, Mercer
              International Inc. and 448380 B.C. Ltd. dated July 3, 1994.
              Incorporated by reference from Form 8-K dated July 3, 1994.
     10.3*    Assignment Agreement between Nalcap Holdings Inc. and CanCapital Corporation
              dated as of January 1, 1992.
     10.4*    Amended and Restated 1992 Stock Option Plan.
     10.5*    1994 Employee Incentive Bonus Plan.
     10.6     Stock Purchase Agreement between CVD Financial Corporation and Mercer
              International Inc. dated March 22, 1995. Incorporated by reference from Item 7,
              Amendment No. 5 to Schedule 13D filed by Mercer International Inc. with respect
              to the common shares of CVD Financial Corporation.
     10.7     Acquisition Agreement between Mercer International Inc. and Five Continents
              International dated for reference March 31, 1995. Incorporated by reference from
              Form 8-K dated August 12, 1995.
</TABLE>

                                       22


<PAGE>   23

<TABLE>
    <S>       <C>
     10.8*    Form of Separation Agreement between Mercer International Inc. and Arbatax
              International Inc.
     21.      List of Subsidiaries of Registrant.
     23.      Consent of Independent Auditors.
     27.      Article 5 - Financial Data Schedule for the Year Ended
              December 31, 1996.
    ---------------
      *       Filed in Form 10-K for prior years.
</TABLE>

(b) Registrant filed no reports on Form 8-K during the fourth quarter of the
    fiscal year.

                                       23
<PAGE>   24

LETTERHEAD

                          INDEPENDENT AUDITORS' REPORT

To the Shareholders
  MERCER INTERNATIONAL INC.

     We have audited the consolidated balance sheets of Mercer International
Inc. and Subsidiaries as of December 31, 1996 and 1995, and the related
consolidated statements of operations, changes in shareholders' equity, and cash
flows for the years ended December 31, 1996, 1995 and 1994. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

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

     In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Mercer
International Inc. and Subsidiaries as of December 31, 1996 and 1995, and the
results of their operations and their cash flows for the years ended December
31, 1996, 1995 and 1994 in conformity with generally accepted accounting
principles.

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

March 12, 1997
Seattle, Washington

                                       24
<PAGE>   25

                           MERCER INTERNATIONAL INC.

                          CONSOLIDATED BALANCE SHEETS
                           DECEMBER 31, 1996 AND 1995
                           (In Thousands of Dollars)

<TABLE>
<CAPTION>
                                                                           1996         1995
                                                                         --------     --------
<S>                                                                      <C>          <C>
ASSETS
Current Assets
  Cash and cash equivalents..........................................    $  9,967     $ 29,230
  Investments........................................................      83,359       65,311
  Receivables........................................................      18,366       17,711
  Inventories........................................................      20,668       27,723
  Other..............................................................         291          643
                                                                         --------     --------
                                                                         132,651..     140,618
Long-Term Assets
  Net assets of spun-off operation...................................       --          55,366
  Investments........................................................       3,759        5,653
  Government receivable..............................................       --          12,450
  Properties.........................................................     125,116      104,038
  Deferred income tax assets.........................................      18,313       10,625
                                                                         --------     --------
                                                                         147,188..     188,132
                                                                         --------     --------
                                                                         $279,839     $328,750
                                                                         ========     ========
LIABILITIES
Current Liabilities
  Accounts payable and accrued expenses..............................    $ 45,324     $ 47,455
  Notes payable......................................................       6,017        2,460
  Current portion of long-term debt..................................       2,647        --
                                                                         --------     --------
                                                                           53,988       49,915
Long-Term Liabilities
  Debt...............................................................      28,610       22,760
  Due to spun-off operation..........................................         368       21,778
  Other..............................................................       2,334        7,282
                                                                         --------     --------
                                                                           31,312       51,820
                                                                         --------     --------
     Total liabilities...............................................      85,300      101,735
SHAREHOLDERS' EQUITY
Shareholders' Equity
  Preferred shares, no par value: 50,000,000
     authorized, and issuable in series
     Series A, 500,000 authorized, none issued and outstanding.......       --           --
     Series B, 3,500,000 authorized, none issued and outstanding.....       --           --
  Shares of beneficial interest, $1 par value:
     unlimited authorized, 14,750,638 and 13,326,023
     issued and outstanding at December 31, 1996 and 1995............      85,965       70,765
  Cumulative translation adjustment..................................     (12,014)      (1,732)
  Net unrealized loss on investments valuation.......................      (2,250)      (2,974)
  Retained earnings..................................................     122,838      160,956
                                                                         --------     --------
                                                                          194,539      227,015
                                                                         --------     --------
                                                                         $279,839     $328,750
                                                                         ========     ========
</TABLE>

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

                                       25
<PAGE>   26

                           MERCER INTERNATIONAL INC.

                     CONSOLIDATED STATEMENTS OF OPERATIONS
              FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
              (In Thousands of Dollars, Except Earnings Per Share)

<TABLE>
<CAPTION>
                                                               1996         1995         1994
                                                             --------     --------     --------
<S>                                                          <C>          <C>          <C>
Revenues
  Sales....................................................  $174,097     $275,332     $147,771
  Supplements..............................................     --           --          44,356
  Investments..............................................    11,060       10,359        2,202
  Other....................................................     1,572       15,046        3,030
                                                             --------     --------     --------
                                                              186,729      300,737      197,359
Expenses
  Cost of sales............................................   145,432      191,726      116,681
  General and administrative...............................    24,863       35,217       19,637
  Litigation settlement....................................     --           7,000        --
  Interest expense.........................................     3,978        4,543        3,522
                                                             --------     --------     --------
                                                              174,273      238,486      139,840
                                                             --------     --------     --------
Income from continuing operations before income taxes and
  minority interest........................................    12,456       62,251       57,519
Income tax benefit.........................................     3,101        9,132          581
                                                             --------     --------     --------
Income from continuing operations before minority
  interest.................................................    15,557       71,383       58,100
Minority interest..........................................     --          (5,746)     (16,601)
                                                             --------     --------     --------
Income from continuing operations..........................    15,557       65,637       41,499
Income (loss) of spun-off operation, net of applicable
  income tax recovery (provision for) income tax of $(219)
  in 1996, $(463) in 1995 and $1,784 in 1994...............       466       (1,454)       4,597
                                                             --------     --------     --------
  Net income...............................................  $ 16,023     $ 64,183     $ 46,096
                                                             ========     ========     ========
Earnings per share
  Income from continuing operations........................  $   1.12     $   5.14     $   3.69
  Income (loss) of spun-off operation......................      0.03        (0.11)        0.41
                                                             --------     --------     --------
Net income.................................................  $   1.15     $   5.03     $   4.10
                                                             ========     ========     ========
</TABLE>

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

                                       26
<PAGE>   27

                           MERCER INTERNATIONAL INC.

           CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
              FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
                           (In Thousands of Dollars)

<TABLE>
<CAPTION>
                                                  SHARES OF BENEFICIAL INTEREST                                NET
                                                ---------------------------------                           UNREALIZED
                           PREFERRED SHARES                              AMOUNT                              LOSS ON
                          -------------------                            PAID IN               CUMULATIVE   INVESTMENT
                          NUMBER OF   AMOUNT    NUMBER OF               EXCESS OF   RETAINED   TRANSLATION  VALUATION
                           SHARES      PAID      SHARES     PAR VALUE   PAR VALUE   EARNINGS   ADJUSTMENT     AMOUNT      TOTAL
                          ---------   -------   ---------   ---------   ---------   --------   ----------   ----------   --------
<S>                       <C>         <C>       <C>         <C>         <C>         <C>        <C>          <C>          <C>
Balance at December 31,
  1993..................    63,517    $1,227    11,758,089   $11,758    $ 21,908    $50,677     $ (6,793)    $ (1,657)   $ 77,120
Repurchase of shares....   (71,517)   (1,072)   (1,778,314)   (1,778)    (17,824)     --          --           --         (20,674)
Shares issued for
  conversion of
  debentures and
  preferred shares and
  exercise of
  warrants..............     8,000      (155)     870,536        870       5,990      --          --           --           6,705
Translation
  adjustments...........     --         --         --          --          --         --           2,043       --           2,043
Reduction of investment
  valuation account.....     --         --         --          --          --         --          --              250         250
Net income..............     --         --         --          --          --        46,096       --           --          46,096
                          ---------   -------   ---------   ---------   ---------   --------   ----------   ----------   --------
Balance at December 31,
  1994..................     --         --      10,850,311    10,850      10,074     96,773       (4,750)      (1,407)    111,540
Repurchase of shares....     --         --        (28,000)       (28)       (638)     --          --           --            (666)
Shares issued for
  acquisition of
  minority interest in
  subsidiaries..........     --         --      2,000,000      2,000      40,000      --          (4,872)      --          37,128
Shares issued for
  conversion of
  debentures and
  exercise of
  warrants..............     --         --         26,212         26         276      --          --           --             302
Shares issued on
  exercise of options...     --         --        477,500        478       7,727      --          --           --           8,205
Translation
  adjustments...........     --         --         --          --          --         --           7,890       --           7,890
Increase of investment
  valuation account.....     --         --         --          --          --         --          --           (1,567)     (1,567)
Net income..............     --         --         --          --          --        64,183       --           --          64,183
                          ---------   -------   ---------   ---------   ---------   --------   ----------   ----------   --------
Balance at December 31,
  1995..................     --         --      13,326,023    13,326      57,439    160,956       (1,732)      (2,974)    227,015
Dividend of shares
  pursuant to spin-off
  transaction...........     --         --         --          --          --       (54,141)       3,406       --         (50,735)
Shares issued for
  conversion
  debentures............     --         --         81,515         82         726      --          --           --             808
Shares issued for
  exercise of options...     --         --        152,500        152       1,478      --          --           --           1,630
Shares issued for the
  settlement of debt....     --         --      1,350,000      1,350      13,831      --          --           --          15,181
Repurchase of shares....     --         --       (159,400)      (159)     (2,260)     --          --           --          (2,419)
Translation
  adjustments...........     --         --         --          --          --         --         (13,688)      --         (13,688)
Decrease in investment
  valuation account.....     --         --         --          --          --         --          --              724         724
Net income..............     --         --         --          --          --        16,023       --           --          16,023
                          ---------   -------   ---------   ---------   ---------   --------   ----------   ----------   --------
Balance at December 31,
  1996..................     --         --      14,750,638   $14,751    $ 71,214    $122,838    $(12,014)    $ (2,250)   $194,539
                          ==========  =======   =========   =========   =========   ========   ==========   =========    ========
</TABLE>

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

                                       27
<PAGE>   28

                           MERCER INTERNATIONAL INC.

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
              FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
                           (In Thousands of Dollars)

<TABLE>
<CAPTION>
                                                               1996         1995         1994
                                                             --------     --------     --------
<S>                                                          <C>          <C>          <C>
Cash Flows from Continuing Operating Activities
  Income from continuing operations........................  $ 15,557     $ 65,637     $ 41,499
  Adjustments to reconcile income from continuing
     operations to cash from continuing operating
     activities
     Depreciation and amortization, net....................   (10,960)     (13,883)     (10,263)
     Gain on sale of property..............................    (1,572)       --           --
     Losses on facilities to be sold.......................     --           --           1,899
     Recognition of preacquisition contingency.............     --         (14,779)       --
     Gains in trading securities...........................    (5,934)      (3,736)       --
     Deferred income taxes.................................    (3,101)      (9,132)        (581)
     Minority interest.....................................     --           5,746       16,601
     Other.................................................       (55)        (400)          40
  Changes in current assets and liabilities net of effects
     of companies acquired
     Investment in trading securities......................   (15,071)     (61,948)       1,068
     Inventories...........................................     5,271       (7,291)      (7,506)
     Receivables...........................................     9,442       33,153      (13,196)
     Accounts payable and accrued expenses.................       287       (9,826)      (9,049)
     Other.................................................      (247)          (9)       1,799
                                                             --------     --------     --------
     Net cash provided by (used in) continuing operating
       activities..........................................    (6,383)     (16,468)      22,311
Cash Flows from Investing Activities of Continuing
  Operations
  Proceeds from the sales of available-for-sale
     securities............................................     1,946        2,364          517
  Purchase of available-for-sale securities................     --          (6,268)        (203)
  Purchase of fixed assets, net of investment grants.......   (18,200)      (8,419)      (9,829)
  Decrease in notes receivable.............................     --           1,219          219
  Purchase of subsidiaries, net of cash acquired...........     --           --          (1,278)
  Other....................................................       (81)          90        --
                                                             --------     --------     --------
     Net cash used in investing activities of continuing
       operations..........................................   (16,335)     (11,014)     (10,574)
Cash Flows from Financing Activities of Continuing
  Operations
  Increase in bank debts...................................     7,504       47,048       34,750
  Decrease in bank debts...................................      (959)     (47,730)     (27,813)
  Net proceeds on the issuance of (cost to repurchase)
     shares of beneficial interest.........................      (789)       7,117      (19,602)
  Redemption of preferred shares...........................     --           --          (1,072)
  Contribution from minority shareholders..................     --           --           7,978
  Debenture redemption.....................................     --           --            (931)
  Other....................................................     --            (634)         518
                                                             --------     --------     --------
     Net cash provided by (used in) financing activities of
       continuing operations...............................     5,756        5,801       (6,172)
Effect of exchange rate changes on cash and cash
  equivalents..............................................    (1,028)       4,062          112
                                                             --------     --------     --------
Net cash provided by (used in) continuing operations.......   (17,990)     (17,619)       5,677
Net cash provided by (used in) spun-off operation..........    (1,273)       4,337       12,619
                                                             --------     --------     --------
Net increase (decrease) in cash and cash equivalents.......   (19,263)     (13,282)      18,296
Cash and Cash Equivalents, beginning of year...............    29,230       42,512       24,216
                                                             --------     --------     --------
Cash and Cash Equivalents, end of year.....................  $  9,967     $ 29,230     $ 42,512
                                                             ========     ========     ========
</TABLE>

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

                                       28
<PAGE>   29

                           MERCER INTERNATIONAL INC.

