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UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, DC 20549

FORM 20-F

[  ] REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) or
12(g) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For The Fiscal Year Ended December 31, 2012

OR

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

OR

[  ] SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES AND EXCHANGE ACT OF 1934

Commission file number 333-179957

MILLAR WESTERN FOREST PRODUCTS LTD.(Exact Name of the Registrant as Specified in its Charter)

Alberta, Canada(Jurisdiction of Incorporation or
Organization)

16640 - 111 Avenue, Edmonton, Alberta, T5M 2S5(Address of Principal Executive Offices)

Kevin A. EdgsonMillar Western Forest Products
Ltd. 16640  111 Avenue Edmonton, Alberta T5M 2S5 (780) 486-8200(Name, Telephone, E-mail and/or Facsimile number and Address of Company
Contact Person)

|Securities registered or to be registered pursuant to
      Section 12(b) of the Act:                                                                                        | NONE                       
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------------
|                                                                                                                                                                             |                            
|Securities registered or to be registered pursuant to
      Section 12(g) of the Act:                                                                                        | NONE                       
|                                                                                                                                                                             |                            
|Securities for which there is a reporting obligation
      pursuant to Section 15(d) of the Act:                                                                             | 8.50% Senior Notes due 2021
|                                                                                                                                                                             |                            
|Indicate the number of outstanding shares of each of the
      issuer's classes of capital or common stock as of the close of the period
      covered by the annual report. | 15,000,002 Common Shares   

Indicate by check mark if the registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Securities Act

YES [   ]                                         NO [X]

1

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Indicate by check mark if the registrant is not required to
file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934.

YES [   ]                                         NO [X]

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 has submitted
electronically and posted on its corporate Web site, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405 of Regulation
S-T during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).

YES [   ]                                         NO [  
]

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

|Large Accelerated Filer [   ] | Accelerated Filer [   ] | Non-Accelerated
      Filer [X]
|----------------------------- | ----------------------- | -------------------------------

Indicate by check mark which basis of accounting the registrant
has used to prepare the financial statements included in this filing:

U.S. GAAP [   ]International Financial Reporting Standards as
issued by the International Accounting Standards
Board [X]Other [   ]

If this is an annual report, indicate by check mark whether the
registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YES [   ]                                         NO [X]

Indicate by check mark whether the registrant has filed all
documents and reports required to be filed by Sections 12, 13 or 15(d) of the
Securities Exchange Act of 1934 subsequent to the distribution of securities
under a plan confirmed by a court.

NOT APPLICABLE

2

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TABLE OF CONTENTS

|                                                        |                                                             |                                                               | **Page**
|------------------------------------------------------- | ----------------------------------------------------------- | ------------------------------------------------------------- | --------
|                                                        |                                                             |                                                               |         
|PRESENTATION
      CONTEXT                              | 5                                                          
|                                                        |                                                             |                                                               |         
|STATEMENT
      REGARDING FORWARD LOOKING INFORMATION . | 5                                                          
|                                                        |                                                             |                                                               |         
|GLOSSARY
      OF CERTAIN TERMS AND DEFINITIONS         | 7                                                          
|                                                        |                                                             |                                                               |         
|PART
      I                                            |                                                             |                                                               | 9       
|                                                        |                                                             |                                                               |         
|ITEM
      1:                                           | IDENTITY
      OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS | 9                                                            
|                                                        |                                                             |                                                               |         
|ITEM
      2:                                           | OFFER
      STATISTICS AND EXPECTED TIMETABLE               | 9                                                            
|                                                        |                                                             |                                                               |         
|ITEM 3:                                                 | KEY INFORMATION                                             |                                                              
|                                                        | A.                                                          | Selected
      financial data                                 | 9       
|                                                        | B.                                                          | Capitalization
      and indebtedness                         | 14      
|                                                        | C.                                                          | Reasons
      for the offer and use of proceeds               | 14      
|                                                        | D.                                                          | Risk
      factors                                            | 14      
|                                                        |                                                             |                                                               |         
|ITEM 4:                                                 | INFORMATION ON THE
      COMPANY                            |                                                              
|                                                        | A.                                                          | History
      and development of the Company                  | 21      
|                                                        | B.                                                          | Business
      overview                                       | 22      
|                                                        | C.                                                          | Organizational
      structure                                | 29      
|                                                        | D.                                                          | Property,
      plants and equipment                          | 29      
|                                                        |                                                             |                                                               |         
|ITEM 5:                                                 | OPERATING AND
      FINANCIAL REVIEW AND PROSPECTS          |                                                              
|                                                        | A.                                                          | Results
      of operations                                   | 32      
|                                                        | B.                                                          | Liquidity
      and capital resources                         | 52      
|                                                        | C.                                                          | Research
      and development                                | 57      
|                                                        | D.                                                          | Trend
      information                                       | 57      
|                                                        | E.                                                          | Off-balance
      sheet arrangements                          | 58      
|                                                        | F.                                                          | Tabular
      disclosure of contractual obligations           | 58      
|                                                        | G.                                                          | Safe
      harbor                                             | 59      
|                                                        |                                                             |                                                               |         
|ITEM 6:                                                 | DIRECTORS, SENIOR MANAGEMENT AND
      EMPLOYEES            |                                                              
|                                                        | A.                                                          | Directors
      and officers                                  | 60      
|                                                        | B.                                                          | Compensation                                                  | 62      
|                                                        | C.                                                          | Board
      practices                                         | 63      
|                                                        | D.                                                          | Employees                                                     | 63      
|                                                        | E.                                                          | Share
      ownership                                         | 63      
|                                                        |                                                             |                                                               |         
|ITEM 7:                                                 | MAJOR SHAREHOLDERS
      AND RELATED PARTY TRANSACTIONS     |                                                              
|                                                        | A.                                                          | Principal
      shareholder                                   | 63      
|                                                        | B.                                                          | Related
      party transactions                              | 64      
|                                                        | C.                                                          | Interests
      of experts and counsel                        | 65      
|                                                        |                                                             |                                                               |         
|ITEM 8:                                                 | FINANCIAL INFORMATION                                       |                                                              
|                                                        | A.                                                          | Consolidated
      statements and other financial information | 65      
|                                                        | B.                                                          | Significant
      changes                                     | 65      
|                                                        |                                                             |                                                               |         
|ITEM 9:                                                 | THE OFFER AND LISTING                                       |                                                              
|                                                        | A.                                                          | Offer
      and listing details                               | 65      
|                                                        | B.                                                          | Plan
      of distribution                                    | 65      
|                                                        | C.                                                          | Markets                                                       | 65      

---

|               | D.                                                                                 | Selling
      shareholders                         | 65
|-------------- | ---------------------------------------------------------------------------------- | -------------------------------------------------- | --
|               | E.                                                                                 | Dilution                                           | 65
|               | F.                                                                                 | Expenses
      of the issue                        | 64
|               |                                                                                    |                                                    |   
|ITEM 10:       | ADDITIONAL INFORMATION                                                             |                                                   
|               | A.                                                                                 | Share
      capital                                | 66
|               | B.                                                                                 | Memorandum
      and articles of association       | 66
|               | C.                                                                                 | Material
      contracts                           | 67
|               | D.                                                                                 | Exchange
      controls                            | 67
|               | E.                                                                                 | Taxation                                           | 67
|               | F.                                                                                 | Dividends
      and paying agents                  | 67
|               | G.                                                                                 | Statement
      by experts                         | 68
|               | H.                                                                                 | Documents
      on display                         | 68
|               | I.                                                                                 | Subsidiary
      information                       | 68
|               |                                                                                    |                                                    |   
|ITEM 11:       | QUANTITATIVE AND
      QUALITATIVE DISCLOSURES ABOUT MARKET RISK                   |                                                   
|               | A.                                                                                 | Commodity
      prices                             | 68
|               | B.                                                                                 | Foreign
      exchange                             | 68
|               | C.                                                                                 | Interest
      rates                               | 69
|               |                                                                                    |                                                    |   
|ITEM
      12: | DESCRIPTION
      OF SECURITIES OTHER THAN EQUITY SECURITIES                       | 69                                                
|               |                                                                                    |                                                    |   
|PART II        |                                                                                    |                                                    |   
|ITEM
      13: | DEFAULTS,
      DIVIDEND ARREARAGES AND DELINQUENCIES                              | 69                                                
|               |                                                                                    |                                                    |   
|ITEM
      14: | MATERIAL
      MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS | 69                                                
|               |                                                                                    |                                                    |   
|ITEM
      15: | CONTROLS
      AND PROCEDURES                                                      | 69                                                
|               |                                                                                    |                                                    |   
|ITEM 16        |                                                                                    |                                                    |   
|               | A.                                                                                 | Audit
      committee financial expert             | 69
|               | B.                                                                                 | Code
      of ethics                               | 70
|               | C.                                                                                 | Principal
      accountant fees and services       | 70
|               | D.                                                                                 | Exemptions
      from the listing standards        | 70
|               | E.                                                                                 | Purchase
      of equity securities by the Issuer  | 70
|               | F.                                                                                 | Change
      in registrants certifying accountant | 70
|               | G.                                                                                 | Corporate
      governance                         | 71
|               | H.                                                                                 | Mine
      safety disclosure                       | 71
|               |                                                                                    |                                                    |   
|PART III       |                                                                                    |                                                    |   
|               |                                                                                    |                                                    |   
|ITEM
      17: | FINANCIAL
      STATEMENTS                                                         | 71                                                
|               |                                                                                    |                                                    |   
|ITEM
      18: | FINANCIAL
      STATEMENTS                                                         | 71                                                
|               |                                                                                    |                                                    |   
|ITEM
      19: | EXHIBITS                                                                           | 71                                                

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As used in this annual report on Form 20-F (this annual
report), unless the context otherwise indicates, the term we, our, "Millar
Western" or the "Company" means Millar Western Forest Products Ltd.

PRESENTATION OF FINANCIAL INFORMATION

We prepare our financial statements in accordance with
International Financial Reporting Standards as issued by the International
Accounting Standards Board, which we refer to as IFRS. Our first full year of
reporting under IFRS was 2011, with a transition date of January 1, 2010, and
comparable periods in 2010 being restated. Prior to January 1, 2011, we prepared
our financial statements in accordance with Canadian generally accepted
accounting principles, which we refer to as Previous GAAP. As a result of the
transition to IFRS, certain of our revenue and cost items have been
reclassified, which affected the calculation of Adjusted EBITDA and Cash
Adjusted EBITDA (each as defined below) in prior periods. Readers should be
aware that financial statements prepared in accordance with IFRS may differ in
certain respects from financial statements prepared in accordance with U.S.
generally accepted accounting principles, which we refer to as U.S. GAAP.

We present our financial statements in Canadian dollars. Except
where otherwise indicated, all dollar amounts are expressed in Canadian dollars,
references to $ or dollars are to Canadian dollars and references to US$
and U.S. dollars are to United States dollars. See Item 3 for exchange rate
information between the Canadian dollar and the United States dollar.

NON-GAAP FINANCIAL MEASURES

We define Adjusted EBITDA as operating income plus unrealized
other income or expenses, depreciation and amortization. Other income or expense
includes both realized and unrealized gains and losses on foreign exchange or
commodity hedging, and foreign-exchange impacts on working capital balances,
with only the realized portion of such income or expense being included in
Adjusted EBITDA and both the realized and unrealized portion being included in
the determination of operating earnings. In addition, we define Cash Adjusted
EBITDA as Adjusted EBITDA plus gains or minus losses related to non-cash
inventory valuation adjustments. Neither Adjusted EBITDA nor Cash Adjusted
EBITDA is a measure of operating performance or liquidity under IFRS or U.S.
GAAP. Such terms, as used in this prospectus, are not necessarily comparable
with similarly titled measures of other companies. Management believes that
Adjusted EBITDA and Cash Adjusted EBITDA may be useful in assessing our
operating performance and as an indicator of our ability to service or incur
indebtedness, make capital expenditures and finance working capital
requirements. The items excluded from Adjusted EBITDA and Cash Adjusted EBITDA
are significant in assessing our operating results and liquidity. Therefore,
neither Adjusted EBITDA nor Cash Adjusted EBITDA should be considered in
isolation or as an alternative to operating earnings, cash flow from operating
activities or other combined income or cash flow data prepared in accordance
with IFRS or U.S. GAAP. See Item 3: Selected Financial Data for a reconciliation
of Adjusted EBIDTA and Cash Adjusted EBITDA to Net Earnings (Loss).

SPECIAL NOTE REGARDING FORWARD LOOKING-STATEMENTS

Certain statements in this annual report are "forward-looking
statements" within the meaning of the United States Private Securities
Litigation Reform Act of 1995. These forward-looking statements are not based on
historical facts but, rather, on our current expectations and our projections
about future events, including our current expectations regarding:

- the future demand for, and sales volumes of, our lumber and pulp products;
- future production volumes, efficiencies and operating costs;
- increases or decreases in the prices of our products;
- our future stability and growth prospects;
- our business strategies, the measures to implement those strategies and
  the benefits to be derived therefrom;

5

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- our future profitability and capital needs, including capital
  expenditures;
- the outlook for and other future developments in our affairs or in the
  industries in which we participate; and
- the effect on us of new accounting releases.

These forward-looking statements generally can be identified by
the use of statements that include words such as "believe", "expect",
"anticipate", "intend", "plan", "likely", "will", "predicts", "estimates",
"forecasts" or other similar words or phrases. Similarly, statements that
describe our objectives, plans or goals are or may be forward-looking
statements. These forward-looking statements are subject to various risks,
uncertainties and other factors that could cause our actual results to differ
materially from the future results expressed or implied by the forward-looking
statements. These risks and uncertainties are described under "Risk Factors" in
Item 3: Key Information.

Any written or oral forward-looking statements made by us or on
our behalf are subject to these factors. In light of these risks, uncertainties
and assumptions, the forward-looking events discussed in this annual report on
Form 20-F may not occur. Actual results could differ materially from those
expressed in any of our forward-looking statements. Other unknown or
unpredictable factors also could harm our future results. Given these
uncertainties, prospective investors are cautioned not to place undue reliance
on such forward-looking statements. The forward-looking statements included in
this annual report are made only as at the date of this annual report. We do not
intend, and do not assume any obligation, to update these forward-looking
statements, except as required by law.

6

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GLOSSARY OF CERTAIN TERMS AND DEFINITIONS

The following terms have the following meanings in this annual
report:

AAC means annual allowable cut, being the amount of
timber that may be harvested in any one year as stipulated in the pertinent
forest management plan for a Forest Management Unit as approved by the Minister
of Environment and Sustainable Resource Development of Alberta;

ADMT means air dried metric tonne, a unit of
measurement of pulp volume, and MADMT means one thousand air dried
metric tonnes;

BCTMP means bleached chemi-thermo-mechanical pulp,
which is pulp produced in a process that uses mild chemicals, heat and
mechanical action to separate cellulose fibers;

BEK means bleached eucalyptus kraft pulp;

coniferous means a type of tree that is cone-bearing
and has needles or scale-like leaves, such as spruce, pine or fir;

Coniferous Timber Quota means the right to harvest a
percentage share of the AAC of coniferous timber within a Forest Management
Unit, as approved by the Alberta Minister of Environment and Sustainable
Resource Development, allocated on a 20-year basis and renewable thereafter for
additional 20-year periods;

deciduous  means a type of tree with broad leaves that
usually shed annually, such as aspen;

Deciduous Timber Allocation means the right to harvest
a specified volume of deciduous timber within a designated area, as approved by
the Alberta Minister of Environment and Sustainable Resource Development,
allocated on a 20-year basis and renewable thereafter for additional 20-year
periods;

dimension lumber means standard commodity lumber,
ranging, in the case of Millar Western, from 1 x 3s to 2 x 10s in varying
lengths, usually 8 to 16;

FMA means a Forest Management Agreement between the
Alberta Minister of Environment and Sustainable Resource Development and a
forest company, generally having a term of 20 years and renewable thereafter for
additional 20-year periods, and providing rights to manage, establish, grow,
harvest and remove timber in a specified area;

foot board measure or fbm or board
foot means a measure of lumber volume equivalent to a one-foot square
board, one inch thick; mfbm is one thousand board feet; and
mmfbm is one million board feet;

Forest Management Unit means an area of forest land
designated by the Minister of Environment and Sustainable Resource Development
of Alberta as a management unit;

FSC means the Forest Stewardship Council. FSC was
established in 1993 and is a voluntary, international certification and labeling
system that promotes responsible forest management and fiber procurement through
its sustainable forest management and chain of custody standards;

hardwood is wood obtained from deciduous species of
trees, such as aspen;

7

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Industries means Millar Western Industries Ltd., the
parent company of Millar Western Forest Products Ltd.;

ISO means the International Organization for
Standardization, a worldwide federation of national standards bodies from
approximately 120 countries. ISO 14001 is an international set of
standards that provide a common approach for documenting and maintaining an
environmental management system;

kraft pulp means pulp produced in a process that uses
strong chemicals to separate cellulose fibers;

Millar Western FMA means the FMA between the Minister
of Environment and Sustainable Resource Development of Alberta and Millar
Western commencing May 14, 1997, in effect for 20 years and renewable thereafter
for additional 20-year periods, pursuant to which the Minister has granted
rights to us to manage, establish, grow, harvest and remove timber on a
perpetual sustained yield basis in the Millar Western forest management area;

Millar Western forest management area means the tract
of forested land over which we have been given rights to manage, establish,
grow, harvest and remove timber on a perpetual sustained yield basis for the
term of the Millar Western FMA;

MSR means machine stress rated, which is a rating
given to lumber in North America that describes its load bearing capability;

NBSK means northern bleached softwood kraft pulp;

Notes and Senior Notes, unless specified as
referring to notes appended to our financial statements or to previously issued
Senior Notes, mean the Companys 8.50% Senior Notes, issued in 2011 and due in
2021;

PEFC means the Programme for the Endorsement of Forest
Certification. Established in 1999, PEFC is a European-based umbrella
organization that endorses national forest certification systems developed
through multi-stakeholder processes and tailored to meet local conditions. As
well as assessing and endorsing national schemes for their consistency with
international standards, PEFC maintains its own chain-of-custody standard;

perpetual sustained yieldmeans the yield of
timber that a forest can produce continuously at a given intensity of management
without impairment of the productivity of the land;

SFImeans the Sustainable Forestry Initiative,
a voluntary, third-party, North America-based forest certification program
established in 1994. SFI is based on principles and measures that promote
sustainable forest management and consider all forest values. It is managed by
SFI Inc., an independent, non-profit organization responsible for maintaining,
overseeing and improving the sustainable forestry certification program. SFI is
endorsed by PEFC;

softwood is wood obtained from coniferous species of
trees, such as spruce, pine or fir;

SPF means spruce, pine and fir, a major category of
softwood lumber; and

wood chips means pieces of wood approximately one inch
square by one-quarter inch thick resulting from the cutting of logs in chippers,
or as a by-product of the lumber manufacturing process, that are typically used
as a feedstock in the pulp making process.

8

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PART I

|ITEM 1: IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND
      ADVISERS.
|--------------------------------------------------------------------

Not applicable.

|ITEM 2: OFFER STATISTICS AND EXPECTED TIMETABLE
|-----------------------------------------------

Not applicable.

|ITEM 3: KEY INFORMATION
|-----------------------

|A. | Selected Financial Data
|-- | -----------------------

The selected historical financial data presented below as at
and for each of the years in the three-year period ended December 31, 2012, have
been derived from, and should be read together with, our audited financial
statements and the accompanying notes included elsewhere in this annual report.
Our audited financial statements are reported in Canadian dollars and have been
prepared in accordance with IFRS.

Our earlier audited financial statements were prepared in
accordance with Previous GAAP, which differs from IFRS in certain respects. The
selected historical financial data presented below as at and for each of the
years in the two-year period ended December 31, 2009, have been derived from,
and should be read together with, our audited financial statements prepared in
accordance with Previous GAAP, which are not included in this annual report.

The selected historical financial data presented below are
qualified in their entirety by the more detailed information appearing in our
financial statements and the related notes, as well as Item 5, Operating and
Financial Review and Prospects, and other financial information included
elsewhere in this annual report. Historical results are not necessarily
indicative of results expected for any future period.

9

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|                                                 |   | Year ended December 31, |  
|------------------------------------------------ | - | ----------------------- | -
|                                                 |   | 2012                    |  
|Statements of earnings
      data:               |   |                         |  
|IFRS                                             |   |                         |  
|Revenue                                          | $ | 332,401                 |  
|Cost of products sold                            |   | 241,039                 |  
|Freight and other
      distribution costs       |   | 53,222                  |  
|Depreciation and amortization                    |   | 13,641                  |  
|General and administration                       |   | 13,781                  |  
|Employees' profit sharing                        |   | -                       |  
|Other expenses (income) (2)                      |   | 7,650                   |  
|Operating earnings                               |   | 3,068                   |  
|Foreign exchange gain (loss)
      on borrowings |   | 4,641                   |  
|Financing expenses (1)                           |   | (20,425                 | )
|(Loss) earnings before income
      taxes        |   | (12,716                 | )
|Income taxes (recovery) expense                  |   | (4,457                  | )
|Net (loss) earnings for the
      year           | $ | (8,259                  | )
|Actuarial losses- net of tax recovery            |   | 317                     |  
|Comprehensive (loss) income
      for the year   | $ | (8,576                  | )
|                                                 |   |                         |  
|Other data:                                      |   |                         |  
|IFRS                                             |   |                         |  
|Adjusted EBITDA (3)                              | $ | 22,755                  |  
|Ratio of earnings to fixed charges (4)           |   | 0.4                     | x
|                                                 |   |                         |  
|Shipments:                                       |   |                         |  
|Pulp (MADMT)                                     |   | 322                     |  
|Lumber (MMFBM)                                   |   | 520                     |  
|Average revenue                                  |   |                         |  
|Pulp ($ per ADMT)                                |   | 553                     |  
|Lumber ($ per MFBM)                              |   | 296                     |  
|                                                 |   |                         |  
|Balance sheets data:                             |   |                         |  
|                                                 |   | Year ended December 31, |  
|                                                 |   | 2012                    |  
|IFRS                                             |   | (in
      thousands)    |  
|Cash                                             | $ | 24,674                  |  
|Restricted cash                                  | $ | 18,824                  |  
|Total assets                                     | $ | 382,175                 |  
|Financial Liabilities -
      borrowings         | $ | 222,745                 |  
|Shareholder's equity                             | $ | 72 620                  |  

10

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|                                           |   | Year ended December 31, |  
|------------------------------------------ | - | ----------------------- | -
|                                           |   | 2009                    |  
|Statements of earnings
      data:         |   | (in
      thousands)    |  
|Previous GAAP                              |   |                         |  
|Revenue                                    | $ | 255,010                 |  
|Cost of products sold                      |   | 186,636                 |  
|Freight and other
      distribution costs |   | 53,391                  |  
|Depreciation and amortization              |   | 21,011                  |  
|General and administration                 |   | 12,329                  |  
|Employees' profit sharing                  |   | -                       |  
|Operating (loss) earnings                  |   | (18,357                 | )
|Foreign exchange gain (loss) on borrowings |   | 31,730                  |  
|Financing expenses (1)                     |   | (18,097                 | )
|Other (expenses) income (5)                |   | (10,156                 | )
|(Loss) before income taxes                 |   | (14,880                 | )
|Income taxes (recovery)                    |   | (7,397                  | )
|Net (loss) for the year                    | $ | (7,483                  | )
|                                           |   |                         |  
|U.S. GAAP                                  |   |                         |  
|Operating (loss) earnings                  | $ | (18,357                 | )
|Net loss                                   | $ | (7,992                  | )
|                                           |   |                         |  
|Other data:                                |   |                         |  
|Previous GAAP                              |   |                         |  
|Adjusted EBITDA (3)                        | $ | (4,910                  | )
|Ratio of earnings to fixed charges (4)     |   | 0.2 x                   |  
|                                           |   |                         |  
|Shipments:                                 |   |                         |  
|Pulp (MADMT)                               |   | 296                     |  
|Lumber (MMFBM)                             |   | 353                     |  
|Average revenue                            |   |                         |  
|Pulp ($ per ADMT)                          |   | 567                     |  
|Lumber ($ per MFBM)                        |   | 246                     |  
|                                           |   |                         |  
|Balance sheets data:                       |   |                         |  
|                                           |   |                         |  
|                                           |   | 2009                    |  
|Previous GAAP                              |   | (in
      thousands)    |  
|Cash                                       | $ | 61,186                  |  
|Total assets                               | $ | 336,138                 |  
|Financial Liabilities -
      borrowings   | $ | 215,939                 |  
|Shareholder's equity                       | $ | 69,764                  |  
|                                           |   |                         |  
|U.S. GAAP                                  |   |                         |  
|Total assets                               | $ | 338,055                 |  
|Shareholders' equity                       | $ | 70 979                  |  

| | (1) | Financing expenses consists of interest expense,
      amortization of deferred financing costs and bank charges. See note 20 to
      our audited financial statements included elsewhere in this annual
      report.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

11

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| | (2) | Other (expense) income includes the gain or loss on
      disposal of property, plant and equipment, foreign exchange gains or
      losses on U.S. dollar cash and working capital, and realized and
      unrealized gains or losses on derivative contracts. See note 19 to our
      audited financial statements included elsewhere in this annual
    report.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (3) | We define Adjusted EBITDA as operating income plus
      unrealized other income or expenses, depreciation and amortization. Other
      income or expense includes both realized and unrealized gains and losses
      on foreign exchange or commodity hedging, and foreign-exchange impacts on
      working capital balances, with only the realized portion of such income or
      expense being included in Adjusted EBITDA and both the realized and
      unrealized portion being included in the determination of operating
      earnings. In addition, we define Cash Adjusted EBITDA as Adjusted EBITDA
      plus gains or minus losses related to non-cash inventory valuation
      adjustments. Neither Adjusted EBITDA nor Cash Adjusted EBITDA is a measure
      of operating performance or liquidity under IFRS, Previous GAAP or U.S.
      GAAP. Adjusted EBITDA, as used in this annual report, is not necessarily
      comparable with similarly titled measures of other companies. Management
      believes that Adjusted EBITDA may be useful in assessing our operating
      performance and as an indicator of our ability to service or incur
      indebtedness, make capital expenditures and finance working capital
      requirements. The items excluded from Adjusted EBITDA are significant in
      assessing our operating results and liquidity. Therefore, Adjusted EBITDA
      should not be considered in isolation or as an alternative to operating
      earnings, cash flow from operating activities or other combined income or
      cash flow data prepared in accordance with IFRS, Previous GAAP or U.S.
      GAAP.
| | (4) | We calculate the ratio of earnings to fixed charges by
      dividing fixed charges into net income (loss) before provision for income
      tax expense (recovery) plus fixed charges. Fixed charges consist of
      interest expense  net, plus amortization of deferred financing expense.
      For the years ended December 31, 2012, 2009 and 2008, the deficiency in
      the ratio of earnings to fixed charges to achieve a one-to-one ratio was
      $12.7 million, $14.9 million and $26.7 million, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | (5) | Other (expense) income includes the gain or loss on
      disposal of property, plant and equipment, foreign exchange gains or
      losses on U.S. dollar cash and working capital.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

Adjusted EBITDA and Cash Adjusted EBITDA are calculated from
net earnings as follows:

|                                                 |   | Year ended December 31, |  
|------------------------------------------------ | - | ----------------------- | -
|                                                 |   | 2012                    |  
|IFRS                                             |   | (in
      thousands)    |  
|Net (loss) earnings for the
      year           | $ | (8,259                  | )
|Income taxes (recovery)
      expense            |   | (4,457                  | )
|Other expenses                                   |   | 6,046                   |  
|Foreign exchange gain (loss)
      on borrowings |   | 4,641                   |  
|Financing expenses                               |   | 20,425                  |  
|Depreciation and amortization                    |   | 13,641                  |  
|Adjusted EBITDA                                  | $ | 22,755                  |  
|Negative (positive) impact of
      inventory    |   |                         |  
|valuation adjustments                            |   | (1,963                  | )
|Cash Adjusted EBITDA                             | $ | 20,792                  |  

|                                                 |   | Year ended December 31, |  
|------------------------------------------------ | - | ----------------------- | -
|                                                 |   | 2009                    |  
|Previous GAAP                                    |   | (in
      thousands)    |  
|Net loss for the year                            | $ | (7,483                  | )
|Income taxes recovery                            |   | (7,397                  | )
|Other expenses (income)                          |   | 2,592                   |  
|Foreign exchange gain (loss)
      on borrowings |   | 31,730                  |  
|Financing expenses                               |   | 18,097                  |  
|Depreciation and amortization                    |   | 21,011                  |  
|Adjusted EBITDA                                  | $ | (4,910                  | )
|Negative (positive) impact of
      inventory    |   |                         |  
|valuation adjustments                            |   | (1,611                  | )
|Cash Adjusted EBITDA                             | $ | (6,521                  | )

12

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EXCHANGE RATE DATA

The following table sets forth, for each period indicated, the
low and high exchange rates for Canadian dollars expressed in U.S. dollars, the
exchange rate at the end of such period and the average of such exchange rates
on the last day of each month during such period, based on the Bank of Canadas
closing rate on such dates:

2012
    2011
    2010
    2009
    2008Low
    0.9618
    0.9480
    0.9307
    0.7698
    0.7731High
    1.0327
    1.0607
    1.0054
    0.9748
    1.0241Period end
    1.0051
    0.9833
    1.0054
    0.9515
    0.8210Average
    1.0000
    1.0110
    0.9706
    0.8757
    0.9381


The following table sets forth, for each of the last six
months, for Canadian dollars expressed in U.S. dollars, the low and high
exchange rates based on the closing rate as described above:

Last six monthsFebruary
    January
    December
    November
    October
    SeptemberLow
    0.9696
    0.9900
    1.0028
    0.9943
    0.9986
    1.0082High
    1.0048
    1.0188
    1.0178
    1.00950
    1.0272
    1.0371


On March 4th, 2013, the Bank of Canadas closing
rate was US$0.9730 = $1.00.

13

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|B. | Capitalization and Indebtedness
|-- | -------------------------------

Not applicable.

|C. | Reasons for the Offer and Use of Proceeds
|-- | -----------------------------------------

Not applicable.

|D. | Risk Factors
|-- | ------------

You should carefully consider the following factors in addition to the other information set forth in this annual report. The following risks could materially and adversely affect our business, our financial condition or results of operations, or
our ability to make payments under our outstanding indebtedness.

Our business is of a cyclical nature and prices of, and demand for, our products and our results of operations may fluctuate significantly based on market factors.

Our financial performance is principally dependent on the selling prices of, and the demand for, the pulp and lumber products we sell. Prices and demand for such products have fluctuated significantly in the past and may fluctuate significantly in
the future. For example, from 2008 to 2012, prices for our pulp and lumber have ranged from a high of US$713 per ADMT and US$381 per mfbm, respectively, to a low of US$422 per ADMT and US$134 per mfbm, respectively. The markets for
pulp and lumber are highly cyclical and affected by such factors as global economic conditions, demand for pulp and paper, residential and commercial construction in North America and Asia, changes in industry production capacity and inventory
levels and other factors beyond our control. Market conditions, demand and selling prices for our products may decline from current levels. Any prolonged or severe weakness in the market for any of our principal products would adversely affect our
business, financial condition, results of operations and cash flows.

The Softwood Lumber Agreement on Canadian softwood lumber shipments to the United States could have a negative effect on our profitability.

The Softwood Lumber Agreement (SLA) was signed on September 12, 2006, to address a longstanding trade dispute between Canada and the United States and, specifically, to resolve litigation arising from, and trade measures imposed following, the
expiry of a prior softwood lumber trade agreement between the two countries in March 2001. Effective for a term of seven years commencing October 12, 2006, with an option to renew for two additional years, the SLA brought about the revocation of
American countervailing and anti-dumping duties on Canadian lumber shipments to the U.S. On January 23, 2012, Canada and the U.S. announced that the SLA would be extended for two years, to October 2015, without modification to any other agreement
terms.

Under the SLA, export charges are imposed on Canadian lumber shipments to the U.S. when the price of lumber is at or below US$355 per thousand board feet, and additional surge penalties are imposed on shipments from certain regions, including
Alberta, when shipments from that region exceed a prescribed level in a given month. The export charges vary according to the market price of lumber, and range from 0 to 15%; the additional surge penalties, when applied, are set at 50% of the
current export charge and so range from 0 to 7.5% .

Given the monthly average benchmark lumber prices recorded during the period, U.S.-bound Alberta lumber shipments, including our shipments, have been subject to a 15% export charge in all but eight months since the SLA came into effect in October
2006. Because Alberta received a market-share allocation that was less than its historic shipment levels, and because U.S. lumber consumption has been in decline, Alberta lumber exports have frequently exceeded the monthly surge-trigger level during
the term of the SLA, thereby also becoming subject to the additional surge penalty.

The charges and penalties imposed under the SLA have had a negative effect on our results of operations. Sales of lumber to the United States represented approximately 10% of our revenue for the year ended December 31, 2012.  If the U.S. deems
Canada or Canadian regions to be out of compliance with the terms of the SLA, it may refer the matter to a binding dispute-settlement process, and if Canada or such Canadian regions are determined to be out of
compliance with the agreement, penalties, including additional export charges, may be imposed. If such a judgment is made affecting Alberta, the imposition of any such penalties could have a negative effect on our profitability.

14

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Intense global competition could limit our ability to effectively market our products, which could have a negative impact on our revenue and profitability.

We compete in North American and overseas export markets with numerous forest products companies, including very large integrated firms that have greater financial resources than we do. Our lumber segment also competes indirectly with firms that
manufacture substitutes for wood building materials. While the principal basis for competition is price, we also compete on the basis of customer service, quality and product type. Our competitive position is influenced by the availability, quality
and cost of fiber, energy and labor, plant efficiencies and productivity and foreign currency fluctuations. Some of our competitors may have lower fiber, energy, labor or other costs than we do, or less stringent environmental and other governmental
regulations to comply with than we do. Other competitors may be less leveraged than we are and, therefore, have greater financial flexibility than we do. In addition, variations in the exchange rates between the Canadian dollar and the U.S. dollar,
and between the U.S. dollar and local currencies in each of our export markets, also affect the relative competitive position of our products when compared to our competitors outside of Canada. Our ability to compete in the markets to which we
export our products is also dependent upon free access and transportation costs to such markets. If we are unable to compete effectively, our revenue could decline, which would have a material adverse effect on our business, financial condition,
results of operations and cash flows.

We may not have the capital required to maintain our facilities and grow our operations.

The production of lumber and pulp is capital intensive. We expect capital expenditures to be approximately $12 million in 2013, $6 million of which would be for maintenance of business projects. Capital expenditures to fund maintenance
projects at our existing facilities are expected to average between $5 million to $7 million per year for the foreseeable future. However, these annual capital expenditures may vary due to fluctuations in requirements for maintenance,
unforeseen events and changes to environmental or other regulations that require capital for compliance. Although we maintain our production equipment with regular periodic and scheduled maintenance, key pieces of equipment in our various production
processes may need to be repaired or replaced before such repair or replacement is scheduled. If we do not have sufficient funds or such repairs or replacements are delayed, the costs of repairing or replacing such equipment and the associated
downtime of the affected production line could have a material adverse effect on our business, financial condition, results of operations and cash flows.

We are exposed to currency exchange risk that could reduce cash flow available to fund our operations and cause our reported earnings to fluctuate materially.

Our operating results are sensitive to fluctuations in the exchange rate of the Canadian dollar to the U.S. dollar, as prices for our products are largely denominated in U.S. dollars or linked to prices quoted in U.S. dollars. In 2012, approximately
64% of our sales were denominated in U.S. dollars (2011, 69%; 2010, 72%), while most of our operating costs were incurred in Canadian dollars. Therefore, an increase in the value of the Canadian dollar relative to the U.S. dollar reduces the amount
of revenue we realize, in Canadian dollar terms, from sales made in U.S. dollars, which reduces our operating margin and the cash flow available to fund our operations.

In addition, we are exposed to currency exchange risk on our debt, including the Senior Notes and interest thereon, and assets denominated in U.S. dollars. Since we present our financial statements in Canadian dollars, any change in the value of the
Canadian dollar relative to the U.S. dollar during a given financial reporting period would result in a foreign currency loss or gain on the translation of our U.S.-dollar-denominated debt and assets into Canadian dollars. Consequently, our reported
earnings could fluctuate materially as a result of foreign-exchange translation gains or losses.

To mitigate the impact of foreign-exchange volatility on our earnings, we typically enter into foreign-exchange forward contracts and/or options to partially hedge our exposure to fluctuations in exchange rates. However, hedging transactions may not
be successful in materially reducing our exposure to exchange rate fluctuations.

15

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A reduction in our fiber supply could affect our ability to operate.

