##### 



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2005 OR o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from  to Commission File No.: 000-09409 MERCER INTERNATIONAL INC. (Exact name of Registrant as specified in its charter)
 Washington
(State or other jurisdiction
of incorporation or organization)
    
    91-6087550(I.R.S. Employer
Identification No.)
 14900 Interurban Avenue South, Suite 282, Seattle, WA 98168(Address of office) (206) 674-4639(Registrants telephone number, including area code) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934during 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 þ NO o Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of
the Exchange Act). YES þ NO o The Registrant had 33,053,455 shares of beneficial interest outstanding as at May 10, 2005.




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##### 



PART I.FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS MERCER INTERNATIONAL INC. CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE MONTHS ENDED MARCH 31, 2005 (Unaudited) 2




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##### 



MERCER INTERNATIONAL INC. CONSOLIDATED BALANCE SHEETS As at March 31, 2005 and December 31, 2004
(Unaudited)
(Euros in thousands) March 31,
    
    
    December 31,2005
    
    
    2004ASSETSCurrent AssetsCash and cash equivalents
    
    
    114,096
    
    
    
    49,568Cash restricted
    
    
    70,421
    
    
    
    45,295Receivables
    
    
    64,058
    
    
    
    54,687Inventories
    
    
    81,330
    
    
    
    52,898Prepaid expenses and other
    
    
    5,481
    
    
    
    4,961Total current assets
    
    
    335,386
    
    
    
    207,409Long-Term AssetsCash restricted
    
    
    19,074
    
    
    
    47,538Property, plant and equipment
    
    
    1,109,765
    
    
    
    936,035Investments
    
    
    
    
    
    
    983Equity method investments
    
    
    3,967
    
    
    
    4,096Deferred note issuance and other costs
    
    
    9,459
    
    
    
    5,069Deferred income tax
    
    
    53,789
    
    
    
    54,5191,196,054
    
    
    
    1,048,240Total assets
    
    
    1,531,440
    
    
    
    1,255,649LIABILITIESCurrent LiabilitiesAccounts payable and accrued expenses
    
    
    82,778
    
    
    
    56,542Construction costs payable
    
    
    67,737
    
    
    
    65,436Debt, current portion
    
    
    102,269
    
    
    
    107,090Total current liabilities
    
    
    252,784
    
    
    
    229,068Long-Term LiabilitiesDebt, less current portion
    
    
    928,803
    
    
    
    777,272Unrealized foreign exchange rate derivative loss
    
    
    4,044
    
    
    
    Unrealized interest rate derivative losses
    
    
    75,127
    
    
    
    75,471Pension and other post-retirement benefit obligations
    
    
    16,622
    
    
    
    Capital leases and other
    
    
    9,513
    
    
    
    9,035Deferred income tax
    
    
    4,341
    
    
    
    2,0621,038,450
    
    
    
    863,840Total liabilities
    
    
    1,291,234
    
    
    
    1,092,908Minority Interest
    
    
    
    
    
    
    SHAREHOLDERS EQUITYShares of beneficial interest
    
    
    180,856
    
    
    
    83,397Additional paid-in capital, stock options
    
    
    14
    
    
    
    14Retained earnings
    
    
    49,509
    
    
    
    69,176Accumulated other comprehensive income
    
    
    9,827
    
    
    
    10,154Total shareholders equity
    
    
    240,206
    
    
    
    162,741Total liabilities and shareholders equity
    
    
    1,531,440
    
    
    
    1,255,649
 The accompanying notes are an integral part of these financial statements. 3




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##### 



MERCER INTERNATIONAL INC. CONSOLIDATED STATEMENTS OF OPERATIONS For Three Months Ended March 31, 2005 and 2004
(Unaudited)
(Euros in thousands, except for loss per share) 2005
    
    
    2004Revenues
    
    
    97,893
    
    
    
    50,316Costs and expenses:Cost of sales
    
    
    90,989
    
    
    
    45,418General and administrative expenses
    
    
    7,798
    
    
    
    6,541Flooding losses and expenses, less grant income
    
    
    
    
    
    
    253Total costs and expenses
    
    
    98,787
    
    
    
    52,212Loss from operations
    
    
    (894
    )
    
    
    (1,896
    )Other income (expense)Interest expense
    
    
    (19,263
    )
    
    
    (2,988
    )Investment income
    
    
    175
    
    
    
    934Derivative financial instruments, net (Note 8)
    
    
    (3,859
    )
    
    
    (22,445
    )Foreign exchange gain on debt
    
    
    2,297
    
    
    
    Impairment of investments
    
    
    (1,645
    )
    
    
    Total other expense
    
    
    (22,295
    )
    
    
    (24,499
    )Loss before income taxes and minority interest
    
    
    (23,189
    )
    
    
    (26,395
    )Income tax (provision) benefit
    
    
    (3,035
    )
    
    
    20Loss before minority interest
    
    
    (26,224
    )
    
    
    (26,375
    )Minority interest
    
    
    6,557
    
    
    
    7,409Net loss
    
    
    (19,667
    )
    
    
    (18,966
    )Retained earnings, beginning of period
    
    
    69,176
    
    
    
    49,196Retained earnings, end of period
    
    
    49,509
    
    
    
    30,230Loss per shareBasic and diluted
    
    
    (0.77
    )
    
    
    (1.11
    )
 The accompanying notes are an integral part of these financial statements. 4




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##### 



MERCER INTERNATIONAL INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS For Three Months Ended March 31, 2005 and 2004
(Unaudited)
(Euros in thousands) 2005
    
    
    2004Net loss
    
    
    (19,667
    )
    
    
    (18,966
    )Other comprehensive loss:Foreign currency translation adjustments
    
    
    (632
    )
    
    
    (1,656
    )Unrealized gains on securitiesUnrealized holding gains arising during the period
    
    
    305
    
    
    
    507Other comprehensive loss
    
    
    (327
    )
    
    
    (1,149
    )Total comprehensive loss
    
    
    (19,994
    )
    
    
    (20,115
    )
 The accompanying notes are an integral part of these financial statements. 5




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##### 



MERCER INTERNATIONAL INC. CONSOLIDATED STATEMENTS OF CASH FLOWS For Three Months Ended March 31, 2005 and 2004
(Unaudited)
(Euros in thousands) 2005
    
    
    2004Cash Flows from (used in) Operating Activities:Net loss
    
    
    (19,667
    )
    
    
    (18,966
    )Adjustments to reconcile net loss to cash flows
from operating activitiesCumulative unrealized losses on derivatives
    
    
    3,754
    
    
    
    22,445Depreciation and amortization
    
    
    11,161
    
    
    
    6,429Unrealized foreign exchange gain on debt
    
    
    (2,297
    )
    
    
    Impairment of investments
    
    
    1,645
    
    
    
    Minority interest
    
    
    (6,557
    )
    
    
    (7,409
    )Deferred income taxes
    
    
    3,009
    
    
    
    (20
    )Stock compensation expense
    
    
    36
    
    
    
    596Other
    
    
    392
    
    
    
    (30
    )Changes in current assets and liabilitiesReceivables
    
    
    (9,565
    )
    
    
    4,014Inventories
    
    
    (8,463
    )
    
    
    (3,014
    )Accounts payable and accrued expenses
    
    
    24,609
    
    
    
    6,015Other
    
    
    (401
    )
    
    
    (1,609
    )Net cash from (used in) operating activities
    
    
    (2,344
    )
    
    
    8,451Cash Flows from (used in) Investing Activities:Purchase of property, plant and equipment, net of
investment grants
    
    
    (4,136
    )
    
    
    (50,640
    )Acquisition of Celgar pulp mill
    
    
    (146,286
    )
    
    
    Sale of available-for-sale securities
    
    
    
    
    
    
    614Net cash used in investing activities
    
    
    (150,422
    )
    
    
    (50,026
    )Cash Flows from (used in) Financing Activities:Cash restricted
    
    
    3,338
    
    
    
    (14,664
    )Increase in construction costs payable
    
    
    2,301
    
    
    
    (29,371
    )Proceeds from borrowings of notes payable and debt
    
    
    323,093
    
    
    
    90,000Repayment of notes payable and debt
    
    
    (178,691
    )
    
    
    (8,384
    )Repayment of capital lease obligations
    
    
    (1,147
    )
    
    
    (243
    )Issuance of shares of beneficial interest
    
    
    66,645
    
    
    
    308Net cash from financing activities
    
    
    215,539
    
    
    
    37,646Effect of exchange rate changes on cash and
cash equivalents
    
    
    1,755
    
    
    
    72Net increase (decrease) in cash and cash equivalents
    
    
    64,528
    
    
    
    (3,857
    )Cash and cash equivalents, beginning of period
    
    
    49,568
    
    
    
    51,993Cash and cash equivalents, end of period
    
    
    114,096
    
    
    
    48,136
 The accompanying notes are an integral part of these financial statements. 6




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##### 



MERCER INTERNATIONAL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THREE MONTHS ENDED MARCH 31, 2005 (Unaudited)
(Euros in thousands, except for shares and per share data) Note 1. Basis of Presentation The interim period consolidated financial statements contained herein include the accounts of
Mercer International Inc. (Mercer Inc.) and its wholly-owned and majority-owned subsidiaries
(collectively, the Company). The interim period consolidated financial statements have been prepared by the Company pursuant to
the rules and regulations of the U.S. Securities and Exchange Commission (the SEC). Certain
information and footnote disclosure normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States have been condensed
or omitted pursuant to such SEC rules and regulations. The interim period consolidated financial
statements should be read together with the audited consolidated financial statements and
accompanying notes included in the Companys latest annual report on Form 10-K for the fiscal year
ended December 31, 2004. In the opinion of the Company, the unaudited consolidated financial
statements contained herein contain all adjustments necessary to present a fair statement of the
results of the interim periods presented. The results for the periods presented herein may not be
indicative of the results for the entire year. Note 2. Stock-Based Compensation The Company has stock-based compensation plans, which are described more fully in the Companys
annual report on Form 10-K for the year ended December 31, 2004. The Company accounts for the
plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock
Issued to Employees, and related interpretations. The following tables illustrate the effect on
net loss and loss per share if the Company had applied the fair value recognition provisions of
Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation. Three Months Ended March 31,2005
    
    
    2004Net LossAs reported
    
    
    (19,667
    )
    
