CATALYST
PAPER CORPORATION
 
 MANAGEMENT’S
DISCUSSION AND ANALYSIS
 
 
 
 
 
 
 
 
 MANAGEMENT’S
DISCUSSION AND ANALYSIS
 
 The
following management discussion and analysis (“MD&A”) of Catalyst Paper
Corporation (the “Company”) should be read in conjunction with the consolidated
financial statements for the years ended December 31, 2007, 2006, and 2005, and
the notes thereto.
  Throughout
this discussion, reference is made to EBITDA, which represents earnings before
interest, taxes, depreciation and amortization, and before other non-operating
income and expenses, EBITDA before specific items, average delivered cash costs
per tonne before specific items, net earnings (loss) before specific items, net
earnings (loss) per share before specific items, and free cash
flow.  Management believes these measures are useful to evaluate the
performance of the Company and its business segments.  As Canadian
Generally Accepted Accounting Principles (“GAAP”) do not define a method of
calculating these measures, securities regulations require that non-GAAP
measures be clearly defined and qualified, and reconciled with their nearest
GAAP measure.  The definition, calculation, and reconciliation of
these non-GAAP measures is provided in Section 9: “Non-GAAP
Measures”.
  In
accordance with industry practice, in this MD&A, the term “tonne” or the
symbol “MT” refers to a metric tonne and the term “ton” or the symbol “ST”
refers to a short ton, an imperial unit of measurement equal to 0.9072 metric
tonnes.
  In
this MD&A, unless otherwise indicated, all dollar amounts are expressed in
Canadian dollars, as are the term “dollars” and the symbols “$” and
“CDN$”.  The term “U.S. dollars” and the symbol “US$” refer to United
States dollars.
  The
information in this report is as at February 13, 2008, which is the date of
filing in conjunction with the Company’s press release announcing its results
for the fourth quarter and twelve months ended December 31,
2007.  Disclosure contained in this document is current to that date,
unless otherwise stated.
  CAUTIONARY
STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
  This
MD&A contains forward-looking statements.  Forward-looking
statements are statements, other than statements of historical fact, that
address or discuss activities, events or developments that the Company expects
or anticipates may occur in the future.  These forward-looking
statements can be identified by the use of words such as “anticipate”, “could”,
“expect”, “seek”, “may”, “likely”, “intend”, “will”, “believe” and similar
expressions or the negative thereof.  These forward-looking statements
reflect management’s current views and are based on certain assumptions
including assumptions as to future economic conditions and courses of action, as
well as other factors management believes are appropriate in the
circumstances.  Such forward-looking statements are subject to risks
and uncertainties and no assurance can be given that any of the events
anticipated by such statements will occur or, if they do occur, what benefit the
Company will derive from them.  A number of factors could cause actual
results, performance or developments to differ materially from those expressed
or implied by such forward-looking statements, including the general economic
conditions in the U.S., Canada and internationally, market conditions and demand
for the Company’s products, the outlook for inventories, production and pricing,
the Company’s ability to successfully obtain performance improvements and cost
savings from its cost reduction initiatives, expected cash flows, capital
expenditures and completion of capital projects, shifts in industry capacity,
fluctuations in foreign exchange and interest rates, fluctuations in
availability and cost of raw materials or energy, the implementation of
environmental legislation requiring capital for operational changes, the
Company’s ability to obtain financing and other factors beyond the Company’s
control.  Additional information concerning these and other factors
can be found in Section 13 of this MD&A under the heading "Risks and
Uncertainties".  The Company disclaims any intention or obligation to
update or revise any forward-looking statements, whether as a result of new
information, future events or otherwise.
  Investors
are cautioned not to place undue reliance on these forward-looking
statements.  No forward-looking statement is a guarantee of future
results.
 
  
 
 
 Table of Contents
 
 
 
 
 Page1.0
              Overview
      and highlights
              42.0
              Segmented
      results – Annual
              213.0
              Segmented
      results – Quarterly
              304.0
              Financial
      condition
              365.0
              Liquidity
      and capital resources
              376.0
              Related
      party transactions
              437.0
              Off-balance
      sheet arrangements
              438.0
              Summary
      of quarterly results
              449.0
              Non-GAAP
      measures
              4510.0
              Critical
      accounting policies and estimates
              4911.0
              Changes
      in accounting policies
              5312.0
              Impact
      of accounting pronouncements affecting future periods
              5413.0
              Risks
      and uncertainties
              5414.0
              Sensitivity
      analysis
              6115.0
              Outlook
              6216.0
              Disclosure
      controls and internal control over financial reporting
              6417.0
              Outstanding
      share data
              65
      
 
 
 1.0
              OVERVIEW
      AND HIGHLIGHTS
  1.1
              Overview of the
      business
  Catalyst
is a leading producer of specialty printing papers and newsprint in North
America.  The Company also produces market kraft pulp and white top
containerboard and owns Western Canada’s largest paper recycling
facility.  With five mills located within a 160-kilometre radius on
the south coast of British Columbia, Catalyst has a combined annual capacity of
2,403,000 tonnes of product.  The Company is headquartered in
Richmond, B.C.
  The
Company is the largest producer of specialty printing papers and newsprint in
Western North America.  Catalyst’s specialty printing papers include
lightweight coated, uncoated mechanical papers (soft-calendered and
machine-finished hi-brites and super-brites) and directory paper.  The
Company is one of the largest producers of directory paper in the world and the
only producer of lightweight coated paper in Western North America.
  The
Company’s business is comprised of three business segments: specialty paper,
newsprint, and pulp.  The split of production capacity between the
three business segments is as follows:
  
 Specialty
paper
  The
specialty paper segment consists of lightweight coated (“LWC”), uncoated
mechanical papers such as soft-calendered (“SC”) and machine-finished (“MF”)
hi-brites and super-brites, and directory.  These specialty printing
paper grades are manufactured on ten1paper
machines in British Columbia at Crofton, Elk Falls, Port Alberni and Powell
River.  The specialty paper business segment has a total production
capacity of 1,123,000 million tonnes.
  Specialty
paper represents the Company’s largest business segment, generating 54% of 2007
consolidated sales revenue.  The Company’s customer base consists
primarily of retailers, magazine and catalogue publishers, commercial printers
and telephone directory publishers.  Specialty printing paper products
are sold primarily through the Company’s sales and marketing personnel in North
America, and through distributors and agents in other geographic
markets.  In 2007, 90% of specialty paper sales volumes were with
customers in North America.  Specialty paper is shipped by ship,
barge, rail or truck, or by a combination of some or all of these transportation
modes.
  Newsprint
  Newsprint
is currently manufactured on five1 paper
machines at Crofton, Elk Falls and Powell River.  The newsprint
business segment has a total annual production capacity of 606,000
tonnes.  Effective September 1, 2007 the Port Alberni No. 4 paper
machine  (“A4”) was indefinitely idled, displacing 134,000 tonnes of
newsprint on a 45.0 g/m2 basis.
  Newsprint
sales generated 20% of 2007 consolidated sales revenue. The newsprint customer
base consists primarily of newsprint publishers located in Western and Central
North America and in Asia. In 2007, 82% of newsprint sales volumes were with
customers in North America, Asia and Australasia. Newsprint is shipped overseas
by deep-sea vessel and inland by ship, barge, rail or truck, or by a combination
of some or all of these transportation modes.
  Pulp
  The pulp
segment consists of Northern Bleached Softwood Kraft (“NBSK”) pulp manufactured
at the Crofton mill and sawdust-based pulp and containerboard manufactured at
the Elk Falls mill.  The pulp business segment has a total market
production capacity of 674,000 tonnes.
  Pulp and
containerboard sales generated 26% of 2007 consolidated sales revenue. The pulp
customer base is located primarily in Europe and Asia and includes producers of
tissue, magazine papers, woodfree printing and writing papers and certain
specialty paper products. The containerboard customer base consists primarily of
corrugated box manufacturers. Pulp and containerboard products are sold
primarily through sales and marketing personnel in Canada, and through a network
of agents in locations throughout the world. In 2007, 79% of pulp and
containerboard sales volumes were with customers in Europe, Asia and
Australasia. The Crofton and Elk Falls pulp mills are located on tidewater and
have deep-sea vessel loading facilities. Pulp and containerboard are shipped by
both break-bulk and container deep-sea vessels.
  The
Company also owns the largest paper recycling facility in Western Canada.
Operated in support of the business segments described above, the recycling
facility has an annual production capacity of 175,000 air-dried equivalent
tonnes of pulp per year, the majority of which is consumed
internally.
  
 
 
 
 
 
 
 
 1
              The
      Company has 11 paper machines.  The number of machines noted in
      the segments above reflects the ability of the Company’s machines to
      switch between newsprint and specialty paper
  grades.
 
 
 
 The chart
below illustrates the Company’s principal paper and pulp products,
their applications, and annual 2008 production capacity:
  PRODUCT
      PROFILESegment
                Specialty
      paper
                Newsprint
                PulpCategory
                Uncoated
      mechanical
                Lightweight
      Coated
                Directory
                Newsprint
                Containerboard
                Market
      pulpSoft-calendered
                Machine-finishedBrand
      names
                Electrasoft
                  Electracal
                  Electraprime
                Electrabrite
                  Electrastar
                Electracote
                Catalyst
                Marathon
                Silverliner
                  Platinumliner
                  Chromiumliner
                  Bronzeliner
                Elk
      Prime
                  Crofton
      KraftBasis
      weight (g/m2)
                45
      – 52
                45
      – 66.5
                44.4
      – 63.6
                28
      – 40
                43
      – 48.8
                127
      – 270
                n/aApplications
                Magazines,
                  Supplements,
                  Catalogues,
                  Inserts,
                  Flyers,
      Direct mail,
                  Directories
                Magazines,
                  Supplements,
                  Inserts,
      Flyers,
                  Direct
      mail,
                  PR
      and corporate communication
                  books/manuals
                Magazines,
                  Catalogues,
                  Inserts,
      Flyers,
                  Direct
      mail
                Telephone
      books,
                  Airline
      schedules,
                  Catalogues
                Newspapers,
                  Inserts,
      Flyers,
                  Supplements,
                  Directories,
                  Timetables
                Packaging
      applications
                Tissue,
                  Freesheet,
                  Specialty
      paper,
                  White-top
      linerboardTotal
      capacity (tonnes)
                540,0001
                231,000
                352,0001
                606,0001,2
                131,000
                543,000%
      of total capacity
                22%
                10%
                15%
                25%
                5%
                23%
  1
              Capacities
      expressed in the above table can vary as the Company is able to switch
      production between products - particularly newsprint, directory and
      machine-finished uncoated grades.
 2
              The
      Company indefinitely curtailed A4 effective September 1, 2007, displacing
      the equivalent of 134,000 tonnes of the Company’s annual newsprint
      production. The capacity noted in the table above has not been adjusted to
      reflect this indefinite
curtailment.
  The chart
below illustrates the annual 2008 production capacity by mill and product
line:
  CAPACITY
      BY MILL LOCATION AND PRODUCT LINESpecialty
      paper
                Newsprint
                PulpMill
      location
                Number
      of Paper machines
                Uncoated
      mechanical
                Lightweight
      Coated
                Directory
                Newsprint
                Containerboard
                Market
      pulpCrofton,
      B.C.
                3
                -
                -
                246,000
                150,000
                -
                343,000Elk
      Falls, B.C.
                3
                153,000
                -
                -
                373,000
                131,000
                200,000Port
      Alberni, B.C.
                22
                -
                231,000
                106,000
                -
                -
                -Powell
      River, B.C.
                3
                387,000
                -
                -
                83,000
                -
                -Total
      capacity (tonnes)
                
                540,0001
                231,000
                352,0001
                606,0001,2
                131,000
                543,000
  1
              Capacities
      expressed in the above table can vary as the Company is able to switch
      production between products - particularly newsprint, directory and
      machine-finished uncoated grades.
 2
              The
      Company indefinitely curtailed A4 effective September 1, 2007, displacing
      the equivalent of 134,000 tonnes of the Company’s annual newsprint
      production. The capacity and number of machines noted in the table above
      have not been adjusted to reflect this indefinite
    curtailment.
 
 
 
 Geographic Sales
Distribution
  The
Company’s products are sold on five continents. At 62% of sales, the North
American market continues to be the Company’s principal market, and is followed
in significance by Asia and Australasia, Latin America, and Europe. The
consolidated sales volume distribution for 2007 was as follows:
  
    The
paper sales volume distribution for 2007 was as follows:
  
  
  
 
 
 The
pulp sales volume distribution for 2007 was as follows:
  
    1.2
              2007 Annual
      Overview
  After
four consecutive years of improvement in operating earnings, 2007 was a
particularly challenging environment for the Company, resulting in the Company’s
earnings declining versus their prior year.  A Canadian dollar that
reached 50 year record highs against the U.S. dollar in 2007, a price downcycle
for most of our paper products, a constrained fibre supply, and the impact of a
strike further affecting coastal fibre supply in the third and fourth quarters,
all combined to create significant headwinds.  However, on the
positive side pulp prices increased rapidly during the year and towards the end
of the year most groundwood paper products started to see positive price
momentum.  In addition, the Company took action to improve
profitability through the indefinite closure of newsprint capacity and the
reduction of approximately 15% of the workforce through the Company’s
restructuring program, which contributed the largest part of another successful
Performance Improvement Program that delivered $81 million of benefit to
operating earnings and EBITDA in 2007.
  The
Company recorded a net loss of $31.6 million, compared to a net loss of $15.9
million in 2006.  EBITDA was $27.0 million, compared to $211.0 million
in 2006. The Company’s results in 2007 included restructuring and
change-of-control costs of $64.7 million and were also negatively impacted by
$25.0 million related to a disruption in fibre supply resulting from the United
Steelworkers of Canada union (“USW”) work stoppage.  EBITDA before
these specific items was $116.7 million, compared to $211.0 million in
2006.
  Restructuring
Initiatives and Change-of-Control
  The
Company announced and implemented, in phases during 2007, a restructuring
program to eliminate approximately 565 positions across the Company, relocate
the corporate office, and centralize certain mill administrative
functions.  This program was substantially completed during the year
and is expected to deliver total annualized cost savings of approximately $67
million.  In 2007, total restructuring costs for this program were
$58.3 million, including $3.0 million of capital expenditures.
  The
Company indefinitely curtailed operations of A4 on September 1,
2007.  Production of directory paper made on A4 was moved to Crofton
and displaced the equivalent of 134,000 tonnes per year of the Company’s least
profitable newsprint business. The curtailment also reduced the Company’s
highest cost fibre and power requirements.
  Significant
management changes occurred during 2007.  Richard Garneau joined the
Company as the President and Chief Executive Officer and David Smales, formerly
Vice-President of Strategy, was appointed Vice-President, Finance and Chief
Financial Officer replacing former President and Chief Executive Officer and
former Vice-President, Finance and Chief Financial Officer, respectively, after
they exercised their rights under change-of-control agreements and left the
Company during the first quarter of 2007.  The Company recorded $8.3
million in severance, pension-benefit and stock-compensation expenses related to
these change-of-control agreements plus $1.1 million relating to certain
employee retention agreements.
  Performance
Improvements
  The
Company continued to deliver on its performance improvement objectives,
including the restructuring program, and realized a year-over-year operating
earnings and EBITDA increase of $81 million from performance
improvements.  A discussion of the 2007 Performance Improvement
Program’s results is provided under “Progress on 2007 Strategic Initiatives” in
Section 1.5, “Strategy”.
  Canadian
Dollar
  The
majority of the Company’s sales are denominated in U.S. dollars. As a result,
the strengthening Canadian dollar, which reached its highest value against the
U.S. dollar in more than 50 years during 2007, had a significant negative
impact on the Company’s operating earnings for the year. The average spot rate
for 2007 was US$0.930 compared to US$0.882 for 2006 and US$0.825 for
2005.  Despite the mitigation provided by the Company’s hedging
program, the currency movement in 2007 reduced EBITDA by $48 million when
compared to 2006.
  The chart
below illustrates the movement of the US$/CDN$ spot rate over the past six
years:
  
   Product
Demand and Pricing
  Market
conditions for the Company’s products were mixed in 2007.
  Coated
mechanical demand was higher in the year largely due to substitution of coated
mechanical grades for coated woodfree.  Supply in the coated market
tightened late in 2007, primarily due to significant North American mill
closures in the latter half of the year combined with lower mill
inventories.  These factors led to improving LWC prices in the second
half of the year.  In December 2007, the Company announced a
third consecutive US$60 per ton price increase for its LWC paper grades,
bringing the total announced increases by the end of the year to $180 per ton
since July 1, 2007.  Despite the recent upward pricing momentum,
the average LWC benchmark price was 6% lower in 2007, compared to
2006.
  Overall
uncoated mechanical demand remained flat.  The increased demand for
high-gloss grades offset the decrease in demand for standard
grades.  Prices softened during the first half of the year, but
started to reverse in the fourth quarter.  The average soft-calendered
A grade (“SC-A”) benchmark price was 4% lower than the previous
year.
  After
robust growth in 2006, directory demand was steady in 2007 due to slower growth
in the number of independent books printed and flat total page and book
circulation for incumbent publishers.   The average directory
benchmark price was 3% higher than in 2006.
  Newsprint
demand continued to weaken at a significant rate during 2007, leading to an
average newsprint benchmark price decrease of 11% from 2006.  Prices
began to stabilize late in the year as capacity closures reduced supply and a
US$25 per tonne price increase was implemented in December 2007 in the
U.S.
  Pulp
demand continued to be strong in 2007.  The combination of strong
demand and tight supply resulted in US$ prices increasing to their highest level
since 1995. The averageNBSK benchmark price in
2007 was 17% higher than in 2006.
  For
containerboard markets, supply and demand remained in balance, with low
inventory and healthy export levels despite flat demand.  The 2007
benchmark price was 4% higher than in 2006.
  Fibre
Costs and Supply
  A
combination of factors made 2007 a difficult year with respect to fibre
supply.  Coming into 2007 low inventory levels throughout the fibre
supply chain, due to lower log volume harvested in the fourth quarter of 2006,
was made more challenging by continued poor weather in Q1, 2007.  This
resulted in higher fibre prices in the first half of the
year.  Although harvesting conditions returned to normal by mid-2007,
the three month USW strike that began in late July and reduced sawmill activity
as a result of poor market conditions for lumber kept fibre prices high all
year.  Overall, increased fibre costs and the total impact of the USW
strike had a negative impact of $103 million on EBITDA in 2007 when compared to
2006.
  Fibre
lost to Catalyst during the USW strike was 284,000 bone dry tonnes, although the
impact was partially mitigated through higher than expected logging activity and
increased supply from other suppliers.  This loss of fibre led to
production curtailments in the third and fourth quarters of 106,100 tonnes of
paper and 44,200 tonnes of pulp and containerboard at the Elk Falls mill; and
10,500 tonnes of pulp at the Crofton mill.
  Liquidity
and Capital assets
  The
Company’s available liquidity was $241 million at the end of 2007, compared to
$324 million at the end of 2006.  Of the $83 million decrease, $41
million was due to a reduction in borrowing base on the Company’s revolving
operating facility as a result of lower accounts receivable and inventory
following curtailment related to the reduced fibre availability in Q4, and the
indefinite closure of A4 in September, 2007.  Lower EBITDA, in large
part due to restructuring and change-of-control costs and the impact of the USW
strike, further reduced the Company’s liquidity.
  In
September 2007, the Company sold the Port Alberni No. 3 (“A3”) paper machine and
ancillary assets.  The Company received proceeds of $1.3 million and
recorded a loss on disposal of $7.5 million.
  1.3
              2007
      highlights
  Ø
              Realized
      year-over-year operating earnings and EBITDA benefits of $81 million from
      the Company’s 2007 Performance Improvement Program, of which $29 million
      was related to workforce
reductions.
 Ø
              Implemented
      a restructuring program which is expected to deliver annualized cost
      savings of approximately $67 million
through:
 o
              total
      workforce reductions of 565;
 o
              relocation
      of the corporate office from Vancouver, B.C. to lower cost premises in
      Richmond, B.C., and
 o
              centralization
      of certain mill administrative functions in Nanaimo,
  B.C.
 Ø
              Indefinitely
      curtailed A4, displacing 134,000 tonnes of the Company’s least profitable
      newsprint production.
 Ø
              Made
      high-return capital investments totalling $56.5 million, including
      $8.1 million to facilitate receipt of de-inked pulp (“DIP”) in more
      efficient crumb form at the Crofton
mill.
 Ø
              Received
      a national energy efficiency stewardship award from CIPEC, an organization
      founded by the federal government in conjunction with business, to promote
      energy efficiency.
 Ø
              Recognized
      for environmental and social responsibility programs
      including:
 o
              Launched
      Catalyst Cooled, a product line whose manufacture results in no net carbon
      emissions – on which Rolling Stone magazine prints and for which the
      Company received the Metafore Innovation Award in the products
      category.
 o
              Recognized
      as the only forest-products company on the Conference Board of Canada’s
      Carbon Disclosure Leadership Index (CDLI), in recognition of transparency
      regarding emissions and reduction
efforts.
 o
              Received
      – “Gift to the Earth” recognition from the WWF, in connection with the
      conservation and management agreement reached for the Great Bear
      Rainforest.
 o
              Recognized
      by the United Way (BC Lower Mainland) for 15 consecutive years of “gold
      level” employee giving, calculated as 80% of an organization’s one-day
      payroll.
 Ø
              Received
      the Canadian Institute of Chartered Accountants award of excellence for
      financial and corporate reporting in the forest products
      category.
  1.4
              Selected annual
      financial information
  (In
      millions of dollars, except where otherwise stated)2007
                
                
                2006
                
                
                2005Sales
                
                $
                1,714.6
                
                
                $
                1,882.5
                
                
                $
                1,823.9Operating
      earnings (loss)
                
                
                (149.4
                )
                
                
                3.9
                
                
                
                (25.1
                )EBITDA1
                
                
                27.0
                
                
                
                211.0
                
                
                
                155.2EBITDA
      before specific items1
                
                
                116.7
                
                
                
                211.0
                
                
                
                161.9Net
      earnings (loss)
                
                
                (31.6
                )
                
                
                (15.9
                )
                
                
                (25.6
                )Net
      earnings (loss) before specific items1
                
                
                (89.3
                )
                
                
                (25.0
                )
                
                
                (64.6
                )Total
      assets
                
                
                2,453.4
                
                
                
                2,637.7
                
                
                
                2,695.9Total
      long-term liabilities
                
                
                1,195.4
                
                
                
                1,338.6
                
                
                
                1,396.8EBITDA
      margin1,2
                
                
                1.6
                %
                
                
                11.2
                %
                
                
                8.5
                %EBITDA
      margin before specific items1,2
                
                
                6.8
                %
                
                
                11.2
                %
                
                
                8.9
                %Net
      earnings (loss) per share (in dollars) – basic and diluted
                
                $
                (0.15
                )
                
                $
                (0.07
                )
                
                $
                (0.12
                )Net
      earnings (loss) per share before specific items (in dollars) – basic and
      diluted1
                
                
                (0.42
                )
                
                
                (0.12
                )
                
                
                (0.30
                )Sales
      (000 tonnes)Specialty paper
                
                
                1,054.8
                
                
                
                990.2
                
                
                
                942.9Newsprint
                
                
                496.3
                
                
                
                699.1
                
                
                
                707.1Total paper
                
                
                1,551.1
                
                
                
                1,689.3
                
                
                
                1,650.0Pulp
                
                
                603.2
                
                
                
                626.2
                
                
                
                603.0Total sales
                
                
                2,154.3
                
                
                
                2,315.5
                
                
                
                2,253.0Production
      (000 tonnes)Specialty paper
                
                
                1,055.4
                
                
                
                983.7
                
                
                
                949.3Newsprint
                
                
                472.8
                
                
                
                703.7
                
                
                
                699.5Total paper
                
                
                1,528.2
                
                
                
                1,687.4
                
                
                
                1,648.8Pulp
                
                
                601.8
                
                
                
                624.3
                
                
                
                590.9Total production
                
                
                2,130.0
                
                
                
                2,311.7
                
                
                
                2,239.7US$/CDN$
      foreign exchangeAverage spot rate3
                
                
                0.930
                
                
                
                0.882
                
                
                
                0.825Period-end spot rate4
                
                
                1.012
                
                
                
                0.858
                
                
                
                0.858Effective rate5
                
                
                0.917
                
                
                
                0.872
                
                
                
                0.807Common
      shares (millions)At period end
                
                
                214.7
                
                
                
                214.6
                
                
                
                214.6Weighted average
                
                
                214.7
                
                
                
                214.6
                
                
                
                214.6
  1
              EBITDA,
      EBITDA before specific items, EBITDA margin, EBITDA margin before specific
      items, net earnings (loss) before specific items, and net earnings (loss)
      per share before specific items are non-GAAP measures.  Refer to
      Section 9, “Non-GAAP Measures” for further
  details.
 2
              EBITDA
      margin and EBITDA margin before specific items are defined as EBITDA and
      EBITDA before specific items, as a percentage of sales and adjusted sales,
      respectively.  Refer to Section 9, “Non-GAAP Measures” for
      further details.
 3
              Average
      spot rate is the average Bank of Canada noon spot rate over the reporting
      period.
 4
              Period-end
      spot rate is the Bank of Canada noon spot rate on December
    31.
 5
              Effective
      rate represents a blended rate which takes account of the applicable spot
      rates, the Company’s revenue hedging program in the period, and
      translation of US$-denominated working capital at period opening and
      closing rates.  See Section 9, “Summary of Quarterly Results”
      for further details.
 
