MERC 10-Q Quarterly Report March 31, 2010

MERC 10-Q Quarter ended March 31, 2010

Exhibits

Exhibits

MERCER INTERNATIONAL INC.

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10-Q 1 c00082e10vq.htm FORM 10-Q Form 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2010


o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File No.: 000-51826

MERCER INTERNATIONAL INC.

(Exact name of Registrant as specified in its charter)


Washington		47-0956945
( State or other jurisdiction		(I.R.S. Employer
of incorporation or organization)		Identification No.)

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

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

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES þ NO o

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months or for such shorter period that the registrant was required to submit and post such files). YES o NO o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):


Large Accelerated Filer o		Accelerated Filer o		Non-Accelerated Filer þ		Smaller Reporting Company o

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

The Registrant had 36,483,204 shares of common stock outstanding as at May 3, 2010.

TABLE OF CONTENTS


PART I. FINANCIAL INFORMATION
	ITEM 1. FINANCIAL STATEMENTS
		INTERIM CONSOLIDATED BALANCE SHEETS
		INTERIM CONSOLIDATED STATEMENTS OF OPERATIONS
		INTERIM CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
		INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS
		NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
	ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
	ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
	ITEM 4. CONTROLS AND PROCEDURES
PART II. OTHER INFORMATION
	ITEM 1. LEGAL PROCEEDINGS
	ITEM 1A. RISK FACTORS
	ITEM 2. UNREGISTERED SALE OF EQUITY SECURITIES AND USE OF PROCEEDS
	ITEM 3. DEFAULTS UPON SENIOR SECURITIES
	ITEM 5. OTHER INFORMATION
	ITEM 6. EXHIBITS
SIGNATURES
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

MERCER INTERNATIONAL INC.

INTERIM CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED MARCH 31, 2010

(Unaudited)

FORM 10-Q
QUARTERLY REPORT — PAGE 2

MERCER INTERNATIONAL INC.

INTERIM CONSOLIDATED BALANCE SHEETS

(Unaudited)
(In thousands of Euros)


	March 31,			December 31,
	2010			2009
ASSETS
Current assets
Cash and cash equivalents (Note 11)	€	48,692		€	51,291
Receivables		90,391			71,143
Inventories (Note 4)		81,730			72,629
Prepaid expenses and other		7,568			5,871

Total current assets		228,381			200,934

Long-term assets
Property, plant and equipment		875,897			868,558
Deferred note issuance and other		7,813			8,186
Deferred income tax		3,698			3,426
Note receivable		2,698			2,727

		890,106			882,897

Total assets	€	1,118,487		€	1,083,831


LIABILITIES
Current liabilities
Accounts payable and accrued expenses	€	105,380		€	85,185
Pension and other post-retirement benefit obligations (Note 7)		619			567
Debt (Note 5)		23,020			16,032

Total current liabilities		129,019			101,784

Long-term liabilities
Debt (Note 5)		810,366			813,142
Unrealized interest rate derivative losses (Notes 6 and 9)		59,418			52,873
Pension and other post-retirement benefit obligations (Note 7)		19,740			17,902
Capital leases and other		11,087			12,157

		900,611			896,074

Total liabilities		1,029,630			997,858


EQUITY
Shareholders’ equity
Share capital (Note 8)		202,939			202,844
Paid-in capital		(5,625	)		(6,082	)
Retained earnings (deficit)		(104,781	)		(97,235	)
Accumulated other comprehensive income (loss)		30,967			23,695

Total shareholders’ equity		123,500			123,222


Noncontrolling interest (deficit) (Note 10)	€	(34,643	)	€	(37,249	)

Total equity		88,857			85,973

Total liabilities and equity	€	1,118,487		€	1,083,831

Commitments and contingencies (Note 11)

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

FORM 10-Q
QUARTERLY REPORT — PAGE 3

MERCER INTERNATIONAL INC.

INTERIM CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)
(In thousands of Euros, except per share data)


	Three Months Ended
	March 31,
	2010			2009

Revenues
Pulp	€	171,121		€	129,033
Energy		9,131			10,539

		180,252			139,572

Costs and expenses
Operating costs		140,409			131,997
Operating depreciation and amortization		13,724			13,401

		26,119			(5,826	)
Selling, general and administrative expenses		8,095			7,145
Sale of emission allowances		—			(558	)

Operating income (loss)		18,024			(12,413	)


Other income (expense)
Interest expense		(16,423	)		(16,549	)
Investment income (loss)		94			(3,202	)
Foreign exchange gain (loss) on debt		(5,231	)		(4,416	)
Gain (loss) on extinguishment of convertible notes (Note 5)		(929	)		—
Gain (loss) on derivative instruments (Note 6)		(6,546	)		(15,013	)

Total other income (expense)		(29,035	)		(39,180	)

Income (loss) before income taxes		(11,011	)		(51,593	)
Income tax benefit (provision) — current		(204	)		(49	)
— deferred		—			3,031

Net income (loss)		(11,215	)		(48,611	)
Less: net loss (income) attributable to noncontrolling interest		3,669			9,261

Net income (loss) attributable to common shareholders		(7,546	)		(39,350	)

Retained earnings (deficit), beginning of period		(97,235	)		(35,046	)

Retained earnings (deficit), end of period	€	(104,781	)	€	(74,396	)


Net income (loss) per share attributable to common shareholders (Note 3):
Basic	€	(0.21	)	€	(1.08	)

Diluted	€	(0.21	)	€	(1.08	)

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

FORM 10-Q
QUARTERLY REPORT — PAGE 4

MERCER INTERNATIONAL INC.

INTERIM CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)
(In thousands of Euros)


	Three Months Ended
	March 31,
	2010			2009

Net income (loss)	€	(11,215	)	€	(48,611	)


Other comprehensive income (loss)
Foreign currency translation adjustment		7,632			(5,369	)
Pension income (expense)		(366	)		(17	)
Unrealized gains (losses) on securities arising during the period		6			314


Other comprehensive income (loss)		7,272			(5,072	)


Total comprehensive income (loss)		(3,943	)		(53,683	)

Comprehensive loss (income) attributable to noncontrolling interest		3,669			9,261


Comprehensive income (loss) attributable to common shareholders	€	(274	)	€	(44,422	)

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

FORM 10-Q
QUARTERLY REPORT — PAGE 5

MERCER INTERNATIONAL INC.

INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)
(In thousands of Euros)


	Three Months Ended
	March 31,
	2010			2009
Cash flows from (used in) operating activities
Net income (loss) attributable to common shareholders	€	(7,546	)	€	(39,350	)
Adjustments to reconcile net income (loss) attributable to common shareholders to cash flows from operating activities
Loss (gain) on derivative instruments		6,546			15,013
Foreign exchange (gain) loss on debt		5,231			4,416
Loss (gain) on extinguishment of convertible notes		929			—
Depreciation and amortization		13,821			13,467
Accretion (income) expense		431			—
Noncontrolling interest		(3,669	)		(9,261	)
Deferred income taxes		—			(3,031	)
Stock compensation expense		506			(33	)
Pension and other post-retirement expense, net of funding		194			(16	)
Inventory provisions		—			4,587
Other		1,003			(2,900	)
Changes in current assets and liabilities
Receivables		(17,144	)		19,981
Inventories		(5,259	)		6,119
Accounts payable and accrued expenses		7,955			(7,221	)
Other		(1,281	)		1,000

Net cash from (used in) operating activities		1,717			2,771


Cash flows from (used in) investing activities
Purchase of property, plant and equipment		(5,850	)		(7,706	)
Proceeds on sale of property, plant and equipment		387			129
Cash, restricted		—			9,469
Notes receivable		(84	)		121

Net cash from (used in) investing activities		(5,547	)		2,013


Cash flows from (used in) financing activities
Repayment of notes payable and debt		(8,250	)		(13,800	)
Repayment of capital lease obligations		(1,004	)		(682	)
Proceeds from borrowings of notes payable and debt		—			10,000
Proceeds from government grants		9,415			—
Payment of deferred note issuance costs		—			(1,969	)

Net cash from (used in) financing activities		161			(6,451	)


Effect of exchange rate changes on cash and cash equivalents		1,070			451


Net increase (decrease) in cash and cash equivalents		(2,599	)		(1,216	)
Cash and cash equivalents, beginning of period		51,291			42,452

Cash and cash equivalents, end of period	€	48,692		€	41,236

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

FORM 10-Q
QUARTERLY REPORT — PAGE 6

MERCER INTERNATIONAL INC.

INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

(Unaudited)
(In thousands of Euros)


	Three Months Ended
	March 31,
	2010			2009

Supplemental disclosure of cash flow information
Cash paid (received) during the period for
Interest	€	14,429		€	28,258
Income taxes		102			29
Supplemental schedule of non-cash investing and financing activities
Acquisition of production and other equipment under capital lease obligations	€	212		€	36
Increase (decrease) in accounts payable relating to investing activities		(983	)		461

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

FORM 10-Q
QUARTERLY REPORT — PAGE 7

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)

Note 1. The Company and Summary of Significant Accounting Policies

Basis of Presentation

The interim consolidated financial statements contained herein include the accounts of Mercer International Inc. (“Mercer Inc.”) and its wholly-owned and majority-owned subsidiaries collectively (the “Company”). The Company’s shares of common stock are quoted and listed for trading on both the NASDAQ Global Market and the Toronto Stock Exchange.

