Canfor Pulp Products Inc.
Annual Report 2016

Plain-text annual report

CANFOR PU LP PRODUCT S INC. 2016 I N T H I S R E P O RT 03 M E S S AG E TO S H A R E H O L D E R S 05 2016 Management’s Discussion and Analysis 06 Company Overview 07 Overview of 2016 11 Overview of Consolidated Results - 2016 Compared to 2015 13 Operating Results by Business Segment - 2016 Compared to 2015 17 Summary of Financial Position 17 Changes in Financial Position 18 Liquidity and Financial Requirements 20 Transactions with Related Parties 21 Selected Quarterly Financial Information 22 Three-Year Comparative Review 23 Fourth Quarter Results 27 Specific Items Affecting Comparability 27 Outlook 28 Critical Accounting Estimates 29 Future Changes in Accounting Policies 30 Risks and Uncertainties 35 Outstanding Share Data 36 Disclosure Controls and Internal Controls Over Financial Reporting 38 CONSOLIDATED FINANCIAL STATEMENTS 39 Management’s Responsibility 40 Independent Auditors’ Report 42 Consolidated Balance Sheets 43 Consolidated Statements of Income 44 Consolidated Statements of Other Comprehensive Income (Loss) 44 Consolidated Statements of Changes in Equity 45 Consolidated Statements of Cash Flows 46 Notes to the Consolidated Financial Statements 66 ADDITIONAL INFORMATION 67 Directors and Officers 68 Corporate and Shareholder Information MESSAGE TO SHAREHOLDERS F R O M T H E P R E S I D E N T A N D C E O In 2016, Canfor Pulp delivered strong operational performance in all of our business lines – NBSK pulp and BCTMP, specialty paper products and renewable energy generation. Global pulp demand was stable, and there continues to be increased demand in China. Paper markets remain strong – we saw recovery in North America after market weakness in the first half of the year, and China continues to recover from a weak 2015. Our energy business had a modest increase in power generation now that the turbines of our three NBSK pulp mills are all operating and selling power, and we project further incremental benefits into 2017. In May, we signed an agreement to form a joint venture with Licella Fibre Fuel Pty Ltd. of Australia to investigate opportunities to integrate Licella’s unique catalytic hydrothermal reactor upgrading platform with our pulp mills to economically convert biomass, including residues from our kraft pulping processes, into biocrude oil to potentially produce next-generation biofuels. The agreement to form the Licella Pulp Joint Venture follows preliminary trials where wood residue from our kraft mills was successfully converted into a stable biocrude oil at Licella’s pilot plants in New South Wales, Australia. If we find we can achieve this economically, this would allow Canfor Pulp to further optimize pulp production capacity while adding a new revenue stream. This is just the latest example of our leadership in innovation. Through Canfor Pulp Innovation, we are ultra-responsive to the needs of our customers and our mills. The centre practices open innovation through a unique network of contractors, suppliers and partners, including world-class consultants in low consistency refining and tissue, research organizations dedicated to the development of next-generation fibre measurement and fibre products, and university researchers. In 2016, our significant achievements in energy efficiency and environmental stewardship – including turbine generator upgrades, updates to operating and maintenance practices, and capital investments to improve our biomass boilers – earned us the Canadian Industry Program for Energy Conservation Leadership Award in the category of Employee Awareness and Training. We continue to look for innovative ways to market our products and support our valued customers. Fibre United, a cooperative sales and marketing agreement we have with Finnish-based UPM-Kymmene, continues to work well for both companies. We are able to provide customers with a wide range of products and enhanced technical services in China, Japan, Europe and North America. In 2016, we announced that Fibre United would expand to Korea, the world’s fifth-largest pulp market. We never lose sight of the fact that while our location in British Columbia gives us a definite fibre advantage, the real strength of Canfor Pulp comes from our skilled and dedicated employees. We work hard to support their ongoing professional development through succession planning and training and development programs, and a promote-from-within culture. For the second year in a row, we received the Industry Training Authority’s 2016 Appreciation Award for our efforts to support the growth of BC’s skilled workforce. We are proud of the fact Canfor Pulp also registered its best three-year average safety performance in 2016. Our medical incident rate of 2.29 is a testament to the continued vigilance and care of all our employees. As we move into 2017, we are confident we will continue to be an industry leader across all our businesses, with strong demand for our quality pulp and paper products. Our success is the outcome of the many contributions from our employees, the excellent guidance and support from members of our Board, and the continued confidence of our shareholders. Brett Robinson President, Canfor Pulp Don Kayne Chief Executive Officer 3 F R O M T H E P R E S I D E N T A N D C E O F R O M T H E C H A I R M A N MESSAGE TO SHAREHOLDERS We are pleased to report that 2016 was another solid year for Canfor Pulp’s pulp and paper products, and our green energy business keeps growing. The Company achieved net income of $57.8 million, or $0.86 a share, and we had an operating income of $98.2 million and a return on invested capital of 13%. Canfor Pulp continued quarterly dividends of $0.0625 per common share in 2016. Through a normal course issuer bid that allows us to purchase for cancellation up to 5% of issued or outstanding common shares, Canfor Pulp repurchased just over 2.2 million common shares in 2016, or about 3.3% of the share value. Combined, Canfor Pulp’s dividends and share repurchases returned more than $41 million to our shareholders. Canfor Pulp has many advantages. By building upon them, we have the opportunity to position the Company to meet the needs of its customers today and into the future. The Company’s premium product quality has enabled Canfor Pulp to develop worldwide demand for our products – primarily in Asia, North America and Europe – and valued customers who can rely on us to provide the products and expertise necessary for them to manufacture their increasingly sophisticated end products. Without a doubt, the biggest advantage Canfor Pulp enjoys is a willingness to be leaders and to find ways to use these advantages to create new opportunities. Our modern kraft mills operate as large-scale biorefineries, manufacturing premium pulp products while producing clean energy. The steam generated in our boilers generates electricity and heats our operations, and the surplus power is exported to the BC electricity network. Through the Licella Pulp Joint Venture, we may one day be producing aviation fuel from our pulp residues. We are delighted that this venture has merited the support of the Canadian Federal Government’s Sustainable Development Technology Canada program, which has awarded $13 million in non-repayable credits to Canfor Pulp to support the Company as it works to convert a promising technology into world-class biorefinery outputs. In 2014, we established a sales and marketing agreement with UPM-Kymmene to offer customers better choice and technical support. Based on the tremendous success that this venture has achieved in meeting and exceeding the expectations of our combined customers, we recently expanded it to include Korea in addition to China, Japan, Europe and North America. On behalf of the Board of Directors of Canfor Pulp, it is a pleasure to be associated with a company with the vision to see future opportunities, and the expertise and passion to make them a reality. My sincere thanks to Canfor Pulp’s management team and dedicated employees who make this possible, and the customers, business partners and shareholders we value so much. Thanks also to my Board colleagues for their advice and significant contributions. And, as he leaves the Board of Directors after more than a decade of service, including as its initial Board Chairman following the spin-out of Canfor Pulp as a separate reporting issuer from its parent company, Canfor Corporation, I wish to acknowledge, with sincere thanks, the many contributions made to the Board, and the Company, by Charles Jago. Thank-you. Michael Korenberg Chairman of the Board 4 2016 MANAGEMENT’S DISCUSSION AND ANALYSIS This Management’s Discussion and Analysis (“MD&A”) provides a review of Canfor Pulp Products Inc.’s (“CPPI” or “the Company”) financial performance for the year ended December 31, 2016 relative to the year ended December 31, 2015, and the financial position of the Company at December 31, 2016. It should be read in conjunction with CPPI’s Annual Information Form and its audited consolidated financial statements and accompanying notes for the years ended December 31, 2016 and 2015. The financial information contained in this MD&A has been prepared in accordance with International Financial Reporting Standards (“IFRS”), which is the required reporting framework for Canadian publicly accountable enterprises. Throughout this discussion, reference is made to Operating Income before Amortization which CPPI considers to be a relevant indicator for measuring trends in the Company’s performance and its ability to generate funds to meet its debt service and capital expenditure requirements, and to pay dividends. Reference is also made to Adjusted Net Income (Loss) (calculated as Net Income (Loss) less specific items affecting comparability with prior periods – for the full calculation, see reconciliation included in the section “Analysis of Specific Material Items Affecting Comparability of Net Income (Loss)”) and Adjusted Net Income (Loss) per Share (calculated as Adjusted Net Income (Loss) divided by weighted average number of shares outstanding during the period). Operating Income before Amortization, Adjusted Net Income (Loss) and Adjusted Net Income (Loss) per Share are not generally accepted earnings measures and should not be considered as an alternative to net income or cash flows as determined in accordance with IFRS. As there is no standardized method of calculating these measures, CPPI’s Operating Income before Amortization, Adjusted Net Income (Loss) and Adjusted Net Income (Loss) per Share may not be directly comparable with similarly titled measures used by other companies. Reconciliations of Operating Income before Amortization to Operating Income (loss) and Adjusted Net Income (Loss) to Net Income (Loss) reported in accordance with IFRS are included in this MD&A. Factors that could impact future operations are also discussed. These factors may be influenced by known and unknown risks and uncertainties that could cause the actual results to be materially different from those stated in this discussion. Factors that could have a material impact on any future oriented statements made herein include, but are not limited to: general economic, market and business conditions; product selling prices; raw material and operating costs; currency exchange rates; interest rates; changes in law and public policy; the outcome of labour and trade disputes; and opportunities available to or pursued by CPPI. All financial references are in millions of Canadian dollars unless otherwise noted. The information in this report is as at February 8, 2017. Forward Looking Statements Certain statements in this MD&A constitute “forward-looking statements” which involve known and unknown risks, uncertainties and other factors that may cause actual results to be materially different from any future results, performance or achievements expressed or implied by such statements. Words such as “expects”, “anticipates”, “projects”, “intends”, “plans”, “will”, “believes”, “seeks”, “estimates”, “should”, “may”, “could”, and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are based on management’s current expectations and beliefs and actual events or results may differ materially. There are many factors that could cause such actual events or results expressed or implied by such forward-looking statements to differ materially from any future results expressed or implied by such statements. Forward-looking statements are based on current expectations and the Company assumes no obligation to update such information to reflect later events or developments, except as required by law. 5COMPANY OVERVIEW CPPI is a company incorporated and domiciled in Canada and listed on The Toronto Stock Exchange. The consolidated financial statements of the Company as at and for the year ended December 31, 2016 comprise the Company and its subsidiary entities. The Company’s operations consist of two Northern Bleached Softwood Kraft (“NBSK”) pulp mills and one NBSK pulp and paper mill located in Prince George, British Columbia, a Bleached Chemi- Thermo Mechanical Pulp (“BCTMP”) mill located in Taylor, British Columbia and a marketing group based in Vancouver, British Columbia. At December 31, 2016, Canfor Corporation (“Canfor”) held a 53.6% interest in CPPI, an increase of 1.7% from December 31, 2015 as a result of CPPI’s share purchases in 2016 under a Normal Course Issuer Bid. Further discussion of the Normal Course Issuer Bid is provided in the “Liquidity and Financial Requirements” section of this document. CPPI employs 1,266 people in its wholly owned subsidiaries and jointly owned operations as at December 31, 2016. The following chart illustrates, on a simplified basis, the ownership structure of CPPI (collectively the Company) as at December 31, 2016. Simplified Ownership Structure CANFOR CORPORATION (British Columbia) 100% of Shares CANADIAN FOREST PRODUCTS LTD. (British Columbia) 53.6% of Shares Shareholders 46.4% of Shares CANFOR PULP PRODUCTS INC. (British Columbia) 100% of Shares CANFOR PULP LTD. (Canada) The Pulp and Paper Business 6Pulp The Company owns and operates three NBSK pulp mills with annual capacity to produce approximately 1.1 million tonnes of northern softwood market kraft pulp, 85% of which is bleached to become NBSK pulp, and approximately 140,000 tonnes of kraft paper. The Northwood pulp mill is a two line mill with annual production capacity of approximately 600,000 tonnes of NBSK pulp, making it the largest NBSK pulp facility in North America. Northwood’s pulp is used to make a variety of products including printing and writing paper, tissue and specialty papers and is primarily delivered to customers in North America and Asia. The Intercontinental pulp mill is a single line pulp mill with annual production capacity of approximately 320,000 tonnes of NBSK pulp. Intercontinental’s pulp is used to make substantially the same product as that of Northwood and is delivered to the same markets. The Prince George pulp and paper mill is an integrated two line pulp and paper mill with an annual market pulp production capacity of approximately 150,000 tonnes. The Prince George pulp and paper mill supplies pulp markets in North America, Europe, Asia, and its internal paper making facilities. On January 30, 2015, the Company purchased from Canfor, the Taylor pulp mill which has an annual capacity of 220,000 tonnes of BCTMP. The Taylor pulp mill supplies pulp markets in North America and Asia. Further discussion of the purchase is provided in “Transactions with Related Parties”, later in this document. Paper CPPI’s paper machine, located at the Prince George pulp and paper mill, has an annual production capacity of approximately 140,000 tonnes of kraft paper. The Prince George pulp and paper mill produces high performance papers, bleached and unbleached kraft and specialty papers. The paper mill supplies primarily North American and European markets. Business Strategy The Company’s overall business strategy is to be a pulp and paper industry leader with strong financial performance accomplished through:  Preserving its low-cost operating position,  Maintaining the premium quality of its products,    Growing the green energy business, Developing an enterprise-wide culture of safety, innovation and engagement, and Capitalizing on attractive growth opportunities. OVERVIEW OF 2016 CPPI had a solid year in 2016, with operating income of $98.2 million and a return on invested capital of 13%. Global pulp demand was relatively stable in 2016 while global inventory levels were on the high end of the balanced range, reflecting slowly increasing pulp capacity through 2016. NBSK pulp list prices to China averaged US$599 per tonne for the year, US$45 per tonne lower than in 2015. BCTMP markets remained under significant pressure through the first half of 2016, but a price recovery in the second half of 2016 resulted in US-dollar prices being broadly in line with the previous year. A 4% weaker Canadian dollar offset part of the impact from the lower NBSK pulp US-dollar prices and, to a lesser extent, higher NBSK pulp shipments in 2016 to lower-margin regions. Operating results for the pulp segment were down $47.4 million from the previous year, mostly due to the aforementioned lower NBSK pulp unit sales realizations, and, to a lesser extent, weather related logistics challenges that impacted shipments around year end. Excluding weather-related disruptions, productivity was in line with the prior year, while fibre costs showed a small improvement, primarily due to lower prices for delivered sawmill residual chips and a lower proportion of higher-cost whole log chips. The favourable BCTMP pricing in the third and fourth quarters of 2016 combined with a 4% weaker Canadian dollar, enabled the Taylor pulp mill to deliver improved operating results in 2016 compared to 2015. The Company’s energy business and its power generation continued to grow in 2016 with the turbines at all three NBSK pulp mills now operating and selling power. The last of these at the Intercontinental pulp mill was completed 7in early 2015 and started selling power in April 2015. With all three turbines operating, the Company is projecting further incremental benefits of these green energy projects into 2017. The Company’s paper business performed well in 2016, continuing on from its strong operating performance in the prior year, as lower slush pulp costs more than offset a slight decrease in paper unit sales realizations. Reduced costs for slush pulp reflected lower global softwood pulp prices, while a moderate decrease in US-dollar kraft paper prices more than offset the favourable movement of the Canadian dollar. During 2016, CPPI and Licella Fibre Fuel Pty Ltd. (“Licella”) agreed to form a joint venture under the name Licella Pulp Joint Venture to investigate opportunities to integrate Licella’s Catalytic Hydrothermal Reactor platform into CPPI’s pulp mills to economically convert biomass into next generation biofuels and biochemicals. Licella is a subsidiary of Ignite Energy Resources Ltd. (“IER”) an Australian energy technology development company. This additional residue stream refining would allow the Company to further optimize pulp production capacity. This agreement follows a successful program of preliminary trials conducted on feedstock from the Company at Licella’s pilot plants located in New South Wales, Australia, in which wood residue streams from CPPI’s kraft process were successfully converted into a stable biocrude oil. In conjunction with the joint venture agreement, CPPI provided a $7.0 million convertible credit facility to IER, the parent company of Licella, which matures on June 21, 2019. In 2016, the Company’s net income included the pre-tax write-down of $7.0 million of advances made in connection with the biofuels initiative to Licella. Notwithstanding the future benefits that may result from this innovative effort, the write-down reflected the research and development nature of the advances. During 2016, the Company continued to repurchase shares under its Normal Course Issuer Bid, repurchasing just over 2.2 million common shares, or approximately 3.3% of the Company’s share capital in 2016. Through 2016, the Company also continued its quarterly dividends of $0.0625 per common share, returning a total of $16.9 million to shareholders in the year. The Company maintained its strong balance sheet through the year, finishing the year with net cash of $1.9 million and a net debt to total capitalization ratio of (0.4)%. A review of the more significant developments and results by operating segment in 2016 follows. Markets and Pricing (i) Pulp – Global market supply pressures contribute to weaker price environment in 2016 despite favourable currency movements Global softwood pulp markets saw moderate downward pressure on average NBSK pulp list prices to China throughout 2016, despite a slight rebound in prices in the second quarter of 2016. While overall global pulp demand was steady, additional hardwood pulp capacity was absorbed into global markets, particularly China, during the year. Global shipments of bleached softwood kraft pulp were up slightly in 2016 compared to 2015, primarily to China where shipment levels were well above trend. Globally, softwood pulp producer inventories increased in the first quarter of 2016 with limited industry maintenance downtime, then fell through the spring maintenance period in the second quarter of 2016. Thereafter, inventories remained at, or slightly above, the high end of the balanced range through the second half of 2016. The benchmark China NBSK pulp list price averaged US$599 per tonne1 in 2016, down US$45 per tonne, or 7%, from the prior year. This was offset in part by a 4% weaker Canadian dollar, resulting in an overall decline in NBSK pulp sales realizations in Canadian dollar terms. 1 Resource Information Systems, Inc. 8The following charts show the NBSK pulp list price movements in 2016 before taking account of customer discounts and rebates (Chart 1), and the global pulp inventory levels (Chart 2). Chart 1 Chart 2 Since the beginning of 2014, CPPI’s sales network has represented and co-marketed UPM-Kymmene (“UPM”) pulp products in North America and Japan, while UPM’s pulp sales network represented and co-marketed CPPI’s products in Europe and China, as part of a strategic sales and marketing cooperation agreement with UPM. This arrangement has been working well for both parties, allowing both CPPI and UPM to sell a broader offering of pulp products and offering enhanced technical service to customers. (ii) Paper - Continued pressure in kraft paper markets in 2016 in spite of boost from weaker Canadian dollar Downward pressure on kraft bleached paper markets, which commenced in the latter half of 2015, continued in 2016. The North American market experienced weakness particularly in the first half of 2016, while the China market showed some indicators of improvement in 2016 after a weak 2015. The lower kraft bleached paper prices were partly offset by the benefits of the weaker Canadian dollar in 2016. 