Fiber is the primary raw material in our products; therefore, maintaining long-term fiber security is important to our business. We obtain approximately 59% of our fiber requirements, based on full production capacity, from the Millar Western Forest
Management Agreement, or Millar Western FMA, Coniferous Timber Quotas and Deciduous Timber Allocations issued by the Alberta Minister of Environment and Sustainable Resource Development, each of which is issued for a period of 20 years and is
renewable, provided we have met our obligations under the agreement. Our FMA, representing approximately 23% of our fiber requirements, and one of our Coniferous Timber Quotas, representing less than one percent of our fiber requirements, expire in
2017, and the balance of our quotas and allocations have expiry dates ranging between 2021 and 2031. The FMA, quotas or allocations may not be renewed or extended on acceptable terms. In addition, the Millar Western FMA and such quotas and
allocations contain terms or conditions that could, under certain circumstances, result in a reduction in the amount of fiber available to us. Any losses to fiber allocations under our land- and volume-based tenures could affect our ability to
maintain current mill operating rates.

In 2005, the Alberta government introduced the Healthy Pine Forest Strategy in response to the then-worsening mountain pine beetle situation in British Columbia. It called for increased harvesting levels in mature and over-mature pine stands to
reduce their vulnerability to infestation and improve overall forest health. Subject to the forest management planning process and approval by Alberta Environment and Sustainable Resource Development, companies can harvest volumes in excess of
historical annual allowable cut volumes to address the infestation concern; however, to ensure long-term sustainability of the forest resources, companies that employ these surge cuts may experience a reduction in their annual allowable cuts in
future years. Our 2007-2016 annual allowable cuts for our tenure areas have been adjusted to reflect the Healthy Pine Forest Strategy and show increases of an average of 42% in our FMA and four of our Coniferous Timber Quotas over annual allowable
cut levels stated in our most recent detailed forest management plan. If these surge volumes are fully harvested, then annual allowable cuts could fall by an average of 8.5% below the volumes stated in our detailed forest management plan, for a
ten-year period beginning in 2017. The drop-down will begin to take effect in our FMA area in 2017, and in the affected Coniferous Timber Quotas during the period 2024 to 2028. We have implemented a series of intensive forest management practices to
improve forest growth and yield, to mitigate these potential annual allowable cut reductions; however, we may have to supplement our existing timber supply with additional open-market timber purchases after 2016, the availability and cost of which
are unknown at this time.

The Government of Alberta has initiated the Land-Use Framework process in response to significant land-use pressures arising during a period of rapid economic expansion and population growth in the province. The Alberta government has divided the
province into seven regions and intends to develop land-use plans for each of the regions that effectively balance competing economic, environmental and social demands. While we view this process as beneficial in providing long-term certainty
regarding resource development, it presents a risk in that the government could increase the amount of land set aside for conservation purposes at the expense of lands currently allocated to the forest products industry for timber production. One
regional plan, the Lower Athabasca Regional Plan, is now complete, and called for timber volume losses in areas supplying our Boyle operations to meet conservation objectives. To compensate for these volume losses, the Alberta government allocated
to us equivalent timber volumes in other locations, with the result that there was no net impact on Boyle's fiber supply. Two additional plans, one for the Upper Athabasca region and the other for the Upper Peace region, could have volume
implications for our Whitecourt and Fox Creek operations; however, the planning processes associated with these plans are yet to begin. The Alberta government may not compensate us for any volume reductions that may result. The loss of fiber supply
to this process could have a material adverse effect on our business, financial condition, results of operation and cash flows.

In addition to fiber from government tenures, we also rely on fiber acquired through multi-year fiber exchange and supply contracts to satisfy approximately 29% of our requirements. These multi-year fiber agreements expire between 2019 and 2021.
While all are renewable, we may not be able to extend these contracts beyond their expiry. If these contracts are not renewed, we may be without sufficient fiber to maintain current production levels, which could have a material adverse effect on
our business, financial condition, results of operation and cash flows.  Under the terms of our multi-year fiber exchange and supply contracts, we provide other companies with wood residuals such as chips, shavings, fines and hog, which are
by-products of the lumber manufacturing process. These
materials, historically considered waste, are converted by third parties into products ranging from pulp and medium density fiberboard to electricity. If the multi-year fiber-exchange contracts are not renewed upon expiry, we could incur revenue
reductions and/or additional disposal costs. Fiber availability or manufacturing disruptions could also impair our ability to provide these by-products in specified quantities and put us in breach of contractual obligations. These outcomes could have
a material adverse effect on our business, financial condition, results of operations and cash flows.

16

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An increase in our fiber costs could have a negative impact on our earnings.

The availability of an economic fiber supply is one of the most important factors affecting the performance of forest products companies. The costs of our fiber, including fees charged for fiber, logging and transportation, and market prices for
purchased fiber, have historically fluctuated and could increase in the future. Any significant increase in the cost of fiber could have a material adverse effect on our business, financial condition, results of operations and cash flows.

The government imposes stumpage fees on all timber harvested on government-owned land and also holds companies responsible for reforestation and reclamation costs. Amendments to government legislation or regulatory regimes may change stumpage-fee
structures payable in relation to the harvesting of timber and may increase the costs through the imposition of additional and more stringent reforestation and silvicultural standards. A material increase to the stumpage rates applicable to the
Millar Western FMA, our Coniferous Timber Quotas or our Deciduous Timber Allocations could have a material adverse effect on our business, financial condition, results of operations and cash flows.

While approximately 88% of our fiber requirements are met through our government timber allocations and fiber exchange and supply agreements with other companies, we purchase the balance of our fiber requirements on the open market. Accordingly, our
operations could be affected by changes in the supply and demand for, and the prices of, purchased fiber.

We rely on independent contractors to harvest timber and haul logs from the forest to our operations. Contractor shortages arising from strong workforce competition in Alberta may require us to increase compensation levels, which could negatively
affect costs, and also could impede our ability to maintain sufficient log supplies in our yards to sustain current mill operating rates. Delivered timber costs are also vulnerable to rising fuel prices and also to log-haul distances. Depending on
the harvesting rotation, we may be travelling greater distances to access our fiber, which could also contribute to higher costs. These outcomes could have a material adverse effect on our business, financial condition, results of operations and
cash flows.

Our ability to harvest timber is subject to natural events that are beyond our control and that could have a negative impact on our operations.

Our ability to harvest timber is subject to natural events such as forest fires, adverse weather conditions, insect infestation, disease and prolonged drought. The occurrence of any of these events could adversely affect our ability to harvest
timber, which could have a material adverse effect on our business, financial condition, results of operations and cash flows.

In 2006 and 2009, Alberta experienced major in-flights of mountain pine beetle from British Columbia, firmly establishing the insect in our province and threatening mature pine stands. Learning from British Columbia’s experience, the Alberta
government responded swiftly with a multi-level Mountain Pine Beetle Action Plan to curb the beetle’s impact. Key activities include enhanced beetle detection and control, along with harvesting and regeneration of infested pine stands.
Building on the provincial plan, we led the development of a regional plan for central Alberta, home to our Whitecourt and Fox Creek operations, which brought greater integration and coordination to industry and government detection, control and
harvesting programs.

These efforts, along with an absence of further in-flights from British Columbia and natural mortality during recent winters, have reduced local mountain pine beetle populations within our operating area, as evidenced by surveys conducted by Alberta
Environment and Sustainable Resource Development. However, the mountain pine beetle remains present in the forests of Alberta’s central region and an ongoing risk to mature pine stands in the area. Any significant increase in mountain pine
beetle populations could negatively affect merchantable pine stands and have a material adverse effect on our business, financial condition, results of operations and cash flows.

17

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Environmental and other government legislation and regulations could increase our cost of doing business or restrict our ability to conduct our business.

We are subject to a wide range of general and industry-specific environmental and other laws and regulations imposed by federal, provincial and local authorities in Canada, including those governing the use, storage, handling, generation, treatment,
emission, release, discharge and disposal of certain hazardous materials and wastes, the remediation of contaminated soil and groundwater, and the health and safety of employees. We are also subject to reforestation requirements and had an accrued
liability of $15.2 million at December 31, 2012 (2011, $15.2 million; 2010, $15.8 million), for future reforestation obligations. Our failure to comply with applicable environmental and safety laws and regulations, and the permit
requirements related thereto, could result in civil or criminal fines or penalties or enforcement actions, including regulatory or judicial orders enjoining or curtailing operations or requiring corrective measures, installation of equipment or
remedial actions, any of which could result in significant capital expenditures or reduced results of operations. In addition, future events, such as any changes in environmental or other laws and regulations, including any new legislation that
might arise or any change in interpretation or enforcement of laws and regulations, may result in additional expenditures or liabilities. These could have a material adverse effect on our business, financial condition, results of operations and cash
flows.

In 2009, the Government of Alberta passed the Electrical Statutes Amendment Act that exempts major electrical transmission projects that are deemed to be critical by the Alberta government from the normal needs and cost assessment processes of the
Alberta Utilities Commission (AUC). This has led to concerns that the public and stakeholders would not be offered sufficient opportunity to provide input into potential projects and that, as a result, Alberta's transmission infrastructure would be
overbuilt, at the expense of ratepayers. As a concession to those concerned about the impacts of the legislation, the Alberta government introduced follow-up legislation in 2012 that returned needs assessment responsibility to the AUC; however, the
requirement for AUC oversight is applicable only to future projects and not to several large projects that have already been approved. With industry responsible for 61% of the transmission costs in Alberta, and considering that we are a major
electricity consumer, this legislation could have significant cost implications for us going forward.

If environmental or other regulatory approvals, licenses or permits are delayed, restricted or not renewed, a variety of operations on our timberlands or at our facilities could be delayed or restricted.

In connection with a variety of operations on our properties, we are required to make regulatory filings with governmental agencies. Any of these agencies could delay review of or reject any of our filings, which could delay or restrict our
manufacturing or logging operations, potentially resulting in an adverse effect on our operating results. For example, while our three sawmills operate, in accordance with provincial legislation, under a code of practice that governs environmental
aspects of their activities, our pulp mill operates under an environmental permit that is granted by an agency of the Government of Alberta and is due to expire on November 1, 2014, if not renewed on or before that date. If we are unable to extend
or renew this or any other material approval, license or permit, or if there is a delay in renewing such approvals, licenses or permits, our business, financial condition, results of operations and cash flows could be materially adversely affected.

Our ability to sell our products could be compromised if environmental certifications are not achieved or renewed, which could have a negative impact on our business, financial condition, results of operations and cash flows.

Sales of our products, especially pulp, are increasingly dependent upon our ability to achieve and maintain certification under internationally recognized standards for sustainable forest management and wood-fiber chain of custody. Certifications
that we currently hold may be terminated for failure to meet the requirements of the certification standard, which could result in lost product sales. As well, existing standards could become more onerous or new certifications may be deemed
necessary by customers, resulting in additional costs. Any of these developments could cause our business, financial condition, results of operations and cash flows to be materially adversely affected. For more details regarding our certifications,
see Item 4, “Business Overview – Material effects of government regulation – Forest certification”.

18

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Our sole shareholder has the ability to direct our operations, and its interests may conflict with the interests of the noteholders.

Our parent, Industries, holds, directly and of record, all of our outstanding common shares. Millar Western Industries Ltd. is wholly owned by Hualkeith Investments Ltd., a corporation controlled by our co-chairmen of the board of directors,
brothers James B. Millar and H. MacKenzie Millar, and other members of the Millar family. James B. Millar and H. MacKenzie Millar together control 55.6% of the outstanding equity of Hualkeith. The Millar family may have interests that differ from
those of noteholders and, therefore, may make decisions that are adverse to their interests.

Our business is subject to many operational risks for which we may not be adequately insured.

Our business is subject to the risks associated with operating pulp mills and sawmills and with logging, such as unforeseen equipment breakdowns, power failures, fires, floods, environmental issues, severe weather and other events that could result
in a temporary or prolonged shutdown of any of our operations. A shutdown at any of our operations could materially adversely affect our business, financial condition, results of operations and cash flows. Although we maintain insurance, including
business interruption insurance, we may incur losses beyond the limits of, or outside the coverage of, such insurance. From time to time, various types of insurance for companies in the pulp and lumber industries have not been available on
commercially acceptable terms or, in some cases, have been unavailable. For example, we do not insure and cannot get insurance against losses of standing timber from any cause, including fire, and insurance against certain environmental risks may
not be available on commercially acceptable terms. In addition, premiums for our existing coverage may increase substantially, and we may be unable to maintain our current insurance coverage.

Changes to costs and benefits arising from our power purchase rights could adversely affect our profitability. Effective January 1, 2001, we entered into two Power Syndicate Agreements (Battle River and Sundance C, respectively) with
an affiliate of Capital Power Corporation (formerly EPCOR Utilities Inc.) and three other industrial participants in Alberta for the purpose of sharing the rights and responsibilities defined in two corresponding Power Purchase Arrangements, which
we refer to as our power purchase rights. In May 2006, we consolidated our power purchase rights under the Sundance C Power Syndicate Agreement and the corresponding Power Purchase Arrangement, which we refer to as the PPA, pursuant to a Swap and
Purchase Agreement among us, CP Energy Marketing LP (formerly EPCOR Merchant and Capital LP) and Capital Power Corporation. The PPA, which is set to expire on December 31, 2020, gives us, along with all other parties to the Sundance C Power
Syndicate Agreement, the right to the generation capacity and substantially all of the associated electricity output from certain existing generating units in the Province of Alberta. We and such other parties are obligated to pay the owner of the
generating units the costs of maintaining and operating the units according to cost schedules set out in the PPA.

The power purchase rights effectively reduce our exposure to fluctuations in market electricity rates. In 2012, we estimate that the power purchase rights provided us savings of $14.2 million (2011, $22.9 million; 2010, $9.6 million),
compared to what we would have paid for power at market rates and, therefore, comprised a meaningful component of our operating performance. The agreements governing our power purchase rights contain termination provisions that are effective upon
the occurrence of a force majeure event. If our power purchase rights were terminated, we would be exposed to fluctuations in market electricity rates, which could have a material adverse effect on our business, financial condition, results of
operations and cash flows.

Although we, along with all other parties to the PPA, have provided financial commitments in relation to the agreement, the other parties to the agreement may fail to perform their obligations over the term of the agreement, which could diminish the
benefits we receive from the arrangement. A failure by Capital Power Corporation, in particular, could adversely affect the savings we realize from our power purchase rights.

Under the PPA, our financial commitment requires us to provide a letter of credit covering the shortfall that would occur if the net present value of the cash flows associated with the power purchase rights were to fall below a specified level.
There has been no requirement to provide such a letter of credit to date, but we may be required to provide one in the future. If we are required to provide such a letter of credit in a large amount, it would limit the amount of credit available to us under our revolving credit
facility, which could have a material adverse effect on our liquidity.

19

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The owner of the Sundance power plant notified us in 2012 of a
force majeure claim regarding a plant outage that had occurred in 2011. We have
an interest in the PPA for the affected plant units and were thus contractually
obligated to pay the plant owner $4.4 million, representing our share of the
claimed amount, in advance of a final determination as to whether or not a force
majeure situation, as specified in the PPA, occurred. We took a provision of
$1.9 million in 2012, and the outstanding balance is $2.6 million. We are of the
view that the outage did not meet the PPA-specified tests for such a
determination and that we should receive reimbursement upon resolution of the
claim. The claim may not be resolved in our favor, however, and we may not
receive such reimbursement.

We have significant indebtedness, which could weaken our
financial condition and limit our ability to fulfill our obligations under our
outstanding indebtedness.

We have a significant amount of indebtedness and significant
debt service obligations. The following table sets forth our total indebtedness,
total shareholders equity, total capitalization and ratio of total indebtedness
to total capitalization:

|                                                          |   | 2012  |  |   | 2011          |  |   | 2010  | 
|--------------------------------------------------------- | - | ----- |  | - | ------------- |  | - | ----- | 
|                                                          |   |       |  |   | (in millions) | 
|Total indebtedness                                        | $ | 309.6 |  | $ | 288.2         |  | $ | 260.3 | 
|Total shareholders' equity                                | $ | 72.6  |  | $ | 81.5          |  | $ | 84.2  | 
|Total capitalization                                      | $ | 382.2 |  | $ | 369.7         |  | $ | 344.5 | 
|                                                          |   |       |  |   |               |  |   |       | 
|Ratio of total indebtedness
      to total capitalization |   | 81.0% |  |   | 78.0%         |  |   | 75.6% | 

This high degree of leverage could have important consequences.
For example, it could:

- make it more difficult for us to satisfy our obligations with respect to
  our outstanding indebtedness;
- increase our vulnerability to adverse economic and industry conditions;
- require us to dedicate a substantial portion of cash from operations to
  the payment of debt service, thereby reducing the availability of cash to fund
  working capital, capital expenditures and other general corporate purposes;
- limit our ability to obtain financing for working capital, capital
  expenditures, general corporate purposes or acquisitions;
- place us at a disadvantage compared to our competitors that have a lower
  degree of leverage; and
- limit our flexibility in planning for, or reacting to, changes in our
  business and in the forest products industry.

We may not generate cash flow sufficient to service all
of our obligations.

Our ability to make payments on and to refinance our
indebtedness, and to fund our operations, working capital and capital
expenditures, depends on our ability to generate cash in the future. Our cash
flow is subject to general economic, industry, financial, competitive,
operating, regulatory and other factors that are beyond our control. Our
business may not generate cash flow in an amount sufficient to enable us to
repay our indebtedness or to fund our other liquidity needs. We estimate that we
will need to generate approximately $26.5 million of cash to fund our interest
and maintenance capital expenditure requirements in 2013. We may need to
refinance all or a portion of our indebtedness on or before maturity. Our
ability to refinance our indebtedness or obtain additional financing will depend
on, among other things:

- our financial condition at the time;
- restrictions in the indenture governing our Senior Notes and the terms
  governing our revolving credit facility; and
- other factors, including the condition of the financial markets or the
  forest products industry.

20

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If we do not generate sufficient cash flow from operations, and if additional borrowing, refinancing, or proceeds of asset sales are not available to us, then we may not have sufficient cash to enable us to meet all of our obligations.

We may be able to incur additional indebtedness, which could further exacerbate the risks associated with our substantial indebtedness.

Although the terms governing our revolving credit facility and the indenture governing the Senior Notes (the “indenture”) contain restrictions on the incurrence of additional indebtedness, additional indebtedness incurred in compliance
with these restrictions could be substantial. As at December 31, 2012, we would have been permitted to borrow up to $46.5 million under our revolving credit facility. In addition, the indenture does not prevent us from incurring obligations,
such as trade payables and operating leases that do not constitute indebtedness. If we incur additional indebtedness or other obligations, the related risks could be magnified.

The agreements governing our indebtedness contain significant restrictions that limit our operating and financial flexibility.

The agreements governing our indebtedness contain covenants that, among other things, limit our ability to:

- incur additional indebtedness;
- pay dividends and make distributions;
- repurchase stock;
- make certain investments;
- transfer or sell assets;
- create liens;
- enter into transactions with affiliates;
- issue or sell stock of subsidiaries;
- create dividend or other payment restrictions affecting restricted subsidiaries; and
- merge, consolidate, amalgamate or sell all or substantially all of our assets to another person.

In addition, our revolving credit facility requires us to maintain specified financial ratios, and we may be unable to meet such ratios. All of these restrictions may limit our ability to execute our business strategy. Moreover, if operating results
fall below current levels, we may be unable to comply with these covenants. If that occurs, our lenders could accelerate our indebtedness, in which case, we may not be able to repay all of our indebtedness.

The ability to enforce civil liabilities in Canada under U.S. securities laws may be limited.

We are incorporated under the laws of the Province of Alberta and substantially all of our assets are located in Canada. All of our directors and officers reside in Canada, and most of their assets are located in Canada. It may not be possible,
therefore, to effect service of process within the United States upon us or our directors and officers. There is uncertainty as to the enforceability (1) in an original action in Canadian courts, of liabilities predicated solely upon United States
federal securities laws and (2) of judgments of United States courts obtained in actions predicated upon the civil liability provisions of United States federal securities laws in Canadian courts. Therefore, persons in the United States may not be
able to secure judgment against us or our directors and officers in a Canadian court or, if successful in securing a judgment against us or them in a U.S. court, may not be able to enforce such judgment in Canada.

|ITEM 4: INFORMATION ON THE COMPANY
|----------------------------------

|A. | History and Development of the Company
|-- | --------------------------------------

We were incorporated as Millar Western Forest Products Ltd. under the Business Corporations Act (Alberta) on September 8, 1997, and had no operations or cash flows from September 8, 1997, to May 12, 1998. On May 13, 1998, we acquired all of
the forest products operations of our parent company, Millar Western Industries Ltd.

21

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(Industries) and its subsidiaries. The predecessor of Industries was first incorporated in 1919 and began logging and sawmilling operations in the Whitecourt area in 1922. Industries completed construction of the Whitecourt pulp mill in 1988 and
acquired the Boyle sawmill in 1993. We completed construction of the current Whitecourt sawmill in 2001. We acquired the Fox Creek sawmill in 2007, and rebuilt it in 2010-11 at a cost of approximately $60 million, approximately $38 million
of which was provided through an insurance settlement. In 2012, we acquired a 100% interest in a related company, Chickadee Creek Energy Inc. (CCEI), which was immediately wound up and dissolved; prior to such acquisition, CCEI was a wholly owned
subsidiary of Industries. In 2012, we commenced construction at our Whitecourt pulp mill of a bio-energy project that is expected to cost $42 million and to be financed through $27.5 million in government grants and $13 million in
interim financing. We have no subsidiaries.

Our head office is located at 16640 - 111 Avenue, Edmonton, Alberta, T5M 2S5, and our registered office is located at 2900 Manulife Place, 10180 - 101 Street, Edmonton, Alberta, T5J 3V5. Our telephone and facsimile numbers are (780) 486-8200 and
(780) 486-8282, respectively. Our authorized capital consists of an unlimited number of common shares, of which 15,000,002 were issued and outstanding as at December 31, 2012.

Our agent for service of process in the United States is CT Corporation System, 111 8th Avenue, New York, New York 10011 (212) 894-8700.

|B. | Business Overview
|-- | -----------------

We are an integrated forest products company active in Alberta, Canada, that produces and markets hardwood and softwood bleached chemi-thermo-mechanical pulp, or BCTMP, and softwood lumber. In the twelve months ended December 31, 2012, we recorded
total revenue of $332.4 million, Adjusted EBITDA of $22.7 million and a net loss of $8.3 million.

We own and operate four production facilities in Alberta, including a BCTMP mill and a sawmill at an integrated complex in Whitecourt and a sawmill in Boyle. In 2011, we completed the reconstruction and start-up of a new sawmill at Fox Creek that
replaced a mill that had been extensively damaged in a fire in August 2008. In 2012, we began construction of a bio-energy project (BEP) adjacent to the Whitecourt BCTMP mill that will convert organic matter in pulp-mill waste into green energy, for
consumption by our pulp operations; completion and startup of the BEP are slated for early 2014.

Our Whitecourt pulp mill produces hardwood, softwood and blended grades of pulp and has an annual production capacity of 320,000 ADMT. Our BCTMP is sold internationally for use in the production of a diverse range of paper products, including coated
and uncoated printing and writing papers, paperboard, specialty papers, tissue and toweling.

Our sawmills produce kiln-dried dimension lumber from spruce, pine and fir, or SPF, for the residential and commercial construction industries. We also produce higher-margin grades, such as machine-stress-rated, or MSR, lumber for load-bearing
applications, as well as specialty products, such as decking. Our Whitecourt, Boyle and Fox Creek sawmills have annual capacities of 330 mmfbm, 140 mmfbm and 120 mmfbm, respectively. Historically, our lumber has sold principally in Canada and the
United States; however, China is now a regular destination for our products, and a small percentage of certain higher-margin grades is shipped to Japan.

Principal markets

Our production of both pulp and lumber provides a diversified revenue base. From 2008 to 2012, 54% of our total revenue came from pulp sales and 46% came from lumber sales. This balance of pulp and lumber production has enabled us to weather
cyclical swings in each of the two distinct markets. In addition, the geographic and product-line diversity of our customers mitigates the impact of a downturn in demand in any one region or product category.

22

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The geographic distribution of our revenue for the periods
indicated is shown in the following table.

Geographic Sales Revenue

|       |                | 2012    |  |   | 2011    |  |   | 2010    | 
|------ | -------------- | ------- |  | - | ------- |  | - | ------- | 
|       | (in thousands) |        
|Canada | $              | 110,166 |  | $ | 82,966  |  | $ | 80,926  | 
|U.S.   |                | 56,342  |  |   | 41,084  |  |   | 52,192  | 
|Europe |                | 36,441  |  |   | 43,263  |  |   | 43,019  | 
|Asia   |                | 119,690 |  |   | 107,924 |  |   | 105,446 | 
|Other  |                | 9,762   |  |   | 9,445   |  |   | 13,800  | 
|       | $              | 332,401 |  | $ | 284,682 |  | $ | 295,383 | 

Pulp

Our pulp, BCTMP, is sold for use in a wide variety of
applications, including paperboard, coated and uncoated papers, tissue and
towels, and specialty and other papers. Our corporate marketing staff, supported
by an international network of independent sales agents, markets pulp to all
major pulp consuming regions, including Europe, Asia, and North America.

BCTMP is used by papermakers in combination with kraft pulps,
primarily to add bulk and opacity to the paper sheet. It is our defined
marketing strategy to keep a diversified portfolio of customers, both
geographically and by end use, to mitigate pulp market volatility.

The following table shows the approximate distribution of our
pulp sales by end-use for the past three years.

Distribution of Pulp Sales, by End Product

|                         |  | 2012 |  |  | 2011 |  |  | 2010 | 
|------------------------ |  | ---- |  |  | ---- |  |  | ---- | 
|Paperboard               |  | 47%  |  |  | 41%  |  |  | 34%  | 
|Coated & uncoated papers |  | 31%  |  |  | 36%  |  |  | 42%  | 
|Tissue & towel           |  | 13%  |  |  | 12%  |  |  | 15%  | 
|Specialty & other        |  | 9%   |  |  | 11%  |  |  | 9%   | 

As shown in the table above, there has been significant growth
in the sale of our pulp for use in multi-ply paperboard, where BCTMP provides a
significant functional advantage and is used as the primary source of fiber in
the middle plies of the sheet. This increased use of BCTMP in the manufacture of
paperboard is also evident in the changing geographic distribution of our pulp
sales and, specifically, rising sales to Asia, a region that has seen strong
growth in paper-making capacity and, particularly, in paperboard capacity.

23

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The following table shows the approximate distribution of our
pulp sales by geographic location.

Distribution of Pulp Sales, by Geographic Market

|               |  | 2012 |  |  | 2011 |  |  | 2010 | 
|-------------- |  | ---- |  |  | ---- |  |  | ---- | 
|Asia           |  | 64%  |  |  | 60%  |  |  | 59%  | 
|Western Europe |  | 19%  |  |  | 23%  |  |  | 22%  | 
|North America  |  | 12%  |  |  | 12%  |  |  | 12%  | 
|Other          |  | 5%   |  |  | 5%   |  |  | 7%   | 

In 2012, our top five pulp customers represented approximately
53% of all the pulp we sold.

Lumber

Our sawmills produce kiln-dried SPF dimension lumber for use in
residential and commercial construction, as well as higher-margin grades, such
as MSR, J-grade and appearance grade, and specialty products, such as decking
and rough fencing. Since 2005, we have focused on developing specialty products
that are less subject to commodity price fluctuations. These products represent
approximately 14% of our total production and are sold directly to end users.
The remainder of our production is sold through a supply chain that includes
retail stores, stocking distributors and wholesale companies. As the commodity
market has improved, we have steadied our supply into these specialty markets,
maintaining a position large enough to manage market risk, but not so
significant that it would impair our ability to benefit from the improving
commodity market. The following table shows the approximate distribution of our
lumber sales by grade.

Distribution of Lumber Sales, by Grade

|                     |  | 2012 |  |  | 2011 |  |  | 2010 | 
|-------------------- |  | ---- |  |  | ---- |  |  | ---- | 
|Commodity            |  | 62%  |  |  | 60%  |  |  | 65%  | 
|J-grade & appearance |  | 15%  |  |  | 17%  |  |  | 13%  | 
|MSR                  |  | 9%   |  |  | 9%   |  |  | 10%  | 
|Specialties          |  | 14%  |  |  | 14%  |  |  | 12%  | 

The principal markets for our lumber products are Canada, the
United States, China and Japan. Lumber sales within North America are handled by
sales staff located in our Edmonton corporate office. All offshore sales are
conducted through an international marketing consortium, Interex Forest Products
Ltd. of Vancouver, of which we are a 17% owner. The following charts show the
approximate distribution of our lumber sales by geographic region.

Distribution of Lumber Sales, by Geographic Market

|       |  | 2012 |  |  | 2011 |  |  | 2010 | 
|------ |  | ---- |  |  | ---- |  |  | ---- | 
|Canada |  | 72%  |  |  | 66%  |  |  | 70%  | 
|U.S.   |  | 18%  |  |  | 13%  |  |  | 20%  | 
|China  |  | 7%   |  |  | 18%  |  |  | 8%   | 
|Japan  |  | 3%   |  |  | 3%   |  |  | 2%   | 

In 2012, our top five lumber customers represented
approximately 46% of all the lumber we sold.

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Seasonality

We conduct a significant amount of its log harvesting and hauling in the winter months, creating a seasonal build-up of working capital. Harvesting usually begins in the fourth quarter, with the balance of harvesting and most hauling activities
occurring in the first quarter of the following year. The build-up of log inventory is typically valued at approximately $40 million, with $5 million to $10 million worth of logs accumulated in the fourth quarter, depending on weather
conditions, and the rest realized in the following year’s first quarter. These log inventories are consumed through the year and reach minimum levels in the third quarter. This seasonal working capital build-up and reduction has a significant
impact on our liquidity through the year.

Sources and availability of raw materials

Fiber

The availability of a secure and economic fiber supply is one of the most important factors affecting the performance of forest products companies.  Fiber supply self-sufficiency is a key competitive element, because direct control and management of
timber resources largely insulates an operator from fluctuations in the market price of fiber. Approximately 88% of the fiber requirement for our pulp mill and sawmill facilities is supplied from timber resources held under long-term agreements with
the Government of Alberta or supplied through multiple-year agreements with other forest products companies, providing a high level of fiber-supply security and cost stability. We purchase the balance of our fiber requirements on the open market.
Our fiber costs are subject to variation depending on factors including the period’s harvesting locations and delivery distances from forest to mill, weather conditions, and normal competitive market pressures related to our harvesting and
hauling contractors. We pay fees, referred to as stumpage, to the Alberta government for all fiber harvested from government-owned lands. Stumpage rates are subject to escalation related to the market price of end products, but remained at the base
rate throughout 2012.

In May 1997, we entered into an FMA with the Alberta Minister of Environment and Sustainable Resource Development, which we refer to as the Millar Western FMA, pursuant to which the Minister has granted us rights to manage, establish, grow, harvest
and remove timber on a perpetual sustained yield basis in a designated area, which we refer to as the Millar Western forest management area. The Millar Western FMA is in effect for 20 years and is renewable every 10 years thereafter for additional
20-year terms. The Millar Western FMA provides that the Alberta Minister of Environment and Sustainable Resource Development may withdraw from the forest management area (i) any land which cannot be harvested without causing substantial harm to the
environment, (ii) any land determined to be required for human or physical resource development of the Province of Alberta, (iii) any land required for commercial and industrial facilities and (iv) any land that is not capable of producing timber.
In the event of such withdrawal, the government will compensate the holder for certain costs and losses associated with such withdrawal. There have been no material withdrawals of land from the Millar Western FMA since its inception.

Our coniferous
annual allowable cut, or AAC, from the Millar Western FMA and Coniferous Timber Quotas is approximately 1,238,000 cubic meters. The deciduous AAC from the Millar Western FMA and Deciduous Timber Allocations is approximately 385,000 cubic meters. We
have entered into several multi-year fiber exchange and purchase contracts with other companies, through which we receive up to 665,000 cubic meters of coniferous timber and up to 140,000 cubic meters of deciduous timber annually.

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The following table sets out our AAC under our current
long-term provincial tenure and fiber available annually under our other fiber
agreements:

|                                            |  | Coniferous     |  |  | Deciduous | 
|------------------------------------------- |  | -------------- |  |  | --------- | 
|                                            |  |                |  |  |           | 
|                                            |  | (cubic meters) | 
|                                            |  |                |  |  |           | 
|Forest Management Agreement
      (1)       |  | 396,000        |  |  | 231,000   | 
|Coniferous Timber Quotas (2)                |  | 842,000        |  |  |          | 
|Deciduous Timber Allocations
      (3)      |  |               |  |  | 154,000   | 
|Exchange agreement and supply contracts (4) |  | 665,000        |  |  | 140,000   | 
|Total annual fiber supply:                  |  | 1,903,000      |  |  | 525,000   | 

| | (1) | Net of third party allocations. Expires 2017 and is
      renewable for additional terms of 20 years.
| | --- | -----------------------------------------------------------------------------------------------------
| | (2) | Expire 2017 to 2026 and are renewable for additional
      terms of 20 years.                        
| | (3) | Expire 2027 and are renewable for additional terms of 20
      years.                                
| | (4) | Exchange and purchase agreements expire 2019 to
    2021.                                            

In addition to deciduous logs, the Whitecourt pulp mill
requires approximately 90,000 bone dry units of coniferous chips per year. This
requirement is supplied entirely by chip residuals from our Whitecourt sawmill,
with surplus chips sent to other manufacturers under multi-year fiber-exchange
agreements.

In previous years, we did not harvest our full AAC under the
Millar Western FMA, Coniferous Timber Quotas or Deciduous Timber Allocations.
With approval from Alberta Environment and Sustainable Resource Development,
these non-sustainable volumes can be carried over for harvest in future years.
Our coniferous carry-over volume from the Millar Western FMA and Coniferous
Timber Quotas is approximately 1.6 million cubic meters. The deciduous carryover
from the Millar Western FMA and Deciduous Timber Allocations is approximately
1.3 million cubic meters. Upon approval, these carry-over volumes will be
available for use over the next 1 to 15 years, depending upon the disposition.

Energy

We use both electricity and natural gas as sources of energy in
our pulp and lumber operations. Fluctuations in the price of electricity can
have a significant impact on our cost of products sold. Electricity costs in
2012 represented approximately 28% of our manufacturing costs for pulp and
approximately 4% of our manufacturing costs for lumber. In January 2001, we
acquired long-term power purchase rights to insulate our pulp and lumber
operations from volatility in the electricity market. The benefit of these
rights is allocated to each operating segment based on its electricity
consumption.

Natural gas is used for heating and in the drying process for
both pulp and lumber and, based on 2012 costs, represents approximately 3% of
the total manufacturing cost of pulp and 1% of the total manufacturing cost of
lumber.

Electricity.Effective January 1, 2001, we entered into
two Power Syndicate Agreements with an affiliate of EPCOR Utilities Inc. and
three other industrial participants in Alberta for the purpose of sharing the
rights and responsibilities defined in two Power Purchase Arrangements, which we
refer to as the PPAs. We invested $20.8 million to acquire a 5.83% share in the
PPAs, which were previously acquired by EPCOR in accordance with a Power Auction
Agreement in 2000 during the deregulation of the electricity market in Alberta.
Effective May 1, 2006, we sold our interest in one of the agreements and
concurrently acquired a greater interest in the remaining agreement. These
transactions were accounted for as a sale and purchase, respectively, to reflect
their commercial substance, resulting in a gain of $32.7 million, an increase in
long-term debt of $15.6 million and an increase in other assets of $46.9
million. In 2009, EPCOR divested its power generation assets, which included its
PPA arrangements, to a new company, Capital Power Corporation.

26

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The PPAs are 20-year agreements that give the holder the right
to the generation capacity of, and substantially all the associated electricity
output from, certain existing generating units in the Province of Alberta. The
PPA holder is obligated to pay the owner of the generating units the costs of
maintaining and operating the units, according to cost schedules set out in the
PPAs. There are no net settlement provisions in the PPAs.

Through our participation in the syndicate, in 2012 we had
indirect control over electrical generating capacity of approximately 592,000
megawatt hours. The PPA expires in 2020. In 2012, the 592,000 megawatt hours
represented slightly more than our current electricity requirements. The
electrical energy required for our operations and that provided through the PPA
are approximately equal. To this extent, our electricity costs are the costs
specified in the schedules to the PPAs plus transmission costs, which mitigates
our exposure to the fluctuations in market electricity rates.

In 2009, the Government of Alberta passed the Electrical
Statutes Amendment Act, which exempts major electrical transmission projects
that are deemed to be critical by the Alberta government from the Alberta
Utilities Commission's (AUCs) normal needs and cost assessment processes. As a
concession to those concerned about the impacts of the legislation, the
government introduced follow-up legislation in 2012 that returned needs
assessment responsibility to the AUC; however, the requirement for AUC oversight
is applicable only to future projects and not to several large projects that
have already been approved. With industry responsible for 61% of the
transmission costs in Alberta, and considering that we are a major electricity
consumer, this legislation could have significant cost implications for us going
forward.

