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Executives

Don Kayne - President and CEO

Alan Nicholl - SVP, Finance and CFO

Wayne Guthrie - SVP, Sales and Marketing

Alistair Cook - SVP, Wood Products Operations Canada

Analysts

David Quezada - Raymond James

Sean Steuart - TD Securities

Mark Kennedy - CIBC World Markets

Paul Quinn - RBC Capital Markets

Canfor Corporation (OTCPK:CFPZF) Q2 2013 Earnings Call July 26, 2013 11:00 AM ET

Operator

Good morning, ladies and gentlemen. Welcome to the joint Canfor Corporation and Canfor Pulp Products Incorporated Second Quarter Results 2013 Conference Call. A recording of the call and a transcript will be available on the Canfor and Canfor Pulp’s website.

During this call Canfor and Canfor Pulp’s Chief Financial Officer will be referring to a slide presentation that is available in the Investor Relations section of each Company’s website. Also, the companies would like to point out that this call will include forward-looking statements. So please refer to the press releases for the associated risks of such statements.

I would now like to turn the meeting over to Mr. Don Kayne, President and CEO of Canfor Corporation and CEO of Canfor Pulp Products Incorporated. Please go ahead, Mr. Kayne.

Don Kayne

Good morning everyone and thanks for joining the Canfor and Canfor Pulp’s Second Quarter Results Conference Call. I will speak briefly to the results of both companies before I turn things over to Alan Nicholl, who is our Chief Financial Officer for both Canfor Corporation and Canfor Pulp Products Incorporated. Alan will provide a more detailed overview of our performance in quarter two after which we will take questions.

With me today to address your questions are Brett Robinson, President of Canfor Pulp; Alistair Cook, Senior Vice President of Wood Products & Operations; Wayne Guthrie, Senior VP of Sales and Marketing for Canfor; and Sean Curran, VP of Sales and Marketing for Canfor Pulp.

So, Canfor Corporation posted a quarter two net income of $110 million, which is an improvement over the net income of 62 posted in quarter one. Of this $100 million, $7.6 million is attributable to Canfor Pulp and the balance to our solid wood business. Improvements in our result over Q1 are largely related to increased shipments of lumber and to a lesser extent improvements in our manufacturing cost.

As you are all well aware, we saw a significant correction in lumber prices from the eight year buy they achieved in quarter one. Mostly the sliding price is supply related, owing to increased shipments and railcar availability. We did however also see reduced housing activities in the United States. Due to unseasonal wet weather housing starts were down 9% from Q1. That being said, we feel that the underlying housing demand in the U.S. remains encouraging and that we will continue to see steady and positive trends in the U.S. housing market going forward.

Canfor announced in late May that we had reached agreement with the Scotch & Gulf Lumber Company in Alabama to acquire their facilities in Mobile, Walton and Jackson, Alabama over a three year period. We expect the deal to close next month. The deal will add about 440 ore feed to our lumber capacity. Increasing our capacity in Southern Yellow Pine will improve our ability to serve our U.S. customer base.

We’ve seen modest improvements in pulp markets through the quarter. Canfor Pulp’s shipments were steady through the quarter and in line with Q1. Results in the current quarter were impacted by the scheduled maintenance outages at Northwood and Intercontinental pulp mills.

We continue to make progress on our capital plans with projects well underway in our Elko and Mackenzie sawmills. The new continuous kiln at our Conway sawmill at South Carolina started up in June. Canfor Pulp’s maintenance capital program progressed well through quarter two and we anticipate that minimal maintenance downtime through Q3 will be reflected in our results.

I’d like to now turn the call over to Alan Nicholl, who will provide more details on our financial results.

Alan Nicholl

Thank you, Don, and good morning, everyone. My comments will focus principally on our financial performance for the second quarter of 2013 by reference to the previous quarter. I’ll discuss the results of Canfor first and then Canfor Pulp second.

