MERCER INTERNATIONAL INC. - Annual Report: 2005 (Form 10-K)

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

For the transition period from ____________ to ____________

Commission File No.: 000-51826

MERCER INTERNATIONAL INC.

Exact name of Registrant as specified in its charter

Suite 2840, 650 West Georgia Street, Vancouver, British Columbia, Canada, V6B 4N8

Address of Office

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

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

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

Common Stock

Title of Class

         Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes o         No þ

         Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Act.    Yes o         No þ

         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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

         Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer.

         Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes o         No þ

         The aggregate market value of the Registrant’s voting and non-voting common equity held by non-affiliates of the Registrant as of June 30, 2005, the last business day of the Registrant’s most recently completed second fiscal quarter, based on the closing price of the voting stock on the Nasdaq National Market on such date, was approximately $198,673,889.

         As of March 14, 2006, the Registrant had 33,169,140 shares of common stock, $1.00 par value, outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

         Certain information that will be contained in the definitive proxy statement for the Registrant’s annual meeting to be held in 2006 is incorporated by reference into Part III of this Form 10-K.

TABLE OF CONTENTS

EXCHANGE RATES

      As of 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. Accordingly, our financial statements for the years ended December 31, 2003, 2004 and 2005 included in this annual report are stated in Euros while certain of our financial information for periods prior to the year ended December 31, 2002 included in this annual report has been restated in Euros. We translate non-Euro denominated assets and liabilities at the rate of exchange on the balance sheet date. Revenues and expenses are translated at the average rate of exchange prevailing during the period.

      The following table sets out exchange rates, based on the noon buying rates in New York City for cable transfers in foreign currencies as certified for customs purposes by the Federal Reserve Bank of New York (the “Noon Buying Rate”) for the conversion of Euros and Canadian dollars to U.S. dollars in effect at the end of the following periods, the average exchange rates during these periods (based on daily Noon Buying Rates) and the range of high and low exchange rates for these periods:

      On March 14, 2006, the Noon Buying Rate for the conversion of Euros and Canadian dollars to U.S. dollars was €0.8316 per U.S. dollar and C$1.1548 per U.S. dollar.

      In addition, certain financial information relating to the Celgar pulp mill, which our subsidiary, Zellstoff Celgar Limited (formerly known as 0706906 B.C. Ltd.), acquired in February 2005, included in this annual report is stated in Canadian dollars while we report our financial results in Euros. The following table sets out exchange rates, based on the noon rates as provided by the Bank of Canada, for the conversion of Canadian dollars to Euros in effect at the end of the following periods, the average exchange rates during these periods (based on daily noon rates) and the range of high and low exchange rates for these periods:

      On March 14, 2006, the noon rate for the conversion of Canadian dollars to Euros was C$1.3888 per Euro.

PART I

ITEM 1.     BUSINESS

      In this document, please note the following:

The Company

General

      Mercer Inc. was originally organized as a business trust under the laws of the State of Washington in 1968. Effective March 1, 2006, it was converted, referred to as the “Conversion”, from a business trust to a corporation organized under the laws of the State of Washington. The Conversion was effected by way of merger and Mercer Inc., the Washington corporation, succeeded to all of the assets, liabilities, rights and obligations of the business trust. See “— The Conversion” below for more information.

      We operate in the pulp and paper business. We are one of the largest producers of market northern bleached softwood kraft, or “NBSK”, pulp in the world. We are the sole kraft pulp producer, and the only producer of pulp for resale, known as “market pulp”, in Germany, which is the largest pulp import market in Europe. Our operations are currently located primarily in eastern Germany and western Canada. We currently employ approximately 1,255 people at our German operations, approximately 400 people are employed at our Celgar mill and 12 people at our office in Vancouver, British Columbia, Canada. We operate three NBSK pulp mills with a consolidated annual production capacity of approximately 1.3 million ADMTs:

      We also own and operate two paper mills located at Heidenau and Fährbrücke, Germany, which produce specialty papers and printing and writing papers and, based upon their current product mix, have an aggregate annual production capacity of approximately 70,000 ADMTs.

History and Development of Business

      We originally invested in various real estate assets with the intention of becoming a real estate investment trust, but in 1985 changed our operational direction to acquiring controlling interests in operating companies. We acquired our initial pulp and paper operations beginning in 1993.

      In late 1999, we completed a major capital project which, among other things, converted the Rosenthal mill to the production of kraft pulp from sulphite pulp, increased its annual production capacity from approximately 160,000 ADMTs to approximately 280,000 ADMTs, reduced costs and improved efficiencies. The aggregate cost of the project was approximately €361.0 million. Subsequent minor capital investments and efficiency improvements increased the Rosenthal mill’s annual production capacity to approximately 310,000 ADMTs, and reduced emissions and energy costs.

      In the third quarter of 2004, we completed construction of the Stendal mill substantially on its planned schedule and budget at an aggregate cost of approximately €1.0 billion. For more information, see “— Stendal Pulp Mill”.

      In February 2005, we completed the Acquisition of substantially all of the assets of Stone Venepal (Celgar) Pulp Inc., or “Celgar”, comprised primarily of the Celgar mill. The aggregate cost of the Acquisition including defined working capital (excluding fees and expenses) was approximately $226 million. See “— Acquisition of Celgar Pulp Mill” below for more information relating to the Acquisition.

      We have also upgraded our Heidenau and Fährbrücke paper mills, which currently principally produce niche products.

      A significant portion of the capital investments at our European pulp and paper mills, including the construction of the Stendal mill, were financed in large part through government guaranteed term financing and government grants. See “— Government Financing”.

      In December 2001, we acquired Landqart AG for approximately €2.7 million, which operates a paper mill in Switzerland that produces bank note and security paper. In 2002, we determined the mill to be a non-core asset and we reorganized and reduced our interest to 39% by selling a 20% interest to a Swiss bank and exchanging the balance for a 49% interest in a limited partnership on a non-cash basis. In 2005, in order to facilitate its disposition, we acquired the outstanding interest in Landqart AG for €0.1 million and certain non-cash assets which had a nil book value.

Organizational Chart

      The following chart sets out our directly and indirectly owned principal operating subsidiaries, their jurisdictions of organization and their principal activities:

The Conversion

      At a special meeting of shareholders held on February 17, 2006, we received the required shareholder approvals in connection with the Conversion of Mercer Inc. from a business trust organized under the laws of the State of Washington to a Washington corporation. The Conversion was completed effective March 1, 2006. The Conversion effected a change in our legal form, but did not result in any change in our business, management, fiscal year, accounting practices, assets or liabilities (except to the extent of legal and other costs of effecting the Conversion and maintaining ongoing corporate status) or location of the principal executive offices and facilities following consummation of the Conversion. We continue to operate under the name “Mercer International Inc.”, are engaged in the same business that we were engaged in prior thereto and our shares of common stock are quoted and listed for trading on the NASDAQ National Market and the Toronto Stock Exchange, respectively.

      We effected the Conversion principally to: (i) extend our limited life to an indefinite term; and (ii) increase our operational flexibility and potential entitlement to additional benefits and advantages of operating as a corporation, and reduce certain administrative burdens and costs of operating as a business trust.

      The Conversion was effected as follows:

      As a result of the Conversion, the shareholders of the business trust became shareholders of Mercer Inc., the Washington corporation, and own exactly the same number of our shares of common stock immediately after the Conversion as the number of shares of the business trust they owned immediately before the Conversion. Each outstanding certificate representing shares in the business trust now represents the same

number of our shares of common stock. New share certificates will be issued if and as certificates are presented for exchange or transfer.

      The Conversion did not result in changes in our historical consolidated carrying amounts of assets, liabilities and shareholders’ equity. In addition, all outstanding and unexercised stock options, warrants or other rights to acquire shares of the business trust, whether pursuant to our outstanding convertible notes, stock option or incentive plans or otherwise, converted into options, warrants or rights to acquire the same number of our shares of common stock on the same terms and conditions and at the same exercise or conversion price applicable to any such options, warrants or rights outstanding prior to the consummation of the Conversion. The stock option, stock incentive and other employee benefit plans and indentures, and credit facilities of the business trust were also continued by us upon the terms and subject to the conditions in effect prior to the Conversion.

      At the effective time of the Conversion, the incumbent trustees and officers of the business trust became our directors and officers except that, as part of the Conversion, we eliminated the staggered board of the business trust and our directors now serve for one-year terms.

Acquisition of Celgar Pulp Mill

      On February 14, 2005, we completed the Acquisition of substantially all of the assets of Celgar for $210 million, of which $170 million was paid in cash and $40 million was paid in our shares, plus $16 million for the defined working capital at the Celgar mill. Our shares issued as part of the consideration for the Acquisition were issued at a price of $9.50 per share.

      The assets acquired are substantially all of the operating assets of Celgar, including real property, plant and equipment, personal property, leaseholds, contractual interests and intellectual property. We did not acquire certain assets of Celgar comprised principally of finished goods inventory, receivables, cash on hand and certain insurance claims. We assumed various employment, pension and benefit, asset retirement and contractual obligations of Celgar. We did not assume any obligations for any current liabilities of Celgar as at the date of closing, except for certain accrued employee liabilities, or any indebtedness of Celgar, whether incurred pre- or post-bankruptcy.

      On closing of the Acquisition, we added approximately 420 employees to our operations who were previously employees of Celgar. The initial positions, base salaries and benefits of such employees are comparable to the positions, salaries and benefits in place immediately prior to closing. The terms of employment, salaries and benefits applicable to such employees are comparable to other similarly situated employees in the pulp business in British Columbia, Canada.

      The Celgar mill is a modern NBSK pulp mill that produces high quality NBSK pulp. It has an annual production capacity of approximately 430,000 ADMTs, and is located near the city of Castlegar, British Columbia, Canada. Completely rebuilt in the 1990s through an C$850 million modernization and expansion project, the Celgar mill was transformed into a low cost Canadian producer of high quality NBSK pulp with a significantly increased production capacity. In 1998, primarily as a result of the indebtedness incurred by Celgar during the modernization process, its directors assigned it into bankruptcy and a trustee in bankruptcy was appointed. Immediately thereafter, two senior secured bank lenders of Celgar appointed the bankruptcy trustee as the receiver for all of the assets and undertakings of Celgar under their security. The bankruptcy trustee had operated the Celgar mill since then until the closing of the Acquisition.

      The Acquisition of the Celgar mill reflects our strategy of acquiring world-class market NBSK pulp production capacity on terms below comparable replacement cost where we can use our management focus to enhance operations, improve profitability and create value for our stakeholders. The Acquisition makes us one of the largest producers of market NBSK pulp in the world. We now have a consolidated annual production capacity of approximately 1.3 million ADMTs of high quality NBSK pulp from three modern NBSK pulp mills located in Europe and North America. This has improved our service to those larger paper and tissue producing customers who wish to develop purchasing arrangements with pulp suppliers that can service them on a worldwide basis. The mill also diversifies our revenue and cost base. Prior to the Acquisition, substantially

all of our revenues resulted from sales in Europe. Approximately 69% of the Celgar mill’s sales in 2005 were in Asia, which is currently the fastest growing market for NBSK pulp imports. The Celgar mill’s costs are largely in Canadian dollars, which has reduced our relative exposure to the exchange rate between the U.S. dollar and Euro.

      We are focusing on improving the operating results of the Celgar mill. We are in the process of implementing a capital improvement project at the mill in the aggregate amount of approximately €20.0 million that we believe will improve price realizations, increase production, improve reliability and lower production costs. The capital improvement project, along with other enhancements and debottlenecking initiatives, will also increase the Celgar mill’s production capacity to approximately 470,000 ADMTs over time. For more information about the capital improvement project at the Celgar mill, see “— Capital Expenditures”.

      We have taken over responsibility for sales at the Celgar mill and are coordinating them with sales at our other pulp mills. We have begun reducing the amount of pulp sold by the mill at a discount in the spot market by more effectively matching it with customer requirements and improving the mill’s pulp brightness consistency. We believe these steps, together with other initiatives, should eliminate the price realization discount incurred by the Celgar mill in comparison to other NBSK pulp mills in British Columbia, Canada over time.

The Financings

      In conjunction with the Acquisition, we 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) by way of separate public offerings. We issued our shares of beneficial interest at a price of $8.50 per share. The net proceeds from the offering of the senior notes, and our shares of beneficial interest and cash on hand were utilized to pay the cash portion of the purchase price of the Acquisition, including defined working capital, transaction costs, to refinance all of the bank indebtedness of our Rosenthal mill and for working capital.

      Upon the completion of the Acquisition, we also established a new revolving working capital facility for the Rosenthal mill in the amount of €40 million with an initial term of five years and for the Celgar mill in the amount of $30 million, with an initial term of one year (that has been extended by 90 days) which, if not renewed, will convert to a one year term loan. See “— Description of Certain Indebtedness” for more information relating to our senior notes and the new working capital facilities.

Competitive Strengths

      Our competitive strengths include the following:

Corporate Strategy

      Our corporate strategy is to create shareholder value by focusing on the expansion of our asset and earnings base through organic growth and acquisitions primarily in Europe and North America. We pursue organic growth through active management and targeted capital expenditures designed to produce a high return by increasing production, reducing costs and improving quality. We seek to acquire interests in companies and assets in the pulp and paper industry and related businesses where we can leverage our experience and expertise in adding value through a focused management approach. Key features of our strategy include:

The Pulp Industry

General

      Pulp is used in the production of paper, tissues and paper related products. Pulp is generally classified according to fiber type, the process used in its production and the degree to which it is bleached. Kraft pulp is produced through a sulphate chemical process in which lignin, the component of wood which binds individual fibers, is dissolved in a chemical reaction. Chemically treated pulp allows the wood’s fiber to retain its length and flexibility, resulting in stronger paper products. Kraft pulp can be bleached to increase its brightness. Kraft pulp is noted for its strength, brightness and absorption properties and is used to produce a variety of products, including lightweight publication grades of paper, tissues and paper related products.

      The market value of kraft pulp depends in part on the fiber used in the production process. There are two primary species of wood used as fiber: softwood and hardwood. Softwood species generally have long, flexible fibers which add strength to paper while fibers from species of hardwood contain shorter fibers which lend bulk and opacity. Prices for softwood pulp are generally higher than for hardwood pulp. Currently, the kraft pulp market is roughly evenly split between softwood and hardwood grades. Most uses of market kraft pulp, including fine printing papers, coated and uncoated magazine papers and various tissue products, utilize a mix of softwood and hardwood grades to optimize production and product qualities. In recent years, production of hardwood pulp, based on fast growing plantation fiber primarily from Asia and South America, has increased much more rapidly than that of softwood grades that have longer growth cycles. As a result of the growth in supply and lower costs, kraft pulp customers in recent years have substituted some of the pulp content in their products to hardwood pulp. Counteracting customers’ increased proportionate usage of hardwood pulp has been the requirement for strength characteristics in finished goods and paper and tissue makers focus on higher machine speeds and lower basis weights for publishing papers which also require the strength characteristics of softwood pulp. We believe that the ability of kraft pulp users to further substitute hardwood for softwood pulp is limited by such requirements.

      NBSK pulp, which is a bleached kraft pulp manufactured using species of northern softwood, is considered a premium grade because of its strength. It generally obtains the highest price relative to other kraft pulps. Southern bleached softwood kraft pulp is kraft pulp manufactured using southern softwood species and does not possess the strength found in NBSK pulp. NBSK pulp is the sole product of the Rosenthal, Stendal and Celgar mills.

      Kraft pulp can be made in different grades, with varying technical specifications, for different end uses. High quality kraft pulp is valued for its reinforcing role in mechanical printing papers, while other grades of kraft pulp are used to produce lower priced grades of paper, including tissues and paper related products.

Pulp Markets

      Producers ranging from small independent manufacturers to large integrated companies produce pulp worldwide. In 2004, more than 130 million ADMTs of kraft pulp were converted into printing and writing papers, tissues, cartonboards and other white grades of paper and paperboard around the world. Approximately 68% of this pulp was produced for internal purposes by integrated paper and paperboard manufacturers, and approximately 32% was produced for sale on the open market.

      Although demand is cyclical, worldwide demand for kraft market pulp has grown at an average rate of approximately 3% annually over the last ten years. The growth rate for NBSK pulp reflects this continuing demand, with growth rates higher than the general softwood kraft group.

      Western Europe accounts for approximately 38% of global market pulp demand with a growth rate of approximately 2% annually over the past ten years. Within Europe, Germany, with its large economy and sizable paper industry, has been the largest pulp market historically relying largely on imports from North America and Scandinavia.

      Demand for market pulp in Asia (excluding Japan) has been growing at approximately 10% annually over the past ten years and currently accounts for approximately 30% of global demand. This demand growth

has been driven by increasing per capita consumption combined with the mandated closure of numerous small, often non-wood based, pulp facilities in China. Canada is the largest exporter to this region.

      We expect Europe and Asia to continue to be significant net importers of pulp in the foreseeable future. The markets for kraft pulp are cyclical in nature and demand for kraft pulp is related to global and regional levels of economic activity. A measure of demand for kraft pulp is the ratio obtained by dividing the worldwide consumption of kraft pulp by the worldwide capacity for the production of kraft pulp, or the “consumption/ capacity ratio”. An increase in this ratio generally occurs when there is an increase in global and regional levels of economic activity without a corresponding increase in industrial capacity. An increase in this ratio generally indicates greater demand as consumption increases, which generally results in rising kraft pulp prices and a build-up of inventories by buyers and a reduction by producers. As prices continue to rise, producers continue to run at higher operating rates. However, an adverse change in global and regional levels of economic activity generally negatively affects demand for kraft pulp, often leading to a high level of inventory build-up by buyers. As demand falls, buyers generally reduce their purchases and rely on inventories of kraft pulp and many producers will run at lower operating rates by taking downtime to limit the build-up of their own inventories.

