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Executives

Don Kayne - President and CEO, Canfor Corp. and CEO, Canfor Pulp Products Inc.

Alan Nicholl - Chief Financial Officer and SVP, Finance

Brett Robinson - President, Canfor Pulp

Wayne Guthrie - Senior Vice President, Marketing

Alistair Cook - Senior Vice President, Operations, Solid Wood

Sean Curran - Vice President, Marketing and Sales, Pulp Group

Analysts

Daryl Swetlishoff - Raymond James

Sean Steuart - TD Securities

Mark Kennedy - CIBC

Paul Quinn - RBC Capital Markets

Canfor Corp. (OTCPK:CFPZF) Q3 2013 Results Earnings Call October 31, 2013 11:00 AM ET

Operator

Good morning, ladies and gentlemen. Welcome to the joint Canfor Corporation and Canfor Pulp Products Inc. Third Quarter Results 2013 Conference Call. A recording of the call and a transcript will be available on the Canfor’s 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 Inc. Please go ahead, Mr. Kayne.

Don Kayne

Thank you, Operator, and good morning, everyone. And thank you for joining us today. With me today is Alan Nicholl, our CFO and Senior Vice President of Finance; Brett Robinson, our President of Canfor Pulp; Wayne Guthrie, our Senior Vice President of Marketing; Alistair Cook, our Senior Vice President of Operations for the Solid Wood side; and Sean Curran, our Vice President of Marketing and Sales for the Pulp Group.

I want to start out today by commenting on the announcement we made last week regarding our Quesnel facility. After 18 months of searching for a different solution, we announced last week the permanent closure of our sawmill in Quesnel. The closure anticipated in March of 2014.

The decision was based solely on fiber availability in the Quesnel area and there's simply not enough timber remaining following the mountain pine beetle epidemic to support all of the mills in that community.

We also announced a fiber exchange agreement with West Fraser that will see us exchange our tenure in the Quesnel area with a comparable volume of tenure in the Morice TSA to supply our Houston facility.

During U.S. housing crisis we had previously closed the Clear Lake and Rustad sawmills, the fiber position of our other facilities remained strong and we are confident we will be able to furnish all our mills with timber for the long-term.

As we have announced, Canfor’s key focus is on taking care of our people who are impacted by this difficult decision. We are committed that every person at once to stay with Canfor will given that opportunity and we will also provide placement assistance for those who wish to remain in the Caribou region. We are working with the USW and the Jobs Ministry in placing employees and will provide regular updates as we progress through that process.

Moving on to results, Canfor posted a net income of $28 million, down from $110 million in Q2. While Canfor Pulp Products Incorporated reported net income of $9 million, up from $8 million in the second quarter.

The consolidated result reflects lower lumbar sales realization, increased market stumpage cost and lower lumbar and pulp shipments. In the Lumbar segment, plant downtime for capital expenditures, impacted productivity and shipments in the quarter.

In the Pulp segment planned and unplanned downtime significantly reduced shipments. Residual issues related to the significant capital invested in the boilers through the Green Transformation Program continued to impact mill performance. Alan Nicholl, our Chief Financial Officer will provide more details on our financials in a moment.

We also completed the phased purchase agreement of Scotch & Gulf Lumbar in Q3. Canfor now owned 25% of Scotch & Gulf, which will increase to 100% over the three year term of the agreement. We have first class management team at Scotch & Gulf and the initial results are very encouraging.

We have continued to make progress on our capital plans, which reflected the significant upgrades in Mackenzie and Elko throughout the quarter. With those upgrades conflict we expect to be running near full capacity in 2014.

So, with that, I will 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 third 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 third 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 third quarter of 2013 Canfor reported shareholder net income of $28 million or $0.20 a share, compared to shareholder net income of $110 million or $0.70 a share reported for the second quarter of 2013 and $21 million or $0.14 a share reported for the third quarter of 2012.

On slide three of our presentation, we highlight various non-operating items, net of tax and non-controlling interest, which affect the comparability of our results between the second and third quarters. In the third quarter, these items had a net positive impact of approximately $2 million or $0.02 a share.

