**Exhibit 13.2**

** **

**Management Report**

 

The consolidated financial statements for the yearsended December 31, 2005 and 2004, are theresponsibility of the managementof Cascades Inc., and have beenreviewed by the Audit Committee and approved by the Board of Directors. They were prepared in accordance with accountingprinciples generally accepted inCanada and include some amounts,which are based on management’s estimates and judgement. Management is also responsible for all other information included in this AnnualReport and for ensuring that this information is consistent with the Company’s consolidated financial statements and business activities.

 

The Management of theCompany is responsibleforthe design, establishment and maintenance of appropriate internal controls and procedures for financial reporting, to ensure that financialstatements for external purposesare fairly presented in conformitywith generally accepted accounting principles. Such internal controls systems are designed to provide reasonable assurance on thereliability of the financialinformation and the safeguarding ofassets.

 

External and internalauditors have free andindependentaccess to the Audit Committee, which is comprised of outside independent directors. The Audit Committee, which meets regularlythroughout the year with membersof the financial management andthe external and internal auditors, reviews the consolidated financial statements and recommends their approval to the Board of Directors.

 

The financial statementshave been audited by PricewaterhouseCoopers LLP, whose report is providedbelow.

 

(Signed)

Alain Lemaire

PRESIDENT AND CHIEF EXECUTIVE OFFICER

KINGSEY FALLS, CANADA

FEBRUARY 22, 2006

 

(Signed)

Christian Dubé

VICE-PRESIDENT AND CHIEF FINANCIAL OFFICER

KINGSEY FALLS, CANADA

FEBRUARY 22, 2006

 

**Auditors’ Report To the Shareholders of Cascades Inc.**

 

We have audited the consolidated balancesheets of Cascades Inc. (the “Company”) as atDecember 31, 2005 and 2004 and the consolidated statements of earnings (loss), retained earnings and cash flows for each of the years in thethree-year period ended December31, 2005. These financialstatements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financialstatements based on our audits.

 

We conducted our audits inaccordance withCanadiangenerally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurancewhether the financial statementsare free of material misstatement.An audit includes examining, on atest basis, evidence supporting the amounts and disclosures in the financialstatements. An audit alsoincludes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financialstatement presentation.

 

In our opinion, theseconsolidated financialstatementspresent fairly, in all material respects, the financial position of the Company as at December 31, 2005 and 2004 and the results ofits operations and its cash flows for each of the years in the three-year period ended December 31,2005 in accordance with Canadiangenerally accepted accountingprinciples.

 

 

 

CHARTERED ACCOUNTANTS

MONTRÉAL, CANADA

FEBRUARY 22, 2006

 

44

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Consolidated Balance Sheets

 
| **As at December 31, 2005 and 2004** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| **(in millions of Canadian dollars)**          | ** ** | **Note**   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
| **Assets**                                                         |       |       |       |       |       |       |       |
| **Current assets**                                                 |       |       |       |       |       |       |       |
| Cash and cash equivalents                                          | ** ** | ** ** |       | **43**     |       | 30         |       |
| Accounts receivable                                                | ** ** | ** ** |       | **545**    |       | 527        |       |
| Inventories                                                        |       | 6          | ** ** | **537**    |       | 559        |       |
| ** **                                                         |       | ** ** |       | **1,125**  |       | 1,116      |       |
| **Property, plant and equipment**                                  |       | 7          | ** ** | **1,562**  |       | 1,700      |       |
| **Other assets**                                                   |       | 8(a)       |       | **233**    |       | 215        |       |
| **Goodwill**                                                       |       | 8(b)       |       | **126**    |       | 113        |       |
| ** **                                                         |       | ** ** |       | **3,046**  |       | 3,144      |       |
| **Liabilities and Shareholders’ Equity**                      |       |       |       |       |       |       |       |
| **Current liabilities**                                            |       |       |       |       |       |       |       |
| Bank loans and advances                                            | ** ** | ** ** |       | **44**     |       | 47         |       |
| Accounts payable and accrued liabilities                           | ** ** | ** ** |       | **543**    |       | 509        |       |
| Current portion of long-term debt                                  |       | 9          | ** ** | **8**      |       | 58         |       |
| ** **                                                         |       | ** ** |       | **595**    |       | 614        |       |
| **Long-term debt**                                                 |       | 9          | ** ** | **1,289**  |       | 1,168      |       |
| **Other liabilities**                                              |       | 10         | ** ** | **265**    |       | 303        |       |
| ** **                                                         |       | ** ** |       | **2,149**  |       | 2,085      |       |
| **Shareholders’ equity**                                      |       |       |       |       |       |       |       |
| Capital stock                                                      |       | 11         | ** ** | **264**    |       | 265        |       |
| Retained earnings                                                  | ** ** | ** ** |       | **669**    |       | 783        |       |
| Cumulative translation adjustments                                 |       | 21         | ** ** | **(36**    | **)**      | 11         |       |
| ** **                                                         |       | ** ** |       | **897**    |       | 1,059      |       |
| ** **                                                         |       | ** ** |       | **3,046**  |       | 3,144      |       |

 

The accompagning notes are an integral part of these consolidatedfinancial statements.

 

 

Approved by the Board of Directors,

 

 
| (Signed)        | (Signed)        |
|-----------------|-----------------|
| Bernard Lemaire | Robert Chevrier |
| DIRECTOR        | DIRECTOR        |

 

45

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Consolidated Statements ofRetained Earnings

 
| **For each of the years in the three-year period ended** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| **December 31, 2005 (in millions of Canadian dollars)**            | ** ** | **Note**   | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** |
| **Balance – Beginning of year**                                                                  | ** ** | ** ** |       | **783**    |       | 778        |       | 749        |       |
| Net earnings (loss) for the year                                                                      | ** ** | ** ** |       | **(97**    | **)**      | 23         |       | 55         |       |
| Dividends on common shares                                                                            | ** ** | ** ** |       | **(13**    | **)**      | (13        | )          | (13        | )          |
| Dividends on preferred shares                                                                         | ** ** | ** ** |       | **—** |       | —     | ** ** | (1         | )          |
| Excess of common share redemption price  over paid-up capital                                         |       | 11(d)      |       | **(4**     | **)**      | (5         | )          | (2         | )          |
| Excess of redemption price of preferred  shares of a subsidiary over recorded capital                 |       | 11(b)      |       | **—** |       | —     |       | (10        | )          |
| **Balance – End of year**                                                                        | ** ** | ** ** |       | **669**    |       | 783        |       | 778        |       |

 

Consolidated Statements ofEarnings (loss)

 
| **For each of the years in the three-year period ended** | ** ** | ** ** | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|------------|------------|----------------|------------|------------|------------|------------|------------|
| **December 31, 2005 (in millions of Canadian dollars,**            | ** ** | ** ** | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **except per share amounts)**                                                          | ** ** | **Note**   | ** ** | **2005**       | ** ** | **2004**   | ** ** | **2003**   | ** ** |
| **Sales**                                                                                             | ** ** | ** ** |       | **3,460**      |       | 3,254      |       | 2,995      |       |
| **Cost of sales and expenses**                                                                        |       |       |       |           |       |       |       |       |       |
| Cost of sales (exclusive of depreciation  and amortization shown below)                               |       | 17(c)      |       | **2,890**      |       | 2,691      |       | 2,463      |       |
| Depreciation and amortization                                                                         | ** ** | ** ** |       | **174**        |       | 159        |       | 143        |       |
| Selling and administrative expenses                                                                   | ** ** | ** ** |       | **317**        |       | 313        |       | 294        |       |
| Unusual gains                                                                                         |       | 13         | ** ** | **(10**        | **)**      | (4         | )          | —     |       |
| Impairment loss on property, plant and  equipment                                                     |       | 14(a)      |       | **67**         | ** ** | 18         |       | —     |       |
| Closure and restructuring costs                                                                       |       | 14(a)      |       | **76**         | ** ** | —     |       | —     |       |
| Loss (gain) on commodity derivative  financial instruments                                            |       | 15(a)      |       | **10**         | ** ** | (2         | )          | 1          |       |
| ** **                                                                                            |       | ** ** |       | **3,524**      | ** ** | 3,175      |       | 2,901      |       |
| **Operating income (loss) from continuing  operations**                                               | ** ** | ** ** |       | **(64**        | **)**      | 79         |       | 94         |       |
| Interest expense                                                                                      | ** ** | ** ** |       | **83**         | ** ** | 76         |       | 80         |       |
| Gain on derivative financial instruments                                                              |       | 15(b)      |       | **(2**         | **)**      | —     |       | —     |       |
| Foreign exchange gain on long-term debt                                                               | ** ** | ** ** |       | **(10**        | **)**      | (18        | )          | (72        | )          |
| Loss on long-term debt refinancing                                                                    | ** ** | ** ** |       | **—**     | ** ** | 1          |       | 22         |       |
| ** **                                                                                            |       | ** ** |       | **(135**       | **)**      | 20         |       | 64         |       |
| **Provision for (recovery of) income taxes**                                                          |       | 16         | ** ** | **(41**        | **)**      | 2          |       | 10         |       |
| **Share of results of significantly influenced  companies**                                           |       | 12         | ** ** | **(7**         | **)**      | (2         | )          | 3          |       |
| **Net earnings (loss) from continuing  operations**                                                   | ** ** | ** ** |       | **(87**        | **)**      | 20         |       | 51         |       |
| **Net earnings (loss) from assets held for  sale**                                                    |       | 4          | ** ** | **(10**        | **)**      | 3          |       | 4          |       |
| **Net earnings (loss) for the year**                                                                  | ** ** | ** ** |       | **(97**        | **)**      | 23         |       | 55         |       |
| **Basic net earnings (loss) from continuing operations  per common share**                            | ** ** | ** ** |       | **(1.07**      | **)**      | 0.25       |       | 0.61       |       |
| **Basic and diluted net earnings (loss) per  common share**                                           |       | 11(e)      |       | **(1.19**      | **)**      | 0.28       |       | 0.66       |       |
| **Weighted average number of common shares outstanding  during the year**                             | ** ** | ** ** |       | **81,136,576** |       | 81,678,884 |       | 81,720,379 |       |

 

The accompagning notes are an integral part of these consolidatedfinancial statements.

 

46

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Consolidated Statements ofCash Flows

 
| **For each of the years in the three-year period ended** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| **December 31, 2005 (in millions of Canadian dollars)**            | ** ** | **Note**   | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** |
| **Operating activities from continuing  operations**                                                  |       |       |       |       |       |       |       |       |       |
| Net earnings (loss) from continuing  operations                                                       | ** ** | ** ** |       | **(87**    | **)**      | 20         |       | 51         |       |
| Adjustments for                                                                                       |       |       |       |       | ** ** |       |       |       |       |
| Depreciation and amortization                                                                         | ** ** | ** ** |       | **174**    | ** ** | 159        |       | 143        |       |
| Unusual gains                                                                                         |       | 13         | ** ** | **(10**    | **)**      | (4         | )          | —     |       |
| Impairment loss on property, plant and  equipment                                                     |       | 14(a)      |       | **67**     | ** ** | 18         |       | —     |       |
| Closure and restructuring costs                                                                       |       | 14(b)      |       | **16**     | ** ** | —     |       | —     |       |
| Unrealized loss on commodity derivative  financial instruments                                        |       | 15(a)      |       | **9**      | ** ** | —     |       | —     |       |
| Amortization of transitional deferred unrealized  gain                                                |       | 15(a)      |       | **(1**     | **)**      | (2         | )          | —     |       |
| Foreign exchange gain on long-term debt                                                               | ** ** | ** ** |       | **(10**    | **)**      | (18        | )          | (72        | )          |
| Loss on long-term debt refinancing                                                                    | ** ** | ** ** |       | **—** | ** ** | 1          |       | 22         |       |
| Future income taxes                                                                                   |       | 16(a)      |       | **(55**    | **)**      | (20        | )          | (1         | )          |
| Share of results of significantly influenced  companies                                               | ** ** | ** ** |       | **(7**     | **)**      | (2         | )          | 3          |       |
| Others                                                                                                | ** ** | ** ** |       | **(2**     | **)**      | 6          |       | 12         |       |
| ** **                                                                                            |       | ** ** |       | **94**     | ** ** | 158        |       | 158        |       |
| ** **                                                                                            |       | ** ** |       | ** ** | ** ** |       |       |       |       |
| Changes in non-cash working capital  components                                                       |       | 17(a)      |       | **(10**    | **)**      | (2         | )          | (32        | )          |
|                                                                                                  |       |       |       | **84**     | ** ** | 156        |       | 126        |       |
| **Investing activities from continuing  operations**                                                  | ** ** | ** ** |       | ** ** | ** ** |       |       |       |       |
| Purchases of property, plant and equipment                                                            | ** ** | ** ** |       | **(121**   | **)**      | (129       | )          | (121       | )          |
| Proceeds from disposal of property, plant and  equipment                                              | ** ** | ** ** |       | **19**     | ** ** | —     |       | —     |       |
| Purchases of other assets                                                                             | ** ** | ** ** |       | **(14**    | **)**      | (9         | )          | (13        | )          |
| Business acquisitions, net of cash acquired                                                           |       | 5(a)       |       | **(52**    | **)**      | (120       | )          | (31        | )          |
| Business disposal, net of cash disposed                                                               |       | 5(e)       | ** ** | **—** | ** ** | 14         |       | —     |       |
|                                                                                                  |       |       |       | **(168**   | **)**      | (244       | )          | (165       | )          |
| **Financing activities from continuing  operations**                                                  | ** ** | ** ** |       | ** ** | ** ** |       |       |       |       |
| Bank loans and advances                                                                               | ** ** | ** ** |       | **(2**     | **)**      | 3          |       | (50        | )          |
| Issuance of senior notes, net of related  expenses                                                    | ** ** | ** ** |       | **—** | ** ** | 156        |       | 974        |       |
| Change in revolving credit facilities, net  of related expenses                                       | ** ** | ** ** |       | **174**    | ** ** | (8         | )          | 155        |       |
| Increase in other long-term debt                                                                      | ** ** | ** ** |       | **4**      | ** ** | 10         |       | 52         |       |
| Payments of other long-term debt                                                                      | ** ** | ** ** |       | **(71**    | **)**      | (49        | )          | (1,052     | )          |
| Premium paid on redemption of long-term  debt                                                         | ** ** | ** ** |       | **—** | ** ** | (1         | )          | (16        | )          |
| Net proceeds from issuances of shares                                                                 | ** ** | ** ** |       | **—** | ** ** | 2          |       | 2          |       |
| Redemption of common shares and preferred shares  of a subsidiary                                     |       | 11(b),(d)  | ** ** | **(6**     | **)**      | (7         | )          | (20        | )          |
| Dividends                                                                                             |       | ** ** |       | **(13**    | **)**      | (13        | )          | (14        | )          |
|                                                                                                  | ** ** | ** ** |       | **86**     | ** ** | 93         |       | 31         |       |
| ** **                                                                                            | ** ** | ** ** |       | ** ** | ** ** |       |       |       |       |
| **Change in cash and cash equivalents during  the year from continuing operations**                   | ** ** | ** ** |       | **2**      | ** ** | 5          |       | (8         | )          |
| **Change in cash and cash equivalents from assets  held for sale**                                    |       | 4, 5(d)    | ** ** | **14**     | ** ** | —     |       | —     |       |
| **Change in cash and cash equivalents during the  year**                                              | ** ** | ** ** |       | **16**     | ** ** | 5          |       | (8         | )          |
| **Translation adjustments on cash and cash  equivalents**                                             | ** ** | ** ** |       | **(3**     | **)**      | (2         | )          | (3         | )          |
| **Cash and cash equivalents – Beginning of  year**                                               | ** ** | ** ** |       | **30**     |       | 27         |       | 38         |       |
| **Cash and cash equivalents – End of year**                                                      | ** ** | ** ** |       | **43**     |       | 30         |       | 27         |       |

 

The accompagning notes are an integral part of these consolidatedfinancial statements.

 

47

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The Company’s operations are organized into and managed by threesegments: packaging products, tissue papers and fine papers.

 

The Company analyzes theperformance of itsoperatingsegments based on their operating income before depreciation and amortization, which is not a measure of performance under Canadiangenerally accepted accountingprinciples (“Canadian GAAP”); however,the chief operating decision-maker uses this performance measure for assessing the operating performance of each reportable segment.Earnings for each segment areprepared on the same basis as thoseof the Company. Intersegment operations are recorded on the same basis as sales to third parties, which is at fair market value.

 

Sales of the Companypresented by reportable segment are as follows:

 
| **For each of the years in the three-year period ended** | ** ** | ** ** | ** ** | **Sales** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|------------|------------|-----------|------------|
| **December 31, 2005 (in millions of Canadian dollars)**            | ** ** | **Note**   | ** ** | **2005**  | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Packaging products**                                                                                |       |       |       |      |       |   |   |   |   |
| Boxboard                                                                                              |       |       |       |      |       |   |   |   |   |
| Manufacturing                                                                                         | ** ** | ** ** |       | **684**   | ** ** | 705 |   | 727 |   |
| Converting                                                                                            | ** ** | ** ** |       | **717**   | ** ** | 513 |   | 292 |   |
| Eliminations and others                                                                               | ** ** | ** ** |       | **(20**   | **)**      | 13 |   | 7 |   |
| ** **                                                                                            |       | ** ** |       | **1,381** | ** ** | 1,231 |   | 1,026 |   |
| Containerboard(1)                                                                                     |       |       |       |      | ** ** |   |   |   |   |
| Manufacturing                                                                                         | ** ** | ** ** |       | **331**   | ** ** | 344 |   | 340 |   |
| Converting                                                                                            | ** ** | ** ** |       | **494**   | ** ** | 489 |   | 480 |   |
| Eliminations and others                                                                               | ** ** | ** ** |       | **(186**  | **)**      | (200 | ) | (191 | ) |
| ** **                                                                                            |       | ** ** |       | **639**   | ** ** | 633 |   | 629 |   |
|                                                                                                  |       |       |       |      | ** ** |   |   |   |   |
| Specialty products                                                                                    | ** ** | ** ** |       | **509**   | ** ** | 509 |   | 484 |   |
|                                                                                                  |       |       |       |      | ** ** |   |   |   |   |
| Eliminations                                                                                          | ** ** | ** ** |       | **(47**   | **)**      | (44 | ) | (38 | ) |
| ** **                                                                                            |       | ** ** |       | **2,482** | ** ** | 2,329 |   | 2,101 |   |
| **Tissue papers**                                                                                     |       |       |       |      | ** ** |   |   |   |   |
| Manufacturing and converting                                                                          | ** ** | ** ** |       | **711**   | ** ** | 665 |   | 620 |   |
| Distribution(2)                                                                                       | ** ** | ** ** |       | **22**    | ** ** | 87 |   | 89 |   |
| Eliminations                                                                                          | ** ** | ** ** |       | **(9**    | **)**      | (35 | ) | (23 | ) |
| ** **                                                                                            |       | ** ** |       | **724**   | ** ** | 717 |   | 686 |   |
| **Fine papers**                                                                                       |       |       |       |      | ** ** |   |   |   |   |
| Manufacturing                                                                                         | ** ** | ** ** |       | **319**   | ** ** | 341 |   | 346 |   |
| Distribution(2)                                                                                       | ** ** | ** ** |       | **421**   | ** ** | 409 |   | 417 |   |
| Eliminations and others                                                                               | ** ** | ** ** |       | **(33**   | **)**      | (36 | ) | (29 | ) |
| ** **                                                                                            |       | ** ** |       | **707**   | ** ** | 714 |   | 734 |   |
| **Eliminations**                                                                                      | ** ** | ** ** |       | **(51**   | **)**      | (68 | ) | (72 | ) |
| **Assets held for sale**                                                                              |       | 4          | ** ** | **(402**  | **)**      | (438 | ) | (454 | ) |
| **Total**                                                                                             | ** ** | ** ** |       | **3,460** |       | 3,254 |   | 2,995 |   |

 

----

(1)     The Company’s containerboard sub-segmentconsists entirely of its interest in Norampac inc. (“Norampac”), a jointventure.

(2)     Some or all of these sub-segments representassets held for sale (see note 4).

