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Executives

James Shepard – President, Chief Executive Officer

Thomas Sitar – Vice President Finance, Chief Financial Officer

Don King – Vice President, Marketing and Sales

Analysts

Darrel Switzerloft – Raymond James

Paul Quinn – RBC Capital Markets

John Koller – Oppenheimer & Close

[Pierre Lacroix – Desjardine Securities]

[Dave Barry – CKPG News]

Canfor Corporation (CFP) Q1 2010 Earnings Call April 30, 2010 11:00 AM ET

Operator

Welcome to the Canfor Corporation first quarter results 2010 conference call. A recording of this call will be available on the company’s web site. During this call, Canfor’s Chief Executive and Chief Financial Officer will be referring to a slide presentation that is available in the Investor Relations section on their website. Also, the company would like to point out that this call will include forward-looking statements so please refer to the press release for the associated risk of such statements.

I would now like to turn the meeting over to Mr. Jim Shepard, President and Chief Executive Officer of Canfor Corporation.

James Shepard

Good morning, everybody and welcome to Canfor’s conference call to discuss the company’s first quarter results of 2010. I’m joined here by Tom Sitar, Canfor’s Vice President of Finance and CFO, Don King, Vice President of Marketing and Sales, and Mark Feldinger, Vice President of Manufacturing. I will give a brief overview of the quarter and then Tom will speak to our financial results.

The combination of our intense focus on cost containment, productivity improvements and customer service is now complimented by rising market prices and that’s starting to show we have some traction at last.

This time last year with reference to the severe economic downturn, I said that we were not at the beginning of the end but we at least we have been at the end of the beginning. Today, I would like to say that we are at the end, but that remains to be seen.

I do however, generally feel that we have passed the worst of it and we came through it in one piece and in good shape. We have a strong balance sheet that will enable us to modernize our facilities to further improve our competitiveness and to take advantage of growth opportunities that are complementary to our focus on becoming the dominant supplier of wood supplier solutions to our highly valued customers.

We have a highly qualified work force that is aligned with our shareholders through incentive plans that are focused on shareholder returns. This I might add, includes all of our hourly people in British Columbia with the signing of a ground breaking agreement with the United Steel Workers that provides the cost reduction elements complemented by a profit incentive program.

We are pleased to report that in the first quarter of 2010, we recorded positive net income. While these results are encouraging, and the market looks favorable for the moment, we are still cautious about the immediate future. There may be rays of sunlight shining right now, but there are still some clouds on the horizon, particularly in the United States like the expected continuation of home mortgage foreclosures, and the continued high unemployment numbers.

For these reasons, we continue to be focused on growing our off shore markets and on cash conservation with prudent capital investment that will enable us to become even more competitive in the future.

That’s not to say that we are not optimistic about the future of Canfor and for the lumber industry. In our view, there is a scenario unfolding globally that will see a worldwide shortage of SBF lumber leading to a strengthening of the lumber price base that will make this industry a good place to invest.

The question at this moment in time is whether or not this current strong lumber price caused by supply constraint will hold up until the long-term reality of the global shortage takes hold. So the good news is that a good lumber market lies ahead. We’re just not sure if it’s here yet permanently or if we have to wait a little longer.

One positive impact of the U.S. housing downturn is that it provided the stimulus to focus on the evolving market of China. The exponential growth that we’ve seen in our shipments to China is only one part of the story. We are also seeing a growing Asian appetite for higher grades of lumber with an increasing percentage of our shipments to China in first quarter being our construction grade to better.

In Japan, which has been an important market for us for many years, we were successful in increasing our market share of prime lumber products.

To further ensure our ability to supply our customers with the lumber product solutions they need, we added a second shift at our Mackenzie sawmill in February. We will also be reopening our Chitin sawmill next month. An incentive program at these operations will engage the efforts and ideas of our hourly workforce and empower them to share in the success of their operations in the future.

As I previously mentioned, we are pleased to say that we have also reached an agreement with the United Steel Workers on a four year agreement that will award our hourly employees in British Columbia with profit based incentives and reinforce the teamwork necessary for high performance at all our mills.

I am cautiously optimistic as I look into the near future. We do believe that prices have firmed, and we hope this trend continues. However, we continue to be cautious about bringing on new capacity. We do not see robust demand coming from U.S. housing starts at this time. We believe most of the effort, pressure and price is related to inventory replenishment and increasing demand offshore.

One thing I can say for sure is that we strategically reduced production throughout the downturn and we will strategically increase production as we see evidence of sustained demand.

For more details of our financial results in the first quarter, I would now like to turn the call over to Tom Sitar.

