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Executives

Don Kayne - President, Chief Executive Officer

Alan Nicholl – SVP – Finance, Chief Financial Officer

Sean Curran - VP, Sales & Marketing, Canfor Pulp

Brett Robinson - President, Canfor Pulp

Wayne Guthrie – SVP, Sales & Marketing

Analysts

Mark Kennedy - CIBC

David Quezada - Raymond James

Paul Quinn - RBC Capital Markets

Canfor Corporation (OTCPK:CFPZF) Q2 2014 Earnings Conference Call July 24, 2014 11:00 AM ET

Operator

Good Morning, ladies and gentlemen. Welcome to the Q2 Analyst Call. I would now like to turn the meeting over to Mr. Don Kayne. Please go ahead Mr. Kayne.

Don Kayne

Thanks, operator. Good morning everybody. Thanks for joining Canfor and Canfor Pulp's second quarter results conference call. I will speak briefly to the result 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 Q2 after which we will take questions.

With me today are Brett Robinson, President of Canfor Pulp, Wayne Guthrie, our Senior VP of Sales and Marketing for Canfor; and Sean Curran, VP of Sales and Marketing for Canfor Pulp.

Canfor's net income for Q2 was $54 million, up from $46 million in Q1. In Q2, shipments from our sawmills was up 33% and for our pulp and paper operations up 23%, including Taylor. Excluding the volume impacts of the closer of Quesnel and Daaquam lumber production was up 6% for the quarter.

Canfor Pulp posted a net income of $19 million in Q2, down from $26 million in Q1. Prices for lumber decreased through the quarter consistent with normal seasonal pricing patterns and our overall realizations were less impacted due to our products and market profiles.

Pulp markets were balanced over the quarter and inventory levels decreased due to reduced supply related to maintenance outages. Prices remained stable in North America and Europe and were down in China.

Despite housing starts being down somewhat in the quarter along with the challenging new home sales report, we remain confident that the U.S. economy will continue to slowly improve.

Demand for both lumber and pulp from China was solid, with volume shipped in line with our plan for pulp and exceeding plan for lumber.

Another significant development over the quarter is the recent Supreme Court decision regarding aboriginal rights. While the decision will have an important implication for government and the treaty process, from Canfor's perspective the decision affirmed things we have known for a long time. We need solid mutually beneficial relationships with the First Nations, whose traditional territories overlap our operating areas.

The decision does place a greater responsibility on the province and our industry to consult and negotiate with First Nations regarding land and resource use within traditional territories.

We have long understood the importance of maintaining good working relationships with the First Nations in our operating areas and facing these on mutual respect and understanding. After all our goals and principles are often very similar and we recognize each has a vital role to play in building economic opportunities within traditional territories.

With those introductory remarks I will now turn the call over to Alan Nicholl to provide more details on Canfor and Canfor Pulp's financial results for the quarter.

Alan Nicholl

Thanks, Don, and good morning everyone. My comments this morning will focus principally on our financial performance for the second quarter of 2014 by reference to the previous quarters.

Full details of our results are contained in the Canfor and Canfor Pulp news releases which were issued on Wednesday and Thursday.

As always you will find an overview slide presentation of both, the Canfor and Canfor Pulp websites in the Investor Relations section under webcast. The presentation highlights consolidated and segmented results along with key adjusting items and I will be referring to this presentation during my comments.

For the second quarter of 2014, Canfor reported shareholder net income of $54 million or $0.39 a share, up from $46 million or $0.33 a share for the first quarter of 2014 and down from $110 million or $0.77 a share reported for the second quarter of 2013.

On Slide 3 of our presentation we highlight various non-operating items net of tax and non-controlling interest, which affect the comparability of the results between the quarters.

In the second quarter of 2014, these items have a net negative impact of approximately $2 million or $0.02 per share. After taking account of these items, the second quarter adjusted shareholder net income was $57 million or $0.41 a share compared to similarly adjusted net income of $46 million or $0.34 per share for the first quarter of 2014.

Slide 4 of our presentation that our second quarter operating income was $97 million, an increase of $13 million from the previous quarter. The positive variance primarily reflected higher shipments across all segments resulting from improved railcars availability and the resolution of the truckers' strike at the Vancouver Port at the end of the first quarter.