In my comments I’ll be referring to our second quarter overview slide presentation, which you’ll find on either the Canfor or Canfor Pulp websites in the Investor Relations section under Webcasts. Full details are contained in the Canfor and Canfor Pulp news releases, both of which were issued yesterday.

For the second quarter of 2013 Canfor reported shareholder net income of $110 million, or $0.77 per share, well ahead of shareholder net income of $62 million or $0.43 per share reported for the first quarter of 2013 and $3 million or $0.02 a share reported for the first quarter of 2012.

On slide three of our presentation, we highlight various non-operating items, net of tax and non-controlling interest, which affect comparability of results between the first and second quarters. In the second quarter, the most material adjusting item was a gain of $33 million or $0.24 a share, related to the sale of our 50% interest in the Peace Valley OSB joint venture.

This gain is composed of net income earned in 2013 plus the estimated fair value of additional consideration that Canfor may earn over the next three years through an earn out arrangement. The other items are largely the typical items that we adjust for each quarter.

The net positive impact of these items in the second quarter was approximately $23 million or $0.16 a share. After taking account of the adjusted items, the second quarter adjusted net income was $88 million or $0.61 a share. This represented an $80 million or $0.12 a share improvement from adjusted net income of $70 million or $0.49 a share for the first quarter of 2013.

With respect to our second quarter operating performance, you’ll see on slide four of our presentation that reported operating income was $128 million, an increase of $28 million from the previous quarter. This increase principally reflects improved results in the lumber segment, mostly due to higher achievements on slightly lower costs.

Operating results for the pulp business was steady relative to prior quarter, as higher sales realizations were largely offset by costs linked to the scheduled outages at Canfor Pulp's Intercon and Northwood Pulp Mills in the quarter. I’ll speak more on our operating performance in a few minutes when I discuss the individual segments.

Slide five shows the Western SPF benchmark lumber prices for (inaudible) and U.S. Housing Starts. U.S. lumber demand receded somewhat in the quarter as total U.S. Housing Starts averaged 872,000 units, a 9% decrease from the previous quarter.

As Don previously highlighted, the decrease was principally due to a sharp drop in the more solitaire multifamily starts, which were down 27% in June. This multifamily starts and more significantly an increase in North American production outset and real car availability accounted for sharp deduction in North American lumber prices in May and June.

Turning to slide 6, you’ll see that the lumber segment reported operating income of a $116 million for the second quarter of 2013, a $27 million increase from the previous quarter. The improvement in second quarter of lumber was largely due to a 12% increase in shipments reflecting both higher production and the improved railcar availability.

Sales realization were probably in line with those of first quarter of 2013, as a combination of stable prices in offshore markets, proportionally higher shipment in April, as well as a weaker Canadian dollar offset the impact of North American price correction that we saw in May and June. Overall unit manufacturing costs were down slightly compared to first quarter.

Canfor’s pulp and paper segment principally comprised of the results of Canfor Pulp Products Inc. As you can see on slide seven, Canfor Pulp Products Inc. reported net income of $8 million or $0.11 per share in the second quarter and this compared to net income of $11 million or $0.15 per share of the first quarter and net income of $3 million or $0.04 per share for the second quarter of 2012.

Staying on slide seven, we highlighted the common non-operating net of tax, which affect the comparability of Canfor Pulp’s results between the first and second quarters. The net negative impact of these items was approximately $8 million or $0.11 per share in the second quarter.

After taking account of these adjustments, Canfor Pulp second quarter adjusted net income was $15 million or $0.22 a share and this represented of $3 million or $0.05 per share increase from the $12 million or $0.17 per share reported for the first quarter of 2013.

The main components of Canfor Pulp's results for the second quarter are highlighted on slide eight of our presentation. Canfor Pulp's operating income was $20 million for the second quarter, which was essentially the same as we reported for the previous quarter. We respect to Canfor Pulp's pulp segment, second quarter operating income was around $15 million. The same is not reported for the previous quarter.

