-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, H0mVNo3wfqGH7rwSE6J6rx0EeguLbQVbocEJ3HoNGaTUZgWHVbeXN8CW/vfSS3rI SbTARzTr3eJOrQ1QdQMbwg== 0000075659-03-000064.txt : 20031114 0000075659-03-000064.hdr.sgml : 20031114 20031114093649 ACCESSION NUMBER: 0000075659-03-000064 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20030930 FILED AS OF DATE: 20031114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MERCER INTERNATIONAL INC CENTRAL INDEX KEY: 0000075659 STANDARD INDUSTRIAL CLASSIFICATION: PAPER MILLS [2621] IRS NUMBER: 916087550 STATE OF INCORPORATION: WA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-09409 FILM NUMBER: 031000605 BUSINESS ADDRESS: STREET 1: 14900 INTERURBAN AVENUE SOUTH STREET 2: SUITE 282 CITY: SEATTLE STATE: WA ZIP: 98168 BUSINESS PHONE: 2066744639 MAIL ADDRESS: STREET 1: 14900 INTERURBAN AVENUE SOUTH STREET 2: SUITE 282 CITY: SEATTLE STATE: WA ZIP: 98168 FORMER COMPANY: FORMER CONFORMED NAME: ASIAMERICA EQUITIES LTD DATE OF NAME CHANGE: 19920109 FORMER COMPANY: FORMER CONFORMED NAME: PACIFIC WEST REALTY TRUST DATE OF NAME CHANGE: 19860219 10-Q 1 doc1.txt ============================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO --- --- COMMISSION FILE NO.: 000-09409 MERCER INTERNATIONAL INC. (Exact name of Registrant as specified in its charter) WASHINGTON 91-6087550 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 14900 INTERURBAN AVENUE SOUTH, SUITE 282, SEATTLE, WA 98168 (Address of office) (206) 674-4639 (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO --- --- Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES X NO --- --- The Registrant had 17,099,899 shares of beneficial interest outstanding as at November 13, 2003. ================================================================================ PART I. FINANCIAL INFORMATION --------------------- ITEM 1. FINANCIAL STATEMENTS MERCER INTERNATIONAL INC. CONSOLIDATED FINANCIAL STATEMENTS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 (UNAUDITED) FORM 10-Q QUARTERLY REPORT - PAGE 2 MERCER INTERNATIONAL INC. CONSOLIDATED BALANCE SHEETS As at September 30, 2003 and December 31, 2002 (Unaudited) (Euros in thousands)
SEPTEMBER 30, DECEMBER 31, 2003 2002 ------------- ------------ ASSETS Current Assets Cash and cash equivalents E 17,554 E 30,261 Cash restricted 8,444 9,459 Investments 511 307 Receivables 35,744 28,132 Cumulative unrealized gains on derivatives 20,407 3,792 Inventories 22,929 16,375 Prepaids and other 8,729 7,891 ------------- ------------ Total current assets 114,318 96,217 Long-Term Assets Cash restricted 40,296 38,795 Properties 649,780 441,990 Investments 7,435 5,592 Equity method investment 6,886 7,019 Deferred income taxes 10,043 10,137 ------------- ------------ 714,440 503,533 ------------- ------------ E 828,758 E 599,750 ============= ============ LIABILITIES Current Liabilities Accounts payable and accrued expenses E 44,971 E 32,866 Construction in progress costs payable 57,771 24,885 Note payable 1,609 832 Note payable, construction in progress 45,000 15,000 Debt, current portion 23,016 16,306 ------------- ------------ Total current liabilities 172,367 89,889 Long-Term Liabilities Debt, construction in progress, less current portion 287,386 146,485 Debt, less current portion 188,740 205,393 Derivative financial instruments, construction in progress 52,633 30,108 Other 1,649 2,906 ------------- ------------ 530,408 384,892 ------------- ------------ Total liabilities 702,775 474,781 Minority Interest - - SHAREHOLDERS' EQUITY Shares of beneficial interest 78,139 76,995 Additional paid-in capital, stock options 208 - Accumulated other comprehensive income (loss) 4,020 (4,815) Retained earnings 43,616 52,789 ------------- ------------ 125,983 124,969 ------------- ------------ E 828,758 E 599,750 ============= ============
The accompanying notes are an integral part of these financial statements. FORM 10-Q QUARTERLY REPORT - PAGE 3 MERCER INTERNATIONAL INC. CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS For Nine Months Ended September 30, 2003 and 2002 (Unaudited) (Euros in thousands, except for earnings per share)
2003 2002 ---------- ---------- Revenues Sales of pulp and paper E 134,935 E 174,289 Transportation 2,850 3,885 Other 6,351 4,868 ---------- ---------- 144,136 183,042 Cost of sales Pulp and paper 131,838 152,270 Transportation 2,388 3,747 ---------- ---------- Gross profit 9,910 27,025 General, administrative and other 12,961 20,400 ---------- ---------- (Loss) income from operations (3,051) 6,625 ---------- ---------- Other income (expense) Interest expense (6,887) (10,838) Investment income (loss) 1,055 (300) Gain on derivative contracts 18,335 10,855 Loss on derivative contracts, interest rate swaps, construction in progress (22,525) (22,011) Gain on derivative contract, currency forward, construction in progress 586 - Settlement expense (630) - Impairment of available-for-sale securities (5,511) - Other 1,182 223 ---------- ---------- Total other expense (14,395) (22,071) ---------- ---------- Loss before income taxes (17,446) (15,446) Income taxes 226 11 ---------- ---------- Loss before minority interest (17,672) (15,457) Minority interest 8,499 8,016 ---------- ---------- Net loss (9,173) (7,441) Retained earnings, beginning of period 52,789 59,111 ---------- ---------- Retained earnings, end of period E 43,616 E 51,670 ========== ========== Loss per share Basic E (0.54) E (0.44) ========== ========== Diluted E (0.54) E (0.44) ========== ==========
The accompanying notes are an integral part of these financial statements. FORM 10-Q QUARTERLY REPORT - PAGE 4 MERCER INTERNATIONAL INC. CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS For Three Months Ended September 30, 2003 and 2002 (Unaudited) (Euros in thousands, except for earnings per share)
2003 2002 ---------- ---------- Revenues Sales of pulp and paper E 43,661 E 54,754 Transportation 828 1,132 Other 1,333 1,019 ---------- ---------- 45,822 56,905 Cost of sales Pulp and paper 45,366 47,667 Transportation 525 1,269 ---------- ---------- Gross profit (69) 7,969 General, administrative and other 4,231 6,004 ---------- ---------- (Loss) income from operations (4,300) 1,965 ---------- ---------- Other income (expense) Interest expense (2,236) (2,739) Investment income 416 367 Gain (loss) on derivative contracts 3,734 (4,026) Gain (loss) on derivative contracts, interest rate swaps, construction in progress 5,419 (22,011) Gain on derivative contract, currency forward, construction in progress 586 - Settlement expense (630) - Other (205) (2,169) ---------- ---------- Total other income (expense) 7,084 (30,578) ---------- ---------- Income (loss) before income taxes 2,784 (28,613) Income taxes 28 - ---------- ---------- Income (loss) before minority interest 2,756 (28,613) Minority interest (1,880) 8,016 ---------- ---------- Net income (loss) 876 (20,597) Retained earnings, beginning of period 42,740 72,267 ---------- ---------- Retained earnings, end of period E 43,616 E 51,670 ========== ========== Income (loss) per share Basic E 0.05 E (1.23) ========== ========== Diluted E 0.05 E (1.23) ========== ==========
The accompanying notes are an integral part of these financial statements. FORM 10-Q QUARTERLY REPORT - PAGE 5 MERCER INTERNATIONAL INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) For Nine Months Ended September 30, 2003 and 2002 (Unaudited) (Euros in thousands)
2003 2002 ---------- ---------- Net loss E (9,173) E (7,441) ---------- ---------- Other comprehensive income: Foreign currency translation adjustments 1,240 3,894 Unrealized gain (loss) on securities Unrealized holding gain (loss) arising during the period 2,084 (2,935) Adjustment for other than temporary decline in value 5,511 - ---------- ---------- 7,595 (2,935) ---------- ---------- Other comprehensive income 8,835 959 ---------- ---------- Total comprehensive loss E (338) E (6,482) ========== ==========
The accompanying notes are an integral part of these financial statements. FORM 10-Q QUARTERLY REPORT - PAGE 6 MERCER INTERNATIONAL INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) For Three Months Ended September 30, 2003 and 2002 (Unaudited) (Euros in thousands)
2003 2002 ---------- ---------- Net income (loss) E 876 E (20,597) ---------- ---------- Other comprehensive income (loss): Foreign currency translation adjustments 115 381 Unrealized gain (loss) on securities 2,345 (1,646) ---------- ---------- Other comprehensive income (loss) 2,460 (1,265) ---------- ---------- Total comprehensive income (loss) E 3,336 E (21,862) ========== ==========
The accompanying notes are an integral part of these financial statements. FORM 10-Q QUARTERLY REPORT - PAGE 7 MERCER INTERNATIONAL INC. CONSOLIDATED STATEMENTS OF CASH FLOWS For Nine Months Ended September 30, 2003 and 2002 (Unaudited) (Euros in thousands)
2003 2002 ---------- ---------- Cash Flows from Operating Activities: Net loss E (9,173) E (7,441) Adjustments to reconcile net loss to cash flows from operating activities Unrealized loss on derivative financial instruments, construction in progress, net 21,939 22,011 Depreciation and amortization 18,135 20,231 Impairment of securities 5,511 - Minority interest (8,499) (8,016) Loss from an equity investee 912 - Stock compensation expense 432 - Changes in current assets and liabilities Investments (166) 4,004 Inventories (6,554) (675) Receivables (8,138) 5,556 Cumulative unrealized gains on derivatives (18,333) 67 Accounts payable and accrued expenses 11,516 (12,363) Other (651) 651 ---------- ---------- Net cash provided by operating activities 6,931 24,025 Cash Flows from Investing Activities: Purchase of properties, net of investment grants received (226,240) (156,526) Sale of properties - 3,513 Purchase of long-term investments - (3,000) Sale of long-term investments 296 966 Other 48 - ---------- ---------- Net cash used in investing activities (225,896) (155,047) Cash Flows from Financing Activities: Cash restricted (486) (29,261) Increase in construction in progress costs payable 34,362 51,826 Increase in notes payable and debt 186,859 107,053 Decrease in notes payable and debt (15,444) (17,570) Equity and loans from minority shareholders - 30,615 Issuance of shares of beneficial interest 913 - ---------- ---------- Net cash provided by financing activities 206,204 142,663 Effect of exchange rate changes on cash and cash equivalents 54 (446) ---------- ---------- Net (decrease) increase in cash and cash equivalents (12,707) 11,195 Cash and cash equivalents, beginning of period 30,261 11,741 ---------- ---------- Cash and cash equivalents, end of period E 17,554 E 22,936 ========== ==========
The accompanying notes are an integral part of these financial statements. FORM 10-Q QUARTERLY REPORT - PAGE 8 MERCER INTERNATIONAL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR NINE MONTHS ENDED SEPTEMBER 30, 2003 (Unaudited) NOTE 1. Basis of Presentation The interim period consolidated financial statements contained herein include the accounts of Mercer International Inc. and its wholly-owned and majority-owned subsidiaries (the "Company"). The interim period consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (the "SEC"). Certain information and footnote disclosure normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such SEC rules and regulations. The interim period consolidated financial statements should be read together with the audited consolidated financial statements and accompanying notes included in the Company's latest annual report on Form 10-K for the fiscal year ended December 31, 2002. In the opinion of the Company, the unaudited consolidated financial statements contained herein contain all adjustments necessary to present a fair statement of the results of the interim periods presented. The results for the periods presented herein may not be indicative of the results for the entire year. NOTE 2. Stock-Based Compensation The Company has a stock-based employee compensation plan, which is described more fully in the Company's annual report on Form 10-K for the year ended December 31, 2002. The Company accounts for the plan under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. On September 10, 2003, the Company granted stock options to acquire up to 100,000 shares of beneficial interest of the Company to David M. Gandossi, the Chief Financial Officer and Secretary of the Company, with a ten year term, exercisable at a price of $5.65 per share, pursuant to an employment agreement between the Company and Mr. Gandossi dated August 7, 2003. The stock options were in-the-money at the date of grant and, accordingly, the intrinsic value of the stock options was recognized as a stock-based compensation expense in accordance with APB Opinion No. 25 and included in the consolidated income statements. The following tables illustrate the effect on net income (loss) and income (loss) per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation: FORM 10-Q QUARTERLY REPORT - PAGE 9
Nine Months Ended September 30, ------------------------------- 2003 2002 ---------- ---------- (Euros in thousands, except per share amounts) Net Loss As reported E (9,173) E (7,441) Deduct: Total stock-based employee compensation expense determined under fair value based methods for all awards, net of any related tax effects (13) (6) Add: Reversal of stock-based compensation expense recognized under APB Opinion No. 25 14 - ---------- ---------- Pro forma E (9,172) E (7,447) ========== ========== Basic Loss Per Share As reported E (0.54) E (0.44) ========== ========== Pro forma E (0.54) E (0.44) ========== ========== Diluted Loss Per Share As reported E (0.54) E (0.44) ========== ========== Pro forma E (0.54) E (0.44) ========== ==========
Three Months Ended September 30, ------------------------------- 2003 2002 ---------- ---------- (Euros in thousands, except per share amounts) Net Income (Loss) As reported E 876 E (20,597) Deduct: Total stock-based employee compensation expense determined under fair value based methods for all awards, net of any related tax effects (5) (2) Add: Reversal of stock-based compensation expense recognized under APB Opinion No. 25 14 - ---------- ---------- Pro forma E 885 E (20,599) ========== ========== Basic Income (Loss) Per Share As reported E 0.05 E (1.23) ========== ========== Pro forma E 0.05 E (1.23) ========== ========== Diluted Income (Loss) Per Share As reported E 0.05 E (1.23) ========== ========== Pro forma E 0.05 E (1.23) ========== ==========
NOTE 3. Earnings Per Share Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of shares outstanding during a period. Diluted earnings per share takes into consideration shares outstanding (computed under basic earnings per share) and potentially dilutive shares. The following table sets out the weighted average number of shares for the purposes of calculating basic and diluted earnings per share for the nine months ended September 30, 2003 and 2002:
Nine Months Ended September 30, ------------------------------- 2003 2002 ---------- ---------- Basic 16,887,262 16,794,899 Diluted 16,887,262 16,794,899
FORM 10-Q QUARTERLY REPORT - PAGE 10 The following table sets out the weighted average number of shares for the purposes of calculating basic and diluted earnings per share for the three months ended September 30, 2003 and 2002:
Three Months Ended September 30, -------------------------------- 2003 2002 ----------- ---------- Basic 16,911,584 16,794,899 Diluted 16,942,973 16,794,899
For the nine months ended September 30, 2003 and 2002 and the three months ended September 30, 2002, warrants and options were not included in the computation of diluted earnings per share because they were anti-dilutive. NOTE 4. Stendal Pulp Mill Project In August 2002, the Company completed financing arrangements for the design, development, financing, construction and operation of a "greenfield" project to construct and operate a 552,000-tonne softwood kraft pulp mill to be located near Stendal, Germany (the "Stendal Project"). The Stendal Project is being implemented through Zellstoff Stendal GmbH ("Stendal"), an approximately 63.6% owned subsidiary of the Company. Two minority shareholders own approximately 29.4% and 7%, respectively, of the project company. Accordingly, the results of the subsidiary are consolidated into the results of the Company. Mercer currently capitalizes the majority of the expenses and all of the interest related to the Stendal Project as it is classified as construction in progress. The construction costs of the Stendal Project will commence to depreciate when the Stendal Project is completed and commences its commercial production. Minority interests on the balance sheet represent the share capital contribution from the minority shareholders, adjusted for their proportionate share of income and loss. NOTE 5. Landqart AG The Company acquired all of the shares of Landqart AG ("Landqart"), which operates a specialty paper mill in Graubunden, Switzerland, in December 2001. The results of Landqart were consolidated into the results of the Company in 2002. The Company reorganized its interest in Landqart in December 2002 by selling a 20% interest to a Swiss bank and exchanging the remaining 80% for an indirect 39% minority interest through a limited partnership on a non-cash basis. As of December 31, 2002, the Company's interest in Landqart is no longer consolidated and is included in the Company's results on an equity basis within other income (expense). NOTE 6. Transactions with Related or Certain Other Parties A trustee and former Chief Financial Officer of the Company, became a Vice President of MFC Bancorp Ltd. ("MFC") in August 2003. As a result, MFC is considered to be a related party. Prior to June 1996, MFC was the Company's 92% owned subsidiary. In June 1996, the Company distributed shares of MFC to its shareholders by way of a special dividend-in-kind and spun off approximately 83% of the issued shares of MFC. Prior to the spin off, MFC provided and arranged for the majority of the Company's financial requirements. From time to time, the Company and MFC (and its affiliates) enter into certain arm's length transactions. As at September 30, 2003: i. The Company owes MFC and its affiliates E37.2 million (including principal, fees and accrued interest) with respect to a bridge loan arranged by a Swiss banking subsidiary of FORM 10-Q QUARTERLY REPORT - PAGE 11 MFC (of which the Company's Chairman, Chief Executive Officer ("CEO") and trustee is currently a non-executive director) as part of the financing for the Stendal Project. Subsequent to September 30, 2003, the Company repaid this bridge loan in full with proceeds from its offering of convertible senior subordinated notes (see Note 10); ii. The Company owes MFC E7.7 million bearing interest at 6%, due April 2004, unsecured; iii. The Company has a current trade receivable of E1.3 million from a subsidiary of MFC in connection with certain pulp sales made under normal market terms; iv. The Company indirectly holds approximately 575,683 common shares of MFC, representing approximately 4.4% of the outstanding common shares of MFC; and v. The Company has a loan receivable from a director of MFC in the amount of E0.2 million. In December 2002, the Company contributed its 80% interest in Landqart to a limited partnership for a 49% interest therein (see Note 5). The other limited partner of the limited partnership is MFC and the general partner is wholly owned by Cade Struktur Corporation ("CSC"), a Canadian public company in which the Company owns an approximate 26% interest and MFC owns 25% of the issued and outstanding shares. The Company's CEO previously served as a director and officer of CSC, although at the time of the Landqart reorganization, the Company's CEO was neither an officer nor a director of CSC. MFC assists with purchases and sales for Landqart. In addition, from time to time, MFC assists with supplier arrangements for Landqart. NOTE 7. New Accounting Standards In April 2003, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS 133, Accounting for Derivative Instruments and Hedging Activities. This Statement is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. In addition, all provisions of this Statement should be applied prospectively. The Company does not anticipate that this Statement will have a material impact on the Company's financial statements. In May 2003, FASB issued SFAS 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. This Statement did not have a material impact on the Company's financial statements. In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"), Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FORM 10-Q QUARTERLY REPORT - PAGE 12 FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. The Company does not anticipate that the adoption of FIN 46 will have a material impact on the results of operations and financial condition of the Company. NOTE 8. Business Segment Information The Company operates in two reportable business segments: pulp and paper. The segments are managed separately because each business requires different production and marketing strategies. Summarized financial information concerning the segments is shown in the following table:
PULP PAPER TOTAL -------- --------- --------- (Euros in thousands) Nine Months Ended September 30, 2003 - ------------------------------------ Sales to external customers E 92,418 E 42,517 E 134,935 Intersegment net sales 2,178 - 2,178 Income (loss) from operations (650) 622 (28) Segment profit 9,155 1,254 10,409 Reconciliation of profit: Total profit for reportable segments E 10,409 Elimination of intersegment profits 4,086 Loss on derivative financial instruments, construction in progress financing, net (21,939) Impairment of available-for-sale securities (5,511) Unallocated amounts, other corporate expenses (4,491) --------- Consolidated loss before income taxes and minority interest E (17,446) ========= The total assets for the Stendal pulp mill under construction were E455,253 thousand and E223,386 thousand as at September 30, 2003 and December 31, 2002, respectively. Nine Months Ended September 30, 2002 - ------------------------------------ Sales to external customers E 98,962 E 75,327 E 174,289 Intersegment net sales 3,919 - 3,919 Income from operations 8,047 1,341 9,388 Segment profit 10,659 133 10,792 Reconciliation of profit: Total profit for reportable segments E 10,792 Elimination of intersegment profits 1,295 Loss on derivative financial instruments, construction in progress financing (22,011) Unallocated amounts, other corporate expenses (5,522) --------- Consolidated loss before income taxes and minority interest E (15,446) =========
FORM 10-Q QUARTERLY REPORT - PAGE 13
PULP PAPER TOTAL -------- --------- --------- (Euros in thousands) Three Months Ended September 30, 2003 - ------------------------------------- Sales to external customers E 30,004 E 13,657 E 43,661 Intersegment net sales 633 - 633 Loss from operations (1,821) (681) (2,502) Segment loss (1,397) (1,550) (2,947) Reconciliation of loss: Total loss for reportable segments E (2,947) Elimination of intersegment profits 934 Gain on derivative financial instruments, construction in progress financing, net 6,005 Unallocated amounts, other corporate expenses (1,208) -------- Consolidated income before income taxes and minority interest E 2,784 ========
Three Months Ended September 30, 2002 - ------------------------------------- Sales to external customers E 30,878 E 23,876 E 54,754 Intersegment net sales 994 - 994 Income from operations 2,473 11 2,484 Segment loss (2,380) (3,243) (5,623) Reconciliation of loss: Total loss for reportable segments E (5,623) Elimination of intersegment profits 462 Loss on derivative financial instruments, construction in progress financing (22,011) Unallocated amounts, other corporate expenses (1,441) --------- Consolidated loss before income taxes and minority interest E (28,613) =========
NOTE 9. Settlement Expense On August 5, 2003, the Company, Greenlight Capital, L.L.C. and Greenlight Capital, Inc. (collectively, "Greenlight") entered into a settlement agreement pursuant to which, among other things: (i) Greenlight agreed to terminate a proxy solicitation which it had commenced; (ii) the Company issued options to acquire an aggregate of up to 375,000 shares of beneficial interest of the Company exercisable at a price of $4.53 per share expiring between September 22, 2003 and June 20, 2004, of which options to acquire 225,000 shares of beneficial interest were exercised on September 16, 2003; and (iii) the Company reimbursed Greenlight $250,000 for a portion of its costs and expenses of the solicitation. The Company used the Black-Scholes model to determine the fair value of these options. The Company recognized expenses aggregating approximately E0.6 million in connection with the settlement in the nine month and three month periods ended September 30, 2003. FORM 10-Q QUARTERLY REPORT - PAGE 14 NOTE 10. Subsequent Events On October 10, 2003, the Company completed the sale of $82.5 million in aggregate principal amount of convertible senior subordinated notes due October 15, 2010. The notes bear interest at a rate of 8.5% per annum and are convertible into the Company's shares of beneficial interest at a conversion price of $7.75 per share. The notes were offered only to qualified institutional buyers in reliance on Rule 144A and to certain buyers outside of the United States in reliance on Regulation S under the Securities Act of 1933, as amended. The net proceeds from the offering of approximately E76.1 million were used to repay in full the Company's indebtedness, including fees and accrued interest, under two bridge loan facilities aggregating approximately E65.9 million and the balance will be used for general corporate purposes, including working capital. NOTE 11. Accounts Payable And Accrued Expenses
As at As at September 30, 2003 December 31,2002 -------------------- ---------------- (Euros in thousands) Trade payables E 15,188 E 13,691 Derivative transactions 1,524 2,303 Break up fee on bridge loans 6,000 - Accounts payable and accrued expenses 22,259 16,872 ---------- --------- E 44,971 E 32,866 ========== =========
