Millar Western Forest Products Ltd. - Form 20-F

20-F 1 form20f.htm 20-F Millar Western Forest Products Ltd. - Form 20-F - Filed by newsfilecorp.com

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 20-F

[ ] REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) or 12(g) OF THE SECURITIES EXCHANGE ACT OF 1934

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For The Fiscal Year Ended December 31, 2016

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

[ ] SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934

Commission file number 333-179957

MILLAR WESTERN FOREST PRODUCTS LTD.
(Exact Name of the Registrant as Specified in its Charter)

Canada
(Jurisdiction of Incorporation or Organization)

16640 - 111 Avenue, Edmonton, Alberta, T5M 2S5
(Address of Principal Executive Offices)

David Anderson
Millar Western Forest Products Ltd.
16640 – 111 Avenue
Edmonton, Alberta T5M 2S5
(780) 486-8200
(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)

Securities registered or to be registered pursuant to Section 12(b) of the Act:

NONE

Securities registered or to be registered pursuant to Section 12(g) of the Act:

NONE

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

NONE

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.

15,000,002 Common Shares

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act

YES [ ] NO [X]

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

YES [X] NO [ ]

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.*

YES [ ] NO [ ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

YES [ ] NO [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.

Large Accelerated Filer [ ]

Accelerated Filer [ ]

Non-Accelerated Filer [X]

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

U.S. GAAP [ ]
International Financial Reporting Standards as issued by the International Accounting Standards Board [X]
Other [ ]

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YES [ ] NO [X]

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15 (d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.

NOT APPLICABLE

* Millar Western Forest Products Ltd. is a “voluntary filer” and is submitting this Form 20-F to satisfy its reporting obligations under the indenture relating to its 8.50% Senior Notes due 2021.

TABLE OF CONTENTS

PRESENTATION OF FINANCIAL INFORMATION				1

NON-GAAP FINANCIAL MEASURES				1

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS				1

GLOSSARY OF CERTAIN TERMS AND DEFINITIONS				2

PART I				5
	ITEM 1:	IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS.		5
	ITEM 2:	OFFER STATISTICS AND EXPECTED TIMETABLE		5
	ITEM 3:	KEY INFORMATION		5
		A.	Selected Financial Data	5
		B.	Capitalization and Indebtedness	7
		C.	Reasons for the Offer and Use of Proceeds	7
		D.	Risk Factors	7
	ITEM 4:	INFORMATION ON THE COMPANY		16
		A.	History and Development of the Company	16
		B.	Business Overview	16
		C.	Organizational Structure	22
		D.	Property, Plants and Equipment	22
	ITEM 5:	OPERATING AND FINANCIAL REVIEW AND PROSPECTS		24
		A.	Results of Operations	24
		B.	Liquidity and Capital Resources	39
		C.	Research and Development	43
		D.	Trend Information	43
		E.	Off-Balance Sheet Arrangements	44
		F.	Tabular Disclosure of Contractual Obligations	44
		G.	Safe Harbor	45
	ITEM 6:	DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES		45
		A.	Directors and Officers	45
		B.	Compensation	47
		C.	Board Practices	48
		D.	Employees	48
		E.	Share Ownership	49
	ITEM 7:	MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS		49
		A.	Principal Shareholder	49
		B.	Related Party Transactions	49
		C.	Interests of experts and counsel	49
	ITEM 8:	FINANCIAL INFORMATION		49
		A.	Consolidated Statements and Other Financial Information	49
		B.	Significant Changes	49
	ITEM 9:	THE OFFER AND LISTING		50
		A.	Offer and Listing Details	50
		B.	Plan of Distribution	50
		C.	Markets	50
		D.	Selling Shareholders	50
		E.	Dilution	50
		F.	Expenses of the Issue	50

	ITEM 10:	ADDITIONAL INFORMATION		50
		A.	Share Capital	50
		B.	Memorandum and Articles of Association	50
		C.	Material Contracts	52
		D.	Exchange Controls	52
		E.	Taxation	52
		F.	Dividends and Paying Agents	52
		G.	Statements by Experts	52
		H.	Documents on Display	52
		I.	Subsidiary Information	52
	ITEM 11:	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		53
		A.	Commodity Prices	53
		B.	Foreign Exchange	53
		C.	Interest Rates	53
	ITEM 12:	DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES		53

PART II				54
	ITEM 13:	DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND		54
	ITEM 14:	USE OF PROCEEDS		54
	ITEM 15:	CONTROLS AND PROCEDURES		54
	ITEM 16			55
		A.	AUDIT COMMITTEE FINANCIAL EXPERT	55
		B.	CODE OF ETHICS	55
		C.	PRINCIPAL ACCOUNTANT FEES AND SERVICES EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT	55
		D.	COMMITTEES	56
			PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND STANDARDS FOR AUDIT COMMITTEES	56
		E.	AFFILIATED PURCHASERS	56
		F.	CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT	56
		G.	CORPORATE GOVERNANCE	56
		H.	MINE SAFETY DISCLOSURE	56

PART III				56
	ITEM 17:	FINANCIAL STATEMENTS		56
	ITEM 18:	FINANCIAL STATEMENTS		56
	ITEM 19:	EXHIBITS		56

As used in this annual report on Form 20-F (this “annual report”), unless the context otherwise indicates, the term “we”, “our”, “Millar Western” or the “Company” means Millar Western Forest Products Ltd.

PRESENTATION OF FINANCIAL INFORMATION

We prepare our financial statements in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board, which we refer to as IFRS. Readers should be aware that financial statements prepared in accordance with IFRS may differ in certain respects from financial statements prepared in accordance with U.S. generally accepted accounting principles, which we refer to as U.S. GAAP.

We present our financial statements in Canadian dollars. Except where otherwise indicated, all dollar amounts are expressed in Canadian dollars, references to “$” or “dollars” are to Canadian dollars and references to “US$” and “U.S. dollars” are to United States dollars. See Item 3, “Key Information”, for exchange rate information between the Canadian dollar and the United States dollar.

Refer to the audited financial statements and the accompanying notes included elsewhere in this annual report for disclosure of matters in response to changes in significant accounting policies inclusive of future pronouncements and measurement assumptions, subsequent events, related party transactions, financial instruments and material changes in in estimates and accounting methods.

NON-GAAP FINANCIAL MEASURES

We define Adjusted EBITDA as operating earnings plus unrealized other income or expense, depreciation and amortization. Operating earnings is net income plus finance expenses, income tax expense or recovery and the foreign exchange gain or loss on debt. Other income or expense includes both realized and unrealized gains and losses on foreign exchange and/or commodity hedging and the foreign-exchange impact on working capital balances. Only the realized portion of such income or expense is included in Adjusted EBITDA, whereas both the realized and unrealized portions are included in the determination of operating earnings.

Adjusted EBITDA is not a measure of operating performance or liquidity under IFRS or U.S. GAAP. Such terms, as used in this annual report, are not necessarily comparable with similarly titled measures of other companies. Management believes that Adjusted EBITDA may be useful in assessing our operating performance and as an indicator of our ability to service or incur indebtedness, make capital expenditures and finance working capital requirements. The items excluded from Adjusted EBITDA are significant in assessing our operating results and liquidity. Therefore, Adjusted EBITDA should not be considered in isolation or as an alternative to operating earnings, cash flow from operating activities or other combined income or cash flow data prepared in accordance with IFRS or U.S. GAAP. See Item 5, “Operating and Financial Review and Prospects”, for a reconciliation of Adjusted EBITDA to Net Earnings (Loss).

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Certain statements in this annual report are “forward-looking statements” within the meaning of the United States Private Securities Litigation Reform Act of 1995. These forward-looking statements are not based on historical facts but, rather, on our current expectations and our projections about future events, including our current expectations regarding:

the implementation and completion of the Note Exchange Transaction (as defined herein) and the Share Exchange Transaction (as defined herein) and the anticipated benefits and consequences of such transactions;
the timing of the Meeting (as defined herein), the Court’s approval of the Plan of Arrangement and the consummation of the Note Exchange Transaction and the Share Exchange Transaction;
the future demand for, and sales volumes of, our lumber and pulp products;
future production volumes, efficiencies and operating costs;
increases or decreases in the prices of our products;
our future stability and growth prospects;
our business strategies, the measures to implement those strategies and the benefits to be derived therefrom;

our future profitability and capital needs, including capital expenditures;
the outlook for and other future developments in our affairs or in the industries in which we participate; and
the effect on us of new accounting releases.

These forward-looking statements generally can be identified by the use of statements that include words such as “believe”, “expect”, “anticipate”, “intend”, “plan”, “likely”, “will”, “predicts”, “estimates”, “forecasts” or other similar words or phrases. Similarly, statements that describe our objectives, plans or goals are or may be forward-looking statements. These forward-looking statements are subject to various risks, uncertainties and other factors that could cause our actual results to differ materially from the future results expressed or implied by the forward-looking statements. These risks and uncertainties are described under “Risk Factors” in Item 3, “Key Information.”

Any written or oral forward-looking statements made by us or on our behalf are subject to these factors. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this annual report on Form 20-F may not occur. Actual results could differ materially from those expressed in any of our forward-looking statements. Other unknown or unpredictable factors also could harm our future results. Given these uncertainties, prospective investors are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements included in this annual report are made only as at the date of this annual report. We do not intend, and do not assume any obligation, to update these forward-looking statements, except as required by law.

GLOSSARY OF CERTAIN TERMS AND DEFINITIONS

The following terms have the following meanings in this annual report:

“AAC” means annual allowable cut, being the amount of timber that may be harvested in any one year as stipulated in the pertinent forest management plan for a Forest Management Unit as approved by the Minister of Agriculture and Forestry of Alberta;

“admt” means air dried metric tonne, a unit of measurement of pulp volume, and “madmt” means one thousand air dried metric tonnes;

“BCTMP” means bleached chemi-thermo-mechanical pulp, which is pulp produced in a process that uses mild chemicals, heat and mechanical action to separate cellulose fibers;

“BEK” means bleached eucalyptus kraft pulp;

“BEP” means Bioenergy Effluent Project;

“coniferous” means a type of tree that is cone-bearing and has needles or scale-like leaves, such as spruce, pine or fir;

“Coniferous Timber Quota” means the right to harvest a percentage share of the AAC of coniferous timber within a Forest Management Unit, as approved by the Alberta Minister of Agriculture and Forestry, allocated on a 20-year basis and renewable thereafter for additional 20-year periods;

“deciduous” means a type of tree with broad leaves that usually shed annually, such as aspen;

“Deciduous Timber Allocation” means the right to harvest a specified volume of deciduous timber within a designated area, as approved by the Alberta Minister of Agriculture and Forestry, allocated on a 20-year basis and renewable thereafter for additional 20-year periods;

“dimension lumber” means standard commodity lumber, ranging, in the case of Millar Western, from 1” x 3”s to 2” x 10”s in varying lengths, usually 8’ to 16’;

“dressed lumber” means lumber that has been planed smooth on four sides and trimmed for length in a planer mill, after being produced as “rough lumber” in a sawmill; the majority of rough lumber output from our three sawmill operations is processed as dressed lumber in each operation’s planer mill, though we do sell volumes of rough lumber in addition to dressed product.

“EPC” means Engineering, Procurement and Construction, a form of contracting agreement; an EPC contractor will typically carry out the detailed engineering design of a project, procure all necessary equipment and materials, and construct to deliver a functioning facility to the client;

“FMA” means a Forest Management Agreement between the Alberta Minister of Agriculture and Forestry and a forest company, generally having a term of 20 years and renewable thereafter for additional 20-year periods, and providing rights to manage, establish, grow, harvest and remove timber in a specified area;

“foot board measure” or “fbm” or “board foot” means a measure of lumber volume equivalent to a one-foot square board, one inch thick; “mfbm” is one thousand board feet; and “mmfbm” is one million board feet;

“Forest Management Unit” means an area of forest land designated by the Minister of Agriculture and Forestry of Alberta as a management unit;

“FSC” means the Forest Stewardship Council, a voluntary, international certification and labeling system that promotes responsible forest management and fiber procurement through its sustainable forest management and chain of custody standards;

“hardwood” is wood obtained from deciduous species of trees, such as aspen;

“Industries” means Millar Western Industries Ltd., the parent company of Millar Western Forest Products Ltd.;

“ISO” means the International Organization for Standardization, a worldwide federation of national standards bodies from approximately 120 countries; “ISO 14001” is an international set of standards that provide a common approach for documenting and maintaining an environmental management system;

“J-grade” is a common name for the highest quality of SPF dimension lumber, preferred in the Japan market;

“kraft pulp” means pulp produced in a process that uses strong chemicals to separate cellulose fibers;

“Millar Western FMA” means the FMA between the Minister of Agriculture and Forestry of Alberta and Millar Western commencing May 14, 1997, in effect for 20 years and renewable thereafter for additional 20-year periods, pursuant to which the Minister has granted rights to us to manage, establish, grow, harvest and remove timber on a perpetual sustained yield basis in the Millar Western forest management area;

“Millar Western forest management area” means the tract of forested land over which we have been given rights to manage, establish, grow, harvest and remove timber on a perpetual sustained yield basis for the term of the Millar Western FMA;

“MSR” means machine stress rated, which is a rating given to lumber in North America that describes its load bearing capability;

“NBSK” means northern bleached softwood kraft pulp;

“Notes” and “Senior Notes”, unless specified as referring to notes appended to our financial statements or to previously issued Senior Notes, mean the Company’s 8.50% Senior Notes, issued in 2011 and due in 2021;

“PEFC” means the Programme for the Endorsement of Forest Certification, a Europe-based umbrella organization that assesses and endorses national forest certification systems for their consistency with international standards, as well as maintaining its own chain-of-custody standard;

“perpetual sustained yield” means the yield of timber that a forest can produce continuously at a given intensity of management without impairment of the productivity of the land;

“PPA” means Power Purchase Arrangement, an agreement defining rights and responsibilities associated with the purchase of electricity output from certain generating units in the province of Alberta.

“rough lumber” means timber sawn into boards and constitutes the output of a sawmill; the majority of rough lumber output from our three sawmill operations is further processed as “dressed lumber” in each operation’s planer mill, though we do sell volumes of rough lumber in addition to dressed product.

“SFI” means the Sustainable Forestry Initiative, a voluntary, third-party, North America-based forest certification program established in 1994. SFI is based on principles and measures that promote sustainable forest management and consider all forest values. It is managed by SFI Inc., an independent, non-profit organization responsible for maintaining, overseeing and improving the sustainable forestry certification program. SFI is endorsed by PEFC;

“softwood” is wood obtained from coniferous species of trees, such as spruce, pine or fir;

“SPF” means spruce, pine and fir, a major category of softwood lumber; and

“wood chips” means pieces of wood approximately one inch square by one-quarter inch thick resulting from the cutting of logs in chippers, or as a by-product of the lumber manufacturing process, that are typically used as a feedstock in the pulp making process.

PART I

ITEM 1: IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS.

Not applicable.

ITEM 2: OFFER STATISTICS AND EXPECTED TIMETABLE

Not applicable.

ITEM 3: KEY INFORMATION

A. Selected Financial Data

The selected historical financial data presented below as at December 31, 2016, and 2015, and for each of the years in the three-year period ended December 31, 2016, have been derived from, and should be read together with, our audited financial statements and the accompanying notes included elsewhere in this annual report. Our audited financial statements are presented in Canadian dollars and have been prepared in accordance with IFRS. The selected historical financial data presented below as at December 31, 2014, 2013, and 2012, and for the years ended December 31, 2013 and 2012, are also presented in accordance with IFRS and have been derived from, and should be read together with, our audited financial statements corresponding to such periods, which are not included in this annual report.

The selected historical financial data presented below are qualified in their entirety by the more detailed information appearing in our financial statements and the related notes, as well as Item 5, “Operating and Financial Review and Prospects”, and other financial information included elsewhere in this annual report. Historical results are not necessarily indicative of results expected for any future period.

		Year ended December 31,
		2016			2015			2014			2013			2012
Statements of earnings data:								(in thousands)

Revenue	$	385,117		$	378,598		$	405,123		$	382,938		$	332,401
Cost of products sold		268,562			280,884			273,852			259,155			241,039
Freight and other distribution costs		64,203			63,961			59,767			53,438			53,222
Depreciation and amortization		10,345			14,568			14,272			13,996			13,641
General and administration		18,269			15,781			18,748			19,061			13,781
Other expense (income)⁽¹⁾		293			3,869			(2,679	)		(11,869	)		7,650
Loss on termination of Power Purchase Arrangement (PPA)		26,624			-			-			-			-
Gain on sale of Boyle assets and liabilities		-			(17,622	)		-			-			-
Operating (loss) earnings		(3,179	)		17,157			41,163			49,157			3,068
Foreign exchange gain (loss) on borrowings		8,673			(47,019	)		(20,265	)		(14,425	)		4,641
Finance expenses, net⁽²⁾		(21,098	)		(23,295	)		(22,086	)		(20,892	)		(20,425	)
(Loss) earnings before income taxes		(15,604	)		(53,157	)		(1,188	)		13,840			(12,716	)
Income taxes (recovery) expense		(7,213	)		(402	)		3,993			7,220			(4,457	)
Net (loss) earnings for the year	$	(8,391	)	$	(52,755	)	$	(5,181	)	$	6,620		$	(8,259	)
Actuarial (gains) losses - net of tax		(353	)		175			1,455			(577	)		317
Comprehensive (loss) income for the year	$	(8,038	)	$	(52,930	)	$	(6,636	)	$	7,197		$	(8,576	)

		Year ended December 31,
		2016		2015		2014		2013		2012
Balance sheets data:						(in thousands)

Cash	$	40,237	$	16,773	$	47,425	$	47,219	$	24,674
Restricted cash	$	-	$	-	$	-	$	7,977	$	18,824
Total assets	$	381,917	$	412,583	$	420,112	$	396,274	$	382,175
Financial liabilities - borrowings	$	303,671	$	317,500	$	263,761	$	240,181	$	222,745
Shareholder's equity	$	7,713	$	15,751	$	69,431	$	78,317	$	72,620

⁽¹⁾	Other (income) expenses includes the gain or loss on insurance proceeds, foreign exchange gains or losses on U.S. dollar cash and working capital, and realized and unrealized gains or losses on derivative contracts. See our audited financial statements included elsewhere in this annual report, including note 18, referring to the three-year period ended December 31, 2016.

⁽²⁾	Finance expenses consist of interest expense, net of interest income. See note 19 to our audited financial statements included elsewhere in this annual report, referring to the three-year period ended December 31, 2016.

EXCHANGE RATE DATA

The following table sets forth, for each period indicated, the low and high exchange rates for Canadian dollars expressed in U.S. dollars, the exchange rate at the end of such period and the average of such exchange rates on the last day of each month during such period, based on the Bank of Canada’s closing rate on such dates:

	2016	2015	2014	2013	2012
Low	0.6821	0.7141	0.8568	0.9314	0.9576
High	0.8002	0.8562	0.9444	1.0188	1.0377
Period End	0.7448	0.7225	0.8620	0.9402	1.0051
Average	0.7550	0.7821	0.9053	0.9710	1.0004

The following table sets forth, for each of the last six months, for Canadian dollars expressed in U.S. dollars, the low and high exchange rates based on the closing rate as described above:

	Last six months
	February	January	December	November	October	September
Low	0.7520	0.7427	0.7354	0.7359	0.7444	0.7530
High	0.7704	0.7645	0.7645	0.7520	0.7689	0.7798

On March 1^st, 2017, the Bank of Canada’s noon rate was US$0.7493 = $1.00.

B. Capitalization and Indebtedness

Not applicable.

C. Reasons for the Offer and Use of Proceeds

Not applicable.

D. Risk Factors

You should carefully consider the following factors in addition to the other information set forth in this annual report. The following risks, including both those common within our industry and those specific to our company, could materially and adversely affect our business, our financial condition or results of operations, or our ability to make payments under our outstanding indebtedness.

Industry-related Risks

Our business is of a cyclical nature, and prices of and demand for our products, and our results of operations, may fluctuate significantly based on market factors.

Our financial performance is principally dependent on the selling prices of, and the demand for, the pulp and lumber products we sell. Prices and demand for such products have fluctuated significantly in the past and may fluctuate significantly in the future. The markets for pulp and lumber are highly cyclical and affected by such factors as global economic conditions, demand for pulp and paper, residential and commercial construction in North America and Asia, changes in industry production capacity and inventory levels and other factors beyond our control. Market conditions, demand and selling prices for our products may decline from current levels. Any prolonged or severe weakness in the market for any of our principal products would adversely affect our business, financial condition, results of operations and cash flows.

Intense global competition could limit our ability to effectively market our products, which could have a negative impact on our revenue and profitability.

We compete in North American and overseas export markets with numerous forest products companies, including very large integrated firms that have greater financial resources than we do. Our lumber segment also competes indirectly with firms that manufacture substitutes for wood building materials. While the principal basis for competition is price, we also compete on the basis of customer service, quality and product type. Our competitive position is influenced by the availability, quality and cost of fiber, energy and labor, plant efficiencies and productivity and foreign currency fluctuations. Some of our competitors may have lower costs, or less stringent environmental and other governmental regulations to comply with, than we do. Some competitors may be less leveraged than we are and, therefore, have greater financial flexibility than we do. In addition, variations in the exchange rates between the Canadian dollar and the U.S. dollar, and between the U.S. dollar and local currencies in each of our export markets, also affect the relative competitive position of our products when compared to our competitors outside of Canada. Our ability to compete in the markets to which we export our products is also dependent upon free access and transportation costs to such markets. If we are unable to compete effectively, our revenue could decline, which would have a material adverse effect on our business, financial condition, results of operations and cash flows.

We are exposed to currency exchange risk that could reduce cash flow available to fund our operations and cause our reported earnings to fluctuate materially.

Our operating results are sensitive to fluctuations in the exchange rate of the Canadian dollar to the U.S. dollar, as prices for our products are largely denominated in U.S. dollars or linked to prices quoted in U.S. dollars, while most of our operating costs are incurred in Canadian dollars. Therefore, an increase in the value of the Canadian dollar relative to the U.S. dollar reduces the amount of revenue we realize, in Canadian dollar terms, from sales made in U.S. dollars, which reduces our operating margin and the cash flow available to fund our operations.

In addition, we are exposed to currency exchange risk on our debt, including the Senior Notes and interest thereon, and current assets denominated in U.S. dollars. Since we present our financial statements in Canadian dollars, any change in the value of the Canadian dollar relative to the U.S. dollar during a given financial reporting period would result in a foreign currency loss or gain on the translation of our U.S.-dollar-denominated debt and assets into Canadian dollars. Consequently, our reported earnings could fluctuate materially as a result of foreign-exchange translation gains or losses.

To mitigate the impact of foreign-exchange volatility on our earnings, we may enter into currency contracts to partially hedge our exposure to fluctuations in exchange rates. However, hedging transactions may not be successful in materially reducing our exposure to exchange rate fluctuations.

Trade actions that may be taken against Canadian softwood lumber shipments to the United States following the expiry of the Softwood Lumber Agreement and its standstill provision period could have a negative effect on our profitability.

The 2006 Softwood Lumber Agreement (SLA) resolved litigation arising from, and trade measures imposed following, the March 2001 expiry of a prior softwood lumber trade agreement between Canada and the United States. Effective for a term of seven years commencing in October 2006 and then extended for two additional years to October 2015, the SLA brought about the revocation of American countervailing and anti-dumping duties on Canadian lumber shipments to the U.S.

Under the SLA, export charges were imposed on Canadian lumber shipments to the U.S. in months when the market price of lumber was at or below US$355 per thousand board feet, and additional surge penalties were imposed on shipments from certain regions, including Alberta, when shipments from that region exceed a prescribed level in a given month. The export charges varied according to the market price of lumber, and ranged from 0 to 15%; the additional surge penalties, when applied, were set at 50% of the current export charge and so ranged from 0 to 7.5% .

The SLA expired on October 12, 2015, commencing a 12-month period during which no trade measures could be imposed, in accordance with the terms of a standstill provision included in the agreement. In November 2016, a coalition of U.S. lumber producers filed a petition asking the U.S. Department of Commerce to investigate Canadian lumber shipments with a view to potentially implementing new trade actions. This investigation is expected to result in countervailing or anti-dumping duties, the magnitude of which are uncertain, being applied to shipments of Canadian lumber to the U.S.

Sales of lumber to the U.S. represent a significant source of our revenue, accounting for approximately 34% of lumber segment revenue in 2016. Any new trade measures imposed by the U.S., such as export duties, could therefore have a material adverse effect on our business, financial condition, results of operations and cash flows.

An increase in our fiber costs could have a negative impact on our earnings.

The availability of an economic fiber supply is one of the most important factors affecting the performance of forest products companies. The costs of our fiber, including fees charged by government, logging and transportation costs, and market prices for purchased fiber, have historically fluctuated and could increase in the future. Any significant increase in the cost of fiber could have a material adverse effect on our business, financial condition, results of operations and cash flows.

The government imposes fees, referred to as “stumpage”, on all timber harvested on government-owned land and also holds companies responsible for reforestation and reclamation costs. Amendments to government legislation or regulatory regimes may change stumpage-fee structures payable in relation to the harvesting of timber and could increase costs through the imposition of additional or more stringent reforestation and silvicultural standards. A material increase to the stumpage rates applicable to the Millar Western FMA, our Coniferous Timber Quotas or our Deciduous Timber Allocations could have a material adverse effect on our business, financial condition, results of operations and cash flows.

While approximately 82% of our fiber requirements are met through our government timber allocations and fiber exchange and supply agreements with other companies, we purchase the balance of our fiber requirements on the open market. Accordingly, our operations could be affected by changes in the supply and demand for, and the prices of, purchased fiber.

We rely on independent contractors to harvest timber and haul logs from the forest to our operations. Contractor compensation and availability could negatively affect costs and also could impede our ability to maintain sufficient log supplies in our yards to sustain current mill operating rates. Delivered timber costs are also affected by variable fuel prices and log-haul distances. Higher fiber costs could have a material adverse effect on our business, financial condition, results of operations and cash flows.

Our ability to harvest timber is subject to natural events that are beyond our control and that could have a negative impact on our operations.

Our ability to harvest timber is subject to natural events such as forest fires, adverse weather conditions, insect infestation, disease and prolonged drought. The occurrence of any of these events could adversely affect our ability to harvest timber, which could have a material adverse effect on our business, financial condition, results of operations and cash flows.

In response to a mountain pine beetle infestation, the Alberta government and forest industry have implemented an action plan that has been effective to date in curbing beetle spread and mitigating associated damage. However, the infestation remains an ongoing risk to the health of mature pine stands in our operating area. Any significant impacts on merchantable pine stands in our area could affect our fiber supply and have a material adverse effect on our business, financial condition, results of operations and cash flows.

If environmental or other regulatory approvals, licenses or permits are delayed, restricted or not renewed, a variety of operations on our timberlands or at our facilities could be delayed or restricted.

In connection with a variety of operations on our properties, we are required to make regulatory filings with governmental agencies. Any of these agencies could delay review of or reject any of our filings, which could delay or restrict our manufacturing or logging operations, potentially resulting in an adverse effect on our operating results. For example, our pulp mill operates under an environmental permit that is due to expire on November 1, 2017, if not renewed on or before that date. We have initiated the renewal procedure for our pulp mill operating permit and expect to obtain the renewal on a timely basis, but if we are unable to renew or extend this or any other material approval, license, permit or certificate, or if we are delayed in doing so, our business, financial condition, results of operations and cash flows could be materially adversely affected.