After taking count of these adjusting items, the third quarter adjusted net income was $26 or $0.18 a share. This represented a $62 million or $0.43 per share decrease from the adjusted net income of $88 million or $0.61 a share reported for the second quarter of 2013. The decline was largely attributable to lower operating earnings from both our lumber and paper and pulp segment.

With respect to our third quarter operating performance, you’ll see on slide four of our presentation that reported operating income was $49 million, a decrease of $79 million from the prior quarter.

This decrease principally reflected lower lumber sales realizations, increased market stumpage costs and lower production and shipment volumes in both the lumber and pulp segments. I’ll speak more on our operating performance in a few moments when I discuss the individual segment.

Slide 4 -- Slide 5 rather shows the Western SPF benchmark lumber price for 2x4 #2&Btr and U.S. housing starts. Due to the government shutdown in the U.S., housing starts were not published for September. However, an average of July and August indicates that U.S. lumber demand increased somewhat as total U.S. housing starts averaged 870,000 units, a 2% increase from the previous quarter. This steadying of demand was reflected in the lumber prices. We stabilized after the sharp correction seen during the second quarter.

As can be seen on Slide 6, the lumber segment reported operating income of $44 million for the third quarter of 2013, which represented a decrease of $73 million from the prior quarter. The third quarter lumber results for the most part reflected lower sales realizations in part resulting from the spillover of the weaker market conditions from June.

Market stumpage driven log of cost increases in DC as well as lower production volumes resulting from capital projects completed during the current quarter. In addition, the lower sales realization also reflected an average export tax of 5%. And in most offshore markets where the majority of pricing is negotiated monthly or quarterly in advance, the carry over of prices from late in the second quarter was more pronounced.

Canfor’s pulp and paper segment principally comprises the results of Canfor product take. As you can see on Slide 7 of the presentation , Canfor Pulp reported net income of $9 million or $0.13 a share compared to a net income of $8 million or $0.11 per share for the previous quarter and the net loss of $5 million or $0.7 per share, for the third quarter of 2012.

Staying on Slide 7, we’ve highlighted the common non-operating items, net of tax, which affect the compatibility of Canfor Pulp’s results between the second and third quarters. The net -- positive impact of these items since third quarter was approximately $4 million or $0.05 a share.

After taking into account of these items, Canfor post third quarter adjusted net income was $6 million or $0.08 a share, which represented the $10 million or $0.14 per share decrease from adjusted net income of $50 million for $0.22 a share reported for the second quarter of 2013.

The main components of Canfor Pulp’s results, the third quarter are highlighted on the slight eight of our presentation. Canfor Pulp’s operating income was $11 million for the third quarter that was down $8 million from the previous quarter.

This reduction was mostly related to the pulp segment with third quarter operating income at $8 million was down $7 million from the previous quarter. This decrease for the most part reflected higher fibre costs and lower production in shipments volumes, much of which related to scheduled outages and power outage disruption from lighting strikes during August.

Global U.S. NBSK pulp list prices held up fairly well during the traditionally slower summer period, with demand and prices to most regions remaining stable during the quarter. Overall, pulp realization showed a modest increase, mostly due to a slightly weaker Canadian dollar.

For the paper segment, Canfor Pulp reported third-quarter operating earnings of $6 million that was down $1 million from the prior quarter. Compared to the second quarter of 2013, lower production shipment levels were again the principal factors for the decrease.

Capital spending in the third quarter totaled $75 million, of which $46 million was in the lumber business and $27 million in Canfor Pulp. For Canfor Pulp, Capital spending included the previously announced turbo-generated upgrade project at Northwood and Intercon and the Northwood turbine upgrade is currently planned to be completed by the end of the first quarter of 2014, with the Intercon upgrade following about a year late. We currently anticipated that our 2013 capital spending for our lumber and pulp businesses will be around $180 million and $50 million respectively.