                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1.  THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     The Company is a business trust organized under the laws of the State of
Washington, USA. Under Washington law shareholders of a business trust have the
same limited liability as shareholders of a corporation. The consolidated
financial statements have been prepared in conformity with generally accepted
accounting principles applicable in the United States of America and are stated
in United States dollars, as rounded to the nearest thousand.

     The Company presently operates in the pulp and paper industry in Europe.
The industry is cyclical in nature and the markets for the Company's products
are affected by fluctuations in supply and demand in each cycle which has an
affect on prices.

Basis of Presentation

     Effective June 3, 1996, the Company completed the spin-off of approximately
83% of the outstanding shares of common stock of Arbatax International Inc.
("Arbatax") as a dividend to the Company's shareholders. Subsequent to the
spin-off, Arbatax changed its name to MFC Bancorp Ltd. The operating results of
Arbatax are included in these consolidated statements of operations and cash
flows for the period of January 1, 1996 through June 2, 1996 and the years ended
December 31, 1995 and 1994. The December 31, 1996 consolidated balance sheet
reflects the reductions related to the spin-off and at December 31, 1995 the net
assets of Arbatax of $55,366 have been reported separately.

Principles of Consolidation

     The consolidated financial statements include the accounts of the Company
and its subsidiaries. Significant intercompany accounts and transactions of
continuing operations have been eliminated. Unless otherwise stated, all notes
relate to continuing operations.

Cash and Cash Equivalents

     Cash and cash equivalents include highly liquid investments with original
maturities of three months or less. These are recorded at cost which
approximates market. The Company maintains cash balances in foreign financial
institutions in excess of insured limits.

Investments

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

Inventories

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

Depreciation

     Depreciable assets are stated at cost. Depreciation of buildings and
production equipment is based on the estimated useful lives of the assets and is
computed using the straight-line method. Buildings are depreciated over a 10 to
50 year life and production equipment over 8 to 20 years.

                                       29
<PAGE>   30

         NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Foreign Currency Translation

     The Company translates foreign assets and liabilities of its subsidiaries
at the rate of exchange at the balance sheet date. Revenues and expenses are
translated at the average rate of exchange throughout the year. Unrealized gains
or losses from these translations are included in the equity section of the
balance sheet. Realized gains or losses are included in general and
administrative expenses in the income statement. The translation adjustments do
not recognize the effect of income tax because the Company expects to reinvest
the amounts indefinitely in operations.

Environmental Conservation

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

Stock-Based Compensation

     Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation," encourages, but does not require, companies to record
compensation cost for stock-based employee compensation plans at fair value. The
Company has chosen to account for stock-based compensation using Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees."
Accordingly, compensation cost for stock options is measured as the excess, if
any, of the quoted market price of the Company's stock at the date of the grant
over the amount an employee is required to pay for the stock.

Earnings Per Share

     Earnings per share is computed on the weighted average number of shares
outstanding during the year, after considering convertible securities, warrants
and options. The weighted average number of shares was 13,935,349, 12,758,753
and 11,255,775 for the years ended December 31, 1996, 1995 and 1994,
respectively.

Accounting for Acquisitions

     Acquisitions have been accounted for using the purchase method. The amount
by which book value of the acquired entity exceeds or is less than cost is
amortized over the estimated benefit period.

Taxes on Income

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

Estimates

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

NOTE 2.  SPIN-OFF OF ARBATAX

     As discussed in Note 1, 83% of Arbatax's common shares were spun-off to the
Company's shareholders effective June 3, 1996. The spin-off was a taxable
transaction for U.S. income tax purposes. However, because

                                       30
<PAGE>   31

         NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

the estimated valuation of the transaction for U.S. tax purposes is less than
the Company's basis in Arbatax, no U.S. income tax has been provided. Further,
no tax was provided in any foreign tax jurisdiction on the transaction because
it has been deemed not taxable under appropriate foreign tax law. Since the
spin-off has not been reviewed by either U.S. or foreign tax authorities, there
can be no assurance that a tax audit may not result in a potential future
liability. But, management believes that it is more likely than not that no
significant income tax will ultimately be incurred because of this transaction.
The separation agreement between the Company and Arbatax contains a tax
indemnification provision.

     Arbatax represented the Company's financial services segment which
consisted of managing insurance, royalties and other activities primarily in
Canada and the United States. Revenues for Arbatax were $14,927 for the period
January 1, 1996 through June 2, 1996, $20,895 and $20,366 for the years ended
December 31, 1995 and 1994, respectively. Revenues included preferred share
dividends from an affiliate of $823 in 1996, $2,967 in 1995 and $3,286 in 1994.

     The Company's December 31, 1996 consolidated balance sheet reflects a
$54,141 reduction in retained earnings and a $3,406 foreign currency translation
adjustment due to the dividend of the Arbatax shares. The following is a summary
of Arbatax's consolidated net assets:

<TABLE>
<CAPTION>
                                                                      JUNE 2, 1996     DECEMBER 31,
                                                                      (UNAUDITED)          1995
                                                                      ------------     ------------
<S>                                                                   <C>              <C>
Assets
  Cash, cash equivalents and investments                                $ 57,190         $ 21,602
  Receivables and other                                                   31,794           17,427
  Due from the Company                                                    20,118           21,778
  Resource properties                                                     24,119           12,643
                                                                        --------         --------
                                                                         133,221           73,450
Liabilities
  Accounts payable and accrued liabilities                                16,581            2,661
  Accrued losses, claims and settlement expenses                          10,062           11,982
  Long-term debt                                                          46,984           --
  Minority interest                                                        3,767            3,441
                                                                        --------         --------
                                                                          77,394           18,084
                                                                        --------         --------
  Consolidated net assets                                               $ 55,827         $ 55,366
                                                                        ========         ========
</TABLE>

     The amount due from the Company was settled on September 5, 1996 with
700,000 shares of the Company's stock at a fair value of $7,787 and a promissory
note amounting to $14,543, inclusive of $2,212 which the Company paid on behalf
of another affiliate. The note is due January 1, 1998 and bears interest at 8%.

NOTE 3.  PULP AND PAPER COMPANIES

Zellstoff-und Papierfabrik Rosenthal GmbH ("ZPR")

     ZPR is a pulp production company located in Germany. Effective July 1,
1994, the Company along with another entity acquired ZPR from a German
governmental agency. The Company acquired the other entity's interest in ZPR
effective April 1, 1995, resulting in ZPR becoming a wholly-owned subsidiary.

