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Executives

Jim Shepard - President and CEO

Tom Sitar - VP Finance & CFO

Don King - VP, Wood Products Marketing and Sales

Mark Feldinger - VP, Wood Products Manufacturing

Analysts

Stephen Atkinson - BMO

Darrel Switzerloft - Raymond James

Jonathan Lethbridge - CIBC

Sean Steuart - TD Newcrest

Paul Quinn - RBC Capital Markets

Canfor Corp. New (OTCPK:CFPZF) Q1 2010 Earnings Call July 30, 2010 10:00 AM ET

Operator

Good morning, ladies and gentlemen. Welcome to the Canfor Corporation second quarter results 2010 conference call. A recording of the call and a transcript will be available on Canfor's website. During this call, Canfor's Chief Executive Officer and Chief Financial Officer will be referring to a slide presentation that is available in the Investor Relations section of 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 risks of such statements. I'll now like to turn the meeting over to Mr. Jim Shepard, the President and Chief Executive Officer of Canfor Corporation. Please go ahead, Mr. Shepard.

Jim Shepard

Thank you, operator. Good morning everybody and welcome to Canfor's conference call to discuss the company's second quarter results for 2010. I'm joined here today by Tom Sitar, Vice President of Finance and CFO; Don Kayne, 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. During our last call, we commented that the price of lumber was very solid and the industry as a whole was breathing a sigh of relief. This quarter we are once again reporting a profit.

For the second quarter we had a net income of $18.1 million or $0.13 per share, showing an improving trend over the $15.6 million or $0.11 per share in the first quarter. Early in the quarter, the price of 2x4 SPF lumber was above $300 per thousand board feet. But by end of the quarter, it had fallen below $200.

Higher lumber prices we experienced caused export prices on Canadian lumber shipped to the US decline to 10% from 15% on BC shipments in May and to zero in June. NBSK pulp prices benefited from a tight global supply, with list prices in the US market exceeding $1,000 per tonne for the first time on record.

The high lumber price we saw earlier in the year was in part related to inventory replenishment and increasing offshore demand rather than any sustainable demand increase in the United States. And consequently, we didn't rush to increase our production as we wanted to see evidence of real improvement of demand.

As it turned out, prices did drop quite sharply. That said, we are moving ahead in our determination to produce more prime grade lumber. This has resulted in our investment in those mills with the green timber supply. As a result, we started up our Chetwynd on one ship during the quarter.

Much like the restart of our Mackenzie division last year, this was achieved through the engagement of our workforce and their commitment to operating as cost effectively as possible. This startup was announced last year and based on demand numbers, we rejected that at that time. And it was not tied to any of the price increase we saw this spring. We also restarted our Quesnel sawmill in June. The product produced by this sawmill is dedicated entirely to the Chinese market and that is a first for our company.

We've never before dedicated an entire sawmill for one country. This not only demonstrates the confidence we have in the future of China, but also is part of our strategy to diversify our markets.

During the first half of 2010, 24% of our SPF lumber sales went to offshore markets, with half of that going to China. That represents a one-third increase in our offshore compared to 2009.

Finally, recently we announced the agreement for the sale of Howe Sound Pulp and Paper to Paper Excellence. This decision involves a non-core asset and reflects our strategy to focus on lumber of production.

Now for more details of our financial results in the second quarter, I'll now turn the call over to Tom Sitar.

Tom Sitar

Thank you, Jim. My comments this morning will focus on our financial results for the second quarter of 2010 and identify those items that affect comparability with other quarters and those factors that contributed significantly to our results. In my comments I will refer to the second quarter overview slide presentation which is on our website.

Also note that for ease of reference, I will be referred to all dollar amounts rounded to the nearest million, except of course for the per share amount and the full details and amounts are shown in our news release.

As Jim said, the second quarter equity shareholder net income which includes our 50.2% share of earnings from Canfor Pulp Limited Partnership with $18 million or $0.13 per share. This compares to a net income of $16 million or $0.11 per share for the first quarter and a net income of $11 million or $0.07 per share for the second quarter of 2009.

On slide three of our presentation, we have highlighted the current quarters' non-operating items that affect comparability and these are: A loss of $9 million or $0.06 per share due to the effect of the translation of our US dollar denominated debt, net of investments, as the Canadian dollar weakens over $0.04 compared to the prior quarter end.

The second item is the $1 million or $0.01 per share of loss on derivative financial instruments. Though the amount is small, this quarter we included for consistency of adjustment between the quarters.

After taking account of these items, the second quarter adjusted net income is $28 million or $0.20 compared to a similarly adjusted net income of $10 million or $0.07 per share for the first quarter of 2010 for an improvement of $18 million.

Slide four shows the history of US housing starts and SPF lumber price in Canadian dollars. This clearly shows the solid wood price rally that commenced early in 2010 before coming to abrupt end mid way through the second quarter. The short-lived nature of this price rally supports our view that it is largely a result of supply factors rather than growing trend in the US.

Turning to our operating performance, now on slide five of our presentation. Total gross sales were $57 million higher than the prior quarter. The company generated positive EBITDA of $103 million, an increase of $25 million from the prior quarter.