 
 
 1.5
              Strategy
  The
Company’s long-term objective is to achieve higher sustainable earnings and
maximize cash flow by strengthening its position as a leading producer of
groundwood printing papers, including specialty printing paper grades and
newsprint.
  Key performance
drivers
  The
Company believes the following key performance drivers are critical to achieving
its strategic goals and creating value for its investors.
  Market
position
 Market
position is a significant driver of the Company’s success.  As one of
the largest producers of specialty printing papers in North America, market
penetration and diversification is important.  The Company’s brand
names are well recognized in the marketplace and it has built a reputation for
reliability, value and service.
  Product
mix
 In recent
years, the Company has expanded the number of grades manufactured in the
market.  The Company has introduced new product lines which include
Electraprime (an “SCA” alternative), Electrastar (a super-brite), Electrabrite
Lite (a lightweight hi-brite), Silverliner (a kraft paper whitetop), and Elk
Prime (a sawdust-based pulp).  These newer and more specialized
products generally provide higher margins than standard commodity
grades.  The Company also manages fluctuations in demand for its
products through its ability to switch production capacity between products,
particularly newsprint, directory, and machine-finished uncoated mechanical
grades.  In addition, market pulp, sawdust-based pulp, and white-top
linerboard further diversify the product mix.
  Supply
chain
 Distribution
costs have a significant impact on net sales realizations. The Company’s strong
and flexible distribution network optimizes all transportation modes available
to it, such as truck, rail, and container and break-bulk shipping.
 
 The mill
sites directly ship break bulk paper and pulp to offshore customers via
regularly scheduled vessels.  The Company operates a central
distribution centre in Surrey, B.C. which receives volumes from its four
manufacturing sites and then ships via rail, truck and container to its
customers.  This allows the Company to choose the most cost effective
transportation mode in conjunction with customer requirements.
 
 The
Company leases 980 rail cars to ensure damage free, on time delivery to its rail
customers and the Company leases five paper barges which it uses to transport
its products to the Surrey distribution centre.  Controlling key
elements of its supply chain have allowed the Company to achieve a high on time
performance and low damage level.  Combined with its focus on lowering
costs and the reduction of inventory levels, the Company improved its service
delivery business processes and further centralized its organization in 2007 to
provide cost-efficient and reliable transportation to customers.
 
 Cost-competitive
manufacturing
 The
Company’s manufacturing costs are key to being competitive over the long term,
particularly with respect to fibre, energy, and labour costs and the Company is
focused on reducing these costs and improving margins.  Over the past
five years, capital expenditures of approximately $423 million have been
directed primarily towards shifting production towards higher-margin printing
papers, reducing unit production costs, increasing machine productivity,
improving product quality, increasing capacity, and meeting or exceeding
environmental regulations.
  In
addition, over the last several years, the Company has developed expertise in
the production of lightweight papers.  Lower basis weight papers
reduce the Company’s costs by decreasing fibre, shipping, and storage and
handling expenses.
  Production
and capacity utilization
 The
ability to increase production rates and minimize production downtime impacts
the Company’s per unit cash costs.  Over the last several years the
Company has been focused on improving machine productivity through several
initiatives such as implementing an asset reliability
program, operator technical training, and increasing focus on
reducing machine dry end losses. These and other initiatives from the Company’s
Performance Improvement Program have been instrumental in improving machine
productivity.
  Corporate
social responsibility
 Corporate
social responsibility is one of the Company’s core values.  The
Company judges success in this area through the safety and well-being of its
employees, the vibrancy of its communities, and the sustainability of the
Company’s practices with respect to their impact on the
environment.  A complete description of the Company’s commitments and
progress in corporate social responsibility is provided in the Company’s 2007
Sustainability Report, produced concurrently with the Company’s 2007 annual
report.
  Key performance
indicators
 The
Company believes the following key performance indicators are meaningful for
measuring the Company’s progress in achieving its strategic goals and creating
value for investors:
  Safety
 The
Company’s first priority is the well-being of its employees.  Key
metrics include the medical incident rate (“MIR”), which is the number of
incidents requiring medical attention per 200,000 hours worked, and the
lost-time injury frequency (“LTI”), which is the number of lost-time injuries
per 200,000 hours worked.  The Company’s overall safety performance
declined on these and other key safety measures during
2007.  Additional details on 2007 safety results are provided in the
Company’s 2007 Sustainability Report, produced concurrently with the Company’s
2007 annual report.
  Performance
Improvement Program
 One of
the characteristics of the Company’s culture is that of engaging its people in
projects that challenge the status quo.  The Company has for several
years aggregated these initiatives on an annual basis into a Performance
Improvement Program.  Performance improvement initiatives challenge
the Company to create innovative and cost-effective business
solutions.  In 2007, the Company launched its sixth consecutive
Performance Improvement Program, which included the 2007 restructuring
program.  A detailed summary of the 2007 Performance Improvement
Program results is available in this section under “Progress on 2007 Strategic
Initiatives”.
  EBITDA
and EBITDA before specific items
 EBITDA
and EBITDA before specific items are widely used in the financial community to
compare the profitability of corporations, and are used by management as an
indicator of relative operating performance.  Further analysis and
discussion of these indicators are provided in all discussions of operations and
in the “Non-GAAP Measures” section.
  Average
sales revenue per tonne
 Average
sales revenue per tonne for each core business provides key insights into how
the Company maximizes its market position and product mix.  The main
factors in revenue growth are U.S. dollar transaction prices, and the
relationship between the Canadian and U.S. dollar.  Details on 2007
results are provided in the “Segmented Results - Annual” and “Segmented Results
- Quarterly” sections.
  Average
delivered cash costs per tonne and average delivered cash costs per tonne before
specific items
 Reducing
cash costs while maintaining product quality is essential to sustaining
profitability in each of the Company’s core businesses.  The Company
continually examines all areas of its business for cost reduction
opportunities.  Details on 2007 results are provided in the “Segmented
Results - Annual” and “Segmented Results - Quarterly” sections.
  Free
cash flow
 Free cash
flow is a measure of cash that is generated by operations and available after
capital expenditures, but before changes in working capital items and proceeds from
divested assets.  Further analysis and discussion of
this indicator is provided in the “Non-GAAP Measures”
section.
  Leverage
and interest coverage
 The
Company’s success also depends on its liquidity and continued ability to finance
its growth.  The Company focuses on total-debt to
total-capitalization, net-debt to net-capitalization, net-debt to EBITDA, and
EBITDA to interest ratios in order to assess its debt
position.  Further analysis and discussion of these indicators are
provided in the “Liquidity and Capital Resources” section.
  Greenhouse
gas emissions (“GHG”)
 The
Company takes its environmental compliance seriously and focuses on continuous
improvement of its performance through operational efficiency and process
innovation.  The Company has achieved a 69% absolute and intensity
reduction of GHGs since 1990 (as measured by direct emissions), and management
believes the Company is well positioned to meet emerging regulatory objectives
and market expectations.  The Company received third-party recognition
for the transparency and depth of its reporting on greenhouse gases in 2007, and
launched a manufactured carbon-neutral product line.  Further details
are provided in the Company’s 2007 Sustainability Report, produced concurrently
with the Company’s 2007 annual report.
  Progress on 2007 strategic
initiatives
  (a)
              Performance
      Improvement Program
  The
Company’s achievements relating to specific performance improvements in 2007,
2006, and 2005 were as follows:
  Performance
      Improvement Program Initiatives(All
      amounts are pre-tax and in millions of dollars)
                
                2007
      Realized
                
                
                2006
      Realized
                
                
                2005
      RealizedWorkforce
      reduction
                
                $
                29
                
                
                $
                -
                
                
                $
                -Product,
      grade, and customer optimization
                
                
                21
                
                
                
                11
                
                
                
                19Productivity
      improvements
                
                
                6
                
                
                
                20
                
                
                
                -Reduce
      energy consumption
                
                
                6
                
                
                
                12
                
                
                
                10Furnish
      costs
                
                
                5
                
                
                
                12
                
                
                
                12Optimize
      chemical usage
                
                
                2
                
                
                
                5
                
                
                
                4Other
                
                
                12
                
                
                
                14
                
                
                
                39Total
      Performance Improvement Program
                
                $
                81
                
                
                $
                74
                
                
                $
                84
  Early in
2007, the Company commenced its sixth consecutive annual Performance Improvement
Program.  Improvements were targeted in the areas of workforce
reductions, product, grade, and customer optimization, and other cost reduction
initiatives.  In 2007, the program delivered $81 million in realized
improvements by the following means:
  Workforce
reduction
 Workforce
reductions related to the 2007 restructuring program resulted in savings of $29
million.  The Company reduced its workforce positions from 3,673 on
January 1, 2007 to 3,038 on January 1, 2008.  The reduction to date
includes 551, or 98%, of the 565 positions targeted for elimination, in addition
to employees laid off as a result of the indefinite closure of the A4 paper
machine.
  Product,
grade, and customer optimization
 This
strategic initiative involved the marketing of higher-value specialty printing
paper products, allowing margin optimization compared to standard
grades.  In 2007, the Company realized EBITDA improvements of $21
million as a result of its various product, grade, and customer optimization
initiatives.
  Sales of
Electraprime were of particular relevance in 2007.  This is a
soft-calendered high-brite paper grade designed to compete as an alternative to
SC-A grades and is used primarily for advertising flyers, inserts and direct
mail.  It continued to be well received in the market with sales of
approximately 125,000 tonnes in 2007, an improvement of approximately 22,000
tonnes, or 21%, from 2006. Electraprime was introduced to the market in 2003 and
the Company intends to continue growing this business.
  In
addition the Company sold approximately 57,200 tonnes of additional directory
paper in 2007 versus 2006 and reduced newsprint volume to take advantage of
stronger directory pricing and weaker newsprint pricing in 2007.
  Productivity
Improvements
 The
Company’s productivity improvement initiatives in 2007 were focused mainly on
increasing asset reliability, improving machine speed and efficiency by cutting
operating and maintenance-related downtime, and reducing dry-end paper losses.
These and other initiatives resulted in savings of $6 million in
2007.
  Reduce
energy consumption
 The
Company is a significant consumer of electrical energy.  The Company
focused on a number of electrical energy initiatives that reduced overall
electrical consumption which included a demand management program with B.C.
Hydro.  This and other energy reduction initiatives resulted in
savings of $6 million in 2007.
  Furnish
costs
 The
Company continued to optimize its furnish mix during the year by substituting
lower-cost furnishes.  These and other initiatives resulted in savings
of $5 million in 2007.
  Optimize
chemical usage
 The
Company had a number of initiatives to reduce the usage and costs of bleaching
and additive chemicals during the year. These and other initiatives resulted in
savings of $2 million in 2007.
  Other
 The
Company also completed a series of smaller initiatives, primarily with respect
to freight, procurement improvements and its maintenance practices.
Approximately $12 million in savings were realized as a result of these
initiatives.
  (b)
              Other strategic
      initiatives
  Preferred
supplier
  Quality
initiatives
 In 2007,
the Company focused further on advancing its preferred supplier status with key
customers by continuing to improve the consistency, runnability and reliability
of its products, and its on-time delivery service. As a result, the Company was
able to maintain low quality claims in 2007.
  
 
 
 Catalyst
Cooled
 In 2007,
the Company launched “Catalyst Cooled”, a product line whose manufacture results
in no net carbon emissions – on which Rolling Stone magazine
prints.  The product is designed for customers who do not want their
paper to contribute to carbon emissions.  The Company intends to keep
growing this product.
  Chain-of-custody
certification
 The
Company has implemented an “independent chain-of-custody” system to certify its
wood fibre supply.  The PricewaterhouseCoopers standard is a
third-party audited system that verifies fibre is derived from a forest managed
in accordance with the requirements of a major sustainability certification
program.  The independent chain-of-custody system tracks the fibre
from source to finished product and provides a valuable tool to assure customers
that paper contains fibre originating from well-managed forests. It is expected
to continue to result in additional sales opportunities.
  1.6
              Consolidated results
      of operations
  Year ended December 31, 2007
compared to year ended December 31, 2006
  Sales
 Sales in
2007 decreased $167.9 million, or 8.9%.  The decline in sales was due
to lower sales volumes due to curtailment relating to the USW strike and
curtailment of the A4 paper machine in September 2007, the strong Canadian
dollar, and lower transaction prices across most paper grades, particularly
newsprint and LWC.  The decrease in sales was partially offset by the
positive impact of average transaction prices for pulp and a more favourable
product mix.
  The
following table highlights the factors that affected the Company’s sales by
segment:
  Sales
      ($ millions)Year
      ended December 31,
                
                
                
                
                
                Increase
      (decrease) from 2006 as a result of2007
                
                
                2006
                
                
                Totalchange
                
                
                Volume1
                
                
                Price
                
                
                Mix
                
                
                
                F/XSpecialty
      paper
                
                $
                919.6
                
                
                $
                918.4
                
                
                $
                1.2
                
                
                $
                61.8
                
                
                $
                (21.4
                )
                
                $
                4.8
                
                
                $
                (44.0
                )Newsprint
                
                
                338.0
                
                
                
                529.8
                
                
                
                (191.8
                )
                
                
                (154.6
                )
                
                
                (29.0
                )
                
                
                3.1
                
                
                
                (11.3
                )Total
      paper
                
                
                1,257.6
                
                
                
                1,448.2
                
                
                
                (190.6
                )
                
                
                (92.8
                )
                
                
                (50.4
                )
                
                
                7.9
                
                
                
                (55.3
                )Pulp
                
                
                457.0
                
                
                
                434.3
                
                
                
                22.7
                
                
                
                (16.0
                )
                
                
                58.7
                
                
                
                1.8
                
                
                
                (21.8
                )Total
                
                $
                1,714.6
                
                
                $
                1,882.5
                
                
                $
                (167.9
                )
                
                $
                (108.8
                )
                
                $
                8.3
                
                
                $
                9.7
                
                
                $
                (77.1
                )
  1
              Decrease
      in volume is due to curtailment of certain assets in the third and fourth
      quarters related to the USW strike and curtailment of the A4 paper
      machine effective September 1,
2007.
  EBITDA
 EBITDA
before specific items was $116.7 million, a decrease of $94.3 million in 2007
compared to 2006.  The negative impact of higher fibre costs, weaker
newsprint and LWC prices, inflation, and the stronger Canadian dollar, more than
offset higher transaction prices for pulp products, and the realization of
benefits from the Performance Improvement Program.  Including the
impact of restructuring and change-of-control costs, and USW strike related
costs, EBITDA decreased $184.0 million in 2007 compared to 2006.
  
 
 
 The
following table summarizes the key changes in EBITDA1and EBITDA before
specific items1 from the year ended
December 31, 2006 to year ended December 31, 2007:
  
 
  1
              EBITDA
      and EBITDA before specific items are non-GAAP measures.  Refer to
      Section 9, "Non-GAAP Measures" for further details.2
              Includes
      foreign exchange impact on costs.
 
  Operating earnings
(loss)
  The
Company recorded an operating loss of $149.4 million in 2007, compared to
operating earnings of $3.9 million for the previous year.  The
decrease was mainly related to the $184.0 million decrease in EBITDA noted
above, offset by the $23.4 million impairment loss recorded in the previous
year.
  Net earnings
(loss)
  Net loss
of $31.6 million ($0.15 per common share) increased $15.7 million compared to a
net loss of $15.9 million ($0.07 per common share) in 2006.  After
adjusting for certain specific items, net loss before specific items in 2007 was
$89.3 million ($0.42 per common share), a decrease of $64.3 million from net
loss before specific items of $25.0 million ($0.12 per common share) in the
previous year.  Refer to Section 9, “Non-GAAP Measures” for details on
net earnings (loss) before specific items.
  The
following table reconciles 2007 net earnings (loss) to 2006:
  ($millions)
                
                Pre-tax
                
                
                After-tax2006
      net earnings (loss)
                
                $
                (69.9
                )
                
                $
                (15.9
                )Lower EBITDA before specific
      items
                
                
                (94.3
                )
                
                
                (62.2
                )Restructuring and
      change-of-control costs
                
                
                (64.7
                )
                
                
                (42.7
                )Impact of the USW
      strike
                
                
                (25.0
                )
                
                
                (16.5
                )Lower amortization
      expense
                
                
                7.3
                
                
                
                4.8Lower impairment
      loss
                
                
                23.4
                
                
                
                15.4Loss
      on disposal of A3 paper machine
                
                
                (7.5
                )
                
                
                (4.9
                )Increase in foreign exchange
      gain on long-term debt
                
                
                104.2
                
                
                
                86.5Lower other income,
      net
                
                
                (9.6
                )
                
                
                (6.3
                )Lower interest
      expense
                
                
                3.1
                
                
                
                2.0Income tax adjustments,
      net
                
                
                -
                
                
                
                6.8Non-controlling
      interest
                
                
                1.4
                
                
                
                1.42007
      net earnings (loss)
                
                $
                (131.6
                )
                
                $
                (31.6
                )
  2.0
              SEGMENTED
      RESULTS - ANNUAL
  2.1
              Specialty
      paper
  (In
      millions of dollars, except where otherwise stated)2007
                
                
                2006
                
                
                2005Sales
                
                $
                919.6
                
                
                $
                918.4
                
                
                $
                900.5EBITDA1
                
                
                26.2
                
                
                
                104.8
                
                
                
                115.8EBITDA
      before specific items1
                
                
                73.4
                
                
                
                104.8
                
                
                
                116.3Operating
      earnings (loss)
                
                
                (75.1
                )
                
                
                9.7
                
                
                
                24.8EBITDA
      margin1,2
                
                
                2.8
                %
                
                
                11.4
                %
                
                
                12.9
                %EBITDA
      margin before specific items1,2
                
                
                8.0
                %
                
                
                11.4
                %
                
                
                12.9
                %Sales
      (000 tonnes)
                
                
                1,054.8
                
                
                
                990.2
                
                
                
                942.9Production
      (000 tonnes)
                
                
                1,055.4
                
                
                
                983.7
                
                
                
                949.3Curtailment
      (000 tonnes)3
                
                
                7.2
                
                
                
                -
                
                
                
                -Average
      sales revenue per tonne
                
                $
                872
                
                
                $
                928
                
                
                $
                955Average
      delivered cash costs per tonne4
                
                
                847
                
                
                
                822
                
                
                
                832Average
      delivered cash costs per tonne before specific items1,4
                
                
                802
                
                
                
                822
                
                
                
                832Benchmark
      pricesSC-A paper, 35 lb.
      (US$/ton)5
                
                
                753
                
                
                
                788
                
                
                
                769LWC paper, No. 5, 40 lb.
      (US$/ton)5
                
                
                786
                
                
                
                836
                
                
                
                847Telephone directory paper, 22.1
      lb. (US$/ton)5
                
                
                740
                
                
                
                721
                
                
                
                675
  1
              EBITDA,
      EBITDA before specific items, EBITDA margin, EBITDA margin before specific
      items, and average delivered cash costs per tonne before specific items
      are non-GAAP measures.  Refer to Section 9, “Non-GAAP Measures”
      for further details.
 2
              EBITDA
      margin and EBITDA margin before specific items are defined as EBITDA and
      EBITDA before specific items as a percentage of sales and adjusted sales,
      respectively.  Refer to Section 9, “Non-GAAP Measures” for
      further details.
 3
              Curtailment
      consists of downtime related to the USW
strike.
 4
              Average
      delivered cash costs per tonne consist of cost of sales, including the
      impact of the USW strike, selling, general and administration (“SG&A”)
      costs, and restructuring and change-of-control
  costs.
 5
              Benchmark
      selling prices are sourced from Resource Information Systems, Inc.
      (“RISI”).
  2.1.1
              Markets
  During
2007, market conditions for most of our specialty printing paper products were
challenging.
  Coated
mechanical demand was 5% higher in 2007 compared to 2006 largely due to
substitution of coated mechanical grades for coated woodfree.  Supply in
the coated market tightened during 2007, primarily due to significant North
American mill closures in the latter half of the year and lower mill
inventories.  Combined, these factors led to stronger LWC prices in the
second half of the year.  In December 2007, the Company announced a third
consecutive US$60 per ton price increase for its LWC paper grades, bringing the
total announced increases by the end of the year to $180 per ton since July 1,
2007.  Despite the recent upward pricing momentum, the average LWC
benchmark price was 6% lower in 2007 compared to 2006.
  Demand
for uncoated mechanical grades was up slightly in 2007.  The demand for
high gloss grades increased 4.9%, due to grade switching from coated mechanical,
offsetting the decrease in demand in standard grades of 3.5%. SC-A pricing was
weak throughout most of 2007, however, a US$30 per ton price increase was
implemented in the fourth quarter.  The average benchmark price for SC-A in
2007 decreased US$35 per ton, or 4%, over 2006.
  Directory
demand remained steady in 2007.  Limited growth was due to slower
growth of independent publishers and flat total page and book circulation for
incumbent publishers.  The average benchmark price for 2007 increased
US$19 per ton.
  