Our ability to sell our products could be compromised if environmental certifications are not achieved or renewed, which could have a negative impact on our business, financial condition, results of operations and cash flows.

Sales of our products, especially pulp, are increasingly dependent upon our ability to achieve and maintain certification under internationally recognized standards for sustainable forest management and wood-fiber chain of custody. Certifications that we currently hold may be terminated for failure to meet the requirements of the certification standard, which could result in lost product sales. As well, existing standards could become more onerous or new certifications may be deemed necessary in order to meet customer requirements, resulting in additional costs. Any of these developments could cause our business, financial condition, results of operations and cash flows to be materially adversely affected. For more details regarding our certifications, see Item 4, “Business Overview – Government regulation – Forest certification”.

Company-specific Risks

We may not have the capital required to maintain our facilities and grow our operations.

Facilities for producing lumber and pulp are capital intensive. Our annual capital expenditures may increase due to changes in requirements for maintenance, unforeseen events, and changes to environmental or other regulations that require capital for compliance. Although we maintain our production equipment with regular, scheduled maintenance, key pieces of equipment in our various production processes may need to be repaired or replaced before such repair or replacement is scheduled. If we do not have sufficient funds or such repairs or replacements are delayed, the costs of repairing or replacing such equipment and the associated downtime of the affected production line could have a material adverse effect on our business, financial condition, results of operations and cash flows.

We may not realize all savings and revenues expected to result from the Bioenergy Effluent Project.

Our Whitecourt pulp mill has substantially completed and is currently commissioning a project (the Bioenergy Effluent Project, or BEP) that has installed new technology to produce a biogas used to generate renewable energy that will displace a portion of the purchased electricity and natural gas used in our mill operations. The project was implemented to enhance pulp mill environmental performance, in part by reducing greenhouse gas emissions, and to strengthen mill economic performance, by cutting operating costs and increasing revenues. Project costs as of December 31, 2016, net of $27.7 million in government grants and a $7.8 million letter of credit recovered from the original EPC contractor, were $86.8 million. We expect to spend an additional net amount of approximately $1.0 million on the project in 2017, funded through cash from operations.

A reduction in our fiber supply could affect our ability to operate.

Fiber is the primary raw material in our products, and maintaining long-term fiber security is therefore important to our business. We obtain approximately 56% of our fiber requirements, based on current production capacity, from a Forest Management Agreement (FMA), Coniferous Timber Quotas and Deciduous Timber Allocations issued by the Alberta Minister of Agriculture and Forestry, each of which is issued for a period of 20 years and is renewable, provided agreement obligations are met. Our FMA is in effect until 2034. Our quotas and allocations have expiry dates ranging between 2021 and 2028. The FMA, quotas and allocations may not be renewed or extended on acceptable terms. In addition, the FMA, quotas and allocations contain terms or conditions that could, under certain circumstances, result in a reduction in the amount of fiber available to us. Any significant reductions to fiber available under our FMA, quotas and allocations could affect our ability to maintain current mill operating rates.

The Millar Western FMA provides that the Minister may withdraw from the forest management area (i) any land which cannot be harvested without causing substantial harm to the environment, (ii) any land determined to be required for human or physical resource development of the Province of Alberta, (iii) any land required for commercial and industrial facilities and (iv) any land that is not capable of producing timber. In the event of such withdrawal, the government may compensate the holder for certain costs and losses associated with such withdrawal. There have been no material withdrawals of land from the Millar Western FMA since its inception.

In 2005, the Government of Alberta introduced the Healthy Pine Strategy, which called for increased harvesting levels in mature and over-mature pine stands to reduce their vulnerability to infestation by the mountain pine beetle and to improve overall forest health. Under the strategy, companies have been permitted to harvest volumes in excess of historical annual allowable cut (AAC) volumes to address the infestation concern; however, to ensure long-term sustainability of the forest resources, companies employing these surge cuts are expected to undergo a reduction in their AAC in future years. In the 2007-2016 period, AAC for our Whitecourt and Fox Creek tenure areas was adjusted to reflect the Healthy Pine Strategy, resulting in AAC increases of an average of 40% in our FMA and six of our Coniferous Timber Quotas. AAC reductions are expected to begin taking effect in our FMA area in 2017 and in the affected Coniferous Timber Quotas during the period 2024 to 2028, with the amount of these reductions yet to be determined. To mitigate these potential reductions, we have implemented a series of intensive forest management practices to improve forest growth and yield; however, we expect to have to supplement our existing timber supply with additional open-market timber purchases starting in 2017, the availability and cost of which are unknown at this time.

The Government of Alberta has initiated the Land-Use Framework process to manage competing land-use pressures. The government has divided the province into seven regions and intends to develop land-use plans for each, with the aim of balancing economic, environmental and social demands. While we view this process as potentially beneficial in providing greater long-term certainty regarding resource development, it presents a risk in that the government could reduce the amount of land allocated to the forest products industry for timber production and may not compensate us for any volume reductions that result. A significant loss of fiber supply resulting from this process, whether directly or through reductions in fiber available for purchase on the open market, could have a material adverse effect on our business, financial condition, results of operation and cash flows.

The Government of Canada has enacted legislation aimed at protecting species at risk, including woodland caribou. Woodland caribou ranges overlap forest management areas in which some of our Coniferous Timber Quotas are embedded. Caribou range planning processes currently being undertaken by the Alberta government, in consultation with industry and other stakeholders and in consideration of both federal and provincial legislative requirements, have the potential to reduce the supply of timber available from these areas. Any significant loss of fiber supply resulting from this process, whether directly or through reductions in fiber available for purchase on the open market, could have a material adverse effect on our business, financial condition, results of operation and cash flows.

In addition to fiber from government tenures, we also rely on fiber acquired through multi-year exchange and supply contracts to satisfy approximately 26% of our requirements. These multi-year fiber agreements expire between 2019 and 2021. While all are renewable, we may not be able to extend these contracts beyond their expiry. If these contracts are not renewed or are modified due to government policy or regulatory changes, we may be without sufficient fiber to maintain current production levels, which could have a material adverse effect on our business, financial condition, results of operation and cash flows. On April 27, 2016, we received notice of force majeure related to a log-chip exchange agreement we have in place with another forest company under which we have received a total of 665,000 cubic meters per year of logs from the other company's Forest Management Agreement area. In the notice of force majeure, we were advised this log volume will be reduced to 500,000 cubic meters per year, effective May 1, 2016. Under the same exchange agreement, Millar Western has delivered 170,000 bone dry units per year of chips to the other company; with force majeure invoked, this volume will be reduced to 135,000 bone dry units.

While we do not expect this change to affect our operations in the near-term, it could affect our long-term fiber supply. We are pursuing options to purchase fiber on the open market and will manage our internal allocations to ensure the least disruption to our operations. We have secured sales for the excess chip volume in the short-term and are pursuing options to address the excess volume over a longer time frame.

Under the terms of the multi-year fiber exchange and supply contracts, we provide other companies with wood residuals. If these contracts are not renewed upon expiry, we could incur revenue reductions and/or additional disposal costs. Fiber availability or manufacturing disruptions could also impair our ability to provide these residuals in specified quantities and put us in breach of contractual obligations. These outcomes could have a material adverse effect on our business, financial condition, results of operations and cash flows.

Exposure to fluctuations in electricity prices could adversely affect our profitability.

On January 1, 2001, we entered into two Power Syndicate Agreements (Battle River and Sundance C, respectively) with an affiliate of Capital Power Corporation (formerly EPCOR Utilities Inc.) and three other industrial participants in Alberta for the purpose of sharing the rights and responsibilities defined in two corresponding Power Purchase Arrangements, which we referred to as our power purchase rights. In May 2006, we consolidated our power purchase rights by swapping our interest in the Battle River agreement for an increased interest in the Sundance C agreement and the corresponding Power Purchase Arrangement, which we refer to as the PPA. On March 24, 2016, Capital Power Corporation gave notice of its intent to terminate its role as buyer of the Sundance C PPA, citing significant changes to the Specified Gas Emitters Regulation in Alberta that had impaired its ability to realize benefits from the arrangement. As a result of this termination, our role as a party to the PPA syndicate was also terminated. The Government of Alberta subsequently challenged the termination and entered into related negotiations with Capital Power Corporation. On November 28, 2016, Capital Power Corporation announced it had reached an agreement with the Government of Alberta to settle the PPA dispute. Under the settlement, the government accepted the termination of the PPA, thereby ending all of our benefits and obligations associated with the PPA.

The PPA had reduced our exposure to fluctuations in market electricity rates. With its termination, we became exposed to these fluctuations, which could have a material adverse effect on our business, financial condition, results of operations and cash flows.

Environmental and other government legislation and regulations could increase our cost of doing business or restrict our ability to conduct our business.

We are subject to a wide range of general and industry-specific environmental and other laws and regulations imposed by federal, provincial and local authorities in Canada, including those governing the use, storage, handling, generation, treatment, emission, release, discharge and disposal of certain hazardous materials and wastes, the remediation of contaminated soil and groundwater, and the health and safety of employees. We are also subject to reforestation requirements and had an accrued liability of $11.7 million at December 31, 2016 (2015 – $12.4 million, 2014 – $14.6 million), for future reforestation obligations.

Our failure to comply with applicable environmental and safety laws and regulations, and associated permit requirements, could result in civil or criminal fines or penalties or enforcement actions, including regulatory or judicial orders enjoining or curtailing operations or requiring corrective measures, installation of equipment or remedial actions, any of which could result in significant capital expenditures or reduced results of operations. In addition, future events, such as any changes in environmental or other laws and regulations, including any new legislation that might arise or any change in interpretation or enforcement of laws and regulations, may result in additional expenditures or liabilities. These could have a material adverse effect on our business, financial condition, results of operations and cash flows.

In the province of Alberta, power consumers are responsible for electricity distribution and transmission costs. Given that we are a major electricity consumer, recent and projected investments in transmission infrastructure could result in significant escalation of our transmission costs.

Under the “Climate Change and Emissions Management Act”, the Government of Alberta has set out intensity-based carbon emissions reduction targets. Facilities that release 50,000 to 100,000 tonnes of CO₂equivalent (CO₂e) per year are required to report their emissions but are not currently subject to reduction requirements. Large emitters, defined as those producing more than 100,000 tonnes of CO₂e per year, are required to reduce their emissions intensity by 15% in 2017 and 20% in 2018, compared to 2007 levels. In lieu of reductions, organizations can remit to a technology fund the amount of $20 during 2017 and $30 beginning in 2018 for every tonne of CO2e generated over a specified limit or buy an equivalent amount of provincially-approved offset credits. In recent years, our Whitecourt pulp mill has released approximately 75,800 tonnes of CO₂e per year, making us responsible for reporting our emissions, though not currently subject to a requirement to reduce the emissions or to pay penalties or purchase offsets in association with them.

Our PPA was linked to a coal-fired electricity plant that qualified as a large emitter, making us responsible, during the period of the agreement, for a portion of penalties associated with its CO₂e emissions. In 2016, we were responsible for approximately 28,779 tonnes of CO2e emissions associated with the PPA. In some previous years, we addressed this obligation by applying offset credits earned through an energy-reduction project conducted in our mill operations and independently verified and registered with provincial authorities. In 2016, we elected to pay the $20/tonne penalty and to bank offset credits for use in future periods, when carbon penalties are expected to rise in accordance with plans announced by the Government of Alberta.

In 2015, the Alberta government announced that it would increase the levy paid by large emitters from $15/tonne of CO₂e emitted to $20/tonne, starting in 2017, and that it would introduce a province-wide carbon levy of $20/tonne in 2017 and increase the levy to $30/tonne in 2018. Associated costs may have a material adverse effect on our business, financial condition, results of operations and cash flows. The government may take additional future measures that could negatively affect us, for example, by lowering the emissions threshold defining “large emitters”, which could require our pulp mill not only to report but to reduce, pay for or offset emissions over a specified threshold, or by further increasing the penalties that apply to these emissions. Such regulatory changes could increase our costs and have a material adverse effect on our business, financial condition, results of operations and cash flows.

Our business is subject to many operational risks for which we may not be adequately insured.

Our business is subject to the risks associated with operating pulp mills and sawmills and with logging, such as unforeseen equipment breakdowns, power failures, fires, floods, environmental issues, severe weather and other events that could result in a temporary or prolonged shutdown of any of our operations. A shutdown at any of our operations could materially adversely affect our business, financial condition, results of operations and cash flows. Although we maintain insurance, including business interruption insurance, we may incur losses beyond the limits of, or outside the coverage of, such insurance. From time to time, various types of insurance for companies in the pulp and lumber industries have not been available on commercially acceptable terms or, in some cases, have been unavailable. For example, we cannot insure against losses of standing timber from any cause, including fire, and insurance against certain environmental risks may not be available on commercially acceptable terms. In addition, premiums for our existing coverage may increase substantially, and we may be unable to maintain our current insurance coverage.

We have significant indebtedness, which could weaken our financial condition and limit our ability to fulfill our obligations under our outstanding indebtedness.

We have a significant amount of indebtedness and significant debt service obligations. This high degree of leverage could have important consequences. For example, it could:

make it more difficult for us to satisfy our obligations with respect to our outstanding indebtedness;
increase our vulnerability to adverse economic and industry conditions;
require us to dedicate a substantial portion of cash from operations to the payment of debt service, thereby reducing the availability of cash to fund working capital, capital expenditures and other general corporate purposes;
limit our ability to obtain financing for working capital, capital expenditures, general corporate purposes or acquisitions;
place us at a disadvantage compared to our competitors that have a lower degree of leverage; and
limit our flexibility in planning for, or reacting to, changes in our business and in the forest products industry.

We may not generate cash flow sufficient to service all of our obligations.

Our ability to make payments on and to refinance our indebtedness, and to fund our operations, working capital and capital expenditures, depends on our ability to generate cash in the future. Our cash flow is subject to general economic, industry, financial, competitive, operating, regulatory and other factors that are beyond our control. Our business may not generate cash flow in an amount sufficient to enable us to repay our indebtedness or to fund our other liquidity needs. We may need to refinance all or a portion of our indebtedness on or before maturity. Our ability to refinance our indebtedness or obtain additional financing will depend on, among other things:

our financial condition at the time;
restrictions in the indenture governing our Senior Notes and the terms governing our revolving credit facility; and

other factors, including the condition of the financial markets or the forest products industry.

If we do not generate sufficient cash flow from operations, and if additional borrowing, refinancing, or proceeds of asset sales are not available to us, then we may not have sufficient cash to enable us to meet all of our obligations.

We may be able to incur additional indebtedness, which could further exacerbate the risks associated with our substantial indebtedness.

Although the terms governing our revolving credit facility and the indenture governing the Senior Notes (the “indenture”) contain restrictions on the incurrence of additional indebtedness, additional indebtedness incurred in compliance with these restrictions could be substantial. As at December 31, 2016, we would have been permitted to borrow up to $38.1 million under our revolving credit facility. In addition, the indenture does not prevent us from incurring obligations, such as trade payables and operating leases, that do not constitute indebtedness. If we incur additional indebtedness or other obligations, the related risks could be magnified.

The agreements governing our indebtedness contain significant restrictions that limit our operating and financial flexibility.

The agreements governing our indebtedness contain covenants that, among other things, limit our ability to:

incur additional indebtedness;
pay dividends and make distributions;
repurchase stock;
make certain investments;
transfer or sell assets;
create liens;
enter into transactions with affiliates;
issue or sell stock of subsidiaries;
create dividend or other payment restrictions affecting restricted subsidiaries; and
merge, consolidate, amalgamate or sell all or substantially all of our assets to another person.

In addition, our revolving credit facility requires us to maintain specified financial ratios, and we may be unable to meet such ratios. All of these covenants may limit our ability to execute our business strategy. Moreover, we may be unable to comply with these covenants. If that occurs, our lenders could accelerate our indebtedness, in which case, we may not be able to repay all of our indebtedness.

Our sole shareholder has the ability to direct our operations, and its interests may conflict with the interests of the Senior Noteholders.

Our parent, Industries, holds, directly and of record, all of our outstanding common shares. Millar Western Industries Ltd. is wholly owned by Hualkeith Investments Ltd., a corporation owned by our co-chairmen of the board of directors, brothers James B. Millar and H. MacKenzie Millar, and other members of the Millar family. James B. Millar and H. MacKenzie Millar together control 55.6% of the outstanding equity of Hualkeith. The Millar family may have interests that differ from those of the Senior Noteholders and, therefore, may make decisions that are adverse to their interests.

The ability to enforce civil liabilities in Canada under U.S. securities laws may be limited.

We are incorporated under the federal laws of Canada and substantially all of our assets are located in Canada. All of our directors and officers reside in Canada, and most of their assets are located in Canada. It may not be possible, therefore, to effect service of process within the United States upon us or our directors and officers. There is uncertainty as to the enforceability (1) in an original action in Canadian courts, of liabilities predicated solely upon United States federal securities laws and (2) of judgments of United States courts obtained in actions predicated upon the civil liability provisions of United States federal securities laws in Canadian courts. Therefore, persons in the United States may not be able to secure judgment against us or our directors and officers in a Canadian court or, if successful in securing a judgment against us or them in a U.S. court, may not be able to enforce such judgment in Canada.

Risks Related to the Note Exchange Transaction

The consummation of the Note Exchange Transaction may not occur for a number of reasons, including as a result of a termination of the Support Agreement

The Company will not complete the Note Exchange Transaction unless and until all conditions precedent to the Note Exchange Transaction, some of which are not under the Company’s control, are satisfied or waived. Even if the Note Exchange Transaction is completed, it may not be completed on the schedule or in the manner currently anticipated. If the Note Exchange Transaction is not completed on the timeline anticipated or on the terms currently anticipated, the Company may incur additional expenses.

Although the Supporting Noteholder has agreed to vote in favor of the Note Exchange Transaction, there can be no assurance that other creditors, securityholders or third parties will not seek to challenge, oppose or delay the Note Exchange Transaction, or the ability to implement the Note Exchange Transaction under the CBCA, nor can there be any assurance that such parties would not be successful in such challenge, opposition or delay.

The Support Agreement may be terminated by the Company or the Supporting Noteholder in certain circumstances. Accordingly, there is no certainty, nor can the Company provide any assurance, that the Support Agreement will not be terminated by either the Company or the Supporting Noteholder before the completion of the Note Exchange Transaction, which may result in the Note Exchange Transaction not proceeding.

The Note Exchange Transaction may not improve the Company’s financial condition to the extent anticipated

The Note Exchange Transaction is intended to enhance the Company’s capital structure and liquidity and provide it with continued financial flexibility. However, the foregoing is contingent on many assumptions that may prove to be incorrect, including without limitation:

the ability of the Company to succeed in continuing to implement its business plan;
that general economic conditions will not deteriorate beyond currently anticipated levels;
that the Company’s sales and relationships with suppliers, customers and contractors will not be materially adversely affected while the Note Exchange Transaction is underway or as a result of such Note Exchange Transaction; and
the Company’s ability to manage costs.

Should any of those assumptions not materialize, the Note Exchange Transaction may not have the effect of providing the Company with the financial flexibility expected or required to implement its business plan.

The Company currently expects to pursue an alternative transaction if the Note Exchange Transaction is not completed

In the event that the Company does not complete the Note Exchange Transaction, the Company currently expects that it will enter into an alternative deleveraging transaction with the Supporting Noteholder involving an exchange of the Notes held by the Supporting Noteholder into new secured notes of the Company. Any such new secured notes issued to the Supporting Noteholder would be effectively senior to the Notes to the extent of the value of the collateral securing such new secured notes. As a result, any such alternative transaction could have a material and adverse impact on the value of the Notes.

The non-implementation of the Note Exchange Transaction could create liquidity risks and force the Company to pursue other alternatives that could have a negative effect on the Company

If the Note Exchange Transaction is not implemented and business operations of the Company continue at their current levels, the Company may not be able to generate sufficient cash flows to repay or refinance its outstanding indebtedness when it matures without raising additional capital. In the current market conditions and the Company’s financial condition, the Company can give no assurance that additional capital will be available on favorable terms, or at all. If the Company defaults under the terms of certain of its indebtedness, the Noteholders could declare all outstanding principal and interest to be due and payable, our lenders could terminate their commitments under our credit agreement to loan money and foreclose against the assets securing such borrowings and the Company could be forced into bankruptcy or liquidation. Further, in the event that the Note Exchange Transaction is not implemented, the Company may be required to pursue other alternatives that could have a more negative effect on the Company and its stakeholders, including non-consensual proceedings under creditor protection legislation.

ITEM 4: INFORMATION ON THE COMPANY

A. History and Development of the Company

We were incorporated as Millar Western Forest Products Ltd. under the Business Corporations Act (Alberta) on September 8, 1997, and on February 28, 2017 we were continued under the Canada Business Corporations Act. On May 13, 1998, we acquired all of the forest products operations of our parent company, Millar Western Industries Ltd. (Industries) and its subsidiaries. The predecessor of Industries was first incorporated in 1919 and began lumber operations in the Whitecourt area in 1922. Industries completed construction of the Whitecourt pulp mill in 1988 and acquired the Boyle sawmill in 1993. We completed construction of the current Whitecourt sawmill in 2001. We acquired the Fox Creek sawmill in 2007, and rebuilt it in 2010-11 at a cost of approximately $60 million, $38 million of which was provided through an insurance settlement. We sold the Boyle sawmill and associated assets in December 2015, for a total value of $32.2 million, which included $1.5 million of working capital and $2.2 million of accrued reforestation liability transferred to the purchaser. We have substantially completed construction of a bioenergy facility at our Whitecourt pulp mill and, at December 31, 2016, had spent a total of $86.8 million on the project, net of government grants and a letter of credit recovered from the original EPC contractor. We expect to spend an additional $1.0 million in 2017, funded through cash from operations.

Our head office is located at 16640 - 111 Avenue, Edmonton, Alberta, T5M 2S5, and our registered office is located at Goodmans LLP, Bay Adelaide Centre, 333 Bay Street, Suite 3400, Toronto, Ontario, M5H 2S7. Our telephone and facsimile numbers are (780) 486-8200 and (780) 486-8282, respectively. Our authorized capital consists of an unlimited number of common shares, of which 15,000,002 were issued and outstanding as at December 31, 2016.

Our agent for service of process in the United States is CT Corporation System, 111 8^th Avenue, New York, New York 10011, (212) 894-8700.

B. Business Overview

We are an integrated forest products company active in Alberta, Canada, that produces and markets softwood lumber and hardwood and softwood bleached chemi-thermo-mechanical pulp, or BCTMP. We own and operate three production facilities in Alberta, including a sawmill and a BCTMP mill at an integrated complex in Whitecourt and a sawmill in Fox Creek. We previously owned and operated a sawmill at Boyle, Alberta; that facility was sold to a third party effective December 22, 2015, and we continued to operate it until February 19, 2016, when the processing of existing log and lumber inventories was completed. We are currently completing commissioning and startup of a newly constructed bioenergy project (the BEP) at the Whitecourt BCTMP mill that will convert organic matter in pulp mill waste into renewable energy for consumption by our pulp operations. The project is expected to be fully operational in the second quarter of 2017.

Our sawmills produce kiln-dried dimension lumber from spruce, pine and fir, or SPF, timber for the residential and commercial construction industries. We also produce higher-margin grades, such as machine-stress-rated, or MSR, lumber for load-bearing applications, as well as specialty products, such as decking. Under our current operating strategy, our sawmills have a combined annual capacity of 450 million foot board measure (mmfbm), with the Whitecourt and Fox Creek facilities having individual annual capacities of 330 mmfbm and 120 mmfbm, respectively. Our Boyle sawmill, sold in December 2015, had operated at rate of 80 mmfbm per year. Our lumber is sold principally in Canada and the United States; China is also a regular destination for our products, and a small volume of certain higher-margin grades is shipped to Japan.

Our Whitecourt pulp mill produces hardwood, softwood and blended grades of pulp and has an annual production capacity of 320,000 air dried metric tonnes (admt). Our BCTMP is sold internationally for use in the production of a diverse range of paper products, including coated and uncoated printing and writing papers, paperboard, specialty papers, tissue and toweling.

Recent Developments

On March 7, 2017, the Board of Directors of the Company (the “Board of Directors”) approved a transaction (the “Note Exchange Transaction”) whereby the Company’s existing $210 million aggregate principal amount of 8.50% senior notes due 2021 (the “Existing Notes”) would be exchanged for 9.0% senior secured notes due 2022 to be issued by the Company (the “New Secured Notes”). In connection with the Note Exchange Transaction, the Board of Directors also approved an agreement with certain funds affiliated with Atlas Holdings, LLC (collectively, the “Supporting Noteholder”), which beneficially owns approximately 36% of the Existing Notes, pursuant to which the Supporting Noteholder would, among other things, support the Note Exchange Transaction and to vote in favor of the Note Exchange Transaction at the Meeting (as defined below).

If the Note Exchange Transaction is consummated, each Noteholder would receive, on the implementation of the Note Exchange Transaction, New Secured Notes in a principal amount equal to 50% of the principal amount of Existing Notes held by such Noteholder as at the voting record date. In addition, each Noteholder that votes in favor of the Note Exchange Transaction on or before March 31, 2017 would receive additional New Secured Notes (the “Early Consent Notes”) in a principal amount equal to 5% of the principal amount of Existing Notes held by such Noteholder as at the voting record date. The New Secured Notes would be secured by a first lien on substantially all of the assets and property of the Company, with the exception of accounts receivable and inventory (the “Priority Collateral”). The New Secured Notes would also be secured by a second lien on the Priority Collateral, which Priority Collateral would continue secure the company’s revolving credit facility on a first-lien basis.

It is a condition to the implementation of the Note Exchange Transaction that the Supporting Noteholder will agree to exchange the approximately US$41.7 million aggregate principal amount of New Secured Notes it receives pursuant to the Note Exchange Transaction for 80% of the common shares of the Company (the “Share Exchange Transaction”). If the Note Exchange Transaction and the Share Exchange Transaction are consummated, the long-term indebtedness of the Company would be reduced from US$210 million of Existing Notes to approximately US$71 million of New Secured Notes. In addition, annual cash interest costs in respect of the Company’s long-term indebtedness would be reduced from approximately US$18 million per year to approximately US$6 million per year.

The Note Exchange Transaction would be implemented by way of the Plan of Arrangement under the CBCA and would be expected to be completed by the end of April, 2017.

Completion of the Note Exchange Transaction will initially be subject to the Ontario Superior Court of Justice (Commercial List) (the “Court”) issuing an interim order authorizing, among other things, the holding of a meeting of Noteholders to vote on the Plan of Arrangement (the “Meeting”), the mailing of information packages to Noteholders, the procedure for submitting voting instructions in respect of the Plan of Arrangement, eligibility requirements to receive Early Consent Notes, and certain other procedural matters.

Provided the interim order is granted by the Court, the Note Exchange Transaction would then be subject to, among other things, approval of the Plan of Arrangement by the affirmative vote of at least 662/3% of the votes cast by Noteholders present in person or by proxy at the Meeting, approval of the Plan of Arrangement by the Court, the receipt of all necessary regulatory approvals, if any, and the satisfaction or waiver of other conditions pursuant to the Plan of Arrangement. If all requisite approvals are obtained, the Plan of Arrangement will bind all Noteholders.

In connection with the transactions described above, on March 7, 2017, the Board of Directors also approved a consent acknowledgment (the “Consent Acknowledgment”) with the lender under our revolving credit facility (the “Bank Lender”) pursuant to which the Bank Lender would consent to, and waive any default under our revolving credit facility in respect of, the Note Exchange Transaction and the Share Exchange Transaction, and the Company would agree to grant the Bank Lender a second-lien security interest in substantially all of our assets and property other than the Priority Collateral. Pursuant to the Consent Acknowledgment, the Company and the Bank Lender would also agree to certain amendments to our revolving credit facility, including certain financial covenants.