9Capital and Operations Review Maintaining steady operational performance and strong balance sheet in light of market pressures and weather challenges Notwithstanding the global softwood pulp market pressures, total pulp production in 2016 was in line with 2015, with higher BCTMP production reflecting a full year’s production at the Taylor pulp mill (11 months in 2015) and a modest improvement in productivity through most of the year, offsetting the impact to operations in late 2016 from inclement weather conditions in British Columbia. Kraft paper production in 2016 was also broadly in line with 2015, reflecting a slight increase in productivity offset by additional scheduled maintenance days in 2016. Scheduled maintenance outages were completed on time at all facilities in 2016. The Company maintained its strong balance sheet position in 2016, finishing the year with a positive net cash position. In addition to solid cash earnings generated for the 2016 year, the Company’s cash from operations also included a reduction in non-cash working capital, in part reflecting the Company’s continued focus on inventory management. Discretionary capital spending continued to prioritize operational excellence, with asset reliability and energy generation remaining key focus areas. 10OVERVIEW OF CONSOLIDATED RESULTS – 2016 COMPARED TO 2015 Selected Financial Information and Statistics (millions of Canadian dollars, except for per share amounts) Sales Operating income before amortization2 Operating income Loss on derivative financial instruments3 Net income 2016 1,101.9 172.0 98.2 - 57.8 $ $ $ $ $ $ $ $ $ $ 2015 1,174.7 208.4 143.2 (8.8) 106.6 Net income per share, basic and diluted ROIC – Consolidated4 Average exchange rate (US$ per C$1.00)5 2 Amortization includes certain capitalized major maintenance costs. 3 Includes gains (losses) from foreign exchange, energy, pulp futures and interest rate swap derivatives (see “Unallocated and Other Items” section for more details). 4 Consolidated Return on Invested Capital (“ROIC”) is equal to operating income/loss, plus realized gains/losses on derivatives and other income/expense, divided by the average invested capital during the year. Invested capital is equal to capital assets, plus long-term investments and net non-cash working capital. 5 Source – Bank of Canada (average noon rate for the period). 23.0% 13.0% 0.755 0.86 0.782 1.52 $ $ $ $ (millions of Canadian dollars) Operating income (loss) by segment: Pulp Paper Unallocated Total operating income Add: Amortization Total operating income before amortization6 Add (deduct): Working capital movements Defined benefit pension plan contributions Income taxes paid, net Other operating cash flows, net Cash from operating activities Add (deduct): Dividends paid Finance expenses paid Capital additions, net Advances to Licella Acquisition of Taylor pulp mill Share purchases Other, net Change in cash / operating loans 6 Amortization includes certain capitalized major maintenance costs. 2016 2015 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 79.6 29.7 (11.1) 98.2 73.8 172.0 19.0 (8.3) (33.6) 0.9 150.0 (16.9) (3.2) (64.0) (7.0) - (24.7) 0.2 34.4 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 127.0 27.6 (11.4) 143.2 65.2 208.4 (32.9) (3.9) (36.0) 9.8 145.4 (96.5) (2.7) (68.3) - (12.6) (25.3) 0.7 (59.3) 11Analysis of Specific Items Affecting Comparability of Net Income After-tax impact (millions of Canadian dollars, except for per share amounts) 2016 2015 Net income, as reported Loss on derivative financial instruments Mark-to-market gain on Taylor pulp mill contingent consideration7 Net impact of above items Adjusted net income Net income per share (EPS), as reported Net impact of above items per share $ $ $ $ $ $ $ 57.8 - - - 57.8 0.86 - $ $ $ $ $ $ $ 106.6 6.5 (1.3) 5.2 111.8 1.52 0.07 Adjusted net income per share 7 As part of the purchase of the Taylor pulp mill on January 30, 2015, CPPI may pay contingent consideration based on the Taylor pulp mill’s future earnings over a three year period. On the acquisition date, the contingent consideration was valued at $1.8 million. During 2015, the contingent consideration liability was revalued to nil, resulting in a gain of $1.8 million (before tax) recorded to Other Income (see further discussion in the “Acquisition of Taylor pulp mill” section). 0.86 1.59 $ $ The Company recorded net income of $57.8 million, or $0.86 per share, for the year ended December 31, 2016, a decrease of $48.8 million, or $0.66 per share, from $106.6 million, or $1.52 per share, reported for the year ended December 31, 2015. Operating income for 2016 was $98.2 million, down $45.0 million from operating income of $143.2 million for 2015. These results primarily reflect decreases in NBSK pulp and kraft paper sales realizations, as the favourable impact of the weaker Canadian dollar was more than offset by the decline in US-dollar NBSK pulp and kraft paper prices, combined with a decline in pulp shipment volumes, primarily due to the weather-related delays in vessel shipments around year end. Excluding weather-related disruptions, productivity was in line with the prior year, while fibre costs were favourable in 2016, primarily due to lower prices for delivered sawmill residual chips and a lower proportion of higher-cost whole log chips. BCTMP sales realizations were in line with the previous year. A more detailed review of the Company’s operational performance and results is provided in “Operating Results by Business Segment – 2016 compared to 2015”, which follows this overview of consolidated results. 12OPERATING RESULTS BY BUSINESS SEGMENT – 2016 COMPARED TO 2015 The following discussion of CPPI’s operating results relates to the operating segments and the non-segmented items as per the Segmented Information note in the Company’s consolidated financial statements. CPPI’s operations include the Pulp and Paper segments. Pulp Selected Financial Information and Statistics – Pulp Summarized results for the Pulp segment for 2016 and 2015 are as follows: (millions of Canadian dollars, unless otherwise noted) Sales Operating income before amortization8 Operating income Capital expenditures Average NBSK pulp price delivered to China - US$9 Average NBSK pulp price delivered to China – Cdn$9 Production – pulp (000 mt)10 Shipments – pulp (000 mt)10 2016 2015 $ $ $ $ $ $ $ $ $ $ $ $ 924.2 149.5 79.6 60.9 599 794 1,217.9 1,201.5 1,006.1 188.5 127.0 62.5 644 824 1,215.4 1,227.6 Marketed on behalf of Canfor (000 mt) 8 Amortization includes certain capitalized major maintenance costs. 9 Per tonne, NBSK pulp list price delivered to China (Resource Information Systems, Inc). Average NBSK pulp price delivered to China in Cdn$ calculated as average pulp price delivered to China – US$ multiplied by the average exchange rate – Cdn$ per US$1.00 according to Bank of Canada average noon rate for the period. 10 Pulp production and shipment volumes in 2015 include BCTMP volumes subsequent to CPPI’s acquisition of the Taylor BCTMP mill on January 30, 2015 (See further discussion in the “Acquisition of Taylor pulp mill” section). Following the acquisition, CPPI no longer markets any product on behalf of Canfor. 15.2 - Overview The Pulp segment reported operating income of $79.6 million for 2016, down $47.4 million from $127.0 million in 2015. These results were mostly due to lower NBSK pulp sales realizations, and to a lesser extent weather-related logistics challenges that impacted shipments around the 2016 year end. Excluding weather-related disruptions, productivity was in line with the prior year, while unit fibre costs showed a small improvement, primarily due to lower prices for delivered sawmill residual chips and a lower proportion of higher-cost whole log chips. Markets As mentioned above, global softwood pulp markets saw moderate downward pressure on average NBSK pulp list prices to China through 2016, despite a slight rebound in prices in the second quarter of 2016. While overall global pulp demand was steady additional hardwood pulp capacity was absorbed into global markets, particularly China, during the year. Global shipments of bleached softwood kraft pulp were up slightly in 2016 compared to 2015, primarily to China where shipment levels were well above trend. At the end of December 2016, World 2011 producers of bleached softwood pulp inventories were at 32 days’ supply, just above the balanced range. By comparison, December 2015 inventories were at 29 days’ supply. Market conditions are generally considered balanced when inventories are in the 27-30 days of supply range. Sales The Company’s pulp shipments in 2016 were 1,201,500 tonnes, down 26,100 tonnes, or 2%, from 2015. Lower pulp shipments reflected the slippage of a vessel shipment to Asia into January 2017, combined with an overall decrease in NBSK pulp shipments to North America through the 2016 year. BCTMP shipments made up approximately 18% of total pulp shipments for 2016, up 2% from 2015, reflecting a full year of the Taylor pulp mill’s shipments. 11 World 20 data is based on twenty producing countries representing 80% of the world chemical market pulp capacity and is based on information compiled and prepared by the Pulp and Paper Products Council (“PPPC”). 13As mentioned, China NBSK pulp list prices averaged US$599 per tonne in 2016, down US$45 per tonne, or 7%. Average NBSK pulp unit sales realizations were moderately lower in 2016 largely reflecting the lower list price to China and a lower-value regional sales mix, which outweighed the benefit of the 4% weaker Canadian dollar in 2016. Average BCTMP unit sales realizations were broadly in line with 2015, reflecting a challenging BCTMP market in the first half of the year, which was offset by favourable improvements in BCTMP markets in the second half of the year, combined with the benefit of the weaker Canadian dollar. During 2016, the Company experienced its first full year of generating power at all three of its NBSK pulp mills, after the Intercontinental pulp mill turbine started selling power in April 2015 and following the ramp-up of the Northwood pulp mill turbines in the previous year. As a result of these green energy projects, the Company’s energy business saw a modest increase in power generation in 2016, which was offset by weather-related operational challenges in the fourth quarter. The Company is projecting further incremental benefits of these green energy projects into 2017. Operations Pulp production in 2016, at 1,217,900 tonnes, was consistent with that produced in 2015. NBSK pulp production saw a slight decrease compared to 2015, primarily due to lower operating rates, particularly in the fourth quarter of 2016 as a result of severe cold weather challenges. 2016 was the Company’s first full year of BCTMP production following the acquisition of the Taylor pulp mill on January 30, 2015. This incremental production, combined with modest improvements in operating rates, resulted in increased BCTMP production when compared to 2015. Pulp unit manufacturing costs were slightly lower compared to 2015 principally due to moderately lower fibre costs, as pulp unit conversion costs were broadly in line with the prior year. The decrease in fibre costs compared to 2015 reflected lower market prices for delivered sawmill residual chips (linked to Canadian dollar NBSK pulp sales realizations) combined with a significant increase in the proportion of lower-cost sawmill residual chips, mostly due to additional chips supplied by Canfor. Paper Selected Financial Information and Statistics – Paper Summarized results for the Paper segment for 2016 and 2015 are as follows: (millions of Canadian dollars, unless otherwise noted) Sales Operating income before amortization12 Operating income Capital expenditures Production – paper (000 mt) Shipments – paper (000 mt) 12 Amortization includes certain capitalized major maintenance costs. Overview 2016 2015 $ $ $ $ $ $ $ $ 176.1 33.5 29.7 1.7 135.8 142.5 166.7 31.2 27.6 5.8 136.8 133.4 Operating income for the paper segment was $29.7 million for 2016 representing a $2.1 million increase from the prior year. This increase in operating income reflected modestly lower paper unit manufacturing costs, due to a decline in slush pulp costs, combined with higher prime bleached shipments. These factors were partially offset by a slight decrease in paper unit sales realizations, as the weaker Canadian dollar was more than offset by a decline in US-dollar kraft paper prices. Markets As mentioned above, downward pressure on kraft bleached paper markets continued in 2016. The North American market experienced weakness particularly in the first half of 2016, while the China market recovered somewhat after a weak 2015. Lower kraft bleached paper prices were partly offset by the benefits of the weaker Canadian dollar in 2016. The Paper Shipping Sack Manufacturers’ Association (“PSSMA”) reported total sack paper shipments to the US were down 5.5% compared to 2015. 14Sales The Company’s paper shipments in 2016 were 142,500 tonnes, an increase of 9,100 tonnes, or 7%, from 2015, principally the result of higher volumes sold to North America. The Company’s prime bleached paper shipments, which attract higher prices, in 2016 represented 86% of prime sales volumes, up 1% from 2015. Paper unit sales realizations decreased slightly in 2016, reflecting the decline in US-dollar kraft paper prices, offset in part, by the favourable impact of the weaker Canadian dollar as well as the proportionately higher prime bleached shipments. Operations Paper production in 2016 was 135,800 tonnes, broadly in line with 2015. This reflects a slight increase in operating rates offset by additional scheduled maintenance days in 2016. Paper unit manufacturing costs were modestly lower compared to 2015, reflecting a moderate decrease in slush pulp costs (linked to lower Canadian dollar market pulp prices), offset in part, by higher maintenance and increased cost of chemicals in 2016. Unallocated and Other Items Selected Financial Information (millions of Canadian dollars) Corporate costs Finance expense, net Loss on derivative financial instruments Other income (expense), net Corporate Costs 2016 2015 $ $ $ $ (11.1) $ (6.6) $ - $ (10.4) $ (11.4) (6.0) (8.8) 14.5 Corporate costs, which comprise corporate, head office and general and administrative expenses, were $11.1 million in 2016, down slightly from the prior year. Finance Income and Expense Net finance expense for 2016 was $6.6 million, up $0.6 million from 2015. The increase principally reflected higher interest earned in 2015 combined with one-time credit facility fees to extend the maturity of the operating loan in 2016 (see further discussion in the “Liquidity and Financial Requirements” section). Interest expense is reported net of interest income. Loss on Derivative Financial Instruments From time to time, the Company uses a variety of derivative financial instruments to reduce its exposure to risks associated with fluctuations in foreign exchange rates, energy costs, interest rates and pulp prices. In 2016, the Company had no derivative financial instruments outstanding. In 2015, the Company recorded a net loss of $8.8 million related to its derivative financial instruments, principally reflecting realized losses on the Company’s foreign exchange and crude oil collars as a result of the significant declines in the Canadian dollar and oil prices through 2015. Additional information on the derivative financial instruments in place at year end can be found in the “Liquidity and Financial Requirements” section, later in this document. Other Income (Expense), Net Net other expense for 2016 of $10.4 million includes the $7.0 million write-down of research and development related advances to Licella, combined with unfavourable foreign exchange movements on US-dollar denominated cash, receivables and payables (see further discussion in the “Licella Pulp Joint Venture” section). In 2015, net other income included favourable foreign exchange movements on US-dollar denominated working capital balances combined with a $1.8 million mark-to-market gain related to the Taylor pulp mill contingent consideration liability, reflecting lower forecast BCTMP prices over the contingent consideration period (see further discussion in the “Acquisition of Taylor pulp mill” section). 15Licella Pulp Joint Venture On May 27, 2016, CPPI and Licella agreed to form a joint venture under the name Licella Pulp Joint Venture to investigate opportunities to integrate Licella’s Catalytic Hydrothermal Reactor platform into CPPI’s pulp mills to economically convert biomass into next generation biofuels and biochemicals. Licella is a subsidiary of IER an Australian energy technology development company. This additional residue stream refining would allow the Company to further optimize pulp production capacity. This agreement follows a successful program of preliminary trials conducted on feedstock from the Company at Licella’s pilot plants located in New South Wales, Australia, in which wood residue streams from CPPI’s kraft process were successfully converted into a stable biocrude oil. In conjunction with the joint venture agreement, CPPI provided a $7.0 million convertible credit facility to IER, the parent company of Licella, which matures on June 21, 2019. In 2016, the Company’s net income included the pre- tax write-down of $7.0 million of advances made in connection with the biofuels initiative to Licella. Notwithstanding the future benefits that may result from this innovative effort, the write-down reflected the research and development nature of the advances. Income Tax Expense The Company recorded an income tax expense of $23.4 million in 2016 with an overall effective tax rate of 29% (2015 - 25%). The reconciliation of income taxes calculated at the statutory rate to the actual income tax provision is as follows: (millions of Canadian dollars) Net income before income taxes Income tax expense at statutory rate of 26% Add (deduct): Permanent difference from capital gains and other non-deductible items Entities with different income tax rates and other tax adjustments Income tax expense Other Comprehensive Income (Loss) 2016 2015 81.2 $ 142.9 (21.1) $ (37.2) $ $ (1.8) (0.5) $ (23.4) $ (0.1) 1.0 (36.3) CPPI measures its accrued benefit obligations and the fair value of plan assets for accounting purposes at the end of each quarter. Any actuarial gains or losses which arise are recognized immediately by means of a credit or charge through Other Comprehensive Income. For 2016, an after-tax loss of $11.5 million was recorded in Other Comprehensive Income, including losses on the defined benefit pension plans and the other non-pension post- employment benefits. The losses in 2016 largely reflected a decrease in the discount rate used to value the net defined benefit obligation, combined with unfavourable actuarial experience adjustments in the pension plans and a return on pension plan assets less than the discount rate. In addition, in 2016, the Company purchased $33.7 million of annuities through its defined benefit plans to mitigate its exposure to the future volatility in the related pension obligations, taking total annuities purchased by the Company in the last three years to approximately $39.8 million. As at December 31, 2016, 24% of the defined benefit pension plan obligations were fully hedged against changes in future discount rates and longevity risk (potential increases in life expectancy of plan members). A further 46% was partially hedged against changes in future discount rates through the plan’s investment in debt securities. At purchase of these annuities, transaction costs of $3.6 million were recognized in Other Comprehensive Income principally reflecting the difference in the annuity rate (which is comparable to solvency rates) as compared to the discount rate used to value the pension obligations on a going concern basis. In 2015, the after-tax gain of $5.6 million recorded to Other Comprehensive Income largely reflected a higher discount rate used to value the net defined benefit obligation and a return on pension plan assets greater than the discount rate coupled with a reduction in the medical claims cost assumptions in the non-pension post-employment plans. 16SUMMARY OF FINANCIAL POSITION The following table summarizes CPPI’s financial position as at December 31, 2016 and 2015: (millions of Canadian dollars, except for ratios) 2016 2015 Cash and cash equivalents Operating working capital Net working capital Property, plant and equipment Other long-term assets Net assets Long-term debt Retirement benefit obligations Long-term provisions Deferred income taxes, net Total equity $ 51.9 $ $ $ 138.9 190.8 518.7 2.2 711.7 50.0 109.1 6.2 61.7 484.7 $ $ $ 711.7 $ 17.5 146.4 163.9 532.3 0.9 697.1 50.0 93.0 6.2 68.2 479.7 697.1 Ratio of current assets to current liabilities Net debt to total capitalization 2.5 : 1 2.1 : 1 (0.4)% 6.3% The ratio of current assets to current liabilities at the end of 2016 was 2.5:1, compared to 2.1:1 at the end of 2015, primarily as a result of higher cash and cash equivalent balances. See further discussion in “Changes in Financial Position” section. The Company’s net debt to capitalization was (0.4)% at December 31, 2016 (December 31, 2015: 6.3%) reflecting the Company’s maintenance of low debt levels and strong cash position at the end of 2016. CHANGES IN FINANCIAL POSITION At the end of 2016, CPPI had $51.9 million of cash and cash equivalents. (millions of Canadian dollars) Cash generated from (used in) Operating activities Financing activities Investing activities Increase (decrease) in cash and cash equivalents 2016 2015 $ $ 150.0 (44.8) (70.8) 34.4 $ $ 145.4 (124.5) (80.2) (59.3) The changes in the components of these cash flows during 2016 are discussed in the following sections. Operating Activities For the 2016 year, CPPI generated cash from operating activities of $150.0 million, up $4.6 million from cash generated of $145.4 million in the previous year. The increase in operating cash flows was principally from favourable movements in non-cash working capital, offset in part by lower cash earnings in 2016. The improvement in non-cash working capital in 2016 related principally to the decline in accounts receivable balances and residual chip inventories. Financing Activities In 2016, cash used in financing activities of $44.8 million was $79.7 million lower than the $124.5 million used in the prior year. During 2016, CPPI paid dividends totaling $16.9 million, or the equivalent of $0.0625 per common share in each quarter. During 2015, CPPI paid a special dividend of $79.0 million, or $1.125 per common share, as well as quarterly dividends totaling $17.5 million, or $0.0625 per common share in each quarter. During 2016, the Company continued its share repurchase activity under its Normal Course Issuer Bid, spending a total of $24.7 million on common share repurchases during the year, compared to a total of $25.3 million on common share repurchases in 172015 (see further discussion of the shares purchased under a Normal Course Issuer Bid in the following “Liquidity and Financial Requirements” section). Finance expenses paid during 2016 were $0.5 million higher than the prior year. Investing Activities Net cash used for investing activities in 2016 was $70.8 million, compared to $80.2 million used in 2015. Capital expenditures of $64.0 million in 2016 were associated with several capital projects including energy, maintenance of business and improvement projects, as well as, to a lesser extent, the acquisition of mobile equipment. Cash used for investing activities also included $7.0 million in advances to Licella, which comprised the aforementioned write- down (see further discussion in the “Licella Pulp Joint Venture” section). On January 30, 2015, CPPI completed the acquisition of the Taylor pulp mill from Canfor for cash consideration of $12.6 million (see further discussion in the “Acquisition of Taylor pulp mill” section). LIQUIDITY AND FINANCIAL REQUIREMENTS Operating Loan and Term Debt At December 31, 2016, the Company had a $110.0 million unsecured operating loan facility which was unused, except for $9.3 million reserved for several standby letters of credit, leaving $100.7 million available and undrawn on the operating facility. In 2015, the maturity date of this facility was extended to January 31, 2019. Subsequent to this extension, in 2016, the maturity date of this facility was extended to January 31, 2020. CPPI had a separate facility to cover letters of credit, which expired on June 30, 2016 and was not extended. Letters of credit covered under the expired facility were transferred to the operating loan facility. CPPI has $50.0 million of floating interest rate term debt. In 2016, the Company extended the maturity of the term debt from November 5, 2018 to January 31, 2020. Debt Covenants CPPI has certain financial covenants on its debt obligations that stipulate a maximum debt to total capitalization ratio. The debt to total capitalization is calculated by dividing total debt by shareholders’ equity plus total debt. In 2015, the minimum net worth financial covenant, which was based on shareholders’ equity, was removed. In circumstances when debt to total capitalization exceeds a threshold, CPPI is subject to an interest coverage ratio that requires a minimum amount of earnings before interest, taxes, depreciation and amortization relative to net interest expense. CPPI is not currently subject to this test. Provisions contained in CPPI’s long-term borrowing agreements also limit the amount of indebtedness that the Company may incur and the amount of dividends it may pay on its common shares. The amount of dividends the Company is permitted to pay under its long-term borrowing agreements is determined by reference to consolidated net earnings less certain restricted payments. Management reviews results and forecasts to monitor the Company’s compliance with these covenant requirements. CPPI was in compliance with all its debt covenants for the year ended December 31, 2016, and expects to remain so for the foreseeable future. Normal Course Issuer Bid On March 7, 2016, the Company renewed its normal course issuer bid whereby it can purchase for cancellation up to 3,446,139 common shares or approximately 5% of its issued and outstanding common shares as of March 1, 2016. The renewed normal course issuer bid is set to expire on March 6, 2017. In 2016, CPPI purchased 2,252,504 common shares for $24.4 million (an average price of $10.83 per common share). Cash payments for share purchases totaled $24.7 million during the year. As a result of the share purchases in 2016, Canfor’s interest in CPPI increased from 51.9% at December 31, 2015 to 53.6% at December 31, 2016. 