<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, 1997, 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 or organization
</TABLE>

                   BURGLISTRASSE 6, 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 27, 1998 was approximately
$147,856,040. The last reported sale price of the common shares of beneficial
interest on the NASDAQ Stock Market's National Market on March 27, 1998 was
$9.75 per share.

     As of March 27, 1998, the Registrant had 15,178,722 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, 1998 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....................................................    4
          The Company.................................................    4
          Products....................................................    5
          Sales, Marketing and Distribution...........................    5
          Fibre.......................................................    7
          Capital Expenditures and Government Financing...............    7
          Pulp Mill Conversion Project................................    9
          Environmental...............................................   10
          Human Resources.............................................   10
          Acquisitions................................................   11
Item 2.   PROPERTIES..................................................   12
Item 3.   LEGAL PROCEEDINGS...........................................   12
Item 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.........   12
                                  PART II
Item 5.   MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
            STOCKHOLDER MATTERS.......................................   13
Item 6.   SELECTED FINANCIAL DATA.....................................   14
Item 7.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
            CONDITION AND RESULTS OF OPERATION........................   14
          Results of Operations.......................................   15
            Year Ended December 31, 1997 Compared to the Year Ended
               December 31, 1996......................................   15
            Year Ended December 31, 1996 Compared to the Year Ended
               December 31, 1995......................................   16
          Liquidity and Capital Resources.............................   18
            Operating Activities......................................   18
            Investing Activities......................................   18
            Financing Activities......................................   19
          Foreign Currency............................................   20
          Cyclical Nature of Business; Competitive Position...........   20
          Year 2000...................................................   21
          European Economic and Monetary Union........................   21
          Conversion Project Uncertainties............................   21
          Inflation...................................................   22
Item 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.................   22
Item 9.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
            ACCOUNTING AND FINANCIAL DISCLOSURE.......................   22
                                  PART III
Item 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT..........   22
Item 11.  EXECUTIVE COMPENSATION......................................   22
Item 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
            MANAGEMENT................................................   22
Item 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..............   22
                                  PART IV
Item 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
            ON FORM 8-K...............................................   23
          Financial Statements........................................   25
          Supplementary Financial Information.........................   42
          SIGNATURES..................................................   43
</TABLE>

                                        2
<PAGE>   3

FORWARD-LOOKING STATEMENTS

Statements in this report, to the extent they are not based on historical
events, constitute forward-looking statements. Forward-looking statements
include, without limitation, statements regarding the outlook for future
operations, forecasts of future costs and expenditures, evaluation of market
conditions, the outcome of legal proceedings, the adequacy of reserves, or other
business plans. Investors are cautioned that forward-looking statements are
subject to an inherent risk that actual results may vary materially from those
described herein. Factors that may result in such variance, in addition to those
accompanying the forward-looking statements, include changes in general economic
and business conditions, cyclical changes in supply and demand for pulp and
paper products, governmental regulations, the ability of management to execute
its business plan, product prices, interest rates, and other economic
conditions; actions by competitors; changing weather conditions and other
natural phenomena; actions by government authorities; uncertainties associated
with legal proceedings; technological development; future decisions by
management in response to changing conditions; and misjudgments in the course of
preparing forward-looking statements.

                                        3
<PAGE>   4

                                     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 operations are
conducted through Spezialpapierfabrik Blankenstein GmbH, formerly called
"Zellstoff-und Papierfabrik Rosenthal GmbH", and its affiliates ("SPB") and its
paper operations are conducted through Dresden Papier AG ("DPAG"), all of which
are wholly-owned subsidiaries of Mercer. The Company previously also operated in
the financial services segment until June 1996, when it completed the spin-off
of its financial services business to its shareholders by way of a special
dividend.

     The Company currently employs 856 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. The Company is proceeding with its plan to convert
the Pulp mill to produce kraft (sulphate) pulp, which is expected to be
completed at or about the end of 1999. See "Business -- Pulp Mill Conversion
Project".

     During the last four and a half years, the Company has implemented
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 $104.1 million on capital investments at
the Company's mills, of which $29.7 million was financed through non-refundable
government grants.

     The Company is now embarking on a strategy of focusing on its core
operations and monetizing its assets that either are not part of such core
operations or do not provide the desired level of return. In accordance with
this strategy, the Company has taken a special charge of $48.5 million in the
fourth quarter of 1997. This charge relates to the limited service life of
various assets due to the conversion of the Pulp mill to produce kraft pulp,
severance and related costs, the write-down of specific capital assets to their
estimated realizable value and a decrease in the deferred income tax asset. The
restructuring will enable the Company to concentrate its management and
financial resources on its core pulp and paper operations and pursue new
opportunities in same or related industries.

     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 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.

                                        4
<PAGE>   5

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 and
                                                                     writing.
</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
byproduct of pulp production, is also sold by the Company to industrial
producers and used in making paints, lacquers, films and printing colours. The
Company is proceeding with its plan to convert the Pulp mill from the production
of sulphite pulp to kraft 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
1997, paper sales conducted through agents were approximately 34% of total paper
sales, compared to approximately 35% in 1996 and 30% in 1995. 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, 1997, there were no
material payment delinquencies. The Company's products are delivered to market
by truck, rail and ship.

                                        5
<PAGE>   6

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

<TABLE>
<CAPTION>
                                                                 YEARS ENDED DECEMBER 31,
                                                             --------------------------------
                                                               1997        1996      1995(1)
                                                             --------    --------    --------
                                                                         (TONNES)
<S>                                                          <C>         <C>         <C>
SALES BY VOLUME
Packaging Papers.........................................     110,428     110,179     121,145
Specialty Papers.........................................      36,991      26,548      29,813
Printing Papers..........................................      54,538      46,416      47,089
Pulp.....................................................     160,432     133,005     126,562
                                                             --------    --------    --------
Total(2).................................................     362,389     316,148     324,609
                                                             ========    ========    ========
                                                                      (IN THOUSANDS)
SALES BY PRODUCT CLASS
Packaging Papers.........................................    $ 29,313    $ 33,165    $ 66,776
Specialty Papers.........................................      29,244      27,012      34,370
Printing Papers..........................................      35,915      36,469      50,960
Pulp.....................................................      75,460      72,456     115,934
Other....................................................       5,405       4,995       7,292
                                                             --------    --------    --------
Total....................................................    $175,337    $174,097    $275,332
                                                             ========    ========    ========
SALES BY GEOGRAPHIC AREA
Germany..................................................    $ 97,525    $101,351    $171,876
European Union(3)........................................      59,794      48,795      72,485
Other....................................................      18,018      23,951      30,971
                                                             --------    --------    --------
Total....................................................    $175,337    $174,097    $275,332
                                                             ========    ========    ========
</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.

(2) Excluding intercompany sales of 4,257, 3,609 and 3,545 tonnes of pulp in
    1997, 1996 and 1995, respectively.

(3) 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, 1997          December 31, 1996             December 31, 1995
------------------------    ------------------------     -------------------------
<S>                         <C>                          <C>
Germany            55.6%    Germany             58.2%    Germany             62.4%
European Union(1)  34.1%    European Union(1)   28.0%    European Union(1)   26.3%
Other              10.3%    Other               13.8%    Other               11.3%

</TABLE>

---------
(1) Not including Germany.

     In 1997 and 1996, 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.

                                        6
<PAGE>   7

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 1997, the Paper mills consumed approximately 172,800
tonnes of waste paper. Prices for fibre were relatively low in 1997 as a result
of excess world pulp inventories and the weak Asian markets. Low market prices
for fibre in 1997 were generally reflected in lower prices for 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 1997, the Pulp mill
consumed approximately 784,805 cubic metres of fibre comprised of approximately
594,394 cubic metres of wood chips and 190,411 cubic metres of pulpwood.

     The cost of fibre for pulp producers in Europe remained relatively low
throughout 1997 due to excess world pulp inventories and a build-up in pulpwood
supply. However, there can be no assurance that fibre costs will not escalate in
the future. During the second half of 1997, there were signs of upward price
pressure for pulpwood in Europe. As a result, fibre costs at the end of 1997
were approximately 20% higher than at the lowest point during the first half. In
1997, the Company reduced its average fibre cost per tonne of pulp produced by
6.8%, compared to 1996. Overall, in 1997, reduced fibre prices were reflected in
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 1997, 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 current terms of such
grants, state governments will provide funding up to 35% of the cost of
qualified investments. Additional non-refundable grants, equal to 5% of
qualified investments, are available from the federal government to the extent
that the qualified investments did not receive maximum state government funding.
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
Bundesanstalt fur Vereinigungsbedingte Sonderaufgaben ("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.

                                        7
<PAGE>   8

     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. In addition, subsidized interest rate loans are
also available from public financial institutions in Germany, which provide
loans at below market interest rates for qualified investments. In 1997, the
Company applied for an 80% state government guarantee on a loan of approximately
$325 million and a subsidized interest rate loan to finance the kraft pulp
conversion project. Although there can be no assurance that the Company will
receive such guarantee and subsidization, government officials have indicated
their support and the Company currently anticipates receiving final approval
around mid-1998. See "Business -- Pulp Mill Conversion Project".

     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, 1997, the aggregate wastewater fees saved by the Company over the
last five years as a result of environmental capital expenditures were $14.3
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       1997       1996       1995      1994(2)          1993(1)
                          --------    -------    -------    -------    -------      ----------------
                                                        (IN THOUSANDS)
<S>                       <C>         <C>        <C>        <C>        <C>          <C>
Capital Expenditures....  $104,110(3) $14,791    $23,865    $18,968    $25,145          $21,341
                          ========    =======    =======    =======    =======          =======
Non-refundable grants...  $ 29,675    $ 1,723    $ 5,328    $ 7,291    $12,882          $ 2,451
                          ========    =======    =======    =======    =======          =======
</TABLE>

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

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

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

(3) To December 31, 1997, capital expenditures have offset $14.3 million in
    wastewater fees.

     In 1997, the Company substantially completed its four year capital
investment program initiated in 1993 to modernize and upgrade the Paper mills
and spent in total $63.2 million thereon. Expenditures under this program in
1997 totalled approximately $5.3 million. Capital investments in 1997 included
the construction of a wastewater treatment plant at the Greiz paper mill which
has been in operation since June 1997 and has significantly reduced effluent
discharges from the production of testliner and corrugated base paper and
related wastewater fees. The Company also completed the construction of a
high-consistency bleaching tower and middle-consistency dilution system, which
are expected to significantly reduce production costs at the Hainsberg paper
mill as high quality waste paper will be substituted with lower quality de-inked
paper in producing recycled graphical paper. In addition, the Company replaced
the turbine at the power plant situated at the Heidenau paper mill. As the
capital investment program has been 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
$3.8 million in 1998.

