Canfor Pulp Products Inc.
Annual Report 2018

Plain-text annual report

2018 ANNUAL REPORT CANFOR PULP PRODUCTS INC. I N T H I S R E P O RT 02 M E S S AG E TO S H A R E H O L D E R S 03 2018 Management’s Discussion and Analysis 04 Company Overview 05 Overview of 2018 08 Overview of Consolidated Results - 2018 Compared to 2017 09 Operating Results by Business Segment - 2018 Compared to 2017 12 Summary of Financial Position 13 Changes in Financial Position 13 Liquidity and Financial Requirements 15 Transactions with Related Parties 16 Licella Pulp Joint Venture 16 Collective Agreements With Labour Unions 16 Selected Quarterly Financial Information 17 Three-Year Comparative Review 18 Fourth Quarter Results 21 Specific Items Affecting Comparability 22 Outlook 22 Critical Accounting Estimates 24 Future Changes in Accounting Policies 24 Risks and Uncertainties 30 Outstanding Share Data 30 Disclosure Controls and Internal Controls Over Financial Reporting 31 C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S 32 Management’s Responsibility Independent Auditors’ Report 33 37 Consolidated Balance Sheets 38 Consolidated Statements of Income 39 Consolidated Statements of Other Comprehensive Income 39 Consolidated Statements of Changes in Equity 40 Consolidated Statements of Cash Flows 41 Notes to the Consolidated Financial Statements 62 A D D I T I O N A L I N F O R M AT I O N 63 Directors and Officers 64 Corporate and Shareholder Information MESSAGE TO SHAREHOLDERS FROM THE CEO Canfor Pulp Products Inc. (Canfor Pulp) had another excellent year in 2018 resulting in record operating income and return on invested capital driven by record-high pricing. NBSK pulp pricing was extremely strong in 2018 as prices traded at record highs before correcting sharply towards the end of the year. Prices were good in all regions primarily driven by solid customer demand for paper products. Looking ahead to 2019, we expect pricing to gradually improve reflecting increasing demand and limited new supply. Asia will continue to be a key region for our pulp products. China is now the largest consumer of pulp in the world and our largest pulp market. As the Chinese middle class continues to grow at a rapid rate, we are seeing increasing demand for tissue, paper and packaging, as well as many specialty end-uses, including liquid packaging. In order to continue to be a leading global resource company, we are working to remain leaders in innovation and sustainability, diversifying our product offerings and executing at our operations every day so we can grow with our world-class customer base. We are investing in technology to modernize our supply chain with a new software system called Pulp Edge, which is scheduled to go-live in 2019. It will result in improved alignment and integration between our customer orders and production. During 2018, we completed a $65 million capital project at our Northwood Pulp Mill with the installation of a new 32-megawatt condensing turbo-generator that was commercialized in early 2019. This project will result in a significant improvement in overall mill energy efficiency and in a reduction in total fuel consumption. We also completed an energy-reduction capital project at our Taylor Pulp Mill by upgrading its refining line. Canfor Pulp continues to make progress on the technology aimed at converting pulp biomass into a renewable biocrude that could be refined into next-generation biofuels and biochemicals. This initiative is indicative of our commitment to innovation and the importance we place on renewable energy. The year did come with some operating challenges. We experienced unplanned downtime at our Northwood Pulp Mill to enable necessary tube replacements to the mill’s No. 5 recovery boiler to rectify damage discovered during routine preventative maintenance inspections. Repairs were completed late in the fourth quarter. As well, the explosion of a natural gas pipeline near Prince George shut off natural gas to all industrial users in the city. Thanks to the resourcefulness of our employees, the impact was minimized, with our Intercontinental Pulp Mill able to continue partial operations on alternative fuels. As always, safety is our top priority and once again our employees delivered an outstanding safety performance in 2018. I am proud that our medical incident rate continues to decline, which was supported by our fourth quarter’s safety performance when we had zero recordable incidents. We will continue undertaking events to promote employee involvement in safety and raise awareness of the importance of working safely. An integral component of Canfor’s continuing success is our workforce. In 2018, we established the Diversity Council to bring together leaders from across our Canadian operations to address the gender gap in our organization. We recognize we have a long way to go, but we are committed to the work that is required to address the gender balance of our company. We believe gender diversity will make us stronger and more competitive. Our senior leadership team continues to grow and strengthen. In March, Alan Nicholl accepted the expanded position of Chief Financial Officer and Executive Vice President, Finance and Canfor Pulp Operations. In April, Martin Pudlas accepted increasing responsibility as the Vice President, Operations and Innovation. In January 2019, Brian Yuen was appointed to the position of Vice President, Pulp and Paper Sales and Marketing. While we experienced some challenges in the latter part of 2018, Canfor Pulp remains well-positioned to play a role in the shift to a more sustainable global economy. I want to take this opportunity to thank our employees for their contributions and to thank my outstanding executive and management team for their leadership and support. I would also like to extend my appreciation to our Board of Directors for their continued support and guidance, and to our shareholders for their ongoing confidence in Canfor Pulp. Don Kayne Chief Executive Officer 2 2018 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, 2018 relative to the year ended December 31, 2017, and the financial position of the Company at December 31, 2018. 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, 2018 and 2017 (available at www.canfor.com). 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 under IFRS 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 other 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 21, 2019. 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. 3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, 2018 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, 2018, Canfor Corporation (“Canfor”) held a 54.8% interest in CPPI, unchanged from December 31, 2017. CPPI employs 1,278 people in its wholly owned subsidiaries and jointly owned operations as at December 31, 2018. The following chart illustrates, on a simplified basis, the ownership structure of CPPI (collectively the Company) as at December 31, 2018. Simplified Ownership Structure CANFOR CORPORATION (British Columbia) 100% of Shares CANADIAN FOREST PRODUCTS LTD. (British Columbia) 54.8% of Shares Shareholders 45.2% of Shares CANFOR PULP PRODUCTS INC. (British Columbia) 100% of Shares CANFOR PULP LTD. (Canada) The Pulp and Paper Business 4Pulp The Company owns and operates three NBSK pulp mills with an annual production capacity of approximately 1.1 million tonnes of northern softwood market kraft pulp, the significant majority of which is bleached to become NBSK pulp, and approximately 140,000 tonnes of kraft paper. The Northwood pulp mill is a two-line pulp 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 specialty products, premium tissue and printing and writing 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 products as that of Northwood and is delivered to North America, Europe and Asia. 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. The Company also owns and operates the Taylor pulp mill, which it purchased from Canfor in early 2015. This BCTMP facility has an annual production capacity of 220,000 tonnes, and supplies pulp markets in North America and Asia. 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, including high performance bleached and unbleached kraft and specialty papers. The paper mill supplies primarily North American, Asian and European markets. Business Strategy CPPI’s overall business strategy is to be a pulp and paper industry leader with strong financial performance, accomplished through: • • • • • • Optimizing the value from its premium quality pulp and paper products in specialty end use applications; Attaining world-class supply chain performance; Preserving its low-cost operating position and maintaining a strong financial position; Growing its green energy business; Developing an enterprise-wide culture of safety, innovation and engagement; and Capitalizing on attractive growth and diversification opportunities. OVERVIEW OF 2018 2018 was an exceptional year for Canfor Pulp, with the Company reporting operating income of $246.6 million and a return on invested capital of 37%, both all-time record-highs. Global pulp market conditions were favourable for pulp producers through most of 2018. Prices to China, the world’s largest consumer of softwood pulp, stayed at historical-high levels for most of 2018 before a falloff in demand later in the year resulted in a sharp decline in prices. For the 2018 year as a whole, NBSK pulp list prices to China averaged US$8781 per tonne, an increase of US$166 per tonne, or 23%, over 2017. Market fundamentals were also positive in North America and Europe, with prices increasing steadily in both regions over the year. North American NBSK pulp list prices averaged US$1,3371 per tonne for 2018, up US$232 per tonne, or 21% from 2017, with discounts largely unchanged year-over-year. BCTMP prices saw similarly strong markets throughout 2018 before a more modest decline near the end of the year. Operating income for the pulp segment were $248.9 million, up $108.4 million from the previous year, as higher NBSK pulp unit sales realizations more than offset the impact of unscheduled production outages in the latter part of 2018. The most significant outage related to an extended fall maintenance outage on one production line at the Company’s Northwood NBSK pulp mill to enable necessary tube replacements to its No. 5 recovery boiler, rectifying damage discovered during routine preventative maintenance inspections in the early fall. Capital-related downtime associated with the Company’s energy reduction project at its Taylor BCTMP mill, as well as a disruption following a third-party natural gas explosion near Prince George in the fall, also contributed to lower production year-over-year. 1 Resource Information Systems, Inc. 5Unit manufacturing costs reflected higher chemical, energy and maintenance spend related to the aforementioned downtime, as well as market-related increases in fibre costs. Canfor Pulp completed two significant energy projects in 2018: the commissioning and start-up of a condensing turbo-generator at its Northwood NBSK pulp mill in December; and the Taylor energy reduction project mid-way through the year. Compared to the prior year, overall power generation decreased, primarily as a result of the aforementioned unscheduled downtime. The Company’s paper business delivered solid operational performance at its Prince George paper machine in 2018. Operating earnings showed a modest decline as higher slush pulp prices, driven by the record-high NBSK pulp prices in the year, more than offset the benefit of improved US-dollar kraft paper prices in the year. In October 2018, the Company paid a special dividend of $2.25 per common share and continued its quarterly dividend of $0.0625 per common share, returning a combined total of $163.2 million to shareholders in the year. The Company maintained its strong balance sheet with no amounts drawn on its loan facilities during 2018, finishing the year with cash of $7 million. A review of the more significant developments and results by operating segment in 2018 follows. Markets and Pricing (i) Pulp – Solid global pulp fundamentals lead to record-high 2018 prices Positive pricing momentum and strong global pulp market conditions experienced in the latter part of 2017 continued well into 2018. NBSK pulp list prices to China for the year averaged US$878 per tonne, an historic high and US$166 per tonne higher than the 2017 average price, although prices weakened later in the year in response to slowing demand and oversupply in that region, ending the year at US$725 per tonne. North American pricing also saw steady positive momentum through 2018 with list prices rising from US$1,210 per tonne in January to US$1,435 per tonne in December, with discounts broadly unchanged year-over-year. Despite strong demand in the first half of the year, global shipments of bleached softwood kraft pulp in 2018 saw modest decreases compared to 2017, partly due to hardwood pulp substitution that occurred at the elevated softwood pulp prices. Global softwood pulp producer inventories increased in the first quarter of 2018 as a result of major weather-related transportation constraints and minimal maintenance downtime, before declining through the spring maintenance period in the second quarter of 2018. In the latter part of 2018, mostly in response to the slowdown of demand from China, global pulp inventories increased steadily, ending the year at 41 days, well-above the balanced range of 27-30 days. The following charts show the NBSK pulp list price movements in 2018, before taking account of customer discounts and rebates (Chart 1), and the global pulp inventory levels (Chart 2). Chart 1 6Chart 2 CPPI’s sales network represents and co-markets UPM-Kymmene (“UPM”) pulp products in North America, Japan and Korea, while UPM’s pulp sales network represents and co-markets CPPI’s products in Europe and China, as part of a strategic sales and marketing cooperation agreement. This arrangement continued to serve both companies well in 2018, with both CPPI and UPM to sell a broader offering of pulp products and enhanced technical service to customers. (ii) Paper – Kraft paper markets remain strong in 2018 Bleached kraft paper markets continued to show strength through 2018. Positive pricing momentum from 2017 continued into the first half of 2018 and remained steady through the balance of the year, supported by solid demand from North America and Asia. Capital and Operations Review Recovery Boiler major repairs resulting in lower production; Major Taylor and Northwood energy projects commissioned Total pulp and paper production in 2018 was down 91,000 tonnes, or 7%, when compared to the prior year, largely due to unscheduled production downtime in the last four months of the year. As highlighted earlier, Northwood extended its scheduled maintenance outage on one production line to enable necessary tube replacements to its recovery boiler. A third-party natural gas explosion near Prince George, also in the fall, impacted all of the Company’s NBSK mills and contributed to the lower production year-over-year. Scheduled downtime in 2018 included capital- related downtime in connection with the commissioning of the Taylor BCTMP mill’s energy reduction project, and planned maintenance outages at its Northwood and Prince George NBSK pulp mills and Prince George paper mill. Capital spending in 2018 totalled $120.5 million and included the completion of the Taylor mill energy reduction project and Northwood’s installation and commissioning of a new 32 megawatt condensing turbo-generator at a combined cost of approximately $100 million, as well as several smaller high-return discretionary projects. Both projects were delivered on time and on budget. In 2019, the Company anticipates increased energy efficiency and a material reduction in fuel consumption as a result of these projects. As previously mentioned, the Company maintained its solid balance sheet position in 2018 with strong cash flows from operations in the year enabling the Company to continue to distribute earnings back to its shareholders, in the form of quarterly dividend payments of $0.0625 per common share and a special dividend in the fourth quarter of $2.25 per common share, for a combined total of $163.2 million, or the equivalent of $2.50 per common share for the year. 7OVERVIEW OF CONSOLIDATED RESULTS – 2018 COMPARED TO 2017 Selected Financial Information and Statistics (millions of Canadian dollars, except for per share amounts) Sales Operating income before amortization2 Operating income Net income Net income per share, basic and diluted ROIC – Consolidated3 $ $ $ $ $ 2018 1,374.3 326.2 246.6 184.4 2.83 37.0% $ $ $ $ $ 2017 1,197.9 229.0 154.6 102.1 1.55 22.8% Average exchange rate (US$ per C$1.00)4 2 Amortization includes amortization of certain capitalized major maintenance costs. 