NOTE 12. Accounting For Derivatives The Company enters into currency swaps, currency forward contracts, and interest rate derivative contracts relating to its Rosenthal pulp mill and interest rate swap agreements and currency forward contract relating to the Stendal pulp mill. Rosenthal has entered into currency swaps in connection with its long-term indebtedness relating to the conversion of the Rosenthal mill to the production of kraft pulp to convert the Euro-denominated debt obligations into U.S. dollars. Stendal has entered into interest rate swaps in connection with its long-term indebtedness relating to the Stendal Project to fix the interest rate thereunder. Rosenthal and Stendal also enter into currency forward contracts, forward rate agreements and interest rate cap agreements, as the case may be, to reduce or limit their exposure to interest rate and currency risks, or to augment their potential gains or to reduce their potential losses. The Company adopted SFAS 133, Accounting for Derivative Instruments and Hedging Activities, effective January 1, 2001. Derivative instruments are measured at fair value at each reporting date. None of the Rosenthal and Stendal derivatives are designated hedges as defined in SFAS 133. Accordingly, any realized and unrealized gain or loss on the Company's derivatives are included in other income (loss) in the determination of the Company's net income (loss). Cumulative unrealized loss on derivatives is included in accounts payable and accrued expenses for Rosenthal and derivative financial instruments, construction in progress for Stendal, on the Company's consolidated balance sheet. The Company is exposed to very modest credit-related risk relating to non-performance by counterparties to derivative contracts. However, the Company does not expect that the counterparties, which are major financial institutions, will fail to meet their obligations. NOTE 13. RECLASSIFICATIONS Certain prior period amounts in the interim period consolidated financial statements contained herein have been reclassified to conform to the current period's presentation. FORM 10-Q QUARTERLY REPORT - PAGE 15 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS In this document: (i) unless the context otherwise requires, "we", "our", "us", the "Company" or "Mercer" mean Mercer International Inc. and its subsidiaries; (ii) information is provided as of September 30, 2003, unless otherwise stated; (iii) all references to monetary amounts are to "Euros", the lawful currency adopted by most members of the European Union, unless otherwise stated; (iv) "E" refers to Euros; and (v) a "tonne" is one metric ton or 2,204.6 pounds. The following discussion and analysis of our results of operations and financial condition for the nine months and three months ended September 30, 2003 should be read in conjunction with our consolidated financial statements and related notes included in this quarterly report, as well as our most recent annual report on Form 10-K for the fiscal year ended December 31, 2002 filed with the Securities and Exchange Commission (the "SEC"). Certain reclassifications have been made to the prior period financial statements to conform with the current period presentation. RESULTS OF OPERATIONS We operate in the pulp and paper business and our operations are located primarily in Germany. Our manufacturing facilities are comprised of: (a) a northern bleached softwood kraft ("NBSK") pulp mill operated by our wholly-owned subsidiary, Zellstoff-und Papierfabrik Rosenthal GmbH & Co., KG ("Rosenthal"), which produces softwood kraft pulp and has an annual production capacity of approximately 300,000 tonnes; (b) a "greenfield" project (the "Stendal project") to construct a new, state-of-the-art NBSK pulp mill, which is designed to have an annual production capacity of approximately 552,000 tonnes, near Stendal, Germany by our 63.6% owned subsidiary, Zellstoff Stendal GmbH ("Stendal"); and (c) two paper mills located at Heidenau and Fahrbrucke, Germany (the "paper mills"), which produce specialty papers and printing and writing papers and have an aggregate annual production capacity of approximately 85,000 tonnes. Total investment costs in respect of the Stendal project are estimated to be approximately E1.0 billion, the majority of which is being financed under a senior project finance facility (the "Stendal Loan Facility") in the amount of E828 million and arranged with Bayerische Hypo-und Vereinsbank AG. The construction of the Stendal mill commenced in August 2002 and is scheduled to be completed in the third quarter of 2004. Costs, including interest, in respect of the Stendal project are capitalized. Our financial performance depends on a number of variables that impact sales and production costs. Sales and production results are influenced largely by the market price for products and raw materials, the mix of products produced and foreign currency exchange rates. Kraft pulp and paper markets are highly cyclical, with prices determined by supply and demand. Demand for kraft pulp and paper is influenced to a significant degree by global levels of economic activity and supply is driven by industry capacity and utilization rates. Our product mix is important because premium grades of kraft pulp and specialty papers generally achieve higher prices and profit margins. Our production costs are influenced by the availability and cost of raw materials, energy and labor, and our plant efficiencies and productivity. Our main raw material is fiber in the form of wood chips and pulplogs for pulp production, and waste paper and pulp for paper production. Fiber costs are primarily affected by the supply of, and demand for, lumber and pulp, which are both highly cyclical. Production costs also depend on the total volume of production. High operating rates and production efficiencies permit us to lower our average cost by spreading fixed costs over more units. FORM 10-Q QUARTERLY REPORT - PAGE 16 Global economic conditions, changes in production capacity and inventory levels are the primary factors affecting kraft pulp and paper prices. Historically kraft pulp and paper prices have been cyclical in nature. Kraft pulp prices, which had been at historically low levels between 1996 and 1999, rebounded in 2000 as a result of recoveries in Asian economies and a decline in capacity resulting from the shut-down of unprofitable or older mills requiring environmental upgrades. This contributed to tightening inventory levels and list prices increasing to an average of approximately $710 per tonne in the fourth quarter of 2000. However, the decline of North American and European economies in 2001 caused a sharp reduction in paper demand. As a result, producer inventories increased markedly and list price levels eroded to an average of approximately $460 per tonne in late 2001. List prices for kraft pulp averaged approximately $463 per tonne in 2002. Low producer inventories in early 2003 resulted in producers increasing list prices for kraft pulp in Europe to approximately $560 per tonne in April 2003. List prices fell during the seasonally weak summer months, and were approximately $510 per tonne in August 2003. Most producers, including ourselves, announced a $20 per tonne price increase for NBSK pulp for September 2003, which was largely implemented. Further price increases of $5 to $15 per tonne were implemented by most producers, including ourselves, in October 2003. Our financial performance for any reporting period is also impacted by changes in the U.S. dollar to Euro exchange rate and in interest rates. Changes in such rates can impact both our operating results and certain derivatives Rosenthal and Stendal use to partially protect against the effect of such changes. Gains or losses on such derivatives are recorded in our earnings either as they are settled or as they are marked to market for each reporting period. See "Item 3. Quantitative and Qualitative Disclosures about Market Risk". While the majority of our sales are invoiced in Euros, pulp prices are generally based on a global industry benchmark price that is quoted in U.S. dollars. As a result, a weakening of the U.S. dollar against the Euro will generally reduce the amount of Euro revenues of our pulp operations. Most of our costs are incurred, and our debt obligations are predominantly denominated, in Euros and do not fluctuate with the U.S. dollar to Euro exchange rate. Thus, a weakening of the U.S. dollar against the Euro tends to reduce our sales revenue, gross profit and income from operations. In order to partially protect against a weakening U.S. dollar, Rosenthal uses derivatives to swap its Euro denominated debt obligations to U.S. dollars (the "Rosenthal Currency Swaps"). Such derivatives effectively convert Rosenthal's loan obligations from Euros into U.S. dollars. Rosenthal's use of U.S. dollar currency derivatives has provided additional protection and augmented its earnings and cash flow during a weakening U.S. dollar environment. Primarily as a result of a weakening of the U.S. dollar versus the Euro, we recognized a net gain of E18.3 million and E3.7 million on the derivatives of Rosenthal, including certain interest rate derivatives, in the nine months and three months ended September 30, 2003, respectively. Stendal, as required under its project financing, entered into variable-to-fixed rate swaps (the "Stendal Interest Rate Swap Agreements") to fix the interest rate for the full term of the Stendal Loan Facility. While such swaps effectively fix the interest cost on the Stendal Loan Facility and provide stability with respect to future interest payments, they have kept Stendal from benefiting from the general decline in interest rates in the later part of 2002 and the first half of 2003. These swaps are marked to market on a quarterly basis taking into account, among other things, all future payments and the yield curve. Declining interest rates in 2003 resulted in a non-cash holding loss of E22.5 million on such swaps in the nine months ended September 30, 2003. However, an increase in long-term European interest rates over the third quarter of 2003 resulted in a non-cash holding gain of FORM 10-Q QUARTERLY REPORT - PAGE 17 E5.4 million on such swaps in the three months ended September 30, 2003. Stendal also entered into a currency forward contract in connection with the Stendal Loan Facility in the third quarter of 2003. This derivative instrument is also marked to market on a quarterly basis. Primarily as a result of the weakening of the U.S. dollar versus the Euro, a non-cash holding gain of E0.6 million on such currency forward contract was recognized for both the nine and three month periods ended September 30, 2003. In the quarter ended September 30, 2003, interest rate trends have partially reversed and the Euro to U.S. dollar exchange rate fluctuated. If the U.S. dollar strengthens against the Euro, unless we settle the Rosenthal Currency Swaps, they may show a mark to market loss in future periods, although (assuming stable pulp prices) we would expect our operations to benefit from higher pulp pricing as the global U.S. dollar benchmark is translated into Euros. Furthermore, if higher interest rates continue, the Stendal variable-to-fixed rate swaps may have a mark to market non-cash holding gain in future periods, which may be offset in part by higher interest rates payable on Rosenthal's debt obligations. See "Item 3. Quantitative and Qualitative Disclosures about Market Risk". NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2002 Selected sales data for the nine months ended September 30, 2003 and 2002 is as follows:
Nine Months Ended September 30, ------------------------------- 2003 2002 ---------- ---------- (unaudited) (Euros in thousands) REVENUES BY PRODUCT CLASS Pulp(1) E 92,418 E 98,962 Papers Specialty papers(2) 30,185 60,816 Printing papers 12,332 14,511 ---------- ---------- Total papers 42,517 75,327 ========== ========== Total(1) E 134,935 E 174,289 ========== ========== REVENUES BY GEOGRAPHIC AREA Germany E 60,596 E 70,178 European Union(3) 56,555 56,967 Eastern Europe and Other 17,784 47,144 ---------- ---------- Total(1) E 134,935 E 174,289 ========== ========== SALES VOLUME BY PRODUCT CLASS (tonnes) Pulp(1) 221,926 217,555 Papers Specialty papers(2) 30,420 47,135 Printing papers 16,568 17,922 ---------- ---------- Total papers 46,988 65,057 ---------- ---------- Total(1) 268,914 282,612 ========== ==========
________ (1) Excluding intercompany sales volumes of 5,166 and 8,528 tonnes of pulp and intercompany net sales revenues of approximately E2.2 million and E3.9 million in the nine months ended September 30, 2003 and 2002, respectively. (2) As of December 31, 2002, our interest in Landqart AG is no longer consolidated and is included in our financial results on an equity basis. Accordingly, sales from the Landqart specialty paper mill are not included in our results for the nine months ended September 30, 2003, but are included for the nine months ended September 30, 2002. The Landqart specialty paper mill sold approximately 13,597 tonnes for approximately E30.4 million in the nine months ended September 30, 2002. (3) Not including Germany. In the nine months ended September 30, 2003, total revenues decreased to E144.1 million from E183.0 million in the nine months ended September 30, 2002, primarily as the current period does not include the revenues of the Landqart specialty paper mill. We reorganized our interest in FORM 10-Q QUARTERLY REPORT - PAGE 18 Landqart AG ("Landqart") in December 2002 and now account for it under the equity method. Primarily as a result thereof, pulp and paper revenues decreased to E134.9 million in the current period from E174.3 million in the comparative period in 2002. Cost of pulp and paper sales in the nine months ended September 30, 2003 decreased to E131.8 million from E152.3 million in the nine months ended September 30, 2002, primarily as a result of the deconsolidation of Landqart. Pulp sales in the current period were E92.4 million, compared to E99.0 million in the comparative period of 2002. U.S. dollar denominated list pulp price increases were more than offset by a 16.8% decline in the U.S. dollar against the Euro in the current period versus the comparative period last year. Average list prices for NBSK pulp in Europe, which were approximately E420 ($440) per tonne at the end of 2002, improved to approximately E441 ($480) per tonne in the first quarter of 2003 and approximately E484 ($550) per tonne in the second quarter of 2003, and were approximately E444 ($500) per tonne in the third quarter of 2003. Our pulp sales realizations were E416 per tonne on average in the current period, compared to E455 per tonne in the first nine months of 2002. Pulp sales by volume increased to 221,926 tonnes in the current period from 217,555 tonnes in the comparative period of 2002. Cost of sales and general, administrative and other expenses for the pulp operations were E101.1 million for the nine months ended September 30, 2003, compared to E98.8 million for the nine months ended September 30, 2002. On average, fiber costs for pulp production increased marginally to E179 per tonne in the current period from E178 per tonne in the nine months ended September 30, 2002. Depreciation within the pulp segment was E16.6 million in the current period, compared to E16.2 million in the comparative period of 2002. Our pulp operations generated an operating loss of E0.7 million in the nine months ended September 30, 2003, compared to operating income of E8.0 million in the nine months ended September 30, 2002. Results for our paper segment during the current period reflect the aforementioned exclusion of the results from the Landqart specialty paper mill, which were included in the results for the nine months ended September 30, 2002. Paper sales in the current period decreased to E42.5 million from E75.3 million in the comparative period in 2002. Sales of specialty papers in the nine months ended September 30, 2003 decreased to E30.2 million from E60.8 million in the nine months ended September 30, 2002. Total paper sales volumes decreased to 46,988 tonnes in the nine months ended September 30, 2003 from 65,057 tonnes in the nine months ended September 30, 2002. On average, prices for specialty papers realized in the nine months ended September 30, 2003 decreased by approximately 23.1% as our product mix changed upon the deconsolidation of the Landqart mill, and for printing papers decreased by approximately 8.1%, compared to the nine months ended September 30, 2002. Cost of sales and general, administrative and other expenses for the paper operations decreased to E42.8 million in the current period from E75.0 million in the comparative period of 2002 as a result of lower paper sales. Paper segment depreciation decreased to E1.5 million in the nine months ended September 30, 2003 from E4.0 million in the prior period. Our paper operations generated operating income of E0.6 million in the nine months ended September 30, 2003, compared to E1.3 million in the nine months ended September 30, 2002. Consolidated general and administrative expenses decreased to E13.0 million in the nine months ended September 30, 2003 from E20.4 million in the nine months ended September 30, 2002, FORM 10-Q QUARTERLY REPORT - PAGE 19 primarily as a result of the exclusion of the results of the Landqart mill and a decrease in professional fees in the current period. For the nine months ended September 30, 2003, we reported a loss from operations of E3.1 million, compared to income from operations of E6.6 million in the comparative period of 2002. Interest expense (excluding capitalized interest of E12.5 million in respect of the Stendal project) in the current period decreased to E6.9 million from E10.8 million in the comparative period of 2002, primarily as a result of lower borrowing costs and lower indebtedness for our operating units. During the current period, we made principal repayments of E12.7 million in respect of the indebtedness of the Rosenthal NBSK pulp mill. Pursuant to the Stendal Loan Facility, Stendal entered into the Stendal Interest Rate Swap Agreements for the full term of the facility to manage the risk exposure with respect to an aggregate maximum amount of approximately E612.6 million of the principal amount of the Stendal Loan Facility. Under these swaps, Stendal pays a fixed rate and receives a floating rate with respect to interest payments calculated on a notional amount. These swaps manage the exposure to variable cash flow risk from the variable interest payments under the Stendal Loan Facility. Stendal also entered into a currency forward contract in connection with the Stendal Loan Facility in the third quarter of 2003. These derivative instruments are marked to market at the end of each reporting period and all unrealized gains and losses are recognized in earnings for such period. A holding loss of E22.5 million and a holding gain of E0.6 million before minority interests was recognized in respect of these swaps and currency forward, respectively, for the nine months ended September 30, 2003. A holding loss of E22.0 million before minority interests was recognized in respect of the swaps in the nine months ended September 30, 2002. We determine market valuations based primarily upon values provided by our counterparties. In addition, Rosenthal has entered into the Rosenthal Currency Swaps to manage its exposure with respect to an aggregate amount of approximately E192.2 million of the principal long-term indebtedness of the Rosenthal mill (the "Rosenthal Loan Facility"). Rosenthal has also entered into currency forward contracts, forward interest rate and interest cap contracts in connection with certain indebtedness relating to the Rosenthal mill. These derivative instruments are also marked to market at the end of each reporting period, and all gains and losses are recognized in earnings for such period. In the nine months ended September 30, 2003, we recognized a net gain of E18.3 million from these derivative contracts, compared to E10.9 million in the prior period. Minority interest in the nine months ended September 30, 2003 amounted to E8.5 million and represented the proportion of the loss of the Stendal project allocated to the two minority shareholders of Stendal. Minority interest in the nine months ended September 30, 2002 amounted to E8.0 million. Our results for the nine months ended September 30, 2003 include an adjustment of E5.5 million for the non-cash aggregate pre-tax earnings impact of other-than-temporary impairment losses on certain of our available-for-sale securities. This adjustment was recorded in other income (expense) in our consolidated statement of operations. This adjustment did not affect our shareholders' equity since all of our available-for-sale securities are marked to market on a quarterly basis and unrealized gains or losses are reported through the statement of comprehensive income in our financial statements and recorded in other comprehensive income (loss) within shareholders' equity on our balance sheet. Such unrealized gains or losses, the cost base and the current marked to market value of our available-for-sale securities are further described in the notes to our annual financial statements. These are legacy investments and are unrelated to our pulp and paper operations. FORM 10-Q QUARTERLY REPORT - PAGE 20 SFAS 115, Accounting for Certain Investments in Debt and Equity Securities, EITF 03-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments, and SEC Staff Accounting Bulletin 59, Accounting for Noncurrent Marketable Equity Securities, provide guidance on determining when an impairment is other-than-temporary, which requires judgment. In making this judgment, we evaluate, among other factors, the duration and extent to which the fair value of an investment is less than its cost; the financial health of and business outlook for the investee, including factors such as industry and sector performance, changes in technology, operational and financing cash flow, the investee's financial position including its appraisal and net asset value, market prices, its business plan and investment strategy; and our intent and ability to hold the investment. For the nine months ended September 30, 2003, we reported a net loss of E9.2 million, or E0.54 per share on a basic and diluted basis, compared to a net loss of E7.4 million, or E0.44 per share on a basic and diluted basis, in the nine months ended September 30, 2002. As the Stendal project is currently under construction and because of its overall size relative to our other facilities, management uses consolidated operating results excluding derivative items relating to the Stendal project to measure the performance and results of our operating units. Management believes this measure provides meaningful information for it and securityholders on the performance of our operating facilities for a reporting period. Upon commencement of commercial production, the Stendal project will be evaluated with our other operating units. For the nine months ended September 30, 2003, we reported a net loss of E9.2 million or E0.54 per share on a diluted basis. If we had excluded items relating to the Stendal project by adding the loss on derivative financial instruments of E22.5 million on the Stendal Interest Rate Swap Agreements to, and subtracting the gain on the currency forward relating to the Stendal Loan Facility of E0.6 million and minority interest of E8.5 million from, the reported net loss of E9.2 million, we would have reported net income of E4.3 million or E0.25 per share on a diluted basis. For the nine months ended September 30, 2002, we reported a net loss of E7.4 million or E0.44 per share on a diluted basis. If we had excluded items relating to the Stendal project by adding the loss on derivative financial instruments of E22.0 million on the Stendal Interest Rate Swap Agreements to, and subtracting minority interests of E8.0 million from, the reported net loss of E7.4 million, we would have reported net income of E6.6 million or E0.39 per share on a diluted basis. This measure 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 generally accepted accounting principles ("GAAP"). We generated operating earnings before interest, taxes, depreciation and amortization ("Operating EBITDA") of E15.1 million in the current period, compared to Operating EBITDA of E26.9 million in the comparative period of 2002. Operating EBITDA is defined as income (loss) from operations plus depreciation and amortization. Operating EBITDA is calculated by adding depreciation and amortization of E18.1 million and E20.2 million to the loss from operations of E3.1 million and income from operations of E6.6 million for each of the nine months ended September 30, 2003 and 2002, respectively. Management uses Operating EBITDA as a benchmark measurement of its own operating results, and as a benchmark relative to its competitors. Management considers it to be a meaningful supplement to operating income as a performance measure primarily because depreciation expense is not an actual cash cost, and varies widely from company to company in a manner that management considers largely independent of the underlying cost efficiency of their operating facilities. In addition, we believe Operating EBITDA is commonly used by securities analysts, investors and other interested parties to evaluate our financial performance. Operating EBITDA does not reflect the impact of a number of items that affect our net income (loss), including financing costs and the effect of derivative instruments. Operating EBITDA is not a measure of FORM 10-Q QUARTERLY REPORT - PAGE 21 financial performance under accounting principles generally accepted in the United States, and should not be considered as an alternative to net income (loss) or income (loss) from operations as a measure of performance, nor as an alternative to net cash from operating activities as a measure of liquidity. 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: (i) Operating EBITDA does not reflect our cash expenditures, or future requirements, for capital expenditures or contractual commitments; (ii) Operating EBITDA does not reflect changes in, or cash requirements for, working capital needs; and (iii) Operating EBITDA does not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments, on our outstanding debt. Because of these limitations, operating EBITDA should not be considered as a measure of liquidity or cash available to us to invest in the growth of our business. Because all companies do not calculate Operating EBITDA in the same manner, Operating EBITDA as calculated by us may differ from Operating EBITDA as calculated by other companies. The following table provides a reconciliation of net loss to (loss) income from operations and Operating EBITDA for the periods indicated:
Nine Months Ended September 30, ------------------------------- 2003 2002 ---------- ---------- (unaudited) (Euros in thousands) Net loss, per income statement E (9,173) E (7,441) Less: Minority interest (8,499) (8,016) Add: Income taxes 226 11 Total other expense 14,395 22,071 ---------- ---------- (Loss) income from operations (3,051) 6,625 Add: Depreciation and amortization 18,135 20,231 ---------- ---------- Operating EBITDA E 15,084 E 26,856 ========== ==========
FORM 10-Q QUARTERLY REPORT - PAGE 22 THREE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2002 Selected sales data for the three months ended September 30, 2003 and 2002 is as follows:
Three Months Ended September 30, -------------------------------- 2003 2002 ---------- ---------- (unaudited) (Euros in thousands) REVENUES BY PRODUCT CLASS Pulp(1) E 30,004 E 30,878 Papers Specialty papers(2) 8,610 19,830 Printing papers 5,047 4,046 ---------- ---------- Total papers 13,657 23,876 ========== ========== Total(1) E 43,661 E 54,754 ========== ========== REVENUES BY GEOGRAPHIC AREA Germany E 19,682 E 23,253 European Union(3) 18,493 16,797 Eastern Europe and Other 5,486 14,704 ---------- ---------- Total(1) E 43,661 E 54,754 ========== ========== SALES VOLUME BY PRODUCT CLASS. (tonnes) Pulp(1) 73,747 67,757 Papers Specialty papers(2) 8,745 15,265 Printing papers 7,234 5,715 ---------- ---------- Total papers 15,979 20,980 ---------- ---------- Total(1) 89,726 88,737 ========== ==========
