e10vq

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 June 30, 2005


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		91-6087550
(State or other jurisdiction		(I.R.S. Employer
of incorporation or organization)		Identification No.)

Suite 2840, 650 West Georgia Street, Vancouver, British Columbia, Canada, V6B 4N8
(Address of office)

(604) 684-1099
(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES 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 33,074,140 shares of beneficial interest outstanding as at August 9, 2005.

MERCER INTERNATIONAL INC.

CONSOLIDATED BALANCE SHEETS

As at June 30, 2005 and December 31, 2004
(Unaudited)
(Euros in thousands)


	June 30,			December 31,
	2005			2004
ASSETS
Current Assets
Cash and cash equivalents	€	105,874		€	49,568
Cash restricted		37,951			45,295
Receivables		75,344			54,687
Inventories		92,037			52,898
Prepaid expenses and other		7,057			4,961

Total current assets		318,263			207,409
Long-Term Assets
Cash restricted		19,074			47,538
Property, plant and equipment		1,109,394			936,035
Investments		4,728			5,079
Deferred note issuance and other costs		9,132			5,069
Deferred income tax		78,238			54,519

		1,220,566			1,048,240

Total assets	€	1,538,829		€	1,255,649

LIABILITIES
Current Liabilities
Accounts payable and accrued expenses	€	101,399		€	56,542
Construction costs payable		34,090			65,436
Debt, current portion		97,618			107,090

Total current liabilities		233,107			229,068
Long-Term Liabilities
Debt, less current portion		952,555			777,272
Unrealized foreign exchange rate derivative losses		47,685			—
Unrealized interest rate derivative losses		95,946			75,471
Pension and other post-retirement benefit obligations		15,728			—
Capital leases and other		9,800			9,035
Deferred income tax		4,143			2,062

		1,125,857			863,840

Total liabilities		1,358,964			1,092,908
Minority Interest		—			—
SHAREHOLDERS’ EQUITY
Shares of beneficial interest		180,916			83,397
Additional paid-in capital, stock options		14			14
Retained earnings (deficit)		(12,642	)		69,176
Accumulated other comprehensive income		11,577			10,154

Total shareholders’ equity		179,865			162,741

Total liabilities and shareholders’ equity	€	1,538,829		€	1,255,649

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

FORM 10-Q
QUARTERLY REPORT — PAGE 3

MERCER INTERNATIONAL INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

For Six Months Ended June 30, 2005 and 2004
(Unaudited)
(Euros in thousands, except for loss per share)


	2005			2004

Revenues	€	227,502		€	100,651


Costs and expenses:
Cost of sales		210,167			88,628
General and administrative expenses		15,316			14,228
Gain on sale of emission credits		(6,288	)		—
Flooding losses and expenses, less grant income		—			669

Total costs and expenses		219,195			103,525

Income (loss) from operations		8,307			(2,874	)


Other income (expense):
Interest expense		(41,463	)		(5,354	)
Investment income		981			1,464
Realized loss on derivative financial instruments		(295	)		—
Unrealized gain (loss) on derivative financial instruments		(73,015	)		7,028
Unrealized foreign exchange loss on debt		(7,509	)		—
Impairment of investments		(1,645	)		—

Total other (income) expense		(122,946	)		3,138


Income (loss) before income taxes and minority interest		(114,639	)		264
Income tax (provision) benefit		21,412			(199	)

Income (loss) before minority interest		(93,227	)		65
Minority interest		11,409			(2,790	)

Net loss		(81,818	)		(2,725	)

Retained earnings, beginning of period		69,176			49,196

Retained earnings (deficit), end of period	€	(12,642	)	€	46,471


Loss per share
Basic and diluted	€	(2.80	)	€	(0.16	)

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

FORM 10-Q
QUARTERLY REPORT — PAGE 4

MERCER INTERNATIONAL INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

For Three Months Ended June 30, 2005 and 2004
(Unaudited)
(Euros in thousands, except for loss per share)


	2005			2004

Revenues	€	129,609		€	50,335


Costs and expenses:
Cost of sales		119,178			43,210
General and administrative expenses		7,518			7,687
Gain on sale of emission credits		(6,288	)		—
Flooding losses and expenses, less grant income		—			416

Total costs and expenses		120,408			51,313

Income (loss) from operations		9,201			(978	)


Other income (expense):
Interest expense		(22,200	)		(2,366	)
Investment income		806			530
Unrealized gain (loss) on derivative financial instruments		(69,451	)		29,473
Unrealized foreign exchange loss on debt		(9,806	)		—

Total other income (expense)		(100,651	)		27,637


Income (loss) before income taxes and minority interest		(91,450	)		26,659
Income tax (provision) benefit		24,447			(219	)

Income (loss) before minority interest		(67,003	)		26,440
Minority interest		4,852			(10,199	)

Net income (loss)		(62,151	)		16,241

Retained earnings, beginning of period		49,509			30,230

Retained earnings (deficit), end of period	€	(12,642	)	€	46,471


Income (loss) per share
Basic	€	(1.88	)	€	0.94

Diluted	€	(1.88	)	€	0.57

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

FORM 10-Q
QUARTERLY REPORT — PAGE 5

MERCER INTERNATIONAL INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

For Six Months Ended June 30, 2005 and 2004
(Unaudited)
(Euros in thousands)


	2005			2004
Cash Flows from (used in) Operating Activities:
Net loss	€	(81,818	)	€	(2,725	)
Adjustments to reconcile net loss to cash flows from operating activities
Cumulative unrealized losses (gains) on derivatives		73,015			(7,028	)
Depreciation and amortization		25,299			12,607
Unrealized foreign exchange loss on debt		7,509			—
Impairment of investments and securities		1,645			—
Minority interest		(11,409	)		2,790
Deferred income taxes		(21,638	)		—
Stock compensation expense		72			616
Other		125			204

Changes in current assets and liabilities
Receivables		(20,742	)		(2,489	)
Inventories		(16,757	)		(17,995	)
Accounts payable and accrued expenses		41,319			12,166
Other		(1,853	)		(1,224	)

Net cash used in operating activities		(5,233	)		(3,078	)

Cash Flows from (used in) Investing Activities:
Purchase of property, plant and equipment		(8,493	)		(117,327	)
Acquisition of Celgar pulp mill		(146,608	)		—
Sale of available-for-sale securities		—			1,161
Other		—			115

Net cash used in investing activities		(155,101	)		(116,051	)

Cash Flows from (used in) Financing Activities:
Cash restricted		35,808			(7,468	)
Decrease in construction costs payable		(31,346	)		(22,974	)
Proceeds from borrowings of notes payable and debt		325,195			126,000
Repayment of notes payable and debt		(183,691	)		(14,782	)
Proceeds from investment grants		342			28,710
Repayment of capital lease obligations		(1,907	)		(633	)
Issuance of shares of beneficial interest		66,645			582

Net cash from financing activities		211,046			109,435

Effect of exchange rate changes on cash and cash equivalents		5,594			(63	)

Net increase (decrease) in cash and cash equivalents		56,306			(9,757	)
Cash and cash equivalents, beginning of period		49,568			51,993

Cash and cash equivalents, end of period	€	105,874		€	42,236

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

FORM 10-Q
QUARTERLY REPORT — PAGE 8

MERCER INTERNATIONAL INC.