      The consumption/ capacity ratio, excluding Indonesian and eastern European pulp producers, was approximately 93% in 2003, approximately 96% in 2004 and approximately 93% in 2005. We expect the long lead time and significant capital investment required to bring new NBSK pulp mills on stream to limit growth in industry capacity in the next few years.

NBSK Pulp Pricing

      Global economic conditions, changes in production capacity, inventory levels, and currency exchange rates are the primary factors affecting NBSK pulp list prices. The average annual European list prices for NBSK pulp between 1990 and 2005 ranged from a low of approximately $444 per ADMT in 1993 to a high of approximately $875 per ADMT in 1995.

      The 1995 price peak was followed by a steep decline as inventory levels for North American and Scandinavian, or “Norscan”, producers grew to over 2.5 million ADMTs by early 1996. Norscan producers produce the majority of the market NBSK pulp sold in North America and Europe and inventory levels held by Norscan producers are considered an industry benchmark in determining industry inventory levels. Between 1996 and 1999, list pulp prices remained relatively low due in part to the Asian financial crisis which began in late 1997.

      Prices started to recover in 1999 due to a combination of factors including a recovery in the Asian economy, the shutdown of unprofitable mills or older mills in need of environmental upgrades and a decline in capacity expansion. This contributed to tightening inventory levels among Norscan producers, which fell to approximately 1.1 million ADMTs in June 2000, resulting in list prices increasing to an average of approximately $710 per ADMT in the fourth quarter of 2000. However, the decline of the American and major European economies in 2001 caused a sharp reduction in paper demand. As a result, Norscan pulp inventories rose to a high of approximately two million ADMTs in early 2001 and list price levels eroded to an average of approximately $460 per ADMT in late 2001. Inventory levels ranged between approximately 1.3 million and 1.9 million ADMTs in 2002, and list prices averaged approximately $463 per ADMT in 2002. The weakening of the U.S. dollar against the Euro and other major currencies and an increase in demand resulting from improving American and major European economies in 2003 resulted in list prices for kraft pulp in Europe increasing to approximately $560 per ADMT in December 2003 despite relatively high inventory levels. List prices for kraft pulp in Europe continued to strengthen in 2004 due to the relatively weak U.S. dollar and improving world economies, and were approximately $625 per ADMT in December 2004. However, list prices for NBSK pulp declined in 2005 primarily due to the strengthening of the U.S. dollar and were approximately $600 per ADMT in Europe at the end of 2005. A producer’s sales realizations will reflect customer discounts, commissions and other items and prices will continue to fluctuate in the future.

The Manufacturing Process

      The following diagram provides a simplified description of the kraft pulp manufacturing process at our pulp mills:

      In order to transform wood chips into kraft pulp, wood chips undergo a multi-step process involving the following principal stages: chip screening, digesting, pulp washing, and screening, bleaching and drying.

      In the initial processing stage, wood chips are screened to remove oversized chips and sawdust and are conveyed to a pressurized digester where they are heated and cooked with chemicals. This occurs in a continuous process at the Celgar and Rosenthal mills and in a batch process at the Stendal mill. This process softens and eventually dissolves the phenolic material called lignin that binds the fibers to each other in the wood.

      Cooked pulp flows out of the digester and is washed and screened to remove most of the residual spent chemicals, called black liquor, and partially cooked wood chips. The pulp then undergoes a series of bleaching stages where the brightness of the pulp is gradually increased. Finally, the bleached pulp is sent to the pulp machine where it is dried to achieve a dryness level of more than 90%. The pulp is then ready to be baled for shipment to customers.

      A significant feature of kraft pulping technology is the recovery system, whereby chemicals used in the cooking process are captured and extracted for re-use, which reduces chemical costs and improves environmental performance. During the cooking stage, dissolved organic wood materials and black liquor are extracted from the digester. After undergoing an evaporation process, black liquor is burned in a recovery boiler. The chemical compounds of the black liquor are collected from the recovery boiler and are reconstituted into cooking chemicals used in the digesting stage through additional processing in the recausticizing plant.

      The heat produced by the recovery boiler is used to generate high-pressure steam. Additional steam is generated by a power boiler through the combustion of biomass consisting of bark and other wood residues from sawmills, residue generated by the effluent treatment system and natural gas. The steam produced by the recovery and power boilers is used to power a turbogenerator to generate electricity, as well as to provide heat for the digesting and pulp drying processes.

The Paper Industry

      The paper industry is global in nature with many international, national and regional producers competing over many different product lines. Prices and profitability in the paper industry are driven primarily by global supply and demand. Demand is strongly influenced by global and regional levels of economic activity. Supply is determined by industry capacity and operating rates. In general, the paper industry has experienced periods of supply and demand imbalance. When demand increases, prices rise, which leads producers to increase their capacity and operating rates. As supply increases in response, price competition increases, driving prices lower.

      We produce principally specialty papers and printing and writing papers. The specialty papers that we produce are comprised of coated and uncoated wallpaper base, non-woven wallpaper base and greaseproof paper.

      Wallpaper can be coated with an agent to enhance its appearance and printing capability. In addition, non-woven wallpaper contains a certain proportion of synthetic fibers so that it does not expand when wet, paste can be applied to the wall instead of the wallpaper and it can be easily torn from the wall, or drystripped. Demand for wallpaper is related to activity in the construction and refurbishing industries, which have been relatively strong due to low interest rates in most industrialized countries. Non-woven wallpapers are the fastest growing category of wallpaper.

      Greaseproof paper is a consumer oriented product that can be used for, among other things, baking and the packaging of food products such as fast foods.

      Printing and writing papers which we produce consist of only uncoated woodfree papers. Woodfree papers generally contain less than 10% mechanical pulp. Uncoated woodfree papers can be finished to enhance their surface and are often used to print less costly products.

Raw Materials

      Our mills are situated in regions which offer an ample and stable supply of fiber. The fiber consumed by our pulp mills consists of wood chips produced by sawmills and pulp logs, which are cyclical in both price and supply. Wood chips are small pieces of wood used to make pulp and are a product of either wood waste from sawmills or pulp logs processed, or chipped, especially for this purpose. Pulp logs consist of lower quality logs not used in the production of lumber. The costs of wood chips and pulp logs are primarily affected by the supply and demand for lumber.

Rosenthal mill

      The wood chips for the Rosenthal mill are sourced from approximately 24 sawmills located in the States of Bavaria and Thuringia within a 150 kilometer radius of the Rosenthal mill. Within this radius, the Rosenthal mill is the largest consumer of wood chips. Given its location and size, the Rosenthal mill is the best economic outlet for the sale of wood chips in the area. In 2005, the Rosenthal mill consumed approximately 1.7 million cubic meters of fiber. Approximately 70%, or approximately 1.2 million cubic meters, of such consumption was in the form of sawmill wood chips. The balance of approximately 30%, or approximately 0.5 million cubic meters, was in the form of pulp logs. Approximately 85% to 90% of the fiber consumed by the Rosenthal mill is spruce and the remainder is pine. We believe the Rosenthal mill’s fiber costs have historically been among the lowest for European pulp producers. The Rosenthal mill’s transportation division handled approximately 45% of our wood chip deliveries to the mill in 2005. While fiber costs and supply are subject to cyclical changes largely in the sawmill industry, we expect that we will be able to continue to obtain an adequate supply of fiber on reasonably satisfactory terms for the Rosenthal mill due to its location and our

long-term relationships with suppliers. We have not historically experienced any fiber supply interruptions at the Rosenthal mill.

      Wood chips for the Rosenthal mill are normally sourced from sawmills under one year or quarterly supply contracts with fixed volumes, which provide for price adjustments. In 2003, we entered into a three-year agreement with one of our existing wood chip suppliers for the supply for the Rosenthal mill of approximately 500,000 cubic meters of wood chips annually until the end of the first quarter of 2006. We are currently negotiating a new agreement with this supplier, which we expect will have similar terms. Pulp logs are partly sourced from the state forest agency in Thuringia on a contract basis and partly from private holders, on the same basis as wood chips. We organize the harvesting of pulp logs sourced from the state forest agency in Thuringia after discussions with the agency regarding the quantities of pulp logs that we require.

      Our own internal wood procurement department handles and sources the fiber requirements for the Rosenthal mill. Five people are employed in the department currently. The department also assisted in sourcing fiber for the start-up of the Stendal mill. We are coordinating the fiber procurement for the Rosenthal and Stendal mills. We believe that handling our own fiber procurement will reduce our operating costs over the long-term due to the elimination of third party fees paid for sourcing fiber.

Stendal mill

      The fiber consumed by the Stendal mill consists of wood chips and pulp logs. We have been ramping up production at the Stendal mill and, when operating at capacity, the Stendal mill will consume approximately 2.8 to 3.0 million cubic meters of fiber annually. The core wood supply region for the Stendal mill includes most of the northern part of Germany within an approximately 240 kilometer radius of the mill. The wood supply potential in this core region is not yet fully utilized and we expect that it should be able to supply all of the fiber needed by the mill. We also purchase wood chips from southwestern and southern Germany. The fiber base in the planned wood supply area for the Stendal mill consists of approximately 65% pine and 35% spruce and fir in 2006. Approximately 20% of the fiber consumed by the Stendal mill in 2006 will be in the form of sawmill wood chips and approximately 80% in the form of pulp logs. The Stendal mill has sufficient chipping capacity to fully operate using solely pulp logs, if required. We source wood chips from sawmills within an approximately 600 kilometer radius of the Stendal mill. We source pulp logs partly from private forest holders and partly from state forest agencies in Thuringia, Sachsen-Anhalt, Mecklenburg-Vorpommern, Sachsen, Niedersachsen, Nordrhein-Westfalen, Hessen and Brandenburg.

      Stendal has established its own wood procurement organization to handle the fiber requirements for the Stendal mill. Currently, there are approximately 129 people employed in this division. This division focuses on three principal activities, being wood procurement and sales, harvesting, and transportation. The procurement and sales main activity is to procure the required wood chip and pulp log assortments for the mill’s annual production. In conjunction with this activity, it may also procure higher quality sawlogs, either through harvesting or through purchases that it can sell or trade with others for wood chips in order to optimize the fiber mix. These trading activities employ approximately 15 people. The harvesting activities in 2006 will focus on acquiring up to approximately 330,000 cubic meters per annum of harvestable timber, of which approximately 85% is expected to be pulp logs and the balance likely to be higher quality logs that could be sold or traded to third parties for wood chips. We currently plan to harvest approximately 90% of this volume directly and contract out the balance to third parties. Approximately 55 employees will be engaged in such harvesting activities. Transportation activities focus on managing, controlling and optimizing shipping and flows of pulp logs to the mill and will employ up to 40 people.

      With the ramp up of the Stendal mill, we believe we are the largest consumer of wood chips and pulp logs in Germany and, together with the Rosenthal mill, provide the best economic outlet for the sale of wood chips in eastern Germany. We are coordinating and integrating the wood procurement activities for the Rosenthal mill and the Stendal mill to realize on a number of potential synergies between them. These include reduced overall personnel and administrative costs, greater purchasing power and coordinated buying and trading

activities. We also believe such coordination and integration of fiber flows will allow us to optimize transportation costs, and the species and fiber mix for both mills.

Celgar mill

      The Celgar mill has a secure supply of high quality fiber that it purchases from a number of Canadian and U.S. suppliers. The supply of fiber at the mill is characterized by a mix of a variety of species (whitewoods and cedar) which allows for production flexibility, custom blending and varied pulp grade mix. When operating at full capacity, the Celgar mill’s annual fiber requirements are approximately 2.4 million cubic meters. Two sources of fiber are used to meet this demand: chips purchased from nearby sawmills and chipping facilities, and roundwood pulp logs purchased from local logging contractors. All of the Celgar mill’s fiber is sourced externally with approximately 90% covered under chip contracts and the balance coming from the pulp logs processed through its woodroom.

      The Celgar mill has entered into long and short-term chip supply agreements with approximately 30 different suppliers from British Columbia, Canada and the U.S. for a total of approximately 2.2 million cubic meters (excluding chips from its own woodroom). This represents approximately 90% of total annual fiber requirements at the mill. The woodroom supplies the remaining chips to meet the Celgar mill’s requirements. The Canadian chip supply agreements contain terms that index the price of the chips to NBSK pulp pricing and therefore the chip costs are correlated with the Celgar mill’s net sales. The majority of the agreements are for periods ranging between two and six years. Several of the longer-term contracts are so-called “evergreen” agreements, where the contract remains in effect until one of the parties elects to terminate. Termination requires a minimum of two, and in some cases, five years written notice. Certain non-evergreen long-term agreements provide for renewal negotiations prior to expiry. The Celgar mill has contracts with three sawmills, which are all owned by the same parent. These sawmills comprise approximately 25% of the Celgar mill’s total fiber supply. Two of these chip agreements each remain in effect until December 31, 2008 and thereafter, if not extended, continue, subject to volume reductions, indefinitely, subject to termination by either party upon two years’ prior notice. The third agreement is an evergreen agreement that remains in effect until terminated upon five years’ prior notice. The chip agreements each contain provisions that may vary chip volume delivery commitments upon the happening of certain events.

      Except for occasional minor purchases from smaller suppliers, the balance of the Celgar mill’s fiber requirements is met by the production of chips from its own woodroom. Currently the woodroom is operating on a one shift basis. To secure the volume of pulp logs required to meet its requirements, the Celgar mill has entered into annual pulp log supply agreements with a number of different suppliers, many of whom are also contract chip suppliers to the mill. The woodroom is capable of running a second shift and additional pulp logs could be purchased to support the ramp up of the woodroom. All of the pulp log agreements can be terminated by either party for any reason, upon seven days’ written notice.

      In addition to existing agreements, opportunities exist for the Celgar mill to secure additional fiber from mills in both Canada and the U.S. The Celgar mill has flexibility in the selection and choice of suppliers, thus assuring continuity of supply as well as the ability to mix species when needed.

Paper mills

      The fiber used by the paper mills consists primarily of pulp and waste paper (recycled paper), which are cyclical in both price and supply. The cost of this fiber is primarily affected by the supply and demand for paper and pulp. In 2005, approximately 86%, or approximately 67,046 ADMTs, of the fiber consumed by our paper mills was in the form of market pulp and chemical additives. Market pulp and chemical additives are available at market prices from various suppliers throughout Europe. The balance of approximately 14%, or approximately 10,837 ADMTs, of the fiber consumed by our paper mills was in the form of waste paper. Germany has extensive waste paper recycling and collection laws which result in a readily available supply. The cost of lower grade waste paper is currently relatively low in comparison to virgin pulp. We have not historically experienced any fiber supply interruptions at our paper mills.

Pulp Cash Production Costs

      Cash production costs for the Rosenthal mill for the periods indicated below are as follows:

     Construction of the Stendal mill was completed, and the mill was started up, in the third quarter of 2004. During 2004, the Stendal mill underwent extensive testing and evaluation. As a result, we believe that cash production costs for pulp produced at the Stendal mill in 2004 are not meaningful as they do not provide an accurate representation of the mill’s future operating performance. Accordingly, they are not included herein. The Stendal mill is designed to have even lower production costs than the Rosenthal mill. As the Stendal mill was ramping up production in 2005, cash production costs for 2005 for the Stendal mill are not necessarily indicative of its future operating performance. The Stendal mill operated at approximately 88% of its initial rated capacity in the fourth quarter of 2005. When the ramp up of the mill is completed, we expect the Stendal mill to operate near its initial rated capacity in 2006. Cash production costs for the Stendal mill for 2005 are as follows:

     Cash production costs for the Celgar mill for 2005 are as follows:

Our Products

      We manufacture and sell NBSK pulp and two primary classes of paper products. Our products are produced from both virgin fiber, being wood chips, pulp logs and chemical woodfree pulp, and recycled fiber, being waste paper.

Pulp

      The kraft pulp produced at the Rosenthal mill is a long-fibered softwood pulp produced by a sulphate cooking process and manufactured primarily from wood chips and pulp logs. A number of factors beyond economic supply and demand have an impact on the market for chemical pulp, including requirements for pulp bleached without any chlorine compounds or without the use of chlorine gas. The Rosenthal mill has the capability of producing both “totally chlorine free” and “elemental chlorine free” pulp. Totally chlorine free pulp is bleached to a high brightness using oxygen, ozone and hydrogen peroxide as bleaching agents, whereas elemental chlorine free pulp is produced by substituting chlorine dioxide for chlorine gas in the bleaching process. This substitution virtually eliminates complex chloro-organic compounds from mill effluent.

      Kraft pulp is valued for its reinforcing role in mechanical printing papers and is sought after by producers of paper for the publishing industry, primarily for magazines and advertising materials. Kraft pulp produced for reinforcement fibers is considered the highest grade of kraft pulp and generally obtains the highest price. Through a focused technical and marketing effort, we have changed the mix of the kraft pulp that we produce at the Rosenthal mill to substantially increase our relative amount of reinforcement fibers from approximately 16% at the beginning of 2000 to approximately 47% at the end of 2005.

      The Rosenthal mill produces pulp for reinforcement fibers to the specifications of certain of our customers. We believe that a number of our customers consider us their supplier of choice. For more information about the facilities at the Rosenthal mill, see “Properties”.

      The kraft pulp produced at the Stendal mill is of a slightly different grade than the pulp produced at the Rosenthal mill as the mix of softwood fiber used is slightly different. This will result in a complementary product more suitable for different end uses. The Stendal mill is capable of producing both totally chlorine free and elemental chlorine free pulp. For more information about the facilities at the Stendal mill, see “— Stendal Pulp Mill” and “Properties”.