3 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. 4 Source – Bank of Canada (monthly average rate for the period). 0.772 0.770 $ $ Selected Cash Flow Information (millions of Canadian dollars) Operating income (loss) by segment: Pulp Paper Unallocated Total operating income Add: Amortization5 Total operating income before amortization Add (deduct): Working capital movements Defined benefit plan contributions, net Income taxes paid, net Other operating cash flows, net Cash from operating activities Add (deduct): Repayment of long-term debt Dividends paid Finance expenses paid Capital additions, net Share purchases Other, net Change in cash / operating loans 5 Amortization includes amortization of certain capitalized major maintenance costs. Analysis of Specific Items Affecting Comparability of Net Income After-tax impact (millions of Canadian dollars, except for per share amounts) Net income, as reported Change in substantively enacted tax legislation Net impact of above items Adjusted net income Net income per share (EPS), as reported Net impact of above items per share Adjusted net income per share 2018 2017 248.9 11.0 (13.3) 246.6 79.6 326.2 (25.6) (6.6) (90.4) 11.6 215.2 - (163.2) (3.3) (120.5) (0.1) 2.1 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ (69.8) $ 140.5 26.0 (11.9) 154.6 74.4 229.0 (6.4) (7.0) (19.1) (1.8) 194.7 (50.0) (16.5) (3.3) (83.1) (17.7) 0.7 24.8 2018 2017 184.4 - 184.4 184.4 2.83 - 2.83 $ $ $ $ $ $ $ 102.1 2.8 2.8 104.9 1.55 0.04 1.59 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 8The Company recorded net income of $184.4 million, or $2.83 per share, for the year ended December 31, 2018, an increase of $82.3 million, or $1.28 per share, from $102.1 million, or $1.55 per share, reported for the year ended December 31, 2017. Operating income for 2018 of $246.6 million, an all-time record-high, was up $92.0 million from operating income of $154.6 million reported for 2017. The significant increase in year-over-year results of the pulp segment were principally due to historically high US-dollar NBSK prices, which more than offset market-related fibre cost increases, the impact of unscheduled production outages and increased chemical, energy and maintenance expenses associated with production outages throughout 2018. The paper segment earnings for 2018 showed a modest decline versus 2017 as higher slush pulp prices, resulting from higher NBSK pulp prices in the year, more than offset the benefit of improved US-dollar kraft paper prices in the year. A more detailed review of the Company’s operational performance and results is provided in “Operating Results by Business Segment – 2018 compared to 2017”, which follows this overview of consolidated results. OPERATING RESULTS BY BUSINESS SEGMENT – 2018 COMPARED TO 2017 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 2018 and 2017 are as follows: (millions of Canadian dollars, unless otherwise noted) Sales Operating income before amortization6 Operating income Capital expenditures Average NBSK pulp price delivered to China - US$7 Average NBSK pulp price delivered to China – Cdn$7 Production – pulp (000 mt) 2018 1,192.9 324.2 248.9 113.3 878 1,137 $ $ $ $ $ $ 2017 1,024.5 210.9 140.5 81.3 712 925 $ $ $ $ $ $ 1,117.4 1,205.0 Shipments – pulp (000 mt) 6 Amortization includes amortization of certain capitalized major maintenance costs. 7 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 monthly average rate for the period. 1,131.7 1,216.4 Markets Positive pricing momentum and strong pulp market conditions, particularly in China, experienced in the latter part of 2017 continued well into 2018, before a marked slowdown in China led to a sharp decline in prices to that region through the last three months of 2018. Demand in North America and other regions, including Europe, was less volatile through 2018 with prices increasing steadily through the year. Global softwood shipments declined 3.2% year-over-year8, as total pulp deliveries to Western Europe and China dropped in the fourth quarter of 2018 with slowing market demand. The decrease in softwood shipments in 2018 contrasts with a 4.2% increase in global hardwood shipments year-over-year9, reflecting hardwood pulp substitution at the historically-high softwood pulp prices, particularly in China. At the end of 2018, World 209 producers of bleached softwood pulp inventories were at 41 days of supply, an increase of eleven days from December 2017, for the most part reflecting the slowdown of demand from China in the fourth quarter. Market conditions are generally considered balanced when inventories are in the 27-30 days of supply range. 8 As reported PPPC statistics. 9 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”). 9Sales The Company’s pulp shipments in 2018 were 1.13 million tonnes, down 85,000 tonnes, or 7%, from 2017. Lower shipments in 2018 reflected the impact of higher scheduled and unscheduled downtime of production during the year, combined with slowing demand from China later in the year. NBSK US-dollar pulp list prices to China averaged US$878 per tonne in 2018, a historic-high, up US$166 per tonne, or 23%, compared to 2017. North American NBSK pulp list prices, averaged US$1,337 per tonne for 2018, up US$232 per tonne, or 21% from 2017 with the discounts largely unchanged year-over-year. Accordingly, NBSK pulp unit sales realizations were up significantly from 2017. Average BCTMP unit sales realizations also showed increases in 2018 from the prior year, reflecting strong BCTMP US-dollar pricing through most of 2018. Energy revenue for 2018 was down compared to the prior year primarily as a result of the previously discussed scheduled and unscheduled operational downtime in the second half of the year. Operations Pulp production in 2018, at 1.12 million tonnes, was down 88,000 tonnes, or 7%, from 2017. In 2018, the Company completed scheduled maintenance outages at its Northwood and Prince George NBSK pulp mills. The largest contributing factor to the lower production during 2018 related to the aforementioned recovery boiler extended downtime at Northwood. Unscheduled downtime at the Company’s three NBSK pulp mills also resulted from a third- party natural gas pipeline explosion in the fourth quarter. Combined, these scheduled and unscheduled outages impacted NBSK pulp production by approximately 115,000 tonnes in 2018, compared to scheduled and unscheduled downtime of NBSK pulp production in 2017 totaling 52,000 tonnes. Pulp production in 2018 also reflected a decline in BCTMP production of approximately 25,000 tonnes year-over year, resulting from capital-related downtime taken for the commissioning of the Taylor BCTMP mill energy reduction project, and its subsequent ramp up in the second half of the year, along with seven days of curtailed BCTMP production in December due to reduced residual fibre availability. Pulp unit manufacturing costs were materially higher when compared to 2017, principally reflecting higher fibre costs, lower productivity and higher maintenance, energy and chemical costs resulting from the aforementioned downtime. The increase in fibre costs compared to 2017 largely reflected higher market-based prices for sawmill residuals (linked to higher Canadian NBSK pulp prices), and, to a lesser extent, an increased proportion of higher-cost whole log chips. Paper Selected Financial Information and Statistics – Paper Summarized results for the Paper segment for 2018 and 2017 are as follows: (millions of Canadian dollars, unless otherwise noted) Sales Operating income before amortization10 Operating income Capital expenditures Production – paper (000 mt) Shipments – paper (000 mt) 10 Amortization includes amortization of certain capitalized major maintenance costs. Markets $ $ $ $ 2018 2017 $ $ $ $ 180.9 15.2 11.0 3.7 134.6 130.2 173.0 29.9 26.0 1.8 138.0 139.0 Bleached kraft paper markets continued to show strength throughout 2018 as positive pricing momentum from 2017 continued into the first half of 2018 and remained steady through the balance of the year. Sales The Company’s paper shipments in 2018 at 130,000 tonnes were down 9,000 tonnes from 2017, reflecting the impact of a second quarter scheduled maintenance outage during the current year (there was no scheduled maintenance outage in 2017), combined with the timing of shipments near year-end. Paper unit sales realizations for 2018 were significantly up from 2017, reflecting an improvement in US-dollar kraft paper prices, as well as proportionately higher prime bleached shipments year-over-year. 10Operations Paper production in 2018 was 135,000 tonnes, down 3,000 tonnes from 2017, principally as a result of scheduled maintenance downtime during the year. Higher paper unit manufacturing costs in 2018 were the result of significant increases in slush pulp costs linked to higher Canadian dollar NBSK market pulp prices. Unallocated and Other Items Selected Financial Information (millions of Canadian dollars) Corporate costs Finance expense, net Other income (expense), net Corporate Costs $ $ $ 2018 (13.3) (4.2) 8.7 $ $ $ 2017 (11.9) (7.2) (6.5) Corporate costs, which comprise corporate, head office and general and administrative expenses, were $13.3 million in 2018, an increase of $1.4 million when compared to the prior year, primarily reflecting costs associated with organizational reductions in senior management. Finance Expense, Net Net finance expense for 2018 was $4.2 million, down $3.0 million from 2017. The decrease principally reflected lower employee future benefit interest costs, combined with an increase in interest income earned on higher cash balances held throughout the year. Other Income (Expense), Net Other income, net of $8.7 million for 2018 principally related to favourable foreign exchange movements on US-dollar denominated working capital balances compared to unfavourable foreign exchange movements on US-dollar denominated working capital balances totalling $6.5 million in the prior year. Income Tax Expense The Company recorded an income tax expense of $66.7 million in 2018 with an overall effective tax rate of 27%. 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 27% (2017 – 26%) Add (deduct): Permanent difference from capital gains and other non-deductible items Entities with different income tax rates and other tax adjustments Change in substantively enacted tax legislation Income tax expense 2018 251.1 $ 2017 140.9 (67.8) $ (36.6) $ $ 0.9 0.2 - $ (66.7) $ (0.1) 0.7 (2.8) (38.8) In 2017, the Provincial Government of British Columbia passed legislation increasing the provincial corporate tax rate from 11% to 12% effective January 1, 2018. A $2.8 million increase to income tax expense was recorded in net income in 2017 to record the impact on deferred taxes, with an additional $0.3 million being recorded in other comprehensive income (loss) as an income tax recovery on defined benefit plan actuarial losses. 11Other Comprehensive Income (Loss) CPPI measures its accrued benefit obligations and the fair value of plan assets for accounting purposes as at December 31 of each year. Any actuarial gains or losses which arise are recognized immediately by means of a credit or an expense through Other Comprehensive Income. For 2018, an after-tax gain of $4.0 million was recorded in Other Comprehensive Income, as losses on the Company’s defined benefit pension plans were more than offset by gains on other non-pension post-employment benefits. The loss associated with the defined benefit post-employment compensation plans largely reflected a lower than anticipated return on plan assets, which was offset in part by the benefit of a higher discount rate used to value the net defined benefit obligation. The non-pension post-employment benefit gain reflected the impact of the higher discount rate and favourable actuarial experience adjustments as a result of the most recent actuarial valuation as at December 31, 2017, which was completed in 2018. In 2018, the Company purchased $8.9 million of buy-in annuities through its defined benefit pension plans, increasing total annuities purchased to $86.0 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 $0.7 million related to the purchase were recognized in other comprehensive income (loss), principally reflecting the difference in the annuity rate compared to the discount rate used to value the obligations on a going concern basis. When taking into account the impact of hedging, 49% of the change to the defined benefit pension plans is fully hedged against changes in discount rates and longevity risk (potential increases in life expectancy of plan members) through buy-in annuities, and a further 20% is partially hedged through the plan’s investment in debt securities. In 2017, the after-tax gain of $18.9 million recorded in Other Comprehensive Income largely reflected gains on other non-pension post-employment benefits, partially offset by losses on the Company’s defined benefit pension plan. 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 financial position as at December 31, 2018 and 2017: (millions of Canadian dollars, except for ratios) Cash and cash equivalents Operating working capital Net working capital Property, plant and equipment and intangible assets Other long-term assets Net assets Retirement benefit obligations Other long-term provisions Deferred income taxes, net Total equity 2018 $ 6.9 $ 161.4 168.3 578.2 3.5 $ 750.0 $ 80.0 6.6 66.8 596.6 $ 750.0 $ 2017 76.7 126.8 203.5 526.7 0.5 730.7 85.2 6.5 67.6 571.4 730.7 Ratio of current assets to current liabilities Net debt to total capitalization 1.9 : 1 (1.2)% 2.3 : 1 (15.5)% The ratio of current assets to current liabilities at the end of 2018 was 1.9:1, compared to 2.3:1 at the end of 2017, primarily as a result of a decrease in cash and cash equivalents following the special dividend in 2018, combined with an increase in accounts payable and accrued liabilities due to timing of spend, offset in part by higher inventory balances. See further discussion in “Changes in Financial Position” section. The Company’s net debt to capitalization was negative 1.2% at December 31, 2018 (December 31, 2017: negative 15.5%) reflecting the Company’s zero debt levels and positive cash position at the end of 2018. 