    
    (18,966
    )Deduct: Total
stock-based employee
compensation expense
determined under fair
value based method for
all awards, net of any
related tax effects
    
    
    (10
    )
    
    
    (15
    )Pro forma
    
    
    (19,677
    )
    
    
    (18,981
    )Basic and Diluted Loss Per ShareAs reported
    
    
    (0.77
    )
    
    
    (1.11
    )Pro forma
    
    
    (0.77
    )
    
    
    (1.11
    )
 7




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##### 



MERCER INTERNATIONAL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THREE MONTHS ENDED MARCH 31, 2005 (Unaudited)
(Euros in thousands, except for shares and per share data) Note 3. Loss Per Share Basic loss per share is computed by dividing loss available to common shareholders by the weighted
average number of shares outstanding during a period. Diluted loss per share takes into
consideration shares outstanding (computed under basic earnings per share) and potentially dilutive
shares. The following table sets out the computation of basic loss per share for the three months
ended March 31, 2005 and 2004, respectively: Three Months EndedMarch 31,2005
    
    
    2004Loss from continuing operations  basic
    
    
    (19,667
    )
    
    
    (18,966
    )Weighted average number of common shares outstanding:Basic
    
    
    25,443,619
    
    
    
    17,155,210Loss from continuing operations per share:Basic
    
    
    (0.77
    )
    
    
    (1.11
    )
 For the three months ended March 31, 2005 and 2004, options and convertible notes were not
included in the computation of diluted loss per share because they were anti-dilutive. Note 4. Acquisition of the Celgar Mill and Related Financings Acquisition On February 14, 2005, the Company completed its acquisition of the Celgar NBSK pulp mill. The
aggregate consideration for the acquisition was 177,100, which included 142,940 in cash,
acquisition related expenditures of 3,346 and 30,814 was paid in shares of beneficial
interest of the Company as more fully described below. The results of the Celgar mill are included
in the consolidated statement of operations since the acquisition date. 8




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MERCER INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THREE MONTHS ENDED MARCH 31, 2005 (Unaudited)
(Euros in thousands, except for shares and per share data) Note 4. Acquisition of the Celgar Mill and Related Financings (contd) The preliminary estimated allocation of the purchase price is summarized below and may be adjusted
when additional information on asset and liability valuations becomes available. Purchase price:Cash (including defined working capital)
    
    
    142,940Equity  shares of beneficial interest
    
    
    30,814Estimated acquisition costs
    
    
    3,346
    177,100Net assets acquired:Receivables
    
    
    32Inventories
    
    
    19,969Prepaids and other assets
    
    
    616Property, plant and equipment
    
    
    176,581Accrued expenses and other liabilities
    
    
    (4,103
    )Pension plan and post-retirement benefits obligation
    
    
    (15,995
    )
    177,100
 Financings In connection with the acquisition, in February 2005, the Company issued an aggregate of 4,210,526
shares of beneficial interest by way of private placement at a price of US$9.50 per share as part
of the consideration for the acquisition of the Celgar mill. In addition, in February 2005, the
Company issued US$310,000 of 9.25% senior unsecured notes due 2013 and an aggregate of 10,768,700
shares of beneficial interest at a price of US$8.50 per share by way of separate public offerings.
The Company used the net proceeds from such public offerings to pay the cash portion of the
purchase price for the Celgar pulp mill, to repay all of the bank indebtedness of its Rosenthal
pulp mill and for working capital. In February 2005, the Company also entered into a 23,132 (US$30,000) revolving working capital
facility for the Celgar pulp mill and a 40,000 revolving term credit facility for its Rosenthal
pulp mill. As at March 31, 2005, the Company had drawn a total of 25,483 against these
facilities. 9




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##### 



MERCER INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THREE MONTHS ENDED MARCH 31, 2005 (Unaudited)
(Euros in thousands, except for shares and per share data) Note 4. Acquisition of the Celgar Mill and Related Financings (contd) Pro Forma Financial Summary (Unaudited) The following pro forma financial summary is presented as if the acquisition of the Celgar pulp
mill was completed as of January 1, 2005 and 2004. The pro forma combined results are not
necessarily indicative of the actual results that would have occurred had the acquisition been
consummated on those dates, or of the future operations of the combined entities. Three Months EndedMarch 31,2005
    
    
    2004Total revenues
    
    
    119,616
    
    
    
    98,245Net loss
    
    
    (28,485
    )
    
    
    (24,826
    )Loss from continuing operations per share:Basic and diluted
    
    
    (0.86
    )
    
    
    (0.77
    )
 Note 5. Business Segment Information The Company operates in two reportable business segments: pulp and paper. The segments are managed
separately because each business requires different production and marketing strategies. The
results of the Celgar mill presented below are from the date of its acquisition on February 14,
2005. 10




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##### 



MERCER INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THREE MONTHS ENDED MARCH 31, 2005 (Unaudited)
(Euros in thousands, except for shares and per share data) Note 5. Business Segment Information (contd) Summarized financial information concerning the segments is shown in the following table: Corporate,Rosenthal
    
    
    Celgar(1)
    
    
    Stendal
    
    
    Total
    
    
    
    
    
    
    Other and
    
    
    ConsolidatedPulp
    
    
    Pulp
    
    
    Pulp
    
    
    Pulp
    
    
    Paper
    
    
    Eliminations
    
    
    TotalThree Months Ended March 31, 2005Sales to external customers
    
    
    34,096
    
    
    
    7,616
    
    
    
    40,798
    
    
    
    82,510
    
    
    
    15,383
    
    
    
    
    
    
    
    97,893Intersegment net sales
    
    
    
    
    
    
    
    
    
    
    1,554
    
    
    
    1,554
    
    
    
    
    
    
    
    (1,554
    )
    
    
    34,096
    
    
    
    7,616
    
    
    
    42,352
    
    
    
    84,064
    
    
    
    15,383
    
    
    
    (1,554
    )
    
    
    97,893Operating costs
    
    
    25,188
    
    
    
    5,135
    
    
    
    37,135
    
    
    
    67,458
    
    
    
    14,231
    
    
    
    (1,687
    )
    
    
    80,002Depreciation and amortization
    
    
    3,268
    
    
    
    823
    
    
    
    6,681
    
    
    
    10,772
    
    
    
    181
    
    
    
    34
    
    
    
    10,987General and administrative
    
    
    1,901
    
    
    
    1,675
    
    
    
    975
    
    
    
    4,551
    
    
    
    1,236
    
    
    
    2,011
    
    
    
    7,79830,357
    
    
    
    7,633
    
    
    
    44,791
    
    
    
    82,781
    
    
    
    15,648
    
    
    
    358
    
    
    
    98,787Income (loss) from operations
    
    
    3,739
    
    
    
    (17
    )
    
    
    (2,439
    )
    
    
    1,283
    
    
    
    (265
    )
    
    
    (1,912
    )
    
    
    (894
    )Interest expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (19,263
    )Investment income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    175Derivative financial instruments, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,859
    )Foreign exchange gain on debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,297Impairment of investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,645
    )(22,295
    )Loss before income taxes and
minority interest
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (23,189
    )Segment assets
    
    
    349,865
    
    
    
    220,739
    
    
    
    915,178
    
    
    
    1,485,782
    
    
    
    24,911
    
    
    
    20,747
    
    
    
    1,531,440Capital expenditures
    
    
    594
    
    
    
    209
    
    
    
    2,460
    
    
    
    3,263
    
    
    
    850
    
    
    
    23
    
    
    
    4,136Three Months Ended March 31, 2004Sales to external customers
    
    
    35,009
    
    
    
    
    
    
    
    
    
    
    
    35,009
    
    
    
    15,307
    
    
    
    
    
    
    
    50,316Intersegment net sales
    
    
    429
    
    
    
    
    
    
    
    
    
    
    
    429
    
    
    
    
    
    
    
    (429
    )
    
    
    35,438
    
    
    
    
    
    
    
    
    
    
    
    35,438
    
    
    
    15,307
    
    
    
    (429
    )
    
    
    50,316Operating costs
    
    
    25,807
    
    
    
    
    
    
    
    
    
    
    
    25,807
    
    
    
    13,758
    
    
    
    (440
    )
    
    
    39,125Depreciation and amortization
    
    
    5,582
    
    
    
    
    
    
    
    
    
    
    
    5,582
    
    
    
    552
    
    
    
    159
    
    
    
    6,293General and administrative
    
    
    1,988
    
    
    
    
    
    
    
    2,741
    
    
    
    4,729
    
    
    
    1,174
    
    
    
    638
    
    
    
    6,541Flooding grants, less losses and
expenses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    253
    
    
    
    
    
    
    
    25333,377
    
    
    
    
    
    
    
    2,741
    
    
    
    36,118
    
    
    
    15,737
    
    
    
    357
    
    
    
    52,212Income (loss) from operations
    
    
    2,061
    
    
    
    
    
    
    
    (2,741
    )
    
    
    (680
    )
    
    
    (430
    )
    
    
    (786
    )
    
    
    (1,896
    )Interest expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,988
    )Investment income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    934Derivative financial instruments, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (22,445
    )(24,499
    )Loss before income taxes and
minority interest
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (26,395
    )Segment assets
    
    
    369,523
    
    
    
    
    
    
    
    557,672
    
    
    
    927,195
    
    
    
    29,444
    
    
    
    34,679
    
    
    
    991,318Capital expenditures
    
    
    622
    
    
    
    
    
    
    
    67,924
    
    
    
    68,546
    
    
    
    852
    
    
    
    1
    
    
    
    69,399
   (1)
    
    The results of the Celgar pulp mill are from the date of its acquisition on February 14, 2005. 11




---



##### 



MERCER INTERNATIONAL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THREE MONTHS ENDED MARCH 31, 2005 (Unaudited)
(Euros in thousands, except for shares and per share data) Note 6. Inventories March 31, 2005
    
    
    December 31, 2004Raw materials
    
    
    54,012
    
    
    
    38,679Work in process and finished goods
    
    
    27,318
    
    
    
    14,219
    81,330
    
    
    
    52,898
 Note 7. Pension and Other Post-Retirement Plans The newly acquired Celgar pulp mill (see Note 4) maintains defined benefit pension plans and
post-retirement benefit plans for certain employees. Pension expense is based on estimates from the
Companys actuary. Pension contributions for the period from acquisition to March 31, 2005 totaled
159. As the mill was acquired in 2005, there are no comparative amounts included in the quarter
ended March 31, 2004. Three Months Ended March 31, 2005Pension Benefits
    