     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, 1997, approximately $37.3 million had been expended on
this program. Expenditures under this program in 1997 totalled $3.5 million, of
which $1.7 million was funded by non-refundable grants. Capital investments in
1997 were substantially directed at the completion of ongoing projects. The
balance of this investment program has been modified as a result of the
Company's plan to convert the Pulp mill to produce kraft pulp. In connection
with the conversion project, the Company, in 1997, incurred expenses of $5.9
million, relating to engineering, environmental impact and other technical and
feasibility studies. The Company anticipates that capital investments at its
Pulp mill, excluding those incurred in connection with the kraft pulp conversion
project, will total approximately $1.7 million in 1998.

                                        8
<PAGE>   9

PULP MILL CONVERSION PROJECT

     The Company is proceeding with its plan 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. The increase in annual pulp production capacity is expected to
substantially increase the Company's annual revenues.

     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, subsidized interest rate loans and cash flow from
operations. Babcock and Brown of London, England, are the financial advisors to
the Company on this project.

     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 has provided the Company with project and permitting
approval for the conversion of its Pulp mill. In addition, the State Government
of Thuringia pledged grants and subsidies in support of the project and provided
commitments for the additional fibre required by the mill after conversion,
provided, however, that the Company complies with certain conditions such as
guaranteeing the employment of at least 480 full-time employees and 24
apprentices for a period of five years after conversion. These grants and
subsidies will be made available to the Company as follows: (i) a fixed grant of
approximately $30.5 million; and (ii) a grant of up to an aggregate of
approximately $62.6 million which will be disbursed in accordance with the total
capital spent on the project. Two Bavarian banks have agreed to provide
long-term project financing to the Company up to an aggregate maximum amount of
$325 million, subject to the Company obtaining governmental guarantees for 80%
of such maximum loan amount. The Company's application for governmental
guarantees is under review and the Company currently anticipates receiving final
approval around mid-1998.

     As a result of the Pulp mill conversion project and to facilitate
financing, the Company has restructured SPB and has created a German limited
partnership to conduct the Pulp mill operations.

     In 1997, the Company completed its engineering, environmental impact and
other technical and feasibility studies and has now received formal project and
permitting approval. The Company's costs in respect of the project in 1997 were
$5.9 million and estimates that, subject to receipt of all necessary financings,
permits and consents in the anticipated time frame, capital expenditures in 1998
will be approximately $100 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 a maximum of three months
downtime prior to the switch over from sulphite to sulphate pulp production. The
Finnish engineering firm Jaakko Poyry OY has been appointed as the project
engineer for the conversion project. The fibre requirements for the converted
mill will continue to be met by the Company's existing sources.

     As a consequence of the conversion project, certain equipment at the Pulp
mill will have a limited service life because either it is no longer useful or
will require substantial modification. Accordingly, in 1997, the Company has
taken a special charge of $26.4 million in respect of such equipment. The
special charge is equal to the excess of the carrying value of the equipment
over its estimated fair value.

     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, there can be no assurance that current governmental
assistance programs will not be amended in the future or that financial
assistance will be
                                        9
<PAGE>   10

provided to the Company on terms satisfactory to it, if at all, or that all
necessary environmental permits will be received on satisfactory terms upon
completion, 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 comply with all applicable
environmental laws and regulations. The Company's total capital expenditures on
environmental projects, excluding those incurred in connection with the kraft
pulp conversion project, were approximately $5.4 million in 1997 and are
expected to be approximately $0.7 million in 1998.

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

     A new wastewater treatment plant at the Greiz paper mill was completed in
1997 and is in operation. The Hainsberg paper mill is currently using the
municipal wastewater treatment plant, but due to increased user charges, the
Company is planning to build its own biological wastewater treatment plant in
1998. The Company, in co-operation with the municipality of Heidenau was
considering building a community wastewater treatment plant on land owned by the
Company, which would have provided the Heidenau paper mill with the services of
a new treatment facility. At this time, however, the Company is reviewing the
cost effectiveness of such a joint venture and is exploring the possibility of
independently building its own wastewater treatment plant.

     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. The Company has reduced its levels of AOX (Adsorbable Organic
Halogen) discharge to 0.6 kilograms per tonne, in order to comply with
prescribed effluent discharge levels. The date by which the Pulp mill had to
further reduce its levels of AOX discharge to 0.4 kilograms per tonne has been
deferred from January 1, 1998 to January 1, 1999. In addition, the Company's
requirement to reduce its levels of COD (Chemical Oxygen Demand) discharge at
the Pulp mill to 50 kilograms per tonne has been postponed from July 1, 1997 to
January 1, 1999. The Company will continue to modify its wastewater and
bleaching facilities at the Pulp mill to meet or exceed these prescribed
regulations, which will be further enhanced as a result of the kraft pulp
conversion project. In 1997, the Company's effluent discharges of heavy metal
occasionally exceeded the applicable limits under prescribed regulations by
approximately a microgram per litre and the Company paid penalties aggregating
approximately $200,000 in respect thereof.

     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
manufacturing plants against wastewater fees for the period of 1993 to 1997,
which totalled approximately $14.3 million. The Company expects that its capital
investment programs for its manufacturing plants will offset the full amount of
wastewater fees that may be payable in 1998 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 856 employees, of which 471 are
engaged in paper operations and 385 in pulp operations. Since the end of 1996,
there were no further contractual obligations of the Company to BVS to maintain
prescribed employment levels at its paper operations.
                                       10
<PAGE>   11

     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 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.

     Effective January 1, 1998, the standard work week for employees in the pulp
and paper industry in eastern Germany is reduced by one hour to 39 hours per
week.

     In the first half of 1997, the Company independently granted its paper
workers a 3% wage increase. Subsequently, the Company entered into a new labour
agreement with its paper workers which required the Company to maintain its
existing employment levels until the end of 1997 and provided for further wage
increases of 3% in September 1997 and 2.5% in December 1997. The labour
agreement was renewed on March 3, 1998 and provides for wage increases of 1.2%
in October 1998, 1.3% in July 1999 and 1.3% in December 1999.

     Effective July 1, 1997, the Company entered into a new five year labour
agreement with its pulp workers which provides for, among other things, wage
increases of 1.5% in September 1997, 2.0% in January 1998, 1.5% in August 1998,
and 2.5% in January 1999 and 2000; a profit sharing plan; and the Company to
maintain its existing employment levels for a period of three years. The labour
agreement establishes a wage rate that will be approximately 90% of the union
wage rate in the year 2000 for pulp workers in western Germany and will be at
par with such rate by the year 2002. The Company's labour agreement provides for
smaller wage increases and slower reduction of the work week than most other
labour agreements in eastern Germany.

ACQUISITIONS

     The Company initially acquired its interest in its paper operations from
BVS effective July 1, 1993. Under the terms of acquisition, BVS: (i) forgave
indebtedness owed by DPAG which was contributed to the capital of DPAG; (ii)
paid non-refundable privatization supplements to DPAG; (iii) compensated DPAG
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 certain maximum amount. In connection
with the acquisition, DPAG undertook, among other things: (i) to make
approximately $57.9 million in capital investments during the period ending
December 31, 1996; (ii) to maintain certain average annual employment levels
until December 31, 1996; and (iii) not to make distributions to its owners prior
to December 31, 1996.

     The Company initially acquired its 70% interest in its pulp operations from
BVS effective July 1, 1994. Under the terms of acquisition, BVS: (i) paid SPB
for the cost of replacing a certain capital asset; (ii) agreed to compensate SPB
for certain employee termination costs; (iii) agreed to indemnify SPB for 90% of
the remediation costs for environmental liabilities of up to a certain maximum
amount; (iv) forgave indebtedness owed by SPB; and (v) agreed to reimburse SPB
for certain interests, fees and charges relating to its bank credit facilities
in 1994. In connection with the acquisition, SPB undertook, among other things,
to make approximately $48.4 million in capital investments during the period
ending December 31, 1998 and to maintain certain average annual employment
levels until December 31, 1998. SPB is restricted from making distributions to
its owners prior to January 1, 1999, however, the Company may expand or invest
through SPB.

     Effective April 1, 1995, the Company acquired the remaining 30% minority
interest and related assets in its pulp and paper operations held by the Shin Ho
Group, a Korean industrial and paper manufacturer.

     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, under German tax laws then in effect, could be carried forward
indefinitely to offset future taxable income. However, the German government has
amended its tax laws to restrict the use of tax losses to offset future taxable
income in taxation years completed after

                                       11
<PAGE>   12

1996. As a result of these amendments, SPB has revised its prior income tax
filings to maximize the benefits under the loss carryforward provisions in
effect in those years.

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.

     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. All of the Paper mills operate their own power plants to produce
electricity.

     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. 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. The Company intends to
divest the Greiz and the Trebsen mills in 1998.

     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 conversion of the Pulp mill to produce kraft pulp is
expected to increase its annual production capacity to 280,000 tonnes.

     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)        1997       1996       1995
-------------                                  -----------------    -------    -------    -------
                                                                    (TONNES)
<S>                                            <C>                  <C>        <C>        <C>
Packaging Papers...........................         120,000(2)      111,002    110,304    138,591
Specialty Papers...........................          40,000          35,654     26,179     34,069
Printing Papers............................          60,000          54,224     45,568     50,245
Pulp.......................................         160,000         157,844    134,950    139,409
                                                    -------         -------    -------    -------
Total......................................         380,000         358,724    317,001    362,314
                                                    =======         =======    =======    =======
</TABLE>

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

(1) Capacity is stated upon the rated capacity of the plants as at December 31,
    1997, 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 corrugated box plant at Heidenau and the
    Raschau paper mill. These plants had a combined annual production capacity
    of 20,000 tonnes.

     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.

                                       12
<PAGE>   13

                                    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,
    1996 and 1997, and for the period ended March 27, 1998:

<TABLE>
<CAPTION>
    FISCAL QUARTER ENDED                                             HIGH      LOW
    --------------------                                            ------    ------
    <S>                                                             <C>       <C>
    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
    March 31....................................................    $12.63    $ 8.63
    June 30.....................................................    $11.75    $ 7.88
    September 30................................................    $11.56    $ 8.13
    December 31.................................................    $13.00    $ 7.94

    1998
    Period ended March 27.......................................    $10.63    $ 8.00
</TABLE>

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

(1) Stock dividend paid.