2017 Projected Capital Spending and Debt Repayments Based on its current outlook for 2017, assuming no deterioration in market conditions during the year, the Company anticipates that it will invest approximately $77.0 million in capital projects, which will consist primarily of various improvement projects as well as maintenance of business expenditures, including major maintenance spending. 18There are no scheduled debt payments in 2017. CPPI has sufficient liquidity in its cash reserves and operating loans to finance its planned capital expenditures as required during 2017. Derivative Financial Instruments As at December 31, 2016, the Company had no derivative financial instruments outstanding. From time to time, CPPI: a. Uses US-dollar derivative financial instruments to partly hedge its exposure to currency risk. The Company did not enter into any US-dollar collars during 2016. b. Uses Western Texas Intermediate (“WTI”) oil contracts as proxy to hedge its diesel purchases. The Company did not enter into any oil collars during 2016. c. Enters into futures contracts on commodity exchanges for pulp. The Company did not enter into any pulp futures contracts during 2016. d. Uses interest rate swaps to reduce its exposure to financial obligations bearing variable interest rates. The Company did not enter into any interest rate swaps during 2016. Commitments The following table summarizes CPPI’s financial contractual obligations at December 31, 2016 for each of the next five years and thereafter: (millions of Canadian dollars) 2017 2018 2019 2020 2021 Thereafter Total Long-term debt obligations Operating leases $ $ - $ - $ - $ 50.0 $ 0.4 0.3 0.2 0.1 0.4 $ 0.3 $ 0.2 $ 50.1 $ - $ - - $ - $ - - $ 50.0 1.0 51.0 Other contractual obligations not included in the table above or highlighted previously are:       The Company has energy agreements with a BC energy company (the “Energy Agreements”) for three of the Company’s mills. These agreements are for the commitment of electrical load displacement and the sale of incremental power from the Company’s pulp and paper mills. These Energy Agreements include incentive grants from the BC energy company for capital investments to increase electrical generation capacity, and also call for performance guarantees to ensure minimum required amounts of electricity are generated, with penalty clauses if they are not met. As part of these commitments, the Company has entered into standby letters of credit for these guarantees. The standby letters of credit have variable expiry dates, depending on the capital invested and the length of the Energy Agreement involved. As at December 31, 2016 the Company had posted $7.7 million of standby letters of credit under these agreements, and had no repayment obligations under the terms of any of these agreements. Contractual commitments totaling $1.6 million, principally related to the construction of capital assets. The Company’s asset retirement obligations represent estimated undiscounted future payments of $9.3 million to remediate the landfills at the end of their useful lives. Payments relating to landfill closure costs are expected to occur at periods ranging from 6 to 35 years which have been discounted at risk free rates ranging from 1.3% to 2.3%. The estimated discounted value is $5.4 million and the amount is included in Other long-term provisions. Obligations to pay pension and other post-employment benefits, for which a net liability for accounting purposes at December 31, 2016 was $109.1 million. As at December 31, 2016, CPPI estimated that it would make contribution payments of $4.4 million to its defined benefit pension plans in 2017 based on the last actuarial valuation for funding purposes. As part of the acquisition of the Taylor pulp mill, CPPI may also pay contingent consideration to Canfor, based on the Taylor pulp mill’s financial performance over a three-year period. Purchase obligations and contractual obligations in the normal course of business. For example, purchase obligations of a more substantial dollar amount generally relate to the pulp business and are subject to “force majeure” clauses. In these instances, actual volumes purchased may vary significantly from contracted amounts depending on the Company's requirements in any given year. 19 TRANSACTIONS WITH RELATED PARTIES The Company undertakes transactions with various related entities. These transactions are in the normal course of business and are generally on similar terms as those accorded to unrelated third parties, except where noted otherwise. The current pricing under the Company’s Fibre Supply Agreement with Canfor expired September 1, 2016. The Company and Canfor agreed to extend the chip pricing formula under these agreements for one year, with the opportunity to extend for one additional year if both parties agree. In 2016, the Company depended on Canfor to provide approximately 63% of its fibre supply. The Company purchased wood chips, logs and hog fuel from Canfor sawmills in the amount of $147.8 million in 2016. Canfor provides certain business and administrative services to the Company under a services agreement. The total amount charged for the services provided by Canfor in 2016 was $12.2 million. The Company provides certain business and administrative services to Canfor under an incidental services agreement. The total amount charged for the services provided to Canfor in 2016 was $3.5 million. At December 31, 2016, an outstanding balance of $10.3 million is due to Canfor. Additional details on related party transactions are contained in Note 16 to CPPI’s 2016 consolidated financial statements. Acquisition of Taylor Pulp Mill On January 30, 2015, CPPI completed the purchase of the Taylor pulp mill from Canfor for cash consideration of $12.6 million including working capital. The acquisition also included a long-term fibre supply agreement under which Canfor will supply the Taylor pulp mill with fibre at prices that approximate fair market value. In addition to the cash consideration paid on the acquisition date, CPPI may also pay contingent consideration to Canfor, based on the Taylor pulp mill’s annual adjusted operating income before amortization over a three year period, starting January 31, 2015. On the acquisition date, the fair value of the contingent consideration was $1.8 million and was recorded as a long-term provision. CPPI recognized long-term assets acquired net of liabilities assumed at a fair value of $2.8 million and net working capital of $11.6 million. The acquisition was accounted for in accordance with IFRS 3, Business Combinations. If the acquisition had occurred on January 1, 2015, CPPI’s consolidated 2015 sales would have increased by approximately $8.9 million and consolidated 2015 net income would have increased by approximately $0.2 million. The Taylor pulp mill’s results are included in the pulp segment. Subsequent to the acquisition date, in 2015, CPPI reversed the $1.8 million contingent consideration provision resulting in a gain recorded to Other income (expense) to reflect lower forecast BCTMP prices over the contingent consideration period. The fair value of the contingent consideration provision was nil at December 31, 2016. 20SELECTED QUARTERLY FINANCIAL INFORMATION Q4 2016 Q3 2016 Q2 2016 Q1 2016 Q4 2015 Q3 2015 Q2 2015 Q1 2015 Sales and income (millions of Canadian dollars) Sales Operating income before amortization13 Operating income Net income Per common share (Canadian dollars) Net income – basic and diluted Book value14 $ 257.8 $ 291.6 $ 257.2 $ 295.3 $ 330.8 $ 294.1 $ 276.0 $ 273.8 $ $ $ $ $ 42.1 $ 50.0 $ 22.1 $ 57.8 $ 56.2 $ 58.7 $ 36.4 $ 22.9 $ 31.0 $ 5.2 $ 39.1 $ 38.6 $ 42.3 $ 20.9 $ 10.1 $ 22.4 $ 2.2 $ 23.1 $ 29.7 $ 31.2 $ 17.7 $ 57.1 41.4 28.0 0.15 $ 0.34 $ 0.03 $ 0.34 $ 0.43 7.27 $ 7.14 $ 6.88 $ 7.15 $ 6.96 $ $ 0.45 $ 0.25 $ 6.65 $ 7.40 $ 0.40 7.17 Dividends declared $ 0.0625 $ 0.0625 $ 0.0625 $ 0.0625 $ 0.0625 $ 0.0625 $ 1.1875 $ 0.0625 Statistics Pulp shipments (000 mt) 275.4 319.8 287.2 319.1 356.2 307.4 291.9 272.1 Paper shipments (000 mt) 33.6 35.5 38.5 34.9 35.4 32.1 33.8 32.1 Average exchange rate – US$/Cdn$ $ 0.750 $ 0.766 $ 0.776 $ 0.728 $ 0.749 $ 0.764 $ 0.813 $ 0.806 Average NBSK pulp list price delivered to China (US$) 13 Amortization includes certain capitalized major maintenance costs. 14 Book value per common share is equal to shareholders’ equity at the end of the period, divided by the number of common shares outstanding at the end of the period. 590 $ 595 $ 600 $ 595 $ 617 $ 638 $ 675 $ 663 $ Sales are primarily influenced by changes in market pulp prices, sales volumes and fluctuations in Canadian dollar exchange rates. Operating income, net income and operating income before amortization are primarily impacted by: sales revenue; freight costs; fluctuations of fibre, chemical and energy prices; level of spending and timing of maintenance downtime; and production curtailments. Net income is also impacted by fluctuations in Canadian dollar exchange rates, the revaluation to the period end rate of US-dollar denominated working capital balances and long- term debt, and revaluation of outstanding energy derivatives, pulp futures and US-dollar forward contracts and collars. (millions of Canadian dollars) Operating income (loss) by segment: Pulp Paper Unallocated Total operating income Add: Amortization Total operating income before amortization15 Add (deduct): Working capital movements Defined benefit pension plan contributions Income taxes paid, net Other operating cash flows, net Cash from operating activities Add (deduct): Dividends paid Finance expenses paid Capital additions, net Advances to Licella Acquisition of Taylor pulp mill Share purchases Other, net Q4 2016 Q3 2016 Q2 2016 Q1 2016 Q4 2015 Q3 2015 Q2 2015 Q1 2015 18.1 $ 8.1 $ (3.3) $ 22.9 $ 19.2 $ 26.7 $ 7.2 $ (2.9) $ 31.0 $ 19.0 $ 1.8 $ 5.5 $ (2.1) $ 5.2 $ 16.9 $ 33.0 $ 8.9 $ (2.8) $ 39.1 $ 18.7 $ 34.4 $ 6.9 $ (2.7) $ 38.6 $ 17.6 $ 38.2 $ 7.1 $ (3.0) $ 42.3 $ 16.4 $ 18.1 $ 5.7 $ (2.9) $ 20.9 $ 15.5 $ 36.3 7.9 (2.8) 41.4 15.7 42.1 $ 50.0 $ 22.1 $ 57.8 $ 56.2 $ 58.7 $ 36.4 $ 57.1 3.8 $ (3.9) $ 31.9 $ (12.8) $ (11.8) $ (10.5) $ (1.1) $ (9.5) (2.1) $ (0.8) $ 4.1 $ (3.6) $ (18.6) $ 2.2 $ (1.4) $ (2.6) $ (1.5) $ (1.2) $ (11.6) $ (3.9) $ (1.7) $ (2.0) $ 2.4 $ (0.5) $ (18.3) $ 2.8 $ (1.3) $ (3.2) $ (0.3) $ (0.4) (12.5) 4.9 47.1 $ 26.1 $ 48.5 $ 28.3 $ 43.1 $ 32.2 $ 30.5 $ 39.6 (4.2) $ (1.1) $ (18.3) $ (3.5) $ $ - $ - $ - (4.1) $ (0.8) $ (14.0) $ $ - - $ (0.3) $ $ - (4.3) $ (0.5) $ (18.6) $ (3.5) $ - $ (19.4) $ - $ (4.3) $ (0.8) $ (13.1) $ $ - - $ (5.0) $ 0.2 $ (4.4) $ (0.7) $ (27.6) $ $ - $ - (9.6) $ 0.1 $ (83.3) $ (0.9) $ (14.5) $ - $ - $ (6.7) $ 0.1 $ (4.4) $ (0.6) $ (12.8) $ $ - - $ (7.3) $ 0.3 $ (4.4) (0.5) (13.4) - (12.6) (1.7) 0.2 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ Change in cash / operating loans 15 Amortization includes certain capitalized major maintenance costs. 20.0 $ $ 6.9 $ 2.2 $ 5.3 $ 0.9 $ (73.1) $ 5.7 $ 7.2 21THREE-YEAR COMPARATIVE REVIEW (millions of Canadian dollars, except per share amounts) Sales Net income Total assets Term debt Net income per share, basic and diluted Dividends declared per share 2016 1,101.9 57.8 837.1 50.0 0.86 0.250 $ $ $ $ $ $ 2015 1,174.7 106.6 841.3 50.0 1.52 1.375 2014 980.5 89.5 827.4 50.0 1.26 0.250 $ $ $ $ $ $ $ $ $ $ $ $ 22FOURTH QUARTER RESULTS Overview The Company recorded operating income of $22.9 million and net income of $10.1 million for the fourth quarter of 2016, compared to operating income of $31.0 million and net income of $22.4 million for the third quarter of 2016 and operating income of $38.6 million and net income of $29.7 million for the fourth quarter of 2015. Net income per share was $0.15 for the fourth quarter of 2016, compared to $0.34 per share in the third quarter of 2016 and $0.43 per share in the fourth quarter of 2015. An overview of the results by business segment for the fourth quarter of 2016 compared to the third quarter of 2016 and the fourth quarter of 2015 follows. Pulp Selected Financial Information and Statistics – Pulp Summarized results for the Pulp segment for the fourth quarter of 2016, third quarter of 2016 and fourth quarter of 2015 were as follows: (millions of Canadian dollars, unless otherwise noted) Sales Operating income before amortization16 Operating income Average NBSK pulp price delivered to China – US$17 Average NBSK pulp price delivered to China – Cdn$17 Production – pulp (000 mt) $ $ $ $ $ Q4 2016 215.9 36.2 18.1 595 794 304.0 $ $ $ $ $ Q3 2016 Q4 2015 $ $ $ $ $ 247.9 44.8 26.7 595 777 312.5 286.9 50.9 34.4 600 801 322.5 Shipments – pulp (000 mt) 16 Amortization includes certain capitalized major maintenance costs. 17 Per tonne, NBSK pulp list price delivered to China (as published by Resource Information Systems, Inc.); Average NBSK pulp price delivered to China in Cdn$ calculated as average NBSK pulp price delivered to China – US$ multiplied by the average exchange rate – Cdn$ per US$1.00 according to Bank of Canada average noon rate for the period. 275.4 319.8 356.2 Overview Operating income for the pulp segment was $18.1 million for the fourth quarter of 2016, down $8.6 million from the third quarter of 2016 and down $16.3 million from the fourth quarter of 2015. Pulp segment results were down compared to the previous quarter reflecting the disruption to operations and logistics caused by challenging weather conditions in British Columbia, which impacted productivity and pulp unit manufacturing costs, as well as shipments around year end. These impacts were partially offset by the improvement in average BCTMP unit sales realizations in the current quarter, reflecting higher market prices combined with the benefit of a 2% weaker Canadian dollar. NBSK pulp unit sales realizations were broadly in line with the previous quarter, as a slightly weaker Canadian dollar was offset by increased pricing pressure from customers. Compared to the fourth quarter of 2015, the impact of inclement weather conditions in British Columbia on pulp production and shipment volumes, as well as a modest decrease in NBSK pulp US-dollar prices, which more than offset an increase in BCTMP prices, were the primary factors accounting for the lower quarter-over-quarter operating income. Pulp unit manufacturing costs were relatively in line with the fourth quarter of 2015, with the weather- related disruptions to operating performance and resulting higher unit conversion costs offset by lower fibre costs in the current quarter. Markets Global softwood pulp markets were relatively stable through most of the fourth quarter of 2016 with average NBSK pulp list prices to China, North America and Europe in line with the third quarter of 2016. Global softwood pulp producer inventory levels saw a slight increase through the quarter and finished at 32 days of supply at the end of December 2016, up 2 days from the end of September 201618. Market conditions are generally considered balanced when inventories are in the 27-30 days of supply range. 18 World 20 data is based on twenty producing countries representing 80% of the world chemical market pulp capacity and is based on information compiled and prepared by the PPPC. 23Global shipments of bleached softwood kraft pulp decreased slightly in October before rebounding in November and December, primarily driven by increased shipments to Asia19. Sales The Company’s pulp shipments in the fourth quarter of 2016 totalled 275,400 tonnes, down 44,400 tonnes, or 14%, from the third quarter of 2016 and down 80,800 tonnes, or 23%, from the fourth quarter of 2015. Lower pulp shipments in the current quarter reflected both the slippage of a vessel shipment to Asia into early January 2017, combined with lower NBSK pulp production. BCTMP shipments made up approximately 19% of the current quarter’s total pulp shipments, representing a 3% increase from the previous quarter. Compared to the fourth quarter of 2015, the decrease in pulp shipments was mostly attributable to a significant drawdown of inventories in late 2015, as well as the lower NBSK pulp production and delayed shipment in the current quarter. The average China US-dollar NBSK pulp list price, as published by RISI, was unchanged from the third quarter of 2016 and average NBSK pulp unit sales realizations were broadly in line with the previous quarter reflecting the benefit of a 2% weaker Canadian dollar offset by increased pricing pressure from customers. Average BCTMP unit sales realizations showed a healthy increase when compared to the previous quarter, reflecting improved BCTMP markets combined with the benefit of a 2% weaker Canadian dollar. Compared to the fourth quarter of 2015, the average China US-dollar NBSK pulp list price was down $5 per tonne, or 1%. The Company’s NBSK pulp unit sales realizations saw a modest decrease when compared to the fourth quarter of 2015 primarily reflecting lower US-dollar prices. BCTMP unit sales realizations increased significantly when compared to the fourth quarter of 2015, primarily reflecting the improvement in BCTMP markets compared to the end of 2015. Energy revenues moderately increased during the fourth quarter of 2016 compared to the previous quarter, primarily reflecting increased power generation and seasonally higher energy prices. Compared to the fourth quarter of 2015, energy revenue was down primarily due to decreased power generation as a result of the weather-related operational challenges in the current quarter. Operations Pulp production in the fourth quarter at 304,000 tonnes was down 8,500 tonnes, or 3%, from the third quarter of 2016, and down 18,500 tonnes, or 6%, compared to the fourth quarter of 2015. Production in the current quarter reflected a lower operating rate, primarily due to the cold weather challenges, which more than offset the quarter- over quarter impact of the scheduled maintenance outages in both comparative quarters. In the third quarter of 2016, the Company completed the scheduled maintenance outages at the Prince George NBSK pulp mill and the Taylor BCTMP mill, which reduced pulp production by 3,700 tonnes of NBSK pulp and 3,100 tonnes of BCTMP, respectively. In the comparative fourth quarter of 2015, the Company completed a scheduled maintenance outage at the Northwood pulp mill which reduced NBSK pulp production by approximately 20,000 tonnes. Pulp unit manufacturing costs saw a slight increase from the previous quarter, reflecting higher energy usage combined with seasonally higher energy costs, as well as the unfavourable impact of the lower production volumes during the current quarter. Fibre costs were relatively flat compared to the third quarter of 2016 reflecting slightly lower market prices for delivered sawmill residual chips (linked to Canadian dollar NBSK pulp sales realizations), offset by a marginal increase in the proportion of higher-cost whole log chips in the current quarter. Pulp unit manufacturing costs were broadly in line with the fourth quarter of 2015 as lower productivity combined with higher energy usage and higher energy costs, was offset by slightly lower fibre costs in the current quarter reflecting lower market prices for delivered sawmill residual chips as well as a decrease in the proportion of higher- cost whole log chips. 19 As reported by Pulp and Paper Products Council (“PPPC”) statistics. 