    
    Post-RetirementBenefitsService cost
    
    
    84
    
    
    
    49Interest cost
    
    
    158
    
    
    
    88Expected return on plan assets
    
    
    (150
    )
    
    
    Net periodic benefit cost
    
    
    92
    
    
    
    137
 Note 8. Derivatives Transactions Three Months Ended March 31,2005
    
    
    2004Realized and unrealized net gain (loss) on interest
rate derivatives
    
    
    49
    
    
    
    (17,466
    )Unrealized net loss on foreign exchange derivatives
    
    
    (4,098
    )
    
    
    (4,979
    )Unrealized gain on natural gas forward supply contract
    
    
    190
    
    
    
    
    (3,859
    )
    
    
    (22,445
    )
 In addition to the derivatives reported in the Companys annual report on Form 10-K for the
year ended December 31, 2004, the Company entered into certain new derivative transactions in the
first three months of 2005. 12




---



##### 



MERCER INTERNATIONAL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THREE MONTHS ENDED MARCH 31, 2005 (Unaudited)
(Euros in thousands, except for shares and per share data) Note 8. Derivatives Transactions (contd) In the first quarter of 2005, Stendal entered into foreign currency derivatives in order to swap
approximately three-quarters of the long-term indebtedness outstanding under the Stendal mills
project loan facility into U.S. dollars as follows: (i) approximately 306,300 was swapped into
U.S. dollars at a rate of 1.2960 with a maturity in October 2017; and (ii) approximately
153,155 was swapped into U.S. dollars at a rate of 1.2990 with a maturity in October 2017.
During the first quarter of 2005, Stendal also entered into a $50,000 currency forward contract at
a rate of 1.3108 with a maturity in February 2006 and a $25,000 currency forward at a rate of
1.3080 with a maturity in September 2005. A net unrealized loss of approximately 4,098 was
recognized in respect of these derivatives in the three months ended March 31, 2005. In April 2005, Stendal entered into foreign currency derivatives in order to swap the balance of
the long-term indebtedness under the Stendal mills project loan facility, being 153,155, into
U.S. dollars at a rate of 1.2799 with a maturity in October 2017. Note 9. Impairment Charges The impairment charge relates to certain available-for-sale securities and a loan receivable from
an investment in a venture company, which in April 2005 proposed to place itself into liquidation.
As a result, management determined to record impairment charges sufficient to reduce its investment
to the net amount estimated to be recovered. 13




---



##### 



MERCER INTERNATIONAL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THREE MONTHS ENDED MARCH 31, 2005 (Unaudited)
(Euros in thousands, except for shares and per share data) Note 10. Restricted Group Supplemental Disclosure The terms of the indenture governing our 9.25% senior unsecured notes requires that we provide the
results of operations and financial condition of Mercer Inc. and our restricted subsidiaries under
the indenture, collectively referred to as the Restricted Group. As at and during the three
months ended March 31, 2005, the Restricted Group was comprised of Mercer Inc., certain holding
subsidiaries and Rosenthal, and the Celgar mill from the date of its acquisition on February 14,
2005. During the three months ended March 31, 2004 and as at December 31, 2004, the Restricted
Group was comprised of Mercer Inc., certain holding subsidiaries and Rosenthal, which was the only
member of the Restricted Group with material operations during this period. We acquired the Celgar
mill in February 2005 and, as a result, its operations for the three months ended March 31, 2004
and financial condition at December 31, 2004 are not included for such periods. The Restricted
Group excludes our paper operations and the Stendal mill. Combined Condensed Balance Sheet March 31, 2005Restricted
    
    
    Unrestricted
    
    
    
    
    
    
    ConsolidatedGroup
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    GroupASSETSCurrent assetsCash and cash equivalents
    
    
    67,457
    
    
    
    46,639
    
    
    
    
    
    
    
    114,096Cash restricted
    
    
    
    
    
    
    70,421
    
    
    
    
    
    
    
    70,421Receivables
    
    
    30,526
    
    
    
    33,532
    
    
    
    
    
    
    
    64,058Inventories
    
    
    45,106
    
    
    
    36,224
    
    
    
    
    
    
    
    81,330Prepaid expenses and other
    
    
    2,666
    
    
    
    2,815
    
    
    
    
    
    
    
    5,481Total current assets
    
    
    145,755
    
    
    
    189,631
    
    
    
    
    
    
    
    335,386Cash restricted
    
    
    
    
    
    
    19,074
    
    
    
    
    
    
    
    19,074Property, plant and equipment
    
    
    390,492
    
    
    
    719,273
    
    
    
    
    
    
    
    1,109,765Other
    
    
    10,049
    
    
    
    4,129
    
    
    
    (752
    )
    
    
    13,426Deferred income tax
    
    
    24,206
    
    
    
    29,583
    
    
    
    
    
    
    
    53,789Due from unrestricted group
    
    
    43,917
    
    
    
    
    
    
    
    (43,917
    )
    
    
    Total assets
    
    
    614,419
    
    
    
    961,690
    
    
    
    (44,669
    )
    
    
    1,531,440LIABILITIESCurrent liabilitiesAccounts payable and accrued expenses
    
    
    36,136
    
    
    
    46,642
    
    
    
    
    
    
    
    82,778Construction costs payable
    
    
    
    
    
    
    67,737
    
    
    
    
    
    
    
    67,737Debt, current portion
    
    
    
    
    
    
    102,269
    
    
    
    
    
    
    
    102,269Total current liabilities
    
    
    36,136
    
    
    
    216,648
    
    
    
    
    
    
    
    252,784Debt, less current portion
    
    
    328,128
    
    
    
    600,675
    
    
    
    
    
    
    
    928,803Due to restricted group
    
    
    
    
    
    
    43,917
    
    
    
    (43,917
    )
    
    
    Unrealized derivatives loss
    
    
    
    
    
    
    79,171
    
    
    
    
    
    
    
    79,171Other
    
    
    19,400
    
    
    
    6,735
    
    
    
    
    
    
    
    26,135Deferred income tax
    
    
    1,773
    
    
    
    2,568
    
    
    
    
    
    
    
    4,341Total liabilities
    
    
    385,437
    
    
    
    949,714
    
    
    
    (43,917
    )
    
    
    1,291,234SHAREHOLDERS EQUITYTotal shareholders equity
    
    
    228,982
    
    
    
    11,976
    
    
    
    (752
    )
    
    
    240,206Total liabilities and shareholders equity
    
    
    614,419
    
    
    
    961,690
    
    
    
    (44,669
    )
    
    
    1,531,440
 14




---



##### 



MERCER INTERNATIONAL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THREE MONTHS ENDED MARCH 31, 2005 (Unaudited)
(Euros in thousands, except for shares and per share data) Note 10. Restricted Group Supplemental Disclosure (contd) Combined Condensed Balance Sheet December 31, 2004Restricted
    
    
    Unrestricted
    
    
    
    
    
    
    ConsolidatedGroup
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    GroupASSETSCurrent assetsCash and cash equivalents
    
    
    45,487
    
    
    
    4,081
    
    
    
    
    
    
    
    49,568Cash restricted
    
    
    
    
    
    
    45,295
    
    
    
    
    
    
    
    45,295Receivables
    
    
    21,791
    
    
    
    33,060
    
    
    
    (164
    )
    
    
    54,687Inventories
    
    
    13,911
    
    
    
    38,987
    
    
    
    
    
    
    
    52,898Prepaid expenses and other
    
    
    1,995
    
    
    
    2,966
    
    
    
    
    
    
    
    4,961Total current assets
    
    
    83,184
    
    
    
    124,389
    
    
    
    (164
    )
    
    
    207,409Cash restricted
    
    
    28,464
    
    
    
    19,074
    
    
    
    
    
    
    
    47,538Property, plant and equipment
    
    
    213,678
    
    
    
    722,394
    
    
    
    (37
    )
    
    
    936,035Other
    
    
    5,936
    
    
    
    4,212
    
    
    
    
    
    
    
    10,148Deferred income tax
    
    
    26,592
    
    
    
    27,927
    
    
    
    
    
    
    
    54,519Due from unrestricted group
    
    
    43,467
    
    
    
    
    
    
    
    (43,467
    )
    
    
    Total assets
    
    
    401,321
    
    
    
    897,996
    
    
    
    (43,668
    )
    
    
    1,255,649LIABILITIESCurrent liabilitiesAccounts payable and accrued expenses
    
    
    19,615
    
    
    
    37,091
    
    
    
    (164
    )
    
    
    56,542Construction costs payable
    
    
    
    
    
    
    65,436
    
    
    
    
    
    
    
    65,436Debt, current portion
    
    
    15,089
    
    
    
    92,001
    
    
    
    
    
    
    
    107,090Total current liabilities
    
    
    34,704
    
    
    
    194,528
    
    
    
    (164
    )
    
    
    229,068Debt, less current portion
    
    
    224,542
    
    
    
    552,730
    
    
    
    
    
    
    
    777,272Due to restricted group
    
    
    
    
    
    
    43,467
    
    
    
    (43,467
    )
    
    
    Unrealized interest rate derivative
    
    
    
    
    
    
    75,471
    
    
    
    
    
    
    
    75,471Other
    
    
    1,878
    
    
    
    7,157
    
    
    
    
    
    
    
    9,035Deferred income tax
    
    
    1,719
    
    
    
    343
    
    
    
    
    
    
    
    2,062Total liabilities
    
    
    262,843
    
    
    
    873,696
    
    
    
    (43,631
    )
    
    
    1,092,908SHAREHOLDERS EQUITYTotal shareholders equity
    
    
    138,478
    
    
    
    24,300
    
    
    
    (37
    )
    
    
    162,741Total liabilities and shareholders equity
    
    
    401,321
    
    
    
    897,996
    
    
    
    (43,668
    )
    
    
    1,255,649
 15




---



##### 



MERCER INTERNATIONAL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THREE MONTHS ENDED MARCH 31, 2005 (Unaudited)
(Euros in thousands, except for shares and per share data) Note 10. Restricted Group Supplemental Disclosure (contd) Combined Condensed Statement of Operations March 31, 2005Restricted
    
    
    Unrestricted
    
    
    
    
    