      The Celgar mill produces high quality kraft pulp that is made from a unique blend of slow growing/long-fiber western Canadian tree species. It is used in the manufacture of high quality paper products. The Celgar mill currently produces the following two grades of elemental chlorine free pulp:

      We believe the Celgar mill’s pulp is known for its excellent product characteristics, including tensile strength, wet strength and brightness. The Celgar mill is a long-established supplier to paper producers in Asia. For more information about the facilities at the Celgar mill, see “Properties”.

Paper

      Our paper manufacturing strategy has focused on utilizing our existing machines, with certain modifications, in combination with our skilled workforce, to principally produce niche products. As a result, we have divested certain paper mills which focused on packaging, carton and recycled printing and writing papers, and shifted our production away from woodfree printing and writing papers.

      The following table sets out the primary classes of paper products that we produce and the mills at which they are produced:

      We sell our wallpaper and non-woven wallpaper base primarily to specialty paper converters and printers. It is used primarily in new construction and in the renovation industry in residential housing and commercial buildings. We sell our greaseproof paper to paper converters supplying the food industry. It is used primarily for wrapping and baking food. We sell our printing and writing papers primarily to traders, converter suppliers and paper wholesalers.

      We currently manufacture specialty and printing paper at two facilities located in Germany. For more information about the facilities at the paper mills, see “Properties”.

Sales, Marketing and Distribution

      The distribution of Mercer’s pulp and paper sales volume and revenues by product class and geographic area are set out in the following table for the periods indicated:

     The following charts illustrate the geographic distribution of our revenues in our primary markets for the periods indicated:

     In 2005, we established a global sales and marketing group that is responsible for conducting all sales and marketing of the kraft pulp produced at our three pulp mills. About eight employees are engaged full time in such activities. We are co-ordinating and integrating the sales and marketing activities at the Rosenthal mill and Stendal mill to realize on a number of synergies between them. These include reduced overall administrative and personnel costs and co-ordinated selling, marketing and transportation activities. We are also coordinating sales from the Celgar mill with our Rosenthal and Stendal mills on a global basis, thereby providing our larger customers with seamless service across all major geographies. Coordinating overall pulp sales from our three pulp mills also allows us to focus our sales on our most transport logical customers.

      The Rosenthal and Stendal mills are currently the only market kraft pulp producers in Germany, which is one of the leading import markets for kraft pulp in western Europe. We therefore have a material competitive transportation cost advantage compared to Norscan pulp producers when shipping to customers in Europe. Due to the location of our German pulp mills, we are able to deliver pulp to many of our customers primarily by truck. Most trucks that deliver goods into eastern Germany generally do not also haul goods out of the region as eastern Germany is primarily an importer of goods. We are therefore able to obtain relatively low freight rates for the delivery of our products to many of our customers. Since many of our customers are located within a 500 kilometer radius of our Rosenthal and Stendal mills, we can generally supply pulp to customers of these mills faster than our competitors because of the short distances between the mills and our customers. For our customers in western Europe, we can, if requested, often supply them with pulp within one day of it being ordered. This permits us to be a “just in time” supplier to these customers.

      Historically, Celgar sold all of its pulp through sales agents. Our sales force has taken over responsibility for supervising and managing all Celgar’s sales agents and performing some of its sales functions directly. We believe such changes will result in reduced agents’ commissions and fees, increased contract sales and improved pulp price realizations. We are also focusing sales from the Celgar mill to our most transport logical customers, including expanding sales from the mill to the U.S. midwest.

      The Celgar mill’s price realizations in recent years have been adversely affected by the amount of pulp that was considered and sold as “off-grade” caused primarily by a combination of technical production issues relating to variations in brightness and high quantities of pitch and talc deposits in the pulp and the mill’s sales structure. We expect to address the amount of off-grade production and sales largely through the €20.0 million capital improvement project that will include two new washers. One of the washers will be installed in the brownstock washing area to address the high pitch and talc deposits that are often encountered in the mill. The other washer will be installed in the EOP stage of the bleach plant to address the variations in pulp brightness. We are also supervising and further coordinating the Celgar mill’s sales with our Rosenthal and Stendal mills.

      The Celgar mill’s pulp production is transported to customers by rail, truck and ocean carrier using strategically located third party warehouses to ensure timely delivery. All overseas exports are shipped through warehouse facilities in the Vancouver, British Columbia area. The majority of Celgar’s pulp for overseas markets is initially delivered primarily by rail to the port of Vancouver for shipment overseas by ocean carrier. As a western Canada based pulp mill, the Celgar mill enjoys a transportation advantage in sales to Asian customers, in comparison to certain other NBSK pulp producers.

      The majority of the Celgar mill’s pulp for domestic markets is shipped by rail to third party warehouses in the U.S. midwest or directly to the customer.

      Our pulp sales are on customary industry terms. At December 31, 2005, we had no material payment delinquencies. In 2005, no single customer accounted for more than 10% of our pulp sales. In 2004, one customer accounted for approximately 10% of our pulp sales. In 2003, one customer, which operates a number of paper mills, accounted for approximately 11% of our pulp sales. Our pulp sales are not dependent upon the activities of any single customer or upon a concentrated group of major customers.

      Our paper sales operations focus primarily on Europe and are responsible for the majority of our paper sales. Our paper sales conducted through agents were approximately 26% of total paper sales in 2005, 2004 and 2003, respectively. We sell the majority of our paper products to paper converters, printers and wallpaper manufacturers.

      Our paper sales are also on customary industry terms. At December 31, 2005, we had no material payment delinquencies. No single customer accounted for more than 10% of our paper sales in 2005, 2004 or 2003. Our paper sales are not dependent upon a single customer or upon a concentrated group of major customers.

Capital Expenditures

      In 2005, we continued with our capital investment programs designed to increase production capacity, improve efficiency and reduce effluent discharges and emissions at our manufacturing facilities. The improvements made at our mills over the past five years have reduced operating costs and increased the competitive position of our facilities.

      Capital investments at the Rosenthal mill were approximately €7.1 million, €3.9 million and €6.9 million in 2005, 2004 and 2003, respectively. Capital investments at the Rosenthal mill in 2005 related mainly to the installation of a wash press in the bleach plant, updating the production control system and network at the mill and the installation of a hydraulic system digester at an aggregate cost of approximately €3.8 million and other projects relating to maintaining the quality and efficiency of the mill. We estimate capital expenditures at the Rosenthal mill to be approximately €13 million for 2006 relating primarily to the wash press in the bleach plant, surface improvements to the chip yard and other smaller projects relating to maintaining the quality and efficiency of the mill.

      Construction of the Stendal mill was completed in the third quarter of 2004. Total capital costs incurred in respect of the project in 2004 were approximately €396.6 million. For more information about the Stendal mill, see “— Stendal Pulp Mill”.

      Since the modernization of the Celgar mill in 1993, Celgar has made other capital expenditures to improve the efficiency of the mill and reduce operating costs. We are in the process of implementing a capital improvement project in the amount of approximately €20.0 million at the Celgar mill to reduce operating costs and increase production capacity and enhance operating efficiency and reliability at the mill. The major components of the capital improvement project at the Celgar mill are the addition of a pre-bleach washer and EOP stage washer and the expansion of a pulp machine dryer at an aggregate cost of approximately C$26.0 million.

      Capital investments at our paper operations were approximately €4.1 million, €4.7 million and €7.8 million in 2005, 2004 and 2003, respectively. In 2006, we estimate capital investments to be approximately €2.5 million including for a new head box bottom wire at the Heidenau mill. Capital

investments at the Heidenau mill in 2005 included capacity increases to the pulper, the addition of a new preparing plant for synthetic fibers and reconstruction of a reel cutter at an aggregate cost of approximately €1.2 million. We continue to review strategic initiatives designed to enhance returns at our paper mills.

      Qualifying capital investments at industrial facilities in Germany to reduce effluent discharges offset wastewater fees that would otherwise be required to be paid. For more information about our environmental capital expenditures, see “— Environmental”.

Government Financing

Grants

      Our capital investment programs in Germany are partially financed through government grants made available by German federal and state governments. Under legislation adopted by the federal and certain state governments of Germany, government grants are provided to qualifying businesses operating in eastern Germany to finance capital investments. The grants are made to encourage investment and job creation. Pursuant to the current terms of these grants, federal and state governments will provide funding for up to 35% of the cost of qualified investments. The terms of such government grants also require that at least one permanent job be created for each €500,000 of capital investment eligible for such grants and that such jobs be maintained for a period of five years from the completion of the capital investment project. Such government grants are not repayable by a recipient unless it fails to complete the proposed capital investment or fails to create or maintain the requisite amount of jobs. In the case of such failure, the government is entitled to revoke the grants and seek repayment unless such failure resulted from material unforeseen market developments beyond the control of the recipient, wherein the government may refrain from reclaiming previous grants. Pursuant to such grants being provided in respect of the Stendal mill, we have agreed to maintain stipulated job levels at the Stendal mill for the specified five-year period. Our commitment to maintain the stipulated number of jobs at the Rosenthal mill for the required five-year period expired in 2005. For more information, see “— Human Resources”. We believe that we are in compliance in all material respects with all of the terms and conditions governing the government grants we have received in Germany.

      Such government grants are not reported in our income. These grants reduce the cost basis of the assets purchased when the grants are received.

      The following table sets out the capital expenditures and government grants recorded by Mercer for the periods indicated:

     In addition, the Stendal mill qualified for approximately €274.5 million of government grants, of which we have received €269.0 million as at December 31, 2005. For more information about the Stendal mill, see “— Stendal Pulp Mill”.

      The following table sets out for the periods indicated the effect of these government grants on the recorded value of such assets in our consolidated balance sheets:

Loan Guarantees

      Loan guarantees are available from German federal and state governments for up to an aggregate of 80% of the borrowed amount for qualifying capital investments made in certain parts of Germany. The federal and state governments are each severally committed to a portion of the guaranteed amount. These guarantees are provided by German federal and state governments to assist any qualifying businesses with financing capital investments. The guarantees permit qualifying businesses to obtain term loans for such capital investments on terms and at interest rates that are more favorable than available in the general market. In addition, subsidized interest rate loans are available from public financial institutions in Germany, which provide loans at below market interest rates for qualified investments.

Stendal Pulp Mill

Stendal Mill

      We are a 63.6% owner in Stendal, which operates the Stendal mill. The other shareholders of Stendal are RWE Industrie-Lösungen GmbH, or “RWE”, as to a 29.4% interest, and MFC Industrial Holdings AG as to a 7.0% interest.

      Construction of the Stendal mill was completed in the third quarter of 2004. The aggregate cost of the Stendal mill was approximately €1.0 billion. The mill is a modern, state-of-the-art single line mill with a designed annual production capacity of approximately 552,000 ADMTs. The overall mill design is based on proven or existing processes and technologies.

      The Stendal mill is located near the town of Stendal, in the German State of Sachsen-Anhalt approximately 300 kilometers north of the Rosenthal mill. As a result of the proximity of the Stendal mill to the Rosenthal mill and the use of similar equipment at both mills, we believe we will be able to realize operating synergies between the two operations, particularly in the areas of raw materials and supplies procurement, production engineering, maintenance and marketing.

      The Stendal mill is the largest market kraft pulp mill in Germany, the only other being our Rosenthal mill. The addition of production from the Stendal mill has allowed us to expand our customer base, as our two pulp mills produce slightly different grades of softwood kraft pulp suitable for different end uses, and we expect to further expand our customer base as the mill continues to ramp up production.

      The summaries of certain material provisions of agreements entered into in connection with the Stendal mill set forth herein are not complete and such summaries, including definitions of certain terms, are qualified in their entirety by reference to such agreements on file with the SEC.

Control and Management

      We, Stendal and its two minority shareholders entered into a shareholders’ agreement dated August 26, 2002 to govern our respective interests in Stendal. The agreement contains terms and conditions customary for these types of agreements, including restrictions on transfers of share capital and shareholder loans other than

to affiliates, rights of first refusal on share and shareholder loan transfers, pre-emptive rights and piggyback rights on dispositions of our interest. The shareholders are not obligated to fund any further equity capital contributions to the project. Pursuant to the shareholders’ agreement, we are entitled to transfer up to 12.5% of our interest in Stendal without the prior consent of the other shareholders. The shareholders’ agreement provides that Stendal’s managing directors may be appointed by holders of a simple majority of its share capital. Further, shareholder decisions, other than those mandated by law or for the provision of financial assistance to a shareholder, are determined by a simple majority of Stendal’s share capital. If a shareholder is in default under the shareholders’ agreement or commits certain acts of insolvency or bankruptcy, it shall be considered to be a defaulting shareholder and must offer to sell its share capital and shareholder loans to the remaining shareholders on a pro rata basis, to a third party nominated by the other shareholders or permit them to be redeemed by Stendal. Other than in circumstances where a shareholder is considered to be a defaulting shareholder, the shareholders’ agreement does not provide for any mandatory or forced purchases and sales of a shareholder’s interest in Stendal.

      We are coordinating and integrating various activities and operations between the Stendal and Rosenthal mills to realize efficiencies and optimize the cost structure of each mill. Such activities include wood procurement, a sales organization that coordinates and handles the sales and marketing of the pulp produced by both mills, purchases of supplies and stores, maintenance activities, workforce and management training and transportation. We are also coordinating sales from the Celgar mill with our Rosenthal and Stendal mills on a global basis, thereby providing our larger customers with seamless service across all major geographies.

EPC Contract

      The Stendal mill was constructed under a €716.0 million fixed-price turn-key engineering, procurement and construction, or “EPC”, contract between Stendal and RWE, referred to as the “principal” or “EPC contractor”. RWE’s obligations under the EPC contract are guaranteed by its parent company.

      The contract price for the completion of the project was fixed. Payments under the EPC contract were made periodically against milestones as and when achieved by RWE.

      Under the EPC contract, RWE was responsible for all planning, design, engineering, procurement, construction and testing in connection with the build-out and start-up of the mill. We were responsible for obtaining legal title and possession of the site and providing the site and certain equipment, materials and services, as well as personnel, raw materials and other items in connection with the start-up of the mill. RWE was also primarily responsible for obtaining construction and operating permits. We constructed approximately €23.5 million of the site infrastructure and additional general site infrastructure connections were constructed by the local government. The costs of such infrastructure construction were 90% subsidized and co-financed by us, among others. Our co-financing obligations amounted to approximately €3.0 million and were funded out of the project loan facility.

      The EPC contract provides for reciprocal indemnities between us and RWE pursuant to which we each agree to indemnify the other in respect of losses or claims arising from negligent, illegal or other wrongful acts in connection with the agreement or arising out of any violation of applicable laws or permits.

Stendal Mill Completion

      Pursuant to the EPC contract, construction of the Stendal mill was completed substantially on its planned schedule and budget in the third quarter of 2004 and the mill is currently ramping up production. Such completion means that the construction and installation of all equipment and works were essentially finished and final checks occurred so that continuous production from the mill could commence. The mill underwent extensive testing and evaluation in December 2004 to determine whether certain performance requirements have been met, referred to as the “Acceptance Test”, and in the first quarter of 2005, we delivered an acceptance certificate and assumed responsibility for the operation of the mill. The Stendal mill is now being operated by Stendal’s personnel.

      Stendal commenced the initial production of pulp in mid-September 2004. The initial pulp produced was off-grade pulp which was primarily sold into the recycled fiber, corrugated board and similar markets. The prices realized on the sale of off-grade pulp are lower than the selling price for on-grade NBSK pulp. In 2005, the Stendal mill ramped up pulp production and quality. In the last quarter of 2005, the mill operated at approximately 88% of its initial rated capacity and we expect it to operate near its initial rated capacity in 2006. See “— Acceptance of the Stendal Mill” below. As the NBSK pulp from the Stendal mill is further accepted in the market, we expect to eliminate its price discount relative to our Rosenthal mill over time.

Acceptance of the Stendal Mill

      The Stendal mill underwent extensive testing and evaluation in December 2004 in connection with its mechanical completion and the Acceptance Test. The Acceptance Test required that the mill continuously produce pulp for a 72-hour period in compliance with specified operational, quality and environmental requirements.

      The test was generally successful and we were pleased with both the quantitative and qualitative aspects of the test. We reviewed the results of the test with the lenders under the project finance facility related to the Stendal mill and certain suppliers. RWE and certain suppliers entered into a definitive agreement with us in the first quarter of 2005 pursuant to which they agreed to implement certain measures at the mill. These included the installation of two additional digesters and related equipment, improvements to the NCG boiler and water treatment plant, reimbursement to Stendal of certain costs and the provision of certain warranties.

      The installation of the two additional digesters was completed in the fourth quarter of 2005 and increased the number of digesters at the Stendal mill from eight to ten. Once fully operational, we believe the additional digesters should increase the annual production capacity of the Stendal mill to in excess of 600,000 ADMTs. We and our consultants believe that the design and capacity of the rest of the mill and fiber availability will, over time, permit the Stendal mill to achieve such increased production volumes. These digesters are also expected to enhance the reliability and overall operating performance of the Stendal mill. The two additional digesters had a capital cost of approximately €8 million, of which we paid €2 million and the balance was paid by RWE and certain suppliers.

      In the first quarter of 2005, we delivered the requisite acceptance certificate to RWE and assumed responsibility for the operation of the mill, subject to RWE’s warranty obligations. Notwithstanding the Acceptance Test, each department of the mill has or will be individually tested on a stand-alone basis for compliance with its design specifications. Such testing is expected to be completed in 2006. Under the EPC contract, RWE warrants conformity to specifications, compliance with permits and laws, suitability for intended use, compliance with performance requirements and warrants against defects in construction, in each case for a period of 18 months after acceptance, subject to extension in certain circumstances. RWE is required under the EPC contract to provide irrevocable bank guarantees in our favor, in agreed upon amounts, as security for an initial advance payment and for any deficiencies arising during the warranty period. In July 2006, RWE is required to provide an additional guarantee in the same form, in respect of the same matters, in an amount not less than 5% of the contract price which shall remain in effect until January 1, 2009.