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

In June 2005, the FASB ratified EITF Issue No. 05-5 (“EITF 05-5”), “Accounting for Early Retirement or Postemployment Programs with Specific Features (such as Terms Specified in Altersteilzeit Early Retirement Arrangements)”. Under an Altersteilzeit (ATZ) Early Retirement Program (Type I and Type II) or an arrangement with the same terms, salary payments should be recognized ratably over the portion of the ATZ period when the employee is providing active services (the “active service period”). Accruals for the termination benefit under Type II should be accrued ratably from the date the employee signs the ATZ contract to the end of the active service period. EITF 05-5 will become effective for reporting periods beginning after December 15, 2005. Management is analyzing the requirements of EITF 05-5 and believes that its adoption will not have any significant impact on the Company’s financial position, results of operations or cash flows.

FORM 10-Q
QUARTERLY REPORT — PAGE 9

MERCER INTERNATIONAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR SIX MONTHS ENDED JUNE 30, 2005

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

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.


	Six Months Ended June 30,
	2005			2004
Net Loss
As reported	€	(81,818	)	€	(2,725	)
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of any related tax effects		(21	)		(29	)

Pro forma	€	(81,839	)	€	(2,754	)


Basic and Diluted Loss Per Share
As reported	€	(2.80	)	€	(0.16	)

Pro forma	€	(2.80	)	€	(0.16	)


	Three Months Ended June 30,
	2005			2004
Net Income (Loss)
As reported	€	(62,151	)	€	16,241
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of any related tax effects		(11	)		(14	)

Pro forma	€	(62,162	)	€	16,227


Basic and Diluted Income (Loss) Per Share
As reported	€	(1.88	)	€	0.94

Pro forma	€	(1.88	)	€	0.57

FORM 10-Q
QUARTERLY REPORT — PAGE 10

MERCER INTERNATIONAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR SIX MONTHS ENDED JUNE 30, 2005

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

Note 3. Income (Loss) Per Share

Basic income (loss) per share is computed by dividing income (loss) available to common shareholders by the weighted average number of shares outstanding during a period. Diluted income (loss) per share takes into consideration shares outstanding (computed under basic earnings (loss) per share) and potentially dilutive shares. The following table sets out the computation of basic income (loss) per share for the six and three months ended June 30, 2005 and 2004, respectively:


	Six Months Ended June 30,						Three Months Ended June 30,
	2005			2004			2005			2004
Income (loss) from continuing operations – basic	€	(81,818	)	€	(2,725	)	€	(62,151	)	€	16,241
Interest on convertible notes, net of tax		—			—			—			69

Income (loss) from continuing operations – diluted	€	(81,818	)	€	(2,725	)	€	(62,151	)	€	16,310

Weighted average number of common shares outstanding:
Basic		29,270,388			17,290,504			33,055,103			17,290,504
Effect of dilutive shares:
Stock options and awards		—			—			—			457,385
Convertible notes		—			—			—			10,645,161

Diluted		29,270,388			17,290,504			33,055,103			28,393,050

Income (loss) from continuing operations per share:
Basic	€	(2.80	)	€	(0.16	)	€	(1.88	)	€	0.94

Diluted	€	(2.80	)	€	(0.16	)	€	(1.88	)	€	0.57

For the six months ended June 30, 2005 and 2004 and the three months ended June 30, 2005, options and convertible notes were not included in the computation of diluted loss per share because they were anti-dilutive.

FORM 10-Q
QUARTERLY REPORT — PAGE 11

MERCER INTERNATIONAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR SIX MONTHS ENDED JUNE 30, 2005

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

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 €177,422, which included €142,940 in cash, acquisition related expenditures of €3,668 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.

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)	€	142,940
Equity – shares of beneficial interest		30,814
Estimated acquisition costs		3,668

	€	177,422


Net assets acquired:
Receivables	€	32
Inventories		19,969
Prepaids and other assets		616
Property, plant and equipment		175,096
Accrued expenses and other liabilities		(4,103	)
Pension plan and post-retirement benefits obligation		(14,188	)

	€	177,422

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 June 30, 2005, the Company had drawn a total of €28,592 against these facilities.

FORM 10-Q
QUARTERLY REPORT — PAGE 12

MERCER INTERNATIONAL INC.

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


	Six Months Ended
	June 30,
	2005			2004
Total revenues	€	249,225		€	197,875
Net income (loss)	€	(90,637	)	€	6,347
Income (loss) from continuing operations per share:
Basic and diluted	€	(2.74	)	€	0.20

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.

FORM 10-Q
QUARTERLY REPORT — PAGE 13

MERCER INTERNATIONAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR SIX MONTHS ENDED JUNE 30, 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			Consolidated
	Pulp			Pulp		Pulp			Pulp			Paper			Eliminations			Total
Six Months Ended June 30, 2005
Sales to external customers	€	65,936		€	48,480	€	81,606		€	196,022		€	31,480		€	—		€	227,502
Intersegment net sales		—			—		3,340			3,340			—			(3,340	)		—

		65,936			48,480		84,946			199,362			31,480			(3,340	)		227,502

Operating costs		47,405			40,554		71,546			159,505			29,601			(3,822	)		185,284
Depreciation and amortization		6,630			4,097		13,454			24,181			379			323			24,883
General and administrative		3,810			2,837		1,677			8,324			2,562			4,430			15,316
Emission credits		(2,135	)		—		(4,153	)		(6,288	)		—			—			(6,288	)

		55,710			47,488		82,524			185,722			32,542			931			219,195

Income (loss) from operations		10,226			992		2,422			13,640			(1,062	)		(4,271	)		8,307
Interest expense																			(41,463	)
Investment income																			981
Derivative financial instruments, net																			(73,310	)
Foreign exchange gain on debt																			(7,509	)
Impairment of investments																			(1,645	)

																			(122,946	)

Loss before income taxes and minority interest																		€	(114,639	)


Segment assets	€	347,935		€	244,361	€	906,244		€	1,498,540		€	24,294		€	15,995		€	1,538,829


Six Months Ended June 30, 2004
Sales to external customers	€	71,031		€	—	€	927		€	71,958		€	28,693		€	—		€	100,651
Intersegment net sales		1,179			—		—			1,179			—			(1,179	)		—

		72,210			—		927			73,137			28,693			(1,179	)		100,651

Operating costs		49,125			—		—			49,125			27,213			(317	)		76,021
Depreciation and amortization		11,136			—		12			11,148			1,141			318			12,607
General and administrative		4,636			—		5,448			10,084			2,643			1,501			14,228
Flooding grants, less losses and expenses		—			—		—			—			669			—			669

		64,897			—		5,460			70,357			31,666			1,502			103,525

Income (loss) from operations		7,313			—		(4,533	)		2,780			(2,973	)		(2,681	)		(2,874	)
Interest expense																			(5,354	)
Investment and other income																			1,464
Derivative financial instruments, net																			7,028

																			3,138

Income before income taxes and minority interest																		€	264


Segment assets	€	365,342		€	—	€	663,193		€	1,028,535		€	28,320		€	(10,899	)	€	1,045,956


(1)		The results of the Celgar pulp mill are from the date of its acquisition on February 14, 2005.