    
    ConsolidatedGroup
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    GroupRevenues
    
    
    41,712
    
    
    
    56,181
    
    
    
    
    
    
    
    97,893Operating costs
    
    
    29,973
    
    
    
    50,029
    
    
    
    
    
    
    
    80,002Operating depreciation and amortization
    
    
    4,125
    
    
    
    6,645
    
    
    
    217
    
    
    
    10,987General and administrative
    
    
    5,587
    
    
    
    2,211
    
    
    
    
    
    
    
    7,79839,685
    
    
    
    58,885
    
    
    
    217
    
    
    
    98,787Income (loss) from operations
    
    
    2,027
    
    
    
    (2,704
    )
    
    
    (217
    )
    
    
    (894
    )Other income (expense)Interest expense
    
    
    (7,671
    )
    
    
    (11,986
    )
    
    
    394
    
    
    
    (19,263
    )Investment income
    
    
    328
    
    
    
    309
    
    
    
    (462
    )
    
    
    175Derivative financial instruments, net
    
    
    (105
    )
    
    
    (3,754
    )
    
    
    
    
    
    
    (3,859
    )Foreign exchange gain on debt
    
    
    2,297
    
    
    
    
    
    
    
    
    
    
    
    2,297Impairment of investments
    
    
    (1,178
    )
    
    
    
    
    
    
    (467
    )
    
    
    (1,645
    )Total other expense
    
    
    (6,329
    )
    
    
    (15,431
    )
    
    
    (535
    )
    
    
    (22,295
    )Loss before income taxes and
minority interest
    
    
    (4,302
    )
    
    
    (18,135
    )
    
    
    (752
    )
    
    
    (23,189
    )Income tax provision
    
    
    (3,115
    )
    
    
    80
    
    
    
    
    
    
    
    (3,035
    )Loss before minority interest
    
    
    (7,417
    )
    
    
    (18,055
    )
    
    
    (752
    )
    
    
    (26,224
    )Minority interest
    
    
    
    
    
    
    6,557
    
    
    
    
    
    
    
    6,557Net loss
    
    
    (7,417
    )
    
    
    (11,498
    )
    
    
    (752
    )
    
    
    (19,667
    )
 16




---



##### 



MERCER INTERNATIONAL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THREE MONTHS ENDED MARCH 31, 2005 (Unaudited)
(Euros in thousands, except for shares and per share data) Note 10. Restricted Group Supplemental Disclosure (contd) Combined Condensed Statement of Operations March 31, 2004Restricted
    
    
    Unrestricted
    
    
    
    
    
    
    ConsolidatedGroup
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    GroupRevenues
    
    
    35,438
    
    
    
    15,307
    
    
    
    (429
    )
    
    
    50,316Operating costs
    
    
    25,357
    
    
    
    13,758
    
    
    
    10
    
    
    
    39,125Operating depreciation and amortization
    
    
    5,582
    
    
    
    552
    
    
    
    159
    
    
    
    6,293General and administrative
    
    
    3,114
    
    
    
    3,915
    
    
    
    (488
    )
    
    
    6,541Flooding grants, less losses and expenses
    
    
    
    
    
    
    253
    
    
    
    
    
    
    
    25334,053
    
    
    
    18,478
    
    
    
    (319
    )
    
    
    52,212Income (loss) from operations
    
    
    1,385
    
    
    
    (3,171
    )
    
    
    (110
    )
    
    
    (1,896
    )Other income (expense)Interest expense
    
    
    (4,076
    )
    
    
    (566
    )
    
    
    1,654
    
    
    
    (2,988
    )Investment income
    
    
    1,106
    
    
    
    150
    
    
    
    (322
    )
    
    
    934Derivative financial instruments, net
    
    
    (4,890
    )
    
    
    (17,555
    )
    
    
    
    
    
    
    (22,445
    )Total other income (expense)
    
    
    (7,860
    )
    
    
    (17,971
    )
    
    
    1,332
    
    
    
    (24,499
    )Income (loss) before income taxes and
minority interest
    
    
    (6,475
    )
    
    
    (21,142
    )
    
    
    1,222
    
    
    
    (26,395
    )Income tax benefit
    
    
    
    
    
    
    20
    
    
    
    
    
    
    
    20Income (loss) before minority interest
    
    
    (6,475
    )
    
    
    (21,122
    )
    
    
    1,222
    
    
    
    (26,375
    )Minority interest
    
    
    
    
    
    
    7,409
    
    
    
    
    
    
    
    7,409Net income (loss)
    
    
    (6,475
    )
    
    
    (13,713
    )
    
    
    1,222
    
    
    
    (18,966
    )
 17




---



##### 



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS In this document: (i) unless the context otherwise requires, references to we, our, us, the
Company or Mercer mean Mercer International Inc. and its subsidiaries; (ii) references to
Mercer Inc. mean the Company excluding its subsidiaries; (iii) information is provided as of
March 31, 2005, unless otherwise stated; (iv) all references to monetary amounts are to Euros,
the lawful currency adopted by most members of the European Union, unless otherwise stated; (v)
 refers to Euros; and (vi) ADMTs refers to air-dried metric tonnes. The following discussion and analysis of our results of operations and financial condition for the
three months ended March 31, 2005 should be read in conjunction with our consolidated financial
statements and related notes included in this quarterly report, as well as our most recent annual
report on Form 10-K for the fiscal year ended December 31, 2004 filed with the Securities and
Exchange Commission (the SEC). Certain reclassifications have been made to the prior period
financial statements to conform with the current period presentation. Results of Operations On February 14, 2005, we completed the acquisition, referred to as the Acquisition, of the Celgar
NBSK pulp mill and its results are included from the date of the Acquisition. In conjunction with
the Acquisition, we publicly sold $310 million in principal amount of 9.25% senior notes maturing
in 2013 and an aggregate of approximately $91 million of our shares of beneficial interest
(including those issued upon the exercise of the underwriters over-allotment option) and
refinanced all of the bank indebtedness of our Rosenthal mill. Effective upon the completion of the
Acquisition, we also established two new revolving credit facilities for the Rosenthal and Celgar
mills. Selected sales data for the three months ended March 31, 2005 and 2004 is as follows: Three Months Ended March 31,2005
    
    
    2004(ADMTs)Sales Volume by Product ClassPulp sales volume by mill:Rosenthal
    
    
    78,804
    
    
    
    81,493Stendal
    
    
    102,073
    
    
    
    Celgar
    
    
    18,347
    
    
    
    Total pulp sales volume(1)
    
    
    199,224
    
    
    
    81,493Paper sales volume
    
    
    16,638
    
    
    
    17,406Total sales volume(1)
    
    
    215,862
    
    
    
    98,899
 18




---



##### 



Three Months Ended March 31,2005
    
    
    2004(in thousands)
(unaudited)Revenues by Product ClassPulp revenues by mill:Rosenthal
    
    
    34,096
    
    
    
    35,009Stendal
    
    
    40,798
    
    
    
    Celgar
    
    
    7,616
    
    
    
    Total pulp revenues(1)
    
    
    82,510
    
    
    
    35,009Paper revenues
    
    
    15,383
    
    
    
    15,307Total revenues(1)
    
    
    97,893
    
    
    
    50,316
   (1)
    
    Excluding intercompany sales volumes of 3,489 and 1,009 ADMTs of pulp and intercompany net
sales revenues of approximately 1.6 million and 0.4 million in the three months ended
March 31, 2005 and 2004, respectively. Selected production data for the three months ended March 31, 2005 and 2004 is as follows: Three Months Ended March 31,2005
    
    
    2004(ADMTs)Production by Product ClassPulp production by mill:Rosenthal
    
    
    75,872
    
    
    
    79,067Stendal
    
    
    107,981
    
    
    
    Celgar
    
    
    60,762
    
    
    
    Total pulp production
    
    
    244,615
    
    
    
    79,067Paper production
    
    
    15,958
    
    
    
    17,068Total production
    
    
    260,573
    
    
    
    96,135
 Three Months Ended March 31, 2005 Compared to Three Months Ended March 31, 2004 Revenues for the three months ended March 31, 2005 increased to 97.9 million from 50.3
million in the comparative period of 2004, primarily because of higher pulp sales resulting from
the inclusion of sales from our Stendal mill. In the three months ended March 31, 2005, the Stendal
mill sold 102,073 ADMTs of NBSK pulp and had sales of 40.8 million. Pulp sales from the Celgar
mill for the quarter were well below customary levels as we rebuilt the finished goods inventory at
the mill, which we did not purchase as part of its Acquisition, and we operated the mill for only
six weeks. Cost of sales and general, administrative and other expenses in the first quarter of 2005 increased
to 98.8 million from 52.2 million in the comparative period of 2004, primarily as a result
of the inclusion of production from our Stendal mill and the operations of the Celgar mill. For the 2005 first quarter, revenues from our pulp operations increased to 84.1 million from
35.4 million in the same period a year ago, primarily as a result of the inclusion of
production from our Stendal mill and higher pulp prices. List prices for NBSK pulp in Europe were
approximately 490 ($642) per ADMT in the first quarter of 2005, approximately 464 ($580)
per ADMT in the first quarter of last year and approximately 466 ($603) in the fourth quarter
of 2004. The increase in NBSK pulp prices was partially offset by the overall weakness of the U.S.
dollar versus the Euro. Pulp sales by volume were 199,224 ADMTs in the current quarter, 81,493
ADMTs in the comparative quarter of 2004 and 192,254 ADMTs in the fourth quarter of last year. Pulp sales realizations decreased to 409 per ADMT on average in the 2005 first quarter from
416 per ADMT in the 2004 first quarter, primarily as a result of lower price realizations of
the 19