The interim 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”). The year-end consolidated balance sheet data was derived from audited financial statements. The footnote disclosure included herein has been prepared in accordance with accounting principles generally accepted for interim financial statements in the United States (“GAAP”). The interim 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, 2009. In the opinion of the Company, the unaudited interim consolidated financial statements contained herein contain all adjustments necessary to fairly present the results of the interim periods included. The results for the periods included herein may not be indicative of the results for the entire year.

The Company has three pulp mills that are aggregated into one reportable business segment, market pulp. Accordingly, the results presented are those of the reportable business segment.

Certain prior year amounts in the interim consolidated financial statements have been reclassified to conform to the current year presentation.

In these interim consolidated financial statements, unless otherwise indicated, all amounts are expressed in Euros (“ € ”). The term “U.S. dollars” and the symbol “$” refer to United States dollars. The symbol “C$” refers to Canadian dollars.

Use of Estimates

Preparation of financial statements and related disclosures in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Significant management judgment is required in determining the accounting for, among other things, doubtful accounts and reserves, depreciation and amortization, future cash flows associated with impairment testing for long-lived assets, derivative financial instruments, environmental conservation and legal liabilities, asset retirement obligations, pensions and post-retirement benefit obligations, income taxes, contingencies, and inventory obsolescence and provisions. Actual results could differ from these estimates, and changes in these estimates are recorded when known.

FORM 10-Q
QUARTERLY REPORT — PAGE 8

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)

Note 1. The Company and Summary of Significant Accounting Policies (continued)

Recently Implemented Accounting Standards

This section highlights recently implemented accounting standards that had an impact on the Company’s financial statements.

In January 2010, the Company adopted Accounting Standards Update (“ASU”) 2010-06, which amends Accounting Standards Codification 820 (“ASC 820”), Fair Value Measurements and Disclosures. This new accounting guidance requires expanded fair value measurement disclosures in quarterly and annual financial statements. The new guidance clarifies existing disclosure requirements for the Level 2 and 3 fair value measurement. Additionally, the new guidance also requires details of significant transfers of assets between Level 1 and Level 2 fair value measurement categories, including the reasons for such transfers, as well as gross presentation of activity within the Level 3 fair value measurement category. This guidance is effective for the Company on January 1, 2010, except for the gross presentation of Level 3 activity, which is effective January 1, 2011. The adoption of this new accounting guidance did not impact the results of operations or the financial position of the Company.

Note 2. Stock-Based Compensation

The Company had a non-qualified stock option plan which provides for options to be granted to officers and employees to acquire a maximum of 3,600,000 common shares including options for 130,000 shares to directors who are not officers or employees. This plan expired in 2008 but unexercised options that were previously granted under this plan remain outstanding. The Company also has a stock incentive plan which provides for options, stock appreciation rights, restricted stock and performance stock to be awarded to employees and outside directors to a maximum of 1,000,000 common shares.

Performance Stock

Grants of performance stock comprise rights to receive stock at a future date that are contingent on the Company and the grantee achieving certain performance objectives.

During the three months ended March 31, 2010, potential stock based performance awards totaled 578,165, which vest on December 31, 2010 (2009 — 530,623). Expense (income) recognized for the three month periods ended March 31, 2010 and 2009 was € 503 and € (59), respectively.

The fair value of performance stock is determined based upon the number of shares awarded and the quoted price of the Company’s stock. Performance stock generally cliff vest three years from the award date. On February 11, 2010, the Company awarded 13,000 performance stock to two employees. As of March 31, 2010, no performance stock had vested (2009 — nil). During the three month periods ended March 31, 2010 and 2009, no performance stock were cancelled.

FORM 10-Q
QUARTERLY REPORT — PAGE 9

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)

Note 2. Stock-Based Compensation (continued)

Restricted Stock

The fair value of restricted stock is determined based upon the number of shares granted and the quoted price of the Company’s stock on the date of grant. Restricted stock generally vests over one year. Expense is recognized on a straight-line basis over the vesting period. Expense recognized for the three month periods ended March 31, 2010 and 2009 was € 3 and € 26, respectively.

As at March 31, 2010, the total remaining unrecognized compensation cost related to restricted stock amounted to approximately € 4 (2009 — € 20), which will be amortized over their remaining vesting period.

During the three month period ended March 31, 2010, no restricted stock awards were granted (2009 - nil). There were no restricted stock awards cancelled during the three month period ended March 31, 2010 (2009 — nil). As at March 31, 2010, 21,000 restricted stock awards remain unvested.

Stock Options

During the three month periods ended March 31, 2010 and 2009, no options were exercised, cancelled or granted and 738,334 options expired in 2010.

Note 3. Net Income (Loss) Per Share Attributable to Common Shareholders


	Three Months Ended
	March 31,
	2010			2009

Net income (loss) attributable to common shareholders — basic and diluted	€	(7,546	)	€	(39,350	)

Net income (loss) per share attributable to common shareholders:
Basic and diluted	€	(0.21	)	€	(1.08	)


Weighted average number of common shares outstanding:
Basic ⁽¹⁾		36,320,190			36,285,027
Effect of dilutive instruments:
Performance rights		—			—
Stock options and awards		—			—
Convertible notes		—			—

Diluted		36,320,190			36,285,027


(1)		The basic weighted average number of shares excludes performance and restricted stock which have been issued, but have not vested as at March 31, 2010 and 2009.

FORM 10-Q
QUARTERLY REPORT — PAGE 10

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)

Note 3. Net Income (Loss) Per Share Attributable to Common Shareholders (continued)

The calculation of diluted net income (loss) per share attributable to common shareholders does not assume the exercise of stock options and awards or the conversion of convertible notes that would have an anti-dilutive effect on earnings per share.

Stock options and awards excluded from the calculation of diluted income (loss) per share attributable to common shareholders because they are anti-dilutive represented 190,000 shares for the three month period ended March 31, 2010 (2009 — 928,334).

Restricted stock excluded from the calculation of diluted income (loss) per share attributable to common shareholders because they are anti-dilutive represented 21,000 shares for the three month period ended March 31, 2010 (2009 — 21,000).

Shares associated with the convertible notes excluded from the calculation of diluted income (loss) per share attributable to common shareholders because they are anti-dilutive represented 20,227,893 shares for the three month period ended March 31, 2010 (2009 — 8,678,065).

Performance stock excluded from the calculation of diluted income (loss) per share attributable to common shareholders because they are anti-dilutive represented 375,586 shares for the three month period ended March 31, 2010 (2009 — 348,648).

Note 4. Inventories


	March 31, 2010		December 31, 2009

Raw materials	€	31,108	€	24,888
Finished goods		25,023		24,198
Work in process and other		25,599		23,543

	€	81,730	€	72,629

FORM 10-Q
QUARTERLY REPORT — PAGE 11

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)

Note 5. Debt

Debt consists of the following:


	March 31, 2010			December 31, 2009

Note payable to bank, included in a total loan credit facility of € 827,950 to finance the construction related to the Stendal mill (a)	€	506,323		€	514,574
Senior notes due February 2013, interest at 9.25% accrued and payable semi-annually, unsecured (b)		229,188			216,299
Subordinated convertible notes due October 2010, interest at 8.5% accrued and payable semi-annually (c)		1,682			16,749
Subordinated convertible notes due January 2012, interest at 8.5% accrued and payable semi-annually (d)		45,166			26,160
Credit agreement with a lender with respect to a revolving credit facility of C$40 million (e)		17,471			16,000
Loan payable to the noncontrolling shareholder of the Stendal mill (f)		30,045			35,881
Credit agreement with a bank with respect to a revolving credit facility of € 25,000 (g)		—			—
Investment loan agreement with a lender with respect to the wash press project at the Rosenthal mill of € 4,351 (h)		3,511			3,511
Credit agreement with a bank with respect to a revolving credit facility of € 3,500 (i)		—			—

		833,386			829,174
Less: current portion		(23,020	)		(16,032	)

Debt, less current portion	€	810,366		€	813,142

The Company made scheduled principal repayments under these facilities of € 8,250 during the three months ended March 31, 2010 (2009 — € 13,800). As of March 31, 2010, the principal maturities of debt are as follows:


Matures	Amount

2010	€	7,893
2011		24,255
2012		70,837
2013 ⁽¹⁾		287,450
2014		40,000
Thereafter		402,951

	€	833,386


(1)		Includes revolving credit facility principal amounts totalling € 17,471.

FORM 10-Q
QUARTERLY REPORT — PAGE 12

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)

Note 5. Debt (continued)

Certain of the Company’s debt agreements were issued under an indenture which, among other things, restricts its ability and the ability of its restricted subsidiaries to make certain payments. These limitations are subject to other important qualifications and exceptions. As at March 31, 2010, the Company was in compliance with the terms of the indenture.

(a)

Note payable to bank, included in a total loan facility of € 827,950 to finance the construction related to the Stendal mill (“Stendal Loan Facility”), interest at rates varying from Euribor plus 0.90% to Euribor plus 1.85% (rates on amounts of borrowing at March 31, 2010 range from 1.85% to 2.44%), principal due in required installments beginning September 30, 2006 until September 30, 2017, collateralized by the assets of the Stendal mill, with 48% and 32% guaranteed by the Federal Republic of Germany and the State of Saxony-Anhalt, respectively, of up to € 468,823 of outstanding principal, subject to a debt service reserve account required to pay amounts due in the following twelve months under the terms of the Stendal Loan Facility; payment of dividends is only permitted if certain cash flow requirements are met.