     The 1995 and 1994 acquisitions resulted in purchase credits which were
allocated to property and equipment. Both credits are being amortized over a
five-year life. The total amount of credit amortized was $11,512, $12,389 and
$5,169 in 1996, 1995 and 1994, respectively. In December 1995, the Company
recorded a pre-acquisition contingent asset of $14,779 which is being amortized
on the straightline method over its estimated useful life of twenty-two years.

                                       31
<PAGE>   32

         NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     Under the 1994 agreement, ZPR received privatization supplements amounting
to $40,274. Since the receivable was due in installments through 1998, it was
discounted at a rate of 5.5%. The total amount of the supplements, net of the
discount, amounting to $38,757 was recorded as revenue in 1994. The net current
portion of the receivable amounted to $4,847 and the long-term portion amounted
to $6,706 at December 31, 1995. The remaining discount at December 31, 1995 was
$711. In 1996, the receivable was paid down to $6,300 which was legally offset
in payment for the utilization of preacquisition income tax loss carryforwards
as originally provided in the acquisition agreement. This amount was considered
in the reduction of the income tax benefit reserve discussed in Note 11.

     ZPR agreed to invest $48,360 in property and equipment improvements through
1998, of which $33,820 has been spent. Also, the governmental agency is to
reimburse ZPR up to a total of $12,000 of defined environmental costs as actual
expenditures take place. At December 31, 1996 and 1995, ZPR recorded $1,949 and
$2,092, respectively, in environmental expenditures as a liability.

     ZPR is not permitted under the original purchase agreement to make
distributions to the Company or make payments on a $12,896 loan payable to the
Company prior to January 1999. The net assets which may not be distributed
amounted to $137,510 at December 31, 1996. However, the Company may expand or
invest through ZPR.

     ZPR has a fiber supply contract with another company which expires December
31, 1997, at a cost-plus rate. ZPR has a labor agreement which expires in June
1997 and Dresden Papier AG has a labour agreement which is currently under
negotiation.

Dresden Papier AG ("DPAG")

     DPAG is a paper manufacturing company located in Germany which the Company
acquired during 1993 from the same governmental agency discussed above. In
addition, the same entity as discussed with ZPR acquired an interest in DPAG
during 1994. The Company purchased the other entity's interest in DPAG effective
April 1, 1995, which resulted in DPAG also becoming a wholly-owned subsidiary.

     The 1993 acquisition resulted in a purchase credit which was allocated to
property and equipment and is being amortized over a five-year period expiring
June 30, 1998. The amortization was $13,712, $15,473 and $14,028 for the years
ended December 31, 1996, 1995 and 1994, respectively. The 1995 purchase resulted
in an excess of cost over the interest in DPAG acquired which is being amortized
over a sixty-month period resulting in amortization of $1,741 for 1996 and
$2,319 for 1995.

     DPAG also received privatization supplements. During 1994, $5,599 of these
supplements was recorded as income. The final supplement payment was received in
1995.

     DPAG has recorded $325 and $6,395 as estimated potential liabilities for
environmental conservation expenditures. The 1993 agreement provides for
reimbursements with respect to the potential liability. The Company has no
reimbursement receivable at December 31, 1996 and $5,465 at December 31, 1995.

     Finally, ZPR and DPAG's revenues are derived from the following geographic
areas:

<TABLE>
<CAPTION>
                                                                      YEARS ENDED DECEMBER 31
                                                                     -------------------------
                                                                     1996      1995      1994
                                                                     -----     -----     -----
<S>                                                                  <C>       <C>       <C>
Germany............................................................  58.2%     62.4%     70.5%
European Union.....................................................  28.0%     26.3%     23.5%
Other..............................................................  13.8%     11.3%      6.0%
</TABLE>

                                       32
<PAGE>   33

         NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 4.  INVESTMENTS

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

<TABLE>
<CAPTION>
                                                                               DECEMBER 31
                                                                           -------------------
                                                                            1996        1995
                                                                           -------     -------
<S>                                                                        <C>         <C>
Bonds....................................................................  $52,043     $58,294
Equity securities........................................................   29,820       7,017
                                                                           -------     -------
                                                                           $81,863     $65,311
                                                                           =======     =======
</TABLE>

     The change in net unrealized holding gains on trading securities which has
been included in earnings was $888 and $3,736 during 1996 and 1995,
respectively. Included with trading securities in current investments at
December 31, 1996 is $1,496 of securities in an affiliate, as described in Note
14.

     Available-for-sale securities consist of equity securities and have been
classified as long-term investments. The fair value of these securities was
$1,015 and $2,900 and the unrealized total losses amounted to $2,250 and $2,974
at December 31, 1996 and 1995, respectively. The loss on investment valuation in
shareholders' equity was decreased by $724 at December 31, 1996 and increased by
$1,567 at December 31, 1995. The Company sold available-for-sale securities
during 1996 for $1,946 which resulted in a realized loss of $415. During 1995,
the Company sold available-for-sale securities representing all of its 34.6%
interest in an affiliate for $2,364. This sale resulted in no gain or loss and
was to another affiliate where a director and officer of the Company was a board
member. During 1994, the proceeds from sales of available-for-sale securities
amounted to $517 and realized gains were $273.

     Included in long-term investments are preferred shares in an affiliate of
the spun-off entity which are stated at cost of $2,744 and $2,753 at December
31, 1996 and 1995, respectively. These securities have no readily determinable
fair value.

Fair Value of Financial Instruments

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

<TABLE>
<CAPTION>
                                                                   1996                 1995
                                                             -----------------   ------------------
                                                             CARRYING    FAIR    CARRYING    FAIR
                                                              AMOUNT    VALUE     AMOUNT     VALUE
                                                             --------   ------   --------   -------
<S>                                                          <C>        <C>      <C>        <C>
Cash and cash equivalents..................................   $9,967    $9,967   $ 29,230   $29,226
Preferred shares in affiliate..............................    2,744     2,744      2,753     2,764
Long-term government receivables...........................    --         --       12,450    12,450
Notes payable..............................................    6,017     6,017      2,460     2,460
Long-term debt.............................................   31,257    30,613     22,760    23,368
</TABLE>

     None of the Company's financial instruments are derivatives. The fair value
of cash and cash equivalents is based on reported market value. The preferred
shares in affiliate's value is based on their retractability feature and
dividend rate compared to other securities. The fair value of government
receivables at December 31, 1995 is equal to the carrying amount because a
discount had already been recorded. The fair value of notes payable was based on
the value of similar debt incurred in the pulp and paper industry. The fair
value of long-term debt was determined using discounted cash flows at prevailing
market rates. The other long-term liabilities which have a carrying value of
$2,334 and $7,282 at December 31, 1996 and 1995, respectively are primarily
accrued environmental liabilities at ZPR and DPAG. These liabilities may be
partially reimbursable. Further, the Company cannot estimate at this time when
these amounts will be paid. Therefore, the fair value of other long-term
liabilities cannot be determined.