FORM 10-Q
QUARTERLY REPORT — PAGE 14

MERCER INTERNATIONAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR SIX MONTHS ENDED JUNE 30, 2005

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

Note 5. Business Segment Information (cont’d)


															Corporate,
	Rosenthal			Celgar⁽¹⁾		Stendal			Total						Other and			Consolidated
	Pulp			Pulp		Pulp			Pulp			Paper			Eliminations			Total
Three Months Ended June 30, 2005
Sales to external customers	€	31,840		€	40,864	€	40,808		€	113,512		€	16,097		€	—		€	129,609
Intersegment net sales		—			—		1,786			1,786			—			(1,786	)		—

		31,840			40,864		42,594			115,298			16,097			(1,786	)		129,609

Operating costs		22,217			35,419		34,411			92,047			15,370			(2,135	)		105,282
Depreciation and amortization		3,362			3,274		6,773			13,409			198			289			13,896
General and administrative		1,909			1,162		702			3,773			1,326			2,419			7,518
Emission credits		(2,135	)		—		(4,153	)		(6,288	)		—			—			(6,288	)

		25,353			39,855		37,733			102,941			16,894			573			120,408

Income (loss) from operations		6,487			1,009		4,861			12,357			(797	)		(2,359	)		9,201

Interest expense																			(22,200	)
Investment income																			806
Derivative financial instruments, net																			(69,451	)
Foreign exchange(loss) on debt																			(9,806	)
Impairment of investments																			—

																			(100,651	)

Loss before income taxes and minority interest																		€	(91,450	)


Three Months Ended June 30, 2004
Sales to external customers	€	36,022		€	—	€	927		€	36,949		€	13,386		€	—		€	50,335
Intersegment net sales		750			—		—			750			—			(750	)		—

		36,772			—		927			37,699			13,386			(750	)		50,335

Operating costs		23,318			—		—			23,318			13,455			123			36,896
Depreciation and amortization		5,554			—		12			5,566			589			159			6,314
General and administrative		2,648			—		2,707			5,355			1,469			863			7,687
Flooding grants, less losses and expenses		—			—		—			—			416			—			416

		31,520			—		2,719			34,239			15,929			1,145			51,313

Income (loss) from operations		5,252			—		(1,792	)		3,460			(2,543	)		(1,895	)		(978	)
Interest expense																			(2,366	)
Investment and other income																			530
Derivative financial instruments, net																			29,473

																			27,637


Income before income taxes and minority interest																		€	26,659


(1)		The results of the Celgar pulp mill are from the date of its acquisition on February 14, 2005.

FORM 10-Q
QUARTERLY REPORT — PAGE 15

MERCER INTERNATIONAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR SIX MONTHS ENDED JUNE 30, 2005

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

Note 6. Inventories


	June 30, 2005		December 31, 2004
Raw materials	€	53,217	€	38,679
Work in process and finished goods		38,820		14,219

	€	92,037	€	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 June 30, 2005 and for the 2005 second quarter totaled €369 and €210, respectively. As the mill was acquired in 2005, there are no comparative amounts included in the quarter ended June 30, 2004.


	Six Months Ended June 30, 2005
	Pension Benefits			Post-Retirement Benefits

Service cost	€	245		€	107
Interest cost		481			234
Expected return on plan assets		(471	)		—

Net periodic benefit cost	€	255		€	341


	Three Months Ended June 30, 2005
	Pension Benefits			Post-Retirement Benefits

Service cost	€	161		€	58
Interest cost		323			146
Expected return on plan assets		(321	)		—

Net periodic benefit cost	€	163		€	204

Note 8. Derivatives Transactions


	Six Months Ended June 30,
	2005			2004

Realized loss on derivative financial instruments	€	(295	)	€	—

Unrealized net loss on interest rate derivatives	€	(20,475	)	€	(1,716	)
Unrealized net gain (loss) on foreign exchange derivatives		(52,372	)		8,744
Unrealized loss on natural gas forward supply contract		(168	)		—

Unrealized gain (loss) on derivative financial instruments	€	(73,015	)	€	7,028

FORM 10-Q
QUARTERLY REPORT — PAGE 16

MERCER INTERNATIONAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR SIX MONTHS ENDED JUNE 30, 2005

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

Note 8. Derivatives Transactions (cont’d)


	Three Months Ended June 30,
	2005			2004

Unrealized net gain (loss) on interest rate derivatives	€	(20,819	)	€	15,751
Unrealized net gain (loss) on foreign exchange derivatives		(48,274	)		13,722
Unrealized loss on natural gas forward supply contract		(358	)		—

Unrealized gain (loss) on derivative financial instruments	€	(69,451	)	€	29,473

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 six months of 2005.

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. In the second quarter of 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 approximately €153,155, into U.S. dollars at a rate of 1.2799 with a maturity in October 2017. During the first quarter of 2005, Stendal 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. During the second quarter of 2005, Stendal also entered into a $25,000 currency forward contract at a rate of 1.2357 with a maturity in September 2005. A net unrealized loss of €52,372 and €48,274 was recorded in respect of these derivatives in the six and three months ended June 30, 2005, respectively.

FORM 10-Q
QUARTERLY REPORT — PAGE 17

MERCER INTERNATIONAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR SIX MONTHS ENDED JUNE 30, 2005

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

Note 9. European Union Emissions Trading Scheme

Beginning in 2005, the Company’s German operations are subject to the European Union Emissions Trading Scheme pursuant to which the Company’s German mills have been granted carbon emission certificates. The German mills estimate that they will have excess carbon emission credits in the current year. As a result, in the second quarter of 2005, the Company’s German pulp mills sold some of their emissions certificates for a gain of €6,288, which contributed to income from operations. Emission credits are recorded at historical cost. If additional credits were required in excess of the amount held by the Company, then a liability would be accrued.

FORM 10-Q
QUARTERLY REPORT — PAGE 18

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 six and three months ended June 30, 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 six and three months ended June 30, 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 six and three months ended June 30, 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.


	June 30, 2005
	Restricted		Unrestricted						Consolidated
	Group		Subsidiaries			Eliminations			Group
ASSETS
Current assets
Cash and cash equivalents	€	62,792	€	43,082		€	—		€	105,874
Cash restricted		—		37,951			—			37,951
Receivables		42,748		32,665			(69	)		75,344
Inventories		54,127		37,910			—			92,037
Prepaid expenses and other		3,631		3,426			—			7,057

Total current assets		163,298		155,034			(69	)		318,263
Cash restricted		—		19,074			—			19,074
Property, plant and equipment		393,047		716,785			(438	)		1,109,394
Other		9,741		4,119			—			13,860
Deferred income tax		22,855		55,383			—			78,238
Due from unrestricted group		44,621		—			(44,621	)		—

Total assets	€	633,562	€	950,395		€	(45,128	)	€	1,538,829


LIABILITIES
Current liabilities
Accounts payable and accrued expenses	€	43,780	€	57,688		€	(69	)	€	101,399
Construction costs payable		—		34,090			—			34,090
Debt, current portion		—		97,618			—			97,618

Total current liabilities		43,780		189,396			(69	)		233,107
Debt, less current portion		353,033		599,522			—			952,555
Due to restricted group		—		44,621			(44,621	)		—
Unrealized derivatives loss		—		143,631			—			143,631
Other		18,555		6,973			—			25,528
Deferred income tax		1,883		2,260			—			4,143

Total liabilities		417,251		986,403			(44,690	)		1,358,964


SHAREHOLDERS’ EQUITY
Total shareholders’ equity		216,311		(36,008	)⁽¹⁾		(438	)		179,865

Total liabilities and shareholders’ equity	€	633,562	€	950,395		€	(45,128	)	€	1,538,829

MERCER INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR SIX MONTHS ENDED JUNE 30, 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, 2004
	Restricted		Unrestricted					Consolidated
	Group		Subsidiaries		Eliminations			Group
ASSETS
Current assets
Cash and cash equivalents	€	45,487	€	4,081	€	—		€	49,568
Cash restricted		—		45,295		—			45,295
Receivables		21,791		33,060		(164	)		54,687
Inventories		13,911		38,987		—			52,898
Prepaid expenses and other		1,995		2,966		—			4,961

Total current assets		83,184		124,389		(164	)		207,409
Cash restricted		28,464		19,074		—			47,538
Property, plant and equipment		213,678		722,394		(37	)		936,035
Other		5,936		4,212		—			10,148
Deferred income tax		26,592		27,927		—			54,519
Due from unrestricted group		43,467		—		(43,467	)		—

Total assets	€	401,321	€	897,996	€	(43,668	)	€	1,255,649


LIABILITIES
Current liabilities
Accounts payable and accrued expenses	€	19,615	€	37,091	€	(164	)	€	56,542
Construction costs payable		—		65,436		—			65,436
Debt, current portion		15,089		92,001		—			107,090

Total current liabilities		34,704		194,528		(164	)		229,068
Debt, less current portion		224,542		552,730		—			777,272
Due to restricted group		—		43,467		(43,467	)		—
Unrealized interest rate derivative		—		75,471		—			75,471
Other		1,878		7,157		—			9,035
Deferred income tax		1,719		343		—			2,062

Total liabilities		262,843		873,696		(43,631	)		1,092,908


SHAREHOLDERS’ EQUITY
Total shareholders’ equity		138,478		24,300		(37	)		162,741

Total liabilities and shareholders’ equity	€	401,321	€	897,996	€	(43,668	)	€	1,255,649

FORM 10-Q
QUARTERLY REPORT — PAGE 20

MERCER INTERNATIONAL INC.