---



##### 



Stendal mill during the quarter when it sold pulp at a discounted price as a result of its start
up. We expect that such discount will be eliminated during the year. In the 2005 first quarter,
producers generally were affected by higher discounts to pulp list prices than previously. Cost of sales and general, administrative and other expenses for the pulp operations increased to
82.8 million in the 2005 first quarter from 36.1 million in the first quarter of 2004,
primarily as a result of the inclusion of 37.1 million of operating costs related to the
Stendal mill and the operations of the Celgar mill. Depreciation for the pulp operations increased to 10.8 million in the current quarter, from
5.6 million in the first quarter of 2004, primarily as a result of the inclusion of 6.7
million of depreciation from the Stendal mill, partially offset by lower depreciation at the
Rosenthal mill. For the first quarter of 2005, our pulp operations generated operating income of 1.3 million,
versus an operating loss of 0.7 million in the first quarter of 2004, primarily as a result of
lower operating, depreciation and other costs at our Rosenthal mill. Revenues from our paper operations in the current quarter were 15.4 million, compared with
15.3 million in the same period of last year. For the first quarter of 2005, total paper sales
volumes were 16,638 ADMTs, versus 17,406 ADMTs in the first quarter of 2004 primarily as a result
of a shift in the product mix at our paper mills. Average prices realized on our paper products in
the current quarter increased slightly, reflecting the shift in the product mix. Cost of sales and general, administrative and other expenses for the paper operations in the first
quarter of 2005 decreased slightly to 15.6 million from 15.7 million in the comparative
quarter of 2004. For the 2005 first quarter, our paper operations generated an operating loss of 0.3 million,
compared to an operating loss of 0.4 million in the first quarter of 2004. In the first quarter of 2005, we had a loss from operations of 0.9 million, compared to 1.9
million in the same period last year, primarily as a result of
operating losses from our Stendal mill. Interest expense in the first quarter of 2005 increased to 19.3 million from 3.0 million in
the year ago period, due to interest expense of 11.8 million relating to the Stendal mill and
higher borrowings resulting primarily from our $310 million senior note issue in February 2005. In
the first quarter of 2004, almost all of the interest associated with the Stendal mill was
capitalized. In the first quarter of 2005, Stendal entered into certain foreign currency derivatives to swap a
portion of its long-term bank indebtedness from Euros to U.S. dollars and certain currency forwards
and we recorded a net non-cash holding loss of 4.1 million before minority interests upon the
marked to market valuation of such derivatives due to the strengthening of the U.S. dollar versus
the Euro at the end of the quarter. In the first quarter of 2004, we recorded a net non-cash
holding loss of 5.0 million before minority interests on the then outstanding currency
derivatives of Rosenthal and Stendal. In the first quarter of 2005, we also recorded a marginal net
gain before minority interests on the marked to market valuation of the Stendal interest rate
derivatives and settlement of the Rosenthal interest rate derivatives versus a net non-cash holding
loss thereon of 17.5 million before minority interests in the first quarter of 2004. See
Quantitative and Qualitative Disclosures About Market Risk for more information about our
derivatives. 20




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##### 



In the first quarter of 2005, minority interest, representing the two minority shareholders
proportionate interest in the Stendal mill, was 6.6 million, compared to 7.4 million in the
first quarter of 2004. On May 6, 2005, our management determined to record, and our Audit Committee approved, an
adjustment of 1.6 million for the non-cash impact of other-than-temporary impairment losses on
our available-for-sale securities and a loan receivable that relate to an investment in a venture
company, which is a legacy investment that we have held since approximately 1996. In April 2005,
the venture company proposed to place itself into liquidation. As a result, management determined
to record impairment charges sufficient to reduce its investment to the net amount estimated to be
recovered. We do not currently expect the impairment charge to result in any future cash
expenditures. We reported a net loss for the first quarter of 2005 of 19.7 million, or 0.77 per basic and
diluted share, which reflected interest expense related to our Stendal mill of 11.8 million,
the net losses on our derivatives of
3.9 million
and the non-cash impairment charge of 1.6 million relating to investments. In the first quarter
of 2004, we reported a net loss of 19.0 million, or 1.11 per basic and diluted share. We generated Operating
EBITDA of
10.1 million and 4.4 million in the three months ended
March 31, 2005 and 2004, respectively. Operating EBITDA is defined as income (loss) from operations
plus depreciation and amortization and non-recurring capital asset impairment charges. Operating
EBITDA is calculated by adding depreciation and amortization and non-recurring capital asset
impairment charges of 11.0 million and 6.3 million to the loss from operations of 0.9
million and 1.9 million for the three months ended March 31, 2005 and 2004, respectively. Management uses Operating EBITDA as a benchmark measurement of its own operating results, and as a
benchmark relative to its competitors. Management considers it to be a meaningful supplement to
operating income as a performance measure primarily because depreciation expense and non-recurring
capital asset impairment charges are not an actual cash cost, and depreciation expense varies
widely from company to company in a manner that management considers largely independent of the
underlying cost efficiency of their operating facilities. In addition, we believe Operating EBITDA
is commonly used by securities analysts, investors and other interested parties to evaluate our
financial performance. Operating EBITDA does not reflect the impact of a number of items that affect our net income
(loss), including financing costs and the effect of derivative instruments. Operating EBITDA is not
a measure of financial performance under GAAP, and should not be considered as an alternative to
net income (loss) or income (loss) from operations as a measure of performance, nor as an
alternative to net cash from operating activities as a measure of liquidity. Operating EBITDA has significant limitations as an analytical tool, and should not be considered in
isolation, or as a substitute for analysis of our results as reported under GAAP. Some of these
limitations are that Operating EBITDA does not reflect: (i) our cash expenditures, or future
requirements, for capital expenditures or contractual commitments; (ii) changes in, or cash
requirements for, working capital needs; (iii) the significant interest expense, or the cash
requirements necessary to service interest or principal payments, on our outstanding debt; (iv)
minority interests on our Stendal NBSK pulp mill operations; (v) the impact of realized or 21




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##### 



marked to market changes in our derivative positions, which can be substantial; and (vi) the impact
of impairment charges against our investments or assets. Because of these limitations, Operating
EBITDA should only be considered as a supplemental performance measure and should not be considered
as a measure of liquidity or cash available to us to invest in the growth of our business. See the
Statement of Cash Flows set out in our consolidated financial statements included herein. Because
all companies do not calculate Operating EBITDA in the same manner, Operating EBITDA as calculated
by us may differ from Operating EBITDA or EBITDA as calculated by other companies. We compensate
for these limitations by using Operating EBITDA as a supplemental measure of our performance and
relying primarily on our GAAP financial statements. The following table provides a reconciliation of net loss to loss from operations and Operating
EBITDA for the periods indicated: Three Months EndedMarch 31,2005
    
    
    2004(in thousands)(unaudited)Net loss
    
    
    (19,667
    )
    
    
    (18,966
    )Minority interest
    
    
    (6,557
    )
    
    
    (7,409
    )Income taxes (benefit)
    
    
    3,035
    
    
    
    (20
    )Interest expense
    
    
    19,263
    
    
    
    2,988Investment income
    
    
    (175
    )
    
    
    (934
    )Derivative financial instruments, net
    
    
    3,859
    
    
    
    22,445Foreign exchange gain on debt
    
    
    (2,297
    )
    
    
    Impairment of investments
    
    
    1,645
    
    
    
    Loss from operations
    
    
    (894
    )
    
    
    (1,896
    )Add: Depreciation and amortization
    
    
    10,987
    
    
    
    6,293Operating EBITDA
    
    
    10,093
    
    
    
    4,397
 Liquidity and Capital Resources The following table is a summary of selected financial information for the periods indicated: As at
    
    
    As atMarch 31,
    
    
    December 31,2005
    
    
    2004(in thousands)(unaudited)Financial PositionCash and cash equivalents
    
    
    114,096
    
    
    
    49,568Working capital (deficit)
    
    
    82,602
    
    
    
    (21,659
    )Property, plant and equipment
    
    
    1,109,765
    
    
    
    936,035Total assets
    
    
    1,531,440
    
    
    
    1,255,649Long-term liabilities
    
    
    1,038,450
    (1)
    
    
    863,840Shareholders equity
    
    
    240,206
    
    
    
    162,741
   (1)
    
    Includes 25.5 million outstanding under the revolving credit facilities for the Rosenthal
and Celgar mills. At March 31, 2005, our cash and cash equivalents were 114.1 million, compared to 49.6
million at December 31, 2004. We also had 70.4 million of cash restricted to pay current
Stendal construction costs payable of 67.7 million at March 31, 2005. We also had 19.1
million of cash restricted in a debt service account for the project financing for the Stendal
mill. At March 31, 2005, we qualified for investment grants related to the Stendal mill totaling
approximately 65.9 million, and expect to qualify for additional investment grants totaling 22




---



##### 



22.6 million, from the federal and state governments of Germany, which we expect to receive in
2005. These grants, when received, will be applied to repay the amounts drawn under the current
portion of a dedicated tranche of the project loan facility relating to the Stendal mill, or the
Stendal Loan Facility. Under our accounting policies, we do not record these grants until they
are received. The grants are not reported in our income and reduce the cost basis of the assets
purchased when they are received. The balance outstanding under such dedicated tranche of the
Stendal Loan Facility will be substantially paid from VAT credits we expect to receive in the
ordinary course. We expect to meet our interest and debt service expenses and the working and maintenance capital
requirements for our operations (other than at Stendal) from cash flow from operations, cash on
hand and the two new credit facilities for the Rosenthal and Celgar mills established in February
2005. We expect to meet the capital requirements for the Stendal mill, including working capital
and potential losses during start-up, through shareholder advances already made to Stendal, the
Stendal Loan Facility (which includes a revolving working capital tranche), the receipt of
government grants, cash on hand and cash flow from operations. Operating Activities Operating activities in the current quarter used cash of 2.3 million, compared to providing
cash of 8.5 million in the comparative period of 2004. An increase in receivables due primarily
to higher sales in the current quarter used cash of 9.6 million in the first quarter of 2005,
compared to a decrease in receivables providing cash of 4.0 million in the comparative quarter
of 2004. An increase in inventories due primarily to the build up of finished goods at the Celgar
mill and higher fiber levels at the Stendal mill related to its start up used cash of 8.5
million in the first quarter of 2005, compared to 3.0 million in the first quarter of 2004. An
increase in accounts payable and accrued expenses provided cash of 24.6 million in the current
period, compared to 6.0 million in the comparative period of 2004, primarily due to higher
production. Investing Activities Investing activities in the three months ended March 31, 2005 used cash of 150.4 million, of
which 146.3 million related to the acquisition of the Celgar pulp mill. The acquisition of
properties, net of investment grants used cash of 4.1 million in the current quarter.
Investing activities used cash of
50.0 million in the three months ended March 31, 2004,
primarily relating to the Stendal mill. We qualify for investment grants from the federal and state governments of Germany and had claim
expenditures of 65.9 million outstanding as of March 31, 2005. We expect to receive our
currently outstanding claim expenditures in 2005. In accordance with our accounting policies, we do
not record these grants until they are received. These grants reduce the cost basis of the assets
purchased with them. Financing Activities Financing activities provided cash of 215.5 million in the three months ended March 31, 2005.
In connection with the acquisition of the Celgar pulp mill, a net increase in indebtedness provided
cash of 144.4 million, the issuance of shares of beneficial interest provided cash of 66.6
million and a decrease in restricted cash provided cash of 3.3 million in the current period.
We fully repaid the project loan facility relating to the Rosenthal mill, or the Rosenthal 23