Stendal Pulp Mill Financing

      Total investment costs in connection with the Stendal pulp mill are approximately €1.0 billion, the majority of which was provided under a senior project finance facility, referred to as the “Stendal Loan Facility”, arranged by Bayerische Hypo-und Vereinsbank AG, referred to as “HVB”, pursuant to a project finance loan agreement, referred to as the “Project Finance Loan Agreement”, entered into between Stendal and HVB. See “— Description of Certain Indebtedness — Stendal Loan Facility”.

      We also contributed financing to Stendal of approximately €63.5 million from cash on hand and through two bridge loans aggregating €45 million from a U.S. investment partnership and a bank. We repaid these bridge loans in October 2003 from our issuance of convertible notes. See “— Description of Certain Indebtedness — Convertible Notes”.

      As the site of the Stendal mill is located in eastern Germany, it qualified for approximately €274.5 million of government grants, which are applied to reduce the cost basis of the assets acquired with such grants. As of December 31, 2005, we had outstanding claim expenditures of €7.0 million of such grants in connection with the Stendal mill, which we expect to receive in 2006. In accordance with our accounting policies, these grants are not recorded by us until they are received.

      Under European Union rules, the Commission of the European Communities, referred to as the “Commission”, was formally notified in March 2002 by Germany of plans to provide support to the Stendal mill through grants and guarantees. The Commission considered these plans and, on June 19, 2002, decided not to raise any objection against such support being provided by the German federal and state governments in respect of the Stendal mill. In its decision, the Commission was not called upon to determine whether the governmental aid schemes, on which the support is based, were acceptable, but was limited to a determination as to whether a reduction of the pre-approved aid level for investment in the German State of Sachsen-Anhalt under the previously approved schemes was required under European Union law in the case of the Stendal mill. In coming to its decision, the Commission generally has a wide margin of discretion in its assessment of facts and data. Under European Union law, member states, competitors or trade associations directly affected by a decision of the Commission may appeal such decision within a period of two months and twenty-four days after publication of the Commission decision. On December 23, 2002, Kronoply and Kronotex, two related manufacturers of, among other things, OSB and MDF boards that do not compete with the Stendal mill by selling pulp or paper, filed an appeal with the Court of First Instance of the European Communities (Luxembourg), referred to as the “Court”, against the Commission decision of June 19, 2002. Generally to be successful, an appeal must show that the Commission failed to comply with procedural requirements or committed a manifest error in assessing facts and data in adopting its decision.

      In late 2004, the Court in an unrelated case determined that the Commission committed a procedural error in determining the amount of state aid that could be granted by Germany to a recipient in a different business. The Court found the Commission erred when reviewing the effect of state aid on competition by only considering capacity utilization and not also considering product demand trends prior to providing its approval. As a result, in that case the Court set aside the Commission approval and remanded the matter back to the Commission to redetermine. The Court’s decision is being appealed by the aid recipient and the government of Germany. If such appeal is unsuccessful, the Commission will have to redetermine the matter based upon its mandated criteria and may come to the same determination as before. The procedure followed by the Commission in this remanded decision was similar to that it used in determining not to reduce the amount of state aid available to the Stendal mill. The remanded case does not affect Stendal’s current entitlement to receive grants, the balance of which are expected to be received in 2006.

      Although no assurance can be provided, we continue to believe that the appellant does not have any standing to bring the appeal as it is not a competitor of Stendal and, in any event, that the appeal is without merit. Further, the procedural error found by the Court in the remanded case was not raised in the Stendal appeal and we do not believe the Court should permit the appellant to amend its appeal at this stage.

      Subject to the Court’s schedule, we believe a hearing as to whether the appellant has standing to bring the appeal could be heard in 2006. If the Court determined the appellant had standing, such decision was upheld on appeal and the matter is not otherwise settled, we believe that a hearing on the merits of the appeal would occur in late 2006 or 2007. In the event the appellant was then successful on the merits and such decision was again upheld on appeal, the issue of whether the amount of state aid granted to the Stendal mill should be reduced would be remanded back to the Commission for reconsideration. Although we cannot assure you as to the outcome of any such redetermination, we believe that, given the Commission’s criteria and the factual circumstances related to the Stendal mill including demand trends in the pulp business, there would be no basis for the Commission to reduce the level of state aid. If the Commission determined to reduce the level of state aid available to the Stendal mill and such decision was upheld on appeal, Stendal would be required to repay a portion of the previously received state aid back to the German government. While we do not expect an adverse outcome, litigation is inherently uncertain and there can be no assurance of the final outcome.

Description of Certain Indebtedness

      The following summaries of certain material provisions of: (i) the Rosenthal working capital facility; (ii) the Stendal Loan Facility; (iii) our convertible notes; (iv) our senior notes; and (v) the Celgar working capital facility, are not complete and these provisions, including definitions of certain terms, are qualified by reference to the applicable documents and the applicable amendments to such documents on file with the SEC.

Rosenthal Loan Facilities

      The credit facilities at the Rosenthal mill consist of a new revolving working capital facility and, prior to its repayment, a project loan facility, referred to as the “Rosenthal Loan Facility”. The Rosenthal Loan Facility was the financing for a major capital project that converted the Rosenthal mill to the production of kraft pulp that was completed in 1999. The outstanding amount under the Rosenthal Loan Facility and under a Rosenthal landfill facility was repaid in February 2005 with a portion of the proceeds of the share and senior note offerings in connection with the Acquisition. See “— The Financings”.

      In conjunction with the Acquisition and the repayment of Rosenthal’s bank indebtedness, in February 2005, we established a revolving term working capital facility for the Rosenthal mill. This €40 million loan facility for the Rosenthal mill, arranged by HVB, consists of a revolving credit facility which may be utilized by way of cash advances or advances by way of letter of credit or bank guarantees. The facility matures in February 2010. The interest payable on cash advances is LIBOR or EURIBOR plus 1.55%, plus certain other costs incurred by the lenders in connection with the facility. Each cash advance is to be repaid on the last day of the respective interest period and in full on the termination date and each advance by way of a letter of credit or bank guarantee shall be repaid on the applicable expiry date of such letter of credit or bank guarantee. An interest period for cash advances shall be three, six or 12 months or any other period as Rosenthal and the lenders may determine. There is also a 0.35% per annum commitment fee on the unused and uncancelled amount of the revolving facility which is payable quarterly in arrears. This facility is secured by a first fixed charge on the inventories, receivables and accounts of Rosenthal. It also provides Rosenthal with a hedging facility relating to the hedging of the interest, currency and pulp prices as they affect Rosenthal pursuant to a strategy agreed to by Rosenthal and HVB from time to time.

Stendal Loan Facility

      The Stendal Loan Facility is in the aggregate amount of €828.0 million and is divided into tranches which cover, among other things, project construction and development costs, financing and start-up costs and working capital, as well as the financing of a debt service reserve account, approved cost overruns and a revolving loan facility to cover any time lag for receipt of grant funding and value-added tax refunds in the amount of €160 million, referred to as “Tranche E”. The Stendal Loan Facility was available for disbursement from August 2002 until the earlier of the issuance by us of a final acceptance certificate for the project and December 2005, except that financing under the Stendal Loan Facility for approved cost overruns will be available for up to one month prior to the first repayment.

      Pursuant to the Project Finance Loan Agreement, interest on the credit facilities was to accrue at variable rates between Euribor plus 0.60% and Euribor plus 1.55% per year. The Project Finance Loan Agreement provides for facilities to allow us to manage our risk exposure to interest rate risk, currency risk and pulp price risk by way of interest rate swaps, Euro and U.S. dollar swaps and pulp hedging transactions, subject to certain controls, including certain maximum notional and at-risk amounts. Pursuant to the terms of the Project Finance Loan Agreement, in 2002 Stendal entered into interest rate swap agreements in respect of borrowings under the Stendal Loan Facility to fix most of the interest costs under the Stendal Loan Facility at a rate of 3.795% per year until April 2004 and at a rate of 5.28% commencing May 2004, plus margin, until final payment in October 2017. For more information, see “Quantitative and Qualitative Disclosures about Market Risk”. In March 2003, as part of its loan syndication, HVB exercised its right under the Stendal Loan Facility to increase its up-front arrangement fee by 20 basis points and the rate of interest under the facility by 30 basis points.

      Stendal has agreed to initially reduce the aggregate advances outstanding under the Stendal Loan Facility, other than in respect of Tranche E, to a maximum of €599.0 million, from a maximum original amount of €638.0 million (assuming no draws for approved cost overruns), on or before the first March 31 or September 30 following the fourth anniversary of the first advance under the Stendal Loan Facility for project construction and development costs. The tranches are generally repayable in installments and mature between the fifth and 15th anniversary of the first advance under the Stendal Loan Facility for project construction and development costs. Subject to various conditions, including a minimum debt service coverage test, Stendal may make distributions, in the form of interest and capital payments on shareholder debt or dividends on equity invested, to its shareholders, including us.

      The tranches under the Stendal Loan Facility for project construction and development costs, financing costs, start-up costs and working capital are severally guaranteed by German federal and state governments in respect of an aggregate of 80% of the principal amount of these tranches, but the tranche under the Stendal Loan Facility for financing and start-up costs, working capital and certain of the project construction and development costs benefiting from these guarantees will be reduced semi-annually by 12.5% per year beginning on the first repayment date following the fourth anniversary of the first advance under the Stendal Loan Facility for each of these costs. Under the guarantees, the German federal and state governments that provide the guarantees are responsible for the performance of our payment obligations for the guaranteed amounts. Approximately €603.0 million was drawn under the Stendal Loan Facility as of December 31, 2005.

      On December 12, 2003, Stendal entered into agreements with Nord Deutsche Landesbank, referred to as “Nord LB”, and the European Investment Bank, referred to as “EIB”. Pursuant to the agreements, EIB provided a refinancing credit facility to Nord LB at preferred interest rates for up to €495.0 million. Such refinancing loan is made to Nord LB for the benefit of the Stendal mill. Instead of actually refinancing the Stendal Loan Facility through Nord LB, and Stendal benefiting from lower interest rates over time, the agreements provide for the disbursement to Stendal of the net present value of the interest rate differential offered to Nord LB by EIB (less a portion retained by Nord LB). Draw down refinancings were completed in 2003 and 2004 which resulted in a net present value of the interest rate differential of approximately €4.1 million being disbursed to Stendal.

      The Stendal Loan Facility is secured by all of the assets of Stendal. In addition, the Project Finance Loan Agreement provides for the establishment of an equity reserve account into which excess start-up cash flows may be deposited. The account will be used to secure claims and amounts owing to the lenders in priority to the funding of the debt service reserve account under the Stendal Loan Facility. The Project Finance Loan Agreement also provides that revenues held by Stendal after certain payments may be paid to a shareholders’ account.

      In connection with the Stendal Loan Facility, we entered into a shareholders’ undertaking agreement, referred to as the “Undertaking”, dated August 26, 2002 with the two minority shareholders in Stendal and HVB in order to finance the shareholders’ contribution to the Stendal mill. Pursuant to the terms of the Undertaking, in August 2002, when we completed financing arrangements for the Stendal mill, referred to as the “Stendal Financing Closing Date”, the shareholders of Stendal, on a pro rata basis, subscribed for €15 million of share capital of Stendal and advanced to it €55 million in subordinated loans. In addition, on a pro rata basis, the shareholders of Stendal agreed to advance to it €30 million of stand-by equity to, among other things, cover approved cost overruns, fund the equity reserve account and partially fund the debt service reserve account under the Stendal Loan Facility. On the Stendal Financing Closing Date, we provided HVB with a cash deposit for our pro rata portion of such equity reserve account. Our total funding commitment under the Undertaking was €63.5 million, all of which was effected in August 2002. Pursuant to the Undertaking, we have agreed, for as long as Stendal has any liability under the Stendal Loan Facility to HVB, to retain control over at least 51% of the voting shares of Stendal. We have no further capital commitments with relation to the Stendal mill.

Convertible Notes

      In October 2003, we issued $82.5 million in aggregate principal amount of 8.5% convertible senior subordinated notes due 2010, referred to as the “convertible notes”.

      We pay interest semi-annually on the convertible notes on April 15 and October 15 of each year, beginning on April 15, 2004. The convertible notes mature on October 15, 2010. The convertible notes are redeemable on and after October 15, 2008, at any time in whole or in part, at our option on not less than 20 and not more than 60 days’ prior notice at a redemption price equal to 100% of the principal amount thereof plus accrued and unpaid interest, if any, to, but not including, the date of redemption, subject to the restrictions in the indenture governing the notes.

      The convertible notes are convertible, at the option of the holder, unless previously redeemed, at any time on or prior to maturity into our shares of beneficial interest at a conversion price of $7.75 per share, which is equal to a conversion rate of approximately 129 shares per $1,000 principal amount of convertible notes, subject to adjustment.

      Holders of the convertible notes have the right to require us to purchase all or any part of the convertible notes 30 business days after the occurrence of a change of control with respect to us at a purchase price equal to the principal amount thereof plus accrued and unpaid interest, if any, to the date of purchase.

      The convertible notes are unsecured obligations of Mercer Inc. and are subordinated in right of payment to existing and future senior indebtedness (including our 9.25% senior notes described below) and are effectively subordinated to all of the indebtedness and liabilities of our subsidiaries. The indenture governing the convertible notes limits the incurrence by us, but not our subsidiaries, of senior indebtedness.

Senior Notes

      In conjunction with the Acquisition of the Celgar mill and the repayment of Rosenthal’s bank indebtedness, in February 2005, we issued $310 million in principal amount of senior notes. The senior notes bear interest at the rate of 9.25% per annum and mature on February 15, 2013. Interest on such notes is payable in arrears on February 15 and August 15 of each year the notes are outstanding, beginning on August 15, 2005. The notes are our senior unsecured obligations and, accordingly, will rank junior in right of payment to all existing and future secured indebtedness and all indebtedness and liabilities of our subsidiaries, equal in right of payment with all existing and future unsecured senior indebtedness and senior in right of payment to the 8.5% convertible senior subordinated notes due 2010 and any future subordinated indebtedness. We may redeem the notes on or after February 15, 2009, in whole or in part, at the applicable redemption prices plus accrued and unpaid interest, if any, to the redemption date. In certain circumstances, we may also redeem up to 35% of the aggregate principal amount of the notes at any time prior to February 15, 2008 at a redemption price of 109.35% of the principal amount, plus accrued and unpaid interest, if any, to the redemption date with the net cash proceeds of certain equity offerings. The notes were issued under an indenture which, among other things, restricts our ability and the ability of our restricted subsidiaries under the indenture to: (i) incur additional indebtedness or issue preferred stock; (ii) pay dividends or make other distributions to our stockholders; (iii) purchase or redeem capital stock or subordinated indebtedness; (iv) make investments; (v) create liens and enter into sale and lease back transactions; (vi) incur restrictions on the ability of our restricted subsidiaries to pay dividends or make other payments to us; (vii) sell assets; (viii) consolidate or merge with or into other companies or transfer all or substantially all of our assets; and (ix) engage in transactions with affiliates. These limitations are subject to other important qualifications and exceptions.

Celgar Working Capital Facility

      In conjunction with the Acquisition, in February 2005, we also established a revolving working capital facility for the Celgar mill. This $30 million loan facility for the Celgar mill consists of a 364 day revolving credit facility, convertible to a one year non-revolving term loan at the election of the borrower. The revolving facility has a term of 364 days (that has been extended by 90 days) and the term facility will mature on the

first anniversary of the conversion date. The borrower is Zellstoff Celgar Limited, which is our wholly owned acquisition subsidiary that acquired the Celgar mill. Availability of drawdowns under the facility is subject to a borrowing base limit that is based upon the Celgar mill’s eligible accounts receivable and inventory levels from time to time. The borrower can request a 364 day extension, not more than 90 days or less than 60 days prior to the maturity date of the revolving facility, and the lenders, in their sole discretion, shall decide whether or not to extend such facility not later than 30 days prior to the maturity date of the revolving facility. The revolving facility is available by way of: (i) Canadian and U.S. denominated advances which bear interest at the agent’s prime rate for Canadian advances and designated base rate for U.S. advances plus, in each case, between 1.5% and 2% per annum depending upon the debt coverage ratio of the borrower in effect at the time; (ii) banker’s acceptances which will be issued at a specified discount rate and will be subject to annualized stamping fees of between 2.5% and 3%, depending upon the debt coverage ratio of the borrower in effect at the time; and/or (iii) LIBOR advances, which will be made available for periods of one, two, three or six months duration and which will bear interest at LIBOR plus between 2.5% and 3%, depending upon the debt coverage ratio of the borrower in effect at the time. Letters of credit and/or letters of guarantee will also be available under the facility up to a maximum of $10 million. There is also a commitment fee payable monthly in arrears on any unutilized and uncancelled amount of the revolving facility. The amount of the fee varies from 0.625% to 0.9% of such amount depending upon the amount drawn under the facility and the borrower’s debt coverage ratio in effect at the time. This facility is secured by a first charge on the current assets of the borrower and a guarantee and postponement of claim delivered by Mercer Inc.

Paper Mill Loan Facilities

      In 2003, our paper operations secured two long-term credit facilities aggregating approximately €2.5 million, which facilities along with certain government grants are being utilized to repair flooding damage suffered by the mills in 2002. One facility totaling approximately €1.0 million matures on June 30, 2009, bears interest at a rate of 2.65% per annum and is repayable in ten equal semi-annual installments. The other facility in the amount of approximately €1.5 million matures on June 30, 2013, bears interest at a rate of 2.65% per annum and is repayable in 16 equal semi-annual installments. Both facilities are guaranteed by Mercer Inc.