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


	Six Months Ended June 30, 2005
	Restricted			Unrestricted						Consolidated
	Group			Subsidiaries			Eliminations			Group
Revenues	€	114,416		€	113,086		€	—		€	227,502


Operating costs		87,260			98,024			—			185,284
Operating depreciation and amortization		10,829			13,616			438			24,883
General and administrative		11,077			4,239			—			15,316
Gain on sale of emission credits		(2,135	)		(4,153	)		—			(6,288	)

		107,031			111,726			438			219,195

Income (loss) from operations		7,385			1,360			(438	)		8,307

Other income (expense)
Interest expense		(15,985	)		(26,571	)		1,093			(41,463	)
Investment income		1,297			777			(1,093	)		981
Derivative financial instruments, net		(463	)		(72,847	)		—			(73,310	)
Unrealized foreign exchange loss on debt		(7,509	)		—			—			(7,509	)
Impairment of investments		(1,645	)		—			—			(1,645	)

Total other expense		(24,305	)		(98,641	)		—			(122,946	)

Loss before income taxes and minority interest		(16,920	)		(97,281	)		(438	)		(114,639	)
Income tax (provision) benefit		(4,776	)		26,188			—			21,412

Loss before minority interest		(21,696	)		(71,093	)		(438	)		(93,227	)
Minority interest		—			11,409			—			11,409

Net loss	€	(21,696	)	€	(59,684	)	€	(438	)	€	(81,818	)


	Six Months Ended June 30, 2004
	Restricted			Unrestricted						Consolidated
	Group			Subsidiaries			Eliminations			Group
Revenues	€	72,210		€	29,620		€	(1,179	)	€	100,651


Operating costs		48,675			27,213			133			76,021
Operating depreciation and amortization		11,136			1,153			318			12,607
General and administrative		6,295			8,091			(158	)		14,228
Flooding grants, less losses and expenses		—			669			—			669

		66,106			37,126			293			103,525

Income (loss) from operations		6,104			(7,506	)		(1,472	)		(2,874	)

Other income (expense)
Interest expense		(6,023	)		(452	)		1,121			(5,354	)
Investment and other income (expense)		1,745			(214	)		(67	)		1,464
Derivative financial instruments, net		(5,272	)		12,300			—			7,028

Total other expense		(9,550	)		11,634			1,054			3,138

Income (loss) before income taxes and minority interest		(3,446	)		4,128			(418	)		264
Income tax provision		(199	)		—			—			(199	)

Income (loss) before minority interest		(3,645	)		4,128			(418	)		65
Minority interest		—			(2,790	)		—			(2,790	)

Net income (loss)	€	(3,645	)	€	1,338		€	(418	)	€	(2,725	)

FORM 10-Q
QUARTERLY REPORT — PAGE 21

MERCER INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR SIX MONTHS ENDED JUNE 30, 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


	Three Months Ended June 30, 2005
	Restricted			Unrestricted						Consolidated
	Group			Subsidiaries			Eliminations			Group
Revenues	€	72,704		€	56,905		€	—		€	129,609


Operating costs		57,287			47,995			—			105,282
Operating depreciation and amortization		6,704			6,971			221			13,896
General and administrative		5,490			2,028			—			7,518
Gain on sale of emission credits		(2,135	)		(4,153	)		—			(6,288	)

		67,346			52,841			221			120,408

Income (loss) from operations		5,358			4,064			(221	)		9,201

Other income (expense)
Interest expense		(8,314	)		(14,585	)		699			(22,200	)
Investment income		970			467			(631	)		806
Derivative financial instruments, net		(358	)		(69,093	)		—			(69,451	)
Unrealized foreign exchange loss on debt		(9,806	)		—			—			(9,806	)
Impairment of investments		(467	)		—			467			—

Total other income (expense)		(17,975	)		(83,211	)		535			(100,651	)

Income (loss) before income taxes and minority interest		(12,617	)		(79,147	)		314			(91,450	)
Income tax (provision) benefit		(1,661	)		26,108			—			24,447

Income (loss) before minority interest		(14,278	)		(53,039	)		314			(67,003	)
Minority interest		—			4,852			—			4,852

Net income (loss)	€	(14,278	)	€	(48,187	)	€	314		€	(62,151	)


	Three Months Ended June 30, 2004
	Restricted			Unrestricted						Consolidated
	Group			Subsidiaries			Eliminations			Group
Revenues	€	36,772		€	14,313		€	(750	)	€	50,335


Operating costs		23,318			13,455			123			36,896
Operating depreciation and amortization		5,554			601			159			6,314
General and administrative		3,181			4,176			330			7,687
Flooding grants, less losses and expenses.		—			416			—			416

		32,053			18,648			612			51,313

Income (loss) from operations		4,719			(4,335	)		(1,362	)		(978	)

Other income (expense)
Interest expense		(1,947	)		114			(533	)		(2,366	)
Derivative financial instruments, net		(382	)		29,855			—			29,473
Investment and other income (expense)		639			(364	)		255			530

Total other income (expense)		(1,690	)		29,605			(278	)		27,637

Income (loss) before income taxes and minority interest		3,029			25,270			(1,640	)		26,659
Income tax provision		(199	)		(20	)		—			(219	)

Income (loss) before minority interest		2,830			25,250			(1,640	)		26,440
Minority interest		—			(10,199	)		—			(10,199	)

Net income (loss)	€	2,830		€	15,051		€	(1,640	)	€	16,241

FORM 10-Q
QUARTERLY REPORT — PAGE 22

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 June 30, 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 C$ refers to Canadian dollars; and (vi) “ADMTs” refers to air-dried metric tonnes.

The following discussion and analysis of our results of operations and financial condition for the six and three months ended June 30, 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.

Six Months Ended June 30, 2005 Compared to Six Months Ended June 30, 2004

Selected sales data for the six months ended June 30, 2005 and 2004 is as follows:


	Six Months Ended June 30,
	2005		2004
	(ADMTs)
Sales Volume by Product Class
Pulp sales volume by mill:
Rosenthal		154,800		156,334
Celgar		118,188		—
Stendal		204,988		—

Total pulp sales volume⁽¹⁾		477,976		156,334
Paper sales volume		34,478		32,789

Total sales volume⁽¹⁾		512,454		189,123

FORM 10-Q
QUARTERLY REPORT — PAGE 23


	Six Months Ended June 30,
	2005		2004
	(in thousands)
Revenues by Product Class
Pulp revenues by mill:
Rosenthal	€	65,936	€	71,031
Celgar		48,480		—
Stendal		81,606		927

Total pulp revenues⁽¹⁾		196,022		71,958
Paper revenues		31,480		28,693

Total revenues⁽¹⁾	€	227,502	€	100,651


(1)		Excluding intercompany sales volumes of 7,594 and 2,549 ADMTs of pulp and intercompany net sales revenues of approximately €3.3 million and €1.1 million in the six months ended June 30, 2005 and 2004, respectively.