Yesterday, the Canfor Pulp Products’ Board announced the dividend payment of $0.05 per share for the quarter, consistent with the guidance given in February of similar payments throughout 2013.

During the third quarter, both Canfor and Canfor Pulp bought bank company shares under existing normal course issuer bid programs. Canfor repurchased 610,000 shares at a cost of around $13 million and Canfor Pulp repurchased around 97,000 shares at a cost of $900,000.

Both targeted capital spending and a strong balance sheet remain our key priorities. We will continue to look for possible opportunities to repurchase additional shares for both companies over the remainder of the year.

In early, August, we completed the first phase of the purchase of Scotch & Gulf Lumber for $29 million, including working capital and transaction costs, representing our initial 25% interest. As a reminder, this is a phase purchase that will take place until August 2016.

As Don has mentioned, after the quarter we announced the permanent closure of our Quesnel mill and the exchange of Timber Tenure with West Fraser. We currently estimate that the severance in closure costs associated with this Quesnel closure will be in the region of $18 million to $20 million before tax.

At the end of the third quarter, Canfor, excluding Canfor Pulp had cash of $61 million, with a saleable liquidity of $335 million. Canfor Pulp had cash of $29 million with a saleable liquidity of $106 million.

Net debt to total capitalization excluding Canfor Pulp was 3%, for Canfor Pulp it was 17% and on a consolidated basis it averaged 8%.

And with that, Don, I will turn the call back over to you.

Don Kayne

All right. Thanks, Alan, and Operator, we will now take questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) The first question is from Daryl Swetlishoff from Raymond James. Please go ahead.

Daryl Swetlishoff - Raymond James

Thanks and good morning, guys. Don, I know you spend a lot of time in Asia recently, and I would be interested in hearing what you saw on the market both in China and Japan, Korea? And secondly, what do you think Canfor can do in terms of export growth to that region of the world over the next couple of years?

Don Kayne

Sure, Daryl. I guess, maybe just talk about Japan first, been there a couple of times in last three months, I would, I guess, our view is in Japan, first of all, its strongest, it’s one of the better years, if not, one of the best years we have had in Japan in many years on a number of fronts, but particular on the housing side has been real good.

What’s encouraging there, I think, is some of the expansion to some of the other segments of the market in Japan, particularly in the seniors housing and commercial builders and those type of things.

So we feel pretty good about Japan, not only this year but going on to next year. There is some concern about the consumption tax in April of next year and the impact that may have, but behind all that we believe that there are just, there will continue to be just solid demand in growth for our products out of British Columbia going forward.

In terms of China, same story there, I know we had some issues this year, I guess in June and maybe once or twice in addition to that. But overall from what we can see there, it’s a very positive, we think that there some of the new administration there is making some progress on what initiatives they have been talking about and putting in place and we think that’s having an impact.

So the market over there, I guess, what’s encouraging, Daryl, more than anything is aside from the solid takeway in terms of demand is the type of demand and we are seeing a very strong and continued growth in value-added type products, which is really what we wanted to see and we are now seeing that in a bigger and bigger way.

In Korea, haven’t been to Korea here lately, but what I will say is there that demand continues also to be consistent and we are seeing relatively good growth there as well on the housing side.

Daryl Swetlishoff - Raymond James

Thanks. Don, how would you define a value-added type product, there would two or better or anything else?

Don Kayne

Yeah. Well, as you know that, those -- that market really began in the low grades, number three and lower, and has progressed to a lot larger percentage of two and better and recently maybe in the last six months we are seeing an ongoing growth in some of the higher grades the home center type product that we ship into the U.S. We are seeing some growth there as well as the J grade and some other products as well in that type of category.

Daryl Swetlishoff - Raymond James

Now, of course, the utility is mostly concrete forming, what sort of end uses would be the better types of lumber?

Don Kayne

Yeah. Multiple uses, I mean, it’s going into new construction and we saw a lot of that in the last three to six months and even recently here on the mission that myself and Wayne attended with the minister so. But I guess some of the other usage aside from that would be mostly on secondary manufacturing used for furniture and interior applications and sidings and tongue and groove paneling and those types of applications. But clearly in the country, we are finding and our people are finding just more opportunities for that all the time.