Natural gas.The natural gas used at our facilities is
supplied under annual supply contracts that are subject to market prices. From
time to time, we manage our gas price exposure by entering into commodity price
forward contracts. We also have rights to a natural gas storage facility located
in Saskatchewan that enables us to dampen seasonal market price variations by
storing gas during periods of low gas pricing and withdrawing gas during periods
of higher pricing.

Other Commodities

Water. Water is supplied under contract to our
Whitecourt and Boyle facilities by the Town of Whitecourt and the Village of
Boyle, respectively. The Fox Creek mill supplies its own water from onsite
wells.

Chemicals.Our Whitecourt pulp mills requirements for
hydrogen peroxide, which is the main chemical used in our pulp bleaching
process, are supplied from a plant located in Alberta under an agreement that
expires in 2014 and that provides us with relatively stable pricing over its
term. Caustic soda, also used in the bleaching process, is provided by a major
producer under a contract that provides for market-based pricing and that
expires December 31, 2013, but will be automatically renewed on an annual basis
unless cancelled by one of the parties. Other bleaching chemicals used in our
Whitecourt pulp mill are supplied by third parties under varying contract terms.
Magnesium sulphate used in our Whitecourt pulp mill is produced and supplied by
Industries, pursuant to a contract. See Item 7, Section B, Related party
transactions.

Government regulation

Environmental matters

Our operations are regulated primarily by the Environmental
Protection and Enhancement Act (Alberta), which we refer to as the AEPEA, and
the Fisheries Act (Canada). We have instituted environmental controls to monitor
our operations to confirm they are in compliance with regulated parameters of
both provincial and federal authorities. Under the AEPEA, the sawmills operate
in accordance with the terms of a code of practice that governs environmental
aspects of their activities, and the pulp mill operates in accordance with an
environmental permit that is due for renewal on or before November 1, 2014.

Our Whitecourt pulp mill does not use chlorine compounds and
therefore does not generate any chlorinated by-products such as dioxins or
furans. The pulp mill has an extended aeration activated biomass wastewater
treatment system. The biomass produced as a waste product from the system is
used as a soil conditioner on agricultural lands, and as feedstock at a local
biomass-fueled electrical generating station. Wood waste from the Whitecourt
pulp mill and sawmill is sent to the same power station, to generate renewable
electricity, and wood waste from the Boyle sawmill is sent to a neighboring pulp
mill for energy generation. The Fox Creek mill is the only company facility that continues to dispose of its wood waste by incineration;
however, we are actively seeking alternatives in advance of the expiry of the
mills wood waste-burner permit in 2015.

27

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The Whitecourt pulp mill is currently developing a $42 million
bio-energy project that will install anaerobic hybrid digesters in advance of
the existing aerobic effluent treatment system, to produce a biogas that will be
used to generate electricity. Besides reducing purchased energy costs and
allowing for pulp production increases, the project is expected to significantly
cut greenhouse gas emissions, reduce freshwater intake, improve the quality of
treated wastewater discharged to a local river, and reduce the production of
biomass and associated impacts of land-spreading.

All forest areas we harvest are reforested to the standards
required under the Timber Management Regulations (Alberta). Since 2007, we have
spent $34.9 million on reforestation and as at December 31, 2012, had an accrued
liability of $15.2 million for future reforestation.

Climate Change and Emissions Management Act

In 2007, the Province of Alberta passed a revision to the
Climate Change and Emissions Management Act that sets out intensity-based
carbon emission reduction targets. Large emitters, defined as those producing
more than 100,000 tonnes of CO2 equivalent per year, are
required to reduce their emission intensity by 12 percent. In lieu of reductions, organizations can remit to a technology fund the amount
of $15 for every tonne of CO2 generated over 100,000 tonnes or
buy an equivalent amount of provincially-approved offset credits, which normally
trade below $15 per tonne. Our PPA is linked to a coal-fired electricity plant
that qualifies as a large emitter, making us responsible for a proportion of
penalties associated with its CO2 emissions. In 2012, we were
responsible for approximately 79,941 tonnes of CO2
equivalent emissions. To address this obligation, we intend to apply offset credits of 71,967 tonnes
of CO2 emitted, earned through
energy reduction projects independently verified and registered with
provincial authorities, with the balance to be provided either by the purchase
of offset credits or through payments into the technology fund.

Forest certification

We have taken a leadership role in the development and
implementation of progressive forest management practices aimed at enhancing
timber yields while protecting diverse forest values and maintaining healthy
forest ecosystems. To provide independent verification of the sustainability of
our forest management activities and legality of our timber procurement systems,
we have sought certification under several third-party audited,
internationally-recognized environmental standards.

In 1995 and 1996, respectively, our Whitecourt and Boyle
woodlands operations were certified to FORESTCARE, a comprehensive code
of practice developed by the Alberta forest industry and one of North Americas
earliest independently-audited forest management standards. In 2005 Whitecourts
and Boyles environmental management systems were certified to the ISO 14001
standard. Our Whitecourt FMA area achieved certification to the Canadian
Standards Associations CSA-Z809 standard for sustainable forest management in
2006. In 2009, rather than renewing its CSA certification, Whitecourt elected
instead to seek certification to the Sustainable Forest Initiative (SFI)
standard, due to its greater compatibility with our tenure system. Our Boyle
woodlands operations achieved SFI certification in 2011. All our volume and
land-based tenures are now certified to the SFI standard. To satisfy different
customer preferences, our Whitecourt and Boyle operations are certified under
two international chain-of-custody standards: the Programme for the Endorsement
of Forest Certification (PEFC) and the Forest Stewardship Council. Chain of
custody certification assesses wood tracking systems to ensure responsible wood
sourcing.

28

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|Standard                                                           |  | Type                            |  |  | Expiry               | 
|------------------------------------------------------------------ |  | ------------------------------- |  |  | -------------------- | 
|                                                                   |  |                                 |  |  | Whitecourt Woodlands | 
|                                                                   |  |                                 |  |  | (includes Fox Creek) | 
|FORESTCARE                                                         |  | Comprehensive Code of Practices |  |  | December 2013        | 
|ISO 14001                                                          |  | Environmental Management System |  |  | January 10, 2015     | 
|Sustainable Forestry Initiative (SFI)                              |  | Sustainable Forest Management   |  |  | January 10, 2015     | 
|Programme for the Endorsement of Forest Certification
      (PEFC) |  | Chain of Custody                |  |  | December 2, 2015     | 
|Forest Stewardship Council                                         |  | Chain of Custody                |  |  | April 25, 2014       | 

Provincial stumpage fees

The Government of Alberta imposes stumpage fees on all timber
harvested on government-owned land. The timber on such land is owned by the
Province of Alberta, and stumpage fees are a form of harvest tax that is
assessed on a market-based fee structure. Under the stumpage system for
coniferous timber, the amount of the stumpage fee increases or decreases, under
a formula, with the benchmark lumber price of kiln-dried 2x4 Two and Better
Western SPF. This relationship effectively lowers our softwood fiber costs when
lumber prices are low. The stumpage system applies to all logs harvested from
the Millar Western FMA and Coniferous Timber Quotas. Reduced stumpage rates
apply to marginal timber, pulpwood and timber affected by fire or insects. The
governments stumpage system for deciduous timber is also market-based. Stumpage
rates do not apply to wood harvested from private lands.

|C. | Organizational Structure
|-- | ------------------------

Not applicable.

|D. | Property, Plants and
Equipment
|-- | ------------------------------

We own and operate four production facilities in Alberta: a
BCTMP mill and a sawmill at an integrated complex in Whitecourt, and sawmills in
Boyle and Fox Creek.

Pulp

Our BCTMP mill, located at Whitecourt, Alberta, commenced
commercial production in July 1988. The pulp mill was constructed at a cost of
approximately $205 million and was designed to produce 210,000 ADMT per year.
Since start up, we have increased the production capacity of the plant by 52%,
to 320,000 ADMT per year, without significant capital investment but, rather,
through a focus on mill optimization and continuous improvement.

29

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BCTMP Mill Operating History



Our BCTMP mill is a two-line facility that employs a
technologically and environmentally advanced process that uses heat, mild
chemicals and mechanical action to produce totally chlorine-free hardwood
(aspen), softwood (SPF), and blended pulps for use in the production of coated
and uncoated printing and writing papers, paperboard, specialty paper, tissue
and toweling.

All hardwood chips used in the pulping process are produced on
site, and all the softwood chips are supplied by the Whitecourt sawmill, located
on the same site.

We are currently constructing a bio-energy project at our
Whitecourt pulp mill. This project will install anaerobic hybrid digesters in
advance of the mills existing aerobic effluent treatment system, to produce a
biogas that will be used to generate electricity. In addition to cutting
greenhouse gas emissions, reducing fresh water intake and improving the quality
of treated wastewater discharged to a local river, the project is expected to
significantly reduce mill operating costs by cutting consumption of purchased
energy and other inputs and allowing for pulp production increases. The project
is expected to cost $42 million and to be financed through $27.5 million in
government grants and $13 million in interim financing. Completion and startup
of the project are slated for early 2014.

Lumber

We own and operate three sawmills, located at Whitecourt, Boyle
and Fox Creek, Alberta. The sawmills have a combined annual capacity of 590
mmfbm of SPF lumber, produced for North American and offshore markets in
dimensions from 1 x 3 to 2 x 10 and lengths from 8 to 16. The mills
products include construction lumber for residential and commercial uses, MSR
lumber for engineered roofing and load-bearing applications and other
higher-value grades and specialty products, including J-grade for the Japanese
housing market.

30

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Sawmill Operating History



The Whitecourt mill site has been home to a series of sawmills since 1926. In June 2001, we completed construction of our current mill, at a total cost of $42.6 million, which was funded from operating cash flow. This project
significantly improved the efficiency of the Whitecourt lumber operation, increased the quality of its products and reduced its manufacturing costs. In 2005-6, we invested $16.6 million in the addition of a new drying kiln and installation of a
small-log line to further increase the efficiency of processing the smaller-diameter logs that are a significant portion of the mill’s total log supply. In addition to the sawmill, our Whitecourt lumber operations comprise four
natural-gas-fired dry kilns and a high-speed planer mill.

We acquired the Boyle sawmill assets and related Coniferous Timber Quotas in September 1993. Our post-acquisition capital expenditure program significantly improved the sawmill’s competitiveness and profitability, including increasing its
capacity by approximately 100%. Further capital improvements were made in 2004-5, with the installation of a new drying kiln and a small-log line at a cost of $10.3 million. The Boyle sawmill is a two-line operation that has a 140
mmfbm/year-capacity when operating on two shifts, but is currently running on a single-shift basis. Other major equipment includes two dry kilns and a planer mill.

In June 2007, we entered into an agreement to purchase a sawmill located at Fox Creek, along with related lumber manufacturing and timber assets. The sale closed August 1, 2007, and we took possession of assets including a three-line, 45
mmfbm/year-capacity sawmill, a planer mill, a kiln, log inventory and mobile equipment. The purchase also included 140,000 cubic meters of timber in quotas and 65,000 cubic meters available through third-party agreements. The total purchase price,
funded from operating cash flow, was $22 million, which included log inventory valued at $3 million and mobile equipment and a maintenance shop valued at $1 million, for a net price of $18 million. On August 29, 2008, a fire broke
out while the sawmill was in operation, destroying most of the sawmill building and its contents. Unaffected by the fire were the mill’s log-handling equipment and other facilities on the mill site, including the planer mill, kiln, mobile shop
and log inventory. All assets were covered by a fire insurance policy, which included a replacement cost provision.

In July 2010, we commenced construction of a replacement sawmill at Fox Creek. The new sawmill, comprising two production lines capable of producing 120 mmfbm of lumber annually on a one-shift basis, started operation in late 2011, and was optimized
over the course of 2012. As part of the reconstruction project, we also invested in other site upgrades, including the installation of new technology in the planer mill to increase grade yields, reduce trim loss and lower labor costs, which was
completed in January 2012. The total cost of the Fox Creek reconstruction project was approximately $60 million, approximately $38
million of which was provided through an insurance settlement.

31

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Capital Expenditures

Our capital expenditures can be categorized as being of two
types: maintenance and discretionary. We consider capital expenditures that are
required to maintain the production capacity of our facilities at current
levels, or expenditures that address safety or environmental matters, to be
maintenance capital expenditures. Capital expenditures that enhance the
productivity or profitability of our operations are considered to be
discretionary capital expenditures. From 2008-2012, maintenance capital
expenditures averaged $2.9 million per year. We estimate that maintenance
capital expenditures will average approximately $5.0  $7.0 million per year for
the foreseeable future.



|ITEM 5: OPERATING AND FINANCIAL REVIEW AND PROSPECTS
|----------------------------------------------------

This managements discussion and analysis of our financial
condition and results of operations (MD&A) is based upon and should be
read in conjunction with our audited financial statements and the accompanying
notes included elsewhere in this annual report.

The MD&A contains historical information, descriptions of
circumstances and statements about future developments or anticipated financial
results. These forward-looking statements are based on certain assumptions or
expectations that, in turn, are subject to various risks or uncertainties. Such
statements are intended to help readers better understand our financial
performance, but readers should exercise caution in relying upon them in
anticipating our future financial performance. See Special Note Regarding
Forward-Looking Statements.

|A. | Results of Operations
|-- | ---------------------

Year ended December 31, 2012, compared to year ended
December 31, 2011

The following table sets out our operating and financial
results for the periods indicated.

32

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|                                            |   | Year ended December
      31, |  
|------------------------------------------- | - | ----------------------------- | -
|                                            |   | 2012                          |  
|                                            |   | (in millions)                 |  
|                                            |   |                               |  
|Statements of earnings
      data:          |   |                               |  
|Revenue                                     | $ | 332.4                         |  
|Cost of products sold                       |   | 241.0                         |  
|Freight and other distribution costs        |   | 53.2                          |  
|Depreciation and amortization               |   | 13.6                          |  
|General and administration                  |   | 13.8                          |  
|Profit sharing                              |   | -                             |  
|Other expenses (income)                     |   | 7.7                           |  
|Operating earnings                          | $ | 3.1                           |  
|Foreign exchange gain (loss) on borrowings  |   | 4.6                           |  
|Finance expenses                            |   | (20.4                         | )
|Net (loss) earnings before income taxes     | $ | (12.7                         | )
|Income taxes (recovery)
      expense       |   | (4.4                          | )
|Net (loss) for the year                     | $ | (8.3                          | )
|Actuarial losses, net of tax
      recovery |   | (0.3                          | )
|Comprehensive (loss) for the year           | $ | (8.6                          | )
|                                            |   |                               |  
|Other data:                                 |   |                               |  
|Average exchange rate
      (US$/C$1.00)1   |   | 1.000                         |  
|Period end exchange rate (US$/C$1.00)       |   | 1.005                         |  

|(1) | Average exchange rates are the daily noon Bank of Canada
      foreign-exchange rates, averaged over the period. Period end exchange
      rates are the closing Bank of Canada rate on the last business day of the
      period. The rates are set forth as U.S. dollars per C$1.00 and are the
      inverse of rates quoted by the Bank of Canada for Canadian dollars per
      US$1.00.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Our results reflected the small benefit of a weakening Canadian
dollar, which declined 1.1% in value relative to the U.S. dollar year-over-year,
helping to boost revenue by a little less than 1%, given that 64% of revenues
were denominated in U.S. dollars. The revenue improvement would normally have
been mitigated by the offsetting exchange-rate impact of U.S.-dollar-denominated
working capital and long-term debt; however, the period-end exchange rate moved
in favour of the Canadian dollar, resulting in an exchange gain.

At $332.4 million, our 2012 revenue was up nearly $48 million,
or 17%, compared to 2011. Stronger lumber shipments and pricing accounted for
the entire increase, as higher pulp shipments were undermined by weaker sales
realizations.

Our cost of products sold rose $34.0 million, or just over 16%,
year over year, primarily due to additional lumber production at the new Fox
Creek facility and, also, to rising fiber costs associated with longer log-haul
distances and higher fuel costs. Freight and other distribution costs were $4.6
million, just over 9% higher in comparison to the comparable period, on
increased shipments for both segments. Depreciation and amortization rose $2.2
million, or 20%, over 2011 as a result of the completion and start-up of the Fox
Creek facility. General and administration decreased to $1.7 million, or 11%,
returning costs to more normalized levels after the 2011 spike attributed to
expenditures associated with professional and consulting fees, as well as
benefit-plan adjustments.

We did not make any provision for profit sharing in the period.

33

---

Other expenses were $7.7 million in 2012 and included $6.9 million in unrealized losses on commodity derivative contracts at year end, a significant change from the $25.9 million in other income recorded in 2011, which had reflected
gains on commodity derivative contracts and the final settlement of the Fox Creek insurance claim.

Operating earnings for 2012 were $3.1 million, down significantly from the $27.6 million recorded for the previous year, which, again, had reflected significant contributions from commodity hedging and the insurance settlement.

We realized a $4.6 million foreign-exchange gain on our U.S.-dollar-denominated debt due the strengthening of the Canadian dollar at the end of the period.

Finance expenses in 2012 were $4.1 million higher than the previous year, with the difference due in large part to the capitalization of $3.6 million in interest expense associated with the Fox Creek reconstruction in 2011. The difference
also reflected our refinancing in the second quarter of 2011 and the higher coupon rate on the newly issued Senior Notes compared to its previous Notes, and to minor impacts, related to changing exchange rates, on U.S.-dollar-denominated interest.

During the period, we acquired a 100% interest in a related company, Chickadee Creek Energy Inc. (CCEI), which was immediately wound up and dissolved. Prior to the acquisition, CCEI was a wholly owned subsidiary of our parent Industries. Immediately
prior to the acquisition, CCEI had no active operations but retained rights to a $3.4 million government grant that had been obtained to facilitate the development of a previously considered biomass energy project. Prior to the dissolution of
CCEI, the $3.4 million government grant and other assets worth $0.1 million were assigned to us. We assumed CCEI’s liabilities in the amount of $0.5 million. We and Industries received approval from the appropriate government
authority to apply the former CCEI grant toward our current bio-energy project at the Whitecourt pulp mill.

We realized a loss before taxes of $12.7 million, which compared unfavorably to income before taxes of $1.2 million in 2011. The year’s results were subject to income tax at a statutory rate of 32%, compared to a rate of 33.5% in 2011.
The effective tax rate for the year varied from the statutory rate because of the manufacturing and processing profits deduction, the non-taxable portion of the unrealized exchange loss on debt, the non-taxable portion of capital gains and the
effect of future income-tax rate reductions. Tax credits related to Scientific Research and Experimental Development (“SR&ED”) claims contributed $0.2 million to the income tax recovery, compared to $0.4 million in 2011.

After a provision for income tax recovery of $4.4 million, we recorded a net loss of $8.3 million for the year, which compares to a net loss of $0.2 million in 2011.

Adjustments through comprehensive income are actuarial valuation changes that are presented net of income tax provision in accordance with IFRS and result in a comprehensive loss of $8.6 million for the period.

34

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|                                                                    |   | Year ended December
      31, |  
|------------------------------------------------------------------- | - | ----------------------------- | -
|                                                                    |   | 2012                          |  
|                                                                    |   | (in millions)                 |  
|Adjusted EBITDA data:                                               |   |                               |  
|Net (loss) for the year                                             | $ | (8.3                          | )
|Add/(subtract)                                                      |   |                               |  
|Income taxes (recovery)
      expense                               |   | (4.4                          | )
|Foreign
      exchange (loss) gain on borrowings                    |   | (4.6                          | )
|Finance expenses                                                    |   | 20.4                          |  
|Refinance
      expenses                                            |   | -                             |  
|Operating earnings                                                  | $ | 3.1                           |  
|Depreciation & amortization                                         |   | 13.6                          |  
|Other unrealized income
      (expense)                             |   | 6.0                           |  
|Adjusted EBITDA, as reported                                        | $ | 22.7                          |  
|Negative (positive)
      impact of inventory valuation adjustments |   | (1.9                          | )
|Cash Adjusted EBITDA                                                | $ | 20.8                          |  

We recorded Adjusted EBITDA of $22.7 million for 2012, down
from the $39.0 million realized in 2011. Included in this calculation was a $1.9
million benefit from non-cash inventory valuation adjustments associated with
the reversal of previous inventory valuation reductions to the lesser market
realization. In comparison, the 2011 Adjusted EBITDA was negatively affected by
a $1.2 million write-down of inventory values. These non-cash inventory
valuation adjustments reflect the lower of the cost to produce and the net
realizable value of both finished-product and log inventories, and the lower of
cost of purchase or market value of other raw material inventories. In the case
of finished-product and log inventories, we forecast the expected timing of
sales related to both inventories to arrive at the valuation adjustment; for
logs, this can be a considerable period into the future, given the length of
time logs may be held prior to their conversion into saleable product. Using
independent estimates of pricing in the future periods, the net realizable value
is approximated and compared to known or expected costs. As price forecasts are
highly volatile, these adjustments may be established and reversed on a regular
basis. Since they do not represent a current cash impact, we calculate a Cash
Adjusted EBITDA to reflect actual cash operating performance. The Cash Adjusted
EBITDA for 2012 was $20.8 million, down from $40.2 million in 2011. At period
end, all inventories were valued at the cost to produce.

35

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**Lumber**

|                                                   |   | Year ended December
      31, |  
|-------------------------------------------------- | - | ----------------------------- | -
|                                                   |   | 2012                          |  
|                                                   |   |                               |  
|Production-SPF-mmfbm                               |   | 459.8                         |  
|Shipments -SPF-mmfbm                               |   | 519.9                         |  
|Benchmark price
      -SPF#2&Better-US$ per mfbm   | $ | 298                           |  
|                                                   |   |                               |  
|Revenue - millions                                 | $ | 153.9                         |  
|Cost of products sold - millions                   |   | 142.4                         |  
|Inventory valuation
      adjustments - millions   |   | (1.9                          | )
|Other realized expense (income) -
      millions   |   | 0.6                           |  
|Adjusted EBITDA -
      millions                   | $ | 12.8                          |  
|Adjusted EBITDA margin - %                         |   | 8%                            |  
|                                                   |   |                               |  
|Other unrealized (expense) income -
      millions |   | (6.8                          | )
|Depreciation &
      amortization - millions       |   | (6.6                          | )
|Operating (loss) earnings - millions               | $ | (0.6                          | )
|                                                   |   |                               |  
|Capital expenditures - millions                    | $ | 4.9                           |  

Improving U.S. housing starts data and continued demand from
China resulted in strong improvement in pricing for the lumber segment during
the year. The spring seasonal rally saw benchmark pricing peak at roughly
US$300/mfbm before declining slightly, then holding fairly steady through the
summer months. The fall period, normally characterized by a late-season rise
followed by a pricing retreat, instead saw steady improvement in the third
quarter followed by a surge through to the end of the year, with prices reaching
a 2012 peak of US$385/mfbm. This positive trend carried over into 2013, with
prices approaching US$400/mfbm in the first quarter. Current pricing is at
levels unseen since the beginning of the downturn some six years ago, and both
domestic and overseas demand appears strong, with supply-side responses as yet
insufficient to dampen the positive pricing outlook for 2013.

Our lumber segment continued to see excellent operating
performance through 2012 at its Whitecourt and Boyle operations and at the newly
constructed Fox Creek sawmill. Combined production for the three facilities was
459.8 million foot board measure (mmfbm), up 95.5 mmfbm, or 26%, from the 364.3
mmfbm achieved in 2011. This increase was largely the result of the 120 mmfbm in
additional capacity from the Fox Creek sawmill, but was offset in part by
unscheduled downtime in the third quarter due to log delivery challenges and
scheduled downtime in the fourth quarter related to the Christmas vacation
period. Shipments for the segment surged by 109.1 mmfbm, or 26.5%, to 519.7
mmfbm, as inventories were reduced by roughly 10%; the value of inventories,
however, increased with the reversal of previous valuation write-downs.

At US$298/mfbm, average benchmark pricing for the year was up
US$42/mfbm, or 16%, compared to 2011. With a modest 1% contribution from a
weakening Canadian dollar, per-unit sales realizations likewise increased
$41/mfbm versus the previous year. The rise in shipments and per-unit pricing
combined to increase segment revenue by $49.0 million, or 47%, to $153.9 million
for the year.

Lumber segment cost of products sold increased by $35.2 million
to $142.4 million in 2012, a 33% rise from 2011. This increase exceeded that
attributed to the higher production levels, with per-unit costs climbing nearly
5% due to higher costs associated with log harvesting and hauling, including
rising fuel prices and longer haul distances. The cost of manufacturing is
likely to increase a further 5% in 2013, due to cost pressures associated with
fiber supply.

36

---

As the markets outlook improved, the previously referenced
inventory valuation reductions were reversed through the year and contributed
$1.9 million in 2012, compared to the write-down of $1.8 million in 2011.

Other realized expense or income represents the cash impact of
foreign-exchange and commodity hedging, as well as realized foreign-exchange
impacts on working capital changes. In 2012, the lumber segment realized a loss
of $0.6 million, primarily on commodity hedging activities, in contrast to the
previous year, which had benefitted by $15.9 million from the same activities.
The relative stability of foreign-exchange rates meant that neither
foreign-exchange hedging nor working capital changes had a significant impact.

The segment reported $12.8 million in Adjusted EBITDA. While
these results were comparable to the $11.8 million realized in 2011, the 2011
results were almost entirely attributable to contributions from commodity
hedging. Excluding the hedging activities, the segment would have realized a
significant improvement year over year. We advise caution in anticipating future
hedging program contributions, as the conditions that gave rise to the
significant benefits realized in 2011 may not recur in the future.

Capital expenditures for the lumber segment were $4.9 million,
$2.0 million of which was for completion of the Fox Creek reconstruction
project, with a further $2.9 million allocated to maintenance-of-business and
smaller, high-return projects. This compared to capital expenditures of $45.1
million in 2011, $43.3 million of which was dedicated to the Fox Creek project.
We expect to spend between $2 million and $3 million on maintenance-of-business
projects in the coming year.

Pulp

|                                                   |   | Year ended December
      31, |  
|-------------------------------------------------- | - | ----------------------------- | -
|                                                   |   | 2012                          |  
|                                                   |   |                               |  
|Production-thousands of
      tonnes               |   | 321.1                         |  
|Shipments -thousands of tonnes                     |   | 322.3                         |  
|Benchmark price -NBSK, US$
      per tonne         | $ | 872                           |  
|Benchmark price -BEK, US$ per tonne                | $ | 757                           |  
|                                                   |   |                               |  
|Revenue - millions                                 | $ | 178.1                         |  
|Cost of products sold -
      millions             |   | 153.7                         |  
|Inventory valuation adjustments - millions         |   | -                             |  
|Other realized expense
      (income) - millions   |   | 1.0                           |  
|Adjusted EBITDA - millions                         | $ | 23.4                          |  
|Adjusted EBITDA margin - %                         |   | 13%                           |  
|                                                   |   |                               |  
|Other unrealized income
      (expense) - millions |   | 0.8                           |  
|Depreciation & amortization - millions             |   | (6.9                          | )
|Operating earnings - millions                      | $ | 17.3                          |  
|                                                   |   |                               |  
|Capital expenditures -
      millions              | $ | 6.5                           |  

Global pulp markets had an uneven year, as modest improvements
in the global economy  usually a reliable indicator for paper and, thus, wood
pulp demand  were undermined by continued uncertainty about future economic
conditions. On the supply side, the addition of new capacity presented further
challenges, especially for hardwood kraft producers. Benchmark pricing for
hardwood pulp grades improved at the start the year, while the softwood market
showed signs of weakness. After strengthening at midyear, both markets fell off
in the third quarter before rebounding modestly to finish the year. Pricing for
the benchmark softwood and, especially, hardwood grades was volatile through the
year, with the average Northern Bleached Softwood Kraft (NBSK) price falling by
more than $100, or over 10%, from 2011, and Bleached Eucalyptus Kraft (BEK) pulp
experiencing swings of nearly US$100, or over 10%, during the year and
recording an average price US$31, or 7%, lower than 2011.

37

---

Pricing for our BCTMP was much more stable, with sales
realizations varying by only $25 through the year, contributing to eight
straight quarters of largely unchanged pricing. We believe this represents a
disengagement from the historic price relationship between BCTMP and the
benchmark grades, particularly for the multi-ply paperboard business that
dominates the Asian BCTMP market. Our ongoing position in fine paper and
tissue/towel applications provides more direct linkage to benchmark grades, but
these segments represent less than 40% of sales. The price stability of the
multi-ply paperboard market, which constituted 47% of our pulp business in 2012,
has a much greater impact on our sales realizations.

Our pulp mill had another high-production year, producing 321.1
thousand ADMT (MADMT), essentially matching the record-setting 321.2 MADMT
produced in 2011. At 322.3 MADMT, shipments were significantly improved,
slightly exceeding production and up from 311.0 MADMT shipped the previous year.
Inventories were largely stable through the year, following a market rebalancing
in 2011 that had resulted in increased inventories. We remain committed to
well-balanced market distribution, both geographically and in terms of end-use
products, while taking into account continued development of the Asian market
and declining paper production in the more mature markets of Europe and North
America.

At $178.1 million, segment revenue was down slightly on
improved shipments, as per-unit sales realizations were approximately 4% lower
in 2012 compared to 2011, even after a 1% contribution from the modestly weaker
Canadian dollar.

Segment cost of products sold rose by approximately 4.6%, to
$153.7 million, due to increases in fiber and energy costs. Included in the pulp
segment costs was $1.6 million of a $1.85 million provision related to our share
of a force majeure claim by the owner of the Sundance power plant in which we
have power purchase rights under our PPA; the balance of the provision was
accounted as a product inventory cost. This force majeure claim remains
unresolved, pending arbitration expected to commence in early 2014.

In 2012, pulp-segment power costs were reduced by $11.1 million
from market rates due to the contribution of our power purchase rights. Based on
per-segment consumption, 91% of the benefit of the power purchase rights was
allocated to the pulp segment, with the balance used to offset power costs in
the lumber segment. The 2012 cost benefit compared unfavorably to the $21.3
million recorded in 2011, which reflected that years higher average electricity
pool pricing.

With $1 million in other realized expense, primarily associated
with foreign-exchange changes to working capital, the segment posted $23.4
million in Adjusted EBITDA. This compared unfavorably to the $35.3 million
realized in 2011.

After accounting for other unrealized income of $0.8 million
relating to foreign-exchange balances at the year end and $6.9 million in
depreciation and amortization, the segment realized operating earnings of $17.3
million in 2012, a reduction from the $26.1 million recorded in 2011.

Capital expenditures of $6.5 million in 2012 included $4.6
million related to our bio-energy project, construction of which began in the
third quarter, and $1.9 million for maintenance-of-business and smaller,
high-return projects, which was consistent with the $1.8 million spent in 2011.

38

---

**Corporate and other**

|                                        |   | Year ended December
      31, |  
|--------------------------------------- | - | ----------------------------- | -
|                                        |   | 2012                          |  
|                                        |   | (in millions)                 |  
|                                        |   |                               |  
|Revenue                                 | $ | 0.4                           |  
|General & administration                |   | 13.9                          |  
|Other realized (income)                 |   | -                             |  
|Adjusted EBITDA                         | $ | (13.5                         | )
|Other unrealized
      (expense) income |   | -                             |  
|Depreciation & amortization             |   | (0.1                          | )
|Operating loss                          | $ | (13.6                         | )
|                                        |   |                               |  
|Capital expenditures                    | $ | 0.3                           |  

Revenue for the corporate and other segment was generated
primarily from fees billed to our parent company for administrative services.
Corporate revenue was essentially un-changed from year to year, with $0.4
million recorded in both 2012 and 2011.

The corporate and other segment recorded negative Adjusted
EBITDA of $13.5 million as compared to negative $8.0 million posted in 2011. The
$5.5 million year over year difference is largely related to our receipt of $7.6
million in final settlement of the Fox creek insurance claim. Without this
settlement, the segments Adjusted EBITDA in 2011 would have compared
unfavorably to the current year, due to the previous periods provision for
profit sharing, higher-than-normal professional and consulting fees and an
amendment to the supplementary defined-benefit pension plan.

39

---

Year ended December 31, 2011, compared to year ended
December 31, 2010

The following table sets out our operating and financial
results for the periods indicated.

**IFRS Statements**

|                                           |   | Year ended December 31, |  
|------------------------------------------ | - | ----------------------- | -
|                                           |   | 2011                    |  
|                                           |   | (in millions)           |  
|                                           |   |                         |  
|Statements of earnings data:               |   |                         |  
|Revenue                                    | $ | 284.6                   |  
|Cost of products sold                      |   | 207.0                   |  
|Freight and other distribution costs       |   | 48.6                    |  
|Depreciation and amortization              |   | 11.4                    |  
|General and administration                 |   | 15.5                    |  
|Profit sharing                             |   | 0.4                     |  
|Other (income) expenses                    |   | (25.9                   | )
|Operating earnings                         | $ | 27.6                    |  
|Foreign exchange (loss) gain on borrowings |   | (5.5                    | )
|Finance expenses                           |   | (16.3                   | )
|Net earnings before income taxes           | $ | 1.2                     |  
|Income taxes expense                       |   | 1.4                     |  
|Net (loss) earnings for the year           | $ | (0.2                    | )
|Actuarial losses, net of tax recovery      |   | (0.2                    | )
|Comprehensive (loss) income for the year   | $ | (0.4                    | )
|                                           |   |                         |  
|Other data:                                |   |                         |  
|Average exchange rate
      (US$/C$1.00)1  |   | 1.011                   |  
|Period end exchange rate (US$/C$1.00)      |   | 0.983                   |  

|(1) | Average exchange rates are the daily noon Bank of Canada
      foreign-exchange rates, averaged over the period. Period end exchange
      rates are the closing Bank of Canada rate on the last business day of the
      period. The rates are set forth as U.S. dollars per C$1.00 and are the
      inverse of rates quoted by the Bank of Canada for Canadian dollars per
      US$1.00.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Under challenging economic and market conditions, both our
financial and operational results remained generally solid in 2011. Despite much
weaker pulp markets and increasing cost pressures, felt particularly in the
lumber segment, our operating earnings stayed consistent with those recorded in
2010, as contributions from lumber hedging and insurance proceeds offset the
years negative pricing trends. The small after-tax loss recorded for the year
presented a sharp contrast with our profit in the previous year and reflected
exchange-rate losses on long-term debt and expenses associated with our
refinancing early in the year.

The markets for both lumber and BCTMP struggled in 2011, due to
supply-demand imbalances related to general economic weakness, which undermined
price levels and stability, and to the relative strength of the Canadian dollar,
which further eroded U.S.-dollar-denominated pricing. However, we had a strong
year of operations, setting new daily, monthly and annual production records at
the pulp mill, successfully rebuilding and restarting the Fox Creek sawmill lost
to fire in 2008 and maintaining productivity and managing costs at all sites in
the face of inflationary pressures.

40

---

With virtually all of our pulp and a significant portion of our
lumber products sold outside Canada, the majority of our sales are denominated
in U.S. dollars. The geographic distribution of revenue for the periods
indicated was as follows:

**Geographic Sales Revenue**

|              |   | Year ended December
      31, | 
|------------- | - | ----------------------------- | 
|              |   | 2011                          | 
|              |   | (in thousands)                | 
|              |   |                               | 
|Canada        | $ | 82,966                        | 
|United States |   | 41,084                        | 
|Europe        |   | 43,263                        | 
|Asia          |   | 107,924                       | 
|Other         |   | 9,445                         | 
|              | $ | 284,682                       | 

Our results were adversely affected by the Canadian dollars
rise in relative value during 2011. An average exchange rate in 2011 of
US$1.011/C$ , more than 4% higher than the 2010 average of US$0.971/C$ , put
downward pressure on sales realizations. While this would normally have been
mitigated by an offsetting exchange-rate impact on long-term debt, a slight
weakening of the Canadian dollar at the year-end resulted in a small unrealized
foreign-exchange loss on our U.S.-dollar-denominated long-term debt.

At $284.7 million, our revenue for 2011 was down $10.7 million,
or 3.6%, from the previous year. Lower pulp pricing more than offset higher
shipments in the pulp segment, compared year over year, and there was little
change in lumber pricing to mitigate climbing costs in our lumber segment.

Cost of products sold rose for both segments, as a result of
increased production and higher energy prices. Freight and other distribution
costs declined, as the impact of rising fuel costs was more than offset by a
reduced payment of export taxes under the SLA, reflecting a lower volume of
lumber shipments to the U.S., and by a minor redistribution of pulp shipments
among geographic markets.

General and administrative costs in 2011 were $15.9 million,
considerably higher than the $13.8 million recorded in 2010. This change
reflected higher-than-normal professional and consulting fees associated with an
insurance review and increased industry and government relations activities. It
also reflected wage and benefits increases and a one-time amendment made to the
supplementary defined-benefit pension plan.

We made provision for the distribution of $0.4 million to our
employees under our profit-sharing program for 2011.