12CHANGES IN FINANCIAL POSITION At the end of 2018, CPPI had $6.9 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 2018 2017 $ $ 215.2 $ (166.6) (118.4) (69.8) $ 194.7 (87.5) (82.4) 24.8 The changes in the components of these cash flows during 2018 are discussed in the following sections. Operating Activities For the 2018 year, CPPI generated cash from operating activities of $215.2 million, up $20.5 million from cash generated of $194.7 million in the previous year. The increase in operating cash flows was principally related to higher cash earnings, partially offset by higher tax installment payments in 2018 and unfavourable movements in non-cash working capital relating principally to higher chip and log inventory volumes on hand, which more than offset increased accounts payable and accrued liabilities, related to timing of spend. Financing Activities In 2018, cash used in financing activities of $166.6 million was $79.1 million higher than the $87.5 million used in the prior year. Financing activities in 2018 comprised quarterly dividend payments totaling $16.4 million (reflecting a dividend of $0.0625 per common share in each quarter) as well as a special dividend to shareholders totaling $146.8 million, or $2.25 per common share, as a result of strong operating cash flows generated. Cash used for financing activities in 2017 included the early repayment of the Company’s $50.0 million long-term debt and a total spend of $17.7 million related to share repurchase activity under its Normal Course Issuer Bid (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 2018 were broadly in line with the prior year. Investing Activities Net cash used for investing activities in 2018 was $118.4 million, compared to $82.4 million used in 2017. Capital expenditures of $120.5 million in 2018 were associated with several capital projects including the aforementioned Northwood and Taylor energy projects, the ongoing development of its new ERP software system, which is scheduled to go-live in 2019, as well as various other maintenance of business and other improvement projects. LIQUIDITY AND FINANCIAL REQUIREMENTS Operating Loan and Term Debt At December 31, 2018, the Company had a $110.0 million unsecured operating loan facility which was unused, except for $11.1 million reserved for several standby letters of credit, leaving $98.9 million available and undrawn on the operating facility. On April 6, 2018, the maturity date of the Company’s principal operating loan facility was extended from January 31, 2020 to April 6, 2022. 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. On December 29, 2017, the Company repaid the full principal balance of its term loan of $50.0 million. The interest rate on the term loan was based on the lenders’ Canadian prime rate or bankers’ acceptance rate in the year of payment. 13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 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, 2018, and expects to remain so for the foreseeable future. Normal Course Issuer Bid On March 5, 2018, the Company renewed its normal course issuer bid whereby up to 3,262,941 common shares or approximately 5% of its issued and outstanding common shares as of March 1, 2018 could be purchased for cancellation. The renewed normal course issuer bid is set to expire on March 6, 2019. In 2018, CPPI purchased 500 common shares at an average price of $13.01 per common share, and paid an additional $0.1 million in relation to common shares purchased in the fourth quarter of 2017. As at December 31, 2018 and February 21, 2019, there were 65,250,759 common shares of the Company outstanding and Canfor’s ownership interest in CPPI was 54.8%. 2019 Projected Capital Spending and Debt Repayments Based on its current outlook, assuming no deterioration in market conditions during the year, the Company anticipates that it will invest approximately $110.0 million in capital projects, which will consist primarily of various improvement projects, as well as the development and implementation of a new ERP software system and other maintenance of business expenditures, including major maintenance spending. CPPI has sufficient liquidity in its cash reserves and operating loans to finance its planned capital expenditures as required during 2019. As at December 31, 2018 the Company has no debt outstanding and as a result no debt due for repayment in 2019. Derivative Financial Instruments As at December 31, 2018, 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 2018. 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 2018. c. Enters into futures contracts on commodity exchanges for pulp. The Company did not enter into any pulp futures contracts during 2018. 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 2018. Commitments The following table summarizes CPPI’s financial contractual obligations at December 31, 2018 for each of the next five years and thereafter: (millions of Canadian dollars) 2019 2020 2021 2022 2023 Thereafter Total Operating leases $ 0.7 $ 0.5 $ 0.3 $ 0.1 $ - $ 0.1 $ 1.7 14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, 2018 the Company had posted $6.7 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 $11.8 million, principally related to the construction of capital assets and development of software systems. 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 4 to 33 years which have been discounted at risk free rates ranging from 1.9% to 2.2%. The estimated discounted value is $6.0 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, 2018 was $80.0 million. As at December 31, 2018, CPPI estimated that it would make contribution payments of $4.7 million to its defined benefit pension plans in 2019 based on the last actuarial valuation for funding purposes. Purchase obligations and contractual obligations in the normal course of business. 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. 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. During the year, the Company and Canfor renegotiated and entered into a Fibre Supply agreement, replacing the previously extended Fibre Supply agreement set to expire on September 1, 2018. This agreement includes a market- based chip pricing formula and was effective July 1, 2018, for a three-year term, to June 30, 2021. In 2018, the Company purchased wood chips, logs and hog fuel from Canfor sawmills in the amount of $252.8 million. 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 2018 was $14.8 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 2018 was $4.0 million. At December 31, 2018, an outstanding balance of $31.6 million is due to Canfor. The Jim Pattison Group is Canfor’s largest shareholder. In August of 2018, The Jim Pattison Group’s ownership interest of Canfor increased above 50%, ending the year at 50.9%. During 2018, CPPI sold paper to subsidiaries owned by The Jim Pattison Group totalling $3.0 million. CPPI also made purchases from subsidiaries owned by The Jim Pattison Group totalling $0.7 million. No amounts related to these sales or purchases were outstanding as at December 31, 2018. Additional details on related party transactions are contained in Note 17 to CPPI’s 2018 consolidated financial statements. 15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. In March 2017, the Canadian Federal Government through its Sustainable Development Technology Canada program announced the funding over several years of approximately $13.2 million, contingent on future spending to allow the Licella Pulp Joint Venture to further develop and demonstrate a technology that will economically convert biomass into biofuels and biochemical. In April 2018, the Company received the first instalment of funding in the amount of $1.9 million. During 2018, the Company, together with its joint venture partner, Licella, actively advanced work associated with the feasibility study and risk reduction process for industrializing this biofuel and biochemical technology. COLLECTIVE AGREEMENTS WITH LABOUR UNIONS In June 2017, the Company ratified new four-year collective agreements with Unifor and PPWC (Public and Private Workers of Canada). Both agreements expire on April 30, 2021. SELECTED QUARTERLY FINANCIAL INFORMATION Q4 2018 Q3 2018 Q2 2018 Q1 2018 Q4 2017 Q3 2017 Q2 2017 Q1 2017 Sales and income (millions of Canadian dollars) Sales Operating income before amortization11 Operating income Net income Per common share (Canadian dollars) Net income – basic and diluted Book value12 Dividends declared Common Share Repurchases $ $ $ $ $ $ 289.7 $ 328.5 $ 396.4 $ 359.7 $ 322.9 $ 284.9 $ 280.9 $ 309.2 36.1 $ 80.7 $ 105.1 $ 104.3 $ 15.6 $ 60.5 $ 85.4 $ 85.1 $ 14.2 $ 42.9 $ 63.0 $ 64.3 $ 85.6 $ 66.8 $ 45.2 $ 39.4 $ 21.1 $ 12.6 $ 50.0 $ 31.5 $ 20.2 $ 54.0 35.2 24.1 0.21 $ 0.66 $ 0.97 $ 0.99 $ 0.69 $ 0.19 $ 0.31 $ 0.36 9.14 $ 11.22 $ 10.62 $ 9.72 $ 8.76 $ 7.78 $ 7.63 $ 7.55 $ 0.0625 $ 2.3125 $ 0.0625 $ 0.0625 $ 0.0625 $ 0.0625 $ 0.0625 $ 0.0625 Share volume repurchased (000 shares) - - - - 8 568 608 264 Shares repurchased (millions of Canadian dollars) Statistics $ - $ - $ - $ - $ 0.1 $ 7.2 $ 7.5 $ 3.0 Pulp shipments (000 mt) 230.7 262.4 328.6 310.0 299.7 303.3 276.3 337.1 Paper shipments (000 mt) 32.0 33.6 32.6 32.0 35.8 34.0 35.5 33.7 Average exchange rate – US$/Cdn$ $ 0.758 $ 0.765 $ 0.774 $ 0.791 $ 0.786 $ 0.798 $ 0.744 $ 0.756 Average NBSK pulp list price delivered to China (US$) 11 Amortization includes amortization of certain capitalized major maintenance costs. 12 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. 887 $ 910 $ 910 $ 805 $ 863 $ 670 $ 670 $ 645 $ 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 operating rates and 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. 16 (millions of Canadian dollars) Operating income (loss) by segment: Pulp Paper Unallocated Total operating income Add: Amortization13 Total operating income before amortization 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): Repayment of long-term debt Dividends paid Finance expenses paid Capital additions, net Share purchases Other, net Q4 2018 Q3 2018 Q2 2018 Q1 2018 Q4 2017 Q3 2017 Q2 2017 Q1 2017 $ $ $ $ $ $ $ $ $ $ $ 15.2 $ 3.5 $ (3.1) $ 15.6 $ 20.5 $ 60.7 $ 3.1 $ (3.3) $ 60.5 $ 20.2 $ 86.6 $ 1.5 $ (2.7) $ 85.4 $ 19.7 $ 86.4 $ 2.9 $ (4.2) $ 85.1 $ 19.2 $ 62.4 $ 7.4 $ (3.0) $ 66.8 $ 18.8 $ 19.0 $ 4.9 $ (2.8) $ 21.1 $ 18.3 $ 28.0 $ 6.6 $ (3.1) $ 31.5 $ 18.5 $ 31.1 7.1 (3.0) 35.2 18.8 36.1 $ 80.7 $ 105.1 $ 104.3 $ 85.6 $ 39.4 $ 50.0 $ 54.0 (9.4) $ 13.7 $ (7.7) $ (22.2) $ (5.2) $ 1.0 $ (2.0) $ (0.2) (1.6) $ (36.3) $ 6.3 $ (1.6) $ (35.2) $ (2.5) $ (1.7) $ 0.2 $ 2.0 $ (1.7) $ (19.1) $ 5.8 $ (2.2) $ (1.5) $ 1.7 $ (1.6) $ (16.5) $ (1.2) $ (1.7) $ (0.9) $ (0.9) $ (1.5) (0.2) (1.4) (4.9) $ 55.1 $ 97.9 $ 67.1 $ 78.4 $ 21.1 $ 44.5 $ 50.7 - $ $ $ (150.9) $ (0.8) $ $ (42.5) $ $ $ $ - 0.6 $ $ - $ (4.1) $ (0.8) $ (33.4) $ $ - 0.7 $ - $ (4.1) $ (1.0) $ (24.8) $ $ - 0.5 $ - $ (4.1) $ (0.7) $ (19.8) $ (0.1) $ 0.3 $ (50.0) $ (4.1) $ (1.0) $ (28.1) $ - $ 0.2 $ $ - (4.1) $ (0.9) $ (19.0) $ (7.5) $ 0.2 $ - $ (4.1) $ (0.7) $ (19.2) $ (7.4) $ 0.1 $ - (4.2) (0.7) (16.8) (2.8) 0.2 Change in cash / operating loans 13 Amortization includes amortization of certain capitalized major maintenance costs. $ (198.5) $ 17.5 $ 68.5 $ 42.7 $ (4.6) $ (10.2) $ 13.2 $ 26.4 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 2018 1,374.3 184.4 932.0 - $ $ $ $ 2.83 $ 2.50 $ 2017 1,197.9 102.1 892.2 - 1.55 0.250 $ $ $ $ $ $ 2016 1,101.9 57.8 837.1 50.0 0.86 0.250 $ $ $ $ $ $ 17FOURTH QUARTER RESULTS Overview The Company recorded operating income of $15.6 million and net income of $14.2 million for the fourth quarter of 2018, compared to operating income of $60.5 million and net income of $42.9 million for the third quarter of 2018 and operating income of $66.8 million and net income of $45.2 million for the fourth quarter of 2017. Net income per share was $0.21 for the fourth quarter of 2018, compared to $0.66 per share in the third quarter of 2018 and $0.69 per share in the fourth quarter of 2017. An overview of the results by business segment for the fourth quarter of 2018 compared to the third quarter of 2018 and the fourth quarter of 2017 follows. Pulp Selected Financial Information and Statistics – Pulp (millions of Canadian dollars, unless otherwise noted) Sales Operating income before amortization14 Operating income Average NBSK pulp price delivered to China – US$15 Average NBSK pulp price delivered to China – Cdn$15 Production – pulp (000 mt) $ $ $ $ $ Q4 2018 243.5 34.7 15.2 805 1,062 223.9 $ $ $ $ $ Q3 2018 Q4 2017 $ $ $ $ $ 280.4 79.8 60.7 887 1,160 285.3 277.3 80.1 62.4 863 1,098 307.6 Shipments – pulp (000 mt) 14 Amortization includes amortization of certain capitalized major maintenance costs. 15 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 monthly average rate for the period. 230.7 299.7 262.4 Markets Reflecting weaker demand from China, global softwood pulp market demand was down in the fourth quarter of 2018, with global softwood pulp producer inventory levels remaining above normal through the quarter. US-dollar NBSK pulp list prices to China averaged US$805 per tonne, down 9% from the prior quarter, with prices ending the year at US$725 per tonne. Global softwood pulp producer inventory levels were well above the balanced range at 41 days16 of supply in December 2018, an increase of 8 days from August 2018, for the most part reflecting a sharp decline in demand from China (generally considered balanced when inventories are in the 27-30 days of supply range). Global shipments of bleached softwood pulp for 2018 declined 3.2%17 when compared to 2017, largely reflecting the decline in demand and timing of shipments in the latter part of the year. Sales The Company’s pulp shipments for the fourth quarter of 2018 totalled 230,700 tonnes, down 31,700 tonnes, or 12%, from the previous quarter and down 69,000 tonnes, or 23%, from the fourth quarter of 2017. The decline in pulp shipments versus the previous quarter reflected the impact of the aforementioned downtime, partly offset by a drawdown of pulp inventories through the period. The anticipated benefit of a slipped vessel shipment from the previous quarter into the fourth quarter was offset by a delayed vessel shipment over the year end. Compared to the fourth quarter of 2017, the decrease in pulp shipments was mostly attributable to operational downtime and weaker market demand from China in the latter part of the current quarter. The average US-dollar NBSK pulp list price to China of US$805 per tonne, as published by RISI, was down US$82 per tonne, or 9%, from the third quarter of 2018, and down US$58 per tonne, or 7%, from the fourth quarter of 2017. NBSK pulp unit sales realizations were broadly in line with the prior quarter as the lower US-dollar NBSK pulp list pricing to China was largely offset by higher US-dollar NBSK pulp list pricing to North America through the quarter, up US$51 per tonne (before the effect of discounts), or 4%, as published by RISI, proportionately higher shipments to North America and a 1 cent, or 1%, weaker Canadian dollar. BCTMP US-dollar pricing came under modest downward pressure during the current quarter; however, the Company’s sales realizations remained steady quarter-over-quarter reflecting the timing of shipments (versus orders) and a weaker Canadian dollar. 