Selected production data for the six months ended June 30, 2005 and 2004 is as follows:


	Six Months Ended June 30,
	2005		2004
	(ADMTs)
Production by Product Class
Pulp production by mill:
Rosenthal		157,315		159,384
Celgar		171,833		—
Stendal		231,719		—

Total pulp production		560,867		159,384
Paper production		33,937		32,407

Total production		594,804		191,791

Revenues for the six months ended June 30, 2005 increased to €227.5 million from €100.7 million in the comparative period of 2004, primarily because of higher pulp sales resulting from the inclusion of sales from our Stendal and Celgar mills. Pulp sales by volume were 477,976 ADMTs in the first half of 2005, compared to 156,334 ADMTs in the comparative period of 2004. In the six months ended June 30, 2005, the Stendal and Celgar mills sold 323,176 ADMTs of NBSK pulp and had sales of €130.1 million.

Cost of sales and general, administrative and other expenses in the first half of 2005 increased to €219.2 million from €103.5 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.

Beginning in 2005, our German operations are subject to the European Union Emissions Trading Scheme pursuant to which our German mills have been granted carbon emission certificates. The German mills estimate that they will have excess carbon emission credits in the current year. As a result, in the second quarter of 2005, our German pulp mills sold some of their emissions certificates for a gain of €6.3 million in the six months ended June 30, 2005, which contributed to income from operations.

For the first half of 2005, revenues from our pulp operations increased to €196.0 million from €72.0 million in the same period a year ago, primarily as a result of the inclusion of production from our Stendal and Celgar mills. List prices for NBSK pulp in Europe were approximately €488 ($628) per ADMT in the first half of 2005, approximately €500 ($613) per ADMT in the first half of last year and approximately €490 ($642) in the first quarter of 2005. The decrease in NBSK pulp prices was partially offset by the strengthening of the U.S. dollar versus the Euro during the current period.

FORM 10-Q
QUARTERLY REPORT — PAGE 24

Pulp sales realizations decreased to €411 per ADMT on average in the first half of 2005 from €443 per ADMT in the first half of 2004, primarily as a result of lower price realizations of the Stendal and Celgar mills. The Stendal mill sold pulp at a discounted price as a result of its start up, which we expect will be eliminated during the year, and the Celgar mill sells a large portion of its production in Asian markets which had lower prices than European markets.

Cost of sales and general, administrative and other expenses for the pulp operations increased to €185.7 million in the first half of 2005 from €70.4 million in the first half of 2004, primarily as a result of the inclusion of €130.0 million of operating costs related to the Stendal and Celgar mills. In the first half of 2005, we recorded a contribution to income from operations of €6.3 million resulting from the sale of excess carbon emission credits by our German pulp mills.

Depreciation for the pulp operations increased to €24.2 million in the current period, from €11.1 million in the first half of 2004, primarily as a result of the inclusion of €17.6 million of depreciation from the Stendal and Celgar mills, partially offset by lower depreciation at the Rosenthal mill.

For the first half of 2005, our pulp operations generated operating income of €13.6 million, versus operating income of €2.8 million in the first half of 2004, primarily as a result of the inclusion of the results of the Stendal and Celgar mills, the sale of excess carbon emission credits by our German pulp mills and lower costs and expenses at our Rosenthal mill.

Revenues from our paper operations in the current period were €31.5 million, compared with €28.7 million in the same period of last year. For the first half of 2005, total paper sales volumes were 34,478 ADMTs, versus 32,789 ADMTs in the first half 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 half of 2005 increased to €32.5 million from €31.7 million in the comparative period of 2004, primarily as a result of the shift in the product mix.

For the first half of 2005, our paper operations generated an operating loss of €1.1 million, compared to an operating loss of €3.0 million in the first half of 2004.

In the first half of 2005, we had income from operations of €8.3 million, compared to a loss from operations of €2.9 million in the same period last year.

Interest expense in the first half of 2005 increased to €41.5 million from €5.4 million in the year ago period, due to interest expense of €26.3 million relating to the Stendal mill and higher borrowings resulting primarily from our $310 million senior note issue in February 2005. In the first half of 2004, almost all of the interest associated with the Stendal mill was capitalized during its construction.

In the first half of 2005, Stendal entered into certain foreign currency derivatives to swap all of its long-term bank indebtedness from Euros to U.S. dollars and certain currency forwards and we recorded a net unrealized non-cash holding loss of €52.4 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 period. In the comparative period of 2004, we recorded a net unrealized non-cash holding gain of €8.7 million before minority interests on the then

FORM 10-Q
QUARTERLY REPORT — PAGE 25

outstanding currency derivatives of Rosenthal and Stendal. In the first half of 2005, as a result of a decrease in long-term European interest rates, we also recorded a net loss of €20.8 million 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 unrealized non-cash holding loss thereon of €1.7 million before minority interests in the comparative period of 2004. See “Quantitative and Qualitative Disclosures About Market Risk” for more information about our derivatives.

In the first half of 2005, minority interest, representing the two minority shareholders’ proportionate interest in the Stendal mill, was €11.4 million, compared to €(2.8) million in the first half 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 half of 2005 of €81.8 million, or €2.80 per basic and diluted share, which reflected the net unrealized non-cash holding losses on our currency and interest rate derivatives of €73.2 million and the unrealized non-cash foreign exchange loss on our long-term debt of €7.5 million, partially offset by the non-cash benefit for income taxes of €21.4 million, and interest expense related to our Stendal mill of €26.3 million and the non-cash impairment charge of €1.6 million relating to investments. In the first half of 2004, we reported a net loss of €2.7 million, or €0.16 per basic and diluted share.

We generated “Operating EBITDA” of €33.2 million and €9.7 million in the six months ended June 30, 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 €24.9 million and €12.6 million to the income from operations of €8.3 million and loss from operations of €2.9 million for the six months ended June 30, 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

FORM 10-Q
QUARTERLY REPORT — PAGE 26

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 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:


	Six Months Ended
	June 30,
	2005			2004
	(in thousands)
	(unaudited)
Net loss	€	(81,818	)	€	(2,725	)
Minority interest		(11,409	)		2,790
Income taxes (benefit)		(21,412	)		199
Interest expense		41,463			5,354
Investment income		(981	)		(1,464	)
Derivative financial instruments, net		73,310			(7,028	)
Foreign exchange loss on debt		7,509			—
Impairment of investments		1,645			—

Income (loss) from operations		8,307			(2,874	)
Add: Depreciation and amortization		24,883			12,607

Operating EBITDA	€	33,190		€	9,733

FORM 10-Q
QUARTERLY REPORT — PAGE 27

Three Months Ended June 30, 2005 Compared to Three Months Ended June 30, 2004

Selected sales data for the three months ended June 30, 2005 and 2004 is as follows:


	Three Months Ended June 30,
	2005		2004
	(ADMTs)
Sales Volume by Product Class
Pulp sales volume by mill:
Rosenthal		75,996		74,841
Celgar		99,841		—
Stendal		102,915		—

Total pulp sales volume⁽¹⁾		278,752		74,841
Paper sales volume		17,840		15,383

Total sales volume⁽¹⁾		296,592		90,224


	(in thousands)
Revenues by Product Class
Pulp revenues by mill:
Rosenthal	€	31,840	€	36,022
Celgar		40,864		—
Stendal		40,808		927

Total pulp revenues⁽¹⁾		113,512		36,949
Paper revenues		16,097		13,386

Total revenues⁽¹⁾	€	129,609	€	50,335


(1)		Excluding intercompany sales volumes of 4,105 and 1,540 ADMTs of pulp and intercompany net sales revenues of approximately €1.8 million and €0.8 million in the three months ended June 30, 2005 and 2004, respectively.