Other income provided a significant contribution to our
financial results in 2011, reflecting gains on commodity hedges and the receipt
of $7.6 million associated with the final settlement of the insurance claim on
the 2008 Fox Creek sawmill fire. These gains more than offset losses associated
with the foreign-exchange impact on working capital balances seen as the
Canadian dollar strengthened through the year.

Despite these individual variances, operating earnings for 2011
were $27.6 million, consistent with the $27.3 million realized in 2010.

We entered 2011 with US$190 million in long-term debt, which
had been translated at the exchange rate of US$1.005/C$ on December 31, 2010. We
ended the year with US$210 million in long-term debt, following a refinancing
that was concluded in April 2011, as described below. The exchange rate at the
time of the new debt issuance was US$0.959/C$ . Our US$210 million in long-term
debt was translated at the exchange rate of US$0.983/C$ on December 31, 2011.
This change in value resulted in an unrealized loss of $5.5 million, compared to
an unrealized gain of $10.7 million in 2010.

41

---

Financing expenses in 2011 were comparable to those in 2010, as
the strong Canadian dollars impact on U.S.-dollar-denominated interest and
interest capitalization associated with the Fox Creek reconstruction project
offset refinancing expenses and a higher coupon rate on our Senior Notes issued
in April 2011.

On April 1, 2011, we refinanced our US$190 million in 7.75%
Senior Notes, due 2013, with US$210 million in 8.5% Senior Notes, due 2021.
Refinancing expenses in the year included the call premium and unamortized
balance of expenses associated with the original issuance of the 2013 Notes. The
refinancing expenses associated with the offering of the initial Notes will be
amortized over the 10-year life of the new bonds.

Operating results for 2011 were subject to income taxes at the
statutory rate of 33.5%, compared to a rate of 35.0% in 2010. The effective tax
rate for 2011 varied from the statutory rate because of the manufacturing and
processing profits deduction, the non-taxable portion of the unrealized exchange
loss on debt, the non-taxable portion of capital gains and the effect of future
income-tax rate reductions. Tax credits related to Scientific Research and
Experimental Development, or SR&ED, claims reduced tax expenses by $0.4
million in 2011, as compared to a tax reduction of $0.9 million for SR&ED
claims in 2010.

After provision for income tax expense of $1.4 million, we
recorded a net loss of $0.2 million in 2011, down from net earnings of $17.7
million in 2010.

Adjustments through comprehensive income are actuarial
valuation changes that are presented net of income tax provision, in accordance
with IFRS.

|                                                                    |   | Year ended December
      31, |  
|------------------------------------------------------------------- | - | ----------------------------- | -
|                                                                    |   | 2011                          |  
|                                                                    |   | (in millions)                 |  
|Adjusted EBITDA data:                                               |   |                               |  
|Net (loss) income for the year                                      | $ | (0.2                          | )
|Add/(subtract)                                                      |   |                               |  
|Income taxes expense                                                |   | 1.4                           |  
|Foreign
      exchange gain (loss) on borrowings                    |   | 5.5                           |  
|Finance expenses                                                    |   | 16.3                          |  
|Refinance
      expenses                                            |   | 4.6                           |  
|Operating earnings                                                  | $ | 27.6                          |  
|Depreciation & amortization                                         |   | 11.4                          |  
|Other unrealized income
      (expense)                             |   | -                             |  
|Adjusted EBITDA, as reported                                        | $ | 39.0                          |  
|Negative (positive)
      impact of inventory valuation adjustments |   | 1.2                           |  
|Cash Adjusted EBITDA                                                | $ | 40.2                          |  

We recorded Adjusted EBITDA of $39.0 million for 2011,
comparable to $41.7 million in 2010. Included in this calculation was $1.2
million in non-cash inventory valuation adjustments. In comparison, the 2010
Adjusted EBITDA benefited from a $2.2 million reversal of previous inventory
valuation adjustments. These non-cash inventory valuation adjustments reflect
the lower of the cost to produce and the net realizable value of both
finished-product and log inventories, and the lower of cost of purchase or
market value of other raw material inventories. In the case of finished-product
and log inventories, we forecast that the expected timing of sales related to
both inventories will arrive at the valuation adjustment; for logs, this can be
a considerable period into the future, given the length of time logs may be held
prior to their conversion into saleable product. Using independent estimates of
pricing in the future periods, the net realizable value is approximated and
compared to known or expected costs. As price forecasts are highly volatile,
these adjustments may be established and reversed on a regular basis. Since they
do not represent a current cash impact, we calculate Cash Adjusted EBITDA to
reflect actual cash operating performance. For 2011, this amount was $40.2
million, up from $39.5 million in 2010.

42

---

**Lumber**

|                                                   |   | Year ended December
      31, |  
|-------------------------------------------------- | - | ----------------------------- | -
|                                                   |   | 2011                          |  
|                                                   |   |                               |  
|Production-SPF-mmfbm                               |   | 364.3                         |  
|Shipments -SPF-mmfbm                               |   | 410.6                         |  
|Benchmark price
      -SPF#2&Better-US$ per mfbm   | $ | 256                           |  
|                                                   |   |                               |  
|Revenue - millions                                 | $ | 104.9                         |  
|Cost of products sold - millions                   |   | 107.2                         |  
|Inventory valuation
      adjustments - millions   |   | 1.8                           |  
|Other realized (income) - millions                 |   | (15.9                         | )
|Adjusted EBITDA -
      millions                   | $ | 11.8                          |  
|Adjusted EBITDA margin - %                         |   | 11%                           |  
|                                                   |   |                               |  
|Other unrealized income (expense) -
      millions |   | 2.0                           |  
|Depreciation &
      amortization - millions       |   | (4.2                          | )
|Operating earnings - millions                      | $ | 9.6                           |  
|                                                   |   |                               |  
|Capital expenditures - millions                    | $ | 45.1                          |  

The extended downturn in the U.S. housing market continued to
affect the North American softwood lumber industry in 2011. Significant
production curtailments and a rise in off-shore sales, principally to China,
brought some improvement in the supply-demand balance. Resulting optimism,
unsupported by any substantial improvement in North American demand, spurred a
short-lived price rally early in the year, providing an opportunity for us to
hedge against subsequent price declines by entering into futures contracts on
the Chicago Mercantile Exchange. As the year progressed, additional supply came
on-stream to take advantage of the higher pricing, driving prices back down. The
expansion of offshore markets showed its benefit, as prices settled, on
relatively flat trading, well above the lows of previous years. The pricing
levels established in the second quarter generally held through the balance of
2011 and continued into the early part of 2012, as market fundamentals remained
largely stagnant and demand and supply fairly well balanced.

We continued to see strong operating performance through 2011
at our Whitecourt and Boyle sawmills. Combined production at the two facilities
was 364.2 million foot board measure, or mmfbm, just 2% lower than the 370.8
mmfbm produced in 2010, when extra planer shifts had been added to reduce
work-in-process inventories. Shipments for the year were 410.6 mmfbm, a modest
increase over the 404.1 mmfbm shipped in 2010. Despite shipments having exceeded
production, as presented, inventories rose slightly. This reflects the fact that
production volumes, as reported, exclude lumber sold in rough form; total
finished and rough lumber volumes exceeded shipments. The value of the inventory
increase was muted by an inventory valuation adjustment of $1.8 million.

Average benchmark pricing was largely consistent year to year,
though there was significant volatility throughout each period. The year started
with prices rising more than 10%, peaking above $300 per thousand foot board
measure, or mfbm, before collapsing, in the second quarter, to lows in the
$200/mfbm range. As previously noted, we took an aggressive hedging position
during the spring price rally, a strategy that provided a benefit of just over
$14 million in realized gains during the year. We recognize the strategic value
of defensive hedging on major inputs and, when appropriate, on product sales;
however, our hedging activities are limited to our capacity for physical
consumption or production of goods and are not entered into for speculative
purposes. We advise caution when considering the hedging program contributions
in 2011, as they may not recur in the future.

43

---

Per-unit sales net realizations generally tracked the direction of benchmark pricing but showed less volatility, reflecting the benefit of our sales into specialty-product and direct-to-end-use markets. Sales realizations declined approximately 6%,
as the strengthening Canadian dollar eroded some of the US-dollar-denominated price moves and as we sold a larger-than-usual proportion of lower-grade products in response to Chinese demand. While we shipped only a modest volume of lumber directly
into China and Japan, we benefited from the growth of those offshore markets through sales to China via domestic intermediaries and also through reduced competition for North American sales.

Our cost of products sold was adversely affected by the $1.8 million inventory write-down previously noted, which accounted for more than half of the per-unit cost increase over the previous year. Pre-start-up costs associated with the Fox Creek
sawmill reconstruction and increased energy costs, especially for log-delivery fuel expenses, accounted for the balance of the year-over-year rise.

The Fox Creek reconstruction was substantially completed in 2011, with the new sawmill starting production by the end of the year and the upgraded planer mill starting production very early in 2012. Of the segment capital expenditures of $45.1
million in 2011 and $20.4 million in 2010, a total of $58.2 million was spent on the rebuilding, upgrading and expansion at Fox Creek, and a further $5.3 million represented capitalized interest and commissioning costs related to the
project.

Our lumber segment recorded revenue of $104.9 million for 2011; the unfavorable comparison with segment revenue of $110.1 million in 2010, when shipments were slightly lower, reflected the impact of foreign exchange and grade mix on per-unit
sales net realizations in the current period. At $107.2 million, cost of products sold was up $7.1 million over 2010, reflecting the Fox Creek pre-start-up costs and higher fuel costs. The price outlook at the year-end resulted in an
inventory valuation write-off of $1.8 million, contrasting with a positive adjustment of $2.8 million in 2010. The combination of these factors would have yielded much weaker segment earnings for the year, but for the significant
contribution from our hedging activities, which contributed the majority of the $15.9 million recorded in other realized gains; the balance of this figure reflected foreign-exchange impacts on working capital and a small contribution from
foreign-exchange hedges. With these gains, the segment recorded $11.8 million in Adjusted EBITDA and $9.6 million in operating earnings for 2011.

44

---

Pulp

|                                                 |   | Year ended December
      31, |  
|------------------------------------------------ | - | ----------------------------- | -
|                                                 |   | 2011                          |  
|                                                 |   |                               |  
|Production-thousands of
      tonnes             |   | 321.2                         |  
|Shipments -thousands of tonnes                   |   | 311.0                         |  
|Benchmark price -NBSK,
      US$ per tonne       | $ | 977                           |  
|Benchmark price -BEK, US$ per tonne              | $ | 788                           |  
|                                                 |   |                               |  
|Revenue - millions                               | $ | 179.3                         |  
|Cost of products sold -
      millions           |   | 146.9                         |  
|Inventory valuation adjustments -
      millions |   | (0.6                          | )
|Other realized (income)
      expense - millions |   | (2.3                          | )
|Adjusted EBITDA - millions                       | $ | 35.3                          |  
|Adjusted EBITDA margin
      - %                 |   | 20%                           |  
|                                                 |   |                               |  
|Other unrealized
      (expense) - millions      |   | (2.2                          | )
|Depreciation & amortization -
      millions     |   | (7.0                          | )
|Operating earnings -
      millions              | $ | 26.1                          |  
|                                                 |   |                               |  
|Capital expenditures -
      millions            | $ | 1.8                           |  

The pulp market started 2011 on a generally positive footing,
though price improvements seen in other market segments did not apply to the
BCTMP sector, which continued to suffer from over-capacity reflecting the
late-2010 start-up of a new BCTMP mill in China. As a result, the traditional
differential in pricing between BCTMP and its comparable benchmark grades
widened, with BCTMP prices falling through the early part of 2011 and kraft
grades rising. The gap was expected to close in the second half of the year, on
continued improvement in demand for BCTMP. As 2011 progressed, however, growing
global economic uncertainty, reflecting renewed credit concerns in Europe, began
to weigh on pulp and paper markets. The positive market tone seen early in the
year was reversed by mid-year, with significant price erosion starting in the
second half of 2011. While the gap between BCTMP and benchmark pricing did close
to more normal levels by the end of the year, this occurred not as a result of
the anticipated increase in demand, but because BCTMP pricing largely held
steady as kraft grades fell during the third and fourth quarters.

Our pulp segment had a strong year operationally in 2011, as
the Whitecourt mill set daily, monthly, quarterly and annual records on the way
to posting year-end production of 321.2 thousand air dried metric tonnes, or
ADMT, and shipments of 311.0 thousand ADMT. These figures, up sharply from the
297.2 thousand ADMT produced and 287.2 thousand ADMT shipped in 2010, reflected
both the positive impact of mill process enhancements made in late 2010 and a
continued commitment to operating excellence on the part of mill personnel.

The inventory rise evident in the difference between production
and shipment volumes resulted, in part, from our focus on increasing our sales
to the European market, which, unlike sales to Asia, require the maintenance of
local site inventory. We consider that our pursuit of well-balanced market
distribution, both geographically and in terms of end-use product, will provide
for enhanced sales stability and long-term enterprise value.

While year-over-year comparisons show average benchmark
bleached eucalyptus kraft, or BEK, pricing declining 7% in 2011, our pulp
segments per-unit sales net realizations decreased by more than 10%, in part
due to the negative impact of a strengthening Canadian dollar on
US-dollar-denominated pricing. Despite the steep decrease in per-unit sales net
realizations, 2011 segment revenue was off only 3% year over year, as increased
shipments helped compensate for lower pricing.

45

---

Cost of products sold rose only in proportion to increased production, as continued efficiency improvements offset rising energy and fuel costs. We recognized a $0.6 million positive inventory valuation adjustment in 2011, related to natural gas
inventories that had been previously written down in 2010. Other realized gains of $2.3 million were related to foreign-exchange gains on working capital balances and a small contribution from foreign-exchange hedging.

In 2011, pulp segment power costs were reduced by $21.3 million below market rates due to the contribution of our power purchase rights; based on per-segment consumption, 93% of the benefit of the power purchase rights was allocated to the pulp
segment, and the balance used to offset power costs in the lumber segment. By comparison, power purchase rights contributed a cost benefit to the pulp segment of $9.0 million in 2010. The greater contribution in 2011 reflected higher power-pool
pricing, the result of increased power demand in the province.

The result of all factors was segment Adjusted EBITDA of $35.3 million for 2011, comparable to the $37.3 million achieved in 2010.

Capital expenditures of $1.8 million for 2011, consistent with the $1.6 million recorded in 2010, were restricted to maintenance of business activities.

46

---

**Corporate and other**

|                                        |   | Year ended December
      31, |  
|--------------------------------------- | - | ----------------------------- | -
|                                        |   | 2011                          |  
|                                        |   | (in millions)                 |  
|                                        |   |                               |  
|Revenue                                 | $ | 0.4                           |  
|General & administration                |   | 15.9                          |  
|Other realized (income)                 |   | (7.5                          | )
|Adjusted EBITDA                         | $ | (8.0                          | )
|Other unrealized
      (expense) income |   | -                             |  
|Depreciation & amortization             |   | (0.1                          | )
|Operating loss                          | $ | (8.1                          | )
|                                        |   |                               |  
|Capital expenditures                    | $ | 0.7                           |  

Revenue for the corporate and other segment was generated
primarily from fees billed to our parent company for administrative services.
Corporate revenue was little changed from year to year, with $0.4 million
recorded in 2011, compared to $0.3 million in 2010.

The corporate and other segment recorded negative Adjusted
EBITDA of $8.0 million in 2011. The significant improvement over the negative
$13.4 million posted in 2010 reflected our receipt of $7.6 million in final
settlement of the Fox Creek insurance claim. Without this amount, the corporate
and other segment would have recorded a $15.6 million Adjusted EBITDA loss,
comparing unfavorably with 2010, as a result of the current periods
higher-than-normal professional and consulting fees, increase to wages and
benefits, and amendment to the supplementary defined-benefit pension plan.

47

---

Results of Operations  Fourth Quarter of 2012

The following table sets out our operating and financial
results for the periods indicated.

|                                            |   | Three months ended |  
|------------------------------------------- | - | ------------------ | -
|                                            |   | Dec. 31/12         |  
|                                            |   | (in millions)      |  
|                                            |   |                    |  
|Statements of earnings
      data:          |   |                    |  
|Revenue                                     | $ | 82.9               |  
|Cost of products sold                       |   | 60.2               |  
|Freight and other distribution costs        |   | 13.0               |  
|Depreciation and amortization               |   | 3.4                |  
|General and administration                  |   | 3.2                |  
|Profit sharing                              |   | -                  |  
|Other expenses (income)                     |   | 9.0                |  
|Operating (loss) earnings                   | $ | (5.9               | )
|Foreign exchange (loss) gain on borrowings  |   | (2.5               | )
|Finance expenses                            |   | (5.1               | )
|Net (loss) earnings before income taxes     | $ | (13.5              | )
|Income taxes (recovery)
      expense       |   | (2.8               | )
|Net (loss) earnings for the year            | $ | (10.7              | )
|Actuarial losses, net of tax
      recovery |   | (0.3               | )
|Comprehensive (loss) income for the year    | $ | (11.0              | )
|                                            |   |                    |  
|Other data:                                 |   |                    |  
|Average exchange rate
      (US$/C$1.00)1   |   | 1.009              |  
|Period end exchange rate (US$/C$1.00)       |   | 1.005              |  

|(1) | Average exchange rates are the daily noon Bank of Canada
      foreign-exchange rates, averaged over the period. Period end exchange
      rates are the closing Bank of Canada rate on the last business day of the
      period. The rates are set forth as U.S. dollars per C$1.00 and are the
      inverse of rates quoted by the Bank of Canada for Canadian dollars per
      US$1.00.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We recorded revenue of $82.9 million for the fourth quarter of
2012, down slightly from the $85.0 million reported in the third quarter of
2012, largely on reduced lumber shipments and lower sales realizations from the
pulp segment. The quarters revenue is, however, much improved over the $71.3
million posted in the fourth quarter of 2011, primarily due to improvements in
lumber pricing and shipments that offset weaker pulp pricing. Cost of products
sold climbed in the quarter against both comparable periods, as higher energy
and transportation costs put pressure on both manufacturing and log
harvesting-and-hauling operations.

We recorded a loss of $8.5 million related to unrealized
mark-to-market valuation adjustments on our lumber derivative contracts. As
lumber prices climbed in the quarter, we began to take a significant hedging
position, effectively protecting the stronger pricing into the future. As the
position was being established in a rising market, it resulted in unrealized
losses at year-end market levels. To safeguard our financial performance, we
entered into derivative contracts on our product sales by forward-selling a
portion of our output at pricing levels that we believe will return a positive
contribution through the coming year.

The result for the quarter was an operating loss of $5.9
million, compared to operating earnings of $8.5 million in the third quarter of
2012 and $0.4 million in the fourth quarter of 2011. We experienced a
foreign-exchange loss of $2.5 million on the value our U.S.-dollar-denominated
debt, as the period-end exchange rate was weaker than that recorded at the end
of the third quarter of 2012. Finance expenses were comparable to the third
quarter of 2012 but higher than the fourth quarter of 2011, which had benefitted
from the capitalization of interest related to the Fox Creek rebuild.

After a provision for income tax recovery of $2.8 million, we
recorded a $10.7 million net loss as compared to net income of $10.0 million for
the third quarter of 2012 and $4.2 million in net income for the fourth quarter
of 2011.

48

---

|                                                                    |   | Three months ended |  
|------------------------------------------------------------------- | - | ------------------ | -
|                                                                    |   | Dec. 31/12         |  
|                                                                    |   | (in millions)      |  
|Adjusted EBITDA data:                                               |   |                    |  
|Net (loss) earnings for the year                                    | $ | (10.7              | )
|Add/(subtract)                                                      |   |                    |  
|Income taxes (recovery) expense                                     |   | (2.8               | )
|Foreign exchange
      gain (loss) on borrowings                    |   | 2.5                |  
|Finance expenses                                                    |   | 5.1                |  
|Operating (loss) earnings                                           | $ | (5.9               | )
|Depreciation & amortization                                         |   | 3.4                |  
|Other unrealized
      income (expense)                             |   | 8.5                |  
|Adjusted EBITDA, as reported                                        | $ | 6.0                |  
|Negative
      (positive) impact of inventory valuation adjustments |   | -                  |  
|Cash Adjusted EBITDA                                                | $ | 6.0                |  

Our Adjusted EBITDA of$6.0 million was unaffected by
non-cash valuation adjustments during the quarter, as these were entirely
reversed in the previous quarter. Such non-cash inventory valuation adjustments
are made to reflect the lower of the cost to produce and the net realizable
value of both finished product and log inventories. Using independent estimates
of pricing in future periods, the net realizable value is approximated and
compared to known costs. As price forecasts are highly volatile, the adjustments
are established and reversed on a regular basis. Since they do not represent a
current cash impact, we calculate a Cash Adjusted EBITDA to reflect actual cash
operating performance.

Lumber

|                                                 |   | Three months ended |  
|------------------------------------------------ | - | ------------------ | -
|                                                 |   | Dec. 31/12         |  
|                                                 |   |                    |  
|Production-SPF-mmfbm                             |   | 109.4              |  
|Shipments -SPF-mmfbm                             |   | 120.8              |  
|Benchmark price
      -SPF#2&Better-US$ per mfbm | $ | 333                |  
|                                                 |   |                    |  
|Revenue - millions                               | $ | 39.3               |  
|Cost of products sold - millions                 |   | 34.2               |  
|Inventory valuation
      adjustments - millions |   | -                  |  
|Other realized expense (income) - millions       |   | 1.1                |  
|Adjusted EBITDA - millions                       | $ | 4.0                |  
|Adjusted EBITDA margin - %                       |   | 10%                |  
|                                                 |   |                    |  
|Other unrealized (expense) income - millions     |   | (8.0               | )
|Depreciation &
      amortization - millions     |   | (1.7               | )
|Operating (loss) earnings - millions             | $ | (5.7               | )
|                                                 |   |                    |  
|Capital expenditures - millions                  | $ | 1.0                |  

Our lumber segment continued to realize the benefits of a
strengthening market, with benchmark pricing climbing over 10%, to $333/mfbm, in
the period. Per-unit sales realizations likewise improved, but lagged the market
due, in part, to the normal delay between sales and shipments but primarily to
reduced shipments toward year end, when we took holiday-related downtime. This
affected not only shipments, but also production, which was also down compared
to the third quarter of 2012.

49

---

Revenue was slightly lower in the period as compared to the
third quarter, as stronger sales realizations were not sufficient to offset the
drop in shipments. Cost of products sold, though lower on reduced production,
actually climbed on a per-unit basis, due to the impact of higher energy costs
and longer haul distances, which increased log costs to all facilities. We
previously advised of the roughly 5% increase in per-unit costs and expect that
log costs will remain at these elevated levels through the coming year.

The other realized loss of $1.1 million in the quarter
represented the impact of previous lumber hedging activities on current period
sales. Likewise, the unrealized loss of $8.0 million represented primarily the
current mark-to-market valuation of existing lumber hedging contracts for
settlement in future periods.

Our lumber segment generated $4.0 million in Adjusted EBITDA
during the fourth quarter, a significant improvement from the $1.0 million for
the same period last year. After accounting for the unrealized losses and the
segments depreciation and amortization, we recorded an operating loss of $5.7
million, off significantly from both comparable periods.

Capital expenditures were limited to maintenance of business
activities largely related to woodlands operations, specifically roads and
bridges required to access new operating areas.

Pulp

|                                                   |   | Three months ended |  
|-------------------------------------------------- | - | ------------------ | -
|                                                   |   | Dec. 31/12         |  
|                                                   |   |                    |  
|Production-thousands of
      tonnes               |   | 83.4               |  
|Shipments -thousands of tonnes                     |   | 81.2               |  
|Benchmark price -NBSK, US$
      per tonne         | $ | 863                |  
|Benchmark price -BEK, US$ per tonne                | $ | 772                |  
|                                                   |   |                    |  
|Revenue - millions                                 | $ | 43.5               |  
|Cost of products sold -
      millions             |   | 38.9               |  
|Inventory valuation adjustments - millions         |   | -                  |  
|Other realized (income)
      expense - millions   |   | (0.6               | )
|Adjusted EBITDA - millions                         | $ | 5.2                |  
|Adjusted EBITDA margin - %                         |   | 12%                |  
|                                                   |   |                    |  
|Other unrealized (expense)
      income - millions |   | (0.5               | )
|Depreciation & amortization - millions             |   | (1.7               | )
|Operating earnings - millions                      | $ | 3.0                |  

From an operational perspective, our pulp segment had a very
strong quarter, challenging the quarterly, monthly and annual production records
set last year. Shipments were also strong in the period, though they modestly
lagged the segments output, thus resulting in slight increases to inventory
levels.

Though benchmark pricing increased 1% to 2% from lows set in
the third quarter of 2012, the BCTMP market, specifically, bottomed out in the
fourth quarter, with per-unit pricing falling off 4%, or $24/ADMT. This drop
marked the first pricing change in seven quarters, and we do not view it as
being indicative of a trend, as we expect pricing to remain in the same range
seen over the past two years into the foreseeable future.

Revenue increased a modest $0.4 million compared to the third
quarter of 2012, as stronger shipments compensated for lower pricing. However,
at $43.5 million revenue was 7% lower than the same period in 2011, which had
similar shipments and strong pricing. At $38.9 million, cost of products sold
was higher than in the third quarter of 2012. This increase reflects the facts
that the current quarter included a $1.6 million provision related to the
previously noted force majeure claim and that the previous quarter had
benefitted from power management activities related to volatility in the electricity market. Cost of
products sold in the fourth quarter of 2011 was consistent with the production
levels, as compared to the current quarter. Per-unit costs for the current
period were within what we would deem a normal range, excluding one-time
contributions such as those experienced in the third quarter of 2012.

50

---

After a modest $0.6 million realized gain on
U.S.-dollar-denominated working capital changes and hedging activities, the
segment recorded $5.2 million in Adjusted EBITDA in the fourth quarter of 2012.
This is a significant drop from comparable quarters, due to lower pricing and
higher costs. Having accounted for unrealized losses, depreciation and
amortization, the segment posted operating earnings of $3.0 million in the
quarter.

The segments capital expenditures of $0.4 million were limited
mainly to maintenance of business projects. Most expenditures related to the
bio-energy project were covered by government grants and, thus, were not
recorded as capital expenditures.

Corporate and other

|                                        |   | Three months ended |  
|--------------------------------------- | - | ------------------ | -
|                                        |   | Dec. 31/12         |  
|                                        |   | (in millions)      |  
|                                        |   |                    |  
|Revenue                                 | $ | 0.1                |  
|General & administration                |   | 3.3                |  
|Other realized expense
      (income)   |   | -                  |  
|Adjusted EBITDA                         | $ | (3.2               | )
|Other unrealized (expense)
      income |   | -                  |  
|Depreciation & amortization             |   | -                  |  
|Operating loss                          | $ | (3.2               | )
|                                        |   |                    |  
|Capital expenditures                    | $ | -                  |  

Our corporate and other segment recorded negative Adjusted
EBITDA of $3.2 million, consistent with the previous quarter but much improved
from the same period last year, which had included additional, one-time
professional fees and an amendment to our supplementary defined benefit
retirement plan.

51

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|B. | Liquidity and Capital
Resources
|-- | -------------------------------

Liquidity and Capital Resources for 2012 compared to
2011

Summary of Financial Position

|                                                     |   | As at December 31, |  
|---------------------------------------------------- | - | ------------------ | -
|                                                     |   | 2012               |  
|                                                     |   |                    |  
|                                                     |   |                    |  
|Cash - millions                                      | $ | 24.7               |  
|Restricted cash - millions                           |   | 18.8               |  
|Current assets - millions                            |   | 159.1              |  
|Current liabilities - millions                       |   | 70.1               |  
|Ratio of current assets to
      current liabilities |   | 2.3                | x
|Financial liabilities - borrowings - millions        |   | 221.7              |  
|Shareholder's equity -
      millions                | $ | 72.6               |  

We ended 2012 with $43.5 million in cash, $18.8 million of
which was restricted cash, for government grants received for the bio-energy
project but not yet expended, as well as for deposits to secure unrealized
losses on futures contracts. Cash from operations, including changes in working
capital, was sufficient to meet our capital investments and financing
activities.

In 2012, we renewed our $50 million revolving credit facility,
extending the expiration to July 15, 2015. The facility is subject to a
borrowing formula based on accounts receivable and inventories. On December 31,
2012, this borrowing base was calculated to be $53.0 million; therefore, all
$50.0 million was available under the facility, with $3.6 million committed to
standby letters of credit.

52

---

|                                                          |   | Year ended December
      31, |  
|--------------------------------------------------------- | - | ----------------------------- | -
|                                                          |   | 2012                          |  
|                                                          |   | (in millions)                 |  
|Selected cash flow
      items Operating activities:      |   |                               |  
|Cash provided by operating activities                     | $ | 21.5                          |  
|Net reforestation                                         |   | (0.2                          | )
|Net change in non-cash working capital items              |   | 4.0                           |  
|                                                          |   | 25.3                          |  
|Investing activities:                                     |   |                               |  
|Additions to property plant
      and equipment           |   | (20.4                         | )
|Changes in working capital for investing
      activities |   | 3.7                           |  
|Receipt of government grants                              |   | 8.7                           |  
|Proceeds on Fox Creek insurance claim                     |   | -                             |  
|Increase in restricted cash                               |   | (6.9                          | )
|Other                                                     |   | 0.2                           |  
|                                                          |   | (14.7                         | )
|Financing activities:                                     |   |                               |  
|Increase in borrowings                                    |   | 4.3                           |  
|Repayment of borrowings                                   |   | (0.9                          | )
|Finance expenses paid                                     |   | (20.1                         | )
|Dividends                                                 |   | (0.8                          | )
|                                                          |   | (17.5                         | )
|                                                          |   |                               |  
|(Decrease) increase in
      cash                         | $ | (6.9                          | )
|                                                          |   |                               |  
|Opening Cash                                              | $ | 31.6                          |  
|Closing Cash                                              | $ | 24.7                          |  
|                                                          |   |                               |  
|Cash and cash equivalents                                 | $ | 24.7                          |  
|Restricted cash                                           |   | 18.8                          |  
|Total cash                                                | $ | 43.5                          |  

We generated $21.5 million in cash from operations in the
current year, a significant decline from the $38.3 million provided in 2011,
reflecting the impact of rising energy and transportation costs on both our
lumber and pulp segments. The impact of improved pricing in the lumber segment
in 2012 was more than offset by significant contributions from the segments
hedging program in 2011, while in 2011 the corporate and other segment
benefitted from the receipt of previously referenced insurance proceeds.

Working capital generated $4.0 million in 2012, compared to the
$4.5 million used in 2011, as increased inventories (related mainly to our
seasonal log inventory build) were more than offset by an increase in cash from
lower accounts receivable (in part due to active factoring of long-term,
letter-of-credit-backed receivables) and higher accounts payable (due mainly to
unrealized losses on derivative contracts and deferred revenue from grant
funding).

Investing activities were $14.7 million in 2012, which included
$2.3 million for the completion of the Fox Creek planer upgrade and $4.6 million
for the bio-energy project. The remaining balance of $4.8 million addressed our
requirements for maintenance of business expenditures for the year.
Comparatively, the $47.6 million in capital investments made last year was
primarily attributable to a $43.2 million expenditure related to the rebuilding
of the

53

---

Fox Creek sawmill and associated site enhancements, and
included $3.6 million in capitalized interest and $1.4 million in capitalized
commissioning costs. The remaining $4.4 million in capital expenditures for 2011
was for maintenance of business capital and certain small, but high-return,
projects. We expect that, going forward, annual capital spending, outside of
major projects, will be in the range of $5 million to $7 million.

Financing activities for the year consisted of $20.1 million
related to the servicing of our long-term debt, $0.9 million in principal
payments for our power-purchase loans and a first-quarter dividend payment of
$0.8 million. This was lower than the previous years expenses paid, which
included financing activities connected to the redemption of our US$190 million
in 7.75% Senior Notes due 2013 and the issuance of US$210 million in 8.50% Notes
due 2021.

Based on our current level of operations, we believe that our
existing cash balance and availability under our revolving credit facility will
provide sufficient liquidity to meet operational cash draws, scheduled interest
payments, long-term debt repayment, capital expenditures and working capital
needs over the next 12 months. However, our future operating performance may be
adversely affected by prevailing economic conditions and by currency, market and
other factors beyond our control, including the factors discussed in Item 3D,
Risk Factors.

Liquidity and Capital Resources for 2011 compared to
2010

Summary of Financial Position

|                                                     |   | As at December 31, |  
|---------------------------------------------------- | - | ------------------ | -
|                                                     |   | 2011               |  
|                                                     |   |                    |  
|                                                     |   |                    |  
|Cash - millions                                      | $ | 31.6               |  
|Restricted cash - millions                           |   | -                  |  
|Current assets - millions                            |   | 147.1              |  
|Current liabilities - millions                       |   | 44.0               |  
|Ratio of current assets to
      current liabilities |   | 3.3                | x
|Financial liabilities - borrowings - millions        |   | 222.6              |  
|Shareholder's equity -
      millions                | $ | 81.5               |  

We ended 2011 with $31.6 million in cash, down from $45.1
million in cash held at the end of 2010. With cash from operations more than
sufficient to compensate for investments in working capital, the refinancing
costs of our long-term debt and normal maintenance of business capital
expenditures during the year, the difference in year-over-year cash balances
reflected the capital investments associated with the Fox Creek sawmill
reconstruction. We also saw working capital needs increase in 2011 due to the
restart of the Fox Creek sawmill.

In 2010, we renewed our $50 million revolving credit facility,
extending the expiration to November 15, 2013. The facility is subject to a
borrowing formula based on accounts receivable and inventory. On December 31,
2011, this borrowing base was calculated to be $55.0 million and, therefore, all
$50 million was available under the facility, $3.6 million of which was
committed to standby letters of credit.

54

---

Selected Cash Flow Items

|                                                          |   | Year ended December
      31, |  
|--------------------------------------------------------- | - | ----------------------------- | -
|                                                          |   | 2011                          |  
|                                                          |   | (in millions)                 |  
|Selected cash flow
      items Operating activities:      |   |                               |  
|Cash provided by operating activities                     | $ | 38.3                          |  
|Net reforestation                                         |   | (0.7                          | )
|Net change in non-cash working capital items              |   | (4.5                          | )
|                                                          |   | 33.1                          |  
|Investing activities:                                     |   |                               |  
|Additions to property plant
      and equipment           |   | (47.6                         | )
|Changes in working capital for investing
      activities |   | 4.3                           |  
|Proceeds on Fox Creek
      insurance claim               |   | 7.6                           |  
|Other                                                     |   | 3.5                           |  
|                                                          |   | (32.2                         | )
|Financing activities:                                     |   |                               |  
|Increase in borrowings                                    |   | 201.3                         |  
|Repayment of borrowings                                   |   | (189.8                        | )
|Finance expenses paid                                     |   | (24.3                         | )
|Dividends                                                 |   | (1.6                          | )
|                                                          |   | (14.4                         | )
|                                                          |   |                               |  
|(Decrease) increase in
      cash                         | $ | (13.5                         | )
|                                                          |   |                               |  
|Opening Cash                                              | $ | 45.1                          |  
|Closing Cash                                              | $ | 31.6                          |  
|                                                          |   |                               |  
|Cash and cash equivalents                                 | $ | 31.6                          |  
|Total cash                                                | $ | 31.6                          |  

We generated $37.6 million in cash from operations in 2011, a
decline from the $42.2 million provided in 2010, reflecting the weaker markets
and higher costs seen in the current period. The balance of cash generated from
operations reflected our continued efforts to manage our assets appropriately
for the current business conditions.

Working capital used a modest $4.5 million in 2011, despite new
requirements associated with the restart of the Fox Creek sawmill. Finished
product inventories increased, as shipments, which had largely matched strong
production levels throughout the year, lagged late in the period due to both
vessel-departure timing and end-of-year order reductions resulting from customer
inventory-management efforts. The finished-product inventory increases were
partly mitigated by a decrease in log inventories, as unseasonably warm weather
hampered harvesting and deliveries, and by a decrease in accounts receivable and
increase in accounts payable, both within normal variations for these accounts.

Total capital expenditures were $47.6 million during 2011.
Netted against the figure were $4.3 million in non-cash adjustments. The
comparable amounts for 2010 were $22.2 million in total capital expenditures,
reduced by $1.5 million in non-cash adjustments. Expenditures on the
reconstruction of the Fox Creek sawmill amounted to $43.2 million in 2011 and
$20.3 million in 2010. Included in both figures was an allowance for capitalized
interest associated with the value of the project investment to date and
commissioning costs. The amount of capitalized interest was $3.6 million in
2011, as compared to $0.4 million in 2010, and capitalized commissioning costs
totaled $1.4 million. The remaining $3.9 million in capital expenditures posted
for 2011 represented maintenance-of-business requirements and investments in
certain small, high-return projects.