On March 13, 2009, the Company finalized an agreement with its lenders to amend its Stendal Loan Facility. The amendment deferred approximately € 164,000 of scheduled principal payments until the maturity date, September 30, 2017, including approximately € 20,000, € 26,000, € 21,000 of scheduled principal payments that were originally due in 2009, 2010, and 2011, respectively. The amendment also provided for a 100% cash sweep, referred to as the “Cash Sweep”, of any cash, in excess of a € 15,000 working capital reserve, held by Stendal which will be used first to fund the debt service reserve account to a level sufficient to service the amounts due and payable under the Stendal Loan Facility during the then following 12 months, or “Fully Funded”, and second to prepay the deferred principal amounts.

(b)

In February 2005, the Company issued $310 million of senior notes due February 2013, which bear interest at 9.25% accrued and payable semi-annually, and are unsecured. The Company may redeem all or a part of the notes at redemption prices (expressed as a percentage of principal amount) equal to 102.31% for the twelve month period beginning on February 15, 2010, and 100.00% beginning on February 15, 2011 and at any time thereafter, plus accrued and unpaid interest.

FORM 10-Q
QUARTERLY REPORT — PAGE 13

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)

Note 5. Debt (continued)

(c)

As at March 31, 2010, the Subordinated Convertible Notes due October 2010 had approximately $2.3 million of principal outstanding. The Subordinated Convertible Notes due October 2010, bear interest at 8.5% accrued and payable semi-annually, are convertible at any time by the holder into common shares of the Company at $7.75 per share and are unsecured. The Company may redeem for cash all or a portion of these notes at any time at 100% of the principal amount of the notes plus accrued and unpaid interest up to the redemption date. See Note 5(d).

(d)

On December 10, 2009, the Company exchanged approximately $43.3 million of Subordinated Convertible Notes due October 2010 through private exchange agreements with the holders thereof for approximately $43.8 million of Subordinated Convertible Notes due January 2012. On January 22, 2010, through an exchange offer, the Company exchanged a further $21.7 million of Subordinated Convertible Notes due October 2010 for approximately $22.0 million of the Company’s Subordinated Convertible Notes due January 2012. The Company recognized both exchange transactions of the Subordinated Convertible Notes as extinguishments of debt in accordance with ASC Topic 470, Debt, because the fair value of the embedded conversion option changed by more than 10% in both transactions. As a result, for the year ended December 31, 2009, the Company accounted for the December 10, 2009 exchange as a debt extinguishment and recognized a gain of € 4,447 in the Consolidated Statement of Operations. For the three months ended March 31, 2010, the Company recognized a loss of € 929 as a result of the January 22, 2010 exchange. The gain and loss, which were determined using fair market values prevailing at the time of the transactions, will both be accreted to income through to January 2012 through interest expense yielding an effective interest rate of approximately 13% on the December 10, 2009 exchange and 3% on the January 22, 2010 exchange.

The Subordinated Convertible Notes due January 2012 bear interest at 8.5%, accrued and payable semi-annually, are convertible at anytime by the holder into common shares of the Company at $3.30 per share and are unsecured. The Company may redeem for cash all or a portion of the notes at anytime at 100% of the principal amount of the notes plus accrued interest up to the redemption date. During the three months ended March 31, 2010, $129,027 of Subordinated Convertible Notes due January 2012 were converted into 39,097 shares.

FORM 10-Q
QUARTERLY REPORT — PAGE 14

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)

Note 5. Debt (continued)

(e)

Credit agreement with respect to a revolving credit facility of C$40 million for the Celgar mill. The credit agreement matures May 2013. Borrowings under the credit agreement are collateralized by the mill’s inventory and receivables and are restricted by a borrowing base calculated on the mill’s inventory and receivables. Canadian dollar denominated amounts bear interest at bankers acceptance plus 3.75% or Canadian prime plus 2.00%. U.S. dollar denominated amounts bear interest at LIBOR plus 3.75% or U.S. base plus 2.00%. As at March 31, 2010, this facility was partially drawn at C$24.0 million and was accruing interest at a rate of approximately 4.19%.

(f)

Loans payable to the noncontrolling shareholder of the Stendal mill bear interest at 7%, which is accrued semi-annually. The loan payable is unsecured, subordinated to all liabilities of the Stendal mill, and is due in 2017. The balance includes principal and accrued interest. See Note 10 — Noncontrolling Interest.

(g)

A € 25,000 working capital facility at the Rosenthal mill that matures in December 2012. Borrowings under the facility are collateralized by the mill’s inventory and receivables and bear interest at approximately Euribor plus 3.50%. As at March 31, 2010, this facility was undrawn.

(h)

On August 19, 2009 the Company finalized an investment loan agreement with a lender relating to the new wash press at the Rosenthal mill. The four-year amortizing investment loan was completed with a total facility of € 4,351 bearing interest at the rate of Euribor plus 2.75%. Borrowings under this agreement are secured by the new wash press equipment. As at March 31, 2010, this facility was drawn by € 3,511 and was accruing interest at a rate of 3.71%.

(i)

On February 8, 2010 the Rosenthal mill finalized a credit agreement with a lender for a € 3,500 facility maturing in December 2012. Borrowings under the facility will bear interest at the rate of the 3-month Euribor plus 3.5% and are secured by certain land at our Rosenthal mill. As at March 31, 2010, this facility was undrawn.

Note 6. Derivative Transactions

The Company is exposed to certain market risks relating to its ongoing business. The Company seeks to manage these risks through internal risk management policies as well as, from time to time, the use of derivatives. Currently, the primary risk managed using derivative instruments is interest rate risk.

FORM 10-Q
QUARTERLY REPORT — PAGE 15

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)

Note 6. Derivative Transactions (continued)

During 2004, the Company entered into certain variable-to-fixed interest rate swaps in connection with the Stendal Loan Facility with respect to an aggregate maximum principal amount of approximately € 612,600 of the total indebtedness under the Stendal Loan Facility. Under the interest rate swaps, the Company pays a fixed rate and receives a floating rate with the interest payments being calculated on a notional amount. Currently, the contracts have an aggregate notional amount of € 486,073 at a fixed interest rate of 5.28% and they mature October 2017 (generally matching the maturity of the Stendal Loan Facility). The Company substantially converted the Stendal Loan Facility from a variable interest rate loan into a fixed interest rate loan, thereby reducing interest rate uncertainty.

The Company recognized an unrealized loss of € 6,546 with respect to these interest rate swaps for the three months ended March 31, 2010 (2009 — € 15,013), in the “Gain (loss) on derivative instruments” line in the Interim Consolidated Statement of Operations and Interim Consolidated Statement of Cash Flows. Derivative instruments are required to be measured at their fair value. Accordingly, the fair value of the interest rate swap is presented in “Unrealized interest rate derivative losses” within the long-term liabilities section in the Interim Consolidated Balance Sheets, which currently amounts to a cumulative unrealized loss of € 59,418 (2009 — € 52,873).

The interest rate derivative contracts are with the same banks that hold the Stendal Loan Facility and the Company does not anticipate non-performance by the banks.

Note 7. Pension and Other Post-Retirement Benefit Obligations

Included in pension and other post-retirement benefit obligations are amounts related to the Company’s Celgar and German mills. The largest component of this obligation is with respect to the Celgar mill which maintains defined benefit pension and post-retirement benefit plans for certain employees (“Celgar Plans”).

Pension benefits are based on employees’ earnings and years of service. The Celgar Plans are funded by contributions from the Company based on actuarial estimates and statutory requirements. Pension contributions for the three month period ended March 31, 2010 totaled € 156 (2009 — € 347).

The Company anticipates based on actuarial estimates that it will make contributions to the defined benefit pension plan of approximately € 303 in 2010.

FORM 10-Q
QUARTERLY REPORT — PAGE 16

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)

Note 7. Pension and Other Post-Retirement Benefit Obligations (continued)

Effective December 31, 2008, the defined benefit plan was closed to new members. In addition, the defined benefit service accrual ceased on December 31, 2008, and members began to receive pension benefits, at a fixed contractual rate, under a new defined contribution plan effective January 1, 2009.


	Three Months Ended March 31,
	2010						2009
				Post-						Post-
	Pension			Retirement			Pension			Retirement
	Benefits			Benefits			Benefits			Benefits

Service cost	€	19		€	93		€	14		€	83
Interest cost		397			183			370			199
Expected return on plan assets		(371	)		—			(311	)		—
Recognized net loss (gain)		104			(74	)		34			(58	)

Net periodic benefit cost	€	149		€	202		€	107		€	224

Note 8. Share Capital

Common shares

The Company has authorized 200,000,000 common shares (2009 — 200,000,000) with a par value of $1 per share.

During the quarter ended March 31, 2010, 39,097 shares were issued as a result of certain holders of the Company’s Subordinated Convertible Notes due January 2012 exercising their conversion option. See Note 5(d) — Debt.

As at March 31, 2010 and December 31, 2009, the Company had 36,483,204 and 36,443,487 common shares issued and outstanding, respectively.

Preferred shares

The Company has authorized 50,000,000 preferred shares (2009 — 50,000,000) with $1 par value issuable in series, of which 2,000,000 shares have been designated as Series A. The preferred shares may be issued in one or more series and with such designations and preferences for each series as shall be stated in the resolutions providing for the designation and issue of each such series adopted by the Board of Directors of the Company. The Board of Directors is authorized by the Company’s articles of incorporation to determine the voting, dividend, redemption and liquidation preferences pertaining to each such series. As at March 31, 2010, no preferred shares had been issued by the Company.

