EXHIBIT 2



MANAGEMENTS RESPONSIBILITY

The management of Norske Skog Canada Limited is responsible for the preparation, integrity and fair presentation of the accompanying consolidated financial statements and other information contained in this Annual Report.  The consolidated financial statements and related notes were prepared in accordance with accounting principles generally accepted in Canada and reflect managements best judgments and estimates.  Financial information provided elsewhere in this Annual Report is consistent with that in the consolidated financial statements.

Management maintains a system of internal controls over financial reporting which encompasses policies, procedures and controls to provide reasonable assurance that assets are safeguarded against loss or unauthorized use, transactions are executed and recorded in accordance with managements authorization, and financial records are accurate and reliable.

The Board of Directors is responsible for satisfying itself that management fulfills its responsibilities for financial reporting and internal control.  The Audit Committee, which is comprised of six non-management members of the Board of Directors, provides oversight to the financial reporting process.  The Audit Committee meets periodically with management, the internal auditors and the external auditors to review the consolidated financial statements, the adequacy of financial reporting, accounting systems and controls and internal and external auditing functions.

The consolidated financial statements have been reviewed by the Audit Committee, which has recommended their approval by the Board of Directors.  These consolidated financial statements have been audited by KPMG LLP, the external auditors, whose report follows.





Russell J. Horner
President and
Chief Financial Officer
      Ralph Leverton
Vice-President, Finance
and
Chief Executive Officer






January 29, 2004





AUDITORS REPORT TO THE SHAREHOLDERS

We have audited the consolidated balance sheets of Norske Skog Canada Limited as at December 31, 2003 and 2002 and the consolidated statements of earnings, retained earnings and cash flows for the years then ended.  These financial statements are the responsibility of the Companys management.  Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with Canadian generally accepted auditing standards.  Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.

In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the Company as at December 31, 2003 and 2002 and the results of its operations and its cash flows for the years then ended in accordance with Canadian generally accepted accounting principles.





Chartered Accountants

Vancouver, Canada

January 20, 2004

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CONSOLIDATED BALANCE SHEETS

(in millions of Canadian dollars)

As at December 3120032002ASSETS
Current assetsAccounts receivable$253.5$277.3Inventories (note 3)235.9242.7Prepaid expenses6.69.2496.0529.2Fixed assets (note 4)2,290.22,326.6Other assets (note 5)30.037.7$2,816.2$2,893.5LIABILITIES
Current liabilitiesAccounts payable and accrued liabilities (note 6)$244.2$288.8Long-term debt (note 7)845.8886.2Other long-term obligations (note 8)272.7188.3Future income taxes (note 9)363.3397.0Deferred credits (note 10)21.08.51,747.01,768.8SHAREHOLDERS EQUITYShare capital (note 11)913.6884.6Retained earnings155.6240.11,069.21,124.7$2,816.2$2,893.5


Commitments, Guarantees and Indemnities (notes 18 and 19)

Contingency (note 20)

See accompanying Notes to Consolidated Financial Statements.





APPROVED BY THE BOARD:



_________________________________

Russell J. Horner

Director













William P. Rosenfeld

Director

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CONSOLIDATED STATEMENTS OF EARNINGS

(in millions of Canadian dollars, except where otherwise stated)



Years ended December 3120032002Gross sales$1,820.5$1,704.0Distribution costs229.3221.7Net sales1,591.21,482.3Operating expensesCost of sales1,458.21,360.4Selling, general and administrative54.765.3Depreciation and amortization189.9178.51,702.81,604.2Operating earnings (loss)(111.6)(121.9)Foreign exchange gain on translation of long-term debt58.212.3Write-down of fixed assets (note 4)(14.2)─Other expense, net (note 13)(3.9)(13.3)Interest expense, net(75.0)(76.2)Earnings (loss) before income taxes(146.5)(199.1)Income tax recovery (note 9)(62.0)(75.8)Net earnings (loss)$(84.5)$(123.3)Basic and diluted earnings (loss) per share (note 12) (in dollars)$(0.41)$(0.64)








CONSOLIDATED STATEMENTS OF RETAINED EARNINGS

(in millions of Canadian dollars)

Years ended December 3120032002Balance, beginning of year$240.1$363.4Net earnings (loss)(84.5)(123.3)Balance, end of year$155.6$240.1








See accompanying Notes to Consolidated Financial Statements.





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CONSOLIDATED STATEMENTS OF CASH FLOWS

(in millions of Canadian dollars)