   The 2007
specialty paper product grade distribution, based on sales volumes, is depicted
in the chart below.
  
   The 2007
geographic sales distribution, based on sales volumes, is depicted in the chart
below.
  
   2.1.2
              Segment
      overview
  The North
American economy is a key driver for the Company’s specialty paper business with
90% of its product sold to this market. Among its initiatives to improve
profitability, the Company continues to look for ways to optimize its product,
customer and geographic mix.
  Sales
volumes for lightweight coated in 2007 were down 13,900 tonnes or 6% from the
previous year as a result of lower production volume in 2007.
  Sales
volumes for uncoated mechanical grades in 2007 increased 21,300 tonnes or 4%
from 2006.  The growth in uncoated mechanical was due to the growth of
Electraprime and Electrabrite into the retail insert market, which was offset by
a decrease in demand for standard grades.
  Sales
volumes for directory in 2007 increased 57,200 tonnes or 21% compared to
2006.  The growth was due to switching production to directory from
newsprint to match increased sales volume opportunities to take advantage of
stronger directory pricing.
  2.1.3
              Operational
      performance
  The specialty paper
business made an operating loss of $75.1 million in 2007 compared to operating
earnings of $9.7 million in 2006.2007 EBITDA before specific
items of $73.4 million, was $31.4 million lower compared to an EBITDA before
specific items of $104.8 million in 2006.
  Sales
volumes increased 64,600 tonnes, or 6.5%, compared to the previous
year.  The increase was largely due to the increased production of
directory grades.  Average sales revenue was down $56 per tonne
compared to the previous year primarily due to the stronger Canadian dollar and
weaker average transaction prices across most grades other than
directory.
  Average
delivered cash costs increased $25 per tonne compared to 2006.  Higher
fibre costs, the impact of restructuring, and USW strike costs more than offset
performance improvements.  Before the impact of specific items,
average delivered cash costs were $802 per tonne, an improvement of $20 per
tonne from the previous year.
  2.1.4
              Outlook
  Conditions
are expected to improve for specialty printing paper products in
2008.  Although demand across most grades is expected to be relatively
flat, supply dynamics are leading to tighter market conditions.
  Coated
mechanical paper demand is expected to be flat, due to an anticipated slowing of
magazine and catalogue circulation and increasing coated mechanical paper prices
which will continue to encourage users to switch to SC-A grades. Recent capacity
closures in Western Europe as well as the rising Euro are expected to result in
lower imports to North America, which should cause the North American coated
market to remain relatively tight in 2008.  Benchmark prices are
expected to increase in 2008.
  Markets
for uncoated mechanical grades are expected to remain relatively stable in 2008.
Demand for high-gloss paper is expected to grow due to grade switching from
coated mechanical and lower-gloss grades.  Reduced imports from Europe
as a result of the strong Euro and increased ocean freight costs, and reduced
capacity in North America should keep North American operating rates
high.  Demand for machine-finished grades is expected to be stable in
2008. Benchmark prices for high-gloss grades are expected to strengthen
throughout the year.
  Directory
demand is expected to be stable through 2008.  Benchmark prices are
expected to be flat.  Contracts are in place for the upcoming year and
price increases are estimated to average 1%.
  
 
 
 2.2
              Newsprint
  (In
      millions of dollars, except where otherwise stated)2007
                
                
                2006
                
                
                2005Sales
                
                $
                338.0
                
                
                $
                529.8
                
                
                $
                529.1EBITDA1
                
                
                (23.7
                )
                
                
                71.8
                
                
                
                58.1EBITDA
      before specific items1
                
                
                (4.4
                )
                
                
                71.8
                
                
                
                64.3Operating
      earnings (loss)
                
                
                (56.9
                )
                
                
                6.9
                
                
                
                12.3EBITDA
      margin1,2
                
                
                (7.0
                )%
                
                
                13.6
                %
                
                
                11.0
                %EBITDA
      margin before specific items1,2
                
                
                (1.2
                )%
                
                
                13.6
                %
                
                
                12.2
                %Sales
      (000 tonnes)
                
                
                496.3
                
                
                
                699.1
                
                
                
                707.1Production
      (000 tonnes)
                
                
                472.8
                
                
                
                703.7
                
                
                
                699.5Curtailment
      (000 tonnes)3
                
                
                98.9
                
                
                
                -
                
                
                
                -Average
      sales revenue per tonne
                
                $
                681
                
                
                $
                758
                
                
                $
                748Average
      delivered cash costs per tonne4
                
                
                729
                
                
                
                655
                
                
                
                666Average
      delivered cash costs per tonne before specific items1,4
                
                
                674
                
                
                
                655
                
                
                
                657Benchmark
      pricesNewsprint 48.8 gsm, West Coast
      delivery (US$/tonne)5
                
                
                579
                
                
                
                649
                
                
                
                600
  1
              EBITDA,
      EBITDA before specific items, EBITDA margin, EBITDA margin before specific
      items, and average delivered cash costs per tonne before specific items
      are non-GAAP measures.  Refer to Section 9, “Non-GAAP Measures”
      for further details.
 2
              EBITDA
      margin and EBITDA margin before specific items are defined as EBITDA and
      EBITDA before specific items as a percentage of sales and adjusted sales,
      respectively.  Refer to Section 9, “Non-GAAP Measures” for
      further details.
 3
              Curtailment
      consists of downtime related to the USW
strike.
 4
              Average
      delivered cash costs per tonne consist of cost of sales, including the
      impact of the USW strike, SG&A costs, and restructuring and
      change-of-control costs.
 5
              Benchmark
      selling prices are sourced
from RISI.
  2.2.1
              Markets
  Newsprint
demand in North America continued to decline in 2007 with total U.S. consumption
down 10.5% year-over-year.  The decline was due to reduced ad lineage,
circulation, reduced web widths, lower basis weights and increased conservation
measures by publishers.  The falling demand resulted in lower
benchmark prices.  The average newsprint benchmark price in 2007 was
US$579 per tonne, down US$70 per tonne or 11%, compared to
2006.  Relatively strong demand overseas compared to weakness in U.S.
consumption resulted in an increase in exports outside North America, but did
not prevent prices from decreasing in 2007.
  
   Approximately
82% of the Company’s newsprint sales volumes were to North America, Asia and
Australasia.  The 2007 geographical sales distribution, based on sales
volumes, is depicted in the chart below.
  
   2.2.2
              Segment
      overview
  In
response to challenging newsprint market conditions, the Company continued its
drive to optimize product mix in 2007 as it shifted production from newsprint to
specialty paper grades, primarily directory.  Overall, newsprint
production decreased by approximately 231,000 tonnes in 2007:
  o
              The
      Company indefinitely curtailed the A4 paper machine in Port Alberni on
      September 1, 2007, displacing the equivalent of 134,000 tonnes per year of
      the Company’s least profitable newsprint business.  Management
      estimates this reduced the Company’s newsprint production by approximately
      44,700 tonnes in 2007.
 o
              The
      Company utilized its ability to swing machine capacity between different
      grades to reduce newsprint and increase production of directory and
      certain uncoated specialty paper
grades.
 o
              In
      addition to these initiatives, management estimates newsprint production
      was also reduced by 98,900 tonnes during the year as a result of the USW
      strike and related fibre supply
disruptions.
  2.2.3
              Operational
      performance
  The
newsprint business made an operating loss of $56.9 million in 2007 compared to
operating earnings of $6.9 million in 2006.  2007 EBITDA before
specific items of negative $4.4 million was $76.2 million lower compared to an
EBITDA before specific items of $71.8 million in 2006.
  Sales
volumes decreased 202,800 tonnes, or 29%, from the previous year, primarily due
to the USW strike related fibre shortage, the flexibility to swing machine
production to increase directory production, and the indefinite closure of the
A4 paper machine in 2007.  Average sales revenue decreased $77 per
tonne compared to the previous year, largely due to lower transaction prices and
the negative impact of the stronger Canadian dollar.
  Average delivered cash
costs increased $74 per tonne from the previous year.  Savings from
performance improvements were more than offset by the restructuring costs,higher fibre costs,
and the impact of the USW strike.  Before the impact of specific
items, average delivered cash costs were $674 per tonne, an
increase of $19 per tonne from
the previous year.
  2.2.4
              Outlook
  The
Company expects the newsprint market to tighten in 2008 due to significant
capacity closures announced by North American
producers.  Approximately 5% of North American capacity is expected to
shut down in the first quarter of 2008.  As a result, newsprint prices
have started to improve following the announcement of a US$25 per tonne increase
effective November 1, 2007 and an announced price increase of US$60 per tonne to
be phased in equally over January, February, and March 2008.  The
average benchmark newsprint price is expected to increase significantly in
2008.
  Pulp
  (In
      millions of dollars, except where otherwise stated)2007
                
                
                2006
                
                
                2005Sales
                
                $
                457.0
                
                
                $
                434.3
                
                
                $
                394.3EBITDA1
                
                
                24.5
                
                
                
                34.4
                
                
                
                (18.7
                )EBITDA
      before specific items1
                
                
                47.7
                
                
                
                34.4
                
                
                
                (18.7
                )Operating
      earnings (loss)
                
                
                (17.4
                )
                
                
                (12.7
                )
                
                
                (62.2
                )EBITDA
      margin1,2
                
                
                5.4
                %
                
                
                7.9
                %
                
                
                (4.7
                %)EBITDA
      margin before specific items1,2
                
                
                9.8
                %
                
                
                7.9
                %
                
                
                (4.7
                %)Sales
      (000 tonnes)
                
                
                603.2
                
                
                
                626.2
                
                
                
                603.0Production
      (000 tonnes)
                
                
                601.8
                
                
                
                624.3
                
                
                
                590.9Curtailment
      (000 tonnes)3
                
                
                54.7
                
                
                
                -
                
                
                
                -Average
      sales revenue per tonne
                
                $
                757
                
                
                $
                693
                
                
                $
                654Average
      delivered cash costs per tonne4
                
                
                717
                
                
                
                638
                
                
                
                684Average
      delivered cash costs per tonne before specific items1,4
                
                
                679
                
                
                
                638
                
                
                
                684Benchmark
      pricesNBSK pulp, Northern Europe
      delivery (US$/tonne)5
                
                
                800
                
                
                
                681
                
                
                
                610White-top linerboard, 42 lb.,
      Eastern U.S. delivery (US$/ton)5
                
                
                697
                
                
                
                673
                
                
                
                608
  1
              EBITDA,
      EBITDA before specific items, EBITDA margin, EBITDA margin before specific
      items, and average delivered cash costs per tonne before specific items
      are non-GAAP measures.  Refer to Section 9, “Non-GAAP Measures”
      for further details.
 2
              EBITDA
      margin and EBITDA margin before specific items are defined as EBITDA and
      EBITDA before specific items as a percentage of sales and adjusted sales,
      respectively.  Refer to Section 9, “Non-GAAP Measures” for
      further details.
 3
              Curtailment
      consists of downtime related to the USW
strike.
 4
              Average
      delivered cash costs per tonne consist of cost of sales, including the
      impact of the USW strike, SG&A costs, and restructuring and
      change-of-control costs.
 5
              Benchmark
      selling prices are sourced from
RISI.
 
 
 
 2.3.1
              Markets
  Pulp
markets were strong throughout 2007 with global pulp shipments up 3%
year-over-year and low world producer and consumer inventories during the year.
Good demand and low inventories provided support for a number of price increases
during the year and brought the Northern Europe  benchmark price to
US$870 per tonne at the end of 2007.  The average Northern Europe NBSK
benchmark price for 2007 was up US$119 per tonne, or 17%, compared to the
previous year.
  The U.S.
containerboard market remained balanced in the year.  U.S. producers
took advantage of stronger currencies against the US$ to increase their export
volume, which resulted in the average 2007 benchmark white-top linerboard price
increasing US$24 per ton, or 4%, compared to 2006.
  
   The
primary markets for the Company’s market pulp are Asia and
Europe.  The 2007 geographical sales distribution, based on sales
volumes, is depicted in the chart below.
  
   2.3.2
              Segment
      overview
  Pulp and
containerboard sales volumes decreased in 2007 by 3.7%, compared to 2006, due to
production curtailment related to the fibre supply shortage as a result of the
USW strike.  However, the Company was able to take advantage of strong
pulp markets to continue to increase its mix of contract business and optimize
sales to customers in its major pulp markets.
  Containerboard
sales volumes in 2007 were 8.7% lower than in the previous year, due to the USW
strike.  The Company continued to focus on improving its customer mix
by targeting North American customers that are more freight
logical.
  As a
result of the USW strike and related fibre supply disruptions in the second half
of the year, the Company temporarily curtailed its Elk Falls pulp mill and
containerboard machine for 50 days and its Crofton pulp mill for 9
days.  Management estimates pulp and containerboard production was
reduced by 54,700 tonnes in the year as a result of these
curtailments.
  2.3.3
              Operational
      performance
  The pulp
and containerboard business made an operating loss of $17.4 million in 2007
compared to an operating loss of $12.7 million in 2006.  2007 EBITDA
before specific items of $47.7 million was $13.3 million higher compared to an
EBITDA before specific items of $34.4 million in 2006.
  Sales
volumes decreased 23,000 tonnes from the previous year.  The decrease
was due to decreased pulp production as a result of the USW strike related fibre
shortage.  Average sales revenue improved $64 per tonne compared to
the previous year, due primarily to higher pulp prices, which more than offset
the negative impact of the stronger Canadian dollar.
  Average
delivered cash costs increased $79 per tonne in 2007 compared to
2006.  Savings from performance improvements were more than offset by
costs associated with the USW strike, higher fibre costs, and restructuring
costs.  Before specific items, average delivered cash costs were $679
per tonne, comparable to the previous year.
  2.3.4
              Outlook
  Demand
for NBSK pulp is expected to remain steady during the first half of 2008, with
the expectation that benchmark prices will increase modestly in early 2008
followed by potentially softer pulp prices in the second half of the
year.  Higher consumption by China is expected to be offset by weaker
demand from markets in the U.S. and Europe, which is expected to limit overall
growth in demand in 2008.
  The
Company is expecting that demand and prices for containerboard will remain flat
in 2008 as North American producers are expected to continue to access export
markets because of the slower U.S. economy.
  
 
 
 3.0
              SEGMENTED
      RESULTS - QUARTERLY
  Selected quarterly financial
information
  (In
      millions of dollars, except where otherwise stated)2007
                
                
                2006TOTAL
                
                
                
                Q4
                
                
                
                Q3
                
                
                
                Q2
                
                
                
                Q1
                
                
                TOTAL
                
                
                
                Q4
                
                
                
                Q3
                
                
                
                Q2
                
                
                
                Q1Sales
                
                $
                1,714.6
                
                
                $
                381.0
                
                
                $
                413.7
                
                
                $
                441.8
                
                
                $
                478.1
                
                
                $
                1,882.5
                
                
                $
                470.6
                
                
                $
                486.0
                
                
                $
                469.6
                
                
                $
                456.3Operating
      earnings (loss)
                
                
                (149.4
                )
                
                
                (27.7
                )
                
                
                (44.3
                )
                
                
                (46.7
                )
                
                
                (30.7
                )
                
                
                3.9
                
                
                
                (3.3
                )
                
                
                17.0
                
                
                
                6.1
                
                
                
                (15.9
                )EBITDA
      1
                
                
                27.0
                
                
                
                15.1
                
                
                
                (0.3
                )
                
                
                (1.9
                )
                
                
                14.1
                
                
                
                211.0
                
                
                
                48.5
                
                
                
                62.8
                
                
                
                52.4
                
                
                
                47.3EBITDA
      before specific items 1
                
                
                116.7
                
                
                
                28.8
                
                
                
                37.4
                
                
                
                17.4
                
                
                
                33.1
                
                
                
                211.0
                
                
                
                48.5
                
                
                
                62.8
                
                
                
                52.4
                
                
                
                47.3Net
      earnings (loss)
                
                
                (31.6
                )
                
                
                12.4
                
                
                
                (18.6
                )
                
                
                0.2
                
                
                
                (25.6
                )
                
                
                (15.9
                )
                
                
                (37.2
                )
                
                
                2.5
                
                
                
                42.4
                
                
                
                (23.6
                )Net
      earnings (loss) before specific items 1
                
                
                (89.3
                )
                
                
                (20.9
                )
                
                
                (16.9
                )
                
                
                (31.8
                )
                
                
                (19.7
                )
                
                
                (25.0
                )
                
                
                (7.2
                )
                
                
                0.6
                
                
                
                (6.7
                )
                
                
                (11.7
                )EBITDA
      margin 1,2
                
                
                1.6
                %
                
                
                4.0
                %
                
                
                (0.1
                %)
                
                
                (0.4
                %)
                
                
                2.9
                %
                
                
                11.2
                %
                
                
                10.3
                %
                
                
                12.9
                %
                
                
                11.2
                %
                
                
                10.4
                %EBITDA
      margin before specific items 1,2
                
                
                6.5
                %
                
                
                6.6
                %
                
                
                8.5
                %
                
                
                3.9
                %
                
                
                6.9
                %
                
                
                11.2
                %
                
                
                10.3
                %
                
                
                12.9
                %
                
                
                11.2
                %
                
                
                10.4
                %Net
      earnings (loss) per share (in dollars) – basic and diluted
                
                $
                (0.15
                )
                
                $
                0.06
                
                
                $
                (0.09
                )
                
                $
                0.00
                
                
                $
                (0.12
                )
                
                $
                (0.07
                )
                
                $
                (0.17
                )
                
                $
                0.01
                
                
                $
                0.20
                
                
                $
                (0.11
                )Net
      earnings (loss) per share before specific items
                  (in
      dollars) – basic and diluted 1
                
                $
                (0.42
                )
                
                $
                (0.10
                )
                
                
                (0.08
                )
                
                
                (0.15
                )
                
                
                (0.09
                )
                
                
                (0.12
                )
                
                
                (0.03
                )
                
                
                0.00
                
                
                
                (0.03
                )
                
                
                (0.06
                )Sales
      (000 tonnes)Specialty
      paper
                
                
                1,054.8
                
                
                
                279.3
                
                
                
                261.1
                
                
                
                259.2
                
                
                
                255.2
                
                
                
                990.2
                
                
                
                252.7
                
                
                
                264.6
                
                
                
                237.8
                
                
                
                235.1Newsprint
                
                
                496.3
                
                
                
                70.7
                
                
                
                119.8
                
                
                
                157.1
                
                
                
                148.7
                
                
                
                699.1
                
                
                
                170.1
                
                
                
                169.5
                
                
                
                178.4
                
                
                
                181.1Total
      paper
                
                
                1,551.1
                
                
                
                350.0
                
                
                
                380.9
                
                
                
                416.3
                
                
                
                403.9
                
                
                
                1,689.3
                
                
                
                422.8
                
                
                
                434.1
                
                
                
                416.2
                
                
                
                416.2Pulp
                
                
                603.2
                
                
                
                136.1
                
                
                
                151.8
                
                
                
                147.4
                
                
                
                167.9
                
                
                
                626.2
                
                
                
                145.5
                
                
                
                155.9
                
                
                
                171.4
                
                
                
                153.4Total
      sales
                
                
                2,154.3
                
                
                
                486.1
                
                
                
                532.7
                
                
                
                563.7
                
                
                
                571.8
                
                
                
                2,315.5
                
                
                
                568.3
                
                
                
                590.0
                
                
                
                587.6
                
                
                
                569.6Production
      (000 tonnes)Specialty
      paper
                
                
                1,055.4
                
                
                
                265.8
                
                
                
                262.6
                
                
                
                270.4
                
                
                
                256.6
                
                
                
                983.7
                
                
                
                249.0
                
                
                
                254.8
                
                
                
                244.2
                
                
                
                235.7Newsprint
                
                
                472.8
                
                
                
                60.9
                
                
                
                110.9
                
                
                
                148.9
                
                
                
                152.1
                
                
                
                703.7
                
                
                
                170.2
                
                
                
                170.0
                
                
                
                179.6
                
                
                
                183.9Total
      paper
                
                
                1,528.2
                
                
                
                326.7
                
                
                
                373.5
                
                
                
                419.3
                
                
                
                408.7
                
                
                
                1,687.4
                
                
                
                419.2
                
                
                
                424.8
                
                
                
                423.8
                
                
                
                419.6Pulp
                
                
                601.8
                
                
                
                144.7
                
                
                
                143.2
                
                
                
                157.1
                
                
                
                156.8
                
                
                
                624.3
                
                
                
                152.8
                
                
                
                162.8
                
                
                
                155.6
                
                
                
                153.1Total
      production
                
                
                2,130.0
                
                
                
                471.4
                
                
                
                516.7
                
                
                
                576.4
                
                
                
                565.5
                
                
                
                2,311.7
                
                
                
                572.0
                
                
                
                587.6
                
                
                
                579.4
                
                
                
                572.7US$/CDN$
      foreign exchangeAverage
      spot rate 3
                
                
                0.930
                
                
                
                1.019
                
                
                
                0.957
                
                
                
                0.911
                
                
                
                0.854
                
                
                
                0.882
                
                
                
                0.878
                
                
                
                0.892
                
                
                
                0.892
                
                
                
                0.866Period-end
      spot rate 4
                
                
                1.012
                
                
                
                1.012
                
                
                
                1.004
                
                
                
                0.940
                
                
                
                0.867
                
                
                
                0.858
                
                
                
                0.858
                
                
                
                0.897
                
                
                
                0.897
                
                
                
                0.857Effective
      rate 5
                
                
                0.917
                
                
                
                0.970
                
                
                
                0.935
                
                
                
                0.916
                
                
                
                0.860
                
                
                
                0.872
                
                
                
                0.878
                
                
                
                0.886
                
                
                
                0.872
                
                
                
                0.853Common
      shares (millions)At
      period-end
                
                
                214.7
                
                
                
                214.7
                
                
                
                214.7
                
                
                
                214.7
                
                
                
                214.6
                
                
                
                214.6
                
                
                
                214.6
                
                
                
                214.6
                
                
                
                214.6
                
                
                
                214.6Weighted
      average
                
                
                214.7
                
                
                
                214.7
                
                
                
                214.7
                
                
                
                214.7
                
                
                
                214.6
                
                
                
                214.6
                
                
                
                214.6
                
                
                
                214.6
                
                
                
                214.6
                
                
                
                214.6
  1
              EBITDA,
      EBITDA before specific items, EBITDA margin, EBITDA margin before specific
      items, net earnings (loss) before specific items, and net earnings (loss)
      per share before specific items are non-GAAP measures.  Refer to
      Section 9, “Non-GAAP Measures” for further
  details.
 2
              EBITDA
      margin and EBITDA margin before specific items are defined as EBITDA and
      EBITDA before specific items, as a percentage of sales and adjusted sales,
      respectively.  Refer to Section 9, “Non-GAAP Measures” for
      further details.
 3
              Average
      spot rate is the average Bank of Canada noon spot rate over the reporting
      period.
 4
              Period-end
      spot rate is the Bank of Canada noon spot
rate.
 5
              Effective
      rate represents a blended rate which takes account of the applicable spot
      rates, the Company’s revenue hedging program in the period, and
      translationof
      US$-denominated working capital at period opening and closing
      rates.  See Section 8, “Summary of Quarterly Results” for
      further details.
 