24Paper Selected Financial Information and Statistics – Paper Summarized results for the Paper segment for the fourth quarter of 2016, third quarter of 2016 and fourth quarter of 2015 were as follows: (millions of Canadian dollars, unless otherwise noted) Sales Operating income before amortization20 Operating income Production – paper (000 mt) Shipments – paper (000 mt) 20 Amortization includes certain capitalized major maintenance costs. Overview Q4 2016 Q3 2016 Q4 2015 $ $ $ 41.8 $ 9.1 $ 8.1 $ 36.0 33.6 $ $ $ 43.6 8.1 7.2 32.4 35.5 43.6 7.9 6.9 35.8 35.4 Operating income for the paper segment at $8.1 million for the fourth quarter of 2016 was up $0.9 million from the third quarter of 2016 and up $1.2 million from the fourth quarter in the prior year. The increase in operating income compared to the third quarter of 2016 primarily reflected the impact of the 2% weaker Canadian dollar, combined with lower paper unit manufacturing costs related to higher production during the current quarter, given the absence of any scheduled maintenance downtime. Compared to the fourth quarter of 2015, paper unit sales realizations remained unchanged, while unit manufacturing costs were modestly lower reflecting lower slush pulp costs and lower maintenance and operating supply costs. Markets Global kraft paper markets were stable through the fourth quarter of 2016. Previously announced price increases in Europe were met with resistance which resulted in very little price movement. Sales The Company’s paper shipments in the fourth quarter of 2016 were 33,600 tonnes, down 1,900 tonnes, or 5%, from the previous quarter and down 1,800 tonnes, or 5% from the fourth quarter of 2015, principally reflecting lower volumes sold to Asia and Europe. Prime bleached shipments, which attract higher prices, were in line with both the third quarter of 2016 and the fourth quarter of 2015. Paper unit sales realizations in the fourth quarter of 2016 were up slightly compared to the previous quarter, reflecting the 2% weaker Canadian dollar, which more than offset a small decline in market prices, and in line with paper unit sales realizations when compared to the fourth quarter of 2015. Operations Paper production for the fourth quarter of 2016 was 36,000 tonnes, up 3,600 tonnes, or 11%, from the previous quarter, principally reflecting the previous quarter’s nine-day scheduled maintenance outage which reduced paper production by approximately 3,300 tonnes. Paper production in the current quarter was broadly in line with fourth quarter of 2015. Paper unit manufacturing costs were modestly lower than the previous quarter, for the most part reflecting the scheduled maintenance outage in the previous quarter. Compared to the fourth quarter of 2015, paper unit manufacturing costs were also modestly lower, reflecting lower slush pulp costs due to slightly lower overall pulp sales realizations in the current quarter along with the timing of spend on maintenance and operating supplies in the current quarter. 25Unallocated Items (millions of Canadian dollars) Corporate costs Finance expense, net Gain (loss) on derivative financial instruments Other income (expense), net Q4 2016 Q3 2016 Q4 2015 $ $ $ $ (3.3) (1.9) - (5.1) $ $ $ $ (2.9) $ (1.6) $ $ $ - 0.8 (2.7) (1.7) 0.9 1.9 Corporate costs were $3.3 million for the fourth quarter of 2016, up from both comparable periods primarily reflecting increases in corporate, head office and general and administrative expenses in the fourth quarter of 2016. Net finance expense for the fourth quarter of 2016 at $1.9 million, was $0.3 million higher from the previous quarter and $0.2 million higher from the fourth quarter of 2015 and relates primarily to one-time credit facility fees to extend the maturity of the operating loan (see further discussion in the “Liquidity and Financial Requirements” section). From time to time, the Company uses a variety of derivative financial instruments as partial economic hedges against unfavourable changes in foreign exchange rates, energy costs, interest rates and pulp prices. In the fourth and third quarters of 2016, the Company had no derivative financial instruments outstanding. Net other expense for the fourth quarter of 2016 of $5.1 million includes the write-down of research and development related advances to Licella (see further discussion in the “Licella Pulp Joint Venture” section), in part offset by favourable exchange movements on US-dollar denominated working capital balances. This is compared to net other income of $0.8 million in the previous quarter and $1.9 million in the fourth quarter of 2015, principally relating to favourable exchange movements on US-dollar denominated working capital balances. Other Comprehensive Income (Loss) In the fourth quarter of 2016, the Company recorded an after-tax gain of $2.5 million related to changes in the valuation of the Company’s employee future benefit plans. The gain reflected a 0.5% increase in the discount rate used to value the employee future benefit plans. During the fourth quarter of 2016, the Company purchased $33.7 million of annuities through its defined benefit plans in order to mitigate its exposure to the future volatility fluctuations in the related pension obligations. At purchase of these annuities, transaction costs of $3.6 million were recognized in Other Comprehensive Income principally reflecting the difference in the annuity rate (which is comparable to solvency rates) as compared to the discount rate used to value the pension obligations on a going concern basis. The Company recorded an after-tax loss of $1.1 million in the previous quarter and an after-tax gain of $0.5 million in the fourth quarter of 2015. For more information, see the “Employee Future Benefits” part of the “Critical Accounting Estimates” section later in this report. Summary of Financial Position The following table summarizes CPPI’s cash flow for the following periods: (millions of Canadian dollars) Increase (decrease) in cash and cash equivalents Operating activities Financing activities Investing activities Q4 2016 20.0 47.1 (5.3) (21.8) $ $ $ $ $ $ $ $ Q3 2016 Q4 2015 $ 6.9 26.1 $ (5.2) $ (14.0) $ 0.9 43.1 (14.7) (27.5) Cash generated from operating activities was $47.1 million in the fourth quarter of 2016, up $21.0 million from the previous quarter and $4.0 million from the fourth quarter of 2015. The increase in operating cash flows compared to the previous quarter principally reflected lower tax installment payments, combined with favourable movements in non-cash working capital, which more than offset the lower cash earnings. The improvement in non-cash working capital related to the decline in accounts receivable balances and chip inventories in the current quarter. Cash used for financing activities was $5.3 million in the fourth quarter of 2016, which was in line with the previous quarter and down $9.4 million from the fourth quarter of 2015. Cash used for financing activities in the current quarter included the Company’s quarterly dividend resulting in a payment $4.2 million ($0.0625 per share) as well as interest paid of $1.1 million, which was an increase compared to both comparative periods. In the third and fourth quarters of 2016, the Company did not repurchase common shares under its Normal Course Issuer Bid, however, in 26the third quarter of 2016, $0.3 million was paid for common shares that were repurchased at the end of the immediately preceding quarter (see further discussion of the shares purchased under the normal course issuer bid in the “Liquidity and Financial Requirements” section). In the fourth quarter of 2015, CPPI purchased 692,985 common shares under its Normal Course Issuer Bid for $9.7 million, of which $9.6 million was paid in that comparative quarter. Cash used for investing activities of $21.8 million in the current quarter primarily related to capital expenditures associated with several capital projects including energy, maintenance of business and improvement projects, as well as, to a lesser extent, the acquisition of mobile equipment. Cash used for investing activities also included a $3.5 million advance to Licella, which formed part of the aforementioned write-down (see further discussion in the “Licella Pulp Joint Venture” section). Q1 2015 28.0 7.0 SPECIFIC ITEMS AFFECTING COMPARABILITY Specific Items Affecting Comparability of Net Income Factors that impact the comparability of the quarters are noted below: After-tax impact (millions of Canadian dollars, except for per share amounts) Q4 2016 Q3 2016 Q2 2016 Q1 2016 Q4 2015 Q3 2015 Q2 2015 Net income, as reported $ 10.1 $ 22.4 $ 2.2 $ 23.1 $ 29.7 $ 31.2 $ 17.7 $ (Gain) loss on derivative financial instruments $ Mark-to market gain on Taylor pulp mill contingent consideration21 Net impact of above items Adjusted net income $ $ $ - - - $ $ $ - $ - $ - $ - - - $ $ $ - $ (0.7) $ 3.6 $ (3.4) $ - $ - $ - $ - $ (1.3) $ - (0.7) $ 3.6 $ (4.7) $ 7.0 10.1 $ 22.4 $ 2.2 $ 23.1 $ 29.0 $ 34.8 $ 13.0 $ 35.0 $ 0.15 $ 0.34 $ 0.03 $ 0.34 $ 0.43 Net income per share (EPS), as reported $ Net impact of above items per share22 Adjusted net income per share22 21 As part of the purchase of the Taylor pulp mill on January 30, 2015, CPPI may pay contingent consideration based on the Taylor pulp mill’s future earnings over a three year period. On the acquisition date, the contingent consideration was valued at $1.8 million. During 2015, the contingent consideration liability was revalued to nil, resulting in a gain of $1.8 million (before tax) recorded to Other Income (see further discussion in the “Acquisition of Taylor pulp mill” section). 22 The year-to-date net impact of the adjusting items per share and adjusted net income per share does not equal the sum of the quarterly per share amounts due to rounding. 0.34 $ 0.03 $ 0.34 $ $ 0.25 $ $ (0.07) $ 0.10 $ 0.18 $ 0.50 (0.01) $ 0.15 $ 0.45 0.42 0.50 - $ - $ 0.05 $ $ $ $ $ - - 0.40 OUTLOOK Pulp Markets For the month of January 2017, the Company announced an increase of US$20 per tonne for NBSK pulp list price to China, equating to US$630 per tonne, and an increase of US$10 per tonne for BCTMP. For the month of February 2017, the Company announced a further US$20 per tonne increase to both its NBSK pulp and BCTMP list prices to China. Global softwood markets are currently seeing positive pricing momentum, for both NBSK pulp and BCTMP, and this is anticipated to continue into the second quarter of 2017, when many pulp producers have their major maintenance shutdowns. The Company has no maintenance outages planned for the first quarter of 2017. Maintenance outages are currently planned at the Northwood pulp mill in the second quarter of 2017 with a projected 25,000 tonnes of reduced production and at the Intercontinental pulp mill in the third quarter of 2017 with a projected 8,000 tonnes of reduced production. A maintenance outage at the Taylor pulp mill is scheduled for the second quarter of 2017 with a projected 3,000 tonnes of reduced production. Paper Markets Kraft paper markets are projected to remain stable through the first quarter of 2017 and into the second quarter of 2017, with steady demand in the North American market continuing to lead the way globally. 27 CRITICAL ACCOUNTING ESTIMATES The preparation of financial statements in conformity with International Financial Reporting Standards (“IFRS”) requires management to make estimates and assumptions that affect the amounts recorded in the financial statements. Management regularly reviews these estimates and assumptions based on currently available information. While it is reasonably possible that circumstances may arise which cause actual results to differ from these estimates, management does not believe it is likely that any such differences will materially affect CPPI’s financial position. Unless otherwise indicated the critical accounting estimates discussed affect all of the Company’s reportable segments. Employee Future Benefits CPPI has various defined benefit and defined contribution plans providing both pension and other non-pension post- retirement benefits to most of its salaried employees and certain hourly employees not covered by forest industry union plans. CPPI also provides certain health care benefits and pension bridging benefits to eligible retired employees. The costs and related obligations of the pension and other non-pension post-retirement benefit plans are accrued in accordance with the requirements of IFRS. CPPI uses independent actuarial firms to perform actuarial valuations of the fair value of pension and other non- pension post-retirement benefit plan obligations. The application of IFRS requires judgments regarding certain assumptions that affect the accrued benefit provisions and related expenses, including the discount rate used to calculate the present value of the obligations, the rate of compensation increase, mortality assumptions and the assumed health care cost trend rates. Management evaluates these assumptions annually based on experience and the recommendations of its actuarial firms. Changes in these assumptions result in actuarial gains or losses, which are recognized in full in each period with an adjustment through Other Comprehensive Income (Loss). The actuarial assumptions used in measuring CPPI’s benefit plan provisions and benefit costs are as follows: Discount rate Rate of compensation increases Initial medical cost trend rate Ultimate medical cost trend rate Year ultimate rate is reached December 31, 2016 December 31, 2015 Defined Benefit Pension Plans 3.9% 3.0% n/a n/a n/a Other Benefit Plans 3.9% n/a 7.0% 4.5% 2022 Defined Benefit Pension Plans 4.1% 3.0% n/a n/a n/a Other Benefit Plans 4.1% n/a 7.0% 4.5% 2021 In addition to the significant assumptions listed in the table above, the average life expectancy of a 65 year old at December 31, 2016 is between 20.9 years and 24.1 years (2015 - 20.9 years and 24.0 years). As at December 31, 2016, the weighted average duration of the defined benefit plan obligation, which reflects the average age of the plan members, is 12.1 years (2015 - 12.0 years). The weighted average duration of the other benefit plans is 14.6 years (2015 - 14.3 years). Assumed discount rates and medical cost trend rates have a significant effect on the accrued retirement benefit obligation and related plan assets. A one percentage point change in these assumptions would have the following effects on the accrued retirement benefit obligation, before taking into account the impact of hedging, and related plan annuity assets for 2016: (millions of Canadian dollars) Defined benefit pension plan liabilities Discount rate Defined benefit pension plan annuity assets Discount rate Other benefit plan liabilities Discount rate Initial medical cost trend rate 1% Increase 1% Decrease $ $ $ $ (16.6) $ 20.4 (3.6) $ 4.3 (12.0) $ 11.4 $ 15.3 (9.5) 28 See “Liquidity and Financial Requirements” section for further discussion regarding the funding position of CPPI’s pension plans. Asset Retirement Obligations CPPI records the estimated fair value of liabilities for asset retirement obligations, such as landfill closures, in the period in which they are incurred. For landfill closure costs, the fair value is determined using estimated closure costs discounted over the estimated useful life. Payments relating to landfill closure costs are expected to occur at periods ranging from 6 to 35 years and have been discounted at risk-free rates ranging from 1.3% to 2.3%. The actual closure costs and periods of payment may differ from the estimates used in determining the year end liability. On initial recognition, the fair value of the liability is added to the carrying amount of the associated asset and amortized over its useful life. The liability is accreted over time through charges to earnings and reduced by actual costs of settlement. Asset Impairments CPPI reviews the carrying values of its long-lived assets, including property, plant and equipment on a regular basis as events or changes in circumstances may warrant. An impairment loss is recognized in net income at the amount that the asset’s carrying amount exceeds its recoverable amount. The recoverable amount is the higher of an asset’s fair value less costs to sell and value in use. No impairments were recorded in 2016 or 2015. Deferred Taxes In accordance with IFRS, CPPI recognizes deferred income tax assets when it is probable that the deferred income tax assets will be realized. This assumption is based on management's best estimate of future circumstances and events. If these estimates and assumptions are changed in the future, the value of the deferred income tax assets could be reduced or increased, resulting in an income tax expense or recovery. CPPI reevaluates its deferred income tax assets on a regular basis. Valuation of Finished Product Inventories Finished product inventories are recorded at the lower of cost and net realizable value. The cost of inventories is based on the weighted average cost principle, and includes raw materials, direct labour, other direct costs and related production overheads (based on normal operating capacity). Net realizable value is the estimated selling price in the ordinary course of business, less estimated costs of completion and selling expenses. CPPI estimates the net realizable value of the finished goods inventories based on actual and forecasted sales orders. Based on these estimates, there were no write-downs of the Company’s finished goods inventories from cost to net realizable at December 31, 2016. FUTURE CHANGES IN ACCOUNTING POLICIES In May 2014, the International Accounting Standards Board (“IASB”) issued IFRS 15, Revenue from Contracts with Customers, which will supersede IAS 18, Revenue, IAS 11, Construction Contracts and related interpretations. The new standard is effective for annual periods beginning on or after January 1, 2018. The Company has performed a preliminary assessment of the impact of the new standard, and currently anticipates no significant impact on its financial statements. In July 2014, the IASB issued IFRS 9, Financial Instruments. The required adoption date for IFRS 9 is January 1, 2018 and the Company does not anticipate the new standard to have a significant impact on its financial statements. In January 2016, the IASB issued IFRS 16, Leases, which will supersede IAS 17, Leases and related interpretations. The required adoption date for IFRS 16 is January 1, 2019 and the Company is in the process of assessing the impact on the financial statements of this new standard. 29RISKS AND UNCERTAINTIES Risks and uncertainties fall into the general business areas of markets, international commodity prices, competition, currency exchange rates, environmental issues, raw materials, capital requirements, dependence on certain relationships, government regulations, public policy and labour disputes, and Native land claims. The future impact of the various uncertainties and potential risks described in the following paragraphs (together with the risks and uncertainties identified under each of the Company’s business segments) cannot be quantified or predicted with certainty. However, CPPI does not foresee unmanageable adverse effects on its business operations from, and believes that it is well positioned to deal with, such matters as may arise. The risks and uncertainties are set out in alphabetical order. Aboriginal Issues CPPI sources the majority of its fibre from areas subject to claims of Aboriginal rights or title. Canadian judicial decisions have recognized the continued existence of Aboriginal rights and title to lands continuously and exclusively used or occupied by Aboriginal groups; however, until recently, the courts have not identified any specific lands where Aboriginal title exists. In June 2014, the Supreme Court of Canada, for the first time, recognized Aboriginal title for the Tsilhqot’in Nation over approximately 1,750 square kilometres of land in central BC (“William decision”). It found that provisions of BC’s Forest Act, dealing with the disposition or harvest of Crown timber, no longer applied to timber located on these lands, but also confirmed provincial law can apply on Aboriginal title lands. While Aboriginal title had previously been assumed over specific, intensively occupied areas such as villages, the William decision marks the first time Canada’s highest court has recognized Aboriginal title over a specific piece of land and, in so doing, affirmed a broader territorial use-based approach to Aboriginal title. The decision also defines what Aboriginal title means and the types of land uses consistent with this form of collective ownership. The impacts of the Supreme Court of Canada’s decision on the timber supply from Crown lands is unknown at this time; and the Company does not know if the decision will lead to changes in BC laws or policies. CPPI supports the work of tenure holders to engage, cooperate and exchange information and views with First Nations and Government to foster good relationships and minimize risks to the Company’s operational plans. Capital Requirements The pulp and paper industries are capital intensive, and the Company regularly incurs capital expenditures to expand its operations, maintain its equipment, increase its operating efficiency and comply with environmental laws. The Company’s total capital expenditures during 2016 were approximately $64.0 million. The Company anticipates available cash resources and cash generated from operations will be sufficient to fund its operating needs and capital expenditures. Competitive Markets The Company’s products are sold primarily in Asia, North America, Japan and Europe. The markets for the Company’s products are highly competitive on a global basis, with a number of major companies competing in each market with no company holding a dominant position. Competitive factors include quality of product, reliability of supply and customer service. The Company’s competitive position is influenced by: the availability, quality, and cost of raw materials; energy and labour costs; free access to markets; currency exchange rates; plant efficiencies; and productivity in relation to its competitors. Currency Exchange Risk The Company’s operating results are sensitive to fluctuations in the exchange rate of the Canadian dollar to the US- dollar, as prices for the Company’s products are denominated in US-dollars or linked to prices quoted in US-dollars. Therefore, an increase in the value of the Canadian dollar relative to the US-dollar reduces the amount of revenue in Canadian dollar terms realized by the Company from sales made in US-dollars, which in turn, reduces the Company’s operating margin and the cash flow available. 