FORM 10-Q
QUARTERLY REPORT — PAGE 17

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)

Note 9. Financial Instruments

The fair value of financial instruments at March 31, 2010 and December 31, 2009 is summarized as follows:


	March 31, 2010				December 31, 2009
	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value

Cash and cash equivalents	€	48,692	€	48,692	€	51,291	€	51,291
Investments		142		142		135		135
Receivables		90,391		90,391		71,143		71,143
Notes receivable		4,044		4,044		3,819		3,819
Accounts payable and accrued expenses		105,380		105,380		85,185		85,185
Debt		833,386		838,190		829,174		769,207
Interest rate derivative contracts — liability		59,418		59,418		52,873		52,873

The carrying value of cash and cash equivalents and accounts payable and accrued expenses approximates the fair value due to the immediate or short-term maturity of these financial instruments. The carrying value of receivables approximates the fair value due to their short-term nature and historical collectability. The fair value of notes receivable was estimated using discounted cash flows at prevailing market rates. The fair value of debt reflects recent market transactions and discounted cash flow estimates. The fair value of the interest rate derivatives is based on observable inputs including applicable yield curves.

The fair value methodologies and, as a result, the fair value of the Company’s investments and derivative instruments are determined based on the fair value hierarchy provided in ASC 820. The fair value hierarchy per ASC 820 is as follows:

Level 1 — Valuations based on quoted prices in active markets for identical assets and liabilities.

Level 2 — Valuations based on observable inputs in active markets for similar assets and liabilities, other than Level 1 prices, such as quoted interest or currency exchange rates.

Level 3 — Valuations based on significant unobservable inputs that are supported by little or no market activity, such as discounted cash flow methodologies based on internal cash flow forecasts.

The Company classified its investments within Level 1 of the valuation hierarchy where quoted prices are available in an active market. Level 1 investments include exchange-traded equities.

FORM 10-Q
QUARTERLY REPORT — PAGE 18

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)

Note 9. Financial Instruments (continued)

The Company’s derivatives are classified within Level 2 of the valuation hierarchy, as they are traded on the over-the-counter market and are valued using internal models that use as their basis readily observable market inputs, such as forward interest rates.

The valuation techniques used by the Company are based upon observable inputs. Observable inputs reflect market data obtained from independent sources. In addition, the Company considered the risk of non-performance of the obligor, which in some cases reflects the Company’s own credit risk, in determining the fair value of the derivative instruments. The counterparty to our interest rate swap derivative is a multi-national financial institution.

The following table presents a summary of the Company’s outstanding financial instruments and their estimated fair values under the hierarchy defined in ASC 820:


	Fair value measurements at March 31, 2010 using:
	Quoted prices in
	active markets for		Significant other		Significant
	identical assets		observable inputs		unobservable inputs
Description	(Level 1)		(Level 2)		(Level 3)		Total

Assets
Investments (a)	€	142	€	—	€	—	€	142


Liabilities
Derivatives (b)
— Interest rate swaps	€	—	€	59,418	€	—	€	59,418


(a)		Based on observable market data.

(b)		Based on observable inputs for the liability (yield curves observable at specific intervals).

Note 10. Noncontrolling Interest

During the quarter, the noncontrolling interest holder agreed to convert certain interest claims totaling € 6,275 borne from shareholder loans into a capital contribution. As a result of this conversion, the Company reduced the amount owing to the noncontrolling shareholder and decreased the noncontrolling shareholders share of losses.

FORM 10-Q
QUARTERLY REPORT — PAGE 19

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)

Note 11. Commitments and Contingencies

As part of the Company’s Green Energy project (the “Green Energy Project”) for the Celgar mill, during 2009 and 2010 the Company entered into a number of contracts for the purchase of a new 48 megawatt condensing turbine-generator set, as well as other related equipment commitments. As at March 31, 2010, the value of the project remaining to be completed is approximately € 18.6 (C$25.5 million), a majority of which is due to be paid within the next year and is being funded by the Canadian Federal Government’s Pulp and Paper Green Transformation Program (the “Program”). Pursuant to a contribution agreement finalized in November 2009, the Program will provide approximately C$40.0 million to complete the Green Energy Project. The Company is also eligible for an additional C$17.7 million under the Program for future qualifying projects.

Included in cash and cash equivalents is approximately C$11.4 million that was provided as part of the Program and is expected to be spent on the Green Energy Project, currently underway at the Celgar mill, during the second quarter of 2010.

The Company is involved in a property transfer tax dispute with respect to the Celgar mill and certain other legal actions and claims arising in the ordinary course of business. While the outcome of these legal actions and claims cannot be predicted with certainty, it is the opinion of management that the outcome of any such claim which is pending or threatened, either individually or on a combined basis, will not have a material adverse effect on the consolidated financial condition, results of operations or liquidity of the Company.

FORM 10-Q
QUARTERLY REPORT — PAGE 20

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)

Note 12. Restricted Group Supplemental Disclosure

The terms of the indenture governing our 9.25% senior unsecured notes require that we provide the results of operations and financial condition of Mercer International Inc. and our restricted subsidiaries under the indenture, collectively referred to as the “Restricted Group”. As at and during the three months ended March 31, 2010 and 2009, the Restricted Group was comprised of Mercer International Inc., certain holding subsidiaries and our Rosenthal and Celgar mills. The Restricted Group excludes the Stendal mill.

Combined Condensed Balance Sheet


	March 31, 2010
	Restricted		Unrestricted						Consolidated
	Group		Subsidiaries			Eliminations			Group
ASSETS
Current assets
Cash and cash equivalents	€	26,083	€	22,609		€	—		€	48,692
Receivables		53,074		37,317			—			90,391
Inventories		56,932		24,798			—			81,730
Prepaid expenses and other		3,872		3,696			—			7,568

Total current assets		139,961		88,420			—			228,381

Property, plant and equipment		375,279		500,618			—			875,897
Deferred note issuance and other		3,170		4,643			—			7,813
Deferred income tax		3,698		—			—			3,698
Due from unrestricted group		71,487		—			(71,487	)		—
Note receivable		2,698		—			—			2,698

Total assets	€	596,293	€	593,681		€	(71,487	)	€	1,118,487


LIABILITIES
Current liabilities
Accounts payable and accrued expenses	€	60,456	€	44,924		€	—		€	105,380
Pension and other post-retirement benefit obligations		619		—			—			619
Debt		2,770		20,250			—			23,020

Total current liabilities		63,845		65,174			—			129,019

Debt		294,248		516,118			—			810,366
Due to restricted group		—		71,487			(71,487	)		—
Unrealized interest rate derivative losses		—		59,418			—			59,418
Pension and other post-retirement benefit obligations		19,740		—			—			19,740
Capital leases and other		6,718		4,369			—			11,087

Total liabilities		384,551		716,566			(71,487	)		1,029,630


EQUITY
Total shareholders’ equity (deficit)		211,742		(88,242	)		—			123,500
Noncontrolling interest (deficit)		—		(34,643	)		—			(34,643	)

Total liabilities and equity	€	596,293	€	593,681		€	(71,487	)	€	1,118,487

FORM 10-Q
QUARTERLY REPORT — PAGE 21

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)

Note 12. Restricted Group Supplemental Disclosure (continued)

Combined Condensed Balance Sheet


	December 31, 2009
	Restricted		Unrestricted						Consolidated
	Group		Subsidiaries			Eliminations			Group
ASSETS
Current assets
Cash and cash equivalents	€	20,635	€	30,656		€	—		€	51,291
Receivables		34,588		36,555			—			71,143
Inventories		52,897		19,732			—			72,629
Prepaid expenses and other		3,452		2,419			—			5,871

Total current assets		111,572		89,362			—			200,934

Property, plant and equipment		362,311		506,247			—			868,558
Deferred note issuance and other		3,388		4,798			—			8,186
Deferred income tax		3,426		—			—			3,426
Due from unrestricted group		72,553		—			(72,553	)		—
Note receivable		2,727		—			—			2,727

Total assets	€	555,977	€	600,407		€	(72,553	)	€	1,083,831


LIABILITIES
Current liabilities
Accounts payable and accrued expenses	€	51,875	€	33,310		€	—		€	85,185
Pension and other post-retirement benefit obligations		567		—			—			567
Debt		2,115		13,917			—			16,032

Total current liabilities		54,557		47,227			—			101,784

Debt		276,604		536,538			—			813,142
Due to restricted group		—		72,553			(72,553	)		—
Unrealized interest rate derivative losses		—		52,873			—			52,873
Pension and other post-retirement benefit obligations		17,902		—			—			17,902
Capital leases and other		6,667		5,490			—			12,157
Deferred income tax		—		—			—			—

Total liabilities		355,730		714,681			(72,553	)		997,858


EQUITY
Total shareholders’ equity (deficit)		200,247		(77,025	)		—			123,222
Noncontrolling interest (deficit)		—		(37,249	)		—			(37,249	)

Total liabilities and equity	€	555,977	€	600,407		€	(72,553	)	€	1,083,831

FORM 10-Q
QUARTERLY REPORT — PAGE 22

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)

Note 12. Restricted Group Supplemental Disclosure (continued)

Combined Condensed Statements of Operations


	Three Months Ended March 31, 2010
	Restricted			Unrestricted						Consolidated
	Group			Subsidiaries			Eliminations			Group

Revenues
Pulp	€	106,417		€	64,704		€	—		€	171,121
Energy		3,375			5,756			—			9,131

		109,792			70,460			—			180,252


Operating costs		81,665			58,744			—			140,409
Operating depreciation and amortization		7,213			6,511			—			13,724
Selling, general and administrative expenses and other		4,841			3,254			—			8,095