Years ended December 3120032002Cash provided by (used for):OperationsNet earnings (loss)$(84.5)$(123.3)Items not requiring (providing) cashDepreciation and amortization189.9178.5Future income taxes(67.9)(91.5)Increase in other long-term obligations17.519.8Foreign exchange gain on translation of long-term debt(58.2)(12.3)Write-down of fixed assets (note 4)14.2Write-off of deferred financing costs15.8Other6.2(3.3)17.2(16.3)Changes in non-cash working capitalAccounts receivable40.430.4Inventories10.2(13.0)Prepaid expenses2.6(4.9)Accounts payable and accrued liabilities(47.9)9.05.321.5Cash provided (used) by operations22.55.2InvestingAcquisition of paper recycling business (note 2)(32.1)Additions to fixed assets(81.4)(82.2)Proceeds from sale of marketable securities39.2Proceeds from sale of fixed assets0.41.5Proceeds from termination of interest rate swaps (note 8)15.93.4Decrease (increase) in other assets1.1(4.4)(96.1)(42.5)FinancingIssue of common shares, net of share issue costs (note 11)(0.1)208.1Increase (decrease) in revolving loan (note 7)(105.7)119.1Issue of long-term debt (note 7)212.7Repayment of long-term debt(386.7)Deferred financing costs(5.6)Decrease in other long-term obligations(27.7)(8.0)73.6(67.5)Cash, decrease during year (1)(104.8)Cash, beginning of year (1)104.8Cash, end of year (1)$$Supplemental information:Income taxes paid$7.1$12.8Net interest paid80.278.3Common shares issued for acquisition of paper recycling
business (note 2)29.1


1.

Cash includes cash and short-term investments.



See accompanying Notes to Consolidated Financial Statements.



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CONSOLIDATED BUSINESS SEGMENTS

(in millions of Canadian dollars)

Year ended December 31, 2003SpecialtiesNewsprintPulpCorporate
AdjustmentsConsolidatedNet sales to external customers$880.1$463.0$248.1$$1,591.2Inter-segment sales171.5(171.5)Operating earnings (loss)(32.5)(56.6)(22.5)(111.6)Depreciation and amortization98.561.729.7189.9Total assets1,424.4775.0591.625.22,816.2Additions to fixed assets28.125.627.781.4Year ended December 31, 2002SpecialtiesNewsprintPulpCorporate
AdjustmentsConsolidatedNet sales to external customers$835.0$440.6$206.7$$1,482.3Inter-segment sales193.1(193.1)Operating earnings (loss)(1.3)(86.0)(34.6)(121.9)Depreciation and amortization91.263.423.9178.5Total assets1,380.0851.8629.132.62,893.5Additions to fixed assets43.919.518.882.2








See accompanying Note 17 to Consolidated Financial Statements.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2003 AND 2002

1.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

These consolidated financial statements of Norske Skog Canada Limited (the Company or NorskeCanada) are expressed in millions of Canadian dollars and are prepared in accordance with Canadian generally accepted accounting principles (Canadian GAAP).  These financial statements differ in certain respects from those prepared in accordance with United States generally accepted accounting principles (U.S. GAAP).  These measurement differences are described in note 21, Differences between United States and Canadian generally accepted accounting principles.

(a)

Basis of Presentation

The consolidated financial statements include the accounts of the Company and from their respective dates of acquisition of control or formation, its wholly-owned subsidiaries and partnership.  The Companys 50.1% proportionate share of Powell River Energy Inc. (PREI), a joint venture between Great Lakes Hydro Income Fund and the Company, is accounted for using the proportionate consolidation method.  All inter-company transactions and amounts have been eliminated on consolidation.

(b)

Use of Estimates

The preparation of financial statements in conformity with Canadian generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. Actual amounts could differ from those estimates.

(c)

Inventories

Inventories, other than supplies which are valued at cost, are valued at the lower of average cost and net realizable value.

(d)

Fixed Assets

Fixed assets are recorded at cost.

Buildings, machinery and equipment are depreciated on a straight-line basis at rates that reflect estimates of the economic lives of the assets. The rates for major classes of assets are:

Buildings

2.5 - 5.0%

Pulp and paper machinery and equipment

5.0%

During periods of major production interruption, an obsolescence amount of 10% of normal depreciation is charged on manufacturing equipment.

No depreciation is charged on capital projects during the period of construction. Start-up costs incurred in achieving normal operating capacity on major capital projects are deferred and amortized over a five-year period.

(e)

Deferred Financing Costs

Deferred financing costs included in other assets on the consolidated balance sheet represent the costs of negotiating and securing the Companys long-term debt.  Related amortization is included in interest expense on a straight-line basis over the term of the debt.

(a)

Share Issue Costs

Direct costs of issuing shares, net of income tax recoveries thereon, are applied to reduce the value of consideration assigned to such shares.

(g)

Revenue Recognition

The Company recognizes revenues upon shipment when the significant risks and rewards of ownership are transferred to the customer.  Title of the products is typically transferred to the customers at the time of shipment and payment is based on agreed prices and credit terms contained on sales invoices.  Customers have no contractual right of return, except in the event of a quality issue.  Distribution costs are classified as a reduction to gross revenue in determining net sales.



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(h)

Foreign Currencies

The majority of the Companys sales are denominated in foreign currencies, principally the U.S. dollar. Revenue and expense items denominated in foreign currencies are translated at the rates of exchange prevailing during the period. Monetary assets and liabilities of the Companys operations denominated in foreign currencies are translated at the period-end exchange rates.  Non-monetary assets and liabilities are translated at rates of exchange in effect when the assets are acquired or obligations incurred.  Foreign exchange gains and losses are reflected in net earnings for the period.

(i)

Derivative Financial Instruments

The Company uses derivative financial instruments for hedging purposes in the management of foreign currency, interest rate and commodity price exposures.  The Companys policy is not to use derivatives for trading or speculative purposes.  Risk management strategies and relationships are assessed on a regular, on-going basis to ensure the derivatives are achieving the intended hedging objectives.