Results for the Lumber segment are highlighted on Slide 5 of our presentation. The current quarter's operating income was $74 million, up $18 million from the previous quarter. This improvement largely reflected the increase in shipments attributable to the improved transportation performance offset in part by a modest reduction in sales realization due to lower prices on a stronger Canadian dollar.

Unit manufacturing costs were down slightly, principally due to continued productivity improvements as well as other seasonal factors.

Total lumber production was down from the previous quarter as a result of closure of Quesnel Sawmill and the sale of our Daaquam Sawmill in the first quarter. Excluding the impact of these mills as Don mentioned, production was up 6% largely due to aforementioned improved productivity.

Log costs were broadly in line with [mills] [ph] in the previous quarter reflecting the consumption of significant volumes of logs harvested in the first quarter. Canfor's Pulp and Paper segment principally comprises the results of Canfor Pulp Products, Inc. As you can see from the Slide 6 of the presentation, Canfor Pulp reported net income of $19 million or $0.27 a share compared to net income of $26 million or $0.36 a share for the first quarter, a net income of $8 million or $0.11 a share for the second quarter of 2013.

After taking a kind of one-time non-operating items net of tax Canfor Pulp's second quarter adjusted net income was $18 million or $0.26 a share. This represented an $8 million or $0.11 a share decrease from adjusted net income of $27 million or $0.37 a share for the first quarter.

As you will see from Slide 7, the decrease in Canfor Pulp's results was largely a function of lower sales realizations, scheduled maintenance on time and higher fibre cost. Sales realizations reflected lower prices to China which offset slight price increases in the US and Europe, the 1% stronger Canadian dollar and a higher proportion of shipments to Asia following the resolution of the Vancouver trucker strike.

Scheduled maintenance outages were taken at the Intercontinental and Prince George Pulp Mills. Higher fibre costs were driven principally by higher freight costs and other seasonal factors.

Canfor Pulp's Paper segment earnings showed a slight decrease quarter-over-quarter largely due to the impact of the planned maintenance outage of the paper machine, which more than offset a modest improvement in unit sales realizations and higher shipments.

Capital spending in the second quarter totaled $63 million of which $39 million was for the lumber business and just over $20 million for Canfor total.

We are currently projecting 2014 total capital spending of approximately $160 million with Canfor and nearly $60 million for Canfor Pulp.

During the second quarter, Canfor repurchased 4.3 million common shares under its renewed normal course issuer bid, reflecting the low share price in the quarter compared to previous periods.

Yesterday the Canfor Pulp Products Inc. Board announced a dividend payment of $0.0625 per share for the quarter consistent with the previous quarter. At the end of the second quarter Canfor, excluding Canfor Pulp had net debt of $177 million with available liquidity of $193 million.

Canfor Pulp had net debt of $12 million with available liquidity of $118 million. Net debt-to-total capitalization excluding Canfor Pulp was 12% - or Canfor Pulp was 3% and on a consolidated basis it was 11%.

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

Don Kayne

All right. Thanks, Alan. Operator, I would now like to open the lines for questions.

Question-and-Answer Session

Operator

Certainly. We will now take questions from the telephone lines. We will first take questions from the financial analysts. (Operator Instructions). The first question is from Mark Kennedy of CIBC. Please go ahead.

Mark Kennedy - CIBC

Good morning. I guess a couple of first questions - more on the pulp side. Just wondering, first of all, could you just characterize where your pulp inventories are now. Are they sort of at normal levels or are you still carrying some excess that would have been built up in the first quarter.

Don Kayne

Okay. Thanks Mark. We will get Sean to answer that question for you.

Sean Curran

Good morning, Mark.

Mark Kennedy - CIBC

Good morning.

Sean Curran

Our pulp inventories are returning to regular target level. It's obviously coming up Q1 was weather related. They were a little higher, as you can see had a reduction quarter-over-quarter of about 9,000 tonnes and we are on track to get them back into line probably another 5,000 to 6,000 tonnes there by the end of the year.

Mark Kennedy - CIBC

Okay. What's your general outlook, Sean, on pulp as you look into the second half of this year and early part of next year, because I guess the sentiment I’m seeing from the industry is that maybe things are looking better than we would have thought a few months back.