      In addition, in 2003, our Fährbrücke paper mill secured three credit facilities aggregating €5.5 million, which facilities along with certain government grants were utilized to finance equipment and construction costs associated with expanding and adapting the paper machine at the mill. In September 2004, we repaid the majority of the outstanding amounts under these credit facilities and permanently reduced the aggregate amount available thereunder to €2.2 million. Two of the facilities aggregating approximately €1.4 million mature on December 30, 2012 and bear interest at rates between 4.15% and 4.3% per annum and are repayable in 16 equal semi-annual installments. The other facility in the amount of approximately €0.8 million matures on March 31, 2009 and bears interest at a rate equal to the three-month Euribor rate plus 1.75% per annum and is repayable in 16 equal quarterly installments. All three facilities are guaranteed by Mercer Inc. as well as to 80% thereof by a German state government. As at December 31, 2005, we had utilized the entire €4.7 million available under the five credit facilities relating to the paper operations.

Environmental

      Our operations are subject to a wide range of environmental laws and regulations, dealing primarily with water, air and land pollution control. In recent years, we have devoted significant financial and management resources to comply with all applicable environmental laws and regulations. Our total capital expenditures on environmental projects at our production facilities were approximately €2.7 million in 2005 and are expected to be approximately €8.7 million in 2006.

      We believe we have obtained all required environmental permits, authorizations and approvals for our operations. We believe our operations are currently in substantial compliance with the requirements of all applicable environmental laws and regulations and our respective operating permits.

      Under German state environmental rules relating to effluent discharges, industrial users are required to pay wastewater fees based upon the amount of their effluent discharge. These rules also provide that an

industrial user which undertakes environmental capital expenditures and lowers certain effluent discharges to prescribed levels may offset the amount of these expenditures against the wastewater fees that they would otherwise be required to pay. As a result, we estimate that the aggregate wastewater fees we saved in 2005 as a result of environmental capital expenditures made at our manufacturing plants in Germany were approximately €2.9 million. We expect that capital investment programs for our manufacturing plants in Germany will mostly offset the wastewater fees that may be payable for 2006 and 2007 and will ensure that our operations continue in substantial compliance with prescribed standards.

      Beginning in 2005, our German operations became subject to the European Union Emissions Trading Scheme pursuant to which our German mills were granted emission allowances. Emission allowances are granted based upon production volumes and the types of fuels consumed by manufacturing facilities in Germany. Excess allowances, which are the result of variations in production volumes and the overall consumption of fuels, are available for sale.

      Environmental compliance is a priority for our operations. To ensure compliance with environmental laws and regulations, we regularly monitor emissions at our mills and periodically perform environmental audits of operational sites and procedures both with our internal personnel and outside consultants. These audits identify opportunities for improvement and allow us to take proactive measures at the mills as considered appropriate.

      The Rosenthal mill has a relatively modern biological wastewater treatment and oxygen bleaching facility. We have significantly reduced our levels of Adsorbable Organic Halogen, or “AOX”, discharge at the Rosenthal mill and we believe the Rosenthal mill’s AOX discharges are substantially below those currently mandated by the German government. Effective January 1, 2001, the Rosenthal mill is required to maintain levels of Chemical Oxygen Demand, or “COD” discharge at the Rosenthal mill below 25 kilograms per ADMT of pulp. The Rosenthal mill is currently in compliance with these levels of COD discharge. We will continue to modify our wastewater and bleaching facilities at the Rosenthal mill, which have been further enhanced as a result of the conversion of the mill to the production of kraft pulp, to meet or exceed prescribed regulations. In addition, in 2003 we completed a strategic capital project to reconstruct the landfill at the Rosenthal mill so that it will be useable for an additional 15 years. The aggregate cost of the project was approximately €7.6 million.

      Although the Rosenthal mill’s overall emission levels for nitric oxide and nitrogen oxide, collectively referred to as “NOx”, were substantially below prescribed levels in 2004, NOx emissions from one gas burner in 2004 exceeded its permitted emission level. We made a claim on the warranty from the supplier of the gas burner who installed a new burner that reduced NOx emission levels to prescribed standards in the third quarter of 2004 at an aggregate cost of €0.9 million, of which €0.5 million was borne by the supplier and the remainder by us.

      The Stendal mill, which commenced operations in September 2004, has been in substantial compliance with applicable environmental laws, regulations and permits, but has experienced certain minor exceedances from time to time which are typical for a mill in the ramp up phase of its operations. Management believes that, as the Stendal mill is a state-of-the-art facility, once the ramp up phase has been completed and all necessary adjustments have been made the mill will operate in compliance with the applicable environmental requirements. Under the terms of the EPC contract, the contractor has provided various representations and warranties as to compliance with permits and laws and is responsible for ensuring such compliance for a period of 18 months from acceptance.

      The Celgar mill has a number of permits regulating air emissions, including those with respect to sulphur dioxide, referred to as “SO₂”. While the mill’s overall SO₂ emissions are generally below one-third of the total SO₂ emissions permitted to be discharged under its air permits, the mill’s lime kiln SO₂ emissions periodically exceed emissions allowed under its individual SO₂ air permit. MWLAP has been advised of the level of SO₂ emissions at the lime kiln and apprised of the mill’s efforts to correct the same. The mill is monitoring the level of SO₂ emissions from the lime kiln and has submitted an application to the MWLAP to amend its air permits to lower overall SO₂ emissions for the mill while increasing the SO₂ emission discharge limit on its lime kiln permit. The requested amendments to the mill’s air permits are classified as minor and have not been

opposed by any third party. Although no assurances can be provided, we expect the MWLAP to approve the amendments of the mill’s air permits in 2006. In the event that such permit amendments are not available, our consulting engineers have preliminarily estimated the capital cost to correct the SO₂ emissions at the lime kiln to be in the range of C$1.5 million to C$2 million. Although the MWLAP has not taken actions or imposed any fines to date, there can be no assurance that any permit amendment will be successful, that MWLAP may not take action in the future or that the capital requirements to address the same will not exceed the preliminary estimates.

      The Celgar mill operates two landfills, a newly commissioned site and an older site. The Celgar mill intends to decommission the old landfill and is developing a closure plan and reviewing such plan with the MWLAP. However, the MWLAP, in conjunction with the local pulp and paper industry, is in the process of developing a standard for landfill closures. In addition, the portion of the landfill owned by an adjacent sawmill continues to be active. Accordingly, the mill has not been able to move forward with the closure. The Celgar mill currently believes it may receive regulatory approval for such closure plan in 2007 and would commence closure activities thereafter. Our consulting engineers have estimated that the closure program will cost up to C$3 million. As the closure program for the old landfill has not been finalized or approved, there can be no assurance that the decommissioning of the old landfill will not exceed such cost estimate.

      We completed construction of a wastewater treatment plant at the Fährbrücke mill in 2005 to biologically treat the wastewater as required by applicable standards at an aggregate cost of approximately €1.8 million. The project was funded through a combination of government grants, a bank loan and our funds.

      Future regulations or permits may place lower limits on allowable types of emissions, including air, water, waste and hazardous materials, and may increase the financial consequences of maintaining compliance with environmental laws and regulations or conducting remediation. Our ongoing monitoring and policies have enabled us to develop and implement effective measures to maintain emissions in material compliance with environmental laws and regulations to date in a cost-effective manner. However, there can be no assurances that this will be the case in the future.

Human Resources

      We currently employ or hold positions for approximately 1,667 people. Our German operations have approximately 1,032 employees working in our pulp operations, including our transportation subsidiaries, and approximately 223 employees working in our paper operations. In addition, there are approximately 12 people working at the office we maintain in Vancouver, British Columbia, Canada. The Celgar mill currently employs approximately 400 people in its operations, the vast majority of which are unionized.

      As the Stendal mill completes its production ramp up in 2006, it and its subsidiaries are expected to employ approximately 580 people. Pursuant to the government grants and financing arranged in connection with the Stendal mill, we have agreed with German state authorities to maintain this number of jobs until 2010.

      Rosenthal and Dresden are bound by collective agreements negotiated with Bergbau-Chemie Energie, or “IG-BCE”, a national union that represents pulp and paper workers. In February 2004, we entered into a new labor agreement with IG-BCE for our pulp workers which provided for a 2% wage increase. The agreement expired at the end of February 2005 and a new agreement was negotiated in the second quarter of 2005, which provides for a 2.5% wage increase for a two year period effective July 1, 2005.

      Stendal has not yet entered into any collective agreements with IG-BCE, although it may do so in 2006. We anticipate that any such agreement would reflect wage levels in accordance with industry standards in this part of Germany. In January 2006, Stendal’s wage levels approximated 90% of the lowest eastern German wage level for a 40 hour work week for similar industrial companies. We expect that, over time, as the Stendal mill ramps up production and subject to general economic conditions, wage levels at the Stendal mill will correspond with those for similarly situated producers in Germany.

      In February 2004, we entered into a new labor agreement with workers at our paper mills which provided for a 1.5% wage increase on each of February 1, 2004, July 1, 2004, January 1, 2005 and July 1, 2005. This

agreement has been extended while we negotiate a new agreement with workers at our paper mills. We currently expect to conclude a new agreement in 2006.

      We consider the relationships with our employees to be good. We have implemented profit sharing plans, training programs and early retirement schemes for the benefit of our German employees. Over 90% of the employees at our German pulp and paper operations have post-secondary education or are trained tradespersons. Although no assurances can be provided, we have not had any significant work stoppages at any of our German operations and we would therefore expect to enter into labor agreements with our pulp and paper workers in Germany without any significant work stoppages at our German mills.

      A collective agreement was reached with the union hourly workers at the Celgar mill in January 2003 which has a term of five years. The agreement provides for wage increases effective May 2003 of 2.5% in each of 2003 and 2004, and 2% in each of the following three years.

Additional Information

      We make available free of charge on or through our website at www.mercerinternational.com annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and all amendments to these reports, as soon as reasonably practicable after we file these materials with the SEC. The public may read and copy any material we file with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may also obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site at www.sec.gov that contains reports, proxy and information statements, and other information regarding us.

      This Annual Report on Form 10-K contains forward looking statements. Statements that are not historical or current facts, including statements about our expectations, anticipated financial results, projected capital expenditures and future business prospects, are forward looking statements. You can identify these statements by our use of words such as “may”, “will”, “expect”, “believe”, “should”, “plan”, “anticipate” and other similar expressions. You can find examples of these statements throughout this report, including the description of business in “Item 1. Business” and the “Management Discussion and Analysis of Financial Condition and Results of Operations”. We cannot guarantee that our actual results will be consistent with the forward looking statements we make in this report. You should review carefully the risk factors listed below, as well as those factors listed in other documents we file with the SEC. We note that additional risks not presently known to us or that we may currently deem immaterial may also impair our business and operations. We do not assume an obligation to update any forward looking statement.

Our level of indebtedness could negatively impact our financial condition and results of operations.

      As of December 31, 2005, we had approximately €950.2 million of indebtedness outstanding, of which €603.0 million is project debt of Stendal. In February 2005, we sold $310 million in principal amount of 9.25% senior notes due 2013 as well as repaid all of the net bank indebtedness of our Rosenthal mill. We may also incur additional indebtedness in the future. Our high debt levels may have important consequences for us, including, but not limited to the following:

      Our ability to repay or refinance our indebtedness will depend on our future financial and operating performance. Our performance, in turn, will be subject to prevailing economic and competitive conditions, as well as financial, business, legislative, regulatory, industry and other factors, many of which are beyond our control. Our ability to meet our future debt service and other obligations may depend in significant part on the success of the Stendal mill, our ability to successfully integrate the Celgar mill into our operations and the extent to which we can implement successfully our business and growth strategy. We cannot assure you that the Stendal mill will be successful, that we will be able to successfully integrate the Celgar mill into our operations or that we will be able to implement our strategy fully or that the anticipated results of our strategy will be realized.

Our business is highly cyclical in nature.

      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.

      Industry capacity can fluctuate as changing industry conditions can influence producers to idle production or permanently close machines or entire mills. In addition, to avoid substantial cash costs in idling or closing a mill, some producers will choose to operate at a loss, sometimes even a cash loss, which can prolong weak pricing environments due to oversupply. Oversupply of our products can also result from producers introducing new capacity in response to favorable pricing trends.

      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, they will continue to fluctuate in the future. Further, we cannot predict the impact of economic weakness in certain world markets or the impact of war, terrorist activity or other events on our markets.

      Prices for our products are driven by many factors outside our control, and we have little influence over the timing and extent of price changes, which are often volatile. Because market conditions beyond our control determine the prices for our products, the price for any one or more of these products may fall below our cash production costs, requiring us to either incur short-term losses on product sales or cease production at one or more of our manufacturing facilities. Therefore, our profitability with respect to these products depends on managing our cost structure, particularly raw materials which represent a significant component of our operating costs and can fluctuate based upon factors beyond our control. If the prices of our products decline, or if raw materials increase, or both, demand for our products may decline and our sales and profitability could be materially adversely affected.

      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.

Our Stendal mill is subject to risks commonly associated with the ramp up of large greenfield industrial projects.

      The Stendal mill has been constructed near the town of Stendal, Germany. The aggregate cost of the mill is approximately €1.0 billion. The performance of the Stendal mill has had a material impact on our financial

condition and operating performance. The construction of the Stendal mill commenced in 2002 and was completed in the third quarter of 2004. We are currently ramping up production at the Stendal mill. Our ongoing ramp up of the Stendal mill is subject to risks commonly associated with the ramp up of large greenfield industrial projects which could result in the Stendal mill experiencing operating difficulties or delays and the Stendal mill may not achieve our planned production, timing, quality, environmental or cost projections, which could have a material adverse effect on our results of operations, financial condition and cash flows. These risks include, without limitation, equipment failures or damage, errors or miscalculations in engineering, design specifications or equipment manufacturing, faulty construction or workmanship, defective equipment or installation, human error, industrial accidents, weather conditions, failure to comply with environmental and other permits, and complex integration of processes and equipment.

The failure to successfully integrate the Celgar mill with our business may adversely affect our results of operations.

      Our future performance will depend in part on how well we integrate the Celgar mill with our operations. The Acquisition is larger than any of the other acquisitions we have made. Integrating the Celgar mill with our operations will be a complex, time consuming and potentially expensive process. Further, the expense of upgrading the Celgar mill to enhance its operations may be more significant than currently anticipated.

      All of the pulp produced by the Celgar mill was sold by third party agents. We are now supervising and performing most of its sales functions directly. We cannot assure you that our internal sales staff and third party agents will be able to sell the combined pulp production of our three pulp mills on terms as favorable as those achieved by such agents previously.

      We estimate that we will incur significant costs associated with the assimilation of the Celgar mill with our operations. The actual costs may substantially exceed our estimates and unanticipated expenses associated with such integration may arise. Furthermore, we may not have identified adverse information or all of the risks concerning the assets we have acquired. If we are unable to address any of these risks, our results of operations and financial condition could be materially adversely affected and the operations of the Celgar mill may not achieve the results or otherwise perform as expected. Further, if the benefits of the Acquisition do not exceed the costs, our financial results will be adversely affected.

      We cannot guarantee that we will successfully integrate the Celgar mill with our operations. If we are unable to address any of these risks, our results of operations and financial condition could be materially adversely affected and the operations of the Celgar mill may not achieve the results or otherwise perform as expected.

We have only limited recourse under the acquisition agreement for losses relating to the Acquisition.

      The diligence conducted in connection with the Acquisition and the indemnification provided in the acquisition agreement may not be sufficient to protect us from, or compensate us for, all losses resulting from the Acquisition. Subject to certain exceptions, the maximum amount we may claim is limited to $30.0 million ($20.0 million in the case of environmental losses). Subject to certain exceptions, the vendor is only liable for misrepresentations or breaches of warranty for 15 months from the closing date of the Acquisition (12 months in the case of environmental losses). A material loss associated with the Acquisition for which there is no adequate remedy under the acquisition agreement could materially adversely affect our results of operations and financial condition and reduce the anticipated benefits of the Acquisition.

We may not be able to enhance the operating performance and financial results or lower the costs of the Celgar mill as planned.

      While we are implementing a number of initiatives to reduce operating costs, increase production and improve the financial results of the Celgar mill, we may not be able to achieve our planned operating improvements, cost reductions, capacity increases or improved price realizations in our expected time periods, if at all. In addition, some of the improvements that we hope to achieve depend upon capital expenditure projects that we are implementing at the Celgar mill. Such capital projects may not be completed in our

expected time periods, if at all, may not achieve the results that we have estimated or may have a cost substantially in excess of our planned amounts.

Increases in our capital expenditures or maintenance costs could have a material adverse effect on our cash flow and our ability to satisfy our debt obligations.

      Our business is capital intensive. Our annual capital expenditures may vary due to fluctuations in requirements for maintenance, business capital, expansion and as a result of changes to environmental regulations that require capital expenditures to bring our operations into compliance with such regulations. In addition, our senior management and board of directors may approve projects in the future that will require significant capital expenditures. Increased capital expenditures could have a material adverse effect on our cash flow and our ability to satisfy our debt obligations. Further, while we regularly perform maintenance on our manufacturing equipment, key pieces of equipment in our various production processes may still need to be repaired or replaced. If we do not have sufficient funds or such repairs or replacements are delayed, the costs of repairing or replacing such equipment and the associated downtime of the affected production line could have a material adverse effect on our business, financial condition, results of operations and cash flows.

Any failure by us to efficiently and effectively manage our growth could adversely affect our business.