---



##### 



Loan Facility, and indebtedness relating to the landfill at the Rosenthal mill in February 2005
from the proceeds of the share and senior note offerings in connection with the Acquisition. An
increase in construction costs payable provided cash of 2.3 million in the current period.
Financing activities provided cash of 37.6 million in the three months ended March 31, 2004,
primarily related to the Stendal mill. As at March 31, 2005, we had utilized the entire 4.7 million available under the five credit
facilities relating to the paper operations. In addition, at March 31, 2005, we had drawn down
approximately 20.0 million of the 40.0 million available under the new revolving term
credit facility relating to the Rosenthal mill and 5.5 million of the $30 million available
under the new revolving credit facility relating to the Celgar mill. We have no material commitments to acquire assets or operating businesses. We anticipate that there
will be acquisitions of businesses or commitments to projects in the future. To achieve our
long-term goals of expanding our asset and earnings base through the acquisition of interests in
companies and assets in the pulp and paper and related businesses, and organically through high
return capital expenditures at our operating facilities, we will require substantial capital
resources. The required necessary resources for such long-term goals will be generated from cash
flow from operations, cash on hand, the sale of securities and/or assets, and borrowing against our
assets. In addition, we have amounts available under a revolving tranche of the Stendal Loan Facility, and
the two new revolving credit facilities established for the Rosenthal and Celgar mills in February
2005. Contractual Obligations and Commitments The following table sets out our contractual obligations and commitments as at March 31, 2005 in
connection with our long-term liabilities, including the obligations and commitments incurred in
connection with the Acquisition of the Celgar mill. Payments Due By PeriodContractual Obligations
    
    2005*
    
    
    2006-2007
    
    
    2008-2009
    
    
    Beyond 2009
    
    
    Total(in thousands)
(unaudited)Long-term debt(1)
    
    
    102,220
    
    
    
    45,072
    
    
    
    66,599
    
    
    
    817,181
    
    
    
    1,031,072Capital
lease obligations(2)
    
    
    2,972
    
    
    
    8,772
    
    
    
    1,664
    
    
    
    44
    
    
    
    13,452Operating
lease obligations(3)
    
    
    1,044
    
    
    
    1,612
    
    
    
    269
    
    
    
    193
    
    
    
    3,118Purchase
obligations(4)
    
    
    141,898
    
    
    
    91,249
    
    
    
    32,248
    
    
    
    7,718
    
    
    
    273,113Other
long-term liabilities(5)
    
    
    1,836
    
    
    
    2,642
    
    
    
    1,631
    
    
    
    10,513
    
    
    
    16,622Total
    
    
    249,970
    
    
    
    149,347
    
    
    
    102,411
    
    
    
    835,649
    
    
    
    1,337,377
   *
    
    After March 31, 2005.(1)
    
    This reflects principal only primarily related to
indebtedness at our Rosenthal, Stendal and Celgar
mills, including under the senior notes issued in February 2005, the
Stendal Loan Facility and convertible notes, and credit facilities
relating to the paper mills. During the 2005 first quarter, we
repaid the Rosenthal Loan Facility and indebtedness relating to the
landfill at the Rosenthal mill. See the notes to our financial statements included herein and in
our Annual Report on Form 10-K for the year ended December 31, 2004 filed with the SEC for a
description of such indebtedness. Does not include
amounts associated with derivatives entered into in connection with the Stendal Loan Facility.
See Quantitative and Qualitative Disclosure about Market Risk for information about our
derivatives.(2)
    
    Capital lease obligations relate to transportation vehicles and production equipment. These
amounts reflect principal and interest.(3)
    
    Operating lease obligations relate to transportation vehicles and other production and office
equipment. 24




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##### 



(4)
    
    Purchase obligations relate primarily to take-or-pay contracts made in the ordinary course of
business, of which purchases of raw materials and supplies totaled approximately 249.4
million.(5)
    
    Other long-term liabilities relate primarily to pension liability. Does not include
obligations under employment agreements. Capital Resources In addition to our new revolving credit facilities for the Rosenthal and Celgar mills and the
revolving working capital tranche of the Stendal Loan Facility, respectively, we may seek to raise
future funding in the debt markets if our indenture relating to our 9.25% senior notes permits,
subject to compliance with the indenture. The indenture governing the senior notes contains various
restrictive covenants, including several that are based on a formulation of the financial measure
EBITDA, which is net income (loss) adjusted to exclude interest, taxes, depreciation and
amortization, certain non-cash charges and extraordinary or otherwise unusual gains or losses, and
certain other items. We refer to this formulation of EBITDA as Indenture EBITDA which is defined
in the senior note indenture as Consolidated EBITDA. The indenture governing the senior notes provides that, in order for Mercer Inc. and its restricted
subsidiaries (as defined in the indenture and which excludes the Stendal mill and our paper
operations) to enter into certain types of transactions, including the incurrence of additional
indebtedness, the making of restricted payments and the completion of mergers and consolidations
(other than, in each case, those specifically permitted by our senior note indenture), we must meet
a minimum ratio of Indenture EBITDA to Fixed Charges as defined in the senior note indenture of 2.0
to 1.0 on a pro forma basis for the most recently ended four full fiscal quarters. This ratio is
referred to and defined as the Fixed Charge Coverage Ratio in the senior note indenture. Our Acquisition of the Celgar mill in February 2005 was a significant transaction for us that has
materially impacted our results of operations and financial condition. The Acquisition will impact
the ability of Mercer Inc. and its restricted subsidiaries under the indenture governing the senior
notes to make distributions and incur additional indebtedness in the future beyond our revolving
credit facilities and certain permitted borrowings under the indenture, and, in that regard, we and
our restricted subsidiaries will be required to meet the Fixed Charge Coverage Ratio. As at March
31, 2005, Mercer Inc. and our restricted subsidiaries under the indenture governing the senior
notes did not meet the Fixed Charge Coverage Ratio of 2.0 to 1.0 as set out in the senior note
indenture. As a result, as at March 31, 2005, Mercer Inc. and its restricted subsidiaries were not
able to make certain distributions and incur additional indebtedness beyond our revolving credit
facilities except as permitted under the indenture. Foreign Currency Effective January 1, 2002, we changed our reporting currency from the U.S. dollar to the Euro as a
significant majority of our business transactions are originally denominated in Euros. By adopting
the Euro, most cumulative foreign currency translation losses were eliminated. However, we hold
certain assets and liabilities in U.S. dollars, Swiss francs and in Canadian dollars. Accordingly,
our consolidated financial results are subject to foreign currency exchange rate fluctuations. We translate foreign denominated assets and liabilities into Euros at the rate of exchange on the
balance sheet date. Unrealized gains or losses from these translations are recorded in our 25




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##### 



consolidated statement of comprehensive income and impact on shareholders equity on the balance
sheet but do not affect our net earnings. In the three months ended March 31, 2005, we reported a net 0.6 million foreign exchange
translation loss and, as a result, the cumulative foreign exchange translation gain decreased to
9.8 million at March 31, 2005 from 10.4 million at December 31, 2004. Based upon the exchange rate at March 31, 2005, the U.S. dollar decreased by approximately 6.5% in
value against the Euro since March 31, 2004. See Quantitative and Qualitative Disclosures about
Market Risk. Results of Operations of the Restricted Group Under Our Senior Note Indenture The indenture governing our 9.25% senior notes requires that we also provide a discussion in annual
and quarterly reports we file with the SEC under Managements Discussion and Analysis of Financial
Condition and Results of Operations of the results of operations and financial condition of Mercer
Inc. and our restricted subsidiaries under the indenture, referred to as the Restricted Group. As
at and during the three months ended March 31, 2005, the Restricted Group was comprised of Mercer
Inc., certain holding subsidiaries and Rosenthal, and the Celgar mill from February 14, 2005, the
date of the Acquisition of the mill. During the three months ended March 31, 2004 and as at
December 31, 2004, the Restricted Group was comprised of Mercer Inc., certain holding subsidiaries
and Rosenthal, which was the only member of the Restricted Group with material operations during
such period. As we acquired the Celgar pulp mill in February 2005, its results of operations and
financial condition are not included in the discussion relating to our Restricted Group for the
three months ended March 31, 2004 and as at December 31, 2004. The Restricted Group excludes our
paper operations and our Stendal mill. The following is a discussion of the results of operations and financial condition of the
Restricted Group. For further information regarding the operating results of the Rosenthal and
Celgar mills, see Note 5 of our quarterly financial statements included herein. For further
information regarding the Restricted Group including, without limitation, a reconciliation to our
consolidated results of operations, see Note 10 of our quarterly financial statements included
herein. Restricted Group Results   Three Months Ended March 31, 2005 Compared to Three Months Ended March
31, 2004 Total revenues for the Restricted Group for the three months ended March 31, 2005 increased to
41.7 million from 35.4 million in the comparative period of 2004, primarily because of the
inclusion of the pulp sales from the Celgar mill. Pulp sales realizations for the Restricted Group
increased to 422 per ADMT on average in the three months ended March 31, 2005 from 416 per
ADMT in the comparative period of 2004, primarily as a result of higher prices. The increase in
NBSK pulp prices was partially offset by the overall weakness of the U.S. dollar versus the Euro. Costs of sales and general, administrative and other expenses for the Restricted Group in the three
months ended March 31, 2005 increased to 39.7 million from 34.1 million in the comparative
period of 2004, primarily as a result of the inclusion of the results of the Celgar mill, partially
offset by lower production costs at the Rosenthal mill. 26