(b) Shareholder Information.  As of March 27, 1998, there were approximately 794
    holders of record of the Company's shares and a total of 15,178,722 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 MFC Bancorp Ltd., formerly "Arbatax International Inc.". 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
    in the amount of $0.03 per share was paid on May 9, 1997 to shareholders of
    record as of April 30, 1997. In March 1998, the Company announced a cash
    dividend payment of $0.04 per share to shareholders of record as of April
    30, 1998. 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.

                                       13
<PAGE>   14

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, 1997. 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, have been classified separately within the Company's financial
statements as "spun-off operations" and are excluded from the amounts of
revenues, expenses, assets and liabilities of the Company's continuing
operations. The following financial information has been reclassified to conform
with the current year's presentation.

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

<TABLE>
<CAPTION>
                                                  YEARS ENDED DECEMBER 31,
                               ---------------------------------------------------------------
                                 1997         1996            1995         1994         1993
                               --------     --------        --------     --------     --------
                                        (IN THOUSANDS, OTHER THAN PER SHARE AMOUNTS)
<S>                            <C>          <C>             <C>          <C>          <C>
Revenues(1)                    $184,107     $186,729        $300,737     $197,359     $ 66,260
Net income (loss) from
  continuing operations......  $(32,623)(2) $ 15,557        $ 65,637     $ 41,499     $ 18,663
Net income (loss) from
  continuing operations, per
  common share,
     Basic...................  $  (2.18)(2) $   1.12        $   5.24     $   3.74     $   1.82
     Diluted.................  $  (2.18)(2) $   1.12        $   5.13     $   3.67     $   1.72
Weighted average common
  shares outstanding,
     Basic...................    14,995       13,829          12,526       11,110       10,276
     Diluted.................    14,995       13,957          12,787       11,323       10,894
Current assets...............  $100,384     $132,651        $140,618     $111,374     $ 71,460
Current liabilities..........  $ 57,753     $ 71,129        $ 73,977     $ 87,679     $ 70,726
Working capital..............  $ 42,631     $ 61,522        $ 66,641     $ 23,695     $    734
Total assets.................  $210,294     $296,980(1)     $369,953(4)  $317,145(4)  $211,133(4)
Long-term liabilities........  $ 17,066     $ 31,312        $ 68,961     $ 93,252     $ 63,262
Shareholders' equity.........  $135,475     $194,539(1)(3)  $227,015(4)  $111,540(4)  $ 77,120(4)
Cash dividends...............  $    450     $  --           $  --        $  --        $  --
</TABLE>

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

(1) Excludes spun-off operations.

(2) Net income from continuing operations before the special charge was $15.8
    million, or $1.06 per share.

(3) After stock dividend.

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

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, 1997
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.

                                       14
<PAGE>   15

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,
                                                             --------------------------------
                                                               1997        1996      1995(1)
                                                             --------    --------    --------
                                                                      (IN THOUSANDS)
<S>                                                          <C>         <C>         <C>
SALES BY PRODUCT CLASS
Packaging Papers.........................................    $ 29,313    $ 33,165    $ 66,776
Specialty Papers.........................................      29,244      27,012      34,370
Printing Papers..........................................      35,915      36,469      50,960
Pulp.....................................................      75,460      72,456     115,934
Other....................................................       5,405       4,995       7,292
                                                             --------    --------    --------
Total....................................................    $175,337    $174,097    $275,332
                                                             ========    ========    ========
                                                                         (TONNES)
SALES BY VOLUME
Packaging Papers.........................................     110,428     110,179     121,145
Specialty Papers.........................................      36,991      26,548      29,813
Printing Papers..........................................      54,538      46,416      47,089
Pulp.....................................................     160,432     133,005     126,562
                                                             --------    --------    --------
Total(2).................................................     362,389     316,148     324,609
                                                             ========    ========    ========
</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.

(2) Excluding intercompany sales of 4,257, 3,609 and 3,545 tonnes of pulp in
    1997, 1996 and 1995, respectively.

YEAR ENDED DECEMBER 31, 1997 COMPARED TO THE YEAR ENDED DECEMBER 31, 1996

     In 1997, revenues decreased marginally to $184.1 million from $186.7
million in 1996, as a result of reduced investment revenues. Despite a volume
sales increase resulting from stronger demand for pulp and paper products, sale
revenues only increased marginally. As the Company's products are principally
sold in deutschmarks, the approximate 14.9% depreciation of the deutschmark
against the U.S. dollar in 1997 compared to 1996 also contributed to lower
revenues. See "Foreign Currency".

     Costs and expenses before the special charge decreased to $168.2 million in
1997 compared to $174.3 million in 1996, primarily as a result of lower
manufacturing costs and decreased fibre costs (raw materials). General and
administration expenses decreased to $23.6 million in 1997 from $24.9 million in
1996. Interest expense decreased to $3.0 million from $4.0 million in 1996 as a
result of lower interest rates and reduced bank debt.

     In 1997, net income from continuing operations before the special charge
was $15.8 million or $1.06 per share, compared to $15.6 million or $1.12 per
share in 1996.

     In 1997, after a special charge of $48.5 million, the Company reported a
loss of $32.6 million or $2.18 per share. The $48.5 million special charge in
1997 included $2.2 million related to restructuring costs, $41.3 million for the
write-down of specific capital assets to their estimated realizable value and
$5.0 million for a decrease in the deferred income tax asset. The organizational
restructuring provision was related to expected employee severance in 1998
required to effect longer term reductions in operating and administration
expenses. The asset write-downs related to the near term replacement at the
Company's Pulp mill of various capital assets which were deemed to be overvalued
in view of their limited remaining service life due to the conversion of the
Pulp mill to produce kraft pulp which totalled $26.4 million, and the Greiz,
Trebsen and Raschau paper mills which are no longer viewed as core assets to the
Company's operations.

                                       15
<PAGE>   16

     Costs and expenses increased to $216.7 million in 1997 compared to $174.3
million in 1996, primarily as a result of the special charge. Net loss from
continuing operations was $32.6 million or $2.18 per share in 1997, compared to
net earnings of $15.6 million or $1.12 per share in 1996.

     In 1997, the Company's sales revenues showed a marginal improvement over
those in 1996, primarily as a result of improved demand for paper pulp and paper
products and lower manufacturing costs. However, the Company's sales prices for
all pulp and paper products were lower in 1997 compared to 1996, as a result of
the devaluation of the deutschmark compared to the U.S. dollar. The demand for
paper products in Europe increased significantly in 1997 compared to 1996,
particularly in the second half of the year. Although the demand for pulp was
strong throughout most of the year, list prices for pulp in 1997 were, on
average, approximately 13.7% lower than in 1996, primarily as a result of high
world pulp inventories and the weak Asian markets. Sulphite pulp prices were
also negatively impacted by competition among sulphite pulp producers and the
price policy implemented by a large eastern European producer to solidify its
market position. The Company's pulp sales increased by 4.1% to $75.5 million in
1997 from $72.5 million in 1996 on a volume increase of 20.6% and an average
price decrease of 13.7%. The demand for dissolving sulphite pulp decreased
significantly in 1997 and only accounted for 16% of the Company's total pulp
production, compared to 27% in 1996. The overall effect of weaker dissolving
sulphite pulp demand was offset by the Company's increased production and sales
of paper grade pulp.

     Paper sales in 1997 decreased by 2.2% to $94.5 million from $96.6 million
in 1996 on a volume increase of 10.3% and an average price decrease of 11.4%.
The average price for all classes of paper declined during 1997. Sales volume
for packaging, specialty and printing papers increased in 1997 by 0.2%, 39.3%
and 17.5%, respectively, compared to 1996. A shortage in light weight coated
paper inventories resulted in stronger demand for paper products in 1997.

     Low pulp and paper prices in 1997 were 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.
Relatively strong pulp and paper markets resulted in manufacturing facilities
operating at or near full production capacity. Recycled fibre costs decreased
dramatically in 1997 and were down approximately 30.7% compared to 1996.
However, there can be no assurance that recycled fibre costs will not escalate
in the future. The price of wood for pulp production also decreased in 1997,
primarily due to a build-up of wood inventories. Towards the end of 1997, the
price of pulpwood began to experience upward pressure in Europe. On average, the
Company's fibre costs for pulp production were down approximately 6.8% in 1997,
compared to 1996 and remained among the lowest in Europe. Decreased fibre costs
in 1997 were generally reflected in lower product prices.

     At the end of 1997, pulp prices decreased as a result of the weak Asian
markets. Although the demand for pulp remains relatively strong, there can be no
assurance that the pulp markets will remain favourable as excess inventories
coming from Asian markets continue to put pressure on pulp prices.

     Paper prices increased slightly in the fourth quarter of 1997, primarily as
a result of an increased demand for all paper grades. Although this progressive
increase in paper prices is expected to continue during the first half of 1998,
there can be no assurance that they will remain favourable.

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 divestiture of the Company's corrugated box plant at
Heidenau and the Raschau 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.

                                       16
<PAGE>   17

     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 $42.2 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.

     In 1996, net earnings from continuing operations were $15.6 million or
$1.12 per share, compared to $65.6 million or $5.13 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 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
preacquisition 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 were
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.

     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
                                       17
<PAGE>   18

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.

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, 1997      DECEMBER 31, 1996
                                                            -----------------      -----------------
                                                          (IN THOUSANDS, OTHER THAN PER SHARE AMOUNTS)
<S>                                                         <C>                    <C>
FINANCIAL POSITION
Working capital...........................................      $ 42,631               $ 61,522
Property, plant and equipment (net).......................        87,806                142,257
Total assets(1)...........................................       210,294                296,980
Long-term government debt.................................         8,338                  9,184
Long-term debt -- other...................................         6,701                 19,426
CAPITAL SOURCES
Shareholders' equity......................................      $135,475               $194,539
Cash flow(1)..............................................         6,920                 14,622
Cash flow per share(1)(2).................................          0.46                   1.05
</TABLE>

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

(1) Cash flow provided by operations before changes on investment in trading
    securities.

(2) On a diluted basis.

     At December 31, 1997, the Company's cash and cash equivalents totalled $4.4
million, a net decrease of $5.6 million from $10.0 million at the end of 1996.
At December 31, 1997, the Company had short-term trading securities totalling
$56.3 million, compared to $81.9 million at December 31, 1996.