55

---

Insurance proceeds of $7.6 million represented final settlement
of the claim on the 2008 Fox Creek sawmill fire. Other investing activities of
$3.5 million in 2011 reflected the net of proceeds on disposal and increase in
other assets and the repayment of loans to certain of our officers; the sale of
miscellaneous assets generated the $0.1 million loss in 2010.

Financing activities for the quarter largely reflected the
impact of the redemption of our US$190 million in 7.75% Senior Notes due 2013
and issuance of US$210 million in 8.5% Notes due 2021. Associated with this
transaction were expenditures related to the refinancing activities, which will
be amortized over the ten-year life of the new Senior Notes, and the payment of
a call premium. In addition, we declared dividends of $2.25 million, of which
$1.5 million was paid in the year, as well as making modest principal repayments
on the power- purchase rights loans #1 and #2.

Liquidity and Capital Resources for the Fourth Quarter of
2012

|                                                          |   | Three months ended |  
|--------------------------------------------------------- | - | ------------------ | -
|                                                          |   | Dec. 31/12         |  
|                                                          |   |                    |  
|Selected cash flow
      items Operating activities:      |   |                    |  
|Cash provided by operating activities                     | $ | 6.1                |  
|Net reforestation                                         |   | 0.5                |  
|Net change in non-cash working capital items              |   | (6.2               | )
|                                                          |   | 0.4                |  
|Investing activities:                                     |   |                    |  
|Additions to property plant
      and equipment           |   | (10.1              | )
|Changes in working capital for investing
      activities |   | (1.0               | )
|Receipt of government grants                              |   | 8.7                |  
|Proceeds on Fox Creek insurance claim                     |   | -                  |  
|Increase in restricted cash                               |   | (6.9               | )
|Other                                                     |   | -                  |  
|                                                          |   | (9.3               | )
|Financing activities:                                     |   |                    |  
|Increase in borrowings                                    |   | 4.3                |  
|Repayment of borrowings                                   |   | (0.2               | )
|Finance expenses paid                                     |   | (0.5               | )
|Dividends                                                 |   | -                  |  
|                                                          |   | 3.6                |  
|                                                          |   |                    |  
|(Decrease) increase in
      cash                         | $ | (5.3               | )
|                                                          |   |                    |  
|Opening Cash                                              | $ | 30.0               |  
|Closing Cash                                              | $ | 24.7               |  
|                                                          |   |                    |  
|Cash and cash equivalents                                 | $ | 24.7               |  
|Restricted cash                                           |   | 18.8               |  
|Total cash                                                | $ | 43.5               |  

56

---

We ended the quarter with $43.5 million in cash, $18.8 million
of which was restricted cash, for government grants received for the bio-energy
project but not yet expended, as well as for deposits to secure unrealized
losses on futures contracts.

Operating results were sufficient to cover investments in
working capital, which were largely related to the start of the seasonal
build-up of log-inventory working-capital. Additions to property, plant and
equipment were limited to maintenance of business activities, as expenditures
related to the bio-energy project were largely covered by grant funds and,
therefore, only minimal amounts were recorded as capital expenditures on a net
basis. Changes in working capital for investing activities represented
previously-accrued net project expenditures. Financing activities included
increased borrowings associated with the bio-energy project for costs incurred
in the previous quarter.

Repayment of borrowings was limited to principal payments on
our power-purchase rights loans, and finance expenses represent interest
payments on these same loans. The previous period included the bi-annual
interest payment for our Senior Notes. The net result was a use of cash of $5.3
million, which was higher than the same period last year, due to the inventory
build with the start-up of the Fox Creek sawmill.

|C. | Research and Development
|-- | ------------------------

We did not conduct significant research and development
activities in 2012.

|D. | Trend Information
|-- | -----------------

The North American lumber market experienced steady improvement
through the latter half of 2012 and into the first quarter of 2013, as an
increasingly positive outlook for the U.S. housing market, continued Asian
demand and a minimal supply response combined to result in one of the strongest
price rallies in years. Rising prices resulted in a reduction in export charges
imposed under the Softwood Lumber Agreement, with charges reduced to 5% in two
months of 2012 and no charges expected in the first quarter of 2013.

Some analysts believe that the end of 2012 represented the
early stage of a sustained and substantial price improvement for lumber. This
outlook is based, in part, on expectations of steady increases in demand from
the U.S., as the American housing market recovers and the renovation and
remodeling market maintains a steady pace, as well as on ongoing demand from
China. It is also supported on the supply side, given that lumber capacity
increases are expected to be constrained by the effects of the mountain pine
beetle infestation on available merchantable timber in British Columbia. Though
we generally agree with this outlook and expect these demand and supply trends
to continue through 2013 and 2014 and into 2015, our forecast is tempered by the
following factors: the recovery of the U.S. housing market is likely to be
uneven, both geographically and seasonally; Chinese buying patterns can be
highly volatile; and the general recovery of the world economy remains fragile
in several regions.

Over the past several years, the strength of general pulp
markets was undermined by the weakness of the global economy, which reduced
paper consumption, and by the start-up of new pulp capacity, which further upset
the demand-supply balance. Pulp manufacturing volumes increased over the past
five years, including during the period of economic upheaval starting in 2008 in
which demand for paper, and therefore pulp, declined significantly. This
capacity growth reflected investment decisions made prior to the onset of the
credit crisis and ensuing recession.

Demand improved through 2010 and 2011 and, by early 2012, much
of the over-capacity had been corrected and shipment-to-capacity ratios had
largely reached historical norms. In late 2012, further new capacity additions
once again challenged the demand/supply balance, though over-capacity in this
period was somewhat mitigated by a stronger global economy.

The pricing outlook for all pulps in the year ahead is expected
to be relatively stable, though stronger prices in the first half of 2013 may
give way to weaker pricing later in the year, as expected new capacity comes
into the market. To the extent our BCTMP output is used in the printing and
writing or tissue and towel sectors, we would expect to see our associated
pricing following the general trend discussed above. However, a significant and
growing portion of our output is used in the Chinese paperboard market, where
BCTMP faces competition from domestic alkaline peroxide mechanical pulp mills,
whose output has a similar functional profile. When market prices drop below the operating costs of these domestic mills, the mills are shut
down and Chinese paperboard producers purchase market BCTMP. When the market
rises, the mills are restarted, creating downward pressure on BCTMP prices. This
developing competition has resulted in enhanced price stability for market BCTMP
producers, as it has created a floor during falling markets and a drag on
increases during rising markets. The combination of these influences leads us to
expect that 2013 will bring generally stable pricing for our BCTMP, with more
downward pressure early in the year, followed by some improvement later in the
year. Any significant moves in the broader pulp market will likely be more muted
in our own results.

57

---

Operationally, we expect our facilities to continue to run at
roughly current levels through 2013. The lumber segment output should reach 520
million board feet with a full year of optimized production at the Fox Creek
mill. We do not currently plan to re-start the idled second shift at our Boyle
operation. The pulp mill should again produce and sell approximately 320,000
ADMT.

We expect to continue seeing upward pressure on our costs,
largely related to rising delivered-log costs associated with increasing fuel
prices, a lack of contractor availability and longer haul distances. While
rising energy costs are also expected to continue to be challenging, increased
volatility in market electricity pricing should bring opportunities for energy
management initiatives at the pulp mill. The labor market is also expected to be
a significant challenge in the year ahead, as our sector faces strong workforce
competition in Alberta from the oil and gas sector, especially for positions
such as the skilled trades.

|E. | Off-Balance Sheet
Arrangements
|-- | ------------------------------

We had no material off-balance sheet arrangements, apart from
$3.6 million committed for standby letters of credit under our revolving credit
facility and $1.7 million for a standby letter of credit for grant funding that
is included in restricted cash and is secured by a term deposit.

|F. | Tabular Disclosure of Contractual
    Obligations
|-- | -------------------------------------------------

The table below summarizes the Company's contractual
obligations as at December 31, 2012.

|                            |               |       |  |   | Payment due by period |  |   |           | 
|--------------------------- | ------------- | ----- |  | - | --------------------- |  | - | --------- | 
|                            | (in millions) |      
|Contractual Obligations (1) |               |       |  |   | Less than             |  |   |           | 
|                            |               | Total |  |   | 1 year                |  |   | 1-2 years | 
|Long-term debt              | $             | 226.9 |  | $ | 1.1                   |  | $ | 5.5       | 
|Fixed-rate interest (2)     |               | 154.0 |  |   | 19.4                  |  |   | 19.2      | 
|Power purchase rights (3)   |               | 185.8 |  |   | 22.0                  |  |   | 22.4      | 
|Total                       | $             | 566.7 |  | $ | 42.5                  |  | $ | 47.1      | 

| | (1) | Contractual obligations are agreements related to debt,
      leases and enforceable agreements to purchase goods or services on
      specified terms but do not include reforestation obligations, accounts
      payable in the ordinary course of business or contingent amounts
      payable.
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (2) | Based on annual interest of US$17.9 million converted at
      a rate of US$1.00/C$.                                                                                                                                                                                                               
| | (3) | Does not include anticipated revenues from the sale of
      power supplied under the power purchase
rights.                                                                                                                                                                                       

58

---

|   |            
|-- | -----------
|G. | Safe Harbor

See Special Note Regarding Forward-Looking Statements.



59

---

|ITEM 6: DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
|--------------------------------------------------

|A. | Directors and Officers
|-- | ----------------------

The following table sets forth certain information with respect
to our directors and executive officers.

|                                   |  |     |  |  | Years of       |  |  |                                                       | 
|---------------------------------- |  | --- |  |  | -------------- |  |  | ----------------------------------------------------- | 
|                                   |  |     |  |  | Industry       |  |  |                                                       | 
|Name                               |  | Age |  |  | **Experience** |  |  | Position                                              | 
|James B. Millar                    |  | 72  |  |  | 50             |  |  | Co-Chairman and
      Director                        | 
|H. MacKenzie Millar                |  | 66  |  |  | 43             |  |  | Co-Chairman and Director                              | 
|J. Craig Armstrong                 |  | 61  |  |  | 39             |  |  | President, Chief
      Executive Officer and Director | 
|Kevin Edgson, C.M.A., M.B.A.       |  | 49  |  |  | 27             |  |  | Vice-President, Chief Financial
      Officer         | 
|Carol Cotton, C.A.                 |  | 55  |  |  | 25             |  |  | Senior
      Vice-President, Corporate                | 
|Ronald J. Reis, P Eng.             |  | 59  |  |  | 38             |  |  | Senior Vice-President, Pulp                           | 
|Stefan Demharter                   |  | 51  |  |  | 30             |  |  | Vice-President,
      Wood Products                   | 
|Brian McConkey                     |  | 48  |  |  | 24             |  |  | Vice-President, Human Resources                       | 
|Robert J. Turner, Q.C. (2)         |  | 66  |  |  |                |  |  | Secretary,
      General Counsel and                  | 
|                                   |  |     |  |  |                |  |  | Director                                              | 
|W. Kenneth Davidson (3)            |  | 62  |  |  |                |  |  | Director                                              | 
|William D. Grace, F.C.A. (1)(2)(3) |  | 77  |  |  |                |  |  | Director                                              | 
|Donald R. Ching (1)(3)             |  | 71  |  |  |                |  |  | Director                                              | 
|Douglas G. Hall (1)(2)(3)          |  | 63  |  |  |                |  |  | Director                                              | 

| | (1) | Member of Audit Committee                  
| | --- | -------------------------------------------
| | (2) | Member of Executive Compensation Committee 
| | (3) | Member of Independent Directors
  Committee

James B. Millar, has served as our Co-Chairman of
the Board and Director since July 2010, and had previously served as Chairman of
the Board and a Director since September 1997. Mr. Millar joined the family
business on a full-time basis in 1963, working in the construction and forest
products divisions of our parent, Industries.  Mr. Millar is a past president of the Alberta Roadbuilders
Association and served on the board of trustees of the University of Alberta
Hospitals Foundation. Mr. Millar has a B.Sc. in Civil Engineering from the
University of Alberta. Mr. Millar is the brother of H. MacKenzie Millar.

H. MacKenzie Millar, has served as our
Co-Chairman of the Board and Director since July 2010, and had previously served
as President, Chief Executive Officer and a Director since September 1997. Mr.
Millar joined the family business on a full-time basis in 1970. Mr. Millar is a
past president of the Alberta Forest Products Association and has served on the
boards of Forintek Canada, Canadian Wood Council, Alberta Research Council and
the Forest Sector Advisory Council to the Government of Canada. In 2010, Mr.
Millar was awarded a lifetime honorary membership in the Alberta Forest Products
Association. Mr. Millar has Bachelor of Arts and Bachelor of  Commerce degrees from the University of Alberta and has served
on the Business Advisory Council to the Faculty of Business of the University of
Alberta. Mr. Millar is the brother of James B. Millar.

60

---

J. Craig Armstrong, has served as President,
Chief Executive Officer and Director since July 2010. Mr. Armstrong had
previously served as Executive Vice-President since July 1998. Prior to this,
Mr. Armstrong had served as our Senior Vice-President, Marketing, since
September 1997. Mr. Armstrong joined Industries in 1987 as Director of Sales and
Marketing and was appointed that companys Senior Vice-President, Marketing, in
1994. Prior to 1987, Mr. Armstrong spent eight years with St. Anne Pulp Sales
and five years as head of sales for Prince Albert Pulp Co. Mr. Armstrong has a
Bachelor of Commerce degree from the University of Saskatchewan.

Kevin Edgson, C.M.A., M.B.A., was
appointed Vice-President and Chief Financial Officer in November, 2006. Prior to
this, Mr. Edgson had served as our Director of Sales and Marketing since 1999.
Mr. Edgson joined Millar Western in 1991 as an operation accountant, and has
held operations, sales/marketing and financial positions in the mills and
corporate office. Mr. Edgson has a Bachelors degree in Economics from the
University of Victoria, a Masters of Business Administration from the University
of Alberta, and a Certified Management Accountant designation.

Carol Cotton, C.A., was appointed Senior
Vice-President, Corporate, in April 2002. Prior to this, Ms. Cotton had served
as our Senior Vice-President and Chief Financial Officer since September 1997.
Ms. Cotton joined Industries in 1988 as Vice-President, Finance, and was
appointed Senior Vice-President and Chief Financial Officer in 1996. Ms. Cotton
has been a member of the Institute of Chartered Accountants of Alberta since
1982 and, prior to 1988, she was a manager with Coopers & Lybrand, chartered
accountants. Ms. Cotton has a Bachelor of Commerce degree from the University of
Alberta.

Ronald J. Reis, P Eng., has served as Senior
Vice-President, Pulp, since 2006. Prior to this, Mr. Reis had served as our
Vice-President, Engineering and Technology, since September 1997. Mr. Reis
joined Industries in 1987 as Corporate Technical Director and was appointed Vice
President, Engineering and Technology in 1992. Prior to 1987, Mr. Reis spent 12
years with BC Forest Products. Mr. Reis has a Chemical Engineering degree from
Lakehead University.

Stefan Demharter,has served as Vice-President,
Wood Products since July 2012. Prior to this, Mr. Demharter had served as
General Manager, Wood Products, since September 2004. Mr. Demharter joined
Millar Western in 2001 as Sawmill Manager and previously held positions with
another forest products company based in Manitoba. Brian McConkey,has served as Vice-President, Human Resources, since July 2012. Prior to
this, Mr. McConkey had served as Director Human Resources since June 2001. Mr.
McConkey joined Millar Western in 1999 as Manager, Human Resources, and was
previously employed by a British Columbia-based forest products company. He has
a Bachelor of Arts degree and a diploma in Human Resource Management.

Robert J. Turner, Q.C., has served as our
Secretary, General Counsel and a Director since September 1997. Mr. Turner is Vice-Chair and Consultant of Fraser Milner
Casgrain LLP, a law firm. Mr. Turner has a Bachelor of Commerce from the
University of Calgary and an L.L.B. from the University of Alberta.

W. Kenneth Davidson, M.B.A., was appointed a
Director in September 1997. Mr. Davidson is an independent consultant, and was
previously Co-Chief Executive Officer of Gordon Capital Corporation, from 1996
to 2001. Before that, he spent 20 years with the Canadian Imperial Bank of
Commerce, serving as Executive Vice-President, Risk Management, for the last
five years of his term. Mr. Davidson holds Bachelor of Science degrees in
Mathematics and business, both from Concordia University, and a Masters in
Business Administration from McMaster University. Mr. Davidson also serves as a
director of Vermillion Energy Inc.

William D. Grace, F.C.A., was appointed a
Director in September 1997. During his business career, Mr. Grace served as
managing partner of the PricewaterhouseCoopers consulting group and as Chief
Financial Officer with several Alberta corporations. Mr. Grace also serves as a
director of Melcor Developments Ltd. and Covenant Health and is the independent
Chairman of the Edmonton Pipe Industry Pension Trust and Health Welfare Funds. Mr. Grace has previously served on numerous other boards of
both private and public companies, including Stantec Inc. and The Forzani Group
Ltd.

61

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Donald R. Ching, was appointed a Director in
September 1997. Mr. Ching is an independent consultant and previously was
President and Chief Executive Officer of AREVA Resources Canada Inc., a uranium
mining company, from 2005 to 2007. From 1996 to 2004, Mr. Ching was President
and Chief Executive Officer of SaskTel, a communications company, and, before
that, was President of Crown Investments Corporation of Saskatchewan, and a
managing partner in a law firm.

Douglas G. Hall, was appointed a Director in
March 1999. Mr. Hall is an independent consultant and previously was Managing
Director of RBC Dominion Securities responsible for corporate and investment
banking activities in Atlantic Canada. Mr. Hall has an M.B.A. from the
University of Western Ontario and a B.A. from Queens University and is also a
Chartered Financial Analyst. Mr. Hall also serves as a director for the Atlantic
Institute of Market Studies, NexC Partners and
Southwest Properties.

Certain of our directors and officers are also directors and
officers of Industries and are therefore in positions involving possible
conflicts of interest. Specifically, James B. Millar, Co-Chairman and a
Director, is also Chairman, Chief Executive Officer and a Director of
Industries; H. MacKenzie Millar, Co-Chairman and a Director, is also the
President and a Director of Industries; Carol Cotton, Senior Vice-President,
Corporate, is also Senior Vice-President and Chief Financial Officer of
Industries, and Robert J. Turner, Secretary, General Counsel and a Director, is
also Secretary and General Counsel of Industries. Our directors and officers are
subject to fiduciary obligations to act in our best interests. Individuals who
are directors and officers of both Millar Western and Industries have agreed
with us that they will dedicate a substantial majority of their time to us in
order to perform their duties as our directors and officers.

|B. | Compensation
|-- | ------------

Executive officers are appointed annually and serve at the
discretion of the Board of Directors. The aggregate amount of compensation we
paid to all directors, officers and key employees as a group, for services in
all capacities in 2012, was $4.0 million.

Our policy provides that each non-employee director is entitled
to receive an annual fee of $18,000 and a fee of $1,500 for each board or
committee meeting attended. The chair of the audit committee of the Board of
Directors is entitled to an additional $7,000 per annum, and the chair of each
other committee is entitled to an additional fee of $3,500 per annum. The total
compensation paid to non-employee directors for the year ended December 31,
2012, was $0.1 million.

We do not have a stock incentive plan and have never granted
stock appreciation rights to any of our directors, officers or employees. We
maintain a defined contribution pension plan for all of our employees. The
aggregate amount that we contributed to the pension plan on behalf of the
employees in 2012 was $2.4 million, of which $0.1 million represented
contributions on behalf of our officers. All of our employees are entitled to
participate on a voluntary basis in a retirement savings plan, or RSP, under
which we match each employees RSP contribution up to a fixed amount. The
aggregate amount of matching RSP contributions paid by us in 2012 was $0.9
million, of which less than $10,000 represented matching contributions on behalf
of our officers.

On January 1, 2000, we established a supplementary defined
benefit pension plan for our executives and certain key employees. Under this
plan, participants will be entitled to a target level of retirement benefits in
combination with the Canada Pension Plan and our other Registered Pension Plans.
The aggregate amount that we contributed to the supplementary pension plan on
behalf of the participants was $0.5 million in 2012.

Employee Profit Sharing Plan

All full-time employees participate in a profit sharing plan
that distributes to employees on an annual basis a percentage of earnings before
income taxes and unusual items, such as unrealized exchange gains or losses on
debt. The percentage of such earnings set aside for distribution under the
employee profit sharing plan is reviewed annually. For the years ended December
31, 2012, 2011, 2010, 2009, and 2008, the amount of such earnings set aside for
distribution was nil, $0.4 million, $1.1 million, nil, and nil,
respectively.

62

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|C. | Board Practices
|-- | ---------------

In accordance with our articles of incorporation and by-laws,
our Board of Directors may consist of up to ten directors, and our current Board
of Directors consists of eight directors. Each director holds office until the
next annual general shareholders' meeting or until the election of his or her
successor, unless the director resigns or the office becomes vacant by reason of
the Director's death, removal or other cause. The start of each director's and
executive officer's term of service is set forth in Item 6(A) above. No
directors have service contracts providing for benefits upon termination of
employment.

The Audit Committee of the Board of Directors currently
consists of independent directors: William D. Grace, Donald R. Ching and Douglas
G. Hall. The Audit Committee is responsible for reviewing our financial
statements and our internal controls, reviewing the work of our independent
auditors, monitoring other financial matters and making recommendations for
approval in respect thereof to the Board of Directors.

The Executive Compensation Committee currently consists of four
members: Douglas G. Hall, William D. Grace, H. MacKenzie Millar and Robert J.
Turner. The Executive Compensation Committee is responsible for reviewing
compensation levels of senior management and other executive compensation
matters.

|D. | Employees
|-- | ---------

As of December 31, 2012, we had 627 full-time employees, all of
whom were non-unionized.

|Location                                 | Employees (1)
|---------------------------------------- | -------------
|Corporate office (Edmonton)              | 50           
|Whitecourt pulp mill                     | 117          
|Whitecourt sawmill                       | 259          
|Boyle sawmill                            | 85           
|Fox Creek sawmill                        | 72           
|Woodlands (Whitecourt, Fox Creek, Boyle) | 44           
|Total                                    | 627          

(1) Does not include part-time or
seasonal employees.

In addition, we employ independent contractors to provide
logging, trucking, road building and forest regeneration services.

|E. | Share Ownership
|-- | ---------------

As the Company is 100% owned by Industries, none of the
individuals described above owns shares in the Company or has options to
purchase any shares.

|ITEM 7: MAJOR SHAREHOLDERS AND RELATED PARTY
      TRANSACTIONS
|---------------------------------------------------------------

|A. | Principal Shareholder
|-- | ---------------------

Industries holds, directly and of record, 15,000,002 common
shares, representing 100% of our outstanding common shares. Industries is a
company with operations in chemicals and other businesses. Industries is owned
100% by Hualkeith Investments Ltd., or Hualkeith, a corporation indirectly owned
100% by James B. Millar, H. MacKenzie Millar and other members of the Millar
family. James B. Millar and H. MacKenzie Millar together control 55.6% of the
outstanding equity of Hualkeith. The registered office of Industries is located
at 2900 Manulife Place, 10180 -101 Street, Edmonton, Alberta, T5J 3V5, and its
executive offices are located at 16640 -111 Avenue, Edmonton, Alberta, T5M 2S5.

63

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There are no arrangements known to us that may at a subsequent
date result in a change in control of us.

By virtue of its ownership of all of our issued and outstanding
common shares, Industries acting alone can elect our entire board of directors
and can approve any transaction requiring shareholder approval.

|B. | Related Party Transactions
|-- | --------------------------

On May 13, 1998, we, Industries, and certain of our executive
officers entered into certain agreements, which are described in greater detail
below. Management believes that such agreements are equivalent to those that
could have been negotiated with unaffiliated, third parties.

Non-Competition Agreement

Industries, James B. Millar and H. MacKenzie Millar entered
into a non-competition agreement, whereby each agreed not to engage, without our
consent, in the operation of or have any financial interest in any business
operation in the forest products industry in Canada or the United States for so
long as Industries, James B. Millar and H. MacKenzie Millar hold, in the
aggregate, at least 10% of our outstanding common shares. The non-competition
agreement does not apply to the purchase of less than a controlling interest of
a publicly traded company engaged in the forest products industry, selling goods
or products to businesses in the forest products industry (provided that the
relationship is strictly supplier-purchaser), or performance under the Corporate
Services Agreement described below. In addition, Industries, James B. Millar and
H. MacKenzie Millar have agreed not to disclose any confidential information or
trade secrets concerning our present and contemplated business.

Trademark
Licensing Agreement

Industries is the registered owner in Canada of the
trademark MILLAR WESTERN, the Millar Western logo and the trademark a
resourceful company. We and Industries entered into a trademark licensing
agreement, which we refer to as the Trademark Licensing Agreement, which grants
to us a non-exclusive, non-transferable license to use the trademarks in Canada
and, where applicable, in the United States, and wherever else in the world the
trademarks are registered, in association with the sale of salt, lumber, wood
chips, pulp, and paper and paper products. Under the license, we will be
required to maintain certain quality standards for wares and services set by
Industries. In addition, we may only use the trademarks in our business or
tradename and not as or in any other corporate, business or tradename. The
Trademark Licensing Agreement may be terminated by either party upon six months
notice to the other party or by Industries in the event of a material breach of
the Trademark Licensing Agreement by us.

Corporate Services Agreement

We entered into a corporate services agreement, which we refer
to as the Corporate Services Agreement, with Industries in 1998, regarding
office, managerial and aircraft services. Pursuant to the Corporate Services
Agreement, Industries has granted us a non-exclusive license to use and occupy
an office building owned by Industries for market rent. We have agreed to supply
to Industries, on a non-exclusive basis, management, finance and accounting,
information systems, purchasing and human resource services as the needs of
Industries dictate. Industries pays us 5% in excess of the costs we incur in
providing such services. All of the persons employed by Industries in forest
products operations remained employees of Industries until December 31, 1998, at
which time they became our employees. Industries agreed to make such employees
available to us, continued to pay such employees and did not terminate or alter
any terms of employment. We reimbursed Industries for all costs incurred by
Industries related to those employees. Industries makes its aircraft available
to us on a standby basis, and we pay a standby fee equal to 100% of the fixed
costs of the aircraft and a proportionate amount of the variable costs equal to
the portion of our use of the aircraft in relation to the total use of the
aircraft. The Corporate Services Agreement may be terminated by either party
upon six months notice.

The agreements described below were assigned to us by
Industries on May 13, 1998. Management believes that such agreements involve the
payment of market rates or are on terms that we would have negotiated with
unaffiliated third parties.

Magnesium Sulphate Supply Agreement

Pursuant to a magnesium sulphate supply agreement, Industries
produces and supplies, and we purchase, all of the magnesium sulphate
requirements of the Whitecourt pulp mill at a price based upon the market rate.
This agreement may be terminated by either party on two months notice.

64

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Services Provided by Directors

Robert J. Turner, Secretary, General Counsel and a Director of
Millar Western, is a consultant at the law firm of Fraser Milner Casgrain LLP,
which received fees of $117,000, $276,000 and $210,000 for general corporate
legal advice provided to us in 2010, 2011 and 2012, respectively. Such
compensation did not exceed 5% of the revenues of Fraser Milner Casgrain LLP
during 2010, 2011 or 2012.

Indebtedness of Directors and Officers

There is no indebtedness outstanding to us by our directors or
executive officers.

|C. | Interests of experts and
counsel
|-- | --------------------------------

Not applicable.

|ITEM 8: FINANCIAL INFORMATION
|-----------------------------

|A. | Consolidated Statements and Other Financial
      Information
|-- | -------------------------------------------------------------

See Item 17: Financial Statements.

|B. | Significant Changes
|-- | -------------------

Not applicable.

|ITEM 9: THE OFFER AND LISTING
|-----------------------------

|A. | Offer and Listing Details
|-- | -------------------------

There is no organized trading market, inside or outside the
United States, for the Notes covered by this annual report.

|B. | Plan of Distribution
|-- | --------------------

Not applicable.

|C. | Markets
|-- | -------

The Notes covered by this annual report are not listed on any
stock exchange or other regulated market.

|D. | Selling Shareholders
|-- | --------------------

Not applicable.

|E. | Dilution
|-- | --------

Not applicable.

|F. | Expenses of the Issue
|-- | ---------------------

Not applicable.

65

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|ITEM 10: ADDITIONAL INFORMATION
|-------------------------------

|A. | Share Capital
|-- | -------------

Not applicable.

|B. | Memorandum and Articles of
  Association
|-- | ----------------------------------------

There are no provisions of the Companys articles or other
constituent documents that describe the Companys objects and purposes.

Under the Business Corporations Act (Alberta), a director may
vote on a proposal, arrangement or contract in which he or she is interested, if
the contract or transaction is:

| | a. | an arrangement by way of security for money lent to or
      obligations undertaken by that director, or by a body corporate in which
      he has an interest, for the benefit of the Company or an
  affiliate,
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                  
| | b. | a contract or transaction relating primarily to that
      director's remuneration as a director, officer, employee or agent of the
      Company or an affiliate,                                               
| |    |                                                                                                                                                                                                                  
| | c. | a contract or transaction for indemnity or liability
      insurance, or                                                                                                                                         
| |    |                                                                                                                                                                                                                  
| | d. | a contract or transaction with an
  affiliate.                                                                                                                                                                   

In the absence of an independent quorum, a director may not
vote compensation to himself or herself. The directors may, without
authorization of the shareholders,

| | a. | borrow money on the credit of the Company,                                                                                                                                                         
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                    
| | b. | issue, reissue, sell or pledge debt obligations of the
      Company,                                                                                                                              
| |    |                                                                                                                                                                                                    
| | c. | subject to certain conditions, give a guarantee on behalf
      of the Company to secure performance of an obligation of any person,
      and                                                     
| |    |                                                                                                                                                                                                    
| | d. | mortgage, hypothecate, pledge or otherwise create a
      security interest in all or any property of the Company, owned or
      subsequently acquired, to secure any obligation of the
  Company.

Such borrowing powers can only be varied by a special
resolution of the shareholders (not less than two-thirds of the votes).

The Company's directors are not subject to any age limit
requirement, and no shares are required for director's qualification.

The following are the rights, preferences and restrictions
attaching to the Company's common shares:

Dividend Rights. The Board of Directors may from time to
time declare dividends payable to shareholders according to their respective
rights and interests in the Company. Dividends may be paid, in money or property
or by issuing fully paid shares of the Company.

Subject to the rights of the holders of any shares of the
Company having rights or privileges superior to the common shares with respect
to any priority in the payment of dividends:

| | a. | each holder of a common share shall be entitled to
      receive dividends as and when declared and payable,
and
| | -- | ----------------------------------------------------------------------------------------------------------------

66

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| | b. | dividends may be declared and paid on the common shares
      to the complete exclusion of the other classes of shares of the
      Company.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------

Rights to Share in Profits or Surplus on Liquidation.
Subject to the rights of the holders of any shares of the Company having rights
or privileges superior to the common shares with respect to priority of
distribution on a liquidation, dissolution or winding-up, each holder of a
common share shall be entitled to receive, on a proportionate basis, the
remaining property of the Company in the event of a liquidation, dissolution or
winding-up of the Company, whether voluntary or involuntary. Any remaining
property shall be paid or distributed in equivalent amount per share on each
outstanding common share and any shares of the Company whose entitlement on a
liquidation, dissolution or winding-up ranks equally with the common shares.

Rights of Retraction. Subject to holders' of shares of a
class or series right to vote separately as a class or series, a special
resolution is required to change the rights of holders of shares of any class or
series of shares of the Company. These are no more significant than required by
law.

Shareholders Meeting. Subject to the Business
Corporations Act (Alberta), the annual meeting of shareholders is held at such
time, and on such day in each year, and at such place or places as the board of
directors, the chairman of the board, the managing director, or the president
may from time to time determine.

The board of directors has the power to call a special meeting
of shareholders at any time.

The only persons entitled to be present at a meeting of
shareholders shall be those entitled to vote thereat, the directors and auditors
of the Company, and others who, although not entitled to vote, are entitled or
required under any provision of the Business Corporations Act (Alberta) or
articles or by-laws to be present at the meeting. Any other person may be
admitted only by invitation of the chairman of the meeting, or with the consent
of the meeting.

There are currently no limitations on the right of foreign or
non-resident owners of Notes to hold or vote such securities imposed by Canadian
law or the Company's articles or other constituent documents.

There are no provisions of the Company's articles or other
constituent documents that would delay, defer or prevent a change of control and
that would operate only with respect to a merger, acquisition or corporate
restructuring involving the Company.

There are no bylaw provisions governing the ownership threshold
above which shareholder ownership must be disclosed.

The Company's articles and other constituent documents do not
contain provisions governing changes in capital that are more stringent than
required by law.

|C. | Material Contracts
|-- | ------------------

Not applicable.

|D. | Exchange Controls
|-- | -----------------

There are currently no limitations imposed by Canadian laws,
decrees or regulations that restrict the import or export of capital, including
foreign exchange controls, or that affect the remittance of dividends, and
interest or other payments to nonresident holders of the Company's securities.

|E. | Taxation
|-- | --------

Not applicable.

|F. | Dividends and Paying
Agents
|-- | ---------------------------

Not applicable.

67

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|G. | Statements by Experts
|-- | ---------------------

Not applicable.

|H. | Documents on Display
|-- | --------------------

The Company's registration statement on Form F-4 ,its annual
and periodic reports and all other filings made with the U.S. Securities and
Exchange Commission may be inspected and copied at the Commission's public
reference facilities in Room 5080, 100F Street, N.E., Washington, D.C., 20549,
and at the regional offices of the Commission. The Commission may be reached at
1-800-SEC-0330 for further information on the public reference rooms. These
Commission filings are also available to the public from commercial document
retrieval services. Reports furnished by the Company with the Commission since
November 26, 2002, are also maintained electronically on the Commission's
website, www.sec.gov.

|I. | Subsidiary Information
|-- | ----------------------

Not applicable.

**ITEM 11: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK**

|A. | Commodity Prices
|-- | ----------------

The markets for pulp and lumber are highly cyclical and
affected by such factors as global economic conditions, world-wide demand for
pulp and paper, residential and commercial construction in North America and
Asia, and changes in industry production capacity and inventory levels. All
these factors have a significant impact on selling prices for our products and
profitability. The following outlines the sensitivity of operating earnings over
the course of a year to changes in commodity prices.

|          |  | Change in **realized price(1)** |  |   | Estimated impact on operating
      **earnings(2)** | 
|--------- |  | ------------------------------- |  | - | --------------------------------------------------- | 
|          |  |                                 |  |   | (in millions)                                       | 
|Pulp(3)   |  | US$50/ADMT                      |  | $ | 16.1                                                | 
|Lumber(4) |  | US$50/mfbm                      |  | $ | 26.0                                                | 

| | (1) | Assumed exchange rate of US$1.00 = $1.00. 
| | --- | ------------------------------------------
| | (2) | Before impact of profit sharing plan.     
| | (3) | Based on annual shipments of 322,000 ADMT.
| | (4) | Based on annual shipments of 520
mmfbm.   

|B. | Foreign Exchange
|-- | ----------------

We sell the majority of our products (64% of 2012 revenue, 69%
of 2011 revenue and 72% of 2010 revenue) outside of Canada, in U.S. dollars.
Consequently, the value of the Canadian dollar versus the U.S. dollar has a
major impact on our revenue and profitability. The value of the Canadian dollar
was US$1.0051 at December 31, 2012, compared to US$0.9833 at December 31, 2011
and 1.0054 at December 31, 2010.

The impact on earnings of fluctuations in currency rates is
partially offset by the corresponding fluctuations in our debt-service payments,
substantially all of which are denominated in U.S. dollars. To further reduce
the impact on earnings of fluctuations in currency rates, we periodically enter
into foreign-exchange forward contracts. We do not use any instruments to manage
our exposure to changes in foreign-currency rates with respect to the principal
value of our U.S.-dollar-denominated debt. We do not hold or issue
foreign-currency financial instruments for trading purposes. Based on sales
revenue for the year ended December 31, 2012, the effect of a US$0.01 change in
the value of the Canadian dollar over the course of the year would affect
operating earnings by approximately $2.0 million.

68

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|C. | Interest Rates
|-- | --------------

The interest rate on the majority of our existing long-term
debt, specifically the US$210.0 million aggregate principal amount of 8.50%
Senior Notes, due 2021, as well as our two power purchase rights loans are all
fixed. The interest rate on our existing revolving credit facility varies with
the prevailing prime rate of the facilitys provider. We do not currently use
any derivative instruments to manage our exposure to changes in market interest
rates.

|ITEM 12: DESCRIPTION OF SECURITIES OTHER THAN EQUITY
      SECURITIES
|---------------------------------------------------------------------

Not applicable.