Global U.S. dollar and DSK pulp list prices moved up between $22 and $40 per ton just depending on the regions where shipments were down slightly. Pulp sales utilization showed a moderate increase reflecting a higher prices as well the weaker Canadian dollar. Unit manufacturing cost increased due to the lower production and higher maintenance cost associated with the scheduled outages in the quarter.

In the paper segment we reported second quarter operating earnings of $7 million. That was up $1 million from the previous quarter. Compared to the first quarter, higher earnings resulted from improved units, sales realizations and more significantly higher shipments.

Capital spending in second quarter totaled $49 million, of which $39 million was for the lumber business and $9 million for Canfor Pulp. Work continued on the Mackenzie and Elco projects, both launched late last year and planed to be completed by the fall of this year.

For Canfor Pulp capital spending included the previously unannounced turbine projects at Northwood and Intercom. We currently anticipate that our 2013 capital spending for lumber and pulp businesses will be around $170 million and $50 million respectively.

Yesterday the Canfor Pulp products Board announced a dividend payment of $0.05 per share for the quarter consistent with the guidance given in February of similar payments through 2013. During the second quarter both Canfor and Canfor Pulp brought back Company shares under the existing normal course issue bid programs. Canfor repurchased 763,000 shares at cost of $14 million and Canfor Pulp repurchased 165,000 shares at the cost of $1.5 million.

While targeted capital spending and strong balance sheet remain key priorities, we will continue to look for possible opportunities to repurchase additional shares for both companies over the balance of 2013.

As previously announced, in May 31, we entered into purchase agreement with Scotch & Gulf Lumber on a phased basis just over 3 years. We expect as Don mentioned to close this acquisition of the first 25% in August. The purchase price is $80 million plus working capital.

At the end of the second quarter, Canfor excluding Canfor Pulp at positive net cash or $24 million with available liquidity of 334 million. Canfor Pulp had net debt of $70 million, with available liquidity of a $106 million. Net debt to total capitalization, excluding Canfor Pulp was negative 2%. For Canfor Pulp its 15% and on a consolidated basis it was 3% and with that Don, I'll turn the call back over to you.

Don Kayne

Right, thanks Alan. I'd now like to open the lines up for questions.

Question-and-Answer Session

Operator

Thank you, Mr. Kayne. We will now take questions from the telephone line. We'll now take questions from the financial analysts. (Operator Instructions). There will be a brief pause while the participants register for questions. Thank you for your patience. Our first question is from David Quezada with Raymond James. Please go ahead.

David Quezada - Raymond James

Just a quick question on cost side for lumber. It seems like the industry in general is experiencing some inflation or debt relative to the first quarter anyway, whereas yours looked kind of more flat. Do you have any insight as to why that may be and maybe just discuss what the outlook is on the cost side going forward?

Don Kayne

Thanks David, I think just a, maybe just make a brief comment on that. I think that we're working continually on our overall costs. We are seeing some of the benefits come through from our capital that we spent over the last couple of three years, which has offset to some degree some of the log cost pressures that we're seeing.

Moving forward we do see probably as others log costs will increase somewhat here just to due to stumpage rates going up in Q3. Uncertain yet where they'll end up in Q4, but certainly on the log cost side we do see some pressure there going on and hopefully we can balance some of that off, at least with the conversion cost side.

David Quezada - Raymond James

And I guess just a follow up. It seems like the price utilization you have this quarter as was stated in the release benefited from a lag on the offshore shipments. How do you see that dynamic playing out next quarter? How does that affect things?

Don Kayne

If markets continue to move up as they have been here recently, hopefully there won't be much of a lag going the other way but I do think we had some good benefit of that on Q2, as you accurately stated. In Q3, with the price drop that we are seeing there'll be some reversal of that but we haven't seen it move back a little bit here in more positive territory. So hopefully that will be mitigated.

Operator

Our next question is from Sean Steuart with TD Securities. Please go ahead.

Sean Steuart - TD Securities

Two questions, Don, I'm wondering if you can just give us an idea of, with respect to M&A opportunities, in the U.S. sales I guess in particular, can you speak to other sort of Scotch & Gulf type opportunities that might be out there and I guess from a broader perspective, are you limiting your consideration to the U.S. sales or are you broadening I guess your regional set that you might look at for M&A opportunities?