OPERATING ACTIVITIES

     Net cash provided by operating activities was $16.0 million in 1997,
compared to net cash of $6.4 million used in operations in 1996. A decrease in
investments and inventories accounted for the majority of cash provided by
operations. Net changes in trading securities provided cash of $9.1 million in
1997, compared to net changes in trading securities which used cash of $21.0
million in 1996. The Company expects to generate sufficient cash flow from
operations to meet its working capital requirements.

INVESTING ACTIVITIES

     Investing activities in 1997 used cash of approximately $17.0 million,
consisting primarily of capital expenditures for upgrades to the Company's
manufacturing plants, compared to $16.3 million in 1996. Property sales provided
proceeds of $3.0 million in 1997, compared to nil in 1996.

     The Company has undertaken significant capital investments to upgrade its
manufacturing plants including approximately $8.8 million in 1997, of which $1.7
million was funded by non-refundable government grants, and approximately $5.9
million was in connection with the conversion project. As a result of the
Company's plan 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 1998, excluding the kraft pulp
conversion project, to be approximately $5.5 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, 1997, the Company has a receivable of
non-refundable grants totalling $86,000. These non-refundable government grants
are not recorded in the income of the Company, but instead reduce the cost base
of the assets purchased by the proceeds thereof. Loan guarantees are also

                                       18
<PAGE>   19

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. In addition, subsidized interest rate
loans are also available from public financial institutions in Germany, which
provide loans at below market interest rates for qualified investments. The
Company has not used such state guarantees and subsidies to date, but has
applied for the same in connection with its conversion plan for the Pulp mill.
See "Business -- Capital Expenditures and Government Financing".

     The Company is proceeding with its plan 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 dioxide
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, governmental
assistance and guarantees for long-term project financing, subsidized interest
rate loans and cash flow from operations. The Company estimates that, subject to
receipt of all necessary financings, permits and consents in the anticipated
time frame, capital expenditures in respect of the conversion project in 1998
will be approximately $100 million. The conversion project is expected to
commence in 1998 and to be completed at or about the end of 1999.

     In conjunction with the aforesaid conversion of the Pulp mill to produce
kraft pulp, the Company is reviewing its product lines, including commodity
grade packaging papers, in order to streamline operations and focus on higher
margin grades, options for forward integration, capacity upgrades and the
modernization of its packaging paper mills. The Company's results for packaging
grade commodity papers have been generally weak in 1997 and performance has been
hindered by, among other things, limited demand as a result of soft economic
conditions in Europe, market over-supply and operational limitations resulting
from small capacities and the current trim width of the Company's packaging
paper machines. Such a review has resulted in the Company pursuing initiatives
with both BVS and the State Government of Saxony to enhance the performance of
such mills, and in the Company's decision to undergo strategic restructuring,
including the reduction of the number of its paper workers and the divestiture
of certain of its assets.

     The Company intends to divest itself of the Greiz and the Trebsen paper
mills and has entered into negotiations with respect to the Greiz mill. The
Company expects to reach an agreement for the sale of the Greiz mill in 1998.

     In July 1997, the Company purchased a $3.5 million senior secured
convertible debenture from Concert Industries Ltd. ("Concert"), a Canadian
manufacturer of air-laid, non-woven paper products. In addition, the Company
entered into an agreement with Concert, subject to conditions, to acquire a
controlling interest therein, which did not complete. In March 1998, the Company
and Concert entered into a debenture amendment agreement to extend the maturity
date of the debenture to September 28, 1998 in consideration of, among other
things, a lower conversion price and extension fees.

FINANCING ACTIVITIES

     Cash used in financing activities was $3.7 million in 1997, primarily as a
result of decreased bank indebtedness and the payment of dividends. Cash
provided by financing activities in 1996 was $5.8 million. The overall
depreciation of the deutschmark against the U.S. dollar in 1997 resulted in an
unrealized foreign exchange translation loss of $0.9 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".

     The Company's pulp and paper operations had net operating tax losses of
approximately $188.0 million at December 31, 1997, which under former German tax
laws could be carried forward indefinitely. However, the German government has
amended its tax laws to restrict the use of tax losses to offset future taxable
income in taxation years completed after 1996. As a result of these amendments,
SPB has revised its prior income tax filings to maximize the benefits under the
loss carryforward provisions in effect in those years and has decreased the
deferred income tax asset by $5.0 million.

                                       19
<PAGE>   20

     In 1997, the Company received, net of share repurchases, proceeds of $1.5
million from the issuance of shares. In 1996, net proceeds used to repurchase
shares were $0.8 million. The payment of dividends used cash of $0.5 million in
1997, compared to nil in 1996.

     The Company is currently in discussions with BVS with respect to certain
matters arising from the purchase agreement for the Company's paper operations,
including the reversal of accruals established at the time of acquisition by the
paper operation for effluent costs and potential reimbursement therefor to BVS.
The Company does not believe it is responsible for any such reimbursement
obligation under the purchase agreement but can give no assurance that BVS will
not seek to make a claim for the same. In the event that BVS were to proceed
with and successfully enforce such a claim before the courts, the same could
have an adverse effect on the Company's paper operations.

     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, 1997. 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. During 1997, the overall
depreciation of the deutschmark against the U.S. dollar resulted in a net $29.4
million foreign exchange translation loss and as a result the cumulative foreign
exchange translation loss was increased from $12.0 million at December 31, 1996
to $41.4 million at December 31, 1997.

     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,
                             ----------------------------   -----------------------------------------------------------
                                         1998                           1997                           1996
                             ----------------------------   ----------------------------   ----------------------------
                                           PERIOD AVERAGE
                              MARCH 27,     TO MARCH 27,    PERIOD END    PERIOD AVERAGE   PERIOD END    PERIOD AVERAGE
                             -----------   --------------   -----------   --------------   -----------   --------------
<S>                          <C>           <C>              <C>           <C>              <C>           <C>
RATES OF EXCHANGE
Deutschmark................      1.8263          1.8234         1.7990          1.7321         1.5389          1.5075
</TABLE>

     Based upon the period average exchange rate in 1997, the U.S. dollar
increased by approximately 12.6% in value against the deutschmark since December
31, 1996.

CYCLICAL NATURE OF BUSINESS; COMPETITIVE POSITION

     The pulp and paper business is cyclical in nature and markets for the
Company's principal products are characterized by periods of supply and demand
imbalance, which in turn affects product prices. The markets for pulp and paper
are highly competitive and sensitive to cyclical changes in the industry
capacity and in the

                                       20
<PAGE>   21

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. In 1998, the federal government of Germany is expected to
implement legislative changes, including a 1% increase in the value-added tax
rate to 16% effective April 1998 and the dismantlement of the monopolistic
structures of the energy markets in Germany to open such markets to foreign
suppliers of gas and electricity. The latter change should result in lower
prices for the supply of gas and electricity from which the Company expects to
benefit by July 1998.

YEAR 2000

     Many of the world's computer systems currently record years in a two-digit
format. These computer systems will be unable to properly interpret dates beyond
the year 1999, which could lead to business disruptions and is commonly referred
to as the "Year 2000 issue". The Company is conducting a comprehensive review of
all significant applications that may require modification to ensure Year 2000
compliance. The Company is utilizing both internal and external resources to
make any required modifications and to test for Year 2000 compliance. The
modification and testing process of all significant applications is expected to
be completed in 1999. In addition, the Company has initiated communications with
its significant suppliers and largest customers to ascertain their Year 2000
readiness and develop contingency plans as required.

     Based upon its current information, management of the Company has
determined that the Year 2000 issue will not pose significant operational
problems for its computers. The total cost to the Company of Year 2000
compliance activities has not been and is not currently anticipated to be
material to its financial position or results of operations in any given year.
The costs and the dates on which the Company plans to complete Year 2000
modification and testing are based on management's best estimates, which were
derived utilizing numerous assumptions of future events. However, there can be
no assurance that these estimates will be achieved and actual results could
differ materially from those anticipated.

EUROPEAN ECONOMIC AND MONETARY UNION

     Effective January 1, 1999, the currencies of the majority of the member
countries of the European Economic and Monetary Union ("EMU") will cease to
exist and will be replaced by a new currency, the "euro". The Company has begun
coordinating the preparations for the euro. These preparations include
modifications of the Company's computer systems and programs for the upcoming
EMU and coordination with customers, suppliers and financial institutions to
ensure a smooth transition to the new currency. The Company expects to be able
to transact business in the euro beginning on January 1, 1999. Costs associated
with the modifications necessary to prepare for the EMU are being expensed by
the Company during the period in which they are incurred. Although the Company's
products are principally sold in deutschmarks, the Company does not anticipate
that the conversion rate for the deutschmark into euro, to be fixed on January
1, 1999, will significantly impact on the Company's results of operations.
However, there can be no assurance that the potential increased competition on
the German market, which is the primary market for the Company's pulp and paper
products resulting from the introduction of the euro will not have an adverse
effect on the Company's results of operations.

CONVERSION PROJECT UNCERTAINTIES

     The Company is subject to various uncertainties in connection with the Pulp
mill conversion project, which may cause fluctuations in operating results such
as availability and cost of materials and labour, construction delays, cost
overruns, weather conditions, government regulations, availability of adequate
financing, increases in long-term interest rates and increases in taxes and
other governmental fees. The conversion project is also subject to extensive and
complex regulations and environmental compliance which may result in additional
delays or the Company incurring substantial costs in relation thereto. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operation".

                                       21
<PAGE>   22

INFLATION

     The Company does not believe that inflation has had a material impact on
revenues or income during 1997.

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 25.

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

     Not applicable.

                                    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 40, 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 50, 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 63, 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 34, has been Chief Financial Officer and a Trustee since
December 1996, a Managing Director of SPB 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 62, has been a Managing Director of SPB 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.

                                       22
<PAGE>   23

                                    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>
    <C>       <S>
     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.
    10.4*     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.
</TABLE>

                                       23
<PAGE>   24
<TABLE>
    <C>       <S>
    21.       List of Subsidiaries of Registrant.
    23.       Independent Auditors Consent.
    27.       Article 5 -- Financial Data Schedule for the Year Ended
              December 31, 1997.
</TABLE>

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

* Filed in Form 10-K for prior years.

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

                                       24
<PAGE>   25

Peterson Sullivan letterhead

                          INDEPENDENT AUDITORS' REPORT

To the Shareholders
Mercer International Inc.