16 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”). 17 As reported by PPPC statistics. 18NBSK pulp unit sales realizations were up significantly from the fourth quarter of 2017, principally reflecting the timing of shipments (versus orders) in the fourth quarter of 2017 and a 3 cent, or 4%, weaker Canadian dollar in the current quarter. Energy revenues were broadly in line with the third quarter of 2018, principally reflecting seasonally higher energy prices offset by reduced power generation at Northwood due to the previously mentioned production downtime in the current quarter. Compared to the fourth quarter of 2017, energy revenues were down substantially, primarily due to reduced power generation largely correlated with the decline in pulp production quarter-over-quarter. Operations Pulp production was down 61,400 tonnes, or 22%, from the previous quarter. This lower production primarily reflected the continuation of the schedule maintenance outage at Northwood from the previous quarter, the aforementioned recovery boiler extended downtime at Northwood, as well as unscheduled downtime taken as a result of a third-party natural gas pipeline explosion which impacted the Company’s three NBSK pulp mills, and, to a lesser extent, several other operational challenges during the current quarter. Combined, these scheduled and unscheduled outages impacted NBSK pulp production by approximately 90,000 tonnes. In addition, in late December, the Company curtailed production at its Taylor BCTMP mill for seven days in the face of reduced residual fibre availability resulting from various sawmill curtailments in the region, which impacted BCTMP production by approximately 5,000 tonnes. In the third quarter of 2018, a scheduled maintenance outage at Northwood and ramp up at Taylor following the commissioning of the energy reduction project, reduced pulp production by approximately 30,000 tonnes. Compared to the fourth quarter of 2017, pulp production was down 83,700 tonnes, or 27%, primarily due to the above noted scheduled and unscheduled outages in the fourth quarter of 2018. At the end of December, the Company experienced kiln-related operational disruptions at two of its NBSK pulp mills. While these challenges have now been resolved, the related production loss was approximately 20,000 tonnes early in the first quarter of 2019. NBSK pulp unit manufacturing costs were up significantly from the previous quarter, in large measure due to reduced productivity in the current quarter as well as higher related maintenance, energy and chemical costs, associated with the unscheduled outages. Fibre costs were broadly in line with the third quarter of 2018. Compared to the fourth quarter of 2017, pulp unit manufacturing costs saw a significant increase, principally due to higher fibre costs, combined with decreased productivity as well as increased maintenance spend and higher energy and chemical costs as a result of the aforementioned downtime. The increased fibre costs in the current quarter when compared to the same period in the prior year, largely reflected significantly higher market-related prices for sawmill residual and whole log chips. Paper Selected Financial Information and Statistics – Paper (millions of Canadian dollars, unless otherwise noted) Sales Operating income before amortization18 Operating income Production – paper (000 mt) $ $ $ Shipments – paper (000 mt) 18 Amortization includes amortization of certain capitalized major maintenance costs. Markets Q4 2018 46.1 $ 4.4 $ 3.5 $ 35.6 32.0 Q3 2018 Q4 2017 $ $ $ 48.1 4.2 3.1 34.1 33.6 45.6 8.4 7.4 35.0 35.8 Global kraft paper markets were steady through the fourth quarter of 2018 following positive pricing and demand momentum in the North American and Asian markets through the first three quarters of 2018. Sales The Company’s paper shipments in the fourth quarter of 2018 were 32,000 tonnes, down 1,600 tonnes, or 5%, from the previous quarter and down 3,800 tonnes, or 11% from the fourth quarter of 2017, principally reflecting the timing of shipments quarter-over-quarter. 19Paper unit sales realizations in the fourth quarter of 2018 were broadly in line with the previous quarter, with lower market-driven US-dollar pricing offsetting a 1% weaker Canadian dollar. Compared to the same quarter of 2017, paper unit sales realizations were up significantly as favourable US-dollar pricing, combined with the weaker Canadian dollar, more than offset higher freight costs. Operations Paper production for the fourth quarter of 2018 was 35,600 tonnes, up 1,500 tonnes, or 4%, from the prior quarter, and broadly in line with production from the fourth quarter of 2017, principally reflecting a solid operating performance in the current quarter despite unscheduled downtime related to a third-party natural gas explosion near Prince George during the current quarter. Paper unit manufacturing costs were broadly in-line with the third quarter of 2018. Compared to the fourth quarter of 2017, paper unit manufacturing costs showed a significant increase largely due to higher slush pulp costs associated with the increased NBSK pulp sales realizations in the current quarter. Unallocated Items (millions of Canadian dollars) Corporate costs Finance expense, net Other income (expense), net Q4 2018 (3.1) (0.9) 4.8 $ $ $ $ $ $ Q3 2018 (3.3) $ (0.8) $ (2.1) $ Q4 2017 (3.0) (1.9) - Corporate costs were $3.1 million for the fourth quarter of 2018, down $0.2 million when compared to the third quarter of 2018 and up $0.1 million when compared to the fourth quarter of 2017. Net finance expense for the fourth quarter of 2018 was $0.9 million, up $0.1 million when compared to the third quarter of 2018 and down $1.0 million when compared to the fourth quarter of 2017. The decrease when compared to the fourth quarter of 2017 largely reflected higher interest earned on cash balances held during the current quarter. Other income, net, of $4.8 million for the fourth quarter of 2018 principally related to favourable foreign exchange movement on US-dollar denominated working capital balances. Other Comprehensive Income (Loss) In the fourth quarter of 2018, the Company recorded an after-tax gain of $1.1 million, down $1.9 million from the third quarter of 2018 as a result of lower than anticipated returns on plan assets. In comparison to the fourth quarter of 2017, the after-tax gain decreased by $28.6 million, largely reflecting the benefit of a 50% reduction in Medical Service Plan (“MSP”) premiums realized in the prior year following a change in legislation in British Columbia. During the fourth quarter of 2018, the Company purchased $8.9 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 $0.7 million were recognized in Other Comprehensive Income principally reflecting the difference in the annuity rate as compared to the discount rate used to value the pension obligations on a going concern basis. For more information, see the “Employee Future Benefits” part of the “Critical Accounting Estimates” section later in this report. 20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 2018 (198.5) (4.9) (151.7) (41.9) $ $ $ $ $ $ $ $ Q3 2018 $ 17.5 55.1 $ (4.9) $ (32.7) $ Q4 2017 (4.6) 78.4 (55.1) (27.9) Cash used in operating activities was $4.9 million in the fourth quarter of 2018, down $60.0 million from the previous quarter and $83.3 million from the fourth quarter of 2017. The decrease in operating cash flows compared to the previous quarter principally reflected lower cash earnings combined with unfavourable movements in non-cash working capital and higher tax installment payments. The increase in non-cash working capital reflected higher chip and log inventories (mostly as a result of the lower production), which more than offset lower accounts receivable balances related to lower shipments during the quarter. Cash used for financing activities was $151.7 million in the fourth quarter of 2018, up $146.8 million from the third quarter of 2018 and $96.6 million from the fourth quarter of 2017. Cash used for financing activities in the current quarter included payment of the Company’s quarterly dividend of $0.0625 per common share and a special dividend of $2.25 per common share, totalling $150.9 million. The Company did not purchase any common shares under its normal course issuer bid in the third and fourth quarters of 2018. In the fourth quarter of 2017, the Company repurchased 7,575 common shares under its normal course issuer bid for $0.1 million, which was paid subsequent to year end (see further discussion of the shares purchased under the “Normal Course Issuer Bid” part of the “Liquidity and Financial Requirements” section). Cash used for financing activities in the fourth quarter of 2017 also included early repayment of the Company’s $50.0 million long-term debt. Cash used for investing activities of $41.9 million in the current quarter primarily related to capital expenditures associated with several capital projects including the aforementioned energy project at the Company’s Northwood NBSK pulp mill as well as ongoing development of its new ERP software system. 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 2018 Q3 2018 Q2 2018 Q1 2018 Q4 2017 Q3 2017 Q2 2017 Q1 2017 Net income, as reported $ 14.2 $ 42.9 $ 63.0 $ 64.3 $ 45.2 $ 12.6 $ 20.2 $ 24.1 Change in substantively enacted tax legislation Net impact of above items Adjusted net income $ $ $ - - $ $ - - $ $ - - $ $ - - $ $ 2.8 $ 2.8 $ - - $ $ - - $ $ - - 14.2 $ 42.9 $ 63.0 $ 64.3 $ 48.0 $ 12.6 $ 20.2 $ 24.1 Net income per share (EPS), as reported $ 0.21 $ 0.66 $ 0.97 $ 0.99 $ 0.69 $ 0.19 Net impact of above items per share19 Adjusted net income per share19 $ $ - $ - $ - $ - $ 0.04 $ - 0.21 $ 0.66 $ 0.97 $ 0.99 $ 0.73 $ 0.19 $ $ $ 0.31 $ 0.36 $ - - 0.31 $ 0.36 19 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. 21OUTLOOK Pulp Markets Notwithstanding high inventory levels, global softwood kraft pulp markets are projected to be steady through the first half of 2019, reflecting an anticipated pick-up in demand from China and reduced supply during the traditional spring maintenance period. The BCTMP market is projected to be steady in the first half of 2019. The Company has no maintenance outages planned for the first quarter of 2019. Maintenance outages are currently planned at the Intercontinental NBSK pulp mill in the second quarter of 2019 with a projected 12,000 tonnes of reduced NBSK pulp production. Additional maintenance outages are scheduled at the Prince George NBSK pulp mill and the Taylor BCTMP mill in the third and fourth quarters of 2019 with a projected 6,000 tonnes of reduced NBSK pulp production and projected 5,000 tonnes of reduced BCTMP production, respectively. No scheduled maintenance outages are planned for the Company’s Northwood NBSK pulp mill in 2019. Paper Markets Bleached kraft paper demand is currently expected to remain solid through the first quarter of 2019. A maintenance outage is currently planned at the Company’s paper machine during the third quarter of 2019 with a projected 4,000 tonnes of reduced paper production. 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, 2018 December 31, 2017 Defined Benefit Pension Plans Other Benefit Plans 3.6% 3.0% 3.6% n/a n/a n/a n/a 5.5% 4.5% 2022 Defined Benefit Pension Plans 3.4% 3.0% n/a n/a n/a Other Benefit Plans 3.4% n/a 6.5% 4.5% 2022 22In addition to the significant assumptions listed in the table above, the average life expectancy of a 65 year old at December 31, 2018 is between 21.1 years and 24.2 years (December 31, 2017 - 21.0 years and 24.1 years). As at December 31, 2018, the weighted average duration of the defined benefit plan obligation, which reflects the average age of the plan members, is 12.0 years (December 31, 2017 - 12.3 years). The weighted average duration of the other benefit plans is 13.3 years (December 31, 2017 - 14.2 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, taking into account the hedging impact of plan annuity assets, for 2018: (millions of Canadian dollars) Defined benefit pension plan liabilities, net of annuity assets Discount rate Other benefit plan liabilities Discount rate Initial medical cost trend rate 1% Increase 1% Decrease $ $ $ (9.9) $ 12.7 (6.5) $ $ 4.4 8.1 (4.0) 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 4 to 33 years and have been discounted at risk-free rates ranging from 1.9% to 2.2%. 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 2018 or 2017. 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, 2018. 23FUTURE CHANGES IN ACCOUNTING POLICIES 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. IFRS 16 introduces a single, on-balance sheet lease accounting model for lessees. A lessee recognizes a right-of-use asset representing its right to use the underlying asset and a lease liability representing its obligation to make lease payments. In addition, the nature of expenses related to those leases will change as IFRS 16 replaces straight-line operating lease expense with a depreciation expense for right-of-use assets and interest expense on lease liabilities. Based on lease data as at December 31, 2018, IFRS 16 will have the following financial statement impact on the Company’s consolidated balance sheet at transition on January 1, 2019, with no material impact to 2019 net income: (millions of Canadian dollars) Right-of-use asset, net of accumulated amortization Lease obligation Retained earnings Increase in assets Increase in liabilities Decrease in equity As at January 1, 2019 1.4 1.5 0.1 $ 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. Indigenous Relations CPPI sources the majority of its fibre from areas subject to claims of Indigenous rights or title. Canadian judicial decisions have recognized the continued existence of Indigenous rights and title to lands continuously and exclusively used or occupied by Indigenous groups; however, until recently, the courts have not identified any specific lands where Indigenous title exists. In June 2014, the Supreme Court of Canada, for the first time, recognized Indigenous 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 Indigenous title lands. While Indigenous 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 Indigenous title over a specific piece of land and, in so doing, affirmed a broader territorial use-based approach to Indigenous title. The decision also defines what Indigenous 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 Indigenous 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 2018 were approximately $120.5 million. The Company anticipates available cash resources and cash generated from operations will be sufficient to fund its operating needs and capital expenditures. 