10-Q 1 doc1.txt ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______ TO _______ COMMISSION FILE NO.: 000-09409 MERCER INTERNATIONAL INC. (Exact name of Registrant as specified in its charter) WASHINGTON 91-6087550 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 14900 INTERURBAN AVENUE SOUTH, SUITE 282, SEATTLE, WA 98168 (Address of office) (206) 674-4639 (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO --- --- Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). YES X NO --- --- The Registrant had 16,794,899 shares of beneficial interest outstanding as at August 14, 2003. ================================================================================ PART I. FINANCIAL INFORMATION --------------------- ITEM 1. FINANCIAL STATEMENTS MERCER INTERNATIONAL INC. CONSOLIDATED FINANCIAL STATEMENTS FOR THE SIX MONTHS ENDED JUNE 30, 2003 (Unaudited) FORM 10-Q QUARTERLY REPORT - PAGE 2 MERCER INTERNATIONAL INC. CONSOLIDATED BALANCE SHEETS As at June 30, 2003 and December 31, 2002 (Unaudited) (Euros in thousands)

June 30, December 31, 2003 2002 ---------- ------------ ASSETS Current Assets Cash and cash equivalents E 21,951 E 30,261 Cash restricted 13,234 9,459 Investments 333 307 Receivables 52,427 31,924 Inventories 20,514 16,375 Prepaid and other 6,339 7,891 ---------- ---------- Total current assets 114,798 96,217 Long-Term Assets Cash restricted 40,859 38,795 Properties 518,248 441,990 Investments 5,391 5,592 Equity method investment 7,159 7,019 Deferred income tax 10,054 10,137 ---------- ---------- 581,711 503,533 ---------- ---------- E 696,509 E 599,750 ========== ========== LIABILITIES Current Liabilities Accounts payable and accrued expenses E 39,785 E 32,866 Construction in progress costs payable 62,339 24,885 Note payable 1,997 832 Note payable, construction in progress 45,000 15,000 Debt, current portion 21,852 16,306 ---------- ---------- Total current liabilities 170,973 89,889 Long-Term Liabilities Debt, construction in progress, less current portion 150,506 146,485 Debt, less current portion 193,186 205,393 Derivative financial instruments, construction in progress 58,052 30,108 Other 2,497 2,906 ---------- ---------- 404,241 384,892 ---------- ---------- Total liabilities 575,214 474,781 Minority interest - - SHAREHOLDERS' EQUITY Shares of beneficial interest 76,995 76,995 Accumulated other comprehensive income (loss) 1,560 (4,815) Retained earnings 42,740 52,789 ---------- ---------- 121,295 124,969 ---------- ---------- E 696,509 E 599,750 ========== ==========

The accompanying notes are an integral part of these financial statements. FORM 10-Q QUARTERLY REPORT - PAGE 3 MERCER INTERNATIONAL INC. CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS For Six Months Ended June 30, 2003 and 2002 (Unaudited) (Euros in thousands, except for earnings per share)

2003 2002 ---------- ---------- Revenues Sales of pulp and paper E 91,274 E 119,535 Transportation 2,022 2,753 Other 5,018 3,849 ---------- ---------- 98,314 126,137 Cost of sales Pulp and paper 86,472 104,603 Transportation 1,863 2,478 ---------- ---------- Gross profit 9,979 19,056 General, administrative and other (8,730) (14,396) ---------- ---------- Income from operations 1,249 4,660 Other income (expense) Interest expense (4,651) (8,099) Investment income (loss) 639 (667) Gain on derivative contracts 14,601 14,881 Loss on derivative contracts, construction in progress (27,944) - Impairment of available-for-sale securities (5,511) - Other 1,387 2,392 ---------- ---------- Total other income (expense) (21,479) 8,507 ---------- ---------- Income (loss) before income taxes and minority interest (20,230) 13,167 Income tax (198) (11) ---------- ---------- Income (loss) before minority interest (20,428) 13,156 Minority interest 10,379 - ---------- ---------- Net income (loss) (10,049) 13,156 Retained earnings, beginning of period 52,789 59,111 ---------- ---------- Retained earnings, end of period E 42,740 E 72,267 ========== ========== Income (loss) per share Basic E (0.60) E 0.78 ========== ========== Diluted E (0.60) E 0.77 ========== ==========

The accompanying notes are an integral part of these financial statements. FORM 10-Q QUARTERLY REPORT - PAGE 4 MERCER INTERNATIONAL INC. CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS For Three Months Ended June 30, 2003 and 2002 (Unaudited) (Euros in thousands, except for earnings per share)

2003 2002 ---------- ---------- Revenues Sales of pulp and paper E 45,041 E 60,328 Transportation 980 1,337 Other 1,892 1,995 ---------- ---------- 47,913 63,660 Cost of sales Pulp and paper 41,472 50,684 Transportation 797 1,436 ---------- ---------- Gross profit 5,644 11,540 General, administrative and other (3,923) (7,766) ---------- ---------- Income from operations 1,721 3,774 Other income (expense) Interest expense (2,188) (4,081) Investment income (loss) 102 (28) Gain on derivative contracts 12,805 18,948 Loss on derivative contracts, construction in progress (17,582) - Other (342) (57) ---------- ---------- Total other income (expense) (7,205) 14,782 ---------- ---------- Income (loss) before income taxes and minority interest (5,484) 18,556 Income tax (186) (11) ---------- ---------- Income (loss) before minority interest (5,670) 18,545 Minority interest 6,543 - ---------- ---------- Net income 873 18,545 Retained earnings, beginning of period 41,867 53,722 ---------- ---------- Retained earnings, end of period E 42,740 E 72,267 ========== ========== Income per share Basic E 0.05 E 1.10 ========== ========== Diluted E 0.05 E 1.08 ========== ==========

The accompanying notes are an integral part of these financial statements. FORM 10-Q QUARTERLY REPORT - PAGE 5 MERCER INTERNATIONAL INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME For Six Months Ended June 30, 2003 and 2002 (Unaudited) (Euros in thousands)

2003 2002 ---------- ---------- Net income (loss) E (10,049) E 13,156 Other comprehensive income: Foreign currency translation adjustments 1,125 3,513 Unrealized gain (loss) on securities Unrealized holding loss arising during the period (261) (1,289) Adjustment for other than temporary decline in value 5,511 - ---------- ---------- 5,250 (1,289) ---------- ---------- Other comprehensive income 6,375 2,224 ---------- ---------- Total comprehensive income (loss) E (3,674) E 15,380 ========== ==========

The accompanying notes are an integral part of these financial statements. FORM 10-Q QUARTERLY REPORT - PAGE 6 MERCER INTERNATIONAL INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME For Three Months Ended June 30, 2003 and 2002 (Unaudited) (Euros in thousands)