________ (1) Excluding intercompany sales volumes of 1,555 and 2,158 tonnes of pulp and intercompany net sales revenues of approximately E0.6 million and E1.0 million in the three months ended September 30, 2003 and 2002, respectively. (2) As of December 31, 2002, our interest in Landqart AG is no longer consolidated and is included in our financial results on an equity basis. Accordingly, sales from the Landqart specialty paper mill are not included in our results for the three months ended September 30, 2003, but are included for the three months ended September 30, 2002. The Landqart specialty paper mill sold approximately 4,537 tonnes for approximately E9.8 million in the three months ended September 30, 2002. (3) Not including Germany. In the three months ended September 30, 2003, total revenues decreased to E45.8 million from E56.9 million in the three months ended September 30, 2002, primarily as the current period does not include the revenues of the Landqart specialty paper mill. Primarily as a result thereof, pulp and paper revenues decreased to E43.7 million in the current period from E54.8 million in the comparative period in 2002. Cost of pulp and paper sales in the three months ended September 30, 2003 decreased to E45.4 million from E47.7 million in the three months ended September 30, 2002, primarily as a result of the deconsolidation of Landqart. Pulp sales in the current period were E30.0 million, compared to E31.0 million in the second quarter of 2003, E31.4 million in the first quarter of 2003 and E30.9 million in the comparative period of 2002. U.S. dollar denominated list pulp price increases were more than offset by a 12.6% decline in the U.S. dollar against the Euro for the current period versus the comparative period last year. Average list prices for NBSK pulp in Europe, which were approximately E486 ($480) per tonne at the end of the third quarter of 2002 and approximately E420 ($440) per tonne at the end of 2002, were approximately E444 ($500) per tonne in the current period. Our pulp sales realizations were FORM 10-Q QUARTERLY REPORT - PAGE 23 E407 per tonne on average in the current period, compared to E445 per tonne in the second quarter of 2003, E400 per tonne in the first quarter of 2003 and E456 per tonne in the third quarter of 2002. Pulp sales by volume were 73,747 tonnes in the current period, compared to 69,700 tonnes in the second quarter of 2003, 78,479 tonnes in the first quarter of 2003 and 67,757 tonnes in the comparative period of 2002. Cost of sales and general, administrative and other expenses for the pulp operations were E33.6 million for the three months ended September 30, 2003, compared to E29.9 million in the three months ended September 30, 2002. On average, per tonne fiber costs for pulp production decreased by approximately 1.7% and 5.4% compared to the three months ended June 30, 2003 and March 31, 2003, respectively, and by approximately 1.1% compared to the three months ended September 30, 2002. Fiber costs amounted to approximately E174 per tonne in the current period, compared to E176 per tonne in the third quarter of 2002. Depreciation within the pulp segment was E5.7 million in the current period, compared to E5.4 million in the comparative period of 2002. Our pulp operations generated an operating loss of E1.8 million in the three months ended September 30, 2003, compared to operating income of E2.6 million in the three months ended June 30, 2003, an operating loss of E1.4 million in the three months ended March 31, 2003 and operating income of E2.5 million in the three months ended September 30, 2002. Results for our paper segment during the current period exclude the results from the Landqart specialty paper mill, which were included in the results for the three months ended September 30, 2002. Paper sales in the current period decreased to E13.7 million from E23.9 million in the comparative period in 2002. Sales of specialty papers in the three months ended September 30, 2003 decreased to E8.6 million from E19.8 million in the three months ended September 30, 2002. Total paper sales volumes decreased to 15,979 tonnes in the three months ended September 30, 2003 from 20,980 tonnes in the three months ended September 30, 2002. On average, prices for specialty papers realized in the three months ended September 30, 2003 decreased by approximately 24.2% as our product mix changed upon the deconsolidation of the Landqart mill, and for printing papers decreased by approximately 1.5%, compared to the three months ended September 30, 2002. Cost of sales and general, administrative and other expenses for our paper operations decreased to E14.7 million in the current period from E24.3 million in the comparative period of 2002 as a result of lower paper sales. Paper segment depreciation decreased to E0.6 million in the three months ended September 30, 2003 from E1.3 million in the prior period. Our paper operations generated an operating loss of E0.7 million in the three months ended September 30, 2003, compared with operating income of E11,000 in the comparative period of 2002. Consolidated general and administrative expenses decreased to E4.2 million in the three months ended September 30, 2003 from E6.0 million in the three months ended September 30, 2002, primarily as a result of the exclusion of the results of the Landqart mill and a decrease in professional fees in the three months ended September 30, 2003. For the three months ended September 30, 2003, we reported a loss from operations of E4.3 million, compared to income from operations of E2.0 million in the comparative period of 2002. Interest expense (excluding capitalized interest of E5.3 million in respect of the Stendal project) in the current period decreased to E2.2 million from E2.7 million in the comparative period of 2002, primarily as a result of lower borrowing costs and lower indebtedness for our operating units. FORM 10-Q QUARTERLY REPORT - PAGE 24 In the current quarter, a non-cash holding gain of E5.4 million before minority interests was recognized in respect of the Stendal Interest Rate Swap Agreements, compared to recognizing a holding loss of E22.0 million in the prior period in respect of these swaps. Stendal also entered into a currency forward contract in connection with the Stendal Loan Facility in the current quarter. A holding gain of E0.6 million before minority interests was recognized in respect of the currency forward contract in the current quarter. In addition, in the three months ended September 30, 2003, we recognized a net gain of E3.7 million from the Rosenthal Currency Swaps, and currency forward contracts, forward interest rate and interest cap contracts in connection with certain indebtedness relating to the Rosenthal mill, compared to recognizing a net loss of E4.0 million in the prior period in respect thereof. Minority interest in the three months ended September 30, 2003 amounted to E(1.9) million and represented the proportion of the gain from the Stendal project allocated to the two minority shareholders of Stendal. Minority interest in the three months ended September 30, 2002 amounted to E8.0 million. For the three months ended September 30, 2003, we reported net income of E0.9 million, or E0.05 per share on a basic and diluted basis, compared to a net loss of E20.6 million, or E1.23 per share on a basic and diluted basis, in the three months ended September 30, 2002. As the Stendal project is currently under construction and because of its overall size relative to our other facilities, management uses consolidated operating results excluding derivative items relating to the Stendal project to measure the performance and results of our operating units. Management believes this measure provides meaningful information for it and securityholders on the performance of our operating facilities for a reporting period. Upon commencement of commercial production, the Stendal project will be evaluated with our other operating units. For the three months ended September 30, 2003, we reported net income of E0.9 million or E0.05 per share on a diluted basis. If we had excluded items relating to the Stendal project by subtracting the gain on the Stendal Interest Rate Swap Agreements of E5.4 million and currency forward relating to the Stendal Loan Facility of E0.6 million from, and adding minority interest of E1.9 million to, the reported net income of E0.9 million, we would have reported a net loss of E3.2 million or E0.19 per share on a diluted basis. For the three months ended September 30, 2002, we reported a net loss of E20.6 million or E1.23 per share on a diluted basis. If we had excluded items relating to the Stendal project by adding the loss on the Stendal Interest Rate Swap Agreements of E22.0 million to, and subtracting the minority interests of E8.0 million from, the reported net loss of E20.6 million, we would have reported a net loss of E6.6 million or E0.39 per share on a diluted basis. This measure has significant limitations as an analytical tool, and should not be considered in isolation, or as a substitute for an analysis of our results as reported under GAAP. We generated Operating EBITDA of E2.0 million in the current quarter, compared to an Operating EBITDA of E7.7 million in the second quarter of 2003, Operating EBITDA of E5.5 million in the first quarter of 2003 and Operating EBITDA of E8.7 million in the comparative quarter of 2002. 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 "Results of Operations - Nine Months Ended September 30, 2003 Compared to Nine Months Ended September 30, 2002" above for additional information. FORM 10-Q QUARTERLY REPORT - PAGE 25 The following table provides a reconciliation of net income (loss) to (loss) income from operations and Operating EBITDA for the periods indicated:
Three Months Ended September 30, -------------------------------- 2003 2002 ---------- ---------- (unaudited) (Euros in thousands) Net income (loss), per income statement E 876 E (20,597) Add (less): Minority interest 1,880 (8,016) Income taxes 28 - Other (income) or expense (7,084) 30,578 ---------- ---------- (Loss) income from operations (4,300) 1,965 Add: Depreciation and amortization 6,254 6,742 ---------- ---------- Operating EBITDA E 1,954 E 8,707 ========== ==========
STENDAL PROJECT STATUS We are implementing the Stendal project, which is a "greenfield" project to construct a new state-of-the-art NBSK pulp mill. The mill will have an annual production capacity of approximately 552,000 tonnes and will be located near the town of Stendal in Germany. As at September 30, 2003, progress on the Stendal project was substantially on schedule and there were no significant deviations from the project budget. At September 30, 2003, the project was approximately 83% completed and approximately 97% of the total engineering was finished. In addition, approximately 85% of the civil works was completed. Progress was made in a number of areas including the erection of the recovery boiler and power boiler, the assembly and installation of evaporation units, the erection of the main equipment for the recausticizing plant and the installation of the fiberline wash presses. In addition, a debarking drum was shipped to the site and lifted into position. Progress was also made in connection with the construction of the infrastructure of the mill site including power, gas and road connections. Power was connected to the mill site and a temporary rail connection to the mill site was available at the end of October 2003, and the gas connection to the site is expected to be completed around the end of December 2003. At the end of September 2003, Stendal employed 69 people, most of whom are part of the management organization charged with supervising the implementation and completion of the Stendal project. During the third quarter, many key positions were filled in respect of the Stendal project, including for the production and maintenance management and wood procurement and logistics operations, as well as the recovery, power and effluent plants. In addition, a number of operating personnel for the mill were hired and training of personnel in connection with the operation of the mill was commenced. A number of key positions are expected to be filled in the fourth quarter of 2003 and first quarter of 2004, including in the areas of purchasing, sales, and technology and customer support. FORM 10-Q QUARTERLY REPORT - PAGE 26 LIQUIDITY AND CAPITAL RESOURCES The following table is a summary of selected financial information for the periods indicated:
As at As at September 30, 2003 December 31,2002 -------------------- ---------------- (unaudited) (Euros in thousands) FINANCIAL POSITION Working capital E (58,049) E 6,328 Properties 649,780 441,990 Total assets(1) 828,758 599,750 Long-term debt(2) 476,126 351,878 Shareholders' equity 125,983 124,969
___________ (1) Includes approximately E404.3 million and E186.9 million related to properties construction in progress at the site of the Stendal mill as at September 30, 2003 and December 31, 2002, respectively. (2) Includes approximately E287.4 million and E146.5 million related to construction in progress at the site of the Stendal mill as at September 30, 2003 and December 31, 2002, respectively. At September 30, 2003, our cash and cash equivalents were E17.6 million, compared to E30.3 million at the end of 2002. We also had E8.4 million of cash restricted to pay construction in progress costs payable and E19.1 million of cash restricted in a debt service account, both relating to the Stendal project. In addition, we had E21.2 million of cash restricted in a debt service account relating to the Rosenthal mill. Short-term trading securities were E0.5 million at September 30, 2003, compared to E0.3 million at December 31, 2002. We had a working capital deficit of E58.0 million (including Stendal construction costs payable of E57.8 million and bridge financing and related expenses of E56.5 million) at September 30, 2003, compared to working capital of E6.3 million at December 31, 2002. The change in our working capital position is primarily attributable to an increase in Stendal construction costs payable for which we had not drawn down funds under the Stendal Loan Facility as at September 30, 2003 and the reclassification of one of our bridge loans in the principal amount of E30 million from long-term to current liabilities. The Stendal construction costs payable will be paid from the Stendal Loan Facility in the ordinary course. The bridge loans and related amounts were repaid on October 10, 2003. See "Certain Relationships" below. On October 10, 2003, we completed the sale of $82.5 million in aggregate principal amount of convertible senior subordinated notes due October 15, 2010. The notes bear interest at a rate of 8.5% per annum and are convertible into our shares of beneficial interest at a conversion price of $7.75 per share. The net proceeds from the offering of approximately E76.1 million were used to repay in full our indebtedness, including fees and accrued interest, under two bridge loan facilities aggregating approximately E65.9 million and the balance will be used for general corporate purposes, including working capital. We expect to continue to generate sufficient cash flow from operations to pay our interest and debt service expenses and meet the working and maintenance capital requirements for our current operations. We currently do not have any revolving credit facilities. From time to time, we have entered into project specific credit facilities to finance capital projects and expect to continue to do so, subject to availability. We expect to meet the capital requirements for the Stendal mill, including working capital and potential losses incurred during start-up, through shareholder advances already made to Stendal and the Stendal Loan Facility, which includes a revolving line of credit for the mill, and, when operational, cash flow from operations. FORM 10-Q QUARTERLY REPORT - PAGE 27 OPERATING ACTIVITIES Operating activities in the nine months ended September 30, 2003 provided cash of E6.9 million, compared to E24.0 million in the nine months ended September 30, 2002. Net changes in trading securities used cash of E0.2 million in the nine months ended September 30, 2003, compared to providing cash of E4.0 million in the nine months ended September 30, 2002. An increase in receivables in the current period used cash of E8.1 million, compared to a decrease in the same providing cash of E5.6 million in the nine months ended September 30, 2002. An increase in cumulative unrealized gains on derivatives used cash of E18.3 million in the current period, compared to a decrease in the same providing cash of E0.1 million in the comparative period in 2002. An increase in inventories used cash of E6.6 million in the current period, compared to E0.7 million in the comparable period of 2002. An increase in accounts payable and accrued expenses provided cash of E11.5 million in the nine months ended September 30, 2003, compared to a decrease in the same using cash of E12.4 million in the nine months ended September 30, 2002. INVESTING ACTIVITIES Investing activities in the nine months ended September 30, 2003 used cash of E225.9 million, primarily as a result of the acquisition of properties, net of investment grants received, of which E217.9 million was attributable to the Stendal project, compared to E155.0 million in the nine months ended September 30, 2002, of which E145.9 million was attributable to the Stendal project. We have applied for investment grants from the federal and state governments of Germany and have claims of E62.6 million outstanding as of September 30, 2003. We expect to receive the full amount of our currently outstanding claims within 12 months. We have received investment grants totaling E66.2 million with respect to the Stendal project in the nine months ended September 30, 2003. In accordance with our accounting policies, we do not record these grants until they are received. These grants reduce the cost basis of the assets purchased with them. Our paper mills have or will have to replace certain equipment that was damaged as a result of flooding in parts of Germany and other eastern European countries during the third quarter of 2002. The aggregate equipment costs are estimated to be approximately E3.3 million, of which approximately E1.6 million was incurred in the nine months ended September 30, 2003. We have applied for German government grants and for assistance under special credit programs instituted by the German government for flooding victims in connection with these and other related costs. As at September 30, 2003, we had received approximately E3.4 million of such grants, of which E1.8 million was recognized as income in the current period and the balance has either been deferred or deducted from the cost of property acquired. Although we have received approval for the full amount of the grants and assistance applied for, there can be no assurance that we will receive any unpaid amounts of such grants and assistance. FINANCING ACTIVITIES Financing activities provided cash of E206.2 million in the nine months ended September 30, 2003. A net increase in indebtedness, primarily related to the Stendal project, provided cash of E186.9 million and an increase in restricted cash used cash of E0.5 million in the current period. We made principal repayments of E12.7 million in connection with the Rosenthal Loan Facility in the nine months ended September 30, 2003. The issuance of shares in connection with the exercise of options provided cash of E0.9 million in the current period. Financing activities provided cash of FORM 10-Q QUARTERLY REPORT - PAGE 28 E142.7 million in the nine months ended September 30, 2002, primarily as a result of a net increase in indebtedness relating to the Stendal project. In 2003, our paper operations secured two term credit facilities aggregating approximately E2.5 million, which facilities along with certain government grants are being utilized to repair flooding damage suffered by the mills in 2002. One facility totaling approximately E1.0 million matures on June 30, 2009, bears interest at a rate of 2.65% per annum and is repayable in ten equal semi-annual installments. The other facility in the amount of approximately E1.5 million matures on June 30, 2013, bears interest at a rate of 2.65% per annum and is repayable in 15 equal semi-annual installments. Both facilities are guaranteed as to 80% thereof by a German governmental agency. An aggregate of approximately E1.8 million was utilized under these facilities as of September 30, 2003. In addition, in 2003, our Fahrbrucke paper mill secured three credit facilities aggregating E5.5 million, which facilities along with certain government grants will be utilized to finance equipment and construction costs associated with expanding, adapting and improving the efficiency of the paper machine at the mill. This will also permit the mill to produce pre-impregnated decor paper. Two of the facilities aggregating E3.5 million mature on December 30, 2012 and bear interest at rates between 4.15% and 4.3% per annum and are repayable in 16 equal semi-annual installments. The other facility in the amount of E2.0 million matures on March 31, 2009 and bears interest at a rate equal to the three-month Euribor rate plus 1.75% per annum and is repayable in 16 equal quarterly installments. All three facilities are guaranteed as to 80% thereof by a German state government. As at September 30, 2003, we had utilized approximately E2.5 million of such facilities. Other than the agreements entered into by Stendal relating to the Stendal project, we had no material commitments to acquire assets or operating businesses at September 30, 2003. We anticipate that there will be acquisitions of businesses or commitments to projects in the future. To achieve our long-term goals of expanding our asset and earnings base through the acquisition of interests in companies and assets in the pulp and paper and related businesses, and organically through high return capital expenditures at our operating facilities, we will require substantial capital resources. The required necessary resources for such long-term goals will be generated from cash flow from operations, cash on hand, borrowing against our assets, the sale of debt and/or equity securities and/or asset sales. FOREIGN CURRENCY We hold certain assets and liabilities in U.S. dollars, Swiss francs and, to a lesser extent, in Canadian dollars. Accordingly, our consolidated financial results are subject to foreign currency exchange rate fluctuations. We translate foreign denominated assets and liabilities into Euros at the rate of exchange on the balance sheet date. Unrealized gains or losses from these translations are recorded as shareholders' equity on the balance sheet and do not affect our net earnings. In the nine months ended September 30, 2003, we reported a net E1.2 million foreign exchange translation gain and, as a result, the cumulative foreign exchange translation gain increased to E4.7 million at September 30, 2003 from E3.5 million at December 31, 2002. Based upon the average exchange rate for the nine months ended September 30, 2003, the U.S. dollar decreased by approximately 16.8% in value against the Euro compared to the same period in 2002. FORM 10-Q QUARTERLY REPORT - PAGE 29 CERTAIN RELATIONSHIPS As part of the financing for the Stendal project, we obtained a E15 million bridge loan from Babcock & Brown Investment Management Partners LP ("Babcock & Brown"), and a E30 million bridge loan arranged by a Swiss banking subsidiary of MFC Bancorp Ltd. ("MFC"), with variable interest rates and specified fees, which were repaid on October 10, 2003. Babcock & Brown was our advisor in connection with the overall financing arrangements for the Stendal project. MFC was our approximately 92% owned subsidiary until June 1996, when we spun-off approximately 83% of the issued shares of MFC to our shareholders by way of a special dividend-in-kind as, among other things, there were no significant synergies between our pulp and paper business and MFC's financial services business. Prior to the spin-off, MFC provided and arranged for the majority of our financial requirements. In addition to the bridge loan, we have other indebtedness to MFC in the amount of approximately E7.7 million which matures in April 2004. We currently hold, directly and indirectly, approximately 575,683 common shares of MFC, representing approximately 4.4% of the outstanding common shares of MFC. Prior to our spin-off of MFC in 1996, Jimmy S.H. Lee, our Chairman, Chief Executive Officer and a trustee was also Chairman and Chief Executive Officer of MFC. Mr. Lee is currently a non-executive director of the Swiss banking subsidiary of MFC and he and members of his family, directly and indirectly, own approximately 2% of MFC's outstanding shares, which shares were in part acquired pursuant to the 1996 spin-off. Ian Rigg, a trustee and our former Chief Financial Officer, became a Vice President of MFC in August 2003. We have in the course of our business entered into transactions and other arrangements with MFC and its affiliates. From time to time, our Rosenthal pulp mill sells pulp to a commodities trading subsidiary of MFC, both for its own account and as an agent for sales to certain parts of Europe. All such transactions are conducted on market terms on an arm's length basis as provided for in the Rosenthal project loan agreements. In December 2002, we contributed our 80% interest in Landqart to a limited partnership in exchange for a 49% interest therein. The other limited partner of the limited partnership is MFC and the general partner is wholly-owned by Cade Struktur Corporation ("CSC"). CSC is a Canadian public company in which we own an approximate 26% interest and MFC owns 25% of CSC's issued and outstanding shares. Mr. Lee, our Chief Executive Officer, previously served as an officer and director of CSC from July 2001 to December 2002. During such time, Mr. Lee received no remuneration of any sort from CSC and did not have any ownership interest therein. At the time of the Landqart reorganization, Mr. Lee was neither an officer nor a director of CSC. MFC assists with purchases and sales for Landqart. In addition, from time to time, MFC assists with supplier arrangements for Landqart. Such arrangements are negotiated between Landqart and MFC. Mr. Lee is a director of Landqart. Through a minority owned affiliate, MFC has an indirect minority interest in AIG Altmark Industrie AG, which is a 7% shareholder of Stendal. FORM 10-Q QUARTERLY REPORT - PAGE 30 CRITICAL ACCOUNTING POLICIES The