Selected production data for the three months ended June 30, 2005 and 2004 is as follows:


	Three Months Ended June 30,
	2005		2004
	(ADMTs)
Production by Product Class
Pulp production by mill:
Rosenthal		81,443		80,317
Stendal		123,738		—
Celgar		111,071		—

Total pulp production		316,252		80,317
Paper production		17,979		15,339

Total production		334,231		95,656

Revenues for the three months ended June 30, 2005 increased to €129.6 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 and Celgar mills. Pulp sales by volume were 278,752 ADMTs in the second quarter of 2005, compared to 74,841 ADMTs in the comparative period of 2004. In the three months ended June 30, 2005, the Stendal and Celgar mills sold 202,756 ADMTs of NBSK pulp and had sales of €81.7 million.

Cost of sales and general, administrative and other expenses in the second quarter of 2005 increased to €120.4 million from €51.3 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. In the second quarter of 2005, we realized a gain of €6.3 million from the sale of excess carbon emission credits by our German mills, which contributed to income from operations.

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QUARTERLY REPORT — PAGE 28

For the second quarter of 2005, revenues from our pulp operations increased to €113.5 million from €36.9 million in the same period a year ago, primarily as a result of the inclusion of production from our Stendal and Celgar mills. List prices for NBSK pulp in Europe were approximately €487 ($613) per ADMT in the second quarter of 2005, compared to approximately €535 ($645) per ADMT in the comparative period of last year. The decrease in NBSK pulp prices was partially offset by the strengthening of the U.S. dollar versus the Euro during the current period.

Pulp sales realizations decreased to €408 per ADMT on average in the second quarter of 2005 from €471 per ADMT in the second quarter of 2004, primarily as a result of lower price realizations of the Stendal and Celgar mills. The Stendal mill sold pulp at a discounted price as a result of its start up, which we expect will be eliminated during the year, and the Celgar mill sells a large portion of its production in Asian markets which had lower sales prices than European markets.

Cost of sales and general, administrative and other expenses for the pulp operations increased to €102.9 million in the second quarter of 2005 from €34.2 million in the comparative period of 2004, primarily as a result of the inclusion of €77.6 million of operating costs related to the Stendal and Celgar mills. In the second quarter of 2005, we recorded a contribution to income from operations of €6.3 million resulting from the sale of excess carbon emission credits by our German pulp mills.

Depreciation for the pulp operations increased to €13.4 million in the current quarter, from €5.6 million in the second quarter of 2004, primarily as a result of the inclusion of €10.0 million of depreciation from the Stendal and Celgar mills, partially offset by lower depreciation at the Rosenthal mill.

For the second quarter of 2005, our pulp operations generated operating income of €12.4 million, versus operating income of €3.5 million in the comparative quarter of 2004, primarily as a result of the inclusion of the results of the Stendal and Celgar mills, the sale of excess carbon emission credits by our German pulp mills and lower costs and expenses at our Rosenthal mill.

Revenues from our paper operations in the current quarter were €16.1 million, compared with €13.4 million in the same quarter of last year. For the second quarter of 2005, total paper sales volumes were 17,840 ADMTs, versus 15,383 ADMTs in the comparative 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 second quarter of 2005 increased to €16.9 million from €15.9 million in the comparative quarter of 2004, primarily as a result of the shift in the product mix.

For the second quarter of 2005, our paper operations generated an operating loss of €0.8 million, compared to an operating loss of €2.5 million in the second quarter of 2004.

In the second quarter of 2005, we had income from operations of €9.2 million, compared to a loss from operations of €1.0 million in the same quarter last year.

FORM 10-Q
QUARTERLY REPORT — PAGE 29

Interest expense in the second quarter of 2005 increased to €22.2 million from €2.4 million in the year ago period, due to interest expense of €14.5 million relating to the Stendal mill and higher borrowings resulting primarily from our $310 million senior note issue in February 2005. In the second quarter of 2004, almost all of the interest associated with the Stendal mill was capitalized during its construction.

Stendal had 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 in the first quarter of 2005. In the second quarter of 2005, Stendal entered into foreign currency derivatives to swap the balance of its long-term indebtedness from Euros to U.S. dollars and a currency forward. We recorded a net unrealized non-cash holding loss of €48.3 million before minority interests upon the marked to market valuation of such currency derivatives due to the strengthening of the U.S. dollar versus the Euro at the end of the quarter. In the comparative quarter of 2004, we recorded a net unrealized non-cash holding gain of €13.7 million before minority interests on the then outstanding currency derivatives of Rosenthal and Stendal. In the second quarter of 2005, as a result of a decrease in long-term European interest rates, we also recorded a net unrealized non-cash holding loss of €20.8 million before minority interests on the marked to market valuation of the Stendal interest rate derivatives versus a net unrealized non-cash holding gain of €15.8 million before minority interests on the interest rate derivatives of Stendal and Rosenthal in the comparative quarter of 2004. See “Quantitative and Qualitative Disclosures About Market Risk” for more information about our derivatives.

In the second quarter of 2005, minority interest, representing the two minority shareholders’ proportionate interest in the Stendal mill, was €4.9 million, compared to €(10.2) million in the second quarter of 2004.

We reported a net loss for the second quarter of 2005 of €62.2 million, or €1.88 per basic and diluted share, which reflected the net unrealized non-cash holding losses on our currency and interest rate derivatives of €69.1 million and the unrealized non-cash foreign exchange loss on our long-term debt of €9.8 million, partially offset by the non-cash benefit for income taxes of €24.4 million, and interest expense related to our Stendal mill of €14.5 million. In the second quarter of 2004, we reported net income of €16.2 million, or €0.94 per basic share and €0.57 per diluted share.

We generated Operating EBITDA of €23.1 million and €5.3 million in the three months ended June 30, 2005 and 2004, respectively, calculated by adding depreciation and amortization and non-recurring capital asset impairment charges of €13.9 million and €6.3 million to the income from operations of €9.2 million and a loss from operations of €1.0 million for the three months ended June 30, 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 our results as reported under GAAP. See the discussion of our results for the first half of 2005 for additional information relating to Operating EBITDA.

FORM 10-Q
QUARTERLY REPORT — PAGE 30

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


	Three Months Ended
	June 30,
	2005			2004
	(in thousands)
	(unaudited)
Net income (loss)	€	(62,151	)	€	16,241
Minority interest		(4,852	)		10,199
Income taxes (benefit)		(24,447	)		219
Interest expense		22,200			2,366
Investment income		(806	)		(530	)
Derivative financial instruments, net		69,451			(29,473	)
Foreign exchange loss on debt		9,806			—

Income (loss) from operations		9,201			(978	)
Add: Depreciation and amortization		13,896			6,314

Operating EBITDA	€	23,097		€	5,336

Liquidity and Capital Resources

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


	As at			As at
	June 30,			December 31,
	2005			2004
	(in thousands)
	(unaudited)
Financial Position
Cash and cash equivalents	€	105,874		€	49,568
Working capital (deficit)		85,156			(21,659	)
Property, plant and equipment		1,109,394			936,035
Total assets		1,538,829			1,255,649
Long-term liabilities		1,125,857	⁽¹⁾		863,840
Shareholders’ equity		179,865			162,741


(1)		Includes €28.6 million outstanding under the revolving credit facilities for the Rosenthal and Celgar mills.