2003 2002 ---------- ---------- Net income E 873 E 18,545 Other comprehensive income: Foreign currency translation adjustments 1,016 2,186 Unrealized loss on securities (148) (2,148) ---------- ---------- Other comprehensive income 868 38 ---------- ---------- Total comprehensive income E 1,741 E 18,583 ========== ==========

The accompanying notes are an integral part of these financial statements. FORM 10-Q QUARTERLY REPORT - PAGE 7 MERCER INTERNATIONAL INC. CONSOLIDATED STATEMENTS OF CASH FLOWS For Six Months Ended June 30, 2003 and 2002 (Unaudited) (Euros in thousands)

2003 2002 ---------- ---------- Cash Flows from Operating Activities: Net income (loss) E (10,049) E 13,156 Adjustments to reconcile net income (loss) to cash flows from operating activities Unrealized loss on derivative financial instruments, construction in progress 27,944 - Depreciation and amortization 11,881 13,489 Impairment of securities 5,511 - Minority interest (10,379) - Loss from equity investee 546 - Changes in current assets and liabilities Investments 14 3,965 Inventories (4,139) (629) Receivables (20,582) (2,639) Accounts payable and accrued expenses 4,649 (16,797) Other 1,579 374 ---------- ---------- Net cash provided by operating activities 6,975 10,919 Cash Flows from Investing Activities: Purchase of properties, net of investment grants received (88,456) (5,223) Sale of properties - 3,513 Other (30) (11) ---------- ---------- Net cash used in investing activities (88,486) (1,721) Cash Flows from Financing Activities: Cash restricted (5,839) 7,532 Increase in construction in progress costs payable 38,931 - Increase in notes payable and debt 49,253 4,170 Decrease in notes payable and debt (9,266) (9,727) ---------- ---------- Net cash provided by financing activities 73,079 1,975 Effect of exchange rate changes on cash and cash equivalents 122 (41) ---------- ---------- Net (decrease) increase in cash and cash equivalents (8,310) 11,132 Cash and cash equivalents, beginning of period 30,261 11,741 ---------- ---------- Cash and cash equivalents, end of period E 21,951 E 22,873 ========== ==========

The accompanying notes are an integral part of these financial statements. FORM 10-Q QUARTERLY REPORT - PAGE 8 MERCER INTERNATIONAL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR SIX MONTHS ENDED JUNE 30, 2003 (Unaudited) Note 1. Basis of Presentation The interim period consolidated financial statements contained herein include the accounts of Mercer International Inc. and its wholly-owned and majority-owned subsidiaries (the "Company"). The interim period consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (the "SEC"). Certain information and footnote disclosure normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such SEC rules and regulations. The interim period consolidated financial statements should be read together with the audited consolidated financial statements and accompanying notes included in the Company's latest annual report on Form 10-K for the fiscal year ended December 31, 2002. In the opinion of the Company, the unaudited consolidated financial statements contained herein contain all adjustments necessary to present a fair statement of the results of the interim periods presented. The results for the periods presented herein may not be indicative of the results for the entire year. Note 2. Stock-Based Compensation The Company has a stock-based employee compensation plan, which is described more fully in our annual report on Form 10-K for the year ended December 31, 2002. The Company accounts for the plan under the recognition and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under the plan had an exercise price equal to or greater than the market value of the underlying common shares on the date of grant. The following tables illustrate the effect on net income (loss) and income (loss) per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," to stock-based employee compensation:

Six Months Ended June 30, ----------------------------- 2003 2002 ---------- ----------- (Euros in thousands, except per share amounts) Net (Loss) Income As reported E (10,049) E 13,156 Deduct: Total stock-based employee compensation expense determined under fair value based methods for all awards, net of any related tax effects (8) (4) ---------- ----------- Pro forma E (10,057) E 13,152 ========== =========== Basic (Loss) Income Per Share As reported E (0.60) E 0.78 ========== =========== Pro forma E (0.60) E 0.78 ========== =========== Diluted (Loss) Income Per Share As reported E (0.60) E 0.77 ========== =========== Pro Forma E (0.60) E 0.77 ========== ===========

FORM 10-Q QUARTERLY REPORT - PAGE 9

Three Months Ended June 30, ----------------------------- 2003 2002 ---------- ----------- (Euros in thousands, except per share amounts) Net Income As reported E 873 E 18,545 Deduct: Total stock-based employee compensation expense determined under fair value based methods for all awards, net of any related tax effects (6) (2) --------- ----------- Pro forma E 867 E 18,543 ========= =========== Basic Income Per Share As reported E 0.05 E 1.10 ========= =========== Pro forma E 0.05 E 1.10 ========= =========== Diluted Income Per Share As reported E 0.05 E 1.08 ========= =========== Pro Forma E 0.05 E 1.08 ========= ===========

Note 3. Earnings Per Share Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of shares outstanding during a period. Diluted earnings per share takes into consideration shares outstanding (computed under basic earnings per share) and potentially dilutive shares. The weighted average number of shares outstanding for the purposes of calculating basic earnings per share was 16,874,899 for the six months and three months ended June 30, 2003 and 2002, respectively. The weighted average number of shares outstanding for the purposes of calculating diluted earnings per share was 16,874,899 and 17,054,998 for the six months ended June 30, 2003 and 2002, respectively, and 16,874,899 and 17,093,390 for the three months ended June 30, 2003 and 2002, respectively. Note 4. Stendal Pulp Mill Project In August 2002, the Company completed financing arrangements for the design, development, financing, construction and operation of a "greenfield" project to construct and operate a 552,000-tonne softwood kraft pulp mill to be located near Stendal, Germany (the "Stendal Project"). The Stendal Project is being implemented through an approximately 63.6% owned subsidiary of the Company. Two minority shareholders own approximately 29.4% and 7%, respectively, of the project company. Accordingly, the results of the subsidiary are consolidated into the results of the Company. Mercer currently capitalizes the majority of the expenses and all of the interest related to the Stendal Project as it is classified as construction in progress. The construction costs of the Stendal Project will commence to depreciate when the Stendal Project is completed and commences its commercial production. Minority interests on the balance sheet represent the share capital contribution from the minority shareholders, adjusted for their proportionate share of income and loss. FORM 10-Q QUARTERLY REPORT - PAGE 10 Note 5. Landqart AG The Company acquired all of the shares of Landqart AG ("Landqart"), which operates a specialty paper mill in Graubunden, Switzerland, in December 2001. The results of Landqart were consolidated into the results of the Company in 2002. The Company reorganized its interest in Landqart in December 2002 by selling a 20% interest to a Swiss bank and exchanging the remaining 80% for an indirect 39% minority interest through a limited partnership on a non-cash basis. As of December 31, 2002, the Company's interest in Landqart is no longer consolidated and is included in the Company's results on an equity basis within other income (expense). Note 6. New Accounting Standards In April 2003, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS 133, Accounting for Derivative Instruments and Hedging Activities. This Statement is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. In addition, all provisions of this Statement should be applied prospectively. The Company does not anticipate that this Statement will have a material impact on the Company's financial statements. In May 2003, FASB issued SFAS 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. This Statement did not have a material impact on the Company's financial statements. In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"), Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. The Company does not anticipate that the adoption of FIN 46 will have a material impact on the results of operations and financial condition of the Company. Note 7. Business Segment Information The Company operates in two reportable business segments: pulp and paper. The segments are managed separately because each business requires different production and marketing strategies. FORM 10-Q QUARTERLY REPORT - PAGE 11 Summarized financial information concerning the segments is shown in the following table:

Pulp Paper Total -------- --------- --------- (Euros in thousands) SIX MONTHS ENDED JUNE 30, 2003 Sales to external customers E 62,414 E 28,860 E 91,274 Intersegment net sales 1,545 - 1,545 Income from operations 1,171 1,303 2,474 Segment profit 10,552 2,804 13,356 Reconciliation of profit: Total profit for reportable segments E 13,356 Elimination of intersegment profits 3,152 Loss on derivative financial instruments, construction in progress financing (27,944) Impairment of available-for-sale securities (5,511) Unallocated amounts, other corporate expenses (3,283) --------- Consolidated loss before income taxes and minority interest E (20,230) ========= The total assets for the Stendal pulp mill under construction was E322,580 thousand and E223,386 thousand as at June 30, 2003 and December 31, 2002, respectively. SIX MONTHS ENDED JUNE 30, 2002 Sales to external customers E 68,084 E 51,451 E 119,535 Intersegment net sales 2,925 - 2,925 Income from operations 5,574 1,330 6,904 Segment profit 13,039 3,376 16,415 Reconciliation of profit: Total profit for reportable segments E 16,415 Elimination of intersegment profits 833 Unallocated amounts, other corporate expenses (4,081) ---------- Consolidated income before income taxes and minority interest E 13,167 =========

FORM 10-Q QUARTERLY REPORT - PAGE 12

Pulp Paper Total -------- --------- --------- (Euros in thousands) THREE MONTHS ENDED JUNE 30, 2003 Sales to external customers E 31,029 E 14,012 E 45,041 Intersegment net sales 675 - 675 Income (loss) from operations 2,609 (763) 1,846 Segment profit (loss) 12,691 (909) 11,782 Reconciliation of profit: Total profit for reportable segments E 11,782 Elimination of intersegment profits 1,923 Loss on derivative financial instruments, construction in progress financing (17,582) Unallocated amounts, other corporate expenses (1,607) --------- Consolidated loss before income taxes and minority interest E (5,484) ========= THREE MONTHS ENDED JUNE 30, 2002 Sales to external customers E 34,451 E 25,877 E 60,328 Intersegment net sales 1,524 - 1,524 Income from operations 3,388 738 4,126 Segment profit 18,906 596 19,502 Reconciliation of profit: Total profit for reportable segments E 19,502 Elimination of intersegment profits 456 Unallocated amounts, other corporate expenses (1,402) --------- Consolidated income before income taxes and minority interest E 18,556 =========

Note 8. Reclassifications Certain prior period amounts in the interim period consolidated financial statements contained herein have been reclassified to conform to the current period's presentation. FORM 10-Q QUARTERLY REPORT - PAGE 13 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Mercer International Inc. is a pulp and paper company and its operations are primarily located in Germany. The following discussion and analysis of our results of operations and financial condition for the six months and three months ended June 30, 2003 should be read in conjunction with our consolidated financial statements and related notes included in this quarterly report, as well as our most recent annual report on Form 10-K for the fiscal year ended December 31, 2002 filed with the Securities and Exchange Commission, or SEC. Certain reclassifications have been made to the prior period financial statements to conform with the current period presentation. In this document: (i) unless the context otherwise requires, "we", "our", "us", the "Company" or "Mercer" mean Mercer International Inc. and its subsidiaries; (ii) information is provided as of June 30, 2003, unless otherwise stated; (iii) all references to monetary amounts are to "Euros", the lawful currency adopted by most members of the European Union, unless otherwise stated; (iv) "E" refers to Euros; and (v) a "tonne" is one metric ton or 2,204.6 pounds. RESULTS OF OPERATIONS - SIX MONTHS ENDED JUNE 30, 2003 Selected sales data for the six months ended June 30, 2003 and 2002 is as follows:

Six Months Ended June 30, ------------------------- 2003 2002 -------- ---------- (unaudited) (Euros in thousands) REVENUES BY PRODUCT CLASS Pulp(1) E 62,414 E 68,084 Papers Specialty papers(2) 21,575 40,986 Printing papers 7,285 10,465 -------- ---------- Total papers 28,860 51,451 -------- ---------- Total(1) E 91,274 E 119,535 ======== ========== REVENUES BY GEOGRAPHIC AREA Germany E 40,914 E 46,925 European Union(3) 38,062 40,170 Eastern Europe and Other 12,298 32,440 -------- ---------- Total(1) E 91,274 E 119,535 ======== ========== SALES VOLUME BY PRODUCT CLASS (tonnes) Pulp(1) 148,179 149,798 Papers Specialty papers(2) 21,675 31,870 Printing papers 9,334 12,207 -------- --------- Total papers 31,009 44,077 -------- --------- Total(1) 179,188 193,875 ======== =========