preparation of financial statements in conformity with generally accepted accounting principles requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Our management routinely makes judgments and estimates about the effects of matters that are inherently uncertain. As the number of variables and assumptions affecting the probable future resolution of the uncertainties increase, these judgments become even more subjective and complex. We have identified certain accounting policies that are the most important to the portrayal of our financial condition and results of operations. For information about our critical accounting policies, see our annual report on Form 10-K for the year ended December 31, 2002. CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION The statements in this report that are not based on historical facts are called "forward-looking statements" within the meaning of the United States Private Securities Litigation Reform Act of 1995. These statements appear in a number of different places in this report and can be identified by words such as "estimates", "projects", "expects", "intends", "believes", "plans", or their negatives or other comparable words. Also look for discussions of strategy that involve risks and uncertainties. Forward-looking statements include statements regarding the outlook for our future operations, forecasts of future costs and expenditures, the evaluation of market conditions, the outcome of legal proceedings, the adequacy of reserves, or other business plans. You are cautioned that any such forward-looking statements are not guarantees and may involve risks and uncertainties. Our actual results may differ materially from those in the forward-looking statements due to risks facing us or due to actual facts differing from the assumptions underlying our estimates. Some of these risks and assumptions include those set forth in reports and other documents we have filed with or furnished to the SEC, including in our annual report on Form 10-K for the year ended December 31, 2002 and current reports on Form 8-K furnished on May 12, 2003 and September 15, 2003. We advise you that these cautionary remarks expressly qualify in their entirety all forward-looking statements attributable to us or persons acting on our behalf. Unless required by law, we do not assume any obligation to update forward-looking statements based on unanticipated events or changed expectations. However, you should carefully review the reports and other documents we file from time to time with the SEC. CYCLICAL NATURE OF BUSINESS; COMPETITIVE POSITION The pulp and paper business is cyclical in nature and markets for our principal products are characterized by periods of supply and demand imbalance, which in turn affects product prices. The markets for pulp and paper are highly competitive and sensitive to cyclical changes in industry capacity and in the global economy, all of which can have a significant influence on selling prices and our earnings. Demand for pulp and paper products has historically been determined by the level of economic growth and has been closely tied to overall business activity. During the past three years, pulp prices have fallen significantly. Our competitive position is influenced by the availability and quality of raw materials and our experience in relation to other producers with respect to inflation, energy, transportation, labor costs, productivity and currency exchange rates. There can be no assurance that we will continue to be competitive in the future, as a result of new technological advancements or otherwise. FORM 10-Q QUARTERLY REPORT - PAGE 31 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to market risks from changes in interest rates, foreign currency exchange rates and equity prices which may affect our results of operations and financial condition and, consequently, our fair value. We manage these risks through internal risk management policies as well as the use of derivative instruments. We use derivative instruments to reduce or limit our exposure to interest rate and currency risks. We may in the future use derivative instruments to reduce or limit our exposure to fluctuations in pulp prices. We also use derivative instruments either to augment our potential gains or to reduce our potential losses, depending on our management's perception of future economic events and developments. These types of derivative instruments are generally highly speculative in nature. They are also very volatile as they are highly leveraged given that margin requirements are relatively low in proportion to notional amounts. Many of our strategies, including the use of derivative instruments and the types of derivative instruments selected by us, are based on historical trading patterns and correlations and our management's expectations of future events. However, these strategies may not be fully effective in all market environments or against all types of risks. Unexpected market developments may affect our risk management strategies during this time, and unanticipated developments could impact our risk management strategies in the future. If any of the variety of instruments and strategies we utilize are not effective, we may incur losses. Rosenthal has entered into the Rosenthal Currency Swaps in connection with our long-term indebtedness relating to the conversion of the Rosenthal mill to the production of kraft pulp. These derivatives have been contracted by Rosenthal using a dedicated credit line within the Rosenthal Loan Facility and assigned for this purpose, and are subject to prescribed controls, including certain maximum amounts for notional and at-risk amounts. As kraft pulp prices are quoted in U.S. dollars and the majority of our business transactions are denominated in Euros, Rosenthal has entered into the Rosenthal Currency Swaps to reduce the effects of exchange rate fluctuations between the U.S. dollar and the Euro on notional amounts under the Rosenthal Loan Facility. Under the Rosenthal Currency Swaps, Rosenthal effectively pays the principal and interest in U.S. dollars and at U.S. dollar borrowing rates. In the nine months ended September 30, 2003, Rosenthal entered into an additional Rosenthal Currency Swap for the notional amount of E124.2 million maturing on September 30, 2008. In addition, Rosenthal has entered into interest rate contracts to either fix or limit the interest rates in connection with certain of its indebtedness, and various currency forwards to reduce or limit its exposure to currency risks and to augment its potential gains or to reduce its potential losses. Stendal has entered into the Stendal Interest Rate Swap Agreements in connection with its long-term indebtedness relating to the Stendal project to fix the interest rate under the Stendal Loan Facility at the then low level, relative to its historical trend and projected variable interest rate. Under the Stendal Interest Rate Swap Agreements, Stendal pays a fixed rate and receives a floating rate with interest payments being calculated on a notional amount. The interest rates payable under the Stendal Loan Facility were swapped at the fixed rates based on the Eur-Euribor rate for the repayment periods of the tranches under the Stendal Loan Facility. Stendal effectively converted the Stendal Loan Facility from a variable interest rate loan into a fixed interest rate loan, thereby reducing interest rate uncertainty. FORM 10-Q QUARTERLY REPORT - PAGE 32 In the third quarter of 2003, Stendal also entered into a currency forward contract for the notional amount of $10.0 million maturing in August 2004 to reduce or limit its exposure to currency risks and to augment its potential gains or reduce its potential losses. For more information concerning market risk and our derivative instruments, see our annual report on Form 10-K for the year ended December 31, 2002 on file with the SEC and current report on Form 8-K dated September 15, 2003 furnished to the SEC. ITEM 4. CONTROLS AND PROCEDURES Our management, with the participation of our Principal Executive Officer and Principal Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")), as of the end of the period covered by this report. Based on such evaluation, our Principal Executive Officer and Principal Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports that we file or submit under the Exchange Act. It should be noted that any system of controls is based in part upon certain assumptions designed to obtain reasonable (and not absolute) assurance as to its effectiveness, and there can be no assurance that any design will succeed in achieving its stated goals. In addition, no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred 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 33 PART II. OTHER INFORMATION ----------------- ITEM 1. LEGAL PROCEEDINGS We are subject to routine litigation incidental to our business. We do not believe that the outcome of such litigation will have a material adverse effect on our business or financial condition. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS On October 10, 2003, we completed the sale of $82.5 million in aggregate principal amount of convertible senior subordinated notes due October 15, 2010. The notes bear interest at a rate of 8.5% per annum and are convertible into our shares of beneficial interest at a conversion price of $7.75 per share, which is equal to a conversion rate of approximately 129 shares per $1,000 principal amount of the notes, subject to adjustment for certain customary anti-dilution matters. The notes were offered only to qualified institutional buyers in reliance on Rule 144A and to certain buyers outside of the United States in reliance on Regulation S under the Securities Act of 1933, as amended. The notes were sold to RBC Dain Rauscher Inc., as the initial purchaser. The aggregate initial purchaser's discounts of the offering were approximately $3.4 million. In connection with the sale of the notes, we amended our shareholder rights plan to provide that the determination of the percentage of outstanding shares of beneficial interest beneficially owned by a person, entity or group of associated persons shall be based upon the number of shares of beneficial interest outstanding as at the date of determination as if the then outstanding notes had been fully converted and to amend the percentage at which a person, entity or group of associated persons becomes an "acquiring person" as defined in the rights plan from 25 percent to 15 percent. See our Form 8-K dated October 15, 2003 on file with the SEC. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS We held our annual meeting of shareholders on August 22, 2003. At the meeting, two Class III trustees were elected to our board of trustees, the appointment of Deloitte & Touche LLP as our independent auditors was ratified and our 2003 Non-Qualified Stock Option Plan was adopted. The votes cast by shareholders at the meeting as to the election of trustees were as follows:
Abstentions and Votes For Votes Withheld Broker Non-Votes --------- -------------- ---------------- Kenneth A. Shields 9,525,666 30,907 - Guy W. Adams . . . 9,330,042 226,531 -
Jimmy S.H. Lee, C.S. Moon, William McCartney, R. Ian Rigg and Graeme Witts continued their respective terms as trustees. In connection with the ratification of the appointment of Deloitte & Touche LLP as our independent auditors, shareholders cast 9,501,773 votes in favour of and 4,500 votes against the ratification of such appointment, and there were 50,300 abstentions and broker non-votes. In connection with the approval of the adoption of our 2003 Non-Qualified Stock Option Plan, shareholders cast 7,112,181 votes in favour of and 2,424,084 votes against the adoption of such plan, and there were 20,308 abstentions and broker non-votes. FORM 10-Q QUARTERLY REPORT - PAGE 34 We also held a special meeting of shareholders on October 3, 2003 at which shareholder approval was sought and obtained for the issuance of up to 10,750,000 of our shares of beneficial interest upon the conversion of convertible senior subordinated notes that we proposed to issue in a private offering, subject to adjustment for customary anti-dilution matters, as described in our proxy statement dated September 22, 2003. At the special meeting, 9,109,861 shares were voted in favour of and 90,665 shares were voted against the proposal, and there were 3,001 abstentions and broker non-votes. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS 4.1 Indenture dated as of October 10, 2003 between Mercer International Inc. and Wells Fargo Bank Minnesota, N.A. Incorporated by reference to the Company's Form 8-K dated October 15, 2003, previously filed with the SEC. 4.2 Registration Rights Agreement dated as of October 10, 2003 between Mercer International Inc. and RBC Dain Rauscher Inc. Incorporated by reference to the Company's Form 8-K dated October 15, 2003, previously filed with the SEC. 4.3 First Amendment dated as of October 5, 2003 to the Rights Agreement dated as of August 20, 1993 between Mercer International Inc. and Computershare Trust Company of Canada. Incorporated by reference to the Company's Form 8-K dated August 6, 2003, previously filed with the SEC. 4.4 Second Amendment dated as of October 10, 2003 to the Rights Agreement dated as of August 20, 1993 between Mercer International Inc. and Computershare Trust Company of Canada. Incorporated by reference to the Company's Form 8-K dated October 15, 2003, previously filed with the SEC. 10.1 Purchase Agreement dated as of October 6, 2003 between Mercer International Inc. and RBC Dain Rauscher Inc. 10.2 Employment Agreement dated for reference August 7, 2003 between Mercer International Inc. and David Gandossi. Incorporated by reference to the Company's Form 8-K dated August 11, 2003, previously filed with the SEC. 10.3 Settlement Agreement dated as of August 5, 2003 among Mercer International Inc., Greenlight Capital, L.L.C. and Greenlight Capital, Inc. Incorporated by reference to the Company's Form 8-K dated August 6, 2003, previously filed with the SEC. 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 FORM 10-Q QUARTERLY REPORT - PAGE 35 Commission and are not "filed" for the purposes of liability under the Securities Exchange Act of 1934, as amended; and (ii) are not to be subject to automatic incorporation by reference into any of the Company's registration statements filed under the Securities Act of 1933, as amended for the purposes of liability thereunder or any offering memorandum, unless the Company specifically incorporates them by reference therein. (b) REPORTS ON FORM 8-K The Company filed the following reports on Form 8-K with respect to the indicated items during the third quarter of 2003: Form 8-K dated July 16, 2003 Item 4. Changes in Registrant's Certifying Accountant Form 8-K dated August 6, 2003 Item 5. Other Events and Regulation FD Disclosure Item 7. Exhibits Form 8-K/A dated August 6, 2003 Item 4. Changes in Registrant's Certifying Accountant Item 7. Exhibits Form 8-K dated August 11, 2003 Item 5. Other Events and Regulation FD Disclosure Item 7. Exhibits Form 8-K dated August 14, 2003 Item 12. Results of Operations and Financial Condition Item 7. Exhibits Form 8-K dated September 12, 2003 Item 5. Other Events and Regulation FD Disclosure Item 7. Exhibits Form 8-K dated September 15, 2003 Item 9. Regulation FD Disclosure Form 10-K dated October 6, 2003 Item 5. Other Events and Regulation FD Disclosure Item 7. Exhibits Form 8-K dated October 10, 2003 Item 5. Other Events and Regulation FD Disclosure Item 7. Exhibits Form 8-K dated October 15, 2003 Item 5. Other Events and Regulation FD Disclosure Item 7. Exhibits FORM 10-Q QUARTERLY REPORT - PAGE 36 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. MERCER INTERNATIONAL INC. By: /s/ David M. Gandossi -------------------------- David M. Gandossi Secretary and Chief Financial Officer Date: November 13, 2003 FORM 10-Q QUARTERLY REPORT - PAGE 37 EX-31.1 3 doc3.txt CERTIFICATION OF PERIODIC REPORT I, Jimmy S.H. Lee, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Mercer International Inc. (the "Registrant"); 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this quarterly report; 4. The Registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the Registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others with those entities, particularly during the period in which this quarterly report is being prepared; b) Evaluated the effectiveness of the Registrant's disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this quarterly report based on such evaluation; and c) Disclosed in this quarterly report any change in the Registrant's internal control over financial reporting that occurred during the Registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Registrant's internal control over financial reporting; and 5. The Registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant's auditors and the audit committee of the Registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the Registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal control over financial reporting. Date: November 13, 2003 /s/ Jimmy S.H. Lee ------------------------- Jimmy S.H. Lee Chief Executive Officer EX-31.2 4 doc4.txt CERTIFICATION OF PERIODIC REPORT I, David M. Gandossi, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Mercer International Inc. (the "Registrant"); 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this quarterly report; 4. The Registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the Registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others with those entities, particularly during the period in which this quarterly report is being prepared; b) Evaluated the effectiveness of the Registrant's disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this quarterly report based on such evaluation; and c) Disclosed in this quarterly report any change in the Registrant's internal control over financial reporting that occurred during the Registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Registrant's internal control over financial reporting; and 5. The Registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant's auditors and the audit committee of the Registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the Registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal control over financial reporting. Date: November 13, 2003 /s/ David M. Gandossi ------------------------ David M. Gandossi Chief Financial Officer EX-32.1 5 doc5.txt CERTIFICATION OF PERIODIC REPORT I, Jimmy S.H. Lee, Chief Executive Officer of Mercer International Inc. (the "Company"), certify pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, that: (1) the Quarterly Report on Form 10-Q of the Company for the quarterly period ended September 30, 2003 (the "Report") fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: November 13, 2003 /s/ Jimmy S.H. Lee ----------------------- Jimmy S.H. Lee Chief Executive Officer _____________________________ A signed original of this written statement required by Section 906 has been provided to Mercer International Inc. and will be retained by Mercer International Inc. and furnished to the Securities and Exchange Commission or its staff upon request. EX-32.2 6 doc6.txt CERTIFICATION OF PERIODIC REPORT I, David M. Gandossi, Chief Financial Officer of Mercer International Inc. (the "Company"), certify pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, that: (1) the Quarterly Report on Form 10-Q of the Company for the quarterly period ended September 30, 2003 (the "Report") fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: November 13, 2003 /s/ David M. Gandossi ------------------------ David M. Gandossi Chief Financial Officer _____________________________ A signed original of this written statement required by Section 906 has been provided to Mercer International Inc. and will be retained by Mercer International Inc. and furnished to the Securities and Exchange Commission or its staff upon request. EX-10.1 7 doc2.txt 8 % Convertible Senior Subordinated Notes due October 15, 2010 MERCER INTERNATIONAL INC. PURCHASE AGREEMENT ------------------ October 6, 2003 RBC DAIN RAUSCHER INC. c/o RBC Capital Markets 200 Bay Street Royal Bank Plaza Toronto, Ontario M5J 2W7 Ladies and Gentlemen: Mercer International Inc., a business trust organized and existing under the laws of Washington (the "COMPANY"), proposes, subject to the terms and conditions stated herein, to issue and sell to RBC Dain Rauscher Inc. (the "INITIAL PURCHASER") $82,500,000 in aggregate principal amount of the Company's 8 % Convertible Senior Subordinated Notes due October 15, 2010 (the "NOTES"). The Notes are to be issued pursuant to an indenture (the "INDENTURE") to be entered into as of the Closing Date (hereinafter defined), between the Company and Wells Fargo Bank Minnesota, N.A., as trustee (the "TRUSTEE"), on the terms set forth therein. The Notes will be convertible into the Company's shares of beneficial interest (the "CONVERSION SHARES") par value $1.00 per share (the "SHARES OF BENEFICIAL INTEREST"). The holders of the Notes will be entitled to the benefits of a registration rights agreement to be dated as of the Closing Date (the "REGISTRATION RIGHTS AGREEMENT") between the Company and the Initial Purchaser pursuant to which the Company agrees to file with the Securities and Exchange Commission (the "COMMISSION") a shelf registration statement pursuant to Rule 415 of the Securities Act (as defined below) relating to the resale of such Notes and the Shares of Beneficial Interest issuable upon conversion of the Notes by holders thereof. This Agreement, the Notes, the Indenture and the Registration Rights Agreement are hereinafter sometimes referred to collectively as the "OPERATIVE DOCUMENTS." The Company has prepared a preliminary offering memorandum (the "PRELIMINARY OFFERING MEMORANDUM") and a final offering memorandum (the "OFFERING MEMORANDUM") (each as amended and supplemented from time to time and including all Incorporated Documents (as defined below)), with respect to the offering and sale of the Notes (the "OFFERING") in the United States and in the provinces of British Columbia, Alberta, Ontario and Quebec (the "PRIVATE PLACEMENT PROVINCES") and in other countries selected by the Initial Purchaser. The Offering Memorandum used in connection with the offering and sale of the Notes in the Private Placement Provinces will include certain additional Information relating to the Offering in Canada and legends and other prescribed Disclosure (the "WRAP INFORMATION") in accordance with applicable Canadian securities legislation in the Private Placement Provinces and the rules, regulations, instruments and orders under such legislation (the "CANADIAN SECURITIES LAWS") and, for purposes of this Agreement, references to the "Offering Memorandum" shall be deemed to include, in the case of the Offering in Canada, the Wrap Information. The Notes and the Shares of Beneficial Interest issuable upon conversion of the Notes have not been registered under the Securities Act of 1933, as amended (the "SECURITIES ACT"), and the Notes are being sold to the Initial Purchaser in reliance on exemptions from or in transactions not subject to the registration requirements of the Securities Act. The Initial Purchaser has advised the Company that it will make offers (the "EXEMPT RESALES") of the Notes on the terms and conditions set forth herein and in the Offering Memorandum solely to (i) persons the Initial Purchaser reasonably believes to be "qualified institutional buyers," ("QIBS") as defined in Rule 144A under the Securities Act ("RULE 144A") and (ii) certain non-U.S. persons outside the United States in reliance upon Regulation S under the Securities Act ("REGULATION S") and, in the case of Regulation S offers and sales in a Private Placement Province, through a dealer registered in such Private Placement Province or under an exemption from the registered dealer requirement under the Canadian Securities Laws and in accordance with exemptions from the prospectus requirements under the Canadian Securities Laws as set out in the Wrap Information (each, an "OFFSHORE INVESTOR"). The QIBs and the Offshore Investors are collectively referred to herein as the "ELIGIBLE PURCHASERS." As used herein, the term "INCORPORATED DOCUMENTS" includes (i) the Company's annual report on Form 10-K for the year ended December 31, 2002, (ii) its definitive proxy statements on Schedule 14A filed with the Commission on August 11, 2003 and September 23, 2003, (iii) its quarterly reports on Form 10-Q for the periods ended March 31, 2003 and June 30, 2003, (iv) its current reports on Form 8-K filed with the Commission on May 5, 2003, May 9, 2003, May 13, 2003, May 13, 2003, June 18, 2003, July 17, 2003, August 7, 2003, August 11, 2003, August 14, 2003, September 12, 2003 and September 16, 2003, (v) its current report on Form 8-K/A filed with the Commission on August 7, 2003, (vi) any future filings (but excluding information furnished to the Commission pursuant to Item 9 or Item 12 of Form 8-K) the Company makes with the Commission under Section 13(a), 13(c), 14 or 15(d) of the Securities Exchange Act of 1934, as amended (the "EXCHANGE ACT"), during the period from the date of the Preliminary Offering Memorandum until all the Notes are sold by the Initial Purchaser, and (vii) any amendments or supplements to any of the foregoing. 