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##### 



Depreciation for the Restricted Group decreased to 4.1 million in the current period from
5.6 million in the comparative period of 2004, primarily as a result of a change in our
depreciation estimate in respect of the Rosenthal mill effective July 1, 2004, which resulted in a
decrease of 2.7 million in cost of sales for the Restricted Group for the three months ended
March 31, 2005. In the first quarter of 2005, the Restricted Group reported income from operations of 2.0
million, compared to 1.4 million in the first quarter of 2004. Interest expense for the
Restricted Group in the three months ended March 31, 2005 increased to 7.7 million from 4.1
million in the year ago period, primarily due to higher borrowings resulting from our $310 million
senior note offering in February 2005. On May 6, 2005, our management determined to record, and our Audit Committee approved, a non-cash
impairment charge of 1.2 million related to an investment in a venture company, which is the
last of a legacy investment that we have held since approximately 1996. The venture company has
proposed to place itself into liquidation and, as a result, management determined to record
impairment charges sufficient to reduce its investment to the net amount expected to be recovered.
We do not currently expect to incur any future cash expenditures related thereto. In the three months ended March 31, 2005, the Restricted Group recorded a net loss of 0.3
million on the settlement of the Rosenthal interest rate derivatives, versus a net non-cash holding
loss of 0.1 million on the marked to market valuation thereon in the comparative period of
2004. In the three months ended March 31, 2004, the Restricted Group recorded a net non-cash
holding loss of 4.8 million upon the marked to market valuation of the then outstanding
currency derivatives relating to the Rosenthal mill. The Restricted Group did not have any currency
derivatives outstanding during the first quarter of 2005 that materially affected its results. The Restricted Group reported a net loss for the three months ended March 31, 2005 of 7.4
million, which reflected higher interest expense of 7.7 million and the non-cash impairment
charge of 1.2 million on investments. In the first quarter of 2004, the Restricted Group
reported a net loss of 6.5 million. The Restricted Group generated Operating EBITDA of 6.2 million and 7.0 million in the
three months ended March 31, 2005 and 2004, respectively. Operating EBITDA is defined as income
(loss) from operations plus depreciation and amortization and non-recurring capital asset
impairment charges. Operating EBITDA for the Restricted Group is calculated by adding depreciation
and amortization and non-recurring capital asset impairment charges of 4.1 million and 5.6
million to the income from operations of 2.0 million and 1.4 million for the three months
ended March 31, 2005 and 2004, respectively. Operating EBITDA has significant limitations as an analytical tool, and should not be considered in
isolation, or as a substitute for analysis of our results as reported under GAAP. See the
discussion of Mercers results for the quarter ended March 31, 2005 for additional information
relating to such limitations and Operating EBITDA. 27




---



##### 



The following table provides a reconciliation of net loss to income from operations and Operating
EBITDA for the Restricted Group for the periods indicated: Three Months EndedMarch 31,2005
    
    
    2004(in
thousands)(unaudited)Restricted Group(1)(2)Net loss
    
    
    (7,417
    )
    
    
    (6,475
    )Income taxes
    
    
    3,115
    
    
    
    Interest expense
    
    
    7,671
    
    
    
    4,076Investment and other income
    
    
    (328
    )
    
    
    (1,106
    )Derivative financial instruments, net
    
    
    105
    
    
    
    4,890Foreign exchange gain on debt
    
    
    (2,297
    )
    
    
    Impairment of investments
    
    
    1,178
    
    
    
    Income from operations
    
    
    2,027
    
    
    
    1,385Add: Depreciation and amortization
    
    
    4,125
    
    
    
    5,582Operating EBITDA
    
    
    6,152
    
    
    
    6,967
   (1)
    
    The results of the Celgar pulp mill are not included for the three months ended March 31,
2004.(2)
    
    See Note 10 of the financial statements included elsewhere herein for a reconciliation to our
consolidated results. Liquidity and Capital Resources of the Restricted Group The following table is a summary of selected financial information for the Restricted Group for the
periods indicated: As at
    
    
    As atMarch 31,
    
    
    December 31,2005
    
    
    2004(in thousands)(unaudited)Restricted Group Financial Position(1)(2)Cash and cash equivalents
    
    
    67,457
    
    
    
    45,487Working capital
    
    
    109,619
    
    
    
    48,480Property, plant and equipment
    
    
    390,492
    
    
    
    213,678Total assets
    
    
    614,419
    
    
    
    401,321Long-term liabilities
    
    

    349,301
    
    
    
    228,139Shareholders equity
    
    
    228,982
    
    
    
    138,478
   (1)
    
    The financial position of the Celgar pulp mill is not included as at December 31, 2004.(2)
    
    See Note 10 of the financial statements included elsewhere herein for a reconciliation to our
consolidated results. At March 31, 2005, the Restricted Group had cash and cash equivalents of 67.5 million,
compared to 45.5 million at December 31, 2004. At March 31, 2005, the Restricted Group had
working capital of
109.6 million. We expect the Restricted Group to meet its interest and debt service expenses and meet the working
and maintenance capital requirements for its current operations from cash flow from operations,
cash on hand and two new credit facilities for the Rosenthal and Celgar mills put into effect in
February 2005. 28




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##### 



Stendal Pulp Mill Start Up At the end of the first quarter of 2005, we delivered an acceptance certificate and assumed
responsibility for the operation of the Stendal mill. In connection with such acceptance, the main
contractor for the mill and certain suppliers have agreed, among other things, to install two
additional digesters and related equipment at the mill, make improvements to the NCG boiler and
waste-water treatment plant, reimburse Stendal for certain costs and have also agreed to provide
certain warranties. We believe that, once installed, the additional digesters should increase the
annual production capacity of the Stendal mill to in excess of 600,000 ADMTs. We expect these
measures to be completed by the end of 2005. During the current quarter, there were some minor production glitches at the Stendal mill which are
customary for the start up of such large scale projects. These glitches related mainly to the
steam turbine, recovery boiler and the electrical network at the
mill, which have mostly been resolved. The mill was shut down for eight days during the quarter for inspections prior to
acceptance of the mill, to conduct certain performance tests, for general adjustment work and for
normal preventative maintenance. The mill operated at approximately 82% of its rated capacity
during the quarter. Our start up of the Stendal mill is subject to risks commonly associated with the start up of large
greenfield industrial projects which could result in the Stendal mill experiencing operating
difficulties or delays in the start-up period and the Stendal mill may not achieve our planned
production, timing, quality or cost projections. These risks include, without limitation,
equipment failures or damage, errors or miscalculations in engineering, design specifications or
equipment manufacturing, faulty construction or workmanship, defective equipment or installation,
human error, industrial accidents, weather conditions, failure to comply with environmental and
other permits, and complex integration of processes and equipment. Critical Accounting Policies The preparation of financial statements and related disclosures in conformity with accounting
principles generally accepted in the United States of America requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and accompanying
notes. Estimates are used for, but not limited to, the accounting for doubtful accounts,
depreciation and amortization, asset impairments, income taxes, and contingencies. Actual results
could differ from these estimates. Our management routinely makes judgments and estimates about the effects of matters that are
inherently uncertain. As the number of variables and assumptions affecting the probable future
resolution of the uncertainties increase, these judgments become even more subjective and complex.
We have identified certain accounting policies that are the most important to the portrayal of our
current financial condition and results of operations. For information about our significant accounting policies, see our annual report on Form 10-K for
the year ended December 31, 2004. 29




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Cautionary Statement Regarding Forward-Looking Information The statements in this report that are not based on historical facts are called forward-looking
statements within the meaning of the United States Private Securities Litigation Reform Act of
1995. These statements appear in a number of different places in this report and can be identified
by words such as estimates, projects, expects, intends, believes, plans, or their
negatives or other comparable words. Also look for discussions of strategy that involve risks and
uncertainties. Forward-looking statements include statements regarding the outlook for our future
operations, forecasts of future costs and expenditures, the evaluation of market conditions, the
outcome of legal proceedings, the adequacy of reserves, or other business plans. You are cautioned
that any such forward-looking statements are not guarantees and may involve risks and
uncertainties. Our actual results may differ materially from those in the forward-looking
statements due to risks facing us or due to actual facts differing from the assumptions underlying
our estimates. Some of these risks and assumptions include those set forth in reports and other
documents we have filed with or furnished to the SEC, including in our annual report on Form 10-K
for the year ended December 31, 2004. We advise you that these cautionary remarks expressly qualify
in their entirety all forward-looking statements attributable to us or persons acting on our
behalf. Unless required by law, we do not assume any obligation to update forward-looking
statements based on unanticipated events or changed expectations. However, you should carefully
review the reports and other documents we file from time to time with the SEC. Cyclical Nature of Business The pulp and paper business is cyclical in nature and markets for our principal products are
characterized by periods of supply and demand imbalance, which in turn affects product prices. The
markets for pulp and paper are highly competitive and are sensitive to cyclical changes in industry
capacity and in the global economy, all of which can have a significant influence on selling prices
and our earnings. Demand for pulp and paper products has historically been determined by the level
of economic growth and has been closely tied to overall business activity. During 2001 and 2002,
pulp list prices fell significantly. Although pulp prices have improved overall since then, we
cannot predict the impact of continued economic weakness in certain world markets or the impact of
war, terrorist activity or other events on our markets. Our production costs are influenced by the availability and cost of raw materials, energy and
labor, and our plant efficiencies and productivity. Our main raw material is fiber in the form of
wood chips and pulp logs for pulp production, and waste paper and pulp for paper production. Fiber
costs are primarily affected by the supply of, and demand for, lumber and pulp, which are both
highly cyclical in nature and can vary significantly by location. Production costs also depend on
the total volume of production. Lower operating rates and production efficiencies during periods of
cyclically low demand result in higher average production costs and lower margins. 30