At June 30, 2005, our cash and cash equivalents were €105.9 million, compared to €49.6 million at December 31, 2004. We also had €38.0 million of cash restricted to pay current Stendal construction costs payable of €34.1 million at June 30, 2005. We also had €19.1 million of cash restricted in a debt service account for the project financing for the Stendal mill. At June 30, 2005, we qualified for investment grants related to the Stendal mill totaling approximately €88.5 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 also recently approved an approximately C$28.5 million strategic capital

FORM 10-Q
QUARTERLY REPORT — PAGE 31

plan for our Celgar mill that we expect will increase the mill’s production capacity, reduce operating costs and improve pulp quality and the mill’s reliability. We expect to meet the costs of such plan from cash on hand, cash flow from operations and our existing credit facility relating to the Celgar mill. 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 first half of 2005 used cash of €5.2 million, compared to €3.1 million in the comparative period of 2004. An increase in receivables due primarily to higher sales used cash of €20.7 million in the first half of 2005, compared to €2.5 million in the comparative period 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 €16.8 million in the first half of 2005, compared to €18.0 million in the first half of 2004. An increase in accounts payable and accrued expenses provided cash of €41.3 million in the first half of 2005, compared to €12.2 million in the comparative period of 2004, primarily due to higher production.

Investing Activities

Investing activities in the six months ended June 30, 2005 used cash of €155.1 million, of which €146.6 million related to the acquisition of the Celgar pulp mill. The acquisition of properties used cash of €8.5 million in the first half of 2005. Investing activities used cash of €116.1 million in the six months ended June 30, 2004, primarily relating to the Stendal mill.

Financing Activities

Financing activities provided cash of €211.0 million in the six months ended June 30, 2005. In connection with the acquisition of the Celgar pulp mill, a net increase in indebtedness provided cash of €141.5 million, the issuance of shares of beneficial interest provided cash of €66.6 million and a decrease in restricted cash provided cash of €35.8 million in the current period. We fully repaid the project loan facility relating to the Rosenthal mill, or the “Rosenthal 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. A decrease in construction costs payable used cash of €31.3 million in the current period. Financing activities provided cash of €109.4 million in the six months ended June 30, 2004, primarily related to the Stendal mill.

As at June 30, 2005, we had utilized the entire €4.7 million available under the five credit facilities relating to the paper operations. In addition, at June 30, 2005, we had drawn down approximately €12.0 million of the €40.0 million available under the new revolving term credit facility relating to the Rosenthal mill and €16.6 million of the $30 million available under the new revolving credit facility relating to the Celgar mill.

We qualify for investment grants from the federal and state governments of Germany and had claim expenditures of €88.5 million outstanding as of June 30, 2005. We expect to receive our currently outstanding claim expenditures in 2005. In accordance with our accounting policies, we

FORM 10-Q
QUARTERLY REPORT — PAGE 32

do not record these grants until they are received. These grants reduce the cost basis of the assets purchased with them.

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.

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 June 30, 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 June 30, 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.

FORM 10-Q
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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 consolidated statement of comprehensive income and impact on shareholders’ equity on the balance sheet but do not affect our net earnings.

In the six months ended June 30, 2005, we reported a net €1.2 million foreign exchange translation gain and, as a result, the cumulative foreign exchange translation gain increased to €11.6 million at June 30, 2005 from €10.4 million at December 31, 2004.

Based upon the exchange rate at June 30, 2005, the U.S. dollar increased by approximately 1% in value against the Euro since June 30, 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 six and three months ended June 30, 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 six and three months ended June 30, 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 six and three months ended June 30, 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 — Six Months Ended June 30, 2005 Compared to Six Months Ended June 30, 2004

Total revenues for the Restricted Group for the six months ended June 30, 2005 increased to €114.4 million from €72.2 million in the comparative period of 2004, primarily because of the

FORM 10-Q
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inclusion of the pulp sales from the Celgar mill. Pulp sales realizations for the Restricted Group decreased to €427 per ADMT on average in the six months ended June 30, 2005 from €443 per ADMT in the comparative period of 2004, primarily as a result of lower sales prices realized by the Celgar mill, which sells a large portion of its production in Asian markets which had lower sales prices than European markets. The decrease in NBSK pulp prices was partially offset by the strengthening of the U.S. dollar versus the Euro during the current period.

Costs of sales and general, administrative and other expenses for the Restricted Group in the six months ended June 30, 2005 increased to €107.0 million from €66.1 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.

Depreciation for the Restricted Group decreased to €10.8 million in the first half of 2005 from €11.1 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 in cost of sales for the Restricted Group for the six months ended June 30, 2005, partially offset by the inclusion of depreciation of the Celgar mill.

In the first half of 2005, the Restricted Group reported income from operations of €7.4 million, compared to €6.1 million in the first half of 2004. Interest expense for the Restricted Group in the six months ended June 30, 2005 increased to €16.0 million from €6.0 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 €1.6 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 six months ended June 30, 2005, the Restricted Group recorded a net loss of €0.3 million on the settlement of the Rosenthal interest rate derivatives, versus a net unrealized non-cash holding loss of €4.8 million on the marked to market valuation thereon in the comparative period of 2004. In the six months ended June 30, 2004, the Restricted Group recorded a net unrealized non-cash holding loss of €0.5 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 half of 2005 that materially affected its results.

The Restricted Group reported a net loss for the six months ended June 30, 2005 of €21.7 million, which reflected higher interest expense of €16.0 million. In the first half of 2004, the Restricted Group reported a net loss of €3.6 million.

The Restricted Group generated “Operating EBITDA” of €18.2 million and €17.2 million in the six months ended June 30, 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 €10.8

FORM 10-Q
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million and €11.1 million to the income from operations of €7.4 million and €6.1 million for the six months ended June 30, 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 six months ended June 30, 2005 for additional information relating to such limitations and Operating EBITDA.

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


	Six Months Ended
	June 30,
	2005			2004
	(in thousands)
	(unaudited)
Restricted Group⁽¹⁾⁽²⁾
Net loss	€	(21,696	)	€	(3,645	)
Income taxes		4,776			199
Interest expense		15,985			6,023
Investment and other income		(1,297	)		(1,745	)
Derivative financial instruments, net		463			5,272
Foreign exchange loss on debt		7,509			—
Impairment of investments		1,645			—

Income from operations		7,385			6,104
Add: Depreciation and amortization		10,829			11,136

Operating EBITDA	€	18,214		€	17,240


(1)		The results of the Celgar pulp mill are not included for the six months ended June 30, 2004.

(2)		See Note 10 of the financial statements included elsewhere herein for a reconciliation to our consolidated results.

Restricted Group Results — Three Months Ended June 30, 2005 Compared to Three Months Ended June 30, 2004

Total revenues for the Restricted Group for the three months ended June 30, 2005 increased to €72.7 million from €36.8 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 decreased to €430 per ADMT on average in the three months ended June 30, 2005 from €471 per ADMT in the comparative period of 2004, primarily as a result of lower sales prices realized by the Celgar mill, which sells a large portion of its production in Asian markets which had lower sales prices than European markets. The decrease in NBSK pulp prices was partially offset by the strengthening of the U.S. dollar versus the Euro during the current period.

Costs of sales and general, administrative and other expenses for the Restricted Group in the three months ended June 30, 2005 increased to €67.3 million from €32.1 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.

Depreciation for the Restricted Group decreased to €6.7 million in the second quarter of 2005 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 in cost of sales for the Restricted Group for the three months ended June 30, 2005, partially offset by the inclusion of depreciation at the Celgar mill.

FORM 10-Q
QUARTERLY REPORT — PAGE 36

In the second quarter of 2005, the Restricted Group reported income from operations of €5.4 million, compared to €4.7 million in the comparative quarter of 2004. Interest expense for the Restricted Group in the three months ended June 30, 2005 increased to €8.3 million from €1.9 million in the year ago period, primarily due to higher borrowings resulting from our $310 million senior note offering in February 2005.