 
 
 Summary of selected
segmented financial information
  (In
      millions of dollars, except where otherwise stated)2007
                
                
                2006Specialty
      paper
                
                TOTAL
                
                
                
                Q4
                
                
                
                Q3
                
                
                
                Q2
                
                
                
                Q1
                
                
                TOTAL
                
                
                
                Q4
                
                
                
                Q3
                
                
                
                Q2
                
                
                
                Q1Sales
                
                $
                919.6
                
                
                $
                234.3
                
                
                $
                222.1
                
                
                $
                225.1
                
                
                $
                238.1
                
                
                $
                918.4
                
                
                $
                234.0
                
                
                $
                245.0
                
                
                $
                218.6
                
                
                $
                220.8EBITDA1
                
                
                26.2
                
                
                
                12.5
                
                
                
                0.0
                
                
                
                4.1
                
                
                
                9.6
                
                
                
                104.8
                
                
                
                18.4
                
                
                
                31.6
                
                
                
                25.7
                
                
                
                29.1EBITDA before specific
      items1
                
                
                73.4
                
                
                
                16.1
                
                
                
                17.6
                
                
                
                17.0
                
                
                
                22.7
                
                
                
                104.8
                
                
                
                18.4
                
                
                
                31.6
                
                
                
                25.7
                
                
                
                29.1Operating
      earnings (loss)
                
                
                (75.1
                )
                
                
                (13.5
                )
                
                
                (26.3
                )
                
                
                (21.1
                )
                
                
                (14.2
                )
                
                
                9.7
                
                
                
                (6.6
                )
                
                
                6.9
                
                
                
                2.8
                
                
                
                6.6EBITDA
      margin1,
      2
                
                
                2.8
                %
                
                
                5.3
                %
                
                
                0.0
                %
                
                
                1.8
                %
                
                
                4.0
                %
                
                
                11.4
                %
                
                
                7.9
                %
                
                
                12.9
                %
                
                
                11.8
                %
                
                
                13.2
                %EBITDA
      margin before specific items1,
      2
                
                
                8.0
                %
                
                
                6.9
                %
                
                
                8.0
                %
                
                
                7.6
                %
                
                
                9.5
                %
                
                
                11.4
                %
                
                
                7.9
                %
                
                
                12.9
                %
                
                
                11.8
                %
                
                
                13.2
                %Sales
      (000 tonnes)
                
                
                1,054.8
                
                
                
                279.3
                
                
                
                261.1
                
                
                
                259.2
                
                
                
                255.2
                
                
                
                990.2
                
                
                
                252.7
                
                
                
                264.6
                
                
                
                237.8
                
                
                
                235.1Production
      (000 tonnes)
                
                
                1,055.4
                
                
                
                265.8
                
                
                
                262.6
                
                
                
                270.4
                
                
                
                256.6
                
                
                
                983.7
                
                
                
                249.0
                
                
                
                254.8
                
                
                
                244.2
                
                
                
                235.7Curtailment
      (000 tonnes)3
                
                
                7.2
                
                
                
                4.0
                
                
                
                3.2
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Average
      sales revenue per tonne
                
                $
                872
                
                
                $
                839
                
                
                $
                850
                
                
                $
                868
                
                
                $
                933
                
                
                $
                928
                
                
                $
                927
                
                
                $
                926
                
                
                $
                920
                
                
                $
                939Average
      delivered cash costs per tonne4
                
                
                847
                
                
                
                794
                
                
                
                849
                
                
                
                852
                
                
                
                896
                
                
                
                822
                
                
                
                853
                
                
                
                806
                
                
                
                811
                
                
                
                815Average
      delivered cash costs per tonne before specific items4
                
                
                802
                
                
                
                783
                
                
                
                781
                
                
                
                802
                
                
                
                845
                
                
                
                822
                
                
                
                853
                
                
                
                806
                
                
                
                811
                
                
                
                815SC-A
      paper, 35 lb. (US$/ton)5
                
                
                753
                
                
                
                770
                
                
                
                745
                
                
                
                745
                
                
                
                752
                
                
                
                788
                
                
                
                787
                
                
                
                800
                
                
                
                785
                
                
                
                780LWC
      paper, No. 5, 40 lb. (US$/ton)5
                
                
                786
                
                
                
                848
                
                
                
                782
                
                
                
                748
                
                
                
                767
                
                
                
                836
                
                
                
                798
                
                
                
                820
                
                
                
                852
                
                
                
                875Telephone
      directory paper, 22.1 lb. (US$/ton)5
                
                
                740
                
                
                
                740
                
                
                
                740
                
                
                
                740
                
                
                
                740
                
                
                
                721
                
                
                
                725
                
                
                
                725
                
                
                
                720
                
                
                
                715NewsprintSales
                
                $
                338.0
                
                
                $
                44.2
                
                
                $
                77.8
                
                
                $
                106.7
                
                
                $
                109.3
                
                
                $
                529.8
                
                
                $
                128.4
                
                
                $
                128.8
                
                
                $
                135.4
                
                
                $
                137.2EBITDA1
                
                
                (23.7
                )
                
                
                (8.3
                )
                
                
                (8.1
                )
                
                
                (4.2
                )
                
                
                (3.1
                )
                
                
                71.8
                
                
                
                14.5
                
                
                
                18.2
                
                
                
                19.3
                
                
                
                19.8EBITDA before specific
      items1
                
                
                (4.4
                )
                
                
                (4.4
                )
                
                
                (0.4
                )
                
                
                (0.2
                )
                
                
                0.6
                
                
                
                71.8
                
                
                
                14.5
                
                
                
                18.2
                
                
                
                19.3
                
                
                
                19.8Operating
      earnings (loss)
                
                
                (56.9
                )
                
                
                (14.5
                )
                
                
                (15.6
                )
                
                
                (13.5
                )
                
                
                (13.3
                )
                
                
                6.9
                
                
                
                1.9
                
                
                
                7.5
                
                
                
                7.4
                
                
                
                (9.9
                )EBITDA
      margin1,
      2
                
                
                (7.0
                %)
                
                
                (18.8
                %)
                
                
                (10.4
                %)
                
                
                (3.9
                %)
                
                
                (2.8
                %)
                
                
                13.6
                %
                
                
                11.3
                %
                
                
                14.1
                %
                
                
                14.3
                %
                
                
                14.4
                %EBITDA
      margin before specific items1,
      2
                
                
                (1.2
                %)
                
                
                (5.5
                %)
                
                
                (0.8
                %)
                
                
                0.0
                %
                
                
                0.0
                %
                
                
                13.6
                %
                
                
                11.3
                %
                
                
                14.1
                %
                
                
                14.3
                %
                
                
                14.4
                %Sales
      (000 tonnes)
                
                
                496.3
                
                
                
                70.7
                
                
                
                119.8
                
                
                
                157.1
                
                
                
                148.7
                
                
                
                699.1
                
                
                
                170.1
                
                
                
                169.5
                
                
                
                178.4
                
                
                
                181.1Production
      (000 tonnes)
                
                
                472.8
                
                
                
                60.9
                
                
                
                110.9
                
                
                
                148.9
                
                
                
                152.1
                
                
                
                703.7
                
                
                
                170.2
                
                
                
                170.0
                
                
                
                179.6
                
                
                
                183.9Curtailment
      (000 tonnes)3
                
                
                98.9
                
                
                
                65.8
                
                
                
                33.1
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Average
      sales revenue per tonne
                
                $
                681
                
                
                $
                625
                
                
                $
                650
                
                
                $
                679
                
                
                $
                735
                
                
                $
                758
                
                
                $
                754
                
                
                $
                761
                
                
                $
                759
                
                
                $
                758Average
      delivered cash costs per tonne4
                
                
                729
                
                
                
                742
                
                
                
                720
                
                
                
                706
                
                
                
                756
                
                
                
                655
                
                
                
                669
                
                
                
                653
                
                
                
                651
                
                
                
                647Average
      delivered cash costs per tonne before specific items4
                
                
                674
                
                
                
                636
                
                
                
                646
                
                
                
                681
                
                
                
                731
                
                
                
                655
                
                
                
                669
                
                
                
                653
                
                
                
                651
                
                
                
                647Newsprint
      48.8 gsm, West Coast delivery (US$/tonne)5
                
                
                579
                
                
                
                565
                
                
                
                561
                
                
                
                584
                
                
                
                606
                
                
                
                649
                
                
                
                649
                
                
                
                658
                
                
                
                651
                
                
                
                640PulpSales
                
                $
                457.0
                
                
                $
                102.5
                
                
                $
                113.8
                
                
                $
                110.0
                
                
                $
                130.7
                
                
                $
                434.3
                
                
                $
                108.2
                
                
                $
                112.2
                
                
                $
                115.6
                
                
                $
                98.3EBITDA1
                
                
                24.5
                
                
                
                10.9
                
                
                
                7.8
                
                
                
                (1.8
                )
                
                
                7.6
                
                
                
                34.4
                
                
                
                15.6
                
                
                
                13.0
                
                
                
                7.4
                
                
                
                (1.6
                )EBITDA before specific items1
                
                
                47.7
                
                
                
                17.1
                
                
                
                20.2
                
                
                
                0.6
                
                
                
                9.8
                
                
                
                34.4
                
                
                
                15.6
                
                
                
                13.0
                
                
                
                7.4
                
                
                
                (1.6
                )Operating
      earnings (loss)
                
                
                (17.4
                )
                
                
                0.3
                
                
                
                (2.4
                )
                
                
                (12.1
                )
                
                
                (3.2
                )
                
                
                (12.7
                )
                
                
                1.4
                
                
                
                2.6
                
                
                
                (4.1
                )
                
                
                (12.6
                )EBITDA
      margin1,
      2
                
                
                5.4
                %
                
                
                10.6
                %
                
                
                6.9
                %
                
                
                (1.6
                %)
                
                
                5.8
                %
                
                
                7.9
                %
                
                
                14.4
                %
                
                
                11.6
                %
                
                
                6.4
                %
                
                
                (1.6
                %)EBITDA
      margin before specific items1,
      2
                
                
                9.8
                %
                
                
                14.2
                %
                
                
                16.2
                %
                
                
                0.5
                %
                
                
                7.5
                %
                
                
                7.9
                %
                
                
                14.4
                %
                
                
                11.6
                %
                
                
                6.4
                %
                
                
                (1.6
                %)Sales
      (000 tonnes)
                
                
                603.2
                
                
                
                136.1
                
                
                
                151.8
                
                
                
                147.4
                
                
                
                167.9
                
                
                
                626.2
                
                
                
                145.5
                
                
                
                155.9
                
                
                
                171.4
                
                
                
                153.4Production
      (000 tonnes)
                
                
                601.8
                
                
                
                144.7
                
                
                
                143.2
                
                
                
                157.1
                
                
                
                156.8
                
                
                
                624.3
                
                
                
                152.8
                
                
                
                162.8
                
                
                
                155.6
                
                
                
                153.1Curtailment
      (000 tonnes)3
                
                
                54.7
                
                
                
                26.8
                
                
                
                27.9
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Average
      sales revenue per tonne
                
                $
                757
                
                
                $
                753
                
                
                $
                750
                
                
                $
                746
                
                
                $
                778
                
                
                $
                693
                
                
                $
                744
                
                
                $
                720
                
                
                $
                674
                
                
                $
                641Average
      delivered cash costs per tonne4
                
                
                717
                
                
                
                672
                
                
                
                699
                
                
                
                759
                
                
                
                732
                
                
                
                638
                
                
                
                636
                
                
                
                637
                
                
                
                630
                
                
                
                652Average
      delivered cash costs per tonne before specific items4
                
                
                679
                
                
                
                637
                
                
                
                622
                
                
                
                743
                
                
                
                719
                
                
                
                638
                
                
                
                636
                
                
                
                637
                
                
                
                630
                
                
                
                652NBSK
      pulp, Northern Europe delivery (US$/tonne)5
                
                
                800
                
                
                
                850
                
                
                
                810
                
                
                
                783
                
                
                
                757
                
                
                
                681
                
                
                
                737
                
                
                
                710
                
                
                
                665
                
                
                
                618White-top
      linerboard, 42 lb., Eastern U.S.delivery (US$/ton)5
                
                
                697
                
                
                
                720
                
                
                
                707
                
                
                
                680
                
                
                
                680
                
                
                
                673
                
                
                
                680
                
                
                
                680
                
                
                
                680
                
                
                
                650
 
  1
              EBITDA,
      EBITDA before specific items, EBITDA margin, EBITDA margin before specific
      items, and average delivered cash costs per tonne before specific items
      are non-GAAP measures.  Refer to Section 9, “Non-GAAP Measures”
      for further details.
 2
              EBITDA
      margin and EBITDA margin before specific items are defined as EBITDA and
      EBITDA before specific items as a percentage of sales and adjusted sales,
      respectively.  Refer to Section 9, “Non-GAAP Measures” for
      further details.
 3
              Curtailment
      consists of downtime related to the USW
strike.
 4
              Average
      delivered cash costs per tonne consist of cost of sales, including the
      impact of the USW strike, SG&A costs, and restructuring and change
      of-control costs.
 5
              Benchmark
      selling prices are sourced from
RISI.
  
 
 Fourth quarter
overview
  The
strengthening Canadian dollar continued to adversely impact the Company’s
results in the fourth quarter.  Despite this, net earnings were
positive in the fourth quarter (“Q4”), primarily due to favourable income tax
adjustments.  The Company recorded net earnings of $12.4 million in
Q4, compared to a net loss of $18.6 million in the third quarter (“Q3”). EBITDA
was $15.1 million in Q4, compared to negative $0.3 million in Q3.
  The
Company’s results included restructuring and change-of-control costs of $2.0
million and $24.4 million for Q4 and Q3, respectively.  Management
estimates the results were negatively impacted by $11.7 million and $13.3
million for Q4 and Q3, respectively, due to the USW strike.  This
strike resulted in the Company’s production decreasing by approximately 96,600
and 64,200 tonnes in Q4 and Q3, respectively.  Production continued to
be curtailed at Elk Falls No. 1 (“E1”) paper machine throughout Q4, and the Elk
Falls No. 2 (“E2”) and Elk Falls No. 5 (“E5”) paper machines were down 9 days
and 44 days, respectively.  In addition, production was curtailed at
the Crofton pulp mill for 9 days during Q4.
  Q4 EBITDA
before specific items of $28.8 million declined $8.6 million compared to EBITDA
before specific items of $37.4 million in Q3.  This decrease was
mainly a result of the Canadian dollar continuing to strengthen.
  3.1
              Three months ended
      December 31, 2007 compared to three months ended September 30,
      2007
  Consolidated results of
operations
  Sales
  Sales in
Q4, 2007 decreased $32.7 million compared to Q3, 2007.The decrease in sales was
largely due to curtailment of newsprint and pulp production in Q3 and Q4
reducing Q4 sales volumes, and the stronger Canadian dollar
more than offsetting the positive impact of higher average transaction prices
for pulp and paper products.
  EBITDA and EBITDA before
specific items
  ($
      millions)
                
                EBITDA(1)
                
                
                EBITDA before Specific
      Items(1)Q3,
      2007
                
                $
                (0.3
                )
                
                $
                37.4Paper
      prices
                
                
                3.3
                
                
                
                3.3Pulp
      prices
                
                
                4.8
                
                
                
                4.8Impact
      of Canadian dollar, net of hedging
                
                
                (7.6
                )
                
                
                (7.6
                )USW
      strike impact
                
                
                1.6
                
                
                
                -Restructuring
      and change-of-control costs
                
                
                22.4
                
                
                
                -Other,
      net
                
                
                (9.1
                )
                
                
                (9.1
                )Q4,
      2007
                
                $
                15.1
                
                
                $
                28.8
  1
              EBITDA
      and EBITDA before specific items are non-GAAP measures.  Refer
      to Section 9, “Non-GAAP Measures” for further
  details.
 
 Operating earnings
(loss)
 The
Company’s operating loss improved by $16.6 million in Q4, compared to Q3, 2007,
and was primarily related to the $15.4 million increase in EBITDA noted
above.
  Net earnings
(loss)
 Net
earnings in Q4, 2007 of $12.4 million ($0.06 per common share) increased $31.0
million compared to a net loss of $18.6 million ($0.09 per common share) in Q3,
2007.  Net earnings for the current quarter included a release of
future income taxes related to the reduction in the federal corporate income tax
rate and the tax uncertainties resolved with the conclusion of an
examination by the Canada Revenue Agency in the amounts of $21.0 million
and $14.0 million, respectively.  After adjusting these and other
specific items, net loss before specific items in Q4, 2007 was $20.9 million
($0.10 per common share), compared to a net loss before specific items of $16.9
million ($0.08 per common share) in the previous quarter.  Refer to
Section 9, “Non-GAAP Measures” for details on net earnings (loss) before
specific items.
  Operational performance –
specialty paper
  The
specialty paper business operating loss decreased $12.8 million in Q4, compared
to Q3, 2007.
  Sales
volumes increased 18,200 tonnes from Q3, 2007 due to an increase in uncoated
paper and directory shipments.  Average sales revenue decreased $11
per tonne from the previous quarter, due to the stronger Canadian dollar which
more than offset higher transaction prices in Q4, 2007.
  Average
delivered cash costs improved $55 per tonne compared to Q3, 2007, due primarily
to lower restructuring costs.  Before the impact of specific items,
average cash costs were $783 per tonne, an increase of $2 per tonne from the
previous quarter.
  Operational performance –
newsprint
  The
newsprint business operating loss decreased by $1.1 million from the previous
quarter.
  Sales
volumes decreased 49,100 tonnes compared to Q3, 2007, primarily due to the USW
strike and the indefinite closure of the A4 paper machine.  Average
sales revenue decreased $25 per tonne from Q3, 2007, due primarily to the
stronger Canadian dollar.
  Average
delivered cash costs increased $22 per tonne from Q3,
2007.  Performance improvements and lower restructuring costs were
more than offset by the impact of seasonally higher energy costs and costs
associated with the USW strike.  Before specific items, average
delivered cash costs were $636 per tonne, an improvement of $10 per tonne from
the previous quarter.
  Operational performance –
pulp
  The pulp
and containerboard business operating earnings increased in Q4 by $2.7 million
from the previous quarter.
  Sales
volumes decreased 15,700 tonnes from Q3, 2007, as a result of the USW strike and
related fibre supply disruptions.  Average sales revenue increased $3
per tonne from Q3, 2007, with higher pulp prices more than offsetting the
stronger Canadian dollar.
  Average
delivered cash costs of $672 per tonne decreased by $27 per tonne compared to
Q3, 2007, primarily due to lower restructuring costs and performance
improvements outweighing seasonally higher energy costs and costs associated
with a maintenance shutdown and the USW strike related curtailment taken at the
Crofton mill.  Before specific items, average delivered cash costs
were $637 per tonne, an increase of $15 per tonne from the previous
quarter.
  3.2
              Three months ended
      December 31, 2007 compared to three months ended December 31,
      2006
  Sales
 Sales
decreased by $89.6 million in Q4, 2007 compared to sales in Q4,
2006.  The negative impact of lower sales volumes, primarily related
to the USW strike, and the curtailment of the A4 paper machine, the stronger
Canadian dollar, and weaker paper prices for the majority of the Company’s paper
grades more than offset improved average transaction prices for the Company’s
pulp products.
  EBITDA and EBITDA before
Specific Items
  ($
      millions)
                
                EBITDA(1)
                
                
                EBITDA before Specific
      Items(1)Q4,
      2006
                
                $
                48.5
                
                
                $
                48.5Paper
      prices
                
                
                (9.7
                )
                
                
                (9.7
                )Pulp
      prices
                
                
                10.9
                
                
                
                10.9Impact
      of Canadian dollar, net of hedging
                
                
                (21.9
                )
                
                
                (21.9
                )Restructuring
      and change-of-control costs
                
                
                (2.0
                )
                
                
                -USW
      strike impact
                
                
                (11.7
                )
                
                
                -Workforce
      reductions
                
                
                12.2
                
                
                
                12.2Fibre
      costs
                
                
                (16.6
                )
                
                
                (16.6
                )Other,
      net
                
                
                5.4
                
                
                