      Expansion of our business, including, particularly, the integration of the Celgar mill into our operations and the ramp up of the Stendal mill, may place strains on our personnel, financial and other resources. In order to successfully manage our growth we must identify, attract, motivate, train and retain skilled managerial, financial, engineering, business development, sales and marketing and other personnel. Competition for these types of personnel is intense. If we fail to efficiently manage our growth and compete for these types of personnel, it could adversely affect the quality of our services and, in turn, materially adversely affect our business and the price of our shares.

We are exposed to currency exchange rate and interest rate fluctuations.

      A large majority of our sales, other than those of the Celgar mill, in 2005 were in products quoted in U.S. dollars while most of our operating costs and expenses were incurred in Euros. In addition, all of the products sold by the Celgar mill are quoted in U.S. dollars and the costs of the Celgar mill are primarily incurred in Canadian dollars. Our results of operations and financial condition are reported in Euros. As a result, our revenues have been adversely affected by the significant decrease in the value of the U.S. dollar relative to the Euro and by a decrease in the value of the U.S. dollar relative to the Canadian dollar. Such shifts in currencies relative to the Euro and the Canadian dollar reduce our operating margins and the cash flow available to fund our operations and to service our debt. This could have a material adverse effect on our business, financial condition, results of operations and cash flows.

      Stendal has entered into variable-to-fixed interest rate swaps to fix interest payments under the Stendal mill financing facility, which had kept Stendal from benefiting from the general decline in interest rates over the last two years. These derivatives are marked to market at the end of each reporting period and all unrealized gains and losses are recognized in earnings for the relevant reporting periods.

We use derivatives to manage certain risk which has caused significant fluctuations in our operating results.

      A significant amount of our sales revenue is based on pulp sales quoted in U.S. dollars while our reporting currency is Euros and our costs are predominantly in Euros and, since the Acquisition of the Celgar pulp mill, in Canadian dollars. We therefore use foreign currency derivative instruments primarily to manage against depreciation of the U.S. dollar against the Euro.

      We also use derivative instruments to limit our exposure to interest rate fluctuations. Concurrently with entering into the Stendal financing, Stendal entered into variable-to-fixed rate interest swaps for the full term of the facility to manage its interest rate risk exposure with respect to a maximum aggregate amount of approximately $612.6 million of the principal amount of such facility. Stendal has also entered into currency

swaps and a currency forward contract in connection with such facility. Rosenthal had also entered into currency swap, currency forward, interest rate and interest cap derivative instruments in connection with its outstanding floating rate indebtedness. Our derivative instruments are marked to market and can materially impact our operating results. For example, our operating results for 2005 included realized and unrealized losses of €68.3 million on currency derivatives and realized and unrealized net losses of €3.5 million on the interest rate derivatives when they were marked to market. Further, in February 2005, we converted a large portion of our long-term indebtedness into U.S. dollars by issuing $310 million of senior notes to refinance all of Rosenthal’s bank indebtedness and to fund a portion of the purchase price for the Acquisition of the Celgar mill. If any of the variety of instruments and strategies we utilize are not effective, we may incur losses which may have a materially adverse effect on our business, financial condition, results of operations and cash flow. Further, we may in the future use derivative instruments to manage pulp price risks. The purpose of our derivative activity may also be considered speculative in nature; we do not use these instruments with respect to any pre-set percentage of revenues or other formula, but either to augment our potential gains or reduce our potential losses depending on our perception of future economic events and developments.

Fluctuations in the price and supply of our raw materials could adversely affect our business.

      Wood chips and pulp logs comprise the fiber used by our three pulp mills. The fiber used by our paper mills consists of waste paper and pulp. Such fiber is cyclical in terms of both price and supply. The cost of wood chips and pulp logs is primarily affected by the supply and demand for lumber. The cost of fiber for our paper mills is primarily affected by the supply and demand for paper and pulp. Demand for these raw materials is determined by the volume of pulp and paper products produced globally and regionally. The markets for pulp and paper products, including our products, are highly variable and are characterized by periods of excess product supply due to many factors, including periods of insufficient demand due to weak general economic activity or other causes. The cyclical nature of pricing for these raw materials represents a potential risk to our profit margins if pulp producers are unable to pass along price increases to their customers.

      We do not own any timberlands or have any long-term governmental timber concessions nor do we have any long-term fiber contracts at our German operations. Although raw materials are available from a number of suppliers, and we have not historically experienced supply interruptions or substantial price increases, our requirements will increase as the Stendal mill reaches its full production capacity and as we upgrade the Celgar mill, and we may not be able to purchase sufficient quantities of these raw materials to meet our production requirements at prices acceptable to us during times of tight supply. In addition, the quality of fiber we receive could be reduced as a result of industrial disputes, material curtailments or shut-down of operations by suppliers, government orders and legislation, acts of god, natural catastrophes, weather and other events beyond our control. An insufficient supply of fiber or reduction in the quality of fiber we receive would materially adversely affect our business, financial condition, results of operations and cash flow. In addition to the supply of wood fiber, we are dependent on the supply of certain chemicals and other inputs used in our production facilities. Any disruption in the supply of these chemicals or other inputs could affect our ability to meet customer demand in a timely manner and would harm our reputation. Any material increase in the cost of these chemicals or other inputs could have a material adverse effect on our business, results of operations, financial condition and cash flows.

We operate in highly competitive markets.

      We sell our products globally, with a large percentage sold in Europe, North America and Asia. The markets for our products are highly competitive. A number of other global companies compete in each of these markets and no company holds a dominant position. For both pulp and paper, many companies produce products that are largely standardized. As a result, the primary basis for competition in our markets has been price. Many of our competitors have greater resources and lower leverage than we do and may be able to adapt more quickly to industry or market changes or devote greater resources to the sale of products than we can. There can be no assurance that we will continue to be competitive in the future.

We are subject to extensive environmental regulation and we could have environmental liabilities at our facilities.

      Our operations are subject to numerous environmental laws as well as permits, guidelines and policies. These laws, permits, guidelines and policies govern, among other things:

      In addition, as a result of our operations, we may be subject to remediation, clean up or other administrative orders, or amendments to our operating permits, and we may be involved from time to time in administrative and judicial proceedings or inquiries. Future orders, proceedings or inquiries could have a material adverse effect on our business, financial condition and results of operations. Environmental laws and land use laws and regulations are constantly changing. New regulations or the increased enforcement of existing laws could have a material adverse effect on our business and financial condition. In addition, compliance with regulatory requirements is expensive, at times requiring the replacement, enhancement or modification of equipment, facilities or operations. There can be no assurance that we will be able to maintain our profitability by offsetting any increased costs of complying with future regulatory requirements.

      We are subject to liability for environmental damage at the facilities that we own or operate, including damage to neighboring landowners, residents or employees, particularly as a result of the contamination of soil, groundwater or surface water and especially drinking water. The costs of such liabilities can be substantial. Our potential liability may include damages resulting from conditions existing before we purchased or operated these facilities. We may also be subject to liability for any off-site environmental contamination caused by pollutants or hazardous substances that we or our predecessors arranged to transport, treat or dispose of at other locations. In addition, we may be held legally responsible for liabilities as a successor owner of businesses that we acquire or have acquired. Except for Stendal, our facilities have been operating for decades and we have not done invasive testing to determine whether or to what extent environmental contamination exists. As a result, these businesses may have liabilities for conditions that we discover or that become apparent, including liabilities arising from non-compliance with environmental laws by prior owners. Because of the limited availability of insurance coverage for environmental liability, any substantial liability for environmental damage could materially adversely affect our results of operations and financial condition.

      Enactment of new environmental laws or regulations or changes in existing laws or regulations might require significant capital expenditures. We may be unable to generate sufficient funds or access other sources of capital to fund unforeseen environmental liabilities or expenditures.

We may incur significant taxes if the U.S. Internal Revenue Service and other non-U.S. taxing authorities do not agree with our tax treatment of the Conversion.

      Changes in tax laws, treaties or regulations or the interpretation or enforcement of these tax laws, treaties or regulations, could adversely affect the tax consequences of the Conversion on us, our subsidiaries and our shareholders. In addition, if the U.S. Internal Revenue Service or other taxing authorities do not agree with our assessment of the effects or interpretation of these laws, treaties and regulations, we could incur a material amount of U.S. federal income tax as a result of the Conversion.

We are subject to risks related to our employees.

      The majority of our employees are unionized. The collective agreement relating to employees at our paper mills in Germany has expired and we are currently negotiating a new agreement with them. The collective agreement relating to our pulp workers at the Rosenthal mill expires in the third quarter of 2007. In addition, we may enter into an initial collective agreement with our pulp workers at the Stendal mill in 2006. The collective agreement relating to our hourly workers at the Celgar mill expires in 2008. Although we have not experienced any work stoppages in the past, there can be no assurance that we will be able to negotiate acceptable collective agreements or other satisfactory arrangements with our employees upon the expiration of our collective agreements or in conjunction with the establishment of a new agreement or arrangement with our pulp workers at the Stendal mill and the paper mills. This could result in a strike or work stoppage by the affected workers. The registration or renewal of the collective agreements or the outcome of our wage negotiations could result in higher wages or benefits paid to union members. Accordingly, we could experience a significant disruption of our operations or higher on-going labor costs, which could have a material adverse effect on our business, financial condition, results of operations and cash flow.

We rely on German federal and state government grants and guarantees.

      We currently benefit from a subsidized capital expenditure program and lower cost of financing as a result of German federal and state government grants and guarantees at our Stendal mill. Should either the German federal or state governments fail to honor or be prohibited from honoring legislative grants and guarantees at Stendal, or should we be required to repay any such legislative grants, this may have a material adverse effect on our business, financial condition, results of operations and cash flow.

We are dependent on key personnel.

      Our future success depends, to a large extent, on the efforts and abilities of our executive and senior mill operating officers. Such officers are industry professionals many of whom have operated through multiple business cycles. Our officers play an integral role in, among other things:

      The loss of one or more of our officers could make us less competitive in these areas which could materially adversely affect our business, financial condition, results of operations and cash flows. We do not maintain any key person life insurance on any of our executive or senior mill operating officers.

We may experience disruptions to our production and delivery.

      A material disruption at one of our manufacturing facilities could prevent us from meeting customer demand, reduce our sales and/or negatively impact our results of operations. Any of our pulp or paper manufacturing facilities could cease operations unexpectedly due to a number of events, including:

      Any such downtime or facility damage could prevent us from meeting customer demand for our products and/or require us to make unplanned capital expenditures. If any of our facilities were to incur significant downtime, our ability to meet our production capacity targets and satisfy customer requirements would be impaired and could have a material adverse effect on our business, financial condition, results of operations and cash flows.

Our insurance coverage may not be adequate.

      We have obtained insurance coverage that we believe would ordinarily be maintained by an operator of facilities similar to our pulp and paper mills. Our insurance is subject to various limits and exclusions. Damage or destruction to our facilities could result in claims that are excluded by, or exceed the limits of, our insurance coverage.

Washington State law and our Articles of Incorporation may have anti-takeover effects which will make an acquisition of our Company by another company more difficult.

      We are subject to the provisions of the Revised Code of Washington, Chapter 23B.19, which prohibits a Washington corporation, including our Company, from engaging in any business combination with an “acquiring person” for a period of five years after the date of the transaction in which the person became an acquiring person, unless the business combination is approved in a prescribed manner. A business combination includes mergers, asset sales as well as certain transactions resulting in a financial benefit to the acquiring person. Subject to certain exceptions, an “acquiring person” is a person who, together with affiliates and associates, owns, or within five years did own, 10% or more of the corporation’s voting stock. We may in the future adopt certain measures that may have the effect of delaying, deferring or preventing a change in control of our Company. Certain of such measures, including, without limitation, a shareholder rights plan, may be adopted without any further vote or action by the holders of our shares. These measures may have anti-takeover effects, which may delay, defer or prevent a takeover attempt that a holder of our shares might consider in its best interest.

      None.

      We lease offices in Seattle, Washington, Vancouver, British Columbia, and in Germany. We own the Rosenthal mill, the Celgar mill and the paper mills and the underlying property. The Stendal mill is situated on property owned by Stendal, our 63.6% owned subsidiary.

      The Rosenthal mill is situated on a 220 acre site near the town of Blankenstein in the State of Thuringia, approximately 300 kilometers south of the Stendal mill. The Saale river flows through the site of the mill. In late 1999, we completed a major capital project which converted the Rosenthal mill to the production of kraft pulp. It is a single line mill with an annual production capacity of approximately 310,000 ADMTs of kraft pulp. The mill is self-sufficient in steam and electrical power. Some excess electrical power which is constantly generated is sold to the regional power grid. The facilities at the mill include:

      The Stendal mill is situated on a 200 acre site owned by Stendal that is part of a larger 1,250 acre industrial park (the rest of which is owned by a minority shareholder of Stendal) near the town of Stendal in the State of Sachsen-Anhalt, approximately 300 kilometers north of the Rosenthal mill and 130 kilometers from the city of Berlin. The mill is adjacent to the Elbe river and has access to harbor facilities for water transportation. Construction of the Stendal mill was completed in the third quarter of 2004. The mill is a single line mill with a designed annual production capacity of approximately 552,000 ADMTs of kraft pulp. The Stendal mill will be self-sufficient in steam and electrical power. Some excess electrical power which is constantly being generated will be sold to the regional power grid. The facilities at the mill include:

      The Celgar mill is situated on a 400 acre site near the city of Castlegar, British Columbia in Canada. The mill is located on the south bank of the Columbia River, approximately 600 kilometers east of the port city of Vancouver, British Columbia, and approximately 32 kilometers north of the Canada-United States border. The city of Seattle, Washington is approximately 650 kilometers southwest of Castlegar. It is a single line mill with a current annual production capacity of approximately 430,000 ADMTs of NBSK pulp. Internal power generating capacity could, with certain capital improvements, enable the Celgar mill to be self-sufficient in electrical power and at times to sell surplus electricity. The facilities at the Celgar mill include:

      The Heidenau mill is situated on a 26 acre site in the town of Heidenau in the State of Saxony at the Elbe river, approximately 120 kilometers east of the Fährbrücke mill and 12 kilometers south of the city of Dresden. The mill was constructed in 1956 and has been continually upgraded. The mill has a rated annual production capacity of approximately 45,000 ADMTs of specialty papers. The facilities at the mill include:

      The Fährbrücke mill is situated on a 27 acre site near the town of Fährbrücke in the State of Saxony, in the western part of the Erzgebirge mountains at the Zwickauer Mulde river. The mill is approximately 100 kilometers east of the Rosenthal mill and approximately 120 kilometers west of the Heidenau mill. The mill was constructed between 1972 and 1973 and has been continually upgraded. The mill has a rated annual production capacity for approximately 40,000 ADMTs of printing and writing papers and specialty papers. The mill uses virgin fiber in producing various grades of printing and writing papers and specialty papers. The facilities at the mill include:

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

     At the end of 2005, substantially all of our pulp related assets relating to the Stendal mill were pledged to secure the Stendal Loan Facility. The working capital facilities established for the Rosenthal and Celgar mills are secured by first charges against the inventories and receivables at the respective mills.

ITEM 3.     LEGAL PROCEEDINGS

      In October 2005, our wholly owned subsidiary, Zellstoff Celgar Limited, received a re-assessment for real property transfer tax payable in British Columbia, Canada, in the amount of approximately €3.5 million in connection with the transfer of the land where the Celgar mill is situated. The Company is contesting the assessment and the amount, if any, that may be payable in connection therewith is not yet determinable. Any additional amount paid in connection with the re-assessment will increase the cost basis of the assets acquired and will not affect earnings.

      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.

      Not applicable.

PART II

      (a) Market Information. Our shares are quoted for trading on the Nasdaq National Market under the symbol “MERC” and listed in U.S. dollars on the Toronto Stock Exchange under the symbol “MRI.U”. The following table sets forth the high and low reported sale prices of our shares on the Nasdaq National Market for each quarter in the two year period ended December 31, 2005, and for the period ended March 14, 2006:

      (b) Shareholder Information. As at March 14, 2006, there were approximately 478 holders of record of our shares and a total of 33,169,140 shares were outstanding.

      (c) Dividend Information. The declaration and payment of dividends is at the discretion of our board of directors. Our board of directors has not declared or paid any dividends on our shares in the past two years and does not anticipate declaring or paying dividends in the foreseeable future.

      (d) Equity Compensation Plans. The following table sets forth information as at December 31, 2005 regarding: (i) our 1992 amended and restated stock option plan under which options to acquire an aggregate of 3,600,000 of our shares may be granted; and (ii) our 2004 Stock Incentive Plan pursuant to which 1,000,000 of our shares may be issued pursuant to options, stock appreciation rights and restricted shares:

     (e) Private Placements. In October 2003, we completed the sale of $82.5 million in aggregate principal amount of convertible senior subordinated notes due October 15, 2010. The notes bear interest at a rate of 8.5% per annum and are convertible into our shares at a conversion price of $7.75 per share, which is equal to a conversion rate of approximately 129 shares per $1,000 principal amount of the notes, subject to adjustment for certain customary anti-dilution matters. The notes were offered only to qualified institutional buyers in reliance on Rule 144A and to certain buyers outside of the United States in reliance on Regulation S under the Securities Act. The notes were sold to RBC Dain Rauscher Inc., as the initial purchaser. The aggregate initial purchaser’s discounts of the offering were approximately $3.4 million.

      In connection with the offering of the notes, we filed a shelf registration statement on Form S-3 (File No. 33-111118) with the SEC in December 2003 to register for resale the notes and shares into which the notes are convertible on behalf of the purchasers of the notes. The shelf registration statement was declared effective by the SEC on January 29, 2004. We will not receive any proceeds from the sale of the notes or shares into which the notes are convertible. The offering contemplated by this shelf registration statement has terminated due to the expiration of our contractual obligation to maintain the effectiveness of this registration statement and, as a result, in December 2005, we filed a post-effective amendment to this registration statement to deregister the securities originally registered under this registration statement.