Thomas Sitar

Thank you, Jim. My comments this morning will focus on our financial results for the first quarter of 2010 and identify those items that affect comparability with the other quarters and those factors that contributed significantly to our results.

During my comments I will refer to our Q1 overview slide presentation, which is on our website in the Investor Relations section webcast tab. I will refer to it periodically. Also note that for ease of reference, I will refer to all dollar amounts rounded to the nearest million except of course, for the per share amounts.

Before I report the net income numbers, please take note that we have adopted a new accounting standard. This change has relocated the non controlling interest accounts from liabilities to shareholders equity, a change that moves our balance sheet closer to how it will look under the international financial reporting standards or IFRS.

The effect of this change is that we now disclose net income as attributable to equity shareholders and not attributable to non controlling interest. The net income attributable to equity shareholders is comparable to the net income reported in prior periods and is also one we report on a per share basis.

Wednesday evening we reported first quarter net income of $33 million compared to a loss of $9 million in Q4 of 2009 and a loss of $70 million in the first quarter a year ago. The first quarter equity shareholder net income was $16 million or $0.11 per share. This compares to a net loss of $17 million or $0.12 per share for the fourth quarter of 2009 and a net loss of $59 million or $0.41 per share in the first quarter of 2009.

I’m now on Slide 4 of our presentation. We have highlighted the current quarter’s unusual items, and I will detail them now. Please note that the amounts I refer to are on an after tax basis.

First, we had a gain of $6 million or $0.04 per share due to the effect of translation of our U.S. dollar denominated debt net of investments as the Canadian dollar strengthened during the quarter.

Second, was the loss of $1 million or $0.01 a share on derivative financial instruments related to our hedging position on U.S. currency, natural gas, diesel and lumber. After taking account of these items, our first quarter adjusted net income is $10 million or $0.07 per share compared to an adjusted net loss of $24 million or $0.17 per share for the fourth quarter of 2009, so an improvement of $34 million.

Slide 5 of our presentation shows the history of U.S. housing starts and SPF lumber prices, clearly showing the rapid rise in lumber price in the first quarter with only a very slight movement up in housing starts. This would suggest that current lumber prices are not driven by any strength in the U.S. house construction activity.

Turning to our operating performance, on Slide 6 of our presentation, total gross revenues were $28 million higher than the prior quarter. The company generated positive EBITDA of $78 million, an increase of $63 million from the prior quarter.

If you remove the effect of recovering inventory devaluations reflected in each quarter’s results, the EBITDA in the first quarter was positive $55 million, an improvement of $40 million from the $15 million EBITDA in the fourth quarter of 2009. Lumber and pulp rates were increased significantly in the first quarter and was the major reason for improved results.

I’ll now comment on each business segment in turn. Slide 7 of our presentation is lumber. The Lumber segment had positive EBITDA of $34 million in the first quarter of 2010 compared to negative EBITDA of $9 million for the previous quarter. We had an inventory valuation recovery of $22 million recorded in the first quarter compared to negligible amounts n the prior quarter.

When these items are adjusted out of EBITDA, EBITDA in Q1was $12 million, we represented a $20 million quarter over quarter improvement. I certainly hope that this is the last quarter on which I have to comment on inventory valuation.

The improvement in Lumber results is primarily due to improved SBF and Southern Yellow Pine lumber prices. This is evidenced by the increase in average benchmark prices of 31% and 42% respectively. These price increases were partially offset by the rising Canadian dollar. Off shore prices lagged those of North America.

Lumber shipments were reduced by about 110 million board feet compared to the fourth quarter, reflecting a significant draw down of finished goods inventory that we had in the fourth quarter of 2009.

Now turning to the Pulp segment, which is Slide 8, the first quarter results reported for the Pulp and Paper segment include Canfor’s Taylor Pulp Mill together with Canfor Limited Partnership. The first quarter EBITDA was $46 million and was up by $16 million compared with the fourth quarter of 2009, again principally from improved pulp prices due to a low global inventory level and continued strong demand.

Results for Canfor’s Pulp Limited Partnership of which we own 50.2% were discussed in Canfor’s Funds income funds news release and conference call earlier this week.

Other comments, for the quarter, our capital expenditures were $13 million, which was comprised of $11 million for solid wood lumber business and $2 million for Canfor Pulp. Going forward, we expect in the Lumber business our capital spending for the full year this year will be about $85 million.

At the end of the quarter, Canfor excluding Canfor Pulp had cash of $59 million and unused lines of credit of approximately $384 million. Our net debt to total capitalization excluding Canfor Pulp was 10% and on a consolidated basis was 14%.

Jim, with that, I would like to turn the call back to you.