Principal markets

Our production of both pulp and lumber provides a diversified revenue base. From 2012 to 2016, 50% of our total revenue came from pulp sales and 50% came from lumber sales. This balance of pulp and lumber production has enabled us to weather cyclical swings in each of the two distinct markets. In addition, the geographic and product-line diversity of our customers mitigates the impact of a downturn in demand in any one region or product category.

The geographic distribution of our revenue for the periods indicated is shown in the following table.

Distribution of Sales Revenue, by Geographic Region

	2016	2015	2014

Canada	26%	31%	30%
China	29%	24%	25%
United States	23%	23%	22%
Other Asia	14%	14%	14%
Europe	6%	7%	7%
Other	2%	1%	2%

Lumber

Our sawmills produce kiln-dried SPF dimension lumber for use in residential and commercial construction, as well as higher-margin grades, such as MSR, J-grade and appearance grade, and specialty products, such as rough decking and fencing. In recent years, we have focused on developing specialty products that are less subject to commodity price fluctuations. These products currently represent approximately 12% of our total production and are sold directly to end users. The remainder of our production is sold through a supply chain that includes retail stores, stocking distributors and wholesale companies.

The following table shows the approximate distribution of our lumber sales by grade.

Distribution of Lumber Sales, by Grade

	2016	2015	2014

Commodity	74%	74%	74%
J-grade & appearance	8%	10%	10%
MSR	6%	4%	3%
Specialties	12%	12%	13%

The principal markets for our lumber products are Canada, the United States, China and Japan. Lumber sales within North America are handled by sales staff located in our Edmonton corporate office. All offshore sales are conducted through an international marketing consortium, Interex Forest Products Ltd. of Vancouver, of which we are a 25% owner.

The following table shows the approximate distribution of our lumber sales by geographic region.

Distribution of Lumber Sales, by Geographic Region

	2016	2015	2014

Canada	59%	57%	56%
U.S.	31%	35%	36%
China	7%	5%	6%
Japan	1%	3%	2%

In 2016, our five largest lumber customers represented approximately 48% of all the lumber we sold.

Pulp

Our type of pulp, BCTMP, is sold for use in a wide variety of applications, including paperboard, coated and uncoated papers, tissue and towels, and specialty and other papers. Our corporate marketing staff, supported by an international network of independent sales agents, sells pulp to all major pulp consuming regions, including Europe, Asia, and North America.

The following table shows the approximate distribution of our pulp sales by end product.

Distribution of Pulp Sales, by End Product

	2016	2015	2014

Paperboard	64%	63%	61%
Coated & uncoated papers	22%	24%	26%
Tissue & towel	5%	5%	6%
Specialty & other	9%	8%	7%

BCTMP is used by papermakers in combination with kraft pulps, primarily to add bulk and opacity to the paper sheet. In recent years, there has been significant growth in the sale of our pulp for use in multi-ply paperboard. This increased use of BCTMP in the manufacture of paperboard has also been evident in rising sales to Asia, a region that has seen strong growth in paper-making capacity and, particularly, in paperboard capacity.

The following table shows the approximate distribution of our pulp sales by geographic region.

Distribution of Pulp Sales, by Geographic Region

	2016	2015	2014

China	54%	52%	49%
Other Asia	28%	28%	22%
Europe	10%	11%	13%
North America	6%	6%	7%
Other	2%	2%	9%

In 2016, our five largest pulp customers represented approximately 46% of all the pulp we sold.

Seasonality

We conduct a significant amount of our log harvesting and hauling in the winter months, creating a seasonal buildup of working capital. Harvesting usually begins in the fourth quarter, with the balance of harvesting and most hauling activities occurring in the first quarter of the following year. The build-up of log inventory over this period is typically valued at $25-$30 million, with $4-$8 million worth of logs accumulated in the fourth quarter, depending on weather conditions, and the rest realized in the following year’s first quarter. These log inventories are consumed through the year and reach minimum levels in the third quarter. This seasonal working capital build-up and reduction has a significant impact on our liquidity through the year.

Sources and availability of raw material

Fiber

The availability of a secure and economic fiber supply is one of the most important factors affecting the performance of forest products companies. Fiber supply self-sufficiency is a key competitive element, because direct control and management of timber resources largely insulates an operator from fluctuations in the market price of fiber. Approximately 82% of the fiber requirement for our pulp mill and sawmill facilities is supplied under long-term agreements with the Government of Alberta and multiple-year agreements with other forest products companies. Our agreements with the Alberta government include a Forest Management Agreement (FMA), Coniferous Timber Quotas and Deciduous Timber Allocations; our agreements with other forest companies include a variety of fiber exchange and supply contracts. We purchase the balance of our fiber requirements on the open market. Our fiber costs are subject to variation depending on factors including the period’s harvesting locations and delivery distances from forest to mill, weather conditions, and normal competitive market pressures related to our harvesting and hauling contractors. We pay fees, referred to as stumpage, to the Alberta government for all fiber harvested from government-owned lands.

In May 1997, we entered into an FMA with the Alberta Minister of Agriculture and Forestry, which we refer to as the Millar Western FMA, pursuant to which the Minister has granted us rights to manage, establish, grow, harvest and remove timber on a perpetual sustained yield basis in a designated area, which we refer to as the Millar Western forest management area. The Millar Western FMA is in effect for 20 years and is renewable every 10 years thereafter for additional 20-year terms; the FMA was renewed in 2014 and is currently in effect until April 30, 2034. The following table sets out our annual allowable cut (AAC) under our current long-term provincial tenure and fiber available annually under our other fiber agreements:

Annual Allowable Cut

	Coniferous	Deciduous
	(cubic meters)

Forest Management Agreement (1)	396,000	273,000
Coniferous Timber Quotas (2)	533,000	—
Deciduous Timber Allocations (3)	—	154,000
Exchange agreement and supply contracts (4)	500,000	140,000
Total annual fiber supply:	1,429,000	567,000

	⁽¹⁾	Net of third-party allocations. Expires 2034 and is renewable every 10 years for additional terms of 20 years. FMA AAC is defined within 10-year detailed forest management plans (DFMPs); a new DFMP will be submitted to the Government of Alberta in the first quarter of 2017 and, once approved, will determine AAC for the 2017-2026 period
	⁽²⁾	Expire 2021 to 2028 and are renewable for additional terms of 20 years.
	⁽³⁾	Expire 2027 and are renewable for additional terms of 20 years.
	⁽⁴⁾	Exchange and purchase agreements expire 2019 to 2021.

In addition to deciduous logs, the Whitecourt pulp mill requires approximately 90,000 bone dry units of coniferous chips per year. This requirement is supplied entirely by chip residuals from our Whitecourt sawmill, and the sawmill’s surplus chips are sent to other manufacturers under multi-year fiber-exchange agreements.

Electricity

Because electricity represents a significant portion of our input costs, we took steps at the time of the deregulation of Alberta’s electricity market to acquire long-term power purchase rights in order to insulate our pulp and lumber operations from anticipated market volatility. In 2001, we became a party to a Power Purchase Arrangement (PPA) syndicate led by Capital Power Corporation. On March 24, 2016, Capital Power Corporation gave notice of its intent to terminate its role as buyer of the Sundance C Power Arrangement, citing significant changes to the Specified Gas Emitters Regulation in Alberta that had impaired its ability to realize benefits from the arrangement. As a result of this termination, the Company’s role as a party to the Power Purchase Arrangement (PPA) syndicate was also terminated. The Government of Alberta subsequently challenged the legitimacy of the termination and entered into negotiations with Capital Power Corporation. On November 28, 2016, Capital Power Corporation announced it had reached an agreement with the Government of Alberta to settle the PPA dispute. Under the settlement, the government accepted the termination of the PPA, thereby ending all of our obligations associated with the PPA.

Other Commodities

Natural gas. The natural gas used at our facilities is supplied under annual supply contracts that are subject to market prices. From time to time, we manage our gas price exposure by entering into commodity price forward contracts.

Water. Water is supplied under contract to our Whitecourt facilities by the Town of Whitecourt. The Fox Creek mill supplies its own water from onsite wells.

Chemicals. Our Whitecourt pulp mill’s requirements for hydrogen peroxide, which is the main chemical used in our pulp bleaching process, are supplied from a plant located in Alberta under an agreement that provides us with relatively stable pricing over its term, and that will expire December 31, 2020. Caustic soda, also used in the bleaching process, is provided by a major producer under a contract that provides for market-based pricing and that will expire December 31, 2017, but will be automatically renewed on an annual basis unless cancelled by one of the parties. Other bleaching chemicals used in our Whitecourt pulp mill are supplied by third parties under varying contract terms. Magnesium sulphate used in our Whitecourt pulp mill is produced and supplied by Industries, pursuant to a contract. See Item 7, Section B, “Related party transactions”.

Government regulation

Environmental matters

Our operations are regulated primarily by the Environmental Protection and Enhancement Act (Alberta), which we refer to as the AEPEA, and the Pulp and Paper Effluent Regulations included within the Fisheries Act (Canada). We have instituted environmental controls to monitor our operations to confirm they are in compliance with regulated parameters of both provincial and federal authorities. Under the AEPEA, our sawmills operate in accordance with the terms of a code of practice that governs environmental aspects of their activities, and our pulp mill operates in accordance with an environmental permit that is due for renewal on or before November 1, 2017. We have initiated the renewal procedure for the pulp mill operating permit and expect to obtain the renewal on a timely basis.

Wood waste from the pulp mill and sawmills is transferred to a third party for use in the manufacture of panelboard or sent to a local biomass-fueled power station to generate renewable electricity.

The Whitecourt pulp mill has an extended aeration activated biomass wastewater treatment system. The biomass, or sludge, produced as a waste product from the system is used as a soil conditioner on agricultural lands. In addition, the pulp mill has recently completed a bioenergy project in which anaerobic hybrid digesters have been installed in advance of the existing aerobic effluent treatment system. The digesters produce a biogas used to generate renewable energy. In addition to reducing purchased energy costs and allowing for pulp production increases, the project is expected to reduce greenhouse gas emissions, freshwater intake and chemical usage, and to improve the quality of treated wastewater discharged to a local river.

All forest areas we harvest are reforested to the standards required under the Timber Management Regulations (Alberta). In the five-year period 2012-2016, we spent $30.9 million on reforestation and as at December 31, 2016, had an accrued liability of $11.7 million for future reforestation.

Climate Change and Emissions Management Act

Under the “Climate Change and Emissions Management Act” the Government of Alberta has set out intensity-based carbon emission reduction targets. Facilities that release 50,000 to 100,000 tonnes of CO₂equivalent (CO₂e) per year are required to report their emissions but are not currently subject to reduction requirements. Large emitters, defined as those producing more than 100,000 tonnes of CO₂e per year, are required to reduce their emissions intensity by a specified percentage, compared to 2007 levels, in each annual reporting period; the required reduction was 15% in 2017 and will be 20% in 2018. In lieu of reductions, organizations can remit to a technology fund a payment for every tonne of CO₂e generated over a specified limit or can buy an equivalent amount of provincially-approved offset credits; in 2017, the payment amount was $20/tonne and, in 2018, the amount will be $30/tonne.

Our Whitecourt pulp mill releases approximately 75,800 tonnes of CO₂e per year, making us responsible for reporting our emissions, though not currently subject to a requirement to reduce the emissions or to pay penalties or purchase offsets in association with them. Our PPA was linked to a coal-fired electricity plant that qualifies as a large emitter, making us responsible for a portion of penalties associated with its CO₂e emissions. In 2016, we were responsible for approximately 28,779 tonnes of CO₂e emissions associated with the PPA. In some previous years, we have addressed this obligation by applying offset credits earned through an energy reduction project conducted in our mill operations and independently verified and registered with provincial authorities. In 2016, we elected to pay the penalty of $20/tonne and to bank offset credits for use in future periods, when carbon penalties are expected to rise, in accordance with plans announced by the Government of Alberta.

Forest certification

To provide independent verification of the sustainability of our forest management activities and legality of our timber procurement systems, we have sought certification under several third-party-audited, internationally recognized environmental standards.

In 1995, our woodlands operations were certified to FORESTCARE, a comprehensive code of practice developed by the Alberta forest industry and one of North America’s earliest independently-audited forest management standards. In 2005, our woodlands environmental management system was certified to the ISO 14001 standard. Our Whitecourt FMA area was certified to the Canadian Standards Association’s CSA-Z809 standard for sustainable forest management in 2006. In 2009, rather than renewing our CSA certification, we elected to seek certification to the Sustainable Forest Initiative (SFI) standard, due to its greater compatibility with our tenure system. All our volume and land-based tenures are now certified to the SFI standard. To satisfy different customer preferences, our operations are certified under two international chain-of-custody standards: the Programme for the Endorsement of Forest Certification (PEFC) and the Forest Stewardship Council (FSC). Chain-of-custody certification assesses wood tracking systems to ensure responsible timber sourcing.

Standard	Type	Expiry
FORESTCARE	Comprehensive Code of Practices	January 2018
ISO 14001	Environmental Management System	January 8, 2018
Sustainable Forestry Initiative (SFI)	Sustainable Forest Management; Fiber Sourcing	January 8, 2018
Forest Stewardship Council (FSC)	Chain of Custody	March 27, 2019
Programme for the Endorsement of Forest Certification (PEFC)	Chain of Custody	November 30, 2020

Provincial stumpage fees

The Government of Alberta imposes stumpage fees on all timber harvested on government-owned land. The timber on such land is owned by the Province of Alberta, and stumpage fees are a form of harvest tax that is assessed on a market-based fee structure. Under the stumpage system for coniferous timber, the amount of the stumpage fee increases or decreases with the benchmark lumber price of kiln-dried, 2x4, Two-and-Better grade Western SPF. The stumpage system applies to all logs harvested from the Millar Western FMA and Coniferous Timber Quotas. Reduced stumpage rates apply to marginal timber, pulpwood and timber affected by fire or insects. The government’s stumpage system for deciduous timber is also market-based. Stumpage rates do not apply to wood harvested from private lands.

C. Organizational Structure

Not applicable.

D. Property, Plants and Equipment

We own and operate three production facilities in Alberta: a sawmill and a BCTMP mill at an integrated complex in Whitecourt, and a sawmill in Fox Creek. We previously owned and operated a sawmill in Boyle, Alberta, which we sold to a third party in December 2015.

Lumber

We own and operate two sawmills, located at Whitecourt and Fox Creek, Alberta. The sawmills have a combined annual capacity of 450 mmfbm of SPF lumber, produced for North American and offshore markets in dimensions from 1” x 3” to 2” x 10” and lengths from 8’ to 16’. The mills’ products include construction lumber for residential and commercial uses, MSR lumber for engineered roofing and load-bearing applications and other higher-value grades, including J-grade for the Japanese housing market, all sold in dressed form. We also sell specialty products, including decking, fencing and timbers, in rough form.

Sawmill Operating History

Our Whitecourt mill site has been home to a series of sawmills since 1926. In June 2001, we completed construction of our current mill, at a total cost of $42.6 million, which was funded from operating cash flow. This project significantly improved the efficiency of the Whitecourt lumber operation, increased the quality of its products and reduced its manufacturing costs. In 2005-2006, we invested $16.6 million in the addition of a new drying kiln and installation of a small-log line to further increase the efficiency of processing the smaller-diameter logs that are a significant portion of the mill’s total log supply. In addition to the sawmill, our Whitecourt lumber operations comprise four natural-gas-fired drying kilns and a high-speed planer mill.

We acquired lumber manufacturing and timber assets at Boyle in 1993, and we upgraded and reopened the facility in 1994 as a two-line sawmill that had an 80 mmfbm/year-capacity when operating on a single-shift basis. We sold the Boyle operation to a third party in December 2015 (see Results of Operations – Year ended December 31, 2015 compared to year ended December 31, 2014, for more detail).

In August 2007, we purchased lumber manufacturing and timber assets at Fox Creek, including a three-line, 45 mmfbm/year-capacity sawmill, a planer mill, a kiln, log inventory, mobile equipment and 140,000 cubic meters/year of timber in quotas and 65,000 cubic meters/year of timber available through third-party agreements, for a net purchase price of $18 million. On August 29, 2008, a fire destroyed the sawmill building and its contents. All assets were covered by a fire insurance policy, which included a replacement cost provision. In July 2010, we commenced construction of a replacement sawmill at Fox Creek. The new sawmill, comprising two production lines capable of producing 120 mmfbm of lumber annually on a one-shift basis, started operation in late 2011, and was optimized over the course of 2012. We also invested in other site upgrades, including new technology in the planer mill to increase yields and lower costs. The total cost of the Fox Creek reconstruction project was approximately $60 million, of which approximately $38 million was provided through an insurance settlement.

Pulp

Our BCTMP mill, located at Whitecourt, Alberta, commenced commercial production in July 1988. The pulp mill was constructed at a cost of approximately $205 million and was designed to produce 210,000 admt per year. Since start up, we have increased the production capacity of the plant by 52%, to 320,000 admt per year, without significant capital investment but through a focus on mill optimization and continuous improvement.

BCTMP Mill Operating History

The mill is a two-line facility that uses heat, mild chemicals and mechanical action to produce totally chlorine-free hardwood (aspen), softwood (SPF), and blended pulps for use in the production of paperboard, coated and uncoated printing and writing papers, specialty paper, tissue and toweling. All hardwood chips used in the pulping process are produced on site, and all the softwood chips are supplied by the Whitecourt sawmill, located on the same site.

We are currently completing commissioning of a newly constructed bioenergy plant at the pulp mill. This project has installed anaerobic hybrid digesters in advance of the mill’s existing aerobic effluent treatment system, to produce a biogas used to generate renewable energy. In addition to reducing purchased energy costs and allowing for pulp production increases, the facility is designed to cut greenhouse gas emissions, reduce freshwater intake and chemical consumption, and improve the quality of treated wastewater discharged to a local river, among other benefits. Project costs to December 31, 2016, net of $27.7 million in government grants and a $7.8 million letter of credit recovered from the original EPC contractor, were $86.8million. We expect to spend an additional net amount of approximately $1.0 million on the project in 2017, funded through cash from operations.

ITEM 5: OPERATING AND FINANCIAL REVIEW AND PROSPECTS

This Management’s Discussion and Analysis of our financial condition and results of operations (“MD&A”), prepared as of March 7, 2017, is based upon and should be read in conjunction with our audited financial statements and the accompanying notes included elsewhere in this annual report.

The MD&A contains historical information, descriptions of circumstances and statements about future developments or anticipated financial results. These forward-looking statements are based on certain assumptions or expectations that, in turn, are subject to various risks or uncertainties. Such statements are intended to help readers better understand our financial performance, but readers should exercise caution in relying upon them in anticipating our future financial performance. See “Special Note Regarding Forward-Looking Statements”.

A. Results of Operations

Year ended December 31, 2016 compared to year ended December 31, 2015

The following table sets out our operating and financial results for the periods indicated.

		Twelve Months Ended
		Dec. 31/16			Dec. 31/15
		(in millions)

Statements of earnings data:
Revenue	$	385.1		$	378.6
Cost of products sold		268.6			280.9
Freight and other distribution costs		64.2			64.0
Depreciation and amortization		10.3			14.6
General and administration		18.3			15.7
Loss on termination of PPA		26.6			-
Other expense (income)		0.3			(13.8	)
Operating (loss) earnings	$	(3.2	)	$	17.2
Foreign exchange gain (loss) on borrowings		8.7			(47.0	)
Finance expenses		(21.1	)		(23.3	)
Net loss before income taxes	$	(15.6	)	$	(53.1	)
Income taxes recovery		(7.2	)		(0.4	)
Net loss	$	(8.4	)	$	(52.7	)
Actuarial gains (losses), net of tax recovery		0.4			(0.2	)
Net loss and comprehensive loss	$	(8.0	)	$	(52.9	)

Reconciliation of Adjusted EBITDA data:
Net loss	$	(8.4	)	$	(52.7	)
(Subtract) add
Income taxes recovery		(7.2	)		(0.4	)
Foreign exchange (gain) loss on borrowings		(8.7	)		47.0
Finance expenses		21.1			23.3
Operating (loss) earnings	$	(3.2	)	$	17.2
Depreciation and amortization		10.3			14.6
Unrealized other expense (income)		2.4			(0.3	)
Adjusted EBITDA	$	9.5		$	31.5

Other data:
Average exchange rate (US$ per C$1.00)¹		0.755			0.783
Period end exchange rate (US$ per C$1.00)		0.745			0.723

⁽¹⁾

Average exchange rates are the daily noon Bank of Canada foreign-exchange rates, averaged over the period. Period end exchange rates are the closing Bank of Canada rate on the last business day of the period. The rates are set forth as U.S. dollars per C$1.00 and are the inverse of rates quoted by the Bank of Canada for Canadian dollars per US$1.00.

Our results for 2016 reflect the termination of the PPA to which we were a party and the subsequent write-down of the PPA asset on our balance sheet, as well as stronger market conditions in the lumber segment and an improvement in pulp markets through the course of the year.

On March 24, 2016, Capital Power Corporation gave notice of its intent to terminate its role as buyer of the Sundance C Power Purchase Arrangement (PPA). As a result of this termination, the Company’s role as a party to the PPA syndicate was also terminated. Subsequently, and as reported in our second quarter results, the Government of Alberta’s Balancing Pool advised that it might challenge the validity or the effective date of the termination. On November 28, 2016, Capital Power Corporation announced an agreement with the Government of Alberta to settle the PPA dispute. Under the settlement, the termination of the PPA was accepted, thereby ending all of our associated obligations, and Capital Power Corporation and its syndicate partners agreed to pay the Balancing Pool $39.0 million, of which our share was $4.4 million. This payment was included in our fourth-quarter and year-end financial results as “Loss on termination of PPA”. There was no change from the previous disclosures related to the loans owing to Capital Power Corporation.

At $385.1 million, revenue was up 1.7% from the previous year, as higher lumber prices and increased pulp shipments outweighed the effects of lower pulp prices and a decrease in lumber production associated with the sale of our Boyle sawmill in the fourth quarter of 2015.

Cost of products sold decreased in 2016, primarily due to lower lumber shipments and reduced energy costs. Freight and other distribution costs were essentially unchanged, as lower lumber shipments offset higher pulp shipments.

Other income was down sharply from the amount recorded in 2015, which had included $17.6 million in proceeds from the Boyle sawmill sale.

Depreciation and amortization declined, reflecting the sale of the Boyle sawmill and the termination of the PPA. The loss recorded on the PPA termination was $26.6 million, comprising a $22.2 million balance sheet write-down and the $4.4 million cash payment to the Balancing Pool.

We posted an operating loss of $3.2 million for 2016, a decrease from operating earnings of $17.2 million in 2015, with the difference primarily due to the write-down of the PPA.

Our US$210 million in long-term debt was translated at the exchange rate of US$0.745/C$ 1.00 on December 31, 2016, compared to US$0.723/C$ 1.00 at December 31, 2015, resulting in a foreign exchange gain of $8.7 million in the period. A $2.2 million decrease in financing expenses for 2016 was due to the favorable impact of exchange rates on U.S-dollar-denominated interest payments and the capitalization of $5.3 million of interest associated with the Bioenergy Effluent Project (BEP) in 2016 compared to $4.0 million in 2015.

We realized a net loss before taxes of $15.6 million, compared to a net loss of $53.1 million in 2015, which had included a $47.0 million foreign exchange loss on borrowings. Our 2016 results were subject to income tax at a statutory rate of 34%, up from 33% in 2015. The effective tax rate for 2016 varied significantly from the statutory rate because of the manufacturing and processing profits deduction and the non-taxable portion of the unrealized exchange gain on debt, the non-taxable portion of the losses associated with termination of the PPA and the effect of future income tax rate reductions.

After a provision for income tax recovery of $7.2 million, we recorded a net loss of $8.4 million in 2016, compared to a net loss of $52.7 million recorded in 2015.

Adjustments through comprehensive income are actuarial valuation changes that are presented net of income tax in accordance with IAS 19R. We recorded an actuarial gain of $0.4 million related to changes in a defined-benefit pension plan which resulted in a comprehensive loss of $8.0 million for the current year.

Lumber

		Twelve Months Ended
		Dec. 31/16			Dec. 31/15
		(in millions)

Production (total sawmill) - SPF - mmfbm		459.9			532.5
Production (dressed lumber) - SPF - mmfbm		412.4			460.9
Shipments - SPF - mmfbm		485.5			526.8
Benchmark price - SPF#2&Better - US$ per mfbm	$	306		$	281

Revenue	$	191.8		$	195.5
Cost of products sold		140.1			158.6
Freight and other distribution costs		19.8			21.2
Other realized income		(0.8	)		(17.4	)
Adjusted EBITDA	$	32.7		$	33.1
Adjusted EBITDA margin - %		17%			17%

Other unrealized expense		(1.0	)		(0.3	)
Depreciation and amortization		(5.6	)		(6.9	)
Operating earnings	$	26.1		$	25.9

Capital expenditures	$	1.5		$	3.3

The U.S. housing market continued its slow recovery in 2016, with housing starts averaging just under 1.2 million units per year, and lumber prices improving from 2015 levels. The average benchmark price was US$306 per thousand board feet (mfbm), up 8.9% from US$281/mfbm in 2015. Lumber segment revenue declined 1.9% year-over-year, however, due to lower production and shipments resulting from the sale of the Boyle sawmill.

Lumber production of 459.9 mmfbm and shipments of 485.5 mmfbm were both lower than 2015, reflecting the Boyle sale, but were both improved from 2015 after adjusting for the loss of production and shipments from the Boyle sawmill.

Freight and other distribution costs declined due to the reduced shipments but remained unchanged on a per-unit basis.

We continue to recognize the strategic value of defensive hedging on major inputs and, when appropriate, on product sales; however, our hedging activities are limited to our capacity for physical consumption or production of goods and are not entered into for speculative purposes. In 2016, our lumber hedging program provided a benefit of $0.7 million, down from $1.8 million in 2015, and the amount was recorded in other realized income.

On a normalized basis, Adjusted EBITDA of $32.7 million improved compared to last year, as the 2015 Adjusted EBITDA of $33.1 million had included $14.1 million from the sale of the Boyle sawmill.

Segment capital expenditures of $1.5 million in 2016 were limited to maintenance-of-business spending and were lower than expenditures of $3.3 million in the previous year.

Pulp

		Twelve Months Ended
		Dec. 31/16			Dec. 31/15
		(in millions)

Production - madmt		321.5			295.9
Shipments - madmt		330.1			300.7

Revenue	$	192.9		$	182.7
Cost of products sold		128.4			122.3
Freight and other distribution costs		44.5			42.8
Other realized (income) expense		(0.8	)		4.0
Adjusted EBITDA	$	20.8		$	13.6
Adjusted EBITDA margin - %		11%			7%

Other unrealized (expense) income		(1.3	)		0.6
Depreciation and amortization		(4.6	)		(7.5	)
Operating earnings	$	14.9		$	6.7

Capital expenditures	$	9.9		$	48.3

After falling in late 2015, BCTMP prices recovered during the course of 2016, as Chinese demand strengthened and pulp inventories were drawn down to relatively low levels. Pulp production of 321.5 thousand tonnes (madmt) was up sharply from 295.9 madmt in 2015, when output had been affected by operational issues with the aerobic effluent treatment system and by an extended maintenance shutdown that included work to complete BEP tie-ins. The effect of lower average selling prices in 2016 was offset by increased shipments and revenue rose to $192.9 million, up 5.6% from 2015.