 

48

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The operating income (loss) before depreciation and amortization fromcontinuing operations and the depreciation and amortization from continuingoperations of the Company presented by reportable segment are as follows:

 

 
| **For each of the years in the three-year period ended** | ** ** | ** ** | ** ** | **Operating income (loss) before depreciation and amortization  and operating income (loss) from continuing operations** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **December 31, 2005 (in millions of Canadian dollars)**            | ** ** | **Note**   | ** ** | **2005**                                                                                                                                                                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Packaging products**                                                                                |       |       |       |                                                                                                                                                                                 |       |   |   |   |   |
| Boxboard                                                                                              |       |       |       |                                                                                                                                                                                 |       |   |   |   |   |
| Manufacturing                                                                                         | ** ** | ** ** |       | **(17**                                                                                                                                                                              | **)**      | 19 |   | 37 |   |
| Converting                                                                                            | ** ** | ** ** |       | **56**                                                                                                                                                                               | ** ** | 45 |   | 15 |   |
| Others                                                                                                | ** ** | ** ** |       | **(6**                                                                                                                                                                               | **)**      | 3 |   | 3 |   |
| ** **                                                                                            |       | ** ** |       | **33**                                                                                                                                                                               | ** ** | 67 |   | 55 |   |
| Containerboard(1)                                                                                     |       |       |       |                                                                                                                                                                                 | ** ** |   |   |   |   |
| Manufacturing                                                                                         | ** ** | ** ** |       | **(14**                                                                                                                                                                              | **)**      | 25 |   | 18 |   |
| Converting                                                                                            | ** ** | ** ** |       | **46**                                                                                                                                                                               | ** ** | 54 |   | 52 |   |
| Others                                                                                                | ** ** | ** ** |       | **10**                                                                                                                                                                               | ** ** | 8 |   | 11 |   |
| ** **                                                                                            |       | ** ** |       | **42**                                                                                                                                                                               | ** ** | 87 |   | 81 |   |
|                                                                                                  |       |       |       |                                                                                                                                                                                 | ** ** |   |   |   |   |
| Specialty products                                                                                    | ** ** | ** ** |       | **34**                                                                                                                                                                               | ** ** | 24 |   | 38 |   |
| ** **                                                                                            |       | ** ** |       | **109**                                                                                                                                                                              | ** ** | 178 |   | 174 |   |
| **Tissue papers**                                                                                     |       |       |       |                                                                                                                                                                                 | ** ** |   |   |   |   |
| Manufacturing and converting                                                                          | ** ** | ** ** |       | **99**                                                                                                                                                                               | ** ** | 74 |   | 72 |   |
| Distribution(2)                                                                                       | ** ** | ** ** |       | **2**                                                                                                                                                                                | ** ** | 2 |   | 1 |   |
| ** **                                                                                            |       | ** ** |       | **101**                                                                                                                                                                              | ** ** | 76 |   | 73 |   |
| **Fine papers**                                                                                       |       |       |       |                                                                                                                                                                                 | ** ** |   |   |   |   |
| Manufacturing                                                                                         | ** ** | ** ** |       | **(105**                                                                                                                                                                             | **)**      | (10 | ) | (5 | ) |
| Distribution(2)                                                                                       | ** ** | ** ** |       | **(9**                                                                                                                                                                               | **)**      | 7 |   | 11 |   |
| ** **                                                                                            |       | ** ** |       | **(114**                                                                                                                                                                             | **)**      | (3 | ) | 6 |   |
| **Corporate**                                                                                         | ** ** | ** ** |       | **7**                                                                                                                                                                                | ** ** | (4 | ) | (3 | ) |
| **Assets held for sale**                                                                              |       | 4          | ** ** | **7**                                                                                                                                                                                | ** ** | (9 | ) | (13 | ) |
| **Operating income before depreciation and  amortization from continuing operations**                 | ** ** | ** ** |       | **110**                                                                                                                                                                              | ** ** | 238 |   | 237 |   |
| **Depreciation and amortization**                                                                     |       |       |       |                                                                                                                                                                                 | ** ** |   |   |   |   |
| Boxboard                                                                                              | ** ** | ** ** |       | **(75**                                                                                                                                                                              | **)**      | (64 | ) | (49 | ) |
| Containerboard                                                                                        | ** ** | ** ** |       | **(39**                                                                                                                                                                              | **)**      | (38 | ) | (37 | ) |
| Specialty products                                                                                    | ** ** | ** ** |       | **(21**                                                                                                                                                                              | **)**      | (20 | ) | (21 | ) |
| Tissue papers                                                                                         | ** ** | ** ** |       | **(37**                                                                                                                                                                              | **)**      | (36 | ) | (36 | ) |
| Fine papers                                                                                           | ** ** | ** ** |       | **(10**                                                                                                                                                                              | **)**      | (11 | ) | (11 | ) |
| Corporate and eliminations                                                                            | ** ** | ** ** |       | **8**                                                                                                                                                                                | ** ** | 8 |   | 9 |   |
| Assets held for sale                                                                                  |       | 4          | ** ** | **—**                                                                                                                                                                           | ** ** | 2 |   | 2 |   |
| ** **                                                                                            |       | ** ** |       | **(174**                                                                                                                                                                             | **)**      | (159 | ) | (143 | ) |
| **Operating income (loss) from continuing  operations**                                               | ** ** | ** ** |       | **(64**                                                                                                                                                                              | **)**      | 79 |   | 94 |   |

 

----

(1)     TheCompany’s containerboard sub-segment consists entirely of its interest in Norampac,a joint venture.

(2)     Someor all of these sub-segments represent assets held for sale (see note 4).

 

49

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Purchases of property, plantand equipment by the Company presented by reportable segment are as follows:

 
| **For each of the years in the three-year period ended** | ** ** | **Purchases of property, plant and equipment** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|
| **December 31, 2005 (in millions of Canadian dollars)**            | ** ** | **2005**                                                                | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Packaging products**                                                                                |       |                                                                    |       |   |   |   |   |
| Boxboard                                                                                              |       |                                                                    |       |   |   |   |   |
| Manufacturing                                                                                         | ** ** | **9**                                                                   |       | 22 |   | 19 |   |
| Converting                                                                                            | ** ** | **28**                                                                  |       | 20 |   | 10 |   |
| Others                                                                                                | ** ** | **2**                                                                   |       | 6 |   | 5 |   |
| ** **                                                                                            |       | **39**                                                                  |       | 48 |   | 34 |   |
| Containerboard(1)                                                                                     |       |                                                                    |       |   |   |   |   |
| Manufacturing                                                                                         | ** ** | **12**                                                                  |       | 13 |   | 14 |   |
| Converting                                                                                            | ** ** | **10**                                                                  |       | 15 |   | 13 |   |
| Others                                                                                                | ** ** | **4**                                                                   |       | 2 |   | 2 |   |
| ** **                                                                                            |       | **26**                                                                  |       | 30 |   | 29 |   |
|                                                                                                  |       |                                                                    |       |   |   |   |   |
| Specialty products                                                                                    | ** ** | **10**                                                                  |       | 16 |   | 19 |   |
| ** **                                                                                            |       | **75**                                                                  |       | 94 |   | 82 |   |
| **Tissue papers**                                                                                     |       |                                                                    |       |   |   |   |   |
| Manufacturing and converting                                                                          | ** ** | **33**                                                                  |       | 20 |   | 25 |   |
| Distribution(2)                                                                                       | ** ** | **—**                                                              |       | 1 |   | — |   |
| ** **                                                                                            |       | **33**                                                                  |       | 21 |   | 25 |   |
| **Fine papers**                                                                                       |       |                                                                    |       |   |   |   |   |
| Manufacturing                                                                                         | ** ** | **9**                                                                   |       | 10 |   | 7 |   |
| Distribution(2)                                                                                       | ** ** | **—**                                                              |       | — |   | 1 |   |
| Others                                                                                                | ** ** | **—**                                                              |       | — |   | 2 |   |
| ** **                                                                                            |       | **9**                                                                   |       | 10 |   | 10 |   |
| **Corporate**                                                                                         | ** ** | **4**                                                                   |       | 5 |   | 5 |   |
| **Assets held for sale**                                                                              | ** ** | **—**                                                              |       | (1 | ) | (1 | ) |
| **Total**                                                                                             | ** ** | **121**                                                                 |       | 129 |   | 121 |   |

 

----

(1)     The Company’s containerboard sub-segmentconsists entirely of its interest in Norampac, a joint venture.

(2)     Some or all of these sub-segments representassets held for sale (see note 4).

 

50

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Identifiable assets and goodwill of the Company presented by reportablesegment are as follows:

 
| ** **                                                | ** ** | **Identifiable assets** | ** ** |
|-----------------------------------------------------------|------------|------------------------------|------------|
| **(in millions of Canadian dollars)** | ** ** | **2005**                     | ** ** | **2004** | ** ** |
| **Packaging products**                                    |       |                         |       |   |   |
| Boxboard                                                  | ** ** | **1,077**                    | ** ** | 997 |   |
| Containerboard(1)                                         | ** ** | **746**                      | ** ** | 744 |   |
| Specialty products                                        | ** ** | **355**                      | ** ** | 378 |   |
| ** **                                                |       | **2,178**                    | ** ** | 2,119 |   |
| **Tissue papers**                                         | ** ** | **542**                      | ** ** | 552 |   |
| **Fine papers**                                           | ** ** | **318**                      | ** ** | 369 |   |
| **Corporate**                                             | ** ** | **152**                      | ** ** | 250 |   |
| **Consolidation revaluation(2)**                          | ** ** | **(146**                     | **)**      | (168 | ) |
| **Intersegment eliminations**                             | ** ** | **(96**                      | **)**      | (61 | ) |
| ** **                                                |       | **2,948**                    | ** ** | 3,061 |   |
| **Investments**                                           | ** ** | **98**                       | ** ** | 83 |   |
| **Total**                                                 | ** ** | **3,046**                    | ** ** | 3,144 |   |
|                                                      |       |                         |       |   |   |
| ** **                                                | ** ** | **Goodwill**                 | ** ** |
| ** **                                                | ** ** | **2005**                     | ** ** | **2004** | ** ** |
| **Packaging products**                                    |       |                         |       |   |   |
| Boxboard                                                  | ** ** | **31**                       | ** ** | 27 |   |
| Containerboard(1)                                         | ** ** | **115**                      | ** ** | 106 |   |
| Specialty products                                        | ** ** | **3**                        | ** ** | 7 |   |
| ** **                                                |       | **149**                      | ** ** | 140 |   |
| **Tissue papers**                                         | ** ** | **10**                       | ** ** | 10 |   |
| **Fine papers**                                           | ** ** | **4**                        | ** ** | 4 |   |
| **Consolidation revaluation(3)**                          | ** ** | **(37**                      | **)**      | (41 | ) |
| **Total**                                                 | ** ** | **126**                      | ** ** | 113 |   |

 

----

(1)           The Company’s containerboard sub-segmentconsists entirely of its interest in Norampac, a joint venture.

(2)           Consolidation revaluation includes adjustmentsof assets resulting from business acquisitions. it also includes the requiredadjustments resulting from the creation of Norampac, consisting mainly ofreduction in property, plant and equipment and goodwill. The following tabledetails the components of the consolidation revaluation relating toidentifiable assets:

 
| ** **                       | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|
| Privatization of subsidiaries(a) | ** ** | **(31**  | **)**      | (44      | )          |
| Creation of Norampac(b)          | ** ** | **(69**  | **)**      | (75      | )          |
| Creation of Norampac(c)          | ** ** | **(41**  | **)**      | (45      | )          |
| Others                           | ** ** | **(5**   | **)**      | (4       | )          |
| ** **                       |       | **(146** | **)**      | (168     | )          |

 

----

(a)   Represents the impact of the privatization ofcertain subsidiaries of the Company on December 31, 2000. The adjustment alsoreflects the accounting impact of the privatization of Cascades S.A. in 2002.

(b)   With respect to the creation of Norampac, theassets and liabilities that were contributed by the Company and Domtar Inc.,the Company’s joint venture partner in Norampac, were recorded at their fairmarket value. However, upon proportionate consolidation of the joint venture,the Company reduced its portion of the contributed assets and liabilities totheir original carrying value.

(c)   A portion of the gain realized on the creationof Norampac was recognized against property, plant and equipment and goodwill. Thenet book value of the deferred gain allocated against goodwill was $22 million.For the years ended December 31, 2005 and 2004, the net book value of thedeferred gain allocated against goodwill was $15 million and $16 million,respectively.

 

(3)           The amounts shown for identifiable assetsinclude a reduction of goodwill for the years ended December 31, 2005 and 2004amounting to $37 million and $41 million, respectively, which are shownseparately in the table above under goodwill.

 

51

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Sales, property, plant and equipment, goodwill, customer relationshipand client lists and other finite-life intangible assets of the Companypresented by geographic segment are as follows:

 
| **For each of the years in the three-year period ended** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| **December 31, 2005 (in millions of Canadian dollars)**            | ** ** | **Note**   | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** |
| **Sales**                                                                                             |       |       |       |       |       |       |       |       |       |
| Operations located in Canada                                                                          |       |       |       |       |       |       |       |       |       |
| Within Canada                                                                                         | ** ** | ** ** |       | **1,563**  |       | 1,571      |       | 1,660      |       |
| To the United States                                                                                  | ** ** | ** ** |       | **514**    |       | 555        |       | 540        |       |
| Offshore                                                                                              | ** ** | ** ** |       | **33**     |       | 54         |       | 51         |       |
| ** **                                                                                            |       | ** ** |       | **2,110**  |       | 2,180      |       | 2,251      |       |
| Operations located in the United States                                                               |       |       |       |       |       |       |       |       |       |
| Within the United States                                                                              | ** ** | ** ** |       | **1,009**  |       | 833        |       | 614        |       |
| To Canada                                                                                             | ** ** | ** ** |       | **152**    |       | 94         |       | 36         |       |
| Offshore                                                                                              | ** ** | ** ** |       | **17**     |       | 31         |       | —     |       |
| ** **                                                                                            |       | ** ** |       | **1,178**  |       | 958        |       | 650        |       |
| Operations located in Europe                                                                          |       |       |       |       |       |       |       |       |       |
| Within Europe                                                                                         | ** ** | ** ** |       | **533**    |       | 496        |       | 461        |       |
| To the United States                                                                                  | ** ** | ** ** |       | **5**      |       | 5          |       | 8          |       |
| To other countries                                                                                    | ** ** | ** ** |       | **36**     |       | 53         |       | 77         |       |
| ** **                                                                                            |       | ** ** |       | **574**    |       | 554        |       | 546        |       |
| Operations located in Mexico                                                                          | ** ** | ** ** |       | **—** |       | —     |       | 2          |       |
| **Assets held for sale – Operations located in  Canada**                                         |       | 4          | ** ** | **(402**   | **)**      | (438       | )          | (454       | )          |
| **Total**                                                                                             | ** ** | ** ** |       | **3,460**  |       | 3,254      |       | 2,995      |       |

 
| ** **                         | ** ** | **2005**  | ** ** | **2004** | ** ** |
|------------------------------------|------------|-----------|------------|----------|------------|
| **Property,  plant and equipment** |       |      |       |     |       |
| Canada                             |       | **930**   |       | 993      |       |
| United States                      |       | **479**   |       | 476      |       |
| Europe                             |       | **153**   |       | 231      |       |
| **Total**                          |       | **1,562** |       | 1,700    |       |

 
| ** **                                                                                     | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| **Goodwill,  customer relationship and client lists and other finite-life intangible  assets** |       |     |       |     |       |
| Canada                                                                                         |       | **101**  |       | 70       |       |
| United States                                                                                  |       | **77**   |       | 76       |       |
| Europe                                                                                         |       | **1**    |       | 1        |       |
| **Total**                                                                                      |       | **179**  |       | 147      |       |

 

52

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

**1  Accounting policies**

 

**Basis ofpresentation**

 

Theconsolidated financial statements have been prepared in accordance withCanadian GAAP and include the significant accounting policies listed below.

 

**Basis ofconsolidation**

 

Theconsolidated financial statements include the accounts of the Company and itssubsidiaries. They also include the portion of the accounts of the jointventures accounted for through the proportionate consolidation method.Investments in significantly influenced companies are accounted for using theequity method.

 

**Variableinterest entities**

 

TheCompany also identifies variable interest entities in which it has an interestand determines whether it is the primary beneficiary of such entities. If theCompany is the primary beneficiary of the variable interest entities identify,those entities are consolidated. A variable interest entity is defined as anentity in which the equity is not sufficient to permit the entity to financeits activities without external financial support, or the equity investors lackeither voting control and obligation to absorb future losses or the right toreceive future returns.

 

**Use ofestimates**

 

Thepreparation of financial statements in conformity with Canadian GAAP requiresthe use of estimates and assumptions that affect the reported amounts of assetsand liabilities in the financial statements and disclosure of contingencies atthe balance sheet date, as well as the reported amounts of revenues andexpenses during the reporting period. On a regular basis and with the availableinformation, management reviews its estimates, including those related toenvironmental costs, pension plans, useful life of property, plant andequipment and impairment of long-lived assets and goodwill. Actual resultscould differ from those estimates. When adjustments become necessary, they arereported in earnings in the period in which they are known.

 

**Revenuerecognition**

 

TheCompany recognizes its sales, which consist quasi exclusively of product sales,when persuasive evidence of an arrangement exists, goods are shipped,significant risks and benefits of ownership are transferred, the price is fixedand determinable, and collection of the resulting receivable is reasonablyassured.

 

**Fairmarket value of financial instruments**

 

TheCompany estimates the fair market value of its financial instruments based oncurrent interest rates, market value and current pricing of financialinstruments with similar terms. Unless otherwise disclosed herein, the carryingvalue of these financial instruments, especially those with current maturitiessuch as cash and cash equivalents, accounts receivable, bank loans andadvances, accounts payable and accrued liabilities, approximates their fairmarket value.

 

**Derivativefinancial instruments**

 

TheCompany uses derivative financial instruments in the management of its foreigncurrency, commodity and interest rate exposures. Except for certain interestrate swap agreements, the Company’s policy is not to utilize derivativefinancial instruments for trading or speculative purposes.

 

TheCompany documents relationships between hedging instruments and hedged items,as well as its risk management objective and strategy for undertaking varioushedge transactions. This process includes linking derivatives to specificassets and liabilities on the balance sheet or to specific firm commitments orforecasted transactions. The Company also assesses whether the derivatives thatare used in hedging transactions are effective in offsetting changes in fairvalues or cash flows of hedged items.

 

53

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

FOREIGNEXCHANGE FORWARD CONTRACTS DESIGNATED AS HEDGING INSTRUMENTS In order to reduce the potential adverseeffects of currency fluctuation, the Company enters into various foreignexchange forward contracts. Realized and unrealized gains and losses on thesederivative financial instruments used to hedge anticipated sales, purchases orinterest expenses denominated in foreign currencies are recognized as anadjustment of sales, cost of sales or interest expenses when the underlyingsale, purchase or interest expense is realized.

 

FOREIGNEXCHANGE FORWARD CONTRACTS AND CURRENCY OPTIONS NOT DESIGNATED AS HEDGINGINSTRUMENTS Foreignexchange forward contracts and currency options not designated as hedginginstruments are recorded at fair value. The fair value of these instruments isreviewed periodically and the resulting gains and losses are reported toearnings.

 

COMMODITYCONTRACTS DESIGNATED AS HEDGING INSTRUMENTS The Company also uses certain swaps andforward contracts on commodities in order to fix the price for nominalquantities of certain raw materials or finished goods to reduce the adverseeffects of changes in raw material costs and sales prices of finished goods.Realized and unrealized gains and losses arising from these contracts arerecognized in sales or cost of sales when the sale or purchase of theunderlying commodity is recorded.

 

COMMODITYCONTRACTS NOT DESIGNATED AS HEDGING INSTRUMENTS The Company uses swaps and forward contractson commodity that are not designated as hedging instruments. These instrumentsare recorded at fair value. The fair value of these contracts is reviewedperiodically and the resulting gains and losses are reported to earnings.

 

INTERESTRATE SWAP AGREEMENT DESIGNATED AS HEDGING INSTRUMENT The Company has entered into an interest rateswap agreement in order to hedge the changes in fair value of a portion of itslong-term debt. Interest expense on the debt is adjusted to include thepayments made or received under the interest rate swaps.

 

INTERESTRATE SWAP AGREEMENTS NOT DESIGNATED AS HEDGING INSTRUMENTS These interest rate swap agreements requirethe exchange of interest payments without actual exchange of the notionalamount on which the payments are based. The Company adjusts the interestexpense on the debt to include payments made or received under interest rateswap agreements. These instruments are accounted for at fair value andresulting gains or losses are included in earnings under Selling andadministrative expenses.

 

OTHERSRealized and unrealizedgains or losses associated with derivative financial instruments, which havebeen terminated or cease to be effective prior to maturity, are deferred undercurrent or long-term assets or liabilities and recognized in earnings in theperiod in which the underlying original hedged transaction is recognized. Inthe event a designated hedged item is sold, extinguished or matures prior tothe termination of the related derivative financial instrument, any realized orunrealized gain or loss on such derivative financial instrument is recognizedin earnings.

 

Derivativefinancial instruments which are not designated as hedges or have ceased to beeffective prior to maturity are recorded at their estimated fair values undercurrent or long-term assets or liabilities with changes in their estimated fairvalues recorded in earnings. Estimated fair value is determined using pricingmodels incorporating current market prices and the contractual prices of theunderlying instruments, the time value of money and yield curves.

 

54

----

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

**Cash andcash equivalents**

 

Cashand cash equivalents include cash on hand, bank balances and short-term liquidinvestments with original maturities of three months or less.

 

**Inventories**

 

Inventoriesof finished goods are valued at the lower of average production cost and netrealizable value. Inventories of raw materials and supplies are valued at thelower of cost and replacement value. Cost of raw materials and supplies isdetermined using the average cost and the first-in, first-out methodsrespectively.

 

**Property,plant and equipment, depreciation and amortization**

 

Property,plant and equipment are recorded at cost, including interest incurred duringthe construction period of certain property, plant and equipment. Depreciationand amortization are calculated on a straight-line basis at annual ratesvarying from 3% to 5% for buildings, 5% to 10% for machinery and equipment, and15% to 20% for automotive equipment, determined according to the estimateduseful life of each class of property, plant and equipment.

 

**Grantsand investment tax credits**

 

Grantsand investment tax credits are accounted for using the cost reduction methodand are amortized to earnings as a reduction of depreciation and amortization,using the same rates as those used to amortize the related property, plant andequipment.

 

**Otherinvestments**

 

Otherinvestments are recorded at cost except when there is a decline in value whichis other than temporary, in which case they are reduced to their estimated netrealizable value.

 

**Goodwill**

 

TheCompany assesses periodically whether a provision for impairment in the valueof goodwill is required. This is accomplished mainly by determining whetherprojected discounted future cash flows exceed the net book value of goodwill ofthe respective business units. Goodwill is tested for impairment annually on December31 or when an event or circumstance occurs that could potentially result in apermanent decline in value.

 

**Impairmentof long-lived assets**

 

Long-livedassets are reviewed for impairment upon the occurence of events or changes incircumstances indicating that the carrying value of the asset may not berecoverable, as measured by comparing their net book value to the estimatedundiscounted future cash flows generated by their use. Impaired assets arerecorded at fair value, determined principally using discounted future cashflows expected from their use and eventual disposition.

 

**Deferredcharges**

 

Deferredcharges are recorded at cost and include, in particular, the issuance costs oflong-term debt, which are amortized on a straight-line basis over theanticipated period of repayment of the respective debt, and start-up costswhich are amortized on a straight-line basis over a period of three to fiveyears from the end of the start-up period.