If you remove the effect of inventory devaluations reflected in each quarter's result, EBITDA in the second quarter was positive $108 million, an improvement of $53 million from the $55 million EBITDA in the first quarter.

Looking at each of our business segments in turn, on slide six now. The lumber segment had EBITDA of $39 million in the second quarter compared to EBITDA of $34 million for the first quarter. We had a net inventory devaluation adjustment of $2 million in the second quarter compared to a $22 million recovery reported in the first quarter.

When these items are adjusted out, EBITDA in the second quarter was $41 million, which represented a $30 million quarter-over-quarter improvement. The improvement in lumber results primarily reflected higher sales realizations due in part to lower export taxes as Jim mentioned them and improved sawmill residual chip prices.

Production was up 5%, mostly as a result of a second shift at Mackenzie to the quarter and the reset of Chetwynd and the Quesnel sawmill. Unit manufacturing costs were little changed compared to the first quarter.

Now turning to the pulp and paper segment. The second quarter results reported for pulp and paper segment includes Canfor's Taylor pulp mill together with Canfor Pulp Limited Partnership. The second quarter EBITDA was $67 million and was up by $21 million compared to the first quarter of 2010, principally due to improved NBSK pulp market prices.

Higher fiber costs resulting from increased residual chip prices and higher freight costs were partially offset by lower energy costs. Canfor Pulp had a record quarter on several measures including profit, total production and production per day.

Details of results of Canfor Pulp Limited Partnership, of which we own 50.2%, were disclosed in Canfor Pulp Income Fund news release and conference call last week. For the quarter, our capital expenditures were $24 million which was comprised of $19 million for the solid wood business and $5 million for Canfor Pulp.

We expect that our capital spending for the full year will be about $100 million on the lumber side. We are taking steps to technologically upgrade some of our mills. These are principally improvements in cost profile and grade outturn rather than increases in capacity.

At the end of the quarter Canfor excluding Canfor Pulp had cash of $187 million and unused lines of credit of approximately $387 million. Our net debt to total capitalization, excluding Canfor Pulp was 3% and on a consolidated basis with Canfor Pulp, it was 6%.

As Jim mentioned, after the quarter we announced the sale of Howe Sound Limited Partnership to Paper Excellence. We expect this transaction to close in the third quarter and due to closing adjustments we will not provide the guidance on proceeds, but we don't expect the transaction to have a material effect on our net income.

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

Jim Shepard

Thank you, Tom. The past few quarters demonstrated how sensitive lumber prices can be to even slight changes to the supply/demand balance. Nevertheless, we will continue to operate in a cost constrained manner reflective of the weak US housing market while focusing on our growth opportunities in the offshore markets.

Longer term, I remain optimistic that the lumber supply/demand balance will tilt substantially in favor of the producers. We have been prudently investing in our key strategic facilities to enhance our competitiveness and ability to be a long term supplier of quality products for our highly valued customers.

Operator I would now like to ask that we take questions through the telephone line.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question is from Stephen Atkinson from BMO. Please go ahead.

Stephen Atkinson - BMO

First thing I was looking at is, do you see any change in slumpage or in wood cost in the near future, especially this coming quarter?

Jim Shepard

No, we do not.

Stephen Atkinson - BMO

And in terms of the export market any changes there or improvements? Obviously there was a pickup earlier in the year, but what's your position now?

Jim Shepard

We see that the market continuing on a [stat] of growth.

Tom Sitar

So, yes, we expect to be pretty consistent for the balance of the year.

Stephen Atkinson - BMO

And can you give me your CapEx for this year next?

Tom Sitar

Well as I said, on the lumber side, $100 million for the full year. And at this point, we haven't provided guidance for next year.

Operator

Our next question is from Darrel Switzerloft from Raymond James. Please go ahead.

Darrel Switzerloft - Raymond James

Jim, maybe you could give us a bit some color on what you are seeing currently in Chinese lumber market? Or, is there any changes? I know that you're one of the most active and I'd appreciate any insight you might have.

Jim Shepard

Well, I think the thing that's most profound about the Chinese market that besides the fact that the volume is growing almost exponentially is the increase of the amount of two and better that we're shipping over there. We leap our start to just a few years ago, its just a bubble economy and low grade lumber for stuff like Greenman and mostly concrete forming, but now its moved into a higher value use. And that is very significant because we see that continuing to happen. That's just basically the improving awareness of the advantages, building with wood in China.

Darrel Switzerloft - Raymond James

What do you think this number two and better score? What sort of end users would you expect that that might be?

Jim Shepard

I guess that was kind of housing construction. Housing.

Darrel Switzerloft - Raymond James

The lumber price increases lagged in the first quarter and that you felt because of your offshore program, with prices down can we expect corresponding kind of benefit as the decreases lag as well in the offshore sales?

Jim Shepard

I'm going to turn that over to Don.

Don Kayne

Yes, exactly, it did lag for sure in Q1. We feel it's very similar in Q2 and we expect that going forward to also be very similar to the US and Canadian markets. The only caveat as always is the timing part of it, which we encounter in every market.