Segment cost of products sold increased by $6.1 million in total, but declined significantly on a per-unit basis, due to lower energy costs.

Freight and other distribution costs were also higher in total, due to increased shipments, but decreased on a per-unit basis as a result of lower ocean freight costs.

Other realized income of $0.8 million for the year reflected gains on working capital balances and contrasted with an expense of $4.0 million in 2015 that had included losses associated with currency hedges.

In 2016, pulp segment power costs were $2.0 million above market rates, due to the long-term pricing arrangement established under our PPA, which affected our first quarter results but was subsequently terminated. Based on per-segment consumption, 92% of the cost of the power purchase rights was allocated to the pulp segment, and the balance was allocated to the lumber segment. Power purchase rights had increased pulp segment costs by $1.3 million in 2015.

The result of all factors was segment Adjusted EBITDA of $20.8 million, up from the $13.6 million achieved in 2015. We recorded an unrealized expense of $1.3 million, primarily related to the revaluation of an embedded derivative in a contract to dispose of our wood waste. Depreciation and amortization was $4.6 million, with the decrease from $7.5 million in 2015 reflecting the write-down of the PPA. The segment recorded operating earnings of $14.9 million in 2016, compared to earnings of $6.7 million in 2015.

Pulp segment capital expenditures of $9.9 million in 2016 included $7.1 million related to the BEP. Total net spending on the BEP at December 31, 2016, was $86.7 million. We expect to spend an additional $1.0 million in 2017 to finish the project. The Combined Heat and Power (CHP) component of the project is operational; construction of the Anaerobic Hybrid Digester (AHD) component is complete and in the final stages of commissioning, and we expect the project to be fully operational in the second quarter of 2017.

Corporate and other

		Twelve Months Ended
		Dec. 31/16			Dec. 31/15
		(in millions)

Revenue	$	0.4		$	0.4
General and administration		18.3			15.7
Loss on termination of PPA		26.6			-
Other realized income		(0.4	)		(0.1	)
Adjusted EBITDA	$	(44.1	)	$	(15.2	)
Depreciation and amortization		(0.1	)		(0.2	)
Operating loss	$	(44.2	)	$	(15.4	)

Capital expenditures	$	0.7		$	0.6

Revenue for the corporate and other supporting cost center was generated primarily from fees billed to our parent company for administrative services. Corporate revenue was unchanged, year-to-year, at $0.4 million. Increases in costs from 2015 reflect an increase in benefit costs, severance payments associated with the elimination of corporate positions, and an increase in consulting fees.

Year ended December 31, 2015 compared to year ended December 31, 2014

The following table sets out our operating and financial results for the periods indicated.

		Year ended December 31,
		2015			2014
		(in millions)

Statements of earnings data:
Revenue	$	378.6		$	405.1
Cost of products sold		280.9			273.9
Freight and other distribution costs		64.0			59.7
Depreciation and amortization		14.6			14.3
General and administration		15.7			18.8
Other income		(13.8	)		(2.7	)
Operating earnings	$	17.2		$	41.1
Foreign exchange loss on borrowings		(47.0	)		(20.2	)
Finance expenses		(23.3	)		(22.1	)
Net loss before income taxes	$	(53.1	)	$	(1.2	)
Income taxes (recovery) expense		(0.4	)		4.0
Net loss before income taxes	$	(52.7	)	$	(5.2	)
Actuarial losses, net of tax recovery	$	(0.2	)		(1.4	)
Net loss and comprehensive loss	$	(52.9	)	$	(6.6	)

Reconciliation of adjusted EBITDA data:
Net loss for the year	$	(52.7	)	$	(5.2	)
(Subtract)/add
Income taxes (recovery) expense		(0.4	)		4.0
Foreign exchange loss on borrowings		47.0			20.2
Finance expenses		23.3			22.1
Operating earnings	$	17.2		$	41.1
Depreciation & amortization		14.6			14.3
Other unrealized (income) expense		(0.3	)		2.0
Adjusted EBITDA	$	31.5		$	57.4

Other data:
Average exchange rate (US$/C$1.00)¹		0.783			0.906
Period end exchange rate (US$/C$1.00)		0.723			0.862

⁽¹⁾

Our results for 2015 reflected weaker market conditions, the effects of a continued decline in the relative value of the Canadian dollar, and the sale of our Boyle sawmill. At $378.6 million, revenue was down $26.5 million, or 6.5%, from the previous year, as lower pricing for lumber and pulp and reduced pulp shipments outweighed the positive impact of exchange rates.

Cost of products sold rose in 2015, primarily due to severance costs associated with the sale of the Boyle operation, which affected our lumber segment, and lower contributions from our power purchase rights, which resulted in higher power costs, primarily in our pulp segment. Freight and other distribution costs were also higher, due to the effects of a weaker Canadian dollar and an increase in the share of our lumber output that was sold on a delivered basis.

Other income increased sharply in 2015, as a result of the sale of our sawmill located in Boyle, Alberta. The sale price of $32.2 million included the value of all mill assets, timber quotas, and log inventories in the field, as well as the operation’s reforestation liability. The net result of the sale was a gain of $17.6 million in other income, which was offset by losses on currency hedges, resulting in total other income of $13.8 million.

We posted operating earnings of $17.2 million for 2015, a decrease from $41.1 million in 2014, with the difference primarily a result of the weaker commodity prices and increased costs.

Our US$210 million in long-term debt was translated at the exchange rate of US$0.723/C$ 1.00 on December 31, 2015, compared to US$0.862/C$ 1.00 at December 31, 2014, resulting in a foreign-exchange loss of $47.0 million in the period. A $1.2 million increase in financing expenses for 2015 was also attributable to the Canadian dollar’s decline.

We realized a net loss before taxes of $53.1 million, compared to a net loss of $1.2 million in the previous year. The year’s results were subject to income tax at a statutory rate of 33%, consistent with the rate applied in 2014. The effective tax rate for 2015 varied significantly from the statutory rate because of the manufacturing and processing profits deduction, the non-taxable portion of the unrealized exchange loss on debt, the non-taxable portion of capital gains and the effect of future income-tax rate reductions.

After a provision for income tax recovery of $0.4 million and an actuarial loss of $0.2 million on assumptions related to a defined-benefit pension plan, we recorded a net loss of $52.9 million in 2015, compared to a net loss of $6.6 million recorded in 2014.

Adjustments through comprehensive income are actuarial valuation changes that are presented net of income tax in accordance with IAS 19R. These adjustments resulted in a comprehensive loss of $52.9 million for the current year.

Lumber

		Year ended December 31,
		2015			2014
		(in millions)

Production (total sawmill)-SPF-mmfbm		532.5			533.9
Production (dressed lumber)-SPF-mmfbm		460.9			463.3
Shipments -SPF-mmfbm		526.8			529.1
Benchmark price -SPF#2&Better-US$ per mfbm	$	281		$	350

Revenue	$	195.5		$	207.2
Cost of products sold		158.6			152.1
Freight and other distribution costs		21.2			15.8
Other realized income		(17.4	)		(2.4	)
Adjusted EBITDA	$	33.1		$	41.7
Adjusted EBITDA margin - %		17%			20%

Other unrealized expense		(0.3	)		(0.8	)
Depreciation & amortization		(6.9	)		(6.8	)
Operating earnings	$	25.9		$	34.1

Capital expenditures	$	3.3		$	5.0

While the U.S. housing market continued its slow recovery in 2015, with housing starts averaging just over 1.1 million units per year, a decrease in Chinese demand and increases in North American production put pressure on lumber prices. The average benchmark price was US$281 per thousand board feet (mfbm), down 19.7% from US$350/mfbm in 2014. However, lumber segment revenue declined only 5.6% year-over-year, reflecting favorable exchange-rate effects. Lumber pricing peaked at the start of the year, in line with normal, seasonal demand, before falling to the year’s low in the second quarter, as supply exceeded demand. Prices recovered briefly as buyers replenished inventories early in the third quarter, but fell back to lower levels through the fourth quarter.

Lumber production of 532.5 mmfbm was consistent with 2014 output, and shipments of 526.8 mmfbm were just under the record volume shipped in 2014. At $158.6 million, segment cost of products sold rose $6.5 million, primarily due to severance costs associated with the sale of the Boyle sawmill and to a $1.2 million write down of log and lumber inventories.

Freight and other distribution costs increased in 2015, primarily due to our continued shift from mill-basis to delivered-basis terms of sale on a portion of our output, and these costs were largely offset by the associated increase in revenues.

Relatively strong lumber prices in the first quarter provided us an opportunity to enter into commodity derivative contracts as a hedge against price exposure through the balance of the year. These lumber hedges provided a benefit of $1.8 million in realized gains in 2015, recorded in other realized income, which was higher than the $1.0 million realized in 2014. We continue to recognize the strategic value of defensive hedging on major inputs and, when appropriate, on product sales; however, our hedging activities are limited to our capacity for physical consumption or production of goods and are not entered into for speculative purposes.

The sale of the Boyle sawmill resulted in a gain of $17.6 million to other income; associated severance costs of $3.5 million were included in cost of products sold. As a result, the lumber segment Adjusted EBITDA and operating earnings of $33.1 million and $25.9 million, respectively, each include a net contribution of $14.1 million related to the Boyle sale.

Segment capital expenditures of $3.3 million in 2015 were limited to maintenance-of-business spending, and were lower than expenditures of $5.0 million in the previous year.

Pulp

		Year ended December 31,
		2015			2014
		(in millions)

Production-madmt		295.9			329.7
Shipments -madmt		300.7			319.4
Benchmark price - NBSK, US$ per admt	$	972		$	1,024
Benchmark price - BEK, US$ per admt	$	785		$	744

Revenue	$	182.7		$	197.5
Cost of products sold		122.3			121.8
Freight and other distribution costs		42.8			43.9
Other realized expense (income)		4.0			(2.3	)
Adjusted EBITDA	$	13.6		$	34.1
Adjusted EBITDA margin - %		7%			17%

Other unrealized income (expense)		0.6			(1.2	)
Depreciation & amortization		(7.5	)		(7.3	)
Operating earnings	$	6.7		$	25.6

Capital expenditures	$	48.3		$	23.6

BCTMP prices declined in 2015, as Chinese demand weakened and the re-start of the Paper Excellence pulp mill in Chetwynd, B.C., resulted in increased supply. Pulp production was 295.9 thousand tonnes (madmt), with the decrease from output of 329.7 madmt in 2014 reflecting operational issues with the aerobic effluent treatment system and an extended maintenance shutdown that included work to complete BEP tie-ins. The effects of lower selling prices and decreased shipments were partially offset by the weaker Canadian dollar, and revenue in 2015 was $182.7 million, compared to $197.5 million in 2014.

Segment cost of products sold increased by $0.5 million in total, but was significantly higher on a per-unit basis. Periods of low and stable electricity prices decrease the contribution of the PPA and limit the effectiveness of other energy management programs employed in the pulp mill which results in higher net energy costs.

Freight and other distribution costs were lower in the period due to reduced shipments, but were higher on a per-unit basis as a result of the weakening Canadian dollar, as most freight costs are denominated in US dollars.

Other realized expense of $4.0 million for the year reflected losses on foreign-exchange contracts and contrasted with income of $2.3 million in 2014.

In 2015, pulp segment power costs were $1.3 million above market rates due to the long-term pricing arrangement resulting from our power purchase agreement. Based on per-segment consumption, 91% of the cost of the power purchase rights was allocated to the pulp segment, and the balance was allocated to power costs in the lumber segment. In contrast, power purchase rights provided cost savings of $5.8 million to the pulp segment in 2014, with the greater contribution reflecting higher power-pool pricing and volatility in that year.

The result of all factors was segment Adjusted EBITDA of $13.6 million, down from the $34.1 million achieved in 2014. After recording unrealized income of $0.6 million related to gains on foreign-exchange, and depreciation and amortization of $7.5 million, the segment recorded operating earnings of $6.7 million in 2015, compared to earnings of $25.6 million in 2014.

Pulp segment capital expenditures of $48.3 million in 2015 included $46.3 million related to the BEP. Total net spending on the BEP at December 31, 2015, was $77.1 million.

Corporate and other

		2015			2014
		(in millions)

Revenue	$	0.4		$	0.4
General & administration		15.7			18.8
Other realized income		(0.1	)		-
Adjusted EBITDA	$	(15.2	)	$	(18.4	)
Depreciation & amortization		(0.2	)		(0.2	)
Operating loss	$	(15.4	)	$	(18.6	)

Capital expenditures	$	0.6		$	0.4

The corporate and other segment recorded negative Adjusted EBITDA of $15.2 million in 2015, compared to the $18.4 million loss posted in 2014, with the difference due to changes in profit sharing provisions.

Results of Operations – Fourth Quarter of 2016

The following table sets out our operating and financial results for the periods indicated.

		Three months ended
		Dec. 31/16			Sep. 30/16			Dec. 31/15
		(in millions)

Statements of earnings data:
Revenue	$	94.8		$	101.7		$	83.4
Cost of products sold		59.3			68.9			63.3
Freight and other distribution costs		15.4			16.4			14.3
Depreciation and amortization		2.2			2.3			3.7
General and administration		5.3			4.0			4.1
Loss on termination of PPA		4.4			-			-
Other expense (income)		1.6			(0.3	)		(14.9	)
Operating earnings (loss)	$	6.6		$	10.4		$	12.9
Foreign exchange (loss) gain on borrowings		(6.5	)		(4.2	)		(10.4	)
Finance expenses		(5.2	)		(5.5	)		(5.9	)
Net (loss) income before income taxes	$	(5.1	)	$	0.7		$	(3.4	)
Income taxes expense (recovery)		0.5			0.9			1.7
Net loss	$	(5.6	)	$	(0.2	)	$	(5.1	)
Actuarial gains (losses), net of tax recovery		0.4			-			(0.2	)
Net loss and comprehensive loss	$	(5.2	)	$	(0.2	)	$	(5.3	)

Reconciliation of Adjusted EBITDA data:
Net loss	$	(5.6	)	$	(0.2	)	$	(5.1	)
Add (subtract)
Income taxes expense (recovery)		0.5			0.9			1.7
Foreign exchange loss (gain) on borrowings		6.5			4.2			10.4
Finance expenses		5.2			5.5			5.9
Operating earnings (loss)	$	6.6		$	10.4		$	12.9
Depreciation and amortization		2.2			2.3			3.7
Unrealized other expense (income)		2.0			-			(6.4	)
Adjusted EBITDA	$	10.8		$	12.7		$	10.2

Other data:
Average exchange rate (US$ per C$1.00)¹		0.750			0.766			0.750
Period end exchange rate (US$ per C$1.00)		0.745			0.762			0.723

⁽¹⁾

We recorded revenue of $94.8 million for the fourth quarter of 2016, up from the fourth quarter of 2015 on increased pulp shipments and higher pulp prices but down from the prior quarter, primarily as a result of lower lumber shipments.

Cost of products sold was down from the previous quarter on lower shipments of both pulp and lumber, and per-unit costs decreased in the lumber segment as a result of inventory adjustments and in the pulp segment due to lower energy costs. Compared to the fourth quarter of 2015, cost of products sold declined, despite increased pulp shipments, as a result of lower lumber shipments and decreased per-unit costs in both segments.

Freight and other distribution costs were lower than the prior quarter on decreased pulp and lumber shipments but higher than the fourth quarter of 2015, as increased pulp shipments outweighed lower lumber shipments.

Depreciation and amortization were unchanged quarter-to-quarter but lower than the fourth quarter of 2016, due to the write-down of the PPA and the sale of the Boyle sawmill.

General and administration costs were higher than prior periods as a result of higher benefit costs, severance payments associated with the elimination of corporate positions, and an increase in consulting fees.

On November 28, 2016, Capital Power Corporation announced an agreement with the Government of Alberta to settle the PPA dispute. Under the settlement, the termination of the PPA was accepted, thereby ending all of our obligations associated with the PPA. Capital Power Corporation and its syndicate partners agreed to pay the balancing pool $39 million, of which our share was $4.4 million. This payment was included in our fourth-quarter and year-end financial results as “Loss on termination of PPA”. There was no change from the previous disclosures related to the loans owing to Capital Power Corporation.

We recorded other expense of $1.6 million, primarily reflecting the revaluation of an embedded derivative within our wood waste disposal contract.

The Canadian dollar weakened relative to its value at the close of the previous quarter, which resulted in a foreign exchange loss of $6.5 million.

After a provision for income tax expense of $0.5 million, we recorded a net loss of $5.6 million for the quarter.

Adjustments through comprehensive income are actuarial valuation changes that are presented net of income tax provision in accordance with IAS 19R. We recorded a $0.4 million actuarial gain related to changes in the defined benefit pension and this adjustment resulted in a comprehensive loss of $5.2 million for the current quarter.

Lumber

		Three months ended
		Dec. 31/16			Sep. 30/16			Dec. 31/15
		(in millions)

Production (total sawmill) - SPF - mmfbm		103.8			118.3			130.7
Production (dressed lumber) - SPF - mmfbm		95.1			107.4			111.8
Shipments - SPF - mmfbm		108.5			129.2			127.2
Benchmark price - SPF#2&Better - US$ per mfbm	$	315		$	320		$	276

Revenue	$	43.5		$	53.0		$	43.8
Cost of products sold		29.3			37.6			37.1
Freight and other distribution costs		4.2			5.6			4.6
Other realized income		(0.1	)		-			(14.8	)
Adjusted EBITDA	$	10.1		$	9.8		$	16.9
Adjusted EBITDA margin - %		23%			18%			39%

Other unrealized (expense) income		(0.9	)		(0.3	)		1.2
Depreciation and amortization		(1.3	)		(1.4	)		(1.7	)
Operating earnings	$	7.9		$	8.1		$	16.4

Capital expenditures	$	0.7		$	0.1		$	0.7

Shipments fell compared to the third quarter, reflecting the normal seasonal reduction in sales activity toward year-end, and revenue fell to $43.5 million from $53.0 million in the prior quarter. Shipments were also lower than the fourth quarter of 2015, due to the sale of the Boyle sawmill, but revenues were virtually unchanged, as higher pricing offset the reduced volume.

Production of 103.8 mmfbm was lower than third-quarter output of 118.3 mmfbm, reflecting a reduced number of operating days during the holiday season.

Segment cost of products sold declined from both comparable periods, on lower shipments, and was also lower on a per-unit basis, due to year-end log inventory adjustments.

Freight costs varied from prior periods, as a result of both sales distributions and differences in the share of volumes sold on a mill-basis and a delivered-basis.

Other realized income was down sharply from the $14.8 million recorded in the fourth quarter of 2015, which included a $17.6 million gain realized from the sale of the Boyle sawmill.

The segment generated Adjusted EBITDA $10.1 million in the fourth quarter, which was higher than the third quarter but lower than the fourth quarter of 2015, which had been affected by the sale of the Boyle sawmill.

Other unrealized expense included the revaluation of an embedded derivative within our waste disposal contract, and depreciation and amortization were virtually unchanged from the third quarter.

The lumber segment had operating earnings of $7.9 million in the quarter.

Segment capital expenditures of $0.7 million in the quarter were limited to maintenance-of-business activities.

Pulp

		Three months ended
		Dec. 31/16			Sep. 30/16			Dec. 31/15
		(in millions)

Production - madmt		82.0			83.6			78.1
Shipments - madmt		81.7			82.4			70.5

Revenue	$	51.2		$	48.6		$	39.5
Cost of products sold		29.9			31.3			26.2
Freight and other distribution costs		11.2			10.8			9.7
Other realized (income) expense		(0.1	)		(0.3	)		6.2
Adjusted EBITDA	$	10.2		$	6.8		$	(2.6	)
Adjusted EBITDA margin - %		20%			14%			-7%

Other unrealized (expense) income		(1.0	)		0.3			5.1
Depreciation and amortization		(0.9	)		(0.9	)		(2.0	)
Operating earnings	$	8.3		$	6.2		$	0.5

Capital expenditures	$	3.8		$	4.2		$	4.2

Pulp production and shipments were lower than the third quarter but increased from the fourth quarter of 2015, in which we had experienced operational issues with our aerobic effluent treatment system.

BCTMP pricing maintained its strength in the fourth quarter and revenue was higher than in both comparable periods.

At $29.9 million, segment cost of products sold declined compared to the third quarter, on slightly reduced shipments and lower energy costs. Freight and other distribution costs were higher than in the third quarter, due to a decrease in the value of the Canadian dollar, which had a negative effect on U.S.-dollar-denominated freight costs.

The pulp segment recorded Adjusted EBITDA of $10.2 million in quarter.

The segment’s fourth quarter capital expenditure of $3.8 million was entirely related to the BEP.

Corporate and other

		Three months ended
		Dec. 31/16			Sep. 30/16			Dec. 31/15
		(in millions)

Revenue	$	0.1		$	0.1		$	0.1
General and administration		5.3			4.0			4.1
Loss on termination of PPA		4.4			-			-
Other realized income		-			-			-
Adjusted EBITDA	$	(9.6	)	$	(3.9	)	$	(4.0	)
Depreciation and amortization		-			-			-
Operating loss	$	(9.6	)	$	(3.9	)	$	(4.0	)

Capital expenditures	$	0.1		$	0.1		$	0.1

Our corporate and other supporting cost center recorded negative Adjusted EBITDA of $9.6 million for the quarter, which included the $4.4 million charge related to the final obligations under the PPA. Other increases from the prior periods were primarily a result of increased benefit costs and higher consulting fees.

Results of Operations – Fourth Quarter of 2015

The following table sets out our operating and financial results for the periods indicated.

		Three months ended
		Dec. 31/15			Sep. 30/15			Dec. 31/14
		(in millions)

Statements of earnings data:
Revenue	$	83.4		$	94.9		$	93.5
Cost of products sold		63.3			72.3			63.3
Freight and other distribution costs		14.3			17.1			14.2
Depreciation and amortization		3.7			3.7			3.6
General and administration		4.1			3.9			5.1
Other (income) loss		(14.9	)		(0.9	)		0.8
Operating earnings (loss)	$	12.9		$	(1.2	)	$	6.5
Foreign exchange loss on borrowings		(10.4	)		(17.9	)		(8.4	)
Finance expenses		(5.9	)		(5.8	)		(5.4	)
Net loss before income taxes	$	(3.4	)	$	(24.9	)	$	(7.3	)
Income taxes expense (recovery)		1.7			(1.4	)		(0.3	)
Net loss	$	(5.1	)	$	(23.5	)	$	(7.0	)
Actuarial losses, net of tax recovery		(0.2	)		-			(1.4	)
Net loss and comprehensive loss	$	(5.3	)	$	(23.5	)	$	(8.4	)

Reconciliation of adjusted EBITDA data:
Net loss	$	(5.1	)	$	(23.5	)	$	(7.0	)
Add (subtract)
Income taxes expense (recovery)		1.7			(1.4	)		(0.3	)
Foreign exchange loss on borrowings		10.4			17.9			8.4
Finance expenses		5.9			5.8			5.4
Operating earnings (loss)	$	12.9		$	(1.2	)	$	6.5
Depreciation and amortization		3.7			3.7			3.6
Unrealized other (income) expense		(6.4	)		2.2			3.4
Adjusted EBITDA	$	10.2		$	4.7		$	13.5

Other data:
Average exchange rate (US$ per C$1.00)¹		0.750			0.764			0.881
Period end exchange rate (US$ per C$1.00)		0.723			0.749			0.862

(1)

We recorded revenue of $83.4 million for the fourth quarter of 2015, down from both prior periods as a result of lower commodity prices and reduced shipments of both lumber and pulp.

Cost of products sold was down from the previous quarter on lower shipments, despite $3.5 million of severance costs associated with the sale of the Boyle sawmill, and was unchanged from the same period of 2014. We also recorded a net gain to other income of $17.6 million due to the sale, which was partially offset by losses related to currency hedges and resulted in other income of $14.9 million for the quarter.

We recorded a foreign exchange loss of $10.4 million on the value of our U.S.-dollar-denominated debt, reflecting the continued weakening of the Canadian dollar.

After a provision for income tax expense of $1.7 million and a $0.2 million actuarial loss related to defined benefit pension assumptions, we recorded a net loss of $5.3 million for the quarter, as compared to net losses of $23.5 million and $8.4 million in the third quarter of 2015 and the fourth quarter of 2014, respectively.

Adjustments through comprehensive income are actuarial valuation changes that are presented net of income tax provision in accordance with IAS 19R. These adjustments resulted in a comprehensive loss of $5.3 million for the current quarter.

Lumber

		Three months ended
		Dec. 31/15			Sep. 30/15			Dec. 31/14
		(in millions)

Production (total sawmill) - SPF - mmfbm		130.7			134.1			130.6
Production (dressed lumber) - SPF - mmfbm		111.8			119.1			114.5
Shipments - SPF - mmfbm		127.2			134.1			129.0
Benchmark price - SPF#2&Better - US$ per mfbm	$	276		$	271		$	340

Revenue	$	43.8		$	50.2		$	50.6
Cost of products sold		37.1			42.7			35.3
Freight and other distribution costs		4.6			6.4			4.2
Other realized income		(14.8	)		(2.0	)		(1.0	)
Adjusted EBITDA	$	16.9		$	3.1		$	12.1
Adjusted EBITDA margin - %		39%			6%			24%

Other unrealized income (expense)		1.2			(0.5	)		(1.4	)
Depreciation and amortization		(1.7	)		(1.8	)		(1.7	)
Operating earnings	$	16.4		$	0.8		$	9.0

Capital expenditures	$	0.7		$	0.8		$	1.1

Although the average benchmark lumber price was slightly higher than in the third quarter, our per-unit sales realizations declined, as we reduced inventories of low-grade products. Shipments fell compared to the third quarter, reflecting the normal, seasonal reduction in sales activity toward year-end, and were also lower than in the same period in 2014, due to the timing of certain shipments.

Production of 130.7 mmfbm was lower than third-quarter output of 134.1 mmfbm, reflecting a reduced number of operating days due to the holiday season, but was essentially unchanged from the same quarter of 2014.

Revenue was lower in the period compared to the third quarter, due to lower shipments and a decline in per-unit sales realizations, and down from the fourth quarter of last year, due to weaker pricing.

Segment cost of products sold declined compared to the third quarter, despite including $3.5 million of severance costs related to the sale of the Boyle sawmill, as those costs were offset by lower shipments and the reversal of a portion of negative inventory valuations incurred in the third quarter. Compared to the same period in 2014, cost of products sold was higher as a result of the severance costs.

Freight costs varied from prior periods as a result of sales distributions and differences in the share of volumes sold on a mill-basis and a delivered-basis.

Other realized income of $14.8 million in the quarter included the $17.6 million gain realized from the sale of the Boyle sawmill.

The segment generated EBITDA $16.9 million in the fourth quarter, which was higher than in both the previous quarter and the fourth quarter of 2014 as a result of the $14.1 million contribution from the sale. Depreciation and amortization were virtually unchanged from the comparable periods, and we recorded lumber segment operating earnings of $16.4 million in the quarter.

Segment capital expenditures of $0.7 million in the quarter were limited to maintenance-of-business activities.