1. Representations and Warranties of the Company. The Company -------------------------------------------------- represents and warrants to, and agrees with, the Initial Purchaser that: (a) The Preliminary Offering Memorandum, as of its date, and the Offering Memorandum as of its date and as of the Closing Date, will not, and any supplement or amendment will not, contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading. The representations and warranties in the preceding sentence do not apply to statements or omissions made in reliance upon and in conformity with information furnished in writing to the Company by the Initial 2 Purchaser and its affiliates specifically for use therein, it being understood and agreed that the only such information is that described as such in Section 7(b) hereof. (b) The Incorporated Documents, at the time they were or are filed with the Commission, conformed and will conform in all material respects with the requirements of the Exchange Act and the rules and regulations of the Commission thereunder, including the filing of all exhibits required to be filed therewith. (c) The Company has been duly organized and is validly existing as a Massachusetts business trust in good standing under the laws of the State of Washington with power and authority (corporate and other) to own its properties and conduct its business as described in the Offering Memorandum; and the Company is duly qualified to do business and is in good standing as a foreign corporation in each jurisdiction in which the character or location of its properties (owned, leased or licensed) or the nature or conduct of its business makes such qualification necessary, except for those failures to be so qualified or in good standing which will not in the aggregate have a material adverse effect on the condition (financial or otherwise), results of operations, business, properties or the construction, development or planned operation of the Stendal Mill or of the Company and its subsidiaries taken as a whole (a "MATERIAL ADVERSE EFFECT"); all of the issued and outstanding Shares of Beneficial Interest of the Company have been duly authorized and validly issued and are fully paid and nonassessable. (d) Each subsidiary of the Company has been duly incorporated or organized and is an existing corporation, partnership or limited partnership in good standing under the laws of the jurisdiction of its incorporation or organization, with power and authority (corporate and other) to own its properties and conduct its business as described in the Offering Memorandum; and each subsidiary of the Company is duly qualified to do business as a foreign corporation in good standing in all other jurisdictions in which its ownership or lease of property or the conduct of its business requires such qualification, except to the extent that the failure to be so qualified would not, individually or in the aggregate, have a Material Adverse Effect; all of the issued and outstanding capital stock of each subsidiary of the Company has been duly authorized and validly issued and is fully paid and nonassessable; and the capital stock of each subsidiary owned by the Company, directly or through subsidiaries, is owned free from liens, encumbrances and defects, other than liens and encumbrances granted pursuant to the terms of the "Bridge Loans", the "Stendal Loan Facility" and/or the "Rosenthal Loan Facility" (as such terms are defined in the Offering Memorandum). (e) Except as described in the Offering Memorandum, since the date on which information is given in the Offering Memorandum, (i) there has been no material adverse change or any development involving a prospective material adverse change in the business, properties, operations, condition (financial or otherwise) or results of operations, assets, liabilities, properties or the construction, development or planned operation of the Stendal Mill of the Company and its subsidiaries taken as a whole, whether or not arising from transactions in the ordinary course of business, and since the respective dates as of which information is given in the Offering Memorandum ("Material Adverse Change"), (ii) neither the Company nor any of its subsidiaries has incurred or undertaken any material liabilities or obligations, direct or contingent, other than as incurred under the "Stendal Loan Facility", or entered into any material transactions, or (iii) declared or paid any dividends or made any distribution of any kind with 3 respect to its capital stock and, except as described in the Offering Memorandum there has not been any change in the capital stock, or any material change in the short-term or long-term debt, or any issuance of options, warrants, convertible securities or other rights to purchase the capital stock, of the Company or any of its subsidiaries,. (f) This Agreement and the transactions contemplated herein have been duly authorized by the Company, and this Agreement has been duly executed and delivered by the Company. (g) The Indenture has been duly authorized by the Company, and, when duly executed and delivered by the Company and duly authorized, executed and delivered by the Trustee, will constitute a legal, valid and binding obligation of the Company, enforceable against the Company in accordance with its terms, subject to applicable bankruptcy, insolvency, fraudulent conveyance, moratorium, reorganization or similar laws relating to or affecting the rights of creditors generally and subject to general principles of equity. (h) The authorized issued and outstanding Shares of Beneficial Interest of the Company are as set forth in the Offering Memorandum in the column entitled "June 30, 2003 - Actual" under the caption "Capitalization" (except for subsequent issuances pursuant to this Agreement or pursuant to reservations, agreements or option plans described in the Offering Memorandum or the Incorporated Documents) and have been duly and validly authorized and issued, are fully paid and non-assessable and were not issued in violation of or subject to any preemptive or similar rights that entitle or will entitle any person to acquire any Shares of Beneficial Interest from the Company upon issuance by the Company of the Conversion Shares upon conversion of the Notes; the Conversion Shares to be issued upon conversion of the Notes have been duly authorized and reserved for issuance upon such conversion and when issued upon such conversion by the Company in accordance with the terms of the Notes and the Indenture, will be validly issued, fully paid and non-assessable, and will not be issued in violation of or subject to any preemptive or similar rights that entitle or will entitle any person to acquire any Shares of Beneficial Interest from the Company upon such issuance of the Conversion Shares by the Company. (i) The Notes have been duly authorized by the Company for issuance and sale to the Initial Purchaser pursuant to this Agreement, and when issued and authenticated in accordance with the terms of the Indenture and delivered against payment therefor in accordance with the terms thereof and hereof, assuming the due authorization, execution and delivery of the Indenture by the Trustee, will be a legal, valid and binding obligation of the Company, enforceable against the Company in accordance with their terms and entitled to the benefits of the Indenture, subject to applicable bankruptcy, insolvency, fraudulent conveyance, moratorium, reorganization or similar laws relating to or affecting the rights of creditors generally and subject to general principles of equity. The Notes and the Indenture will conform in all material respects to the descriptions thereof contained in the Offering Memorandum. (j) The Registration Rights Agreement has been duly authorized by the Company, and, assuming due execution and delivery by the Initial Purchaser, when executed and delivered by the Company, will be a legal, valid and binding obligation of the Company, enforceable against the Company in accordance with its terms, subject to applicable bankruptcy, 4 insolvency, fraudulent conveyance, moratorium, reorganization or similar laws affecting the rights of creditors generally and subject to general principles of equity. The Registration Rights Agreement will conform in all material respects to the description thereof contained in the Offering Memorandum. (k) The execution, delivery, and performance of the Operative Documents and the consummation of the transactions contemplated therein, including, without limitation, the issuance and delivery of the Conversion Shares upon due conversion of the Notes in accordance with the terms of the Notes and the Indenture, do not and will not (i) as at the Closing Date and assuming the application of funds as set forth in the "Use of Proceeds" section of the Offering Memorandum conflict with or result in a breach of any of the terms and provisions of, or constitute a default (or an event which with notice or lapse of time, or both, would constitute a default) under, or result in the creation or imposition of any lien, charge or encumbrance upon any property or assets of the Company or any of its subsidiaries pursuant to, any indenture, mortgage, deed of trust, loan agreement or other agreement, instrument, franchise, license or permit to which the Company or any of its subsidiaries is a party or by which the Company or any of its subsidiaries or their respective properties or assets may be bound or (ii) violate or conflict with any provision of the Declaration of Trust or by-laws of the Company or any of the governing instruments of its subsidiaries or (iii) violate or conflict with any judgment, decree, order, statute, rule or regulation of any court or any public, governmental or regulatory agency or body having jurisdiction over the Company or any of its subsidiaries or any of their respective properties or assets. (l) No consent, approval, authorization, order, registration, filing, qualification, license or permit of or with any court or any public, governmental or regulatory agency or body having jurisdiction over the Company or any of its subsidiaries or any of their respective properties or assets is required for the execution, delivery and performance of the Operative Documents or the consummation of the transactions contemplated therein, including, without limitation, the issuance, sale and delivery of the Notes to be issued, sold and delivered by the Company hereunder and the issuance and delivery of the Conversion Shares upon due conversion of the Notes in accordance with the terms of the Notes, except the filing of (i) the Offering Memorandum and Wrap Information with the Ontario Securities Commission, (ii) reports of trades made in the relevant jurisdiction and any required fees, with the securities commission or similar regulatory authority in the applicable Private Placement Provinces (the "CANADIAN COMMISSIONS"), (iii) a certificate prepared in accordance with Policy Statement 41-601Q of the Commission des valeurs mobilieres du Quebec, and (iv) if required, a private placement questionnaire and undertaking by each Canadian purchaser of the Notes in the prescribed form with the Toronto Stock Exchange (the "TSX"), and (v) such consents, approvals, authorizations, orders, registrations, filings, qualifications, licenses and permits as may be required (A) under state securities or blue sky laws or the laws of countries outside the U.S. and Canada in connection with the purchase and distribution of the Notes by the Initial Purchaser in the manner contemplated herein and in the Offering Memorandum or (B) in connection with the Company's obligations under the Registration Rights Agreement, including the qualification of the Indenture under the Trust Indenture Act. (m) Except as disclosed in the Offering Memorandum or the Incorporated Documents, or as would not have a Material Adverse Effect, each of the Company and its 5 significant subsidiaries (i) possesses the permits, licenses, consents and other authorizations all grants, subsidies, guarantees, consents, approvals and other authorizations from appropriate German government agencies ("STATE AID GRANTS") (collectively, the "GOVERNMENT LICENSES") issued by, and has made all filings with, the appropriate regulatory entities necessary to own, lease and operate its properties and to conduct businesses now operated or, in the case of the plant under construction in Stendal, Germany, proposed to be operated by it, and (ii) all such Government Licenses are valid and in full force and effect. Except as will be described in the Offering Memorandum, or as would not have a Material Adverse Effect: (i) each of the Company and its significant subsidiaries is in compliance with the terms and conditions of all such Government Licenses; (ii) neither the Company nor any subsidiary has received any notice from any regulatory entity that allows, or after notice or lapse of time or both, would allow revocation, modification, suspension or termination of any Government License including any claim against the Company or any of the subsidiaries for repayment of any benefit received under State Aid Grants or would result in any other material impairment of the rights of the holder of any such Government License; and (iii) to the knowledge of the Company and its subsidiaries, no regulatory entity is considering limiting, suspending or revoking any Government License or is investigating any of them, other than ordinary course administrative and covenant compliance reviews. (n) Except as disclosed in the Offering Memorandum or the Incorporated Documents, there is no legal or governmental proceeding to which the Company or any of its subsidiaries is a party, or of which any property of the Company or any of its subsidiaries is the subject which, singularly or in the aggregate, if determined adversely to the Company or any of its subsidiaries, would reasonably be expected to have a Material Adverse Effect, and to the knowledge of the Company, no such proceeding is threatened or contemplated by governmental authorities or threatened or contemplated by others. (o) Neither the Company nor any of its affiliates has taken prior to the date of this Agreement, directly or indirectly, any action designed to cause or result in, or which constitutes or which might reasonably be expected to constitute, the stabilization or manipulation of the price of any security of the Company or any of its subsidiaries to facilitate the sale or resale of the Notes. (p) Peterson Sullivan P.L.L.C., who have audited the financial statements and supporting schedules as set forth or incorporated by reference in the Offering Memorandum, are, to the Company's knowledge, independent public accountants as required by the Securities Act and the rules and regulations of the Commission promulgated thereunder (the "RULES AND REGULATIONS"), and are not and have not engaged in any non-audit activities that are prohibited by Section 201(a) of the Sarbanes-Oxley Act of 2002. (q) Deloitte & Touche LLP, who have performed the procedures specified by the American Institute of Certified Public Accountants as described in Statement of Accounting Standard No. 100 with respect to the six month period ended June 30, 2003 as set forth or incorporated by reference in the Offering Memorandum, are, to the Company's knowledge, independent public accountants as required by the Securities Act and the Rules and Regulations, and are not and have not engaged in any non-audit activities that are prohibited by Section 201(a) of the Sarbanes-Oxley Act of 2002. 6 (r) The financial statements, including the notes thereto, and supporting schedules as set forth or incorporated by reference in the Offering Memorandum present fairly in all material respects the financial position and results of operations of the Company and its consolidated subsidiaries and as of the dates indicated and for the periods specified; except as otherwise stated in the Offering Memorandum, such financial statements have been prepared in conformity with United States generally accepted accounting principles applied on a consistent basis throughout the periods involved. (s) Except as disclosed in the Offering Memorandum, no holder of securities of the Company has any rights to the registration of securities of the Company as a result of the execution of the Operative Documents or the consummation of the transactions contemplated therein (other than pursuant to the Registration Rights Agreement), and any such rights so disclosed have either been fully complied with by the Company or effectively waived by the holders thereof. (t) Except as disclosed in the Offering Memorandum, no relationship, direct or indirect, exists between or among the Company or any of its subsidiaries on the one hand, and the trustees, directors, officers, stockholders, customers or suppliers of the Company or any of its subsidiaries on the other hand, that would be required by the Securities Act to be described in the Offering Memorandum if the Offering Memorandum were a prospectus included in a registration statement on Form S-1 filed with the Commission. (u) The Company is not, and after giving effect to the offering and sale of the Notes will not be, an "investment company" under the Investment Company Act of 1940, as amended. (v) The Company and its significant subsidiaries have good and marketable title in fee simple to all real property owned by the Company and its significant subsidiaries and have good and marketable title to all personal property owned by them, in each case free and clear of all liens, encumbrances and defects, except such as: (i) are described in the Offering Memorandum or the Incorporated Documents; or (ii) would not singularly or in the aggregate result in a Material Adverse Effect; and any real property and buildings held under lease by the Company or any of its significant subsidiaries are held by them under valid, subsisting and enforceable leases with such exceptions as are not material to the Company and its subsidiaries taken as a whole, and do not materially interfere with the ongoing use made of such property and buildings by the Company and its significant subsidiaries. (w) Except as would not have a Material Adverse Effect, the Company and each of its significant subsidiaries have accurately prepared and timely filed all federal, state, provincial and other tax returns that are required to be filed by it and has paid or made provision for the payment of all taxes, assessments, governmental or other similar charges, including without limitation, all sales and use taxes and all taxes that the Company and each of its subsidiaries is obligated to withhold from amounts owing to employees, creditors and third parties, with respect to the periods covered by such tax returns (whether or not such amounts are shown as due on any tax return). Except as would not have a Material Adverse Effect, no deficiency assessment with respect to a proposed adjustment of the Company's or any of its subsidiaries' federal, state, provincial or other taxes is pending or, to the knowledge of the 7 Company, threatened. There is no tax lien, whether imposed by any federal, state, provincial or other taxing authority, outstanding against the assets, properties or business of the Company or any of its significant subsidiaries. (x) Each of the Company and its subsidiaries (i) makes and keeps accurate books and records and (ii) maintains internal accounting controls that provide reasonable assurance that (A) transactions are executed in accordance with management's authorization, (B) transactions are recorded as necessary to permit preparation of its financial statements and to maintain accountability for its assets, (C) access to its assets is permitted only in accordance with management's authorization, direction or policies and (D) the reported accountability for its assets is compared with existing assets at reasonable intervals. Since December 31, 2002, neither the Company nor any of its subsidiaries has made any change in its internal controls that would be reportable in any filing under the Exchange Act pursuant to Item 307 of Regulation S-K. The Company maintains disclosure controls and procedures (as defined in Rule 13a-14 under the Exchange Act) sufficient to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act, is recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms. (y) The Company has adopted a written code of ethics that applies to its principal executive officer, principal financial officer, principal accounting officer or controller or persons performing similar functions. Since the adoption of its code of ethics, the Company has not made any amendment to or granted any waiver thereunder. (z) The Shares of Beneficial Interest are registered pursuant to Section 12(g) of the Exchange Act and are quoted on the Nasdaq National Market (the "NASDAQ NATIONAL MARKET") and posted and listed for trading on the TSX. On or before the Closing Time, the Conversion Shares will be authorized for quotation on the Nasdaq National Market and conditionally approved for listing on the TSX subject only to the filing of certain documents, and the Company has taken no action designed to, or likely to have the effect of, terminating the registration of the Shares of Beneficial Interest under the Exchange Act or de-listing the Shares of Beneficial Interest from the Nasdaq National Market or the TSX, nor has the Company received any notification that the Commission, the Nasdaq National Market or the TSX is contemplating terminating such registration or listing. (aa) The Company is a reporting issuer, or its equivalent, under the securities laws of British Columbia, Alberta, Ontario and Quebec, is not in default of any applicable Canadian Securities Laws, is not included in the list of defaulting reporting issuers maintained by any of the relevant Canadian Commissions, and is, and will at the Closing Date be, a "qualifying issuer" for the purposes of Multilateral Instrument 45-102 of the Canadian Securities Administrators and corresponding provisions of Canadian Securities Laws applicable in the Province of Quebec. (bb) Neither the Company nor any of its subsidiaries (i) is in violation of its charter or by-laws, (ii) is in default (and no event has occurred which, with notice or lapse of time or both, would constitute such a default) under, or result in the creation or imposition of any lien, charge or encumbrance upon any property or assets of the Company or any of its subsidiaries pursuant to, any indenture, mortgage, deed of trust, loan agreement or other 8 agreement or instrument to which it is a party or by which it is bound or to which any of its property or assets is subject, or (iii) except as disclosed in the Offering Memorandum or Incorporated Documents, is in violation in any respect of any statute or any judgment, decree, order, rule or regulation of any court or governmental or regulatory agency or body having jurisdiction over the Company or any of its subsidiaries or any of their properties or assets, except in the case of (i), (ii) and (iii) above any violation or default that would not have a Material Adverse Effect. Without limitation of the foregoing, the Company's subsidiaries are in material compliance with all covenants applicable to them in the Stendal Project Facility and the Rosenthal Facility (as defined in the Offering Memorandum). (cc) Except as described in the Offering Memorandum, no labor disturbance with the employees of the Company or any of its subsidiaries exists or, to the knowledge of the Company, is imminent that would reasonably be expected to have a Material Adverse Effect. (dd) The Company and each of its significant subsidiaries carry, or are covered by, insurance in such amounts and covering such risks as in the Company's reasonable determination is adequate for the conduct of their respective businesses and the value of their respective properties. (ee) The Company does not maintain, contribute to, or have any obligation to contribute to, and has never maintained, contributed to or had any obligation to contribute to, any "employee pension benefit plan" (as defined in Section 3(2) of the Employee Retirement Income Security Act of 1974, as amended, including the regulations and published interpretations thereunder ("ERISA")), which is subject to Title IV of ERISA or Section 412 of the Internal Revenue Code of 1986. (ff) Except as disclosed in the Offering Memorandum or the Incorporated Documents and except as would not, singularly or in the aggregate, result in a Material Adverse Effect, (i) there has been no storage, generation, transportation, handling, treatment, disposal, discharge, emission, or other release of any kind of toxic or other wastes or other hazardous substances by, due to, or caused by the Company (or, to the Company's knowledge, any other entity for whose acts or omissions the Company is or may be liable) upon any other property now or previously owned or leased by the Company or any of its subsidiaries, or upon any other property, in violation of any statute or any ordinance, rule, regulation, order, judgment, decree or permit or which would, under any statute or any ordinance, rule (including rule of common law), regulation, order, judgment, decree or permit, give rise to any liability, and (ii) there has been no disposal, discharge, emission or other release of any kind onto such property or into the environment surrounding such property of any toxic or other wastes or other hazardous substances with respect to which the Company or any of its subsidiaries has knowledge. (gg) The Company, its subsidiaries or any other person associated with or acting on behalf of the Company or its subsidiaries including, without limitation, any trustee, director, officer, agent or employee of the Company or its subsidiaries, has not, directly or indirectly, while acting on behalf of the Company or its subsidiaries (i) used any corporate funds for unlawful contributions, gifts, entertainment or other unlawful expenses relating to political activity; (ii) made any unlawful payment to foreign or domestic government officials or employees or to foreign or domestic political parties or campaigns from corporate funds; (iii) 9 violated or is in violation of any provision of the Foreign Corrupt Practices Act of 1977, as amended; or (iv) made any other unlawful payment. (hh) The statistical and market-related data included or incorporated by reference in the Offering Memorandum are based on or derived from sources that the Company reasonably believes to be reliable and accurate. (ii) None of the Company or any of its affiliates (as defined in Rule 501(b) under the Securities Act) or any person acting on such person's behalf (other than the Initial Purchaser and its affiliates, as to whom no representation is made) has sold, offered for sale, solicited offers to buy or otherwise negotiated in respect of any security (as such term is defined in the Securities Act) that is or would be integrated with the sale of the Notes in a manner that would require registration under the Securities Act. (jj) When the Notes are issued and delivered pursuant to this Agreement, the Notes will not be of the same class (within the meaning of Rule 144A) as any securities of the Company which are listed on a national securities exchange registered under Section 6 of the Exchange Act or quoted in a United States automated inter-dealer quotation system. (kk) The Company is subject to Section 13 or Section 15(d) of the Exchange Act and is in compliance with the provisions of such Section. (ll) Assuming compliance by the Initial Purchaser with its representations, warranties and covenants set forth herein, the compliance by the Initial Purchaser with the offering and transfer procedures and restrictions described in the Offering Memorandum, the accuracy of the representations and warranties made by the purchasers to whom the Initial Purchaser resells Notes in accordance with the Offering Memorandum and the condition that any subsequent purchasers receive a copy of the Offering Memorandum prior to such sale, no registration under the Securities Act of the Notes and no filing of a prospectus in accordance with the Canadian Securities Laws to qualify the distribution of the Notes is required for the sale of the Notes to the Initial Purchaser as contemplated hereby and in the Offering Memorandum or for the Exempt Resales or to qualify the Indenture under the Trust Indenture Act of 1939, as amended. No form of general solicitation or general advertising (as those terms are defined in Regulation D under the Securities Act) has been used by the Company or any of its affiliates or any person acting on such person's behalf (other than the