James Shepard

Thank you, Tom. Operator, I would now like to ask that we take questions from the telephone lines.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question is from Darrel Switzerloft – Raymond James.

Darrel Switzerloft – Raymond James

Do you think you could expand on your China market strategy. Just give us a sense of your commitment to that market longer term. Obviously it weighed on your results for the first quarter even though it was good for North American industry, but what are you seeing in that market longer term and what role will Canfor play in it?

James Shepard

Quite frankly, I see China emerging as the – they say that China will pass the United States within ten years and I don’t think there’s any doubt of it on the basis of my visits there over the last couple of years. Every time I go back there after six months, I’m astounded by the growth that I’ve seen.

When we first started to sell in China, quite frankly we just saw opportunity, but we didn’t know what the opportunity looked like. Initially we were selling low-grade lumber. Two things; basically low grade lumber for forming for concrete which is a way is like feeding the enemy, but also the low grade went into remanufacturing billets for finished furniture and interior furnishings that got shipped back around the world.

That was the initial, but then along came that disastrous earthquake in Szechwan a couple of years ago which was a disastrous event. But what it did was, it really illustrated the safety advantages of wood frame construction because after that disaster, it was evaluated. There were some wood frame homes that stood up to the quake very well. They were undamaged quite frankly.

And that revelation was not unlike what happened in Colby many years ago in Japan, which reopened the pathway for wood frame construction in the Japanese market. So that was another opportunity we saw there, but as we’ve gone back over there, we’re seeing opportunities for example in infill walls, even in reinforced concrete office buildings.

Just to give you an example, when we were over there visiting with Minister Bell, we’ve met over three times with him now, but the first time we were over there, we toured the Szechwan area and we drove through these cities. They call them towns, but quite frankly they were cities of one, two and three million people and we drive through these streets, and there’d be as far as the eye could see, we’d see these buildings, six, eight, ten stories high, and they stopped the bus.

We got out and started walking along the street. They wanted us just to have a look and see what the impact of the earthquake was, and it was very eerie, because we realized that all of these buildings, the windows were open and the curtains were blowing out through the windows and it became evident there wasn’t a soul in any of these buildings.

The reason was, they were all condemned. When you looked closely, you’d see these cracks going up the side of the building. Without exaggeration, we saw hundreds of buildings like that. They will all need to be replaced.

So the construction needs for China, that’s just the example of earthquake, but the other example is the estimate is there’s 20 million people moving into the urban part of China every year. Two-thirds the size of Canada is happening.

So there’s so many opportunities in China, it really stretches the imagination and quite frankly we continue to focus on where the most opportunistic ways will be for shipping our product there. But while we’re doing that, the net effect is we’re taking a considerable amount of volume off the North American market and that’s certainly having a positive impact on the lumber prices today and that will continue.

Operator

You're next question comes from Paul Quinn – RBC Capital Markets.

Paul Quinn – RBC Capital Markets

In terms of your product mix or shift in geographies, could you sort of give us a breakdown in Q1 in terms of what you shipped to the U.S., Canada and Asia?

Don King

Basically we’re about 25% overseas in total for the first quarter and that will likely go down a little bit in the second quarter but certainly in the first quarter 25% and about 20% into Canada and the balance U.S.

Paul Quinn – RBC Capital Markets

And that overseas split between China and Japan is?

Don King

It’s a bit over half of that would be China.

Paul Quinn – RBC Capital Markets

In terms of, lots have been talked about this sort of demand less recovery in lumber prices and it’s really supply related. What’s your sense of the inventory in the distribution channels?

Don King

Definitely low across the board everywhere. I think that’s been going on for the last two years, a steady reduction in overall inventories in all areas of the supply chain, and that would apply basically globally. So with all the production that’s come off the market the last couple of years, combined with everybody focusing hard on reducing working capital overall, I think that’s really contributed a lot to what we’ve seen recently in the quick spike up in prices.

Paul Quinn – RBC Capital Markets

Just so I understand, you’d still characterize it as low even they’ve somewhat done some rebuilding?

Don King

Absolutely. No question. It’s been going on for such a long time, this reduction. There’s been some increase for sure, but we still believe there’s a very low, very tight inventory situation across North America and even to some degree overseas, particularly in Japan.

Paul Quinn – RBC Capital Markets

In terms of the labor agreement, first congratulations, second if you could give us some high level sort of idea about what the incentives are within the deal.

James Shepard

Basically what it does is, it involves an investment by the hourly workers of the Steel Workers, which basically is a reduction of wage costs to Canfor of 7% for two years. That’s one of the highlights.