Don Kayne

I think Sean, just in a broad sense, I think that first of all that the southern region of the United States is certainly an area that we believe has got a great future. That's why we entered into that deal that we have recently with Scotch & Gulf. We think there are some good opportunities down there.

How much is available and where and so forth, we're working hard as we have been to try to make sure that whatever we do is in the strategic areas that really fit with what we have already, but certainly I would say just as a general statement that we definitely believe that's a critical region for us going forward and we'll continue to focus on it as we have. That gives you enough of information with us kind of where we are right now. So it's a key area for us and we'll continue to look for opportunities.

Sean Steuart - TD Securities

The sequential lumber volume pickups this quarter, I guess the MD&A suggested that some of it was extra shifts, and I'm wondering if you could just quantify how much that contributed to the volume pick up this quarter and presumably down at these levels you're not running those extra shifts now. So I'm just trying to gauge I guess how much that might have benefited Q2 volumes and how much get back in IT this quarter

Don Kayne

I think I wouldn’t expect that we'd see much of a change at all. I mean where we are, some of the increase that we saw in Q2 was also capital programs that we spent in the mills we are operating, In progressing there we are some benefit from that obviously from all the capital. In addition there has been some extra shifting as a result of that, but where we're at today we'll probably see, I would say probably quarter-over-quarter pretty flat actually and not a lot of significant difference there and we're kind of comfortable with where we are today.

Sean Steuart - TD Securities

And then last question, Don, just wondering if you can give us an update of where things stand with labor negotiations?

Don Kayne

Yes, for sure, well as you know I'm sure that they expired June 30th with the steel workers and we’ve had numerous conversations, our bargaining group has had with the steel workers has been going, it has been going well, made some good progress on several of the issues and we still have a few more to iron out yet. And so I would expect that we will continue to make solid progress through August and hopefully we will be able to tell you about the result in August.

Operator

Our next question is from Mark Kennedy with CIBC World Markets. Please go ahead.

Mark Kennedy - CIBC World Markets

First question, just again on fiber cost, you are going into Q3, we heard numbers like in BC, stumpage rates could be going up, sort of $5 to $7 cubic meter in Q3. Would you agree with that kind of range for yourself?

Don Kayne

Yes, we would.

Mark Kennedy - CIBC World Markets

And then again depending on how I got to see the market place component of that worked so, you may see some of that actually come off again in Q4, I guess right?

Don Kayne

That’s correct, if prices were to stay where they were, we would expect that.

Mark Kennedy - CIBC World Markets

And then just in terms of your overall sort of CapEx profile, I know it’s probably early, you’re probably haven’t done your detail 2014, but do you sort of envisage, sort of 2014 CapEx levels being consistent with 2013 or is there any reason they would step up?

Don Kayne

No, they would be at least where they are at 2013.

Mark Kennedy - CIBC World Markets

But any magnitude for a significant increase on something?

Don Kayne

Not necessarily, and I think Mark, just be very similar to what it was in 2013. So it just may be additional capital that we are looking at for high return projects and that to be determined yet. But certainly I would say that the 2013 number would be a minimum.

Mark Kennedy - CIBC World Markets

Okay and would that sort of be similar for Canfor Pulp too, that its number would sort of stay in that $50 million range, next year as well?

Don Kayne

Yes, that would be accurate.

Mark Kennedy - CIBC World Markets

And then finally, obviously you will see some pressures here in Q3 with fiber, but just trying to get a sense for how much further sort of manufacturing, productivity or what else could help offset that fiber cost from productivity pickups. Is there still more sort of cost improvement coming from the productivity side in Q3, do you think?