24Climate Change The Company’s operations are subject to adverse events brought on by both natural and man-made disasters. These events include, but are not limited to, severe weather conditions, forest fires, earthquakes and timber diseases and insect infestations. These events could damage or destroy the Company’s operating facilities, adversely affect Canfor’s timber supply or result in reduced transportation availability. These events could have similar effect on the facilities of the Company’s suppliers and customers. Any of the damage caused by these events could increase costs and decrease production capacity at the Company’s operations having an adverse effect on the Company’s financial results. The Company believes there are reasonable insurance arrangements in place to cover certain outcomes of such incidents however; there can be no guarantees that these arrangements will fully protect the Company against such losses. Competitive Markets The Company’s products are sold primarily in Asia and North America, with smaller volumes to other markets. 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 price, quality of product, volume, availability and reliability of supply, financial viability and customer service. The Company’s competitive position is influenced by: the availability, quality, and cost of raw materials; chemical, 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. 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 cyclical and may be characterized by (i) periods of excess product supply due to industry capacity additions, increased global 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, to some degree, been unpredictable. Dependence on Canfor In 2018, approximately 66% of the fibre used by the Company was derived from the Fibre Supply Agreements 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 2018, the Company’s top five customers accounted for approximately 33% 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 common share through 2018 and may, subject to market conditions, continue to pay a comparable level of dividends through 2019. The Company also paid a special dividend of $146.8 million ($2.25 per common share) to the shareholders of the Company as a result of strong cash generated by the business during the year. There is no assurance that the dividends will be maintained at this level and the market 25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 benefits to certain salaried employees. Benefits are based on a combination of years of service and final average salary. Cash payments required to fund the pension plan are determined by actuarial valuation completed at least once every three years, with the most recent actuarial valuation for the largest plan completed as of December 31, 2017. 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. The Company utilizes investments in buy-in annuities to reduce its exposure to these risks. Future cash flows from the annuities match the amount and timing of benefits payable under the plans, substantially mitigating the exposure to future volatility in the related pension obligations. For CPPI’s pension benefit 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, net of annuity assets, by an estimated $9.9 million and a one percentage point decrease in the discount rate would increase the accrued benefit obligation by an estimated $12.7 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. 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. 26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 Price 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. (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, or redemption date, of three months or less. The cash and cash equivalents balance at December 31, 2018 is $6.9 million. CPPI utilizes credit insurance to manage the risk associated with trade accounts receivables. As at December 31, 2018, approximately 78% of the outstanding trade accounts receivables are covered under credit insurance. In addition, CPPI requires letters of credit on certain export trade accounts 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 accounts receivable balance at December 31, 2018 is $108.6 million before a loss allowance of $1.0 million. At December 31, 2018, approximately 98% of the trade accounts receivable balance are within CPPI’s established credit terms. (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, 2018, CPPI has no amounts drawn on its operating loan facility. At December 31, 2018 CPPI had accounts payable and accrued liabilities of $182.0 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. At December 31, 2018 CPPI had no fixed interest rate swaps outstanding. 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 and non-pension post-retirement 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. An increase (decrease) in the value of the Canadian dollar by US$0.01 would result in a pre-tax loss (gain) of approximately $1.2 million in relation to working capital balances denominated in US-dollars at year end (including cash, accounts receivable and accounts payable). 27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). CPPI had no foreign exchange derivatives outstanding at December 31, 2018. (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 Company’s 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, 2018. (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). CPPI had no WTI oil collars outstanding at December 31, 2018. 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. Earnings Sensitivities Estimates of the sensitivity of CPPI's pre-tax results to currency fluctuations and prices for its principal products, based on 2019 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 20 BCTMP – US$10 change per tonne 20 Natural gas cost – $1 change per gigajoule Chip cost – $1 change per tonne Canadian dollar – US$0.01 change per Canadian dollar21 Impact on annual pre-tax earnings $ 10 $ 3 $ 8 $ 3 $ 10 20 Excluding impacts of exchange rate, freight, discounting, potential change in fibre costs and other deductions. 21 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 28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 major competition in the global 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 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, failure or unsuccessful implementation and integration 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 to develop and enhance 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. 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 Agreements 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 one of these agreements expires June 30, 2021, and may be amended as necessary to ensure it is reflective of market conditions. 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. The impact of the Mountain Pine Beetle infestation in the region continues to impact overall fibre supply for the interior sawmills. The Prince George Timber Supply Area allowable annual cut (“AAC”) has recently been reduced and is scheduled for another reduction in 2023. This has the potential to significantly reduce the availability of residual chips that the Company currently consumes from regional 29sawmills, and an increased reliance on higher-cost whole log chips will be required. A lower AAC in the region may also reduce the availability of pulpwood for whole log chips. Residual chip pricing also depends on current sawmills running at current levels. If the residual chip supply is reduced as a result of AAC reductions, lower sawmill production or sawmill closures, whether temporary or permanent, it is expected that the market price for wood chips will increase. The Company is not always able to increase the selling prices of its products in response to increases in raw material costs. 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. Any inability to negotiate acceptable contracts with the Unifor and PPWC 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. OUTSTANDING SHARE DATA At February 21, 2019 there were 65,250,759 common shares issued and outstanding. 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, 2018, and have concluded that they are effective. The CEO and CFO acknowledge responsibility for the design of ICFR, and confirm that there were no changes in these controls that occurred during the year ended December 31, 2018 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, 2018, the CEO and CFO have concluded that these controls are operating effectively. During the year ended December 31, 2018, the Company successfully completed the implementation of a new general ledger system across all of its divisions and locations. The Company’s internal controls were maintained or supplemented by controls added during this system implementation and related process improvements. Additional information about the Company, including its 2018 Annual Information Form, is available at www.sedar.com or at www.canfor.com. 30C ONSO LIDATE D FI NANCIAL STATEM ENTS 31 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. Canfor Pulp Products Inc. maintains systems of internal controls over financial reporting, 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 Audit Committee meets periodically throughout the year with management, external auditors and internal auditors to review their respective responsibilities, results of the reviews of internal controls over financial reporting, 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 21, 2019 Don B. Kayne Chief Executive Officer Alan Nicholl Chief Financial Officer 32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. Opinion We have audited the consolidated financial statements of Canfor Pulp Products Inc. (the “Company”), which comprise: − the consolidated balance sheets as at December 31, 2018 and December 31, 2017; − the consolidated statements of income for the years then ended; − the consolidated statements of comprehensive income for the years then ended; − the consolidated statements of changes in equity for the years then ended; − the consolidated statements of cash flows for the years then ended; and, − notes to the consolidated financial statements, including a summary of significant accounting policies (Hereinafter referred to as the “financial statements”). In our opinion, the accompanying financial statements present fairly, in all material respects, the consolidated financial position of the Company as at December 31, 2018 and December 31, 2017, and its consolidated financial performance and its consolidated cash flows for the years then ended in accordance with International Financial Reporting Standards. Basis for Opinion We conducted our audit in accordance with Canadian generally accepted auditing standards. Our responsibilities under those standards are further described in the “Auditors’ Responsibilities for the Audit of the Financial Statements” section of our auditors’ report. We are independent of the Company in accordance with the ethical requirements that are relevant to or audit of the financial statements in Canada and we have fulfilled our other responsibilities in accordance with these requirements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our 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. 33 Other Information Management is responsible for the other information. Other information comprises: − the information included in Management’s Discussion and Analysis filed with the relevant Canadian Securities Commissions. − the information, other than the financial statements and the auditors’ report thereon, included in the “2018 Canfor Pulp Products Inc. Annual Report”. Our opinion on the financial statements does not cover the other information and we do not and will not express any form of assurance conclusion thereon. In connection with our audit of the financial statements, our responsibility is to read the other information identified above and, in doing so, consider whether the other information is materially inconsistent with the financial statements or our knowledge obtained in the audit, or otherwise appears to be materially misstated. We obtained Management’s Discussion and Analysis filed with the relevant Canadian Securities Commissions as at the date of this auditors’ report. If, based on the work we have performed on this other information, we conclude that there is a material misstatement of this other information, we are required to report that fact in the auditors’ report. We have nothing to report in this regard. The 2018 Canfor Pulp Products Inc. Annual Report is expected to be made available to us after the date of this auditors’ report. If, based on the work we will perform on this other information, we conclude that there is a material misstatement of this other information, we are required to report that fact to those charged with governance for the financial statements. Responsibilities of Management and Those Charged with Governance for the Financial Statements Management is responsible for the preparation and fair presentation of the financial statements in accordance with International Financial Reporting Standards, and for such internal control as management determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error. In preparing the financial statements, management is responsible for assessing the Company’s ability to continue as a going concern, disclosing as applicable, matters related to going concern and using the going concern basis of accounting unless management either intends to liquidate the Company or to cease operations, or has no realistic alternative but to do so. Those charged with governance for the financial statements are responsible for overseeing the Company’s financial reporting process. 