 

**Environmentalcosts**

 

Environmentalexpenditures are expensed or capitalized depending upon their future economicbenefit. Expenditures incurred to prevent future environmental contaminationare capitalized and amortized on a straight-line basis at annual rates varyingfrom 5% to 10%. Expenditures that relate to an existing condition caused bypast operations, and which do not contribute to current or future revenuegeneration, are expensed. A provision for environmental cost is recorded whenit is probable that a liability has been incurred and the costs can be reasonablyestimated.

 

55

----

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

**Assetretirement obligations**

 

Assetretirement obligations are recognized at fair value in the period in which theCompany incurred such an obligation and if a reasonable estimate of the fairvalue can be made. The associated costs are capitalized as part of the carryingvalue of the related asset and depreciated over its remaining useful life. Theliability is accreted using a credit-adjusted risk-free interest rate of theCompany.

 

**Employeefuture benefits**

 

TheCompany offers funded and non-funded defined benefit pension plans, somedefined contribution pension plans, and group registered retirement savingsplans that provide retirement benefit payments for most of its employees. Thedefined benefit pension plans are usually contributory and are based on thenumber of years of service and, in most cases, based on the average salaries orcompensation at the end of career. Retirement benefits are, in some cases,partially adjusted based on inflation. The Company also contributes to itsemployee’s complementary retirement benefit plans and other post-employmentbenefit plans, such as group life insurance and medical and dental care plans.However, these benefits, other than pension plans, are not funded.

 

Thecost of pensions and other retirement benefits earned by employees isactuarially determined using the projected benefit method pro-rated on years ofservice and management’s best estimate of expected plan investment performance,salary escalations, retirement ages of employees and expected health carecosts. The accrued benefit obligation is evaluated using the market interestrate at the evaluation date.

 

Forthe purpose of calculating the expected return on plan assets, those assets arevalued at fair value. Past service costs arising from a plan amendment areamortized on a straight-line basis over the average remaining service period ofthe group of employees active at the date of the amendment. The excess of thenet actuarial gain or loss over the greater of (a) 10% of the accrued benefitobligation at the beginning of the year and (b) 10% of the fair value of planassets at the beginning of the year, is amortized over the average remainingservice period of active employees, which may vary from 5 to 19 years (weightedaverage of 13 years) in 2005 depending on the plan (2004–8 to 19 years(weighted average of 13 years).

 

Whenrestructuring a plan causes a curtailment and a settlement at the same time,the curtailment is accounted for before the settlement.

 

Themeasurement date of the retirement benefit plans is December 31 of each year.An actuarial evaluation is performed at least every three years. The lastevaluation took place on December 31, 2003 for almost half of the plans and onDecember 31, 2004 for most of the other plans.

 

**Incometaxes**

 

TheCompany uses the liability method in accounting for income taxes. According tothis method, future income taxes are determined using the difference betweenthe accounting and tax bases of assets and liabilities. Future income taxassets and liabilities are measured using substantively enacted tax rates ineffect in the year in which these temporary differences are expected to berecovered or settled. Future income tax assets are recognized when it is morelikely than not that the assets will be realized.

 

**Foreigncurrency translation**

 

***Foreign currency transactions***

 

Transactionsdenominated in currencies other than the business unit currency measurement arerecorded at the rate of exchange prevailing at the transaction date. Monetaryassets and liabilities denominated in foreign currencies are translated at therate of exchange prevailing at the balance sheet date. Gains and losses relatedto the portion of the long-term debt designated as a hedge of the netinvestment of the Company in self-sustaining foreign operations

 

56

----

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

arerecorded in cumulative translation adjustments net of related income taxes.Unrealized gains and losses on translation of other monetary assets andliabilities are reflected in the determination of the net results for the year.

 

***Foreign operations***

 

TheCompany’s foreign operations are defined as self-sustaining. The assets andliabilities of these operations are translated into Canadian dollars at therate of exchange prevailing at the balance sheet date. Revenues and expensesare translated at the average exchange rate for the year. Translation gains andlosses are deferred and shown as a separate component of shareholders’ equityas cumulative translation adjustments.

 

**Stock-basedcompensation**

 

TheCompany applies, since January 1, 2002, the fair value method of accounting forstock-based compensation awards granted to officers and key employees. Thismethod consists of recording expenses to earnings based on the vesting periodof the options granted. The fair value is calculated based on the Black-Scholesoption pricing model. This model was developed for use in estimating the fairvalue of traded options that have no vesting restrictions and are fullytransferable. When stock options are exercised, any consideration paid byemployees as well as the related stock based compensation are credited tocapital stock.

 

**Earningsper common share**

 

Earningsper common share is determined using the weighted average number of commonshares outstanding during the year. Diluted earnings per common share is determinedusing the treasury stock method to evaluate the dilutive effect of stockoptions, convertible instruments and equivalents, when applicable. Under thismethod, instruments with a dilutive effect, basically when the average marketprice of a share for the period exceeds the exercise price, are considered tohave been exercised at the beginning of the period and the proceeds receivedare considered to have been used to redeem common shares of the Company at theaverage market price for the period.

 

**Comparativefigures**

 

Certainreclassifications have been made to the prior years’ figures to conform to thepresentation adopted in 2005.

 

**2  Changes in accounting policies**

 

**Newaccounting standards adopted**

 

a)VARIABLE INTEREST ENTITIESOn January 1, 2005, the Companyadopted prospectively Accounting Guideline 15(“AcG-15”), ***“Consolidation of variable interest entities”****.*The new guideline requires companies toidentify variable interest entities in which they hold a variable interest todetermine whether they are the primary beneficiary of such entities and, if so,to consolidate them. A variable interest entity is defined as an entity inwhich the equity is not sufficient to permit that entity to finance itsactivities without external support, or the equity investors lack either votingcontrol and obligation to absorb future losses or the right to receive futurereturns. The application of this standard had no material impact on thefinancial position or results of operations of the Company.

 

b)HEDGING RELATIONSHIPS On January 1, 2004, the Company adoptedprospectively Accounting Guideline 13 (“AcG-13”) regarding hedge accounting. Incompliance with the criteria required by AcG-13, hedge accounting requires theCompany to document the risk management strategy used. Upon executing a hedgingcontract, management documents the hedged item, namely asset, liability oranticipated transaction, the characteristics of the hedging instrument used andthe selected method of assessing effectiveness. The prior accounting policy hasbeen maintained for hedging relationships deemed to be effective January 1,2004. Consequently, realized and unrealized gains and

 

57

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

losseson hedges continue to be deferred until the hedged item is realized so as toallow matching in the statement of earnings. Hedge accounting was continued asat January 1, 2004 for hedging relationships existing as at December 31, 2003that satisfied the conditions of AcG-13. Hedging relationships existing as atDecember 31, 2003 that did not satisfy the conditions of AcG-13 were recordedat fair value as at January 1, 2004, resulting in an increase in assets of $3.7million and in liabilities of $0.1 million. The related unrealized gain of $3.6million was deferred and presented under “Other liabilities” on the balance sheet.

 

c)ASSET RETIREMENTOBLIGATIONS On January 1, 2004,the Company adopted retroactively, without prior period restatement, the newrecommendations of the CICA relating to asset retirement obligations. Thisstandard requires that the fair value of a liability for an asset retirementobligation be recognized in the period in which it is incurred if a reasonableestimate of fair value can be made. The application of this standard did nothave any significant impact on the financial position or results of operationsof the Company.

 

**Newaccounting standards not yet adopted**

 

d)NON-MONETARY TRANSACTIONS In June 2005 , the CICA revised the exitingSection 3830, ***“Non-monetary Transactions”****,*and replace it by Section 3831, ***“Non-monetaryTransactions”****.*Therevised standard replaces the current exception from measurement of anon-monetary transaction at fair value for non-monetary exchanges which do notrepresent the culmination of the earnings process, with an exception based onwhether the transaction has commercial substance. The revised standard will beapplied to non-monetary transactions initiated in periods beginning afterJanuary 1, 2006.

 

e)FINANCIAL INSTRUMENTS,HEDGING, CAPITAL ASSETS AND COMPREHENSIVE INCOME In January 2005, the CICA published four new sections: Section 1530, ***“ComprehensiveIncome”****;*Section 3251, ***“Equity”****;*Section 3855, ***“Financial Instruments – Recognition and Measurement”****;*and Section 3865, ***“Hedges”****.*Thesenew standards regarding recognition and measurement of financial instruments,hedging and comprehensive income have been issued to allow harmonisation withthe generally accepted accounting policies already used in the United States(U.S. GAAP). These new standards have to be adopted by the Company at thelatest for the period beginning January 1, 2007, but early adoption isencouraged. The Company is presently evaluating the impact of these newstandards.

 

**3  Measurement uncertainty**

 

TheCompany evaluates the net book value of its long-lived assets when events orchanges in circumstances indicate that the net book value of the assets may notbe recoverable. To evaluate long-lived assets, the Company determines if theundiscounted future cash flows of operating activities exceed the net bookvalue of the assets at the valuation date. Estimates of future cash flows andfair value are based on judgment and could change.

 

Duringthe fourth quarter of 2005, impairment tests on long-lived assets wereperformed on eight operating units due to their operating loss. Four of theseunits are part of the Boxboard group, three are part of the Containerboardgroup of the Packaging products segment and one is in the Fine papers segment.These tests resulted in an impairment charge to the Blendecques, Franceboxboard mill amounting to €20 million ($28 million or $19 million after tax).The combined net book value of the property, plant and equipment, net ofimpairment of the above operating unit, is $314 million as at December 31,2005, including $86 million in the joint venture.

 

58

----

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

Accordingto the results of the impairment tests performed, it is not necessary to recordan impairment loss for these operating units, with the exception of theimpairment loss on property, plant and equipment disclosed above and in note14. However, given the sensitivity of certain key assumptions used, such asexchange rates, selling prices and costs of raw materials and energy, there isa measurement uncertainty regarding certain operating units because it ispossible that variations in future conditions could require a modification ofthe stated amount of long-lived assets when new impairment tests will beconducted.

 

**4  Assets held for sale**

 

Duringthe fourth quarter of 2004, the Company decided to initiate a divestiture planfor its distribution activities in the Fine papers and Tissue papers segments.Consequently, assets, liabilities, earnings and cash flows from theseactivities for the current period and for all comparative periods areclassified as assets held for sale. Financial information relating to these assetsheld for sale is as follows: 

 
| ** **                                               | ** ** | **2005**   | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| Condensed balance sheet                                  |       |       |       |     |       |     |       |
| Current assets                                           | ** ** | **99**     | ** ** | 126      |       |     |       |
| Long-term assets                                         | ** ** | **5**      | ** ** | 9        |       |     |       |
| Current liabilities                                      | ** ** | **22**     | ** ** | 29       |       |     |       |
| Condensed statement of earnings                          |       |       | ** ** |     |       |     |       |
| Sales                                                    | ** ** | **402**    | ** ** | 438      |       | 454      |       |
| Depreciation and amortization                            | ** ** | **—** | ** ** | 2        |       | 2        |       |
| Operating income (loss)(1)                               | ** ** | **(7**     | **)**      | 7        |       | 11       |       |
| Interest expenses                                        | ** ** | **2**      | ** ** | 3        |       | 3        |       |
| Income taxes                                             | ** ** | **1**      | ** ** | 1        |       | 4        |       |
| Net earnings (loss) from assets held for  sale           | ** ** | **(10**    | **)**      | 3        |       | 4        |       |
| Net earnings (loss) per share from assets  held for sale | ** ** | **(0.12**  | **)**      | 0.03     |       | 0.05     |       |
| Condensed statement of cash flows                        |       |       | ** ** |     |       |     |       |
| Cash flows from operating activities                     | ** ** | **16**     | ** ** | 1        |       | 14       |       |
| Cash flows from investing activities                     | ** ** | **14**     | ** ** | (1       | )          | (1       | )          |
| Cash flows from financing activities                     | ** ** | **(16**    | **)**      | —   |       | (13      | )          |

 

----

(1) Operating income (loss) includes thefollowing items:

 
| ** **                                                                       | ** ** | **Note**   | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|
| Gain on disposal of the distribution activities  of the Tissue papers segment    |       | 5(d)       | ** ** | **1**    |       | —   |       | —   |       |
| Provision on disposal of the distribution activities  of the Fine papers segment |       | (a)        | ** ** | **(9**   | **)**      | —   |       | —   |       |
| Legal settlement                                                                 |       | (b)        | ** ** | **(10**  | **)**      | —   |       | —   |       |
| ** **                                                                       |       | ** ** |       | **(18**  | **)**      | —   |       | —   |       |

 

59

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

a)On November 17, 2005, the Company announced that it had reached an agreementfor the sale of its paper merchant division known as Cascades Resources, thedistribution activities of its Fine papers segment, to Coast Paper Limited, asubsidiary of PaperlinX Limited, for a purchase price of approximately $85million. The Company expects to complete this transaction by the end ofFebruary 2006 subject to regulatory approval and other normal closing conditions.The Company recorded a loss of $9 million ($7 million after-tax) to bring thebook value of the net assets to be sold to their net estimated realizablevalue. The final selling price will be adjusted during the year 2006.

 

b)In 2003, the Company was informed that Cascades Resources was the subject of aninquiry by the Canadian Commissioner of Competition as to whether this divisionand its competitors had colluded to unduly reduce market competition betweenpaper merchants in Canada. On January 9, 2006, the Company entered a guiltyplea in Ontario Superior Court relating to sales in Ontario and Québec ofcarbonless sheet paper. Pursuant to the plea, the Company has agreed to pay atotal of $12.5 million, in equal installments over a period of six and a halfyears. The first payment will be due in January 2008. In 2005, a loss of $10million was recorded in earnings representing the discounted amount of theliability which is presented as “Other liabilities” in the balance sheet.

 

**5  Business acquisitions and disposals**

 

a)2005 ACQUISITIONS On January 14, 2005, the Company acquiredcertain assets of Dover Industries Limited, located in Burlington (Ontario) acash consideration of $8 million and on October 14, 2005 the Company paid $6million to acquire certain assets of the paperboard division of Fraser Paperslocated in Edmundston, New Brunswick. Both units are part of the convertingsector of the boxboard group.

 

OnOctober 11, 2005, a joint venture of the Company acquired the assets of threecorrugated products converting plants from SPB Canada inc. respectively locatedin Montréal, Québec, Le Gardeur, Québec, and Belleville, Ontario, for anapproximate consideration of $75 million (the Company’s share amounted to $38million).

 

Duringthe second quarter of 2005, the Company made its final payment amounting to $57million (US$46 million) with respect to the acquisition of Dopaco, Inc.announced in August 2004, which resulted in an adjustment to goodwill amountingto $3 million (US$2 million).

 

b)2004 ACQUISITIONS On February 18, 2004 and June 3, 2004, theCompany acquired the 50% interest held by its partners in Cascades Sonoco S.A.for an amount of nil and in Greenfield SAS for a cash consideration of $2million (€1.5 million). On March 11, 2004, the Company acquired the assets of atissue mill located in Memphis, Tennessee, from American Tissue or affiliatesthereof, for a cash consideration of $15 million (US$11.4 million). On April 2,2004, a joint venture of the Company acquired the shares of Johnson CorrugatedProducts Corp., a corrugated products plant in Thompson, Connecticut, for anapproximate cash consideration of $15 million (US$11.7 million). The Company’s50% share of the purchase price amounted to $8 million

 

60

----

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

(US$5.9million). On June 11, 2004, a joint venture of the Company acquired thenon-controlling interest of its subsidiary for a cash consideration of $14million. The Company’s 50% share of the purchase price amounted to $7 million.

 

OnAugust 24, 2004, the Company acquired the remaining outstanding shares (50%) ofDopaco, Inc., a U.S. producer of packaging products for the quick servicerestaurant industry, for an approximate consideration of $139 million (US$106.5million), of which $82 million (US$63 million) had been paid in cash at the closingdate and a balance initially estimated at $57 million (US$43.5 million) waspayable in May 2005 based on a financial formula. The balance sheet and resultsof Dopaco, Inc. are fully consolidated since that date. On August 27, 2004, ajoint venture of the Company acquired the assets of AIM Corrugated ContainerCorp., a corrugated products plant in Lancaster, New York, for an approximatecash consideration of $21 million (US$16 million). The Company’s 50% share ofthe purchase price amounted to $10 million (US$8 million).

 

c)2003 ACQUISITIONS On March 6, 2003 , the Company acquired 50%of the assets of La Compagnie Greenfield S.A. as part of its Packaging productsgroup for $0.6 million (€0.3 million). On April 14, 2003, a joint venture ofthe Company acquired a corrugated products converting plant as part of itsPackaging products group, located in Schenectady, New York. The aggregatepurchase price, subject to certain adjustments, was $32 million (US$22 million)and comprised $20 million (US$14 million) in cash and all the operating assetsof its Dallas-Fort Worth, Texas plant valued at $12 million (US$8 million). TheCompany’s 50% share in the cash portion of the purchase price amounted to $10million (US$7 million).

 

OnOctober 1, 2003, the Company increased its investment in Dopaco, Inc. from 40%to 50% for a consideration of $17 million (US$12.4 million). The balance sheetand results of Dopaco have been proportionally consolidated since October 1,2003.

 

OnDecember 22, 2003, the Company completed the acquisition of all shares inScierie P. H. Lemay ltée, a Canadian company operating a sawing and a planingplant, for a consideration of $3 million. Prior to this transaction, theCompany had a 50% holding in that company.

 

Theseacquisitions have been accounted for using the purchase method and the accountsand results of operations of these entities have been included in theconsolidated financial statements since their respective dates of acquisition.The following allocations of the purchase prices to the identifiable assetsacquired and liabilities assumed resulted in goodwill of $10 million for theyear ended December 31, 2005 (2004–$33 million; 2003–$7 million). None of theabove-mentioned goodwill is expected to be deductible for tax purposes with theexception of an amount of $10 million on December 31, 2005 (2004–$5 million).The purchase price allocations presented in the table below for the acquisitionof SPB have not been completed yet with respect to the identification andvaluation of other potential intangible assets, future employee benefits,restructuring costs and working capital adjustments. 

 

61

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 
| ** **                               | ** ** | **2005**      | ** ** |
|------------------------------------------|------------|---------------|------------|
| **Acquired company**                | ** ** | **Dover**     | ** ** | **Fraser** | ** ** | **SPB** | ** ** | ** ** | ** ** |
| ** **                               | ** ** | **Packaging** | ** ** | **Packaging** | ** ** | **Packaging** | ** ** | ** ** | ** ** |
| **Business segment**                | ** ** | **products**  | ** ** | **products** | ** ** | **products** | ** ** | **Total** | ** ** |
| Accounts receivable                      | ** ** | **—**    | ** ** | **—** | ** ** | **8** | ** ** | **8** | ** ** |
| Inventories                              | ** ** | **—**    | ** ** | **—** | ** ** | **5** | ** ** | **5** | ** ** |
| Property, plant and equipment            | ** ** | **3**         | ** ** | **1** | ** ** | **22** | ** ** | **26** | ** ** |
| Customer relationship and client lists   | ** ** | **5**         | ** ** | **5** | ** ** | **—** | ** ** | **10** | ** ** |
| Goodwill                                 | ** ** | **—**    | ** ** | **—** | ** ** | **10** | ** ** | **10** | ** ** |
| ** **                               | ** ** | **8**         | ** ** | **6** | ** ** | **45** | ** ** | **59** | ** ** |
| Accounts payable and accrued liabilities | ** ** | **—**    | ** ** | **—** | ** ** | **(4** | **)** | **(4** | **)** |
| Other liabilities                        | ** ** | **—**    | ** ** | **—** | ** ** | **(3** | **)** | **(3** | **)** |
| **Total consideration paid**             | ** ** | **8**         | ** ** | **6** | ** ** | **38** | ** ** | **52** | ** ** |

 
| ** **                                | ** ** | **2004**      | ** ** |
|-------------------------------------------|------------|---------------|------------|
| ** **                                | ** ** | ** **    | ** ** | **AIM &** | ** ** | **American** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Acquired company**                 | ** ** | **Dopaco**    | ** ** | **Johnson** | ** ** | **Tissue** | ** ** | **Others** | ** ** | ** ** | ** ** |
| ** **                                | ** ** | **Packaging** | ** ** | **Packaging** | ** ** | **Tissue** | ** ** | **Packaging** | ** ** | ** ** | ** ** |
| **Business segment**                 | ** ** | **products**  | ** ** | **products** | ** ** | **papers** | ** ** | **products** | ** ** | **Total** | ** ** |
| Cash and cash equivalents                 |       | 2             |       | 1 |   | — |   | 1 |   | 4 |   |
| Accounts receivable                       |       | 26            |       | 3 |   | — |   | 4 |   | 33 |   |
| Inventories                               |       | 38            |       | — |   | — |   | 6 |   | 44 |   |
| Property, plant and equipment             |       | 123           |       | 8 |   | 15 |   | 3 |   | 149 |   |
| Customer relationship and client lists    |       | 26            |       | — |   | — |   | 4 |   | 30 |   |
| Goodwill                                  |       | 24            |       | 9 |   | — |   | — |   | 33 |   |
|                                      |       | 239           |       | 21 |   | 15 |   | 18 |   | 293 |   |
| Accounts payable and accrued liabilities  |       | (27           | )          | (2 | ) | — |   | (8 | ) | (37 | ) |
| Long-term debt                            |       | (17           | )          | — |   | — |   | (3 | ) | (20 | ) |
| Other liabilities                         |       | (46           | )          | (1 | ) | — |   | 2 |   | (45 | ) |
|                                      |       | 149           |       | 18 |   | 15 |   | 9 |   | 191 |   |
| Less: Investments realized in prior years |       | (10           | )          | — |   | — |   | — |   | (10 | ) |
| Less: Balance of purchase price           |       | (57           | )          | — |   | — |   | — |   | (57 | ) |
| **Total consideration paid**              |       | 82            |       | 18 |   | 15 |   | 9 |   | 124 |   |