                                       33
<PAGE>   34

         NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 5.  CURRENT RECEIVABLES

<TABLE>
<CAPTION>
                                                                              DECEMBER 31
                                                                          --------------------
                                                                           1996         1995
                                                                          -------      -------
<S>                                                                       <C>          <C>
Sale of paper and pulp products........................................   $10,146      $10,387
Sale of property.......................................................     2,391        --
Government.............................................................     --           4,847
Other..................................................................     5,829        2,477
                                                                          -------      -------
                                                                          $18,366      $17,711
                                                                          =======      =======
</TABLE>

NOTE 6.  INVENTORIES

<TABLE>
<CAPTION>
                                                                              DECEMBER 31
                                                                          --------------------
                                                                           1996         1995
                                                                          -------      -------
<S>                                                                       <C>          <C>
Pulp and paper
  Raw materials........................................................   $ 9,426      $13,211
  Work in process and finished goods...................................    11,242       14,512
                                                                          -------      -------
                                                                          $20,668      $27,723
                                                                          =======      =======
</TABLE>

NOTE 7.  PROPERTIES

<TABLE>
<CAPTION>
                                                                              DECEMBER 31
                                                                         ---------------------
                                                                           1996         1995
                                                                         --------     --------
<S>                                                                      <C>          <C>
Land...................................................................  $ 14,740     $ 12,060
Buildings..............................................................    21,769       16,166
Production and other equipment.........................................   124,858       99,714
                                                                         --------     --------
                                                                          161,367      127,940
Less: Accumulated depreciation                                             36,251       23,902
                                                                         --------     --------
                                                                         $125,116     $104,038
                                                                         ========     ========
</TABLE>

     Depreciation expense was $13,373, $13,431 and $8,553 for the years ended
December 31, 1996, 1995 and 1994, respectively.

NOTE 8.  NOTES PAYABLE

<TABLE>
<CAPTION>
                                                                               DECEMBER 31
                                                                           -------------------
                                                                            1996         1995
                                                                           ------       ------
<S>                                                                        <C>          <C>
Bank loan, 7% interest payable monthly, due April 1997,
  collateralized by inventory..........................................    $3,077       $2,460
Bank loan, 6.5% interest payable monthly, due February 1997,
  collateralized by inventory..........................................     1,981         --
Bank loan, 10% interest, due July 1997, unsecured......................       959         --
                                                                           ------       ------
                                                                           $6,017       $2,460
                                                                           ======       ======
</TABLE>

                                       34
<PAGE>   35

         NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 9.  LONG-TERM DEBT

<TABLE>
<CAPTION>
                                                                              DECEMBER 31
                                                                          --------------------
                                                                           1996         1995
                                                                          -------      -------
<S>                                                                       <C>          <C>
Note payable to spun-off entity, 8% interest, due January 1998,
  unsecured............................................................   $14,543      $ --
Loan from governmental agency, 7% interest payable annually, due 2004,
  collateralized by fixed assets.......................................     6,584        7,035
Loan from governmental agency, non-interest bearing, due 2001..........     3,249        3,487
Bank loan, 9.25% interest, due 1998, collateralized by securities......     --          10,406
Subordinated debenture, Series I, interest at 6% due annually,
  due December 31, 1997................................................     1,079        1,587
Bank loan, interest at 5.5% payable quarterly, principal due in March
  2001, collateralized by land and buildings...........................     2,924        --
Bank loan, interest at LIBOR plus 2% (5.125% at December 31, 1996)
  payable monthly, due in March 2001, collateralized by land and
  buildings............................................................     1,631        --
Note payable, interest at 13.5% payable $256 per quarter,
  due June 1998, unsecured.............................................     1,247        --
Other..................................................................     --             245
                                                                          -------      -------
                                                                           31,257       22,760
Less: Current portion..................................................     2,647        --
                                                                          -------      -------
                                                                          $28,610      $22,760
                                                                          =======      =======
</TABLE>

     During 1996, the $10,406 bank loan above was increased to $13,418 which was
paid down to $959 as of December 31, 1996. The payment was made by transferring
650,000 shares of the Company with a market value of $7,394 and other securities
with a fair value of $5,065. The remaining balance was paid with 100,000 of the
Company's shares subsequent to year-end and is classified as a current note
payable.

     Series I subordinated debentures have a total of 65,880 warrants attached
at December 31, 1996, which entitle the debenture holder to purchase one share
of beneficial interest at $10.25 in 1997.

     As of December 31, 1996, the principal maturities of long-term debt are as
follows:

<TABLE>
<CAPTION>
            MATURES                                                      AMOUNT
            -------                                                      -------
            <S>                                                          <C>
            1997.....................................................    $ 2,647
            1998.....................................................     16,439
            1999.....................................................      2,022
            2000.....................................................      2,022
            2001.....................................................      1,544
            Thereafter...............................................      6,583
                                                                         -------
                                                                         $31,257
                                                                         =======
</TABLE>

     Interest paid amounted to $2,693 in 1996, $3,697 in 1995 and $2,230 in
1994. Interest amounting to $246, $668 and $880 has been capitalized in property
and equipment during 1996, 1995 and 1994, respectively.

                                       35
<PAGE>   36

         NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 10.  ACCOUNTS PAYABLE AND ACCRUED EXPENSES

<TABLE>
<CAPTION>
                                                                               DECEMBER 31
                                                                           -------------------
                                                                            1996        1995
                                                                           -------     -------
<S>                                                                        <C>         <C>
Accounts payable and accrued expenses....................................  $11,835     $ 8,637
Trade payables...........................................................   25,773      37,865
Payable for securities...................................................    6,838       --
Other....................................................................      878         953
                                                                           -------     -------
                                                                           $45,324     $47,455
                                                                           =======     =======
</TABLE>

NOTE 11.  INCOME TAXES

     The current recovery of (provision for) income taxes on income consists of
the following:

<TABLE>
<CAPTION>
                                                                      YEAR ENDED DECEMBER 31
                                                                    ---------------------------
                                                                     1996        1995      1994
                                                                    -------     ------     ----
<S>                                                                 <C>         <C>        <C>
U.S...............................................................  $(1,456)    $2,380     $581
Non U.S...........................................................    4,557      6,752      --
                                                                    -------     ------     ----
Recovery of income taxes..........................................  $ 3,101     $9,132     $581
                                                                    =======     ======     ====
</TABLE>

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

<TABLE>
<CAPTION>
                                                                    YEAR ENDED DECEMBER 31
                                                                -------------------------------
                                                                 1996        1995        1994
                                                                -------    --------    --------
<S>                                                             <C>        <C>         <C>
U.S. Federal statutory rates on income from continuing
  operations before considering minority interest.............  $ 4,234    $ 20,907    $ 19,988
Reduction in taxes resulting from:
  Non U.S. income.............................................   (2,778)    (20,907)    (19,988)
  Benefit of operating loss carryforward......................   (1,456)      --          --
                                                                -------    --------    --------
                                                                $ --       $  --       $  --
                                                                =======    ========    ========
</TABLE>

     In 1995, a U.S. tax benefit was recognized based on a temporary difference
resulting from a litigation settlement. The provision in 1996 represents a
partial utilization of that benefit. Management believes that, while realization
of the remaining U.S. income tax benefits amounting to $924 is not assured, that
it is more likely than not that they will be realized. The Company's U.S. net
operating losses amounting to approximately $2,718 at December 31, 1996 will
expire in 2011 if not utilized.