Initial Purchaser and its affiliates, as to whom no representation is made) in connection with the offer and sale of any of the Notes. (mm) The Offering Memorandum and Wrap Information, as of its date, and each amendment or supplement thereto, as of its date, will contain the information specified in, and will meet the requirements of the applicable Canadian Securities Laws. (nn) None of the Company or any of its affiliates or any person acting on such person's behalf (other than the Initial Purchaser and its affiliates, as to whom no representation is made) has engaged or will engage in any directed selling efforts within the meaning of Regulation S with respect to the Notes. (oo) The Company and its affiliates and all persons acting on such person's behalf (other than the Initial Purchaser and its affiliates, as to whom no representation is made) 10 have complied with and will comply with the offering restrictions requirements of Regulation S in connection with the offering of the Notes outside the United States. (pp) Each of the Notes and the Conversion Shares will bear the legends (and such other legends as may be required under the Indenture) provided for under "Notice to Investors" in the Offering Memorandum, and each of the Notes and the Conversion Shares offered and sold in the Private Placement Provinces will bear the legend set forth under "Resale Restrictions" in the Wrap Information, in each case, for the time period and upon the other terms stated therein. (qq) None of the execution, delivery and performance of this Agreement, the issuance and sale of the Notes, the application of the proceeds from the issuance and sale of the Notes and the consummation of the transactions contemplated hereby and thereby as set forth in the Offering Memorandum, will violate Regulations T, U or X promulgated by the Board of Governors of the Federal Reserve System or analogous foreign laws and regulations. (rr) Except as disclosed in the Offering Memorandum, there are no contracts, agreements or understandings between the Company and any person that would give rise to a valid claim against the Company or the Initial Purchaser for a brokerage commission, finder's fee or other like payment in connection with the sale of the Notes. (ss) The Company held a special meeting of shareholders on October 3, 2003, such meeting was duly noticed and at such meeting the Company obtained requisite shareholder approval of the issuance of the Notes and the Conversion Shares as set forth in the Company's Definitive Proxy Statement dated September 23, 2003. (tt) As of the Closing Date, the purchase by any shareholder of the Company who owns less than 15% of the outstanding Shares of Beneficial Interest of a pro rata share of the Notes being sold in the Offering will not constitute a "Triggering Event" under the Company's Rights Plan as amended. (uu) The Company and its affiliates and all persons acting on such person's behalf (other than the Initial Purchaser and its affiliates, as to whom no representation is made), have complied with and will comply to the best of their knowledge with the provisions of the paragraph "Plan of Distribution - Sale Restrictions" in the Offering Memorandum 2. Purchase, Sale and Delivery of the Notes. ---------------------------------------------- (a) On the basis of the representations, warranties, covenants and agreements herein contained, but subject to the terms and conditions herein set forth, the Company agrees to sell to the Initial Purchaser and the Initial Purchaser agrees to purchase from the Company all of the Notes at a purchase price of 95.912% of the principal amount thereof, plus accrued interest, if any. (b) Payment of the purchase price for, and delivery of the Notes shall be made at the office of Sangra Moller, 1000 Cathedral Place, 925 West Georgia Street, Vancouver BC V62 3L2, or at such other place as may be agreed upon by you and the Company, at 7:00 A.M., Vancouver time, on October 10, 2003 (unless postponed in accordance with the provisions of 11 Section 9 hereof) or at such other time and date as shall be agreed upon by you and the Company (such time and date of payment and delivery being herein called the "CLOSING DATE"). The Notes to be delivered to you shall be registered in the form of one or more permanent global notes in definitive form (the "GLOBAL NOTES") deposited with the Trustee as custodian for The Depository Trust Company ("DTC") and registered in the name of Cede & Co., as nominee for DTC. Interests in any permanent global Notes will be held only in book-entry form through DTC, except in the limited circumstances described in the Offering Memorandum. The Company will permit you to examine the Global Notes at least one full business day prior to the Closing Date. (c) Payment of the purchase price for the Notes shall be made to the Company by wire transfer of immediately available (same day) funds to the bank account designated by the Company on the Closing Date against delivery of the Global Notes to the Initial Purchaser through the facilities of DTC. 3. Representations, Warranties and Covenants of the Initial Purchaser. ------------------------------------------------------------------- The Initial Purchaser represents and warrants to, and agrees with, the Company that: (a) The Initial Purchaser is a QIB. (b) The Initial Purchaser (A) is not acquiring the Notes with a view to any distribution thereof that would violate the Securities Act or the securities laws of any state of the United States, the Private Placement Provinces or any other applicable jurisdiction and (B) will be reoffering and reselling the Notes only to those it reasonably believes to be QIBs in reliance on Rule 144A and in certain offshore transactions in reliance upon Regulation S, including, in the case of offers and sales in the Private Placement Provinces, in accordance with exemptions from the prospectus requirements under the Canadian Securities Laws as set out in the Wrap Information. (c) No form of general solicitation or general advertising (as those terms are defined in Regulation D under the Securities Act) has been or will be used by the Initial Purchaser or any of its representatives in connection with the offer and sale of any of the Notes, including, but not limited to, articles, notices or other communications published in any newspaper, magazine or similar medium or broadcast over television or radio, or any seminar or meeting whose attendees have been invited by any general solicitation or general advertising. (d) The Initial Purchaser agrees that, in connection with the Exempt Resales, it will solicit offers to buy the Notes only from, and will offer to sell the Notes only to, Eligible Purchasers. The Initial Purchaser further acknowledges and agrees that such Eligible Purchasers shall acknowledge and agree (or be deemed to acknowledge and agree) that (A) such Notes will not have been registered under the Securities Act, will not have been qualified by a prospectus filed under applicable Canadian Securities Laws and may be offered, resold, pledged or otherwise transferred only (I) to a person whom the seller reasonably believes is a QIB purchasing for its own account or for the account of a QIB in a transaction meeting the requirements of Rule 144A, (II) in an offshore transaction complying with Rule 903 or 904 of Regulation S of the Securities Act, subject to clause (y) below, (III) pursuant to an exemption 12 from registration under the Securities Act provided by Rule 144 (if available), or (IV) pursuant to an effective registration statement under the Securities Act, (x) in each of cases (I) through (IV) in accordance with any applicable securities laws of any state of the United States or any jurisdiction outside of the U.S. and Canada, and (y) in the case of such a transaction in the Private Placement Provinces or to or for the account or benefit of a Canadian resident through the services of a dealer registered in the purchaser's province or under an exemption from the registered dealer requirement under the Canadian Securities Laws and pursuant to an exemption from the prospectus requirements of applicable Canadian Securities Laws, (B) such person shall not engage in hedging transactions with regard to the Notes and the Shares of Beneficial Interest issuable upon conversion of the Notes unless in Compliance with the Securities Act; and (C) the purchaser will, and each subsequent holder is required to, notify any purchaser of the Notes of the resale restrictions referred to in (A) and (B) above. (e) The Initial Purchaser and its affiliates or any person acting on such person's behalf have not engaged and will not engage in any directed selling efforts within the meaning of Regulation S with respect to the Notes. (f) The Initial Purchaser agrees that it has not offered or sold and will not offer or sell the Notes in the United States or to, or for the benefit or account of, a U.S. Person (other than a distributor), in each case, as defined in Rule 902 under the Securities Act (i) as part of its distribution at any time and (ii) otherwise until one year after the later of the commencement of the offering of the Notes pursuant hereto and the Closing Date, other than in accordance with Regulation S or another exemption from the registration requirements of the Securities Act. The Initial Purchaser agrees that, during such one-year distribution compliance period, it will not cause any advertisement with respect to the Notes (including any "tombstone" advertisement) to be published in any newspaper or periodical or posted in any public place and will not issue any circular relating to the Notes, except such advertisements as are permitted by and include the statements required by Regulation S. (g) The Initial Purchaser will deliver at or prior to the sale to each purchaser of the Notes from such Initial Purchaser in connection with its initial distribution of the Notes, whether by mail, delivery, electronic or other means, a copy of the Offering Memorandum, as amended and supplemented at the date of such delivery. (h) The Initial Purchaser agrees that, at or prior to confirmation of a sale of the Notes by it to any distributor, dealer or person receiving a selling concession, fee or other remuneration during the one-year distribution compliance period referred to in Rule 903(b)(3) under the Securities Act, it will send to such distributor, dealer or person receiving a selling concession, fee or other remuneration a confirmation or notice to substantially the following effect: "The Notes covered hereby have not been registered under the U.S. Securities Act of 1933, as amended (the "SECURITIES ACT"), and may not be offered and sold within the United States or to, or for the account or benefit of, U.S. persons (i) as part of your distribution at any time or (ii) otherwise until one year after the later of the commencement of the Offering and the Closing Date, except in either case in accordance with Regulation S under the Securities Act (or Rule 144A or to an 13 institutional accredited investor in transactions that are exempt from the registration requirements of the Securities Act), and during such one year period you may not engage in hedging transactions with regard to the Notes and the Shares of Beneficial Interest issueable upon conversion of the Notes unless in compliance with the Securities Act, and in connection with any subsequent sale by you of the Notes covered hereby in reliance on Regulation S during the period referred to above to any distributor, dealer or person receiving a selling concession, fee or other remuneration, you must deliver a notice to substantially the foregoing effect. Terms used above have the meanings assigned to them in Regulation S." (i) Offers and sales of the Notes in the Private Placement Provinces will be made only by the Initial Purchaser or an affiliate, in either case, provided that it is registered in an appropriate category or exempt from registration under the Canadian Securities Laws in respect of such offers and sales. (j) The Initial Purchaser agrees to assist the Company in all reasonable respects to secure compliance with applicable Canadian Securities Laws in connection with the Offering in Canada, and shall timely provide the Company or its agent with the information required to enable the Company to comply with its obligations under subsection 4(i), including details of any Eligible Purchaser resident in a Private Placement Province and related information necessary to complete any form or certificate prescribed by a Canadian Commission in connection with the Offering in Canada, including, but not limited to, Ontario Securities Commission Form 45-501F1. (k) The Initial Purchaser has taken no action, and will take no action, in any jurisdiction (either on its own or as an agent of the Company) in connection with the Offering that as a direct result of which any action, filing or registration would be required in any such jurisdiction (other than (x) the filing of (i) the Offering Memorandum and Wrap Information with the Ontario Securities Commission, (ii) reports of the trades in the prescribed form prepared and executed in accordance with applicable Canadian Securities Laws, (iii) a certificate prepared in accordance with Policy Statement 41-601Q of the Commission des valeurs mobilieres du Quebec, and (iv) if required, a private placement questionnaire and undertaking by each Canadian purchaser of the Notes in the prescribed form with the TSX, and (y) such consents, approvals, authorizations, orders, registrations, filings, qualifications, licenses and permits as may be required (i) under state securities or Blue Sky laws in connection with the purchase and distribution of the Notes by the Initial Purchaser or (ii) in connection with the Company's obligations under the Registration Rights Agreement), or that would independently result in the breach of the applicable securities laws, statutes, rules or regulations (whether by the Initial Purchaser or the Company) in any such jurisdiction. The Initial Purchaser will comply with all applicable securities laws, statutes, rules and regulations in connection with the Offering in each jurisdiction in which it purchases, offers, sells or delivers Notes or distributes or causes to be distributed the Offering Memorandum in connection with the Exempt Resales. (l) The Initial Purchaser will promptly notify the Company in writing of the completion of the sale of the Notes by it. 14 (m) The Initial Purchaser and its affiliates and all persons acting on such person's behalf, have complied with and will comply to the best of their knowledge with the provisions of the paragraph "Plan of Distribution - Sale Restrictions" in the Offering Memorandum. 4. Covenants of the Company. The Company covenants and agrees with the ------------------------ Initial Purchaser that: (a) The Company shall, as soon as practicable and in any event not later than 24 hours after the execution of this Agreement (or such other period as agreed to by the Initial Purchaser, acting reasonably), finalize the Offering Memorandum and deliver it pursuant to Section 4(e) below. (b) The Company shall notify you (and, if requested by you, shall confirm such notice in writing) (i) of the filing of any information relating to the offering of the Notes with any securities exchange or any other regulatory body in the United States or Canada, and (ii) of the issuance by the Commission or any U.S. state securities commission or by any Canadian or foreign regulatory authority of any stop order, or the receipt by the Company of any other notification, suspending the qualification or exemption from qualification of the Notes for offering and sale in any jurisdiction, or the initiation or threatening of any proceeding for that purpose. If the Commission or any U.S. state securities commission or any Canadian or foreign regulatory authority proposes or enters a stop order or order of similar effect at any time with respect to the transactions contemplated by this Agreement, the Company shall make every reasonable effort to prevent the issuance of any such stop order and, if issued, to obtain the lifting of such order as soon as possible. (c) The Company shall not at any time make any amendment of or supplement to the Offering Memorandum (including the Incorporated Documents) without the Initial Purchaser's consent, which shall not be unreasonably withheld or delayed. (d) If, at any time prior to the completion of the sale of the Notes, any event occurs or condition exists as a result of which it is necessary, in the opinion of counsel for the Initial Purchaser or for the Company, acting reasonably, to amend or supplement the Offering Memorandum in order that the Offering Memorandum will not include any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading, or if it is necessary, in the opinion of such counsel, acting reasonably, at any such time to amend or supplement the Offering Memorandum in order to comply with the requirements of the Securities Act or the Rules and Regulations or the Canadian Securities Laws, the Company shall promptly notify you (unless counsel for the Initial Purchaser already has expressed such an opinion) and prepare, subject to subsection 4(c), such amendment or supplement (in form and substance satisfactory to you) as may be necessary to correct such statement or omission or to effect such compliance. (e) The Company shall promptly deliver to the Initial Purchaser such number of copies of the Preliminary Offering Memorandum and Offering Memorandum and all amendments of and supplements thereto, if any, and all Incorporated Documents or any 15 amendment thereof or supplement thereto, as you may reasonably request. The Company hereby consents to the use of such copies by the Initial Purchaser in connection with the sale of the Notes. Prior to 2:00 P.M., Vancouver time on the second business day next succeeding the date of this Agreement, the Company shall, without charge, furnish the Initial Purchaser with copies of the Offering Memorandum in New York City and Toronto, respectively, in such quantities as you may reasonably request, and the Company shall deliver to the Initial Purchaser, without charge, during the period prior to the completion of the sale of the Notes, such number of copies of the Offering Memorandum (as supplemented or amended) as the Initial Purchaser may reasonably request. (f) The Company shall not file any document under the Exchange Act before the completion of the sale of the Notes by the Initial Purchaser if the document would be deemed to be incorporated by reference into the Offering Memorandum, of which the Initial Purchaser shall not previously have been advised and furnished a copy or to which the Initial Purchaser shall have reasonably objected in writing or that is not in compliance with the Exchange Act or the rules and regulations of the Commission promulgated thereunder. (g) The Company shall use its reasonable efforts, in cooperation with you, to qualify the Notes under the securities or blue sky laws of such jurisdictions within the United States as you may designate and to maintain such qualification in effect for so long as required for the sale of the Notes; provided, however, that in no event shall the Company be obligated in connection therewith to qualify as a foreign corporation or to execute a general consent to service of process or to subject itself to taxation in respect of doing business in any jurisdictions in which it is not otherwise so subject. (h) The Company shall use all reasonable efforts to secure compliance with the Canadian Securities Laws on a timely basis in connection with the distribution of the Notes to Eligible Purchasers in the Private Placement Provinces on a prospectus-exempt basis, including without limitation, by filing as soon as practicable after the Closing Date and in any event within the periods stipulated under the Canadian Securities Laws and at the Company's expense all private placement forms, trade reports or other documents required to be filed in connection with the Exempt Resales in the Private Placement Provinces and paying all fees required in connection therewith. (i) The Company shall use its reasonable efforts to maintain its status as a reporting issuer, or its equivalent, under the securities laws of British Columbia, Alberta, Ontario and Quebec, and to timely comply with its continuous disclosure and other obligations under the Canadian Securities Laws. (j) During the period of 180 days from the date of the Offering Memorandum, the Company shall not, directly or indirectly, without the prior written consent of RBC Dain Rauscher Inc., issue, sell, offer or agree to sell, grant any option for the sale of, pledge, make any short sale or maintain any short position, establish or maintain a "put equivalent position" (within the meaning of Rule 16a-1(h) under the Exchange Act), enter into any swap, derivative transaction or other arrangement that transfers to another, in whole or in part, any of the economic consequences of ownership of the Shares of Beneficial Interest (whether any such transaction is to be settled by delivery of Shares of Beneficial Interest, other securities, cash or other consideration) or otherwise dispose of, any Shares of Beneficial Interest (or any securities convertible into, exercisable for or exchangeable for Shares of Beneficial Interest, including the Notes, (the "EXCHANGEABLE SHARES")) or interest therein of the Company, or Shares of Beneficial Interest or any securities convertible into, exercisable for or exchangeable for Shares of Beneficial Interest of any of its subsidiaries, and the Company shall obtain the undertaking of each of its officers and trustees as have been heretofore designated by you and listed on Schedule I attached hereto not to engage in any of the aforementioned transactions on their own behalf, other than the Company's sale of the Notes hereunder and (A) the Company's issuance of Shares of Beneficial Interest upon (i) the conversion or exchange of outstanding convertible or exchangeable securities (including the Notes and the Conversion Shares), or (ii) the exercise of currently outstanding options; (B) the grant of options under, or the issuance of Shares of Beneficial Interest upon the exercise thereof pursuant to, employee stock option plans in effect on the date hereof; or (C) the Company's issuance of any Shares of Beneficial Interest or other securities for the purpose of acquiring a business, any assets or any securities, so long as the recipient of such shares or other securities agrees to be subject to similar restrictions for the remaining balance of such 180-day period. (k) During the period of two years from the Closing Date the Company shall furnish to you copies of any reports to holders of the Notes, and deliver to you as soon as they are available, copies of any periodic reports and financial statements furnished to or filed with the Commission or any national or foreign securities exchange on which any class of securities of the Company is listed to the extent such documents are not available on the SEC's website. (l) For so long as any of the Notes or the Conversion Shares are "restricted securities" within the meaning of the Securities Act and during any period in which the Company is not subject to Section 13 or 15(d) of the Exchange Act, the Company shall furnish to any holder or beneficial owner of the Notes or the Conversion Shares in connection with any sale thereof and any prospective purchaser of such Notes or Conversion Shares from such holder or beneficial owner (upon the request of such holders, beneficial owners or prospective purchasers) the information required by Rule 144A(d)(4) under the Securities Act. (m) The Company shall not sell, offer for sale or solicit offers to buy or otherwise negotiate in respect of any security (as defined in the Securities Act) that would be integrated with the sale of the Notes in a manner that would require the registration under the Securities Act of the sale to the Initial Purchaser or the Eligible Purchasers of the Notes or to take any other action that would result in the sale of the Notes not being exempt from registration under the Securities Act. (n) The Company shall not take, directly or indirectly, any action designed to, or that could reasonably be expected to, cause or result in stabilization or manipulation of the price of any security of the Company. Except as permitted by the Securities Act and approved by the Initial Purchaser (which approval will not be unreasonably withheld or delayed), the Company shall not distribute any offering material in connection with the offering and sale of the Notes other than the Offering Memorandum. (o) The Company shall apply the net proceeds it receives from the sale of the Notes as set forth under "Use of Proceeds" in the Offering Memorandum. 17 (p) The Company shall use its reasonable efforts to effect the inclusion of the Notes for trading in the PORTAL market and to obtain approval of the Notes by DTC for "book-entry" transfer. (q) Until the earlier of (i) the second anniversary of the Closing Date and (ii) the first date of effectiveness of the registration statement to be filed pursuant to the Registration Rights Agreement, the Company will not, and will not permit any of its "controlled" "affiliates" (as defined in Rule 405 under the Securities Act) to, resell any of the Notes or Conversion Shares that constitute "restricted securities" under Rule 144 that have been reacquired by any of them. (r) None of the Company or any of its affiliates or any person acting on such person's behalf (other than the Initial Purchaser and its affiliates, as to whom no representation is made) will solicit any offer to buy or offer or sell the Notes (i) by means of any form of general solicitation or general advertising (as those terms are defined in Regulation D under the Securities Act), including, but not limited to, articles, notices or other communications published in any newspaper, magazine, or similar medium or broadcast over television or radio, or any seminar or meeting whose attendees have been invited by any general solicitation or general advertising, or (ii) in any manner involving a public offering within the meaning of Section 4(2) of the Securities Act. (s) The Company shall at all times reserve and keep available, free of preemptive or similar rights, Shares of Beneficial Interest for the purpose of enabling the Company to satisfy any obligations to issue the Conversion Shares upon conversion of the Notes. (t) The Company shall refuse to register any transfer of the Notes or the Conversion Shares not made (i) in accordance with the provisions of Regulation S (Rule 901 through 905, and Preliminary Notes), (ii) pursuant to registration under the Securities Act or (iii) pursuant to an available exemption from registration. 