 

62

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 
| ** **                                  | ** ** | **2003**       | ** ** |
|---------------------------------------------|------------|----------------|------------|
| **Acquired company**                   | ** ** | **Greenfield** | ** ** | **Schenectady** | ** ** | **Dopaco** | ** ** | **Scierie Lemay** | ** ** | ** ** | ** ** |
| ** **                                  | ** ** | **Packaging**  | ** ** | **Packaging** | ** ** | **Packaging** | ** ** | **Packaging** | ** ** | ** ** | ** ** |
| **Business segment**                   | ** ** | **products**   | ** ** | **products** | ** ** | **products** | ** ** | **products** | ** ** | **Total** | ** ** |
| Accounts receivable                         |       | —         |       | 2 |   | 19 |   | 4 |   | 25 |   |
| Inventories                                 |       | 2              |       | 2 |   | 27 |   | 9 |   | 40 |   |
| Property, plant and equipment               |       | —         |       | 11 |   | 107 |   | 16 |   | 134 |   |
| Other assets                                |       | —         |       | — |   | 10 |   | 4 |   | 14 |   |
| Goodwill                                    |       | —         |       | 2 |   | 4 |   | 1 |   | 7 |   |
|                                        |       | 2              |       | 17 |   | 167 |   | 34 |   | 220 |   |
| Bank loans and advances                     |       | —         |       | — |   | — |   | (5 | ) | (5 | ) |
| Accounts payable and accrued liabilities    |       | (1             | )          | (1 | ) | (22 | ) | (6 | ) | (30 | ) |
| Long-term debt                              |       | —         |       | — |   | (14 | ) | (10 | ) | (24 | ) |
| Other liabilities                           |       | —         |       | — |   | (32 | ) | (3 | ) | (35 | ) |
|                                        |       | 1              |       | 16 |   | 99 |   | 10 |   | 126 |   |
| Less: Fair market value of assets exchanged |       | —         |       | (6 | ) | — |   | — |   | (6 | ) |
| Less: Investments realized in prior years   |       | —         |       | — |   | (82 | ) | (7 | ) | (89 | ) |
| **Total consideration paid**                |       | 1              |       | 10 |   | 17 |   | 3 |   | 31 |   |

 

d) 2005 DISPOSALS On March 31, 2005 , the Company sold the distribution activities of itsTissue papers segment for a total consideration of $16 million. Of the totalselling price, $14 million was received at closing; $1 million will be receivedat the first anniversary date and $1 million in four instalments due March 31,2006 to March 31, 2009. The disposal of the net assets resulted in a gain of $1million before related income taxes of $0.5 million.

 
| **Business segment**                | ** ** | **Tissue papers** | ** ** |
|------------------------------------------|------------|------------------------|------------|
| Accounts receivable                      | ** ** | **11**                 | ** ** |
| Inventories                              | ** ** | **7**                  | ** ** |
| Property, plant and equipment            | ** ** | **4**                  | ** ** |
| Other assets                             | ** ** | **1**                  | ** ** |
| ** **                               | ** ** | **23**                 | ** ** |
| Accounts payable and accrued liabilities | ** ** | **(8**                 | **)**      |
| ** **                               | ** ** | **15**                 | ** ** |
| Gain on disposal                         | ** ** | **1**                  | ** ** |
| Balance of sale price - other assets     | ** ** | **(2**                 | **)**      |
| **Total consideration received**         | ** ** | **14**                 | ** ** |

 

e) 2004 DISPOSALS On May 10, 2004, the Company sold the assets of two of its fiberboardpanel businesses (Packaging products segment) located in Canada for a totalconsideration of $16 million. Of this transaction price, $14 million wasreceived at closing and $2 million will be received at the latest in 2011. TheCompany realized a gain of $4 million before related income taxes of $1million.

 

63

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

**6  Inventories**

 
| ** **     | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------|------------|----------|------------|----------|------------|
| Finished goods | ** ** | **288**  |       | 284      |       |
| Raw materials  | ** ** | **114**  |       | 130      |       |
| Supplies       | ** ** | **135**  |       | 145      |       |
| ** **     |       | **537**  |       | 559      |       |

 

**7  Property, plant and equipment**

 
| ** **              | ** ** | ** ** | ** ** | **Accumulated**  | ** ** | ** ** | ** ** |
|-------------------------|------------|------------|------------|------------------|------------|------------|------------|
| **2005**                | ** ** | **Cost**   | ** ** | **depreciation** | ** ** | **Net**    | ** ** |
| Lands                   | ** ** | **54**     | ** ** | **—**       | ** ** | **54**     | ** ** |
| Buildings               | ** ** | **437**    | ** ** | **151**          | ** ** | **286**    | ** ** |
| Machinery and equipment | ** ** | **2,484**  | ** ** | **1,321**        | ** ** | **1,163**  | ** ** |
| Automotive equipment    | ** ** | **55**     | ** ** | **43**           | ** ** | **12**     | ** ** |
| Others                  | ** ** | **75**     | ** ** | **28**           | ** ** | **47**     | ** ** |
| ** **              | ** ** | **3,105**  | ** ** | **1,543**        | ** ** | **1,562**  | ** ** |

 
| ** **              | ** ** | ** ** | ** ** | **Accumulated**  | ** ** | ** ** | ** ** |
|-------------------------|------------|------------|------------|------------------|------------|------------|------------|
| **2004**                | ** ** | **Cost**   | ** ** | **depreciation** | ** ** | **Net**    | ** ** |
| Lands                   |       | 52         |       | —           |       | 52         |       |
| Buildings               |       | 436        |       | 140              |       | 296        |       |
| Machinery and equipment |       | 2,491      |       | 1,207            |       | 1,284      |       |
| Automotive equipment    |       | 52         |       | 41               |       | 11         |       |
| Others                  |       | 72         |       | 15               |       | 57         |       |
|                    |       | 3,103      |       | 1,403            |       | 1,700      |       |

 

Property, plant andequipment include assets under capital leases with a cost of $16 million andaccumulated depreciation of $10 million as at December 31, 2005 (2004–$9 millionand $3 million respectively). Other property, plant and equipment include itemsthat are not depreciated, such as machinery and equipment in the process ofinstallation with a book value of $12 million (2004–$28 million), deposits onpurchases of property, plant and equipment amounting to $14 million (2004–$12million) and unused properties, machinery and equipment with a net book valueof $15 million (2004–$10 million) which do not exceed their estimated netrealizable value.

 

Depreciationof property, plant and equipment amounted to $169 million for the year endedDecember 31, 2005 (2004–$157 million; 2003–$141 million).

 

64

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

**8  Other assets and goodwill**

 

a) Other assets are detailedas follows: 

 
| ** **                                             | ** ** | **Note**   | ** ** | **2005**   | ** ** | **2004** | ** ** |
|--------------------------------------------------------|------------|------------|------------|------------|------------|----------|------------|
| Investments in significantly influenced  companies (1) | ** ** | ** ** | ** ** | **90**     |       | 74       |       |
| Other investments                                      | ** ** | ** ** | ** ** | **8**      |       | 9        |       |
| Deferred charges                                       |       | (c)        |       | **36**     |       | 38       |       |
| Employee future benefits                               |       | (18b)      |       | **46**     |       | 52       |       |
| Fair value of derivative financial  instruments        | ** ** | ** ** | ** ** | **—** |       | 8        |       |
| Customer relationship and client lists                 |       | (c)        |       | **38**     |       | 30       |       |
| Other finite-life intangible assets                    |       | (c)        |       | **15**     |       | 4        |       |
| ** **                                             |       | ** ** | ** ** | **233**    |       | 215      |       |

 

----

(1)  Investments in significantly influencedcompanies include a 43% interest in Boralex Inc. for a net book value of $82million and a market value of $108 million (2004- $73 million, $68 million).

 

b) Goodwill fluctuated asfollows:

 
| ** **                                     | ** ** | **2005**                    | ** ** |
|------------------------------------------------|------------|-----------------------------|------------|
| ** **                                     | ** ** | **Packaging products** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | ** **                  | ** ** | **Container-** | ** ** | **Specialty** | ** ** | ** ** | ** ** | **Tissue** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | **Boxboard**                | ** ** | **board** | ** ** | **products** | ** ** | **Sub-total** | ** ** | **papers** | ** ** | **Total** | ** ** |
| Carrying value of goodwill –              |       |                        |       |   |   |   |   |   |   |   |   |   |   |
| Beginning of year                              | ** ** | **27**                      | ** ** | **74** | ** ** | **2** | ** ** | **103** | ** ** | **10** | ** ** | **113** | ** ** |
| Goodwill resulting from business  acquisitions | ** ** | **3**                       | ** ** | **10** | ** ** | **—** | ** ** | **13** | ** ** | **—** | ** ** | **13** | ** ** |
| Amortization of a deferred gain(1)             | ** ** | **—**                  | ** ** | **1** | ** ** | **—** | ** ** | **1** | ** ** | **—** | ** ** | **1** | ** ** |
| Foreign currency translation and others        | ** ** | **1**                       | ** ** | **(2** | **)** | **—** | ** ** | **(1** | **)** | **—** | ** ** | **(1** | **)** |
| Carrying value of goodwill – End of year  | ** ** | **31**                      | ** ** | **83** | ** ** | **2** | ** ** | **116** | ** ** | **10** | ** ** | **126** | ** ** |

 
| ** **                                     | ** ** | **2004**                    | ** ** |
|------------------------------------------------|------------|-----------------------------|------------|
| ** **                                     | ** ** | **Packaging products** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | ** **                  | ** ** | **Container-** | ** ** | **Specialty** | ** ** | ** ** | ** ** | **Tissue** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | **Boxboard**                | ** ** | **board** | ** ** | **products** | ** ** | **Sub-total** | ** ** | **papers** | ** ** | **Total** | ** ** |
| Carrying value of goodwill –              |       |                        |       |   |   |   |   |   |   |   |   |   |   |
| Beginning of year                              |       | 5                           |       | 66 |   | 2 |   | 73 |   | 10 |   | 83 |   |
| Goodwill resulting from business  acquisitions |       | 24                          |       | 9 |   | — |   | 33 |   | — |   | 33 |   |
| Amortization of a deferred gain(1)             |       | —                      |       | 1 |   | — |   | 1 |   | — |   | 1 |   |
| Foreign currency translation and others        |       | (2                          | )          | (2 | ) | — |   | (4 | ) | — |   | (4 | ) |
| Carrying value of goodwill – End of year  |       | 27                          |       | 74 |   | 2 |   | 103 |   | 10 |   | 113 |   |

 

----

(1)   On December30, 1997, the Company and Domtar Inc. merged their respective containerboardand corrugated packaging operations to form Norampac, a 50-50 joint venture. Aportion of the gain realized on the transaction was recorded against property,plant and equipment and goodwill. Under current accounting standards, theportion of the deferred gain allocated to goodwill is amortized on astraight-line basis over a period of 25 years.

 

65

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

c) Other intangible assetsare detailed as follows: 

 
| ** **                             | ** ** | **2005**   | ** ** | **2004**         | ** ** |
|----------------------------------------|------------|------------|------------|------------------|------------|
| ** **                             | ** ** | ** ** | ** ** | **Accumulated**  | ** ** | ** ** | ** ** | ** ** | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
| ** **                             | ** ** | **Cost**   | ** ** | **amortization** | ** ** | **Net** | ** ** | **Cost** | ** ** | **amortization** | ** ** | **Net** | ** ** |
| Deferred charges                       |       |       |       |             |       |   |   |   |   |   |   |   |   |
| Start-up cost                          | ** ** | **12**     | ** ** | **5**            | ** ** | **7** |   | 34 |   | 24 |   | 10 |   |
| Financing costs                        | ** ** | **33**     | ** ** | **12**           | ** ** | **21** |   | 33 |   | 9 |   | 24 |   |
| Other                                  | ** ** | **10**     | ** ** | **2**            | ** ** | **8** |   | 10 |   | 6 |   | 4 |   |
| ** **                             | ** ** | **55**     | ** ** | **19**           | ** ** | **36** |   | 77 |   | 39 |   | 38 |   |
| Customer relationship and client lists | ** ** | **42**     | ** ** | **4**            | ** ** | **38** |   | 32 |   | 2 |   | 30 |   |
| Other finite-life intangible assets    | ** ** | **16**     | ** ** | **1**            | ** ** | **15** |   | 7 |   | 3 |   | 4 |   |
| ** **                             | ** ** | **58**     | ** ** | **5**            | ** ** | **53** |   | 39 |   | 5 |   | 34 |   |

 

Amortization of deferredcharges and other finite-life intangible assets calculated on a straight-linebasis amounted to $10 million for the year ended December 31, 2005 (2004–$8million; 2003–$5 million).

 

Theweighted average amortization period is as follows (in number of years):

 
| Start-up cost                          |   | 4  |   |
|----------------------------------------|--------|----|--------|
| Financing costs                        |   | 9  |   |
| Other                                  |   | 5  |   |
| Deferred charges                       |   | 7  |   |
| Customer relationship and client lists |   | 23 |   |
| Other finite-life intangible assets    |   | 20 |   |

 

The estimated aggregateamount of amortization expense for intangible assets in each of the next fiveyears is as follows:

 
| **Years ending December 31,** | ** ** | ** ** | ** ** |
|----------------------------------------------|------------|------------|------------|
| 2006                                         |       | 10         |       |
| 2007                                         |       | 8          |       |
| 2008                                         |       | 7          |       |
| 2009                                         |       | 7          |       |
| 2010                                         |       | 6          |       |

 

66

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

**9  Long-term debt**

 
| ** **                                                                                           | ** ** | **Note**   | ** ** | **2005**   | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|----------|------------|
| **Cascades Inc. and its subsidiaries**                                                               |       |       |       |       |       |     |       |
| Revolving credit facility, weighted average  rate of 4.38% as at December 31, 2005, maturing in 2010 |       | (a)        | ** ** | **167**    |       | 159      |       |
| Term credit facility, bearing interest at  4.48% as at December 31, 2005, maturing in 2012           | ** ** | ** ** |       | **100**    |       | —   |       |
| 7.25% Unsecured senior notes of US$675  million, maturing in 2013                                    |       | (a), (c)   | ** ** | **787**    |       | 813      |       |
| Balance of purchase price                                                                            |       | 5(a), (b)  | ** ** | **—** |       | 52       |       |
| Capital lease obligations                                                                            |       | (c), (f)   | ** ** | **11**     |       | 5        |       |
| Other debts                                                                                          | ** ** | ** ** |       | **19**     |       | 19       |       |
| ** **                                                                                           |       | ** ** |       | **1,084**  |       | 1,048    |       |
| Less: Current portion                                                                                | ** ** | ** ** |       | **7**      |       | 56       |       |
| ** **                                                                                           |       | ** ** |       | **1,077**  |       | 992      |       |

 

**Joint ventures**

 

The Company’s proportionateshare of the following debts of joint ventures does not give to their holdersany recourse against the assets or general credit of Cascades Inc. and itssubsidiaries.

 
| ** **                                                                                            | ** ** | **Note**  | ** ** | **2005**  | ** ** | **2004** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|-----------|------------|-----------|------------|----------|------------|
| Revolving  credit facility, weighted average rate of 3.95% as at December 31, 2005,  maturing in 2008 |       | (b)       | ** ** | **58**    |       | 10       |       |
| 6.75%  Unsecured senior notes of US$250 million (Cascades portion US$125 million),  maturing in 2013  |       | (b),  (c) | ** ** | **146**   |       | 151      |       |
| Other debts                                                                                           |       |      | ** ** | **9**     |       | 17       |       |
|                                                                                                  |       |      | ** ** | **213**   |       | 178      |       |
| Less: Current portion                                                                                 |       |      | ** ** | **1**     |       | 2        |       |
|                                                                                                  |       |      | ** ** | **212**   |       | 176      |       |
| **Total**                                                                                             |       |      |       |      |       |     |       |
| Long-term debt                                                                                        |       |      | ** ** | **1,297** |       | 1,226    |       |
| Less: Current portions                                                                                |       |      | ** ** | **8**     |       | 58       |       |
|                                                                                                  |       |      | ** ** | **1,289** |       | 1,168    |       |

 

a)                 On October 31, 2005, the Company completedthe refinancing of its $500 million credit facility originally put in place inFebruary 2003. This new $550 million credit facility includes a $450 millionfive-year revolving facility maturing in 2010 and a seven-year $100 millionterm facility maturing in 2012. The seven-year term facility can be reimbursedwithout penalty, at the company’s option any time prior to maturity. Its obligationsunder this new revolving credit facility are secured by all inventory andreceivables of Cascades and its North American subsidiaries and by theproperty, plant and equipment of three of its mills.

 

OnFebruary 5, 2003, the Company issued new unsecured senior notes for anaggregate amount of US$450 million, which were subsequently registered with theSecurities and Exchange Commission of the United States. These notes, bearing a7.25% coupon,

 

67

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

willmature in 2013 and are redeemable all or in part at the option of the Companyunder certain conditions and subject to payment of a redemption premium.

 

OnJuly 8, 2003, the Company completed a private placement of US$100 million of7.25% senior notes due in 2013, which are treated as part of the same series of7.25% senior notes due in 2013 issued in February, as described above. Thesesenior notes were subsequently registered with the Securities and ExchangeCommission of the United States. The issuance of these senior notes wascompleted at a price of 104.50% or an effective interest rate of 6.61%.

 

OnDecember 2, 2004, the Company completed a private placement of US$125 millionof 7.25% senior notes due in 2013, which are treated as part of the same seriesof 7.25% senior notes due in 2013 issued in February 2003, as described above.These senior notes were subsequently registered with the Securities andExchange Commission of the United States. The issuance of these senior noteswas completed at a price of 105.50% or an effective interest rate of 6.376%.

 

b)                On May 28, 2003, a joint venture of theCompany, Norampac Inc., completed a series of transactions to substantiallyrefinance all of its existing credit facilities. Norampac secured a newfive-year revolving credit facility of $350 million. Its obligations under thisnew revolving credit facility are secured by all inventory and receivables ofNorampac and its North American subsidiaries, and by the property, plant andequipment of two of its mills and three of its converting facilities. Inaddition, Norampac issued new unsecured senior notes for an aggregate amount ofUS$250 million, which were subsequently registered with the Securities andExchange Commission of the United States. These notes, bearing a 6.75% coupon,will mature in 2013 and are redeemable in all or in part at the option of thejoint venture under certain conditions and subject to payment of a redemptionpremium.

 

c)                 As at December 31, 2005, the fair value ofthe unsecured senior notes and the capital lease obligations of Cascades Inc.and its subsidiaries and joint ventures was estimated at $827 million and $141million respectively (December 31, 2004- $865 million and $158 millionrespectively) based on the market value of the senior notes and on discountedfuture cash flows using interest rates available for issues with similar termsand average maturities.

 

d)                As at December 31, 2005, the long-term debtincluded amounts denominated in foreign currencies of US$839 million and €28million (December 31, 2004–US$933 million and €31 million).

 

Asat December 31, 2005, accounts receivable and inventories totallingapproximately $593 million (2004–$589 million) as well as property, plant andequipment totalling approximately $160 million (2004–$156 million) were pledgedas collateral for the long-term debt of Cascades Inc. and its subsidiaries.

 

Accountsreceivable and inventory totalling approximately $146 million (2004–$149million) as well as property, plant and equipment totalling approximately $77million (2004–$75 million) were pledged as collateral for the long-term debt ofa joint venture.

 

e)                 Under various credit agreements, the Companyand joint ventures are subject to a number of covenants, including themaintenance of certain financial ratios.

 

68

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

f )                The estimated aggregate amount of repaymentson long-term debt, excluding capital lease obligations, in each of the nextfive years is as follows:

 
| ** **                                   | ** ** | **Cascades Inc.**             | ** ** | ** **              | ** ** |
|----------------------------------------------|------------|------------------------------------|------------|-------------------------|------------|
| **Years ending December 31,** | ** ** | **and its subsidiaries** | ** ** | **Joint ventures** | ** ** |
| 2006                                         |       | 2                                  |       | 1                       |       |
| 2007                                         |       | 2                                  |       | 1                       |       |
| 2008                                         |       | 1                                  |       | 59                      |       |
| 2009                                         |       | 1                                  |       | 1                       |       |
| 2010                                         |       | 168                                |       | 3                       |       |
| Thereafter                                   |       | 899                                |       | 148                     |       |

 

g) As at December 31, 2005,future minimum payments under capital lease obligations are as follows:

 
| ** **                                       | ** ** | **Cascades Inc.**                  | ** ** | ** **              | ** ** |
|--------------------------------------------------|------------|------------------------------------|------------|-------------------------|------------|
| **Years ending December  31,**         | ** ** | **and its subsidiaries** | ** ** | **Joint ventures** | ** ** |
| 2006                                             |       | 6                                  |       | —                  |       |
| 2007                                             |       | 5                                  |       | —                  |       |
| 2008                                             |       | 1                                  |       | —                  |       |
|                                             |       | 12                                 |       | —                  |       |
| Less: Interest (weighted average rate of  6.45%) |       | 1                                  |       | —                  |       |
|                                             |       | 11                                 |       | —                  |       |
| Less: Current portion                            |       | 5                                  |       | —                  |       |
|                                             |       | 6                                  |       | —                  |       |

 

h) As at December 31, 2005,the Company and joint ventures had unused credit facilities of $274 million and$126 million respectively (December 31, 2004–$334 million and $168 millionrespectively).