     We have audited the accompanying consolidated balance sheets of Mercer
International Inc. and Subsidiaries as of December 31, 1997 and 1996, and the
related consolidated statements of operations, changes in shareholders' equity,
and cash flows for the years ended December 31, 1997, 1996 and 1995. 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 financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Mercer
International Inc. and Subsidiaries as of December 31, 1997 and 1996, and the
consolidated results of their operations and their cash flows for the years
ended December 31, 1997, 1996 and 1995, in conformity with generally accepted
accounting principles.

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

March 16, 1998
Seattle, Washington

                                       25
<PAGE>   26

                           MERCER INTERNATIONAL INC.

                          CONSOLIDATED BALANCE SHEETS
                           DECEMBER 31, 1997 AND 1996
                           (IN THOUSANDS OF DOLLARS)

<TABLE>
<CAPTION>
                                                                  1997        1996
                                                                --------    --------
<S>                                                             <C>         <C>
ASSETS
Current Assets
  Cash and cash equivalents.................................    $  4,414    $  9,967
  Investments...............................................      56,285      81,863
  Receivables...............................................      22,329      18,366
  Inventories...............................................      15,799      20,668
  Other.....................................................       1,557       1,787
                                                                --------    --------
     Total current assets...................................     100,384     132,651
Long-Term Assets
  Properties................................................      87,806     142,257
  Investments...............................................       4,118       3,759
  Note receivable...........................................       7,000          --
  Deferred income tax assets................................      10,986      18,313
                                                                --------    --------
                                                                 109,910     164,329
                                                                --------    --------
                                                                $210,294    $296,980
                                                                ========    ========
LIABILITIES
Current Liabilities
  Accounts payable and accrued expenses.....................    $ 50,172    $ 62,465
  Notes payable.............................................       3,252       6,017
  Debt......................................................       4,329       2,647
                                                                --------    --------
     Total current liabilities..............................      57,753      71,129
Long-Term Liabilities
  Debt......................................................      15,039      28,610
  Other.....................................................       2,027       2,702
                                                                --------    --------
                                                                  17,066      31,312
                                                                --------    --------
     Total liabilities......................................      74,819     102,441

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, 15,033,722 and 14,750,638 issued and
    outstanding at December 31, 1997 and 1996..............       88,603      85,965
Cumulative translation adjustment...........................     (41,376)    (12,014)
Net unrealized loss on investments valuation................      (1,517)     (2,250)
Retained earnings...........................................      89,765     122,838
                                                                --------    --------
                                                                 135,475     194,539
                                                                --------    --------
                                                                $210,294    $296,980
                                                                ========    ========
</TABLE>

   The accompanying notes are an integral part of these financial statements.
                                       26
<PAGE>   27

                           MERCER INTERNATIONAL INC.

                     CONSOLIDATED STATEMENTS OF OPERATIONS
              FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
                (IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
                                                                1997        1996        1995
                                                              --------    --------    --------
<S>                                                           <C>         <C>         <C>
Revenues
  Sales...................................................    $175,337    $174,097    $275,332
  Investments.............................................       8,770      11,060      10,359
  Other...................................................       --          1,572      15,046
                                                              --------    --------    --------
                                                               184,107     186,729     300,737
Expenses
  Cost of sales...........................................     141,559     145,432     191,726
  Special charges.........................................      48,452       --          --
  General and administrative..............................      23,600      24,863      42,217
  Interest expense........................................       3,046       3,978       4,543
                                                              --------    --------    --------
                                                               216,657     174,273     238,486
                                                              --------    --------    --------
Income (loss) from continuing operations before income
  taxes and minority interest.............................     (32,550)     12,456      62,251
Income tax benefit (provision)............................         (73)      3,101       9,132
                                                              --------    --------    --------
Income (loss) from continuing operations before minority
  interest................................................     (32,623)     15,557      71,383
Minority interest.........................................       --          --         (5,746)
                                                              --------    --------    --------
Income (loss) from continuing operations..................     (32,623)     15,557      65,637
Income (loss) of spun-off operation, net of applicable
  income tax provision of $219 in 1996 and $463 in 1995...       --            466      (1,454)
                                                              --------    --------    --------
     Net income (loss)....................................    $(32,623)   $ 16,023    $ 64,183
                                                              ========    ========    ========
Basic earnings (loss) per share
  Income (loss) from continuing operations................    $  (2.18)   $   1.12    $   5.24
  Income (loss) of spun-off operation.....................          --        0.03       (0.12)
                                                              --------    --------    --------
     Net income (loss)....................................    $  (2.18)   $   1.15    $   5.12
                                                              ========    ========    ========
Diluted earnings (loss) per share
  Income (loss) from continuing operations................    $  (2.18)   $   1.12    $   5.13
  Income (loss) of spun-off operation.....................       --           0.03       (0.11)
                                                              --------    --------    --------
     Net income (loss)....................................    $  (2.18)   $   1.15    $   5.02
                                                              ========    ========    ========
</TABLE>

   The accompanying notes are an integral part of these financial statements.
                                       27
<PAGE>   28

                           MERCER INTERNATIONAL INC.

           CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
              FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
                (IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
                                                                                                       NET
                                       SHARES OF BENEFICIAL INTEREST                                UNREALIZED
                                   -------------------------------------                             LOSS ON
                                                            AMOUNT PAID               CUMULATIVE    INVESTMENT
                                     NUMBER                 IN EXCESS OF   RETAINED   TRANSLATION   VALUATION
                                   OF SHARES    PAR VALUE    PAR VALUE     EARNINGS   ADJUSTMENT      AMOUNT      TOTAL
                                   ----------   ---------   ------------   --------   -----------   ----------   --------
<S>                                <C>          <C>         <C>            <C>        <C>           <C>          <C>
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 of
  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
Shares issued for conversion of
  debentures.....................       6,731          7           62           --           --           --           69
Shares issued for exercise of
  options........................     169,500        169        1,332           --           --           --        1,501
Shares issued for the settlement
  of debt........................     100,000        100          901           --           --           --        1,001
Shares issued for the payment of
  debenture interest.............       4,853          5           45           --           --           --           50
Shares issued for cash...........      11,000         11           89           --           --           --          100
Repurchase of shares.............      (9,000)        (9)         (74)          --           --           --          (83)
Payment of dividends.............          --         --           --         (450)          --           --         (450)
Translation adjustments..........          --         --           --           --      (29,362)          --      (29,362)
Decrease in investment valuation
  account........................          --         --           --           --           --          733          733
Net loss.........................          --         --           --      (32,623)          --           --      (32,623)
                                   ----------    -------      -------      --------    --------      -------     --------
Balance at December 31, 1997.....  15,033,722    $15,034      $73,569      $89,765     $(41,376)     $(1,517)    $135,475
                                   ==========    =======      =======      ========    ========      =======     ========
</TABLE>

   The accompanying notes are an integral part of these financial statements.
                                       28
<PAGE>   29

                           MERCER INTERNATIONAL INC.

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
              FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
                           (IN THOUSANDS OF DOLLARS)

<TABLE>
<CAPTION>
                                                                1997        1996        1995
                                                              --------    --------    --------
<S>                                                           <C>         <C>         <C>
Cash Flows from Continuing Operating Activities
  Income (loss) from continuing operations................    $(32,623)   $ 15,557    $ 65,637
  Adjustments to reconcile income (loss) from continuing
     operations to cash from continuing operating
     activities
  Special charges.........................................      48,452          --          --
  Depreciation............................................      13,252      11,851      11,660
  Gain on sale of property................................        (991)     (1,572)         --
  Noncash asset acquisition...............................          --          --     (14,779)
  Deferred income taxes...................................          --      (3,101)     (9,132)
  Minority interest.......................................          --          --       5,746
  Other...................................................        (512)        (55)       (400)
Changes in current assets and liabilities
  Investment in trading securities........................       9,060     (21,005)    (65,684)
  Inventories.............................................       1,953       5,271      (7,291)
  Receivables.............................................      (7,150)      9,442      33,153
  Accounts payable and accrued expenses...................     (15,561)    (22,524)    (35,369)
  Other...................................................         100        (247)         (9)
                                                              --------    --------    --------
     Net cash provided by (used in)
       continuing operating activities....................      15,980      (6,383)    (16,468)
Cash Flows from Continuing Investing Activities
  Proceeds from the sales of available-for-sale
     securities...........................................          --       1,946       2,364
  Purchase of available-for-sale securities...............          --          --      (6,268)
  Sale of property........................................       3,024          --          --
  Purchase of fixed assets, net of investment grants......     (13,068)    (18,200)     (8,419)
  Increase (decrease) in notes receivable.................      (7,000)         --       1,219
  Other...................................................          33         (81)         90
                                                              --------    --------    --------
     Net cash used in continuing investing activities.....     (17,011)    (16,335)    (11,014)
Cash Flows from Continuing Financing Activities
  Increase in bank debts..................................       2,010       7,504      47,048
  Decrease in bank debts..................................      (6,676)       (959)    (47,730)
  Net proceeds on the issuance of (cost to repurchase)
     shares of beneficial interest........................       1,518        (789)      7,117
  Dividends...............................................        (450)         --          --
     Other................................................         (70)         --        (634)
                                                              --------    --------    --------
     Net cash provided by (used in) continuing financing
       activities.........................................      (3,668)      5,756       5,801
Effect of exchange rate changes on cash and cash
  equivalents.............................................        (854)     (1,028)      4,062
                                                              --------    --------    --------
Net cash used in continuing operations....................      (5,553)    (17,990)    (17,619)
Net cash flows from spun-off operation....................          --      (1,273)      4,337
                                                              --------    --------    --------
Net decrease in cash and cash equivalents.................      (5,553)    (19,263)    (13,282)
Cash and Cash Equivalents, beginning of year..............       9,967      29,230      42,512
                                                              --------    --------    --------
Cash and Cash Equivalents, end of year....................    $  4,414    $  9,967    $ 29,230
                                                              ========    ========    ========
</TABLE>

   The accompanying notes are an integral part of these financial statements.
                                       29
<PAGE>   30

                           MERCER INTERNATIONAL INC.

                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1.  THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     Mercer International Inc. and subsidiaries ("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 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. These fluctuations have significant effects on the cost of materials for
the Company and the eventual sales price of products. The amounts in the notes
are rounded to the nearest thousand except for the per share amounts.

BASIS OF PRESENTATION

     The consolidated financial statements include the accounts of the Company
and its subsidiaries. Significant intercompany accounts and transactions of
continuing operations have been eliminated.