Darrel Switzerloft - Raymond James

So prices in the after markets just be clear, could hold up better than the North American trend?

Don Kayne

Absolutely.

Operator

Our next question is from Jonathan Lethbridge from CIBC. Please go ahead.

Jonathan Lethbridge - CIBC

I was just wondering if you could provide a quick breakdown or rough breakdown of the shipments in China by grade or quality.

Jim Shepard

Don, go ahead.

Don Kayne

We've increased significantly as Jim mentioned, I mean, two years it was basically zero and some of the higher grades now. So we're now up, is 30% plus now, and we see that continue to increase much higher even going forward as we continue to expand the different markets than rather just the industrial and the boring markets that Jim also comment on.

Jonathan Lethbridge - CIBC

The other question, I just have two others. In terms of restructuring cost, can you provide a breakdown, the 5.8? I think most of it was in lumber, so I just wondering whether you had balance with?

Jim Shepard

We don't provide the detail of the breakdown, so I am not ready to split that any further than that.

Jonathan Lethbridge - CIBC

And the last question on CapEx. In terms of the $100 million, is it going to be focused on a few mills or will it be widespread amongst most of your mills?

Tom Sitar

It's focused on several mills and specific projects. Sure, there are some parts of that that apply to net maintenance capital throughout the fleet but the majority are several projects at key mills.

Jim Shepard

Them two key areas; first of all, we're making very focused investments to improve the cost competitiveness of our mills but we're also investing specifically those mills that have a good future with green fiber supply.

Operator

Our next question from Sean Steuart from TD Newcrest. Please go ahead.

Sean Steuart - TD Newcrest

Just wondering if you can comment on the balance sheet. You are arguably in an over capitalized position now, lots of liquidity and not a lot of debt. Can you comment on, I guess your near-term strategy or are you just content to sort of wait through the trough and pricing before you start to spend more aggressively and maybe some thoughts on consolidation activity given the strength of the balance sheet?

Tom Sitar

Sean, you know that in terms of consolidation activity, we won't comment on the future looking speculation. But in terms of capital, spending $100 million for this year is a decent number in a pretty slow market even though with being [front up]. And we do have plans for further upgrades to our mills just as Jim commented and continuing to improve the cost competitiveness, grade outturn and we do have time for higher spending next year but the specifics of that stage we're not ready to comment on but we do a growing plan for improving those numbers of our mills.

Sean Steuart - TD Newcrest

When you look at the balance so Tom, are you comfortable with the debt to equity ratio of your capital structure right now or is it something you'd prefer to lever up a little bit over time.

Tom Sitar

Well, we won't lever up the balance sheet just so that we believe its the balance sheet, that will be a result of investment activity and the markets that we face. And I think we've been very happy with the strength of the balance sheet to take us through this recent downturn and price syndicate. We are not completely out of it yet.

Jim Shepard

We're going to keep our product dry for the time being.

Operator

Our next question is from Paul Quinn from RBC Capital Markets.

Paul Quinn - RBC Capital Markets

Just had a question on Southern yellow pine, some prices jumped significant in the quarter? Your production was up but not as significant as some of other producers. Can you comment on that?

Jim Shepard

Well I guess the thing I can comment Paul is [Dawn]. I can comment a little bit on the price increase. I mean spruce and yellow pine increase, and as you know yellow pine increased more significantly and we attribute that primarily just to low inventory levels, on the Southern yellow pine site going in from a [rough] standpoint. But also they had very little log inventories as well and that combined with the poor weather that was existent in the first quarter in the southeast, that also made it very difficult for lot of the yellow pine producers to bring in logs, which caused them a further shortage. So I think those two things plus recourse, there has been some pretty good curtailment as well in the Southern yellow pine site as we well. So if you add all that together, there was just more pressure on the supply side on yellow pine perhaps and spruce.

Paul Quinn - RBC Capital Markets

And in terms of your response for that price increase, is that just a strategy that you didn't expect the prices to stay up high?

Jim Shepard

Our determination is to maintain our production to meet the demands of the marketplace and we wanted to wait and see if there is a sustainability to what looked like a market recovery and it turned out it was the, as you can see was a Roman candle market recovery right up and right down.

Paul Quinn - RBC Capital Markets

And just in terms of your conversion cost I guess overall, pretty happy with the way mills are operating right now?

Jim Shepard

Mark you go ahead.

Mark Feldinger

We're reasonably happy with where we are. We still have improvements that we are targeting and we will make.

Paul Quinn - RBC Capital Markets

So in terms of it, it looked like you were at two-thirds operating rate in Q2. Looks like you will be weighing about 75% in Q3 here. Should we expect cost increases you're bringing on; I guess arguably higher cost mills?

Mark Feldinger

We would not expect to see that based upon our projections.

Operator

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

Jim Shepard

Okay. Well thank you everybody for coming online and showing your interest in Canfor. We are cautiously optimistic as we go into the future. Like I say, long term, we are extremely optimistic about the supply/demand equation in front of us for lumber, for Southern Yellow Pine and for SPF. Thanks for your interest. We look forward to talking to you at the next quarter end.

Operator

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

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