Pulp

		Three months ended
		Dec. 31/15			Sep. 30/15			Dec. 31/14
		(in millions)

Production - madmt		78.1			78.8			78.7
Shipments - madmt		70.5			72.8			69.8
Benchmark price - NBSK, US$ per admt	$	947		$	967		$	1,025
Benchmark price - BEK, US$ per admt	$	788		$	808		$	738

Revenue	$	39.5		$	44.6		$	42.8
Cost of products sold		26.2			29.6			28.0
Freight and other distribution costs		9.7			10.7			10.0
Other realized expense (income)		6.2			(0.9	)		(1.6	)
Adjusted EBITDA	$	(2.6	)	$	5.2		$	6.4
Adjusted EBITDA margin - %		-7%			12%			15%

Other unrealized income (expense)		5.1			(1.6	)		(2.0	)
Depreciation and amortization		(2.0	)		(1.8	)		(1.9	)
Operating earnings	$	0.5		$	1.8		$	2.5

Capital expenditures	$	4.2		$	17.3		$	16.4

Pulp production, at 78.1 madmt, was consistent with both comparable periods, but shipments were down from the previous quarter due to vessel-timing issues.

BCTMP pricing was under continued pressure in the quarter, and the positive impact of a weaker Canadian dollar did not fully offset a decline in U.S.-dollar-denominated market prices. This, in combination with lower shipments, resulted in reduced revenue compared to both prior periods.

At $26.2 million, segment cost of products sold was lower than the third quarter, on the decreased shipments and lower energy costs. Freight and other distribution costs were also down compared to prior periods, as a decrease in ocean freight rates more than offset negative currency effects.

During the quarter, the pulp segment recorded a realized expense of $6.2 million and unrealized income of $5.1 million, reflecting in part a reclassification of items between the two accounts. The reclassification did not affect operating earnings, as both realized and unrealized portions of other income are included; however, it did affect Adjusted EBITDA, which excludes the unrealized portion of other income. As a result, Adjusted EBITDA in the fourth quarter of 2015 showed a loss of $2.6 million, which was down from both comparable quarters.

The segment’s fourth quarter capital expenditure of $4.2 million was entirely related to the BEP.

Corporate and other

		Three months ended
		Dec. 31/15			Sep. 30/15			Dec. 31/14
		(in millions)

Revenue	$	0.1		$	0.1		$	0.1
General and administration		4.1			4.0			5.1
Other realized income		-			(0.1	)		-
Adjusted EBITDA	$	(4.0	)	$	(3.8	)	$	(5.0	)
Depreciation and amortization		-			-			-
Operating loss	$	(4.0	)	$	(3.8	)	$	(5.0	)

Capital expenditures	$	0.1		$	0.2		$	0.1

Our corporate and other supporting cost center recorded negative Adjusted EBITDA of $4.0 million for the quarter, with the change from comparable quarters primarily reflecting differences in the profit sharing provision.

B. Liquidity and Capital Resources

Liquidity and Capital Resources for 2016 compared to 2015

Summary of Financial Position

		As at
		Dec. 31/16			Dec. 31/15
		(in millions)

Cash	$	40.2		$	16.8
Current assets		145.0			156.0
Current liabilities		55.4			57.1
Ratio of current assets to current liabilities		2.6	x		2.7	x
Financial liabilities - borrowings		297.2			313.1
Shareholder's equity		7.7			15.8

We ended 2016 with $40.2 million in cash. We expect capital requirements in 2017 to be $5.6 million, of which $1.0 million will be associated with the BEP. Financing expenses are expected to be $29.9 million and to consist of interest payments on the long-term debt and interest and principal payments on the BEP capital lease and the PPA loans. Upon completion of the BEP, we do not expect any capital expenditures beyond normal maintenance of business activities. Financing expenses will vary with changes in the value of the Canadian dollar relative to the U.S. dollar.

In 2014, we renewed our $50.0 million revolving credit facility, extending the expiration to July 15, 2018. The facility is subject to a borrowing formula based on our levels of inventory and accounts receivable. On December 31, 2016, the amount available under the facility was $50.0 million, with $11.9 million committed to letters of credit.

Selected Cash Flow Items

		Twelve Months Ended
		Dec. 31/16			Dec. 31/15
		(in millions)
Selected cash flow items Operating activities:
Cash provided by operating activities	$	27.9		$	14.8
Net reforestation		0.1			0.3
Net change in non-cash working capital items		32.7			(6.0	)
		60.7			9.1
Investing activities:
Additions to property plant and equipment		(8.1	)		(47.8	)
Proceeds on disposal of property, plant and equipment		0.1			28.5
Receipt of government grants		2.1			-
Other		0.2			-
		(5.7	)		(19.3	)
Financing activities:
Increase in borrowings		10.0			8.2
Repayment of borrowings		(15.3	)		(2.0	)
Finance expenses paid		(26.3	)		(25.9	)
Dividends		-			(0.7	)
		(31.6	)		(20.4	)

Increase (decrease) in cash	$	23.4		$	(30.6	)

Opening Cash	$	16.8		$	47.4
Closing Cash	$	40.2		$	16.8

Total cash and cash equivalents	$	40.2		$	16.8

We generated $60.7 million in cash from operations after changes in working capital in 2016, an increase from the $9.1 million provided in 2015, reflecting higher revenues associated with higher lumber prices and increased pulp shipments.

Working capital generated $32.7 million in 2016, a significant increase from the $6.0 million used in 2015, with the difference attributed to lower inventories of logs, lumber and pulp.

Financing activities in 2016 were related to the draw of $10.0 million on our revolving credit facility in the first quarter, which was subsequently repaid in the second quarter. Repayment of borrowings represented this payment as well as payments on our power purchase loans and the BEP capital lease. Borrowings in 2015 consisted of $8.2 million in interim BEP financing that was subsequently converted into a capital lease.

Liquidity and Capital Resources for 2015 compared to 2014

Summary of Financial Position

		As at December 31,
		2015		2014
		(in millions)

Cash	$	16.8	$	47.4
Restricted cash		-		-
Current assets		156.0		190.0
Current liabilities		57.1		60.1
Ratio of current assets to current liabilities		2.7 x		3.2 x
Financial liabilities - borrowings	$	313.1	$	262.4
Shareholder's equity		15.8		69.4

We ended 2015 with $16.8 million in cash. During the year ended December 31, 2015, we increased borrowings by $8.2 million, received $27.5 million of cash from the sale of the Boyle sawmill and drew down cash balances by $30.6 million, primarily to fund additions to property, plant and equipment, and finance expenses and increases in working capital.

In 2014, we renewed our $50.0 million revolving credit facility, extending the expiration to July 15, 2018. The facility is subject to a borrowing formula based on our levels of inventory and accounts receivable. In December 2015, we increased our credit facility to $70.0 million for the period between February 1, 2016 and April 30, 2016, under the same terms and conditions as the original credit facility. On December 31, 2015, the amount available under the facility was $50.0 million, with $3.9 million committed to letters of credit.

Selected Cash Flow Items

		Year ended December 31,
		2015			2014
		(in millions)
Selected cash flow items Operating activities:
Cash provided by operating activities	$	14.8		$	57.7
Net reforestation		0.3			0.7
Net change in non-cash working capital items		(6.0	)		(14.0	)
		9.1			44.4
Investing activities:
Additions to property plant and equipment		(47.8	)		(24.4	)
Proceeds on disposal of property, plant and equipment		28.5			-
Receipt of government grants		-			1.5
Other		-			0.1
		(19.3	)		(22.8	)
Financing activities:
Increase in borrowings		8.2			4.0
Repayment of borrowings		(2.0	)		(1.2	)
Finance expenses paid		(25.9	)		(22.0	)
Dividends		(0.7	)		(2.2	)
		(20.4	)		(21.4	)

(Decrease) increase in cash	$	(30.6	)	$	0.2

Opening Cash	$	47.4		$	47.2
Closing Cash	$	16.8		$	47.4

Total cash	$	16.8		$	47.4

We generated $9.1 million in cash from operations in 2015, a decrease from the $44.4 million provided in 2014, reflecting lower revenues associated with weaker prices in both lumber and pulp and lower pulp shipments.

Working capital used $6.0 million in 2015, down from $14.0 million in 2014, with the difference attributed to lower accounts receivable as a result of discounting pulp sales letters of credit.

Financing activities in 2015 were related to the receipt of $8.2 million in interim BEP financing, which was subsequently converted into a capital lease. Repayment of borrowings represented payments on our power purchase loans and the BEP capital lease. Borrowings in 2014 consisted of $4.0 million in interim BEP financing, and repayment of borrowings in that period reflected principal payments on the power purchase loans.

C. Research and Development

We did not conduct significant research and development activities in 2016.

D. Trend Information

Continued strength in the U.S. housing market contributed to rising North American lumber prices through the course of 2016. Most analysts expect further lumber price improvement in 2017 and 2018, based on expectations of increased demand from the U.S., continued Chinese demand and a limited response in terms of increased Canadian supply, due to reduced fiber availability in British Columbia. Though we generally agree that domestic demand and other fundamentals are favorable, our outlook is tempered by expected increases in overall North American production and the effect of a trade dispute with the U.S. related to Canadian softwood lumber imports.

On November 25, 2016 a coalition of U.S. lumber producers petitioned the Department of Commerce and the U.S. International Trade Commission to investigate alleged subsidies to Canadian producers and to impose countervailing and anti-dumping duties against Canadian imports. The investigation is ongoing and it is likely that some form of duties will be imposed against Canadian softwood lumber exports to the U.S. The amount of such duties is not known at this time and the preliminary determination of countervailing duties and anti-dumping duties are expected in April 2017 and June 2017 respectively. In addition, if the U.S. Department of Commerce determines that “critical circumstances” apply, duties could be applied retroactively up to 90 days prior to the preliminary determinations. Millar Western was not chosen by the U.S department of Commerce as a mandatory respondent in the investigations and will be subject to an “all other” rate determined as a weighted average of the rates imposed upon companies that have been chosen as mandatory respondents.

We deny the allegations of subsidies and dumping and are actively participating in Canadian industry efforts to defend itself against the allegations.

In 2016, the hardwood BCTMP market recovered, as demand rose on increased buying by Chinese paperboard producers, while supply stayed relatively unchanged. We expect the U.S.-dollar-denominated pricing to remain strong in the first half of the year but, potentially, to come under pressure in the second half of 2017, as the expected start-up of a new bleached hardwood kraft mill in Indonesia would weigh on the pulp market generally.

In 2017, we expect our lumber facilities in Whitecourt and Fox Creek to continue to run at operating rates similar to those achieved in 2016, for combined production of approximately 455 million board feet. The pulp mill is expected to produce approximately 325,000 tonnes, up slightly from 321,500 tonnes in 2016.

E. Off-Balance Sheet Arrangements

We had no material off-balance sheet arrangements, apart from $11.9 million committed for standby letters of credit under our revolving credit facility.

F. Tabular Disclosure of Contractual Obligations

The table below summarizes the Company’s contractual obligations ⁽¹⁾⁽⁴⁾ as at December 31, 2016.

		Payments due by period
		(in millions)
										More
				Less		1-2		3-5		than
		Total		than 1 year		years		years		5 years

Long-term debt	$	305.8	$	6.5	$	6.7	$	292.6	$	-
Fixed-rate interest ⁽²⁾	$	104.1	$	24.9	$	24.6	$	54.6	$	-
Total	$	409.9	$	31.4	$	31.3	$	347.2	$	-

⁽¹⁾	Contractual obligations are stated as undiscounted amounts and are agreements related to debt, leases and enforceable agreements to purchase goods or services on specified terms but do not include reforestation obligations, accounts payable in the ordinary course of business or contingent amounts payable.
⁽²⁾	Based on annual interest of US$17.9 million converted at a rate of US$0.7448/C$1.00.
⁽³⁾	Our net pension liability of $1.3 million is not included as we are uncertain about the timing and amount of liability.

G. Safe Harbor

See “Special Note Regarding Forward-Looking Statements”.

ITEM 6: DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

A. Directors and Officers

The following table sets forth certain information with respect to our directors and executive officers.

		Years of
		Industry
Name	Age	Experience	Position
James B. Millar	76	54	Co-Chairman and Director
H. MacKenzie Millar	70	47	Co-Chairman and Director
J. Craig Armstrong	65	43	President, Chief Executive Officer and Director
Carol Cotton, CPA, CA	59	29	Senior Vice-President
Ronald J. Reis, Peng⁽⁴⁾	63	42	Senior Vice-President, Pulp
David Anderson, MBA, CFA	43	20	Vice-President, Finance, and Chief Financial Officer
Stefan Demharter	55	34	Vice-President, Wood Products
Brian McConkey	52	28	Vice-President, Human Resources
Robert J. Turner, QC ⁽²⁾	70		Secretary, General Counsel and Director
Gordon J. Clanachan ⁽¹⁾⁽³⁾	62		Director, Audit Committee Chair
Donald R. Ching ^(1)(2)(3)	75		Director
W. Kenneth Davidson ⁽³⁾⁽⁴⁾	66		Director
Douglas G. Hall ^(1)(2)(3)	67		Director

⁽¹⁾	Member of Audit Committee
⁽²⁾	Member of Executive Compensation Committee
⁽³⁾	Member of Independent Directors Committee
⁽⁴⁾	Retired, effective December 31, 2016

James B. Millar has served as our Co-Chairman of the Board and Director since July 2010, and had previously served as Chairman of the Board and a Director since September 1997. Mr. Millar joined the family business on a full-time basis in 1963, working in the construction and forest products divisions of our parent, Industries. Mr. Millar is a past president of the Alberta Roadbuilders Association and served on the board of trustees of the University of Alberta Hospitals Foundation. Mr. Millar has a B.Sc. in Civil Engineering from the University of Alberta. Mr. Millar is the brother of H. MacKenzie Millar.

H. MacKenzie Millar has served as our Co-Chairman of the Board and Director since July 2010, and had previously served as President and Chief Executive Officer and a Director since September 1997. Mr. Millar joined the family business on a full-time basis in 1970. Mr. Millar is a past president of the Alberta Forest Products Association and has served on the boards of Forintek Canada, Canadian Wood Council, Alberta Research Council and the Forest Sector Advisory Council to the Government of Canada. In 2010, Mr. Millar was awarded an honorary membership in the Alberta Forest Products Association. Mr. Millar has Bachelor of Arts and Bachelor of Commerce degrees from the University of Alberta and has served on the Business Advisory Council to the Faculty of Business of the University of Alberta. Mr. Millar is the brother of James B. Millar.

J. Craig Armstrong has served as President, Chief Executive Officer and Director since July 2010. Mr. Armstrong had previously served as Executive Vice-President since July 1998. Prior to this, Mr. Armstrong had served as our Senior Vice-President, Marketing, since September 1997. Mr. Armstrong joined Industries in 1987 as Director of Sales and Marketing and was appointed that company’s Senior Vice-President, Marketing, in 1994. Prior to 1987, Mr. Armstrong spent 13 years with other forest products companies. Mr. Armstrong is a past president of the Alberta Forest Products Association and serves on the boards of the Forest Products Association of Canada and the Sustainable Forestry Initiative. Mr. Armstrong has a Bachelor of Commerce degree from the University of Saskatchewan.

David Anderson, MBA, CFA has served as Vice-President, Finance, and Chief Financial Officer since June 2015. Prior to this, Mr. Anderson had served as Vice-President Finance and Business Development; Manager, Lumber Sales; and Manager, Pulp Sales, since joining Millar Western in 2005, and had previously held positions in another forest products company. Mr. Anderson holds a Bachelor of Science in Forestry degree, a Master’s in Business Administration degree and is a CFA charterholder.

Carol Cotton, CPA, CA, was appointed Senior Vice-President in April 2002. Prior to this, Ms. Cotton had served as our Senior Vice-President and Chief Financial Officer since September 1997. Ms. Cotton joined Industries in 1988 as Vice-President, Finance, and was appointed Senior Vice-President and Chief Financial Officer in 1996. Ms. Cotton has been a member of the Chartered Professional Accountants of Alberta since 1982 and has a Bachelor of Commerce degree from the University of Alberta.

Ronald J. Reis, PEng, retired effective December 31, 2016, after having served as Senior Vice-President, Pulp, since 2006. Prior to this, Mr. Reis had served as our Vice-President, Engineering and Technology, since September 1997. Mr. Reis joined Industries in 1987 as Corporate Technical Director and was appointed Vice President, Engineering and Technology in 1992. Prior to 1987, Mr. Reis spent 12 years with another forest products company. Mr. Reis has a Chemical Engineering degree from Lakehead University.

Stefan Demharter, AScT, has served as Vice-President, Wood Products since July 2012. Prior to this, Mr. Demharter had served as General Manager, Wood Products, since September 2004. Mr. Demharter joined Millar Western in 2001 as Sawmill Manager and previously held positions with another forest products company. Mr. Demharter has a Diploma of Technology in Wood Products from the British Columbia Institute of Technology and a Certified Applied Science Technologist designation from the Province of British Columbia.

Brian McConkey has served as Vice-President, Human Resources, since July 2012. Prior to this, Mr. McConkey had served as Director Human Resources since June 2001. Mr. McConkey joined Millar Western in 1999 as Manager, Human Resources, and was previously employed by another forest products company. Mr. McConkey has a Bachelor of Arts degree and a diploma in Human Resource Management.

Robert J. Turner, QC, has served as our Secretary, General Counsel and a Director since September 1997. Mr. Turner is a Consultant of Dentons Canada LLP, a law firm, and was previously a Vice-Chair and Consultant of Fraser Milner Casgrain LLP. Mr. Turner has served on boards including Alberta YMCA, the University of Lethbridge, Edmonton Space and Science Foundation and Edmonton Eskimo Football Club. Mr. Turner has a Bachelor of Commerce degree from the University of Calgary and a Bachelor of Laws degree from the University of Alberta.

Gordon J. Clanachan, FCA, ICD.D, was appointed a director in August 2014, and serves as the chair of our audit committee. Previously President and CEO of RaiLink Ltd. and a Senior Manager of Price Waterhouse, Mr. Clanachan serves on boards including Melcor Developments Ltd., Chandos GP Corp. and the Edmonton Pipe Industry Pension Plan, and has previously served on the boards of the University of Alberta and the Edmonton Regional Airports Authority. A graduate of Glasgow University, Mr. Clanachan is a member of the Institute of Corporate Directors and the Canadian Institute of Chartered Accountants, and has been designated a Fellow of Chartered Accountants by the Chartered Professional Accountants of Canada.

Donald R. Ching was appointed a Director in September 1997. Mr. Ching is an independent consultant and previously was President and Chief Executive Officer of AREVA Resources Canada Inc., a uranium mining company, from 2005 to 2007. From 1996 to 2004, Mr. Ching was President and Chief Executive Officer of SaskTel, a communications company, and, before that, was President of Crown Investments Corporation of Saskatchewan, and a managing partner in a law firm.

W. Kenneth Davidson, MBA, retired effective December 31, 2016. Mr. Davidson had been appointed a Director in September 1997. Mr. Davidson is an independent consultant, and was previously Co-Chief Executive Officer of Gordon Capital Corporation, from 1996 to 2001. Before that, he spent 20 years with the Canadian Imperial Bank of Commerce, serving as Executive Vice-President, Risk Management, for the last five years of his term. Mr. Davidson holds Bachelor of Science degrees in Mathematics and Business, both from Concordia University, and a Master’s in Business Administration degree from McMaster University.

Douglas G. Hall was appointed a Director in March 1999. Mr. Hall, a corporate director, was a Managing Director of RBC Dominion Securities for 25 years. Mr. Hall has a Master’s in Business Administration degree from the University of Western Ontario and a Bachelor of Arts degree from Queen’s University and is a Chartered Financial Analyst. Mr. Hall also serves as a director of Pattern Energy Group, NexC Partners, Purpose Investments, Stanfield's and Southwest Properties.

Certain of our directors and officers are also directors and officers of Industries and are therefore in positions involving possible conflicts of interest. Specifically, James B. Millar, Co-Chairman and a Director, is also Chairman, Chief Executive Officer and a Director of Industries; H. MacKenzie Millar, Co-Chairman and a Director, is also the President and a Director of Industries; J. Craig Armstrong, President and Chief Executive Officer and a Director, is also Executive Vice-President of Industries; Carol Cotton, Senior Vice-President, is also Vice-President and Chief Financial Officer of Industries, and Robert J. Turner, Secretary, General Counsel and a Director, is also Secretary and General Counsel of Industries. Our directors and officers are subject to fiduciary obligations to act in our best interests. Individuals who are directors and officers of both Millar Western and Industries have agreed with us that they will dedicate a substantial majority of their time to us in order to perform their duties as our directors and officers.

B. Compensation

Executive officers are appointed annually and serve at the discretion of the Board of Directors. The aggregate amount of compensation we paid to all directors and officers as a group, for services in all capacities in 2016, was $4.5 million.

Our policy provides that each non-employee director is entitled to receive an annual fee of $22,000 and a fee of $1,500 for each board or committee meeting attended. The chair of the Audit Committee of the Board of Directors is entitled to an additional $10,000 per annum, and the chair of each other committee is entitled to an additional fee of $5,000 per annum. The total compensation paid to non-employee directors for the year ended December 31, 2016, was $0.2 million.

We do not have a stock incentive plan and have never granted stock appreciation rights to any of our directors, officers or employees. We maintain a defined contribution pension plan for all of our employees. The aggregate amount that we contributed to the pension plan on behalf of the employees in 2016 was $2.6 million, of which $0.2 million represented contributions on behalf of our officers. All of our employees are entitled to participate on a voluntary basis in a retirement savings plan, or RSP, under which we match each employee’s RSP contribution up to a fixed amount. The aggregate amount of matching RSP contributions paid by us in 2016 was $0.9 million, of which less than $4,000 represented matching contributions on behalf of our officers.

On January 1, 2000, we established a supplementary defined benefit pension plan for our executives and certain key employees. Under this plan, participants will be entitled to a target level of retirement benefits in combination with the Canada Pension Plan and our other Registered Pension Plans. The aggregate amount that we contributed to the supplementary pension plan on behalf of the participants was $1.0 million in 2016.

Employee Profit Sharing Plan

All full-time employees participate in a profit sharing plan that distributes to employees on an annual basis a percentage of earnings before income taxes and unusual items, such as unrealized exchange gains or losses on debt. The percentage of such earnings set aside for distribution under the employee profit sharing plan is reviewed annually. For the years ended December 31, 2016, 2015, 2014, 2013 and 2012, the amount of such earnings set aside for distribution was nil, nil, $2.5 million, $3.2 million and nil, respectively.

C. Board Practices

In accordance with our articles of incorporation and by-laws, our Board of Directors may consist of up to ten directors, and our current Board of Directors consists of eight directors. Each director holds office until the next annual general shareholders’ meeting or until the election of his or her successor, unless the director resigns or the office becomes vacant by reason of the Director’s death, removal or other cause. The start of each director’s and executive officer’s term of service is set forth in Item 6(A) above. No directors have service contracts providing for benefits upon termination of employment.

The Audit Committee of the Board of Directors currently consists of three independent directors: Gordon J. Clanachan, Donald R. Ching and Douglas G. Hall. The Audit Committee is responsible for reviewing our financial statements and our internal controls, reviewing the work of our independent auditors, monitoring other financial matters and making recommendations for approval in respect thereof to the Board of Directors.

The Executive Compensation Committee currently consists of three members: Douglas G. Hall, Donald R. Ching and Robert J. Turner. The Executive Compensation Committee is responsible for reviewing compensation levels of senior management and other executive compensation matters.

D. Employees

As of December 31, 2016, we had 544 full-time employees, all of whom were non-unionized.

Location		Employees ⁽¹⁾
Edmonton corporate office		47
Whitecourt pulp mill		121
Whitecourt sawmill		274

Fox Creek sawmill		73
Woodlands		29
Total		544

⁽¹⁾Does not include part-time or seasonal employees.

In addition to our full-time employees, we employed independent contractors to provide logging, trucking, road building and forest regeneration services.

E. Share Ownership

As the Company is 100% owned by Industries, none of the individuals described above owns shares in the Company or has options to purchase any shares.

ITEM 7: MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

A. Principal Shareholder

Industries holds, directly and of record, 15,000,002 common shares, representing 100% of our outstanding common shares. Industries is a company with operations in chemicals and other businesses. Industries is owned 100% by Hualkeith Investments Ltd., or Hualkeith, a corporation indirectly owned 100% by James B. Millar, H. MacKenzie Millar and other members of the Millar family. James B. Millar and H. MacKenzie Millar together control 55.6% of the outstanding equity of Hualkeith. The registered office of Industries is located at 2900 Manulife Place, 10180 -101 Street, Edmonton, Alberta, T5J 3V5, and its executive offices are located at 16640 -111 Avenue, Edmonton, Alberta, T5M 2S5.

Except as disclosed elsewhere in this annual report, there are no arrangements known to us that may at a subsequent date result in a change in control of us. See “Business Overview – Recent Developments”.

By virtue of its ownership of all of our issued and outstanding common shares, Industries acting alone can elect our entire board of directors and can approve any transaction requiring shareholder approval.

B. Related Party Transactions

On May 13, 1998, we, Industries, and certain of our executive officers entered into certain agreements, covering non-competition, trademark licensing, corporate services, and magnesium sulphate supply. Management believes that such agreements are equivalent to those that could have been negotiated with unaffiliated, third parties.

Services Provided by Directors

Robert J. Turner, Secretary, General Counsel and a Director of Millar Western, is a consultant at the law firm of Dentons LLP (formerly Fraser Milner Casgrain LLP), which received fees of $241,872, $225,894 and $165,000 for general corporate legal advice provided to us in 2016, 2015 and 2014, respectively. Such compensation did not exceed 5% of the revenues of Dentons during 2016, 2015 or 2014.

Indebtedness of Directors and Officers

There is no indebtedness outstanding to us by our directors or executive officers.

C. Interests of experts and counsel

Not applicable.

ITEM 8: FINANCIAL INFORMATION

A. Consolidated Statements and Other Financial Information

See Item 17, “Financial Statements.”

B. Significant Changes

Not applicable.

ITEM 9: THE OFFER AND LISTING

A. Offer and Listing Details

There is no organized trading market, inside or outside the United States, for the Notes covered by this annual report.

B. Plan of Distribution

Not applicable.

C. Markets

The Notes covered by this annual report are not listed on any stock exchange or other regulated market.

D. Selling Shareholders

Not applicable.

E. Dilution

Not applicable.

F. Expenses of the Issue

Not applicable.

ITEM 10: ADDITIONAL INFORMATION

A. Share Capital

Not applicable.

B. Memorandum and Articles of Association

There are no provisions of the Company’s articles or other constituent documents that describe the Company’s objects and purposes.

Under the CBCA, a director may vote on a proposal, arrangement or contract in which he or she is interested, if the contract or transaction is:

	a.	an arrangement by way of security for money lent to or obligations undertaken by that director, or by a body corporate in which he has an interest, for the benefit of the Company or an affiliate,

	b.	a contract or transaction relating primarily to that director’s remuneration as a director, officer, employee or agent of the Company or an affiliate,

	c.	a contract or transaction for indemnity or liability insurance, or

	d.	a contract or transaction with an affiliate.

In the absence of an independent quorum, a director may not vote compensation to himself or herself.

The directors may, without authorization of the shareholders:

	a.	borrow money on the credit of the Company,

	b.	issue, reissue, sell or pledge debt obligations of the Company,

	c.	subject to certain conditions, give a guarantee on behalf of the Company to secure performance of an obligation of any person, and

	d.	mortgage, hypothecate, pledge or otherwise create a security interest in all or any property of the Company, owned or subsequently acquired, to secure any obligation of the Company.

Such borrowing powers can only be varied by a special resolution of the shareholders (not less than two-thirds of the votes).

The Company’s directors are not subject to any age limit requirement, and no shares are required for director’s qualification.

The following are the rights, preferences and restrictions attaching to the Company’s common shares:

Dividend Rights. The Board of Directors may from time to time declare dividends payable to shareholders according to their respective rights and interests in the share capital of the Company. Dividends may be paid, in money or property or by issuing fully paid shares of the Company.