     Effective June 3, 1996, the Company completed the spin-off of approximately
83% of the outstanding shares of common stock of its subsidiary, MFC Bancorp
Ltd. ("MFC") as a dividend to the Company's shareholders. MFC's operating
results are included in these consolidated statements of operations and cash
flows for the period January 1, 1996 through June 2, 1996, and for the year
ended December 31, 1995.

     MFC represented the Company's financial services segment which included
activities in the United States and Canada. Revenues for MFC were $14,927 for
the period January 1, 1996 through June 2, 1996 (inclusive of $823 in preferred
dividends from an affiliate) and $20,895 in 1995 (inclusive of $2,967 in
preferred dividends from an affiliate). Included in the net assets spun-off was
an amount payable by the Company which was settled in September 1996 with
700,000 shares of the Company's stock valued at $7,787 and a promissory note
amounting to $14,543 due January 1, 1999, with interest at 8%. Further, the
Company paid to MFC $2,212 which was due from another affiliate as part of the
separation agreement.

     Certain reclassifications have been made to prior year financial statements
to conform with the current year presentation.

CASH AND CASH EQUIVALENTS

     Cash and cash equivalents include highly liquid investments with original
maturities of three months or less and 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, for trading securities any unrealized gains or losses are included
in the results of operations. 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.

                                       30
<PAGE>   31

PROPERTIES

     Depreciable properties are stated at cost unless the estimated future
undiscounted cash flows expected to result from either the use of an asset or
its eventual disposition is less than its carrying amount in which case an
impairment loss is recognized based on the fair value of the asset.

     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.

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.

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.

                                       31
<PAGE>   32

EARNINGS PER SHARE

     In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, "Earnings Per Share" ("FAS 128").
Under FAS 128, basic and diluted earnings per share are to be presented. Basic
earnings per share is computed by dividing income available to common
shareholders by the weighted average number of common shares outstanding in the
period. Diluted earnings per share takes into consideration common shares
outstanding (computed under basic earnings per share) and potentially dilutive
common shares. FAS 128 is effective for interim and annual financial statements
ending after December 15, 1997. The adoption of FAS 128 resulted in a
restatement of the Company's earnings per share in prior periods.

NEW ACCOUNTING STANDARDS

     Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income," is effective for years beginning after December 15, 1997.
The primary objective of this statement is to report and disclose a measure
("Comprehensive Income") of all changes in equity of a company that result from
transactions and other economic events of the period other than transactions
with owners. The Company does not anticipate that the statement will have a
significant impact on its future financial statements.

     Statement of Financial Accounting Standards No. 131, "Disclosure About
Segments of an Enterprise and Related Information," is effective for years
beginning after December 15, 1997. This statement requires use of the
"management approach" model for segment reporting. The management approach model
is based on the way a company's management organizes segments within the company
for making operating decisions and assessing performance. Reportable segments
are based on products and services, geography, legal structure, management
structure, or any other manner in which management disaggregates a company. The
Company does not anticipate that the adoption of the statement will have a
significant impact on its financial statements other than potentially providing
more financial statement disclosures.

     Statement of Financial Standards No. 132, "Employers' Disclosures About
Pensions and Other Postretirement Benefits," standardizes the disclosure
requirements for pensions and other postretirement benefits. This statement
requires additional information on changes in benefit obligations and fair
values of plan assets. It revises prior standards and is effective for years
beginning after December 15, 1997. Because the Company does not currently have
any significant employee benefit plans nor intends to initiate any in the
near-term, there should not be an impact on its financial statements.

NOTE 2.  SPECIAL CHARGES

     The Company has two wholly-owned subsidiaries located in Germany which
operate in the pulp and paper industries. Spezialpapierfabrik Blankenstein GmbH
("SPB") operates primarily in the pulp industry. The other subsidiary, Dresden
Papier AG ("DPAG"), is a manufacturer of recycled paper products.

     During 1997, management decided to enhance the production efficiency of
SPB's pulp mill and to emphasize the production of kraft pulp rather than
sulphite pulp. Sulphite pulp production has accounted for a significant amount
of SPB's pulp production. Management expects the efficiency improvements and the
product conversion will increase production by 75% to 280,000 metric tons of
pulp annually, reduce energy and labor costs, and improve the quality of the
final product. Management estimates that SPB will incur expenditures of
approximately $325,000 during the conversion process which is expected to begin
in 1998 and be completed by the fourth quarter of 1999. During this period, pulp
production will be reduced. However, the effect on operating results due to the
reduction in pulp output cannot be determined at this time.

     As a consequence of SPB's conversion, certain equipment will either no
longer be useful or will need significant modification. Therefore, such
equipment has been deemed impaired and written down to its estimated fair value.
Fair value was determined based on engineering estimates as well as disposal
values experienced in the industry. Accordingly, an unrealized impairment loss
of $26,385 has been included in special charges in the results of operations for
1997. The unrealized loss represents the excess of the equipment's carrying
value of $29,164 over estimated fair value of $2,779.
                                       32
<PAGE>   33

     Also, during 1997, management decided to sell three of DPAG's paper mills.
Management believes that the mills to be sold no longer fit with their strategic
plan for DPAG's future operations. Management anticipates that the mills will be
sold in the near-term. In connection with the plan of disposal, management
believes that the carrying values of these mills exceed their estimated fair
values based on current market data. Therefore, an unrealized loss of $14,901
has been included as part of special charges in the 1997 results of operations.
The unrealized loss represents the difference between carrying value of $28,415
over estimated fair value of $13,514 of these mills. The estimated results of
operations of these mills was a combined loss of approximately $2,400 for the
year ended December 31, 1997.

     The amounts classified as special charges in the 1997 statements of
operations, which total $48,452, consists of the unrealized impairment losses
above amounting to $41,286, a decrease in the deferred income tax asset of
$4,992, and $2,174 of employee severance and other costs. However, these special
charges are based on estimates. These estimates may change in the near-term, and
the change may be material.

     SPB was previously known as Zellstoff-und Papierfabrik Rosenthal GmbH. The
name change occurred in 1997.

     SPB has a fiber supply contract with another company which expires December
1998, with six months notice required at a cost-plus rate. SPB and DPAG have
labor agreements which expire in the year 2002 and 1999, respectively.

     SPB's and DPAG's revenues were derived from the following geographic areas:

<TABLE>
<CAPTION>
                                                                YEARS ENDED DECEMBER 31
                                                                -----------------------
                                                                1997     1996     1995
                                                                -----    -----    -----
<S>                                                             <C>      <C>      <C>
Germany.....................................................    55.6%    58.2%    62.4%
European Union..............................................    34.1%    28.0%    26.3%
Other.......................................................    10.3%    13.8%    11.3%
</TABLE>

NOTE 3.  INVESTMENTS

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

<TABLE>
<CAPTION>
                                                                   DECEMBER 31
                                                                ------------------
                                                                 1997       1996
                                                                -------    -------
<S>                                                             <C>        <C>
Bonds.......................................................    $33,464    $52,043
Equity securities...........................................     22,821     29,820
                                                                -------    -------
                                                                $56,285    $81,863
                                                                =======    =======
</TABLE>

     The change in net unrealized holding gains on trading securities which has
been included in earnings was $1,067, $888 and $3,736 during 1997, 1996 and
1995, respectively. Included within equity securities are investments in two
companies that represent 50% and 45% of the total value of equity securities at
December 31, 1997 and 1996, respectively.

                                       33
<PAGE>   34

     Available-for-sale securities consist of equity securities and have been
classified as long-term investments. These securities may be summarized as
follows:

<TABLE>
<CAPTION>
                                                                         DECEMBER 31
                                                                -----------------------------
                                                                 1997       1996       1995
                                                                -------    -------    -------
<S>                                                             <C>        <C>        <C>
Proceeds from sales.........................................    $ --       $ 1,946    $ 2,364
Realized gains..............................................      --           415      --
Fair value held.............................................      1,488      1,015      2,900
Cost of securities held.....................................      3,005      3,265      5,874
Unrealized loss in shareholders' equity.....................     (1,517)    (2,250)    (2,974)
</TABLE>

     Sales of available-for-sale securities in 1995 represented all of the
Company's 34.6% interest in an affiliate. The sale resulted in no gain or loss
and was to another affiliate where a Company officer and director was a board
member.

     Included in long-term investments are preferred shares in an affiliate of
MFC which are stated at cost of $2,630 and $2,744 at December 31, 1997 and 1996,
respectively.

FAIR VALUE OF FINANCIAL INSTRUMENTS

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

<TABLE>
<CAPTION>
                                                             1997                   1996
                                                      -------------------    -------------------
                                                      CARRYING     FAIR      CARRYING     FAIR
                                                       AMOUNT      VALUE      AMOUNT      VALUE
                                                      --------    -------    --------    -------
<S>                                                   <C>         <C>        <C>         <C>
Cash and cash equivalents.........................    $ 4,414     $ 4,414    $ 9,967     $ 9,967
Loan receivable...................................      3,484       3,484         --          --
Note receivable...................................      7,000       7,000         --          --
Preferred shares in affiliate.....................      2,630       2,630      2,744       2,744
Notes payable.....................................      3,252       3,252      6,017       6,017
Long-term debt....................................     19,368      18,543     31,257      30,613
</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 loan
receivable of $3,484 bears interest at 8%, is collateralized by inventory,
accounts receivable and property, and will be due in 1998. The value of the loan
receivable is estimated at its face amount due to its terms. The note receivable
is from one company, bears interest at 7%, is due on July 31, 2000, and has no
collateral. Its value is based on the value of similar long-term receivables.
The preferred shares in affiliate's value is based on their retractability
feature and dividend rate compared to other securities. 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 $2,027 and $2,334 at December 31, 1997 and 1996, respectively
are primarily an accrued environmental liability at SPB and a pension liability
at 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.