 

**10  Other liabilities**

 
| ** **                                           | ** ** | **Note**   | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| Employee future benefits                             |       | 18(b)      | ** ** | **85**   |       | 84       |       |
| Future income taxes                                  |       | 16(c)      | ** ** | **160**  |       | 214      |       |
| Unrealized gain on  derivative financial instruments | ** ** | ** ** |       | **6**    |       | 5        |       |
| Legal settlement                                     |       | 4(b)       | ** ** | **10**   |       | —   |       |
| Other                                                | ** ** | ** ** |       | **4**    |       | —   |       |
| ** **                                           | ** ** | ** ** |       | **265**  |       | 303      |       |

 

69

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

**11  Capital stock******

 
| ** **                                       | ** ** | **Note**   | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| Common shares                                    |       | (a)        | ** ** | **259**  |       | 261      |       |
| Adjustment relating to  stock options and others |       | (c)        | ** ** | **5**    |       | 4        |       |
| ** **                                       | ** ** | ** ** |       | **264**  |       | 265      |       |

 

a) The authorized capitalstock of the Company consists of an unlimited number of common shares, withoutnominal value, and an unlimited number of Class A and B shares issuable inseries without nominal value. Over the past two years, the common shares havefluctuated as follows:

 
| ** **                                 | ** ** | ** ** | ** ** | **2005**           | ** ** | **2004**   | ** ** |
|--------------------------------------------|------------|------------|------------|--------------------|------------|------------|------------|
| ** **                                 | ** ** | ** ** | ** ** | **Number**         | ** ** | ** ** | ** ** | **Number** | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | **Note**   | ** ** | **of shares** | ** ** | **$**      | ** ** | **of shares** | ** ** | **$** | ** ** |
| Balance – Beginning of year           |       |       | ** ** | **81,361,580**     | ** ** | **261**    |       | 81,731,387 |   | 262 |   |
| Shares issued on exercise of stock options |       | (c)        | ** ** | **12,560**         | ** ** | **—** |       | 133,893 |   | 1 |   |
| Redemption of common shares                |       | (d)        | ** ** | **(555,600**       | **)**      | **(2**     | )          | (503,700 | ) | (2 | ) |
| Balance – End of year                 |       |       | ** ** | **80,818,540**     | ** ** | **259**    |       | 81,361,580 |   | 261 |   |

 

b) In 2003, the Companypurchased the totality of 4,300,000 Class B preferred shares of a subsidiaryfor a consideration of $16 million. The excess of the redemption price of $10million over the recorded capital is included in retained earnings.

 

c) Under the terms of a share option planadopted on December 15, 1998 for officers and key employees of the Company andits joint ventures, 6,534,701 common shares have been specifically reserved forissuance. Each option will expire at a date not to exceed 10 years followingthe date the option was granted. The exercise price of an option shall not belower than the market value of the share at the date of grant, determined asthe average of the closing price of the share on the Toronto Stock Exchange onthe five trading days preceding the date of grant. The terms for exercising theoptions granted before December 31, 2003 are 25% of the number of shares underoption within 12 months after the date of grant, and up to an additional 25%every 12 months after the first, second and third anniversary dates of grant.The terms for exercising the options granted in 2004 and thereafter are 25% ofthe number of shares under option within the first anniversary date of grant,and up to an additional 25% every 12 months after the second, third and fourthanniversary dates of grant. The options cannot be exercised if the market valueof the share is lower than its book value at the date of grant.

 

70

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

Changes in the number ofoptions outstanding as at December 31 are as follows: 

 
| ** **                             | ** ** | **2005**            | ** ** | **2004**     | ** ** | **2003**            | ** ** |
|----------------------------------------|------------|---------------------|------------|--------------|------------|---------------------|------------|
| ** **                             | ** ** | ** **          | ** ** | **Weighted** | ** ** | ** **          | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                             | ** ** | ** **          | ** ** | **average**  | ** ** | ** **          | ** ** | **average** | ** ** | ** ** | ** ** | **average** | ** ** |
| ** **                             | ** ** | **Number**          | ** ** | **exercise** | ** ** | **Number**          | ** ** | **exercise** | ** ** | **Number** | ** ** | **exercise** | ** ** |
| ** **                             | ** ** | **of options** | ** ** | **price**    | ** ** | **of options** | ** ** | **price** | ** ** | **of options** | ** ** | **price** | ** ** |
| Beginning of year                      | ** ** | **1,756,986**       | ** ** | **10.67**    |       | 1,494,942           |       | 9.83 |   | 1,378,610 |   | 8.82 |   |
| Granted                                | ** ** | **390,181**         | ** ** | **12.73**    |       | 407,723             |       | 13.02 |   | 321,596 |   | 13.04 |   |
| Exercised                              | ** ** | **(12,560**         | **)**      | **9.47**     |       | (133,893            | )          | 8.27 |   | (180,115 | ) | 7.92 |   |
| Forfeited                              | ** ** | **(19,440**         | **)**      | **13.10**    |       | (11,786             | )          | 13.10 |   | (25,149 | ) | 8.99 |   |
| End of year                            | ** ** | **2,115,167**       | ** ** | **11.03**    |       | 1,756,986           |       | 10.67 |   | 1,494,942 |   | 9.83 |   |
| Options exercisable – End of year | ** ** | **766,001**         | ** ** | **7.60**     |       | 1,131,655           |       | 9.35 |   | 935,011 |   | 8.55 |   |

 

The following options wereoutstanding as at December 31, 2005:

 
| ** **            | ** ** | **Options outstanding** | ** ** | **Options exercisable** | ** ** |
|-----------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **            | ** ** | **Number**                   | ** ** | **Weighted average**    | ** ** | **Number** | ** ** | **Weighted average** | ** ** | ** ** | ** ** |
| **Year granted** | ** ** | **of options**          | ** ** | **exercise price**      | ** ** | **of options** | ** ** | **exercise price** | ** ** | **Expiration** | ** ** |
| 1996                  |       | 34,200                       |       | 6.64                         |       | 34,200 |   | 6.64 |   | 2006 |   |
| 1999                  |       | 321,969                      |       | 8.47                         |       | 321,969 |   | 8.47 |   | 2009 |   |
| 2000                  |       | 71,936                       |       | 7.76                         |       | 71,936 |   | 7.76 |   | 2010 |   |
| 2001                  |       | 337,896                      |       | 6.82                         |       | 337,896 |   | 6.82 |   | 2011 |   |
| 2002                  |       | 265,361                      |       | 13.24                        |       | — |   | — |   | 2012 |   |
| 2003                  |       | 294,289                      |       | 13.04                        |       | — |   | — |   | 2013 |   |
| 2004                  |       | 399,335                      |       | 13.02                        |       | — |   | — |   | 2014 |   |
| 2005                  |       | 390,181                      |       | 12.73                        |       | — |   | — |   | 2015 |   |
|                  |       | 2,115,167                    |       |                         |       | 766,001 |   |   |   |   |   |

 

The following assumptionswere used in 2005, 2004 and 2003 to estimate the fair value, at the date ofgrant, of each option issued to employees:

 
| ** **                                     | ** ** | **2005**    | ** ** | **2004**   | ** ** | **2003** | ** ** |
|------------------------------------------------|------------|-------------|------------|------------|------------|----------|------------|
| Risk-free interest rate                        | ** ** | **3.9**     | **%**      | 4.3        | %          | 4.8      | %          |
| Expected dividend yield                        | ** ** | **1.26**    | **%**      | 1.24       | %          | 1.21     | %          |
| Expected life of the options                   | ** ** | **6 years** | ** ** | 6 years    |       | 6 years  |       |
| Expected volatility                            | ** ** | **26**      | **%**      | 29         | %          | 28       | %          |
| Weighted average fair value of issued  options | ** ** | **$**       | **3.69**   | ** ** | $          | 4.07     |       | $ | 4.36 |   |
|                                                |            |             |            |            |            |          |            |  |  |  |

 

d) In 2005, in the normalcourse of business, the Company renewed its redemption program of a maximum of4,068,707 common shares with the Toronto Stock Exchange which representapproximately 5% of issued and outstanding common shares. The redemptionauthorization is valid from March 11, 2005 to March 10, 2006. In 2005, theCompany redeemed 555,600 common shares under this program for a considerationof approximately $6 million (2004–$7 million; 2003–$4 million).

 

71

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

e) The basic and diluted netearnings (loss) per common share for the years ended December 31, 2005, 2004and 2003 are calculated as follows: 

 
| ** **                                              | ** ** | **2005**   | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| Net earnings (loss)                                     | ** ** | **(97.5**  | **)**      | 22.6     |       | 54.7     |       |
| Dividends – Preferred shares                       | ** ** | **—** | ** ** | —   |       | (0.5     | )          |
| Net earnings (loss) available to common  shareholders   | ** ** | **(97.5**  | **)**      | 22.6     |       | 54.2     |       |
| Weighted average common shares                          | ** ** | **81.1**   | ** ** | 81.7     |       | 81.7     |       |
| Dilution effect of stock options                        | ** ** | **—** | ** ** | 0.2      |       | 0.2      |       |
| Adjusted weighted average common shares                 | ** ** | **81.1**   | ** ** | 81.9     |       | 81.9     |       |
| Basic and diluted net earnings (loss) per  common share | ** ** | **(1.19**  | **)**      | 0.28     |       | 0.66     |       |

 

In2005, because of the net loss, no potential common shares are included in thecomputation of diluted per share amount.

 

Incalculating diluted earnings per share for 2004 and 2003, 625,331 and 559,931stock options were excluded due to their antidilutive effect.

 

f) The Company offered toits Canadian employees a share purchase plan of its common stock. Employees cancontribute, on a voluntary basis, up to a maximum of 5% of their salary and, ifcertain conditions are met, the Company will contribute to the plan 25% of theemployee’s contribution.

 

Theshares are purchased on the market on a predetermined date each month. For theyears ended December 31, 2005, 2004 and 2003, the Company’s contribution to theplan amounted to $0.6 million annually.

 

g) DEFERRED SHARE UNIT PLAN On June 30, 2005, the Company adopted aDeferred Share Unit Plan for the benefit of its external directors allowingthem to receive all or a portion of their annual compensation in the form ofDeferred Share Units (DSUs). A DSU is a notional unit equivalent in value tothe Company’s common share. Upon resignation from the Board of Directors,participants are entitled to receive the payment of their cumulated DSUs in theform of cash based on the average price of the Company’s common shares astraded on the open market during the five days before the date of theresignation of the participant.

 

TheDSU expense and the related liability are recorded at the grant date. Theliability is adjusted periodically to reflect any variation in the market valueof the common shares. As at December 31, 2005, the Company had a total of18,527 DSUs outstanding, representing a long-term liability of $0.2 million.

 

**12  Share of results of significantly influencedcompanies**

 

On February 20, 2002, asignificantly influenced company, Boralex Inc., sold seven power stations to anincome fund. In 2003, this gain was subsequently adjusted by Boralex Inc. TheCompany thus recorded its share of that adjustment representing a loss of $3million net of related future income taxes.

 

72

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

**13  Unusual gains**

 
| ** **                                                             | ** ** | **Note** | ** ** | **2005**   | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------------------------------------------|------------|----------|------------|------------|------------|----------|------------|----------|------------|
| Gain on disposal of  property, plant and equipment                     |       | (a)      | ** ** | **(11**    | **)**      | —   |       | —   |       |
| Impairment  charge of investment in a significantly influenced company |       |     | ** ** | **1**      |       | —   |       | —   |       |
| Gain on business disposal                                              |       | 5(e)     | ** ** | **—** |       | (4       | )          | —   |       |
|                                                                   |       |     | ** ** | **(10**    | **)**      | (4       | )          | —   |       |

 

----

(a) In 2005, a joint ventureof the Company realized a gain of $8 million ($6 million after tax), (share ofthe Company is $4 million or $3 million after tax), on the disposal of abuilding of one of its corrugated products plant and the Company sold awarehouse of the corporate segment resulting in a gain of $11 million. A gainof $7 million has been recorded in earnings ($6 million after tax) and theremaining portion of the gain has been deferred and will be recognized over theterm of a two year lease agreement entered into with the buyer.

 

**14  Impairment of property, plant and equipmentand closure and restructuring costs**

 

In 2005, the Companyannounced the permanent shutdown of its Fine papers Thunder Bay (Ontario) milland a joint venture company announced the permanent shutdown of one machine atits Red Rock mill in Ontario. A joint venture company also closed threecorrugated products converting units in Montréal (Québec), Concord (Ontario)and in Buffalo (New York). The Company also decided to close some equipment atits St-Jérôme (Québec) Fine papers mill, at its Montréal (Québec) boxboardconverting plant and at its Toronto (Ontario) Tissue converting unit. The Companyand a joint venture also reduced the value of some fixed assets that are not inuse to their net realizable value.

 

In2004, the Company recorded an impairment loss of $18 million ($12 million aftertax) related to the property, plant and equipment of its de-inked pulp milllocated in Cap-de-la-Madeleine, Québec, which was temporarily closed in March2003. The Company decided to permanently shutdown this facility. The book valueof those assets has been written down to their fair value representing the presentvalue of the estimated net proceeds from dismantling, redeployment or disposal.Those assets are part of the Specialty products group in the Packaging productssegment.

 

73

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

a) The impairment chargesand closure and restructuring costs are detailed as follows:

 
| ** **                             | ** ** | ** ** | ** ** | ** **     | ** ** | **2005**          | ** ** | **2004**       | ** ** | **2003**   | ** ** |
|----------------------------------------|------------|------------|------------|----------------|------------|-------------------|------------|----------------|------------|------------|------------|
| ** **                             | ** ** | ** ** | ** ** | ** **     | ** ** | **Closure and**   | ** ** | ** **     | ** ** | ** ** | ** ** |
| ** **                             | ** ** | ** ** | ** ** | ** **     | ** ** | **restructuring** | ** ** | ** **     | ** ** | ** ** | ** ** |
| ** **                             | ** ** | **Note**   | ** ** | **Impairment** | ** ** | **costs**         | ** ** | **Impairment** | ** ** | ** ** | ** ** |
| Boxboard – Montréal          |       |       | ** ** | **—**     | ** ** | **2**             |       | —         |       | —     |       |
| Boxboard – Blendecques            |       | 3          | ** ** | **28**         | ** ** | **—**        |       | —         |       | —     |       |
| Containerboard – Red Rock         |       |       | ** ** | **7**          | ** ** | **4**             |       | —         |       | —     |       |
| Containerboard – Montréal,   |       |       |       |           |       |              |       |           |       |       |       |
| Concord and Buffalo                    |       |       | ** ** | **2**          | ** ** | **4**             |       | —         |       | —     |       |
| Specialty products – pulp  mill   |       |       | ** ** | **—**     | ** ** | **—**        |       | 18             |       | —     |       |
| Tissue – Toronto                  |       |       | ** ** | **—**     | ** ** | **2**             |       | —         |       | —     |       |
| Fine papers – Thunder Bay         |       |       | ** ** | **20**         | ** ** | **58**            |       | —         |       | —     |       |
| Fine papers – St-Jérôme |       |       | ** ** | **2**          | ** ** | **6**             |       | —         |       | —     |       |
| Others                                 |       |       | ** ** | **8**          | ** ** | **—**        |       | —         |       | —     |       |
|                                   |       |       | ** ** | **67**         | ** ** | **76**            |       | 18             |       | —     |       |

 

b) The following table showsreconciliation of all closure and restructuring cost provisions which should bepaid in 2006:

 
| ** **                       | ** ** | **2005**   | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------|------------|------------|------------|----------|------------|----------|------------|
| Balance – Beginning of year | ** ** | **—** | ** ** | —   |       | —   |       |
| Additional provisions            |       |       | ** ** |     |       |     |       |
| Severance and pension liability  | ** ** | **57**     | ** ** | —   |       | —   |       |
| Write-down of inventories        | ** ** | **13**     | ** ** | —   |       | —   |       |
| Others                           | ** ** | **6**      | ** ** | —   |       | —   |       |
| Non-monetary items               |       |       | ** ** |     |       |     |       |
| Write-down of inventories        | ** ** | **(13**    | **)**      | —   |       | —   |       |
| Pension liability adjustments    | ** ** | **(3**     | **)**      | —   |       | —   |       |
| Closure cost payments            |       |       | ** ** |     |       |     |       |
| Severance                        | ** ** | **(5**     | **)**      | —   |       | —   |       |
| Balance – End of year       | ** ** | **55**     | ** ** | —   |       | —   |       |

 

**15  Loss (gain) on derivative financialinstruments**

 

a) The loss (gain) oncommodity derivative financial instruments is as follows:

 
| ** **                                                          | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Unrealized loss on commodity derivative financial  instruments      | ** ** | **9**    | ** ** | —   |       | —   |       |
| Realized loss on commodity derivative  financial instruments        | ** ** | **2**    | ** ** | —   |       | 1        |       |
| Amortization of transitional deferred  unrealized gain under AcG-13 | ** ** | **(1**   | **)**      | (2       | )          | —   |       |
| ** **                                                          |       | **10**   | ** ** | (2       | )          | 1        |       |

 

74

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

b) During the first quarterof 2005, the Company entered into an interest rate swap agreement for anotional amount of US$125 million maturing in 2013 relating to the Company’s7.25% unsecured senior notes. During the second quarter, the Company cancelledthis swap agreement and as this instrument was not designated as a hedge, a gainof $2.3 million was recorded.

 

**16  Income taxes**

 

a) The provision for(recovery of ) income taxes is as follows:

 
| ** ** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------|------------|----------|------------|----------|------------|----------|------------|
| Current    | ** ** | **14**   | ** ** | 22       |       | 11       |       |
| Future     | ** ** | **(55**  | **)**      | (20      | )          | (1       | )          |
| ** ** |       | **(41**  | **)**      | 2        |       | 10       |       |

 

b) The provision for incometaxes based on the effective income tax rate differs from the provision forincome taxes based on the combined basic rate for the following reasons:

 
| ** **                                                                                                                     | ** ** | **2005**   | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| Provision for (recovery of) income taxes  based on the combined basic Canadian and provincial income tax rate                  | ** ** | **(55**    | **)**      | 9        |       | 26       |       |
| Adjustment of income taxes arising from the  following:                                                                        |       |       | ** ** |     |       |     |       |
| Adjustment related to deduction for  manufacturing and processing and income from active businesses carried on in  Québec | ** ** | **11**     | ** ** | 2        |       | (4       | )          |
| Difference in statutory income tax rate of foreign  operations                                                                 | ** ** | **—** | ** ** | (5       | )          | —   |       |
| Unrecognized tax benefit arising from  current losses of subsidiaries                                                          | ** ** | **1**      | ** ** | 1        |       | 2        |       |
| Non-taxable portion of foreign exchange  gain on long-term debt                                                                | ** ** | **(2**     | **)**      | (3       | )          | (18      | )          |
| Recognized tax benefit arising from  previously incurred losses of subsidiaries                                                | ** ** | **(9**     | **)**      | (5       | )          | (9       | )          |
| Permanent differences                                                                                                          | ** ** | **4**      | ** ** | 1        |       | 1        |       |
| Large corporations tax                                                                                                         | ** ** | **2**      | ** ** | 4        |       | 4        |       |
| Increase in future income taxes resulting from  a substantively enacted change in tax rates                                    | ** ** | **4**      | ** ** | —   |       | 5        |       |
| Others                                                                                                                         | ** ** | **3**      | ** ** | (2       | )          | 3        |       |
| ** **                                                                                                                     |       | **14**     | ** ** | (7       | )          | (16      | )          |
| Provision for (recovery of) income taxes                                                                                       | ** ** | **(41**    | **)**      | 2        |       | 10       |       |

 

75

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

c) Future income taxesinclude the following items:

 
| ** **                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------|------------|----------|------------|----------|------------|
| **Future income tax assets**               |       |     | ** ** |     |       |
| Tax benefit arising from income tax losses | ** ** | **124**  | ** ** | 113      |       |
| Employee future benefits                   | ** ** | **28**   | ** ** | 21       |       |
| Unused tax credits                         | ** ** | **10**   | ** ** | 6        |       |
| Others                                     | ** ** | **23**   | ** ** | 13       |       |
| Valuation allowance                        | ** ** | **(14**  | **)**      | (25      | )          |
| ** **                                 |       | **171**  | ** ** | 128      |       |
| **Future income tax liabilities**          |       |     | ** ** |     |       |
| Property, plant and equipment              | ** ** | **241**  | ** ** | 262      |       |
| Exchange gain on long-term debt            | ** ** | **41**   | ** ** | 36       |       |
| Employee future benefits                   | ** ** | **13**   | ** ** | 15       |       |
| Other assets                               | ** ** | **29**   | ** ** | 26       |       |
| Others                                     | ** ** | **7**    | ** ** | 3        |       |
| ** **                                 |       | **331**  | ** ** | 342      |       |
| **Future income taxes**                    | ** ** | **160**  | ** ** | 214      |       |

 

d) Certain subsidiaries haveaccumulated losses for income tax purposes amounting to approximately $358million which may be carried forward to reduce taxable income in future years.The future tax benefit resulting from the deferral of $327 million of theselosses has been recognized in the accounts as a future income tax asset. Theseunused losses for income tax purposes may be claimed in years ending no laterthan 2025 for an amount of $222 million and indefinitely for an amount of $136million.