     Both ZPR and DPAG have German tax net operating losses which may be carried
forward indefinitely. ZPR has approximately $97,000 and DPAG has $145,000 of
such losses available as of December 31, 1996.

     In 1994, the tax benefit associated with ZPR's tax losses was fully
reserved. During 1995, management, in consultation with industry experts,
undertook a study to determine if the reserve should be reduced. Management
considered plant improvements, more efficient utilization of labor and the
significant downward price trends in the pulp market, among other factors, to
determine an appropriate reserve reduction. Management concluded that a
reduction of $6,752 was appropriate for 1995 given the state of the pulp market.
During 1996, because the pulp market had stabilized to a degree, management,
along with its consultants, again considered a further reduction in the reserve.
Based on the factors considered in the original study together with the analysis
performed in 1996, the reserve was reduced by $4,557. Even though realization of
the resulting benefit is not assured, management believes that it is more likely
than not that the reductions in ZPR's reserve are appropriate. Included in the
deferred tax asset is the $6,300 paid to a German governmental agency to utilize
ZPR's tax losses as required under the 1994 purchase agreement discussed in Note
3. This amount will be amortized based on the tax loss benefit utilized
annually.

                                       36
<PAGE>   37

         NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     The Company has continued to fully reserve DPAG's tax loss benefit. Even
though the Company is seeking alternative uses for these losses, management
believes that it does not have sufficient information necessary to reduce the
reserve. There are no other temporary differences at either ZPR or DPAG.

     Income from foreign source operations amounted to $20,015, $72,437 and
$58,805 for the years ended December 31, 1996, 1995 and 1994, respectively.
These amounts are intended to be indefinitely reinvested in operations. Further,
any U.S. income tax benefit which may be attributable to the stock option plan
or unrealized losses in available-for-sale securities have been fully reserved.

     The Company has foreign tax credits available to be used against U.S.
income tax resulting from general limitation income in the approximate amount of
$2,500. Of these credits, $900 will expire in 1999 and $1,600 in 2000 if they
are not utilized.

NOTE 12.  STOCK-BASED COMPENSATION

     The Company has a non-qualified stock option plan which provides for
options to be granted to officers and employees to acquire a maximum of
1,000,000 shares of beneficial interest. Additionally, the plan provides that
options may be granted to directors who are not officers or employees to acquire
up to 100,000 shares.

     During 1996, options to acquire 139,500 shares at $21.50, 35,000 shares at
$13.88 and 60,000 shares at $9.50 were granted to officers and employees of the
Company. The 35,000 options and the 60,000 options vest one-third at the grant
date and one-third each year thereafter. All other options discussed in this
note vest one-half at the grant date and the rest at the end of one year. All
options have a contractual life of ten years. Also during 1996, directors of the
Company were granted options to acquire 12,000 shares at $20.50.

     The Company repriced the 139,500 options granted to employees and the
12,000 granted to directors during August 1996. After consideration of this
repricing, the weighted fair value per option granted in 1996 amounted to $3.33
each.

     During 1995, options to acquire 600,000 shares at $19.75 each were granted
to officers and employees of the Company. The weighted fair value of these
options was $5.03 each.

     During 1994, options to acquire 435,000 shares at $12.50 each were granted
to officers and employees. In addition, directors of the Company were granted
options to acquire 6,000 shares at $14.13. In prior years, directors were
granted 12,000 options to acquire shares at $14.13.

     Following is a summary of the status of the plan during 1996 and 1995:

<TABLE>
<CAPTION>
                                                                                       WEIGHTED
                                                                      NUMBER OF        AVERAGE
                                                                       SHARES       EXERCISE PRICE
                                                                      ---------     --------------
<S>                                                                   <C>           <C>
Outstanding at January 1, 1995......................................    453,000         $12.55
Granted.............................................................    600,000          19.75
Exercised...........................................................   (477,500)         16.29
Forfeited...........................................................    (45,000)         18.14
                                                                       --------         ------
Outstanding at December 31, 1995....................................    530,500          16.84
Granted.............................................................    246,500          15.58
Exercised...........................................................   (152,500)         10.69
Forfeited...........................................................   (229,000)         17.33
                                                                       --------         ------
Outstanding at December 31, 1996....................................    395,500         $14.88
                                                                       ========         ======
</TABLE>

                                       37
<PAGE>   38

         NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     Following is a summary of the status of options outstanding at December 31,
1996:

<TABLE>
<CAPTION>
                      OUTSTANDING OPTIONS                               EXERCISABLE OPTIONS
----------------------------------------------------------------     --------------------------
                             WEIGHTED AVERAGE        WEIGHTED                       WEIGHTED
  EXERCISE                      REMAINING            AVERAGE                        AVERAGE
 PRICE RANGE     NUMBER      CONTRACTUAL LIFE     EXERCISE PRICE     NUMBER      EXERCISE PRICE
-------------    -------     ----------------     --------------     -------     --------------
<S>              <C>         <C>                  <C>                <C>         <C>
$9.50-13.88      156,000            9.2               $10.98          92,666         $10.89
$16.89-18.47     239,500            8.7               $17.41         196,000         $17.21
</TABLE>

Compensation

     The Company applies Accounting Principles Board Opinion No. 25 in
accounting for its stock option plan. There was no compensation cost incurred
based on options granted in either 1996 or 1994. However, compensation costs
charged to operations was $420 in 1995 as a result of options granted. Had
compensation cost been recognized on the basis of fair value pursuant to
Statement of Financial Accounting Standards No. 123, net income and earnings per
share would have been adjusted as follows:

<TABLE>
<CAPTION>
                                                                               DECEMBER 31
                                                                           -------------------
                                                                            1996        1995
                                                                           -------     -------
<S>                                                                        <C>         <C>
Net Income
  As reported............................................................  $16,023     $64,183
                                                                           =======     =======
  Pro forma..............................................................  $15,027     $63,205
                                                                           =======     =======
Primary Earnings Per Share
  As reported............................................................  $  1.15     $  5.03
                                                                           =======     =======
  Pro forma..............................................................  $  1.08     $  4.95
                                                                           =======     =======
</TABLE>

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

<TABLE>
<CAPTION>
                                                                             1996       1995
                                                                            ------     ------
<S>                                                                         <C>        <C>
Risk-free interest rate...................................................    5.0%       5.0%
                                                                                 2          2
Expected life of the options..............................................   years      years
Expected volatility.......................................................  49.62%     38.45%
Expected dividend yield...................................................    0.0%       0.0%
</TABLE>

NOTE 13.  SHAREHOLDERS' EQUITY

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

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

     Also, during a prior year the Company authorized the issuance of 3.5
million shares of Cumulative Retractable Convertible Preferred Shares, Series B
at a price of $20 per share. These shares have a cumulative

                                       38
<PAGE>   39

         NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

dividend rate of up to 4%, a liquidation preference of $20 per share plus unpaid
dividends, a redemption right beginning January 1, 2004 at $20 per share plus
unpaid dividends and may convert up to 10% of the issued and outstanding shares
into common shares based on dividing the issue price plus unpaid dividends by
$20 per share.