Foreign exchange exposure to foreign currency receipts and related receivables, primarily in U.S. currency, is managed through the use of foreign exchange forward contracts and options.  Resulting foreign exchange translation gains and losses are recognized when realized on maturity in Net sales.



Price risk associated with the sale of products or purchase of certain inputs, primarily oil and gas is managed from time to time, through the use of commodity swaps.  Resulting realized gains and losses are recognized when realized on maturity in Net sales or Cost of sales.



Foreign currency exposure on long-term debt denominated in U.S. currency is managed through the use of forward contracts and options.  Resulting gains and losses are accrued under other assets or liabilities on the balance sheet and recognized in Foreign exchange gain(loss) on translation of  long-term debt, offsetting the respective translation gains and losses recognized on the underlying foreign currency long-term debt.  The forward premium or discount on forward foreign exchange contracts used to hedge foreign currency long-term debt is initially deferred and amortized prospectively as an adjustment to interest expense over the term of the forward contract.



Exposure to interest rates on long-term debt is managed through the use of interest swaps.  These swap agreements require the periodic exchange of payments without the exchange of the notional principal amount on which the payments are based.  Settlement amounts under interest swap agreements are recognized as adjustments to interest expense.

(j)

Income Taxes

Income taxes are accounted for using the liability method. Future income tax assets and liabilities are based on temporary differences (differences between the accounting basis and the tax basis of the assets and liabilities) and non-capital loss carry-forwards and are measured using the enacted or substantively enacted tax rates and laws expected to apply when these differences reverse.  Future tax benefits, including non-capital loss carry-forwards, are recognized to the extent that realization of such benefits is considered more likely than not. The effect on future tax assets and liabilities of a change in tax rates is recognized in earnings in the period that substantive enactment or enactment occurs.

(a)

Deferred Credits

Deferred credits represent the excess of amounts assigned to future income tax assets for tax losses acquired in other than business combinations over the consideration paid.  Deferred credits are amortized to income tax expense in proportion to the net reduction in the future income tax asset that gave rise to the deferred credit.

(l)

Environmental Costs

Environmental expenditures are expensed or capitalized depending upon their future economic benefit.  Expenditures that prevent future environmental contamination are capitalized as fixed assets.  Expenditures that relate to an existing condition caused by past operations are expensed.  Liabilities are recorded on an undiscounted basis when rehabilitation efforts are likely to occur and the costs can be reasonably estimated.



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(m)

Employee Future Benefits

The estimated cost for pensions and other post-retirement benefits provided to employees by the Company is accrued using actuarial techniques and assumptions during the employees active years of service.

(n)

Earnings Per Share

Basic earnings (loss) per share are computed by dividing net earnings (loss) by the weighted average shares outstanding during the reporting period.  Diluted earnings (loss) per share are computed using the treasury stock method.

(o)

Marketable Securities

Marketable securities are valued at the lower of cost or quoted market value.

(p)

Stock-based Compensation Plans

The Company accounts for stock-based payments to non-employees, and employee awards that are direct awards of stock, call for settlement in cash or other assets, or are stock appreciation rights that call for net settlement by the issuance of equity instruments, granted on or after January 1, 2002, using the fair-value method.  No compensation cost is recorded for all other stock-based employee compensation awards.  Consideration paid by employees on the exercise of stock options is recorded as share capital and contributed surplus.  The Company discloses the pro forma effect of accounting for these awards under the fair value method (see note 11(c)).

(q)

Comparative Figures

Certain comparative figures have been reclassified to conform with the presentation adopted for the current year.

2.

ACQUISITION OF PAPER RECYCLING BUSINESS

On December 1, 2003, the Company completed the acquisition of a paper recycling business from Newstech Recycling Partnership (the Acquisition) for a total purchase price of $61.1 million, including a working capital adjustment payment of $2.5 million at closing.

The Companys consideration comprised of $31.5 million in cash, $29.0 million in equity and $0.6 million in transaction costs.  The value of the 8,693,988 common shares issued was determined by the weighted average trading price of the Companys common shares over the two-day period before December 1, 2003, which was the date the terms of the acquisition were agreed to and announced.

The Acquisition has been accounted for using the purchase method of accounting and the results of the operations of the business have been consolidated from the date of acquisition.  The following amounts have been assigned to the assets and liabilities acquired, based on their fair values as at December 1, 2003.

Assets acquired:Net working capital$4.5Fixed assets84.388.8Liabilities assumed:Future income taxes27.7Fair-value of net assets acquired$61.1




Under the terms of the Acquisition, the Company will lease land and buildings housing the operations for an initial term of 20 years, with a 10-year renewal option.



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3.

INVENTORIES

20032002Specialties$47.4$56.7Newsprint28.022.8Pulp16.016.8Wood chips, pulp logs, and other raw materials50.258.8Operating and maintenance supplies94.387.6$235.9$242.7


4.