 

**17  Additional information**

 

a) Changes in non-cashworking capital components are detailed as follows:

 
| ** **                               | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Accounts receivable                      | ** ** | **(47**  | **)**      | (16      | )          | 6        |       |
| Inventories                              | ** ** | **(23**  | **)**      | (24      | )          | 5        |       |
| Accounts payable and accrued liabilities | ** ** | **60**   | ** ** | 38       |       | (43      | )          |
| ** **                               |       | **(10**  | **)**      | (2       | )          | (32      | )          |

 

b) Additional information 

 
| ** **                                                             | ** ** | **2005**   | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| Amortization of deferred financing costs  included in interest expense | ** ** | **4**      |       | 4        |       | 4        |       |
| Interest paid                                                          | ** ** | **83**     |       | 76       |       | 73       |       |
| Income taxes paid                                                      | ** ** | **26**     |       | 9        |       | 37       |       |
| Business acquisition in exchange for  non-monetary consideration       | ** ** | **—** |       | —   |       | 6        |       |

 

76

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

c) Cost of sales

 
| ** **            | ** ** | **2005**   | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------|------------|------------|------------|----------|------------|----------|------------|
| Foreign exchange loss | ** ** | **—** |       | (4       | )          | (9       | )          |

 

**18 Employee future benefits**

 

a) The expense for employeefuture benefits as at December 31 is as follows:

 
| ** **                                                                                                    | ** ** | **2005**               | ** ** | **2004**             | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                                                                    | ** ** | **Pension plans** | ** ** | **Other plans** | ** ** | **Pension plans** | ** ** | **Other plans** | ** ** |
| Current service cost                                                                                          | ** ** | **14**                 | ** ** | **3**                | ** ** | 14 |   | 5 |   |
| Interest cost                                                                                                 | ** ** | **32**                 | ** ** | **5**                | ** ** | 31 |   | 4 |   |
| Past service costs                                                                                            | ** ** | **9**                  | ** ** | **—**           | ** ** | 3 |   | 2 |   |
| Actual return on plan assets                                                                                  | ** ** | **(67**                | **)**      | **—**           | ** ** | (48 | ) | — |   |
| Actuarial losses on accrued benefit  obligation                                                               | ** ** | **93**                 | ** ** | **7**                | ** ** | 24 |   | 3 |   |
| Business acquisitions and disposal                                                                            | ** ** | **35**                 | ** ** | **4**                | ** ** | — |   | — |   |
| Others                                                                                                        | ** ** | **—**             | ** ** | **(4**               | **)**      | 4 |   | (1 | ) |
| Benefit costs before adjustments to recognize  the long-term nature of employee future benefit costs          | ** ** | **116**                | ** ** | **15**               | ** ** | 28 |   | 13 |   |
| Difference between expected return and actual  return on plan assets for the year                             | ** ** | **32**                 | ** ** | **—**           | ** ** | 15 |   | — |   |
| Difference between actuarial loss for the  year and actuarial loss on accrued benefit obligation for the year | ** ** | **(92**                | **)**      | **(8**               | **)**      | (22 | ) | (2 | ) |
| Difference between amortization of past  service costs and actual plan amendments for the year                | ** ** | **(8**                 | **)**      | **—**           | ** ** | (2 | ) | (1 | ) |
| Others                                                                                                        | ** ** | **1**                  | ** ** | **—**           | ** ** | (4 | ) | — |   |
| Adjustments to recognize the long-term nature  of employee future benefit costs                               | ** ** | **(67**                | **)**      | **(8**               | **)**      | (13 | ) | (3 | ) |
| Recognized costs for defined benefit  pension plans                                                           | ** ** | **49**                 | ** ** | **7**                | ** ** | 15 |   | 10 |   |
| Recognized costs for defined contribution  pension plans                                                      | ** ** | **13**                 | ** ** | **—**           | ** ** | 12 |   | — |   |
| Total expense for employee future benefits                                                                    | ** ** | **62**                 | ** ** | **7**                | ** ** | 27 |   | 10 |   |

 

77

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

Total cash payments foremployee future benefits for 2005, consisting of cash contributed by theCompany to its funded pension plans, including its defined contribution plans,and cash payments made directly to beneficiaries for its unfunded other benefitplans, including its collective RRSPs, are $39 million (2004–$36 million).Total estimated cash payments for employee future benefits are $39 million for2006.

 

b) The funded status of thedefined benefit plans and the other complementary retirement benefit plans andpost-employment benefit plans as at December 31 are as follows: 

 
| ** **                                            | ** ** | **2005**               | ** ** | **2004**             | ** ** |
|-------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                            | ** ** | **Pension plans** | ** ** | **Other plans** | ** ** | **Pension plans** | ** ** | **Other plans** | ** ** |
| **Accrued benefit obligation**                        |       |                   |       |                 |       |   |   |   |   |
| Beginning of year                                     | ** ** | **536**                | ** ** | **85**               | ** ** | 480 |   | 78 |   |
| Current service cost                                  | ** ** | **14**                 | ** ** | **3**                | ** ** | 14 |   | 5 |   |
| Interest cost                                         | ** ** | **32**                 | ** ** | **5**                | ** ** | 31 |   | 4 |   |
| Employees’ contributions                         |       | **5**                  | ** ** | **—**           | ** ** | 6 |   | — |   |
| Actuarial losses                                      | ** ** | **93**                 | ** ** | **7**                | ** ** | 24 |   | 3 |   |
| Benefits paid                                         | ** ** | **(26**                | **)**      | **(5**               | **)**      | (29 | ) | (6 | ) |
| Business acquisitions and disposals                   | ** ** | **(4**                 | **)**      | **5**                | ** ** | 10 |   | (1 | ) |
| Past service costs                                    | ** ** | **9**                  | ** ** | **—**           | ** ** | 3 |   | 2 |   |
| Others                                                | ** ** | **—**             | ** ** | **(4**               | **)**      | (3 | ) | — |   |
| End of year                                           | ** ** | **659**                | ** ** | **96**               | ** ** | 536 |   | 85 |   |
| **Plan assets**                                       |       | ** **             | ** ** | ** **           | ** ** |   |   |   |   |
| Beginning of year                                     | ** ** | **514**                | ** ** | **—**           | ** ** | 468 |   | — |   |
| Actual return on plan assets                          | ** ** | **67**                 | ** ** | **—**           | ** ** | 48 |   | — |   |
| Employer’s contributions                         |       | **21**                 | ** ** | **5**                | ** ** | 18 |   | 6 |   |
| Employees’ contributions                         |       | **5**                  | ** ** | **—**           | ** ** | 6 |   | — |   |
| Benefits paid                                         | ** ** | **(26**                | **)**      | **(5**               | **)**      | (29 | ) | (6 | ) |
| Business acquisitions and disposals                   | ** ** | **(8**                 | **)**      | **—**           | ** ** | 5 |   | — |   |
| Others                                                | ** ** | **—**             | ** ** | **—**           | ** ** | (2 | ) | — |   |
| End of year                                           | ** ** | **573**                | ** ** | **—**           | ** ** | 514 |   | — |   |
| **Reconciliation of funded status**                   |       | ** **             | ** ** | ** **           | ** ** |   |   |   |   |
| Fair value of plan assets                             | ** ** | **573**                | ** ** | **—**           | ** ** | 514 |   | — |   |
| Accrued benefit obligation                            | ** ** | **659**                | ** ** | **96**               | ** ** | 536 |   | 85 |   |
| Funded status of plan – deficit                  | ** ** | **(86**                | **)**      | **(96**              | **)**      | (22 | ) | (85 | ) |
| Unrecognized net actuarial loss                       | ** ** | **83**                 | ** ** | **16**               | ** ** | 58 |   | 8 |   |
| Unamortized transitional balance                      | ** ** | **(2**                 | **)**      | **—**           | ** ** | (2 | ) | — |   |
| Unamortized past service costs                        | ** ** | **20**                 | ** ** | **3**                | ** ** | 9 |   | 4 |   |
| Others                                                | ** ** | **—**             | ** ** | **—**           | ** ** | (1 | ) | (1 | ) |
| Accrued benefit asset (liability) – End of  year | ** ** | **15**                 | ** ** | **(77**              | **)**      | 42 |   | (74 | ) |

 

78

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

The net amount recognized onthe balance sheet as at December 31 is detailed as follows:

 
| ** **                                                                               | ** ** | **2005**               | ** ** |
|------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                               | ** ** | **Pension plans** | ** ** | **Other plans** | ** ** | **Total** | ** ** |
| Employee future benefit asset, included in  Other assets                                 | ** ** | **46**                 | ** ** | **—** | ** ** | **46** | ** ** |
| Employee future benefit liability, included  in Other liabilities                        | ** ** | **(8**                 | **)**      | **(77** | **)** | **(85** | **)** |
| Employee future benefit liability, included  in accounts payable and accrued liabilities | ** ** | **(23**                | **)**      | **—** | ** ** | **(23** | **)** |
| ** **                                                                               | ** ** | **15**                 | ** ** | **(77** | **)** | **(62** | **)** |

 
| ** **                                                        | ** ** | **2004**               | ** ** |
|-------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                        | ** ** | **Pension plans** | ** ** | **Other plans** | ** ** | **Total** | ** ** |
| Employee future benefit asset, included in  Other assets          |       | 52                     |       | — |   | 52 |   |
| Employee future benefit liability, included  in Other liabilities |       | (10                    | )          | (74 | ) | (84 | ) |
|                                                              |       | 42                     |       | (74 | ) | (32 | ) |

 

c) The following amountsrelate to plans that are not fully funded as at December 31:

 
| ** **                 | ** ** | **2005**               | ** ** | **2004**             | ** ** |
|----------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                 | ** ** | **Pension plans** | ** ** | **Other plans** | ** ** | **Pension plans** | ** ** | **Other plans** | ** ** |
| Fair value of plan assets  | ** ** | **329**                | ** ** | **—**           |       | 240 |   | — |   |
| Accrued benefit obligation | ** ** | **(399**               | **)**      | **(96**              | **)**      | (283 | ) | (85 | ) |
| Funded deficit             | ** ** | **(70**                | **)**      | **(96**              | **)**      | (43 | ) | (85 | ) |

 

d) The main actuarialassumptions adopted in measuring the accrued benefit obligation and expenses asat December 31 are as follows:

 
| ** **                                               | ** ** | **2005**               | ** ** | **2004**              | ** ** |
|----------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                               | ** ** | **Pension plans** | ** ** | **Other plans**  | ** ** | **Pension plans** | ** ** | **Other plans** | ** ** |
| **Accrued benefit obligation as at December  31**        |       |                   |       |                  | ** ** |   |   |   |   |
| Discount rate                                            | ** ** | **5.00**               | **%**      | **5.00**              | **%**      | 6.00 | % | 6.00 | % |
| Rate of compensation increase                            | ** ** | **2.00 – 4.25**   | **%**      | **2.25 – 4.25**  | **%**      | 2.50 – 4.25 | % | 2.50 – 4.25 | % |
| **Benefit costs for years ended December 31**            |       |                   |       |                  | ** ** |   |   |   |   |
| Discount rate                                            | ** ** | **6.00**               | **%**      | **6.00**              | **%**      | 6.25 | % | 6.25 | % |
| Expected long-term return on assets                      | ** ** | **7.00**               | **%**      | **—**            | ** ** | 7.00 | % | — |   |
| Rate of compensation increase                            | ** ** | **2.50 – 4.25**   | **%**      | **2.50 – 4.25**  | **%**      | 2.50 – 4.25 | % | 2.50 – 4.25 | % |
| **Assumed health-care cost trend rates at  December 31** |       |                   |       |                  | ** ** |   |   |   |   |
| Rate increase in health-care costs                       | ** ** | ** **             |       | **6.90 – 12.00** | **%**      |   |   | 7.30 – 12.50 | % |
| Cost trend rates decline to                              | ** ** | ** **             |       | **4.70 – 8.00**  | **%**      |   |   | 4.70 – 8.00 | % |
| Year the rate should stabilize                           | ** ** | ** **             |       | **2012**              | ** ** |   |   | 2012 |   |

 

79

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

e) Assumed rate increases inhealth-care cost have a significant effect on the amounts reported for thehealth-care plans. A 1% change in assumed health-care cost trend rates wouldhave the following effects for 2005:

 
| ** **                                                        | ** ** | **Increase of 1%** | ** ** | **Decrease of 1%** | ** ** |
|-------------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| Current service costs and interest costs |       | 4.3                          |       | (3.6                         | )          |
| Accrued benefit obligation, end of year                           |       | 60.7                         |       | (55.1                        | )          |

 

f) The plan assetsallocation and investment target allocation as at December 31 are detailed asfollows:

 
| ** **                 | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------|------------|----------|------------|----------|------------|
| **Plan assets allocation** |       |     | ** ** |     |       |
| Money market               | ** ** | **3**    | **%**      | 2        | %          |
| Debt securities            | ** ** | **36**   | **%**      | 38       | %          |
| Equity securities          | ** ** | **61**   | **%**      | 60       | %          |
| Total                      | ** ** | **100**  | **%**      | 100      | %          |

 

The plan assets do notinclude shares or debt securities of the Company, its joint venture and itssignificantly influenced companies. Annual benefit annuities, of an approximatevalue of $2 million, are pledged by insurance contracts established by theCompany.

 
| ** **                       | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|
| **Investment target allocation** |       |     | ** ** |     |       |
| Money market                     | ** ** | **3**    | **%**      | 3        | %          |
| Debt securities                  | ** ** | **41**   | **%**      | 40       | %          |
| Equity securities                | ** ** | **56**   | **%**      | 57       | %          |
| Total                            | ** ** | **100**  | **%**      | 100      | %          |

 

Target allocation isestablished so as to maximize return while considering an acceptable level ofrisk in order to meet the plan obligations on a long-term basis.

 

Investmentobjectives for the plan assets are the following: optimizing return whileconsidering an acceptable level of risk, maintaining an adequatediversification, controlling the risk according to different asset categories,and maintaining a long-term objective of return on investments.

 

Investmentguidance is established for each investment manager. It includes parametersthat must be followed by managers and presents criteria for diversification,non-eligible assets and minimum quality of investments as well as for returnobjectives.

 

80

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

Unless indicated otherwise,the managers cannot use any derivative product or invest more than 10% of theirassets in one particular security.

 

g) ESTIMATED FUTURE BENEFIT PAYMENTS Future benefit payments for defined benefitpension plans and other post-employment benefits, considering futureparticipation, are estimated as follows:

 
| ** ** | ** ** | **Pension plans** | ** ** | **Other plans** | ** ** |
|------------|------------|------------------------|------------|----------------------|------------|
| 2006       |       | 21                     |       | 4                    |       |
| 2007       |       | 23                     |       | 5                    |       |
| 2008       |       | 24                     |       | 5                    |       |
| 2009       |       | 26                     |       | 6                    |       |
| 2010       |       | 28                     |       | 6                    |       |
| 2011-2014  |       | 168                    |       | 82                   |       |

 

**19 Commitments and contingencies**

 

a) Future minimum paymentsunder operating leases and other commercial commitments (mainly composed of rawmaterials, natural gas, steam and electricity) for the next years are asfollows:

 
| ** **                               | ** ** | ** **                | ** ** | **Other commercial** | ** ** |
|------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| **Years ending December  31,** | ** ** | **Operating leases** | ** ** | **commitments**           | ** ** |
| 2006                                     |       | 40                        |       | 120                       |       |
| 2007                                     |       | 33                        |       | 101                       |       |
| 2008                                     |       | 25                        |       | 77                        |       |
| 2009                                     |       | 21                        |       | 51                        |       |
| 2010                                     |       | 16                        |       | 42                        |       |
| Thereafter                               |       | 43                        |       | 105                       |       |

 

b) The Company hasguaranteed the payment of approximately $4 million under operating leases heldby third parties. The Company also guaranteed residual values at the expirationof lease contracts of certain equipment for an approximate amount of $1million. Management of the Company does not believe that these guarantees arelikely to be called and, as such, no liability has been recognized in theconsolidated financial statements.

 

Inaddition, a subsidiary of the Company has guaranteed the debt of one of itsjoint ventures. The maximum amount guaranteed is US$8.7 million. As at December31, 2005, the debt of this joint venture, guaranteed by that subsidiary,amounts to US$5.5 million (2004–US$3.5 million). Management does not believethat this guarantee is likely to be called and, as a result, no liability hasbeen recognized in the consolidated financial statements.

 

c) In the normal course ofoperations, the Company is a party of various legal actions and contingencies,mostly related to contract disputes, environmental and product warranty claims,and labor issues. While the final outcome with respect to auctions outstandingor pending as at December 31, 2005, cannot be predicted with certainty, it ismanagement’s opinion that the settlement will not

 

81

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

have a material adverseimpact on the Company’s consolidated financial position, the results of itsoperations or its cash flows.

 

d) An action was filedagainst the Company on October 4, 2004, in the Supreme Court of the State ofNew York, Niagara County, by ServiceCore, Inc., alleging that the Companybreached a Finder’s Agreement in respect of gypsum board dated April 1999 andseeking damages in excess of US$9 million. The Company removed the action tothe United States District Court for the Western District of New York and filedan answer denying the allegations of breach of the Finder’s Agreement. TheCompany is vigorously contesting the claim but is unable to determine theoutcome of the action at this time.

 

e) On January 9, 2006,Cascades Fine Papers Group Inc., a subsidiary of the Company, Domtar Inc. andUnisource Canada Inc. plead guilty to two infractions under the Competition Actrelating to the sale of carbonless paper sheets during the years of 1999 and2000 in the provinces of Québec and Ontario (the “infractions”). On January 10,2006 the Company was informed that a class action based on the infractions hasbeen filed against Cascades Fine Paper Group Inc., Domtar Inc. and UnisourceCanada Inc. before the Québec Superior Court claiming damages totaling $10million. On January 12, 2006, the Company was informed that a second classaction had been filed in the Québec Superior Court against the same defendantsbased on the infractions claiming damages for an undetermined amount. OnFebruary 6, 2006, the Company was informed that a third class action based onthe infractions was filed against the same defendants as well as Coast PaperLtd. in the Ontario Superior Court for damages totaling $25 million. CascadesFine Papers Group Inc. intends to vigorously defend itself against theseclaims. The Company is unable to predict the outcome of these claims at thistime.

 

**20 Financial instruments**

 

The Company and some of itssubsidiaries and joint ventures utilize a variety of derivative financialinstruments to limit their exposure to foreign currency and commodityfluctuations as well as changing interest rates but do not hold or issue suchfinancial instruments for trading purposes with the exception of certaininterest rate swap agreements as described below.

 

**Currency risks**

 

The Company is exposed tocurrency risks as a result of its export of goods produced in Canada, theUnited States, France, Germany, Sweden and England. These risks are partiallycovered by purchases, debt service and forward exchange contracts.

 

82

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

TheCompany and a joint venture entered into various foreign exchange arrangementsas follows: 

 
| ** **                                                     | ** **    | **2005**         | ** **                | **2004**               | ** **              | **2005**             | ** ** | **2004**        | ** ** | **2005**        | ** ** | **2004** | ** ** |
|----------------------------------------------------------------|---------------|------------------|---------------------------|------------------------|-------------------------|----------------------|------------|-----------------|------------|-----------------|------------|----------|------------|
|                                                           |          |             |                      |                   |                    |                 |       |            |       |
| Foreign exchange forward contracts  (sell US$ for CAN$)   |          | Weighted average |                      |                   |                    |                 |       | Notional amount |       |
|                                                           | exchange rate |             | Unrealized gain (loss)    |                   | (in millions of US$)    |                 |
| 0 to 12 months                                                 | ** **    | **1.2411**       |                      | 1.3484                 | ** **              | **1.4**              |       | 10.3            | ** ** | **17**          |       | 71       |       |
| 13 to 24 months                                                | ** **    | **1.1697**       |                      | 1.3116                 | ** **              | **—**           |       | 0.1             | ** ** | **2**           |       | 1        |       |
|                                                           |          |             |                      |                   |                    |                 |       |            |       |
| Foreign exchange forward contracts  (buy US$ for CAN$)    |          | Weighted average |                      |                   |                    |                 |       | Notional amount |       |
|                                                           | exchange rate |             | Unrealized gain (loss)    |                   | (in millions of US$)    |                 |
| 0 to 12 months                                                 | ** **    | **1.1644**       |                      | 1.1796                 | ** **              | **—**           |       | 0.9             | ** ** | **20**          |       | 44       |       |
|                                                           |          |             |                      |                   |                    |                 |       |            |       |            |       |
|                                                           |          |             |                      |                   |                    |                 |       |            |       | Notional amount |       |
| Currency  option instruments                                   |          | Strike rate      |                      | Unrealized gain (loss) |                    | (in millions of US$) |       |
| 0 to 12 months                                                 |          | **1.17 to 1.30** |                      | 1.40 to 1.45           | ** **              | **0.4**              |       | —          | ** ** | **81**          |       | 8        |       |
| 13 to 24 months                                                |          | **1.23 to 1.30** |                      | —                 | ** **              | **0.2**              |       | —          | ** ** | **3**           |       | —   |       |
|                                                           |          |             |                      |                   |                    |                 |       |            |       |
| Foreign exchange forward contracts  (sell € for CAN$)     |          | Weighted average |                      |                   |                    |                 |       | Notional amount |       |
|                                                           | exchange rate |             | Unrealized gain (loss)(1) |                   | (in millions of €) |                 |
| 0 to 12 months                                                 | ** **    | **—**       |                      | 1.6641                 | ** **              | **—**           |       | 1.3             | ** ** | **—**      |       | 29       |       |
|                                                           |          |             |                      |                   |                    |                 |       |            |       |
| Foreign exchange forward contracts  (sell US$ for €) |          | Weighted average |                      |                   |                    |                 |       | Notional amount |       |
|                                                           | exchange rate |             | Unrealized gain (loss)    |                   | (in millions of US$)    |                 |
| 0 to 12 months                                                 | ** **    | **0.8267**       |                      | 0.7867                 | ** **              | **(0.1**             | **)**      | (0.2            | )          | **4**           |       | 2        |       |
|                                                           |          |             |                      |                   |                    |                 |       |            |       |
| Foreign exchange forward contracts  (buy US$ for €)  |          | Weighted average |                      |                   |                    |                 |       | Notional amount |       |
|                                                           | exchange rate |             | Unrealized gain (loss)    |                   | (in millions of US$)    |                 |
| 0 to 12 months                                                 | ** **    | **—**       |                      | 0.8152                 | ** **              | **—**           |       | 0.2             | ** ** | **—**      |       | 2        |       |
|                                                           |          |             |                      |                   |                    |                 |       |            |       |
| Foreign exchange forward contracts  (sell GBP for SEK)         |          | Weighted average |                      |                   |                    |                 |       | Notional amount |       |
|                                                           | exchange rate |             | Unrealized gain (loss)    |                   | (in millions of GBP)    |                 |
| 0 to 12 months                                                 | ** **    | **13.9285**      |                      | —                 | ** **              | **(0.3**             | **)**      | —          | ** ** | **5**           |       | —   |       |
| 13 to 24 months                                                | ** **    | **13.8260**      |                      | —                 | ** **              | **—**           |       | —          | ** ** | **1**           |       | —   |       |
|                                                           |          |             |                      |                   |                    |                 |       |            |       |
| Foreign exchange forward contracts  (sell € for SEK)      |          | Weighted average |                      |                   |                    |                 |       | Notional amount |       |
|                                                           | exchange rate |             | Unrealized gain (loss)    |                   | (in millions of €) |                 |
| 0 to 12 months                                                 | ** **    | **9.5599**       |                      | —                 | ** **              | **(0.1**             | **)**      | —          | ** ** | **5**           |       | —   |       |
| 13 to 24 months                                                | ** **    | **9.5275**       |                      | —                 | ** **              | **—**           |       | —          | ** ** | **1**           |       | —   |       |
|                                                           |          |             |                      |                   |                    |                 |       |            |       |
| Foreign exchange forward contracts  (sell GBP for €)      |          | Weighted average |                      |                   |                    |                 |       | Notional amount |       |
|                                                           | exchange rate |             | Unrealized gain (loss)    |                   | (in millions of GBP)    |                 |
| 0 to 12 months                                                 | ** **    | **1.4473**       |                      | 1.4366                 | ** **              | **—**           |       | (0.3            | )          | **6**           |       | 10       |       |

 

----

(1)In 2004, the unrealized gain was recognized in earnings since these contractswere not designated as hedges.