NOTE 14.  TRANSACTIONS WITH AFFILIATES

     In connection with the spin-off discussed in Note 2, the Company assumed
the debt of an affiliate of Arbatax in the amount of $2,052. In prior years, the
Company had been the guarantor on the loan. In exchange for the assumption, the
Company received shares in a publicly-traded affiliate having a fair value of
$1,496, which is less than fair value at December 31, 1996, and a note for $556.
The note is due in quarterly installments of $256 until paid, bears interest at
10% and is unsecured. Under the terms of the exchange, the affiliate may replace
the shares with other assets. The affiliate is engaged in a legal action which
could result in replacement. Therefore, these shares are being held as a
temporary investment stated at the transfer price.

     After the spin-off discussed in Note 2, the Company had a remaining 9%
interest in the outstanding shares of the spun-off entity. These shares which
had a fair value of $5,065, were used to reduce the debt described in Note 9.

     During 1996, ZPR acquired bonds in a subsidiary of the spun-off entity with
a face amount of $5,922 for $4,548. ZPR acquired $6,000 in convertible
debentures of the spun-off entity. The spun-off entity acquired the subsidiary's
bonds for $5,922 and ZPR recorded income of $1,374 as a result of this
transaction for the year ended December 31, 1996. Finally, ZPR converted the
debentures into 857,143 common shares of the spun-off entity at the market
price.

     The Company has net receivables from two officers and directors amounting
to $366 as of December 31, 1996. An entity related to one of these
officer-directors charged fees of $232 to the Company during 1996 and was due
$77 from the Company at December 31, 1996.

     The Company incurred accounting and management fees to an affiliate
amounting to $191 and $535 during 1996 and 1995, respectively. The Company has
an open account payable to this affiliate amounting to $217 and $972 at December
31, 1996 and 1995, respectively. Further, the Company has an open receivable
from the affiliate amounting to $426 as of December 31, 1996.

     During 1994, the Company acquired 650,000 of its shares from an affiliate
for $8,786 which was the amount the affiliate paid for the shares during 1993.
The amount paid by the Company was approximately market value at date of
acquisition.

NOTE 15.  SUPPLEMENTAL DISCLOSURES WITH RESPECT TO STATEMENTS OF CASH FLOWS

     Significant noncash transactions in 1996 included:

     1.   The Company received 546,441 shares of common stock and a note in
        exchange for assuming debt amounting to $2,052 of an affiliate. The
        shares had a fair value of $1,496 and the note amounted to $556.

     2.   The Company settled its amount payable to the spun-off entity with
        700,000 shares of its common stock with a fair value of $7,787 and a
        promissory note for $14,543.

     3.   The Company paid bank debt of $12,459 with 650,000 of the Company's
        shares with a market value of $7,394 and securities with a fair value of
        $5,065.

     4.   As discussed in Note 2, the Company spun-off 83% of Arbatax amounting
        to $50,735 net of a foreign currency translation adjustment.

                                       39
<PAGE>   40

         NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     Significant noncash transactions in 1995 included:

     1.   During the year, 2,000,000 shares of beneficial interest amounting to
        $42,000 were issued to acquire another entity's thirty percent ownership
        in ZPR and DPAG.

     2.   A preacquisition contingency amounting to $14,779 was recorded as an
        asset which reflects the value of a waste disposal site at ZPR.

     Significant noncash transactions in 1994 included:

     1.   During the year, 8,000 preferred shares were converted into shares of
        beneficial interest on a one-for-one basis. Also, warrants attached to
        $6,208 of bonds were exchanged for shares of beneficial interest.

     2.   The Company acquired 650,000 shares of beneficial interest from an
        affiliate for $8,786 in exchange for assumption of debt and the
        elimination of a receivable.

NOTE 16.  CONTINGENCIES

     ZPR and DPAG are required to pay certain charges based on water pollution
levels at their manufacturing facilities. Unpaid charges can be reduced by
investing in qualifying equipment that results in less water pollution. ZPR and
DPAG believe equipment investments already made will offset most of these
charges, but they have not received final determination from the appropriate
authorities. Accordingly, a liability for these water charges has only been
recognized to the extent that equipment investments have not been made.

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

                                       40
<PAGE>   41

                           MERCER INTERNATIONAL INC.

                SUPPLEMENTARY FINANCIAL INFORMATION (UNAUDITED)
                            QUARTERLY FINANCIAL DATA
                     (Thousands, Except per Share Amounts)

<TABLE>
<CAPTION>
                                                                   QUARTER ENDED
                                              --------------------------------------------------------
                                              MARCH 31       JUNE 30      SEPTEMBER 30     DECEMBER 31
                                              --------       -------      ------------     -----------
<S>                                           <C>            <C>          <C>              <C>
1996
Net Sales..................................    49,873         49,677         46,164           41,015
Gross profit...............................    13,258         10,298          9,860            7,881
Income before extraordinary items and
  cumulative effect of a change in
  accounting...............................     5,860          2,873          3,140            3,684
Income before extraordinary items and
  cumulative effect of a change in
  accounting, per share*...................      0.43           0.21           0.23             0.25
Net income.................................     5,890          3,309          3,140            3,684
1995
Net Sales..................................    75,225         80,505         76,529           68,478
Gross profit...............................    26,642         24,949         24,860           32,560
Income before extraordinary items and
  cumulative effect of a change in
  accounting...............................    12,394         15,501         17,686           20,056
Income before extraordinary items and
  cumulative effect of a change in
  accounting, per share*...................      1.13           1.19           1.33             1.48
Net Income.................................    12,019         15,617         17,761           18,786
</TABLE>

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

*on a fully diluted basis

                                       41
<PAGE>   42

                                   SIGNATURES

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

Dated: March 24, 1997                     MERCER INTERNATIONAL INC.