NOTE 4. RECEIVABLES

<TABLE>
<CAPTION>
                                                                   DECEMBER 31
                                                                ------------------
                                                                 1997       1996
                                                                -------    -------
<S>                                                             <C>        <C>
Sale of paper and pulp products.............................    $10,280    $10,146
Loan receivable.............................................      3,484         --
Sale of property............................................         --      2,391
Other.......................................................      8,565      5,829
                                                                -------    -------
                                                                $22,329    $18,366
                                                                =======    =======
</TABLE>

                                       34
<PAGE>   35

NOTE 5. INVENTORIES

<TABLE>
<CAPTION>
                                                                   DECEMBER 31
                                                                ------------------
                                                                 1997       1996
                                                                -------    -------
<S>                                                             <C>        <C>
Pulp and paper
  Raw materials.............................................    $10,073    $ 9,426
  Work in process and finished goods........................      5,726     11,242
                                                                -------    -------
                                                                $15,799    $20,668
                                                                =======    =======
</TABLE>

NOTE 6. PROPERTIES

<TABLE>
<CAPTION>
                                                                    DECEMBER 31
                                                                --------------------
                                                                  1997        1996
                                                                --------    --------
<S>                                                             <C>         <C>
Land........................................................    $ 14,993    $ 14,740
Buildings...................................................      18,440      21,769
Production and other equipment..............................     102,032     141,999
                                                                --------    --------
                                                                 135,465     178,508
Less: Accumulated depreciation..............................      47,659      36,251
                                                                --------    --------
                                                                $ 87,806    $142,257
                                                                ========    ========
</TABLE>

NOTE 7.  NOTES PAYABLE

<TABLE>
<CAPTION>
                                                                  DECEMBER 31
                                                                ----------------
                                                                 1997      1996
                                                                ------    ------
<S>                                                             <C>       <C>
Bank loan, 6.5% interest, payable monthly, callable with
  four weeks notice, collateralized by inventory............    $1,676    $ --
Bank loan, 6.5% interest, payable monthly, callable with
  four weeks notice, collateralized by inventory............     1,576      --
Bank loan, 7% interest, payable monthly, due April 1997,
  collateralized by inventory...............................      --       3,077
Bank loan, 6.5% interest, payable monthly, due February
  1997, collateralized by inventory.........................      --       1,981
Bank loan, 10% interest, due July 1997, unsecured...........      --         959
                                                                ------    ------
                                                                $3,252    $6,017
                                                                ======    ======
</TABLE>

                                       35
<PAGE>   36

NOTE 8.  LONG-TERM DEBT

<TABLE>
<CAPTION>
                                                                   DECEMBER 31
                                                                ------------------
                                                                   1997       1996
                                                                -------    -------
<S>                                                             <C>        <C>
Note payable, 8% interest, due January 1999, unsecured......    $ 4,474    $14,543
Loan from governmental agency, 7% interest payable annually,
  due 2004, collateralized by fixed assets..................      5,559      6,584
Loan from governmental agency, non-interest bearing, due in
  annual installments of $556, payments beginning June 30,
  1997, unsecured...........................................      2,779      3,249
Bank loan, interest at 5.5% payable quarterly, principal
  payments of $357 are due semi-annually, collateralized by
  land and buildings........................................      2,502      2,924
Bank loan, interest at LIBOR plus 2% (resulting in a rate of
  5.53% at December 31, 1997) interest payable monthly,
  principal payments of $116 are due quarterly,
  collateralized by land and buildings......................      1,395      1,631
Note payable, interest at 13.5%, payable $256 per quarter,
  due June 1998, unsecured..................................        315      1,247
Note payable, interest at a bank's discount rate plus 2%
  (resulting in a rate of 4.5% at December 31, 1997)
  interest payable quarterly, due on demand, collateralized
  by land and buildings.....................................      1,668      --
Other.......................................................        676      1,079
                                                                -------    -------
                                                                 19,368     31,257
Less: Current portion.......................................      4,329      2,647
                                                                -------    -------
                                                                $15,039    $28,610
                                                                =======    =======
</TABLE>

     As of December 31, 1997, the principal maturities of long-term debt are as
follows:

<TABLE>
<CAPTION>
MATURES                                                          AMOUNT
-------                                                         -------
<S>                                                             <C>
1998........................................................    $ 4,329
1999........................................................      6,428
2000........................................................      1,730
2001........................................................      1,320
2002........................................................      --
Thereafter..................................................      5,561
                                                                -------
                                                                $19,368
                                                                =======
</TABLE>

     Interest paid amounted to $3,161 in 1997, $2,693 in 1996 and $3,697 in
1995. Interest amounting to $246 and $668 has been capitalized in property and
equipment during 1996 and 1995, respectively. There was no interest capitalized
in 1997.

NOTE 9.  ACCOUNTS PAYABLE AND ACCRUED EXPENSES

<TABLE>
<CAPTION>
                                                                   DECEMBER 31
                                                                ------------------
                                                                   1997       1996
                                                                -------    -------
<S>                                                             <C>        <C>
Trade payables..............................................    $17,925    $25,773
Accounts payable and accrued expenses.......................     26,353     28,976
Payable for securities......................................      5,894      6,838
Other.......................................................      --           878
                                                                -------    -------
                                                                $50,172    $62,465
                                                                =======    =======
</TABLE>

     At December 31, 1996, accrued expenses amounting to $17,141 were combined
with SPB and DPAG properties. In the 1997 consolidated financial statements,
this amount has been classified in December 31, 1996, liabilities.

                                       36
<PAGE>   37

NOTE 10.  INCOME TAXES

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

<TABLE>
<CAPTION>
                                                                   YEAR ENDED DECEMBER 31
                                                                ----------------------------
                                                                 1997       1996       1995
                                                                -------    -------    ------
<S>                                                             <C>        <C>        <C>
U.S.........................................................    $   (73)   $(1,456)   $2,380
Non U.S.....................................................     (4,992)     4,557     6,752
                                                                -------    -------    ------
Deferred recovery of (provision for) income taxes...........    $(5,065)   $ 3,101    $9,132
                                                                =======    =======    ======
</TABLE>

     The 1997 provision includes $4,992 which has been allocated to special
charges.

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

<TABLE>
<CAPTION>
                                                                    YEAR ENDED DECEMBER 31
                                                                ------------------------------
                                                                 1997       1996        1995
                                                                -------    -------    --------
<S>                                                             <C>        <C>        <C>
U.S. Federal statutory rates on income from continuing
  operations before considering minority interest...........    $11,091    $(4,234)   $(21,165)
Increase (decrease) in taxes resulting from:
  Non U.S. income...........................................     (7,991)     6,805      24,630
  Valuation allowance.......................................     (8,165)       530       5,667
                                                                -------    -------    --------
                                                                $(5,065)   $ 3,101    $  9,132
                                                                =======    =======    ========
</TABLE>

     Deferred tax assets are composed of the following:

<TABLE>
<CAPTION>
                                                                  1997         1996
                                                                ---------    ---------
<S>                                                             <C>          <C>
Non U.S. tax loss carryforwards.............................    $ 104,553    $ 134,552
Difference in non U.S. tax basis of depreciable assets......       22,955       --
U.S. tax loss carryforward..................................        2,114          924
Foreign tax credits.........................................        2,500        2,500
                                                                ---------    ---------
                                                                  132,122      137,976
Valuation allowance.........................................     (121,136)    (119,663)
                                                                ---------    ---------
  Net deferred tax asset....................................    $  10,986    $  18,313
                                                                =========    =========
</TABLE>

     The non U.S. tax loss carryforwards are attributable to the operations of
SPB and DPAG. During 1995 and 1996, management, in consultation with industry
experts, decreased the valuation allowance by $11,309 ($4,557 in 1996 and $6,752
in 1995). During 1997, the German government changed the tax law with respect to
the utilization of tax losses. The change potentially restricts utilization of
tax losses by successor entities in an acquisition. Because the tax law change
is subject to future interpretation, the Company has recorded a tax benefit for
the total amount of the losses and provided a reserve primarily for those losses
occurring prior to acquisition. Management believes that, while realization of
the deferred tax assets is not assured, it is more likely than not that they
will be realized.

     The Company's U.S. net operating losses of approximately $7,100 at December
31, 1997. Losses of $3,600 and $3,500 will expire in 2011 and 2012,
respectively, if not used. The remaining German tax losses of approximately
$188,000 at December 31, 1997, may be carried forward indefinitely.

     Income (loss) from foreign source operations amounted to $(23,503), $20,015
and $72,437 for the years ended December 31, 1997, 1996 and 1995, respectively.
These amounts are intended to be indefinitely reinvested in operations. Further,
any U.S. income tax benefit which may be attributable to the unrealized losses
in available-for-sale securities have been fully reserved.

                                       37
<PAGE>   38

     The Company's foreign tax credits are 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 11.  STOCK-BASED COMPENSATION

     The Company has a non-qualified stock option plan which provides for
options to be granted to officers and employees to acquire a maximum of
2,000,000 shares of beneficial interest including options for 100,000 shares to
directors who are not officers or employees.

     During 1997, options to acquire 635,000 shares of beneficial interest at
$8.50 were granted to officers and employees of the Company which vest one-third
at grant date and one-third each year for the next two years. These options
expire in ten years. The weighted fair value of these options was $2.71 each.

     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 were to vest one-third at the
grant date and one-third each year for the next two years. 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 expire in 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.

     Following is a summary of the status of the plan during 1997, 1996 and
1995:

<TABLE>
<CAPTION>
                                                                NUMBER OF    WEIGHTED 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
Granted.....................................................     635,000            8.50
Exercised...................................................    (169,500)           8.85
Forfeited...................................................     (60,000)          13.88
                                                                --------          ------
Outstanding December 31, 1997...............................     801,000          $11.01
                                                                ========          ======
</TABLE>

     Following is a summary of the status of options outstanding at December 31,
1997:

<TABLE>
<CAPTION>
                    OUTSTANDING OPTIONS                           EXERCISABLE OPTIONS
------------------------------------------------------------   --------------------------
                         WEIGHTED AVERAGE   WEIGHTED AVERAGE             WEIGHTED AVERAGE
  EXERCISE                  REMAINING           EXERCISE                     EXERCISE
PRICE RANGE    NUMBER    CONTRACTUAL LIFE        PRICE         NUMBER         PRICE
------------   -------   ----------------   ----------------   -------   ----------------
<S>            <C>       <C>                <C>                <C>       <C>
$8.50-11.66    596,500         9.6               $ 8.77        246,165        $ 9.15
$16.89-18.47   204,500         7.9               $17.50        204,500        $17.50
</TABLE>

                                       38
<PAGE>   39

COMPENSATION

     The Company applies Accounting Principles Board Opinion 25 in accounting
for its stock option plan. There was no compensation expense incurred based on
options granted in either 1997 or 1996. 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>
                                                                  1997       1996       1995
                                                                --------    -------    -------
<S>                                                             <C>         <C>        <C>
Net Income (Loss)
  As reported...............................................    $(32,623)   $16,023    $64,183
                                                                ========    =======    =======
  Pro forma.................................................    $(33,484)   $15,027    $63,205
                                                                ========    =======    =======
Basic Earnings (Loss) Per Share
  As reported...............................................    $  (2.18)   $  1.15    $  5.12
                                                                ========    =======    =======
  Pro forma.................................................    $  (2.23)   $  1.08    $  5.04
                                                                ========    =======    =======
Diluted Earnings (Loss) Per Share
  As reported...............................................    $  (2.18)   $  1.15    $  5.02
                                                                ========    =======    =======
  Pro forma.................................................    $  (2.23)   $  1.08    $  4.94
                                                                ========    =======    =======
</TABLE>

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

<TABLE>
<CAPTION>
                                                                 1997       1996       1995
                                                                -------    -------    -------
<S>                                                             <C>        <C>        <C>
Risk-free interest rate.....................................        6.0%       5.0%       5.0%
Expected life of the options................................    2 years    2 years    2 years
Expected volatility.........................................      49.80%     49.62%     38.45%
Expected dividend yield.....................................        0.0%       0.0%       0.0%
</TABLE>

NOTE 12.  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 shares will be entitled to an aggregate dividend of 100 times any
dividends declared on shares of beneficial interest and an aggregate of 100
times any payment to shares of beneficial interest on merger or liquidation.