FIXED ASSETS

2003CostAccumulated
DepreciationNet Book
ValueProperty, plant and equipmentSpecialties and newsprint$2,804.1$978.2$1,825.9Pulp925.1460.8464.3$3,729.2$1,439.0$2,290.2




2002CostAccumulated
DepreciationNet Book
ValueProperty, plant and equipmentSpecialties and newsprint$2,659.9$824.6$1,835.3Pulp935.6444.3491.3$3,595.5$1,268.9$2,326.6




In December 2003, the Company recorded a write-down of $14.2 million relating to the permanent closure of a portion of its pulp producing capacity at its Elk Falls mill in early 2004.  Related severance costs of $1.9 million have been recorded in “Cost of sales”.

5.

OTHER ASSETS

20032002Deferred financing costs$25.2$25.8Forward foreign currency contracts hedging long-term debt─6.7Deferred charges and other4.85.2$30.0$37.7


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6.

ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

20032002Trade accounts payable$127.7$174.1Accrued payroll and related liabilities71.868.7Other44.746.0$244.2$288.8


7.

LONG-TERM DEBT

The Companys long-term debt, all of which matures beyond one year, is as follows:

20032002RecourseSenior notes, 8.625% due June 2011 (US$400.0 million;
2002 - US$250.0 million)$521.2$394.9Senior notes, 10% due March 2009 (US$200.0 million)274.5335.0795.7729.9Revolving operating loan of up to $350.0 million due July 2006 with interest based on CDN prime rates/U.S. base rates or LIBOR/BA rates, at the Companys option12.5118.7808.2848.6Non-recourse (PREI)First Mortgage Bonds, 6.387% due July 200937.637.6$845.8$886.2




On May 15, 2003, the Company issued an additional US$150.0 million 8.625% Senior Notes (Notes) due June 2011.  The Notes were issued at a premium amount of US$4.4 million to yield 8%.  Proceeds were used to repay the outstanding balance on the revolving operating loan and for general corporate purposes.

Substantially all of the assets of the Company are pledged as security under the revolving loan.  During the year ended December 31, 2003, the Company negotiated certain amendments to the revolving loan of $350.0 million, including an option to increase the borrowing base, and an agreement to extend the maturity for $335.0 million of the loan by one year, to July 2006.  The Company elected to change the borrowing base formula, which resulted in an increased availability under the revolving loan effective July 31, 2003.  Subsequent to December 31, 2003, the maturity for the remaining $15.0 million was also extended by one year, to July 2006.

The revolving loans availability is determined by a borrowing base, calculated on accounts receivable and inventory balances, and includes covenants to maintain the funded debt/capitalization ratio below 60%, secured debt/capitalization ratio below 30%, and shareholders equity above $779.3 million as at December 31, 2003.  At the end of the current year, the borrowing base on the $350.0 million revolving operating loan was $343.4 million.  After drawings of $12.5 million and outstanding letters of credit of $25.7 million, $305.2 million was available to the Company.  An interest coverage covenant is applicable in certain circumstances if the Company incurs secured debt other than under its revolving operating loan.  No such debt has been incurred.



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The indentures and agreements governing the Companys senior notes and revolving operating loan contain customary restrictive covenants, including restrictions on the incurrence of additional indebtedness, certain payments including dividends and investments in other persons, the creation of liens, sale and leaseback transactions, certain amalgamations, mergers, consolidations and the use of proceeds arising from certain sales of assets and certain transactions with affiliates.  At December 31, 2003, the Company remained in compliance with the covenants under both its credit facilities and bond indentures.  However, the Companys Consolidated Fixed Charge Ratio of the bond indentures was below the 2.0:1 threshold, which, while not constituting a default, does prohibit the payment of dividends and limits the amount of additional debt that can be incurred outside of the existing credit facilities.

Scheduled long-term debt repayments

Recourse
DebtNon-recourse
Debt2004$$2005200612.520072008Thereafter795.737.6$808.2$37.6


Fair value of long-term debt

The following estimated fair value of the long-term debt at December 31, 2003 and 2002 has been determined based on managements best estimate of the fair value to refinance debt with similar terms at the respective year-end dates:

20032002Recourse$845.4$875.4Non-recourse39.238.7$884.6$914.1


8.

OTHER LONG-TERM OBLIGATIONS

20032002Post-retirement benefits (note 14)$125.7$112.7Pension plans (note 14)57.851.1Forward foreign currency contracts hedging long-term debt55.4─Deferred gain on termination of interest rate swaps10.2─Environmental, remedial, and other23.624.5$272.7$188.3


Fixed-to-floating interest rate swaps on US$105.0 million were terminated during the current year for proceeds of $15.9 million.  The proceeds are being amortized as a reduction of interest expense based on the U.S. swap curve at the time of termination.



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9.

INCOME TAXES

The tax effects of temporary differences that give rise to significant future tax liabilities (assets) are as follows:

20032002Future tax liabilityFixed assets$557.6$512.0Other49.039.4606.6551.4Future tax assetsNon-capital loss carry-forwards(154.3)(56.9)Employee future benefits(65.5)(60.9)Other(34.5)(47.7)(254.3)(165.5)Valuation allowance11.011.1(243.3)(154.4)Net future income tax liability$363.3$397.0


The components of income tax recovery are as follows:

20032002Current$5.9$15.7Future(67.9)(91.5)$(62.0)$(75.8)


The reconciliation of income taxes calculated at the statutory rate to the actual income tax provision is as follows:

20032002Income tax recovery at Canadian statutory rates$(52.1)(35.5)%$(70.7)(35.5)%Increase (decrease) in income taxes for:Non-taxable income and expenses(8.9)(6.1)(1.9)(1.0)Difference in foreign tax rate(2.4)(1.6)Change in the future income tax estimate for prior years(9.7)(4.9)Release of deferred credits(5.3)(3.6)Large corporations tax5.23.55.72.9Other1.51.00.80.4Income tax recovery$(62.0)(42.3)%$(75.8)(38.1)%


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10.