Subject to the rights of the holders of any shares of the Company having rights or privileges superior to the common shares with respect to any priority in the payment of dividends:

	a.	each holder of a common share shall be entitled to receive dividends as and when declared and payable, and

	b.	dividends may be declared and paid on the common shares to the complete exclusion of the other classes of shares of the Company.

Rights to Share in Profits or Surplus on Liquidation. Subject to the rights of the holders of any shares of the Company having rights or privileges superior to the common shares with respect to priority of distribution on a liquidation, dissolution or winding-up, each holder of a common share shall be entitled to receive, on a proportionate basis, the remaining property of the Company in the event of a liquidation, dissolution or winding-up of the Company, whether voluntary or involuntary. Any remaining property shall be paid or distributed in equivalent amount per share on each outstanding common share and any shares of the Company whose entitlement on a liquidation, dissolution or winding-up ranks equally with the common shares.

Rights of Retraction. Subject to holders’ of shares of a class or series right to vote separately as a class or series, a special resolution is required to change the rights of holders of shares of any class or series of shares of the Company. These are no more significant than required by law.

Shareholders Meeting. Subject to the CBCA, the annual meeting of shareholders is held at such time, and on such day in each year, and at such place or places as the board of directors, the chairman of the board, the managing director, or the president may from time to time determine.

The board of directors has the power to call a special meeting of shareholders at any time.

The only persons entitled to be present at a meeting of shareholders shall be those entitled to vote thereat, the directors and auditors of the Company, and others who, although not entitled to vote, are entitled or required under any provision of the CBCA or articles or by-laws to be present at the meeting. Any other person may be admitted only by invitation of the chairman of the meeting, or with the consent of the meeting.

There are currently no limitations on the right of foreign or non-resident owners of Notes to hold or vote such securities imposed by Canadian law or the Company’s articles or other constituent documents.

There are no provisions of the Company’s articles or other constituent documents that would delay, defer or prevent a change of control and that would operate only with respect to a merger, acquisition or corporate restructuring involving the Company.

There are no bylaw provisions governing the ownership threshold above which shareholder ownership must be disclosed.

The Company’s articles and other constituent documents do not contain provisions governing changes in capital that are more stringent than required by law.

C. Material Contracts

Not applicable.

D. Exchange Controls

There are currently no limitations imposed by Canadian laws, decrees or regulations that restrict the import or export of capital, including foreign exchange controls, or that affect the remittance of dividends, and interest or other payments to nonresident holders of the Company’s securities.

E. Taxation

Not applicable.

F. Dividends and Paying Agents

Not applicable.

G. Statements by Experts

Not applicable.

H. Documents on Display

The Company’s registration statement on Form F-4, its annual and periodic reports and all other filings made with the U.S. Securities and Exchange Commission may be inspected and copied at the Commission’s public reference facilities in Room 5080, 100F Street, N.E., Washington, D.C., 20549, and at the regional offices of the Commission. The Commission may be reached at 1-800-SEC-0330 for further information on the public reference rooms. These Commission filings are also available to the public from commercial document retrieval services. Reports furnished by the Company with the Commission since November 26, 2002, are also maintained electronically on the Commission’s website, www.sec.gov.

I. Subsidiary Information

Not applicable.

ITEM 11: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

A. Commodity Prices

The markets for pulp and lumber are highly cyclical and affected by such factors as global economic conditions, world-wide demand for pulp and paper, residential and commercial construction in North America and Asia, and changes in industry production capacity and inventory levels. All these factors have a significant impact on selling prices for our products and profitability. The following outlines the sensitivity of operating earnings over the course of a year to changes in commodity prices.

	Changes in realized		Estimated impact on
	price ⁽¹⁾		operating earnings ⁽²⁾
			(millions)

Pulp ⁽³⁾	US$50/admt	$	16.0
Lumber ⁽⁴⁾	US$50/mfbm	$	23.0

⁽¹⁾	Assumed exchange rate of US$1.00 = C$1.00.
⁽²⁾	Before impact of profit sharing plan.
⁽³⁾	Based on annual shipments of 320 madmt.
⁽⁴⁾	Based on annual shipments of 460 mmfbm.

B. Foreign Exchange

We sell the majority of our products (70% of 2016 revenue, 68% of 2015 revenue and 67% of 2014 revenue) in U.S. dollars. Consequently, the value of the Canadian dollar versus the U.S. dollar has a major impact on our revenue and profitability. The value of the Canadian dollar was US$0.7448 at December 31, 2016, compared to US$0.7225 at December 31, 2015, and US$0.8620 at December 31, 2014.

The impact on earnings of fluctuations in currency rates is partially offset by the corresponding fluctuations in our debt-service payments, substantially all of which are denominated in U.S. dollars. To further reduce the impact on earnings of fluctuations in currency rates, we periodically enter into foreign-exchange forward contracts. We do not use any instruments to manage our exposure to changes in foreign-currency rates with respect to the principal value of our U.S.-dollar-denominated debt. We do not hold or issue foreign-currency financial instruments for trading purposes. Based on sales revenue for the year ended December 31, 2015, the effect of a US$0.01 change in the value of the Canadian dollar over the course of the year would affect operating earnings by approximately $2.1 million.

C. Interest Rates

The interest rate on the majority of our existing long-term debt, specifically the US$210.0 million aggregate principal amount of 8.50% Senior Notes, due 2021, as well as our power purchase rights loan and BEP capital lease are fixed. The interest rate on our existing revolving credit facility varies with the prevailing prime rate of the facility’s provider. We do not currently use any derivative instruments to manage our exposure to changes in market interest rates.

ITEM 12: DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

Not applicable.

PART II

ITEM 13: DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

Not applicable.

ITEM 14: MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

Not applicable.

ITEM 15: CONTROLS AND PROCEDURES

Disclosure Controls and Procedures. Our principal executive officer and principal financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report, have concluded that, as at such date, our disclosure controls and procedures were effective in timely alerting them to material information relating to us required to be disclosed in our reports filed or submitted under the Exchange Act. Notwithstanding the foregoing, there can be no assurance that our disclosure controls and procedures will detect or uncover all failures within our company to disclose all material information otherwise required to be set forth in our periodic reports.

Management’s Annual Report on Internal Control over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board. Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2016, based on the criteria set forth in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. This evaluation included review of the documentation of controls, evaluation of the design effectiveness of controls, testing of the operating effectiveness of controls and a conclusion on this evaluation. Based on this evaluation, management has concluded that our internal control over financial reporting was effective as of December 31, 2016.

Attestation Report of the Registered Public Accounting Firm. This annual report does not include a report of our independent auditor regarding our internal control over financial reporting due to our not being an “accelerated filer” or a “large accelerated filer”, as such terms are defined in Rule 12b-2 under the Exchange Act.

Changes in Internal Control over Financial Reporting. There was no change in our internal control over financial reporting that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Our management, including our principal executive officer and principal financial officer, does not expect that our disclosure controls and procedures or internal controls and procedures will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.

Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

ITEM 16

A. AUDIT COMMITTEE FINANCIAL EXPERT

Gordon J. Clanachan is an audit committee financial expert and is independent (as defined under the rules and regulations of the New York Stock Exchange).

The Securities and Exchange Commission has indicated that the designation of a person as an audit committee financial expert does not make such person an “expert” for any purpose, impose on such person any duties, obligations or liability that are greater than those imposed on such person as a member of the Company’s Audit Committee and Board of Directors in the absence of such designation and does not affect the duties, obligations or liability of any other member of the Audit Committee or the Board of Directors.

B. CODE OF ETHICS

We have adopted a code of ethics that applies to our principal executive officer, principal financial officer, principal accounting officer, and persons fulfilling similar functions. The code of ethics is filed as an exhibit to this annual report for the year ended December 31, 2016. A copy of the code of ethics will be provided to any person without charge upon such person’s request in writing at the address set forth on the cover of this annual report.

C. PRINCIPAL ACCOUNTANT FEES AND SERVICES

We paid the following fees to PricewaterhouseCoopers LLP in each of the years ended December 31, 2016, 2015 and 2014, for professional services:

		2016		2015		2014
				(in thousands)
Audit Fees ⁽¹⁾	$	299.2	$	345.4	$	259.3
Audit-Related Fees	$	-	$	-	$	-
Tax Fees ⁽²⁾	$	37.6	$	34.1	$	24.6
All Other Fees ⁽³⁾	$	20.1	$	19.7	$	97.8
	$	356.9	$	399.2	$	381.7

⁽¹⁾	Audit fees comprise professional services for the audit of our annual financial statements, review of our interim financial statements, and services normally provided in connection with our statutory and regulatory filings.

⁽²⁾	Tax fees comprise amounts paid for tax compliance and advisory services.

⁽³⁾	All other fees comprise amounts paid for the audit of expenditures under the Alberta government’s Forest Resource Improvement Program, consultations on accounting developments and the accounting for potential corporate transactions.

Our Audit Committee approved 100% of the fees paid to PricewaterhouseCoopers LLP in 2016, 2015 and 2014 and has a pre-approval policy with respect to permitted non-audit services. Under this policy, subject to certain conditions, specified audit-related services, tax compliance, audit services and tax services may be presented to the Audit Committee for pre-approval as a category of services on an annual or project basis. On an annual basis, management is required to update the Audit Committee in respect of the actual amount of fees in comparison to the pre-approved estimate. All non-audit services not otherwise pre-approved by the Audit Committee must be pre-approved by the Audit Committee on an individual basis.

No audit-related fees, tax fees or other non-audit fees were approved by the Audit Committee pursuant to paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation S-X.

D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES

Not Applicable.

E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS

Not Applicable.

F. CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT

Not Applicable.

G. CORPORATE GOVERNANCE

Not Applicable.

H. MINE SAFETY DISCLOSURE

Not Applicable.

PART III

ITEM 17: FINANCIAL STATEMENTS

The Auditor’s Report and Financial Statements for the Company are attached hereto as itemized under Item 19(a) and are incorporated herein by reference. Such Financial Statements have been prepared on the basis of International Financial Reporting Standards as issued by the International Accounting Standards Board.

ITEM 18: FINANCIAL STATEMENTS

Not applicable. See Item 17, “Financial Statements.”

ITEM 19: EXHIBITS

(a) Financial Statements

(i) Independent Auditor’s Report.

(ii) Statements of Financial Position as at December 31, 2016 and 2015.

(iii) Statements of Operations and Comprehensive Income (Loss) for the years ended December 31, 2016, 2015 and 2014.

(iv) Statements of Changes in Equity for the years ended December 31, 2016, 2015 and 2014.

(v) Statements of Cash Flows for the years ended December 31, 2016, 2015 and 2014.

(vi) Notes to the Financial Statements.

(vii) Financial Statement Schedules are omitted because they are not applicable, not required or because the required information is included in the Financial Statements filed herein.

(b) Exhibits

Exhibit	Description of Exhibit
Number
1.1(1)	Certificate, Articles of Incorporation and Articles of Amendment.
1.2†	Articles of Continuance.
1.3(1)	By-laws.
2.1(3)	Indenture dated as of April 7, 2011, among the Company, The Bank of New York Mellon, as trustee, and BNY Trust Company of Canada as co-trustee.
2.2(3)	Registration Rights Agreement, dated as of April 7, 2011, among the Company and Goldman, Sachs & Co., HSBC Securities & Co., HSBC Securities (USA) Inc. and KKR Capital Markets LLC.
2.3(3)	Form of Exchange Note (included in Exhibit 2.1).
2.4(3)	Credit Facility Letter dated as of December 29, 2006, from HSBC Bank Canada to the Registrant.
2.5(3)	First Supplemental Credit Facility Letter dated as of September 12, 2007, from HSBC Bank Canada to the Registrant.
2.6(3)	Second Supplemental Credit Facility Letter dated as of March 26, 2008, from HSBC Bank Canada to the Registrant.
2.7(3)	Third Supplemental Credit Facility Letter dated as of April 22, 2008, from HSBC Bank Canada to the Registrant.
2.8(3)	Fourth Supplemental Credit Facility Letter dated as of August 13, 2009, from HSBC Bank Canada to the Registrant.
2.9(3)	Fifth Supplemental Credit Facility Letter dated as of May 25, 2010, from HSBC Bank Canada to the Registrant.
2.10(3)	Sixth Supplemental Credit Facility Letter dated as of September 17, 2010, from HSBC Bank Canada to the Registrant.
2.11(3)	Seventh Supplemental Credit Facility Letter dated as of April 6, 2011, from HSBC Bank Canada to the Registrant.
2.12(5)	Credit Facility Letter dated as of April 16, 2012, from HSBC Bank Canada to the Registrant.
2.13(5)	First Supplemental Credit Facility Letter dated as of August 27, 2012, from HSBC Bank Canada to the Registrant.
2.14(6)	Second Supplemental Credit Facility Letter dated as of June 19, 2014, from HSBC Bank Canada to the Registrant
2.15†	Third Supplemental Credit Facility Letter dated as of December 8, 2015, from HSBC Canada to the Registrant
2.16†	Loan Agreement dated as of June 30, 2016 between CP Energy Marketing L.P. and the Registrant.
2.17(3)	Tax Loan Agreement dated as of February 22, 2007, between the Registrant and CP Energy Marketing LP (formerly known as EPCOR Merchant and Capital LP).
2.18(3)	Letter of Understanding dated June 5, 2006, among the Registrant, CP Energy Marketing LP (formerly known as EPCOR Merchant and Capital LP) and Capital Power PPA Management Inc. (formerly known as EPCOR PPA Management Inc.).
4.1(1)	Forest Management Agreement dated May 14, 1997, between the Minister of Environmental Protection of Alberta and the Registrant.
4.2(1)	Corporate Services Agreement dated May 13, 1998, between the Registrant and Millar Western Industries Ltd.
4.3(1)	Non-Competition Agreement dated as of May 13, 1998, among the Registrant, Millar Western Industries Ltd., James B. Millar and H. MacKenzie Millar.
4.4(3)	Trademark Licensing Agreement dated May 13, 1998, between the Registrant and Millar Western Industries Ltd.
4.5(3)	Fox Creek Site Land Lease dated as of December 10, 2010, between the Registrant and the Province of Alberta.
4.6(2)	Power Syndicate Agreement (Sundance C) dated January 1, 2001, among the Registrant, Capital Power Corporation (formerly known as EPCOR Utilities Inc.) and certain industry participants.
4.7(3)	Power Purchase Arrangement (Sundance C).
4.8(3)	Millar Western PPI Swap and Purchase Agreement dated as of May 19, 2006, among the Registrant, CP Energy Marketing LP (formerly EPCOR Merchant and Capital LP) and Capital Power Corporation (formerly known as EPCOR Utilities Inc.).
11.1(4)	Code of Ethics.
12.1†	Certification of the Chief Executive Officer, J. Craig Armstrong, required by 17 CFR 240.15d-14(a).
12.2†	Certification of the Chief Financial Officer, David Anderson, required by 17 CFR 240.15d-14(a).

13.1†	Certification of the Chief Executive Officer, J. Craig Armstrong, required by 17 CFR 240.15d-14(b) and 18 U.S.C. Section 1350.
13.2†	Certification of the Chief Financial Officer, David Anderson, required by 17 CFR 240.15d-14(b) and 18 U.S.C. Section 1350.
21†	Subsidiaries of the Registrant

---------------

(1)	Incorporated by reference from the Registrant’s Form F-4 filed with the Securities and Exchange Commission (Commission File No. 333-8960).
(2)	Incorporated by reference from the Registrant’s Form 20-F filed with the Securities and Exchange Commission on June 4, 2002 (Commission File No. 333-08960).
(3)	Incorporated by reference from the Registrant’s Form F-4 filed with the Securities and Exchange Commission (Commission File No. 333-179957).
(4)	Incorporated by reference from the Registrant’s Form 20-F filed with the Securities and Exchange Commission on March 5, 2013 (Commission File No. 333-112898).
(5)	Incorporated by reference from the Registrant’s Form 20-F filed with the Securities and Exchange Commission on March 5, 2014 (Commission File No. 333-112898).
(6)	Incorporated by reference from the Registrant’s Form 20-F filed with the Securities and Exchange Commission on March 4, 2015 (Commission File No. 333-112898)

† Filed herewith.

SIGNATURE

The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.

MILLAR WESTERN FOREST PRODUCTS LTD.

Dated: March 8, 2017	By:	/s/ David Anderson
		David Anderson
		Vice-President, Finance, and Chief Financial
		Officer

Millar Western Forest Products Ltd.

Financial Statements
December 31, 2016 and 2015

Independent Auditor’s Report

To the Shareholders of Millar Western Forest Products Ltd.

We have audited the accompanying financial statements of Millar Western Forest Products Ltd., which comprise the statements of financial position as at December 31, 2016 and 2015 and the statements of changes in equity, operations and comprehensive loss and cash flows for each of the three years in the period ended December 31, 2016, and the related notes, which comprise a summary of significant accounting policies and other explanatory information.

Management’s responsibility for the financial statements
Management is responsible for the preparation and fair presentation of these financial statements in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board 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.

Auditor’s responsibility
Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards and the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. Canadian generally accepted auditing standards also require that we comply with ethical requirements.

An audit involves performing procedures to obtain audit evidence, on a test basis, about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. We were not engaged to perform an audit of the company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing 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 over financial reporting. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting principles and policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.

We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our audit opinion.

Opinion
In our opinion, the financial statements present fairly, in all material respects, the financial position of Millar Western Forest Products Ltd. as at December 31, 2016 and 2015 and its financial performance and its cash flows for each of the three years in the period ended December 31, 2016 in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board.

(signed) "PricewaterhouseCoopers LLP"

Chartered Professional Accountants

Edmonton, Alberta
March 7, 2017

Millar Western Forest Products Ltd.

Statements of Financial Position

As at December 31

(in thousands of Canadian dollars)

	2016		2015
	$		$

Assets

Current assets
Cash and cash equivalents (note 5)	40,237		16,773
Accounts and other receivables (note 6)	32,738		34,136
Inventories (note 7)	63,328		92,868
Prepaid expenses	8,651		12,262

	144,954		156,039

Property, plant and equipment (note 8)	225,174		222,836
Intangible assets (note 9)	10,396		31,979
Other assets (note 10)	1,393		1,729

	381,917		412,583

Liabilities

Current liabilities
Accounts payable and accrued liabilities (note 12)	45,707		47,894
Financial liabilities – borrowings (note 13)	6,476		4,438
Reforestation obligations (note 14)	3,210		4,749

	55,393		57,081

Financial liabilities – borrowings (note 13)	297,195		313,062
Asset retirement obligations (note 14)	1,316		1,446
Other obligations (note 15)	4,324		2,285
Reforestation obligations (note 14)	8,480		7,634
Deferred income taxes (note 20)	6,194		12,853
Post-employment benefit obligation (note 21)	1,302		2,471

	374,204		396,832

Shareholder’s Equity

Share capital (note 16)	65,500		65,500
Retained deficit	(57,787	)	(49,749	)

	7,713		15,751

	381,917		412,583

Approved by the Board of Directors

(signed) "H. MacKenzie Millar" Director

(signed) "J. Craig Armstrong" Director

The accompanying notes are an integral part of these financial statements.

Millar Western Forest Products Ltd.

Statements of Changes in Equity

For the years ended December 31

(in thousands of Canadian dollars)

		Retained
	Share	(deficit)		Total
	capital	earnings		equity
	$	$		$

Balance – January 1, 2014	65,500	12,817		78,317

Net loss for the year	-	(5,181	)	(5,181	)

Remeasurement loss that will not be reclassified to net (loss) income	-	(1,455	)	(1,455	)

Dividends (note 16)	-	(2,250	)	(2,250	)

Balance – December 31, 2014	65,500	3,931		69,431

Net loss for the year	-	(52,755	)	(52,755	)

Remeasurement loss that will not be reclassified to net (loss) income	-	(175	)	(175	)

Dividends (note 16)	-	(750	)	(750	)

Balance – December 31, 2015	65,500	(49,749	)	15,751

Net loss for the year	-	(8,391	)	(8,391	)

Remeasurement gain that will not be reclassified to net loss	-	353		353

Balance – December 31, 2016	65,500	(57,787	)	7,713

The accompanying notes are an integral part of these financial statements.

Millar Western Forest Products Ltd.

Statements of Operations and Comprehensive Loss

For the years ended December 31

(in thousands of Canadian dollars)

	2016		2015		2014
	$		$		$

Revenue	385,117		378,598		405,123

Cost of products sold (excluding depreciation and amortization)	268,562		280,884		273,852
Freight and other distribution costs	64,203		63,961		59,767
Depreciation and amortization	10,345		14,568		14,272
General and administration	18,269		15,781		18,748
Other expense (income), net (note 18)	293		3,869		(2,679	)
Loss on termination of Power Purchase Arrangement (PPA) (note 13)	26,624		-		-
Gain on sale of Boyle assets and liabilities (note 8)	-		(17,622	)	-

	388,296		361,441		363,960

Operating (loss) earnings	(3,179	)	17,157		41,163

Foreign exchange gain (loss) on borrowings	8,673		(47,019	)	(20,265	)

Finance expenses, net (note 19)	(21,098	)	(23,295	)	(22,086	)

Net loss before income taxes	(15,604	)	(53,157	)	(1,188	)

Income tax (recovery) expense (note 20)	(7,213	)	(402	)	3,993

Net loss for the year	(8,391	)	(52,755	)	(5,181	)

Remeasurement gain (loss) that will not be reclassified to net loss – net of tax of $118 (2015 – $58; 2014 – $485)	353		(175	)	(1,455	)

Comprehensive loss for the year	(8,038	)	(52,930	)	(6,636	)

The accompanying notes are an integral part of these financial statements.

Millar Western Forest Products Ltd.

Statements of Cash Flows

For the years ended December 31

(in thousands of Canadian dollars)

	2016		2015		2014
	$		$		$

Cash provided by (used in)

Operating activities
Net loss for the year	(8,391	)	(52,755	)	(5,181	)
Adjustments for
Finance expenses	21,098		23,295		22,086
Depreciation and amortization	10,345		14,568		14,272
Deferred income tax (recovery) expense	(6,777	)	(278	)	4,245
Unrealized exchange (gain) loss on borrowings	(8,673	)	47,019		20,265
Unrealized loss on derivative contracts	1,516		993		2,074
Reforestation expense	3,514		7,235		7,151
Loss on disposal of property, plant and equipment	260		423		49
Loss on termination of PPA assets (note 13)	20,620		-		-
Increase in demand loan value on termination of PPA (note 13)	1,595		-		-
Gain on sale of Boyle assets and liabilities	-		(17,622	)	-
Inventory valuation to net realizable value	(1,157	)	1,157		-
Greenhouse gas credits (note 10)	(1,708	)	(1,413	)	-
Other	(833	)	(679	)	(117	)
Reforestation expenditures	(3,374	)	(6,917	)	(6,466	)

	28,035		15,026		58,378

Net change in non-cash working capital items (note 26)	32,731		(5,967	)	(14,012	)

	60,766		9,059		44,366

Investing activities
Additions to property, plant and equipment (note 26)	(8,121	)	(47,826	)	(24,326	)
Receipt of government grants (note 8)	2,175		-		1,500
Proceeds on disposal of property, plant and equipment	131		28,535		28
Decrease in other assets (note 10)	201		7		42

	(5,614	)	(19,284	)	(22,756	)

Financing activities
Increase in borrowings	10,000		8,235		4,037
Repayment of borrowings	(15,407	)	(2,013	)	(1,220	)
Finance expenses paid	(26,281	)	(25,899	)	(21,971	)
Dividends	-		(750	)	(2,250	)

	(31,688	)	(20,427	)	(21,404	)

Increase (decrease) in cash and cash equivalents during the year	23,464		(30,652	)	206

Cash and cash equivalents – Beginning of year	16,773		47,425		47,219

Cash and cash equivalents – End of year	40,237		16,773		47,425

The accompanying notes are an integral part of these financial statements.

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

1	General information

	Millar Western Forest Products Ltd. (the Company) is incorporated and located in Canada. The address of the Company’s corporate office is 16640 – 111 Avenue, Edmonton, Alberta, Canada T5M 2S5.

	The Company is a subsidiary of Millar Western Industries Ltd., with the ultimate parent being Hualkeith Investments Ltd.

	The Company is an integrated forest products company with facilities in Canada producing lumber and pulp. The lumber segment consists of two sawmill operations that produce and market dimension lumber. The pulp segment consists of a pulp operation that manufactures and markets a number of different grades of bleached chemi-thermo-mechanical pulp (BCTMP).

2	Summary of significant accounting policies

	Statement of compliance

	These financial statements and the notes thereto have been prepared in accordance with International Financial Reporting Standards (IFRS), as issued by the International Accounting Standards Board (IASB).

	These financial statements were approved by the Company’s board of directors on March 7, 2017.

	The significant accounting policies used in the preparation of these financial statements are as follows:

	Basis of measurement

	These financial statements have been prepared on the historical cost basis, unless otherwise noted.

	Foreign currency

	i)	Functional and presentation currency

		Items included in the financial statements of the Company are measured using the Canadian dollar, which is the Company’s functional currency.

		The Company has no operations outside of Canada; however, the Company does have significant exposure to foreign currency exchange rate movements as a result of its long-term debt, which is denominated in US dollars, and its export sales, which are denominated primarily in US dollars (note 23).

	ii)	Transactions and balances

		Foreign currency transactions are translated into Canadian dollars by applying exchange rates in effect at the transaction date. At each reporting year-end, monetary assets and liabilities denominated in foreign currencies are converted into Canadian dollars at rates of exchange prevailing on that date. Gains and losses on exchange differences are recognized in the statements of operations and comprehensive loss.

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

Cash and cash equivalents

Cash and cash equivalents are defined as cash on hand and short-term deposits held with banks and money market instruments with original maturity dates of less than three months.

Financial instruments

	i)	Financial assets

		The Company classifies its financial assets either at fair value through profit/loss (FVTPL) or as loans and receivables. The classification depends on the purpose for which the financial assets were acquired. Management determines the classification of its financial assets at initial recognition.

		Financial assets at FVTPL are financial assets held for trading and include derivative instruments for which cash flow hedging has not been applied. Financial assets at FVTPL are carried at fair value, with changes in fair value recorded in other income.

		Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market, and include cash and cash equivalents, and accounts and other receivables. Loans and receivables are recognized initially at their face amount, except when fair value is materially different, and are subsequently measured at amortized cost using the effective interest method, less a provision for impairment. A provision for impairment is established when there is objective evidence the Company will not be able to collect all amounts due, according to the original terms of the instrument.

		The Company may enter into transactions to sell trade receivables to third parties. If the risks and rewards of ownership of the receivables are transferred to the purchaser, the transaction is accounted for as a sale, and the receivables are derecognized. If the risks and rewards of ownership of the receivables are neither transferred nor retained and if control is not retained over the receivables, the transaction is accounted for as a sale.

	ii)	Financial liabilities

		Accounts payable and accrued liabilities are non-interest bearing and are recognized initially at their face amount, except when fair value is materially different, and are subsequently measured at amortized cost using the effective interest method. Borrowings are recognized initially at fair value, net of any directly attributable transaction costs, and are subsequently measured at amortized cost using the effective interest method.

	iii)	Derivative financial instruments

		From time to time, the Company enters into foreign exchange instruments to hedge a portion of its expected foreign currency denominated revenue over periods of up to 12 months into the future. The Company also enters into forward sales contracts for pulp or lumber, in order to reduce the impact of market volatility on its product sales, and enters into forward purchase contracts for natural gas, in order to reduce the impact of market volatility on its gas purchases. These contracts are classified as derivative instruments.