Another highlight, and this is the most important, is that there’s a proviso there for profit sharing for all the hourly workers and the steel workers in the company. And that is hugely important because what that really does is align our hourly workers with our objectives for our shareholders. Just as we have a bonus plan for our salary people, basically it means that everybody that’s employed at Canfor now, whether it’s me, the executive management, salary or hourly, we’re all aligned to do the best we can to get a return on our investment.

Paul Quinn – RBC Capital Markets

That profit sharing, is that based off the specific mill economics or is it overall?

James Shepard

It’s return on capital employed by the whole company, the lumber business as a company. We do have a couple of mills that are specifically by mill, but those were agreements that were basically a foreshadow of what we finally concluded, but those were mills that have been shut down for an extensive period of time.

Paul Quinn – RBC Capital Markets

Noticing your very strong balance sheet and then trying to reconcile this vision of being the dominant supplier of wood with the worldwide shortage of SPF lumber, you’ve got a majority of your operations in Mountain Pine View, B.C. What’s the vision going forward here.

James Shepard

We said the dominant supplier of wood product solutions to our highly valued customers. So we are not just a manufacturing company. We are a marketing company. But we’re very strategic and deliberate about where we sell our products and what grades we produce from the logs we have to cut.

Operator

You're next question comes from John Koller – Oppenheimer & Close.

John Koller – Oppenheimer & Close

I was wondering what capacity utilization in the quarter was for lumber.

Thomas Sitar

60%.

John Koller – Oppenheimer & Close

Also looking at the rise in price on the lumber now at a lower U.S. tax. I know it’s sort of up in the air, but do you expect to over that limit in Q3 or Q4?

James Shepard

Over the $355 million do you mean?

John Koller – Oppenheimer & Close

Exactly.

James Shepard

I don’t think so.

Operator

You're next question comes from [Pierre Lacroix – Desjardine Securities]

[Pierre Lacroix – Desjardine Securities]

Can you remind us what is your long-term commitment to the Pulp business and talking about the assets as well, maybe you could remind us what is your strategic view on the OSB and Polar Board assets and also if there’s any progress on that side to eventually looking at these assets.

James Shepard

As far as the Pulp business is concerned, through the last three years we went through the absolute worst lumber market that anybody can ever remember. The cash distribution from the pulp was a very nice outrigger for us to have, so it was a welcome source of cash. So it served us very well and it continues to do so and certainly as you can see, the pulp business is just as good if not better than lumber pricing these days and those cash distributions are continuing to be welcome.

So as far as we’re concerned, our relationship and our investment there is a good one and we haven’t any plans to do anything about it at this point.

As far as OSB is concerned, we continue to be in the OSB business from the point of view that we’re a 50% partner with Louisiana Pacific at our plant up in Peace River country, and it’s really a nice return for us.

Polar Board is a facility we shut down a couple of years ago and it has been for sale and it continues to be or sale. So our long time approach is not a strategic prime business for us.

[Pierre Lacroix – Desjardine Securities]

Otherwise it’s an assets that is non core for you and might be divested over time.

James Shepard

It’s non-core.

Operator

You're next question comes from [Dave Barry – CKPG News]

[Dave Barry – CKPG News]

You talked about possible expansion with the situation now being what it is. Can you enlighten us a little bit about that and maybe specifically talk about plans in northern British Columbia?

James Shepard

Possible expansion, I’m not sure. Are you thinking in terms of mill start-ups? Is that what you’re thinking of?

[Dave Barry – CKPG News]

You did talk about modernization and possibly expanding businesses, which I took as possible purchases of other companies.

James Shepard

I didn’t say that. I did say modernization but that is something that is ongoing. We have done some on a limited basis in the last couple of years because we’ve been constrained with our focus on cash to make sure our balance sheet remains healthy. But we have introduced and built energy systems at Fort St. John and just completing at Mackenzie right now.

But we certainly will be looking at modernization of our mills not only in British Columbia but also in Albert and North and South Carolina, and we’ll be picking those locations that have the best economic equation. But certainly British Columbia will see some definite investment as we go forward.

[Dave Barry – CKPG News]

Can you give me anything specific on northern British Columbia or are we not that far down the road yet?

James Shepard

We’re not at the point we’re ready to make any announcements, but we certainly will be looking at northern British Columbia, let’s face it, is the bulk of our operations here in British Columbia. So there’ll be some announcements in the months ahead so stay tuned on that.

Operator

There are no further questions. I’d like to turn the meeting back to Mr. Shepard.

James Shepard

I want to thank you for your interest and we’ll speak to you all next quarter.

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Source: Canfor Corporation Q1 2010 Earnings Call Transcript
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