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

                                       39
<PAGE>   40

NOTE 13.  EARNINGS PER SHARE

     The earnings per share data required under FAS 128 for years ended December
31 is summarized as follows:

<TABLE>
<CAPTION>
                                                                        INCOME (LOSS)
                                                               -------------------------------
                                                                 1997       1996        1995
                                                               --------    -------    --------
<S>                                                            <C>         <C>        <C>
Income (loss) from continuing operations...................    $(32,623)   $15,557    $ 65,637
Effect of dilutive securities, interest on convertible
  debentures...............................................       --            11          15
                                                               --------    -------    --------
                                                               $(32,623)   $15,568    $ 65,652
                                                               ========    =======    ========
</TABLE>

<TABLE>
<CAPTION>
                                                                         SHARES
                                                         --------------------------------------
                                                            1997          1996          1995
                                                         ----------    ----------    ----------
<S>                                                      <C>           <C>           <C>
Basic earnings per share, weighted number of shares
  outstanding........................................    14,994,826    13,829,056    12,525,519
Effect of dilutive securities:
  Convertible debentures.............................            --        21,756        28,436
  Warrants...........................................            --        33,900        77,281
  Options............................................            --        72,393       155,953
                                                         ----------    ----------    ----------
                                                         14,994,826    13,957,105    12,787,189
                                                         ==========    ==========    ==========
</TABLE>

     For the year ended December 31, 1997, convertible debentures, warrants and
options were not included in the computation of diluted EPS because they are
anti-dilutive. Options to acquire 192,500 were outstanding at December 31, 1996,
but were not included in the computation of diluted shares because the options'
exercise price was greater than the average market price of the shares. The
Company issued 145,000 additional shares subsequent to December 31, 1997.

NOTE 14.  TRANSACTIONS WITH AFFILIATES

     In connection with the spin-off discussed in Note 1, the Company assumed
the debt, which it had previously guaranteed, of an affiliate of MFC in the
amount of $2,052. 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, 1997, and a note for $556. The note was paid in full
in 1997. Under the terms of the exchange, the affiliate may replace the shares
with other assets.

     During 1996, SPB acquired bonds in a subsidiary of the spun-off entity with
a face amount of $5,922 for $4,548. SPB acquired $6,000 in convertible
debentures of the spun-off entity. The spun-off entity acquired the subsidiary's
bonds for $5,922 and SPB recorded income of $1,374 as a result of this
transaction for the year ended December 31, 1996. Finally, SPB 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 trustees amounting to
$360 and $366 as of December 31, 1997 and 1996, respectively. An entity related
to one of these trustees was reimbursed for expenses and fees of $224 and $232
during 1997 and 1996, respectively, and was due $55 and $77 from the Company at
December 31, 1997 and 1996, respectively.

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

     Significant noncash transactions in 1997 include:

     -  Bank debt was extinguished with 100,000 of the Company's shares of
        beneficial interest which approximated fair value.

     -  Note payable of $5,226 was extinguished with trading securities with the
        same market value.
                                       40
<PAGE>   41

     -  Shares of beneficial interest with a fair value of $50 were issued as
        payment for debenture interest.

     Significant noncash transactions in 1996 include:

     -  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.

     -  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.

     -  The Company paid bank debt of $12,459 with 650,000 of the Company's
        shares having a market value of $7,394 and MFC shares remaining after
        the spin-off with a fair value of $5,065.

     -  As discussed in Note 1, the Company spun-off 83% of MFC amounting to
        $50,735 net of a foreign currency translation adjustment.

     Significant noncash transactions in 1995 include:

     -  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 SPB and DPAG.

NOTE 16.  COMMITMENTS AND CONTINGENCIES

     At December 31, 1997 and 1996, SPB has recorded a liability for
environmental conservation expenditures of $1,668 and $1,949, respectively. DPAG
has also recorded $278 and $325 at December 31, 1997 and 1996, respectively, as
estimated potential liabilities for environmental conservation expenditures.
Management believes the liability amount recorded is sufficient, however, future
regulations in Germany may result in additional liability.

     SPB 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. SPB 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.

     SPB is not permitted under its original purchase agreement to make
distributions to the Company or make payments on a certain loan payable to the
Company prior to January 1999. The assets which may not be distributed amount to
approximately $117,000 at December 31, 1997. However, the Company may expand or
invest through SPB.

     The Company is currently negotiating with an agency of the German
government to conclude and settle its remaining obligations under the original
contract under which SPB and DPAG were acquired from the government.

     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.

                                       41
<PAGE>   42

                           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>
1997
Net Sales............................................   44,354     45,740      48,306         45,707
Gross profit.........................................    9,886     10,949      10,978         10,735
Income before extraordinary items and cumulative
  effect
  of a change in accounting..........................    3,184      4,111       4,754        (44,672)
Income before extraordinary items and cumulative
  effect
  of a change in accounting, per share*..............     0.21       0.27        0.31          (2.97)
Net income...........................................    3,184      4,111       4,754        (44,672)

1996
Net Sales............................................   49,873     49,677      46,916         40,263
Gross profit.........................................   13,258     10,298      10,612          7,129
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
</TABLE>

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

* on a diluted basis

                                       42
<PAGE>   43

                                   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 27, 1998                     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 27, 1998
-----------------------------------------------------
Jimmy S.H. Lee
Chairman, Chief Executive Officer
and Trustee

/s/ Michel Arnulphy                                      Date: March 27, 1998
-----------------------------------------------------
Michel Arnulphy
Trustee

/s/ C.S. Moon                                            Date: March 27, 1998
-----------------------------------------------------
C.S. Moon
Trustee

/s/ M. Reidel                                            Date: March 27, 1998
-----------------------------------------------------
M. Reidel
Chief Financial Officer and Trustee
</TABLE>

                                       43
<PAGE>   44

Peterson Sullivan 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 25 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 16, 1998
Seattle, Washington

                                       44
<PAGE>   45

                           MERCER INTERNATIONAL INC.

          SCHEDULE 1 -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT

BALANCE SHEET

<TABLE>
<CAPTION>
                                                                   DECEMBER 31,
                                                                ------------------
                                                                 1997       1996
                                                                -------    -------
<S>                                                             <C>        <C>
ASSETS
  Cash......................................................      4,414      9,967
  Receivables...............................................     29,329     18,366
  Inventories...............................................     15,799     20,668
  Investments...............................................     60,403     85,622
  Properties................................................     87,806    142,257
  Deferred income tax assets................................     10,986     18,313
  Other.....................................................      1,557      1,787
                                                                -------    -------
                                                                210,294    296,980
                                                                =======    =======
LIABILITIES AND SHAREHOLDERS' EQUITY
  Accounts payable and accrued expenses.....................     52,199     65,167
  Debt......................................................     22,620     37,274
  Shareholders' equity......................................    135,475    194,539
                                                                -------    -------
                                                                210,294    296,980
                                                                =======    =======
</TABLE>

STATEMENT OF OPERATIONS

<TABLE>
<CAPTION>
                                                                  YEARS ENDED DECEMBER 31,
                                                                -----------------------------
                                                                 1997       1996       1995
                                                                -------    -------    -------
<S>                                                             <C>        <C>        <C>
Revenues
  Pulp and paper and related sales..........................    175,337    174,097    275,332
  Investments...............................................      8,770     11,060     10,359
  Other.....................................................         --      1,572     15,046
                                                                -------    -------    -------
                                                                184,107    186,729    300,737
Expenses
  Cost of sales.............................................    141,559    145,432    191,726
  General and administrative................................     23,600     24,863     42,217
  Interest..................................................      3,046      3,978      4,543
  Special charges...........................................     48,452         --         --
  Income tax (recovery).....................................         73     (3,101)    (9,132)
  Minority interest.........................................         --         --      5,746
                                                                -------    -------    -------
                                                                216,730    171,172    235,100
                                                                -------    -------    -------
Income (loss) from continuing operations....................    (32,623)    15,557     65,637
                                                                =======    =======    =======
</TABLE>

                                       45
<PAGE>   46

STATEMENT OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                  YEARS ENDED DECEMBER 31,
                                                                -----------------------------
                                                                 1997       1996       1995
                                                                -------    -------    -------
<S>                                                             <C>        <C>        <C>
Net cash provided by (used in) operating activities.........     15,980     (6,383)   (16,468)
Net cash used in investing activities, purchase of fixed
  assets....................................................    (17,011)   (16,335)   (11,014)
Net cash provided by (used in) financing activities.........     (4,522)     4,728      9,863
Net cash provided by (used in) spun-off operation...........         --     (1,273)     4,337
                                                                -------    -------    -------
Net change in cash..........................................     (5,553)   (19,263)   (13,282)
Cash and cash equivalent, beginning of year.................      9,967     29,230     42,512
                                                                -------    -------    -------
Cash and cash equivalent, end of year.......................      4,414      9,967     29,230
                                                                =======    =======    =======
</TABLE>

                                       46
<PAGE>   47

                                 EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT NO.   DESCRIPTION OF EXHIBIT
-----------   ----------------------
<C>           <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.

   10.4*      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.        Independent Auditors Consent.

   27.        Article 5 -- Financial Data Schedule for the Year Ended
              December 31, 1997.
</TABLE>

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

* Filed in Form 10-K for prior years.

                                       47