5. Payment of Expenses. Whether or not the transactions contemplated --------------------- in this Agreement are consummated or this Agreement is terminated, the Company hereby agrees to pay all costs and expenses incident to the performance of the obligations of the Company hereunder, and under the Indenture and the Registration Rights Agreement, including the following: (i) the fees, disbursements and expenses of the Company's counsel and accountants in connection with the qualification of the Notes and the Conversion Shares for distribution in the United States and, on a prospectus-exempt basis, in Canada and all other expenses in connection with the preparation and printing of the Preliminary Offering Memorandum and the Offering Memorandum and amendments and supplements thereto and the mailing and delivering of copies thereof in connection with sale of the Notes; (ii) the cost of producing this Agreement, the Blue Sky memoranda, any notice or similar filing reasonably requested by the Initial Purchaser in any jurisdiction outside the U.S. and Canada, closing documents (including any compilations thereof) and any other documents in connection with the offering, purchase, sale and delivery of the Notes; (iii) all expenses in connection with the qualification or registration of the Notes for offering and sale under state securities laws as provided in Section 4(g) hereof, including the reasonable fees and disbursements of counsel for the Initial Purchaser in connection with such qualification and in connection with the Blue Sky survey; (iv) all fees and expenses in connection with listing and qualifying the Notes for trading in the PORTAL market; and (v) all 18 travel expenses of the Company's officers and employees and any other expense of the Company incurred in connection with attending or hosting meetings, if any, with prospective purchasers of the Notes. The Company also will pay or cause to be paid: (i) the reasonable costs and expenses of the Initial Purchaser, including the fees and disbursements of their counsel, travel expenses and other out-of-pocket expenses; (ii) the cost of preparing the Global Notes; (iii) the cost and charges of the Trustee, including the reasonable fees and disbursements of counsel to the Trustee; and (iv) all other reasonable costs and expenses incident to the performance of its obligations hereunder which are not otherwise specifically provided for in this Section 5. 6. Conditions of Initial Purchaser's Obligations. The obligations of ----------------------------------------------- the Initial Purchaser to purchase and pay for the Notes as provided herein shall be subject to the accuracy of the representations and warranties of the Company herein contained, as of the date hereof and as of the Closing Date or such other date as may be specified therein (for purposes of this Section 6 "Closing Date" shall refer to the Closing Date for the Notes) to the absence from any certificates, opinions, written statements or letters furnished to you or to Initial Purchaser's Counsel (as defined below) pursuant to this Section 6 of any misstatement or omission, to the performance by the Company of its obligations hereunder, and to each of the following additional conditions: (a) At the Closing Date, you shall have received the opinion of Heller Ehrman White & McAuliffe LLP, special U.S. counsel for the Company, dated the Closing Date, addressed to the Initial Purchaser and substantially in the form attached hereto as Annex I. In giving such opinion, counsel may state that, insofar as such opinion involves factual matters, they have relied upon certificates of officers of the Company and certificates of public officials. (b) At the Closing Date, you shall have received the opinion of Sangra, Moller, Canadian counsel for the Company, dated the Closing Date, addressed to the Initial Purchaser and in substantially the form attached hereto as Annex II. In giving such opinion, counsel may state that, insofar as such opinion involves factual matters, they have relied upon certificates of officers of the Company and certificates of public officials. (c) At the Closing Date, you shall have received the opinion of Latham & Watkins, special U.S. counsel for the Initial Purchaser, dated the Closing Date, addressed to the Initial Purchaser and in form and substance reasonably satisfactory to the Initial Purchaser, covering such matters as are customarily covered in such opinions. (d) All proceedings taken in connection with the sale of the Notes as herein contemplated shall be in form and substance reasonably satisfactory to you and to the Initial Purchaser's Counsel, and the Company shall have furnished to Initial Purchaser's Counsel such documents as they reasonably request for the purpose of enabling them to pass upon certain matters pursuant to subsections (c) above. (e) At the Closing Date, you shall have received a certificate of the Chief Executive Officer and President and the Chief Financial Officer of the Company in their capacities as officers of the Company, dated as of the Closing Date, to the effect that (i) the representations and warranties of the Company set forth in Section 1 hereof are accurate as of the date hereof and as of the Closing Date (or such other date as may be specified) with the same 19 force and effect as though expressly made on such date, (ii) as of the Closing Date, the obligations of the Company to be performed or complied with hereunder on or prior thereto have been duly performed or complied with, and (iii) subsequent to the respective date of the most recent financial statements in the Offering Document, the Company and its subsidiaries have not sustained any material loss or interference with their respective businesses or properties from fire, flood, hurricane, accident or other calamity, whether or not covered by insurance, or from any labor dispute or any legal or governmental proceeding, and there has not been any change, or any development involving a change, in the business, properties, operations, condition (financial or otherwise), or results of operations of the Company and its subsidiaries taken as a whole, except in each case as described in or contemplated by the Offering Memorandum or as would not have a Material Adverse Effect. (f) On the date hereof and at the Closing Date, you shall have received a comfort letter in respect of the Offering Memorandum from Peterson Sullivan P.L.L.C., former independent public accountants for the Company, dated as of the date hereof or the Closing Date, as the case may be, addressed to the Initial Purchaser and in form and substance reasonably satisfactory to the Initial Purchaser containing statements and information of the type ordinarily included in accountants' "comfort letters" to initial purchasers with respect to the financial statements and certain financial information contained in the Offering Memorandum and Incorporated Documents. (g) On the date hereof and at the Closing Date, you shall have received a comfort letter in respect of the Offering Memorandum from Deloitte & Touche LLP, independent public accountants for the Company, dated as of the date hereof and as of the Closing Date, as the case may be, addressed to the Initial Purchaser and in form and substance reasonably satisfactory to the Initial Purchaser containing statements and information of the type ordinarily included in accountants' "comfort letters" to initial purchasers with respect to interim unaudited financial statements and certain financial information contained in the Offering Memorandum and Incorporated Documents. (h) Subsequent to the execution and delivery of this Agreement, there shall not have been any Material Adverse Change which, in the judgment of the Initial Purchaser, acting reasonably, makes it impracticable or inadvisable to proceed with the offering or the delivery of the Notes on the terms and in the manner contemplated by this Agreement and the Offering Memorandum, including, without limitation the Exempt Resales (exclusive of any amendment or supplement thereto). (i) You shall have received a lock-up agreement from each trustee and officer of the Company as shall have been heretofore designated by you and listed on Schedule II hereto substantially in the form attached hereto as Annex III. (j) The Company and the Trustee shall have entered into the Indenture, and the Initial Purchaser shall have received an executed copy thereof. (k) The Company and the Initial Purchaser shall have entered into the Registration Rights Agreement, and the Initial Purchaser shall have received an executed copy thereof. 20 (l) At the Closing Date, the Notes shall have been designated for trading in the PORTAL market. (m) The Company shall have furnished the Initial Purchaser and Initial Purchaser's Counsel with such other certificates, opinions or other documents as they may have reasonably requested. The Initial Purchaser may in its sole discretion waive compliance with any conditions to its obligations hereunder. 7. Indemnification. --------------- (a) The Company shall indemnify and hold harmless the Initial Purchaser, its directors, officers and employees and each person, if any, who controls the Initial Purchaser within the meaning of Section 15 of the Securities Act or Section 20(a) of the Exchange Act (including each affiliate of the Initial Purchaser who is deemed a third party beneficiary pursuant to Section 12 hereof (an "AFFILIATED DEALER"), its directors, officers and employees and any controlling person of such affiliate) against any and all losses, liabilities, claims, damages and expenses whatsoever as incurred (including but not limited to reasonable attorneys' fees and any and all expenses whatsoever incurred in investigating, preparing or defending against any litigation, commenced or threatened, or any claim whatsoever, and any and all amounts paid in settlement of any claim or litigation), joint or several, to which they or any of them may become subject under the Securities Act, the Exchange Act, the Canadian Securities Laws or otherwise, insofar as such losses, liabilities, claims, damages or expenses (or actions in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of a material fact contained in the Offering Memorandum (including the Incorporated Documents) or in any supplement thereto or amendment thereof, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading; provided, however, that the Company will not be liable in any such case to the extent but only to the extent that any such loss, liability, claim, damage or expense arises out of or is based upon any such untrue statement or alleged untrue statement or omission or alleged omission made therein in reliance upon and in conformity with written information transmitted to the Company by the Initial Purchaser and its affiliates expressly for use therein. This indemnity agreement will be in addition to any liability that the Company may otherwise have including under this Agreement. (b) The Initial Purchaser shall indemnify and hold harmless the Company, each of the trustees of the Company, each of the officers of the Company and each other person, if any, who controls the Company within the meaning of Section 15 of the Securities Act or Section 20(a) of the Exchange Act, against any losses, liabilities, claims, damages and reasonable expenses whatsoever as incurred (including but not limited to attorneys' fees and any and all expenses whatsoever incurred in investigating, preparing or defending against any litigation, commenced or threatened, or any claim whatsoever, and any and all amounts paid in settlement of any claim or litigation), joint or several, to which they or any of them may become subject under the Securities Act, the Exchange Act, the Canadian Securities Laws or otherwise, insofar as such losses, liabilities, claims, damages or expenses (or actions in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of a material fact 21 contained in the Offering Memorandum (including the Incorporated Documents) or in any amendment thereof or supplement thereto, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, in each case to the extent, but only to the extent, that any such loss, liability, claim, damage or expense arises out of or is based upon any such untrue statement or alleged untrue statement or omission or alleged omission made therein in reliance upon and in conformity with written information furnished by the Initial Purchaser expressly for use therein; it being agreed and understood that for all purposes of this Agreement, the only information furnished by the Initial Purchaser consists of the following information in the Offering Memorandum: the sections titled "Discounts and Expenses" (except for the last sentence thereof) and "Price Stabilization and Short Positions" (including in the second paragraph thereof, with respect to the absence of representations by the Initial Purchaser) under the caption "Plan of Distribution" in the Offering Memorandum. This indemnity will be in addition to any liability that any Initial Purchaser may otherwise have including under this Agreement. (c) Promptly after receipt by an indemnified party under subsection (a) or (b) above of notice of any claims or the commencement of any action, such indemnified party shall, if a claim in respect thereof is to be made against the indemnifying party under such subsection, notify each party against whom indemnification is to be sought in writing of the claim or the commencement thereof (but the failure so to notify an indemnifying party shall not relieve it from any liability which it may have under this Section 7). In case any such claim or action is brought against any indemnified party, and it notifies an indemnifying party of the commencement thereof, the indemnifying party will be entitled to participate therein, and to the extent it may elect by written notice delivered to the indemnified party promptly after receiving the aforesaid notice from such indemnified party, to assume the defense thereof with counsel satisfactory to such indemnified party. Notwithstanding the foregoing, the indemnified party or parties shall have the right to employ its or their own counsel in any such case, but the fees and expenses of such counsel shall be at the expense of such indemnified party or parties unless (i) the employment of such counsel shall have been authorized in writing by one of the indemnifying parties in connection with the defense of such action, (ii) the indemnifying parties shall not have employed counsel to have charge of the defense of such action within a reasonable time after notice of commencement of the action or (iii) such indemnified party or parties shall have reasonably concluded that there may be defenses available to it or them that are different from or additional to those available to one or all of the indemnifying parties (in which case the indemnifying parties shall not have the right to direct the defense of such action on behalf of the indemnified party or parties), in any of which events the fees and expenses of one counsel selected by all the indemnified parties to represent them all shall be borne by the indemnifying parties. No indemnifying party shall, without the prior written consent of the indemnified party, effect any settlement or compromise of, or consent to the entry of judgment with respect to, any pending or threatened action in respect of which the indemnified party is or reasonably could have been a party and indemnity or contribution may be or could have been sought hereunder by the indemnified party (an "ACTION"), unless such settlement, compromise or judgment (x) includes an unconditional release of the indemnified party from all liability on claims that are the subject matter of such action and (y) does not include a statement as to or an admission of fault, culpability or a failure to act, by or on behalf of the indemnified party. No indemnified party shall, without the prior written consent of the indemnifying party, effect any settlement or 22 compromise of, or consent to the entry of judgment with respect to, any Action, unless such settlement, compromise or consent includes an unconditional release of such indemnified party from all liability on claims that are the subject matter of such Action. 8. Contribution. In order to provide for contribution in circumstances ------------ in which the indemnification provided for in Section 7 hereof is for any reason held to be unavailable from any indemnifying party or is insufficient to hold harmless a party indemnified thereunder, the Company and the Initial Purchaser shall contribute to the aggregate losses, claims, damages, liabilities and expenses of the nature contemplated by such indemnification provision (including any investigation, legal and other expenses incurred in connection with, and any amount paid in settlement of, any action, suit or proceeding or any claims asserted, but after deducting in the case of losses, claims, damages, liabilities and expenses suffered by the Company any contribution received by the Company from persons, other than the Initial Purchaser, who may also be liable for contribution, including persons who control the Company within the meaning of Section 15 of the Securities Act or Section 20(a) of the Exchange Act, and officers and directors of the Company) as incurred to which the Company and one or both of the Initial Purchaser may be subject, in such proportions as is appropriate to reflect the relative benefits received by the Company and the Initial Purchaser from the offering of the Notes or, if such allocation is not permitted by applicable law, in such proportion as is appropriate to reflect not only the relative benefits referred to above but also the relative fault of the Company and the Initial Purchaser in connection with the statements or omissions which resulted in such losses, claims, damages, liabilities or expenses, as well as any other relevant equitable considerations. The relative benefits received by the Company and the Initial Purchaser shall be deemed to be in the same proportion as (x) the total proceeds from the Offering (net of discounts and commissions but before deducting expenses) received by the Company and (y) the discounts and commissions received by the Initial Purchaser. The relative fault of the Company and of the Initial Purchaser shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the Company or the Initial Purchaser and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The Company and the Initial Purchaser agree that it would not be just and equitable if contribution pursuant to this Section 8 were determined by pro rata allocation (even if the Initial Purchaser were treated as one entity for such purpose) or by any other method of allocation which does not take account of the equitable considerations referred to above. Notwithstanding the provisions of this Section 8, the Initial Purchaser shall not be required to contribute any amount in excess of the amount by which the total price at which the Notes purchased by it and sold to Eligible Purchasers were offered to hereby exceeds the amount of any damages that the Initial Purchaser has otherwise been required to pay by reason of such untrue or alleged untrue statement or omission or alleged omission. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. For purposes of this Section 8, each person, if any, who controls the Initial Purchaser within the meaning of Section 15 of the Securities Act or Section 20(a) of the Exchange Act shall have the same rights to contribution as the Initial Purchaser, and each person, if any, who controls the Company within the meaning of Section 15 of the Securities Act or Section 20(a) of the Exchange Act and each officer and director of the Company shall have the same rights to contribution as the Company. Any party entitled to contribution will, promptly after receipt of 23 notice of commencement of any action, suit or proceeding against such party in respect of which a claim for contribution may be made against another party or parties, notify each party or parties from whom contribution may be sought, but the omission to so notify such party or parties shall not relieve the party or parties from whom contribution may be sought from any obligation it or they may have under this Section 8 or otherwise. 9. Survival of Representations and Agreements. All representations and ------------------------------------------- warranties, covenants, agreements and other statements of the Company or its officers and the Initial Purchaser set forth in or made pursuant to this Agreement, including the agreements contained in Section 5, the indemnity agreements contained in Section 7 and the contribution agreements contained in Section 8, shall remain operative and in full force and effect regardless of any investigation made by or on behalf of the Initial Purchaser or any controlling person thereof or by or on behalf of the Company, any of its officers and trustees or any controlling person thereof, and shall survive delivery of and payment for the Notes to and by the Initial Purchaser. The representations contained in Section 1 and the agreements contained in Sections 5, 7, 8 and 10(b) hereof shall survive the termination of this Agreement, including termination pursuant to Section 10 hereof. 10. Termination. ----------- (a) The Initial Purchaser shall be entitled, at its option, to terminate, without liability on its part, its obligations under this Agreement by giving written notice to that effect to the Company at or prior to the Closing Date if: (i) trading in the Company's securities on the Nasdaq National Market has been suspended or made subject to material limitations; (ii) trading on the New York Stock Exchange or on the Nasdaq National Market shall have been suspended or been made subject to material limitations, or minimum or maximum prices for trading shall have been fixed, or maximum ranges for prices for securities shall have been required, on the New York Stock Exchange or on the Nasdaq National Market or by order of the Commission or any other governmental authority having jurisdiction; (iii) a banking moratorium has been declared by a state, provincial or federal authority in the United States or if any new restriction materially adversely affecting the distribution of the Notes shall have become effective; (iv) there has occurred any outbreak or escalation of hostilities or acts of terrorism involving the United States or Canada, or there is a declaration of a national emergency or war by the United States or Canada such that the effect of any such event in your reasonable judgment makes it impracticable or inadvisable to proceed with the offering, sale and delivery of the Notes on the terms contemplated by the Offering Memorandum; (v) in relation to the Company, the Notes or the Shares of Beneficial Interest, any inquiry, investigation or other proceeding is commenced, threatened or announced or any order or ruling is issued by any officer of such exchange or market, or by the Commission, any of the Canadian Commissions or any other regulatory authority in Canada or the United States, or if any law or regulation under or pursuant to any statute of Canada or of any province thereof or of the United States or any state or territory thereof is promulgated or changed which, in the reasonable opinion of the Initial Purchaser, operates to prevent or materially restrict trading in or the distribution of the Notes or shares of the Shares of Beneficial Interest in the United States; or (vi) there should develop, occur, or come into effect any occurrence of national or international consequence or any action, law or regulation, inquiry, or other occurrence of any nature whatsoever, including, without limiting the generality of the foregoing, any military conflict, civil insurrection, or any terrorist action, which, 24 in the reasonable opinion of the Initial Purchaser, seriously affects or may seriously affect the financial markets or the business of the Company and its subsidiaries taken as a whole, and/or prevents or materially restricts the trading in or the distribution of the Notes in the United States or Canada. (b) If this Agreement is terminated pursuant to any of the provisions hereof, or if the sale of the Notes provided for herein is not consummated because any condition to the obligations of the Initial Purchaser set forth herein is not satisfied or because of any refusal, inability or failure on the part of the Company to perform any agreement herein or comply with any provision hereof, the Company shall, subject to demand by you, reimburse the Initial Purchaser for all out-of-pocket expenses (including the reasonable fees and expenses of their counsel), incurred by the Initial Purchaser in connection herewith. 11. Notices. All communications hereunder, except as may be otherwise ------- specifically provided herein, shall be in writing, and: (a) if sent to the Initial Purchaser, shall be mailed, delivered or faxed and confirmed in writing, to: RBC Capital Markets Royal Bank Plaza, 4th Floor, South Tower 200 Bay Street Toronto, Ontario M5J 2W7 Ph: (416) 842-7593 Fax: (416) 842-7650 Attention: Derek Neldner, Managing Director with copies to: Lawson Lundell 1600 Cathedral Place 925 West Georgia Street Vancouver, BC V6C 3L2 Attention: Gordon R. Chambers Latham & Watkins LLP 633 West Fifth Street Los Angeles, CA 90071 Attention: Mark Stegemoeller 25 (b) if sent to the Company, shall be mailed, delivered or faxed and confirmed in writing, to: Mercer International Inc. 14900 Interurban Ave. South Suite 271 Seattle, WA 98168 Ph: (206) 674-4639 Fax: (206) 674-4629 Attention: David Gandossi with copies to: Sangra, Moller 1000 Cathedral Place 925 West Georgia Street Vancouver, BC V62 3L2 Attention: Harjit Sangra provided, however, that any notice to the Initial Purchaser pursuant to Section 7 shall be delivered or sent by mail or facsimile transmission to the Initial Purchaser at its address set forth in its acceptance facsimile to you, which address will be supplied to any other party hereto by you upon request. Any such statements, requests, notices or agreements shall take effect at the time of receipt thereof. 12. Successors and Assigns. This Agreement shall inure solely to the ------------------------ benefit of, and shall be binding upon, the Initial Purchaser and the Company and the controlling persons, directors, trustees, officers, employees and agents referred to in Sections 7 and 8, and their respective successors and assigns, and no other person shall have or be construed to have any legal or equitable right, remedy or claim under or in respect of or by virtue of this Agreement or any provision herein contained. The term "successors and assigns" shall not include a purchaser, in its capacity as such, of Notes from the Initial Purchaser. Any Affiliated Dealer that is duly qualified and authorized to sell the Notes in the United States or Canada pursuant to the Offering Memorandum, and so offers and sells the Notes shall be deemed a third party beneficiary of the representations and warranties of the Company contained in Section 1, the covenants of the Company contained in Section 4, the indemnification and contribution obligations of the Company contained in Sections 7 and 8 and the officers' certificates, legal opinions and other documents required to be delivered to the Initial Purchaser pursuant to this Agreement, and each such affiliate shall have the right to enforce such provisions of this Agreement to the same extent as if it were an Initial Purchaser. 