DEFERRED CREDITS

20032002Beginning of year$8.5$8.5Net price adjustment related to acquired tax losses17.8Adjustment related to release of deferred credits(5.3)End of year$21.0$8.5




In prior years, the Company acquired from wholly owned subsidiaries of Fletcher Challenge Limited (FCL), the Companys majority shareholder up to July 28, 2000, companies with tax losses carried forward.  The purchase price of these companies is subject to adjustment under certain conditions.  In 2003, the Company recorded a downward adjustment of $17.8 million (net of taxes of $1.5 million on the interest component) to the purchase price (2002 - nil).  This adjustment has been recorded as an increase to deferred credits.

11.

SHARE CAPITAL

(a)

Authorized, Issued and Outstanding

2003
   
   
   2002Shares
   
   $
  
   Shares
  $Authorized:Common shares
   
   Unlimited
   
   
   UnlimitedPreferred shares
   
   100,000,000
   
   
   100,000,000Issued and outstanding:Common shares
   
   214,604,120
   
   913.6
   205,910,132
   
   884.6Continuity of common shares:Beginning of year
   
   205,910,132
   
   884.6
   174,810,132
   
   673.1Issued for Acquisition (note 2)
   
   8,693,988
   
   29.1
   
   
   Issued for cash
   
   
   
   
   31,100,000
   
   217.7Share issue costs (net of income taxrecovery of $0.1 million;2002-$3.4 million)
   
   
   
   (0.1)
   
   
   (6.2)End of year
   
   214,604,120
   
   913.6
   205,910,132
   
   884.6


(b)

Stock Option Plans

The Company has an employee share option plan for its key officers and management.  Granted options have a term of five years and are exercisable as to 1/3 on and after the first anniversary date, as to 2/3 on and after the second anniversary date and as to all on and after the third anniversary date, unless the market price of the common shares exceeds a specified acceleration price, at which time all of the options are exercisable.  The stock option plan provides for the issuance of up to a maximum of 5.0 million common shares.  Details of the Companys share option plan for the years ended December 31, 2003 and 2002 are as follows:



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20032002Number of Common SharesWeighted
Average
Exercise PriceNumber of Common 
SharesWeighted
Average
Exercise PriceBeginning of year4,722,000$6.081,330,000$6.60Granted100,0005.813,412,0005.89ExercisedExpired or cancelled(326,500)6.20(20,000)7.13End of year4,495,500$6.074,722,000$6.08


The following table summarizes information about stock options outstanding at December 31, 2003:

Options OutstandingOptions ExercisableExercise PricesNumber Outstanding at Dec. 31, 2003Weighted Average Remaining Option Life (yrs)Weighted Average Exercise PriceNumber Exercisable at Dec. 31, 2003Weighted Average Exercise PriceAccelerated Price$6.601,221,5002.7$6.60814,334$6.60$9.47$7.131,051,0003.1$7.13350,333$7.13$10.00$5.252,123,0003.8$5.25707,667$5.25$7.54$5.81100,0004.1$5.81$$8.354,495,5003.4$6.071,872,334$6.19$8.66


(c)

Stock-based Compensation

The Company applies settlement accounting for recording share options granted to directors, officers, and employees.  If the fair-value method had been used to determine compensation cost for share options granted to directors, officers, and employees, the Companys net loss and loss per share would have been as follows:

20032002Net earnings (loss):As reported$(84.5)$(123.3)Pro forma(86.5)(123.9)Net earnings (loss) per common share:As reported(0.41)(0.64)Pro forma(0.42)(0.64)


The fair value of share options was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:

20032002Risk-free interest rate4.9%5.0%Annual dividends per shareNilNilExpected stock price volatility27.3%27.3%Expected option life (in years)4.04.0Average fair value of options granted$$1.73$$1.75


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12.

EARNINGS PER SHARE

The following weighted average number of shares were used for computation of earnings per share:

20032002Net earnings (loss) reported$(84.5)$(123.3)Weighted average shares used in computation of basic earnings per share (in millions)206.6193.4Weighted average shares from assumed conversion of dilutive options (in millions)Weighted average shares used in computation of diluted earnings per share (in millions)206.6193.4Basic and diluted earnings (loss) per share (in dollars)$(0.41)$(0.64)


13.

OTHER EXPENSE, NET

20032002Write-off of deferred financing costs$$15.8Gain on sale of marketable securities(4.8)Other3.92.3$3.9$13.3


14.

EMPLOYEE FUTURE BENEFITS

The Company maintains pension benefit plans, which include defined benefit and defined contribution segments, that are available to all salaried employees and to hourly employees not covered by union pension plans. Employees hired subsequent to January 1, 1994 are enrolled in the defined contribution segment.