                5.4Q4,
      2007
                
                $
                15.1
                
                
                $
                28.8
  1
              EBITDA
      and EBITDA before specific items are non-GAAP measures.  Refer
      to Section 9, “Non-GAAP Measures” for further
  details.
  EBITDA
before specific items decreased by $19.7 million in Q4, 2007 compared to the
same period in 2006.  The negative impact of the stronger Canadian
dollar, weaker average paper prices, and higher fibre costs were the primary
drivers of the decrease and more than offset improved average transaction prices
for the Company’s pulp products and the realization of benefits from performance
improvements, particularly from workforce reductions.  Including the
impact of the USW strike and restructuring and change-of-control costs, EBITDA
decreased by $33.4million in Q4, 2007
compared to the same period in 2006.
  Operating earnings
(loss)
 Operating
loss increased by $24.4 million in Q4, 2007 compared to the same period in
2006.  The increase in operating loss from the comparative period was
primarily related to the $33.4 million decrease in EBITDA noted above, which was
partially offset by a $9.0 million decrease in amortization
expense.  Q4, 2006 amortization expense included an impairment loss of
$4.3 million related to assets that had been previously idled and $1.5 million
related to the permanent closure of the A3 paper machine.
  Net earnings
(loss)
 Net
earnings were $12.4 million ($0.06 per common share) in Q4, 2007, an increase of
$49.6 million from the comparative period in 2006.  Net earnings for
the current quarter included a release of future income taxes related to the
reduction in the federal corporate income tax rate and tax uncertainties
resolved with the conclusion of an examination by the Canada Revenue Agency in
the amounts of $21.0 million and $14.0 million, respectively.  Net
loss before these and other specific items in Q4 was $20.9 million ($0.10 per
common share) compared to a net loss before specific items of $7.2 million
($0.03 per common share) in Q4, 2006.  Refer to Section 9, “Non-GAAP
Measures” for details on net earnings (loss) before specific items.
  Operational performance –
specialty paper
  The
specialty paper business operating loss increased $6.9 million in Q4, 2007,
compared to the same period in 2006.
  Sales
volumes increased 26,600 tonnes, from the comparative period in 2006.The increase from Q4,
2006 was largely due to switching machine production to specialty paper grades
from newsprint. Average sales revenue decreased by $88 per tonne, due primarily
to the stronger Canadian dollar and, to a lesser extent, weaker prices across
most paper grades.
  Average delivered cash costs decreased
$59 per tonne, from the comparative period in 2006.  This was
primarily due to performance improvements which more than offset the impact of
higher fibre costs and restructuring costs.Before the impact of
specific items, average delivered cash costs were $783 per tonne, a decrease of
$70 per tonne from the comparative period in 2006.
  Operational performance –
newsprint
  The
newsprint business operating loss increased $16.4 million in Q4, 2007, compared
to the same period in 2006.
  Sales
volumes decreased 99,400 tonnes from the comparable period, primarily due to the
flexibility to swing machine production to increase directory and specialty
paper production in 2007, the USW strike, and the indefinite closure of the A4
paper machine in September 2007.  Average sales revenue decreased $129
per tonne due to lower transaction prices and the negative impact of the
stronger Canadian dollar.
  Average
delivered cash costs increased $73 per tonne from the comparative period in
2006.  The impact of costs associated with the USW strike, higher
fibre costs and restructuring costs more than offset cost savings from
performance improvements.Before the impact of
specific items, average delivered cash costs were $636 per tonne, a decrease of
$33 per tonne from the comparative period in 2006.
  Operational performance -
pulp
  The pulp
and containerboard business operating earnings decreased by $1.1 million in Q4,
2007, compared to the same period in 2006.
  Sales
volumes decreased 9,400 tonnes from the comparative period, primarily due to the
curtailment of production in Q4, 2007 due to the USW strike.  Average
sales revenue increased $9 per tonne with higher average transaction prices
outpacing the strengthening Canadian dollar.
  Average
delivered cash costs increased $36 per tonne, from the comparative period as
significantly increased pulp fibre costs and costs associated with the USW
strike more than offset performance improvements.  Before the
impact of specific items, average delivered cash costs were $637 per tonne, an
increase of $1 per tonne, from the comparative period in 2006.
  4.0
              FINANCIAL
      CONDITION
  The
following table highlights the significant changes between the consolidated
balance sheets as at December 31, 2007, and December 31, 2006:
  (In
      millions of dollars)
                2007
                2006
                Variance
                CommentWorking
      capital
                $    221.3
                $    282.3
                $(61.0)
                Decrease
      reflects lower cash and cash equivalents, and receivables, partly offset
      by increase in current other assets  as a result of adoption of
      CICA Section 3855 “Financial Instruments – Recognition and Measurement”
      and lower payables levels  before back-out of non-cash
      items.  Lower receivables and payables primarily due to
      curtailment in Q4, 2007.Capital
      assets
                1,912.8
                2,023.1
                (110.3)
                Amortization
      expense exceeded capital asset additions.  Refer to the
      “Investing Activities” section for additional details on capital asset
      additions.Other
      assets
                51.1
                40.8
                10.3
                Increase
      reflects higher long-term pension asset  and long-term
      derivative financial instruments , partly offset by the reclassification
      of deferred financing costs to long-term debt  pursuant to CICA
      Section 3855 “Financial Instruments – Recognition and Measurement”
      guidelines.Total
      debt
                785.8
                860.5
                (74.7)
                Decrease
      reflects the stronger Canadian dollar, the reclassification of deferred
      financing costs to long-term debt, partly offset by increased utilization
      of our revolving operating facility.Employee
      future benefits
                211.7
                187.2
                24.5
                Increase
      reflects a number of early retirements as part of the Company’s
      restructuring initiative, the change in underlying actuarial assumptions,
      and a reclassification from other long term obligations.Other
      long-term obligations
                26.9
                23.3
                3.6
                Increase
      reflects liabilities related to the Company’s restructuring initiative,
      partly offset by reclassification  to employee future
      benefits.Future
      income taxes and deferred credits
                172.2
                269.4
                (97.2)
                Decrease
      includes $22.4 million related to a reduction in corporate income tax
      rates and $14.0 million favourable outcome on an outstanding
      issue.  The balance of the reduction primarily relates to future
      income taxes on 2007 losses.Contributed
      surplus
                12.1
                9.3
                2.8
                Increase
      relates to the recording of stock-based compensation.
 
 
 5.0
              LIQUIDITY AND CAPITAL
RESOURCES
  Selected
annual financial information
  (In
      millions of dollars, except where otherwise stated)2007
                
                
                2006
                
                
                2005Cash
      flows (used) provided by operationsbefore
      changes in non-cash working capital
                
                $
                (52.8
                )
                
                $
                136.8
                
                
                $
                72.2Changes
      in non-cash working capital
                
                
                50.1
                
                
                
                (9.6
                )
                
                
                (11.5
                )Cash
      flows (used) provided byOperations
                
                
                (2.7
                )
                
                
                127.2
                
                
                
                60.7Investing
    activities
                
                
                (83.7
                )
                
                
                (85.8
                )
                
                
                (93.0
                )Financing
    activities
                
                
                50.9
                
                
                
                (5.9
                )
                
                
                6.3Capital
      spending
                
                
                85.8
                
                
                
                93.2
                
                
                
                95.2Amortization1
                
                
                176.4
                
                
                
                207.1
                
                
                
                180.3Capital
      spending as % of amortization
                
                
                49
                %
                
                
                45
                %
                
                
                53
                %Total
      debt to total capitalization2,3
                
                
                44
                %
                
                
                46
                %
                
                
                46
                %Net
      debt to net capitalization4,5
                
                
                44
                %
                
                
                45
                %
                
                
                46
                %Net
      debt to EBITDA4,6
                
                
                29.1
                
                
                
                3.9
                
                
                
                5.6EBITDA
      to interest6
                
                
                0.4
                
                
                
                2.9
                
                
                
                2.1
  1   2006
amortization expense includes a $19.1 million impairment loss related to the
permanent closure of the A3 paper machine, and $4.3 million in other asset
impairments.
 2   Total
debt comprises long-term debt, including current portion.
 3   Total
capitalization comprises total debt and shareholders’ equity.
 4   Net
debt comprises total debt, less cash on hand.
 5   Net
capitalization comprises net debt and shareholders’ equity.
 6   EBITDA is a
non-GAAP measure.  Refer to Section 9, "Non-GAAP measures" for further
details.
  Selected
quarterly financial information
  (In
      millions of dollars, except where otherwise stated)2007
                
                
                2006TOTAL
                
                
                
                Q4
                
                
                
                Q3
                
                
                
                Q2
                
                
                
                Q1
                
                
                TOTAL
                
                
                
                Q4
                
                
                
                Q3
                
                
                
                Q2
                
                
                
                Q1Cash
      flows (used) provided by operationsbefore changes
                  in
      non-cash operating working capital
                
                $
                (52.8
                )
                
                $
                3.1
                
                
                $
                (18.1
                )
                
                $
                (29.2
                )
                
                $
                (8.6
                )
                
                $
                136.8
                
                
                $
                41.6
                
                
                $
                40.3
                
                
                $
                20.2
                
                
                $
                34.7Changes
      in non-cash working capital
                
                
                50.1
                
                
                
                30.4
                
                
                
                (15.8
                )
                
                
                25.9
                
                
                
                9.6
                
                
                
                (9.6
                )
                
                
                1.5
                
                
                
                (27.4
                )
                
                
                18.2
                
                
                
                (1.9
                )Cash
      flows provided (used) byOperations
                
                
                (2.7
                )
                
                
                33.5
                
                
                
                (33.9
                )
                
                
                (3.3
                )
                
                
                1.0
                
                
                
                127.2
                
                
                
                43.1
                
                
                
                12.9
                
                
                
                38.4
                
                
                
                32.8Investing
    activities
                
                
                (83.7
                )
                
                
                (17.8
                )
                
                
                (23.7
                )
                
                
                (22.2
                )
                
                
                (20.0
                )
                
                
                (85.8
                )
                
                
                (39.6
                )
                
                
                (18.8
                )
                
                
                (16.8
                )
                
                
                (10.6
                )Financing
    activities
                
                
                50.9
                
                
                
                (15.7
                )
                
                
                57.6
                
                
                
                9.0
                
                
                
                –
                
                
                
                (5.9
                )
                
                
                0.9
                
                
                
                (0.1
                )
                
                
                (0.1
                )
                
                
                (6.6
                )Capital
      spending
                
                
                85.8
                
                
                
                17.5
                
                
                
                25.0
                
                
                
                23.0
                
                
                
                20.3
                
                
                
                93.2
                
                
                
                41.0
                
                
                
                22.9
                
                
                
                17.5
                
                
                
                11.8Amortization1
                
                
                176.4
                
                
                
                42.8
                
                
                
                44.0
                
                
                
                44.8
                
                
                
                44.8
                
                
                
                207.1
                
                
                
                51.8
                
                
                
                45.8
                
                
                
                46.3
                
                
                
                63.2Capital
      spending as % of amortization
                
                
                49
                %
                
                
                41
                %
                
                
                57
                %
                
                
                51
                %
                
                
                45
                %
                
                
                45
                %
                
                
                79
                %
                
                
                50
                %
                
                
                38
                %
                
                
                19
                %Total
      debt to total capitalization2,3
                
                
                44
                %
                
                
                44
                %
                
                
                45
                %
                
                
                44
                %
                
                
                46
                %
                
                
                46
                %
                
                
                46
                %
                
                
                44
                %
                
                
                44
                %
                
                
                46
                %Net
      debt to net capitalization4,5
                
                
                44
                %
                
                
                44
                %
                
                
                45
                %
                
                
                44
                %
                
                
                46
                %
                
                
                45
                %
                
                
                45
                %
                
                
                43
                %
                
                
                43
                %
                
                
                46
                %Net
      debt to EBITDA4,6
                
                
                29.1
                
                
                
                52.0
                
                
                
                n/a
                
                
                
                n/a
                
                
                
                58.3
                
                
                
                3.9
                
                
                
                17.0
                
                
                
                12.7
                
                
                
                15.1
                
                
                
                17.9EBITDA
      to interest6
                
                
                0.4
                
                
                
                1.0
                
                
                
                n/a
                
                
                
                n/a
                
                
                
                0.8
                
                
                
                2.9
                
                
                
                2.7
                
                
                
                3.4
                
                
                
                2.8
                
                
                
                2.6
  1
              Quarter
      1, 2006 amortization expense includes a $17.6 million impairment loss
      related to the permanent closure of the A3 paper machine. Quarter 4, 2006
      amortization expense includes a $1.5 million impairment loss related to
      the permanent closure of the A3 paper machine and $4.3 million in other
      asset impairments.
 2
              Total
      debt comprises long-term debt, including current
  portion.
 3
              Total
      capitalization comprises total debt and shareholders’
    equity.
 4
              Net
      debt comprises total debt, less cash on
hand.
 5
              Net
      capitalization comprises net debt and shareholders’
  equity.6
              EBITDA
      is a non-GAAP measure.  Refer to Section 9, "Non-GAAP measures" for
      further details.
  The
Company’s principal cash requirements are for interest payments on its debt and
for capital expenditures and working capital fluctuations. Cash flows are funded
through operations and, where necessary, through the revolving operating
facility (the “Facility”).  If necessary, liquidity requirements may
be funded through the issuance of debt, equity or both.  Access to
current and alternative sources of financing at competitive cost is dependent
upon the Company’s credit ratings and capital market conditions.  The
Company believes that the cash flow from operations and the Facility will be
sufficient to meet its anticipated capital expenditures and debt service
obligations in the near and intermediate term.
  5.1
              Operating
      activities
  Cash used
by operating activities in 2007 was $2.7 million, compared to cash provided of
$127.2 million in the previous year.  The decrease of $129.9 million
from the previous year is primarily related to $184.0 million decrease in
EBITDA.  This was partially offset by reductions in accounts
receivable.
  5.2
              Investing
      activities
  Cash used
for investing activities in 2007 was $83.7 million, compared to $85.8 million in
the previous year.  Investing activities are largely comprised of
capital spending.  Consequently, movements in cash flows are primarily
due to changes in capital spending.
  Capital
spending for 2007 was $85.8 million.  Major capital investments during
the year included $8.1 million of the $10.8 million Crumb DIP project,
which is expected to reduce the Company’s DIP costs, a $4.2 million dryer
upgrade to Crofton’s No. 1 paper machine, a $5.1 million product distribution
initiative at the Elk Falls division, and various other high-return capital
projects.
  5.3
              Financing
      activities
  Cash
provided by financing activities in 2007 was $50.9 million, compared to cash
used of $5.9 million in the previous year.  The increase from the
comparative period was primarily due to borrowing on the Facility of $47.5
million related to the decrease in operating cash flow.
  5.3.1
              Capital
      resources
  The
Company’s capital resources at December 31, 2007 included the amount available
under the Facility.  The Facility, together with operating cash flows,
is expected to enable the Company to meet its minimum payments.
  The
following table presents the aggregate amount of future cash outflows for
contractual obligations as of December 31, 2007, excluding amounts due for
interest on outstanding indebtedness.
  
 Payments
      Due by Period(In
      millions of dollars)
                
                2008
                
                
                2009
                
                
                2010
                
                
                2011
                
                
                2012
                
                
                ThereafterTotal
      debt
                
                $
                1.2
                
                
                $
                122.5
                
                
                $
                0.7
                
                
                $
                389.7
                
                
                $
                0.8
                
                
                $
                270.9Operating
      leases
                
                
                10.1
                
                
                
                9.0
                
                
                
                8.0
                
                
                
                7.5
                
                
                
                5.6
                
                
                
                32.0Other
      commitments
                
                
                2.2
                
                
                
                2.2
                
                
                
                2.2
                
                
                
                2.2
                
                
                
                0.7
                
                
                
                -Total
                
                $
                13.5
                
                
                $
                133.7
                
                
                $
                10.9
                
                
                $
                399.4
                
                
                $
                7.1
                
                
                $
                302.9
  
  
 
 
 Availability
on the Company’s $350 million Facility at period-end is summarized in
the  following table:
  (In
      millions of dollars)2007
                
                
                2006Q4
                
                
                
                Q3
                
                
                
                Q2
                
                
                
                Q1
                
                
                
                Q4
                
                
                
                Q3
                
                
                
                Q2
                
                
                
                Q1Borrowing
      base
                
                $
                309.0
                
                
                $
                326.9
                
                
                $
                350.0
                
                
                $
                350.0
                
                
                $
                350.0
                
                
                $
                350.0
                
                
                $
                335.1
                
                
                $
                345.5Letters
      of credit
                
                
                20.7
                
                
                
                20.7
                
                
                
                20.7
                
                
                
                22.8
                
                
                
                26.4
                
                
                
                22.7
                
                
                
                22.7
                
                
                
                22.3Amount
      drawn, net
                
                
                47.5
                
                
                
                67.1
                
                
                
                9.4
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Available
      to be drawn
                
                $
                240.8
                
                
                $
                239.1
                
                
                $
                319.9
                
                
                $
                327.2
                
                
                $
                323.6
                
                
                $
                327.3
                
                
                $
                312.4
                
                
                $
                323.2
  As of
December 31, 2007, the Company had $240.8 million available on its $350 million
Facility.  The amount drawn on the Facility increased by $47.5 million
in the year and the
Company’s available liquidity decreased by $82.8 million.  Of this
decrease, $41.0 million was due to a reduction in borrowing base on the
Company’s Facility as a result of lower accounts receivable and inventory
following curtailment related to the USW strike and the indefinite closure of
the A4 paper machine in September, 2007.  The Company also spent $85.8
million related to its capital expenditure program and $23.6 million related to
the ongoing restructuring program.Availability under the
Facility is determined by a borrowing base, which is calculated based on
accounts receivable and inventory balances.  At December 31, 2007 the
Company is in compliance with the covenants under its Facility, which includes
covenants to maintain the funded debt/capitalization ratio below 60%, secured
debt/capitalization ratio below 30%, and shareholders’ equity above $779.3
million.  At December 31, 2007, as calculated under the Facility, the
Company’s funded debt/capitalization ratio was 42% (December 31, 2006 – 44%),
secured debt/capitalization ratio was 4% (December 31, 2006 – 2%), and
shareholders’ equity was $988.6 million (December 31, 2006 – $1,005.8
million).
  5.3.2
              Debt
  Total
long-term debt outstanding as at December 31, 2007 was $785.8
million.  The Company’s net debt to net capitalization ratio as at
December 31, 2007, was 44%, or 1% lower than December 31, 2006.
  
 
 
 The
following table illustrates the changes in the Company’s long-term debt for the
year ended December 31, 2007:
  Issue
                
                January
      1, 20071
                
                
                Net
      increase (decrease)
                
                
                Foreign
      exchange
                
                
                December
      31, 2007(In
      millions of dollars)RecourseSenior notes, 8.625% due June
      2011 (US$400.0 million)
                
                $
                459.3
                
                
                $
                0.5
                
                
                $
                (70.9
                )
                
                $
                388.9Senior notes, 7.375% due March
      2014 (US$250.0 million)
                
                
                288.8
                
                
                
                2.1
                
                
                
                (44.3
                )
                
                
                246.6Revolving operating facility of
      up to $350.0 million dueJuly
      2009 with interest based on Canadian Prime/BA rates
                  or U.S. Base/LIBOR
      rates
                
                
                –
                
                
                
                47.1
                
                
                
                -
                
                
                
                47.1Capital
      lease obligation
                
                
                5.0
                
                
                
                3.6
                
                
                
                -
                
                
                
                8.6Non-recourse
      (PREI)First mortgage bonds, 6.387%
      due July 2009
                
                
                74.5
                
                
                
                0.1
                
                
                
                -
                
                
                
                74.6Subordinated promissory
      notes
                
                
                19.5
                
                
                
                -
                
                
                
                -
                
                
                
                19.5Loan payable
                
                
                1.0
                
                
                
                (0.5
                )
                
                
                -
                
                
                
                0.5Less
      current portion
                
                
                (1.8
                )
                
                
                0.6
                
                
                
                
                
                
                
                (1.2
                )Total
      long-term debt
                
                $
                846.3
                
                
                $
                53.5
                
                
                $
                (115.2
                )
                
                $
                784.6
  1
              Effective
      January 1, 2007, the Company adopted the CICA Sections “Comprehensive
      Income”, 3251 “Equity”, 3855 “Financial Instruments – Recognition and
      Measurement”, 3861 “Financial Instruments – Disclosure and Presentation”,
      and 3865 “Hedges”.
  