		93,719			68,509			—			162,228

Operating income (loss)		16,073			1,951			—			18,024


Other income (expense)
Interest expense		(7,320	)		(10,264	)		1,161			(16,423	)
Investment income (loss)		1,239			16			(1,161	)		94
Foreign exchange gain (loss) on debt		(5,231	)		—			—			(5,231	)
Gain (loss) on extinguishment of convertible notes		(929	)		—			—			(929	)
Gain (loss) on derivative instruments		—			(6,546	)		—			(6,546	)

Total other income (expense)		(12,241	)		(16,794	)		—			(29,035	)

Income (loss) before income taxes		3,832			(14,843	)		—			(11,011	)
Income tax benefit (provision)		(161	)		(43	)		—			(204	)

Net income (loss)		3,671			(14,886	)		—			(11,215	)
Less: net loss (income) loss attributable to noncontrolling interest		—			3,669			—			3,669

Net income (loss) attributable to common shareholders	€	3,671		€	(11,217	)	€	—		€	(7,546	)


	Three Months Ended March 31, 2009
	Restricted			Unrestricted						Consolidated
	Group			Subsidiaries			Eliminations			Group

Revenues
Pulp	€	75,016		€	54,017		€	—		€	129,033
Energy		4,016			6,523			—			10,539

		79,032			60,540			—			139,572


Operating costs		74,435			57,562			—			131,997
Operating depreciation and amortization		6,704			6,697			—			13,401
Selling, general and administrative expenses and other		3,303			3,284			—			6,587

		84,442			67,543			—			151,985

Operating income (loss)		(5,410	)		(7,003	)		—			(12,413	)


Other income (expense)
Interest expense		(7,302	)		(10,356	)		1,109			(16,549	)
Investment income (loss)		916			(3,009	)		(1,109	)		(3,202	)
Foreign exchange gain (loss) on debt		(4,416	)		—			—			(4,416	)
Gain (loss) on derivative instruments		—			(15,013	)		—			(15,013	)

Total other income (expense)		(10,802	)		(28,378	)		—			(39,180	)

Income (loss) before income taxes		(16,212	)		(35,381	)		—			(51,593	)
Income tax benefit (provision)		208			2,774			—			2,982

Net income (loss)		(16,004	)		(32,607	)		—			(48,611	)
Less: net loss (income) loss attributable to noncontrolling interest		—			9,261			—			9,261

Net income (loss) attributable to common shareholders	€	(16,004	)	€	(23,346	)	€	—		€	(39,350	)

FORM 10-Q
QUARTERLY REPORT — PAGE 23

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)

Note 12. Restricted Group Supplemental Disclosure (continued)

Combined Condensed Statement of Cash Flows


	Three Months Ended March 31, 2010
	Restricted			Unrestricted			Consolidated
	Group			Group			Group
Cash flows from (used in) operating activities
Net income (loss) attributable to common shareholders	€	3,671		€	(11,217	)	€	(7,546	)
Adjustments to reconcile net income (loss) attributable to common shareholders to cash flows from operating activities
Loss (gain) on derivative instruments		—			6,546			6,546
Foreign exchange (gain) loss on debt		5,231			—			5,231
Loss (gain) on extinguishment of convertible notes		929			—			929
Depreciation and amortization		7,310			6,511			13,821
Accretion (income) expense		431			—			431
Noncontrolling interest		—			(3,669	)		(3,669	)
Stock compensation expense		506			—			506
Pension and other post-retirement expense, net of funding		194			—			194
Other		388			615			1,003
Changes in current assets and liabilities
Receivables		(16,382	)		(762	)		(17,144	)
Inventories		(193	)		(5,066	)		(5,259	)
Accounts payable and accrued expenses		(2,845	)		10,800			7,955
Other ⁽¹⁾		1,062			(2,343	)		(1,281	)

Net cash from (used in) operating activities		302			1,415			1,717

Cash flows from (used in) investing activities
Purchase of property, plant and equipment		(4,927	)		(923	)		(5,850	)
Proceeds on sale of property, plant and equipment		54			333			387
Note receivable		(84	)		—			(84	)

Net cash from (used in) investing activities		(4,957	)		(590	)		(5,547	)

Cash flows from (used in) financing activities
Repayment of notes payable and debt		—			(8,250	)		(8,250	)
Repayment of capital lease obligations		(382	)		(622	)		(1,004	)
Proceeds from government investment grants		9,415			—			9,415

Net cash from (used in) financing activities		9,033			(8,872	)		161
Effect of exchange rate changes on cash and cash equivalents		1,070			—			1,070


Net increase (decrease) in cash and cash equivalents		5,448			(8,047	)		(2,599	)
Cash and cash equivalents, beginning of period		20,635			30,656			51,291

Cash and cash equivalents, end of period	€	26,083		€	22,609		€	48,692


(1)		Includes intercompany working capital related transactions.

FORM 10-Q
QUARTERLY REPORT — PAGE 24

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)

Note 12. Restricted Group Supplemental Disclosure (continued)

Combined Condensed Statement of Cash Flows


	Three Months Ended March 31, 2009
	Restricted			Unrestricted			Consolidated
	Group			Group			Group
Cash flows from (used in) operating activities
Net income (loss) attributable to common shareholders	€	(16,004	)	€	(23,346	)	€	(39,350	)
Adjustments to reconcile net income (loss) attributable to common shareholders to cash flows from operating activities
Loss (gain) on derivative instruments		—			15,013			15,013
Foreign exchange (gain) loss on debt		4,416			—			4,416
Depreciation and amortization		6,770			6,697			13,467
Noncontrolling interest		—			(9,261	)		(9,261	)
Deferred income taxes		(226	)		(2,805	)		(3,031	)
Stock compensation expense		(33	)		—			(33	)
Pension and other post-retirement expense, net of funding		(16	)		—			(16	)
Inventory provisions		3,233			1,354			4,587
Other		(21	)		(2,879	)		(2,900	)
Changes in current assets and liabilities
Receivables		15,753			4,228			19,981
Inventories		1,599			4,520			6,119
Accounts payable and accrued expenses		394			(7,615	)		(7,221	)
Other ⁽¹⁾		(11,115	)		12,115			1,000

Net cash from (used in) operating activities		4,750			(1,979	)		2,771


Cash flows from (used in) investing activities
Purchase of property, plant and equipment		(7,175	)		(531	)		(7,706	)
Proceeds on sale of property, plant and equipment		52			77			129
Cash, restricted		—			9,469			9,469
Note receivable		121			—			121

Net cash from (used in) investing activities		(7,002	)		9,015			2,013


Cash flows from (used in) financing activities
Repayment of notes payable and debt		(5,550	)		(8,250	)		(13,800	)
Repayment of capital lease obligations		(143	)		(539	)		(682	)
Proceeds from borrowings of notes payable and debt		10,000			—			10,000
Payment of deferred note issuance costs		—			(1,969	)		(1,969	)

Net cash from (used in) financing activities		4,307			(10,758	)		(6,451	)

Effect of exchange rate changes on cash and cash equivalents		451			—			451


Net increase (decrease) in cash and cash equivalents		2,506			(3,722	)		(1,216	)
Cash and cash equivalents, beginning of period	€	26,176		€	16,276		€	42,452

Cash and cash equivalents, end of period	€	28,682		€	12,554		€	41,236


(1)		Includes intercompany working capital related transactions.

FORM 10-Q
QUARTERLY REPORT — PAGE 25

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

In this document: (i) unless the context otherwise requires, references to “we”, “our”, “us”, the “Company” or “Mercer” mean Mercer International Inc. and its subsidiaries; (ii) references to “Mercer Inc.” mean the Company excluding its subsidiaries; (iii) information is provided as of March 31, 2010, unless otherwise stated; (iv) all references to monetary amounts are to “Euros”, the lawful currency adopted by most members of the European Union, unless otherwise stated; (v) “ € ” refers to Euros, “$” refers to U.S. dollars and “C$” refers to Canadian dollars; and (vi) “ADMTs” refers to air-dried metric tonnes.

Results of Operations

General

We operate three northern bleached softwood kraft (“NBSK”) pulp mills through our wholly owned subsidiaries, Rosenthal and Celgar, and our 74.9% owned subsidiary, Stendal, which have a consolidated annual production capacity of approximately 1.5 million ADMTs.

The following discussion and analysis of our results of operations and financial condition for the three months ended March 31, 2010 should be read in conjunction with our interim 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, 2009 filed with the Securities and Exchange Commission (“SEC”).

Current Market Environment

As global economies have increasingly shown signs of recovery, global pulp markets have continued to strengthen. Pulp prices have dramatically increased as worldwide demand has outstripped fiber supply in many regions, including Europe.

FORM 10-Q
QUARTERLY REPORT — PAGE 26

First Quarter Operational Snapshot

Selected production, sales and exchange rate data for the three months ended March 31, 2010 and 2009 is as follows:


	Three Months Ended March 31,
	2010		2009
Pulp Production (’000 ADMTs)		329.5		345.6
Scheduled Production Downtime (’000 ADMTs)		18.2		—
Pulp Sales (’000 ADMTs)		332.9		336.7
Pulp Revenues (in millions)	€	171.1	€	129.0

NBSK pulp list prices in Europe ($/ADMT)	$	860	$	585
NBSK pulp list prices ( € /ADMT)	€	621	€	449
Average pulp sales realizations ( € /ADMT) ⁽¹⁾	€	507	€	377

Energy Production (’000 MWh)		337.7		356.3
Energy Sales (’000 MWh)		107.1		112.2
Energy Revenue (in millions)	€	9.1	€	10.5
Average energy sales realizations ( € /MWh)	€	85	€	94

Average Spot Currency Exchange Rates
€ / $ ⁽²⁾		0.7230		0.7676
C$ / $ ⁽²⁾		1.0413		1.2448
C$ / € ⁽³⁾		1.4406		1.6217


(1)		Sales realizations after discounts. Incorporates the effect of pulp price variations occurring between the order and shipment dates.