30Cyclicality of Product Prices The Company’s financial performance is dependent upon the selling prices of its pulp and paper products, which have fluctuated significantly in the past. The markets for these products are highly cyclical and may be characterized by (i) periods of excess product supply due to industry capacity additions, increased production and other factors; and (ii) periods of insufficient demand due to weak general economic conditions. The economic climate of each region where the Company’s products are sold has a significant impact upon the demand, and therefore, the prices for pulp and paper. Prices of pulp, in particular, have historically been unpredictable. Dependence on Canfor In 2016, approximately 63% of the fibre used by the Company was derived from the Fibre Supply Agreement with Canfor. The Company’s financial results could be materially adversely affected if Canfor is unable to provide the current volume of wood chips as a result of mill closures, whether temporary or permanent. Dependence on Key Customers In 2016, the Company’s top five customers accounted for approximately 34% of its pulp sales. In the event that the Company cannot maintain these customer relationships or the demand from these customers is diminished for any reason in the future, there is a risk that the Company would be forced to find alternative markets in which to sell its pulp, which in turn, could result in lower prices or increased distribution costs thereby adversely affecting its sales margins. Dividends CPPI paid quarterly dividends of $0.0625 per share through 2016 and may, subject to market conditions, continue to pay a comparable level of dividends through 2017. In 2015, the Company also paid a special dividend of $79.0 million ($1.1250 per share) to the shareholders of the Company as a result of strong cash generated by the business in 2014 and 2015. There is no assurance that the dividends will be maintained at this level and the market value of CPPI shares may fluctuate depending on the amount of dividends paid in the future. The board retains the discretion to change the policy at any time and reviews the policy on a quarterly basis. Employee Future Benefits The Company, in participation with Canfor, has several defined benefit plans, which provide pension and other non- pension post-retirement benefits to certain salaried and hourly employees. The defined benefit pension plans are based on a combination of years of service and final average salary. CPPI’s other non-pension post-retirement benefit plans are non-contributory and include a range of health care and other benefits. Cash payments required to fund the registered pension plan are determined by an actuarial valuation completed at least once every three years, with the most recent actuarial valuation completed as of December 31, 2015. Other non-pension post-retirement benefit plans are unfunded, and the Company makes payments as required to cover liabilities as they arise. The funded surplus (deficit) of each defined benefit plan is calculated as the difference between the fair market value of plan assets and an actuarial estimate of future liabilities. Any deficit in the registered plans determined following an actuarial valuation must be funded in accordance with regulatory requirements, normally over 5 or 15 years. Some of the unregistered plans are also partially funded. Through its pension funding requirements, the Company through Canfor, is exposed to the risk of fluctuating market values for the securities making up the plan assets, and to changes in prevailing interest rates which determine the discount rate used in calculating the estimated future liabilities. The funding requirements may also change to the extent that other assumptions used are revised, such as inflation rates or mortality assumptions. For CPPI’s defined benefit pension plans, a one percentage point increase in the discount rate used in calculating the actuarial estimate of future liabilities would reduce the accrued benefit obligation by an estimated $16.6 million and a one percentage point decrease in the discount rate would increase the accrued benefit obligation by an estimated $20.4 million. These changes would only impact the Company’s funding requirements in years where a new actuarial funding valuation was performed and regulatory approval for a change in funding contributions was obtained. 31Environmental Laws, Regulations and Compliance The Company is subject to a wide range of general and industry-specific laws and regulations relating to the protection of the environment, including those governing air emissions, wastewater discharges, the storage, management and disposal of hazardous substances and wastes, the cleanup of contaminated sites, landfill operation and closure obligations, and health and safety matters. These laws and regulations require the Company to comply with specific requirements as described in regulations. Regulations may also require the Company to obtain authorizations and comply with the authorization requirements of the appropriate governmental authorities which have considerable discretion over the terms and timing of said authorizations and permits. The Company has incurred, and expects to continue to incur, capital, operating and other expenditures complying with applicable environmental laws and regulations and as a result of environmental remediation on asset retirement obligations. It is possible that the Company could incur substantial costs, such as civil or criminal fines, sanctions and enforcement actions, cleanup and closure costs, and third-party claims for property damage and personal injury as a result of violations of, or liabilities under, environmental laws and regulations. The amount and timing of environmental expenditures is difficult to predict, and, in some cases, the Company’s liability may exceed forecasted amounts. The discovery of additional contamination or the imposition of additional cleanup obligations at the Company’s or third-party sites may result in significant additional costs. Any material expenditure incurred could adversely impact the Company’s financial condition or preclude the Company from making capital expenditures that would otherwise benefit the Company’s business. Enactment of new environmental laws or regulations or changes in existing laws or regulations, or interpretation thereof, could have a significant impact on the Company. Financial Risk Management and Earnings Sensitivities Demand for pulp and paper products is closely related to global business conditions and tends to be cyclical in nature. Product prices can be subject to volatile change. CPPI competes in a global market and the majority of its products are sold in US-dollars. Consequently, changes in foreign currency relative to the Canadian dollar can impact CPPI’s revenues and earnings. Financial Risk Management CPPI is exposed to a number of risks as a result of holding financial instruments. These risks include credit risk, liquidity risk and market risk. The CPPI internal Risk Management Committee manages risk in accordance with a Board approved Risk Management Controls Policy. The policy sets out the responsibilities, reporting and counter party credit and communication requirements associated with all of the Company’s risk management activities. Responsibility for overall philosophy, direction and approval is that of the Board of Directors. (a) Credit risk: Credit risk is the risk of financial loss to CPPI if a counterparty to a financial instrument fails to meet its contractual obligations. Financial instruments that are subject to credit risk include cash and cash equivalents and accounts receivable. Cash and cash equivalents includes cash held through major Canadian and international financial institutions as well as temporary investments with an original maturity date of three months or less. CPPI utilizes credit insurance to manage the risk associated with trade receivables. As at December 31, 2016, approximately 81% of the outstanding trade receivables are covered under credit insurance. In addition, CPPI requires letters of credit on certain export trade receivables and regularly discounts these letters of credit without recourse. CPPI recognizes the sale of the letters of credit on the settlement date, and accordingly reduces the related trade accounts receivable balance. CPPI’s trade receivable balance at December 31, 2016 was $75.9 million. At December 31, 2016, approximately 99% of the trade accounts receivable balance was within CPPI’s established credit terms. 32 (b) Liquidity risk: Liquidity risk is the risk that CPPI will be unable to meet its financial obligations as they come due. The Company manages liquidity risk through regular cash flow forecasting in conjunction with an adequate committed operating loan facility. At December 31, 2016, CPPI had no amounts drawn on its operating loans, and had accounts payable and accrued liabilities of $125.4 million, all of which are due within twelve months of the balance sheet date. (c) Market risk: Market risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in interest rates, foreign currency, commodity and energy prices. (i) Interest Rate risk: CPPI is exposed to interest rate risk through its current financial assets and financial obligations bearing variable interest rates. CPPI may use interest rate swaps to reduce its exposure to financial obligations bearing variable interest rates (See “Derivative Financial Instruments” section later in this document). As noted earlier in this section (under “Employee Future Benefits”), CPPI is also exposed to interest rate risk in relation to the measurement of the Company’s pension liabilities. (ii) Currency risk: CPPI is exposed to foreign exchange risk primarily related to the US-dollar, as CPPI products are sold globally with prices primarily denominated in US-dollars or linked to prices quoted in US-dollars with certain expenditures transacted in US-dollars. In addition, the Company holds financial assets and liabilities in US- dollars. These primarily include US-dollar bank accounts, investments and trade accounts. A portion of the currency risk associated with US-dollar denominated sales is naturally offset by US-dollar denominated expenses. A portion of the remaining exposure is sometimes covered by foreign exchange collar contracts that effectively limit the minimum and maximum Canadian dollar recovery related to the sale of those US-dollars (See “Derivative Financial Instruments” section later in this document). (iii) Commodity price risk: CPPI’s financial performance is dependent on the selling price of its products and the purchase price of raw material inputs. Consequently, CPPI is exposed to changes in commodity prices for pulp and paper, as well as changes in fibre, freight, chemical and energy prices. The markets for pulp and paper are cyclical and are influenced by a variety of factors. These factors include periods of excess supply due to industry capacity additions, periods of decreased demand due to weak global economic activity, inventory destocking by customers and fluctuations in currency exchange rates. During periods of low prices, CPPI is subject to reduced revenues and margins, which adversely impact profitability. The Company may periodically use derivative instruments to mitigate commodity price risk (See “Derivative Financial Instruments” section later in this document). (iv) Energy price risk: CPPI is exposed to energy price risk relating to purchases of natural gas and diesel oil for use in its operations. The annual exposure is from time to time hedged up to 100% through the use of floating to fixed swap contracts or option contracts with maturity dates up to a maximum of eighteen months. In the case of diesel, CPPI uses WTI oil contracts to hedge its exposure (See “Derivative Financial Instruments” section later in this document). Derivative Financial Instruments Subject to risk management policies approved by its Board of Directors, CPPI, from time to time, uses derivative instruments, such as forward exchange contracts and option contracts to hedge future movements of exchange rates and futures and forward contracts to hedge pulp prices, commodity prices and energy costs. See section “Liquidity and Financial Requirements” for details of CPPI’s derivative financial instruments outstanding at year end. 33Earnings Sensitivities Estimates of the sensitivity of CPPI's pre-tax results to currency fluctuations and prices for its principal products, based on 2017 forecast production and year end foreign exchange rates, are set out in the following table: (millions of Canadian dollars) NBSK Pulp – US$10 change per tonne 23 BCTMP – US$10 change per tonne 23 Natural gas cost – $1 change per gigajoule Chip cost – $1 change per tonne Canadian dollar – US$0.01 change per Canadian dollar24 Impact on annual pre-tax earnings $ 14 $ 3 $ 4 $ 2 $ 5 23 Excluding impacts of exchange rate, freight, discounting, potential change in fibre costs and other deductions. 24 Represents impact on operating income and excludes the impact on operating loans denominated in US$. Decrease of US$0.01 per Canadian dollar results in an increase to pre-tax annual earnings and an increase of US$0.01 per Canadian dollar results in a decrease to pre-tax annual earnings. Governmental Regulations The Company is subject to a wide range of general and industry-specific environmental, health and safety and other laws and regulations imposed by federal, provincial and local authorities. If the Company is unable to extend or renew a material approval, license or permit required by such laws, or if there is a delay in renewing any material approval, license or permit, the Company’s business, financial condition, results of operations and cash flows could be materially adversely affected. In addition, future events such as any changes in these laws and regulations or any change in their interpretation or enforcement, or the discovery of currently unknown conditions, may give rise to unexpected expenditures or liabilities. Increased Industry Production Capacity The Company currently faces substantial competition in the pulp industry and may face increased industry competition in the years to come if new manufacturing facilities are built or if existing mills are improved. If increases in pulp production capacity exceed increases in pulp demand, selling prices for pulp could decline and adversely affect the Company’s business, financial condition, results of operations and cash flows, and the Company may not be able to compete with competitors who have greater financial resources and who are better able to weather a prolonged decline in prices. Information Technology Security CPPI’s information technology systems serve an important role in the operation of its business. CPPI relies on various technologies to access fibre, operate its production facilities, interact with customers, vendors and employees and to report on its business. Interruption or failure of CPPI’s information technology systems could result in material and adverse impacts on the Company’s financial condition, operations, production, sales, and reputation and could also result in environmental and physical damage to Company operations or surrounding areas. CPPI’s information technology systems and networks could be interrupted or fail due to a variety of causes, such as natural disaster, fire, power outages, vandalism, or cyber-based attacks. Any such interruption or failure could result in operational disruptions or the misappropriation of sensitive or proprietary data that could subject CPPI to civil and criminal penalties, litigation or have a negative impact on the Company’s reputation. There can be no assurance that such disruptions or misappropriations and the resulting repercussions will not negatively impact the Company’s cash flows and have a material adverse effect on its business, operations, financial condition and operational results. Although to date CPPI has not experienced any material losses relating to cyber risks, there can be no assurance that the Company will not incur such losses in the future. CPPI’s risk and exposure cannot be fully mitigated due to the nature of these threats. The Company continues the development and enhancement of internal controls, policies and procedures designed to protect systems, servers, computers, software, data and networks from attack, damage or unauthorized access remain a priority. CPPI has established a Management Cyber Risk Committee to assess and monitor risk mitigation efforts and to respond to emerging threats. As cyber threats continue to evolve, the Company may be required to expend additional resources to continue to modify or enhance protective measures or to investigate and remediate any security vulnerabilities. 34Maintenance Obligations and Facility Disruptions The Company’s manufacturing processes are vulnerable to operational problems that can impair its ability to manufacture its products. The Company could experience a breakdown in any of its machines, or other important equipment, and from time to time, the Company schedules planned and incurs unplanned outages to conduct maintenance that cannot be performed safely or efficiently during operations. Such disruptions could cause significant loss of production, which could have a material adverse effect on the Company’s business, financial condition and operating results. Raw Material Costs The principal raw material utilized by the Company in its manufacturing operations is wood chips. The Company’s evergreen Fibre Supply Agreement with Canfor contains a pricing formula that currently results in the Company paying market price for wood chips and contains provisions to adjust the pricing to reflect market conditions. The current pricing under the agreement expired September 1, 2016, and may be amended as necessary to ensure it is reflective of market conditions. The Company and CFP agreed to extend the chip pricing formula under these agreements for one year, with the opportunity to extend for one additional year if both parties agree. Prices for wood chips are not within the Company’s control and are driven by market demand, product availability, environmental restrictions, logging regulations, the imposition of fees or other restrictions on exports of lumber into the US and other matters. In a period of sawmill rationalization or reduced sawmill wood chip supply, increased reliance on higher-cost whole log chips may be required. The Company is not always able to increase the selling prices of its products in response to increases in raw material costs. Residual chip pricing depends on current sawmills running at current levels. In order to meet the raw materials requirements of its mills, the Company may be forced to further supplement with increased purchases of higher-cost whole log chips. Transportation Services The Company relies on third parties for transportation of its products, as well as delivery of raw materials principally by railroad, trucks and ships. If any significant third party transportation providers were to fail to deliver the raw materials or products or distribute them in a timely manner, the Company may be unable to sell those products at full value, or at all, or be unable to manufacture its products in response to customer demand, which may have a material adverse effect on its financial condition and operating results. In addition, if any of these significant third parties were to cease operations or cease doing business with the Company, the Company may be unable to replace them at a reasonable cost. Transportation services may also be impacted by seasonal factors, which could impact the timely delivery of raw materials and distribution of products to customers and have a resulting material adverse impact on CPPI’s financial condition and operating results. As a result of increased government regulation on truck driver work hours and rail capacity constraints, access to adequate transportation capacity has at times been strained and could affect the Company’s ability to move its wood chips, pulp and paper at market competitive prices. Work Stoppages Any labour disruptions and any costs associated with labour disruptions at the Company’s mills could have a material adverse effect on the Company’s production levels and results of operations. The Company’s collective agreements with UNIFOR and PPWC at its Prince George operations expire on April 30, 2017. Any inability to negotiate acceptable contracts with the unions as they expire could result in a strike or work stoppage by the affected workers, and increased operating costs as a result of higher wages or benefits paid to unionized workers. CPPI has received Notice to Bargain from the UNIFOR and the PPWC. Bargaining will commence on May 1, 2017. OUTSTANDING SHARE DATA At December 31, 2016 and February 8, 2017, there were 66,699,368 common shares issued and outstanding. 35DISCLOSURE CONTROLS AND INTERNAL CONTROLS OVER FINANCIAL REPORTING The Company has established disclosure controls and procedures to ensure that information disclosed in this MD&A and the related financial statements was properly recorded, processed, summarized and reported to the Board of Directors and the Audit Committee. The Company’s chief executive officer (“CEO”) and chief financial officer (“CFO”) have evaluated the effectiveness of these disclosure controls and procedures for the year ended December 31, 2016, and have concluded that they are effective. The CEO and CFO acknowledge responsibility for the design of internal controls over financial reporting (“ICFR”), and confirm that there were no changes in these controls that occurred during the year ended December 31, 2016 which materially affected, or are reasonably likely to materially affect, the Company’s ICFR. Based upon their evaluation of these controls for the year ended December 31, 2016, the CEO and CFO have concluded that these controls are operating effectively. Additional information about the Company, including its 2016 Annual Information Form, is available at www.sedar.com or at www.canfor.com. 3637CONS OLIDATE D FIN ANCIA L STAT EM ENT S 38MANAGEMENT’S RESPONSIBILITY The information and representations in these consolidated financial statements are the responsibility of management and have been approved by the Board of Directors. The consolidated financial statements were prepared by management in accordance with International Financial Reporting Standards and, where necessary, reflect management’s best estimates and judgments at this time. It is reasonably possible that circumstances may arise which cause actual results to differ. Management does not believe it is likely that any differences will be material. Canfor Pulp Products Inc. maintains systems of internal accounting controls, policies and procedures to provide reasonable assurance as to the reliability of the financial records and the safeguarding of its assets. The Board of Directors is responsible for ensuring that management fulfills its responsibilities for financial reporting and is ultimately responsible for reviewing and approving the financial statements. The Board carries out these activities primarily through its Audit Committee. The Audit Committee is comprised of three Directors who are not employees of the Company. The Committee meets periodically throughout the year with management, external auditors and internal auditors to review their respective responsibilities, results of the reviews of internal accounting controls, policies and procedures and financial reporting matters. The external and internal auditors meet separately with the Audit Committee. The consolidated financial statements have been reviewed by the Audit Committee and approved by the Board of Directors. The consolidated financial statements have been audited by KPMG LLP, the external auditors, whose report follows. February 8, 2017 Don B. Kayne Chief Executive Officer Alan Nicholl Chief Financial Officer 39KPMG LLP PO Box 10426 777 Dunsmuir Street Vancouver BC V7Y 1K3 Canada Telephone (604) 691-3000 Fax (604) 691-3031 INDEPENDENT AUDITORS’ REPORT To the Shareholders of Canfor Pulp Products Inc. We have audited the accompanying consolidated financial statements of Canfor Pulp Products Inc., which comprise the consolidated balance sheets as at December 31, 2016 and December 31, 2015, the consolidated statements of income, other comprehensive income (loss), changes in equity and cash flows for the years then ended, and notes, comprising a summary of significant accounting policies and other explanatory information. Management’s Responsibility for the Consolidated Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International Financial Reporting Standards, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditors’ Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we comply with ethical requirements and plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on our judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, we consider internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our audit opinion. KPMG LLP is a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. KPMG Canada provides services to KPMG LLP. 40 Opinion In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of Canfor Pulp Products Inc. as at December 31, 2016 and December 31, 2015, and its consolidated financial performance and its consolidated cash flows for the years then ended in accordance with International Financial Reporting Standards. Chartered Professional Accountants February 8, 2017 Vancouver, Canada 41 Canfor Pulp Products Inc. Consolidated Balance Sheets (millions of Canadian dollars) ASSETS Current assets Cash and cash equivalents Accounts receivable - Trade - Other Inventories (Note 5) Prepaid expenses Total current assets Property, plant and equipment (Note 6) Other long-term assets Total assets LIABILITIES Current liabilities Accounts payable and accrued liabilities (Note 7) $ 125.4 $ Total current liabilities Long-term debt (Note 9) Retirement benefit obligations (Note 10) Other long-term provisions Deferred income taxes, net (Note 14) Total liabilities EQUITY Share capital (Note 12) Retained earnings (deficit) Total equity Total liabilities and equity 125.4 50.0 109.1 6.2 61.7 $ 352.4 $ $ $ 491.6 (6.9) 484.7 837.1 $ $ $ $ Commitments (Note 18) & Subsequent Event (Note 24) The accompanying notes are an integral part of these consolidated financial statements. APPROVED BY THE BOARD Director, S.E. Bracken-Horrocks Director, M.J. Korenberg As at December 31, 2016 As at December 31, 2015 $ $ 51.9 75.9 16.8 166.5 5.1 316.2 518.7 2.2 $ 837.1 $ 17.5 101.8 17.5 163.8 7.5 308.1 532.3 0.9 841.3 144.2 144.2 50.0 93.0 6.2 68.2 361.6 508.2 (28.5) 479.7 841.3 42 Canfor Pulp Products Inc. Consolidated Statements of Income (millions of Canadian dollars, except per share data) Sales Costs and expenses Manufacturing and product costs Freight and other distribution costs Amortization Selling and administration costs Operating income Finance expense, net (Note 13) Loss on derivative financial instruments (Note 20) Other income (expense), net (Note 21) Net income before income taxes Income tax expense (Note 14) Net income Net income per common share: (in Canadian dollars) Attributable to equity shareholders of the Company - Basic and diluted (Note 12) The accompanying notes are an integral part of these consolidated financial statements. Years ended December 31, 2015 2016 $ 1,101.9 $ 1,174.7 746.8 155.5 73.8 27.6 1,003.7 98.2 (6.6) - (10.4) 81.2 (23.4) $ 57.8 $ 769.3 169.0 65.2 28.0 1,031.5 143.2 (6.0) (8.8) 14.5 142.9 (36.3) 106.6 $ 0.86 $ 1.52 43Canfor Pulp Products Inc. Consolidated Statements of Other Comprehensive Income (Loss) (millions of Canadian dollars) Net income Other comprehensive income (loss) Items that will not be recycled through net income: Defined benefit plan actuarial gains (losses) (Note 10) Income tax recovery (expense) on defined benefit plan actuarial gains (losses) (Note 14) Other comprehensive income (loss), net of tax Total comprehensive income Consolidated Statements of Changes in Equity (millions of Canadian dollars) Share capital Balance at beginning of year Share purchases (Note 12) Balance at end of year (Note 12) Retained earnings (deficit) Balance at beginning of year Net income Defined benefit plan actuarial gains (losses), net of tax Dividends declared Share purchases (Note 12) Balance at end of year Total equity The accompanying notes are an integral part of these consolidated financial statements. Years ended December 31, 2016 2015 $ 57.8 $ 106.6 (15.5) 4.0 (11.5) 7.6 (2.0) 5.6 $ 46.3 $ 112.2 Years ended December 31, 2016 2015 $ $ 508.2 $ (16.6) 491.6 $ $ (28.5) $ 57.8 (11.5) (16.9) (7.8) (6.9) $ $ $ 522.1 (13.9) 508.2 (32.5) 106.6 5.6 (96.5) (11.7) (28.5) 484.7 $ 479.7 44 Canfor Pulp Products Inc. Consolidated Statements of Cash Flows (millions of Canadian dollars) Cash generated from (used in): Operating activities Net income Items not affecting cash: Amortization Income tax expense Changes in mark-to-market value of derivative financial instruments Employee future benefits Finance expense, net Write-down of advances to Licella (Note 21) Other, net Defined benefit plan contributions, net Income taxes paid, net Net change in non-cash working capital (Note 15) Financing activities Finance expenses paid Dividends paid Share purchases (Note 12) Investing activities Additions to property, plant and equipment, net Advances to Licella (Note 21) Acquisition of Taylor pulp mill (Note 22) Other, net Increase (decrease) in cash and cash equivalents* Cash and cash equivalents at beginning of year* Years ended December 31, 2016 2015 $ 57.8 $ 106.6 73.8 23.4 - 5.1 6.6 7.0 (0.8) (8.3) (33.6) 131.0 19.0 150.0 (3.2) (16.9) (24.7) (44.8) (64.0) (7.0) - 0.2 (70.8) 34.4 17.5 65.2 36.3 (1.0) 5.5 6.0 - (0.4) (3.9) (36.0) 178.3 (32.9) 145.4 (2.7) (96.5) (25.3) (124.5) (68.3) - (12.6) 0.7 (80.2) (59.3) 76.8 17.5 Cash and cash equivalents at end of year* $ 51.9 $ *Cash and cash equivalents include cash on hand less unpresented cheques. The accompanying notes are an integral part of these consolidated financial statements. 45 Canfor Pulp Products Inc. Notes to the Consolidated Financial Statements Years ended December 31, 2016 and 2015 (millions of Canadian dollars unless otherwise noted) 1. Reporting Entity Canfor Pulp Products Inc. (“CPPI”) is a company incorporated and domiciled in Canada and listed on The Toronto Stock Exchange. The address of the Company’s registered office is 100-1700 West 75th Avenue, Vancouver, British Columbia, Canada, V6P 6G2. The consolidated financial statements of the Company as at and for the year ended December 31, 2016 comprise the Company and its subsidiaries (together referred to as “CPPI” or “the Company”). The Company’s operations consist of two Northern Bleached Softwood Kraft (“NBSK”) pulp mills and one NBSK pulp and paper mill located in Prince George, British Columbia, a Bleached Chemi-Thermo Mechanical Pulp (“BCTMP”) mill located in Taylor, British Columbia and a marketing group based in Vancouver, British Columbia. At December 31, 2016, Canfor Corporation (“Canfor”) held a 53.6% interest in CPPI, an increase of 1.7% from December 31, 2015 as a result of share purchases in 2016 (Note 12). 2. Basis of Preparation Statement of compliance The consolidated financial statements of the Company have been prepared in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”). The consolidated financial statements were authorized for issue by the Board of Directors on February 8, 2017. Basis of measurement The consolidated financial statements have been prepared on a historical cost basis, except for the following material items:     Financial instruments classified as fair value through net income are measured at fair value; Financial instruments classified as available-for-sale are measured at fair value with gains or losses, other than impairment losses, recorded in other comprehensive income until realized; Asset retirement obligations are measured at the discounted value of expected future cash flows; and The retirement benefit surplus and obligation related to the defined benefit pension plans are net of the accrued benefit obligation and the fair value of the plan assets. Use of estimates and judgments The preparation of the consolidated financial statements in accordance with IFRS requires management to make judgments, estimates and assumptions that affect the application of accounting policies and the reported amounts of assets, liabilities, income and expenses. Actual results may differ from these estimates. The Company regularly reviews its estimates and assumptions; however, it is possible that circumstances may arise which cause actual results to differ from management estimates, and these differences could be material. Revisions to accounting estimates are recognized in the period in which the estimates are revised and in any future periods affected. Information about the significant areas of estimation uncertainty and critical judgments in applying accounting policies that have the most significant effect on the amounts recognized in the consolidated financial statements is included in the applicable notes:      Note 6 – Property, Plant and Equipment Note 10 – Employee Future Benefits; Note 11 – Asset Retirement Obligations; Note 14 – Income Taxes; and Note 21 – Licella Pulp Joint Venture. 463. Significant Accounting Policies The following accounting policies have been applied to the financial information presented. Basis of consolidation Subsidiaries are entities controlled by the Company. Control exists when CPPI is able to govern the financial and operating activities of those other entities to generate returns for the Company. Inter-company transactions, balances and unrealized gains and losses on transactions between different entities within the Company are eliminated. For joint operations, the Company recognizes its assets, liabilities and transactions, including its share of those incurred jointly, in its consolidated financial statements. Business combinations Business combinations are accounted for using the acquisition method as at the acquisition date. Transaction costs in connection with business combinations are expensed as incurred. Cash and cash equivalents Cash and cash equivalents include cash in bank accounts and highly liquid money market instruments with original maturities of three months or less from the date of acquisition, and are valued at cost, which approximates market value. Cash is presented net of unpresented cheques. When the amount of unpresented cheques is greater than the amount of cash, the net amount is presented as cheques issued in excess of cash on hand. Interest is earned at variable rates dependent on amount, credit quality and term of the Company’s deposits. Financial instruments Non-derivative financial instruments Non-derivative financial instruments comprise trade and other receivables, cash and cash equivalents, loans and advances, and trade and other payables. Non-derivative financial instruments are recognized initially at fair value plus, for instruments not at fair value through net income, any directly attributable transaction costs. Subsequent to initial recognition, non-derivative financial instruments are measured as described below: Financial assets at fair value through net income - An instrument is classified at fair value through net income if it is held for trading or is designated as such upon initial recognition. Financial instruments at fair value through net income are measured at fair value, and changes therein are recognized in the statements of income, with attributable transaction costs being recognized in net income when incurred. Available-for-sale financial assets - Available-for-sale financial assets are non-derivatives that are either designated in this category or not classified in any other categories. These are measured at fair value through other comprehensive income, other than impairment losses. Loans and receivables - Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. These are measured at amortized cost using the effective interest method, less any impairment losses. The effective interest method is used to spread the total costs of or income from a financial instrument over the life of the instrument. Financial assets included within this category for CPPI are trade and other receivables, and cash and cash equivalents. Other liabilities - All of CPPI’s financial liabilities are measured at amortized cost using the effective interest method. Derivative financial instruments CPPI uses derivative financial instruments in the normal course of its operations as a means to manage its foreign exchange, interest rate, pulp price, and energy price risk. The Company’s policy is not to utilize derivative financial instruments for trading or speculative purposes. CPPI’s derivative financial instruments are not designated as hedges for accounting purposes. Consequently, such derivatives for which hedge accounting is not applied are carried on the balance sheet at fair value, with changes in fair value (realized and unrealized) being recognized in the statements of income as ‘gain (loss) on derivative financial instruments’. The fair value of the derivatives is determined with reference to period end market trading prices for derivatives with comparable characteristics. 47Inventories Inventories include pulp, paper, wood chips, logs, and materials and supplies. These are measured at the lower of cost and net realizable value. The cost of inventories is based on the weighted average cost principle, and includes raw materials, direct labour, other direct costs and related production overheads (based on normal operating capacity). Net realizable value is the estimated selling price in the ordinary course of business, less estimated costs of completion and selling expenses. Property, plant and equipment Items of property, plant and equipment, including expenditure on major overhauls, are measured at cost less accumulated amortization and impairment losses. Cost includes expenditures which are directly attributable to the acquisition of the asset. The cost of self-constructed assets includes the cost of materials and direct labour, borrowing costs (as applicable), and any other costs directly attributable to bringing assets to be used in the manner intended by management. Expenditure on major overhauls, refits or repairs is capitalized where it enhances the life or performance of an asset above its originally assessed standard of performance. Certain expenditures relating to replacement of components incurred during major maintenance are capitalized and amortized over the estimated benefit period of such expenditures. The costs of the day-to-day servicing of property, plant and equipment are recognized in net income as incurred. The cost of replacing a major component of an item of property, plant and equipment is recognized in the carrying amount of the item if it is probable that the future economic benefits embodied within the part will flow to CPPI and its cost can be measured reliably. The carrying amount of the replaced component is removed. Amortization is recognized in net income on a straight-line basis over the estimated useful lives of each component of an item of property, plant and equipment, as set out in the table below. Land is not amortized. The majority of CPPI’s amortization expense for property, plant and equipment relates to manufacturing and product costs. Amortization methods, useful lives and residual values are reviewed, and adjusted if appropriate, at each reporting date. The following rates have been applied to CPPI’s capital assets: Buildings Pulp and paper machinery and equipment Mobile equipment Office furniture and equipment Major overhauls Government assistance 10 to 40 years 20 years 4 years 10 years 1 to 2 years Government assistance relating to the acquisition of property, plant and equipment is recorded as a reduction of the cost of the asset to which it relates, with any amortization calculated on the net amount. Government grants related to income are recognized as income or a reimbursement of costs on a systematic basis over the periods necessary to match them with the related costs which they were intended to compensate. Asset impairment CPPI’s property, plant and equipment are reviewed for impairment whenever events or circumstances indicate that the carrying amount may not be recoverable. An impairment loss is recognized in net income at the amount the asset’s carrying amount exceeds its recoverable amount. The recoverable amount is the higher of an asset’s fair value less costs of disposal and value in use. For the purposes of assessing impairment, assets are grouped at the lowest levels for which there are separately identifiable cash inflows that are largely independent of cash inflows from other assets or groups of assets (cash-generating unit or “CGU”). 48Non-financial assets, for which impairment was recorded in a prior period, are reviewed for possible reversal of the impairment at each reporting date. When an impairment loss is reversed, the increased carrying amount of the asset cannot exceed the carrying amount that would have been determined (net of amortization) had no impairment loss been recognized in prior years. Financial assets are reviewed at each reporting date to determine whether there is evidence indicating they are impaired. A financial asset is considered to be impaired if objective evidence indicates that one or more events have had a negative impact on estimated future cash flows from that asset. An impairment loss in respect of a financial asset measured at amortized cost is calculated as the difference between its carrying amount and the present value of the estimated future cash flows discounted at the original effective interest rate. All impairment losses are recognized in net income and are not reversed. Employee future benefits Defined contribution plans A defined contribution plan is a post-employment benefit plan under which an entity makes contributions to a separate entity and has no legal or constructive obligation to pay further amounts. Obligations for contributions to defined contribution plans are recognized as an employee future benefits expense when they are earned. For hourly employees covered by industry union defined contribution plans, the statement of income is charged with CPPI’s contributions required under the collective agreements. Defined benefit plans A defined benefit plan is a post-employment benefit plan other than a defined contribution plan. CPPI, in participation with Canfor, has defined benefit plans that provide both pension and other non-pension post-retirement benefits to most of its salaried employees and certain hourly employees not covered by forest industry union plans. The other non-pension post-retirement benefits include certain health care benefits and pension bridging benefits to eligible retired employees. The surplus and obligation recognized in the balance sheet in respect of a defined benefit pension plan is the net of the accrued benefit obligation and the fair value of the plan assets. The accrued benefit obligation, the related service cost and, where applicable, the past service cost is determined separately for each defined benefit pension plan based on actuarial determinations using the projected unit credit method. Under the projected unit credit method, the accrued benefit obligation is calculated as the present value of each member’s prospective benefits earned in respect of credited service prior to the valuation date and the related service cost is calculated as the present value of the benefits the member is assumed to earn for credited service in the ensuing year. The actuarial assumptions used in these calculations, such as salary escalation and health care inflation, are based upon best estimates selected by CPPI. The discount rate assumptions are based on the yield at the reporting date on high quality corporate bonds that have maturity dates approximating the terms of CPPI’s obligations. Actuarial gains and losses can arise from differences between actual and expected outcomes or changes in the actuarial assumptions. Actuarial gains and losses, including the return on plan assets, are recognized in other comprehensive income on a quarterly basis and in the period in which they occur. 49Provisions CPPI recognizes a provision if, as a result of a past event, it has a present legal or constructive obligation that can be estimated reliably, and it is probable that an outflow of economic benefits will be required to settle the obligation. The provision recorded is management’s best estimate of the expenditure required to settle the present obligation at the end of the reporting period. Provisions are determined by discounting the expected future cash flows at a pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the liability. The expense arising from the unwinding of the discount due to the passage of time is recorded as a finance expense. The main class of provision recognized by CPPI is as follows: Asset retirement obligations CPPI recognizes a liability for asset retirement obligations in the period in which they are incurred. The site restoration costs are capitalized as part of the cost of the related item of property, plant and equipment and amortized on a basis consistent with the expected useful life of the related asset. Asset retirement obligations are discounted at the risk-free rate in effect at the balance sheet date. Revenue recognition CPPI’s revenues are substantially derived from the sale of pulp, paper and energy. Revenue is measured at the fair value of the consideration received or receivable net of applicable sales taxes, returns, rebates and discounts and after eliminating sales within the Company. Revenue is recognized when the significant risks and rewards of ownership have been transferred to the buyer, recovery of the consideration is probable, the associated costs and possible returns of the goods can be estimated reliably, there is no continuing management involvement with the goods, and the amounts of revenue can be measured reliably. Energy revenue is recognized when CPPI has met the terms and conditions under both its electricity purchase and load displacement agreements. Amounts charged to customers for shipping and handling are recognized as revenue, and shipping and handling costs incurred by CPPI are reported as a component of freight and other distribution costs. Income taxes Income tax expense comprises current and deferred tax. Current and deferred taxes are recognized in net income except to the extent that they relate to items recognized directly in equity or in other comprehensive income. Current tax is the expected tax payable or receivable on the taxable income or loss for the period, using the tax rates enacted or substantively enacted at the reporting date, and any adjustment to tax payable in respect of previous periods. CPPI recognizes deferred income tax in respect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes. Deferred income tax is measured at tax rates expected to be applied to the temporary differences when they reverse, based on the laws that have been enacted or substantively enacted by the reporting date. A deferred income tax asset is recognized for unused tax losses, tax credits and deductible temporary differences, to the extent that it is probable that future taxable profits will be available against which they can be utilized. Deferred income tax assets are reviewed at each reporting date and are reduced to the extent that it is no longer probable that the related tax benefit will be realized. Investment tax credits are credited to manufacturing and product costs in the period in which it becomes reasonably assured that the Company is entitled to them. Unused investment tax credits are recorded as other current or long- term assets in the Company’s balance sheet, depending upon when the benefit is expected to be received. Foreign currency translation Items included in the financial statements of each of the Company’s entities are measured using the currency of the primary economic environment in which the entity operates (the “functional currency”). The consolidated financial statements are presented in Canadian dollars, which is the Company’s functional currency. 