34 Auditors’ Responsibilities for the Audit of the Financial Statements Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditors’ report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with Canadian generally accepted auditing standards will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements. As part of an audit in accordance with Canadian generally accepted auditing standards, we exercise professional judgment and maintain professional skepticism throughout the audit. We also: − Identify and assess the risks of material misstatement of the financial statements, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control. − Obtain an understanding of internal control relevant to the audit 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 Company's internal control. − Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made by management. − Conclude on the appropriateness of management's use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the Company's ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in our auditors’ report to the related disclosures in the financial statements or, if such disclosures are inadequate, to modify our opinion. Our conclusions are based on the audit evidence obtained up to the date of our auditors’ report. However, future events or conditions may cause the Company to cease to continue as a going concern. − Evaluate the overall presentation, structure and content of the financial statements, including the disclosures, and whether the financial statements represent the underlying transactions and events in a manner that achieves fair presentation. − Communicate with those charged with governance for the financial statements regarding, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit. 35 − Provide those charged with governance for the financial statements with a statement that we have complied with relevant ethical requirements regarding independence, and communicate with them all relationships and other matters that may reasonably be thought to bear on our independence, and where applicable, related safeguards. Chartered Professional Accountants The engagement partner on the audit resulting in this auditors’ report is John Desjardins. Vancouver, Canada February 21, 2019 36 Canfor Pulp Products Inc. Consolidated Balance Sheets (millions of Canadian dollars) ASSETS Current assets Cash and cash equivalents Accounts receivable - Trade - Other Income taxes receivable Inventories (Note 6) Prepaid expenses Total current assets Property, plant and equipment and intangible assets (Note 7) Other long-term assets Total assets LIABILITIES Current liabilities Accounts payable and accrued liabilities (Note 8) $ 182.0 $ Total current liabilities Retirement benefit obligations (Note 11) Other long-term provisions Deferred income taxes, net (Note 15) Total liabilities EQUITY Share capital (Note 13) Retained earnings Total equity Total liabilities and equity 182.0 80.0 6.6 66.8 $ 335.4 $ $ $ $ 480.9 115.7 596.6 932.0 $ $ $ Commitments and Contingencies (Note 19) and 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, C.A. Pinette As at December 31, 2018 As at December 31, 2017 $ 6.9 $ 107.6 11.4 5.4 207.1 11.9 350.3 578.2 3.5 $ 932.0 $ 76.7 101.5 14.3 - 165.5 7.0 365.0 526.7 0.5 892.2 161.5 161.5 85.2 6.5 67.6 320.8 480.9 90.5 571.4 892.2 37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 14) Other income (expense), net Net income before income taxes Income tax expense (Note 15) Net income Years ended December 31, 2017 2018 $ 1,374.3 $ 1,197.9 870.9 145.4 79.6 31.8 786.7 155.0 74.4 27.2 1,127.7 1,043.3 246.6 (4.2) 8.7 251.1 (66.7) $ 184.4 $ 154.6 (7.2) (6.5) 140.9 (38.8) 102.1 Net income per common share: (in Canadian dollars) Attributable to equity shareholders of the Company - Basic and diluted (Note 13) The accompanying notes are an integral part of these consolidated financial statements. $ 2.83 $ 1.55 38Canfor Pulp Products Inc. Consolidated Statements of Other Comprehensive Income (millions of Canadian dollars) Net income Other comprehensive income Items that will not be recycled through net income: Defined benefit plan actuarial gains (Note 11) Income tax expense on defined benefit plan actuarial gains (Note 15) Other comprehensive income, 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 13) Balance at end of year (Note 13) Retained earnings (deficit) Balance at beginning of year Net income Defined benefit plan actuarial gains, net of tax Dividends declared (Note 23) Share purchases (Note 13) Balance at end of year Total equity The accompanying notes are an integral part of these consolidated financial statements. Years ended December 31, 2017 2018 $ 184.4 $ 102.1 5.5 (1.5) 4.0 25.2 (6.3) 18.9 $ 188.4 $ 121.0 Years ended December 31, 2017 2018 $ $ $ $ $ 480.9 $ - 491.6 (10.7) 480.9 $ 480.9 90.5 $ 184.4 4.0 (163.2) - 115.7 $ (6.9) 102.1 18.9 (16.5) (7.1) 90.5 596.6 $ 571.4 39 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 Employee future benefits Finance expense, net Other, net Defined benefit plan contributions Income taxes paid, net Net change in non-cash working capital (Note 16) Financing activities Repayment of long-term debt (Note 10) Finance expenses paid Dividends paid (Note 23) Share purchases (Note 13) Investing activities Additions to property, plant and equipment and intangible assets, net (Note 7) Other, net Increase (decrease) in cash and cash equivalents* Cash and cash equivalents at beginning of year* Cash and cash equivalents at end of year* *Cash and cash equivalents include cash on hand less unpresented cheques. The accompanying notes are an integral part of these consolidated financial statements. Years ended December 31, 2018 2017 $ 184.4 $ 102.1 79.6 66.7 4.0 4.2 (1.1) (6.6) (90.4) 240.8 (25.6) 215.2 - (3.3) (163.2) (0.1) (166.6) (120.5) 2.1 (118.4) (69.8) 76.7 $ 6.9 $ 74.4 38.8 4.3 7.2 0.4 (7.0) (19.1) 201.1 (6.4) 194.7 (50.0) (3.3) (16.5) (17.7) (87.5) (83.1) 0.7 (82.4) 24.8 51.9 76.7 40 Canfor Pulp Products Inc. Notes to the Consolidated Financial Statements Years ended December 31, 2018 and December 31, 2017 (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, 2018 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, 2018, and February 21, 2019, Canfor Corporation (“Canfor”) held a 54.8% interest in CPPI, unchanged from December 31, 2017. 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 21, 2019. 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 measured at fair value; 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 may cause actual results to differ from management’s estimates. 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 7 – Property, Plant and Equipment and Intangible Assets; Note 11 – Employee Future Benefits; Note 12 – Asset Retirement Obligations; and Note 15 – Income Taxes. Certain comparative amounts for the prior year have been reclassified to conform to the current year’s presentation. 41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. Cash and cash equivalents Cash and cash equivalents include cash in bank accounts and liquid money market instruments with original maturities, or redemption dates, of three months or less from the date of acquisition, and are valued at amortized 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 Financial instruments comprise cash and cash equivalents, trade and other accounts receivables, accounts payable and accrued liabilities and operating loans. From time to time, CPPI uses derivative financial instruments in the normal course of its operations as a means to manage its foreign exchange, interest rate, commodity price, and energy price risk. The Company’s policy is not to utilize derivative financial instruments for trading or speculative purposes. When applicable, CPPI’s derivative financial instruments are not designated as hedges for accounting purposes. CPPI’s financial instruments are classified and measured as follows: Financial Assets: Cash and cash equivalents Trade and other accounts receivables Financial Liabilities: Accounts payable and accrued liabilities Operating loans Classification and measurement of financial assets Amortized cost Amortized cost Amortized cost Amortized cost Financial assets are classified as either measured at amortized cost, fair value through other comprehensive income (“FVOCI”), or fair value through net income (“FVTPL”) based on the business model in which a financial asset is managed, its contractual cash flow characteristics and when certain conditions are met: • • • Amortized cost – measured at amortized cost using the effective interest rate method. Where applicable, amortized cost is reduced by impairment losses. Interest income, foreign exchange gains and losses and impairments are recognized in net income. FVOCI – measured at FVOCI if not designated as FVTPL. Interest income, foreign exchange gains and losses and impairments are recognized in net income. Other net gains and losses are recognized in other comprehensive income (“OCI”). On derecognition, gains and losses accumulated in OCI are reclassified to net income. FVTPL – measured at FVTPL if not classified as amortized cost or FVOCI with net gains and losses, including any interest or dividend income, recognized in net income. Equity investments are required to be classified as measured at fair value. However, on initial recognition of an equity investment that is not held-for-trading, the Company may irrevocably elect to present subsequent changes in the investments fair value in OCI. This election is made on an investment by investment basis. The Company does not currently hold any equity investments. 42Classification and measurement of financial liabilities Financial liabilities are classified as either measured at amortized cost or FVTPL. A financial liability is classified as FVTPL if it is held-for-trading, a derivative or it is designated such on initial recognition. Financial liabilities at FVTPL are measured at fair value with net gains and losses, including interest expense, recognized in net income. Other financial liabilities are subsequently measured at amortized cost using the effective interest rate method. Interest expense and foreign exchange gains and losses are recognized in net income. Any gains or losses on derecognition are also recognized in net income. Impairment The Company applies the simplified approach in determining expected credit losses (“ECLs”), which requires a probability-weighted estimate of expected lifetime credit losses to be recognized upon initial recognition of financial assets measured at amortized cost and contract assets. Credit losses are measured as the present value of cash shortfalls from all possible default events, discounted at the effective interest rate of the financial asset. Loss allowances for financial assets at amortized cost are deducted from the gross carrying amount of the assets. Inventories Inventories include pulp, paper, wood chips, logs, and materials and supplies. These are measured at the lower of cost and net realizable value, and are presented net of applicable write-downs. 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 the location and condition necessary for it 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, roads and paving Pulp and paper machinery and equipment Mobile equipment Office furniture and equipment Major overhauls 10 to 40 years 8 to 20 years 4 years 10 years 1 to 5 years 43Intangible assets Computer software Software development costs relate to major software systems purchased or developed by the Company. These costs are amortized on a straight-line basis over periods of four to ten years. Government assistance 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 and intangible assets 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 to sell 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”). 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. 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 forest industry union defined contribution or benefit 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 certain 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/or 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 or legislated amounts payable. Actuarial gains and losses, including the return on plan assets, are recognized in other comprehensive income in the period in which they occur. 44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 derived from the sale of pulp, paper, and energy. Revenue is measured based on the consideration specified in a contract with a customer, net of applicable sales taxes, returns, rebates and discounts and after eliminating sales within the Company. Revenue for pulp and paper is recognized when control of products is transferred to customers. Energy revenue is recognized at month-end based on energy produced and transferred to the customer under the terms and conditions of electricity purchase and load displacement agreements. The timing of transfer of control to customers varies depending on the individual terms of the contract of sale, but is typically at the time pulp and paper is loaded onto a truck or rail carrier, upon vessel departure, or when pulp and kraft paper has been picked up by the buyer at a designated transfer point at the Company’s mill or warehouse. The amount of revenue recognized is adjusted for commissions, volume rebates and discounts at the point in time control is transferred. 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 taxes. 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. 45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. The majority of CPPI’s 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 and intangible assets. 4. Changes in significant accounting policies IFRS 9 – Financial Instruments Effective January 1, 2018, the Company adopted IFRS 9, Financial Instruments which supersedes IAS 39, Financial Instruments: Recognition and Measurement, and sets out requirements for the recognition, measurement, impairment and derecognition of financial assets and liabilities, as well as general hedge accounting. While the existing requirements for the classification and measurement of financial liabilities are largely retained under IFRS 9, financial assets are required to be classified as measured at amortized cost, FVOCI or FVTPL. The table below outlines the original measurement categories under IAS 39 and the new measurement categories under IFRS 9 for each class of the Company’s financial instruments at January 1, 2018: Financial Assets: Cash and cash equivalents Trade and other accounts receivables Financial Liabilities: Accounts payable and accrued liabilities Operating loans Original Classification Under IAS 39 New Classification Under IFRS 9 Loans and receivables Loans and receivables Other liabilities Other liabilities Amortized cost Amortized cost Amortized cost Amortized cost There have been no changes to the carrying values of our financial instruments at January 1, 2018, or to previously reported figures as a result of the classification changes outlined above. There was no impact of the new hedging requirements, as CPPI had no derivative instruments at the transition date. IFRS 9 also replaces the incurred loss impairment model under IAS 39 with an ECL model. CPPI has elected to apply the simplified approach in determining ECLs, which requires a probability-weighted estimate of expected lifetime credit losses to be recognized upon initial recognition of financial assets measured at amortized cost and contract assets. Credit losses are measured as the present value of cash shortfalls from all possible default events, discounted at the effective interest rate of the financial asset. Loss allowances for financial assets at amortized cost are deducted from the gross carrying amount of the assets. At January 1, 2018, the identified impairment losses were not significant or material and therefore no changes in loss allowances were recognized. IFRS 15 – Revenue from Contracts with Customers Effective January 1, 2018, the Company adopted IFRS 15, Revenue from Contracts with Customers, which supersedes IAS 18, Revenue, IAS 11, Construction Contracts and related interpretations, and establishes a comprehensive framework for determining whether, how much and when revenue is recognized. 46In the comparative period, revenue was measured at the fair value of consideration received or receivable, net of applicable sales tax, rebates and discounts and after eliminating sales within the Company. Revenue was previously recognized when the significant risks and rewards of ownership had been transferred to the buyer, recovery of consideration was probable, the associated costs and possible returns of the goods could be reliably estimated, there was no continuing management involvement with the goods, and the amount of revenue could be reliably measured. Under the new standard, however, revenue from the sale of goods is measured based on the consideration specified in a contract with a customer and is recognized when a customer obtains control of the goods or services. The Company has applied the full retrospective method upon transition to IFRS 15, with no resulting quantitative impact to the consolidated financial statements. 