----------- (1) Excluding intercompany sales volumes of 3,611 and 6,370 tonnes of pulp and intercompany net sales revenues of approximately E1.5 million and E2.9 million in the six months ended June 30, 2003 and 2002, respectively. (2) As of December 31, 2002, our interest in Landqart AG is no longer consolidated and is included in our financial results on an equity basis. Accordingly, sales from the Landqart specialty paper mill are not included in our results for the six months ended June 30, 2003, but are included for the six months ended June 30, 2002. The Landqart specialty paper mill sold approximately 9,060 tonnes for approximately E20.6 million in the six months ended June 30, 2002. (3) Not including Germany. FORM 10-Q QUARTERLY REPORT - PAGE 14 In the six months ended June 30, 2003, total revenues decreased to E98.3 million from E126.1 million in the six months ended June 30, 2002, primarily as the current period does not include the revenues of the Landqart specialty paper mill. We reorganized our interest therein in December 2002 and now account for it under the equity method. In the current period, pulp and paper revenues decreased to E91.3 million from E119.5 million in the comparative period in 2002, primarily as a result of the deconsolidation of Landqart. Cost of pulp and paper sales in the six months ended June 30, 2003 decreased to E86.5 million from E104.6 million in the six months ended June 30, 2002, primarily as a result of the deconsolidation of Landqart. Pulp sales in the current period were E62.4 million, compared to E68.1 million in the comparative period of 2002. U.S. dollar denominated list pulp price increases were more than offset by an 18.7% decline in the U.S. dollar against the Euro for the current period versus the comparative period last year. Average list prices for northern bleached softwood kraft ("NBSK") pulp in Europe, which were approximately E477 ($470) per tonne in the second quarter of 2002, decreased to approximately E420 ($440) per tonne at the end of 2002, before improving to approximately E441 ($480) per tonne in the first quarter of 2003 and approximately E484 ($550) per tonne in the second quarter of 2003. The Company's pulp sales realizations were E421 per tonne on average in the current period, compared to E455 per tonne in the first six months of 2002. Pulp sales by volume decreased marginally to 148,179 tonnes in the current period from 149,798 tonnes in the comparative period of 2002. Cost of sales and general, administrative and other expenses for the pulp operations were E67.5 million for the six months ended June 30, 2003, compared to E69.0 million for the six months ended June 30, 2002. On average, per tonne fiber costs for pulp production increased by approximately 4.0% compared to the six months ended June 30, 2002. Depreciation within the pulp segment was E10.9 million in the current period, compared to E10.8 million in the comparative period of 2002. The Company's pulp operations generated operating income of E1.2 million in the six months ended June 30, 2003, compared to E5.6 million in the six months ended June 30, 2002. Results for the Company's paper segment during the current period reflect the aforementioned exclusion of the results from the Landqart specialty paper mill, which were included in the results for the six months ended June 30, 2002. Paper sales in the current period decreased to E28.9 million from E51.5 million in the comparative period in 2002. Sales of specialty papers in the six months ended June 30, 2003 decreased to E21.6 million from E41.0 million in the six months ended June 30, 2002. Total paper sales volumes decreased to 31,009 tonnes in the six months ended June 30, 2003 from 44,077 tonnes in the six months ended June 30, 2002. On average, prices for specialty papers realized in the six months ended June 30, 2003 decreased by approximately 22.6% as our product mix changed upon the deconsolidation of the Landqart mill, and for printing papers decreased by approximately 9.0%, compared to the six months ended June 30, 2002. Cost of sales and general, administrative and other expenses for the paper operations decreased to E28.1 million in the current period from E50.7 million in the comparative period of 2002 as a result of lower paper sales. Paper segment depreciation decreased to E1.0 million in the six months ended June 30, 2003 from E2.7 million in the prior period. The Company's paper operations generated operating income of E1.3 million in each of the six months ended June 30, 2003 and 2002. FORM 10-Q QUARTERLY REPORT - PAGE 15 Consolidated general and administrative expenses decreased to E8.7 million in the six months ended June 30, 2003 from E14.4 million in the six months ended June 30, 2002, primarily as a result of the exclusion of the results of the Landqart mill and a decrease in professional fees in the current period. For the six months ended June 30, 2003, the Company reported income from operations of E1.2 million, compared to E4.7 million in the comparative period of 2002. Interest expense (excluding capitalized interest of E7.2 million in respect of the Stendal project) in the current period decreased to E4.7 million from E8.1 million in the comparative period of 2002, primarily as a result of lower borrowing costs and lower indebtedness for our operating units. During the current period, the Company made principal repayments of E6.5 million in respect of the indebtedness of the Rosenthal NBSK pulp mill. Pursuant to the E828 million loan facility (the "Stendal Loan Facility") for the Company's greenfield project (the "Stendal project") to construct an approximately 552,000 tonne NBSK pulp mill near Stendal, Germany, the Company's 63.6% owned subsidiary, Zellstoff Stendal GmbH ("Stendal"), entered into variable-to-fixed rate interest swaps (the "Stendal Interest Rate Swap Agreements") for the full term of the facility to manage the risk exposure with respect to an aggregate maximum amount of approximately E612.6 million of the principal amount of the Stendal Loan Facility. Under these swaps, Stendal pays a fixed rate and receives a floating rate with respect to interest payments calculated on a notional amount. These swaps manage the exposure to variable cash flow risk from the variable interest payments under the Stendal Loan Facility. The swaps are marked to market at the end of each reporting period and all unrealized gains and losses are recognized in earnings for such period. A holding loss of E27.9 million before minority interests was recognized in respect of these swaps for the six months ended June 30, 2003. We determine market valuations based primarily upon values provided by our counterparties. In addition, the Company's wholly-owned subsidiary that operates the Rosenthal NBSK pulp mill, Zellstoff-und Papierfabrik Rosenthal GmbH & Co., KG ("Rosenthal"), has entered into currency swaps (the "Rosenthal Currency Swaps") to manage its exposure with respect to an aggregate amount of approximately E198.4 million of the principal long-term indebtedness of the Rosenthal mill (the "Rosenthal Loan Facility"). Rosenthal has also entered into currency forward contracts, forward interest rate and interest cap contracts in connection with certain indebtedness relating to the Rosenthal mill. These derivative instruments are also marked to market at the end of each reporting period, and all gains and losses are recognized in earnings for such period. In the six months ended June 30, 2003, the Company recognized a net gain of E14.6 million from these derivative contracts. Minority interest in the six months ended June 30, 2003 amounted to E10.4 million and represented the proportion of the loss of the Stendal project allocated to the two minority shareholders of Stendal. There was no minority interest in the six months ended June 30, 2002. Our results for the six months ended June 30, 2003 include an adjustment of E5.5 million for the non-cash aggregate pre-tax earnings impact of other-than-temporary impairment losses on certain of our available-for-sale securities. This adjustment was recorded in other income (expense) in our consolidated statement of operations. This adjustment did not affect our shareholders' equity since all of our available-for-sale securities are marked to market on a quarterly basis and unrealized gains or losses are reported through the statement of comprehensive income in our financial statements and recorded in other comprehensive income (loss) within shareholders' equity on our balance sheet. Such unrealized gains or losses, the cost base and the current marked to market value of our available-for-sale securities are further described in the notes to our annual financial statements. These are legacy investments and are unrelated to our pulp and paper operations. The majority of FORM 10-Q QUARTERLY REPORT - PAGE 16 this adjustment relates to an investment in a company operating in China. The Company could not quantify the long-term effect of the SARS outbreak in China on such investment and, accordingly, the Company wrote down such investment to its fair value. SFAS 115, Accounting for Certain Investments in Debt and Equity Securities, EITF 03-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments, and SEC Staff Accounting Bulletin 59, Accounting for Noncurrent Marketable Equity Securities, provide guidance on determining when an impairment is other-than-temporary, which requires judgment. In making this judgment, we evaluate, among other factors, the duration and extent to which the fair value of an investment is less than its cost; the financial health of and business outlook for the investee, including factors such as industry and sector performance, changes in technology, operational and financing cash flow, the investee's financial position including its appraisal and net asset value, market prices, its business plan and investment strategy; and our intent and ability to hold the investment. For the six months ended June 30, 2003, the Company reported a net loss of E10.0 million, or E0.60 per share on a basic and diluted basis, compared to a net income of E13.2 million, or E0.78 per share on a basic basis or E0.77 per share on a diluted basis, in the six months ended June 30, 2002. As the Stendal project is currently under construction and because of its overall size relative to the Company's other facilities, management uses consolidated operating results excluding derivative items relating to the Stendal project to measure the performance and results of the Company's operating units. Management believes this measure provides meaningful information on the performance of its operating facilities for a reporting period. For the six months ended June 30, 2003, the Company reported a net loss of E10.0 million or E0.60 per share on a diluted basis. If the Company had excluded items relating to the Stendal project by adding the loss on derivative financial instruments of E27.9 million to, and subtracting minority interest of E10.4 million from, the reported net loss of E10.0 million, the Company would have reported net income of E7.5 million or E0.45 per share on a diluted basis. The Company generated operating earnings before interest, taxes, depreciation and amortization ("Operating EBITDA") of E13.1 million in the current period, compared to Operating EBITDA of E18.1 million in the comparative period of 2002. Operating EBITDA is defined as income (loss) from operations plus depreciation and amortization. Operating EBITDA is calculated by adding depreciation and amortization of E11.9 million and E13.5 million to income from operations of E1.2 million and E4.7 million for each of the six months ended June 30, 2003 and 2002, 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 is not an actual cash cost, and 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, the Company believes Operating EBITDA is commonly used by securities analysts, investors and other interested parties to evaluate the Company's financial performance. Operating EBITDA does not reflect the impact of a number of items that affect the Company's net income (loss), including financing costs and the effect of derivative instruments. Operating EBITDA is not a measure of financial performance under accounting principles generally accepted in the United States, 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. Because all companies do not calculate Operating EBITDA in the same manner, Operating EBITDA as calculated by the Company may differ from Operating EBITDA as calculated by other companies. FORM 10-Q QUARTERLY REPORT - PAGE 17 The following table provides a reconciliation of Operating EBITDA to income from operations for the periods indicated:

Six Months Ended June 30, ------------------------- 2003 2002 ----------- ---------- (unaudited) (Euros in thousands) Income from operations, per income statement E 1,249 E 4,660 Add: Depreciation and amortization 11,881 13,489 ----------- ---------- Operating EBITDA E 13,130 E 18,149 =========== ==========

RESULTS OF OPERATIONS - THREE MONTHS ENDED JUNE 30, 2003 Selected sales data for the three months ended June 30, 2003 and 2002 is as follows:

Three Months Ended June 30, --------------------------- 2003 2002 ---------- ---------- (unaudited) (Euros in thousands) REVENUES BY PRODUCT CLASS Pulp(1) E 31,029 E 34,451 Papers Specialty papers(2) 10,519 20,549 Printing papers 3,493 5,328 ---------- ---------- Total papers 14,012 25,877 ---------- ---------- Total(1) E 45,041 E 60,328 ========== ========== REVENUES BY GEOGRAPHIC AREA Germany E 20,743 E 22,556 European Union(3) 17,246 22,402 Eastern Europe and Other 7,052 15,370 ---------- ---------- Total(1) E 45,041 E 60,328 ========== ========== SALES VOLUME BY PRODUCT CLASS (tonnes) Pulp(1) 69,700 76,300 Papers Specialty papers(2) 10,539 15,432 Printing papers 4,763 6,093 ---------- ---------- Total papers 15,302 21,525 ---------- ---------- Total(1) 85,002 97,825 ========== ==========