                                          By: /s/ Jimmy S.H. Lee
                                              ---------------------------------
                                              Jimmy S.H. Lee
                                              Chairman

     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

<TABLE>
<S>                                              <C>
/s/ Jimmy S.H. Lee                               Date: March 24, 1997
---------------------------------------------
Jimmy S.H. Lee
Chairman, Chief Executive Officer
and Trustee

/s/ Michel Arnulphy                              Date: March 24, 1997
---------------------------------------------
Michel Arnulphy
Trustee

/s/ C.S. Moon                                    Date: March 24, 1997
---------------------------------------------
C.S. Moon
Trustee

/s/ M. Reidel                                    Date: March 24, 1997
---------------------------------------------
M. Reidel
Trustee
</TABLE>

                                       42
<PAGE>   43

LETTERHEAD

                          INDEPENDENT AUDITORS' REPORT

To the Shareholders
  MERCER INTERNATIONAL INC.

     Our report on the consolidated financial statements of Mercer International
Inc. is included on page 24 of this Form 10-K. In connection with our audits of
such financial statements, we have also audited the related financial statement
schedule listed in Item 14 of this Form 10-K.

     In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly in all material respects the information set forth
therein.

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

March 12, 1997
Seattle, Washington

                                       43
<PAGE>   44

                           MERCER INTERNATIONAL INC.

          SCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT

BALANCE SHEET

<TABLE>
<CAPTION>
                                                                              DECEMBER 31,
                                                                           -------------------
                                                                            1996        1995
                                                                           -------     -------
<S>                                                                        <C>         <C>
ASSETS
  Cash...................................................................    9,967      29,230
  Receivables............................................................   18,366      30,161
  Inventories............................................................   20,668      27,723
  Investments............................................................   87,118      70,964
  Investment in spun-off operations......................................        0      55,366
  Properties.............................................................  125,116     104,038
  Deferred income tax assets.............................................   18,313      10,625
  Other..................................................................      291         643
                                                                           -------     -------
                                                                           279,839     328,750
                                                                           =======     =======
LIABILITIES AND SHAREHOLDERS' EQUITY
  Accounts payable and accrued expenses..................................   48,026      76,515
  Debt...................................................................   37,274      25,220
  Shareholders' equity...................................................  194,539     227,015
                                                                           -------     -------
                                                                           279,839     328,750
                                                                           =======     =======
</TABLE>

STATEMENT OF OPERATIONS

<TABLE>
<CAPTION>
                                                                   YEARS ENDED DECEMBER 31,
                                                                -------------------------------
                                                                 1996        1995        1994
                                                                -------     -------     -------
<S>                                                             <C>         <C>         <C>
Revenues
  Pulp and paper and related sales and supplements............  174,097     275,332     192,127
  Investments.................................................   11,060      10,359       2,202
  Other.......................................................    1,572      15,046       3,030
                                                                -------     -------     -------
                                                                186,729     300,737     197,359
Expenses
  Pulp and paper costs........................................  145,432     191,726     116,681
  General and administrative..................................   24,863      35,217      19,637
  Interest....................................................    3,978       4,543       3,522
  Settlement of litigation....................................        0       7,000           0
  Income tax recovery.........................................   (3,101)     (9,132)       (581)
  Minority interest...........................................        0       5,746      16,601
                                                                -------     -------     -------
                                                                171,172     235,100     155,860
                                                                -------     -------     -------
Income from continuing operations.............................   15,557      65,637      41,499
                                                                =======     =======     =======
</TABLE>

                                       44
<PAGE>   45

STATEMENT OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                   YEARS ENDED DECEMBER 31,
                                                                -------------------------------
                                                                 1996        1995        1994
                                                                -------     -------     -------
<S>                                                             <C>         <C>         <C>
Net cash provided by (used in) operating activities...........   (6,383)    (16,468)     22,311
Net cash used by investing activities, purchase of fixed
  assets......................................................  (16,335)    (11,014)    (10,574)
Net cash provided by (used in) financing activities...........    4,728       9,863      (6,060)
Net cash provided by (used in) spun-off operation.............   (1,273)      4,337      12,619
                                                                -------     -------     -------
Net change in cash............................................  (19,263)    (13,282)     18,296
Cash and cash equivalent, beginning of year...................   29,230      42,512      24,216
                                                                -------     -------     -------
Cash and cash equivalent, end of year.........................    9,967      29,230      42,512
                                                                =======     =======     =======
</TABLE>

                                       45
<PAGE>   46

                                 EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT NO.   DESCRIPTION OF EXHIBIT
-----------   ----------------------
<S>           <C>
         3.1(a)* Restated Declaration of Trust of the Company as filed with the
              Secretary of State of Washington on June 11, 1990 together with an
              Amendment to Declaration of Trust dated December 12, 1991.
           (b)* Amendments to Declaration of Trust dated July 8, 1993; August 17, 1993;
              and September 9, 1993.
         3.2* Trustees' Regulations dated September 24, 1973.
         4.1  Shareholder Rights Plan. Incorporated by reference from Form 8-A dated
              August 17, 1993.
         4.2  Trust Indenture for Convertible Subordinated Debentures between Mercer
              International Inc. and Montreal Trust Company of Canada dated as of
              September 10, 1992. Incorporated by reference from Form 8-K of Mercer
              International Inc. dated October 31, 1992.
         4.3* Trust Indenture for Subordinated Debentures between Mercer
              International Inc. and Montreal Trust Company of Canada as Trustee
              dated as of December 22, 1992.
        10.1  Acquisition Agreement among Treuhandanstalt, Dresden Papier AG, Dresden
              Papier Holding GmbH, Mercer International Inc., and Shin Ho Paper Mfg.
              Co., Ltd. Incorporated by reference from Form 8-K dated September 20,
              1993.
        10.2  Acquisition Agreement among Treuhandanstalt, Zellstoff- und Papierfabrik
              Rosenthal GmbH, Raboisen Einhundertsechsundfunfzigste Vermogens-
              verwaltungsgesellschaft GmbH, to be renamed ZPR Zellstoff- und
              Papierfabrik Rosenthal Holding GmbH, Mercer International Inc. and
              448380 B.C. Ltd. dated July 3, 1994. Incorporated by reference from
              Form 8-K dated July 3, 1994.
        10.3* Assignment Agreement between Nalcap Holdings Inc. and CanCapital
              Corporation dated as of January 1, 1992.
        10.4* Amended and Restated 1992 Stock Option Plan.
        10.5* 1994 Employee Incentive Bonus Plan.
        10.6  Stock Purchase Agreement between CVD Financial Corporation and Mercer
              International Inc. dated March 22, 1995. Incorporated by reference from
              Item 7, Amendment No. 5 to Schedule 13D filed by Mercer International
              Inc. with respect to the common shares of CVD Financial Corporation.
        10.7  Acquisition Agreement between Mercer International Inc. and Five
              Continents International dated for reference March 31, 1995.
              Incorporated by reference from Form 8-K dated August 12, 1995.
        10.8* Form of Separation Agreement between Mercer International Inc. and
              Arbatax International Inc.
        21.   List of Subsidiaries of Registrant.
        23.   Consent of Independent Auditors.
        27.   Article 5 - Financial Data Schedule for the Year Ended
              December 31, 1996.
---------------
         *    Filed in Form 10-K for prior years.
</TABLE>

                                       46