 The
Company is in compliance with the covenants under its senior notes
indentures.  The Company’s Fixed Charge Coverage Ratio (“FCC Ratio”)
under the senior notes indentures calculated on a 12-month trailing average was
0.8:1 as at December 31, 2007 (3.0:1 as at December 31, 2006).  While
the FCC Ratio is below 2.0:1, the Company is limited in the amount of additional
debt it may incur to “permitted debt” under the senior notes.  Under
the indenture of the 8.625% senior notes, “permitted debt” includes a) the
existing 8.625% and 7.375% senior notes, b) a credit facility basket in an
amount equal to the greater of  i) $725 million, and ii) the sum of
75% of the book value of the Company’s accounts receivable, 50% of the book
value of the Company’s inventory, and $290 million, against which in either case
utilization under the Company’s $350 million Facility is applied, c) purchase
money debt and capital lease obligations in an amount equal to 5% of
consolidated tangible assets, d) a $40 million general basket, and e) a $5
million basket for accommodation guarantees, trade or standby letters of credit,
performance bonds, bankers’ acceptances and surety notes.  The
indenture for the 7.375% notes contains larger debt baskets, but while the
8.625% notes remain outstanding the Company is bound by their more restrictive
provisions.
  Also
under the senior note covenants, the Company is restricted from making certain
payments, including the payment of dividends, unless the balances in its
restricted payments baskets are positive.  The Company’s restricted
payments baskets under the 8.625% and 7.375% senior notes were negative $189.0
million and negative $164.0 million, respectively, as at December 31, 2007
(negative $72.5 million and negative $47.5 million, respectively, as at December
31, 2006), as a result of the accumulation of losses in recent
years.
  Credit
Rating
  In June
2007, Moody’s Investors Services, Inc. (“Moody’s”) revised the outlook on the
Company’s debt ratings to negative from stable due to an expectation that with
weak industry conditions and currency related pressures, the Company’s
profitability and cash flow would decline during the year.
  In June
2007, Standard & Poor’s Rating Services (“S&P”) lowered outlook to
negative from stable and in October 2007 its long-term corporate credit and
senior unsecured ratings to B from B+.  The strong Canadian currency
and weak newsprint prices were the primary factors cited in the
downgrade.
  In
January 2008, Dominion Bond Rating Service (“DBRS”) confirmed its senior
unsecured debt rating as BB and the outlook as negative.
  The
following table highlights the Company’s credit ratings and outlook with
Moody’s, S&P and DBRS as at December 31, 2007, 2006, and 2005:
  December
      31,2007
                2006
                2005Moody’sOutlook
                Negative
                Stable
                NegativeCorporate
      family rating
                B1
                B1
                B1Senior
      unsecured debt
                B2
                B2
                B1Senior
      secured credit facility
                Ba1
                Ba1
                Ba3Standard
      & Poor’sOutlook
                Negative
                Stable
                StableLong-term
      issuer credit
                B
                B+
                B+Senior
      unsecured debt
                B
                B+
                B+Senior
      secured debt
                BB-
                BB-
                BB-Dominion
      Bond Rating ServiceOutlook
                Negative
                Negative
                NegativeSenior
      unsecured debt
                BB
                BB
                BB
  5.3.3
              Financial
      instruments
  In the
normal course of business, the Company is exposed to foreign currency and price
risk associated with revenues and long-term debt, which are predominately in
U.S. dollars, and energy costs.  In accordance with its foreign
exchange risk management program, the Company manages its exposure to these
risks through the use of financial instruments.  The Company also uses
interest rate swaps to reduce its exposure to long-term fixed interest rates
associated with its senior notes.  The Company does not enter into
financial instruments for speculative purposes.
  On
January 1, 2007, the Company adopted the Canadian Institute of Chartered
Accountants (“CICA”) Handbook Section 3855, Financial Instruments – Recognition
and Measurement, and Section 3865, Hedges.Under these new
guidelines the Company records all derivatives in its balance sheet at fair
value.  For further details, refer to Section 11.0, “Changes in
Accounting Policies”.
  Revenue risk management
instruments
 In
respect of revenues, the Company uses foreign currency options and forward
contracts to sell U.S. dollars.  At December 31, 2007, the Company had
foreign currency options and forward contracts with a notional principal of
US$581 million with major financial institutions.  Changes in the fair
values of derivatives that qualify and are designated as cash flow hedges are
deferred and recorded as a component of “Accumulated other comprehensive income”
(“AOCI”) until the underlying transaction is recorded in
earnings.  When the hedged item affects earnings, the gain or loss is
reclassified from “AOCI” to “Sales”.  Any ineffective portion of a
hedging derivative’s change in fair value and the portion that is excluded from
the assessment of hedge effectiveness is recognized immediately in
“Sales”.  At December 31, 2007, instruments having a notional
principal of US$404 million are designated as hedging instruments.  At
year-end exchange rates, these instruments are reported at their fair value,
which was $32.9 million at the end of 2007.
  At
December 31, 2007, commodity swap agreements were outstanding to fix the sales
price on NBSK pulp and containerboard for 23,500 metric tonnes, and 1,750 short
tons, respectively, within the next 12 months at a weighted average PIX price of
US$823 per tonne and US$580 per ton.  These contracts are not
designated as hedging instruments for accounting purposes and are reported at
their fair value, which was negative $1.0 million at the end of
2007.
  Long-term debt risk
management instruments
 In
respect of long-term debt, the Company is party to US$228 million at December
31, 2007, in forward foreign exchange contracts and options to acquire U.S.
dollars over a seven-year period.  These instruments are not
designated as hedging instruments for accounting purposes, and are included in
“Other long-term obligations” on the balance sheet at their fair
value.  Settlements and changes in fair value are recognized in
earnings as “Foreign exchange gain (loss) on long-term debt”.  At
period-end exchange rates, these instruments are reported at their fair value,
which was negative $5.4 million at the end of 2007.
  Energy cost risk management
instruments
 To hedge
against the effect of energy cost fluctuations, the Company enters into
contracts to fix the price of a portion of the Company’s oil and gas
requirements.  The contracts are not designated as hedging instruments
for accounting purposes and are reported on the balance sheet at their fair
value.  Settlements and changes in fair value are recognized in “Cost
of sales”.  At period-end contract rates, these instruments are
reported at their fair value, which was negative $0.2 million at the end of
2007.
  Interest rate
swaps
 The
Company occasionally uses interest rate swap contracts to manage its net
exposure to interest rate changes.  At December 31, 2007, the Company
had pay-floating, receive-fixed interest rate swap contracts for notional US$80
million, and has designated them as hedging instruments. These derivatives are
recorded on the balance sheet at their fair value.  The effective
portion of changes in the fair value of the derivatives is netted in “Long-term
debt” and the ineffective portion is recognized in “Interest expense,
net”.  The Company will receive a fixed rate of 7.375%, and pay a
floating rate averaging U.S. six-month LIBOR plus 2.0%.  At period-end
swap rates, these instruments are reported at their fair value, which was $4.1
million at the end of 2007.
  6.0
              RELATED PARTY
TRANSACTIONS
  Effective
October 23, 2006, Third Avenue Management LLC (“TAM”) became a significant
shareholder together with its subsidiaries and affiliates. The Company did not
undertake any transactions with TAM during the year ended December 31,
2007.
  Directors and
employees
  The
Company undertakes certain transactions with companies affiliated with its
directors.  These transactions are in the normal course of business
and are on the same terms as those accorded to third parties.  During
2007, the Company paid aggregate fees of approximately $8.7 million (2006 - $0.4
million) primarily for obligations under a building lease, for services related
to trucking chips and sawdust, and other consulting services to companies
affiliated with directors of the Company.  In 2007, the Company also
paid $0.7 million (2006 - $3.9 million) primarily for chemicals used in the
manufacturing process to a company affiliated with a former officer and
director of the Company. The Company charged these costs to “Cost of
sales”.
  The
Company has advanced interest-free loans to a now former officer of the
Company.  As at December 31, 2007, the balance outstanding was $0.1
million (2006 - $0.1 million).  These loans were issued prior to the
enactment of the United States Sarbanes-Oxley Act of 2002, which prohibits such
loans, effective July 30, 2002.  The Company has made no loans to any
of its directors or officers since that date.
  7.0
              OFF-BALANCE SHEET
ARRANGEMENTS
  Guarantees
  Business
dispositions
  The
Company sold a portion of its operations in June 2001.  In this
regard, the Company provided a 10-year environmental indemnity with a maximum
liability to the Company of $12.5 million.  This liability has
subsequently been reduced by expenditures related to certain decommissioning
projects.  The Company provided a tax indemnity, which continues while
the relevant tax years of the indemnified parties remain open to
audit.  The Company also provided a general indemnity capped at $5
million, which expired in 2004.  The purchaser of the operations has
advised the Company that, based on the terms of the purchase and sale agreement,
it believes it may be entitled to indemnification under the general indemnity in
connection with certain labour matters.  The Company is unable to
estimate any potential liability under these indemnities as the amounts are
dependent upon the outcome of future contingent events, the nature and
likelihood of which cannot be determined at this time.  As such, no
liability has been recorded for these potential obligations.
  Loans
  The
Company has entered into a building lease agreement whereby it will continue to
make the prescribed lease payments directly to the financial institution holding
the mortgage on the building in the event the lessor is no longer able to meet
its contractual obligations.  At December 31, 2007, the value of the
mortgage was $10.6 million.  This agreement does not increase the
Company’s liability beyond the obligations for the building lease.
  Recycling plant
acquisition
  In
connection with the acquisition of the paper recycling business in December
2003, the Company has provided indemnities with respect to representations and
warranties related to general corporate matters and to the shares that were
issued to the vendors.  Liability under these indemnities expires in
November 2008, except that the indemnity related to title to the shares does not
expire.  The Company does not expect any significant claims with
respect to these indemnities.  The Company has also provided
indemnities with respect to general environmental matters under its lease of the
land and buildings.  The Company has agreed to indemnify the landlord
for all costs, claims and damages related to any release by the Company of any
hazardous substances on the property or the breach by the Company of its
environmental covenants under the lease or any environmental
laws.  This indemnity is indefinite and survives after the lease is
terminated.  The Company is not liable for pre-existing environmental
conditions.
  8.0
              SUMMARY OF QUARTERLY
RESULTS
  The
following table highlights selected financial information for the eight
consecutive quarters ending December 31, 2007:
  (In
      millions of dollars, except per share amounts)2007
                
                
                2006Q4
                
                
                
                Q3
                
                
                
                Q2
                
                
                
                Q1
                
                
                
                Q4
                
                
                
                Q3
                
                
                
                Q2
                
                
                
                Q1Sales
                
                $
                381.0
                
                
                $
                413.7
                
                
                $
                441.8
                
                
                $
                478.1
                
                
                $
                470.6
                
                
                $
                486.0
                
                
                $
                469.6
                
                
                $
                456.3EBITDA1
                
                
                15.1
                
                
                
                (0.3
                )
                
                
                (1.9
                )
                
                
                14.1
                
                
                
                48.5
                
                
                
                62.8
                
                
                
                52.4
                
                
                
                47.3Net
      earnings (loss)
                
                
                12.4
                
                
                
                (18.6
                )
                
                
                0.2
                
                
                
                (25.6
                )
                
                
                (37.2
                )
                
                
                2.5
                
                
                
                42.4
                
                
                
                (23.6
                )Net
      earnings (loss) per share – basic and diluted
                
                $
                0.06
                
                
                $
                (0.09
                )
                
                $
                0.00
                
                
                $
                (0.12
                )
                
                $
                (0.17
                )
                
                $
                0.01
                
                
                $
                0.20
                
                
                $
                (0.11
                )
  1
              EBITDA
      is a non-GAAP measure.  Refer to Section 9, “Non-GAAP Measures”
      for further details.
  In Q1,
2007, the net loss improved by $11.6 million ($0.05 per common share), compared
to Q4, 2006, due largely to a $32.8 million increase in the after-tax foreign
exchange gain arising from the translation of U.S.-dollar-denominated debt, and
due to the absence of a $3.8 million after-tax impairment loss recorded in the
previous quarter.  These improvements were offset by $12.5 million in
after-tax restructuring and change-of-control costs.
  In Q2,
2007, the $25.8 million ($0.12 per common share) improvement in net earnings,
compared to Q1, 2007, was related primarily to a $37.5 million increase in the
after-tax foreign exchange gain on the translation of U.S.-dollar-denominated
debt, and a $1.4 million release of future income taxes related to the reduction
in the federal corporate income tax rate, which was partially offset by an
increase of $0.2 million in after-tax restructuring and change-of-control costs
and $0.8 million in after-tax finance related fees.
  In Q3,
2007, the $18.8 million ($0.09 per common share) decrease in net earnings,
compared to Q2, 2007, was due largely to a $16.0 million decrease in the
after-tax foreign exchange gain arising from the translation of
U.S.-dollar-denominated debt, a negative impact of $8.8 million in after-tax
costs related to the USW strike, an after-tax loss of $4.9 million on the sale
of the A3 paper machine, and a $3.4 million after-tax increase in restructuring
and change-of-control costs.
  In Q4,
2007, the $31.0 million ($0.15 per common share) improvement in net earnings,
compared to Q3, 2007, was due largely to a $35.0 million release of future
income taxes, of which $21.0 million related to the reduction in the federal
corporate income tax rate, and $14.0 million related to tax uncertainties
resolved with the conclusion of an examination by the Canada Revenue Agency and
a decrease of $14.7 million in after-tax and change-of-control costs in
Q4.
  
 
 
 The
following table reconciles the average spot exchange rate to the Company’s
effective rate for the eight consecutive quarters ending December 31,
2007:
  US$/CDN$
      foreign exchange
                
                2007
                
                
                2006Q4
                
                
                
                Q3
                
                
                
                Q2
                
                
                
                Q1
                
                
                
                Q4
                
                
                
                Q3
                
                
                
                Q2
                
                
                
                Q1Average
      spot rate
                
                
                1.019
                
                
                
                0.957
                
                
                
                0.911
                
                
                
                0.854
                
                
                
                0.878
                
                
                
                0.892
                
                
                
                0.892
                
                
                
                0.866Revaluation of U.S. dollarworking
      capital
                
                
                0.008
                
                
                
                0.040
                
                
                
                0.051
                
                
                
                0.006
                
                
                
                (0.023
                )
                
                
                (0.001
                )
                
                
                0.022
                
                
                
                (0.001
                )Impact of
    hedging
                
                
                (0.059
                )
                
                
                (0.053
                )
                
                
                (0.035
                )
                
                
                (0.002
                )
                
                
                0.018
                
                
                
                (0.006
                )
                
                
                (0.037
                )
                
                
                (0.010
                )Other
                
                
                0.002
                
                
                
                (0.009
                )
                
                
                (0.011
                )
                
                
                0.002
                
                
                
                0.005
                
                
                
                0.001
                
                
                
                (0.005
                )
                
                
                (0.002
                )Effective
      rate
                
                
                0.970
                
                
                
                0.935
                
                
                
                0.916
                
                
                
                0.860
                
                
                
                0.878
                
                
                
                0.886
                
                
                
                0.872
                
                
                
                0.853
  9.0
              NON-GAAPMEASURES
  EBITDA
(earnings before interest, taxes, depreciation and amortization and before other
non-operating income and expenses), as defined equates to operating earnings
(loss) plus amortization.  As Canadian GAAP does not define a method
of calculating EBITDA, the measure as calculated by the Company might not be
comparable to similarly-titled measures reported by other
entities.  The Company focuses on EBITDA, as the Company believes this
measure enables comparison of its results between periods without regard to debt
service, income taxes, and capital expenditure requirements.  As such,
the Company believes it would be useful for investors and other users to be
aware of this measure so they can better assess the Company’s operating
performance.  EBITDA should not be considered by an investor as an
alternative to net earnings, an indicator of the financial performance of the
Company, or an alternative to cash flows as a measure of liquidity.
  The
Company incurred some specific items in 2007 and 2006 that adversely or
positively affected its average delivered cash costs per tonne, EBITDA,
operating earnings (loss), and net earnings (loss), making the comparison of
results difficult from period to period. The Company believes it is useful for
readers to be aware of these items as it provides an indication of performance
and comparative trends, excluding these specific items. Specific items include
foreign exchange gain or loss on long-term debt, asset impairments,
restructuring and change-of-control costs, financing related fees, income tax
adjustments, the impact of significant labour disruptions, and other significant
items of an unusual or non-recurring nature.  The Company believes
this is useful supplemental information, however, the Company’s measures
excluding specific items have no standardized meaning under Canadian GAAP and
might not be comparable to similarly-titled measures reported by other
entities.  Readers should be cautioned that average delivered cash
costs per tonne before specific items, EBITDA before specific items, EBITDA
margin before specific items, net earnings (loss) before specific items and net
earnings (loss) per share before specific items should not be confused with or
used as an alternative to measures prescribed by Canadian GAAP.
  The
Company has reported free cash flow because management believes it would be
useful for investors and other users to be aware of this measure so they can
better assess the Company’s operating performance.  Free cash flow
excludes certain working capital changes and other sources and uses of cash,
which are disclosed in the consolidated statements of cash flows. As Canadian
GAAP does not define a method of calculating free cash flow, the measure as
calculated by the Company might not be comparable to similarly-titled measures
reported by other entities and should not be considered an alternative to the
consolidated statements of cash flows.  While the closest GAAP measure
is cash provided by operating activities less cash used by  investing
activities, free cash flow generated by operations is cash available after
capital expenditures, but before proceeds from divested assets and changes in
certain working capital items.
  Refer to
the tables below for a reconciliation of net earnings (loss) to EBITDA and
EBITDA before specific items, the impact of specific items by segment, net
earnings (loss) as reported to net earnings (loss) before specific items, and
reconciliation of free cash flow with cash provided by operating activities less
cash used by investing activities and management’s calculation of free cash
flow.
  Reconciliation of net
earnings (loss) to EBITDA and EBITDA before specific items
  (In
      millions of dollars)
                
                2007
                
                
                2006
                
                
                2005Net
      earnings (loss)
                
                $
                (31.6
                )
                
                $
                (15.9
                )
                
                $
                (25.6
                )Amortization
                
                
                176.4
                
                
                
                183.7
                
                
                
                180.3Impairment
      loss
                
                
                -
                
                
                
                23.4
                
                
                
                -Foreign
      exchange (gain) loss on translation of long-term debt
                
                
                (103.9
                )
                
                
                0.3
                
                
                
                (24.7
                )Other
      (income) expense, net
                
                
                15.3
                
                
                
                (1.8
                )
                
                
                (4.5
                )Interest
      expense, net
                
                
                70.7
                
                
                
                73.8
                
                
                
                75.7Income
      tax recovery
                
                
                (100.0
                )
                
                
                (54.0
                )
                
                
                (46.6
                )Non-controlling
      interest
                
                
                0.1
                
                
                
                1.5
                
                
                
                0.6EBITDA
                
                $
                27.0
                
                
                $
                211.0
                
                
                $
                155.2Specific
      items:Restructuring
    costs
                
                
                55.3
                
                
                
                –
                
                
                
                6.7Change-of-control
      costs
                
                
                9.4
                
                
                
                –
                
                
                
                -Impact of USW
    strike
                
                
                25.0
                
                
                
                –
                
                
                
                -Total
      specific items
                
                
                89.7
                
                
                
                –
                
                
                
                6.7EBITDA
      before specific items
                
                $
                116.7
                
                
                $
                211.0
                
                
                $
                161.9
 
 
  Reconciliation of net
earnings (loss) to EBITDA and EBITDA before specific items by
quarter
  (In
      millions of dollars)
                
                2007
                
                
                2006Total
                
                
                
                Q4
                
                
                
                Q3
                
                
                
                Q2
                
                
                
                Q1
                
                
                Total
                
                
                
                Q4
                
                
                
                Q3
                
                
                
                Q2
                
                
                
                Q1Net
      earnings (loss)
                
                $
                (31.6
                )
                
                $
                12.4
                
                
                $
                (18.6
                )
                
                $
                0.2
                
                
                $
                (25.6
                )
                
                $
                (15.9
                )
                
                $
                (37.2
                )
                
                $
                2.5
                
                
                $
                42.4
                
                
                $
                (23.6
                )Amortization
                
                
                176.4
                
                
                
                42.8
                
                
                
                44.0
                
                
                
                44.8
                
                
                
                44.8
                
                
                
                183.7
                
                
                
                46.0
                
                
                
                45.8
                
                
                
                46.3
                
                
                
                45.6Impairment
      loss
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                23.4
                
                
                
                5.8
                
                
                
                -
                
                
                
                -
                
                
                
                17.6Foreign
      exchange (gain) loss onlong-term
      debt
                
                
                (103.9
                )
                
                
                (8.9
                )
                
                
                (33.9
                )
                
                
                (53.2
                )
                
                
                (7.9
                )
                
                
                0.3
                
                
                
                31.6
                
                
                
                (0.1
                )
                
                
                (31.6
                )
                
                
                0.4Other
      (income) expense, net
                
                
                15.3
                
                
                
                6.6
                
                
                
                7.2
                
                
                
                1.8
                
                
                
                (0.3
                )
                
                
                (1.8
                )
                
                
                (1.7
                )
                
                
                0.4
                
                
                
                (0.5
                )
                
                
                -Interest
      expense, net
                
                
                70.7
                
                
                
                15.4
                
                
                
                18.4
                
                
                
                18.4
                
                
                
                18.5
                
                
                
                73.8
                
                
                
                18.3
                
                
                
                18.4
                
                
                
                18.7
                
                
                
                18.4Income
      tax expense (recovery)
                
                
                (100.0
                )
                
                
                (53.2
                )
                
                
                (17.4
                )
                
                
                (14.2
                )
                
                
                (15.2
                )
                
                
                (54.0
                )
                
                
                (13.8
                )
                
                
                (4.4
                )
                
                
                (24.4
                )
                
                
                (11.4
                )Non-controlling
      interest
                
                
                0.1
                
                
                
                0.0
                
                
                
                0.0
                
                
                
                0.3
                
                
                
                (0.2
                )
                
                
                1.5
                
                
                
                (0.5
                )
                
                
                0.2
                
                
                
                1.5
                
                
                
                0.3EBITDA
                
                
                27.0
                
                
                
                15.1
                
                
                
                (0.3
                )
                
                
                (1.9
                )
                
                
                14.1
                
                
                
                211.0
                
                
                
                48.5
                
                
                
                62.8
                
                
                
                52.4
                
                
                
                47.3Specific
      items:Restructuring
    costs
                
                
                55.3
                
                
                
                1.4
                
                
                
                24.1
                
                
                
                19.0
                
                
                
                10.8
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Change-of-control
      costs
                
                
                9.4
                
                
                
                0.6
                
                
                
                0.3
                
                
                
                0.3
                
                
                
                8.2
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Impact of USW
      strike
                
                
                25.0
                
                
                
                11.7
                
                
                
                13.3
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Total
      specific items
                
                
                89.7
                
                
                
                13.7
                
                
                
                37.7
                
                
                
                19.3
                
                
                
                19.0
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -EBITDA
      before specific items
                
                $
                116.7
                
                
                $
                28.8
                
                
                $
                37.4
                
                
                $
                17.4
                
                
                $
                33.1
                
                
                $
                211.0
                
                
                $
                48.5
                
                
                $
                62.8
                
                
                $
                52.4
                
                
                $
                47.3
 
 
 
 Impact of specific items by
segment in 2007 by quarter
  (In
      millions of dollars, except where otherwise stated)2007Total
                
                
                
                Q4
                
                
                
                Q3
                
                
                
                Q2
                
                
                
                Q1Specific
      items:Sales
                
                $
                (80.7
                )
                
                $
                (55.0
                )
                
                $
                (25.7
                )
                
                $
                -
                
                
                $
                -Cost of sales
                
                
                55.7
                
                
                
                43.3
                
                
                
                12.4
                
                
                
                -
                
                
                
                -Impact of the USW strike1
                
                
                (25.0
                )
                
                
                (11.7
                )
                
                
                (13.3
                )
                
                
                -
                
                
                
                -Restructuring
    costs
                
                
                (55.3
                )
                
                
                (1.4
                )
                
                
                (24.1
                )
                
                
                (19.0
                )
                
                
                (10.8
                )Change-of-control
      costs
                
                
                (9.4
                )
                
                
                (0.6
                )
                
                
                (0.3
                )
                
                
                (0.3
                )
                
                
                (8.2
                )EBITDA impact of specific
      items
                
                $
                (89.7
                )
                
                $
                (13.7
                )
                
                $
                (37.7
                )
                
                $
                (19.3
                )
                
                $
                (19.0
                )Segment
      EBITDA favourable (unfavourable) impact of specific itemsSpecialty paper
                
                $
                (47.2
                )
                
                $
                (3.6
                )
                
                $
                (17.6
                )
                
                $
                (12.9
                )
                
                $
                (13.1
                )Newsprint
                
                
                (19.3
                )
                
                
                (3.9
                )
                
                
                (7.7
                )
                
                
                (4.0
                )
                
                
                (3.7
                )Pulp
                
                
                (23.2
                )
                
                
                (6.2
                )
                
                
                (12.4
                )
                
                
                (2.4
                )
                
                
                (2.2
                )Total
                
                $
                (89.7
                )
                
                $
                (13.7
                )
                
                $
                (37.7
                )
                
                $
                (19.3
                )
                
                $
                (19.0
                )Segment
      EBITDA favourable (unfavourable) impact of restructuring and
      change-of-control costs onlySpecialty paper
                
                $
                (42.2
                )
                
                $
                (1.8
                )
                
                $
                (14.4
                )
                
                $
                (12.9
                )
                
                $
                (13.1
                )Newsprint
                
                
                (12.9
                )
                
                
                (0.4
                )
                
                
                (4.8
                )
                
                
                (4.0
                )
                
                
                (3.7
                )Pulp
                
                
                (9.6
                )
                
                
                0.2
                
                
                
                (5.2
                )
                
                
                (2.4
                )
                
                
                (2.2
                )Total
                
                $
                (64.7
                )
                
                $
                (2.0
                )
                
                $
                (24.4
                )
                
                $
                (19.3
                )
                
                $
                (19.0
                )Lost
      sales due to USW strike (000 tonnes)Specialty paper
                
                
                3.2
                
                
                
                0.4
                
                
                
                2.8
                
                
                
                -
                
                
                
                -Newsprint
                
                
                82.8
                
                
                
                62.2
                
                
                
                20.6
                
                
                
                -
                
                
                
                -Pulp
                
                
                44.0
                
                
                
                26.8
                
                
                
                17.2
                
                
                
                -
                
                
                
                -Total
                
                
                130.0
                
                
                
                89.4
                
                
                
                40.6
                
                
                
                -
                
                
                
                -Curtailed
      production due to USW strike (000 tonnes)Specialty paper
                
                
                7.2
                
                
                
                4.0
                
                
                
                3.2
                
                
                
                -
                
                
                
                -Newsprint
                
                
                98.9
                
                
                
                65.8
                
                
                
                33.1
                
                
                
                -
                
                
                
                -Pulp
                
                
                54.7
                
                
                
                26.8
                
                
                
                27.9
                
                
                
                -
                
                
                
                -Total
                
                
                160.8
                
                
                
                96.6
                
                
                
                64.2
                
                
                
                -
                
                
                
                -
  1
              The
      impact of the USW strike is based on management
      estimates.  There were no significant restructuring and
      change-of-control costs or USW strike related costs in
    2006.
  