(2)		Average Federal Reserve Bank of New York noon spot rate over the reporting period.

(3)		Average Bank of Canada noon spot rates over the reporting period.

Three Months Ended March 31, 2010 Compared to Three Months Ended March 31, 2009

Pulp revenues for the three months ended March 31, 2010 increased by approximately 32.6% to € 171.1 million from € 129.0 million in the comparative quarter of 2009, primarily due to significantly higher pulp prices. Revenues from the sale of excess energy decreased by approximately 13.3% in the first quarter to € 9.1 million from € 10.5 million in the same quarter last year, primarily due to the absence of a one-time grid access fee rebate received in 2009.

Pulp sales volume decreased marginally to 332,869 ADMTs in the current quarter from 336,659 ADMTs in the comparative period of 2009. In the first quarter of 2010, average pulp sales realizations increased by approximately 34.5% to € 507 per ADMT from € 377 per ADMT in the same period last year, primarily due to significantly higher pulp prices.

Pulp prices in the first quarter of 2010 were higher than in the same period last year due to a strengthening in global pulp markets. List prices for NBSK pulp in Europe were approximately € 621 ($860) per ADMT in the current quarter compared to approximately € 449 ($585) per ADMT in the first quarter of 2009 and € 558 ($800) at the end of 2009.

Pulp production decreased to 329,455 ADMTs in the current quarter from 345,620 ADMTs in the same quarter of 2009, primarily due to 10 days of scheduled maintenance downtime at our Stendal mill and production curtailments of approximately 17,000 tonnes at our German mills caused by limited fiber supply availability in early 2010. We have 12 days (approximately 17,000 tonnes) of scheduled maintenance downtime planned for our Celgar mill in the second quarter of 2010.

FORM 10-Q
QUARTERLY REPORT — PAGE 27

During the first quarter of 2010, our pulp inventories increased marginally to € 25.0 million from € 24.2 million at the end of the prior quarter. Our raw material inventories increased to € 31.1 million in the current quarter from € 24.9 million at the end of the fourth quarter of 2009 as a result of higher fiber costs in Germany and seasonal restocking at our Celgar mill.

Costs and expenses in the first quarter of 2010 increased to € 162.2 million from € 152.0 million in the comparative period of 2009, primarily due to higher fiber costs in Germany, and the costs associated with annual maintenance at the Stendal mill.

In the first quarter of 2010, operating depreciation and amortization increased slightly to € 13.7 million from € 13.4 million in the same quarter last year.

Overall, our fiber costs increased by approximately 6.0% in the first quarter of 2010 from the same period in 2009. At our Celgar mill, fiber costs were lower as the mill benefited from an increase in the residual supply of fiber and the corresponding decrease in fiber from third party field chippers. We currently expect fiber costs at our Celgar mill to decrease slightly in the short-term, primarily due to the increased availability of residual woodchips. Fiber costs at our German mills were higher due to the impact of reduced harvesting rates and increased demand from the European board industry. As we move into the second quarter of the year, we expect further upward pressure in pricing for our German mills due to increasing production in the European board industry, but also expect harvesting levels to increase, which should cause pricing to level off thereafter.

For the first quarter of 2010, we recorded operating income of € 18.0 million compared to an operating loss of € 12.4 million in the comparative quarter of 2009, primarily due to higher pulp price realizations.

Interest expense in the first quarter of 2010 decreased marginally to € 16.4 million from € 16.5 million in the comparative quarter of 2009, due to lower debt levels being partially offset by accretion expense related to the exchange of our convertible notes.

Our Stendal mill recorded an unrealized loss of € 6.5 million on the mark to market of its interest rate derivatives at the end of the current quarter, compared to an unrealized loss of € 15.0 million in the same period last year.

In the first quarter of 2010, we recorded a foreign exchange loss of € 5.2 million on our foreign currency denominated debt compared to a loss of € 4.4 million in the same period of 2009.

In the first quarter of 2010, we completed an exchange (the “Exchange”) of approximately € 15.4 million ($21.7 million) in aggregate principal amount of our 8.5% Convertible Senior Subordinated Notes due 2010 (the “2010 Convertible Notes”) for new 8.5% Convertible Senior Subordinated Notes due 2012 (the “2012 Convertible Notes”). We recorded a loss of approximately € 0.9 million on the extinguishment of the 2010 Convertible Notes.

In the first quarter of 2010, the noncontrolling shareholder’s interest in the Stendal mill’s loss was € 3.7 million, compared to € 9.3 million of loss in the same quarter last year.

We reported a net loss attributable to common shareholders for the first quarter of 2010 of € 7.5 million, or € 0.21 per basic and diluted share, which included aggregate non-cash, unrealized losses of € 11.8 million on the Stendal interest derivatives and foreign exchange loss on our debt. In the first quarter of 2009, net loss attributable to common shareholders was € 39.4 million, or € 1.08 per basic and diluted share.

FORM 10-Q
QUARTERLY REPORT — PAGE 28

Operating EBITDA in the first quarter of 2010 was € 31.8 million compared to Operating EBITDA of € 23.5 million in the prior quarter and € 1.1 million in the first quarter of 2009. Operating EBITDA is defined as operating income (loss) plus depreciation and amortization and non-recurring capital asset impairment charges. 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) attributable to common shareholders, including financing costs and the effect of derivative instruments. Operating EBITDA is not a measure of financial performance under the accounting principles generally accepted in the United States of America (“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) noncontrolling interests on our Stendal mill operations; (v) the impact of realized or marked to market changes in our derivative positions, which can be substantial; and (vi) the impact of impairment charges against our investments or assets. Because of these limitations, Operating EBITDA should only be considered as a supplemental operational 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 interim 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 operational performance and relying primarily on our GAAP financial statements.

FORM 10-Q
QUARTERLY REPORT — PAGE 29

The following table provides a reconciliation of net income (loss) attributable to common shareholders to operating income (loss) and Operating EBITDA for the periods indicated:


	Three Months Ended
	March 31,
	2010			2009
	(in thousands)
Net income (loss) attributable to common shareholders	€	(7,546	)	€	(39,350	)
Net income (loss) attributable to noncontrolling interest		(3,669	)		(9,261	)
Income taxes (benefits)		204			(2,982	)
Interest expense		16,423			16,549
Investment (income) loss		(94	)		3,202
Foreign exchange (gain) loss on debt		5,231			4,416
Loss on extinguishment of convertible notes		929			—
Loss (gain) on derivative instruments		6,546			15,013

Operating income (loss)		18,024			(12,413	)
Add: Depreciation and amortization		13,821			13,467

Operating EBITDA	€	31,845		€	1,054

Liquidity and Capital Resources

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


	As at		As at
	March 31,		December 31,
	2010		2009
	(in thousands)
Financial Position
Cash and cash equivalents	€	48,692	€	51,291
Working capital		99,362		99,150
Property, plant and equipment		875,897		868,558
Total assets		1,118,487		1,083,831
Long-term liabilities		900,611		896,074
Total equity		88,857		85,973

Sources and Uses of Funds

Our principal sources of funds are cash flows from operations, cash on hand and the revolving working capital loan facilities for our Celgar and Rosenthal mills. Our principal uses of funds consist of operating expenditures, payments of principal and interest on the project loan facility relating to our Stendal mill (“Stendal Loan Facility”), capital expenditures and interest payments on our outstanding 9.25% senior notes (“Senior Notes”) and the 2012 Convertible Notes.

In the last quarter of 2009, our Celgar mill was allocated approximately C$57.7 million in credits under the Canadian government’s Pulp and Paper Green Transformation Program (the “GTP”). The GTP’s objective is to improve the environmental performance of Canada’s pulp and paper industry by funding, by way of government grants, approved capital projects with environmental benefits, such as investments in energy efficiency. Subsequently, in November 2009, we entered into a non-repayable contribution agreement with the Department of Natural Resources Canada (“NRCan”) whereby NRCan agreed to provide approximately C$40.0 million ( € 29.1 million) in grants towards certain costs associated with our green energy project at our Celgar mill (the “Celgar Energy Project”). In December 2009, we received an initial grant of C$12.9 million from NRCan and an additional grant of C$13.9 million during the first quarter of 2010 which have been or will be used to pay outstanding Celgar Energy Project costs. Currently, our Celgar mill has approximately C$11.4 million of grant monies that we expect to be spent in the second quarter.

FORM 10-Q
QUARTERLY REPORT — PAGE 30

In the first quarter of 2010, capital expenditures related to the Celgar Energy Project totaled approximately € 4.9 million (C$7.0 million) and we expect the remaining costs for the project to be approximately € 18.6 million (C$25.5 million) substantially all of which will be financed through the C$40.0 million grant from the Canadian federal government under the GTP.

As at March 31, 2010, our cash and cash equivalents were approximately € 48.7 million, compared to approximately € 51.3 million at the end of 2009 and we had working capital of approximately € 99.4 million compared to approximately € 99.2 million at the end of 2009.

Debt Covenants

Our long-term obligations contain various financial tests and covenants customary to these types of arrangements.

As at March 31, 2010, we were in full compliance with all of the covenants of our indebtedness.