Daryl Swetlishoff - Raymond James

Thanks for that, Don. I'll turn it over.

Don Kayne

Thanks, Daryl.

Operator

Thank you. The following question is from Sean Steuart from TD Securities. Please go ahead.

Sean Steuart - TD Securities

Thanks. Good morning, everyone. Couple of questions on the pulp side, wondering if you can review your downtime plans for 2014 and I guess mostly asking around Intercon, if you're going to undergo a similar shut for boiler work to I guess similar to what you did with Northwood this year.

Don Kayne

Sean, I’ll let Brett answer that question.

Brett Robinson

2014, we won’t be doing major modifications but boiler is in good shape and then there is no plans to do anything with the actual boiler. We do have a larger piping maintenance project on the high-pressure steam piping that would be on the other side of the boiler. It’s about 14 day outage planned for 2014 and we have minis plans at Northwood and PG as well.

Sean Steuart - TD Securities

Okay. Thanks, Brett. And I have a question for Alan, again on Canfor Pulp. After you pay off this November note maturity I guess liquidity for that company would get a little bit tight. Can you talk about any thoughts around maybe a new debt issue to shore up liquidity a little bit at Canfor Pulp?

Alan Nicholl

Yeah. Good morning, Sean. So the current plan is to, as you say to use the cash we have on hand and our operating facility which is, I think you are aware $110 million. So we will be using part cash and part op facility to repay the U.S. debt. We have plans in place to continue to keep our balance sheet very strong and you will see that play right here in the fourth quarter. But liquidity is not a concern for me. Maintaining the strength of our balance sheet is a key priority for us as you would expect.

Sean Steuart - TD Securities

Could you speak to scope of the size of the potential debt issue you might look at?

Alan Nicholl

Well, not just yet, Sean but I can say that I think it will provide comfort to all looking our balance sheet, we’ll do something.

Sean Steuart - TD Securities

Got it. Okay. That's all I had. Thanks, guys.

Alan Nicholl

Thanks, Sean.

Operator

(Operator Instructions) The following question is from Mark Kennedy from CIBC. Please go ahead.

Mark Kennedy - CIBC

Good morning. So, I’m fighting a bit of cold here, so excuse my voice. But just wondering if you can give us or are you prefer to give us CapEx guidance for 2014 for both pulp and Canfor Corp?

Alan Nicholl

Yeah. Good morning, Mark and I’d be happy to do that. We are still working through that today. But today, we think it’s a going to be in the kind of $150 million, $170 million range for lumber and around $150 million for pulp. But it’s still early days and we are still working through those numbers but that would be our preliminary guidance.

Mark Kennedy - CIBC

Okay. And then out of that $170 million, Alan, how much of that would you classify as maintenance versus discretionary?

Alan Nicholl

Yeah, I would say around $50 million is probably more typical maintenance effort there and the rest is discretionary.

Mark Kennedy - CIBC

Okay. And then so by the end of next year where would you say you are in terms of getting your mill, your sawmill network, upgraded to where you want it to be? Are you 90% of the way there or can you give us any sort of guideline there?

Alan Nicholl

Yes. Well, I think, just going back to our previously announced $300 million capital initiative, I think we’ll be substantially done with that by the end of this year and beginning of next year. And I think, to a large degree, a lot of our heavy lifting will be done and then a lot of the significant projects that we’ve started will be done there. Efforts will be more on the smaller project aimed at -- saw more productivity for the lot of our -- a lot of our major efforts will be completed.

Mark Kennedy - CIBC

Okay. And then on the volume side, how should we think about that say going into I guess 2015. So with the closure of the Quesnel Mill you'll be losing Awata Bota. I think it's a couple of hundred million board feet of capacity there. But I guess with these other modernizations you're going to make it up so but would you say net, net you should be sort of even on the volume heading into 2015?