The Restricted Group did not have any interest rate or currency derivatives outstanding during the second quarter of 2005 that materially affected its results. In the three months ended June 30, 2004, the Restricted Group recorded a net unrealized non-cash holding loss of €4.7 million on the marked to market valuation of the Rosenthal interest rate derivatives, which were settled in the first quarter of 2005, and a net unrealized non-cash holding gain of €4.4 million upon the marked to market valuation of the then outstanding currency derivatives relating to the Rosenthal mill.

The Restricted Group reported a net loss for the three months ended June 30, 2005 of €14.3 million, which reflected higher interest expense of €8.3 million. In the comparative quarter of 2004, the Restricted Group reported net income of €2.8 million.

The Restricted Group generated Operating EBITDA of €12.1 million and €10.3 million in the three months ended June 30, 2005 and 2004, respectively. Operating EBITDA for the Restricted Group is calculated by adding depreciation and amortization and non-recurring capital asset impairment charges of €6.7 million and €5.6 million to the income from operations of €5.4 million and €4.7 million for the three months ended June 30, 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 six months ended June 30, 2005 for additional information relating to such limitations and Operating EBITDA.

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


	Three Months Ended
	June 30,
	2005			2004
	(in thousands)
	(unaudited)
Restricted Group⁽¹⁾⁽²⁾
Net income (loss)	€	(14,278	)	€	2,830
Income taxes		1,661			199
Interest expense		8,314			1,947
Investment and other income		(970	)		(639	)
Derivative financial instruments, net		358			382
Foreign exchange loss on debt		9,806			—
Impairment of investments		467			—

Income from operations		5,358			4,719
Add: Depreciation and amortization		6,704			5,554

Operating EBITDA	€	12,063		€	10,273


(1)		The results of the Celgar pulp mill are not included for the three months ended June 30, 2004.

(2)		See Note 10 of the financial statements included elsewhere herein for a reconciliation to our consolidated results.

FORM 10-Q
QUARTERLY REPORT — PAGE 37

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 at
	June 30,		December 31,
	2005		2004
	(in thousands)
	(unaudited)
Restricted Group Financial Position⁽¹⁾⁽²⁾
Cash and cash equivalents	€	62,792	€	45,487
Working capital		119,518		48,480
Property, plant and equipment		393,047		213,678
Total assets		633,562		401,321
Long-term liabilities		373,471		228,139
Shareholders’ equity		216,311		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 June 30, 2005, the Restricted Group had cash and cash equivalents of €62.8 million, compared to €45.5 million at December 31, 2004. At June 30, 2005, the Restricted Group had working capital of €119.9 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.

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.

FORM 10-Q
QUARTERLY REPORT — PAGE 38

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.

FORM 10-Q
QUARTERLY REPORT — PAGE 39

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 long-term indebtedness under the Stendal Loan Facility from Euros into U.S. dollars and certain currency forwards. In the second quarter of 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 and a currency forward.

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.

FORM 10-Q
QUARTERLY REPORT — PAGE 40

The following table sets forth the maturity date, the notional amount and the recognized gain or loss in the six and three months ended June 30, 2005 for derivatives related to the Rosenthal and Stendal mills that were in effect during these periods that affected our results:


				Recognized Gain			Recognized Gain
				(Loss) in			(Loss) in
				Six Months Ended			Three Months Ended
Derivative Instrument	Maturity Date	Notional Amount		June 30, 2005			June 30, 2005
		(unaudited)		(unaudited)			(unaudited)
		(in millions)		(in thousands)			(in thousands)
Interest Rate Derivatives
Rosenthal Interest Rate Cap Agreements⁽¹⁾	Settled	$	178.3	€	(295	)	€	-
Stendal Interest Rate Swaps⁽²⁾	October 2017	€	1,147.5		(20,475	)		(20,819	)

				€	(20,770	)	€	(20,819	)

Foreign Exchange Rate Derivatives
Stendal Currency Swap⁽³⁾	October 2017	€	306.3	€	(24,571	)	€	(22,278	)
Stendal Currency Swap⁽⁴⁾	October 2017	€	153.2		(12,778	)		(11,027	)
Stendal Currency Swap⁽⁵⁾	October 2017	€	153.2		(10,336	)		(10,336	)
Stendal Currency Forward	September 2005	$	25.0		(379	)		(393	)
Stendal Currency Forward	September 2005	$	25.0		(1,497	)		(1,497	)
Stendal Currency Forward	February 2006	$	50.0		(2,811	)		(2,743	)

				€	(52,372	)	€	(48,274	)


(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 June 30, 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.

(5)		For €153.2 million of the outstanding principal amount under the Stendal Loan Facility, all repayment installments from April 18, 2005 until October 2, 2017 were swapped into U.S. dollar amounts at a rate of U.S. 1.2799. 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.

FORM 10-Q
QUARTERLY REPORT — PAGE 41

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 significant 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.

FORM 10-Q
QUARTERLY REPORT — PAGE 42

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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS

We held our annual meeting of shareholders on June 14, 2005. At the meeting, two Class II trustees were elected to our board of trustees and the selection of Deloitte & Touche LLP as our independent auditors was ratified.

The votes cast by shareholders at the meeting as to the election of trustees were as follows:


	Votes For		Votes Withheld		Abstentions and Broker Non-Votes
Jimmy S.H. Lee		26,502,486		77,690		—
William D. McCartney		26,503,186		76,990		—

Kenneth A. Shields, Graeme A. Witts, Eric Lauritzen and Guy W. Adams continued their respective terms as trustees.

In connection with the ratification of the selection of Deloitte & Touche LLP as our independent auditors, shareholders cast 26,502,118 votes in favour of and 70,836 votes against such ratification and there were 7,222 shares withheld from voting with no abstentions and broker non-votes.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)

Exhibits


Exhibit
No.		Description

4.1*		Amendment to Registration Rights Agreement dated May 30, 2005 between Mercer International Inc. and KPMG Inc.

4.2*		Registration Rights Agreement dated February 10, 2005 between Mercer International Inc. and Royal Bank of Canada.

4.3*		Amendment to Registration Rights Agreement dated May 30, 2005 between Mercer International Inc. and Royal Bank of Canada.

31.1		Section 302 Certification of Chief Executive Officer

31.2		Section 302 Certification of Chief Financial Officer

32.1**		Section 906 Certification of Chief Executive Officer

FORM 10-Q
QUARTERLY REPORT — PAGE 43


	2005			2004

Net loss	€	(81,818	)	€	(2,725	)


Other comprehensive income (loss):
Foreign currency translation adjustments		1,118			2,352
Unrealized gains on securities
Unrealized holding gains (losses) arising during the period		305			(250	)


Other comprehensive income		1,423			2,102


Total comprehensive loss	€	(80,395	)	€	(623	)


	2005			2004

Net income (loss)	€	(62,151	)	€	16,241


Other comprehensive income (loss):
Foreign currency translation adjustments		1,750			696
Unrealized gains on securities
Unrealized holding gains (losses) arising during the period		—			257


Other comprehensive income		1,750			953


Total comprehensive income (loss)	€	(60,401	)	€	17,194


	MERCER INTERNATIONAL INC.
	By:	/s/ David M. Gandossi
		David M. Gandossi
		Secretary and Chief Financial Officer


(1)		Shareholders' equity does not include government grants received or receivable related to the Stendal mill. Shareholders' equity is impacted by the unrealized non-cash marked to market valuation losses on derivative financial instruments.


*		Incorporated by reference to Form 8-K filed on November 23, 2004, as amended on June 3, 2005.

**		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.