 

Currencyoptions are contracts whereby the Company and one of the joint ventures havethe right, but not the obligation, to sell or buy U.S. dollars at the strikerate if the U.S. dollar trades below that rate. In accordance with the contracts,the Company and the joint venture have the obligation to sell or buy U.S.dollars at the strike rate if the U.S. dollar trades above a specific rate. Inaddition, some of the option instruments of the Company include knock-outagreements at rates between 1.12 to 1.14.

 

The fair value of theforeign exchange arrangement generally reflects the estimated amounts theCompany would have received or paid to settle the contracts at year-end.

 

83

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

**Interest rate risks**

 

As at December 31,2005, approximately 26% (2004–17%) of the Company’s long-term debt was atvariable rates.

 

In addition, a joint ventureholds certain interest rate swap agreements not designated as hedges. Theseagreements, maturing from 2008 to 2012, have been contracted to fix interest ata weighted average rate of 8.20% on a notional amount of US$5.4 million (theshare of the Company is US$ 2.7 million). As at December 31, 2005, these agreementsare recorded as liabilities at their fair value of $0.4 million (2004–$0.6million).

 

In April 2004, a jointventure entered into interest rate swaps maturing in 2013. These contracts aredesignated as hedges of the change in fair value of a portion of the jointventure’s long-term debt. Accordingly, the interest rate went from a fixed rateof 6.75% to an average variable rate in 2005 of 6.23% (2004–3.96%) for anotional amount of US$50 million (the share of the Company is US$25 million).As at December 31, 2005, the fair value of these instruments representedan unrealized gain of $1.1 million (2004–$0.8 million).

 

**Credit risks**

 

The Company is exposed tocredit risk on the accounts receivable from its customers. In orderto reduce this risk, the Company’s creditpolicies include the analysis of the financial position of its customers andthe regular review of their credit limits. In addition, the Company believesthere is no particular concentration of credit risks due to the geographicdiversity of customers and the procedures for the management of commercial risks.Derivative financial instruments include an element of credit risk should thecounterparty be unable to meet its obligations. The Company reduces this riskby dealing with creditworthy financial institutions.

 

**Commodity price risk**

 

The Company and a jointventure entered into various derivative financial instruments whereby it setsthe price for notional quantities of old corrugated containers, electricity,natural gas, bleached 42-lb. kraft linerboard and 26-lb. semi-chemical corrugatedmedium. In 2003, gains and losses resulting from these contracts were appliedto earnings only when they were realized. In 2004 and in 2005, gains and lossesarising from electricity and natural gas contracts were applied to earningsonly when they were realized, whereas all other types of contracts wereaccounted for at fair value. The fair value of these contracts representedunrealized gains (losses) as follows:

 
| ** **                              | ** ** | ** **          | ** ** | ** **          | ** ** | **2005**                      | ** ** |
|-----------------------------------------|------------|---------------------|------------|---------------------|------------|-------------------------------|------------|
| ** **                              | ** ** | **Quantity**        | ** ** | **Maturing period** | ** ** | **Unrealized gains (losses)** | ** ** |
| Old  corrugated containers              | ** ** | **596,500 s.t.**    | ** ** | **2006 to 2008**    | ** ** | **(2.3**                      | **)**      |
| Electricity                             | ** ** | **135,571 MWh**     | ** ** | **2006 to 2007**    | ** ** | **4.6**                       | ** ** |
| Natural gas                             |       |                |       |                |       |                          |       |
| Canadian portfolio                      | ** ** | **8,598,820 GJ**    | ** ** | **2006 to 2010**    | ** ** | **18.5**                      | ** ** |
| American porfolio                       | ** ** | **3,315,000 mmBtu** | ** ** | **2006 to 2010**    | ** ** | **8.0**                       | ** ** |
| Unbleached  42-lb. kraft linerboard     | ** ** | **10,000 s.t.**     | ** ** | **2006**            | ** ** | **(0.2**                      | **)**      |
| 26-lb.  semi-chemical corrugated medium | ** ** | **—**          | ** ** | **—**          | ** ** | **—**                    | ** ** |

 

84

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 
| ** **                              | ** ** | ** **    | ** ** | ** **          | ** ** | **2004**                      | ** ** |
|-----------------------------------------|------------|---------------|------------|---------------------|------------|-------------------------------|------------|
| ** **                              | ** ** | **Quantity**  | ** ** | **Maturing period** | ** ** | **Unrealized gains (losses)** | ** ** |
| Old  corrugated containers              |       | 573,500 s.t.  |       | 2005 to 2007        |       | 6.7                           |       |
| Electricity                             |       | 301,404 MWh   |       | 2005 to 2007        |       | 1.9                           |       |
| Natural gas                             |       |          |       |                |       |                          |       |
| Canadian portfolio                      |       | 3,880,050 GJ  |       | 2005 to 2007        |       | 2.5                           |       |
| American porfolio                       |       | 496,788 mmBtu |       | 2005 to 2007        |       | (0.1                          | )          |
| Unbleached  42-lb. kraft linerboard     |       | 74,000 s.t.   |       | 2005 to 2006        |       | (2.3                          | )          |
| 26-lb.  semi-chemical corrugated medium |       | 5,000 s.t.    |       | 2005                |       | (0.3                          | )          |

 

**21 Cumulative translation adjustments**

 
| ** **                                                                                                                                       | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| **Balance –  Beginning of year**                                                                                                            | ** ** | **11**   |       | 14       |       | 48       |       |
| Effect of  changes in exchange rates during the year:                                                                                            |       |     |       |     |       |     |       |
| On net  investment in self-sustaining foreign subsidiaries                                                                                       | ** ** | **(63**  | **)**      | (36      | )          | (90      | )          |
| On certain long-term debt denominated in  foreign currency designated as a hedge of the net investments in self-sustaining  foreign subsidiaries | ** ** | **21**   | ** ** | 41       |       | 69       |       |
| Future  income taxes on designated long-term debt                                                                                                | ** ** | **(4**   | **)**      | (8       | )          | (13      | )          |
| Increase in future income taxes resulting  from a substantively created change in tax rates                                                      | ** ** | **(1**   | **)**      | —   |       | —   |       |
| **Balance –  End of year**                                                                                                                  | ** ** | **(36**  | **)**      | 11       |       | 14       |       |

 

**22 Related party transactions**

 

The Company entered into the followingtransactions with related parties:

 
| ** **                                              | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Joint  ventures(1)                                      |       |     |       |     |       |     |       |
| Sales                                                   | ** ** | **33**   |       | 25       |       | 26       |       |
| Revenue from services                                   | ** ** | **13**   |       | 12       |       | 21       |       |
| Purchases                                               | ** ** | **23**   |       | 27       |       | 26       |       |
| Significantly influenced companies                      |       |     |       |     |       |     |       |
| Sales                                                   | ** ** | **16**   |       | 11       |       | 48       |       |
| Purchases                                               | ** ** | **7**    |       | 15       |       | 15       |       |
| Entity controlled by a related director of  the Company |       |     |       |     |       |     |       |
| Purchases                                               | ** ** | **2**    |       | 6        |       | 7        |       |

 

----

(1) Represent the portionof transactions or balances not eliminated upon proportionate consolidation ofthe joint ventures.

 

85

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

These transactions occurredin the normal course of operations and are measured at the exchange amount,which is the amount of consideration established and agreed to by the relatedparties.

 

The balance sheets as at December 31included the following balances with related parties:

 
| ** **                                              | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------------------------------|------------|----------|------------|----------|------------|
| Joint  ventures(1)                                      |       |     |       |     |       |
| Accounts receivable                                     | ** ** | **6**    |       | 5        |       |
| Accounts payable                                        | ** ** | **6**    |       | 5        |       |
| Significantly  influenced companies                     |       |     |       |     |       |
| Accounts receivable                                     | ** ** | **3**    |       | 1        |       |
| Entity  controlled by a related director of the Company |       |     |       |     |       |
| Accounts payable                                        | ** ** | **1**    |       | 1        |       |

 

----

(1) Represent theportion of transactions or balances not eliminated upon proportionateconsolidation of the joint ventures.

 

**23 Interests in joint ventures**

 

The major components of theinterests in joint ventures in the consolidated financial statements are asfollows:

 
| ** **                                             | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Consolidated  balance sheets                           |       |     | ** ** |     |       |     |       |
| Current assets                                         | ** ** | **224**  | ** ** | 213      |       | 237      |       |
| Long-term assets                                       | ** ** | **486**  | ** ** | 497      |       | 572      |       |
| Current liabilities                                    | ** ** | **101**  | ** ** | 109      |       | 121      |       |
| Long-term debt, net                                    | ** ** | **212**  | ** ** | 173      |       | 188      |       |
| Consolidated  statements of earnings                   |       |     | ** ** |     |       |     |       |
| Sales                                                  | ** ** | **758**  | ** ** | 866      |       | 756      |       |
| Depreciation and amortization                          | ** ** | **35**   | ** ** | 41       |       | 34       |       |
| Operating income                                       | ** ** | **57**   | ** ** | 80       |       | 61       |       |
| Financial expenses                                     | ** ** | **13**   | ** ** | 13       |       | 17       |       |
| Net earnings                                           | ** ** | **14**   | ** ** | 51       |       | 25       |       |
| Consolidated  statements of cash flows                 |       |     | ** ** |     |       |     |       |
| Operating activities                                   | ** ** | **44**   | ** ** | 55       |       | 42       |       |
| Investing activities                                   | ** ** | **(68**  | **)**      | (66      | )          | (44      | )          |
| Financing activities                                   | ** ** | **35**   | ** ** | 11       |       | 2        |       |
| Additional  information                                |       |     | ** ** |     |       |     |       |
| Cash and cash equivalents at end of year               | ** ** | **18**   | ** ** | 8        |       | 12       |       |
| Total assets                                           | ** ** | **710**  | ** ** | 710      |       | 809      |       |
| Total debt(1)                                          | ** ** | **222**  | ** ** | 195      |       | 211      |       |
| Dividends received by the Company from  joint ventures | ** ** | **33**   | ** ** | 19       |       | 16       |       |

 

----

(1) Includes bank loans andadvances, current portion of long-term debt and long-term debt.

 

86

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

**24 Subsequent event**

 

In 2005, the Companyannounced the permanent shutdown of its Fine papers Thunder Bay, Ontario mill.The operations ceased on January 21, 2006. According to CICA Section 3475,*“Disposal**of long-lived assets and discontinued operations”*, this activity will be presented as adiscontinued operations starting with the first quarter of 2006. Financialinformation related to this activity is as follows:

 
| ** **                                                          | ** ** | **2005**  | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------------------------|------------|-----------|------------|----------|------------|----------|------------|
| Total assets  (net of impairment charge)                            | ** ** | **26**    |       | 66       |       |     |       |
| Sales                                                               | ** ** | **156**   |       | 161      |       | 159      |       |
| Depreciation  and amortization                                      | ** ** | **2**     |       | 2        |       | 3        |       |
| Operating  loss                                                     | ** ** | **(13**   | **)**      | (12      | )          | (13      | )          |
| Net loss,  including impairment and closure and restructuring costs | ** ** | **(65**   | **)**      | (10      | )          | (11      | )          |
| Per share                                                           | ** ** | **(0.80** | **)**      | (0.12    | )          | (0.13    | )          |

 

**25 Summary of differences betweenCanadian and United States generally accepted accounting principles**

 

The consolidated financialstatements have been prepared in accordance with Canadian GAAP which differs incertain respects from U.S. GAAP. Such differences, as they relate to theCompany, are summarized below.

 

**New accounting policies underU.S. GAAP**

 

a) VARIABLE INTEREST ENTITIES Effective January 1, 2004, the Companyadopted FIN 46, “*Consolidation of Variable Interest Entities*”. The primary objective of thisinterpretation is to provide guidance on the identification of and financialreporting for entities over which control is achieved through means other thanvoting rights; such entities are known as variable interest entities (VIEs). Theadoption of this standard did not have any material impact on the Company’sfinancial position or results of operations.

 

b) ACCOUNTING FOR ASSET RETIREMENT OBLIGATION On January 1, 2003, the Company appliedSFAS 143, *“Accountingfor Asset Retirement Obligations”*. This standard requires that the fair value of a liability for anasset retirement obligation be recognized in the period in which it is incurredif a reasonable estimate of fair value can be made. Effective December 15,2005, the Company also adopted FIN 47 which clarifies the notion of “conditionalasset retirement obligation” as used in SFAS 143. The application of thesestandards did not have any impact on the Company’s financial position orresults of operations.

 

87

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

**Reconciliation of net earnings,shareholders’ equity and balance sheet**

 

c) The following summarysets out the material adjustments to the Company’s reported net earnings, shareholders’equity and balance sheet which would be made in order to reconcile to U.S.GAAP. It also sets out a reconciliation of shareholders’ equity under U.S.GAAP:

 

Reconciliation of net earnings (loss)

 
| ** **                                                                                                  | ** ** | **Note**   | ** ** | **2005**   | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|----------|------------|----------|------------|
| Net earnings (loss) under Canadian GAAP                                                                     | ** ** | ** ** |       | **(97**    | **)**      | 23       |       | 55       |       |
| U.S. GAAP adjustments:                                                                                      |       |       |       |       | ** ** |     |       |     |       |
| Start-up costs                                                                                              |       | d          | )          | **—** | ** ** | (2       | )          | —   |       |
| Gain realized on formation of Norampac                                                                      |       | e          | )          | **(4**     | **)**      | (5       | )          | (4       | )          |
| Unrealized exchange gains (losses) arising from  foreign exchange forward contracts                         |       | f          | )          | **(4**     | **)**      | (2       | )          | 7        |       |
| Unrealized gains (losses) arising from  change in fair values of commodity derivative financial instruments |       | g          | )          | **—** | ** ** | (1       | )          | 3        |       |
| Unrealized gains from interest rate swaps                                                                   |       | h          | )          | **—** | ** ** | —   |       | 1        |       |
| Employee future benefits                                                                                    |       | i          | )          | **(3**     | **)**      | 1        |       | 2        |       |
| Dividends on preferred shares of a  subsidiary                                                              |       | k          | )          | **—** | ** ** | —   |       | 1        |       |
| Excess of redemption price of Class B preferred  shares on their paid-up capital                       |       | w          | )          | **—** | ** ** | (1       | )          | —   |       |
| Tax effect on above adjustments                                                                             | ** ** | ** ** |       | **6**      | ** ** | 3        |       | (4       | )          |
| Non-controlling interests                                                                                   | ** ** | ** ** |       | **—** | ** ** | —   |       | (1       | )          |
| Net earnings (loss) under U.S. GAAP                                                                         | ** ** | ** ** |       | **(102**   | **)**      | 16       |       | 60       |       |
| Net earnings (loss) under U.S. GAAP from continuing  operations                                             | ** ** | ** ** |       | **(92**    | **)**      | 13       |       | 56       |       |
| Net earnings (loss) under U.S. GAAP from assets  held for sale                                              | ** ** | ** ** |       | **(10**    | **)**      | 3        |       | 4        |       |
| ** **                                                                                                  |       | ** ** |       | **(102**   | **)**      | 16       |       | 60       |       |
| Basic net earnings (loss) under U.S. GAAP  from continuing operations per common share                      | ** ** | ** ** |       | **(1.15**  | **)**      | 0.17     |       | 0.68     |       |
| Basic and diluted net earnings (loss) under  U.S. GAAP per common share                                     | ** ** | ** ** |       | **(1.27**  | **)**      | 0.20     |       | 0.73     |       |

 

88

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

Statementof changes in shareholders’ equity under U.S. GAAP

 
| ** **                                                                                             | ** ** | **2005**              | ** ** | **2004**   | ** ** | **2003**              | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|------------|------------|-----------------------|------------|
| ** **                                                                                             | ** ** | **Number  of shares** | ** ** | **$**      | ** ** | **Number  of shares** | ** ** | **$** | ** ** | **Number  of shares** | ** ** | **$** | ** ** |
| Common stock                                                                                           |       |                  |       |       |       |                  |       |   |   |   |   |   |   |
| Balance at beginning of year                                                                           | ** ** | **81,361,580**        | ** ** | **261**    |       | 81,731,387            |       | 262 |   | 81,826,272 |   | 261 |   |
| Shares issued on exercise of stock options                                                             | ** ** | **12,560**            | ** ** | **—** |       | 133,893               |       | 1 |   | 180,115 |   | 2 |   |
| Redemption of common shares                                                                            | ** ** | **(555,600**          | **)**      | **(2**     | **)**      | (503,700              | )          | (2 | ) | (275,000 | ) | (1 | ) |
| Balance at end of year                                                                                 | ** ** | **80,818,540**        | ** ** | **259**    | ** ** | 81,361,580            |       | 261 |   | 81,731,387 |   | 262 |   |
| Adjustment relating to stock options                                                                   |       |                  |       |       | ** ** |                  |       |   |   |   |   |   |   |
| Balance at beginning of year                                                                           | ** ** | ** **            |       | **7**      | ** ** |                  |       | 4 |   |   |   | 3 |   |
| Adjustment of the year                                                                                 | ** ** | ** **            |       | **1**      | ** ** |                  |       | 3 |   |   |   | 1 |   |
| Balance at end of year                                                                                 | ** ** | ** **            |       | **8**      | ** ** |                  |       | 7 |   |   |   | 4 |   |
| Retained earnings                                                                                      |       |                  |       |       | ** ** |                  |       |   |   |   |   |   |   |
| Balance at beginning of year                                                                           | ** ** | ** **            |       | **830**    | ** ** |                  |       | 832 |   |   |   | 788 |   |
| Net earnings (loss) for the year                                                                       | ** ** | ** **            |       | **(102**   | **)**      |                  |       | 16 |   |   |   | 60 |   |
| Dividend on common shares                                                                              | ** ** | ** **            |       | **(13**    | **)**      |                  |       | (13 | ) |   |   | (13 | ) |
| Dividend on preferred shares                                                                           | ** ** | ** **            |       | **—** | ** ** |                  |       | — |   |   |   | (1 | ) |
| Excess of common share redemption price  over their paid-up capital                                    | ** ** | ** **            |       | **(4**     | **)**      |                  |       | (5 | ) |   |   | (2 | ) |
| Balance at end of year                                                                                 | ** ** | ** **            |       | **711**    | ** ** |                  |       | 830 |   |   |   | 832 |   |
| Cumulative other comprehensive income                                                                  |       |                  |       |       | ** ** |                  |       |   |   |   |   |   |   |
| Balance at beginning of year                                                                           | ** ** | ** **            |       | **2**      | ** ** |                  |       | 4 |   |   |   | 38 |   |
| Annual changes – net of tax                                                                       |       |                  |       |       | ** ** |                  |       |   |   |   |   |   |   |
| Foreign currency translation                                                                           | ** ** | ** **            |       | **(48**    | **)**      |                  |       | (3 | ) |   |   | (34 | ) |
| Minimum pension liability                                                                              | ** ** | ** **            |       | **(8**     | **)**      |                  |       | (4 | ) |   |   | — |   |
| Unrealized exchange gains (loss) arising  from foreign exchange forward contracts designated as hedges | ** ** | ** **            |       | **(4**     | **)**      |                  |       | 5 |   |   |   | — |   |
| Unrealized gain arising from commodity  derivative financial instruments designated as hedges          | ** ** | ** **            |       | **1**      | ** ** |                  |       | — |   |   |   | — |   |
| Balance at end of year                                                                                 | ** ** | ** **            |       | **(57**    | **)**      |                  |       | 2 |   |   |   | 4 |   |
| Rounding                                                                                               | ** ** | ** **            |       | **—** | ** ** |                  |       | 1 |   |   |   | 1 |   |
| Shareholders’ equity – End of year                                                           | ** ** | ** **            |       | **921**    | ** ** |                  |       | 1,101 |   |   |   | 1,103 |   |

 

89

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

Reconciliationof shareholders’ equity

 
| ** **                                                                                         | ** ** | **Note**   | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|
| Shareholders’ equity under Canadian GAAP                                                      | ** ** | ** ** |       | **897**  | ** ** | 1,059    |       | 1,056    |       |
| U.S. GAAP adjustments:                                                                             |       |       |       |     | ** ** |     |       |     |       |
| Start-up costs                                                                                     |       | d          | )          | **(7**   | **)**      | (7       | )          | (5       | )          |
| Gain realized on formation of Norampac                                                             |       | e          | )          | **53**   | ** ** | 57       |       | 62       |       |
| Unrealized exchange gains arising from  foreign exchange forward contracts                         |       | f          | )          | **1**    | ** ** | 12       |       | 7        |       |
| Unrealized gains arising from change in  fair values of commodity derivative financial instruments |       | g          | )          | **5**    | ** ** | 3        |       | 4        |       |
| Employee future benefits                                                                           |       | i          | )          | **(12**  | **)**      | (9       | )          | (10      | )          |
| Minimum pension liability                                                                          |       | j          | )          | **(32**  | **)**      | (21      | )          | (16      | )          |
| Tax effect on above adjustments                                                                    | ** ** | ** ** |       | **7**    |       | (2       | )          | (5       | )          |
| Excess of redemption price of Class B  preferred shares on their paid-up capital              |       | w          | )          | **9**    | ** ** | 9        |       | 10       |       |
| Shareholders’  equity under U.S. GAAP                                                         | ** ** | ** ** |       | **921**  | ** ** | 1,101    |       | 1,103    |       |

 

Reconciliation of balance sheet

 
| ** **                                | ** ** | ** **                                 | ** ** | ** **         | ** ** | **2005**       | ** ** | ** **         | ** ** | **2004**       | ** ** |
|-------------------------------------------|------------|--------------------------------------------|------------|--------------------|------------|----------------|------------|--------------------|------------|----------------|------------|
| ** **                                | ** ** | **Note**                                   | ** ** | **Canadian  GAAP** | ** ** | **U.S.  GAAP** | ** ** | **Canadian  GAAP** | ** ** | **U.S.  GAAP** | ** ** |
| Property,  plant and equipment            |       | e), m) and w)                              | ** ** | **1,562**          | ** ** | **1,601**      |       | 1,700              |       | 1,742          |       |
| Other assets  and goodwill (long-term)    |       | from d) to i)   and t)                     | ** ** | **359**            | ** ** | **376**        |       | 328                |       | 354            |       |
| Accounts  payable and accrued liabilities |       | f), g) and h)                              | ** ** | **543**            | ** ** | **543**        |       | 509                |       | 507            |       |
| Other  liabilities (long-term)            |       | d), e), f),   g), j), k), m), n)   and (w) | ** ** | **265**            | ** ** | **297**        |       | 303                |       | 331            |       |
| Shareholders’  equity                |       | from d) to m)  and w)                 | ** ** | **897**            | ** ** | **921**        |       | 1,059              |       | 1,101          |       |

 

The amounts shown in theabove table include joint ventures accounted for by the proportionateconsolidation method, as indicated under (s), in accordance with both Canadianand U.S. GAAP.