 
 
 Reconciliation of net
earnings (loss) as reported to net earnings (loss) before specific
items
  (In
      millions of dollars and after-tax, except where otherwise
      stated)2007
                
                
                2006
                
                
                2005Net
      earnings (loss) as reported
                
                $
                (31.6
                )
                
                $
                (15.9
                )
                
                $
                (25.6
                )Specific
      items (after taxes):Foreign exchange loss (gain) on
      long-term debt
                
                
                (86.2
                )
                
                
                0.2
                
                
                
                (20.7
                )Impairment and loss on
      disposal
                
                
                4.9
                
                
                
                15.4
                
                
                
                -Restructuring and
      change-of-control costs
                
                
                42.7
                
                
                
                -
                
                
                
                -USW strike
impact
                
                
                16.5
                
                
                
                -
                
                
                
                -Third Avenue Management tender
      offer
                
                
                –
                
                
                
                2.2
                
                
                
                -Financing related
      fees
                
                
                0.8
                
                
                
                -
                
                
                
                -Income tax
      adjustments
                
                
                (36.4
                )
                
                
                (26.9
                )
                
                
                (18.3
                )Net
      earnings (loss) before specific items
                
                $
                (89.3
                )
                
                $
                (25.0
                )
                
                $
                (64.6
                )Net
      earnings (loss) per share in dollars:
                  As reported
                
                $
                (0.15
                )
                
                $
                (0.07
                )
                
                $
                (0.12
                )Before specific
      items
                
                $
                (0.42
                )
                
                $
                (0.12
                )
                
                $
                (0.30
                )
  Reconciliation of net
earnings (loss) as reported to net earnings (loss) before specific items by
quarter
  (In
      millions of dollars and after-tax, except where otherwise
      stated)2007
              
              
              2006TOTAL
              
              
              
              Q4
              
              
              
              Q3
              
              
              
              Q2
              
              
              
              Q1
              
              
              TOTAL
              
              
              
              Q4
              
              
              
              Q3
              
              
              
              Q2
              
              
              
              Q1Net
      earnings (loss) as reported
              
              $
              (31.6
              )
              
              $
              12.4
              
              
              $
              (18.6
              )
              
              $
              0.2
              
              
              $
              (25.6
              )
              
              $
              (15.9
              )
              
              $
              (37.2
              )
              
              $
              2.5
              
              
              $
              42.4
              
              
              $
              (23.6
              )Specific
      items (after taxes):Foreign exchange loss (gain) onlong-term
      debt
              
              
              (86.2
              )
              
              
              (7.4
              )
              
              
              (28.1
              )
              
              
              (44.1
              )
              
              
              (6.6
              )
              
              
              0.2
              
              
              
              26.2
              
              
              
              (0.1
              )
              
              
              (26.2
              )
              
              
              0.3Impairment and loss on
      disposal
              
              
              4.9
              
              
              
              -
              
              
              
              4.9
              
              
              
              -
              
              
              
              -
              
              
              
              15.4
              
              
              
              3.8
              
              
              
              -
              
              
              
              -
              
              
              
              11.6Restructuring and
      change-of-control costs
              
              
              42.7
              
              
              
              1.4
              
              
              
              16.1
              
              
              
              12.7
              
              
              
              12.5
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -USW strike
impact
              
              
              16.5
              
              
              
              7.7
              
              
              
              8.8
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Third Avenue Management tender
      offer
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              2.2
              
              
              
              -
              
              
              
              2.2
              
              
              
              -
              
              
              
              -Financing related
      fees
              
              
              0.8
              
              
              
              -
              
              
              
              -
              
              
              
              0.8
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Income tax
      adjustments
              
              
              (36.4
              )
              
              
              (35.0
              )
              
              
              -
              
              
              
              (1.4
              )
              
              
              -
              
              
              
              (26.9
              )
              
              
              -
              
              
              
              (4.0
              )
              
              
              (22.9
              )
              
              
              -Net
      earnings (loss) before specific items
              
              $
              (89.3
              )
              
              $
              (20.9
              )
              
              $
              (16.9
              )
              
              $
              (31.8
              )
              
              $
              (19.7
              )
              
              $
              (25.0
              )
              
              $
              (7.2
              )
              
              $
              0.6
              
              
              $
              (6.7
              )
              
              $
              (11.7
              )Net
      earnings (loss) per share in dollars:
                As reported
              
              $
              (0.15
              )
              
              $
              0.06
              
              
              $
              (0.09
              )
              
              $
              0.00
              
              
              $
              (0.12
              )
              
              $
              (0.07
              )
              
              $
              (0.17
              )
              
              $
              0.01
              
              
              $
              0.20
              
              
              $
              (0.11
              )Before specific
      items
              
              $
              (0.42
              )
              
              $
              (0.10
              )
              
              $
              (0.08
              )
              
              $
              (0.15
              )
              
              $
              (0.09
              )
              
              $
              (0.12
              )
              
              $
              (0.03
              )
              
              $
              0.00
              
              
              $
              (0.03
              )
              
              $
              (0.06
              )
 
 
 
 The
following reconciles free cash flow with cash provided by operating activities
less cash used by investing activities:
  Years
      ended December 31 (in millions)
                
                2007
                
                
                2006
                
                
                2005Cash
      provided by operating activities
                
                $
                (2.7
                )
                
                $
                127.2
                
                
                $
                60.7Cash
      used by investing activities
                
                
                (83.7
                )
                
                
                (85.8
                )
                
                
                (93.0
                )Proceeds
      from the sale of property and other assets
                
                
                (6.5
                )
                
                
                (3.5
                )
                
                
                (3.5
                )Other
      investing activities
                
                
                4.4
                
                
                
                (3.9
                )
                
                
                1.3Non-cash
      working capital changes except changes in taxes and
    interest
                
                
                (30.3
                )
                
                
                9.0
                
                
                
                12.6Other1
                
                
                32.4
                
                
                
                0.6
                
                
                
                2.7Free
      Cash Flow
                
                $
                (86.4
                )
                
                $
                43.6
                
                
                $
                (19.2
                )
  1
              2007
      includes restructuring expenses, net of payments, in "Employee future
      benefits" and "Other long-term obligations" of $11.4 million and $8.1
      million, respectively, on the balance
sheet.
  The
following shows management’s calculation of free cash flow:
  Years
      ended December 31 (in millions)
                
                2007
                
                
                2006
                
                
                2005EBITDA
                
                $
                27.0
                
                
                $
                211.0
                
                
                $
                155.2Cash
      interest paid, net
                
                
                (67.8
                )
                
                
                (71.5
                )
                
                
                (75.3
                )Capital
      expenditures
                
                
                (85.8
                )
                
                
                (93.2
                )
                
                
                (95.2
                )Income
      taxes paid
                
                
                (0.5
                )
                
                
                (2.7
                )
                
                
                (3.9
                )Restructuring
      cost expense, over payments
                
                
                40.7
                
                
                
                -
                
                
                
                -Free
      Cash Flow
                
                $
                (86.4
                )
                
                $
                43.6
                
                
                $
                (19.2
                )
  10.0
              CRITICAL ACCOUNTING POLICIES AND
    ESTIMATES
  The
preparation of financial statements in conformity with Canadian GAAP requires
companies to establish accounting policies and to make estimates that affect
both the amount and timing of recording of assets, liabilities, revenues and
expenses. Some of these estimates require judgments about matters that are
inherently uncertain.
  Note 2 to
the December 31, 2007 consolidated financial statements includes a summary of
the significant accounting policies used in their preparation. While all of the
significant accounting policies are important to the consolidated financial
statements, some of these policies may be viewed as involving a high degree of
judgement.  On an ongoing basis using currently available information,
management reviews its estimates, including those related to environmental and
legal liabilities, impairment of long-lived assets, pension and post-retirement
benefits, provision for bad and doubtful accounts, and income
taxes.  Actual results could differ from these estimates.
  The
following accounting policies require management’s most difficult, subjective
and complex judgements, and are subject to a fair degree of measurement
uncertainty.
  10.1
              Environmental and
      legal liabilities
  Environmental
and legal liabilities are recorded on an undiscounted basis when it is
considered probable that a liability has been incurred and the amount of the
loss can be reasonably estimated. Liabilities for environmental matters require
evaluations of applicable environmental regulations and estimates of remediation
alternatives and the costs thereof. Provisions for liabilities relating to legal
actions and claims require judgments regarding projected outcomes and the range
of loss, based on such factors as historical experience and recommendations of
legal counsel.
  As at
December 31, 2007, the Company had a provision of approximately $13million for
environmental, remedial and other obligations.  The Company expects
capital expenditures relating to known environmental matters, including
compliance issues and the assessment and remediation of the environmental
condition of the Company’s properties, will total approximately $1 million
in 2008.
  10.2
              Impairment of
      long-lived assets
  The
Company reviews long-lived assets, primarily plant and equipment, for impairment
when events or changes in circumstances indicate that the carrying value of
these assets may not be recoverable.  The Company tests for impairment
using a two-step methodology:
  (i)
              Testing
      for impairment is accomplished by determining whether the projected
      undiscounted future cash flows from operations exceed the net carrying
      amount of the assets as of the assessment date,
  and
 (ii)
              If
      assets are determined to be impaired in step (i), then such impaired
      assets are written down to their fair value, determined principally by
      using discounted future cash flows expected from their use and eventual
      disposition.
  Estimates
      of future cash flows and fair value require judgements, assumptions and
      estimates and may change over time. Due to the variables associated with
      judgments and assumptions used in these tests, the precision and accuracy
      of estimates of impairment charges are subject to significant
      uncertainties and may change significantly as additional information
      becomes known.  Long-lived assets represented approximately 78%
      of total assets as at December 31, 2007.  If future developments
      were to differ adversely from management’s best estimate of key
      assumptions and associated cash flows, the Company could potentially
      experience future material impairment
charges.
  In the
fourth quarter of 2007, as a result of rapid strengthening of the Canadian
dollar and the decline in North American consumption of newsprint, the Company
conducted step (i) impairment tests on its paper and pulp assets. Estimates of
future cash flows used to test the recoverability of  long-lived
assets included key assumptions related to foreign exchange rates, forecast
prices, estimated useful life of the long-lived assets, production levels,
production costs, market supply and demand, inflation, weighted average cost of
capital, and capital spending.  The assumptions are derived from
information generated internally, independent industry research firms, and other
external published reports and forecasts.  The useful life of the Company’s
assets was estimated at 20 years for paper assets and 5 to10 years for pulp
assets.  Product sales prices and foreign exchange assumptions for
years 2008 to 2012 were based on forecasts prepared by Resource Information
Systems Inc. (“RISI”), an independent external firm.  The foreign exchange
assumption was CDN$1.00=US$1.015 in 2008 declining to CDN$1.00=US$0.8512 by
2012.  Product sales prices and foreign exchange rate assumptions for 2013
and subsequent years were estimated by management based on long-term trend
pricing for product sales prices and a long term expected foreign exchange rate
of CDN$=US$0.8800.  The Company concluded that an impairment charge
for the pulp and paper assets was not required in 2007 as the estimated
undiscounted cash flows exceeded the carrying values.
 10.3
              Pension and
      post-retirement benefits
  The
Company maintains various employee future benefit plans, which include defined
benefit pension and post-retirement benefit plans. The Company retains
independent actuarial firms to perform actuarial valuations of the fair value of
the Company’s defined benefit pension and post-retirement benefit plan assets
and benefit obligations, and advise on the amounts to be recorded in the
Company’s financial statements. This information is determined using certain
assumptions, based on historical and market data that directly impact the fair
value of the assets and obligations as well as the charges disclosed in the
Company’s financial statements. These assumptions include:
  ·
              The
      discount rate which is used to estimate the actuarial present value of the
      various plan obligations.  The Company, assisted by independent
      actuarial advisors, sets the discount rate assumption annually to reflect
      the rates available on high-quality debt instruments, with cash flows that
      are expected to match the timing and amount of expected benefit
      payments.  The discount rate, as at December 31, 2007, was
      estimated to be 5.25%.
 ·
              The
      long-term return on assets used to estimate the growth in the value of
      invested assets available to satisfy certain obligations.  The
      Company, with the assistance of independent actuarial firms, annually sets
      the expected rate of return on plan assets to reflect the current view of
      long-term investment returns.  As at December 31, 2007, a rate
      of return of 7.0% was determined by management in consultation with its
      independent actuarial advisors.
 ·
              Salary
      increases used to estimate the impact that future compensation increases
      will have on pension and other post-retirement obligations.  As
      at December 31, 2007, the rate of compensation increase of 2.5% was
      determined by management in consultation with its independent actuarial
      advisors.
 ·
              Health care trend rates and mortality rates used to estimate
      the impact that future health care costs will have on pension and
      post-retirement obligations. As at December 31, 2007, a health care trend
      rate of 8.0% was determined by management in consultation with its
      independent actuarial advisors.  The health care trend rate is
      expected to decline by 0.5% annually, and the ultimate health care trend
      rate is estimated to be 4.5%.
  Actual experience can vary significantly from estimates and could
materially impact the estimated cost of employee benefit plans and future cash
requirements.
  The
following table provides a sensitivity analysis of the key weighted average
economic assumptions used in measuring the accrued pension benefit obligation,
and the accrued other employee future benefit and related net periodic benefit
cost for 2007.  This sensitivity analysis should be used with caution
as it is hypothetical and changes in each key assumption may not be
linear.  The sensitivities in each key variable have been calculated
independently of each other.
  
 
 
 
 Pension
      benefit plans
                
                
                Other
      benefit plans(In
      millions of dollars)
                
                Accrued
      benefit obligation
                
                
                Net
      2007 expense
                
                
                Accrued
      benefit obligation
                
                
                Net
      2007 expenseExpected
      rate of return on assetsImpact
      of:1% increase
                
                NA
                
                
                
                (2.7
                )
                
                NA
                
                
                NA1% decrease
                
                NA
                
                
                
                2.7
                
                
                NA
                
                
                NADiscount
      rateImpact
      of:1% increase
                
                
                (34.5
                )
                
                
                (1.5
                )
                
                
                (30.7
                )
                
                
                (4.4
                )1% decrease
                
                
                37.9
                
                
                
                4.7
                
                
                
                35.7
                
                
                
                5.0Assumed
      overall health care cost trendImpact
      of:1% increase
                
                NA
                
                
                NA
                
                
                
                39.7
                
                
                
                6.31% decrease
                
                NA
                
                
                NA
                
                
                
                (31.0
                )
                