5. Accounting Standards Issued and Not Applied 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. IFRS 16 introduces a single, on-balance sheet lease accounting model for lessees. A lessee recognizes a right-of-use asset representing its right to use the underlying asset and a lease liability representing its obligation to make lease payments. In addition, the nature of expenses related to those leases will change as IFRS 16 replaces straight-line operating lease expense with an amortization expense for right-of-use assets and interest expense on lease liabilities. IFRS 16 may be applied retrospectively to each prior period presented (full retrospective approach), or with the cumulative effect of adoption recognized at initial application (modified retrospective approach). The Company has elected to apply the modified retrospective approach upon adoption at January 1, 2019, measuring the right-of-use asset at its carrying amount had the standard been applied at commencement of the lease. The short-term and low- value recognition exemptions available under the standard will be utilized, along with certain practical expedients. Based on lease data as at December 31, 2018, IFRS 16 is estimated to have the following financial statement impact on the Company’s consolidated balance sheet at transition on January 1, 2019, with no material impact to 2019 net income: (millions of Canadian dollars) Right-of-use asset, net of accumulated amortization Lease obligation Retained earnings Increase in assets Increase in liabilities Decrease in equity As at January 1, 2019 1.4 1.5 0.1 $ The full quantification of the new standard will be disclosed in the condensed consolidated interim financial statements for the first quarter of 2019. 6. Inventories (millions of Canadian dollars) Pulp Paper Wood chips and logs Materials and supplies $ As at December 31, 2018 83.2 22.2 48.3 53.4 $ As at December 31, 2017 78.5 14.9 19.9 52.2 $ 207.1 $ 165.5 There were no inventory write-downs at December 31, 2018 or December 31, 2017. Inventory expensed in 2018 includes manufacturing and product costs and amortization. 477. Property, Plant and Equipment and Intangible Assets (millions of Canadian dollars) Cost Balance at January 1, 2017 Additions1 Disposals Transfers Balance at December 31, 2017 Additions1 Disposals Transfers Balance at December 31, 2018 Amortization Balance at January 1, 2017 Amortization for the year Disposals Balance at December 31, 2017 Amortization for the year Disposals Balance at December 31, 2018 Carrying Amounts At January 1, 2017 At December 31, 2017 At December 31, 2018 Land and improvements Buildings, machinery and equipment Other property, plant and equipment2 Construction in progress Intangible assets3 Total property, plant and equipment and intangible assets $ $ $ $ $ $ $ $ $ 5.4 $ - - - 5.4 $ - - - 5.4 $ - - - - - - - $ $ $ 1,578.3 - (38.7) 28.8 1,568.4 - (32.3) 98.2 1,634.3 $ $ $ (1,101.0) $ (53.4) 37.1 (1,117.3) $ (56.8) 31.0 (1,143.1) $ 41.7 - (25.4) 23.3 39.6 0.4 (22.4) 41.0 58.6 $ $ 18.3 $ 77.5 - (52.1) 43.7 $ 113.3 - (139.2) $ 17.8 $ (24.0) $ (20.9) 25.4 (19.5) $ (22.3) 22.4 (19.4) $ - - - - - - - $ $ $ 8.4 4.8 (1.5) - 11.7 18.7 (1.7) - 28.7 (6.7) (0.1) 1.5 (5.3) (0.5) 1.7 (4.1) 5.4 $ 5.4 $ 5.4 $ 477.3 451.1 491.2 $ $ $ $ 17.7 20.1 $ 39.2 $ 1.7 18.3 $ 43.7 $ 6.4 17.8 $ 24.6 $ $ $ $ $ $ $ $ $ 1,652.1 82.3 (65.6) - 1,668.8 132.4 (56.4) - 1,744.8 (1,131.7) (74.4) 64.0 (1,142.1) (79.6) 55.1 (1,166.6) 520.4 526.7 578.2 1Net of capital expenditures financed by government grants. 2 Other property, plant and equipment is comprised of major overhauls and capitalized landfill retirement costs. 3At December 31, 2018, intangible assets included $20.2 million of work in progress assets (December 31, 2017 - $5.7 million) and as such had no related amortization in the period. 8. Accounts Payable and Accrued Liabilities (millions of Canadian dollars) Trade payables and accrued liabilities Accrued payroll and related liabilities Income tax payable 9. Operating Loans (millions of Canadian dollars) Available operating loans: Operating loan facility Letters of credit Total available operating loan facility As at December 31, 2018 137.1 44.9 - $ As at December 31, 2017 102.6 39.7 19.2 $ $ 182.0 $ 161.5 As at December 31, 2018 As at December 31, 2017 $ $ 110.0 (11.1) 98.9 $ $ 110.0 (9.2) 100.8 On April 6, 2018, the maturity date of the Company’s principal operating loan facility was extended from January 31, 2020 to April 6, 2022. 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. As at December 31, 2018, the Company is in compliance with all covenants relating to its operating loan facility. 48 10. Long-Term Debt On December 29, 2017, the Company repaid the full principal balance of its term loan of $50.0 million. Prior to repayment, the interest rate on the term loan was based on the lenders’ Canadian prime rate or bankers’ acceptance rate in the year of payment. 11. 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 2018 were $17.0 million (December 31, 2017 - $16.8 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 and other 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, 2018, CPPI has one registered defined benefit pension plan for which an actuarial valuation is performed at least every three years. The largest pension plan underwent an actuarial valuation for funding purposes as of December 31, 2017, which was completed in 2018. The next actuarial valuation for funding purposes is currently scheduled for December 31, 2020, to be completed in 2021. 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 an actuarial valuation as of December 31, 2017, which was completed in 2018. Information about CPPI’s defined benefit plans, in aggregate, is as follows: Fair market value of plan assets (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 Benefit payments Administration expense Defined Benefit Pension Plans $ 2018 Other Benefit Plans - - - 1.6 - (1.6) - 130.1 $ 4.4 (8.1) 5.0 0.1 (4.7) (0.1) Defined Benefit Pension Plans 123.9 $ 4.8 1.8 4.3 0.1 (4.7) (0.1) $ 2017 Other Benefit Plans - - - 2.7 - (2.7) - End of year $ 126.7 $ - $ 130.1 $ - Plan assets consist of the following: Asset category Equity securities Debt securities Annuities Cash and cash equivalents As at December 31, 2018 As at December 31, 2017 Percentage of Plan Assets 14% 26% 60% 0% 100% 36% 8% 56% 0% 100% 49Accrued benefit obligations 2018 (millions of Canadian dollars) Beginning of year Current service cost Settlement adjustment Interest cost Employee contributions Benefit payments Actuarial loss (gain) Other End of year Defined Benefit Pension Plans $ $ 158.8 $ 2.8 - 5.3 0.1 (4.7) (6.6) - 155.7 $ $ Other Benefit Plans 54.9 1.3 - 1.8 - (1.6) (7.0) (0.2) 49.2 $ Defined Benefit Pension Plans 148.0 $ 2.9 - 5.7 0.1 (4.7) 6.8 - 158.8 $ 2017 Other Benefit Plans 83.6 2.1 (0.5) 3.2 - (2.7) (30.3) (0.5) 54.9 Of the defined benefit pension plan obligation of $155.7 million (December 31, 2017 - $158.8 million), $140.2 million (December 31, 2017 - $143.3 million) relates to plans that are wholly or partly funded and $15.5 million (December 31, 2017 - $15.5 million) relates to plans that are wholly unfunded, with letters of credit securing $4.4 million (December 31, 2017 - $2.5 million) of the unfunded liability. The total obligation for the non-pension post-retirement benefit plans of $49.2 million (December 31, 2017 - $54.9 million) is unfunded. Annuity contracts The Company purchased $8.9 million (December 31, 2017 - $37.3 million) of buy-in annuities through its defined benefit pension plans during the year, increasing total annuities purchased to $86.0 million at December 31, 2018 (December 31, 2017 - $77.1 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 $0.7 million (December 31, 2017 - $1.6 million) related to the purchase were recognized in other comprehensive income (loss), principally reflecting the difference in the annuity rate compared to the discount rate used to value the obligations on a going concern basis. Voluntary Retiree Buyout Program In October 2017, certain non-pension post-retirement benefit plan members of the Company were given an offer to receive lump-sum payment in exchange for settlement of their future non-pension post-retirement benefit obligations under the Voluntary Retiree Buyout Program (“the Program”). Acceptance of the offer constitutes an irrevocable election to terminate future benefit obligations by plan members, and as such, settlement was recorded at the time of election by members. The deadline for elections made under the Program was October 31, 2017, and the resulting payments were made from November 2017 through January 2018. Under the program, $1.3 million of non-pension post-retirement benefit obligations were settled and derecognized in 2017, resulting in a settlement adjustment of $0.5 million, which was included in operating income. For the year ended December 31, 2018, $0.3 million was paid out under the Program (December 31, 2017 - $0.5 million). Medical Services Plan changes On November 2, 2017, the Legislative Assembly of British Columbia enacted the Budget Measures Implementation Act, 2017, which included a 50% reduction in Medical Services Plan (“MSP”) premiums effective January 1, 2018. This change in legislation was recognized in actuarial financial assumptions in 2017, and resulted in a $28.5 million pre-tax reduction of the non-pension post-retirement benefit obligation and a corresponding gain recognized through other comprehensive income (loss). In addition, in measuring the accrued benefit obligation at December 31, 2017, the MSP growth trend rate actuarial financial assumption was reduced from 4.5% to 2.0% resulting in an additional $9.3 million pre-tax gain recognized through other comprehensive income (loss) in 2017. 50$ $ $ $ $ $ Reconciliation of funded status of defined benefit plans to amounts recorded in the financial statements (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 December 31, 2018 Other Benefit Plans December 31, 2017 Defined Benefit Pension Plans Other Benefit Plans 126.7 $ - $ 130.1 $ (155.7) (49.2) (29.0) $ (1.8) (30.8) $ (49.2) $ - (158.8) (28.7) $ (1.6) (49.2) $ (30.3) $ - (54.9) (54.9) - (54.9) The following table shows the before tax impact on net income and other comprehensive income of the Company’s defined benefit pension and other non-pension post-retirement benefit plans: 2018 2017 Defined Benefit Pension Plans Other Benefit Plans Defined Benefit Pension Plans Other Benefit Plans (millions of Canadian dollars) Recognized in net income Current service cost Settlement adjustment Administrative cost Interest cost Other Total expense included in net income Recognized in other comprehensive income Actuarial (gain) – experience Actuarial loss (gain) – financial assumptions Return on plan assets less (greater) than discount rate Administrative costs greater than expected 2.8 - 0.1 0.9 - 3.8 $ 1.3 - - 1.8 (0.2) $ 2.9 $ - - 0.9 - $ 2.9 $ 3.8 $ $ (4.1) (2.9) (3.3) $ 10.1 (2.2) $ (4.4) 8.1 - - - (1.8) 0.1 5.1 $ (30.3) 2.1 (0.5) - 3.2 (0.2) 4.6 (0.1) (30.2) - - Total loss (gain) in other comprehensive income $ 1.5 $ (7.0) $ 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, 2018 December 31, 2017 Defined Benefit Pension Plans Other Benefit Plans Defined Benefit Pension Plans Other Benefit Plans 3.6% 3.0% n/a n/a n/a 3.6% n/a 5.5% 4.5% 2022 3.4% 3.0% n/a n/a n/a 3.4% n/a 6.5% 4.5% 2022 In addition to the significant assumptions listed in the table above, the average life expectancy of a 65-year-old at December 31, 2018 is between 21.1 years and 24.2 years (December 31, 2017 - 21.0 years and 24.1 years). As at December 31, 2018, the weighted average duration of the defined benefit plan obligation, which reflects the average age of the plan members, is 12.0 years (December 31, 2017 - 12.3 years). The weighted average duration of the other benefit plans is 13.3 years (December 31, 2017 - 14.2 years). 51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, including the hedging impact of plan annuity assets, for 2018: (millions of Canadian dollars) Defined benefit pension plan liabilities, net of annuity assets Discount rate Other benefit plan liabilities Discount rate Initial medical cost trend rate 1% Increase 1% Decrease $ $ $ (9.9) (6.5) 4.4 $ $ $ 12.7 8.1 (4.0) When taking into account the impact of hedging, 49% (December 31, 2017 - 45%) of the change to the defined benefit pension plans is fully hedged against changes in discount rates and longevity risk (potential increases in life expectancy of plan members) through buy-in annuities, and a further 20% (December 31, 2017 - 17%) is partially hedged through the plan’s investment in debt securities. As at December 31, 2018, contribution payments of $4.7 million are estimated to be made to the Company’s defined benefit pension plans in 2019 based on the last actuarial valuation for funding purposes. Defined contribution and other plans The total expense recognized in 2018 for CPPI’s defined contribution plans was $2.8 million (December 31, 2017 - $2.5 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 $7.6 million in 2018 (December 31, 2017 - $7.3 million). 12. Asset Retirement Obligations The following table provides a reconciliation of the asset retirement obligations as at December 31, 2018 and December 31, 2017: (millions of Canadian dollars) Asset retirement obligations at beginning of year Accretion expense Changes in estimates Asset retirement obligations at end of year 2018 2017 5.5 0.1 0.4 6.0 $ $ 5.4 0.1 - 5.5 $ $ 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 4 to 33 years and have been discounted at risk-free rates ranging from 1.9% to 2.2% (December 31, 2017 - 1.9% to 2.3%). 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. 5213. 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 year4 4Based on trade date. 2018 2017 Number of Shares 65,251,259 (500) 65,250,759 Amount 480.9 - 480.9 $ $ Number of Shares 66,699,368 (1,448,109) 65,251,259 Amount 491.6 (10.7) 480.9 $ $ 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 2018 is 65,250,763 (December 31, 2017 - 65,887,110), and reflects common shares purchased under the Company’s normal course issuer bid. Normal course issuer bid On March 5, 2018, the Company renewed its normal course issuer bid whereby up to 3,262,941 common shares or approximately 5% of its issued and outstanding common shares as of March 1, 2018 could be purchased for cancellation. In 2018, CPPI purchased 500 common shares at an average price of $13.01, and paid $0.1 million related to the purchase of shares in the fourth quarter of 2017. As at December 31, 2018, based on the trade date, there were 65,250,759 common shares of the Company outstanding and Canfor’s ownership interest in CPPI was 54.8% (December 31, 2017 - 54.8%). In 2017, under a previous normal course issuer bid, the Company purchased 1,448,109 common shares for $17.8 million (an average of $12.29 per common share), of which $10.7 million was charged to share capital and $7.1 million was charged to retained earnings. As at February 21, 2019 there were 65,250,759 common shares of the Company outstanding. 