Sean Curran

Yes. I would say the sentiment in the market is reflecting that. There has been a change over, I would say the last six months. However, we are going to remain cautious and conservative on our pricing forecast and mainly because all the hardwood projects, the two remaining ones for this year are now in production. We expect them to be fully into commercial into the stream by end of Q3, latest Q4. Also, we have seen some swing kind of just in the NBSK, in the softwood world, in Chile as well the U.S. south.

But what's offsetting that I think that's where the sentiment is changing. The demand has been quite good in all regions. So I think you have to be a little bit conservative to go forward and we will remain conservative on pricing forecast through the end of the year.

Mark Kennedy - CIBC

Great. Okay.

Sean Curran

Okay.

Mark Kennedy - CIBC

Then finally, I guess, just on the balance sheet for Canfor Pulp like it looks like you guys should have zero net debt by the end of Q3 here, so how do you envisage using that balance sheet in terms of the various options in front of you, whether it's increased dividends, stock buybacks or whatever?

Alan Nicholl

Yes. Good morning. I think it's a pretty similar story to what we have said in previous quarters, Mark. Namely that as Sean alluded to we still are adopting a bit of cautious stance, if you will, with respect to potential market price impact of this new hardwood capacity. I mean our overriding objectives remain top quartile performance at our mills. We are keen to take advantage of energy projects, the latest of which have been in (Inaudible) as you are aware, but that's our focus and we are very keen to maintain what we consider as one of the strongest balance sheets in industry, so to the extent that those primary objectives are maintained and there are opportunities, we will look to potentially take advantage of some share repurchasing activity and of course our Board does review dividends on a quarterly basis, although our view is that 6.25 is a sustainable dividend and we want it to be for the foreseeable future.

Don Kayne

Mark, just to emphasize – of all that Alan said is absolutely correct is that absolute focus on the balance sheet is going to continue to be and has been our number one focus.

Mark Kennedy - CIBC

Right. Okay. Good. Then finally, this will just be my last one then I will get back in the queue, but I guess maybe for Brett, you did mention in your release on Canfor Pulp that you did have some production interruptions at the beginning of the third quarter here. Just wondering if you could flush it out a little more for us?

Brett Robinson

Sure we have had a number of reliability challenges, specifically around the [inaudible] on the number one, recovery boiler at Northwood. We are just pushing that out to our major outage to deal with that. We believe we will get that behind us in the fourth quarter and this boiler is running very well. The design changes are delivering what they need to deliver and we just need to work through and make sure we have a proper pick that’s going to last long term.

Mark Kennedy - CIBC

So you are expecting sort of outage loss of 10,000 tonnes. That doesn't look to be growing then for this quarter?

Brett Robinson

No.

Mark Kennedy - CIBC

Great. Thank you very much.

Don Kayne

Thanks, Mark.

Operator

Thank you. The following question is from David Quezada of Raymond James. Please go ahead.

David Quezada - Raymond James

Yes. Good morning, guys. Wondering if you could give us just a really quick summary of the capital program and what projects are ongoing right now. Just an update there and maybe just a follow-up, particular attention on the bio energy projects, [inaudible] what else is in the pipeline?

Don Kayne

Yes. Sure, Dave. I think, first of all on the sawmill side, we are continuing our capital program as we have embarked on about three years ago and basically right now we are in the midst of an upgrade at Houston, we are upgrading a planer there and we are putting [inaudible] into that in terms of optimization and planning capacity and so forth and a new building there as well to house it. That's underway. We are also in some startups at Mackenzie. Currently, and getting past the other ones that we had that you heard about at Elko as well as Grande Prairie, which were also both, running well now.

In terms of the energy capital, Brett, maybe you can talk a little about that in terms of where we are at around that.

Brett Robinson

Sure. We completed the Northwood upgrade earlier this year and we are now actively building the Intercon turbine. Project is going well, it's on schedule for Q1 startup 2015, $32 million project and then looking out beyond that, we are developing projects and trying to figure out we have an option within our power contract that we plan to fulfill within the two years. I think, by the end of 2016, beginning in 2017, we will have our last power project on line, we’re just flushing that all up.

Brett Robinson

Just to give you an order of magnitude in total cost, overall our net cost for capital would be about $160 million, I think we provided guidance before on an annual basis for lumber and it was 60 for pulp.

David Quezada - Raymond James

Great. That's helpful. Thank you. The only other question I had was, I guess, now that the consumption tax implementation at the time has happened, have you seen any changes in that market?