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

Derivatives are recognized at fair value on the date the Company becomes a party to the contract and are subsequently remeasured at fair value. The Company does not enter into speculative contracts and does not apply hedge accounting; therefore, unrealized gains and losses on derivatives are recorded in earnings at each year-end.

The Company has reviewed all significant contractual agreements and determined there is one embedded derivative within other obligations (note 15) that must be separated from the host contract and recorded at fair value.

Details of the Company’s classification of financial instruments are provided in note 23.

Impairment of financial assets

At each reporting date, the Company assesses whether there is objective evidence that a financial asset carried at amortized cost is impaired. If such evidence exists, the Company recognizes an impairment loss, with the loss being the difference between the amortized cost of the asset and the recoverable amount. The carrying amount of the asset is reduced by this amount, either directly or indirectly, through the use of an allowance account.

Impairment losses on financial assets carried at amortized cost are reversed in subsequent periods if the amount of the loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognized.

Inventories

The Company’s inventories include logs, pulp, lumber and operating and maintenance supplies.

Pulp, lumber, and log inventories are recorded at the lower of cost and net realizable value (NRV). Cost is determined using average cost and comprises raw materials, direct labour and other direct costs, and related production overheads consistent with the normal level of production. NRV represents the estimated selling price for inventories in the ordinary course of business, less the estimated costs of completion and selling expenses.

Processing materials and supplies are recorded at weighted average cost, recalculated at each transaction date.

Cost of products sold, as presented in the statements of comprehensive loss, includes all inventories expensed in the year, as well as changes in inventory valuation provisions. When reasons for a write down of inventory have ceased to exist, the write down is reversed.

Property, plant and equipment

Property, plant and equipment are stated at cost less accumulated depreciation and accumulated impairment losses. Cost includes expenditures that are directly attributable to the acquisition or construction of the asset, including commissioning costs and borrowing costs. Subsequent costs are included in the asset’s carrying value or are recognized as a separate asset, as appropriate, only when it is probable that future economic benefits associated with the item will flow to the Company and the cost can be measured reliably. The carrying amount of a replaced asset is removed when the item is replaced. Repair and maintenance costs are charged to the statements of operations and comprehensive loss during the year in which they are incurred. Depreciation is recognized on a straight-line basis.

The estimated useful lives of the various components of the Company’s major asset classes are as follows:

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

Buildings – sawmill	20 – 60 years
Buildings – pulp mill	15 – 60 years
Buildings – other	8 – 15 years
Process equipment - sawmill	5 – 50 years
Process equipment – pulp mill	5 – 50 years
Mobile equipment	3 – 10 years
Ancillary equipment	5 – 15 years
Furniture, office and computer equipment	5 – 50 years
Bridges	10 – 50 years
Roads and yards	10 – 50 years

The Company allocates the amount initially recognized in respect of an item of property, plant and equipment to its significant components and depreciates each component separately. Assets under construction are recognized at cost and are not depreciated until the assets are available for use. Residual values and useful lives of the assets are reviewed annually and adjusted if appropriate.

Gains and losses on disposal of property, plant and equipment are determined by comparing the proceeds with the carrying amount of the assets and are included as part of other income in the statements of operations and comprehensive loss.

Intangible assets

The Company’s intangible assets include timber rights, computer software and power purchase rights. These assets are capitalized and amortized in the statements of operations and comprehensive loss, on a straight-line basis over the period of their expected useful lives, as follows:

Timber rights	10 – 60 years
Computer software	5 – 15 years
Power purchase rights (note 13)	20 years

Assets under construction are recognized at cost and are not depreciated until the assets are available for use.

Impairment of non-financial assets

Property, plant and equipment and intangible assets with finite useful lives are tested for impairment when events or changes in circumstances indicate the carrying amount may not be recoverable. If any such indications exist, the recoverable amount of the asset is determined. For the purposes of measuring recoverable amounts, assets are grouped at the lowest levels for which there are separately identifiable cash flows (cash generating units or CGUs). The recoverable amount is the higher of an asset’s fair value, less costs of disposal, and its value in use, which is defined as the present value of the expected future cash flows of the relevant assets or CGU. An impairment loss is recognized for the amount by which the asset’s carrying amount exceeds its recoverable amount.

The Company evaluates impairment losses for potential reversals when events or circumstances warrant such consideration. An impairment loss is reversed only to the extent that the asset’s carrying amount does not exceed the carrying amount that would have been determined, net of amortization, if no impairment loss had been recognized.

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

Greenhouse gas credits

The Company earns greenhouse gas (GHG) credits by creating projects that reduce greenhouse gas emissions. To the extent not utilized to offset GHG penalties incurred, credits are recorded at their estimated fair value. Credits are subsequently measured at FVTPL.

Borrowing costs

Borrowing costs attributable to the acquisition, construction or production of qualifying assets are added to the cost of those assets, until such time as the assets are ready for their intended use. Transaction costs related to debt refinancing are deferred and amortized over the life of the associated debt. All other borrowing costs are recognized as finance expenses in the statements of operations and comprehensive loss in the period in which they are incurred.

Employee benefits

	i)	Pension obligations

		The Company has defined contribution plans providing pension benefits to most of its employees, and for certain key employees the Company has a supplementary defined benefit pension plan.

		The cost of defined contribution pension plans is charged to expense as the contributions become payable.

		The cost of defined benefit plans is determined using the projected benefit method, prorated on service and management’s best estimates of expected plan investment performance, salary increases and retirement ages of employees in the plan. The related pension liability recognized in the statements of financial position is the present value of the defined benefit obligation at the year-end date, less the fair value of the plan assets.

		Actuarial valuations for defined benefit plans are carried out annually, or when any significant changes to the plan or membership may require a revaluation to be completed.

		Actuarial gains and losses are recognized in the period in which they occur, in other comprehensive income (OCI), without recycling through earnings in subsequent periods. The costs of past service benefits are recognized as an expense in the statements of operations and comprehensive loss.

	ii)	Profit sharing

		The Company recognizes a liability and an expense for profit sharing, based on a formula that takes into consideration the loss before taxes of the Company after certain adjustments.

	iii)	Other obligations

		The Company offers a supplemental vacation program for select employees. The employees can use the vacation at their discretion, and the vacation can be carried forward until the end of employment. The Company accrues for unused vacation at each year-end.

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

Provisions

Provisions for environmental reclamation, restructuring costs and legal claims, where applicable, are recognized when the Company has a present legal or constructive obligation as a result of past events, when it is more likely than not that an outflow of resources will be required to settle the obligation, and when the amount can be reliably estimated. Provisions are measured at management’s best estimate of the expenditure required to settle the obligation at the end of the reporting period, and are discounted to present value where the effect is material, using a risk-free rate. The Company performs evaluations to identify onerous contracts and, where applicable, records provisions for such contracts.

Forestry legislation in Alberta requires the Company to incur the cost of reforestation of areas of land on which timber is harvested under the terms of its quotas and forest management agreement. Accordingly, the Company records a liability for the costs of reforestation in the period in which the timber is harvested. In periods subsequent to the initial measurement, changes in the liability resulting from the passage of time and work performed and revisions to reforestation estimates are recognized in the statements of operations and comprehensive loss as they occur.

Income taxes

Income tax comprises current and deferred tax. Income tax is recognized in the statements of operations and comprehensive loss.

Current tax is the expected tax payable on the taxable income for the year, using tax rates enacted or substantively enacted at the end of the reporting period and any adjustment to tax payable in respect of previous years.

Deferred income taxes are recognized for the future tax consequences attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred income tax liabilities or assets are measured using substantively enacted rates anticipated to apply in the periods in which the differences are expected to reverse. Deferred income tax assets are recorded in the financial statements if realization is considered more likely than not.

Deferred income tax assets and liabilities are presented as non-current.

Investment tax credits are recognized through income tax expense/recovery when it is considered probable the tax credit will be utilized against taxable earnings.

Revenue

Revenue is derived from the sale of pulp and lumber and from administrative services provided to related parties. It is measured at the fair value of the consideration received or receivable, net of claims, rebates, returns and discounts, for the sale of goods and services in the ordinary course of the Company’s business. Historical experience is used to estimate and provide for discounts and returns. Volume discounts are assessed based on anticipated annual purchases.

Revenue is recognized when the significant risks and rewards of ownership have been transferred to the customer, the sales price and costs can be measured reliably, and it is probable that the economic benefits will flow to the Company. These criteria are generally met at the time the product is shipped to the customer; title and risk have passed to the customer; and acceptance of the product, when contractually required, has been obtained.

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

	Government grants

	Grants received under government incentive programs are recognized initially as deferred revenue at fair value when there is reasonable assurance they will be received and the Company will comply with the conditions associated with the grant. Grants that compensate the Company for the cost of an asset are deducted against the carrying amount of the asset.

	Segment reporting

	Operating segments are reported in a manner consistent with the internal reporting provided to the chief operating decision maker. The chief operating decision maker has been identified as the Company’s senior executive team, which collectively makes strategic decisions for the segments.

3	Critical accounting estimates and judgments

	The preparation of financial statements requires management to use judgment in applying its accounting policies and estimates and assumptions about the future. Estimates and other judgments are continually evaluated and are based on management’s experience and other factors, including expectations about future events that are believed to be reasonable under the circumstances. The following discusses the most significant accounting judgments and estimates the Company has made in the preparation of the financial statements:

	Useful lives of timber rights

	The Company’s timber rights comprise various agreements and contracts that have fixed terms but contain renewal provisions that could extend the lives of the rights indefinitely. In estimating the useful lives of timber rights, management has generally assumed that renewals will occur in the normal course of business, with useful lives not to exceed 60 years. If the Company was unable to obtain a renewal in the future for a material agreement, this would have an impact on amortization, as well as in the determination of discounted cash flows used in impairment tests for other long-lived assets.

	Reforestation obligation

	The Company is required to reforest the areas of land on which timber is harvested under the terms of its quotas and forest management agreements. Accordingly, the Company records a liability for the estimated costs of reforestation in the period in which the timber is harvested (note 14) with any changes in initial measurement recognized in the statements of operations and comprehensive loss as they occur. The timing of the reforestation payments is based on the estimated period required to attain free-to-grow status in a given area, which is generally between 12 to 15 years. Due to the general, long-term nature of the liability, the most significant areas of uncertainty in estimating the provision are the amount and timing of future costs that will be incurred as, depending on the location and environment of the land, the reforestation costs can vary significantly.

	Long-term derivative liability

	The Company’s long-term derivative liability – Biomass agreement arises from a long-term contract for the supply of biomass to Whitecourt Power Limited Partnership (WPLP) (note 15). The underlying formula that determines the amount the Company pays or receives on a quarterly basis contains many variables and meets the definition of an embedded derivative, requiring its carrying cost to be recorded at fair value with all measurements recognized in the statement of operations and comprehensive loss. The embedded derivative is included in level 2 of the fair value hierarchy as it has been valued using a discounted cash flow model. Due to the long-term nature of the liability, the most significant areas of uncertainty in estimating the current fair value are future expectations of estimated monthly total units of power generation by WPLP, the estimated monthly proportion of WPLP’s biomass consumption that is transported from the Company, Alberta Consumer Price Index metrics, monthly Alberta Pool Price projections from the Alberta Electric System Operator and Canadian dollar discount curves. Depending on fluctuations in these underlying variables the estimated fair value of the instrument can vary significantly.

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

	Functional currency

	The functional currency of the Company is the currency of the primary economic environment in which the entity operates. The Company has determined that its functional currency is the Canadian dollar. Determination of functional currency involves certain judgments to determine the primary economic environment and the Company reconsiders its functional currency whenever there is a change in events and conditions which determined the primary economic environment. There have been no such changes during the year ended December 31, 2016.

4	Changes in accounting policies

	The IASB periodically issues new standards and amendments or interpretations to existing standards. The new pronouncements listed below are those that the Company considers relevant to its financial reporting.

	The following standards have been issued but not yet applied.

	•	IFRS 9, Financial Instruments – In November 2009, IFRS 9 was issued and in October 2010 was further amended. IFRS 9 addresses classification and measurement of financial assets and replaces the multiple category and measurement models in International Accounting Standards (IAS) 39 - Financial Instruments: Recognition and Measurement, for debt instruments with a new mixed measurement model having only two categories: amortized cost and fair value through profit or loss. IFRS 9 also replaces the models for measuring equity instruments and such instruments are either recognized at fair value through profit or loss or at fair value through other comprehensive earnings. This standard is effective for annual periods beginning on or after January 1, 2018. The Company is in the process of assessing the impact of this new standard.

	•	IFRS 15, Revenue from Contracts with Customers – In May 2014, IFRS 15 was issued. This standard addresses revenue recognition and establishes principles for reporting information about the nature, amount, timing and uncertainty of revenue and cash flows arising from an entity’s contracts with customers. Revenue is recognized when a customer obtains control of a good or service and thus has the ability to control its use and obtain the benefits from the good or service. The standard replaces IAS 18 - Revenue, IAS 11 - Construction Contracts and the related interpretations. The standard is effective for annual periods beginning on or after January 1, 2018 with earlier application permitted. The Company is in the process of assessing the impact of this new standard.

	•	IFRS 16, Leases – On January 13, 2016, IFRS 16 was issued which requires, among other things, lessees to recognize leases traditionally recorded as operating leases in the same manner as financing leases. The standard is effective for annual periods beginning on or after January 1, 2019 with earlier application permitted. The Company has not yet assessed the impact of the new standard.

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

	•	IAS 12 amendment, Recognition of deferred tax assets for unrealized losses - The amendments made to IAS 12 in January 2016 clarify the accounting for deferred tax where an asset is measured at fair value and that fair value is below the asset’s tax base. These amendments become effective on January 1, 2017, and the Company is in the process of completing an initial assessment of the potential impact of their adoption.

	•	IAS 7 amendment, Disclosure initiative - Going forward, entities will be required to explain changes in their liabilities arising from financing activities. This includes changes arising from cash flows (e.g. drawdowns and repayments of borrowings) and non-cash changes such as acquisitions, disposals, accretion of interest and unrealized exchange differences. Changes in financial assets must be included in this disclosure if the cash flows were, or will be, included in cash flows from financing activities. These amendments become effective on January 1, 2017, and their adoption will result in additional disclosures as explained above.

There are no other standards or amendments or interpretations to existing standards issued but not yet effective that are expected to have a material impact on the financial statements.

5	Cash and cash equivalents

	Cash on deposit at Canadian banks earns interest at the bank’s prime rate minus 1.95%. The bank’s prime rate as at December 31, 2016 was 2.70% (2015 – 2.70%). As of December 31, 2016 the Company had no restricted cash (2015 - $nil).

6	Accounts and other receivables

	2016	2015
	$	$

Trade receivables	26,229	23,610
Intercompany receivables (note 22(a))	190	145
Other receivables	6,319	10,381

	32,738	34,136

	Current trade and other receivables are unsecured and non-interest bearing. Normal payment terms for the Company are 30 days (see also note 23).

7	Inventories

	2016	2015
	$	$

Logs	19,542	34,858
Pulp	16,181	21,584
Lumber	14,425	22,867
Operating and maintenance supplies	13,180	13,559

	63,328	92,868

In 2016, the Company reversed a $1.2 million inventory write down recorded at December 31, 2015. The amount reversed was included in cost of products sold.

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

8	Property, plant and equipment

					Process
	Land		Buildings		equipment		Other		Total
	$		$		$		$		$

Year ended December 31, 2015
As at January 1, 2015	2,463		43,070		139,222		7,851		192,606
Additions	-		1,244		50,006		247		51,497
Disposals	(355	)	(1,454	)	(8,495	)	(1,319	)	(11,623	)
Depreciation for the year	-		(1,718	)	(6,634	)	(1,292	)	(9,644	)

As at December 31, 2015	2,108		41,142		174,099		5,487		222,836


As at December 31, 2015
Cost	2,108		79,994		375,029		14,862		471,993
Accumulated depreciation	-		(38,852	)	(200,930	)	(9,375	)	(249,157	)

Net book value	2,108		41,142		174,099		5,487		222,836

Year ended December 31, 2016
As at January 1, 2016	2,108		41,142		174,099		5,487		222,836
Additions	-		10		10,830		711		11,551
Reclassification of costs	-		29,375		(29,375	)	-		-
Disposals	-		(50	)	(27	)	(315	)	(392	)
Depreciation for the year	-		(1,621	)	(6,248	)	(952	)	(8,821	)

As at December 31, 2016	2,108		68,856		149,279		4,931		225,174

As at December 31, 2016
Cost	2,108		109,309		356,404		14,924		482,745
Accumulated depreciation	-		(40,453	)	(207,125	)	(9,993	)	(257,571	)

Net book value	2,108		68,856		149,279		4,931		225,174

Included in the above net book values are assets under construction, and therefore not being depreciated, in the amount of $2.1 million as at December 31, 2016 (2015 – $77.1 million).

During 2016, the Company completed construction of a bioenergy effluent project (BEP) at its BCTMP mill at Whitecourt, Alberta. The project involved the construction and integration of three anaerobic hybrid digesters into the BCTMP mill’s existing aerobic effluent treatment system, and the installation of a biogas-fueled power plant and other project components. The project qualified for a total of $27.7 million in government grants, of which $27.7 million (2015 - $25.5 million) had been received by the Company and expended on the project as at December 31, 2016. On completion, the Company reclassified $29.4 million from process equipment to buildings.

Total expenditures on the project to December 31, 2016 were $122.2 million, resulting in a net expenditure of $86.7 million, after receipt of the above grants and $7.8 million retained from the EPC contractor. The Company received $20.2 million (2015 – $20.2 million) in interim financing (note 13) to partially fund project costs. On September 15, 2015, the interim financing loan converted into a capital lease.

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

	In 2016, borrowing costs of $5.3 million (2015 – $4.0 million) were capitalized for the construction of the BEP based on an average annual interest rate of 8.4% (2015 – 8.7%).

	Effective December 22, 2015, the Company sold the Boyle, Alberta sawmill assets and liabilities to a third party. The sale price of $32.2 million included the value of all mill assets, timber quotas, and log inventories in the field, as well as the operation’s reforestation liability. The gain on sale included in income was $17.6 million. As of December 31, 2016, $1.0 million remained in the other receivables balance relating to the sale proceeds.

9	Intangible assets

					Power
	Timber		Computer		purchase
	rights		software		rights		Total
	$		$		$		$

Year ended December 31, 2015
As at January 1, 2015	10,468		644		26,045		37,157
Additions	523		187		-		710
Disposals	(860	)	(103	)	-		(963	)
Amortization for the period	(450	)	(134	)	(4,341	)	(4,925	)

As at December 31, 2015	9,681		594		21,704		31,979

As at December 31, 2015
Cost	16,807		10,055		67,783		94,645
Accumulated amortization	(7,126	)	(9,461	)	(46,079	)	(62,666	)

Net book value	9,681		594		21,704		31,979

Year ended December 31, 2016
As at January 1, 2016	9,681		594		21,704		31,979
Additions	559		-		-		559
Disposals / terminations	-		-		(20,619	)	(20,619	)
Amortization for the period	(305	)	(133	)	(1,085	)	(1,523	)

Closing net book value	9,935		461		-		10,396

As at December 31, 2016
Cost	17,366		10,055		-		27,421
Accumulated amortization	(7,431	)	(9,594	)	-		(17,025	)

Net book value	9,935		461		-		10,396

Included in the above net book values are assets under construction, and therefore not being amortized, in the amount of $1.3 million as at December 31, 2016 (2015 – $0.7 million).

Power purchase rights

In 2001 and 2006, the Company entered into agreements to acquire the rights to a portion of the electricity generated from certain power plants in Alberta. In the first quarter of 2016, this arrangement was terminated (note 13).

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

10	Other assets

	2016	2015
	$	$

Greenhouse gas credits	1,278	1,413
Other	115	316

	1,393	1,729

	The Company holds approximately 66,974 Alberta-based carbon offset credits verified by an independent party and registered with the Alberta government. These credits are valued at fair value and, with the emergence of a secondary market for greenhouse credits, have been recorded at valuation of $19 per credit. $1.0 million was paid during the year in order to satisfy the requirements outlined in the Specified Gas Emitters Regulation in Alberta. Additionally, effective June 30, 2016, the Company sold 96,922 greenhouse gas credits for $1.8 million in an emission offset purchase agreement (note 13).

11	Revolving credit facility

	The Company has a $50 million revolving credit facility maturing July 15, 2018. The credit facility was undrawn as at December 31, 2016, and December 31, 2015. The facility is subject to a borrowing formula based on the Company’s levels of inventory and accounts receivable. The amount available as at December 31, 2016 under the facility was $50.0 million (2015 – $50.0 million), of which $11.9 million (2015 – $3.9 million) was committed to letters of credit. The interest rate on this facility is floating and may, at the Company’s option, be based on the Canada bank prime rate or US base rate, plus a spread of 2.00%. The Company has the option of basing the rate on LIBOR plus a spread of 3.25%. Collateral pledged for the facility is a first charge on all accounts receivable and domestic inventory of the Company.

12	Accounts payable and accrued liabilities

	2016	2015
	$	$

Trade payables	19,814	20,681
Payable to related parties (note 22(b))	464	238
Accrued expenses	22,921	26,433
Customer deposits	2,494	-
Derivative contracts	14	542

	45,707	47,894

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

13	Financial liabilities – borrowings

	2016		2015
	$		$

Unsecured Senior notes – US$210 million	281,967		290,640
Less: Financing expenses	(2,116	)	(2,613	)
Power purchase rights loan #1	-		8,345
Power purchase rights loan #2	-		1,592
Capital Power loan	7,201		-
BEP capital lease obligation (note 8)	16,619		19,536

	303,671		317,500
Less: Current portion	6,476		4,438

	297,195		313,062

Principal repayments required are as follows:

		$

2017		6,476
2018		6,723
2019		3,084
2020		7,537
2021		281,967

Unsecured Senior Notes

On April 1, 2011, the Company issued US$210 million in Senior Notes due April 1, 2021, bearing interest at 8.5%, payable semi-annually, on April 1 and October 1 of each year. The notes are unsecured obligations of the Company and rank equally and rateably with all existing and future unsecured indebtedness of the Company.

The Company incurred $5.0 million of financing costs relating to the issuance, which are offset against the borrowings and are amortized over the expected ten-year term of the notes.

The indenture governing the unsecured Senior Notes contains certain restrictions on the ability of the Company to incur additional indebtedness, pay dividends or distributions, make investments, issue or repurchase share capital, create liens, or engage in sale and leaseback transactions, mergers, consolidations and sales of assets and transactions with affiliates. As at December 31, 2016, the Company was not in violation of any of these restrictions.

Power Purchase Rights and Related Loans

Effective March 24, 2016, Capital Power Corporation gave notice of its intent to terminate its role as buyer of the Sundance C Power Purchase Arrangement. As a result of this termination, the Company’s role as a party to the Power Purchase Arrangement (PPA) syndicate was also terminated. The Company had $9.4 million in loans related to the acquisition of its share of the PPA, which were recorded at fair value and amortized using the effective interest rate method. As a result of the PPA termination, the loans’ cash value of $11.0 million became due and payable to Capital Power on June 30, 2016. The differential, a loss of $1.6 million, was recorded along with the $20.6 million loss on termination of the PPA asset.

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

	Effective June 30, 2016, the Company entered into an emission offset purchase agreement, whereby 96,922 greenhouse gas credits were sold to Capital Power for the purchase price of $1.8 million, which partially offset the $10.7 million of principal remaining on the loans at the end of June. This resulted in a gain of $0.4 million on the sale of the greenhouse credits over the recorded value amount of $1.4 million. The remaining loan balance of $8.9 million will be paid in equal monthly payments of $0.3 million from July 31, 2016 to December 31, 2018, with interest accrued at an effective annual rate of 5.48%. The loan is secured by a letter of credit, which will be periodically reduced as the loan is repaid. As of December 31, 2016, the remaining balance of the letter of credit to Capital Power was $7.5 million.

	Subsequent to Capital Power’s announcement of its intent to terminate the PPA, and as disclosed by the Company in its second quarter earnings results, the Government of Alberta’s Balancing Pool advised that it might challenge the validity or the effective date of the termination. On November 28, 2016, Capital Power Corporation announced an agreement with the Government of Alberta to settle the PPA dispute. Under the settlement, the termination of the PPA was accepted, thereby ending all Company obligations associated with the PPA. Capital Power Corporation and its syndicate partners agreed to pay the balancing pool $39 million, of which the Company’s share was $4.4 million. This payment was included in the fourth quarter and year-end financial results as “Loss on termination of PPA”.

	BEP Capital Lease Obligation

	In 2012, the Company obtained interim financing capacity in the amount of $20.2 million, bearing interest at the Canada bank prime rate plus 2%, to procure key components of the BEP (note 8). On September 15, 2015, the interim financing loan converted into a capital lease, bearing interest of 4.45% over a 60-month period. At the end of the lease term, the Company will have the option to purchase the equipment for a defined option price embedded in the lease agreement.

14	Reforestation and asset retirement obligations

			Asset
	Reforestation		retirement
	obligation		obligations		Total
	$		$		$

As at December 31, 2014	14,574		2,004		16,578
Change in accrual	4,771		(585	)	4,186
Change in provision	(45	)	27		(18	)
Expenditures during the year	(6,917	)	-		(6,917	)

As at December 31, 2015	12,383		1,446		13,829
Less: Current portion	4,749		-		4,749

As at December 31, 2015	7,634		1,446		9,080



As at December 31, 2015	12,383		1,446		13,829
Change in accrual	2,781		-		2,781
Change in provision	(100	)	(130	)	(230	)

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

			Asset
	Reforestation		retirement
	obligation		obligations	Total
	$		$	$

Expenditures during the year	(3,374	)	-	(3,374	)

As at December 31, 2016	11,690		1,316	13,006
Less: Current portion	3,210		-	3,210

As at December 31, 2016	8,480		1,316	9,796

	The estimated undiscounted cash flows required to settle the reforestation obligations as at December 31, 2016 were $12.1 million (2015 – $12.7 million), with payments spread over 14 years. The most significant area of uncertainty is the estimate of future costs to be incurred. The estimated cash flows have been adjusted for inflation and discounted using the risk free-rates, ranging from 0.73% to 2.21% as at December 31, 2016.

	The asset retirement obligations are to reclaim land leased from the Province of Alberta. These obligations represent estimated undiscounted future payments of $5.2 million to reclaim the land. The payments are expected to occur at least 60 years into the future and have been discounted at a risk-free rate of 2.31%.

15	Other obligations

	2016	2015
	$	$

Long-term derivative liability – Biomass agreement	4,324	2,280
Other	-	5

	4,324	2,285

On March 2, 2015, the Company and WPLP entered into a 15-year biomass supply agreement effective January 1, 2015. On the day that is 180 days before the tenth anniversary of the commencement date, the Company and WPLP have the option to extend the agreement for five additional years.

Pursuant to the agreement, the Company supplies WPLP with 100% of the biomass that WPLP needs to run its power generation facility. WPLP has no obligation to pay any compensation for the acquisition of the biomass other than transportation costs. However, WPLP, or the Company, may have to compensate the other party quarterly based on a formula that considers the quarterly weighted average of the monthly Alberta Pool Price as well as sharing net revenues from compliance environment attributes received by WPLP related to power generation. If power prices fall below a certain threshold, the Company is required to pay based on the formula, and if the prices are above another threshold, the Company will receive payment from WPLP.