-------- (1) Excluding intercompany sales volumes of 1,482 and 3,359 tonnes of pulp and intercompany net sales revenues of approximately E0.6 million and E1.5 million in the three months ended June 30, 2003 and 2002, respectively. (2) As of December 31, 2002, our interest in Landqart AG is no longer consolidated and is included in our financial results on an equity basis. Accordingly, sales from the Landqart specialty paper mill are not included in our results for the three months ended June 30, 2003, but are included for the three months ended June 30, 2002. The Landqart specialty paper mill sold approximately 4,498 tonnes for approximately E10.6 million in the three months ended June 30, 2002. (3) Not including Germany. In the three months ended June 30, 2003, total revenues decreased to E47.9 million from E63.7 million in the three months ended June 30, 2002, primarily as the current period does not include the revenues of the Landqart specialty paper mill. In the current period, pulp and paper revenues decreased to E45.0 million from E60.3 million in the comparative period in 2002, primarily as a result of the deconsolidation of Landqart. FORM 10-Q QUARTERLY REPORT - PAGE 18 Cost of pulp and paper sales in the three months ended June 30, 2003 decreased to E41.5 million from E50.7 million in the three months ended June 30, 2002, primarily as a result of the deconsolidation of Landqart. Pulp sales in the current period were E31.0 million, compared to E31.4 million in the first quarter of 2003 and E34.5 million in the comparative period of 2002. U.S. dollar denominated list pulp price increases were more than offset by a 19.1% decline in the U.S. dollar against the Euro for the current period versus the comparative period last year. Average list prices for NBSK pulp in Europe, which were approximately E477 ($470) per tonne at the end of the second quarter of 2002, decreased to approximately E420 ($440) per tonne at the end of 2002, before improving to approximately E484 ($550) per tonne in the current period. The Company's pulp sales realizations were E445 per tonne on average in the current period, compared to E400 per tonne in the three months ended March 31, 2003 and E452 per tonne in the second quarter of 2002. Pulp sales by volume decreased to 69,700 tonnes in the current period from 78,479 tonnes in the first quarter of 2003 and 76,300 tonnes in the comparative period of 2002, as a result of lower demand. Cost of sales and general, administrative and other expenses for the pulp operations were E31.1 million for the three months ended June 30, 2003, compared to E34.3 million in the three months ended June 30, 2002. On average, per tonne fiber costs for pulp production decreased by approximately 3.8% compared to the three months ended March 31, 2003, and increased by approximately 4.1% compared to the three months ended June 30, 2002. Depreciation within the pulp segment was E5.5 million in the current period, compared to E5.4 million in the comparative period of 2002. The Company's pulp operations generated operating income of E2.6 million in the three months ended June 30, 2003, compared to an operating loss of E1.4 million in the preceding three months and operating income of E3.4 million in the three months ended June 30, 2002. Results for the Company's paper segment during the current period exclude the results from the Landqart specialty paper mill, which were included in the results for the three months ended June 30, 2002. Paper sales in the current period decreased to E14.0 million from E25.9 million in the comparative period in 2002. Sales of specialty papers in the three months ended June 30, 2003 decreased to E10.5 million from E20.5 million in the three months ended June 30, 2002. Total paper sales volumes decreased to 15,302 tonnes in the three months ended June 30, 2003 from 21,525 tonnes in the three months ended June 30, 2002. On average, prices for specialty papers realized in the three months ended June 30, 2003 decreased by approximately 25.0% as our product mix changed upon the deconsolidation of the Landqart mill, and for printing papers decreased by approximately 16.1%, compared to the three months ended June 30, 2002. Cost of sales and general, administrative and other expenses for the paper operations decreased to E14.9 million in the current period from E25.4 million in the comparative period of 2002 as a result of lower paper sales. Paper segment depreciation decreased to E0.5 million in the three months ended June 30, 2003 from E1.3 million in the prior period. The Company's paper operations generated an operating loss of E0.8 million in the three months ended June 30, 2003, compared with operating income of E0.7 million in the comparative period of 2002. FORM 10-Q QUARTERLY REPORT - PAGE 19 Consolidated general and administrative expenses decreased to E3.9 million in the three months ended June 30, 2003 from E7.8 million in the three months ended June 30, 2002, primarily as a result of the exclusion of the results of the Landqart mill and a decrease in professional fees in the three months ended June 30, 2003. For the three months ended June 30, 2003, the Company reported income from operations of E1.7 million, compared to E3.8 million in the comparative period of 2002. Interest expense (excluding capitalized interest of E4.0 million in respect of the Stendal project) in the current period decreased to E2.2 million from E4.1 million in the comparative period of 2002, primarily as a result of lower borrowing costs and lower indebtedness for our operating units. Pursuant to the Stendal Loan Facility, Stendal entered into the Stendal Interest Rate Swap Agreements for the full term of the facility to manage the risk exposure with respect to an aggregate maximum amount of approximately E612.6 million of the principal amount of the Stendal Loan Facility. The swaps are marked to market at the end of each reporting period and all unrealized gains and losses are recognized in earnings for such period. A holding loss of E17.6 million before minority interests was recognized in respect of these swaps for the three months ended June 30, 2003. We determine market valuations based primarily upon values provided by our counterparties. In addition, Rosenthal has entered into the Rosenthal Currency Swaps to manage its exposure with respect to an aggregate amount of approximately E198.4 million of the principal long-term indebtedness under the Rosenthal Loan Facility. Rosenthal has also entered into currency forward contracts, forward interest rate and interest cap contracts in connection with certain indebtedness relating to the Rosenthal mill. These derivative instruments are also marked to market at the end of each reporting period, and all gains and losses are recognized in earnings for such period. In the three months ended June 30, 2003, the Company recognized a net gain of E12.8 million from these derivative contracts. The results of Landqart did not have a material impact on the Company's results for the three months ended June 30, 2003. Minority interest in the three months ended June 30, 2003 amounted to E6.5 million and represented the proportion of the loss of the Stendal project allocated to the two minority shareholders of Stendal. There was no minority interest in the three months ended June 30, 2002. For the three months ended June 30, 2003, the Company reported net income of E0.9 million, or E0.05 per share on a basic and diluted basis, compared to a net income of E18.5 million, or E1.10 per share on a basic basis or E1.08 per share on a diluted basis, in the three months ended June 30, 2002. As the Stendal project is currently under construction and because of its overall size relative to the Company's other facilities, management uses consolidated operating results excluding derivative items relating to the Stendal project to measure the performance and results of the Company's operating units. Management believes this measure provides meaningful information on the performance of its operating facilities for a reporting period. For the three months ended June 30, 2003, the Company reported net income of E0.9 million or E0.05 per share on a diluted basis. If the Company had excluded items relating to the Stendal project by adding the loss on derivative financial instruments of E17.6 million to, and subtracting minority interest of E6.5 million from, the reported net income of E0.9 million, the Company would have reported net income of E11.9 million or E0.71 per share on a diluted basis. FORM 10-Q QUARTERLY REPORT - PAGE 20 The Company generated Operating EBITDA of E7.7 million in the current quarter, compared to an Operating EBITDA of E5.5 million in the first quarter of 2003 and Operating EBITDA of E10.5 million in the comparative quarter of 2002. Operating EBITDA is calculated by adding depreciation and amortization of E6.0 million, E5.9 million and E6.7 million to the income from operations of E1.7 million, loss from operations of E0.5 million and income from operations of E3.8 million for each of the three months ended June 30, 2003, March 31, 2003 and June 30, 2002, 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 is not an actual cash cost, and varies widely from company to company in a manner that management considers largely independent of the underlying cost efficiency of their operating facilities. Because all companies do not calculate Operating EBITDA in the same manner, Operating EBITDA as calculated by the Company may differ from Operating EBITDA as calculated by other companies. The following table provides a reconciliation of Operating EBITDA to income from operations for the periods indicated:

Three Months Ended June 30, --------------------------- 2003 2002 ---------- ---------- (unaudited) (Euros in thousands) Income from operations, per income statement E 1,721 E 3,774 Add: Depreciation and amortization 5,960 6,720 ---------- ---------- Operating EBITDA E 7,681 E 10,494 ========== ==========

Stendal Project Status ------------------------ We are implementing the Stendal project, which is a "greenfield" project to construct a new state-of-the-art NBSK pulp mill. The mill will have an annual production capacity of approximately 552,000 tonnes and will be located near the town of Stendal in Germany. As at June 30, 2003, progress on the Stendal project was substantially on schedule and there were no significant deviations from the project budget. At June 30, 2003, the project was approximately 68% completed and approximately 91% of the total engineering was finished. In addition, approximately 65% of the civil works was completed. Progress was made in a number of areas including the installation of the batch digesters and towers for the bleach plant, commencement of the erection of the recovery boiler and power boiler and assembly of large storage tanks. In addition, progress was made in connection with the construction of the infrastructure of the mill site including power, gas and road connections. At the end of June 2003, Stendal employed 30 people, most of whom are part of the management organization charged with supervising the implementation and completion of the Stendal project. During the second quarter, the Company filled many key positions, including for the production and maintenance management and wood procurement and logistics operations, and the recruitment process for operating personnel for the mill was commenced. FORM 10-Q QUARTERLY REPORT - PAGE 21 LIQUIDITY AND CAPITAL RESOURCES The following table is a summary of selected financial information for the periods indicated:

As at as at June 30, 2003 December 31, 2002 ----------------- ----------------- (unaudited) (Euros in thousands) FINANCIAL POSITION Working capital E (56,175) E 6,328 Properties 518,248 441,990 Total assets(1) 696,509 599,750 Long-term debt(2) 343,692 351,878 Shareholders' equity 121,295 124,969