The defined benefit segment provides a pension based on years of service and earnings. For the defined contribution segment, the Companys contributions are based on a percentage of an employees earnings with the Companys funding obligations being satisfied upon crediting contributions to an employees account.

The Company provides other benefit plans consisting of group health care and life insurance benefits to eligible retired employees and their dependents.  Assumed health care trend rates have a significant effect on the amounts reported for the post-retirement medical plans.

Information concerning the Companys defined benefit plans, in aggregate, is as follows:

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Pension Benefit PlansOther Benefit Plans2003200220032002Plan assetsFair value at beginning of year$224.0$253.8$$Actual return on plan assets11.1(11.2)Service cost of defined contribution segment(4.5)(4.2)Employee contributions0.50.6Company contributions9.79.94.93.5Other0.30.5Benefit payments(25.1)(25.4)(4.9)(3.5)Fair value of plan assets at end of year216.0224.0Accrued benefit obligationBeginning of year320.4300.2160.1115.3Service cost of defined benefit segment5.64.44.23.3Interest cost on accrued benefit obligation20.120.311.09.1Employee contributions0.50.6Benefit payments(25.1)(25.4)(4.6)(3.5)Powell River and Alberni downsizing19.4Changes to the Provincial Medical Services Plan36.2Actuarial loss (gain) and other adjustments7.00.912.9(0.3)Accrued benefit obligation at end of year328.5320.4183.6160.1Plan deficit112.596.4183.6160.1Unrecognized amountsTransitional balance0.31.1Past service costs(0.5)(0.9)2.52.8Actuarial gain (loss)(54.5)(45.5)(60.4)(50.2)Employee future benefits liability$57.8$51.1$125.7$112.7




The Companys net expense for Company-maintained benefit plans is:

Pension Benefit Plans20032002Current service cost$8.7$8.6Interest cost20.420.6Expected return on plan assets(16.5)(20.1)Amortization of unrecognized amounts2.10.3$14.7$9.4




Other Benefit Plans20032002Current service cost$4.3$3.4Interest cost11.29.3Amortization of unrecognized amounts2.71.7$18.2$14.4


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Actuarial assumptions used in accounting for the Company-maintained benefit plans are:

20032002Discount rate6.25%6.50%Expected return on plan assets7.50%7.50%Compensation increases3.00%3.00%Health care trend rate  medical and dental5.00%5.00%Health care trend rate  extended health (decrease in 1% increments until 2012 and thereafter to 5%; 2002 - decrease in 1% increments until 2006 and thereafter to 5%)14.00%9.00%


Unionized employees of the Company and its subsidiaries are members of industry-wide benefit plans to which the Company contributes a predetermined amount per hour worked by an employee. The pension expense for these plans is equal to the Companys contribution of $18.4 million in the year (year ended December 31, 2002 - $16.2 million).

The asset allocation for the Companys defined benefit pension plans, by asset category, were as follows:

Plan assets at year-end20032002Equity securities61.0%54.3%Fixed income securities39.045.7Total100.0%100.0%


15.

FINANCIAL INSTRUMENTS

(a)

Derivative Financial Instruments

The Company uses financial instruments to reduce its exposure to foreign currency and price risk associated with its revenues, energy costs and long-term debt.  The Company also uses interest rate swaps to reduce its exposure to long-term fixed interest rates associated with its senior notes.

(b)

Revenue and Cost Hedging Instruments

Foreign currency options and forward contracts outstanding to sell U.S. dollars were as follows:

OptionsFloorCeilingForward ContractsTermUS$MillionsAverage RateUS$MillionsAverage RateUS$MillionsAverage
RateAs at December 31, 2003:0 to 12 months$3241.4477$1421.5756$561.576413 to 24 months1051.3647541.453991.5269As at December 31, 2002:0 to 12 months$2971.5595$2851.6095$1181.533013 to 24 months1331.56951271.6263381.6123






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At December 31, 2003, no commodity price hedging instruments were outstanding in respect of products sold.  The Company has oil swaps to purchase 377,000 barrels (bbls) at an average contract rate of US$23.37 per bbl, settling between January 2004 and March 2005 and natural gas swaps to purchase 1.6 million gigajoules (Gj) at an average contract rate of US$3.89 per Gj, settling between January 2004 and October 2004.

(c)

Long-term Debt Hedging Instruments

The Company has forward foreign exchange contracts to acquire U.S. dollars totalling US$264.1 million over a four-year period at rates averaging 1.5153.

(d)

Credit Risk

The Company is exposed to credit risk on accounts receivable from customers. Its customers are mainly in the newspaper publishing, commercial printing and paper manufacturing businesses.  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, credit insurance for a majority of its receivables, and bank letters of credit as required.

The Company is exposed to credit risk with counterparties to the Companys options and forward foreign currency contracts.  The Company limits the possibility of non-performance by dealing with major financial institutions.