Don Kayne

Well, we’re basically saying on Quesnel. Mark, it’s Don. We’ll be about -- impacted that on an annual basis about $230 million, $240 million and we would expect that through all those initiatives that you spoke about there will be at least half of that, who will be able to be recovered and we’re hoping for more than that.

Mark Kennedy - CIBC

Okay, that’s great. That’s it for me, thank you.

Operator

Thank you. The next question is from Paul Quinn from RBC Capital Markets. Please go ahead.

Paul Quinn - RBC Capital Markets

Yes. Thanks very much. I think on the Q2 call you mentioned you had the CAD40 million you were going to spend at Elko and Mackenzie and I think you had a question of about additional spending at Houston. Maybe now that I guess your Houston mill has got adequate fiber going forward. Is there a plan in place to upgrade that mill?

Don Kayne

Yes, we are. We’re looking at that right now, Paul and we expect to hear something on that here over the next little while, probably over the next four to eight weeks. We should have some more solid -- solid things to say to you around that but absolutely that’s the plan.

Paul Quinn - RBC Capital Markets

So when you describe 2014 as running near full capacity, what is full capacity for Canfor right now?

Don Kayne

Combined everything including the Canfor, Southern Pine and everything is above 5.2.

Paul Quinn - RBC Capital Markets

Great. And just question on capital allocation, especially at a Canfor Pulp side, just noticed a share repurchase. How do you look at that versus an increase in the dividend and what's the -- what the metrics you're following around that?

Alan Nicholl

Yes. Good morning, Paul. I mean, I think just to reiterate our priorities for Canfor Pulp are debt repayment and select capital projects such as the energy projects that we can understand they are undertaking.

For us I think we look at both and we kept awarded by both those areas where we are comfortable with dividend level for this quarter as we mentioned we do continue to review that every quarter and assembling with the share purchasing, we take a similar approach there so and that’s really kind of, I’m not sure, what we seek to do and we do look pretty closely on it under our mindful of market conditions and how they may impact our allocation.

Paul Quinn - RBC Capital Markets

Okay. And just lastly on that, I guess, pulp operations it seems like you had significant trouble at Northwood ever since you re-did the major $100 and I guess, $110 million or $120 million boiler upgrade. Have we -- following that Q3 shut here, is that -- do you think you've got the operational issues behind you on that mill?

Don Kayne

Brett, go ahead.

Brett Robinson

Yeah. Paul, it’s Brett here. Absolutely. We are feeling good about it. We now have that broiler running right where the models said it should be, we don’t have any carryover and we’re watching closely it, obviously a real concern from a safety perspective, we don’t want to get any wrong. So we’re being very conscious on our approach there.

The guys have done a great job and these broilers looking much better as well through the quarter, I would just also remind you that the lighting outages resulted in nine outages at our facility, which cause tremendous challenges through the quarter for us.

Paul Quinn - RBC Capital Markets

All right. Fair enough. Good to hear. And maybe a question for, Sean, just on future pulp markets, in your commentary, I think, you mentioned, you're happy with the momentum going into Q4, but worried about, maybe worried was too strong a word, but the additional pulp capacity coming on in 2014? How do you see pricing environment in 2014 now?

Sean Curran

And well, thanks, Paul. Here is Sean. I will say that we are following exactly what we did breakdown and say, Q4 we see strength continuing through to the end of the year mainly driven by demand and tighter supply.

Early part of 2014, I think like most people are looking at now is there is some concern about the increase supply coming in, Russia coming on full stream and the hard wood coming in.

But as we look further into the year 2000 -- end of 2014 we should see a better demand/supply balance. So first part of the year might be little bit more of a challenge but balance of the year toward the end should be little bit better.

Paul Quinn - RBC Capital Markets

Great. That's all I had. Thanks, guys. Good luck.

Don Kayne

Thanks, Paul.

Operator

Thank you. There are no further questions registered at this. This now concludes today’s conference call. We thank all participants for joining us today. Please disconnect your line at this time.

Don Kayne

Thank you, Operator, and thanks everybody for attending and we’ll talk to you at the end of Q4?

Operator

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

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