--------- (1) Includes approximately E270.5 million and E186.9 million related to properties construction in progress at the site of the Stendal mill as at June 30, 2003 and December 31, 2002, respectively. (2) Includes approximately E150.5 million and E146.5 million related to construction in progress at the site of the Stendal mill as at June 30, 2003 and December 31, 2002, respectively. At June 30, 2003, our cash and cash equivalents were E22.0 million, compared to E30.3 million at the end of 2002. We also had E13.2 million of cash restricted to pay construction in progress costs payable and E19.1 million of cash restricted in a debt service account, both relating to the construction in progress at the site of the Stendal mill. In addition, we had E21.8 million of cash restricted in a debt service account relating to the Rosenthal mill. Short-term trading securities were E0.3 million at both June 30, 2003 and December 31, 2002. We had a working capital deficit of E56.2 million (including Stendal construction costs payable of E62.3 million and bridge financing and related expenses of E54.9 million) at June 30, 2003, compared to working capital of E6.3 million at December 31, 2002. However, the Stendal Loan Facility provides the necessary resources for the continued construction of the Stendal project. We expect to continue to generate sufficient cash flow from operations to pay our interest and debt service expenses and meet the working and maintenance capital requirements for our operations. We currently do not have any revolving credit facilities. From time to time, we have entered into project specific credit facilities to finance capital projects and expect to continue to do so, subject to availability. In connection with our obligation to repay or refinance two bridge loans in the principal amounts of E15 million and E30 million which mature in October 2003 and April 2004, respectively, and fees and accrued interest thereon, incurred in connection with the Stendal project, we intend to issue new debt, equity or convertible securities in 2003 (the "Financing"). As at June 30, 2003, the aggregate principal amount, fees and accrued interest relating to the repayment of the bridge loans was E54.9 million, subject to reduction in limited exceptions for capital raising activities using the services of affiliates of the bridge lenders. The bridge loan in the principal amount of E15 million may be extended to April 2004 with the consent of the lender. We intend to seek such consent if the Financing is not completed prior to the maturity of such bridge loan. There can be no assurance that such consent will be obtained or that the Financing will be completed. We may also pursue asset sales to raise capital to repay the bridge loan. If we do not obtain the consent of the lender, complete the Financing or raise sufficient capital through asset sales to repay the bridge loan, this could have a materially adverse effect on our results of operations and financial condition. FORM 10-Q QUARTERLY REPORT - PAGE 22 Operating Activities --------------------- Operating activities in the six months ended June 30, 2003 provided cash of E7.0 million, compared to E10.9 million in the six months ended June 30, 2002. Net changes in trading securities provided nominal cash in the six months ended June 30, 2003, compared to E4.0 million in the six months ended June 30, 2002. Receivables in the current period and in the six months ended June 30, 2002 used cash of E20.6 million and E2.6 million, respectively. An increase in inventories used cash of E4.1 million in the current period, compared to E0.6 million in the comparable period of 2002. An increase in accounts payable and accrued expenses provided cash of E4.6 million in the six months ended June 30, 2003, compared to a decrease in the same using cash of E16.8 million in the six months ended June 30, 2002. Investing Activities --------------------- Investing activities in the six months ended June 30, 2003 used cash of E88.5 million, primarily as a result of the acquisition of properties, net of investment grants received, of which E84.0 million was attributable to the Stendal project. The sale of properties provided cash of E3.5 million in the six months ended June 30, 2002. We have applied for investment grants from the federal and state governments of Germany and have claims of E50.9 million outstanding as of June 30, 2003. We received E28.8 million with respect to the Stendal project in the six months ended June 30, 2003, which reduced the acquisition costs relating to the Stendal project. We expect to receive the full amount of our currently outstanding claims in the second half of 2003. In accordance with our accounting policies, we do not record these grants until they are received. Our Paper mills have or will have to replace certain equipment that was damaged as a result of flooding in parts of Germany and other eastern European countries during the third quarter of 2002. The aggregate equipment costs are estimated to be approximately E3.3 million, of which approximately E0.7 million was incurred in the six months ended June 30, 2003. We have applied for German government grants and for assistance under special credit programs instituted by the German government for flooding victims in connection with these costs. As at June 30, 2003, we had received approximately E2.4 million of such grants, of which E1.7 million was recognized as income in the current period and the balance has been deferred. Although we have received approval for the full amount of the grants and assistance applied for, there can be no assurance that we will receive any unpaid amounts of such grants and assistance. Financing Activities --------------------- Financing activities provided cash of E73.1 million in the six months ended June 30, 2003. An increase in construction costs payable relating to the Stendal project provided cash of E38.9 million and an increase in indebtedness, primarily in connection with the Stendal project, provided cash of E49.3 million in the six months ended June 30, 2003. An increase in restricted cash used cash of E5.8 million in the current period. We made principal repayments of E6.5 million in connection with the Rosenthal Loan Facility in the six months ended June 30, 2003. Financing activities provided cash of E2.0 million in the six months ended June 30, 2002, primarily as a result of a decrease in restricted cash and an increase in indebtedness during the period. FORM 10-Q QUARTERLY REPORT - PAGE 23 Other than the agreements entered into by Stendal relating to the Stendal project, we had no material commitments to acquire assets or operating businesses at June 30, 2003. 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, borrowing against our assets, the sale of debt and/or equity securities and/or asset sales. FOREIGN CURRENCY We hold certain assets and liabilities in U.S. dollars, Swiss francs and, to a lesser extent, in Canadian dollars. Accordingly, our consolidated financial results are subject to foreign currency exchange rate fluctuations. We translate foreign denominated assets and liabilities into Euros at the rate of exchange on the balance sheet date. Unrealized gains or losses from these translations are recorded as shareholders' equity on the balance sheet and do not affect our net earnings. In the six months ended June 30, 2003, we reported a net E1.1 million foreign exchange translation gain and, as a result, the cumulative foreign exchange translation gain increased to E4.6 million at June 30, 2003 from E3.5 million at December 31, 2002. Based upon the average exchange rate for the six months ended June 30, 2003, the U.S. dollar decreased by approximately 18.7% in value against the Euro compared to the same period in 2002. CRITICAL ACCOUNTING POLICIES The preparation of financial statements in conformity with generally accepted accounting principles requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Our management routinely makes judgments and estimates about the effects of matters that are inherently uncertain. As the number of variables and assumptions affecting the probable future resolution of the uncertainties increase, these judgments become even more subjective and complex. We have identified certain accounting policies that are the most important to the portrayal of our financial condition and results of operations. For information about our critical accounting policies, see our annual report on Form 10-K for the year ended December 31, 2002. CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION The statements in this report that are not based on historical facts are called "forward-looking statements" within the meaning of the United States Private Securities Litigation Reform Act of 1995. These statements appear in a number of different places in this report and can be identified by words such as "estimates", "projects", "expects", "intends", "believes", "plans", or their negatives or other comparable words. Also look for discussions of strategy that involve risks and uncertainties. Forward-looking statements include statements regarding the outlook for our future operations, FORM 10-Q QUARTERLY REPORT - PAGE 24 forecasts of future costs and expenditures, the evaluation of market conditions, the outcome of legal proceedings, the adequacy of reserves, or other business plans. You are cautioned that any such forward-looking statements are not guarantees and may involve risks and uncertainties. Our actual results may differ materially from those in the forward-looking statements due to risks facing us or due to actual facts differing from the assumptions underlying our estimates. Some of these risks and assumptions include those set forth in reports and other documents we have filed with or furnished to the SEC, including in our annual report on Form 10-K for the year ended December 31, 2002 and current report on Form 8-K furnished on May 12, 2003. We advise you that these cautionary remarks expressly qualify in their entirety all forward-looking statements attributable to us or persons acting on our behalf. Unless required by law, we do not assume any obligation to update forward-looking statements based on unanticipated events or changed expectations. However, you should carefully review the reports and other documents we file from time to time with the SEC. CYCLICAL NATURE OF BUSINESS; COMPETITIVE POSITION 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 sensitive to cyclical changes in industry capacity and in the global economy, all of which can have a significant influence on selling prices and our earnings. Demand for pulp and paper products has historically been determined by the level of economic growth and has been closely tied to overall business activity. During the past three years, pulp prices have fallen significantly. Our competitive position is influenced by the availability and quality of raw materials and our experience in relation to other producers with respect to inflation, energy, transportation, labor costs, productivity and currency exchange rates. There can be no assurance that we will continue to be competitive in the future, as a result of new technological advancements or otherwise. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to market risks from changes in interest rates, foreign currency exchange rates and equity prices which may affect our results of operations and financial condition and, consequently, our fair value. We manage these risks through internal risk management policies as well as the use of derivative instruments. We use derivative instruments to reduce or limit our exposure to interest rate and currency risks. We may in the future use derivative instruments to reduce or limit our exposure to fluctuations in pulp prices. We also use derivative instruments either to augment our potential gains or to reduce our potential losses, depending on our management's perception of future economic events and developments. These types of derivative instruments are generally highly speculative in nature. They are also very volatile as they are highly leveraged given that margin requirements are relatively low in proportion to notional amounts. Many of our strategies, including the use of derivative instruments and the types of derivative instruments selected by us, are based on historical trading patterns and correlations and our management's expectations of future events. However, these strategies may not be fully effective in all market environments or against all types of risks. Unexpected market developments may affect our risk management strategies during this time, and unanticipated developments could impact our risk management strategies in the future. If any of the variety of instruments and strategies we utilize are not effective, we may incur losses. FORM 10-Q QUARTERLY REPORT - PAGE 25 Rosenthal has entered into the Rosenthal Currency Swaps in connection with our long-term indebtedness relating to the conversion of the Rosenthal mill to the production of kraft pulp. These derivatives have been contracted by Rosenthal using a dedicated credit line within the Rosenthal Loan Facility and assigned for this purpose, and are subject to prescribed controls, including certain maximum amounts for notional and at-risk amounts. As NBSK pulp prices are quoted in U.S. dollars and the majority of our business transactions are denominated in Euros, Rosenthal has entered into the Rosenthal Currency Swaps to reduce the effects of exchange rate fluctuations between the U.S. dollar and the Euro on notional amounts under the Rosenthal Loan Facility. Under the Rosenthal Currency Swaps, Rosenthal effectively pays the principal and interest in U.S. dollars and at U.S. dollar borrowing rates. In the six months ended June 30, 2003, Rosenthal entered into an additional Rosenthal Currency Swap for the notional amount of E124.2 million maturing on September 30, 2008. In addition, Rosenthal has entered into interest rate contracts to either fix or limit the interest rates in connection with certain of its indebtedness, and various currency forwards to reduce or limit its exposure to currency risks and to augment its potential gains or to reduce its potential losses. Stendal has entered into the Stendal Interest Rate Swap Agreements in connection with its long-term indebtedness relating to the Stendal project to fix the interest rate under the Stendal Loan Facility at the then low level, relative to its historical trend and projected variable interest rate. Under the Stendal Interest Rate Swap Agreements, Stendal pays a fixed rate and receives a floating rate with interest payments being calculated on a notional amount. The interest rates payable under the Stendal Loan Facility were swapped at the fixed rates based on the Eur-Euribor rate for the repayment periods of the tranches under the Stendal Loan Facility. Stendal effectively converted the Stendal Loan Facility from a variable interest rate loan into a fixed interest rate loan, thereby reducing interest rate uncertainty. For more information concerning market risk and our derivative instruments, see the Company's annual report on Form 10-K for the year ended December 31, 2002. ITEM 4. DISCLOSURE CONTROLS AND PROCEDURES Within 90 days prior to the date of this report, we carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic reports filed with the SEC. It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of certain events, and there can be no assurance that any design will succeed in achieving its stated goals under all future conditions, regardless of how remote. In addition, we reviewed our internal controls, and there have been no significant changes in our internal controls or in other factors that could significantly affect those controls subsequent to the date of their last evaluation. FORM 10-Q QUARTERLY REPORT - PAGE 26 PART II. OTHER INFORMATION ----------------- ITEM 1. LEGAL PROCEEDINGS The Company is subject to routine litigation incidental to its business. The Company does not believe that the outcome of such litigation will have a material adverse effect on its business or financial condition. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 31.1 Section 302 Certification of Chief Executive Officer 31.2 Section 302 Certification of Chief Financial Officer 32.1* Section 906 Certification of Chief Executive Officer 32.2* Section 906 Certification of Chief Financial Officer ----------- *In accordance with Release 33-8212 of the Commission, these Certifications: (i) are "furnished" to the Commission and are not "filed" for the purposes of liability under the Securities Exchange Act of 1934, as amended; and (ii) are not to be subject to automatic incorporation by reference into any of the Company's registration statements filed under the Securities Act of 1933, as amended for the purposes of liability thereunder or any offering memorandum, unless the Company specifically incorporates them by reference therein. (b) Reports on Form 8-K The Company filed the following reports on Form 8-K with respect to the indicated items during the second quarter of 2003: Form 8-K dated May 5, 2003 Item 7. Exhibits Item 9. Regulation FD Disclosure Form 8-K dated May 9, 2003 Item 7. Exhibits Form 8-K dated May 12, 2003 Item 9. Regulation FD Disclosure Form 8-K dated May 13, 2003 Item 4. Changes in Registrant's Certifying Accountant Item 7. Exhibits Form 8-K dated June 18, 2003 Item 5. Other Events and Regulation FD Disclosure Item 7. Exhibits FORM 10-Q QUARTERLY REPORT - PAGE 27 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. MERCER INTERNATIONAL INC. By: /s/ R. Ian Rigg ------------------------------------- R. Ian Rigg Secretary and Chief Financial Officer Date: August 14, 2003 FORM 10-Q QUARTERLY REPORT - PAGE 28