 

d) Under Canadian GAAP,start-up costs are deferred and amortized over a period not exceeding fiveyears. Under U.S. GAAP, start-up costs are accounted for under Statement ofPosition (“SOP”) No. 98-5, *“Reporting on the Costs of Start-up Activities”*, and are included in the statement ofearnings in the period they are incurred.

 

e) On December 30,1997, the Company and Domtar Inc. merged their respective container-board andcorrugated packaging operations to form Norampac Inc., a 50-50 joint venture.Under Canadian GAAP, a portion of the gain realized on the transaction of anoriginal amount of approximately $58 million, net of tax, was recorded against property,plant and equipment and goodwill. Under U.S. GAAP, this gain would have beenrecognized in earnings on December 30, 1997.

 

90

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

In addition, under U.S.GAAP, additional liabilities would have been included in the allocation of thepurchase price at the date of the transaction with respect to employee futurebenefits with a corresponding adjustment to goodwill.

 

f) Under Canadian GAAP, gainsand losses arising from foreign exchange forward contracts used to hedgeanticipated sales, purchases or interest are charged to earnings as anadjustment of sales, cost of sales or financial expenses when the underlyingsale, purchase or interest is recorded. Under U.S. GAAP, the foreign exchangeforward contracts concluded before January 1, 2004 are not designated ashedges as defined in SFAS 133, *“Accounting for Derivative Instruments and HedgingActivities”*; therefore, the unrealizedgains and losses from these contracts are charged to earnings as they arise.Under U.S. GAAP, foreign exchange forward contracts entered into after January 1,2004 are designated as hedges, as defined by SFAS 133.

 

g) Under Canadian GAAP,gains and losses arising from swap commodity contracts designated as hedges arecharged to earnings only when realized. Under U.S. GAAP, the unrealized gainsand losses arising from these contracts, which do not meet requirements ofhedging as defined in SFAS 133, *“Accounting for Derivative Instruments and Hedging Activities”*, are charged to earnings. For contracts initiatedprior to January 1, 2004, the Company had elected to not designate thesecontracts as hedging instruments for U.S. GAAP reporting purposes. Accordingly,those contacts are marked to market and the resulting unrealized gains andlosses are recorded to earnings.

 

h) Under Canadian GAAP,unrealized gains and losses on interest rate swaps concluded before January 1,2004 and designated as hedges are not recognized in the financial statements.Under U.S. GAAP, these contracts are not designated as hedges and therefore,the unrealized gains and losses are included in earnings.

 

i) Since the adoption ofCICA 3461, *“Employee Future Benefits”*, on January 1, 2000, the treatment of pension costs is notmaterially different from U.S. GAAP. The remaining adjustments result from theamortization of actuarial losses and gains which arose prior to January 1,2000.

 

j) Solely under U.S. GAAP, aminimum pension liability adjustment must be recorded when the accumulatedbenefit obligation of a plan is greater than the fair value of its assets. Theexcess of its liability over the intangible asset, which can also be recordedfor the plan, is recorded in other comprehensive income in shareholders’equity.

 

k) Under Canadian GAAP,dividends on mandatorily redeemable preferred shares of a subsidiary arecharged to earnings as interest expense. Under U.S. GAAP, declared dividendsprior to July 1, 2003 are charged to earnings but as non-controlling interests.Since July 1, 2003, in accordance with SFAS 150, *“Accounting for CertainFinancial Instruments with Characteristics of Both Liabilities and Equity”*, dividends are charged to earnings as interestexpense.

 

91

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

In addition, under U.S.GAAP, declared dividends prior to July 1, 2003 would have been shown as afinancing activity in the cash flows statement. Since July 1, 2003, thesedividends are shown as an operating activity, as they are under Canadian GAAP.

 

l) Under Canadian GAAP,income tax rates of substantively enacted tax laws must be used to calculatefuture income tax assets and liabilities, while under U.S. GAAP, only incometax rates of enacted laws can be used.

 

m) On December 31,2000, the Company acquired shares held by non-controlling shareholders in threeof its subsidiaries (the “privatized subsidiaries”) in exchange for commonshares of the Company. Under Canadian GAAP, the fair value of $6.85 attributedto the shares issued represents the quoted market value of the Company’s sharesat the date of privatization. Under U.S. GAAP, the fair value attributed to theshares issued would have been $6.67 which represents the quoted market value ofthe Company’s shares during a reasonable period before and after the date thetransaction was agreed upon and announced. Since the excess of the net bookvalue of the non-controlling interests over their purchase price has beenrecorded under Canadian GAAP as a decrease of property, plant and equipment andfuture income tax liabilities, the adjustment resulting from a differentmeasurement date as stated above would affect these accounts accordingly.

 

In addition, Canadian GAAPto U.S. GAAP reconciliation items described under (d) to (l) and affectingthe privatized subsidiaries prior to December 31, 2000 would affect thecomputation of the net book value of the non-controlling interests andtherefore the adjustment to property, plant and equipment and future income taxliabilities at the date of the privatization.

 

n) Comprehensive income

 
| ** **                                                                                                                                | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net earnings  (loss) under U.S. GAAP                                                                                                      | ** ** | **(102** | **)**      | 16       |       | 60       |       |
| Foreign currency translation                                                                                                              | ** ** | **(48**  | **)**      | (3       | )          | (34      | )          |
| Minimum pension liability adjustment, net  of related income taxes(1)                                                                     | ** ** | **(8**   | **)**      | (4       | )          | —   |       |
| Unrealized exchange gains (losses) arising  from foreign exchange forward contracts designated as hedges, net of related  income taxes(2) | ** ** | **(4**   | **)**      | 5        |       | —   |       |
| Unrealized gain arising from commodity  derivative financial instruments designated as hedges, net of related income  taxes(3)            | ** ** | **1**    | ** ** | —   |       | —   |       |
| Comprehensive  income (loss) under U.S. GAAP                                                                                              | ** ** | **(161** | **)**      | 14       |       | 26       |       |

 

----

| (1) | The minimum pension  liability adjustment represents $7.5 million, $4.4 million and $0.3 million  for the years ended December 31, 2005, 2004 and 2003 respectively, net  of related income taxes of $3.8 million, $1.5 million and $0.1 million for  the years ended December 31, 2005, 2004 and 2003 respectively. |
|-----|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | The unrealized exchange  loss of $4.2 million for the years ended December 31, 2005 (2004 –  unrealized gain of $5.1 million) is net of related income taxes of $2.1  million (2004 – $2.7 million).                                                                                                            |
| (3) | The unrealized gain of $1.1  million for the years ended December 31, 2005 is net of related income  taxes of $0.7 million.                                                                                                                                                                                               |

 

92

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

o) Accumulated other comprehensive income

 
| ** **                                                                                                                               | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Cumulative  translation adjustments                                                                                                      | ** ** | **(37**  | **)**      | 11       |       |
| Cumulative  minimum pension liability adjustments, net of related income taxes                                                           | ** ** | **(22**  | **)**      | (14      | )          |
| Cumulative unrealized exchange gains  arising from foreign exchange forward contracts designated as hedges, net of  related income taxes | ** ** | **1**    |       | 5        |       |
| Cumulative unrealized gain arising from  commodity derivative financial instruments designated as hedges, net of  related income taxes   | ** ** | **1**    |       | —   |       |
| ** **                                                                                                                               |       | **(57**  | **)**      | 2        |       |

 

p) For pension plans wherethe accumulated benefit obligation (“ABO”) exceeds the fair value of plan assetsunder U.S. GAAP, the projected benefit obligation (“PBO”), ABO and fair valueof plan assets are as follows:

 
| ** **                 | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------|------------|----------|------------|----------|------------|
| PBO                        | ** ** | **424**  |       | 166      |       |
| ABO                        | ** ** | **408**  |       | 154      |       |
| Fair value  of plan assets | ** ** | **335**  |       | 122      |       |

 

q) The following disclosureis required by U.S. GAAP. However, the information presented is based onamounts published according to Canadian GAAP.

 
| ** **                                                                                                                      | ** ** | **2005**   | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|
| ** **                                                                                                                      | ** ** | **Canada** | ** ** | **Other countries** | ** ** | **Total** | ** ** |
| Net earnings (loss) from continuing  operations before income taxes and share of results of significantly  influenced companies | ** ** | **(186**   | **)**      | **51** | ** ** | **(135** | **)** |
| Provision  for recovery of income taxes                                                                                         |       |       |       |   |   |   |   |
| Current                                                                                                                         | ** ** | **(7**     | **)**      | **21** | ** ** | **14** | ** ** |
| Future                                                                                                                          | ** ** | **(55**    | **)**      | **(4** | **)** | **(59** | **)** |
| Future income taxes resulting from an  increase in tax rates                                                                    | ** ** | **4**      | ** ** | **—** | ** ** | **4** | ** ** |
| ** **                                                                                                                      | ** ** | **(58**    | **)**      | **17** | ** ** | **(41** | **)** |
| Net earnings (loss) from continuing  operations before share of results of significantly influenced companies                   | ** ** | **(128**   | **)**      | **34** | ** ** | **(94** | **)** |

 

93

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 
| ** **                                                                                                                      | ** ** | **2004**   | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|
| ** **                                                                                                                      | ** ** | **Canada** | ** ** | **Other countries** | ** ** | **Total** | ** ** |
| Net earnings (loss) from continuing  operations before income taxes and share of results of significantly  influenced companies |       | (24        | )          | 44 |   | 20 |   |
| Provision for income taxes                                                                                                      |       |       |       |   |   |   |   |
| Current                                                                                                                         |       | 6          |       | 16 |   | 22 |   |
| Future                                                                                                                          |       | (14        | )          | (6 | ) | (20 | ) |
|                                                                                                                            |       | (8         | )          | 10 |   | 2 |   |
| Net earnings (loss) from continuing  operations before share of results of significantly influenced companies                   |       | (16        | )          | 34 |   | 18 |   |

 
| ** **                                                                                                               | ** ** | **2003**   | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|
| ** **                                                                                                               | ** ** | **Canada** | ** ** | **Other countries** | ** ** | **Total** | ** ** |
| Net earnings from continuing operations  before income taxes and share of results of significantly influenced  companies |       | 47         |       | 17 |   | 64 |   |
| Provision for recovery of income taxes                                                                                   |       |       |       |   |   |   |   |
| Current                                                                                                                  |       | 7          |       | 4 |   | 11 |   |
| Future                                                                                                                   |       | —     |       | (6 | ) | (6 | ) |
| Future income taxes resulting from an  increase in tax rates                                                             |       | 5          |       | — |   | 5 |   |
|                                                                                                                     |       | 12         |       | (2 | ) | 10 |   |
|                                                                                                                     |       |       |       |   |   |   |   |
| Net earnings from continuing operations  before share of results of significantly influenced companies                   |       | 35         |       | 19 |   | 54 |   |

 

94

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

r)     The disclosure of the following amounts is required by U.S.GAAP:

 
| ** **                                         | ** ** | **2005**   | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| Payment on operating leases                        | ** ** | **42**     | ** ** | 45       |       | 37       |       |
| Payment on capital lease                           | ** ** | **2**      | ** ** | 2        |       | 7        |       |
| Loss (gain) on foreign currency                    |       |       | ** ** |     |       |     |       |
| Realized                                           | ** ** | **(7**     | **)**      | 1        |       | 7        |       |
| Unrealized                                         | ** ** | **7**      | ** ** | 3        |       | 2        |       |
|                                               | ** ** | ** ** | ** ** |     |       |     |       |
| Trade accounts receivable                          | ** ** | **462**    | ** ** | 452      |       |     |       |
| Provision for bad debt                             | ** ** | **(12**    | **)**      | (13      | )          |     |       |
| Accounts receivable from related companies         | ** ** | **8**      | ** ** | 7        |       |     |       |
| Other accounts receivable                          | ** ** | **45**     | ** ** | 44       |       |     |       |
| Income tax receivable                              | ** ** | **24**     | ** ** | 19       |       |     |       |
| Prepaid expenses                                   | ** ** | **18**     | ** ** | 18       |       |     |       |
| ** **                                         |       | **545**    | ** ** | 527      |       |     |       |
| Trade accounts payable                             |       | **359**    | ** ** | 351      |       |     |       |
| Accounts payable to related companies              | ** ** | **6**      | ** ** | 7        |       |     |       |
| Marginal salaries and benefits payable             | ** ** | **108**    | ** ** | 79       |       |     |       |
| Interest payable                                   | ** ** | **22**     | ** ** | 25       |       |     |       |
| Income taxes payable on benefit                    | ** ** | **4**      | ** ** | 5        |       |     |       |
| Capital expenditures included in accounts  payable | ** ** | **10**     | ** ** | 13       |       |     |       |
| Others                                             | ** ** | **34**     | ** ** | 29       |       |     |       |
| ** **                                         |       | **543**    | ** ** | 509      |       |     |       |

 

95

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

Valuation and qualifying accounts 

 
| ** **                              | ** ** | **2005**                                       | ** ** |
|-----------------------------------------|------------|------------------------------------------------|------------|
| ** **                              | ** ** | **Balance  at beginning  of period** | ** ** | **Additions charged  to expenses** | ** ** | **Deductions** | ** ** | **Balance at end  of period** | ** ** |
| Provision for doubtful accounts         | ** ** | **13**                                         |       | 4 |   | (5 | ) | 12 |   |
| Provision for obsolete inventory        | ** ** | **8**                                          |       | 10 |   | — |   | 18 |   |
| Valuation allowance for tax purposes(1) | ** ** | **25**                                         |       | — |   | (11 | ) | 14 |   |

 
| ** **                              | ** ** | **2004**                                       | ** ** |
|-----------------------------------------|------------|------------------------------------------------|------------|
| ** **                              | ** ** | **Balance  at beginning  of period** | ** ** | **Additions charged  to expenses** | ** ** | **Deductions** | ** ** | **Balance at end  of period** | ** ** |
| Provision for doubtful accounts         |       | 13                                             |       | 6 |   | (6 | ) | 13 |   |
| Provision for obsolete inventory        |       | 8                                              |       | — |   | — |   | 8 |   |
| Valuation allowance for tax purposes(1) |       | 28                                             |       | — |   | (3 | ) | 25 |   |

 
| ** **                              | ** ** | **2003**                                       | ** ** |
|-----------------------------------------|------------|------------------------------------------------|------------|
| ** **                              | ** ** | **Balance  at beginning  of period** | ** ** | **Additions charged  to expenses** | ** ** | **Deductions** | ** ** | **Balance at end  of period** | ** ** |
| Provision for doubtful accounts         |       | 11                                             |       | 7 |   | (5 | ) | 13 |   |
| Provision for obsolete inventory        |       | 11                                             |       | — |   | (3 | ) | 8 |   |
| Valuation allowance for tax purposes(1) |       | 33                                             |       | — |   | (5 | ) | 28 |   |

 

----

(1)     Thedeductions in the valuation allowance for tax purposes are detailed as follows:

 
| ** **                                                                      | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Foreign currency translation                                                    | ** ** | **(3**   | **)**      | 1        |       | 2        |       |
| Unrecognized tax benefit arising from  current losses of subsidiaries           | ** ** | **1**    | ** ** | 1        |       | 2        |       |
| Recognized tax benefit arising from  previously incurred losses of subsidiaries | ** ** | **(9**   | **)**      | (5       | )          | (9       | )          |
| ** **                                                                      |       | **(11**  | **)**      | (3       | )          | (5       | )          |

 

s) Under Canadian GAAP,investments in joint ventures are accounted for using the proportionate consolidationmethod. Under U.S. GAAP, investments in joint ventures are accounted for usingthe equity method. The different accounting treatment affects only the displayand classification of financial statement items and not net earnings or shareholders’equity. Rules prescribed by the *U.S. Securities and Exchange Commission*(“SEC”) permit the use of the proportionateconsolidation method in the reconciliation to U.S. GAAP provided the jointventure is an operating entity and the significant financial operating policiesare, by contractual arrangement, jointly controlled by all parties having anequity interest in the joint venture. As required, the Company discloses innote 23 the major components of its financial statements resulting from the useof the proportionate consolidation method to account for its interests in jointventures.

 

t) Under Canadian GAAP, theCompany’s deferred financing costs are amortized on a straight-line basis overthe anticipated period of repayment of the underlying debt. Under U.S. GAAP,such costs are

 

96

----

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Foreach of the years in the three-year period ended december 31, 2005—(tabularamounts in millions of Canadian dollars, except per share amounts)

 

 

amortized under the interestmethod. Amortization under both methods was not materially different for eachof the periods presented.

 

u) Under U.S. GAAP, theamounts for each category of cash flows from assets held for sale presented in note4 would be presented directly on the statement of cash flows.

 

v) Under U.S. GAAP, thepremium paid on redemption of long-term debt would be classified as an operatingactivity and not as cash flow used in financing activities. In addition, under U.S.GAAP, financing charges incurred in 2005, 2004 and 2003 amounting to $2million, $2 million and $29 million respectively would be classified underoperating activities rather than financing activities.

 

w) Under Canadian GAAP, the Class Bpreferred shares of a subsidiary are included under capital stock (note 11(b)).Under U.S. GAAP, these preferred shares would be shown on the balance sheet asa non-controlling interest. As described in note 11(b), in 2003, the Companyredeemed all of the outstanding Class B preferred shares of a subsidiaryfor a consideration of $16 million. Under Canadian GAAP, the excess of theredemption price of $10 million over the recorded capital was included inretained earnings. Under U.S. GAAP, as these preferred shares represent a non-controllinginterest, the excess of $10 million would have been recorded as an increase of$15 million in property, plant and equipment and an increase of $5 million infuture income tax liabilities. The adjustment of $15 million in property, plantand equipment is amortized on a straight-line basis over a period of 20 years.In addition, under U.S. GAAP, the premium paid on redemption would beclassified under investing activities rather than financing activities.

 

**Accounting pronouncement not yet implementedunder U.S. GAAP**

 

x) ACCOUNTING CHANGES AND ERROR CORRECTIONS In May 2005, the FASB published SFAS154, *“AccountingChanges and Error Corrections”*.This new standard establishes, unless impracticable, retrospective applicationas the required method for reporting change in accounting principle in the absenceof explicit transition requirements specific to the newly adopted accountingprinciple. This new standard is effective for accounting changes andcorrections of errors made in fiscal years beginning after December 15,2005.

 

y) EXCHANGE OF NON-MONETARY ASSETS In December 2004, the FASB publishedSFAS 153, *“Exchangesof Non-monetary Assets – an amendment of APB Opinion No. 29”*. This standard, which is equivalent to theCanadian standard, requires exchanges of certain non-monetary assets to bemeasured at fair value unless the exchange lacks commercial substance. This standardwill be effective for exchanges occurring in fiscal years beginning after June 15,2005.

 

z) INVENTORY In November 2004 , the FASB published SFAS 151, *“Inventory Costs – anamendment to ARB No. 43, Chapter 4”*. This standard requires the allocation to inventory of fixed general manufacturingcosts that exceed the costs related to a normal and stable production. It also requiresthe allocation to inventory of abnormal costs related to assets not in service,freight costs, handling costs, and production of non-standard products. SFAS151 applies to open periods as of June 15, 2005 but its anticipatedapplication is permitted. The Company is presently evaluating the impact ofthis new standard.

 

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