14. Finance Expense, Net (millions of Canadian dollars) Interest expense on borrowings Interest expense on retirement benefit obligations, net Interest income Other expense Finance expense, net 15. Income Taxes The components of income tax expense are as follows: (millions of Canadian dollars) Current Deferred Income tax expense 2018 (3.3) (2.7) 1.9 (0.1) (4.2) $ $ 2017 (3.7) (4.1) 0.7 (0.1) (7.2) $ $ 2018 (69.0) 2.3 $ 2017 (39.3) 0.5 (66.7) $ (38.8) $ $ 53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 27.0% (2017 – 26.0%) Add (deduct): Entities with different income tax rates and other tax adjustments Permanent difference from capital gains and other non-deductible items Change in substantively enacted tax legislation Income tax expense 2018 2017 $ (67.8) $ (36.6) 0.2 0.9 - 0.7 (0.1) (2.8) $ (66.7) $ (38.8) In 2017, the Provincial Government of British Columbia passed legislation increasing the provincial corporate tax rate from 11% to 12% effective January 1, 2018. Accordingly, a $2.8 million increase to income tax expense was recorded in net income in 2017 to record the impact on deferred taxes, with an additional $0.3 million being recorded in other comprehensive income as an income tax recovery on defined benefit plan actuarial losses. In addition, a tax expense of $1.5 million in relation to actuarial gains on the defined benefit plans (December 31, 2017 - expense of $6.6 million, before the tax rate adjustment) was recorded in other comprehensive income for the year ended December 31, 2018. 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 16. Net Change in Non-Cash Working Capital (millions of Canadian dollars) Accounts receivable Inventories Prepaid expenses Accounts payable and accrued liabilities Net increase in non-cash working capital 17. Related Party Transactions As at December 31, 2018 As at December 31, 2017 $ $ $ $ $ $ 21.2 3.6 24.8 (91.5) (0.1) (91.6) $ (66.8) $ 22.6 1.9 24.5 (91.9) (0.2) (92.1) (67.6) $ $ 2018 (2.4) (41.6) (2.9) 21.3 $ (25.6) $ 2017 (24.4) 0.6 4.8 12.6 (6.4) 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 2018, the Company depended on Canfor to provide approximately 66% (December 31, 2017 - 62%) 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 pricing under one of the Company’s Fibre Supply Agreements with Canfor expired on September 1, 2018. During 2018, the Company and Canfor entered into a new pricing agreement, which includes a market-based chip pricing formula. The new pricing agreement is effective July 1, 2018, for a three-year term, to June 30, 2021. The Company purchased wood chips, logs and hog fuel from Canfor sawmills in the amount of $252.8 million in 2018 (December 31, 2017 - $175.3 million). 54Canfor provides certain business and administrative services to CPPI under a services agreement. The total amount charged for the services provided by Canfor in 2018 was $14.8 million (December 31, 2017 - $12.5 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 2018 was $4.0 million (December 31, 2017 - $3.8 million). These amounts are included as cost recoveries in manufacturing and product costs and selling and administration costs. At December 31, 2018, an outstanding balance of $31.6 million (December 31, 2017 - $13.1 million) was due to Canfor. The Jim Pattison Group is Canfor’s largest shareholder. In August of 2018, The Jim Pattison Group’s ownership interest of Canfor increased above 50%, ending the year at 50.9%. During 2018, CPPI sold paper to subsidiaries owned by The Jim Pattison Group totalling $3.0 million (December 31, 2017 - $3.5 million). CPPI also made purchases from subsidiaries owned by The Jim Pattison Group totalling $0.7 million (December 31, 2017 - $0.3 million). No amounts related to these sales or purchases were outstanding as at December 31, 2018 or December 31, 2017. During 2018, the Company 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 11, Employee Future Benefits, and Note 22, 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 2018 3.1 0.1 3.2 $ $ 2017 3.4 0.2 3.6 $ $ Short-term benefits for members of the Board of Directors include an annual retainer as well as attendance fees. 18. Segment Information The Company has two reportable segments, pulp and paper, which operate as separate business units and represent separate product lines. The following summary describes the operations of each of the Company’s reportable segments: • Pulp – Includes purchase of residual fibre, and production and sale of pulp products, including NBSK pulp and BCTMP as well as energy revenues; and • Paper – Includes production and sale of paper products, including bleached, unbleached and coloured kraft paper. 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. In accordance with the new revenue standard, IFRS 15, described in Note 4, sales from contracts with customers have been disaggregated by segment. 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. There was no quantitative financial statement impact as a result of the adoption of IFRS 15. 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. 55 - 246.6 79.6 120.5 932.7 1,197.9 - 154.6 74.4 83.1 892.2 (millions of Canadian dollars) Year ended December 31, 2018 Sales from contracts with customers Sales to other segments Operating income (loss) Amortization Capital expenditures5 Identifiable assets Pulp Paper Unallocated Elimination Adjustment Total $ 1,192.9 $ 180.9 $ 0.5 $ - $ 1,374.3 119.7 248.9 75.3 113.3 841.7 - 11.0 4.2 3.7 66.1 - (13.3) 0.1 3.5 24.9 (119.7) - - - - $ Year ended December 31, 2017 Sales from contracts with customers Sales to other segments Operating income (loss) Amortization Capital expenditures5 Identifiable assets 5 Capital expenditures represent cash paid for capital assets during the periods and include capital expenditures that were partially financed by government grants. 1,024.5 92.0 140.5 70.4 81.3 751.3 0.4 - (11.9) 0.1 - 85.7 173.0 - 26.0 3.9 1.8 55.2 (92.0) - - - - $ $ $ $ - 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 2018 2017 $ $ 81.0 840.9 323.7 60.3 68.4 78.3 710.0 288.8 49.1 71.7 $ 1,374.3 $ 1,197.9 19. Commitments and Contingencies At the end of the year, CPPI has contractual commitments for the construction of capital assets for $11.8 million (December 31, 2017 - $12.2 million). These commitments are expected to be settled over the following year. In addition, CPPI has committed to operating leases for property, plant and equipment with future minimum lease payments under these operating leases as follows: (millions of Canadian dollars) Within one year Between one and five years More than five years Total As at December 31, 2018 0.7 0.9 0.1 $ As at December 31, 2017 0.5 0.7 - $ $ 1.7 $ 1.2 During the year ended December 31, 2018, $2.6 million (December 31, 2017 - $1.9 million) was recognized as an expense for operating leases. In the ordinary course of its business activities, the Company may be subject to, or enter into, legal actions and claims with customers, unions, suppliers or others. In circumstances where the Company is not able to determine the outcome of a legal action and claim, no amount is recognized in the consolidated financial statements, with an amount accrued only when a reliable estimate of the obligation can be made. Although there can be no assurance as to the disposition of a legal action and claim, it is the opinion of the Company’s management, based upon the information available at this time, that the expected 56outcome of a legal action and claim, individually or in aggregate, is unlikely to have a material adverse effect on the operating results and financial condition of the Company as a whole. 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, 2018, CPPI has $6.7 million of standby letters of credit (December 31, 2017 - $6.7 million) under these agreements, and has no repayment obligations under the terms of any of these agreements. 20. 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. CPPI’s internal Risk Management Committee manages risk in accordance with a Board approved Price Risk Management Controls Policy. This policy provides the framework for risk management related to commodity price, foreign exchange, interest rate and counterparty credit risk of Canfor. 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, accounts receivable and contract assets. Cash and cash equivalents includes cash held through major Canadian and international financial institutions as well as temporary investments with an original maturity date, or redemption date, of three months or less. The cash and cash equivalents balance at December 31, 2018 is $6.9 million (December 31, 2017 - $76.7 million). CPPI utilizes credit insurance to mitigate the risk associated with some of its trade accounts receivables. As at December 31, 2018, approximately 78% (December 31, 2017 - 76%) of the outstanding trade accounts receivables are covered under credit insurance. In addition, CPPI requires letters of credit on certain export trade accounts 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 accounts receivable balance at December 31, 2018 is $108.6 million, before a loss allowance of $1.0 million (December 31, 2017 - $101.7 million and $0.2 million, respectively). At December 31, 2018, approximately 98% (December 31, 2017 - 99%) of the trade accounts receivable balance are within CPPI’s established credit terms. 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, 2018, and December 31, 2017, CPPI has no amounts drawn on its operating loan facility. At December 31, 2018 CPPI had accounts payable and accrued liabilities of $182.0 million (December 31, 2017 - $161.5 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. 57(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, 2018 and December 31, 2017, 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 $1.2 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, 2018 and December 31, 2017. (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 Company’s 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, 2018 and December 31, 2017. (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, 2018 and December 31, 2017, the Company had no WTI oil collars outstanding. 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. 58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 cash Total equity As at December 31, 2018 $ $ $ - (6.9) (6.9) 596.6 589.7 As at December 31, 2017 - (76.7) (76.7) 571.4 494.7 $ $ $ The Company manages its capital structure through rigorous planning, budgeting and forecasting processes, and ongoing management of operations, investments and capital expenditures. In 2018, 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 cost reduction initiatives. Neither the Company nor any of its subsidiaries are subject to externally imposed capital requirements. 21. Financial Instruments CPPI’s cash and cash equivalents, trade and other accounts receivables, loans and advances, operating loans, and accounts payable and accrued liabilities are classified as measured at amortized cost in accordance with IFRS 9, adopted by the Company on January 1, 2018 (Note 4). The carrying amounts of these instruments at December 31, 2018, approximate fair value. When applicable, derivative instruments are classified as measured at FVTPL. 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, directly or indirectly; Level 3 – Inputs that are not based on observable market data. At times, the Company uses a variety of derivative financial instruments to reduce its exposure to risks associated with fluctuations in foreign exchange rates, energy costs and interest rates. As at December 31, 2018 and December 31, 2017, the Company had no derivative financial instruments outstanding. 22. 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, 2018, the Company’s share of the joint venture’s expenses was $2.1 million (December 31, 2017 - $1.1 million) which have 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, of which $3.8 million has been contributed as at December 31, 2018. In March 2017, the Canadian Federal Government through its Sustainable Development Technology Canada program announced the funding over several years of approximately $13.2 million, contingent on future spending. Advance funding of $1.9 million was received in April 2018 for the period October 1, 2017 through to the time at which the terms of funding have been met, which is currently estimated as March 31, 2019. Of this amount, $0.7 million has been recognized as an offset to costs within manufacturing and product costs for the year ended December 31, 2018. 5923. Special Dividend On November 13, 2018, the Company paid a special dividend of $146.8 million ($2.25 per share) to the shareholders of the Company. The special dividend was paid as a result of strong cash generated by the business over the last year. 24. Subsequent Event On February 21, 2019, the Board of Directors declared a quarterly dividend of $0.0625 per share, payable on March 13, 2019, to the shareholders of record on March 6, 2019. 6061 ADDI TION AL INF ORMATION 62 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, 2018 are as below. For more information visit www.canfor.com. Peter Bentley, O.C., O.B.C., LL.D.(2)(3)(4)(5) Chairman Emeritus Canfor Corporation Vancouver, British Columbia, Canada Barbara Hislop(1)(3)(4) President European Regional Council Burley, Hampshire, United Kingdon William Stinson(1)(2)(4)(5) Chairman and Chief Executive Officer Westshore Terminals Investment Corporation Vancouver, British Columbia, Canada Stan Bracken-Horrocks, FCPA, FCA (1)(3)(5) Corporate Director Kelowna, British Columbia, Canada Donald Kayne Chief Executive Officer Canfor Pulp Products Inc. Tsawwassen, British Columbia, Canada Conrad Pinette Chairman Canfor Pulp Products Inc. Vancouver, British Columbia, Canada John Baird(3)(4)(5) Corporate Director Toronto, Ontario, 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, 2018 are as below. For more information visit www.canfor.com. David Calabrigo, Q.C. Senior Vice President, Corporate Development, Legal Affairs and Corporate Secretary Vancouver, British Columbia, Canada Alan Nicholl Chief Financial Officer and Executive Vice President, Finance and Canfor Pulp Operations West Vancouver, British Columbia, Canada Peter Hart(6) Vice President, Pulp and Paper Sales and Marketing Vancouver, British Columbia, Canada Donald Kayne Chief Executive Officer Tsawwassen, British Columbia, Canada Martin Pudlas Vice President, Operations and Innovation Prince George, British Columbia, Canada Conrad Pinette Chairman Vancouver, 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 . ( 6 ) O n F e b r u a r y 2 8 , 2 0 19 P e t e r H a r t d e p a r t e d C a n f o r P u l p P r o d u c t s I n c . , a n d h i s p o s i t i o n a s V i c e P r e s i d e n t , P u l p a n d P a p e r S a l e s a n d M a r k e t i n g . H i s t i t l e , r o l e a n d r e s p o n s i b i l i t i e s w e r e a s s u m e d b y B r i a n Y u e n . 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 . 63 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 Westin Wall Centre at 3099 Corvette Way, Richmond BC, on Wednesday, May 1, 2019 at 11:30 a.m. Auditors KPMG LLP Vancouver, BC Transfer Agent and Registrar AST Trust Company (Canada) 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. Media Contact Michelle Ward Director, Corporate Communications Canfor Corporation T: (604) 661-5225 E: communications@canfor.com Canfor Pulp Products Inc. Head Office #230 – 1700 West 75th Avenue Vancouver, BC, V6P 6G2 T: (604) 661-5241 E: info@canfor.com www.canfor.com Investor Contact Patrick Elliott Vice President, Corporate Finance and Strategy Canfor Corporation T: (604) 661-5441 E: patrick.elliott@canfor.com Canfor Pulp Innovation 138 – 8610 Glenlyon Parkway Burnaby, BC, V5J 0B6 T: (604) 228-6710 64 CANFOR.COM 

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