Don Kayne

For sure, our focus continues to be, and it’s really the fundamental reason why we have invested so heavily the last several years, as we have, is to get our cost in top quartile and as you know why, I think Mark, as we announced we are spending another $40 million at Elko and another $40 million Mackenzie and also looking at probably Houston as well. So that will further improve our operating cost overall as a company. And so yes, over the next six to 12 months we would expect ongoing improvements.

Mark Kennedy - CIBC World Markets

Okay, and then finally just comments in terms of what your big buyers of the U.S. market are saying right now as they sort of look into the back half of 2013 and into 2014, because certainly there has been some concern with the bump in mortgage rates and the weaker housing start numbers with softer June. There are some customers that are restraining, the cycle is slowing but I am not really convinced, that’s the case.

Don Kayne

Now I'm going to let, Alistair and Wayne have been out in the U.S., you recently saw that. I will let Wayne answer that one.

Wayne Guthrie

Thanks Don. Our U.S customers, genuinely are cautiously optimistic, and I know that’s bit of an overused term but I think going into Q1 they were enjoying a nice uptick in businesses, they definitely slowed down in Q2. When they looked at the back half of the year in 2014, they do expect better activity, they expect increased sales, but the well-documented issues of portability, labor shortages and the lack of developed land will continue to be headwinds here as we go through 2014. So it will probably grind higher, but lots of headwinds out there still.

Operator

Our next question is from Paul Quinn with RBC Capital Markets. Please go ahead.

Paul Quinn - RBC Capital Markets

Just wanted to build on, I guess the previous question on cost inflations, especially in the log side. I guess you in agreement with that $5 to $7 increase in BC stumpage that we are seeing in July but what are you experiencing in terms of cost inflation on the logs that you're purchasing outside of your tenures?

Don Kayne

I would say on that, it was probably the similar number. We don’t look at it as closely but for the most part we probably in the ballpark, very similar, probably may be either on the lower end of the $5 to $7.

Paul Quinn - RBC Capital Markets

Okay then, how would you quantify what you are experiencing at your mill in Alberta? Is that going up like a half or a quarter of like what you are seeing the price increase in BC?

Alistair Cook

In Alberta obviously we are going to see actual decrease here in quarter three on a stumpage basis.

Paul Quinn - RBC Capital Markets

Okay and then just, I guess just rounded out in the U.S., cost is near on the log side were pretty flat in the quarter. What is your expectation going forward?

Don Kayne

No change there at all Paul. It has been flat like you said or mentioned and we don’t expect any change there going forward.

Paul Quinn - RBC Capital Markets

When do you expect a change from the U.S stump? Is that a '14 event or is that a '15?

Don Kayne

No, I think it’s out ways (ph), right? It could be another 12 to 18 months. There is always going to be a little pressure here and there but overall we think we can keep it relatively flat.

Paul Quinn - RBC Capital Markets

Okay and then just moving over to China, just if you can give us some color on what are you seeing in that market, whether you are seeing growth in shipment volumes and or whether you expect growth in shipment volumes in '13 over '12 and what do you expect for the back of the year?

Don Kayne

On that one Paul, we just think it’s been flat. The last quarter-over-quarter we haven’t seen any decrease and going forward as we have been continually, we believe offshore markets are going to provide us with continued diversification opportunity and a strategic advantage. As we have been doing for several years, we’re consistent in our belief on the Asian markets and how much is going to increase, hard to say but it will be probably relatively flat for the balance of this year which will still be a fairly big increase from last year.

Paul Quinn - RBC Capital Markets

Okay and then if you could just round off I guess the pulp maintenance schedule for the balance of the year?

Alan Nicholl

For the balance of the year we got the PG shut in the fourth quarter and it`s mini-major. So it will be fixed stage relatively small compared to the shots we’ve already completed.

Operator

Thank you. (Operator Instructions). There are no further questions registered at this time. I would like to turn the meeting back over to you, Mr. Kayne.

Don Kayne

All right, thanks operator and thanks everyone who participated this morning and we’ll look forward to talking to you at the end of Q3. Thanks very much.

Operator

Thank you. The conference call has now ended. Please disconnect your lines at this time. We thank you for your participation.

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