The underlying quarterly mechanism within the agreement meets the definition of an embedded derivative requiring its initial measurement at fair value, with any subsequent re-measurements to fair value being recognized in the statement of operations and comprehensive loss. At December 31, 2016 the estimated fair value of the embedded derivative using a discounted cash flow model, based on the factors and estimates described in note 3, was $4.3 million (2015 – $2.3 million).

Actual payments in the year ended December 31, 2016 resulting from the agreement were $8.5 million (2015 - $4.3 million) and are recorded in cost of products sold.

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

16	Share capital

Authorized
Unlimited number of common shares, no par value

Issued and fully paid

	2016	2015
	$	$

15,000,002 common shares	65,500	65,500

The Company declared and paid dividends of $nil in 2016 (2015 - $0.8 million, 2014 - $2.3 million).

17	Expenses by nature

	2016	2015	2014
	$	$	$

Changes in inventories of finished goods and work- in-progress	12,680	1,117	(6,805	)
Raw materials and consumables used	167,731	179,242	184,801
Depreciation and amortization	10,345	14,568	14,272
Wages and employee benefits expense	62,727	72,381	67,140
Transportation	64,203	63,961	59,767
Loss on termination of PPA	26,624	-	-
Other expenses	43,986	30,172	44,785

	388,296	361,441	363,960

18	Other (expense) income, net

	2016		2015		2014
	$		$		$


Loss on disposal of property, plant and equipment	(260	)	(423	)	(49	)
Gain on sale of greenhouse gas credits (note 13)	388		-		-
Foreign exchange gain	53		4,872		4,697
Insurance proceeds	-		73		-
Change in unrealized gain (loss) on derivative contracts	528		1,287		(2,074	)
Change in unrealized loss on long-term derivative liability (note 15)	(2,044	)	(2,280	)	-
Realized gain (loss) on derivative contracts	960		(7,398	)	105
Other gains	82		-		-

	(293	)	(3,869	)	2,679

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

19	Finance expenses, net

	2016		2015		2014
	$		$		$

Interest expense on borrowings	25,418		26,578		22,527
Less: Interest capitalized on qualifying assets	5,279		4,032		798

Net interest expense on borrowings	20,139		22,546		21,729
Other interest and bank charges	1,063		891		683
Interest income	(104	)	(142	)	(326	)

	21,098		23,295		22,086

20	Income tax (recovery) expense

	The following analysis describes the difference between the effective tax rate reflected in the provision for income taxes and the statutory rates applicable to the Company.

	2016		2015		2014
	$		$		$

Loss before income taxes	(15,604	)	(53,157	)	(1,188	)

Income taxes based on combined federal and provincial income tax rates of 34.0% (2015 – 33.0%; 2014 – 32.0%)	(5,305	)	(17,547	)	(380	)

Increase (decrease) resulting from
Manufacturing and processing deduction of 7%	1,092		3,721		83
Non-taxable portion of unrealized (gain) loss on debt	(1,171	)	6,115		2,533
Non-taxable portion of capital gains	-		(84	)	-
Non-deductible income (taxable) and other items	85		72		(141	)
SRED investment tax credits - net	(743	)	(95	)	(635	)
Impact of enacted rates	-		544		-
Change in unrealized tax capital losses for which no deferred tax asset was recognized	(1,171	)	6,872		2,533

Income tax (recovery) expense	(7,213	)	(402	)	3,993

Current income tax recovery	(436	)	(124	)	(252	)
Deferred income tax (recovery) expense	(6,777	)	(278	)	4,245

Income tax (recovery) expense	(7,213	)	(402	)	3,993

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

The weighted average applicable tax rate was 34.0% (2015 – 33.0%; 2014 – 32.0%) .

Current income tax recovery includes no (2015 – $0.1 million recovery; 2014 – $0.3 million recovery) prior year adjustments.

The Company did not recognize a deferred income tax asset of $10.9 million (2015 – $12.1 million; 2014 – $5.3 million) in respect of unrealized foreign exchange losses on long-term debt.

As at December 31, 2016, the Company had approximately $34.2 million of federal and $39.5 million of provincial non-capital losses available to reduce future years’ income for tax purposes, subject to confirmation by taxation authorities. The losses for both jurisdictions commence expiry in the December 31, 2032 taxation year.

The movement in the deferred income tax account is as follows:

	2016		2015
	$		$


As at January 1	12,853		13,189
Credit to the statements of operations and comprehensive loss	(6,777	)	(278	)
Tax credit (charge) relating to components of other comprehensive loss	118		(58	)

As at December 31	6,194		12,853

Significant components of the Company’s deferred income tax assets and liabilities are as follows:

	2016		2015
	$		$

Deferred income tax assets
Reforestation costs	2,795		2,757
Capital lease obligation	4,487		5,275
Research and development expenditures	3,681		2,765
Non-capital loss available for carry forward	9,871		5,967
Investment tax credits	2,754		2,451
Other accrued liabilities	1,969		1,874

	25,557		21,089

Deferred income tax liabilities
Property, plant and equipment	(31,751	)	(33,947	)
Long-term debt	-		5

	(31,751	)	(33,942	)

Net deferred income tax liability	(6,194	)	(12,853	)

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

	2016		2015
	$		$

Deferred income tax assets
To be recovered after more than 12 months	25,051		20,393
To be recovered within 12 months	506		696

Deferred income tax liabilities
To be incurred after more than 12 months	(31,751	)	(33,942	)

Net deferred income tax liability	(6,194	)	(12,853	)

21	Employee benefit plans

	2016		2015
	$		$

Statements of financial position obligations for
Defined benefit pension plan	1,302		2,471
Post-employment benefits	5		23
Supplemental vacations	1,510		1,609

Statements of operations and comprehensive loss (charges) recovery
Defined benefit pension plan	(302	)	(312	)
Post-employment medical benefits	18		81
Supplemental vacations	99		(21	)

Defined contribution plans

The total expense for the Company’s defined contribution pension benefits is as follows:

	2016	2015
	$	$

Plans providing defined contribution pension benefits	3,462	3,928

Defined benefit pension plan

On January 1, 2000, the Company established a supplementary defined benefit pension plan for certain key employees. Contributions by the Company are made in accordance with independent actuarial valuations. The effective date for the last actuarial valuation was December 31, 2016.

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

Information regarding the defined benefit pension plan is as follows:

	2016		2015
	$		$

Change in benefit obligation
Obligation – Beginning of year	9,390		9,050
Actuarial (gain) loss	(450	)	84
Current service cost	225		214
Past service cost	-		-
Benefits paid	(633	)	(305	)
Interest cost	360		347

Obligation – End of year	8,892		9,390

Change in plan assets at fair value
Plan assets – Beginning of year	6,919		6,124
Employer contributions	1,000		1,000
Actual return on plan assets	304		100
Benefits paid	(633	)	(305	)

Plan assets – End of year	7,590		6,919

Net plan liability	1,302		2,471

	2016	2015	2014
	$	$	$
Components of pension expense
Interest expense	77	98	58
Current service costs	225	214	148
Past service costs	-	-	100

Net expense	302	312	306

	2016		2015		2014
	$		$		$
Components of remeasurement gain (loss)
Demographic assumptions	147		-		(834	)
Financial assumptions	(58	)	(64	)	(1,021	)
Experience assumptions	361		(20	)	(32	)
Return on plan assets, excluding amounts included in interest expense (income)	21		(149	)	(53	)
Net of tax	(118	)	58		485

Net impact on comprehensive loss	353		( 175	)	(1,455	)

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

	2016	2015	2014
	%	%	%

Plan assets by asset category
Equity securities	31	31	31
Debt securities	14	14	13
Other	55	55	56

	100	100	100

The overall expected rate of return is based on the actuary’s median annualized future return, which is, in turn, based on the target asset mix and equity risk premium, less allowances for investment expenses and active equity management.

The actuarial assumptions to determine the benefit obligation at the end of the year are as follows:

	2016	2015
	%	%
To determine benefit obligation at end of year
Discount rate	3.80	3.90
Rate of compensation increase	3.50	3.50
Rate of price inflation	2.00	2.00

The assumed discount rate has a significant effect on the benefit obligation. A change in this assumption would have the following effect on the 2016 obligation:

	0.5% increase		0.5% decrease

Discount rate	(513	)	(536	)

22	Related party transactions

	The Company enters into transactions with Millar Western Industries Ltd. (Industries), its parent company.

The Company earned revenue from Industries as follows:

	2016	2015	2014
	$	$	$

Administration fees	388	382	378

Other fees	155	110	156

Included in accounts receivable relating to these transactions	190	145	194

Administration fees are established at the cost to the Company plus a 5% mark up.

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

The Company incurred costs charged by Industries as follows:

	2016	2015	2014
	$	$	$

Chemical purchases	970	935	1,100

Other services	2,523	2,287	2,584

Accounts payable to Industries	464	238	245

		Chemical purchases are charged to the Company at the same prices used for arm’s-length parties; facility and equipment transactions are charged at the cost to Industries.

	c)	Key management compensation is as follows:

		Key management includes members of the executive and officers of the Company. The compensation for services of key management is as follows:

	2016	2015	2014
	$	$	$

Short-term benefits	3,299	3,229	4,824
Post-employment benefits	1,178	1,172	1,206

	4,477	4,401	6,030

Short-term benefits include salaries, current benefits and profit shares paid or payable.

23	Financial instruments and financial risk factors

	Carrying and fair value of financial instruments by category:

					2016

		Loans	Other
	Held for	and	financial	Carrying
	trading	receivables	liabilities	value	Fair value
	$	$	$	$	$

Financial assets
Cash and cash equivalents	-	40,237	-	40,237	40,237
Accounts receivable
Trade and other	-	32,738	-	32,738	32,738
Other assets	-	1,393	-	1,393	1,393

	-	74,368	-	74,368	74,368
Financial liabilities
Accounts payable
Trade and other	14	-	45,693	45,707	45,707
Borrowings	-	-	303,671	303,671	190,180
Other obligations	4,324	-	-	4,324	4,324

	4,338	-	349,364	353,702	240,211

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

					2015

		Loans	Other
	Held for	and	financial	Carrying
	trading	receivables	liabilities	value	Fair value
	$	$	$	$	$

Financial assets
Cash and cash equivalents	-	16,773	-	16,773	16,773
Accounts receivable
Trade and other	-	34,136	-	34,136	34,136
Other assets	-	1,729	-	1,729	1,729

	-	52,638	-	52,638	52,638

Financial liabilities
Accounts payable
Trade and other	542	-	47,352	47,894	47,894
Borrowings	-	-	317,500	317,500	175,635
Other obligations	2,280	-	5	2,285	2,285

	2,822	-	364,857	367,679	225,814

The estimated fair value of financial instruments is based on relevant market prices and information available at the year-end.

The fair value of short-term financial assets and liabilities, which include cash and cash equivalents, accounts and other receivables, other assets, accounts payable and accrued liabilities, approximates their carrying value, due to the short-term nature of these financial assets and liabilities.

The fair value of the Senior Notes included in borrowings as at December 31, 2016 was estimated to be US$123.9 million (2015 – US$107.4 million), based on the most recent bid price.

Financial assets and liabilities that are recognized on the statements of financial position at fair value are classified in a hierarchy that is based on the significance of the inputs used in making the measurements. The three levels of the hierarchy are:

Level 1 – unadjusted quoted prices in active markets for identical assets or liabilities;

Level 2 – inputs other than quoted prices that are observable for the asset or liability, either directly (that is, as prices) or indirectly (that is, as derived from prices); and

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

Level 3 – inputs that are not based on observable market data.

Derivative instruments are included in Level 2 of the fair value hierarchy as they are valued using pricing models or discounted cash flow models. These models require a variety of inputs, including, but not limited to, contractual terms, market prices, forward price curves, yield curves, and credit spreads. These inputs are obtained from or corroborated with the market where possible.

The fair value of fixed commodity forward sale and purchase contracts is calculated using a discounted cash flow method, based on forward commodity prices. The fair value of forward exchange contracts is calculated using a forward pricing model (Level 3).

Financial risk management

The Company’s activities expose it to a variety of financial risks: market risk, foreign currency risk, interest rate risk, liquidity risk and credit risk. The Company’s risk management strategy focuses on the unpredictability of financial and commodity markets and seeks to reduce related potential adverse effects on the Company’s financial performance.

The Company’s risk management policies require that significant risks are reviewed with the Company’s board of directors. The Company’s methods for managing financial risks, outlined below, remain unchanged for the year ended December 31, 2016.

	i)	Market risk

		From time to time, the Company enters into forward contracts for both lumber and pulp to reduce commodity price risk. The Company does not enter into such agreements for speculative or trading purposes. These contracts are generally settled financially but may, at the Company’s discretion, be settled by physical delivery of the finished product. Contracts outstanding at the end of the year are recorded at their fair value, and any unrealized gains or losses are included in other income. As at December 31, 2016, the Company had $nil US-dollar-denominated forward lumber commodity contracts outstanding (2015 – $nil; 2014 – $nil). In 2016, the Company had a realized gain on commodity contracts of $0.7 million (2015 – gain of $1.8 million; 2014 – gain of $1.5 million) in other income.

	ii)	Foreign currency risk

		A foreign currency risk arises when future commercial transactions or recognized assets or liabilities are denominated in a currency that is not the Company’s functional currency. The Company is exposed to foreign currency risk on sales, purchases and the maturity of its $210 million in long-term debt which is denominated in US dollars.

		A significant portion of the Company’s sales, approximately 70% of its 2016 revenue (2015 – 68%; 2014 – 67%), was denominated in US currency, and as at December 31, 2016, the Company had $23.4 million (2015 – $21.5 million; 2014 – $30.1 million) in US dollar denominated accounts receivable. Consequently, the Company is exposed to foreign currency exchange risk, as changes in foreign currency rates affect the future cash flows of accounts receivable.

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

		The impact on earnings of fluctuations in currency rates is partially offset by the corresponding fluctuation in interest payments, substantially all of which are denominated in US dollars. To further reduce the impact on earnings of fluctuations in currency rates, the Company may enter into currency contracts to hedge US dollar positions, but does not hold or issue foreign currency financial instruments for speculative or trading purposes. As at December 31, 2016, the Company had US$12.0 million (2015 – US$6.0 million; 2014 – US$49.0 million) in outstanding forward exchange contracts, with a weighted average contract rate of C$1.3409/US$1.00 (2015 – C$1.3425/US$1.00; 2014 – C$1.1282/US$1.00). The Company had no (2015 – US$9.0 million; 2014 – $1.0 million) outstanding collar options contracts. The Company recorded the amount of unrealized gain on these currency contracts for the year ended December 31, 2016, of $0.5 million (2015 – $1.3 million gain; 2014 – $1.8 million loss) in other expense (income).

		A significant portion of the Company’s products are sold at prices denominated in US dollars or based on prevailing US dollar prices, and a significant portion of operational costs and expenses are incurred in Canadian dollars. Therefore, an increase in the value of the Canadian dollar relative to the US dollar reduces the revenue in Canadian dollar terms realized by the Company from sales made in US dollars, which reduces operating margin and the cash flow available to fund operations. The Company’s US dollar denominated long-term debt provides a partial offset to exchange exposure. The Company has not entered into any financial instruments to mitigate the foreign currency risk associated with the long-term debt.

		The US dollar financial position exposure as at December 31, 2016 was US$28.7 million (2015 – US$19.6 million) in net working capital and US$210.0 million (2015 – US$210.0 million) in long-term debt. Based on these balances, with other variables unchanged, a $0.01 change in the exchange rate for one US dollar into Canadian currency would have resulted in a $2.0 million (2015 – $2.1 million; 2014– $2.5 million) change in earnings.

	iii)	Interest rate risk

		The interest rates on the majority of the Company’s long-term debt are fixed; consequently, the Company is not significantly exposed to fair value changes on long-term debt when the market rate of interest changes. The interest rate on the Company’s revolving credit facility does fluctuate with the market; however, there was no balance drawn on the facility as at December 31, 2016. Interest rate exposure mainly relates to interest receipts on the Company’s cash balance of $40.2 million (2015 - $16.8 million) at the end of the year. The Company does not currently use any derivative instruments to manage its exposure to changes in market interest rates.

	iv)	Credit risk

		Credit risk is the risk customers or counterparties to certain financial contracts will fail to pay amounts due or perform their obligations under a contract. The Company is exposed to credit risk primarily through its accounts receivable. The Company manages this risk through the establishment of credit policies and limits that are applied in the selection of counterparties and through ongoing management review of all receivable balances past due, with the objective of identifying at an early stage matters that could potentially delay the collection of funds.

		To mitigate the risk associated with customer or counterparty failure to meet obligations, the Company insures most trade receivables to 90% of the value of the invoice. The proportion of accounts thus insured amounted, as at December 31, 2016, to 90% of the Company’s total trade receivables; the remaining balance was predominantly represented by receivables with other forest products companies relating to fibre agreements, for which the Company held outstanding payables in similar amounts. The maximum exposure to credit risk for receivables as at December 31, 2016 was $33 million. The Company and the insurer work in concert to regularly review the creditworthiness of existing and future customers and establish that credit limits are commensurate with credit risk. All new trade customers must be insurable under the terms of the policy.

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

The concentration of credit risk of accounts receivable is limited, as accounts receivable are widely distributed among customers and geographic locations. A summary of accounts and other receivables is as follows:

	2016	2015
	$	$

Current	24,931	21,589
30 – 60 days	1,298	2,003
61 – 90 days	-	18
91 – 120 days	-	-
Greater than 120 days	-	-

Total trade receivables	26,229	23,610
Other receivables	6,509	10,526

Total accounts receivable	32,738	34,136

		During 2016, the Company recorded $0.1 million in bad debt expense (2015 – $0.2 million).

		Periodically, the Company enters into agreements with third parties for the sale of certain trade receivables arising from pulp export sales to China. Total receivables sold during the year ended December 31, 2016 were US$54.5 million (2015 – US$63.1 million). As the risks and rewards of ownership over the receivables were transferred, the receivables were derecognized at the date of the transaction and no gain or loss was recognized. Related fees in the amount of $0.2 million (2015 – $0.3 million) were shown as a reduction in revenue.

	v)	Liquidity risk

		Liquidity risk arises from the possibility the Company will not be able to meet its financial obligations as they fall due. The Company manages liquidity risk by forecasting cash flows to identify potential financing requirements, and by maintaining access to additional financing in the form of a working capital supported revolving credit facility in the amount of $50 million (note 11), which is due July 15, 2018. This credit facility requires the Company to meet certain covenants. The Company was in compliance with these covenants as at December 31, 2016.

		The following are contractual cash flow maturities (including interest) of financial liabilities:

	<1 year	1-2 years	3-5 years	>5 years	Total
	$	$	$	$	$

Borrowings	31,428	31,350	347,157	-	409,935
Accounts payable and accrued liabilities	45,707	-	-	-	45,707

	77,135	31,350	347,157	-	455,642

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

24	Capital management

	The Company is privately owned and, accordingly, management defines capital as cash and shareholder’s equity, with the source of its capital being operations. It is the Company’s objective to manage its capital to ensure adequate resources exist to support operations while maintaining business growth. The Company’s financial results are primarily influenced by the prevailing market prices for pulp and lumber and the relative value of the Canadian and US dollars; therefore, it manages and adjusts its capital structure as needed, in light of the economic conditions and the risk characteristics of the underlying assets. To maintain or adjust the capital structure, the Company may issue new debt to replace existing debt with different characteristics.

	The Company does not have any externally imposed capital requirements.

25	Segmented information

	The Company’s operations are located in Canada. The Company’s reportable segments are strategic business units that manufacture and sell different products. The business units are managed separately, as each business requires different manufacturing technology and marketing strategies. The Company has two reportable segments: lumber and pulp; and one supporting cost centre: corporate and other. The lumber segment manufactures dimension lumber for sale primarily in Canada, the United States and Asia. The pulp segment manufactures bleached chemi-thermo-mechanical pulp for sale to papermakers worldwide. Included in corporate and other are the combined results from the Company’s management fees and unallocated corporate and other expenses.

	The accounting policies applied to the reporting segments are as described in note 2. The Company evaluates the performance of each segment based on operating earnings. The Company does not allocate financing expenses or income taxes to its business segments. The Company accounts for intersegment revenue and transfers as if the transfers were to third parties at current market prices.

	Product segments

Lumber	2016		2015		2014
	$		$		$

Revenue from external customers	191,815		195,528		207,272
Cost of products sold	(140,133	)	(158,525	)	(152,139	)
Freight and other distribution costs	(19,780	)	(21,235	)	(15,764	)
Depreciation and amortization	(5,588	)	(6,942	)	(6,838	)
Other (expense) income	(244	)	(455	)	1,599
Gain on sale of Boyle assets and liabilities	-		17,622		-

Operating earnings	26,070		25,993		34,130

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

Pulp	2016		2015		2014
	$		$		$

Revenue from external customers	192,914		182,688		197,473
Cost of products sold	(128,368	)	(122,291	)	(121,671	)
Freight and other distribution costs	(44,423	)	(42,726	)	(44,003	)
Depreciation and amortization	(4,663	)	(7,482	)	(7,263	)
Other (expense) income	(518	)	(3,464	)	1,080

Operating earnings	14,942		6,725		25,616

Corporate and other	2016		2015		2014
	$		$		$

Revenue from related parties	388		382		378
Cost of products sold	(61	)	(68	)	(42	)
General and administration	(18,269	)	(15,781	)	(18,748	)
Depreciation and amortization	(94	)	(144	)	(171	)
Other income	469		50		-
Loss on termination of PPA	(26,624	)	-		-

Operating loss	(44,191	)	(15,561	)	(18,583	)

	2016		2015		2014
	$		$		$

Revenue from external customers and related parties	385,117		378,598		405,123
Cost of products sold and general and administration	(286,831	)	(296,665	)	(292,600	)
Freight and other distribution costs	(64,203	)	(63,961	)	(59,767	)
Depreciation and amortization	(10,345	)	(14,568	)	(14,272	)
Other (expense) income	(293	)	(3,869	)	2,679
Loss on termination of PPA	(26,624	)	-		-
Gain on sale of Boyle assets and liabilities	-		17,622		-

Operating (loss) earnings	(3,179	)	17,157		41,163

Cost of products sold for the lumber segment is net of chip transfers to the pulp segment of $6.6 million (2015 – $5.8 million; 2014 – $6.5 million).

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

Expenditures on property, plant and equipment and intangible assets

	2016	2015
	$	$

Lumber	1,501	3,262
Pulp	9,912	48,310
Corporate and other	697	634

	12,110	52,206

Expenditures on property, plant and equipment and intangible assets are net of government grant funding of $2.2 million (2015 – nil; 2014 – $1.5 million).

Identifiable assets

	2016	2015
	$	$

Lumber	164,281	199,223
Pulp	175,255	194,149
Corporate and other	42,381	19,211

	381,917	412,583

The Company’s assets are all located in Canada. Revenue is attributed to geographic locations based on shipping destination as follows:

Geographic sales revenue

	2016	2015	2014
	$	$	$

Canada	100,967	115,597	122,859
United States	89,355	85,838	90,085
Europe	23,255	25,387	25,773
China	110,506	91,548	100,450
Other Asia	55,035	54,847	58,603
Other	5,999	5,381	7,353

	385,117	378,598	405,123

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

26	Supplementary cash flow information Net change in non-cash working capital items

	2016		2015		2014
	$		$		$

Accounts receivable and other	1,398		8,768		(2,540	)
Inventories	30,697		(6,218	)	(13,654	)
Prepaid expenses	2,778		115		(2,468	)
Accounts payable and accrued liabilities	(2,142	)	(8,632	)	4,650

	32,731		(5,967	)	(14,012	)

	2016		2015		2014
	$		$		$

Additions to property, plant and equipment and intangible assets	(14,285	)	(52,206	)	(30,479	)
Changes in working capital for investing activities	885		348		5,355
Interest capitalized on qualifying assets	5,279		4,032		798

	(8,121	)	(47,826	)	(24,326	)

	2016		2015		2014
	$		$		$

Interest paid	25,323		25,150		21,614

Income taxes refunded	(436	)	(124	)	(252	)

Millar Western Forest Products Ltd.

Notes to Financial Statements

For the years ended December 31

All amounts in text and tabular format are expressed in thousands of Canadian dollars, unless otherwise noted

27	Subsequent event

	On March 7, 2017, the Board of Directors of the Company approved an agreement by the Company with a supporting noteholder (the Supporting Noteholder) to pursue a transaction (the Note Exchange Transaction) whereby all of the existing unsecured senior notes in the amount of US$210 million (Existing Notes) (note 13) would be exchanged for 9.0% senior secured notes due 2022 to be issued by the Company (New Secured Notes).

	If the Note Exchange Transaction is consummated, each Noteholder shall receive, on the implementation of the Note Exchange Transaction, New Secured Notes in a principal amount equal to 50% of the principal amount of Existing Notes held by such Noteholder as at the voting record date. In addition, each Noteholder that votes in favor of the Note Exchange Transaction on or before March 31, 2017 would receive additional New Secured Notes (the Early Consent Notes) in a principal amount equal to 5% of the principal amount of Existing Notes held by such Noteholder as at the voting record date. The New Secured Notes will be secured by a first position on substantially all of the assets and property of the Company, with the exception of accounts receivable and inventory (the Priority Collateral). The Company will also provide a second position in respect of the New Secured Notes on the Priority Collateral, which will continue to be pledged as collateral on a first priority basis in respect of the revolving credit facility (note 11).

	It is a condition to the implementation of the Note Exchange Transaction that the Supporting Noteholder will agree to exchange approximately US$41.7 million principal amount of New Secured Notes it receives pursuant to the Note Exchange Transaction for 80% of the equity of the Company (the Share Exchange Transaction). If the Note Exchange Transaction and the Share Exchange Transaction are consummated, the indebtedness of the Company would be reduced from US$210 million to approximately US$71 million. Annual cash interest costs in respect of the Company’s note indebtedness would be reduced from approximately US$18 million per year to approximately US$6 million per year.

	The Note Exchange Transaction would be implemented by way of the Plan of Arrangement under the CBCA and would be expected to be completed by the end of April, 2017.

	Completion of the Note Exchange Transaction will initially be subject to the Ontario Superior Court of Justice (Commercial List) (the Court) issuing an interim order authorizing, among other things, the holding of a meeting of Noteholders to vote on the Plan of Arrangement (the Meeting), the mailing of information packages to Noteholders, the procedure for submitting voting instructions in respect of the Plan of Arrangement, eligibility requirements to receive Early Consent Notes, and certain other procedural matters.

	Provided the interim order is granted by the Court, the Note Exchange Transaction would then be subject to, among other things, approval of the Plan of Arrangement by the affirmative vote of at least 662/3% of the votes cast by Noteholders present in person or by proxy at the Meeting, approval of the Plan of Arrangement by the Court, the receipt of all necessary regulatory approvals, if any, and the satisfaction or waiver of other conditions pursuant to the Plan of Arrangement. If all requisite approvals are obtained, the Plan of Arrangement will bind all Noteholders.

	In connection with the transactions described above, on March 7, 2017, the Board of Directors of the Company also approved the entering into by the Company of a consent acknowledgment (Consent Acknowledgment) with the lender under our revolving credit facility (Bank Lender) pursuant to which the Bank Lender would consent to, and waive any default under our revolving credit facility in respect of, the Note Exchange Transaction and the Share Exchange Transaction, and the Company would agree to grant the Bank Lender a second-lien security interest in substantially all of our assets and property other than the Priority Collateral. Pursuant to the Consent Acknowledgment, the Company and the Bank Lender would also agree to certain amendments to our revolving credit facility, including certain financial covenants.