PART II

|ITEM 13: DEFAULTS, DIVIDEND ARREARAGES AND
      DELINQUENCIES
|--------------------------------------------------------------

Not applicable.

|ITEM 14: MATERIAL MODIFICATIONS TO THE RIGHTS OF
      SECURITY HOLDERS AND USE OF **PROCEEDS**
|-----------------------------------------------------------------------------------------------

Not applicable.

|ITEM 15: CONTROLS AND PROCEDURES
|--------------------------------

Our principal executive officer and principal financial
officer, after evaluating the effectiveness of our disclosure controls and
procedures (as defined in Exchange Act Rule 13a-15(e)) as of the end of the
period covered by this report, have concluded that, as at such date, our
disclosure controls and procedures were effective in timely alerting them to
material information relating to us required to be disclosed in our reports
filed or submitted under the Exchange Act. Notwithstanding the foregoing, there
can be no assurance that our disclosure controls and procedures will detect or
uncover all failures within our company to disclose all material information
otherwise required to be set forth in our periodic reports.

Changes in Internal Control Over Financial Reporting.
There was no change in our internal control over financial reporting that
occurred during the period covered by this report that has materially affected,
or is reasonably likely to materially affect, our internal control over
financial reporting.

This annual report does not include a report of managements
assessment regarding internal control over financial reporting or an attestation
report of the Companys registered public accounting firm due to a transition
period established by rules of the Securities and Exchange Commission for newly
public companies.

|ITEM 16A: AUDIT COMMITTEE FINANCIAL EXPERT
|------------------------------------------

William D. Grace is an audit committee financial expert and is
independent (as defined under the rules and regulations of the New York Stock
Exchange).

The Securities and Exchange Commission has indicated that the
designation of a person as an audit committee financial expert does not make
such person an expert for any purpose, impose on such person any duties,
obligations or liability that are greater than those imposed on such person as a
member of the audit committee and the Companys Board of Directors in the
absence of such designation and does not affect the duties, obligations or
liability of any other member of the audit committee or the Board of Directors.

69

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|ITEM 16B: CODE OF ETHICS
|------------------------

We have adopted a code of ethics that applies to our principal
executive officer, principal financial officer, principal accounting officer and
persons fulfilling similar functions. The code of ethics is filed as an exhibit
to this annual report for the year ended December 31, 2012. A copy of the code
of ethics will be provided to any person without charge upon such person's
request in writing to our Chief Financial Officer at the address set forth on
the cover of this annual report.

|ITEM 16C: PRINCIPAL ACCOUNTANT FEES AND SERVICES
|------------------------------------------------

We paid the following fees to PricewaterhouseCoopers LLP in
each of the years ended December 31, 2010, 2011 and 2012 for professional
services:

|                   |                | 2010 |  |   | 2011 |  |   | 2012 | 
|------------------ | -------------- | ---- |  | - | ---- |  | - | ---- | 
|                   | (in thousands) |     
|Audit fees (1)     | $              | 233  |  | $ | 224  |  | $ | 279  | 
|Audit-related fees |                | -    |  |   | -    |  |   | -    | 
|Tax fees (2)       |                | 24   |  |   | 24   |  |   | 25   | 
|All other fees (3) |                | 110  |  |   | 189  |  |   | 28   | 
|                   | $              | 367  |  | $ | 437  |  | $ | 332  | 

| | (1) | Audit fees comprise professional services for the audit
      of our annual financial statements, review of our interim financial
      statements, and services normally provided in connection with our
      statutory and regulatory filings.         
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (2) | Tax fees comprise amounts paid for tax compliance and
      advisory services.                                                                                                                                                                            
| | (3) | All other fees comprise amounts paid for the audit of
      expenditures under the Alberta governments Forest Resource Improvement
      Program, consultations on accounting developments and the accounting for
      potential corporate transactions.

Our audit committee approved 100% of the fees paid to
PricewaterhouseCoopers LLP in 2010, 2011 and 2012 and has a pre-approval policy
with respect to permitted non-audit services. Under this policy, subject to
certain conditions, specified audit-related services, tax compliance, audit
services and tax services may be presented to the Audit Committee for
pre-approval as a category of services on an annual or project basis. On an
annual basis, management is required to update the audit committee in respect of
the actual amount of fees in comparison to the pre-approved estimate. All
non-audit services not otherwise pre-approved by the audit committee must be
pre-approved by the audit committee on an individual basis.

No audit-related fees, tax fees or other non-audit fees were
approved by the Audit Committee pursuant to paragraph (c)(7)(i)(C) of Rule 2-01
of Regulation S-X.

|ITEM 16D: EXEMPTIONS FROM THE LISTING STANDARDS FOR
      AUDIT COMMITTEES
|--------------------------------------------------------------------------

Not Applicable.

|ITEM 16E: PURCHASES OF EQUITY SECURITIES BY THE ISSUER
      AND AFFILIATED **PURCHASERS**
|------------------------------------------------------------------------------------------

Not Applicable.

|ITEM 16F: CHANGE IN REGISTRANTS CERTIFYING
      ACCOUNTANT
|------------------------------------------------------------

Not Applicable.

70

---

|ITEM 16G: CORPORATE GOVERNANCE
|------------------------------

Not Applicable.

|ITEM 16H: MINE SAFETY DISCLOSURE
|--------------------------------

Not Applicable.

PART III

|ITEM 17: FINANCIAL STATEMENTS
|-----------------------------

The Auditor's Report and Financial Statements for the Company
are attached hereto as itemized under Item 19(a) and are incorporated herein by
reference. Such Financial Statements have been prepared on the basis of
International Financial Reporting Standards as issued by the International
Accounting Standards Board.

|ITEM 18: FINANCIAL STATEMENTS
|-----------------------------

Not applicable. See Item 17.

|ITEM 19: EXHIBITS
|-----------------

|(a) | Financial Statements
|--- | --------------------

(i) Auditors' Report.

(ii) Balance Sheets as at December 31, 2011 and 2012. 
(iii) Statements of Earnings for the years ended December 31,
2010, 2011 and 2012. 
(iv) Statements of Retained Earnings for the years ended
December 31, 2010, 2011 and 2012.
(v) Statements of Cash Flows for the years
ended December 31, 2010, 2011 and 2012. 
(vi) Notes to the Financial Statements. 
(vii) Financial Statement Schedules are omitted because they
are not applicable, not required or because the required information is included
in the Financial Statements filed herein.

(b) Exhibits --------

|Exhibit Number | Description of Exhibit                                                                                                                                                                                
|-------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|1.1*           | Certificate, Articles of
      Incorporation and Articles of Amendment.                                                                                                                               
|1.2*           | By-laws.                                                                                                                                                                                              
|2.1***         | Indenture dated as of April 7,
      2011, among the Company, The Bank of New York Mellon, as trustee, and BNY
      Trust Company of Canada as co-trustee.                                           
|2.2***         | Registration Rights Agreement, dated as of
      April 7, 2011, among the Company and Goldman, Sachs & Co., HSBC
      Securities & Co., HSBC Securities (USA) Inc. and KKR Capital Markets
      LLC.
|2.3***         | Form of Exchange Note (included
      in Exhibit 2.1).                                                                                                                                                
|2.4***         | Credit Facility Letter dated as of December 29,
      2006, from HSBC Bank Canada to the Registrant.                                                                                                  
|2.5***         | First Supplemental Credit
      Facility Letter dated as of September 12, 2007, from HSBC Bank Canada to
      the Registrant.                                                                        
|2.6***         | Second Supplemental Credit Facility Letter
      dated as of March 26, 2008, from HSBC Bank Canada to the Registrant.                                                                                 
|2.7***         | Third Supplemental Credit
      Facility Letter dated as of April 22, 2008, from HSBC Bank Canada to the
      Registrant.                                                                            

71

---

|2.8***          | Fourth Supplemental Credit Facility Letter
      dated as of August 13, 2009, from HSBC Bank Canada to the Registrant.                                                                                                                                  
|--------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|2.9***          | Fifth Supplemental Credit Facility Letter dated
      as of May 25, 2010, from HSBC Bank Canada to the Registrant.                                                                                                                                      
|2.10***         | Sixth Supplemental Credit Facility Letter dated
      as of September 17, 2010, from HSBC Bank Canada to the Registrant.                                                                                                                                
|2.11***         | Seventh Supplemental Credit Facility Letter
      dated as of April 6, 2011, from HSBC Bank Canada to the Registrant.                                                                                                                                   
|2.12***         | SD Extension Loan Agreement dated as of June 5,
      2006, between the Registrant and CP Energy Marketing LP (formerly known as
      EPCOR Merchant and Capital LP).                                                                                  
|2.13***         | Tax Loan Agreement dated as of February 22,
      2007, between the Registrant and CP Energy Marketing LP (formerly known as
      EPCOR Merchant and Capital LP).                                                                                      
|2.14***         | Letter of Understanding dated June 5, 2006,
      among the Registrant, CP Energy Marketing LP (formerly known as EPCOR
      Merchant and Capital LP) and Capital Power PPA Management Inc. (formerly
      known as EPCOR PPA Management Inc.).       
|4.1*            | Forest Management Agreement dated May 14, 1997,
      between the Minister of Environmental Protection of Alberta and the
      Registrant.                                                                                                             
|4.2*            | Corporate Services Agreement dated May 13,
      1998, between the Registrant and Millar Western Industries Ltd.                                                                                                                                        
|4.3*            | Non-Competition Agreement dated as of May 13,
      1998, among the Registrant, Millar Western Industries Ltd., James B.
      Millar and H. MacKenzie Millar.                                                                                          
|4.4***          | Trademark Licensing Agreement dated May 13,
      1998, between the Registrant and Millar Western Industries Ltd.                                                                                                                                       
|4.5***          | Fox Creek Site Land Lease dated as of December
      10, 2010, between the Registrant and the Province of Alberta.                                                                                                                                      
|4.6**           | Power Syndicate Agreement (Sundance C) dated
      January 1, 2001, among the Registrant, Capital Power Corporation (formerly
      known as EPCOR Utilities Inc.) and certain industry participants.                                                   
|4.7***          | Power Purchase Arrangement (Sundance C).                                                                                                                                                                                                                
|4.8***          | Millar Western PPI Swap and Purchase Agreement
      dated as of May 19, 2006, among the Registrant, CP Energy Marketing LP
      (formerly EPCOR Merchant and Capital LP) and Capital Power Corporation
      (formerly known as EPCOR Utilities Inc.).
|7.1****         | Computation of Ratio of Earnings to Fixed
      Charges.                                                                                                                                                                                                
|11.1****        | Code of Ethics.                                                                                                                                                                                                                                         
|12.1****        | Certification of the Chief Executive Officer,
      J. Craig Armstrong required by 17 CFR 240.15d-14(a).                                                                                                                                                
|12.2****        | Certification of the Chief Financial Officer,
      Kevin A. Edgson required by 17 CFR 240.15d-14(a).                                                                                                                                                   
|13.1****        | Certification of the Chief Executive Officer,
      J. Craig Armstrong required by 17 CFR 240.15d-14(b) and 18 U.S.C. Section
      1350.                                                                                                               
|13.2****        | Certification of the Chief Financial Officer,
      Kevin A. Edgson required by 17 CFR 240.15d-14(b) and 18 U.S.C. Section
      1350.                                                                                                                  
|---------------

|*    | Incorporated by reference from the Registrant's Form F-4
      filed with the Securities and Exchange Commission (Commission File No.
      333-8960).                  
|---- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|**   | Incorporated by reference from the Registrant's Form 20-F
      filed with the Securities and Exchange Commission on June 4, 2002
      (Commission File No. 333-08960).
|***  | Incorporated by reference from the Registrant's Form F-4
      filed with the Securities and Exchange Commission (Commission File No.
      333-179957).                
|**** | Filed herewith.                                                                                                                                                         

72

---

SIGNATURE

The registrant hereby certifies that it meets all of the
requirements for filing on Form 20-F and that it has duly caused and authorized
the undersigned to sign this annual report on its behalf.

|                     | MILLAR WESTERN FOREST PRODUCTS LTD.
|-------------------- | -----------------------------------
|                     |                                    
|Dated: March 5, 2013 | By: /s/ Kevin A. Edgson            
|                     | Kevin A.
      Edgson              
|                     | Chief
      Financial Officer      

73

---











Millar Western ForestProducts Ltd.

Financial Statements December
31, 2012 and 2011

---

March 4, 2013



Independent Auditors Report

To the Shareholder of Millar Western Forest Products Ltd.

We have audited the accompanying financial statements of Millar
Western Forest Products Ltd., which comprise the statements of financial
position as at December 31, 2012 and 2011 and the statements of operations and
comprehensive (loss) income, changes in equity and cash flows for each of the
three years in the period ended December 31, 2012, and the related notes, which
comprise a summary of significant accounting policies and other explanatory
information.

Managements responsibility for thefinancial
statementsManagement is responsible for the preparation and fair
presentation of these financial statements in accordance with International
Financial Reporting Standards as issued by the International Accounting
Standards Board, and for such internal control as management determines is
necessary to enable the preparation of financial statements that are free from
material misstatement, whether due to fraud or error.

Auditors responsibilityOur responsibility is to express an opinion on these financial statements
based on our audits. We conducted our audits in accordance with Canadian
generally accepted auditing standards and the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free from material misstatement. Canadian generally accepted
auditing standards also require that we comply with ethical requirements.

An audit involves performing procedures to obtain audit
evidence about the amounts and disclosures in the financial statements. The
procedures selected depend on the auditors judgment, including the assessment
of the risks of material misstatement of the financial statements, whether due
to fraud or error. In making those risk assessments, the auditor considers
internal control relevant to the entitys preparation and fair presentation of
the financial statements in order to design audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the entitys internal control. An audit also
includes evaluating the appropriateness of accounting policies used and the
reasonableness of accounting estimates made by management, as well as evaluating
the overall presentation of the financial statements.

We believe that the audit evidence we have obtained in our
audits is sufficient and appropriate to provide a basis for our audit opinion.

---

OpinionIn our opinion, the financial statements present fairly, in all material
respects, the financial position of Millar Western Forest Products Ltd. as at
December 31, 2012 and 2011 and its financial performance and its cash flows for
each of the three years in the period ended December 31, 2012 in accordance with
International Financial Reporting Standards as issued by the International
Accounting Standards Board.





(signed) PricewaterhouseCoopers LLP

Chartered Accountants

Edmonton, Alberta

---

|Millar Western Forest Products Ltd.         
|--------------------------------------------
|Statement of Financial Positions            
|As at December
      31, 2012 and 2011      
|                                            
|(expressed in thousands of Canadian dollars)

|                                                   |  | 2012    |  |  | 2011    | 
|-------------------------------------------------- |  | ------- |  |  | ------- | 
|                                                   |  | $       |  |  | $       | 
|                                                   |  |         |  |  |         | 
|Assets                                             |  |         |  |  |         | 
|                                                   |  |         |  |  |         | 
|Current assets                                     |  |         |  |  |         | 
|Cash and cash equivalents (note 5)                 |  | 24,674  |  |  | 31,630  | 
|Restricted cash (note 5)                           |  | 18,824  |  |  | -       | 
|Accounts and other receivables (note 6)            |  | 26,006  |  |  | 37,783  | 
|Inventories (note 7)                               |  | 77,588  |  |  | 67,968  | 
|Prepaid expenses                                   |  | 12,018  |  |  | 9,746   | 
|                                                   |  |         |  |  |         | 
|                                                   |  | 159,110 |  |  | 147,127 | 
|Property, plant and equipment(note
      8)        |  | 175,295 |  |  | 172,818 | 
|Intangible assets(note 10)                         |  | 44,860  |  |  | 49,488  | 
|Other assets(note 11)                              |  | 2,910   |  |  | 315     | 
|                                                   |  |         |  |  |         | 
|                                                   |  | 382,175 |  |  | 369,748 | 
|                                                   |  |         |  |  |         | 
|Liabilities                                        |  |         |  |  |         | 
|                                                   |  |         |  |  |         | 
|Current liabilities                                |  |         |  |  |         | 
|Accounts payable and accrued liabilities (note 13) |  | 63,960  |  |  | 37,855  | 
|Reforestation obligations (note 15)                |  | 5,070   |  |  | 5,205   | 
|Financial liabilities  borrowings (note 14)       |  | 1,092   |  |  | 978     | 
|                                                   |  |         |  |  |         | 
|                                                   |  | 70,122  |  |  | 44,038  | 
|Financial liabilities  borrowings(note 14)        |  | 221,653 |  |  | 222,576 | 
|Asset retirement obligations(note 15)              |  | 2,206   |  |  | 2,002   | 
|Other obligations                                  |  | 331     |  |  | 260     | 
|Reforestation obligations(note 15)                 |  | 10,163  |  |  | 9,986   | 
|Deferred income taxes(note 21)                     |  | 1,893   |  |  | 6,440   | 
|Post-employment benefit obligation(note 22)        |  | 3,187   |  |  | 2,920   | 
|                                                   |  |         |  |  |         | 
|                                                   |  | 309,555 |  |  | 288,222 | 
|                                                   |  |         |  |  |         | 
|Shareholders equity                               |  |         |  |  |         | 
|                                                   |  |         |  |  |         | 
|Share capital(note 16)                             |  | 65,500  |  |  | 61,500  | 
|Retained earnings                                  |  | 7,120   |  |  | 20,026  | 
|                                                   |  |         |  |  |         | 
|                                                   |  | 72,620  |  |  | 81,526  | 
|                                                   |  |         |  |  |         | 
|                                                   |  | 382,175 |  |  | 369,748 | 

Approved by the Board of Directors

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

---

|Millar Western Forest Products Ltd.                 
|----------------------------------------------------
|Statements of Changes in Equity                     
|For the years
      ended December 31, 2012 and 2011
|                                                    
|(expressed in thousands of Canadian dollars)        

|                                                           |  | Share   |  |  | Retained |   |  | Total  |  
|---------------------------------------------------------- |  | ------- |  |  | -------- | - |  | ------ | -
|                                                           |  | capital |  |  | earnings |   |  | equity |  
|                                                           |  | $       |  |  | $        |   |  | $      |  
|                                                           |  |         |  |  |          |   |  |        |  
|Balance  January 1, 2010                                  |  | -       |  |  | 67,552   |   |  | 67,552 |  
|                                                           |  |         |  |  |          |   |  |        |  
|Net income for the year                                    |  | -       |  |  | 17,659   |   |  | 17,659 |  
|                                                           |  |         |  |  |          |   |  |        |  
|Actuarial losses                                           |  | -       |  |  | (986     | ) |  | (986   | )
|                                                           |  |         |  |  |          |   |  |        |  
|Balance  December 31, 2010                                |  | -       |  |  | 84,225   |   |  | 84,225 |  
|                                                           |  |         |  |  |          |   |  |        |  
|Net loss for the year                                      |  | -       |  |  | (229     | ) |  | (229   | )
|                                                           |  |         |  |  |          |   |  |        |  
|Actuarial losses                                           |  | -       |  |  | (220     | ) |  | (220   | )
|                                                           |  |         |  |  |          |   |  |        |  
|Adjustment to stated capital (note 16)                     |  | 61,500  |  |  | (61,500  | ) |  | -      |  
|                                                           |  |         |  |  |          |   |  |        |  
|Dividends (note 16)                                        |  | -       |  |  | (2,250   | ) |  | (2,250 | )
|                                                           |  |         |  |  |          |   |  |        |  
|Balance  December 31, 2011                                |  | 61,500  |  |  | 20,026   |   |  | 81,526 |  
|                                                           |  |         |  |  |          |   |  |        |  
|Net loss for the year                                      |  | -       |  |  | (8,259   | ) |  | (8,259 | )
|                                                           |  |         |  |  |          |   |  |        |  
|Acquisition of Chickadee Creek Energy Inc.
      (note 17) |  | -       |  |  | (330     | ) |  | (330   | )
|                                                           |  |         |  |  |          |   |  |        |  
|Actuarial losses                                           |  | -       |  |  | (317     | ) |  | (317   | )
|                                                           |  |         |  |  |          |   |  |        |  
|Adjustment to stated capital (note 16)                     |  | 4,000   |  |  | (4,000   | ) |  | -      |  
|                                                           |  |         |  |  |          |   |  |        |  
|Balance  December 31, 2012                                |  | 65,500  |  |  | 7,120    |   |  | 72,620 |  

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

---

|Millar Western Forest Products Ltd.                     
|--------------------------------------------------------
|Statements of Operations and Comprehensive (Loss) Income
|For the years
      ended December 31, 2012 and 2011    
|                                                        
|(expressed in thousands of Canadian dollars)            

|                                                                                  |  | 2012    |   |  | 2011    |   |  | 2010    |  
|--------------------------------------------------------------------------------- |  | ------- | - |  | ------- | - |  | ------- | -
|                                                                                  |  | $       |   |  | $       |   |  | $       |  
|                                                                                  |  |         |   |  |         |   |  |         |  
|Revenue                                                                           |  | 332,401 |   |  | 284,682 |   |  | 295,383 |  
|                                                                                  |  |         |   |  |         |   |  |         |  
|Cost of products sold (excluding
      depreciation and amortization)             |  | 241,039 |   |  | 207,019 |   |  | 183,863 |  
|Freight and other distribution costs                                              |  | 53,222  |   |  | 48,563  |   |  | 49,565  |  
|Depreciation and amortization                                                     |  | 13,641  |   |  | 11,349  |   |  | 11,029  |  
|General and administration                                                        |  | 13,781  |   |  | 15,929  |   |  | 13,766  |  
|Other expenses (income) (note 19)                                                 |  | 7,650   |   |  | (25,751 | ) |  | 9,843   |  
|                                                                                  |  |         |   |  |         |   |  |         |  
|                                                                                  |  | 329,333 |   |  | 257,109 |   |  | 268,066 |  
|                                                                                  |  |         |   |  |         |   |  |         |  
|Operating earnings                                                                |  | 3,068   |   |  | 27,573  |   |  | 27,317  |  
|                                                                                  |  |         |   |  |         |   |  |         |  
|Foreign exchange gain (loss) on
      borrowings                                  |  | 4,641   |   |  | (5,518  | ) |  | 10,716  |  
|                                                                                  |  |         |   |  |         |   |  |         |  
|Financing expenses(note 20)                                                       |  | (20,425 | ) |  | (20,847 | ) |  | (17,460 | )
|                                                                                  |  |         |   |  |         |   |  |         |  
|(Loss) earnings before income taxes                                               |  | (12,716 | ) |  | 1,208   |   |  | 20,573  |  
|                                                                                  |  |         |   |  |         |   |  |         |  
|Income taxes (recovery) expense(note 21)                                          |  | (4,457  | ) |  | 1,437   |   |  | 2,914   |  
|                                                                                  |  |         |   |  |         |   |  |         |  
|Net (loss) earnings for the year                                                  |  | (8,259  | ) |  | ( 229   | ) |  | 17,659  |  
|                                                                                  |  |         |   |  |         |   |  |         |  
|Actuarial losses  (net of tax recovery
      2012-$106, 2011- $74 and 2010-$330) |  | (317    | ) |  | (220    | ) |  | (986    | )
|                                                                                  |  |         |   |  |         |   |  |         |  
|Comprehensive (loss) income for the
      year                                    |  | (8,576  | ) |  | ( 449   | ) |  | 16,673  |  

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

---

|Millar Western Forest Products Ltd.                 
|----------------------------------------------------
|Statements of Cash Flows                            
|For the years
      ended December 31, 2012 and 2011
|                                                    
|(expressed in thousands of Canadian dollars)        

|                                                               |  | 2012    |   |  | 2011     |   |  | 2010    |  
|-------------------------------------------------------------- |  | ------- | - |  | -------- | - |  | ------- | -
|                                                               |  | $       |   |  | $        |   |  | $       |  
|                                                               |  |         |   |  |          |   |  |         |  
|Cash provided by (used in)                                     |  |         |   |  |          |   |  |         |  
|                                                               |  |         |   |  |          |   |  |         |  
|Operating activities                                           |  |         |   |  |          |   |  |         |  
|Net (loss) earnings for the year                               |  | (8,259  | ) |  | (229     | ) |  | 17,659  |  
|Adjustments for                                                |  |         |   |  |          |   |  |         |  
|Finance expenses                                               |  | 20,425  |   |  | 20,847   |   |  | 16,842  |  
|Depreciation and
      amortization                            |  | 13,641  |   |  | 11,349   |   |  | 11,029  |  
|Deferred income tax expense (recovery)                         |  | (4,325  | ) |  | 1,685    |   |  | 2,994   |  
|Unrealized
      exchange (gain) loss on borrowings            |  | (4,641  | ) |  | 12,222   |   |  | (10,716 | )
|Unrealized loss (gain) on derivative contracts                 |  | 6,612   |   |  | (2,594   | ) |  | 3,126   |  
|Reforestation
      expense                                    |  | 7,077   |   |  | 6,549    |   |  | 7,001   |  
|(Gain)
      loss on disposal of property, plant and equipment |  | (45     | ) |  | (436     | ) |  | 1,119   |  
|Fox Creek
      insurance claim                                |  | -       |   |  | (7,600   | ) |  | -       |  
|Inventory valuation                                            |  | (1,963  | ) |  | 1,242    |   |  | (2,166  | )
|Other                                                          |  | 120     |   |  | 1,872    |   |  | 49      |  
|Reforestation expenditures                                     |  | (7,256  | ) |  | (7,325   | ) |  | (4,693  | )
|                                                               |  |         |   |  |          |   |  |         |  
|                                                               |  | 21,386  |   |  | 37,582   |   |  | 42,244  |  
|Net change in non-cash working capital items (note 27)         |  | 3,895   |   |  | (4,499   | ) |  | (20,245 | )
|                                                               |  |         |   |  |          |   |  |         |  
|                                                               |  | 25,281  |   |  | 33,083   |   |  | 21,999  |  
|                                                               |  |         |   |  |          |   |  |         |  
|Investing activities                                           |  |         |   |  |          |   |  |         |  
|Additions to property, plant and equipment
      (note 27)     |  | (16,598 | ) |  | (43,324  | ) |  | (20,620 | )
|Receipt of government grants (note 9)                          |  | 8,655   |   |  | -        |   |  | -       |  
|Proceeds on disposal of property, plant and
      equipment    |  | 205     |   |  | 1,358    |   |  | 330     |  
|Proceeds on Fox Creek insurance claim                          |  | -       |   |  | 7,600    |   |  | -       |  
|Increase in restricted cash (note 5)                           |  | (6,952  | ) |  | -        |   |  | -       |  
|Acquisition of Chickadee Creek Energy Inc. (note 17)           |  | 36      |   |  | -        |   |  | -       |  
|(Increase) decrease in other assets                            |  | (46     | ) |  | 2,186    |   |  | (384    | )
|                                                               |  |         |   |  |          |   |  |         |  
|                                                               |  | (14,700 | ) |  | (32,180  | ) |  | (20,674 | )
|                                                               |  |         |   |  |          |   |  |         |  
|Financing activities                                           |  |         |   |  |          |   |  |         |  
|Increase in borrowings                                         |  | 4,312   |   |  | 201,348  |   |  | -       |  
|Repayment of borrowings                                        |  | (978    | ) |  | (189,850 | ) |  | (784    | )
|Finance expenses paid                                          |  | (20,121 | ) |  | (24,335  | ) |  | (16,663 | )
|Dividends                                                      |  | (750    | ) |  | (1,500   | ) |  | -       |  
|                                                               |  |         |   |  |          |   |  |         |  
|                                                               |  | (17,537 | ) |  | (14,337  | ) |  | (17,447 | )
|                                                               |  |         |   |  |          |   |  |         |  
|Decrease in cash and cash
      equivalents                    |  | (6,956  | ) |  | (13,434  | ) |  | (16,122 | )
|                                                               |  |         |   |  |          |   |  |         |  
|Cash and cash equivalents  Beginning of
      year            |  | 31,630  |   |  | 45,064   |   |  | 61,186  |  
|                                                               |  |         |   |  |          |   |  |         |  
|Cash and cash equivalents  End of
      year                  |  | 24,674  |   |  | 31,630   |   |  | 45,064  |  

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

---

|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

|1 | General information                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|  | Millar Western Forest Products Ltd. (the Company) is
      incorporated and located in Canada. The address of the Companys corporate
      office is 16640  111 Avenue, Edmonton, Alberta, Canada T5M 2S5.                                                                                                                                                                                                                                                                                                                                                                
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|  | The Company is a subsidiary of Millar Western Industries
      Ltd. and the ultimate parent is Hualkeith Investments Ltd.                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|  | The Company is an integrated forest products company with
      facilities in Canada producing lumber and pulp. The lumber segment
      consists of three sawmill operations that produce and market dimension
      lumber. The pulp segment consists of a pulp operation that manufactures
      and markets a number of different grades of bleached
      chemi-thermo-mechanical pulp, (BCTMP).                                                                                                                                                                       
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|2 | Summary of significant accounting
  policies                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|  | The Company prepares its financial statements in
      accordance with Canadian generally accepted accounting principles (GAAP)
      as defined in the Handbook of the Canadian Institute of Chartered
      Accountants (CICA Handbook). In 2010, the CICA Handbook was revised to
      incorporate International Financial Reporting Standards (IFRS) as issued
      by the International Accounts Standards Board (IASB) and required publicly
      accountable enterprises to apply these standards effective for years
      beginning on or after January 1, 2011.
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|  | These financial statements were approved by the Companys
      board of directors on March 4, 2013.                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|  | The significant accounting policies used in the
      preparation of these financial statements are as follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|  | Basis of measurement                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|  | These financial statements have been prepared under the
      historical cost convention, except for the revaluation of certain
      financial assets and liabilities to fair value.                                                                                                                                                                                                                                                                                                                                                                                       
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|  | Foreign currency translation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|  | i)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

1

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|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

| | ii) | Transactions and balances                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |     | Foreign currency transactions are translated into
      Canadian dollars by applying exchange rates in effect at the transaction
      date. At each reporting period end, monetary assets and liabilities
      denominated in foreign currencies are converted to Canadian dollars at
      rates of exchange prevailing on that date. Gains and losses on exchange
      differences are recognized in the statement of operations and
      comprehensive (loss) income.

Cash and cash equivalents

Cash and cash equivalents are defined
as cash on hand, deposits held with banks and money-market instruments with
maturity dates of less than three months from the date they are acquired.

Financial instruments

| | i)  | Financial assets                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |     | The Company classifies its financial assets in the
      following categories: at fair value through earnings, loans and
      receivables, and available for sale. The classification depends on the
      purpose for which the financial assets were acquired. Management
      determines the classification of its financial assets at initial
      recognition.                                                                                                                                                                                                                                                                                                                             
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |     | Financial assets at fair value through earnings are
      financial assets held for trading and include derivative instruments for
      which cash-flow hedging has not been applied. Financial assets at fair
      value through earnings are carried at fair value, with changes in fair
      value generally recorded in other income (expense).                                                                                                                                                                                                                                                                                                                                             
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |     | Loans and receivables are non-derivative financial assets
      with fixed or determinable payments that are not quoted in an active
      market, and include cash and cash equivalents, and accounts and notes
      receivable. Loans and receivables are recognized initially at face amount,
      except when fair value is materially different, and are subsequently
      measured at amortized cost using the effective-interest method, less a
      provision for impairment. A provision for impairment is established when
      there is objective evidence that the Company will not be able to collect
      all amounts due, according to the original terms of the
  instrument.
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |     | The Company may enter into transactions to sell trade
      receivables to third parties. If the risks and rewards of ownership of the
      receivables are transferred to the purchaser, the transaction is accounted
      for as a sale and the receivables are derecognized. If the risks and
      rewards of ownership of the receivables are neither transferred nor
      retained, the transaction is accounted for as a sale if control is not
      retained over the receivables.                                                                                                                                                                                                     
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | ii) | Financial liabilities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |     | Accounts payable and accrued liabilities are non-interest
      bearing and are recognized initially at face amount, except when fair
      value is materially different, and are subsequently measured at amortized
      cost using the effective-interest method. Borrowings are recognized
      initially at fair value, net of any directly attributable transaction
      costs, and are subsequently measured at amortized cost using the
      effective-interest method.                                                                                                                                                                                                                

2

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|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

| | iii) | Derivative financial instruments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | ---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |      | From time to time, the Company enters into
      forward-exchange contracts to hedge a portion of its expected
      foreign-currency-denominated revenue over periods of up to 12 months into
      the future. The Company also enters into forward-sales contracts for pulp
      or lumber, in order to reduce the impact of market volatility on its
      product sales, and enters into forward-purchase contracts for natural gas,
      in order to reduce the impact of market volatility on its gas purchases.
      These contracts are classified as derivative instruments.
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |      | Derivatives are recognized at fair value on the date the
      Company becomes a party to the contract and are subsequently re-measured
      at fair value. The Company does not enter into speculative contracts and
      does not apply hedge accounting; therefore, unrealized gains and losses on
      derivatives are recorded in earnings at each period end.                                                                                                                                                                                                                   
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |      | The Company has reviewed all significant contractual
      agreements and determined that there are no material embedded derivatives
      that must be separated from the host contract and recorded at fair
      value.                                                                                                                                                                                                                                                                                                                                                               
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |      | Details of the Companys classification of financial
      instruments are provided in note 24.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

Impairment of financial assets

At each reporting date, the Company
assesses whether there is objective evidence that a financial asset carried at
amortized cost is impaired. If such evidence exists, the Company recognizes an
impairment loss, with the loss being the difference between the amortized cost
of the asset and the value of the estimated future cash flows, discounted using
the instruments original effective interest rate. The carrying amount of the
asset is reduced by this amount either directly or indirectly through the use of
an allowance account.

Impairment losses on financial assets
carried at amortized cost are reversed in subsequent periods if the amount of
the loss decreases and the decrease can be related objectively to an event
occurring after the impairment was recognized.

Inventories

The Companys inventories include pulp,
lumber, logs, processing materials and supplies.

Pulp, lumber, and log inventories are
recorded at the lower of cost and net realizable value (NRV). Cost is determined
using average cost and comprises raw-materials, direct-labour and other direct
costs, and related production overheads consistent with the normal level of
production. NRV represents the estimated selling price for inventories in the
ordinary course of business, less the estimated costs of completion and selling
expenses.

Processing materials and supplies are
recorded at weighted average cost, recalculated at each transaction date.

Cost of products sold, as presented in
  the statement of comprehensive income, includes all inventories expensed in
  the period, as well as changes in inventory valuation provisions. When reasons
  for a write-down of inventory have ceased to exist, the write-down is reversed.

3

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|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

Property, plant and equipment

Property, plant and equipment are
stated at cost less accumulated depreciation and accumulated impairment losses.
Cost includes expenditures that are directly attributable to the acquisition or
construction of the asset including commissioning costs and borrowing costs.
Subsequent costs are included in the assets carrying value or are recognized as
a separate asset, as appropriate, only when it is probable that future economic
benefits associated with the item will flow to the Company and the cost can be
measured reliably. The carrying amount of a replaced asset is removed when the
item is replaced. Repair and maintenance costs are charged to the statement of
operations and comprehensive (loss) income during the period in which they are
incurred. Depreciation is recognized on a straight-line basis.

The estimated useful lives of the
various components of the Companys major assets classes are as follows:

Buildings  Sawmill
    40  60 yearsBuildings  Pulp mill
    40  60 yearsBuildings  Other
    15  30 yearsProcess equipment - Sawmill
    25  40 yearsProcess equipment  Pulp mill
    20  50 yearsMobile equipment
    5  10 yearsAncillary equipment
    10  25 yearsFurniture, office and computer equipment
    5  20 yearsBridges
    20  30 yearsRoads and yards
    30  50 years


The Company allocates the amount
initially recognized in respect of an item of property, plant and equipment to
its significant components and depreciates each component separately. Residual
values and useful lives of the assets are reviewed annually and adjusted if
appropriate.

Gains and losses on disposals of
property, plant and equipment are determined by comparing the proceeds with the
carrying amount of the assets and are included as part of Other (income)
expenses in the statement of operations and comprehensive (loss) income.

Intangible assets

The Companys intangible assets include
timber rights, computer software and power purchase rights. These assets are
capitalized and amortized in the statement of operations and comprehensive
(loss) income, on a straight-line basis over the period of their expected useful
lives, as follows:

Timber rights
    10  60 yearsComputer software
    5  15 yearsPower purchase rights
    20 years


4

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|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

Impairment of non-financial assets

Property, plant and equipment and
intangible assets are tested for impairment whenever events or changes in
circumstances indicate the carrying amount may not be recoverable. For the
purposes of measuring recoverable amounts, assets are grouped at the lowest
levels for which there are separately identifiable cash flows (cash-generating
units or CGUs). The recoverable amount is the higher of an assets fair value,
less costs to sell, and its value in use, which is defined as the present value
of the expected future cash flows of the relevant assets or CGU. An impairment
loss is recognized for the amount by which the assets carrying amount exceeds
its recoverable amount.

The Company evaluates impairment losses
for potential reversals when events or circumstances warrant such consideration.

Borrowing costs

Borrowing costs attributable to the
acquisition, construction or production of qualifying assets are added to the
cost of those assets, until such time as the assets are substantially ready for
their intended use. All other borrowing costs are recognized as finance expenses
in the statement of operations and comprehensive (loss) income in the period in
which they are incurred.