(e)

Fair-value

Estimated fair-values of financial instruments, which differ from carrying values, are as follows:

As at December 31, 2003As at December 31, 2002Carrying
ValueFair 
ValueCarrying
ValueFair 
ValueForward contracts and options hedging future U.S. dollar receipts$15.3$74.1$─$(8.7)Commodity swaps hedging future oil and gas purchases─3.6──Forward contracts hedging long-term debt repayable in U.S. dollars(55.4)(50.0)6.712.7Fixed to floating interest rate swaps───16.9


The fair-value of options and forward foreign currency contracts is based on mid-market rates from financial institutions.



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16.

RELATED PARTY TRANSACTIONS

Related parties include Norske Skogindustrier ASA (Norske Skog), together with its subsidiaries and affiliates and Norske Skog North America LLC, a joint venture between Norske Skog and the Company.  Transactions or balances with these related parties, not otherwise disclosed in these financial statements, are as follows:

20032002Norske SkogSelling, general and administrative$0.1$0.2Accounts receivable19.3─Norske Skog North America LLCCommission expenses4.23.8Net loss0.10.1Investment (US$0.5 million)0.80.8Accounts payable0.20.3


The Company participated in Norske Skogs global property and liability insurance programs from January 1, 2001 to June 30, 2002.

Product sales to related parties are in accordance with normal trade practices.

In prior years, the Company acquired, from wholly-owned subsidiaries of FCL (now subsidiaries of Norske Skog), companies with tax losses carried forward.  The purchase price of these companies is subject to adjustment under certain conditions and $19.3 million was included in accounts receivable as at December 31, 2003 with respect to such adjustments.

The Company undertakes certain transactions with companies affiliated with directors of the Company.  These transactions are in the normal course of business and are on the same terms as those accorded to non-related parties.  During 2003, the Company paid aggregate fees of $0.1 million (2002 - $0.1 million) primarily for legal services to companies affiliated with directors of the Company.  The Company has charged the costs to selling, general and administrative expenses.

The Company has advanced interest-free loans to three officers of the Company.  As at December 31, 2003, the balance outstanding is $0.6 million (2002 - $0.7 million).

17.

SEGMENTED INFORMATION

The Company operates in three business segments:

Specialties  Manufacture and sale of groundwood specialty printing papers and kraft paper

Newsprint  Manufacture and sale of newsprint

Pulp  Manufacture and sale of softwood pulps

Effective January 1, 2003, the Company segregated its kraft paper activities (previously referred to as containerboard) from its pulp business segment and included it in its specialties business segment.  Segment information for prior periods has been restated to reflect these changes.

The segments are managed separately and all manufacturing facilities are located in Canada.

The accounting policies of the segments are the same as described in the Summary of Significant Accounting Policies (note 1). Segment performance is evaluated based on operating earnings (loss).  Inter-segment sales consist of slush pulp transfers at cost.

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2003Net Sales by Shipment DestinationSpecialtiesNewsprintPulpTotalCanada$94.6$73.7$2.0$170.3United States637.9264.7─902.6Asia and Australasia82.287.2140.1309.5Latin America60.737.41.099.1Europe and other4.7─105.0109.7$880.1$463.0$248.1$1,591.22002Net Sales by Shipment DestinationSpecialtiesNewsprintPulpTotalCanada$96.5$80.4$1.4$178.3United States618.9231.71.0851.6Asia and Australasia64.079.897.0240.8Latin America54.848.74.6108.1Europe and Other0.8─102.7103.5$$835.0$$440.6$$206.7$1,482.3


18.

COMMITMENTS

a)

Capital Commitments

In late 2002, the Company commenced work on an upgrade to its recovery boiler at its Elk Falls mill.  The total cost of this project is estimated at $45.1 million.  As at December 31, 2003, the Company had incurred costs of $23.2 million and had firm commitments of $19.9 million in connection with this project.

b)

Other

The Company is committed to make the following future minimum payments under various operating leases in each of the years ended December 31:

2004$9.620059.220069.020077.520087.4Subsequent years58.7$101.4


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19.

GUARANTEES AND INDEMNITIES

The Company has, over time, provided various indemnities with respect to tax, environment, and general representations and warranties on sales of portions of its business, acquisitions, and commodity contracts.  Significant existing indemnities are as follows:

a)

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 also provided a tax indemnity, which continues while the relevant tax years of the indemnified parties remain open to audit and a general indemnity, capped at $5 million, which expires in 2004.  The Company is unable to estimate its 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.

b)

In connection with dispositions of certain businesses in 1997, the Company provided tax indemnities, which survive while the relevant tax years of the indemnified parties remain open to audit.  The Company does not expect any significant claims with respect to these liabilities and has therefore not recorded any related liability.

c)

The Company has provided a guarantee capped at US$5.0 million in connection with the purchase and sale of natural gas for its manufacturing operations.  The guarantee is cancellable upon 20 business days notice.

d)

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 have been 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.

20.

CONTINGENCY

In the normal course of its business activities, the Company is subject to a number of claims and legal actions that may be made by customers, suppliers and others in respect of which either an adequate provision has been made or for which no material liability is expected.

21.