50The majority of CPPI sales are denominated in foreign currencies, principally the US dollar. Transactions in foreign currencies are translated to the functional currency at exchange rates on the dates of transactions. Monetary assets and liabilities denominated in foreign currencies at the reporting date are translated to the functional currency at the exchange rate on that date. Foreign currency differences arising on translation are recognized in net income. The assets and liabilities of foreign operations are translated to the Canadian dollar at exchange rates on the reporting date. The income and expenses of foreign operations are translated to the Canadian dollar at exchange rates on the transaction dates. Foreign exchange differences are recognized in other comprehensive income. Segment reporting Operating segments are reported in a manner consistent with the internal reporting provided to the chief operating decision-maker. Segment results reported to the chief operating decision-maker include items directly attributable to a segment as well as those that can be allocated on a reasonable basis. Unallocated items mainly comprise interest- bearing liabilities, head office expenses, and income tax assets and liabilities. Segment capital expenditure is the total cost incurred during the period to acquire property, plant and equipment. 4. Accounting Standards Issued and Not Applied In May 2014, the International Accounting Standards Board (“IASB”) issued IFRS 15, Revenue from Contracts with Customers, which will supersede IAS 18, Revenue, IAS 11, Construction Contracts and related interpretations. The new standard is effective for annual periods beginning on or after January 1, 2018. The Company has performed a preliminary assessment of the impact of the new standard, and currently anticipates no significant impact on its financial statements. In July 2014, the IASB issued IFRS 9, Financial Instruments. The required adoption date for IFRS 9 is January 1, 2018 and the Company does not anticipate the new standard to have a significant impact on its financial statements. In January 2016, the IASB issued IFRS 16, Leases, which will supersede IAS 17, Leases and related interpretations. The required adoption date for IFRS 16 is January 1, 2019 and the Company is in the process of assessing the impact on the financial statements of this new standard. 5. Inventories (millions of Canadian dollars) Pulp Paper Wood chips and logs Materials and supplies As at December 31, 2016 84.2 $ As at December 31, 2015 71.2 $ 15.7 15.4 51.2 20.9 21.9 49.8 $ 166.5 $ 163.8 The above inventory balances are stated after inventory write-downs from cost to net realizable value. There were no inventory write-downs at December 31, 2016 (2015 - $0.5 million). In 2016, of the total manufacturing and product costs of $746.8 million, $394.7 million related to the costs of raw materials, consumables and changes in finished products (2015 - $422.1 million). 51 Land and improvements Buildings, machinery and equipment Asset retirement - landfill Construction in progress Major overhauls 6. Property, Plant and Equipment (millions of Canadian dollars) Cost Balance at January 1, 2015 Additions1 Acquisitions (Note 22) Disposals Transfers Balance at December 31, 2015 Additions1 Disposals Transfers Balance at December 31, 2016 Amortization Balance at January 1, 2015 Amortization for the year Disposals Balance at December 31, 2015 Amortization for the year Disposals Balance at December 31, 2016 $ 5.4 $ - - - - 5.4 $ - - - 5.4 $ - - - - - - - $ $ $ $ $ $ $ $ Carrying Amounts At January 1, 2015 At December 31, 2015 At December 31, 2016 1Net of capital expenditures financed by government grants. 5.4 $ 5.4 $ 5.4 $ $ $ $ $ $ $ $ $ 1,480.7 0.3 4.0 (10.6) 66.0 1,540.4 - (10.6) 48.5 1,578.3 (1,018.2) (49.5) 9.9 (1,057.8) (50.5) 7.3 (1,101.0) $ 2.1 0.9 0.1 - - 3.1 - (0.2) - 2.9 $ $ $ (1.0) $ (0.1) - (1.1) $ (0.1) - (1.2) $ 39.4 68.8 - - (92.1) 16.1 63.7 - (61.5) 18.3 - - - - - - - 462.5 482.6 477.3 $ $ $ 1.1 2.0 1.7 $ $ $ 39.4 16.1 18.3 $ $ $ $ $ $ $ $ $ Total 1,562.1 70.0 4.1 (30.3) - 1,605.9 63.7 (25.9) - 1,643.7 34.5 - - (19.7) 26.1 40.9 - (15.1) 13.0 38.8 $ $ $ (18.8) $ (15.6) 19.7 (14.7) $ (23.2) 15.1 (22.8) $ (1,038.0) (65.2) 29.6 (1,073.6) (73.8) 22.4 (1,125.0) $ 15.7 26.2 $ 16.0 $ 524.1 532.3 518.7 7. Accounts Payable and Accrued Liabilities (millions of Canadian dollars) Trade payables and accrued liabilities Accrued payroll and related liabilities Income tax payable Other 8. Operating Loans (millions of Canadian dollars) Available operating loans: Operating loan facility Facility for letters of credit Total operating loan facility Letters of credit Total available operating loan facility As at December 31, 2016 71.9 As at December 31, 2015 75.6 $ 37.4 1.1 15.0 125.4 $ 37.5 13.4 17.7 144.2 As at December 31, 2016 As at December 31, 2015 110.0 $ - 110.0 (9.3) 100.7 $ 110.0 20.0 130.0 (13.0) 117.0 $ $ $ $ The terms of the Company’s operating loan facility include interest payable at floating rates that vary depending on the ratio of debt to total capitalization, and is based on the lenders’ Canadian prime rate, bankers acceptances, US dollar base rate or US dollar LIBOR rate, plus a margin. The facility has certain financial covenants including a covenant based on maximum debt to total capitalization of the Company. In 2015, the maturity date of this facility was extended to January 31, 2019 and the minimum net worth financial covenant, which was based on shareholders’ equity, was removed. Subsequent to this extension, in 2016, the maturity date of this facility was extended to January 31, 2020. No amounts were drawn on the operating loan facility as at December 31, 2016 (2015 - nil). 52 CPPI had a separate facility to cover letters of credit, which expired in 2016. At December 31, 2016, $9.3 million of letters of credit outstanding are covered under the general operating loan facility. As at December 31, 2016, the Company is in compliance with all covenants relating to its operating loans. 9. Long-Term Debt CPPI has a $50.0 million unsecured non-revolving term loan with no penalty for early repayment. In 2016, CPPI extended the maturity date on the term loan from November 5, 2018 to January 31, 2020. The interest rate on the term loan is based on the lenders’ Canadian prime rate or bankers acceptance rate in the year of payment. The term debt has certain financial covenants including a covenant based on maximum debt to total capitalization of the Company. In 2015, the minimum net worth financial covenant, which was based on shareholders’ equity, was removed. Provisions contained in CPPI’s long-term borrowing agreements also limit the amount of indebtedness that the Company may incur and the amount of dividends it may pay on its common shares. The amount of dividends the Company is permitted to pay under its long-term borrowing agreements is determined by reference to consolidated net earnings less certain restricted payments. As at December 31, 2016, the Company is in compliance with all covenants relating to its long-term debt. Fair value of total long-term debt At December 31, 2016, the fair value of the Company’s long-term debt approximates its amortized cost of $50.0 million (2015 - $50.0 million). 10. Employee Future Benefits The Company, in participation with Canfor, has several funded and unfunded defined benefit pension plans, defined contribution plans, and other non-pension post-retirement benefit plans that provide benefits to substantially all salaried employees and certain hourly employees. The defined benefit pension plans are based on years of service and final average salary. CPPI’s other non-pension post-retirement benefit plans are non-contributory and include a range of health care and other benefits. Total cash payments for employee future benefits for 2016 were $17.8 million (2015 - $13.1 million), consisting of cash contributed by CPPI to its funded pension plans, cash payments directly to beneficiaries for its unfunded other non-pension post-retirement benefit plans, and cash contributed to its defined contribution plans. Defined benefit plans CPPI measures its accrued retirement benefit obligations and the fair value of plan assets for accounting purposes as at December 31 of each year. As at December 31, 2016, CPPI has one registered defined benefit pension plan for which an actuarial valuation is performed every three years. The pension plan underwent an actuarial valuation for funding purposes as of December 31, 2015, which was completed in 2016. In addition, CPPI has other non-contributory benefit plans that provide certain non-pension post-retirement benefits to its members. The other non-contributory plans also underwent a valuation as of December 31, 2015, which was completed in 2016. 53Information about CPPI’s defined benefit plans, in aggregate, is as follows: Fair market value of plan assets 2016 2015 (millions of Canadian dollars) Beginning of year Interest income on plan assets Return on plan assets greater (less) than discount rate Employer contributions Employee contributions Taylor pulp mill transfer Benefit payments Administration expense End of year Plan assets consist of the following: Asset category Equity securities Debt securities Annuities Cash and cash equivalents Accrued benefit obligations (millions of Canadian dollars) Beginning of year Current service cost Interest cost Employee contributions Benefit payments Actuarial loss (gain) Taylor pulp mill transfer Other End of year Defined Benefit Pension Plans 119.0 $ $ Other Benefit Plans - $ 4.9 (1.6) 6.3 0.1 - (4.7) (0.1) $ 123.9 $ - - 2.0 - - (2.0) - - Defined Benefit Pension Plans 108.9 4.5 2.4 2.0 0.1 6.9 (5.7) (0.1) Other Benefit Plans - $ - - 1.8 - - (1.8) - - $ 119.0 $ As at December 31, 2016 As at December 31, 2015 Percentage of Plan Assets 15% 56% 29% - 100% 17% 77% 5% 1% 100% 2016 2015 Defined Benefit Pension Plans 135.9 $ $ Other Benefit Plans 74.9 $ Defined Benefit Pension Plans 125.9 Other Benefit Plans 76.9 $ 2.8 5.5 0.1 (4.7) 8.4 - - 1.9 3.0 - (2.0) 5.5 - 0.3 3.2 5.1 0.1 (5.7) 0.1 7.2 - 2.1 2.9 - (1.8) (5.2) - - $ 148.0 $ 83.6 $ 135.9 $ 74.9 Of the defined benefit pension plan obligation of $148.0 million (2015 - $135.9 million), $132.8 million (2015 - $121.4 million) relates to plans that are wholly or partly funded and $15.2 million (2015 - $14.5 million) relates to plans that are wholly unfunded. At December 31, 2016, certain liabilities for pension benefit plans were secured by letters of credit in the amount of $1.6 million (2015 - $1.4 million). The total obligation for the other benefit plans of $83.6 million (2015 - $74.9 million) is unfunded. 54 Annuity contracts In 2016, the Company purchased $33.7 million of buy-in annuities through its defined benefit pension plans, increasing total annuities purchased to $39.8 million. Future cash flows from the annuities will match the amount and timing of benefits payable under the plans, substantially mitigating the exposure to future volatility in the related pension obligations. Transaction costs of $3.6 million related to the purchase were recognized in other comprehensive income (loss), principally reflecting the difference in the annuity rate (which is comparable to solvency rates) compared to the discount rate used to value the obligations on a going concern basis. At December 31, 2016, reflecting the buy-in annuities, 24% (2015 - 4%) of the defined benefit pension plan obligations were fully hedged against changes in future discount rates and longevity risk (potential increases in life expectancy of plan members). A further 46% was partially hedged against changes in future discount rates through the plan’s investment in debt securities (2015 - 67%). Reconciliation of funded status of defined benefit plans to amounts recorded in the financial statements December 31, 2016 December 31, 2015 (millions of Canadian dollars) Fair market value of plan assets Accrued benefit obligations Funded status of plans – deficit Other pension plans Total accrued benefit liability, net Components of pension cost Defined Benefit Pension Plans 123.9 $ (148.0) Other Benefit Plans - (83.6) Defined Benefit Pension Plans $ 119.0 $ (135.9) (24.1) $ (83.6) $ (16.9) $ (1.4) - (1.2) Other Benefit Plans - (74.9) (74.9) - (25.5) $ (83.6) $ (18.1) $ (74.9) $ $ $ The following table shows the before tax impact on net income and other comprehensive income (loss) of the Company’s defined benefit pension and other non-pension post-retirement benefit plans: (millions of Canadian dollars) Recognized in net income Current service cost Administration expense Interest cost Other Total charge included in net income Recognized in other comprehensive income (loss) Actuarial loss (gain) – experience Actuarial loss (gain) – financial assumptions Return on plan assets less (greater) than discount rate Administration expense less than expected Total charge (credit) included in other comprehensive 2016 2015 Defined Benefit Pension Plans Other Benefit Plans Defined Benefit Pension Plans Other Benefit Plans $ $ $ 2.8 $ 1.9 $ 0.1 0.6 - - 3.0 0.3 3.5 $ 5.2 $ 4.6 $ (0.1) $ 3.8 1.6 - 5.6 - - 3.2 0.2 0.6 - 4.0 3.4 (3.3) (2.4) (0.1) $ $ $ 2.1 - 2.9 (0.1) 4.9 3.1 (8.3) - - income (loss) $ 10.0 $ 5.5 $ (2.4) $ (5.2) 55 Significant assumptions The actuarial assumptions used in measuring CPPI’s benefit plan provisions and benefit costs are as follows: Discount rate Rate of compensation increases Initial medical cost trend rate Ultimate medical cost trend rate Year ultimate rate is reached December 31, 2016 Defined Benefit Pension Plans 3.9% 3.0% n/a n/a n/a Other Benefit Plans 3.9% n/a 7.0% 4.5% 2022 December 31, 2015 Defined Benefit Pension Plans 4.1% Other Benefit Plans 4.1% 3.0% n/a n/a n/a n/a 7.0% 4.5% 2021 In addition to the significant assumptions listed in the table above, the average life expectancy of a 65 year old at December 31, 2016 is between 20.9 years and 24.1 years (2015 - 20.9 years and 24.0 years). As at December 31, 2016, the weighted average duration of the defined benefit plan obligation, which reflects the average age of the plan members, is 12.1 years (2015 - 12.0 years). The weighted average duration of the other benefit plans is 14.6 years (2015 - 14.3 years). Sensitivity analysis Assumed discount rates and medical cost trend rates have a significant effect on the accrued retirement benefit obligation and related plan assets. A one percentage point change in these assumptions would have the following effects on the accrued retirement benefit obligation, before taking into account the impact of hedging, and related plan annuity assets for 2016: (millions of Canadian dollars) Defined benefit pension plan liabilities Discount rate Defined benefit pension plan annuity assets Discount rate Other benefit plan liabilities Discount rate Initial medical cost trend rate 1% Increase 1% Decrease $ $ $ $ (16.6) $ 20.4 (3.6) $ 4.3 (12.0) 11.4 $ $ 15.3 (9.5) As at December 31, 2016, CPPI estimates that it will make contribution payments of $4.4 million to its defined benefit pension plans in 2017 based on the last actuarial valuation for funding purposes. Defined contribution and other plans The total expense recognized in 2016 for CPPI’s defined contribution plans was $2.3 million (2015 - $2.2 million). CPPI contributes to a pulp industry pension plan providing pension benefits. This plan is accounted for as a defined contribution plan. Contributions to this plan, not included in the expense for the defined contribution plan above, amounted to $7.2 million in 2016 (2015 - $7.0 million). 11. Asset Retirement Obligations The following table provides a reconciliation of the asset retirement obligations as at December 31, 2016 and 2015: (millions of Canadian dollars) Asset retirement obligations at beginning of year Accretion expense Acquisitions (Note 22) Changes in estimates Asset retirement obligations at end of year $ 2016 5.5 0.1 - (0.2) 5.4 $ 2015 3.5 0.1 1.0 0.9 5.5 $ $ 56 CPPI’s asset retirement obligations represent estimated undiscounted future payments of $9.3 million to remediate landfills at the operations at the end of their useful lives. The payments are expected to occur at periods ranging from 6 to 35 years and have been discounted at risk-free rates ranging from 1.3% to 2.3% (2015 - 1.0% to 2.2%). The $0.2 million of changes in estimates associated with the asset retirement obligations principally reflect higher discount rates used in the valuation of the obligations. CPPI has certain assets that have indeterminable retirement dates and, therefore, there is an indeterminate settlement date for the related asset retirement obligations. As a result, no asset retirement obligations are recorded for these assets. These assets include wastewater and effluent ponds that will have to be drained once the related operating facility is closed and storage sites for which removal of chemicals, fuels and other related materials will be required once the related operating facility is closed. When the retirement dates of these assets become determinable and an estimate can be made, an asset retirement obligation will be recorded. It is possible that changes in future conditions could require a material change in the recognized amount of the asset retirement obligations. The asset retirement obligations balance is included in other long-term provisions on the balance sheet. 12. Share Capital Authorized Unlimited number of common shares, no par value. Issued and fully paid (millions of Canadian dollars, except number of shares) Common shares at beginning of year Common shares purchased Common shares at end of year Number of Shares 68,951,872 (2,252,504) 66,699,368 2016 $ $ Amount 508.2 Number of Shares 70,829,823 (16.6) (1,877,951) 2015 $ 491.6 68,951,872 $ Amount 522.1 (13.9) 508.2 The holders of common shares are entitled to vote at all meetings of shareholders of the Company and are entitled to receive dividends when declared. Basic net income per share is calculated by dividing the net income available to common shareholders by the weighted average number of common shares outstanding during the period. The weighted average number of common shares outstanding for 2016 is 67,519,888 (2015 - 70,105,543), and reflects common shares purchased under the Company’s normal course issuer bid. Normal course issuer bid On March 7, 2016, the Company renewed its normal course issuer bid whereby it can purchase for cancellation up to 3,446,139 common shares or approximately 5% of its issued and outstanding common shares as of March 1, 2016. The renewed normal course issuer bid is set to expire on March 6, 2017. In 2016, CPPI purchased 2,252,504 common shares for $24.4 million (an average price of $10.83 per common share), of which $16.6 million was charged to share capital and $7.8 million was charged to retained earnings. Cash payments for share purchases totaled $24.7 million during the year. As a result of the share purchases in 2016, Canfor’s interest in CPPI increased from 51.9% at December 31, 2015 to 53.6% at December 31, 2016. In 2015, under a previous normal course issuer bid, CPPI purchased 1,877,951 common shares for $25.6 million (an average price of $13.63 per common share), of which $13.9 million was charged to share capital and $11.7 million was charged to retained earnings. Cash payments for share purchases totaled $25.3 million during the 2015 year. 13. Finance Expense, Net (millions of Canadian dollars) Interest expense on borrowings Interest expense on retirement benefit obligations, net Interest income Other Finance expense, net 2016 2015 $ $ (3.0) (3.6) 0.2 (0.2) (6.6) $ $ (3.0) (3.5) 0.7 (0.2) (6.0) 5714. Income Taxes The components of income tax expense are as follows: (millions of Canadian dollars) Current Deferred Income tax expense 2016 (25.9) 2.5 (23.4) $ $ $ $ 2015 (35.6) (0.7) (36.3) The reconciliation of income taxes calculated at the statutory rate to the actual income tax provision is as follows: (millions of Canadian dollars) Income tax expense at statutory rate of 26.0% Add (deduct): Permanent difference from capital gains and other non-deductible items Entities with different income tax rates and other tax adjustments Income tax expense 2016 2015 $ (21.1) $ (37.2) (1.8) (0.5) (23.4) $ (0.1) 1.0 (36.3) $ In addition to the amounts recorded to net income, a tax recovery of $4.0 million was recorded in other comprehensive income (loss) for the year ended December 31, 2016 (2015 - expense of $2.0 million) in relation to actuarial gains/losses on the defined benefit plans. The tax effects of the significant components of temporary differences that give rise to deferred income tax assets and liabilities are as follows: (millions of Canadian dollars) Deferred income tax assets Retirement benefit obligations Other Deferred income tax liabilities Depreciable capital assets Other Total deferred income taxes, net 15. Net Change in Non-Cash Working Capital (millions of Canadian dollars) Accounts receivable Inventories Prepaid expenses Accounts payable and accrued liabilities Net decrease (increase) in non-cash working capital 16. Related Party Transactions As at December 31, 2016 As at December 31, 2015 $ $ $ $ $ $ $ 28.0 2.1 30.1 $ (91.2) $ (0.6) (91.8) (61.7) $ 23.9 2.1 26.0 (93.9) (0.3) (94.2) (68.2) 2016 2015 24.2 (2.9) 2.5 (4.8) 19.0 $ (49.7) (4.8) 4.4 17.2 $ (32.9) CPPI undertakes transactions with various related entities. These transactions are in the normal course of business and are generally on similar terms as those accorded to unrelated third parties, except where noted otherwise. In 2016, the Company depended on Canfor to provide approximately 63% (2015 - 64%) of its fibre supply as well as certain key business and administrative services. As a result of these relationships, the Company considers its operations to be dependent on its ongoing relationship with Canfor. The current market-based pricing under the Company’s Fibre Supply Agreement with Canfor expired September 1, 2016. The Company and Canfor agreed to extend the chip pricing formula under this agreement one year with the opportunity to extend for one additional year if both parties agree. The Company purchased wood chips, logs and hog fuel from Canfor sawmills in the amount of $147.8 million in 2016 (2015 - $182.2 million). 