Cash Flow Analysis

Cash Flows from Operating Activities. We operate in a cyclical industry and our operating cash flows vary accordingly. Our principal operating cash expenditures are for labor, fiber, chemicals and debt service.

Working capital levels fluctuate throughout the year and are affected by maintenance downtime, changing sales patterns, seasonality and the timing of receivables and the payment of payables and expenses.

Operating activities provided cash of € 1.7 million and € 2.8 million in the three months ended March 31, 2010 and 2009, respectively, primarily as a result of increased operating income being offset by working capital movements. An increase in receivables used cash of € 17.1 million in the first three months of 2010, compared to a decrease in receivables providing cash of € 20.0 million in the first three months of 2009. An increase in inventories used cash of € 5.3 million in the first three months of 2010, compared to a decrease in inventories providing cash of € 6.1 million in the first three months of 2009. An increase in accounts payable and accrued expenses provided cash of € 8.0 million in the first three months of 2010, compared to a decrease in accounts payable and accrued expenses using cash of € 7.2 million in the first three months of 2009.

Cash Flows from Investing Activities. Investing activities in the first three months of 2010 used cash of € 5.5 million, compared to providing cash of € 2.0 million in the same period of 2009. Capital expenditures in the first three months of 2010 used cash of € 5.9 million compared to € 7.7 million in the same period of 2009.

Cash Flows from Financing Activities. In the first three months of 2010, financing activities provided cash of € 0.2 million, compared to using cash of € 6.5 million in the same period last year. Repayment of indebtedness and leases used cash of € 9.3 million and € 14.5 million in the three months ended March 31, 2010 and 2009, respectively. The three months ended March 31, 2010 also included government grants for our Celgar Energy Project, which provided cash of € 9.4 million.

FORM 10-Q
QUARTERLY REPORT — PAGE 31

Capital Resources

Other than commitments totaling approximately € 18.6 million relating to the Celgar Energy Project to be completed in 2010, we have no material commitments to acquire assets or operating businesses. We expect the remaining costs to complete the Celgar Energy Project to be funded from government funding credits under the GTP.

Future Liquidity

Based upon the current level of operations and our current expectations for future periods in light of the current economic environment, and in particular, current and expected pulp pricing and foreign exchange rates, we believe that cash flow from operations and available cash, together with available borrowings will be adequate to meet our liquidity needs in the next 12 months.

Contractual Obligations and Commitments

There were no material changes outside the ordinary course to any of our contractual obligations during the first quarter of 2010.

Foreign Currency

Our reporting currency is the Euro as the majority of our business transactions are denominated in Euros. However, we hold certain assets and liabilities in U.S. dollars and Canadian dollars. Accordingly, our consolidated financial results are subject to foreign currency exchange rate fluctuations.

We translate foreign denominated assets and liabilities into Euros at the rate of exchange on the balance sheet date. Unrealized gains or losses from these translations are recorded in our consolidated statement of comprehensive income and impact on shareholders’ equity on the balance sheet but do not affect our net earnings.

In the three months ended March 31, 2010, accumulated other comprehensive income increased by € 7.3 million to € 31.0 million, primarily due to the foreign exchange translation.

Based upon the exchange rate at March 31, 2010, the U.S. dollar weakened by approximately 2.0% in value against the Euro since March 31, 2009. See “Quantitative and Qualitative Disclosures about Market Risk”.

Results of Operations of the Restricted Group under our Senior Note Indenture

The indenture governing our 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”. The Restricted Group is comprised of Mercer Inc., our Rosenthal and Celgar mills and certain holding subsidiaries. The Restricted Group excludes our Stendal mill.

FORM 10-Q
QUARTERLY REPORT — PAGE 32

The following is a discussion of the results of operations and financial condition of the Restricted Group. For further information regarding the Restricted Group including, without limitation, a reconciliation to our consolidated results of operations, see Note 12 of our interim consolidated financial statements included herein.

Restricted Group Results — Three Months Ended March 31, 2010 Compared to Three Months Ended March 31, 2009

Pulp revenues for the Restricted Group for the three months ended March 31, 2010 increased by approximately 41.9% to € 106.4 million from € 75.0 million in the comparative period of 2009, primarily due to higher pulp prices. Revenues from the sale of excess energy decreased by approximately 15.0% in the current quarter to € 3.4 million from € 4.0 million in the same period last year, primarily due to the absence of a one-time grid access fee rebate received in 2009.

Pulp prices were higher in the first quarter of 2010 than in the same period last year due to continued strengthening in global pulp markets. List prices for NBSK pulp in Europe were approximately € 621 ($860) per ADMT in the current quarter compared to approximately € 449 ($585) per ADMT in the first quarter of 2009.

Pulp sales volume of the Restricted Group increased to 207,431 ADMTs in the first quarter of 2010 from 193,791 ADMTs in the comparative period of 2009. In the first quarter of 2010, average pulp sales realizations for the Restricted Group increased by approximately 32.6% to € 513 per ADMT from € 387 per ADMT in the same period last year.

Pulp production for the Restricted Group increased to 210,336 ADMTs in the first quarter of 2010 from 199,429 ADMTs in the same period of 2009, primarily as a result of increased mill reliability. We have 12 days (approximately 17,000 tonnes) of scheduled maintenance downtime planned for our Celgar mill in the second quarter of 2010.

Costs and expenses for the Restricted Group in the first quarter of 2010 increased to € 93.7 million from € 84.4 million in the comparative period of 2009.

Pulp inventories for the Restricted Group increased to € 18.0 million from € 15.9 million at the end of the prior quarter, primarily as a result of seasonal restocking at our Celgar mill and rising fiber costs in Germany.

In the first quarter of 2010, operating depreciation and amortization for the Restricted Group increased to € 7.2 million from € 6.7 million in the same period last year.

Overall, fiber costs of the Restricted Group in the first quarter of 2010 were largely unchanged compared to the same period of 2009 due to increased German fiber prices being offset by lower fiber costs at our Celgar mill.

In the first quarter of 2010, the Restricted Group reported operating income of 16.1 million compared to an operating loss of € 5.4 million in the first quarter of 2009, primarily due to higher pulp revenues resulting from improved pulp prices.

Interest expense of € 7.3 million for the Restricted Group in the first quarter of 2010 remained relatively consistent with the same quarter last year, with lower debt levels being offset by accretion expense related to the exchange of our convertible notes.

FORM 10-Q
QUARTERLY REPORT — PAGE 33

In the first quarter of 2010, the Restricted Group recorded a loss on foreign currency denominated debt of € 5.2 million, compared to a loss of € 4.4 million in the comparative quarter of 2009.

During the first quarter of 2010, in connection with the Exchange, the Restricted Group recorded a loss of approximately € 0.9 million on the extinguishment of the 2010 Convertible Notes.

The Restricted Group reported net income attributable to common shareholders for the first quarter of 2010 of € 3.7 million compared to a net loss attributable to common shareholders of € 16.0 million in the same period last year.

In the first quarter of 2010, the Restricted Group reported Operating EBITDA of € 23.4 million compared to Operating EBITDA of € 1.4 million in the comparative quarter of 2009 and Operating EBITDA of € 7.8 million in the fourth quarter of 2009. Operating EBITDA is defined as operating income (loss) plus depreciation and amortization and non-recurring capital asset impairment charges. 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 three months ended March 31, 2010 for additional information relating to such limitations and Operating EBITDA.

The following table provides a reconciliation of net income (loss) attributable to common shareholders to operating income (loss) and Operating EBITDA for the Restricted Group for the periods indicated:


	Three Months Ended
	March 31,
	2010			2009
	(in thousands)
Restricted Group ⁽¹⁾
Net income (loss) attributable to common shareholders	€	3,671		€	(16,004	)
Income taxes (benefits)		161			(208	)
Interest expense		7,320			7,302
Investment (income) loss		(1,239	)		(916	)
Foreign exchange (gain) loss on debt		5,231			4,416
Loss on extinguishment of convertible notes		929			—

Operating income (loss)		16,073			(5,410	)
Add: Depreciation and amortization		7,310			6,770

Operating EBITDA ⁽¹⁾	€	23,383		€	1,360


(1)		See Note 12 of the interim consolidated financial statements included elsewhere herein for a reconciliation to our consolidated results.

FORM 10-Q
QUARTERLY REPORT — PAGE 34

Liquidity and Capital Resources of the Restricted Group

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


	As at		As at
	March 31,		December 31,
	2010		2009
	(in thousands)
Restricted Group Financial Position ⁽¹⁾
Cash and cash equivalents	€	26,083	€	20,635
Working capital		76,116		57,015
Property, plant and equipment		375,279		362,311
Total assets		596,293		555,977
Long-term liabilities		320,706		301,173
Total equity		211,742		200,247


(1)		See Note 12 of the interim consolidated financial statements included elsewhere herein for a reconciliation to our consolidated results.

At March 31, 2010, the Restricted Group had cash and cash equivalents of approximately € 26.1 million, compared to approximately € 20.6 million at the end of 2009 and had working capital of approximately € 76.1 million compared to working capital of approximately € 57.0 million at the end of 2009. The increase in working capital was primarily due to the impact of higher sales realizations on accounts receivable in 2010.

We currently expect the Restricted Group to meet its interest and debt service obligations and meet the working and maintenance capital requirements for its operations for the next 12 months with cash flow from operations, cash on hand and available borrowings.