DIFFERENCES BETWEEN UNITED STATES AND CANADIAN GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

The Companys consolidated financial statements have been prepared in accordance with Canadian GAAP.  Significant differences to U.S. GAAP are set forth below:



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Earnings20032002Net earnings (loss) in accordance with Canadian GAAP$(84.5)$(123.3)U.S. dollar revenue hedges (a)67.524.6U.S. dollar long-term debt hedges (a)(0.6)15.6Fixed to floating interest swaps (a)(6.7)18.0Commodity swaps (a)3.6Income tax impact of above items(22.8)(19.6)Net earnings (loss) in accordance with U.S. GAAP(43.5)(84.7)Unrealized gain on securities held as available-for-sale, net of deferred income taxes (b)(4.4)Minimum pension liability adjustment, net of deferred income taxes of $1.7 million (2002 - $7.9 million) (c)(3.1)(14.1)Comprehensive income (loss) in accordance with U.S. GAAP$(46.6)$(103.2)Basic and diluted net earnings (loss) per share in accordance with U.S. GAAP (in dollars)$(0.21)$(0.44)Basic and diluted weighted average number of shares in accordance with U.S. GAAP (in millions)206.6193.4






20032002Balance sheet componentsCanadian GAAPU.S.
GAAPCanadian GAAPU.S.
GAAPOther assets$30.0$92.8$37.7$61.6Current liabilities244.2244.2288.8297.5Other long-term obligations272.7295.4188.3222.3Future income taxes363.3376.5397.0389.2Shareholders equity1,069.21,096.11,124.71,113.7


(a)

Financial Instruments

Under Canadian GAAP, the Company follows hedge accounting for derivative financial instruments, including foreign exchange forward contracts and options, interest rate swaps, and commodity swaps.  Under U.S. GAAP, the Company does not apply hedge accounting and records all derivatives on a marked to market basis at each reporting period.

(b)

Marketable Securities

Under Canadian GAAP, marketable securities are valued at the lower of cost and quoted market value.  Under U.S. GAAP, these securities are classified as available-for-sale and are carried at fair value.  Unrealized gains and losses, net of tax, are reported as comprehensive income.

(c)

Pensions

Under U.S. GAAP, the Company recognizes a minimum pension liability adjustment which represents the excess of the unfunded accumulated pension benefit obligation over the fair value of the plan assets.  There is no such requirement under Canadian
GAAP.

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(d)

Distribution Costs

Under Canadian GAAP, the Company includes distribution costs as a deduction in determining net sales in the statement of earnings.  Under U.S. GAAP, distribution costs are included as operating expenses.  As a result, net sales, cost of sales and operating expenses under U.S. GAAP would increase by $229.3 million for the year ended December 31, 2003 (2002 - $221.7 million).

(e)

Comprehensive Income

Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income, requires that a company classify items of other comprehensive income by their nature in a financial statement and display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of the balance sheet.

(f)

Investment in Joint Venture

The investment in PREI, a joint venture, is accounted for under the proportionate consolidation method for the purposes of Canadian GAAP.  Under U.S. GAAP, investments in joint ventures are accounted for under the equity method.  However, rules prescribed by the SEC permit the use of the proportionate consolidation method in the reconciliation to U.S. GAAP provided the joint venture is an operating entity and the significant financial operating policies are, by contractual arrangement, jointly controlled by all parties having an equity interest in the joint venture.  Accordingly, for purposes of this U.S. GAAP reconciliation, the Company has used the proportionate consolidation method and no GAAP difference arises.

Condensed joint venture financial information with respect to the Companys 50.1% interest in PREI which is proportionately consolidated, is as follows:

As at December 3120032002Balance sheetsCurrent assets$0.9$1.4Fixed assets57.257.1Other assets1.31.1$59.4$59.6Current liabilities$1.4$1.0Long-term liabilities74.474.6Deficit(16.4)(16.0)$59.4$59.6


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Years ended December 3120032002Statements of earningsNet sales$9.5$9.5Cost of sales2.22.7Depreciation and amortization1.60.7Operating earnings (loss)5.76.1Other expense, net0.6Interest expense5.64.6Income tax expense (recovery)(0.1)1.5Net earnings (loss)$(0.4)$Statements of cash flowsCash provided by (used for):Operations$1.1$1.5Financing(1.0)Investing(1.7)(0.1)


(g)

Recent Pronouncements

In August 2001 the Financial Accounting Standards Board (FASB) issued Statement No.143, Accounting for Asset Retirement Obligations, (SFAS 143), which requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred and a corresponding increase in the carrying amount of the related long-lived asset and is effective for fiscal years beginning after June 15, 2002.  The Company adopted SFAS 143 effective January 1, 2003, which had no material effect on the consolidated financial statements.



In July 2002 the FASB issued Statement No.146, Accounting for Costs Associated with Exit or Disposal Activities (SFAS 146).  SFAS 146 applies to costs associated with an exit activity (including restructuring) or with a disposal of long-lived assets.  Under SFAS 146, a company will record a liability for a cost associated with an exit or disposal activity when that liability is incurred and can be measured at fair value.  SFAS 146 will require entities to disclose information about its exit and disposal activities, the related costs, and changes in those costs in the notes to the interim and annual financial statements that include the period in which an exit activity is initiated and in any subsequent period until the activity is completed.  SFAS 146 is effective for exit or disposal activities initiated after December 31, 2002, with earlier adoption encouraged.  The Company adopted SFAS 146 effective January 1, 2003, which had no material effect on the consolidated financial statements.



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