      In February 2005, pursuant to the Acquisition of the Celgar mill, we issued 4,210,526 of our shares at a price of $9.50 per share to the vendor of the Celgar mill for gross proceeds of $40 million in reliance on Regulation S under the Securities Act. In connection with the offering of the shares, we filed a shelf registration statement on Form S-3 (File No. 333-125808) with the SEC in June 2005 to register these shares for resale on behalf of the purchaser. The shelf registration statement was declared effective by the SEC on August 12, 2005. We will not receive any proceeds from the sale of the shares under the shelf registration statement.

ITEM 6.     SELECTED FINANCIAL DATA

      The following table sets forth selected historical financial and operating data as at and for the periods indicated. Effective January 1, 2002, we changed our reporting currency from the U.S. dollar to the Euro. Accordingly, the following selected financial data for periods prior to the year ended December 31, 2002 has been restated in Euros and reclassified to conform with the current year’s presentation. The following selected financial data is qualified in its entirety by, and should be read in conjunction with, our consolidated financial statements and related notes contained in this annual report and “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.

      We commenced construction of our Stendal mill in August 2002. Construction of our Stendal mill was completed in the third quarter of 2004 and the mill is currently in the ramp up phase. The following selected financial data for 2004 includes the operating results of the Stendal mill from its start up in September 2004.

      The following selected financial data reflects the results of operations and financial condition of the Celgar mill from the time of its Acquisition in February 2005.

      The following discussion and analysis of our financial condition and results of operations as at and for the three years ended December 31, 2005 should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this annual report. The following management discussion and analysis of our financial condition and results of operations is based upon the financial statements as at and for the three years ended December 31, 2005.

      The following Management’s Discussion and Analysis of Financial Condition and Results of Operations reflects the results of operations and financial condition of the Celgar mill with an annual production capacity of approximately 430,000 ADMTs from the time of its acquisition in February 2005. In addition, our Stendal mill with an initial annual production capacity of approximately 552,000 ADMTs only commenced production in mid-September 2004.

Results of Operations

      We operate in the pulp and paper business and our operations are located primarily in Germany and Western Canada. Our manufacturing facilities are comprised of: (a) an NBSK pulp mill operated by our wholly-owned subsidiary, Rosenthal, near Blankenstein, Germany, which has an annual production capacity of approximately 310,000 ADMTs; (b) a newly constructed, state-of-the-art NBSK pulp mill, with an initial design production capacity of approximately 552,000 ADMTs per year, near Stendal, Germany owned and operated by our 63.6% owned subsidiary, Stendal; (c) since the Acquisition in February 2005, the Celgar NBSK pulp mill with an annual production capacity of approximately 430,000 ADMTs located near Castlegar, British Columbia, Canada; and (d) two paper mills located at Heidenau and Fährbrücke, Germany, which produce specialty papers and printing and writing papers and, based upon their current product mix, have an aggregate annual production capacity of approximately 70,000 ADMTs.

      The Stendal mill was completed substantially on its planned schedule and budget in the third quarter of 2004 and we are currently ramping up production. Total investment costs in respect of the Stendal mill were approximately €1.0 billion, the majority of which was financed under the Stendal Loan Facility in the amount of €828 million. The Stendal mill underwent extensive testing and evaluation in December 2004 and, in the first quarter of 2005, we delivered an acceptance certificate and assumed responsibility for the operation of the mill. See “Business — Stendal Pulp Mill”.

      Effective September 18, 2004, the Stendal mill was started up and we commenced expensing all of the costs, including interest, related to the Stendal mill. Prior to that date, most of the costs, including interest, relating thereto were capitalized.

      During the fourth quarter of 2005, the Stendal mill took 14 days of planned downtime for maintenance and other improvements at which time it also installed two new digesters and certain additional measures were implemented as agreed to by the principal contractor and certain suppliers in connection with the Acceptance Test. Once fully operational, we believe the additional digesters should increase the annual production capacity of the Stendal mill to in excess of 600,000 ADMTs. The Stendal mill reached approximately 88% of its initial rated capacity in the fourth quarter of 2005. When the ramp up of the Stendal mill is completed in 2006, we expect the mill to operate near its initial rated capacity. See “Business — Stendal Pulp Mill”.

      In February 2005, we acquired the Celgar pulp mill for approximately $210 million. The Celgar mill is a modern NBSK pulp mill that produces high quality NBSK pulp. Since its acquisition, we have been integrating the mill with our operations and are in the process of implementing approximately €20.0 million in capital projects at the mill. For more information about the Acquisition of the Celgar mill, see “Business — The Company — Acquisition of Celgar Pulp Mill”. Our results for the year ended December 31, 2005 include revenues of €139.2 million and operating costs of €148.0 million relating to the Celgar mill.

      In conjunction with the Acquisition, we sold $310 million principal amount of 9.25% senior notes and approximately $91 million of our shares by way of separate public offerings, the net proceeds of which, together with cash on hand, were utilized to pay the cash portion of the purchase price for the Acquisition,

including defined working capital, transaction costs, to refinance all of the bank indebtedness of our Rosenthal mill and for working capital. Effective upon closing of the Acquisition, we established a new revolving working capital facility for the Rosenthal mill in the amount of €40 million and for the Celgar mill in the amount of $30 million. See “Business — The Financings” for more information.

      Our financial performance depends on a number of variables that impact sales and production costs. Sales and production results are influenced largely by the market price for products and raw materials, the mix of products produced and foreign currency exchange rates. Kraft pulp and paper markets are highly cyclical, with prices determined by supply and demand. Demand for kraft pulp and paper is influenced to a significant degree by global levels of economic activity and supply is driven by industry capacity and utilization rates. Our product mix is important because premium grades of NBSK pulp and specialty papers generally achieve higher prices and profit margins.

      Our production costs are influenced by the availability and cost of raw materials, energy and labor, and our plant efficiencies and productivity. Our main raw material is fiber in the form of wood chips and pulp logs for pulp production, and waste paper and pulp for paper production. Wood chip and pulp log costs are primarily affected by the supply of, and demand for, lumber and pulp, which are both highly cyclical. Production costs also depend on the total volume of production. High operating rates and production efficiencies permit us to lower our average cost by spreading fixed costs over more units.

      Global economic conditions, changes in production capacity and inventory levels are the primary factors affecting kraft pulp and paper prices. Historically kraft pulp and paper prices have been cyclical in nature. The average annual European list prices for NBSK pulp between 1990 and 2004 ranged from a low of $444 per ADMT in 1993 to a high of $875 per ADMT in 1995. Following a decline in demand in 2001, list prices for NBSK pulp also declined and averaged approximately $463 per ADMT in 2002. An increase in demand resulting from improving American and major European economies and the weakening of the U.S. dollar against the Euro and other major currencies in 2003 resulted in European list prices for NBSK pulp increasing to approximately $560 per ADMT in December 2003 despite relatively high inventory levels. List prices for NBSK pulp in Europe continued to strengthen overall in 2004 due to the relatively weak U.S. dollar and improving world economies, and were approximately $625 per ADMT in December 2004. List prices for NBSK pulp weakened in 2005 primarily due to the strengthening of the U.S. dollar and were approximately $600 per ADMT in Europe at the end of 2005. List prices for NBSK pulp were also generally lower in Asia in 2005. List prices for NBSK pulp improved to approximately $620 per ADMT in Europe in February 2006 and producers are seeking a further $20 per ADMT price increase in the first quarter of 2006. In February 2006, list prices in Asian markets also improved by approximately $50 per ADMT compared to the 2005 fourth quarter levels. However, there can be no assurance that higher list prices for NBSK pulp will be achieved or that they will not fall in the future. A producer’s sales realizations will reflect customer discounts, commissions and other items and NBSK pulp prices will continue to fluctuate in the future.

      Our financial performance for any reporting period is also impacted by changes in the U.S. dollar to Euro and Canadian dollar exchange rates and in interest rates. Changes in currency rates affect our operating results because the price for our principal product, NBSK pulp, is generally based on a global industry benchmark that is quoted in U.S. dollars, even though our sales are primarily invoiced in Euros and Canadian dollars. Therefore, a weakening of the U.S. dollar against the Euro and the Canadian dollar will generally reduce the amount of revenues of our pulp operations. Most of our operating costs at our German mills, including our debt obligations under the Stendal Loan Facility and/or Rosenthal working capital facility, are incurred in Euros. Most of our operating costs at the Celgar mill, including under its working capital facility, are in Canadian dollars. These costs do not fluctuate with the U.S. dollar to Euro or Canadian dollar exchange rates. Thus, a weakening of the U.S. dollar against the Euro and/or the Canadian dollar tends to reduce our sales revenue, gross profit and income from operations. The effect of such weakening against the Euro has been partially offset by gains from time to time on foreign currency derivatives we put into place to protect against such currency movements.

      Changes in interest rates can impact our operating results because the indebtedness we incurred under the credit facilities established for our pulp mills provide for floating rates of interest.

      Changes in currency exchange and interest rates also impact certain foreign currency and interest rate derivatives Rosenthal used and Stendal uses to partially protect against the effect of such changes. Gains or losses on such derivatives are included in our earnings, either as they are settled or as they are marked to market for each reporting period. See “Quantitative and Qualitative Disclosures about Market Risk”.

      During 2005, Stendal entered into currency swaps in the aggregate principal amount of €612.6 million to convert all of its long-term indebtedness under the Stendal Loan Facility from Euros into U.S. dollars, as well as certain currency forwards, some of which matured in 2005, collectively referred to as the “Currency Derivatives”. A net unrealized non-cash holding loss of €66.1 million before minority interests was recorded in respect of the Currency Derivatives that were outstanding at the end of 2005 and a net realized loss of €2.2 million before minority interests was recorded in respect of such Currency Derivatives that matured during 2005, compared to a realized gain of approximately €44.5 million upon the settlement of the currency derivatives relating to the Rosenthal and Stendal mills in 2004. See “Quantitative and Qualitative Disclosures About Market Risk” for more information.

      Stendal, as required under its project financing, entered into variable-to-fixed rate interest swaps, referred to as the “Stendal Interest Rate Swaps”, in August 2002 to fix the interest rate on approximately €612.6 million of indebtedness for the full term of the Stendal Loan Facility. Rosenthal had also entered into forward interest rate and interest cap contracts, referred to as the “Rosenthal Interest Rate Contracts” and, together with the Stendal Interest Rate Swaps, the “Interest Rate Contracts”, in respect of a portion of its long-term indebtedness under the Rosenthal Loan Facility. The Rosenthal Interest Rate Contracts were settled in February 2005 in connection with the repayment of the Rosenthal Loan Facility. See “Business  — The Financings”.

      In the year ended December 31, 2005, we recorded a net unrealized non-cash holding loss of €3.2 million before minority interests on the marked to market valuation of the Stendal Interest Rate Contracts and a realized loss of €0.3 million upon the settlement of the Rosenthal Interest Rate Contracts, versus a net unrealized non-cash holding loss of €32.3 million before minority interests on the Rosenthal and Stendal Interest Rate Contracts in the year ended December 31, 2004.

      Improving world economies resulted in an increase in interest rates in 2005. If world economies continue to strengthen, we would expect interest rates to continue to rise from their historically low levels. Higher interest rates could result in our recording marked to market non-cash holding gains on the Stendal Interest Rate Contracts in future periods. However, a fall in interest rates could result in our recording non-cash holding losses on the Stendal Interest Rate Contracts in future periods when they are marked to market. See “Quantitative and Qualitative Disclosures about Market Risk”.

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

Year Ended December 31, 2005 Compared to Year Ended December 31, 2004

      Revenues for the year ended December 31, 2005 increased to €513.9 million from €237.2 million in the comparative period of 2004, because of higher pulp sales resulting from the inclusion of a full year of results of our Stendal mill and the results of our Celgar mill from February 2005. Pulp sales by volume were 1,101,304 ADMTs in 2005, compared to 421,716 ADMTs in 2004. In the year ended December 31, 2005, the Stendal and Celgar mills sold 783,133 ADMTs of NBSK pulp and had sales of €315.2 million.

      Cost of sales and general, administrative and other expenses in the year ended December 31, 2005 increased to €497.6 million from €255.2 million in the comparative period of 2004, primarily as a result of the inclusion of a full year’s results of our Stendal mill and the results of our Celgar mill. We commenced expensing all of the costs, including interest, relating to the Stendal mill effective September 2004 when the mill was started up, prior to which most of the costs, including interest, relating to the Stendal mill were capitalized during its construction.

      In the year ended December 31, 2005, revenues from our pulp operations increased to €452.4 million from €182.5 million in 2004, primarily as a result of the inclusion of a full year of sales at our Stendal mill and sales from our Celgar mill. List prices for NBSK pulp in Europe were approximately €490 ($610) per ADMT in 2005, compared to approximately €496 ($616) per ADMT last year. The decrease in NBSK pulp prices was partially offset by the strengthening of the U.S. dollar versus the Euro in 2005.

      Pulp mill net sales realizations decreased to €407 per ADMT on average in the year ended December 31, 2005 from €423 per ADMT in 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 ramp up 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 €434.9 million in the year ended December 31, 2005 from €190.4 million in 2004, primarily as a result of €322.0 million of operating costs related to the Stendal and Celgar mills. Beginning in 2005, our German operations became subject to the European Union Emissions Trading Scheme, pursuant to which our German mills have been granted emission allowances. In the year ended December 31, 2005, we recorded a contribution to income from operations of €17.3 million resulting from the sale of emission allowances by our German pulp mills.

      On average, our fiber costs for pulp production at the Rosenthal mill decreased marginally compared to last year.

      Depreciation for the pulp operations increased to €50.9 million in the current period, from €26.8 million in 2004, primarily as a result of €37.8 million of depreciation from the Stendal and Celgar mills, partially offset by lower depreciation at the Rosenthal mill.

      For the year ended December 31, 2005, the pulp operations generated operating income of €23.9 million, versus an operating loss of €5.1 million last year, primarily as a result of higher operating income at our German pulp mills including income from operations of €8.3 million from our Stendal mill, partially offset by an operating loss at our Celgar mill. The strengthening of the Canadian dollar from February 14, 2005, the date of the Acquisition of the Celgar mill, by approximately 5.6% versus the U.S. dollar in 2005 negatively impacted the results of our Celgar mill.

      Paper sales in the year ended December 31, 2005 were €61.5 million, compared with €55.0 million in the same period of last year as a result of higher sales volumes and a shift in the product mix at our paper mills.

      Cost of sales and general, administrative and other expenses for the paper operations in the year ended December 31, 2005 decreased to €63.8 million from €64.7 million in the year ended December 31, 2004.

      For the year ended December 31, 2005, our paper operations generated an operating loss of €2.3 million, compared to an operating loss of €9.8 million in 2004, which included a non-cash impairment charge of €6.0 million related to the Fährbrücke paper mill.

      In the year ended December 31, 2005, we had income from operations of €16.3 million, compared to a loss from operations of €18.0 million last year (which included a €6.0 million non-cash impairment charge), primarily as a result of higher income from, and the sale of emission allowances by, our German pulp mills. Interest expense in the year ended December 31, 2005 increased to €86.9 million from €23.7 million a year ago, due to interest associated with our $310 million senior note issue completed in February 2005 and higher borrowings relating to the Stendal mill. We capitalized most of the interest relating to the Stendal mill prior to its start up in mid-September 2004.

      In the year ended December 31, 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. Due to the strengthening of the U.S. dollar versus the Euro in 2005, we recorded a net unrealized non-cash holding loss of €66.1 million before minority interests upon the marked to market valuation of the Currency Derivatives that were outstanding at the end of the 2005 period and a net realized loss of €2.2 million before minority interests in respect of such derivatives that matured during the period. In 2004, we recorded a realized gain of €44.5 million before minority interests upon the settlement of the currency derivatives relating to the Stendal and Rosenthal mills due to the weakening of the U.S. dollar versus the Euro in 2004. In the year ended December 31, 2005, as a result of a decrease in long-term European interest rates, we also recorded an unrealized non-cash holding loss of €3.2 million before minority interests on the marked to market valuation of the Stendal Interest Rate Contracts and a net realized loss of €0.3 million before minority interests upon the settlement of the Rosenthal Interest Rate Contracts. In 2004, we recorded a net unrealized non-cash holding loss of €32.3 million before minority interests on the marked to market valuation of the Rosenthal and Stendal Interest Rate Contracts. See “Quantitative and Qualitative Disclosures About Market Risk” for more

information about our derivatives. We also recorded an unrealized non-cash foreign exchange loss on our long-term debt of €4.2 million in 2005 due to the weakening of the Euro versus the U.S. dollar.

      In the year ended December 31, 2005, minority interest, representing the two minority shareholders’ proportionate interest in the Stendal mill, was €17.7 million, compared to €2.5 million in 2004.

      On May 6, 2005, our management determined to record, and our Audit Committee approved, an adjustment of €1.7 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 was a legacy investment that we had 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 year ended December 31, 2005 of €117.1 million, or €3.75 per basic and diluted share, which reflected generally weak pulp markets, the realized and unrealized net losses on our currency and interest rate derivatives of €71.8 million, interest expense relating to our Stendal mill of €56.8 million, the unrealized non-cash foreign exchange loss on our long-term debt of €4.2 million and the non-cash impairment charge of €1.7 million relating to investments, partially offset by a non-cash benefit for income taxes of €10.8 million. In 2004, we reported net income of €20.0 million, or €1.15 per basic share and €0.89 per diluted share, which included an income tax benefit of €44.2 million relating to a reorganization of certain of our subsidiary companies.