                
                (5.1
                )
  10.4
              Provision for bad debt
      and doubtful accounts
  The
Company uses generally accepted practices in estimating required provisions for
doubtful accounts and bad-debt losses arising on trade and other receivable
balances. The Company’s estimate of the required allowance is a matter of
judgement and the actual loss eventually sustained may be more or less than
estimated.
  The
Company regularly reviews the collectibility of its accounts
receivable.  The Company records its allowance for doubtful accounts
based on its best estimate of any potentially uncollectible accounts by
highlighting those that are specifically high risk and applying judgement to
determine its estimate.  Consideration is given to current economic
conditions and specific customer circumstances to determine the amount of any
bad-debt expense to be recorded.  While the Company has not
experienced any significant bad-debt expense in prior periods, declines in the
economy could result in collectibility concerns.  Accounts receivable
balances for individual customers could potentially be material at any given
time.  The Company manages its credit risk principally through credit
policies, which include the analysis of the financial position of its customers
and the regular review of their credit limits.  The Company also
subscribes to credit insurance for a majority of its receivables,
periodically  purchases accounts receivable puts on certain customers,
and obtains bank letters of credit for some export markets or
customers.
  As at
December 31, 2007, “Accounts receivable” comprised 8.7% of total
assets.  Included in this balance was a provision of $2.8 million for
doubtful accounts, or 1.3% of accounts receivable (as at December 31,
2006, $3.1 million for doubtful accounts, or 1.1% of accounts
receivable).
  In
January 2008, one of the Company's larger customers, QuebecorWorld
(less than 5% of sales), filed for bankruptcy protection in both
Canada and the U.S.  This customer continues to operate under the
Canadian and U.S. bankruptcy laws, and continues to purchase from the Company
under certain terms and conditions.  Based on the estimated recoveries
from this customer and the Company's credit insurer, the Company
believes its allowance for doubtful accounts as at December 31, 2007 is adequate
to provide for probable losses existing in accounts receivable as
at December 31, 2007.
  10.5
              Income
      taxes
  The
amounts recorded for future income tax assets and liabilities are based on
various judgments, assumptions and estimates. Future tax assets and liabilities
are measured using enacted or substantively enacted tax rates for the years in
which assets and liabilities are expected to be recovered or
settled.  For these years, a projection is made of taxable income and
estimates made of the ultimate recovery or settlement of temporary
differences.  The projection of future taxable income is based on
management’s best estimate and may vary from actual.
  The
Company’s future tax assets are mainly composed of temporary differences
relating to employee future benefits and loss carryforwards.  Future
tax liabilities are mainly composed of temporary differences pertaining to
property, plant and equipment.  Estimating the ultimate settlement
period for these temporary differences requires judgment.  The
reversal of these temporary differences is expected to be at future
substantially enacted rates which could change due to changes in income tax
laws.  As a result, a change in the timing of reversal or in the
income tax rate could materially affect the future tax expense recorded in the
consolidated statement of earnings. A one-percentage-point change in the
Company’s reported effective income tax rate would have the effect of changing
the income tax expense by approximately $5.8 million.
  In
addition, the Company records provisions for federal, provincial and foreign
taxes based on the respective tax laws of the jurisdictions in which the Company
operates and its judgment as to the appropriate allocation of income and
deductions to those jurisdictions.  Canadian, U.S. and international
tax laws are subject to interpretation and the Company’s judgment may be
challenged by taxation authorities.  In such circumstances, the final
resolution of these challenges can result in settlements that differ from the
Company’s estimated amounts.
  11.0
              CHANGES IN ACCOUNTING
  POLICIES
  On
January 1, 2007, the Company adopted the new recommendations  of
the CICA Handbook Section 3855, “Financial Instruments - Recognition and
Measurement”, Section 1530, “Comprehensive Income”, Section 3865, “Hedges”,
Section 3861, “Financial Instruments – Disclosure and
Presentation”,  and Section 3251, “Equity”.  These standards
introduce new requirements for recognition, measurement and disclosure of
financial instruments, when and how hedge accounting may be applied, establishes
the concept of comprehensive income and rules for reporting it and establishes
rules for the presentation of equity and changes in equity.  Prior
period financial statements are not revised for the adoption of these new
standards.
  The
adoption of these standards resulted in the Company recording on its balance
sheet, at fair value, certain revenue and interest rate derivative financial
instruments that were previously off balance sheet and the reclassification of
its deferred financing costs against long-term debt.  The detailed
adjustments are provided in note 2(c) in the Company’s 2007 annual consolidated
financial statements.
  12.0
              IMPACT OF ACCOUNTING PRONOUNCEMENTS AFFECTING FUTURE
      PERIODS
  The new
recommendations of the CICA Handbook Section 3031, “Inventories” provides
significantly more guidance on the measurement of inventory and requires
enhanced disclosures.  This standard is effective for interim and
annual financial statements for fiscal years beginning on or after January 1,
2008.  The transitional rules for this standard require retrospective
application at the beginning of the fiscal year.  While the Company is
currently assessing the impact of these new recommendations on its consolidated
financial statements, it does not expect the recommendations to have a
significant impact on its consolidated earnings.
  The new
recommendations of the CICA Handbook Section 1535, “Capital Disclosures”
requires entities to provide additional disclosures relating to the Company’s
objectives, policies and processes for managing capital.  This
standard is effective for interim and annual financial statements for fiscal
years beginning on or after October 1, 2007.
  The CICA
has released two new Handbook sections related to financial instruments: Section
3862, “Financial Instruments – Disclosures” and Section 3863, “Financial
Instruments – Presentation”.  These standards enhance existing
disclosures in previously issued Section 3861, “Financial Instruments –
Disclosures and Presentation”.  The new recommendations under Section
3862, “Financial Instruments – Disclosures” require additional disclosures,
relative to those currently required, with an emphasis on risks associated with
both recognized and unrecognized financial instruments to which an entity is
exposed during the period and at the balance sheet date, and how the entity
manages those risks. This standard is effective for interim and annual financial
statements for fiscal years beginning on or after October 1, 2007.
  13.0
              RISKS AND
UNCERTAINTIES
  The
Company produces and markets pulp and paper products that are sold
globally.  The Company seeks to differentiate its product lines from
those of other producers by supplying specialty products that add value for
customers.  However, like most companies in the forest products
industry in North America, the Company faces business risks and
uncertainties.  These fall into the general business areas of markets,
international commodity prices, currency exchange rates, environmental issues,
fibre supply, government regulation and policy, and for Canadian companies,
trade barriers and potential impacts of Aboriginal rights, including unresolved
Aboriginal land claims in British Columbia.
  In order
to address these risks and effectively manage them, the Company’s management has
developed a process for managing risk and the interrelationships risks have with
the Company’s strategic plan.  Management provides regular updates to
the Audit Committee, works with corporate and operational management to
identify, measure and prioritize the critical risks facing the Company, and
manages these risks by ensuring that they are adequately addressed through
mitigating procedures where appropriate.  The objectives of the risk
management function include developing a common framework for understanding what
constitutes principal business risks, ensuring that risk management activities
are aligned with business strategies, and providing an effective mechanism for
governance in the area of risk management.
  A
discussion of the principal uncertainties to which the Company is subject
follows.
  13.1
              Fluctuations in
      Markets and Prices
  The
Company’s markets are commodity-based and cyclical in nature.  Markets
for the principal products are affected by fluctuations in supply and demand
within each cycle, which in turn affect product prices.  Demand has
historically been determined by the level of economic growth and has been very
closely tied to overall business activity and personal income and the strength
of print media advertising.  The Company has limited influence over
the timing and extent of price changes for its products.  See Section
14.0, "Sensitivity Analysis" for further details regarding the Company’s
sensitivity to product price fluctuations.
  The North
American and global economies and the market for the Company’s products has
weakened significantly over a period of several years and market conditions are
expected to continue to be challenging over the next year.  North
American newsprint consumption declined in 2007 by 10.5% from 2006, and by 6.3%
in 2006 from 2005.  The Company believes this decline in newsprint
demand will continue, although it has been able to mitigate the impact in part
through its ability to switch grades.  Adverse effects on the demand
for our products may decrease our sales, operating earnings and cash
flows.
  Trends in
advertising, electronic data transmission and storage, and the internet could
have further adverse effects on traditional print media including our products
and those of our customers.  Our newspaper, telephone directory and
retail customers may make increasing use of other forms of media and advertising
instead of newsprint, uncoated groundwood and coated papers made by
us.  The extent to which the use of other media sources will reduce
demand for our products, and the timing of any such reduction, is
unknown.
  13.2
              Global
      competition
  Pulp and
paper markets are highly competitive global commodity markets in which producers
compete primarily on the basis of price.  A majority of the Company’s
production is directed to markets outside Canada, where Canadian producers
generally compete with American, European and Asian producers.  Many
of the Company’s competitors are larger and have greater financial resources
than the Company and some of the mills operated by the Company’s competitors are
lower cost producers than the mills the Company operates.
  13.3
              International
      sales
  A
significant portion of the Company’s sales are outside Canada and the United
States. Therefore, the Company faces a number of risks including tariffs and
other trade barriers, unfavourable business conditions or political and economic
instability in certain foreign markets, fluctuations in foreign currencies, and
difficulty in obtaining distribution and support.
  Under the
terms of the Company’s distribution agreement relating to the sale of paper in
certain international markets, either party on six-months’ notice may terminate
the agreement.  If the agreement is terminated, the Company will be
required to replace the distributor within the six-month notice period in order
to minimize disruptionto sales activities in
the relevant market.
  13.4
              Foreign
      exchange
  The
Company’s profitability is subject to fluctuations in foreign currencies,
particularly the U.S. dollar.  Nearly all of the Company’s sales are
in U.S. dollars, while a substantial portion of the Company’s costs and expenses
are incurred, and results of operations and financial conditions are reported,
in Canadian dollars. The value of the Canadian dollar in relation to the U.S.
dollar has increased significantly in recent years.  Further increases
in the value of the Canadian dollar relative to the U.S. dollar would reduce the
amount of revenue in Canadian dollar terms realized by the Company on sales made
in U.S. dollars.
  Fluctuations
in foreign currencies affect the Company’s competitive position in world
markets.  Apart from the value of the Canadian dollar relative to the
U.S. dollar, the Company’s competitiveness in world markets is affected by the
relative strength of the currencies of other producing countries.  The
Company is also exposed to currency exchange risk on debt denominated in U.S.
dollars, including its 7.375% and 8.625% senior notes.
  Under a
Board-approved foreign exchange risk management program, the Company manages a
portion of its currency exposure through the use of currency options and forward
contracts to hedge anticipated future sales denominated in foreign currencies
and U.S.-dollar-denominated debt.  The Company’s hedging policy for
revenues includes 33% to 67% of 0- to 12–month and 0% to 25% of 13- to 24-month
U.S. dollar net exposure.  The revenue hedge program mitigates the
impact of any rapid movements in currency by 20% to 40% over the near term. In
addition, the Company considers future U.S. dollar revenues to provide a partial
natural hedge for its U.S.-dollar-denominated debt.
  13.5
              Fibre
      supply
  Since the
Company has no significant timber holdings, operations are dependent on the
supply by third parties of wood fibre. Approximately 48% of the Company’s fibre
needs are provided by five suppliers.  The Company’s fibre supply
could be reduced as a result of events beyond its control, such as industrial
disputes, natural disasters, material curtailments, and shutdown of operations
by suppliers or the Company for market or other reasons. Market-related
curtailments or shutdowns can be influenced by both seasonal and cyclical
factors such as raw material availability, finished goods inventory levels, or
interest rates and underlying demand for lumber in key markets.
  Long-term
fibre contracts with third parties are conducted at market prices or at prices
determined under market-based formulas and represent approximately 69% of the
Company’s pulp and paper mills’ wood fibre requirements.  The solid
wood segment of British Columbia’s forest industry has undergone significant
consolidation and downsizing.  As a result, there is no assurance that
the Company will continue to be able to access wood fibre at the same levels
achieved in the past; therefore, costs may be negatively impacted.
  In 2007,
U.S. housing starts declined 25% from 2006.  The weak U.S. housing
markets and the decline in other market conditions have caused British
Columbia’s lumber producers to reduce their operations.  The result is
that such producers are not currently able to supply the Company with wood fibre
at historical levels or prices.  In early 2008 the Corporation
announced curtailments of some of its operations as a result of its inability to
obtain sufficient fibre at cost effective prices to enable it to run at full
capacity.  Further curtailments may be required if market conditions
continue to decline.
  The
current infestation of the mountain pine beetle in the interior of British
Columbia is expected to affect the long-term fibre supply in that region. The
beetle attacks lodgepole pine forests and once attacked, pine trees typically
die within the year. Approximately 30% of the Company’s fibre supply comes from
the British Columbia interior and it is used primarily by the Powell River paper
mill and Crofton kraft pulp mill. In three to five year’s time, the infestation
could have a significant impact on the availability and cost of fibre used by
those mills.
  In
addition, government regulations and aboriginal issues may also lower the supply
of wood fibre.  The Province of British Columbia owns approximately
95% of all timberlands and could introduce legislation to reduce wood fibre
supply.  Aboriginal groups have claimed aboriginal title over
substantial portions of British Columbia’s timberlands, including areas where
the forest tenures held by the Company’s suppliers are
located.  Although the renewal of forest tenures held by the Company’s
suppliers may be adversely impacted by claims of aboriginal title, the specific
impact cannot be estimated at this time.
  The
Company is also a large consumer of old newspapers and
magazines.  Ownership of Western Canada’s largest paper recycling
facility enables the Company to secure 100% of its recycled fibre needs from
this facility.  While the supply remains reliable, the pricing is
determined by the market and is subject to variability. Demand and prices for
old newspapers have been increasing in recent periods due primarily to increased
export demand.
  The
“Sensitivity Analysis” section provides further details about the Company’s
sensitivity to fibre cost movements.
  13.6
              Labour
      disruptions
  Approximately
three quarters of the Company’s pulp and paper mill employees are members of the
Communications, Energy & Paperworkers Union of Canada (“CEP”), the Pulp,
Paper and Woodworkers of Canada (“PPWC”) or the Canadian Office and Professional
Employees Union (“COPE”) unions.  Collective agreements with the CEP
and PPWC unions expire in April 2008.  The CEP Local 592 maintenance
workers and Local 686 paperworkers in the Company’s Port Alberni mill have voted
to accept a 5-year tentative agreement subject to the re-start of
A4.  Negotiations with the other Locals are ongoing.  If an
agreement is not reached, a strike or work stoppage by the CEP or PPWC could
have a material adverse effect on the Company’s operations.  The
Company’s collective agreement with COPE, the smallest of the three unions,
expires on April 30, 2012.  Distribution centre employees are members
of the Christian Labour Association of Canada (“CLAC”) and nine employees at the
Port Alberni operations are members of the Office and Technical Employees Union
(“OTEU”). The collective agreement with CLAC and OTEU both expire in April
2012.
  The
Company believes its labour relations are strong and does not anticipate labour
disruptions in its operations. However, the Company may not be able to negotiate
an acceptable contract with any of the Company’s unions upon expiration of these
existing contracts. This could result in a strike or work stoppage by the
affected workers. Renewal of contracts could result in higher wages or benefits
paid to union members. Therefore, the Company could experience a significant
disruption of its operations or higher ongoing labour costs, which could have a
material adverse effect on the business, financial condition, results of
operations and cash flow.
  Many of
the Company’s suppliers and service providers are unionized.  Strikes
or work stoppages by members of those unions could result in a significant
disruption of operations or higher operating costs, which could have a material
adverse effect on the business.
  Negotiations
between the B.C. Maritimes Employers’ Association (“BCMEA”) and the
International Longshoreman Workers’ Union (“ILWU”) are ongoing.  In
2007, the Company’s sales to international customers were not impacted as there
was no work stoppage associated with these negotiations.  In the event
where the parties fail to reach a labour agreement and a work stoppage occurs,
there would be an interruption to the Company’s sales to international
customers.
  13.7
              Aboriginal
      claims
  The
Company’s ability to operate its manufacturing facilities may be affected by
aboriginal groups’ claims of aboriginal title and rights.  The
governments of Canada and British Columbia have established a formal process to
negotiate settlements with aboriginal groups throughout British Columbia in
order to resolve these land claims.  It is the policy of the
governments that ownership of lands held in fee simple by third parties such as
the Company will not be affected by treaty negotiations.  In the case
of the Powell River mill, the site has been included in areas to which an
aboriginal group has asserted aboriginal title both through treaty negotiations
with government and by commencing an action in the Supreme Court of British
Columbia.  While the Company and other industrial companies have been
named as parties in the court proceeding along with the two governments of
Canada and British Columbia, counsel for the aboriginal group has advised the
Company that the plaintiffs are currently negotiating with the two governments
and have no intention of proceeding with the action at this
time.  Based on the history of similar proceedings, the Company
expects that it would take many years before a final court decision could be
rendered if the court proceeding were pursued.
  Recent
Supreme Court of Canada decisions have confirmed that the governments of Canada
and British Columbia are obligated to consult with and, in certain
circumstances, accommodate aboriginal groups whenever there is a reasonable
prospect their decisions, such as the decision to issue or amend a regulatory
permit, may affect aboriginal groups’ rights or title.  This duty of
consultation and accommodation may affect the Company’s ability to obtain or
amend necessary regulatory permits on a timely basis and may influence the
conditions set out in such permits. In mid-2005 the Government of British
Columbia initiated a “new relationship” policy related to Aboriginal interests
that recognizes the need to find pre-treaty solutions to advance the
consultation process and to reconcile governmental interests and Aboriginal
interests.  This new relationship policy is directed, in part, at improving
decision-making affecting land and resource use.  It is unclear what, if
any, impact the new relationship policy will have on governmental decision
making as it affects the Company.
  13.8
              Energy
      costs
  The
Company is a significant consumer of electrical power.
  The
Company’s electricity supply contracts are provincially regulated, and
historically pricing has been very stable.  The regulatory commission of
the British Columbia Hydro and Power Authority (“BC Hydro”), approved an
increase of 1.64% over BC Hydro’s rate prior to July 2006, effective February 1,
2007 and is charging an additional rate rider of 2% on all customer bills for
the period February 1, 2007 to March 31, 2008.  During Q4, BC Hydro
proposed rate adjustments for industrial customers under its Stepped Rates
program.  Under the proposal, the Tier 2 rate would rise from $54.00
to $74.00, and will be accompanied by a proportionate downward adjustment of the
Tier 1 rate.  For the current BC Hydro fiscal year, the Company is not
expected to consume any Tier 2 power.  BC Hydro also is proposing a
general increase for all customers, intended to take affect April 1,
2008.  While the amount of the proposed increases is uncertain, the
Company expects BC Hydro rate increases to be more significant in the future in
response to a new B.C. energy policy mandating self-sufficiency by
2016.  The Company believes that the Province’s electricity rates will
continue to be low relative to other regions in North America, although future
changes in electricity prices could have a significant impact on the Company’s
earnings.
  The
majority of the Company’s fossil fuels, particularly oil and natural gas, are
purchased on the spot market, which can fluctuate significantly depending on
various external factors.
  A portion
of the Company’s exposure to fluctuating fossil fuel prices is managed through
the use of financial instruments and physical supply contracts, under a
Board-approved energy program.  The Company’s energy hedging policy is
restricted to 20-70% of the net exposure for oil and gas.  In
addition, the Company reduces its exposure to fossil fuel prices through the use
of lower priced alternatives.
  Freight
charges and chemical expenses also vary with oil and diesel fuel
prices.
  The
“Sensitivity Analysis” section provides further details about the Company’s
sensitivity to energy cost fluctuations.
  13.9
              Legal
      proceedings
  In the
ordinary course of business, the Company occasionally will become party to legal
proceedings, which are generally related to contract disputes and employment
law.  As at December 31, 2007, the final results of currently ongoing
legal proceedings, while not immediately determinable, are not expected to have
a material effect on financial results.
  13.10
              Prior period
      losses
  The
Company has recorded a net loss in 7 of the last 12 quarters.  These
losses have arisen primarily as a result of the strengthening Canadian dollar
and, to a lesser extent, market conditions.  Should the Canadian
dollar continue to strengthen, or should market conditions deteriorate to a
greater extent, the Company may, over time, need to rely to a greater extent on
its Facility and, if necessary, additional sources of funding.
  In
particular, the Company’s pulp operations face significant challenges with the
strong Canadian dollar and the cost and availability of fibre.  Based
on current projections the Company expects to operate its pulp facilities, but
deterioration in market conditions or unplanned major capital expenditures may
necessitate temporary or permanent curtailment.
  13.11
              Debt
  The
Company has a significant amount of debt, and its debt agreements contain
various restrictive and financial covenants.  The Company’s ability to
pay interest on and satisfy its debt obligations will depend on its future
operating performance and ability to obtain additional debt or equity financing
when necessary.  Prevailing economic conditions and financial,
business and other factors beyond the Company’s control may affect its ability
to make these payments.  In addition, the Company’s debt level may
limit its ability to obtain additional financing and increase its vulnerability
to interest rate fluctuations. Should the challenging market conditions
continue, the Company may, over time, have to rely to a greater extent on its
Facility and, if necessary, additional sources of funding.
  13.12
              Environmental
      matters
  The
Company’s operations are subject to a wide range of general and
industry-specific environmental laws and regulations related to waste
management.  The costs of compliance with such laws and regulations can be
significant.  The Company could also incur significant costs, such as civil
or criminal fines, sanctions and enforcement actions (including orders requiring
remedial actions) and third party claims for property damage and personal
injury, as a result of violations of, or liabilities under, environmental laws
and regulations.  The Company continually monitors its environmental
performance and believes that its facilities are operating in substantial
compliance with environmental laws and regulations.
  The
federal government has recently indicated its intent to regulate priority air
pollutants and greenhouse gases under the Clean Air Act.  The forest
products sector is named as one of the targeted sectors for regulation. 
The impact and associated cost of any such regulation is currently unknown,
although it is anticipated that the government will consult with industry before
finalizing any regulations.
  The
province of British Columbia is a signatory to the Western Climate Initiative,
an organization of nine western provinces and states, whose mandate is to obtain
a 15% reduction in greenhouse gases among member entities by 2020.  In
addition, the British Columbia government has announced a goal of reducing the
provincial inventory of greenhouse gases by 33% by 2020.  These
organizations are in the early stages of developing policies to achieve their
goals.  It is too early to determine what their policies will be, the
impact on the Company and whether the Company will have a deficit or surplus of
carbon credits under any relevant regulatory scheme.
  14.0
              SENSITIVITY
ANALYSIS
  The
Company’s earnings are sensitive to fluctuations in:
  Product
price
  The
Company’s products are commodity-based and cyclical in nature.  As a
result, earnings are sensitive to price changes, with the effect of price
changes on specialty paper grades and newsprint being the greatest.
  Foreign
exchange
  The
Company’s products are primarily sold in Canada, the United States, Asia and
Australasia, Latin America and Europe. The majority of sales are denominated in
foreign currencies, principally the U.S. dollar. As a result, the Company is
exposed to foreign currency risk on accounts receivable and future
sales.
  Energy
costs
  The
Company’s earnings could be significantly impacted by changes in prices and
terms of energy supply contracts, as the Company is a significant consumer of
electrical power, fossil fuels, and inputs whose pricing is highly correlated to
energy.
  Fibre
  The
Company’s supply of fibre is subject to market influences and has some degree of
variability.  Fibre supply includes wood chips, logs, sawdust and old
newspapers (“ONP”).
  The
Company’s annual EBITDA, net earnings and earnings per share are estimated to be
impacted by changes in product prices, foreign exchange and input costs as
follows:
  (In
      millions of dollars, except per-share amounts)
                
                EBITDA5
                
                
                Net
      earnings1
                
                
                Earnings
                  per
      shareProduct
      prices2A
      US$10 per tonne change in the sales price of:Specialty paper
                
                $
                10.9
                
                
                $
                7.2
                
                
                $
                0.03Newsprint
                
                
                6.1
                
                
                
                4.0
                
                
                
                0.02Pulp
                
                
                5.0
                
                
                
                3.3
                
                
                
                0.02Foreign
      exchange3A
      US$0.01 change in the U.S. dollar relative to the Canadian
      dollar
                
                $
                10.8
                
                
                $
                6.8
                
                
                $
                0.03Energy
      cost sensitivity4A
      5% change in the price of:Natural gas and oil – direct
      purchases
                
                $
                2.9
                
                
                $
                1.9
                
                
                $
                0.01Electricity – direct
      purchases
                
                
                7.5
                
                
                
                4.9
                
                
                
                0.02Fibre
      sensitivity4A
      5% change in the price of:Wood chips and
      sawdust
                
                $
                16.3
                
                
                $
                10.8
                
                
                $
                0.05ONP
                
                
                1.4
                
                
                
                0.9
                
                
                Less
      than $0.01
  1   Based
on an expected tax rate of 34%.
 2   Based
on full 2007 capacities.
 3   Based
on a movement from US$1.01 to US$1.02, and excludes the Company’s hedging
program and the impact of the Company’s translation of U.S.-dollar-denominated
debt.
 4   Based
on 2007 consumption levels.
 5
              EBITDA is a non-GAAP measure.  Refer to Section
      9, “Non-GAAP Measures” section for further
      details.
  15.0
              OUTLOOK
  2008 is
likely to be impacted by a number of significant factors.  A slowing
U.S. economy and the possibility of a U.S. recession will result in challenging
market conditions for our paper products in North America, although supply
factors will also play a key role.  Challenging U.S. lumber markets
are likely to continue to impact the level of sawmill activity with a
corresponding impact on fibre availability and cost for pulp and paper
producers.
  Fibre
costs and supply
  Weak log
markets and a lack of road development due to the USW strike have contributed to
a slower start-up of coastal logging operations in 2008.  U.S. lumber
market fundamentals are expected to remain weak in 2008 as the housing market
continues to decline.  Lumber prices continued to deteriorate in early 2008
and the amount of sawmill curtailment in B.C. and across North America is
expected to increase.  The Company’s Elk Falls E1 paper machine is
currently curtailed, equivalent to 38,200 tonnes of newsprint production in Q1,
as a result of the current shortage of virgin fibre.  Based on the level of
sawmill curtailment going forward, further curtailment of the Company’s
operations could be required.
  On
February 7, 2008, TimberWest announced the permanent closure of its Campbell
River sawmill, to be effective from May 9, 2008.  The Company’s Elk Falls
pulp and paper mill is adjacent to this sawmill and receives all the chips,
sawdust and hog fuel that it produces.   As an alternative, TimberWest has
agreed to supply logs to the Company to replace a portion of the lost chip
supply that will occur once the sawmill is shut.  However, these logs are
unlikely to be converted into chips until lumber market conditions improve and
sawmill activity increases.  Unless a cost effective replacement for the
TimberWest fibre supply can be obtained (which the Company does not believe is
likely in the short term), the Company expects to lose the equivalent of
approximately 60,000 tonnes of paper production or 35,000 tonnes of pulp
production (depending on the allocation of remaining fibre supplies) in the
second half of 2008 as a result of this closure.
  Demand
and pricing
  The
Company expects price increases for most paper grades, despite flat demand for
these grades, due to recent capacity closures and relatively low paper
inventory.  Fibre supply challenges are also expected to contribute to
upward price pressure.  Demand for NBSK pulp is expected to remain
steady during the first half of 2008, with the expectation that benchmark prices
will increase modestly in early 2008 and potentially soften in the latter half
of the year due to increased capacity in the market.
  In
addition, net European paper exports to North America are expected to be lower
in 2008 due to the strong Euro and reduced European paper capacity compared to
previous years.
  Labour
negotiations
  Approximately
three quarters of the Company’s pulp and paper mill employees are members of
various local Unions.  Collective agreements with the CEP and PPWC
unions expire in April 2008.  Negotiations with these unions are
ongoing and currently the CEP Local 592 maintenance workers and Local 686
paperworkers in the Company’s Port Alberni mill have voted to accept a 5-year
tentative agreement subject to the re-start of A4. At this time, the Company is
not anticipating a work stoppage will result from 2008 labour
negotiations.
  CDN/US$
exchange rates
  Although
the Canadian dollar has weakened slightly in early 2008, it is expected to
remain strong due to a relatively strong labour market, strong global commodity
markets, high energy prices and lower U.S. interest rates due to a weaker U.S.
economy.
  
 
 
 Capital
spending
  The
Company’s program of high return capital projects was largely completed in 2007
and capital spending is expected to decline closer to basic maintenance levels
of approximately $35 million in 2008.
  Acquisition
in 2008
  On
February 11, 2008, the Company announced that it has entered into a definitive
agreement with a subsidiary of AbitibiBowater to acquire its Snowflake Arizona
recycled newsprint mill for cash consideration of US$161 million.  The
purchase price excludes trade receivables of approximately US$19 million that
are being retained by AbitibiBowater.  The acquisition will be financed
through a combination of the Company’s revolving credit facilities and a
proposed $125 million rights offering.  The acquisition will increase the
Company’s total newsprint production capacity to approximately 980,000 metric
tonnes.
 
  16.0
              DISCLOSURECONTROLS AND INTERNAL CONTROL OVER FINANCIAL
      REPORTING
  The
Company conducted an evaluation under the supervision and with the participation
of the Company’s management, including the chief executive officer and chief
financial officer, as of December 31, 2007, of the effectiveness of the design
and operation of the Company’s disclosure controls and procedures.  Based
on this evaluation, the Company’s chief executive officer and chief financial
officer concluded that such disclosure controls and procedures, as defined in
Canada by Multilateral Instrument 52-109, Certification of Disclosure in
Issuers’ Annual and Interim filings, and in Rules13a-15(e) and 15d-15(e)
promulgated under the United States Securities Exchange Act of 1934, as amended
(“the U.S. Exchange Act”), are effective to ensure that information required to
be disclosed by the Company in reports it files or submits under applicable
Canadian and U.S. securities laws is (a) recorded, processed, summarized and
reported within the time periods specified in the rules and forms of the
Canadian and U.S. securities regulatory authorities and (b) accumulated and
communicated to the Company’s management including the Company’s chief executive
officer and chief financial officer, or persons performing similar functions, as
appropriate, to allow timely decisions regarding required
disclosure.  It should be noted that while the Company’s disclosure
controls and procedures are designed to provide a reasonable level of assurance
of achieving their objectives, the Company’s chief executive officer and chief
financial officer do not expect that the Company’s disclosure controls and
procedures or internal control over financial reporting will prevent all errors
and fraud. A control system, no matter how well conceived or operated, can
provide only reasonable, not absolute, assurance that the objectives of the
control system are met.
  There
have been no changes in the Company’s internal control over financial reporting
that occurred during the period ended December 31, 2007, that have materially
affected, or are reasonably likely to materially affect, the Company’s internal
control over financial reporting.
  Section
404 of the United States Sarbanes-Oxley Act,
“Management Assessment of Internal Controls” (“Section 404”), continues to
require that management (a) have the responsibility for establishing and
maintaining an adequate internal control structure and procedure for financial
reporting, and (b) assess and report on the effectiveness of internal control
over financial reporting annually.  As of December 31, 2007,
management has assessed the effectiveness of the Company’s internal control over
financial reporting.  Based on this assessment, management has
determined the Company’s internal control over financial reporting was effective
as of December 31, 2007, and issued Management’s Report on Financial Statements
and Assessment of Internal Control over Financial Statements dated February 5,
2008 to that effect.
  The
Company’s Audit Committee, as part of its oversight role, has reviewed and
recommended the approval of this MD&A to the board of
directors.  The board of directors has read and approved this
MD&A.  Through discussions with management, the board of directors
and the Audit Committee have satisfied themselves that management has
implemented the necessary disclosure controls.
  17.0
              OUTSTANDING SHARE
DATA
  At
February 13, 2008, the Company had 214,684,129 common shares issued and
outstanding.
  Additional
information about the Company including its most recent Annual
Information Form is available on the Company’s website at www.catalystpaper.com,
or the Canadian Securities Administrator’s electronic filing website at www.sedar.com.