13. Governing Law. This Agreement shall be governed by and construed in ------------- accordance with the laws of the State of New York, but without regard to any applicable principles of conflicts of law. 26 14. Counterparts. This Agreement may be executed in any number of ------------- counterparts, each of which when so executed shall be deemed to be an original and all of which taken together shall constitute one and the same agreement. 15. Headings. The headings in this Agreement are inserted for -------- convenience of reference only, are not to be considered part of this Agreement and shall in no way modify or restrict any of the terms or provisions hereof. 16. Time is of the Essence. Time shall be of the essence of this -------------------------- Agreement. As used herein, the term "business day" shall mean any day when the Commission's office in Washington, D.C. is open for business. 18. Entire Agreement. This Agreement is intended by the parties as a ----------------- final expression of their agreement and intended to be a complete and exclusive statement of the agreement and understanding of the parties hereto in respect of the subject matter contained herein. There are no restrictions, promises, warranties or undertakings, other than those set forth or referred to herein with respect to the registration rights granted by the Company with respect to the Notes and the Conversion Shares. 19. Severability. If any one or more of the provisions contained ------------ herein, or the application thereof in any circumstance, is held invalid, illegal or unenforceability, the validity, legality and enforceability of any such provision in every other respect and of the remaining provisions contained herein shall not be affected or impaired thereby. (signature page follows) 27 If the foregoing correctly sets forth the understanding between you and the Company, please so indicate in the space provided below for that purpose, whereupon this letter shall constitute a binding agreement among us. Very truly yours, MERCER INTERNATIONAL INC. /s/ Jummy Lee By: ------------------------------ Name: Title: By: ------------------------------ Name: Title: (additional signature page follows) Accepted as of the date first above written. RBC DAIN RAUSCHER INC. /s/ Peter de Vos By: -------------------------------------- Name: Peter de Vos Title: Head of Corporate Finance signature page to purchase agreement SCHEDULE I Jimmy S.H. Lee C.S. Moon William McCartney Graeme Witts Wolfram Ridder Guy W. Adams David M. Gandossi R. Ian Rigg Kenneth A. Shields ANNEX I Form of Opinion of Heller Ehrman White & McAuliffe LLP ------------------------------------------------------ 1. The Company has been duly formed and is validly existing as a Massachusetts trust under the laws of the State of Washington. 2. The Company has all necessary Massachusetts trust power and Massachusetts trust authority to conduct its business as described in the Offering Memorandum, to offer, issue and sell the Notes and the Conversion Shares and to perform its obligations under the Operative Documents. 3. The Company has an authorized capitalization as set forth under the caption "Capitalization" in the Offering Memorandum; and the issued Shares of Beneficial Interest and the Conversion Shares conform in all material respects to the descriptions thereof contained in the Offering Memorandum. 4. The Conversion Shares have been duly authorized by all necessary action on the part of the Company and, when issued by the Company to satisfy the conversion rights of the Notes in accordance with the terms of the Notes and the Indenture, will be duly issued, fully paid and non-assessable. 5. The Company has reserved for issuance the Conversion Shares in a number of authorized but unissued Shares of Beneficial Interest sufficient to satisfy the conversion rights of the Notes, and no further approval or authority of the shareholders or the Board of Trustees of the Company is required for the issuance of such Conversion Shares. 6. This Purchase Agreement has been duly authorized by all necessary action on the part of the Company, and has been duly executed and delivered on behalf of the Company. 7. The Indenture has been duly authorized by all necessary action on the part of the Company, and has been duly executed and delivered on behalf of the Company and, assuming the due authorization, execution and delivery of the Indenture by the Trustee, is the valid and binding obligation of the Company, enforceable against the Company in accordance with its terms, subject to (i) bankruptcy, insolvency, fraudulent conveyance, moratorium, reorganization and other laws of general applicability relating to or affecting creditors' rights and (ii) general principles of equity (regardless of whether considered in a proceeding in equity or at law). 8. The Notes have been duly authorized by all necessary action on the part of the Company and have been executed and delivered on behalf of the Company for issuance and sale to the Initial Purchaser pursuant to the Purchase Agreement and, when issued and authenticated in accordance with the terms of the Indenture and delivered against payment therefor in accordance with the terms thereof and of the Purchase Agreement, assuming the due authorization, execution and delivery of the Indenture by the Trustee, will constitute the valid and binding obligations of the Company, enforceable against the Company in accordance with their terms and entitled to the benefits of the Indenture, subject to (i) bankruptcy, insolvency, fraudulent conveyance, moratorium, reorganization and other similar laws of general ANNEX I-1 applicability relating to or affecting creditors' rights and (ii) general principles of equity (regardless of whether considered in a proceeding in equity or at law). 9. The Registration Rights Agreement has been duly authorized by all necessary action on the part of the Company, and has been duly executed and delivered by the Company and, assuming the due authorization, execution and delivery of the Registration Rights Agreement by the Initial Purchaser, when executed and delivered by the Company, will constitute the valid and binding obligation of the Company, enforceable against the Company in accordance with its terms, subject to (i) bankruptcy, insolvency, fraudulent conveyance, moratorium, reorganization and other laws of general applicability related to or affecting creditors' rights and (ii) general principles of equity (regardless of whether considered in a proceeding in equity or at law). 10. The execution, delivery, and performance of the Operative Documents and the consummation of the transactions contemplated thereby by the Company do not and will not violate any provision of the Declaration of Trust or Trustee's Regulations of the Company or, to the best knowledge of such counsel, any federal or New York statute, rule or regulation known by such counsel to be generally applicable to similar transactions. 11. The issuance of the Notes, and issuance of the Conversion Shares by the Company to satisfy the conversion rights of the Notes, will not require approval of the shareholders of the Company under Washington law. 12. No consent, approval, authorization, order, registration, filing, qualification, license or permit of or with any court or any public, governmental, or regulatory agency or body having jurisdiction over the Company or any of its properties or assets is required under any law or regulation of the United States or of the State of New York, under the Massachusetts Trust Act of 1959 or the Washington Business Corporation Act for the execution, delivery and performance of the Operative Documents or the consummation of the transactions contemplated thereby, except for (1) such as may be required under state securities or Blue Sky laws in connection with the purchase and distribution of the Notes by the Initial Purchaser (as to which such counsel expresses no opinion), (2) such as may be required under the Securities Act or the Exchange Act and the Trust Indenture Act of 1939, as amended and (3) such as are required under the Registration Rights Agreement in connection with the Company's obligations thereunder. 13. No registration under the Securities Act of the Notes or the Conversion Shares, and no qualification of the Indenture under the Trust Indenture Act of 1939, as amended is required for the offer and sale of the Notes by the Company to the Initial Purchaser or the reoffer and resale of the Notes by the Initial Purchaser to the initial purchasers therefrom solely in the manner contemplated by the Offering Memorandum, the Purchase Agreement and the Indenture, assuming the representations, warranties and covenants of the Company and the Initial Purchaser in Sections 1, 3 and 4 of the Purchase Agreement have been and will be complied with. 14. When the Notes are issued and delivered pursuant to this Agreement, no Note will be of the same class (within the meaning of Rule 144A) as any securities of the Company that ANNEX I-2 are listed on a national securities exchange registered under Section 6 of the Exchange Act or that are quoted in a United States automated inter-dealer quotation system. 15. The statements under the caption "Material United States Federal Income Tax Considerations" in the Offering Memorandum, while not purporting to address all possible federal tax consequences of investing in a Note, insofar as they constitute statements of United States federal income tax law or legal conclusions, accurately summarize the material United States income tax consequences to holders of the Notes. 16. The Company is not an "investment company," as such term is defined in the Investment Company Act. 17. The purchase by an existing shareholder who owns less than 15% of the outstanding shares of beneficial interest of the Company of a pro rata portion of the Notes being sold in the offering does not constitute a "Triggering Event" under the Company's Rights Plan as amended. The purchase by an Eligible Purchase of Notes in this Offering will not constitute a Triggering Event under the Company's Rights Plan as amended, so long as, upon consummation of the Offering, no purchaser is the beneficial owner of 15% or more in the aggregate of the Company's outstanding shares of beneficial interest and the shares of beneficial interest into which the Notes are convertible. ANNEX I-3 ANNEX II Form of Opinion of Sangra, Moller --------------------------------- 1. To such counsel's knowledge and other than as set forth in the Offering Memorandum, there are no legal or governmental proceedings pending to which the Company or any of its significant subsidiaries is a party or of which any property of the Company or any of its significant subsidiaries is the subject that is likely to, individually or in the aggregate, have a Material Adverse Effect; and, to such counsel's knowledge, no such proceedings are threatened or contemplated by governmental authorities or threatened by others. 2. To such counsel's knowledge, the execution, delivery and performance of the Operative Documents and the consummation of the transactions contemplated thereby by the Company do not and will not (A) conflict with or result in a breach of any of the terms and provisions of, or constitute a default (or an event which with notice or lapse of time, or both, would constitute a default) under, or result in the creation or imposition of any lien, charge or encumbrance upon any property or assets of the Company or any of its subsidiaries pursuant to, any indenture, mortgage, deed of trust, loan agreement or any other agreement, instrument, franchise, license or permit identified to such counsel as material and listed as exhibits to the Company's Annual Report on Form 10-K for the year ended December 31, 2002 and the Company's Quarterly reports on Form 10-Q for the periods ended March 31, 2003 and June 30, 2003, or (B) violate or conflict with any applicable laws of the Province of British Columbia or the federal laws of Canada applicable therein, or, to the knowledge of such counsel, any judgment, decree, order, rule or regulation of any court or any public, governmental or regulatory agency or body having jurisdiction over the Company or any of its significant subsidiaries or any of their respective properties or assets. For purposes of this opinion, counsel may assume that all courts of competent jurisdiction would enforce agreements and orders not expressly governed by Canadian law as written but would apply the laws of the Province of British Columbia. 3. The offering, issue, sale and delivery of the Notes by the Company to the Initial Purchaser and by the Initial Purchaser to its affiliates who are permitted under applicable securities laws to offer and sell the Notes in the Private Placement Provinces (the "Affiliates") in compliance with the terms of this Agreement, the Offering Memorandum and the Wrap Information is exempt, either by statute, rule, regulation, interpretation note or order, from the prospectus requirements of the applicable Canadian Securities Laws, and no prospectus is required nor are other documents required to be filed, proceedings taken or approvals, permits, consents, orders or authorizations of regulatory authorities obtained under the applicable Canadian Securities Laws to permit the offering, issue, sale and delivery of the Notes by the Company in accordance with this Purchase Agreement. 4. The offering, issue, sale and delivery of the Notes by the Initial Purchaser or its Affiliates to the Eligible Purchasers, in each case, in accordance with the terms and conditions set forth in this Agreement, the Offering Memorandum and the Wrap Information and assuming the accuracy of the representations and warranties of such parties therein, are exempt from the prospectus requirements of the Canadian Securities Laws, and no documents are required to be filed, proceedings taken or approvals, permits, consents or authorizations of regulatory ANNEX II-1 authorities obtained under the applicable Canadian Securities Laws in connection therewith, other than those which have been obtained and, with respect to the distribution of the Notes, except for the filing with the relevant Canadian Commissions in each Private Placement Province in which an Eligible Purchaser is resident, by or on behalf of the Company, within the prescribed time periods, of (i) a copy of the Offering Memorandum and Wrap Information with the Ontario Securities Commission, (ii) a report of the trade in the prescribed form, prepared and executed in accordance with applicable Canadian Securities Laws, and (iii) a certificate prepared in accordance with Policy Statement 41-601Q of the Commission des valuers mobilieres du Quebec, together with any prescribed fees. 5. The first trade of the Notes sold by the Initial Purchaser or its Affiliates to purchasers resident in a Private Placement Province, except Quebec, other than a trade which is otherwise exempt under the Canadian Securities Laws, will be a distribution subject to the prospectus and registration requirements of the Canadian Securities Laws to the extent that they apply, unless: (a) the Company is and has been a reporting issuer in a Private Placement Province specified in Multilateral Instrument 45-102 for the four months immediately preceding the trade; (b) at least four months have elapsed from the date of issue of the Notes; (c) the legend requirements of Multilateral Instrument 45-102 have been satisfied; (d) the trade is not a "control distribution", as such term is defined in Multilateral Instrument 45-102; (e) no unusual effort is made to prepare the market or to create a demand for the Notes that are the subject of the trade; (f) no extraordinary commission or consideration is paid to a person or company in respect of the trade; and (g) if the seller is an insider or officer of the Company, the seller has no reasonable grounds to believe that the Company is in default of securities legislation. 6. The first trade of the Notes sold by the Initial Purchaser or its Affiliates to purchasers resident in the Province of Quebec, other than a trade which is otherwise exempt under the Securities Act (Quebec), will be a distribution subject to the prospectus and registration requirements of the Securities Act (Quebec) to the extent that it applies, unless: (a) the Company was a reporting issuer in Quebec for a period of four months immediately preceding the alienation; (b) the purchaser and subsequent purchasers have in aggregate kept the securities for at least four months; (c) no extraordinary commission or consideration is paid concerning the alienation; (d) no effort is made to prepare the market or create a demand for the Notes that are the subject of the alienation; and ANNEX II-2 (e) where the seller is an insider of the Company, the seller has no reason to believe that the Company is in default of any securities legislation. 7. The Conversion Shares have been authorized for quotation on the Nasdaq National Market. 8. The issuance of Conversion Shares by the Company to Eligible Purchasers resident in a Private Placement Province will be exempt from the prospectus and registration requirements of the Canadian Securities Laws, and no documents are required to be filed, proceedings taken or approvals, permits, consents or authorizations of regulatory authorities obtained under the Canadian Securities Laws in connection therewith, provided that: (a) no commission or other remuneration is paid or given to others in respect of the trade, except for administrative or professional services or for services performed by a registered dealer; and (b) the Company files with the Canadian Commission in the Private Placement Province in which such Eligible Purchaser is resident the required notice and pays the applicable fee in accordance with applicable Canadian Securities Laws. 9. The first trade in Conversion Shares by purchasers resident in a Private Placement Province, except Quebec, other than a trade which is otherwise exempt under Canadian Securities Laws, will be a distribution subject to the prospectus and registration requirements of the Canadian Securities Laws, unless: (a) the Company is and has been a reporting issuer in a Private Placement Province specified in Multilateral Instrument 45-102 for the four months immediately preceding the trade; (b) at least four months have elapsed from the date of issue of the Notes; (c) the legend requirements of Multilateral Instrument 45-102 have been satisfied; (d) the trade is not a "control distribution", as such term is defined in Multilateral Instrument 45-102; (e) no unusual effort is made to prepare the market or to create a demand for the Conversion Shares that are the subject of the trade; (f) no extraordinary commission or consideration is paid to a person or company in respect of the trade; and (g) if the seller is an insider or officer of the Company, the seller has no reasonable grounds to believe that the Company is in default of securities legislation. 10. The first trade in Conversion Shares by purchasers in the Province of Quebec, other than a trade which is otherwise exempt under Securities Act (Quebec), will be a distribution subject to the prospectus and registration requirements of the Securities Act (Quebec), unless: (a) the issuer was a reporting issuer in Quebec for a period of four months immediately preceding the alienation; ANNEX II-3 (b) the purchaser and subsequent purchasers have in aggregate kept the securities for at least four months; (c) no extraordinary commission or consideration is paid concerning the alienation; (d) no effort is made to prepare the market or create a demand for the Conversion Shares that are the subject of the alienation; and (e) where the seller is an insider of the Company, the seller has no reason to believe that the Company is in default of any securities legislation. 11. The statements in the Wrap Information under the caption "Rights of Action", insofar as such statements purport to describe or summarize the legal matters, documents, statutes, regulations or proceedings referred to therein, are accurate descriptions or summaries in all material respects. 12. No registration, filing or recording of the Indenture under the federal laws of Canada or the laws of the Province of British Columbia is necessary in order to preserve or protect the validity or enforceability of the Indenture or the Notes issued thereunder. 13. Subject to the limitations and qualifications set out therein and based on a certificate of an officer of the Company as to certain factual matters, the statements in the Wrap Information under the heading "Certain Canadian Federal Income Tax Considerations for Canadian Residents" fairly describe in all material respects the principal Canadian federal income tax consequences under the Income Tax Act (Canada) insofar as they purport to describe the provisions of law referred to therein generally applicable to the holders of Notes and Conversion Shares referred to therein. 14. The Shares of Beneficial Interest to be issued upon conversion of the Notes have been conditionally approved for listing on the TSX, subject only to the filing of certain documents. 15. The statements set forth in the Offering Memorandum under the captions "Description of Notes" and "Description of Capital Stock," insofar as it purports to constitute a summary of the Notes and the Conversion Shares and under the captions "Business - Rosenthal Conversion Project and Financing," "Business - Stendal Pulp Mill Project and Financing - Project Financing," "Description of Certain Indebtedness," and "Plan of Distribution," insofar as they purport to describe the provision of the laws and documents referenced therein, are accurate summaries in all material respects. In addition, such opinion shall also contain a statement that such counsel has participated in conferences with officers and representatives of the Company, representatives of the independent public accountants for the Company and the Initial Purchaser at which the contents of the Offering Memorandum and related matters were discussed and, as a result of such participation, no facts have come to the attention of such counsel that cause such counsel to believe that the Offering Memorandum (including the Incorporated Documents), as of its date (or any amendment thereof or supplement thereto made prior to the Closing Date as of the date of such amendment or supplement) and as of the Closing Date, contained or contains an untrue statement of a material fact or omitted or omits to state any material fact required to be stated ANNEX II-4 therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading (it being understood that such counsel need express no belief or opinion with respect to the financial statements and schedules and other financial data included therein or omitted therefrom). ANNEX II-5 ANNEX III Form of Lock-Up Agreement ------------------------- RBC DAIN RAUSCHER INC. Royal Bank Plaza 4th Floor, South Tower 200 Bay Street Toronto, Ontario M5J 2W7 Re: Mercer International Inc. --------------------------- Ladies and Gentlemen: In consideration of the agreement of RBC Dain Rauscher Inc. to act as Initial Purchaser for the proposed offering (the "OFFERING") of Convertible Senior Subordinated Notes (the "NOTES") of Mercer International Inc., a business trust organized under the laws of the State of Washington (the "COMPANY"), as contemplated by an offering memorandum, the undersigned hereby (i) agrees that the undersigned will not, directly or indirectly, during a period of one hundred eighty (180) days from the date of the purchase agreement entered into in connection with the Offering (the "LOCK-UP PERIOD"), without the prior written consent of RBC Dain Rauscher Inc. (such consent not to be unreasonably withheld or delayed), issue, sell, offer or agree to sell, grant any option for the sale of, pledge, make any short sale or maintain any short position, establish or maintain a "put equivalent position" (within the meaning of Rule 16-a-1(h) under the Securities Exchange Act of 1934, as amended), enter into any swap, derivative transaction or other arrangement that transfers to another, in whole or in part, any of the economic consequences of ownership of (whether any such transaction is to be settled by delivery of Shares of Beneficial Interest of the Company (the "SHARES OF BENEFICIAL INTEREST"), other securities, cash or other consideration), or otherwise dispose of, any Shares of Beneficial Interest (or any securities convertible into, exercisable for or exchangeable for Shares of Beneficial Interest, including the Notes, (the "EXCHANGEABLE SHARES")) or interest therein of the Company, or any Shares of Beneficial Interest or any securities convertible into, exercisable for or exchangeable for Shares of Beneficial Interest or interest therein of any of its subsidiaries, unless it is a condition to any such transfer that the transferee certifies in writing to RBC Dain Rauscher Inc. that (x) such transferee is receiving and holding the Shares of Beneficial Interest or other securities subject to the provisions of this Agreement and that there shall be no further transfer of such Shares of Beneficial Interest or other securities except in accordance with this Agreement, and (y) such transferee will comply with the terms of this Agreement as if such transferee were bound by this Agreement, and (ii) authorizes the Company during the Lock-Up Period to cause the transfer agent to decline to transfer and/or to note stop transfer restrictions on the transfer books and records of the Company with respect to any Shares of Beneficial Interest and any securities convertible into, exercisable for or exchangeable for Shares of Beneficial Interest (including the Notes and the Exchangeable Shares) for which the undersigned is the record or beneficial holder. The undersigned agrees that any Shares of Beneficial Interest received upon exercise of options granted to the undersigned will also be subject to this Agreement. The ANNEX III-1 undersigned further agrees, from the date hereof until the end of the Lock-up Period, that the undersigned will not exercise and will waive his, her or its rights, if any, to require the Company to register its Shares of Beneficial Interest and to receive notice thereof. The undersigned hereby represents and warrants that the undersigned has full power and authority to enter into the agreements set forth herein, and that, upon request, the undersigned will execute any additional documents necessary in connection with implementing the agreements, authorizations and other terms hereof. Any obligations of the undersigned shall be binding upon the successors and assigns of the undersigned. Very truly yours, Dated: , 2003 ----------------- ANNEX III-2 -----END PRIVACY-ENHANCED MESSAGE-----