      We generated “Operating EBITDA” of €68.4 million and €17.2 million in the years ended December 31, 2005 and 2004, respectively. Operating EBITDA is defined as income (loss) from operations plus depreciation and amortization and non-recurring capital asset impairment charges. Operating EBITDA is calculated by adding depreciation and amortization and non-recurring capital asset impairment charges of €52.0 million and €35.1 million to the income from operations of €16.3 million and loss from operations of €18.0 million for the years ended December 31, 2005 and 2004, respectively.

      Management uses Operating EBITDA as a benchmark measurement of its own operating results, and as a benchmark relative to its competitors. Management considers it to be a meaningful supplement to operating income as a performance measure primarily because depreciation expense and non-recurring capital asset impairment charges are not an actual cash cost, and depreciation expense varies widely from company to company in a manner that management considers largely independent of the underlying cost efficiency of their operating facilities. In addition, we believe Operating EBITDA is commonly used by securities analysts, investors and other interested parties to evaluate our financial performance.

      Operating EBITDA does not reflect the impact of a number of items that affect our net income (loss), including financing costs and the effect of derivative instruments. Operating EBITDA is not a measure of financial performance under GAAP, and should not be considered as an alternative to net income (loss) or income (loss) from operations as a measure of performance, nor as an alternative to net cash from operating activities as a measure of liquidity.

      Operating EBITDA has significant limitations as an analytical tool, and should not be considered in isolation, or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are that Operating EBITDA does not reflect: (i) our cash expenditures, or future requirements, for capital expenditures or contractual commitments; (ii) changes in, or cash requirements for, working capital needs; (iii) the significant interest expense, or the cash requirements necessary to service interest or principal payments, on our outstanding debt; (iv) minority interests on our Stendal NBSK pulp mill operations; (v) the impact of realized or marked to market changes in our derivative positions, which can be substantial; and (vi) Operating EBITDA does not reflect 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:

Year Ended December 31, 2004 Compared to Year Ended December 31, 2003

      Revenues for the year ended December 31, 2004 increased to €237.2 million from €185.7 million in the comparative period of 2003, primarily because of higher pulp sales resulting from the start up of production at our Stendal mill in mid-September 2004. In 2004, pulp sales by volume increased to 421,716 ADMTs from 303,655 ADMTs in 2003. In 2004, the Stendal mill produced 132,694 ADMTs of NBSK pulp and had sales of €42.3 million.

      Cost of sales and general, administrative and other expenses in the year ended December 31, 2004 increased to €255.2 million from €190.2 million in the comparative period of 2003, primarily as a result of the inclusion of production from our Stendal mill. We commenced expensing all of the costs, including interest, relating to the Stendal mill effective September 2004, prior to which most of the costs, including interest, relating to the Stendal mill were capitalized.

      In the year ended December 31, 2004, revenues from our pulp operations increased to €182.5 million from €129.3 million in 2003 as a result of higher prices and production from our Rosenthal mill and the inclusion of production from our Stendal mill. List prices for NBSK pulp in Europe were approximately €496 ($616) per ADMT in 2004, compared to approximately €453 ($523) per ADMT last year. The increase in NBSK pulp prices was partially offset by the weakness of the U.S. dollar versus the Euro in 2004.

      Pulp mill net sales realizations increased to €423 per ADMT on average in the year ended December 31, 2004 from €417 per ADMT in 2003, primarily as a result of higher prices, partially offset by lower price realizations of the Stendal mill during its start up when it sold pulp at a discounted price. We expect that such discount will be eliminated over time.

      Cost of sales and general, administrative and other expenses for the pulp operations increased to €190.4 million in the year ended December 31, 2004 from €133.1 million in 2003, primarily as a result of the inclusion of €63.8 million of operating costs related to the Stendal mill.

      On average, our fiber costs for pulp production at the Rosenthal mill decreased by approximately 3.9% compared to last year.

      Depreciation for the pulp operations increased to €26.8 million in the current period, from €21.9 million in 2003, primarily as a result of the inclusion of €9.0 million of depreciation from the Stendal mill. A change effective July 1, 2004 in our depreciation estimate in respect of our Rosenthal mill resulted in a decrease of €4.4 million in cost of sales.

      For the year ended December 31, 2004, the pulp operations generated an operating loss of €5.1 million, versus an operating loss of €1.5 million in 2003, primarily as a result of a loss from operations of €20.6 million from our Stendal mill. Such loss from our Stendal mill resulted primarily from expensing certain costs associated with the mill prior to its start up and the higher production costs and lower price realizations it incurred during its start up.

      Paper sales in the year ended December 31, 2004 were €55.0 million, compared with €56.4 million in 2003, primarily as a result of a shift in the product mix at the paper mills.

      Cost of sales and general, administrative and other expenses for the paper operations in the year ended December 31, 2004 increased to €64.7 million from €56.3 million in the year ended December 31, 2003, primarily as a result of a non-cash €6.0 million impairment charge relating to our paper operations. In November 2004, our management determined to record and our audit committee approved a non-cash impairment charge of €6.0 million to write-off the carrying value of our Fährbrücke paper mill assets. Based upon its current product mix, the mill has an annual production capacity of approximately 35,000 ADMTs and produces primarily printing and writing paper. We determined to take the impairment charge as the Fährbrücke mill has generated weaker than expected returns over a period of time despite changes to its product mix. We do not expect the impairment charge in and of itself to result in future cash expenditures as we intend to continue to operate the Fährbrücke mill.

      For the year ended December 31, 2004, our paper operations generated an operating loss of €9.8 million, which included the non-cash impairment charge of €6.0 million, compared to operating income of €0.1 million in 2003.

      In 2004, we had a loss from operations of €18.0 million, compared to a loss of €4.5 million last year, primarily as a result of a loss from operations of €20.6 million from our Stendal mill and the €6.0 million non-cash impairment charge related to our Fährbrücke paper mill. Interest expense (excluding capitalized interest of €27.2 million relating to the Stendal pulp mill) in the year ended December 31, 2004 increased to €23.7 million from €11.5 million a year ago, due to higher borrowings resulting primarily from our $82.5 million convertible note issue in October 2003 and the inclusion of interest expense of €12.2 million relating to the Stendal mill. We capitalized most of the interest relating to the Stendal mill prior to its start up in mid-September 2004.

      In the year ended December 31, 2004, we recorded a gain of €44.5 million before minority interests upon the settlement of the currency derivatives relating to the Stendal and Rosenthal mills due to the weakening of the U.S. dollar versus the Euro in 2004. In 2003, we recorded a gain of €29.3 million before minority interests on our then outstanding currency derivatives. In the year ended December 31, 2004, we also recorded an unrealized non-cash holding loss of €32.3 million before minority interests on the marked to market valuation of the Interest Rate Contracts versus a net loss thereon of €13.2 million before minority interests in 2003.

      In the year ended December 31, 2004, minority interest, representing the two minority shareholders’ proportionate interest in the Stendal mill, was €2.5 million, compared to €5.6 million in 2003.

      Our results for 2003 included an adjustment of €5.6 million for the non-cash impact of other-than-temporary impairment losses on our available-for-sale securities.

      During the fourth quarter of 2004, we completed a reorganization of certain of our German subsidiary companies and tax field audits for years prior to 2001 of certain of our German subsidiaries were completed. As a result, we re-evaluated our income tax provision and deferred income tax asset valuation allowance and recorded an income tax benefit of €44.2 million for the year ended December 31, 2004.

      We reported net income for the year ended December 31, 2004 of €20.0 million, or €1.15 per basic share and €0.89 per diluted share, which reflected the positive impact of the net gain on derivative instruments and

the income tax benefit, partially offset by the loss from our Stendal mill. In 2003, we reported a net loss of €3.6 million, or €0.21 per basic and diluted share.

      We generated “Operating EBITDA” of €17.2 million and €19.4 million in the years ended December 31, 2004 and 2003, 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 €35.1 million and €23.9 million to the loss from operations of €18.0 million and €4.5 million for the years ended December 31, 2004 and 2003, 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 our results for the year ended December 31, 2005 for additional information relating to such limitations and Operating EBITDA.

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

Liquidity and Capital Resources

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

     At December 31, 2005, our cash and cash equivalents were €83.5 million, compared to €49.6 million at the end of 2004. We also had €7.0 million of cash restricted to pay construction costs and €24.6 million of cash restricted in a debt service account, both related to the Stendal mill. At December 31, 2005, we qualified for

investment grants related to the Stendal mill totaling approximately €7.0 million from the federal and state governments of Germany, which we expect to receive in 2006. These grants, when received, will be applied to repay the amounts drawn under the dedicated tranche of 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 the 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) for the next 12 months from cash flow from operations, cash on hand and the two revolving working capital facilities for the Rosenthal and Celgar mills in the amounts of €40 million and $30 million, respectively.

      We expect to meet the capital requirements for the Stendal mill, including working capital and potential losses during ramp up, interest and debt services expenses for the next 12 months through cash on hand, cash flow from operations, shareholder advances already made to Stendal, the Stendal Loan Facility (which includes a revolving working capital tranche) and the receipt of government grants.

Operating Activities

      We operate in a cyclical industry and our operating cash flows vary accordingly. Our principal operating cash expenditures are for compensation, fiber, chemicals and interest.

      Operating activities in 2005 provided cash of €11.3 million, compared to €9.6 million in 2004. An increase in receivables due primarily to higher pulp sales used cash of €18.8 million in 2005, compared to €21.7 million in 2004. An increase in inventories due primarily to the Acquisition of the Celgar mill used cash of €4.2 million in 2005, compared to €29.0 million in 2004. An increase in accounts payable and accrued expenses primarily due to higher pulp production provided cash of €50.3 million in 2005, compared to €17.3 million in 2004.

      Working capital is subject to cyclical operating needs, the timing of collection of receivables and government grants, and the payment of payables and expenses. In 2005, the increase in working capital was primarily attributable to the receipt of government grants of €84.7 million and higher receivables and inventories resulting from the Acquisition of the Celgar mill.

Investing Activities

      Investing activities in 2005 used cash of €108.2 million primarily related to the Acquisition of the Celgar mill which used cash of €146.6 million and the purchase of property, plant and equipment primarily attributable to the Stendal mill which used cash of €22.0 million, partially offset by a decrease in restricted cash which provided cash of €61.2 million. Investing activities in 2004 used cash of €357.3 million primarily attributable to the Stendal mill.

      We expect capital expenditures in 2006, including the capital improvement project at the Celgar mill, to total approximately €34.0 million. This level of capital expenditure could increase or decrease as a result of a number of factors, including our financial results and future economic conditions. Our planned capital spending in 2006 will be for efficiency and quality projects, replacement projects and on-going environmental compliance.

Financing Activities

      Financing activities provided cash of €126.9 million in the year ended December 31, 2005. A net increase in indebtedness, primarily related to the Acquisition of the Celgar mill, provided cash of €40.7 million in 2005. The issuance of shares primarily in connection with the Acquisition of the Celgar mill provided cash of €66.6 million in 2005. We fully repaid the outstanding amount under the Rosenthal Loan Facility of approximately €143.1 million (net of restricted cash) and indebtedness relating to the landfill at the Rosenthal mill in the amount of approximately €7.6 million 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 €64.2 million and the repayment of capital lease obligations used cash of €6.4 million in 2005. In 2005, the receipt of government grants related to the Stendal mill provided cash of €84.7 million compared to €103.6 million in 2004. Under our accounting policies, these grants are not recorded until received and are not recorded in our income but reduce the cost basis of the assets purchased. Further, the drawdown of minority shareholder advances to Stendal provided cash of €5.5 million in 2005. Financing activities provided cash of €343.5 million in 2004, primarily as a result of a net increase in indebtedness relating to the Stendal mill.

      At December 31, 2005, we had drawn down Nil of the €40.0 million revolving term credit facility relating to the Rosenthal mill and C$14.6 million of the $30.0 million revolving credit facility relating to the Celgar mill. As at December 31, 2005, we had utilized the entire €4.7 million available under the five credit facilities relating to the paper operations. For information about these credit facilities, see “Business — Description of Certain Indebtedness”.

      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 revolving working capital facilities established for the Rosenthal and Celgar mills.

Contractual Obligations and Commitments

      The following table sets out our contractual obligations and commitments as at December 31, 2005 in connection with our long-term liabilities.

Capital Resources

      In addition to our €40 million and $30 million 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) to enter into certain types of transactions, including the incurrence of additional indebtedness, the making of restricted payments and distributions 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. As at December 31, 2005, Mercer Inc. and our restricted subsidiaries under the indenture governing the senior notes did not meet the Fixed Charge Coverage Ratio. For a description of our senior notes and credit facilities, see “Business — Description of Certain Indebtedness”.

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, Canadian dollars and Swiss francs. 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 year ended December 31, 2005, we reported a net €5.2 million foreign exchange translation gain and, as a result, the cumulative foreign exchange translation gain reported within comprehensive income increased to €15.6 million at December 31, 2005 from €10.5 million at December 31, 2004.

      Based upon the exchange rate at December 31, 2005, the U.S. dollar increased by approximately 13% in value against the Euro since December 31, 2004. See “Quantitative and Qualitative Disclosures about Market Risk”.

Results of Operations of the Restricted Group Under Our Senior Note Indenture

      The indenture governing our 9.25% senior notes requires that we also provide a discussion in annual and quarterly reports we file with the SEC under Management’s Discussion and Analysis of Financial Condition and Results of Operations of the results of operations and financial condition of Mercer Inc. and our restricted subsidiaries under the indenture, referred to as the “Restricted Group”. As at and during the year ended December 31, 2005, the Restricted Group was comprised of Mercer Inc., certain holding subsidiaries and Rosenthal, and the Celgar mill from the time of its Acquisition in February 2005. As at and during the years ended December 31, 2004 and 2003, 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 periods. 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 the Restricted Group for 2004 and 2003. 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 Rosenthal, see Note 16 of our annual financial statements included herein. For further information regarding the Restricted Group including, without limitation, a reconciliation to our consolidated results of operations, see Note 22 of our annual financial statements included elsewhere herein.

Restricted Group Results — Year Ended December 31, 2005 Compared to Year Ended December 31, 2004

      Total revenues for the Restricted Group for the year ended December 31, 2005 increased to €276.4 million from €142.2 million in the comparative period of 2004, primarily because of the inclusion of pulp sales from the Celgar mill. Pulp sales realizations for the Restricted Group decreased to €413 per ADMT on average in the year ended December 31, 2005 from €446 per ADMT in 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 in 2005. As part of enhancing our sales and marketing group and activities, in November 2005 Mercer Inc. assumed responsibility for the pulp sales of the Stendal mill for which it receives a fee from Stendal of approximately 1.4% of sales.

      Costs of sales and general, administrative and other expenses for the Restricted Group in the year ended December 31, 2005 increased to €265.7 million from €129.7 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 was €23.9 million in the current period, versus €17.8 million in 2004, primarily as a result of the inclusion of depreciation of the Celgar mill, partially offset by lower depreciation at our Rosenthal mill.

      In the year ended December 31, 2005, the Restricted Group reported income from operations of €10.7 million, compared to €12.4 million last year, primarily as a result of higher operating income from our Rosenthal mill, offset by an operating loss at our Celgar mill. The strengthening of the Canadian dollar from February 14, 2005, the date of the Acquisition of the Celgar mill, by approximately 5.6% versus the U.S. dollar in 2005 negatively impacted the results of our Celgar mill. Interest expense for the Restricted Group in the year ended December 31, 2005 increased to €32.4 million from €10.9 million a year ago, 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 €1.7 million related to an investment in a venture company, which is the last of a legacy investment that we have held since approximately 1996. We do not currently expect to incur any future cash expenditures related thereto.

      In the year ended December 31, 2005, the Restricted Group realized a loss of €0.3 million on the settlement of the Rosenthal interest rate derivatives, versus a marginal unrealized non-cash holding loss on the marked to market valuation of the interest rate derivatives related to the Rosenthal mill in 2004. In the year ended December 31, 2004, the Restricted Group recorded a realized gain of approximately €13.3 million on the settlement of the currency derivatives related to the Rosenthal mill. The Restricted Group did not have any currency derivatives outstanding during 2005 that materially affected its results. In addition, the Restricted Group recorded an unrealized non-cash foreign exchange loss on debt of €4.2 million in 2005.

      The net loss for the Restricted Group for the year ended December 31, 2005 was €25.2 million, which reflected generally weak markets, higher interest expense of €32.4 million, the unrealized non-cash foreign exchange loss on debt of €4.2 million and the non-cash impairment charge of €1.7 million on investments. The overall strength of the Canadian dollar versus the U.S. dollar in 2005 negatively impacted the results of our Celgar mill. In 2004, the Restricted Group reported net income of €35.1 million, which included an income tax benefit of €17.2 million relating to a reorganization of certain of our subsidiary companies and the gain on derivative instruments of €13.3 million.

      The Restricted Group generated “Operating EBITDA” of €34.6 million and €30.2 million in the years ended December 31, 2005 and 2004, respectively. Operating EBITDA is defined as income (loss) from operations plus depreciation and amortization and non-recurring capital asset impairment charges. Operating EBITDA for the Restricted Group is calculated by adding depreciation and amortization and non-recurring capital asset impairment charges of €23.9 million and €17.8 million to the income from operations of €10.7 million and €12.4 million for the years ended December 31, 2005 and 2004, respectively.

      Operating EBITDA has significant limitations as an analytical tool, and should not be considered in isolation, or as a substitute for analysis of our results as reported under GAAP. See the discussion of Mercer’s results for the year ended December 31, 2005 for additional information relating to such limitations and Operating EBITDA.

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

Restricted Group Results — Year Ended December 31, 2004 Compared to Year Ended December 31, 2003