Employee benefits

| | i) | Pension obligations                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | The Company has defined-contribution plans providing
      pension benefits to most of its employees, and for certain key employees
      the Company has a supplementary defined-benefit pension plan.                                                                                                                                                                                                                                                                                   
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | The cost of defined-contribution pension plans is charged
      to expense as the contributions become payable.                                                                                                                                                                                                                                                                                                                                                                           
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | The cost of defined-benefit plans is determined using the
      projected-benefit method, prorated on service and managements best
      estimates of expected plan investment performance, salary increases and
      retirement ages of employees in the plan. The related pension liability
      recognized in the statement of financial position is the present value of
      the defined-benefit obligation at the period-end date, less the fair value
      of the plan assets.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | Actuarial valuations for defined-benefit plans are
      carried out annually, or when any significant changes to the plan or
      membership may require a revaluation to be completed.                                                                                                                                                                                                                                                                                                 
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | Actuarial gains and losses are recognized in the period
      in which they occur, in other comprehensive income (OCI), without
      recycling through earnings in subsequent periods. The costs of
      past-service benefits are recognized as an expense in the statement of
      operations and comprehensive (loss) income.                                                                                                                                                       

5

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|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

| | ii)  | Profit sharing                                                                                                                                                                                                                                                                     
| | ---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |      |                                                                                                                                                                                                                                                                                    
| |      | The Company recognises a liability and an expense for
      profit sharing, based on a formula that takes into consideration the net
      income before taxes of the Company after certain adjustments.                                                                           
| |      |                                                                                                                                                                                                                                                                                    
| | iii) | Other obligations                                                                                                                                                                                                                                                                  
| |      |                                                                                                                                                                                                                                                                                    
| |      | The Company offers a supplemental vacation program for
      select employees. The employees can use the vacation at their discretion,
      and the vacation can be carried forward until the end of employment. The
      Company accrues for unused vacation at each period
end.

Provisions

Provisions for environmental
reclamation, restructuring costs and legal claims, where applicable, are
recognized when the Company has a present legal or constructive obligation as a
result of past events, when it is more likely than not that an outflow of
resources will be required to settle the obligation, and when the amount can be
reliably estimated. Provisions are measured at managements best estimate of the
expenditure required to settle the obligation at the end of the reporting
period, and are discounted to present value where the effect is material using a
risk-free rate. The Company performs evaluations to identify onerous contracts
and, where applicable, records provision for such contracts.

Forestry legislation in Alberta
requires the Company to incur the cost of reforestation of areas of land on
which timber is harvested under the terms of its quotas and forest management
agreement. Accordingly, the Company records a liability for the costs of
reforestation in the period in which the timber is harvested. In periods
subsequent to the initial measurement, changes in the liability resulting from
the passage of time and work performed and revisions to reforestation estimates
are recognized in the statement of operations and comprehensive (loss) income as
they occur.

Income taxes

Income tax comprises current and
deferred tax. Income tax is recognized in the statement of operations and
comprehensive (loss) income.

Current tax is the expected tax payable
on the taxable income for the year, using tax rates enacted or substantively
enacted, at the end of the reporting period, and any adjustment to tax payable
in respect of previous years.

Deferred income taxes are recognized
for the future tax consequences attributable to the differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred income tax liabilities or assets are
measured using substantively enacted rates anticipated to apply in the periods
in which the differences are expected to reverse. Deferred income tax assets are
recorded in the financial statements if realization is considered more likely
than not.

6

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|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

|  | Deferred income tax assets and liabilities are presented
      as non-current.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  | Investment tax credits are recognized through income-tax
      expense/recovery when it is considered probable that the tax credit will
      be utilized against taxable earnings.                                                                                                                                                                                                                                                                                                                                                                                                           
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  | Revenue                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  | Revenue is derived from the sale of pulp and lumber and
      from administrative services provided to related parties. It is measured
      at the fair value of the consideration received or receivable, net of
      claims, rebates, returns and discounts, for the sale of goods and services
      in the ordinary course of the Companys business. Historical experience is
      used to estimate and provide for discounts and returns. Volume discounts
      are assessed based on anticipated annual purchases.                                                                 
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  | Revenue is recognized when the significant risks and
      rewards of ownership have been transferred to the customer, the sales
      price and costs can be measured reliably, and it is probable that the
      economic benefits will flow to the Company. These criteria are generally
      met at the time the product is shipped to the customer; title and risk
      have passed to the customer; and acceptance of the product, when
      contractually required, has been obtained.                                                                                              
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  | Government grants                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  | Grants received under government incentive programs are
      recognized initially as deferred revenue at fair value when there is
      reasonable assurance that they will be received and the Company will
      comply with the conditions associated with the grant. Grants that
      compensate the Company for the cost of an asset are deducted against the
      carrying amount of the asset.                                                                                                                                                                                      
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  | Segment reporting                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  | Operating segments are reported in a manner consistent
      with the internal reporting provided to the chief operating
      decision-maker. The chief operating decision-maker has been identified as
      the Companys senior executive team, which collectively makes strategic
      decisions for the segments.                                                                                                                                                                                                                                                                      
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|3 | Critical accounting estimates and
  judgments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  | The preparation of financial statements requires
      management to use judgment in applying its accounting policies and
      estimates and assumptions about the future. Estimates and other judgments
      are continually evaluated and are based on managements experience and
      other factors, including expectations about future events that are
      believed to be reasonable under the circumstances. The following discusses
      the most significant accounting judgments and estimates that the company
      has made in the preparation of the financial
statements:

7

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|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

Power purchase rights

The Companys power purchase rights
arise from a long-term contract for the purchase of power. The underlying
contract that determines the amount the Company pays for power contains many
variables and meets the definition of a derivative contract. However, since the
Company expects to use substantially all of the power supplied under the
contract in its normal operations, the derivative contract is not carried at
fair value in the financial statements. The most difficult and subjective
judgement in the application of this policy is in the determination of normal
usage. Since the contract is for a period of twenty years, management considers
all appropriate facts and circumstances in making this assessment, including
historical experience and long-term expected power usage in its facilities based
on normal production levels. If management determines in the future that the
contract does not meet the exception for normal purchases, the contract would be
carried on the balance sheet at fair value, and since an active market does not
exist for these types of contracts, valuation techniques would be required to
determine fair value.

Useful lives of timber rights

The Companys timber rights comprise
various agreements and contracts that have fixed terms but contain renewal
provisions that could extend the lives of the rights indefinitely. In estimating
the useful lives of timber rights, management has generally assumed that
renewals will occur in the normal course of business, with useful lives not to
exceed 60 years. If the Company was unable to obtain a renewal in the future for
a material agreement, this would have an impact on amortization, as well as in
the determination of discounted cash flows used in impairment tests for other
long-lived assets.

Impairment of long-lived assets

In assessing the impairment of
long-lived assets, the Company generally has determined its recoverable amount
by calculating value in use for its cash generating units using a discounted
cash flow analysis. Key assumptions that have a significant impact on the
value-in-use calculation are the discount rate used for future cash flows and
the forecasted pricing and sales volumes for the products sold by the Company
during the forecast period. Changes in these key assumptions could cause a
material adjustment to the carrying amounts of long-lived assets within the next
financial year.

Recovery of amounts relating to the
Power Purchase Arrangement

The Company made payments of $4.4
million relating to a claim as described in note 11. In estimating the amount to
record as a recoverable asset, the Company considered several possible outcomes
for settlement, the insurance it has available, and the legal and technical
arguments related to each possible settlement scenario. Given the uncertainty
around settlement in the future, the Company assigned equal probability to all
scenarios and recorded an asset for $2.6 million. Where the final outcome of
this matter is different from the recorded amount, any difference will be
reflected in the statement of operations and comprehensive (loss) income in that
period.

8

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|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

|4 | Changes in accounting policies and
  estimates                                                                                                                                                                                     
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                    
|  | The IASB periodically issues new standards and amendments
      or interpretations to existing standards. The new pronouncements listed
      below are those that the Company considers relevant to its financial
      reporting.

| |  | IFRS 9, Financial Instruments  In November 2009 IFRS 9
      was issued and in October 2010 was further amended. IFRS 9 addresses
      classification and measurement of financial assets and replaces the
      multiple category and measurement models in IAS 39 for debt instruments
      with a new mixed measurement model having only two categories: amortized
      cost and fair value through profit and loss. IFRS 9 also replaces the
      models for measuring equity instruments and such instruments are either
      recognized at fair value through profit or loss or at fair value through
      other comprehensive earnings. IFRS 9 is effective for annual periods
      beginning on or after January 1, 2015 with earlier application permitted.
      The Company has not assessed the impact of IRFS 9.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |  | IFRS 13, Fair Value Measurement  In May 2011 IFRS 13 was
      issued which defines fair value, establishes a framework for measuring
      fair value and sets out disclosure requirements for fair value
      measurements. Prior to the introduction of the standard there was no
      single source of guidance on fair value measurement. IFRS 13 is effective
      for annual periods beginning on or after January 1, 2013 with earlier
      application permitted. The Company has not assessed the impact of the
      standard.                                                                                                                                                                                                                                                                                        
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |  | IAS 1, Presentation of Financial Statements 
      Presentation of financial statements was amended and requires companies to
      group items presented within OCI based on whether they may be subsequently
      reclassified to profit or loss. This amendment to IAS 1 is effective for
      annual periods beginning on or after July 1, 2012 with full retrospective
      application. Early adoption is permitted. The Company does not expect this
      amendment to have a significant effect on its financial statements.                                                                                                                                                                                                                                                                                             
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |  | IAS 19, Amendment, Employee Benefits  In June 2011 IAS
      19 was amended. The amendment will result in changes to the recognition
      and measurement of defined benefit pension expense and termination
      benefits, the most significant impact to the Company being the replacement
      of interest cost and expected return on plan assets with a net interest
      amount that is calculated by applying a single discount rate to the net
      defined liability (asset). The amendment is effective for annual periods
      beginning on or after January 1, 2013 with earlier application permitted.
      The Company does not expect the impact of the amendment to be material to
      operations.                                                                                                          

9

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|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

|5 | Cash and cash equivalents and restricted
    cash
|- | -------------------------------------------------

| |                                    |  | 2012   |  |  | 2011   | 
| | ---------------------------------- |  | ------ |  |  | ------ | 
| |                                    |  | $      |  |  | $      | 
| |                                    |  |        |  |  |        | 
| | Deposits at banks and cash on hand |  | 24,674 |  |  | 31,574 | 
| | Short-term deposits                |  | -      |  |  | 56     | 
| |                                    |  |        |  |  |        | 
| |                                    |  | 24,674 |  |  | 31,630 | 

Deposits at banks earn interest at
Canadian banks prime rate minus 1.95% . Short-term deposits with maturities of
three months or less from the date they were acquired earn interest at the
respective short-term deposit rate. Canadian banks prime rate at December 31,
2012 is 3%.

| |                                                     |  | 2012   |  |  | 2011 | 
| | --------------------------------------------------- |  | ------ |  |  | ---- | 
| |                                                     |  | $      |  |  | $    | 
| | Restricted Cash                                     |  |        |  |  |      | 
| | Government grant
      funds                        |  | 11,872 |  |  | -    | 
| | Cash collateral for unrealized derivative contracts |  | 6,952  |  |  | -    | 
| |                                                     |  |        |  |  |      | 
| |                                                     |  | 18,824 |  |  | -    | 

|  | The Company received grant funding for the bioenergy
      effluent project (note 9) that has specific restrictions under the terms
      of the grant agreements, thereby limiting the Companys ability to use the
      funds other than for the project. As various conditions are met, or
      project payments are made, funds will be released or used by the Company
      to satisfy project costs incurred. Of the $11.9 million of funds held at
      December 31, 2012, $10.2 million earns interest at Canadian banks prime
      rate minus 1.95%, while the remainder is non-interest bearing. In
      addition, a letter of credit of $1.7 million has been committed as
      collateral for a portion of the funds in favor or the Province of Alberta.
      Restrictions related to all funds are expected to be met in
2013.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|  | The Company has funds on deposit to cover unrealized
      losses on derivative contracts. Deposits are returned to the Company when
      the derivative contracts expire or the unrealized loss is reduced. These
      funds are non- interest bearing.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|6 | Accounts and other
receivables                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

| |                                    |  | 2012   |   |  | 2011   |  
| | ---------------------------------- |  | ------ | - |  | ------ | -
| |                                    |  | $      |   |  | $      |  
| |                                    |  |        |   |  |        |  
| | Trade receivables                  |  | 17,364 |   |  | 31,184 |  
| | Allowance for doubtful accounts    |  | (43    | ) |  | (124   | )
| | Intercompany receivables (note 23) |  | 39     |   |  | 40     |  
| | Other receivables                  |  | 8,646  |   |  | 6,485  |  
| | Income tax recoverable             |  | -      |   |  | 198    |  
| |                                    |  |        |   |  |        |  
| |                                    |  | 26,006 |   |  | 37,783 |  

Current trade and other receivables are
unsecured and non-interest bearing. Normal payment terms for the Company are 30
days (see also note 24).

10

---

|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

|7 | Inventories
|- | -----------

| |                                    |  | 2012   |  |  | 2011   | 
| | ---------------------------------- |  | ------ |  |  | ------ | 
| |                                    |  | $      |  |  | $      | 
| |                                    |  |        |  |  |        | 
| | Logs                               |  | 23,757 |  |  | 16,223 | 
| | Pulp                               |  | 21,182 |  |  | 21,418 | 
| | Lumber                             |  | 18,632 |  |  | 17,213 | 
| | Operating and maintenance supplies |  | 14,017 |  |  | 13,114 | 
| |                                    |  |        |  |  |        | 
| |                                    |  | 77,588 |  |  | 67,968 | 

|  | In 2011, the Company recognized write-downs of
      inventories to net realizable value of $1.9 million, which was included in
      cost of products sold. There were no similar write-downs in
2012.
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                        
|8 | Property, plant and
equipment                                                                                                                                                                          

ProcessLand
    
    
    Buildings
    
    
    equipment
    
    
    Other
    
    
    Total$
    
    
    $
    
    
    $
    
    
    $
    
    
    $Year ended December 31, 2011At January 1, 2011
    
    1,799
    
    
    28,786
    
    
    96,356
    
    
    5,788
    
    
    132,729Additions
    
    1,262
    
    
    19,082
    
    
    25,622
    
    
    1,584
    
    
    47,550Disposals
    
    (798
    )
    
    (55
    )
    
    (1
    )
    
    (68
    )
    
    (922
    )Depreciation for the year
    
    -
    
    
    (3,375
    )
    
    (2,074
    )
    
    (1,090
    )
    
    (6,539
    )At December 31, 2011
    
    2,263
    
    
    44,438
    
    
    119,903
    
    
    6,214
    
    
    172,818At December 31, 2011Cost
    
    2,263
    
    
    81,221
    
    
    321,101
    
    
    17,186
    
    
    421,771Accumulated depreciation
    
    -
    
    
    (36,783
    )
    

    (201,198
    )
    
    (10,972
    )
    
    (248,953
    )Net book value
    
    2,263
    
    
    44,438
    
    
    119,903
    
    
    6,214
    
    
    172,818Year ended December 31, 2012At January 1, 2012
    
    2,263
    
    
    44,438
    
    
    119,903
    
    
    6,214
    
    
    172,818Additions
    
    -
    
    
    1,177
    
    
    8,746
    
    
    1,577
    
    
    11,500Disposals
    
    -
    
    
    (7
    )
    
    (94
    )
    
    (113
    )
    
    (214
    )Depreciation for the year
    
    -
    
    
    (1,525
    )
    
    (6,073
    )
    
    (1,211
    )
    
    (8,809
    )Net book value
    
    2,263
    
    
    44,083
    
    
    122,482
    
    
    6,467
    
    
    175,295


11

---

|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

Assets under construction included
    
    
    
    
    
    
    
    Processin net book value above
    
    Land
    
    
    Buildings
    
    
    equipment
    
    
    Other
    
    
    Total$
    
    
    $
    
    
    $
    
    
    $
    
    
    $At December 31, 2012
    
    -
    
    
    36
    
    
    6,743
    
    
    177
    
    
    6,956At December 31, 2011
    
    -
    
    
    475
    
    
    5,909
    
    
    173
    
    
    6,557


|   | In 2012, depreciation of $8.8 million (2011  $6.5
      million) was presented in depreciation and amortization expense on the
      statement of operations and comprehensive (loss) income.                                                                                                                                                                                                                                              
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   | Borrowing costs of $0.1 million (2011  $3.6 million)
      were capitalized for the Fox Creek sawmill rebuild based on an average
      annual capitalization rate of 8.2% (2011  8.4%).                                                                                                                                                                                                                                                  
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                             
|9  | Bioenergy effluent project                                                                                                                                                                                                                                                                                                                                                                                                                  
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   | In 2012, the Company commenced a bioenergy effluent
      project (BEP) at its BCTMP mill at Whitecourt, Alberta. The project
      involves construction and integration of two anaerobic hybrid digesters
      into the BCTMP mills existing aerobic effluent treatment system.
      Construction commenced in the third quarter of 2012, with substantial
      completion expected by the first quarter of 2014.                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   | The project qualified for a total of $27.5 million in
      government grants, of which $20.5 million had been received by the Company
      at December 31, 2012. Of the amounts received, $11.9 million is presented
      in restricted cash (note 5), with the offset recorded in deferred grants
      (note 13), and $8.6 million is recorded against total project expenditures
      of $13.6 million incurred to December 31, 2012.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                             
|10 | Intangible assets                                                                                                                                                                                                                                                                                                                                                                                                                           

| |                                   |  |        |   |  |          |   |  | Power    |   |  |         |  
| | --------------------------------- |  | ------ | - |  | -------- | - |  | -------- | - |  | ------- | -
| |                                   |  | Timber |   |  | Computer |   |  | purchase |   |  |         |  
| |                                   |  | rights |   |  | software |   |  | rights   |   |  | Total   |  
| |                                   |  | $      |   |  | $        |   |  | $        |   |  | $       |  
| |                                   |  |        |   |  |          |   |  |          |   |  |         |  
| | Year ended December 31, 2011      |  |        |   |  |          |   |  |          |   |  |         |  
| | At
      January 1, 2011          |  | 10,558 |   |  | 293      |   |  | 43,409   |   |  | 54,260  |  
| | Additions                         |  | -      |   |  | 38       |   |  | -        |   |  | 38      |  
| | Amortization
      for the period |  | (426   | ) |  | (43      | ) |  | (4,341   | ) |  | (4,810  | )
| |                                   |  |        |   |  |          |   |  |          |   |  |         |  
| | At December 31, 2011              |  | 10,132 |   |  | 288      |   |  | 39,068   |   |  | 49,488  |  
| |                                   |  |        |   |  |          |   |  |          |   |  |         |  
| | At December 31, 2011              |  |        |   |  |          |   |  |          |   |  |         |  
| | Cost                              |  | 15,732 |   |  | 9,590    |   |  | 67,783   |   |  | 93,105  |  
| | Accumulated
      amortization    |  | (5,600 | ) |  | (9,302   | ) |  | (28,715  | ) |  | (43,617 | )
| |                                   |  |        |   |  |          |   |  |          |   |  |         |  
| | Net book value                    |  | 10,132 |   |  | 288      |   |  | 39,068   |   |  | 49,488  |  

12

---

|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

| |                                   |  |        |   |  |          |   |  | Power    |   |  |         |  
| | --------------------------------- |  | ------ | - |  | -------- | - |  | -------- | - |  | ------- | -
| |                                   |  | Timber |   |  | Computer |   |  | purchase |   |  |         |  
| |                                   |  | rights |   |  | software |   |  | rights   |   |  | Total   |  
| |                                   |  | $      |   |  | $        |   |  | $        |   |  | $       |  
| |                                   |  |        |   |  |          |   |  |          |   |  |         |  
| | Year ended December 31, 2012      |  |        |   |  |          |   |  |          |   |  |         |  
| | At January 1, 2012                |  | 10,132 |   |  | 288      |   |  | 39,068   |   |  | 49,488  |  
| | Additions                         |  | -      |   |  | 204      |   |  | -        |   |  | 204     |  
| | Amortization
      for the period |  | (426   | ) |  | (65      | ) |  | (4,341   | ) |  | (4,832  | )
| |                                   |  |        |   |  |          |   |  |          |   |  |         |  
| | Closing net book value            |  | 9,706  |   |  | 427      |   |  | 34,727   |   |  | 44,860  |  
| |                                   |  |        |   |  |          |   |  |          |   |  |         |  
| |                                   |  |        |   |  |          |   |  |          |   |  |         |  
| | At December 31, 2012              |  |        |   |  |          |   |  |          |   |  |         |  
| | Cost                              |  | 15,732 |   |  | 9,639    |   |  | 67,783   |   |  | 93,154  |  
| | Accumulated
      amortization    |  | (6,026 | ) |  | (9,212   | ) |  | (33,056  | ) |  | (48,294 | )
| |                                   |  |        |   |  |          |   |  |          |   |  |         |  
| | Net book value                    |  | 9,706  |   |  | 427      |   |  | 34,727   |   |  | 44,860  |  

|   | Power purchase rights                                                                                                                                                                                                                                                                                                                                
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                                                                                                                                                                                      
|   | In 2001 and 2006, the Company entered into agreements to
      acquire the rights to a portion of the electricity generated from certain
      power plants in Alberta. These 20-year agreements give the Company the
      entitlement and obligation to purchase, at largely predetermined prices,
      approximately 80 megawatts of electricity.
|   |                                                                                                                                                                                                                                                                                                                                                      
|   | In 2012, amortization of $4.31 million (2011  $4.31
      million) was presented in depreciation and amortization expense on the
      statement of operations and comprehensive (loss) income.                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                      
|11 | Other assets                                                                                                                                                                                                                                                                                                                                         

| |                   |  | 2012  |  |  | 2011 | 
| | ----------------- |  | ----- |  |  | ---- | 
| |                   |  | $     |  |  | $    | 
| |                   |  |       |  |  |      | 
| | Recovery from PPA |  | 2,549 |  |  | -    | 
| | Other             |  | 361   |  |  | 315  | 
| |                   |  |       |  |  |      | 
| |                   |  | 2,910 |  |  | 315  | 

13

---

|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

|   | Recovery of amounts relating to the Power Purchase
      Arrangement                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   | The Company was notified on July 26, 2012, that TransAlta
      Generation Partnership, owner of the Sundance power plant, would be making
      a force majeure claim against participants in the Sundance Power Purchase
      Arrangement (PPA), with respect to the 2011 third quarter outage of the
      plants Unit 6 due to a transformer failure. The Company has an 11.27%
      interest in the Sundance PPA for Units 5 and 6 and thus is contractually
      responsible for paying its share of the claimed amount in advance of final
      determination as to whether or not a force majeure situation, as specified
      in the PPA, occurred. Based on legal and technical arguments, we do not
      believe it meets the PPA-specified tests for such a determination.
      However, the Company paid its share of the claim in the third quarter of
      2012 of $4.4 million to meet contractual obligations and set up a
      receivable for the full amount. The Company reviewed all possible outcomes
      for settlement of the claim and has set up a provision of $1.9 million
      before tax (see note 3). This leaves a balance of $2.6 million
      recoverable, pending final resolution of the claim. This amount is
      included in other assets on the balance sheet.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|12 | Revolving credit facility                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   | The Company has a $50 million revolving credit facility
      maturing July 15, 2015. The credit facility was undrawn at December 31,
      2012, and December 31, 2011. The facility is subject to a borrowing
      formula based upon the Companys levels of inventory and accounts
      receivable. The amount available at December 31, 2012, under the facility
      was $50.0 million (2011  $50.0 million), of which $3.6 million (2011 
      $3.6 million) was committed to letters of credit. The interest rate on
      this facility is floating and may, at the Companys option, be based upon
      the Bank Prime Rate or U.S. Base Rate, plus a spread of 2.00%. The Company
      has the option of basing the rate on LIBOR plus a spread of 3.25%.
      Collateral pledged for the facility is a first charge on all accounts
      receivable and domestic inventory of the Company.                                                                                                                                                                                                                                                                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|13 | Accounts payable and accrued
  liabilities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

| |                                         |  | 2012   |  |  | 2011   | 
| | --------------------------------------- |  | ------ |  |  | ------ | 
| |                                         |  | $      |  |  | $      | 
| |                                         |  |        |  |  |        | 
| | Trade payables                          |  | 20,961 |  |  | 16,561 | 
| | Payable to related parties (note 23(b)) |  | 650    |  |  | 898    | 
| | Accrued expenses                        |  | 23,525 |  |  | 20,396 | 
| | Deferred grants (note 9)                |  | 11,872 |  |  | -      | 
| | Derivative contracts                    |  | 6,952  |  |  | -      | 
| |                                         |  |        |  |  |        | 
| |                                         |  | 63,960 |  |  | 37,855 | 

14

---

|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

|14 | Financial liabilities 
  borrowings
|-- | ------------------------------------

| |                                     |  | 2012    |   |  | 2011    |  
| | ----------------------------------- |  | ------- | - |  | ------- | -
| |                                     |  | $       |   |  | $       |  
| |                                     |  |         |   |  |         |  
| | Unsecured senior notes  US$210,000 |  | 208,929 |   |  | 213,570 |  
| | Less: Financing expenses            |  | (4,107  | ) |  | (4,604  | )
| | Power purchase rights loan #1       |  | 11,500  |   |  | 12,334  |  
| | Power purchase rights loan #2       |  | 2,111   |   |  | 2,254   |  
| | BEP Loan                            |  | 4,312   |   |  | -       |  
| |                                     |  |         |   |  |         |  
| |                                     |  | 222,745 |   |  | 223,554 |  
| | Less: Current portion               |  | 1,092   |   |  | 978     |  
| |                                     |  |         |   |  |         |  
| |                                     |  | 221,653 |   |  | 222,576 |  

Principal repayments required are as
follows:

$2013
    
    1,0922014
    
    5,5312015
    
    1,3622016
    
    1,5212017
    
    1,699Thereafter
    
    215,646


On April 1, 2011, the Company redeemed
its US$190 million in senior notes due November 2013 and issued US$210 million
in senior notes due April 1, 2021, bearing interest at 8.5%, payable
semi-annually, on April 1 and October 1 of each year. The new notes are
unsecured obligations of the Company and rank equally and rateably with all
existing and future unsecured indebtedness of the Company.

The Company incurred $5.0 million of
financing costs relating to the issuance of US$210 million of unsecured senior
notes. The financing costs are offset against the borrowings and are amortized
over the ten-year life of the notes.

The indenture governing the unsecured
senior notes contains certain restrictions on the ability of the Company to
incur additional indebtedness, pay dividends or distributions, make investments,
issue or repurchase share capital, create liens, or engage in sale and leaseback
transactions, mergers, consolidations and sales of assets and transactions with
affiliates. At December 31, 2012, the Company is not in violation of any of
these restrictions.

In 2006, the Company was provided with
a $15.6 million loan to acquire additional power purchase rights as described in
note 10. The loan is repayable in equal monthly payments of $0.2 million,
including principal and interest, from May 31, 2006, to December 31, 2020.
Interest is accrued on the loan at an effective annual rate of 12%.

15

---

|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

|   | In 2007, the Company was provided with a further $5.1
      million loan in connection with the power purchase rights. The loan is
      non-interest bearing and is repayable in equal annual payments of $0.4
      million from February 23, 2008, to December 31, 2020. The loan is being
      amortized using an effective annual interest rate of 9.75%.                           
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                                                                                                                                                                                                                           
|   | Collateral for both of the power purchase rights loans
      consists of a first charge on the additional interest acquired in 2006 and
      an obligation to provide a letter of credit to the lender if the net
      present value of the Companys power purchase rights falls below a
      predetermined level. As at December 31, 2012, a letter of credit was not
      required.
|   |                                                                                                                                                                                                                                                                                                                                                                                           
|   | The Company has obtained interim financing in the amount
      of $13.2 million, bearing interest at Canadian Banks Prime Rate plus 2%,
      to procure the biogas scrubber and power island, key project components
      for the BEP (note 9), of which $4.3 million was advanced at December 31,
      2012.                                                                         
|   |                                                                                                                                                                                                                                                                                                                                                                                           
|15 | Other obligations                                                                                                                                                                                                                                                                                                                                                                         

| |                              |  |               |   |  | Asset       |  |  |        |  
| | ---------------------------- |  | ------------- | - |  | ----------- |  |  | ------ | -
| |                              |  | Reforestation |   |  | retirement  |  |  |        |  
| |                              |  | obligation    |   |  | obligations |  |  | Total  |  
| |                              |  | $             |   |  | $           |  |  | $      |  
| |                              |  |               |   |  |             |  |  |        |  
| | At December 31, 2010         |  | 15,808        |   |  | 1,046       |  |  | 16,854 |  
| | Additional provisions        |  | 6,708         |   |  | 956         |  |  | 7,664  |  
| | Expenditures during the year |  | (7,325        | ) |  | -           |  |  | (7,325 | )
| |                              |  |               |   |  |             |  |  |        |  
| | At December 31, 2011         |  | 15,191        |   |  | 2,002       |  |  | 17,193 |  
| | Less: Current portion        |  | 5,205         |   |  | -           |  |  | 5,205  |  
| |                              |  |               |   |  |             |  |  |        |  
| | At December 31, 2011         |  | 9,986         |   |  | 2,002       |  |  | 11,988 |  
| |                              |  |               |   |  |             |  |  |        |  
| | At December 31, 2011         |  | 15,191        |   |  | 2,002       |  |  | 17,193 |  
| | Additional provisions        |  | 7,298         |   |  | 204         |  |  | 7,502  |  
| | Expenditures during the year |  | (7,256        | ) |  | -           |  |  | (7,256 | )
| |                              |  |               |   |  |             |  |  |        |  
| | At December 31, 2012         |  | 15,233        |   |  | 2,206       |  |  | 17,439 |  
| | Less: Current portion        |  | 5,070         |   |  | -           |  |  | 5,070  |  
| |                              |  |               |   |  |             |  |  |        |  
| | At December 31, 2012         |  | 10,163        |   |  | 2,206       |  |  | 12,369 |  

The estimated undiscounted cash flows
required to settle the reforestation obligations at December 31, 2012, were
$15.6 million (2011  $15.6 million), with payments spread over 14 years. The
most significant area of uncertainty is the estimate of future costs to be
incurred. The estimated cash flows have been adjusted for inflation and
discounted using the risk-free rates ranging from 1.1% to 2.3% at December 31,
2012.

The asset retirement obligations are to
reclaim land leased from the Province of Alberta. These obligations represent
estimated undiscounted future payments of $8.3 million to reclaim the land. The
payments are expected to occur at least 40 years into the future and have been
discounted at a risk-free rate of 2.4% .

16

---

|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

|16 | Share capital                                 
|-- | ----------------------------------------------
|   |                                               
|   | Authorized                                    
|   |                                               
|   | Unlimited number of no-par value common shares
|   |                                               
|   | Issued and fully paid                         

| |                          |  | 2012   |  |  | 2011   | 
| | ------------------------ |  | ------ |  |  | ------ | 
| |                          |  | $      |  |  | $      | 
| |                          |  |        |  |  |        | 
| | 15,000,002 common shares |  | 65,500 |  |  | 61,500 | 

|   | On March 31, 2011, the shareholder passed a resolution to
      increase the stated capital of the Company to $27.5 million, and on May
      31, 2011, the shareholder passed a resolution to increase the stated
      capital by an additional $34.0 million. On December 17, 2012, the
      shareholder passed a resolution to increase the stated capital by $4.0
      million.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   | The shareholder declared dividends of $2.25 million in
      2011, of which $1.5 million was paid in 2011 and the balance of $0.75
      million in 2012.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|17 | Acquisition of Chickadee Creek Energy
  Inc.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   | Effective September 12, 2012, the Company acquired a 100%
      interest in a related company, Chickadee Creek Energy Inc. (CCEI), and
      simultaneously wound CCEI up into the Company. Prior to the acquisition,
      CCEI was a wholly owned subsidiary of the Companys parent, Millar Western
      Industries Ltd. . At the time of the transaction, CCEI had no active
      operations; however, it had previously secured a government grant and had
      recently obtained approval from the appropriate government authority to
      direct the grant proceeds to the BEP, as described in note 9. Since the
      transaction was between companies under common control, and since CCEI had
      no active operations, it has been accounted for as an asset acquisition at
      predecessor carrying amounts. The following table summarizes the assets
      acquired and liabilities assumed in the
transaction.

17

---

|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

$Assets acquiredCash
    
    36Restricted cash
    
    3,445Deferred income taxes
    
    1163,597Liabilities assumedAccounts
      payable
    
    51Deferred grant revenue
    
    3,445Payable
      to parent (unsecured, non-interest bearing)
    
    4313,927Net deficiency in assets acquired
    
    ( 330
    )


|   | The net deficiency in assets acquired has been presented
      as a reduction of the Companys retained earnings in the statement of
      shareholders equity, reflecting the net transfer of resources to the
      parent.
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                                                               
|18 | Expenses by nature                                                                                                                                                                                                            

| |                                                                     |  | 2012    |   |  | 2011    |   |  | 2010    |  
| | ------------------------------------------------------------------- |  | ------- | - |  | ------- | - |  | ------- | -
| |                                                                     |  | $       |   |  | $       |   |  | $       |  
| |                                                                     |  |         |   |  |         |   |  |         |  
| | Changes in inventories of finished goods
      and work in progress |  | (2,959  | ) |  | (5,423  | ) |  | (6,524  | )
| | Raw materials and consumables used                                  |  | 155,817 |   |  | 136,605 |   |  | 121,793 |  
| | Depreciation and amortization                                       |  | 13,641  |   |  | 11,349  |   |  | 11,029  |  
| | Wages and employee benefits expense                                 |  | 60,211  |   |  | 56,424  |   |  | 49,861  |  
| | Transportation                                                      |  | 53,221  |   |  | 48,563  |   |  | 49,565  |  
| | Other expenses                                                      |  | 49,402  |   |  | 9,591   |   |  | 42,342  |  
| |                                                                     |  |         |   |  |         |   |  |         |  
| |                                                                     |  | 329,333 |   |  | 257,109 |   |  | 268,066 |  

18

---

|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

|19 | Other (expenses)
income
|-- | -----------------------

| |                                                                |  | 2012   |   |  | 2011   |  |  | 2010   |  
| | -------------------------------------------------------------- |  | ------ | - |  | ------ |  |  | ------ | -
| |                                                                |  | $      |   |  | $      |  |  | $      |  
| |                                                                |  |        |   |  |        |  |  |        |  
| | Gain (loss) on disposal of property, plant
      and equipment |  | 45     |   |  | 436    |  |  | (1,119 | )
| | Foreign exchange (loss) gain                                   |  | (839   | ) |  | 963    |  |  | (2,593 | )
| | Fox Creek insurance claim                                      |  | -      |   |  | 7,600  |  |  | -      |  
| | Change in unrealized (loss) gain on derivative contracts       |  | (6,612 | ) |  | 2,594  |  |  | (3,125 | )
| | Realized (loss) gain on derivative
      contracts             |  | (244   | ) |  | 14,158 |  |  | (3,006 | )
| |                                                                |  |        |   |  |        |  |  |        |  
| |                                                                |  | (7,650 | ) |  | 25,751 |  |  | (9,843 | )

|   | In November 2011, the insurer of the Fox Creek facility
      paid the remaining $7.6 million payable from the 2008 fire damage to the
      sawmill.
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                      
|20 | Financing expenses                                                                                                                                   

| |                                                 |  | 2012   |   |  | 2011   |   |  | 2010   |  
| | ----------------------------------------------- |  | ------ | - |  | ------ | - |  | ------ | -
| |                                                 |  | $      |   |  | $      |   |  | $      |  
| |                                                 |  |        |   |  |        |   |  |        |  
| | Interest expense on borrowings                  |  | 19,694 |   |  | 19,400 |   |  | 17,223 |  
| | Less: Interest capitalized on qualifying assets |  | 106    |   |  | 3,555  |   |  | 381    |  
| |                                                 |  |        |   |  |        |   |  |        |  
| | Net interest expense on borrowings              |  | 19,588 |   |  | 15,845 |   |  | 16,842 |  
| | Refinancing charges                             |  | -      |   |  | 4,590  |   |  | -      |  
| | Other interest and bank charges                 |  | 1,027  |   |  | 775    |   |  | 991    |  
| | Interest income                                 |  | (190   | ) |  | (363   | ) |  | (373   | )
| |                                                 |  |        |   |  |        |   |  |        |  
| |                                                 |  | 20,425 |   |  | 20,847 |   |  | 17,460 |  

In April 2011, the Company incurred
refinancing charges relating to the redemption of US$190 million of unsecured
senior notes that included a premium on redemption of borrowings of $2.78
million and amortization of deferred financing costs of $1.81 million.