Credit Ratings

Standard & Poor’s Rating Services (“S&P”) and Moody’s Investors Service, Inc. (“Moody’s”) base their assessment of our credit risk on the business and financial profile of the Restricted Group only. Factors that may affect our credit rating include changes in our operating performance and liquidity. Credit rating downgrades can adversely impact, among other things, future borrowing costs and access to capital markets.

In 2009, we were subject to several rating actions by Moody’s and S&P. In February 2009, S&P lowered our credit rating to B- with negative implications, citing the pulp market environment and potential liquidity issues. In June 2009, Moody’s downgraded our Probability of Default Rating (“PDR”) and Corporate Family Rating (“CFR”) to Caa1 from B2.

Certain corporate restructurings, including some exchange offers, can affect credit ratings. In December 2009, immediately following the completion of the exchange offer for our 2010 Convertible Notes, S&P initially lowered the Restricted Group’s credit rating to SD. Subsequently, on December 15, 2009, S&P raised the Restricted Group’s credit rating to CCC+ with a negative outlook, citing the reduction in debt maturing in 2010. In January 2010, S&P confirmed the CCC+ rating but changed their outlook to positive, citing improved liquidity but maintaining concern for pulp market volatility.

FORM 10-Q
QUARTERLY REPORT — PAGE 35

Critical Accounting Policies

The preparation of financial statements and related disclosures in conformity with GAAP requires management to make estimates and assumptions that affect both the amount and the timing of the recording of assets, liabilities, revenues, and expenses in the consolidated financial statements and accompanying note disclosure. 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.

Our significant accounting policies are disclosed in Note 1 to our annual report on Form 10-K for the fiscal year ended December 31, 2009. While all of the significant accounting policies are important to the consolidated financial statements, some of these policies may be viewed as having a high degree of judgment. On an ongoing basis, using currently available information, management reviews its estimates, including those related to the accounting for pensions and post-retirement benefits, provisions for bad debt and doubtful accounts, derivative instruments, impairment of long-lived assets, deferred taxes, inventory provisions and environmental conservation and legal liabilities. Actual results could differ from these estimates.

We have identified certain accounting policies that are the most important to the portrayal of our current financial condition and results of operations.

For information about both our significant and critical accounting policies, see our annual report on Form 10-K for the fiscal year ended December 31, 2009.

New Accounting Standards

See Note 1 to the Company’s interim consolidated financial statements included in Item 1.

Cautionary Statement Regarding Forward-Looking Information

The statements in this report that are not reported financial results or other historical information are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 , as amended. 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:

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our markets;

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demand and prices for our products;

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our level of indebtedness;

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raw material costs and supply;

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energy prices, sales and our initiatives to enhance sales of surplus energy;

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capital expenditures;

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the economy;

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foreign exchange rates — particularly the U.S. dollar and Canadian dollar; and

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derivatives.

FORM 10-Q
QUARTERLY REPORT — PAGE 36

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 fiscal year ended December 31, 2009. 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

Revenues

The pulp business is highly cyclical in nature and markets for our principal products are characterized by periods of supply and demand imbalance, which in turn affects product prices. Pulp markets are highly competitive and are sensitive to cyclical changes in the global economy, industry capacity and foreign exchange rates, all of which can have a significant influence on selling prices and our operating results. The length and magnitude of industry cycles have varied over time but generally reflect changes in macro economic conditions and levels of industry capacity.

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 has historically been determined by the level of economic growth and has been closely tied to overall business activity. From 2006 to mid-2008, pulp prices steadily improved. However, in the latter half of 2008, a global economic crisis resulted in a sharp decline of pulp prices from a high of $900 per ADMT to $635 per ADMT at the end of 2008. Beginning in the second quarter of 2009 prices began to improve, rising from a low of $575 per ADMT in March 2009 to $890 per ADMT at the end of the current quarter. As the global economic situation continues to improve, pulp prices will also likely continue to recover and experience further upward momentum. Nonetheless, there may be renewed price deterioration in the future.

Prices for pulp 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 price for pulp, such pulp 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 mills. Therefore, our profitability 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 prices for our raw materials increase, or both, our results of operations could be materially adversely affected.

FORM 10-Q
QUARTERLY REPORT — PAGE 37

Costs

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. Fiber costs are primarily affected by the supply of, and demand for, lumber which is 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.

Currency

The majority of our sales are in products quoted in U.S. dollars while most of our operating costs and expenses, other than those of the Celgar mill, are incurred in Euros. In addition, all of the products sold by the Celgar mill are quoted in U.S. dollars and the Celgar mill costs are primarily incurred in Canadian dollars. Our results of operations and financial condition are reported in Euros. As a result, our revenues are adversely affected by a decrease in the value of the U.S. dollar relative to the Euro and 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. Conversely, an increase in the U.S. dollar versus the Euro and the Canadian dollar positively impacts our revenues by increasing our operating margins and cash flow.

FORM 10-Q
QUARTERLY REPORT — PAGE 38

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risks from changes in interest rates and foreign currency exchange rates, particularly the exchange rate between the Euro and the U.S. dollar and the Canadian dollar versus the U.S. dollar and the Euro. Changes in these rates may affect our results of operations and financial condition and, consequently, our fair value. We seek to manage these risks through internal risk management policies, as well as the use of derivatives. We use derivatives to reduce or limit our exposure to interest rate and currency risks. We may in the future use derivatives to reduce or limit our exposure to fluctuations in pulp prices. We also use derivatives to reduce our potential losses or to augment our potential gains, depending on our management’s perception of future economic events and developments. These types of derivatives are generally highly speculative in nature. They are also very volatile as they are highly leveraged given that margin requirements are relatively low in proportion to notional amounts.

Many of our strategies, including the use of derivatives, and the types of derivatives selected by us, are based on historical trading patterns and correlations and our management’s expectations of future events. However, these strategies may not be 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 significant losses.

All of our derivatives are marked to market at the end of each reporting period, and all unrealized gains and losses are recognized in earnings for a reporting period. We determine market valuations based primarily upon observable inputs including applicable yield curves.

During the first three months of 2010, we recorded an unrealized loss of € 6.5 million on our outstanding interest rate derivatives compared to an unrealized loss of € 15.0 million in the comparative period of 2009.

We are also subject to some energy price risk, primarily for the electricity that our operations purchase.

FORM 10-Q
QUARTERLY REPORT — PAGE 39

ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures. Our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 , as amended (the “Exchange Act”)), as of the end of the period covered by this report. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is accumulated and communicated to management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. Based on such evaluation, our principal executive officer and principal financial officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports that we file or submit under the Exchange Act.

It should be noted that any system of controls is based in part upon certain assumptions designed to obtain reasonable (and not absolute) assurance as to its effectiveness, and there can be no assurance that any design will succeed in achieving its stated goals.

Changes in Internal Controls. There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

FORM 10-Q
QUARTERLY REPORT — PAGE 40

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Our wholly owned subsidiary, Zellstoff Celgar Limited (“Celgar”), reached an agreement with the City of Castlegar British Columbia (the “City”), in regard to our previously disclosed dispute over the City’s 2009 property tax rate bylaw. In accordance with such agreement, Celgar agreed to pay the remaining balance of its 2009 taxes owing to the City, including penalties and interest, and in return the City agreed to moderately reduce Celgar’s property taxes annually from 2010 to 2012, with additional moderate reductions possible between 2013 and 2015.

We are subject to routine litigation incidental to our business, including those described in our latest annual report on Form 10-K for the fiscal year ended December 31, 2009. We do not believe that the outcome of such litigation will have a material adverse effect on our business or financial condition.

ITEM 1A. RISK FACTORS

There have been no material changes to the factors disclosed in Item 1A. Risk Factors in our latest annual report on Form 10-K for the fiscal year ended December 31, 2009.

ITEM 2. UNREGISTERED SALE OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS


Exhibit
No.			Description

	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.

FORM 10-Q
QUARTERLY REPORT — PAGE 41

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.

Date: May 4, 2010

FORM 10-Q
QUARTERLY REPORT — PAGE 42

TABLE OF CONTENTS

Part I Item 1. Financial Statements Note 1. The Company and Summary Of Significant Accounting Policies Note 1. The Company and Summary Of Significant Accounting Policies (continued)Note 2. Stock-based Compensation Note 2. Stock-based Compensation (continued)Note 3. Net Income (loss) Per Share Attributable To Common Shareholders Note 3. Net Income (loss) Per Share Attributable To Common Shareholders (continued)Note 4. Inventories Note 5. Debt Note 5. Debt (continued)Note 6. Derivative Transactions Note 6. Derivative Transactions (continued)Note 7. Pension and Other Post-retirement Benefit Obligations Note 7. Pension and Other Post-retirement Benefit Obligations (continued)Note 8. Share Capital Note 9. Financial Instruments Note 9. Financial Instruments (continued)Note 10. Noncontrolling Interest Note 11. Commitments and Contingencies Note 12. Restricted Group Supplemental Disclosure Note 12. Restricted Group Supplemental Disclosure (continued)Item 2. Management S Discussion and Analysis Of Financial Condition and Results Of Operations Item 3. Quantitative and Qualitative Disclosures About Market Risk Item 4. Controls and Procedures Part II. Other Information Part II Item 1. Legal Proceedings Item 1A. Risk Factors Item 2. Unregistered Sale Of Equity Securities and Use Of Proceeds Item 3. Defaults Upon Senior Securities Item 5. Other Information Item 6. Exhibits

Exhibit 31.1 Exhibit 31.2 Exhibit 32.1 Exhibit 32.2

MERCER INTERNATIONAL INC.

/s/ David M. Gandossi

David M. Gandossi

Secretary and Chief Financial Officer