58 Canfor provides certain business and administrative services to CPPI under a services agreement. The total amount charged for the services provided by Canfor in 2016 was $12.2 million (2015 - $11.5 million). These amounts are included in manufacturing and product costs and selling and administration costs. CPPI provides certain business and administrative services to Canfor under an incidental services agreement. The total amount charged for the services provided to Canfor in 2016 was $3.5 million (2015 - $3.6 million). These amounts are included as cost recoveries in manufacturing and product costs and selling and administration costs. The Company has a demand loan agreement with Canfor whereby each party may borrow funds from the other party at its discretion. As part of the agreement, the demand loan maturity may not exceed three months, and interest expense is calculated based on the difference between the borrower’s annualized borrowing rate and the average return on highly-rated short-term investments. At December 31, 2016, no amounts are outstanding on the demand loan. At December 31, 2016, an outstanding balance of $10.3 million (2015 - $15.6 million) is due to Canfor. During 2016, CPPI also made contributions to certain post-employment benefit plans for the benefit of CPPI employees and provided services to its joint venture with Licella Fibre Fuel Pty Ltd. See Note 10, Employee Future Benefits, and Note 21, Licella Pulp Joint Venture, for further details. Key management personnel Key management includes members of the Board of Directors and the senior executive management team. The compensation expense for key management for services is as follows: (millions of Canadian dollars) Short-term benefits Post-employment benefits Termination benefits 2016 2015 3.0 0.2 0.1 3.3 $ $ 3.4 0.1 0.5 4.0 $ $ Short-term benefits for most members of the Board of Directors include an annual retainer as well as attendance fees. 5917. Segment Information The Company has two reportable segments which operate as separate business units and represent separate product lines. Sales between the pulp and paper segments are accounted for at prices that approximate fair value. These include sales of slush pulp from the pulp segment to the paper segment. Information regarding the operations of each reportable segment is included in the following table. The accounting policies of the reportable segments are described in Note 3. The Company’s interest-bearing liabilities are not considered to be segment liabilities, but rather, are managed centrally by the treasury function. Other liabilities are not split by segment for the purposes of allocating resources and assessing performance. (millions of Canadian dollars) Year ended December 31, 2016 Pulp Paper Unallocated Elimination Adjustment Total Sales to external customers $ 924.2 $ 176.1 $ 1.6 $ - $ 1,101.9 Sales to other segments Operating income (loss) Amortization Capital expenditures2 Identifiable assets Year ended December 31, 2015 85.9 79.6 69.9 60.9 719.9 - 29.7 3.8 1.7 55.6 - (11.1) 0.1 1.4 61.6 Sales to external customers $ 1,006.1 $ 166.7 $ 1.9 $ (85.9) - - - - - - 98.2 73.8 64.0 837.1 $ 1,174.7 Sales to other segments Operating income (loss) 93.4 127.0 - 27.6 - (11.4) (93.4) - - 143.2 Amortization Capital expenditures2 Identifiable assets 841.3 2Capital expenditures represent cash paid for capital assets during the periods and include capital expenditures that were partially financed by government grants. Capital expenditures for the year ended December 31, 2015 exclude the assets purchased as part of the acquisition of the Taylor pulp mill (Note 22). 746.4 30.9 64.0 62.5 61.5 68.3 65.2 5.8 0.1 3.6 - - - - Geographic information CPPI’s products are marketed worldwide, with sales made to customers in a number of different countries. The following table presents revenue based on the geographical location of CPPI’s customers: (millions of Canadian dollars) Sales by location of customer Canada Asia United States Europe Other 2016 2015 $ 77.4 $ 615.9 279.8 59.4 69.4 78.8 631.9 356.1 74.3 33.6 $ 1,101.9 $ 1,174.7 60 18. Commitments At the end of the year, CPPI has contractual commitments for the construction of capital assets for $1.6 million (2015 - $1.8 million). These commitments are expected to be settled over the following year. CPPI has committed to operating leases for property, plant and equipment. As at December 31, 2016 and 2015, the future minimum lease payments under these operating leases were as follows: (millions of Canadian dollars) Within one year Between one and five years Total As at December 31, 2016 0.4 $ 0.6 1.0 $ As at December 31, 2015 0.4 0.4 0.8 $ $ During the year ended December 31, 2016, $1.7 million (2015 - $2.3 million) was recognized as an expense in the statement of income in respect to operating leases. Energy Agreements The Company has entered into energy agreements with a BC energy company (the “Energy Agreements”) for three of the Company’s mills. These agreements are for the commitment of electrical load displacement and the sale of incremental power from the Company’s pulp and paper mills. These Energy Agreements include incentive grants from the BC energy company for capital investments to increase electrical generation capacity, and also call for performance guarantees to ensure minimum required amounts of electricity are generated, with penalty clauses if they are not met. As part of these commitments, the Company has entered into standby letters of credit for these guarantees. The standby letters of credit have variable expiry dates, depending on the capital invested and the length of the Energy Agreement involved. As at December 31, 2016, CPPI has $7.7 million of standby letters of credit (2015 - $11.6 million) under these agreements, and has no repayment obligations under the terms of any of these agreements. 19. Financial Risk and Capital Management Financial risk management CPPI is exposed to a number of risks as a result of holding financial instruments. These risks include credit risk, liquidity risk and market risk. The CPPI internal Risk Management Committee manages risk in accordance with a Board approved Risk Management Controls Policy. The policy sets out the responsibilities, reporting and counterparty credit and communication requirements associated with all of the Company’s risk management activities. Responsibility for overall philosophy, direction and approval is that of the Board of Directors. Credit risk: Credit risk is the risk of financial loss to CPPI if a counterparty to a financial instrument fails to meet its contractual obligations. Financial instruments that are subject to credit risk include cash and cash equivalents and accounts receivable. Cash and cash equivalents includes cash held through major Canadian and international financial institutions as well as temporary investments with an original maturity date of three months or less. The cash and cash equivalents balance at December 31, 2016 is $51.9 million (2015 - $17.5 million). CPPI utilizes credit insurance to manage the risk associated with trade receivables. As at December 31, 2016, approximately 81% (2015 - 78%) of the outstanding trade receivables are covered under credit insurance. In addition, CPPI requires letters of credit on certain export trade receivables and regularly discounts these letters of credit without recourse. CPPI recognizes the sale of the letters of credit on the settlement date, and accordingly reduces the related trade accounts receivable balance. CPPI’s trade receivable balance at December 31, 2016 is $75.9 million (2015 - $101.8 million). At December 31, 2016, approximately 99% (2015 - 99%) of the trade accounts receivable balance are within CPPI’s established credit terms. 61 Liquidity risk: Liquidity risk is the risk that CPPI will be unable to meet its financial obligations as they come due. The Company manages liquidity risk through regular cash flow forecasting in conjunction with an adequate committed operating loan facility. At December 31, 2016, CPPI has no amounts drawn (2015 - no amounts drawn) on its operating loans and has accounts payable and accrued liabilities of $125.4 million (2015 - $144.2 million), all of which are due within twelve months of the balance sheet date. Market risk: Market risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in interest rates, foreign currency, commodity and energy prices. (i) Interest rate risk: CPPI is exposed to interest rate risk through its current financial assets and financial obligations bearing variable interest rates. CPPI may use interest rate swaps to reduce its exposure to financial obligations bearing variable interest rates. At December 31, 2016 and 2015, CPPI had no fixed interest rate swaps outstanding. (ii) Currency risk: CPPI is exposed to foreign exchange risk primarily related to the US dollar, as CPPI products are sold globally with prices primarily denominated in US dollars or linked to prices quoted in US dollars with certain expenditures transacted in US dollars. In addition, the Company holds financial assets and liabilities in US dollars. These primarily include US dollar bank accounts, investments and trade accounts. An increase (decrease) in the value of the Canadian dollar by US$0.01 would result in a pre-tax loss (gain) of approximately $1.1 million in relation to working capital balances denominated in US dollars at year end (including cash, accounts receivable and accounts payable). A portion of the currency risk associated with US dollar denominated sales is naturally offset by US dollar denominated expenses. A portion of the remaining exposure is sometimes covered by foreign exchange collar contracts that effectively limit the minimum and maximum Canadian dollar recovery related to the sale of those US dollars. CPPI had no foreign exchange derivatives outstanding at December 31, 2016 and 2015. (iii) Commodity price risk: CPPI’s financial performance is dependent on the selling price of its products and the purchase price of raw material inputs. Consequently, CPPI is exposed to changes in commodity prices for pulp and paper, as well as changes in fibre, freight, chemical and energy prices. The markets for pulp and paper are cyclical and are influenced by a variety of factors. These factors include periods of excess supply due to industry capacity additions, periods of decreased demand due to weak global economic activity, inventory destocking by customers and fluctuations in currency exchange rates. During periods of low prices, CPPI is subject to reduced revenues and margins, which adversely impact profitability. From time to time, CPPI enters into futures contracts on commodity exchanges for pulp. Under the Price Risk Management Controls Policy, up to 1% of pulp sales may be sold in this way. CPPI had no pulp futures contracts outstanding at December 31, 2016 and 2015. (iv) Energy price risk: CPPI is exposed to energy price risk relating to purchases of natural gas and diesel oil for use in its operations. The annual exposure is from time to time hedged up to 100% through the use of floating to fixed swap contracts or option contracts with maturity dates up to a maximum of eighteen months. In the case of diesel, CPPI uses Western Texas Intermediate (“WTI”) oil contracts to hedge its exposure. At December 31, 2016 and 2015, the Company had no WTI oil collars outstanding. 62Capital management CPPI’s objectives when managing capital are to maintain a strong balance sheet and a globally competitive cost structure that ensures adequate liquidity to maintain and develop the business through the commodity price cycle. CPPI’s capital is comprised of net debt and shareholders’ equity: (millions of Canadian dollars) Total debt (including operating loans) Less: Cash and cash equivalents Net debt (cash) Total equity As at December 31, 2016 50.0 51.9 (1.9) 484.7 482.8 $ $ $ As at December 31, 2015 50.0 17.5 32.5 479.7 512.2 $ $ $ The Company has certain financial covenants on its debt obligations including a maximum debt to total capitalization ratio, which is calculated by dividing total debt by shareholders’ equity plus total debt. CPPI’s strategy is to ensure it remains in compliance with all of its existing debt covenants to ensure continuous access to capital. CPPI was in compliance with all its debt covenants for the years ended December 31, 2016 and 2015. The Company manages its capital structure through rigorous planning, budgeting and forecasting processes, and ongoing management of operations, investments and capital expenditures. In 2016, to meet CPPI’s operating, growth and return on invested capital objectives, the Company’s management of capital comprised share purchases and dividends, investment in the Company’s operations, development of energy-related assets, and sustainable working capital reduction initiatives. Neither the Company nor any of its subsidiaries are subject to externally imposed capital requirements. 20. Financial Instruments CPPI’s cash and cash equivalents, accounts receivable, loans and advances, operating loans, accounts payable and accrued liabilities, and long-term debt are measured at amortized cost subsequent to initial recognition. Derivative instruments are measured at fair value. IFRS 13, Fair Value Measurement, requires classification of these items within a hierarchy that prioritizes the inputs to fair value measurement. The three levels of the fair value hierarchy are: Level 1 – Unadjusted quoted prices in active markets for identical assets or liabilities; Level 2 – Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly; Level 3 – Inputs that are not based on observable market data. The Company uses a variety of derivative financial instruments from time to time to reduce its exposure to risks associated with fluctuations in foreign exchange rates, pulp prices, energy costs and interest rates. During 2015, the Company settled all of its derivative financial instruments and none are outstanding as at December 31, 2016 (2015 - nil). The following table summarizes the losses on the Company’s level 2 derivative financial instruments for the years ended December 31, 2016 and 2015: (millions of Canadian dollars) Foreign exchange collars Energy derivatives Interest rate swaps Loss on derivative financial instruments 2016 - - - - $ $ $ $ 2015 (8.3) (0.4) (0.1) (8.8) There were no financial instrument transfers between fair value hierarchy levels in 2016 or 2015. 63 21. Licella Pulp Joint Venture On May 27, 2016, CPPI and Licella Fibre Fuel Pty Ltd. (“Licella”) agreed to form a joint venture under the name Licella Pulp Joint Venture to investigate opportunities to integrate Licella’s Catalytic Hydrothermal Reactor platform into CPPI’s pulp mills to economically convert biomass into next generation biofuels and biochemicals. Licella is a subsidiary of Ignite Energy Resources Ltd. (“IER”) an Australian energy technology development company. Under IFRS 11, Joint Arrangements, the joint venture is classified as a joint operation and CPPI will recognize its assets, liabilities and transactions, including its share of those incurred jointly, in its consolidated financial statements. For the year ended December 31, 2016, the Company’s share of the joint venture’s expenses was $1.6 million, which has been recognized in manufacturing and product costs. The Company is required to contribute the first $20.0 million of any funding requirements, including cash and non-cash contributions, to the joint venture. In conjunction with the joint venture agreement and CPPI’s commitment to innovation and the development of potentially transforming technology, CPPI provided a convertible credit facility to IER, the parent company of Licella, which matures on June 21, 2019. The advances on this credit facility are convertible, at CPPI’s option, into common shares of IER. With regards to the convertible credit facility, during 2016, CPPI advanced $7.0 million to Licella and exercised its option to convert $3.5 million of the amount advanced into common shares of IER. Due to the inherent nature of this type of innovation and technology development, CPPI considers these advances to be substantially research and development in nature. As a result, at December 31, 2016, CPPI has recognized losses of $7.0 million in other income (expense). This reflects the Company’s consideration of the intrinsic risk associated with these advances. 22. Purchase of Taylor Pulp Mill On January 30, 2015, CPPI completed the purchase of the Taylor pulp mill from Canfor for cash consideration of $12.6 million including working capital. The acquisition also included a long-term fibre supply agreement under which Canfor will supply the Taylor pulp mill with fibre at prices that approximate fair market value. In addition to the cash consideration paid on the acquisition date, CPPI may also pay contingent consideration to Canfor, based on the Taylor pulp mill’s annual adjusted operating income before amortization over a three-year period, starting January 31, 2015. On the acquisition date, the fair value of the contingent consideration was $1.8 million and was recorded as a long-term provision. CPPI recognized long-term assets acquired net of liabilities assumed at a fair value of $2.8 million and net working capital of $11.6 million. The acquisition was accounted for in accordance with IFRS 3, Business Combinations. If the acquisition had occurred on January 1, 2015, CPPI’s consolidated 2015 sales would have increased by approximately $8.9 million and consolidated 2015 net income would have increased by approximately $0.2 million. The Taylor pulp mill’s results are recorded in the pulp segment. Subsequent to the acquisition date, in 2015, CPPI reversed the $1.8 million contingent consideration provision resulting in a gain recorded to other income to reflect lower forecast Bleached Chemi-Thermo Mechanical Pulp prices over the contingent consideration period. The fair value of the contingent consideration provision was nil at December 31, 2016. 23. Special Dividend In 2015, the Company paid a special dividend of $79.0 million ($1.1250 per share) to the shareholders of the Company. The special dividend was paid as a result of strong cash generated by the business in 2014 and 2015. 24. Subsequent Event On February 8, 2017, the Board of Directors declared a quarterly dividend of $0.0625 per share, payable on February 28, 2017, to shareholders of record on February 21, 2017. 6465ADDITI ON AL INFORMATIO N 66DIRECTORS AND OFFICERS DIRECTORS The name and municipality, province and country of residence of the Directors of the Company and their principal occupations as at December 31, 2016 are as below. For more information visit www.canfor.com. John Baird (4)(5) Corporate Director Toronto, Ontario, Canada Conrad Pinette (2)(4)(5) Corporate Director Vancouver, British Columbia, Canada Charles Jago, PH.D., C.M., O.B.C.(2)(4) Corporate Director Prince George, British Columbia, Canada William Stinson (1)(2)(4)(5) Chairman and Chief Executive Officer Westshore Terminals Investment Corporation Vancouver, British Columbia, Canada Peter Bentley, O.C., O.B.C., LL.D. (2)(3)(4)(5) Chairman Emeritus Canfor Corporation Vancouver, British Columbia, Canada Stan Bracken-Horrocks, FCPA, FCA (1)(3)(5) Corporate Director Kelowna, British Columbia, Canada Michael Korenberg (1)(3)(5) Chairman Canfor Pulp Products Inc. and The Wreath Group West Vancouver, British Columbia, Canada OFFICERS The name and municipality, province and country of residence of the executive officers of the Company and the offices held by them as at December 31, 2016 are as below. For more information visit www.canfor.com. Michael Korenberg Chairman West Vancouver, British Columbia, Canada Alan Nicholl Chief Financial Officer West Vancouver, British Columbia, Canada Martin Pudlas Vice President, Operations Prince George, British Columbia, Canada Donald Kayne Chief Executive Officer Tsawwassen, British Columbia, Canada David Calabrigo, Q.C. Corporate Secretary Vancouver, British Columbia, Canada Peter Hart Vice President, Pulp and Paper Sales and Marketing Vancouver, British Columbia, Canada Brett Robinson President Tsawwassen, British Columbia, Canada (1) M e m b e r o f t h e A u d i t C o m m i t t e e , w h i c h r e v i e w s t h e C o m p a n y ’s f i n a n c i a l s t a t e m e n t s , t h e s c o p e a n d r e s u l t s o f t h e e x t e r n a l a u d i t o r ’s w o r k , t h e a d e q u a c y o f i n t e r n a l a c c o u n t i n g a n d a u d i t p r o g r a m s a n d c o m p l i a n c e w i t h a c c o u n t i n g a n d r e p o r t i n g s t a n d a r d s . ( 2 ) M e m b e r o f t h e J o i n t M a n a g e m e n t R e s o u r c e s a n d C o m p e n s a t i o n C o m m i t t e e , w h i c h o v e r s e e s c o m p e n s a t i o n p o l i c i e s a p p r o v e d b y t h e B o a r d a n d m a k e s r e c o m m e n d a t i o n s t o t h e B o a r d r e g a r d i n g e x e c u t i v e c o m p e n s a t i o n . ( 3 ) M e m b e r o f t h e J o i n t C o r p o r a t e G o v e r n a n c e C o m m i t t e e , w h i c h e n s u r e s t h a t t h e C o m p a n y t h r o u g h i t s B o a r d o f D i r e c t o r s s u s t a i n s a n e f f e c t i v e a p p r o a c h t o c o r p o r a t e g o v e r n a n c e . ( 4 ) M e m b e r o f t h e J o i n t E n v i r o n m e n t a l , H e a l t h a n d S a f e t y C o m m i t t e e , w h i c h d e v e l o p s , r e v i e w s a n d m a k e s r e c o m m e n d a t i o n s o n m a t t e r s r e l a t e d t o t h e C o m p a n y ’s e n v i r o n m e n t a l , h e a l t h a n d s a f e t y p o l i c i e s , a n d m o n i t o r s c o m p l i a n c e w i t h t h o s e p o l i c i e s a n d w i t h g o v e r n m e n t r e g u l a t i o n . ( 5 ) M e m b e r o f t h e J o i n t C a p i t a l E x p e n d i t u r e C o m m i t t e e , w h i c h r e v i e w s p r o p o s e d c a p i t a l e x p e n d i t u r e s . T h e t e r m o f o f f i c e o f e a c h D i r e c t o r e x p i r e s o n t h e d a t e o f t h e n e x t A n n u a l G e n e r a l M e e t i n g o f t h e C o m p a n y . 67 CANFOR PULP INNOVATION Canfor Pulp Innovation (“CPI”) was established and charged with a “search and apply” mandate for technology which determined that we adopt an Open Innovation approach to Canfor Pulp’s R&D investment. Located in a purpose built facility in Burnaby, CPI is unique in Canada, right- sized and ultra-responsive to Canfor Pulp’s customers and mills. CPI operates under 4 strategic themes: cost reduction, strength & quality, tissue, and new products. Delivering an annual program comprising of approximately twenty projects, CPI’s Open Innovation delivery model comprises of 4 levels: CPI staff; contracted industry leading expertise; and partnerships and technical contracts. Sponsored research with an international suite of collaborators is now delivering new opportunities from our growing intellectual property portfolio. CPI is delivering opportunities for continuous customer and mill improvements contributed to ensuring that Canfor Pulp remains a global quality and technology leader in NBSK. CORPORATE AND SHAREHOLDER INFORMATION Annual General Meeting The Annual General Meeting of Canfor Pulp Products Inc. will be held at the Terminal City Club at 837 West Hastings Street, Vancouver, BC, on Wednesday, April 26, 2017 at 11:30 a.m. Auditors KPMG LLP Vancouver, BC Transfer Agent and Registrar CST Trust Company 1600 - 1066 W. Hastings St. Vancouver, BC V6E 3X1 Stock Listing Toronto Stock Exchange Symbol: CFX CPPI also produces an Annual Information Form. To obtain this publication or more information about the Company, please contact Canfor Pulp Products Inc. or visit our website at http://canfor.com/investor-relations Investor Contact Patrick Elliott Vice President & Treasurer Canfor Corporation T: (604) 661-5441 E: patrick.elliott@canfor.com Media Contact Corinne Stavness Senior Director, Corporate Affairs Canfor Corporation T: (604) 661-5225 E: corinne.stavness@canfor.com Katrina Wilson Corporate Controller Canfor Pulp Products Inc. T: (604) 661-5349 E: katrina.wilson@canforpulp.com Canfor Pulp Innovation 138 – 8610 Glenlyon Parkway Burnaby, BC V5J 0B6 T: (604) 228-6710 Canfor Pulp Products Inc. Head Office #230 – 1700 West 75th Avenue Vancouver, BC V6P 6G2 T: (604) 661-5241 E: info@canforpulp.com www.canfor.com 68 WWW.CANFOR.COM WWW.CANFOR.COM 

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