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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to market risks from changes in interest rates and foreign currency exchange rates,
particularly the exchange rate between the U.S. dollar and the Euro, which may affect our results
of operations and financial condition and, consequently, our fair value. We manage these risks
through internal risk management policies as well as the use of derivatives. We use derivatives to
reduce or limit our exposure to interest rate and currency risks. We may in the future use
derivatives to reduce or limit our exposure to fluctuations in pulp prices. We also use derivatives
to reduce our potential losses or to augment our potential gains, depending on our managements
perception of future economic events and developments. These types of derivatives are generally
highly speculative in nature. They are also very volatile as they are highly leveraged given that
margin requirements are relatively low in proportion to notional amounts. Many of our strategies, including the use of derivatives, and the types of derivatives selected by
us, are based on historical trading patterns and correlations and our managements expectations of
future events. However, these strategies may not be fully effective in all market environments or
against all types of risks. Unexpected market developments may affect our risk management
strategies during this time, and unanticipated developments could impact our risk management
strategies in the future. If any of the variety of instruments and strategies we utilize are not
effective, we may incur losses. All of our derivatives are marked to market at the end of each reporting period, and all unrealized
gains and losses are recognized in earnings for a reporting period. We determine market valuations
based primarily upon valuations provided by our counterparties. In the first quarter of 2005, Stendal entered into currency swaps to convert a portion of its
indebtedness under the Stendal Loan Facility from Euros into U.S. dollars and certain currency
forwards. In April 2005, Stendal entered into a currency swap to convert the balance of its
long-term indebtedness under the Stendal Loan Facility from Euros into U.S. dollars. In addition, Stendal had entered into certain interest rate swaps in connection with its long-term
indebtedness relating to the Stendal mill to fix the interest rate under the Stendal Loan Facility.
Rosenthal had also entered into certain interest rate contracts to either fix or limit the interest
rates in connection with certain of its indebtedness. In February 2005, we settled the Rosenthal
interest rate contracts in connection with the repayment of the Rosenthal Loan Facility. 31




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The following table sets forth the maturity date, the notional amount and the recognized gain or
loss in the three months ended March 31, 2005 for derivatives related to the Rosenthal and Stendal
mills that were in effect during this period that affected our results: Recognized Gain(Loss) inThree Months EndedDerivative Instrument
    
    Maturity Date
    
    Notional Amount
    
    
    March 31, 2005(unaudited)
    
    
    (unaudited)(in millions)
    
    
    (in thousands)Interest Rate DerivativesRosenthal Interest Rate Cap Agreements(1)
    
    Settled
    
    $
    178.3
    
    
    
    (295
    )Stendal Interest Rate Swaps(2)
    
    October 2017
    
    
    1,147.5
    
    
    
    344
    49Foreign Exchange Rate DerivativesStendal Currency Swap(3)
    
    October 2017
    
    
    306.3
    
    
    
    (2,293
    )Stendal Currency Swap(4)
    
    October 2017
    
    
    153.2
    
    
    
    (1,751
    )Stendal Currency Forward
    
    September 2005
    
    $
    25.0
    
    
    
    14Stendal Currency Forward
    
    February 2006
    
    $
    50.0
    
    
    
    (68
    )
    (4,098
    )
   (1)
    
    Rosenthal had entered into two forward interest rate contracts with notional amounts of
$106.2 million (2003: $118.6 million) and $72.1 million (2003: $74.0 million), both maturing
on September 28, 2007 with a strike rate of 6.8%. These derivatives were settled in February
2005.(2)
    
    In connection with the Stendal Loan Facility, in 2002 Stendal entered into the Stendal
Interest Rate Swaps, which are variable-to-fixed interest rate swaps, for the term of the
Stendal Loan Facility, with respect to an aggregate maximum amount of approximately 612.6
million of the principal amount of the long-term indebtedness under the Stendal Loan Facility.
The swaps took effect on October 1, 2002 and are comprised of three contracts. The first
contract commenced in October 2002 for a notional amount of 4.1 million, gradually
increasing to 464.9 million, with an interest rate of 3.795%, and matured in May 2004. The
second contract commenced in May 2004 for a notional amount of 464.9 million, gradually
increasing to 612.6 million, with an interest rate of 5.28%, and matures in April 2005.
The third contract commenced in April 2005 for a notional amount of 612.6 million, with an
interest rate of 5.28%, and the notional amount gradually decreases and the contract
terminates upon the maturity of the Stendal Loan Facility in October 2017. As at December 31,
2004 and March 31, 2005, the notional amounts of the outstanding two contracts was 612.6
million and 612.6 million, respectively.(3)
    
    For 306.3 million of the outstanding principal amount under the Stendal Loan Facility,
all repayment installments from February 7, 2005 until October 2, 2017 were swapped into U.S.
dollar amounts at a rate of U.S. 1.2960. The interest rate was swapped into the following
payments: pay six-month U.S. dollar to LIBOR rate plus 12 basis points and receive the
six-month Euribor.(4)
    
    For 153.2 million of the outstanding principal amount under the Stendal Loan Facility,
all repayment installments from April 1, 2005 until October 2, 2017 were swapped into U.S.
dollar amounts at a rate of U.S. 1.2990. The interest rate was swapped into the following
payments: pay six-month U.S. dollar to LIBOR rate plus 13 basis points and receive the
six-month Euribor. For more information, see our annual report on Form 10-K for the year ended December 31, 2004. 32




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ITEM 4. CONTROLS AND PROCEDURES Pursuant to the Acquisition of the Celgar NBSK pulp mill in February 2005, we have instituted
certain disclosure controls and procedures and internal control over financial reporting at the
Celgar mill. While we believe such disclosure controls and procedures are effective and that we
have adequate internal control over financial reporting at the Celgar mill, we are continuing to
refine and implement consistent procedures and controls at the mill and strengthen and integrate
the mills business practices and internal controls. As a result, we may in the future identify deficiencies in the mills procedures and controls that
we may need to remediate or we may need to implement improvements to the procedures and controls at
the mill. In the event our Principal Executive Officer, Principal Financial Officer or independent
auditors determine that the procedures and controls at the mill are not effective or adequate,
investor perception of us may be materially adversely affected and, among other things, this could
cause a decline in the market price of our securities. Disclosure Controls and Procedures.Our management, with the participation of our Principal
Executive Officer and Principal Financial Officer, has evaluated the effectiveness of our
disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under
the Securities Exchange Act of 1934, as amended (the Exchange Act)), as of the end of the period
covered by this report. Based on such evaluation, our Principal Executive Officer and Principal
Financial Officer have concluded that, as of the end of such period, our disclosure controls and
procedures are effective in recording, processing, summarizing and reporting, on a timely basis,
information required to be disclosed by us in the reports that we file or submit under the Exchange
Act. It should be noted that any system of controls is based in part upon certain assumptions designed
to obtain reasonable (and not absolute) assurance as to its effectiveness, and there can be no
assurance that any design will succeed in achieving its stated goals. Changes in Internal Controls.Except as noted herein, there have been no changes in
our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under
the Exchange Act) during the period covered by this report that have materially affected, or are
reasonably likely to materially affect, our internal control over financial reporting. 33




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PART II.OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS We are subject to routine litigation incidental to our business. We do not believe that the
outcome of such litigation will have a material adverse effect on our business or financial
condition. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES In February 2005, pursuant to the Acquisition of the Celgar mill, we issued 4,210,526 of our shares
of beneficial interest at a price of $9.50 per share to the vendor of the Celgar mill for gross
proceeds of $40 million in reliance on Regulation S under the Securities Act. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a)   Exhibits ExhibitNo.
    
  Description1.1
    
    Underwriting Agreement dated February 8, 2005 between Mercer
International Inc. and RBC Capital Markets Corporation, on
behalf of itself and CIBC World Markets Corp., Raymond James &
Associates Inc. and D.A. Davidson & Co. Incorporated by
reference from Form 8-K dated February 10, 2005.1.2
    
    Underwriting Agreement dated February 8, 2005 among Mercer
International Inc. and RBC Capital Markets Corporation and
Credit Suisse First Boston LLC, on behalf of themselves and
CIBC World Markets Corp. Incorporated by reference from Form
8-K dated February 10, 2005.1.3
    
    Amendment to Rights Agreement. Incorporated by reference from
Form 8-K dated February 10, 2005.4.1
    
    First Supplemental Indenture dated February 14, 2005 to the
Indenture dated December 10, 2004 between Mercer International
Inc. and Wells Fargo Bank, N.A. Incorporated by reference from
Form 8-K dated February 17, 2005.10.1
    
    Revolving Credit Facility Agreement among D&Z Holding GmbH,
Zellstoff-und Papierfabrik Rosenthal GmbH & Co. KG, ZPR
Beteiligungs GmbH and Bayerische Hypo-und Vereinsbank AG dated
February 9 2005. Incorporated by reference from Form 8-K
dated February 17, 2005.10.2
    
    Shareholders Undertaking Agreement dated February 9, 2005
relating to the Revolving Credit Facility Agreement.
Incorporated by reference from Form 8-K dated February 17,
2005.
 34




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10.3
    
    Operating Credit Agreement among 0706906 B.C. Ltd. (now known
as Zellstoff Celgar Limited), Royal Bank of Canada and HSBC
Bank Canada dated for reference February 11, 2005.
Incorporated by reference from Form 8-K dated February 17,
2005.10.4
    
    Amendment and Restatement Agreement No. 1 relating to the
Stendal Project Facility Agreement. Incorporated by reference
from Form 8-K dated March 28, 2005.31.1
    
    Section 302 Certification of Chief Executive Officer31.2
    
    Section 302 Certification of Chief Financial Officer32.1*
    
    Section 906 Certification of Chief Executive Officer32.2*
    
    Section 906 Certification of Chief Financial Officer
   *
    
    In accordance with Release 33-8212 of the Commission, these Certifications: (i) are
furnished to the Commission and are not filed for the purposes of liability under the
Securities Exchange Act of 1934, as amended; and (ii) are not to be subject to automatic
incorporation by reference into any of the Companys registration statements filed under the
Securities Act of 1933, as amended for the purposes of liability thereunder or any offering
memorandum, unless the Company specifically incorporates them by reference therein.  (b)
    Reports on Form 8-K The Company filed the following reports on Form 8-K with respect to the indicated items
during the first quarter of 2005: Form 8-K dated February 2, 2005Item 8.01. Other EventsForm 8-K dated February 10, 2005Item 1.01. Entry into Definitive Material AgreementItem 8.01. Other EventsItem 9.01. Financial Statements and ExhibitsForm 8-K dated February 17, 2005Item 2.01. Completion of Acquisition or Disposition of AssetsItem 8.01. Other EventsItem 9.01. Financial Statements and ExhibitsForm 8-K dated March 11, 2005Item 2.02. Results of Operations and Financial ConditionItem 9.01. Financial Statements and ExhibitsForm 8-K dated March 28, 2005Item 1.01. Entry into Definitive Material AgreementItem 9.01. Financial Statements and Exhibits
 35




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly authorized. MERCER INTERNATIONAL INC.By:
    /s/ David M. GandossiDavid M. GandossiSecretary and Chief Financial Officer Date: May 10, 2005 36