19

---

|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

|21 | Income tax expense                                                                                                                                                                       
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                          
|   | The following analysis describes the difference between
      the effective tax rate reflected in the provision for income taxes and the
      statutory rates applicable to the Company.

| |                                                                                                                                         |  | 2012    |   |  | 2011   |   |  | 2010   |  
| | --------------------------------------------------------------------------------------------------------------------------------------- |  | ------- | - |  | ------ | - |  | ------ | -
| |                                                                                                                                         |  | $       |   |  | $      |   |  | $      |  
| |                                                                                                                                         |  |         |   |  |        |   |  |        |  
| | (Loss) income before income taxes                                                                                                       |  | (12,716 | ) |  | 1,208  |   |  | 20,573 |  
| |                                                                                                                                         |  |         |   |  |        |   |  |        |  
| | Income taxes based on combined federal and
      provincial
      income           
      tax rates of 32.0% (2011  33.5%; 2010  35%) |  | (4,069  | ) |  | 405    |   |  | 7,262  |  
| |                                                                                                                                         |  |         |   |  |        |   |  |        |  
| | Increase (decrease) resulting from                                                                                                      |  |         |   |  |        |   |  |        |  
| | Manufacturing
      and processing deduction of 7%                                                                                      |  | 890     |   |  | (85    | ) |  | (1,452 | )
| | Non-taxable
      portion of unrealized (gain) loss on debt                                                                             |  | (580    | ) |  | 1,619  |   |  | (1,500 | )
| | Non-taxable
      portion of capital gains                                                                                              |  | (25     | ) |  | (1,620 | ) |  | (10    | )
| | Non-deductible(taxable)
      income and other items                                                                                    |  | 173     |   |  | 181    |   |  | (44    | )
| | SRED investment
      tax credits - net                                                                                                 |  | (266    | ) |  | (638   | ) |  | (910   | )
| | Impact of enacted rates                                                                                                                 |  | -       |   |  | 47     |   |  | (432   | )
| | Change
      in unrealized tax capital losses for which
      no                       deferred
      tax asset was recognized          |  | (580    | ) |  | 1,528  |   |  | -      |  
| |                                                                                                                                         |  |         |   |  |        |   |  |        |  
| | Income tax (recovery) expense                                                                                                           |  | (4,457  | ) |  | 1,437  |   |  | 2,914  |  
| |                                                                                                                                         |  |         |   |  |        |   |  |        |  
| | Current income tax recovery                                                                                                             |  | (132    | ) |  | (248   | ) |  | (80    | )
| | Deferred income tax (recovery) expense                                                                                                  |  | (4,325  | ) |  | 1,685  |   |  | 2,994  |  
| |                                                                                                                                         |  |         |   |  |        |   |  |        |  
| | Income tax (recovery) expense                                                                                                           |  | (4,457  | ) |  | 1,437  |   |  | 2,914  |  

The weighted average applicable tax
rate was 32.0% (2011  33.5%; 2010  35%). The decrease in rate is due to a
previously legislated decrease in the federal statutory corporate income tax
rate from fiscal 2011 to fiscal 2012.

Current income tax recovery includes a
$0.132 million recovery in respect to prior year adjustments.

The Company did not recognize a
deferred income tax asset of $0.95 million (2011 - $1.5 million; 2010  $nil) in
respect of unrealized foreign exchange losses on long-term debt.

At December 31, 2012, the Company had
approximately $43.1 million of federal and $43.2 million of provincial
non-capital losses available to reduce future years income for tax purposes,
subject to confirmation by taxation authorities. The losses for both
jurisdictions commence expiry in the December 31, 2029, taxation year.

20

---

|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

The movement of the deferred income tax
account is as follows:

| |                                                                                  |  | 2012   |   |  | 2011  |  
| | -------------------------------------------------------------------------------- |  | ------ | - |  | ----- | -
| |                                                                                  |  | $      |   |  | $     |  
| |                                                                                  |  |        |   |  |       |  
| | At January 1                                                                     |  | 6,440  |   |  | 4,829 |  
| | (Credit) charge to the statement of income                                       |  | (4,325 | ) |  | 1,685 |  
| | Tax credit related to acquisition of
      Chickadee Creek Energy Inc.  note 17 |  | (116   | ) |  | -     |  
| | Tax credit relating to components of other comprehensive
      income            |  | (106   | ) |  | (74   | )
| |                                                                                  |  |        |   |  |       |  
| | At December 31                                                                   |  | 1,893  |   |  | 6,440 |  

Significant components of the Companys
deferred income tax assets and liabilities are as follows:

| |                                                    |  | 2012    |   |  | 2011    |  
| | -------------------------------------------------- |  | ------- | - |  | ------- | -
| |                                                    |  | $       |   |  | $       |  
| |                                                    |  |         |   |  |         |  
| | Deferred income tax assets                         |  |         |   |  |         |  
| | Reforestation
      costs                          |  | 3,256   |   |  | 3,301   |  
| | Research and development expenditures              |  | 962     |   |  | 924     |  
| | Non-capital loss
      available for carry forward |  | 10,905  |   |  | 4,392   |  
| | Investment tax credits                             |  | 1,874   |   |  | 1,740   |  
| | Other accrued
      liabilities                    |  | 2,876   |   |  | 1,234   |  
| |                                                    |  |         |   |  |         |  
| |                                                    |  | 19,873  |   |  | 11,591  |  
| |                                                    |  |         |   |  |         |  
| | Deferred income tax liabilities                    |  |         |   |  |         |  
| | Property, plant and equipment                      |  | (21,132 | ) |  | (17,150 | )
| | Long-term debt                                     |  | (634    | ) |  | (881    | )
| |                                                    |  |         |   |  |         |  
| |                                                    |  | (21,766 | ) |  | (18,031 | )
| |                                                    |  |         |   |  |         |  
| | Net deferred income tax liability                  |  | (1,893  | ) |  | (6,440  | )

The Company has recognized a deferred
tax asset of $0.023 million in regards to non-refundable and refundable
investment tax credits derived from research and development expenditures
incurred in 2012.

| |                                                 |  | 2012    |   |  | 2011    |  
| | ----------------------------------------------- |  | ------- | - |  | ------- | -
| |                                                 |  | $       |   |  | $       |  
| |                                                 |  |         |   |  |         |  
| | Deferred income tax assets                      |  |         |   |  |         |  
| | To be recovered
      after more than 12 months |  | 19,157  |   |  | 10,787  |  
| | To
      be recovered within 12 months          |  | 716     |   |  | 804     |  
| |                                                 |  |         |   |  |         |  
| | Deferred income tax liabilities                 |  |         |   |  |         |  
| | To be recovered
      after more than 12 months |  | (21,766 | ) |  | (18,031 | )
| |                                                 |  |         |   |  |         |  
| | Net deferred income tax liability               |  | (1,893  | ) |  | (6,440  | )

21

---

|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

|22 | Employee benefit plans
|-- | ----------------------

| |                                     |  | 2012  |   |  | 2011  |  
| | ----------------------------------- |  | ----- | - |  | ----- | -
| |                                     |  | $     |   |  | $     |  
| |                                     |  |       |   |  |       |  
| | Balance sheet obligations for       |  |       |   |  |       |  
| | Defined-benefit
      pension plan  |  | 3,187 |   |  | 2,920 |  
| | Post-employment benefits            |  | 303   |   |  | 423   |  
| | Supplemental
      vacations        |  | 1,333 |   |  | 1,316 |  
| | Income statement charges (recovery) |  |       |   |  |       |  
| | Defined-benefit
      pension plan  |  | 370   |   |  | 1,873 |  
| | Post-employment medical benefits    |  | (120  | ) |  | 214   |  
| | Supplemental
      vacations        |  | 17    |   |  | (11   | )

Defined-contribution plans

The total expense for the Companys
pension benefits are as follows:

| |                                                             |  | 2012  |  |  | 2011  | 
| | ----------------------------------------------------------- |  | ----- |  |  | ----- | 
| |                                                             |  | $     |  |  | $     | 
| |                                                             |  |       |  |  |       | 
| | Plans providing defined contribution
      pension benefits |  | 3,278 |  |  | 2,964 | 

Defined-benefit pension plan

On January 1, 2000, the Company
established a supplementary defined-benefit pension plan for certain key
employees. Contributions by the Company are made in accordance with independent
actuarial valuations. The effective date for the last actuarial valuation was
December 31, 2012.

Information regarding this plan is as
follows:

| |                                      |  | 2012  |   |  | 2011  |  
| | ------------------------------------ |  | ----- | - |  | ----- | -
| |                                      |  | $     |   |  | $     |  
| |                                      |  |       |   |  |       |  
| | Change in benefit obligation         |  |       |   |  |       |  
| | Obligation 
      Beginning of year |  | 6,669 |   |  | 4,682 |  
| | Actuarial loss (gain)                |  | 493   |   |  | 165   |  
| | Current service
      cost           |  | 176   |   |  | 138   |  
| | Benefits paid                        |  | (225  | ) |  | (141  | )
| | Interest cost                        |  | 283   |   |  | 245   |  
| | Amendments                           |  | -     |   |  | 1,580 |  
| |                                      |  |       |   |  |       |  
| | Obligation  End of year             |  | 7,396 |   |  | 6,669 |  

22

---

|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

| |                                       |  | 2012  |   |  | 2011  |  
| | ------------------------------------- |  | ----- | - |  | ----- | -
| |                                       |  | $     |   |  | $     |  
| | Change in plan assets at fair value   |  |       |   |  |       |  
| | Plan assets 
      Beginning of year |  | 3,749 |   |  | 3,402 |  
| | Employer contributions                |  | 526   |   |  | 526   |  
| | Actual return on
      plan assets    |  | 159   |   |  | (38   | )
| | Benefits paid                         |  | (225  | ) |  | (141  | )
| |                                       |  |       |   |  |       |  
| | Plan assets  End of year             |  | 4,209 |   |  | 3,749 |  
| |                                       |  |       |   |  |       |  
| | Net plan liability                    |  | 3,187 |   |  | 2,920 |  

| |                                |  | 2012 |   |  | 2011  |   |  | 2010 |  
| | ------------------------------ |  | ---- | - |  | ----- | - |  | ---- | -
| |                                |  | $    |   |  | $     |   |  | $    |  
| | Components of pension expense  |  |      |   |  |       |   |  |      |  
| | Interest costs                 |  | 283  |   |  | 245   |   |  | 193  |  
| | Expected return on plan assets |  | (89  | ) |  | (90   | ) |  | (77  | )
| | Current service
      costs    |  | 176  |   |  | 138   |   |  | 78   |  
| | Plan amendments                |  | -    |   |  | 1,580 |   |  | -    |  
| |                                |  |      |   |  |       |   |  |      |  
| | Net expense                    |  | 370  |   |  | 1,873 |   |  | 194  |  

| |                               |  | 2012 |  |  | 2011 |  |  | 2010 | 
| | ----------------------------- |  | ---- |  |  | ---- |  |  | ---- | 
| |                               |  | %    |  |  | %    |  |  | %    | 
| |                               |  |      |  |  |      |  |  |      | 
| | Plan assets by asset category |  |      |  |  |      |  |  |      | 
| | Equity securities             |  | 27   |  |  | 28   |  |  | 28   | 
| | Debt securities               |  | 13   |  |  | 20   |  |  | 20   | 
| | Other                         |  | 60   |  |  | 52   |  |  | 52   | 
| |                               |  |      |  |  |      |  |  |      | 
| | Total                         |  | 100  |  |  | 100  |  |  | 100  | 

The overall expected rate of return is
based on the actuarys median annualized future return based on the target asset
mix and equity risk premium, less allowances for investment expenses and active
equity management.

The significant actuarial assumptions
used are as follows:

| |                                                  |  | 2012 |  |  | 2011 | 
| | ------------------------------------------------ |  | ---- |  |  | ---- | 
| |                                                  |  | %    |  |  | %    | 
| |                                                  |  |      |  |  |      | 
| | To determine benefit obligation at end of year   |  |      |  |  |      | 
| | Discount rate                                    |  | 3.8  |  |  | 4.3  | 
| | Rate of
      compensation increase              |  | 3.7  |  |  | 3.5  | 
| | Expected long-term rate of return on plan assets |  | 2.25 |  |  | 2.5  | 

23

---

|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

|23 | Related-party transactions                                                                                      
|-- | ----------------------------------------------------------------------------------------------------------------
|   |                                                                                                                 
|   | The Company enters into transactions with Millar Western
      Industries Ltd. (Industries), its parent
company.

| | a) | The Company earned revenue from Industries as
    follows:
| | -- | ----------------------------------------------------------

| |                                                                      |  | 2012 |  |  | 2011 |  |  | 2010 | 
| | -------------------------------------------------------------------- |  | ---- |  |  | ---- |  |  | ---- | 
| |                                                                      |  | $    |  |  | $    |  |  | $    | 
| |                                                                      |  |      |  |  |      |  |  |      | 
| | Administration fees                                                  |  | 367  |  |  | 373  |  |  | 295  | 
| |                                                                      |  |      |  |  |      |  |  |      | 
| | Included in accounts receivable relating to
      these transactions |  | 39   |  |  | 40   |  |  | 31   | 

| |    | Fees are established at the cost to the Company plus a 5%
      mark-up.
| | -- | ------------------------------------------------------------------------
| |    |                                                                         
| | b) | The Company incurred costs charged by Industries as
      follows:      

| |                                |  | 2012  |  |  | 2011  |  |  | 2010  | 
| | ------------------------------ |  | ----- |  |  | ----- |  |  | ----- | 
| |                                |  | $     |  |  | $     |  |  | $     | 
| |                                |  |       |  |  |       |  |  |       | 
| | Chemical purchases             |  | 922   |  |  | 891   |  |  | 735   | 
| |                                |  |       |  |  |       |  |  |       | 
| | Other services                 |  | 1,862 |  |  | 1,751 |  |  | 1,691 | 
| |                                |  |       |  |  |       |  |  |       | 
| | Accounts payable to Industries |  | 650   |  |  | 898   |  |  | 152   | 

| |    | Chemical purchases are charged to the Company at the same
      prices used for arms-length parties; facility and equipment transactions
      are charged at the cost of the parent company. Included in accounts
      payable is $431 thousand assumed in the CCEI purchase (note 17).
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                          
| | c) | Key management compensation                                                                                                                                                                                                                                                              
| |    |                                                                                                                                                                                                                                                                                          
| |    | Key management includes members of the executive and
      officers of the Company. The compensation for key management for services
      is as follows:                                                                                                                                

| |                          |  | 2012  |  |  | 2011  |  |  | 2010  | 
| | ------------------------ |  | ----- |  |  | ----- |  |  | ----- | 
| |                          |  | $     |  |  | $     |  |  | $     | 
| |                          |  |       |  |  |       |  |  |       | 
| | Short-term benefits      |  | 3,294 |  |  | 3,359 |  |  | 2,880 | 
| | Post-employment benefits |  | 703   |  |  | 713   |  |  | 719   | 
| |                          |  |       |  |  |       |  |  |       | 
| |                          |  | 3,997 |  |  | 4,072 |  |  | 3,599 | 

Short-term benefits include salaries,
current benefits and profit share paid or payable.

24

---

|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

|24 | Financial instruments and financial risk
      factors             
|-- | -------------------------------------------------------------------
|   |                                                                    
|   | Carrying and fair value of financial instruments by
      category:

December 31, 2012Loans
      
      
      OtherHeld for
      
      
      and
      
      
      financial
      
      
      Carryingtrading
      
      
      receivables
      
      
      liabilities
      
      
      value
      
      
      Fair value$
      
      
      $
      
      
      $
      
      
      $
      
      
      $Financial assetsCash
        and short-term investments
      
      -
      
      
      43,498
      
      
      -
      
      
      43,498
      
      
      43,498Accounts
        receivableTrade and other
      
      -
      
      
      28,556
      
      
      -
      
      
      28,556
      
      
      28,556Other
        assets
      
      -
      
      
      361
      
      
      -
      
      
      361
      
      
      361-
      
      
      72,415
      
      
      -
      
      
      72,415
      
      
      72,415Financial liabilitiesAccounts payableTrade and other
      
      -
      
      
      -
      
      
      45,006
      
      
      45,006
      
      
      45,006Derivatives
      
      6,952
      
      
      -
      
      
      -
      
      
      6,952
      
      
      6,952Borrowings
      
      -
      
      
      -
      
      
      222,745
      
      
      222,745
      
      
      210,6316,952
      
      
      -
      
      
      267,751
      
      
      274,703
      
      
      262,589


December 31, 2011Loans
      
      
      OtherHeld for
      
      
      and
      
      
      financial
      
      
      Carryingtrading
      
      
      receivables
      
      
      liabilities
      
      
      value
      
      
      Fair value$
      
      
      $
      
      
      $
      
      
      $
      
      
      $Financial assetsCash
        and short-term investments
      
      -
      
      
      31,630
      
      
      -
      
      
      31,630
      
      
      31,630Accounts
        receivableTrade and other
      
      -
      
      
      36,599
      
      
      -
      
      
      36,599
      
      
      36,599Other
        assets
      
      -
      
      
      118
      
      
      -
      
      
      118
      
      
      118-
      
      
      68,347
      
      
      -
      
      
      68,347
      
      
      68,347Financial liabilitiesAccounts payableTrade and other
      
      -
      
      
      -
      
      
      37,515
      
      
      37,515
      
      
      37,515Derivatives
      
      340
      
      
      -
      
      
      -
      
      
      340
      
      
      340Borrowings
      
      -
      
      
      -
      
      
      223,554
      
      
      223,554
      
      
      175,526340
      
      
      -
      
      
      261,069
      
      
      261,409
      
      
      213,381


25

---

|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

The estimated fair value of financial
instruments is based on relevant market prices and information available at the
period end.

The fair value of short-term financial
assets and liabilities, which include cash and cash equivalents, restricted
cash, accounts and other receivables, accounts payable and accrued liabilities,
approximates their carrying value, due to the short-term nature of these
financial assets and liabilities.

The fair value of the senior notes
included in borrowings at December 31, 2012, was estimated to be US$197.4
million (2011  US$158.6 million) based upon the most recent bid price. The fair
value of the power purchase rights loans, included in borrowings, at December
31, 2012, was estimated to be $14.2 million, based on a market interest rate
assumption of 9.52% .

Financial assets and liabilities that
are recognized on the balance sheet at fair value are classified in a hierarchy
that is based on significance of the inputs used in making the measurements. The
three levels of the hierarchy are:

Level 1  unadjusted quoted prices in
active markets for identical assets or liabilities;

Level 2  inputs other than quoted
prices that are observable for the asset or liability, either directly (that is,
as prices) or indirectly (that is, as derived from prices); and

Level 3  inputs that are not based on
observable market data.

Derivative instruments are included in
Level 2 of the fair value hierarchy as they are valued using pricing models or
discounted cash flow models. These models require a variety of inputs,
including, but not limited to, contractual terms, market prices, forward price
curves, yield curves, and credit spreads. These inputs are obtained from or
corroborated with the market where possible.

The fair value of fixed commodity
forward sale and purchase contracts is calculated using a discounted cash flow
method based on forward commodity prices. The fair value of forward exchange
contracts is calculated using a forward pricing model.

Financial risk management

The Companys activities expose it to a
variety of financial risks: market risk, foreign-currency risk, interest-rate
risk, liquidity risk and credit risk. The Companys risk-management strategy
focuses on the unpredictability of financial and commodity markets and seeks to
reduce related potential adverse effects on the Companys financial performance.

The Companys risk-management policies
require that significant risks are reviewed with the Companys board of
directors. The Companys methods for managing financial risks, outlined below,
remain unchanged in the year ended December 31, 2012.

26

---

|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

| | i)  | Market risk                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |     | From time to time, the Company enters into forward
      contracts for both lumber and pulp to reduce commodity-price risk. The
      Company does not enter into such agreements for speculative or trading
      purposes. These contracts are generally settled financially but may, at
      the Companys discretion, be settled by physical delivery of the finished
      product. Contracts outstanding at the end of the period are recorded at
      their fair value, and any unrealized gains or losses are included in other
      income (expenses). At December 31, 2012, the Company had $59.4 million in
      U.S.-dollar denominated forward lumber commodity contracts outstanding
      (2011  $nil; 2010  US$38.8 million), resulting in an unrealized loss of
      $7.0 million (2011  $nil; 2010  loss of $3.3 million) in other income.
      At December 31, 2012, the average contract price was $334 per one thousand
      board feet and all contracts mature in 2013. In 2012, the Company had a
      realized loss on commodity contracts of $0.7 million (2011  gain of $14.3
      million; 2010  loss of $3.8 million) in other income. A US$10 change in
      the contract pricing on the outstanding commodity contracts would result
      in a financial impact of $1.8 million.
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | ii) | Foreign-currency risk                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |     | A foreign-currency risk arises when future commercial
      transactions or recognized assets or liabilities are denominated in a
      currency that is not the Companys functional currency. The Company is
      exposed to foreign-currency risk arising primarily with respect to
      U.S.-dollar-denominated sales and long-term debt.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |     | A significant portion of the Companys sales,
      approximately 64% of its 2012 revenue (2011  69%; 2010  72%), were
      denominated in U.S. currency, and at December 31, 2012, the Company had
      $16.0 million (2011  $29.0 million; 2010  $28.0 million) in
      U.S.-dollar-denominated accounts receivable. Consequently, the Company is
      exposed to foreign-currency-exchange risk, as changes in foreign-currency
      rates affect the future cash flows of accounts receivable.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |     | The impact on earnings of fluctuations in currency rates
      is somewhat offset by the corresponding fluctuations in interest payments,
      substantially all of which are denominated in U.S. dollars. To further
      reduce the impact on earnings of fluctuations in currency rates, the
      Company may enter into forward- exchange contracts to sell U.S. dollars
      but does not hold or issue foreign-currency financial instruments for
      speculative or trading purposes. At December 31, 2012, the Company had
      $nil (2011  $19.0 million; 2010  $6.0 million) in outstanding
      forward-exchange contracts, with an average contract rate of $nil (2011 
      $0.9991; 2010  $1.05) and recorded the amount of unrealized loss on these
      forward-exchange contracts in 2012 of $nil million (2011  $0.3 million;
      2010  gain of $0.3 million) in other income.                                                                                                                                                                                                                                                                                                                                                                                                              
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |     | The Company is exposed to a foreign-currency risk on the
      maturity of its US$210 million in long-term debt; it has not entered into
      any financial instruments to mitigate this risk.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |     | If the value of the Canadian dollar was different than
      the rates used by the Company to determine the carrying amount of its
      U.S.-dollar-denominated financial instruments at December 31, 2012 by
      $0.01/US, the impact on net income before taxes would be $2.1
    million.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

27

---

|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

| | iii) | Interest-rate risk                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | ---- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |      | The interest rates on the majority of the Companys
      long-term debt are fixed; consequently, the Company is not significantly
      exposed to fair-value changes on long-term debt when the market rate of
      interest changes. The interest rate on the Companys revolving credit
      facility does fluctuate with the market; however, there was no balance
      drawn on the facility at December 31, 2012. The Company does not currently
      use any derivative instruments to manage its exposure to changes in market
      interest rates.                                                                                                                                                                                                                                                                                                                                                                       
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | iv)  | Credit risk                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |      | Credit risk is the risk that customers or counterparties
      to certain financial contracts will fail to pay amounts due or perform
      their obligations under a contract. The Company is exposed to credit risk
      primarily through its accounts receivable. The Company manages this risk
      through the establishment of credit policies and limits that are applied
      in the selection of counterparties and through ongoing management review
      of all receivable balances past due, with the objective of identifying at
      an early stage matters that could potentially delay the collection of
      funds.                                                                                                                                                                                                                                                                                             
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |      | To mitigate the risk associated with customer or
      counterparty failure to meet obligations, the Company insures most trade
      receivables to 90% of the value of the invoice. The proportion of accounts
      thus insured amounted, at December 31, 2012, to 90% of the Companys total
      trade receivables; the remaining balance was predominantly represented by
      receivables with other forest products companies relating to fibre
      agreements, for which the Company held outstanding payables in similar
      amounts. The maximum exposure to credit risk for receivables at the
      reporting date was $26.0 million. The Company and the insurer work in
      concert to regularly review the creditworthiness of existing and future
      customers and ensure credit limits are commensurate with credit risk. All
      new trade customers must be insurable under the terms of the
  policy.
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |      | The concentration of credit risk of accounts receivable
      is limited, as accounts receivable are widely distributed among customers
      and geographic locations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

| |                                 |  | 2012   |   |  | 2011   |  
| | ------------------------------- |  | ------ | - |  | ------ | -
| | As at                           |  | $      |   |  | $      |  
| |                                 |  |        |   |  |        |  
| | Current                         |  | 16,718 |   |  | 31,012 |  
| | 30-60 days                      |  | 595    |   |  | -      |  
| | 61-90 days                      |  | 2      |   |  | -      |  
| | 91-120 days                     |  | 6      |   |  | -      |  
| | Greater than 120 days           |  | 43     |   |  | 172    |  
| |                                 |  |        |   |  |        |  
| | Total trade receivables         |  | 17,364 |   |  | 31,184 |  
| | Other receivables               |  | 8,685  |   |  | 6,723  |  
| | Allowance for doubtful accounts |  | (43    | ) |  | (124   | )
| |                                 |  |        |   |  |        |  
| | Total accounts receivable       |  | 26,006 |   |  | 37,783 |  

During 2012, the Company recorded bad
debt expense of $0.1 million (2011  $0.1 million).

28

---

|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

| |    | In 2012, the Company entered into agreements with
      third-parties for the sale of certain trade receivables arising from pulp
      export sales to China. Total receivables sold during the year were US$48.4
      million (2011  $nil). The 2012 transactions were recorded as a sale since
      the risks and rewards of ownership over the receivables were transferred.
      Accordingly, the receivables were derecognized at the date of the
      transaction and no gain or loss was recognized.                                                                                                      
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | v) | Liquidity risk                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    | Liquidity risk arises from the possibility that the
      Company will not be able to meet its financial obligations as they fall
      due. The Company manages liquidity risk by forecasting cash flows to
      identify potential financing requirements, and by maintaining access to
      additional financing in the form of a working- capital-supported revolving
      credit facility in the amount of $50 million, which is due July 15, 2015.
      This credit facility requires the Company to meet certain covenants. The
      Company was in compliance with these covenants at December 31,
  2012.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    | The following are contractual cash-flow maturities
      (including interest) of financial liabilities:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

<1 year
    
    
    1-2 years
    
    
    3-5 years
    
    
    >5 years
    
    
    Total$
    
    
    $
    
    
    $
    
    
    $
    
    
    $Borrowings
    
    20,534
    
    
    24,683
    
    
    60,955
    
    
    274,687
    
    
    380,859Accounts payable and accrued liabilities
    
    45,006
    
    
    -
    
    
    -
    
    
    -
    
    
    45,00665,540
    
    
    24,683
    
    
    60,955
    
    
    274,687
    
    
    425,865


|25 | Capital management                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   | The Company is privately owned and, accordingly,
      management defines capital as cash and shareholders equity, with the
      source of its capital being operations. It is the Companys objective to
      manage its capital to ensure adequate resources exist to support
      operations while maintaining business growth. The Companys financial
      results are primarily influenced by the prevailing market prices for pulp
      and lumber and the relative value of the Canadian and U.S. dollars;
      therefore, it manages and adjusts its capital structure as needed, in
      light of the economic conditions and the risk characteristics of the
      underlying assets. To maintain or adjust the capital structure, the
      Company may issue new debt to replace existing debt with different
      characteristics.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   | The Company does not have any externally imposed capital
      requirements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

29

---

|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

|26 | Segmented information                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   | The Companys operations are located in Canada. The
      Companys reportable segments are strategic business units that
      manufacture and sell different products. The business units are managed
      separately, as each business requires different manufacturing technology
      and marketing strategies. The Company has three reportable segments:
      lumber, pulp and corporate and other. The lumber segment manufactures
      dimension lumber for sale primarily in Canada, the United States and Asia.
      The pulp segment manufactures bleached chemi-thermo- mechanical pulp for
      sale to papermakers worldwide. Included in corporate and other are the
      combined results from the Companys management fees and unallocated
      corporate and other expenses.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   | The accounting policies applied to the reporting segments
      are as described in note 2. The Company evaluates the performance of each
      segment based upon operating earnings. The Company does not allocate
      financing expenses or income taxes to its business segments. The Company
      accounts for inter-segment revenue and transfers as if the transfers were
      to third parties at current market prices.                                                                                                                                                                                                                                                                                                                                                                    
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   | Product segments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

| |                                      |  | 2012     |   |  | 2011     |   |  | 2010    |  
| | ------------------------------------ |  | -------- | - |  | -------- | - |  | ------- | -
| | Lumber                               |  | $        |   |  | $        |   |  | $       |  
| |                                      |  |          |   |  |          |   |  |         |  
| | Revenue from external customers      |  | 153,839  |   |  | 104,902  |   |  | 110,074 |  
| | Cost of products sold                |  | (129,374 | ) |  | (101,913 | ) |  | (87,523 | )
| | Freight and other distribution costs |  | (11,071  | ) |  | (7,145   | ) |  | (9,810  | )
| | Depreciation and amortization        |  | (6,565   | ) |  | (4,219   | ) |  | (3,985  | )
| | Other (expense) income               |  | (7,446   | ) |  | 17,935   |   |  | 2,498   |  
| |                                      |  |          |   |  |          |   |  |         |  
| | Operating (loss) earnings            |  | ( 617    | ) |  | 9,560    |   |  | 11,254  |  

| |                                      |  | 2012     |   |  | 2011     |   |  | 2010    |  
| | ------------------------------------ |  | -------- | - |  | -------- | - |  | ------- | -
| | Pulp                                 |  | $        |   |  | $        |   |  | $       |  
| |                                      |  |          |   |  |          |   |  |         |  
| | Revenue from external customers      |  | 178,195  |   |  | 179,407  |   |  | 185,013 |  
| | Cost of products sold                |  | (111,626 | ) |  | (105,084 | ) |  | (96,317 | )
| | Freight and other distribution costs |  | (42,151  | ) |  | (41,418  | ) |  | (39,755 | )
| | Depreciation and amortization        |  | (6,950   | ) |  | (7,031   | ) |  | (6,965  | )
| | Other (expense) income               |  | (200     | ) |  | 268      |   |  | (12,403 | )
| |                                      |  |          |   |  |          |   |  |         |  
| | Operating earnings                   |  | 17,268   |   |  | 26,142   |   |  | 29,573  |  

| |                               |  | 2012    |   |  | 2011    |   |  | 2010    |  
| | ----------------------------- |  | ------- | - |  | ------- | - |  | ------- | -
| | Corporate and other           |  | $       |   |  | $       |   |  | $       |  
| |                               |  |         |   |  |         |   |  |         |  
| | Revenue from related parties  |  | 367     |   |  | 373     |   |  | 296     |  
| | Cost of products sold         |  | (39     | ) |  | (22     | ) |  | (23     | )
| | General and administration    |  | (13,781 | ) |  | (15,929 | ) |  | (13,766 | )
| | Depreciation and amortization |  | (126    | ) |  | (99     | ) |  | (79     | )
| | Other (expense) income        |  | (4      | ) |  | 7,548   |   |  | 62      |  
| |                               |  |         |   |  |         |   |  |         |  
| | Operating loss                |  | (13,583 | ) |  | (8,129  | ) |  | (13,510 | )

30

---

|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

| |                                                           |  | 2012     |   |  | 2011     |   |  | 2010     |  
| | --------------------------------------------------------- |  | -------- | - |  | -------- | - |  | -------- | -
| | Total                                                     |  | $        |   |  | $        |   |  | $        |  
| |                                                           |  |          |   |  |          |   |  |          |  
| | Revenue from external customers and related
      parties |  | 332,401  |   |  | 284,682  |   |  | 295,383  |  
| | Cost of products sold and general and administration      |  | (254,820 | ) |  | (222,948 | ) |  | (197,629 | )
| | Freight and other distribution costs                      |  | (53,222  | ) |  | (48,563  | ) |  | (49,565  | )
| | Depreciation and amortization                             |  | (13,641  | ) |  | (11,349  | ) |  | (11,029  | )
| | Other (expense) income                                    |  | (7,650   | ) |  | 25,751   |   |  | (9,843   | )
| |                                                           |  |          |   |  |          |   |  |          |  
| | Operating earnings                                        |  | 3,068    |   |  | 27,573   |   |  | 27,317   |  

Cost of products sold for the lumber
segment is net of chip transfers to the pulp segment of $6.6 million (2011 -
$5.8 million; 2011  $6.1 million).

Expenditures on property, plant and
equipment and intangibles

| |                     |  | 2012   |  |  | 2011   | 
| | ------------------- |  | ------ |  |  | ------ | 
| |                     |  | $      |  |  | $      | 
| |                     |  |        |  |  |        | 
| | Lumber              |  | 4,902  |  |  | 45,088 | 
| | Pulp                |  | 6,455  |  |  | 1,789  | 
| | Corporate and other |  | 347    |  |  | 712    | 
| |                     |  |        |  |  |        | 
| |                     |  | 11,704 |  |  | 47,589 | 

Identifiable assets

| |                     |  | 2012    |  |  | 2011    | 
| | ------------------- |  | ------- |  |  | ------- | 
| |                     |  | $       |  |  | $       | 
| |                     |  |         |  |  |         | 
| | Lumber              |  | 207,136 |  |  | 191,105 | 
| | Pulp                |  | 123,705 |  |  | 144,503 | 
| | Corporate and other |  | 51,334  |  |  | 34,140  | 
| |                     |  |         |  |  |         | 
| |                     |  | 382,175 |  |  | 369,748 | 

The Companys assets are all located in
Canada. Revenue is attributed to geographic locations based on shipping
destination as follows:

Geographic sales revenue

| |               |  | 2012    |  |  | 2011    |  |  | 2010    | 
| | ------------- |  | ------- |  |  | ------- |  |  | ------- | 
| |               |  | $       |  |  | $       |  |  | $       | 
| |               |  |         |  |  |         |  |  |         | 
| | Canada        |  | 110,166 |  |  | 82,966  |  |  | 80,926  | 
| | United States |  | 56,342  |  |  | 41,084  |  |  | 52,192  | 
| | Europe        |  | 36,441  |  |  | 43,263  |  |  | 43,019  | 
| | Asia          |  | 119,690 |  |  | 107,924 |  |  | 105,446 | 
| | Other         |  | 9,762   |  |  | 9,445   |  |  | 13,800  | 
| |               |  |         |  |  |         |  |  |         | 
| |               |  | 332,401 |  |  | 284,682 |  |  | 295,383 | 

31

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|Millar Western Forest Products Ltd.                         
|------------------------------------------------------------
|Notes to Financial Statements                               
|December 31, 2012 and 2011                                  
|                                                            
|(tabular amounts expressed in thousands of Canadian dollars)

|27 | Supplementary cash-flow information
      Net change in non-cash working capital items
|-- | --------------------------------------------------------------------------------------

| |                                          |  | 2012   |   |  | 2011   |   |  | 2010    |  
| | ---------------------------------------- |  | ------ | - |  | ------ | - |  | ------- | -
| |                                          |  | $      |   |  | $      |   |  | $       |  
| |                                          |  |        |   |  |        |   |  |         |  
| | Accounts receivable and other            |  | 9,227  |   |  | 4,013  |   |  | (10,230 | )
| | Inventories                              |  | (7,657 | ) |  | (7,099 | ) |  | (6,003  | )
| | Prepaid expenses                         |  | (2,052 | ) |  | (973   | ) |  | (3,070  | )
| | Accounts payable and accrued liabilities |  | 4,377  |   |  | (440   | ) |  | (942    | )
| |                                          |  |        |   |  |        |   |  |         |  
| |                                          |  | 3,895  |   |  | (4,499 | ) |  | (20,245 | )

| |                                                                        |  | 2012    |   |  | 2011    |   |  | 2010    |  
| | ---------------------------------------------------------------------- |  | ------- | - |  | ------- | - |  | ------- | -
| |                                                                        |  | $       |   |  | $       |   |  | $       |  
| |                                                                        |  |         |   |  |         |   |  |         |  
| | Additions to property, plant and equipment
      and intangible assets |  | (20,389 | ) |  | (47,589 | ) |  | (22,156 | )
| | Changes in working capital for investing activities                    |  | 3,685   |   |  | 710     |   |  | 1,154   |  
| | Interest capitalized on qualifying assets                              |  | 106     |   |  | 3,555   |   |  | 382     |  
| |                                                                        |  |         |   |  |         |   |  |         |  
| |                                                                        |  | (16,598 | ) |  | (43,324 | ) |  | (20,620 | )

| |                       |  | 2012   |   |  | 2011   |   |  | 2010   |  
| | --------------------- |  | ------ | - |  | ------ | - |  | ------ | -
| |                       |  | $      |   |  | $      |   |  | $      |  
| | Interest paid         |  | 19,284 |   |  | 15,390 |   |  | 16,283 |  
| |                       |  |        |   |  |        |   |  |        |  
| | Income taxes refunded |  | (330   | ) |  | (50    | ) |  | (80    | )

32

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