Don Kayne

I think on that all we’ve seen really is just it’s been continues to be strong although since that's happened as well a little bit of a decrease compared to past years for sure and we recognize we are coming of a record year least year, but this year we saw a little bit of a slowdown during Q2.

David Quezada - Raymond James

Okay. Great. Thank you. That's all for me.

Operator

Thank you. (Operator Instructions) The following question is from Paul Quinn of RBC Capital Markets. Please go ahead.

Paul Quinn - RBC Capital Markets

Yes. Thanks. Good morning, guys. Just a couple of follow-up on pulp issues that you have been having. Maybe you can give us a little bit of a history course on just Northwood recovery boiler upgrade what that was done and it seems to me that it seems like every six months you have an issue with our recovery boiler and are you confident at the end of the day that you have after the year major shut in Q4 that you have got the province…

Don Kayne

The Northwood recovery boiler came on in Q4 2012 and it is root of legal case that I can't get into discussing. We did need to change service providers and found the solution that's working. It was the point I was trying to make earlier, is that is running extremely well, but we had some reliability issues in between that we really need to deal with, so the boiler runs really well and then we have had some downs that were unexpected and when we get through the outage in the fall, I do believe that will resolve. These are normal-type issues for a boiler of this type and we are going to resolve it beginning October.

Paul Quinn - RBC Capital Markets

Okay. Then just if you could the incremental energy add from, I guess, your Northwood project and could you quantify what is and when Intercon comes on in Q1 of '15?

Don Kayne

Incremental, are you talking in terms of just our sales or - as we are doing both.

Paul Quinn - RBC Capital Markets

Yes. Dollar is what matters to investors, so.

Alan Nicholl

Okay. I think, Paul, what we said in the past this still remains true is that, by the time we get the Intercon in and everything settled in there, I think we are targeting roughly north of $30 million EBITDA.

Paul Quinn - RBC Capital Markets

Okay. Just for '14 here, what are we looking at in terms of increment before Intercon gets…

Alan Nicholl

We don't. Maybe, we can take this offline, but that's the way I would answer that is we are expecting more than double our EBITDA in 2014 versus 2015.

Paul Quinn - RBC Capital Markets

Okay. I guess, just moving on the lumber side. The lumber production is pretty impressive given the recent shut. Just wondering if you got a notional sort of production figure that you think you would be able to run at in 2015-2016. Are we sort of running that for the Canfor right now?

Don Kayne

No. Paul. It's Don. No, we are not running max yet as I mentioned just mostly due to some of the startups that we are in. Certainly, by 2015, we would expect the bulk of that to be done. In terms of capacity production number versus capacity in 2015, I would say it's probably going to be in the neighborhood of 92% to 95%, something like that as all the mills that we spent the capital on should be for the most part completed into 2015, so we should be up…

Paul Quinn - RBC Capital Markets

Okay. You guys referenced the First Nations decision by the Supreme Court. Have you noticed any - is a conversation between Confor and Nations changed since February?

Don Kayne

Not at all. The matter of fact that, I think, we have commented on it before, but just for business relatively new decision here, Paul. I mean, we think exceptionally strong relationships with the First Nations and have had for a long, long time. In addition to that, when we purchased the 10 mega assets we were fortunate that they had also had a very strong relationship with some of the bands down in the south, - in particular, but just overall it's something that we have always focused on. We recognize that they are key stakeholders for the company not just now, but in the past and I think going forward, the relationships we have we will just carry those on and of course kind of build them even stronger, but it's not something where we will change really in terms of our approach.

Paul Quinn - RBC Capital Markets

Okay. Last question just on overall U.S. housing recovery seems to be kind of disappointing here. Does that affect in a material way your plan at Canfor or [lumber production].

Don Kayne

Say that again.

Paul Quinn - RBC Capital Markets

Okay. I will say it differently, because I can't remember what I said.

Alan Nicholl

I was hoping.

Paul Quinn - RBC Capital Markets

We have got a more muted recovery in the U.S. housing market. Just wondering if that has a material effect on the way you run your operations from a production standpoint.

Don Kayne

Not at all. Matter of fact, we have been preparing for a long time both, U.S. market it's probably coming back to where we were get there ever or going to be while, so that's really been the thrust for the diversification strategy that we have had geographically for many years both, on the pulp side really and lumber side, so we think we are well on the road on that and we build sustainable businesses and pretty much everywhere we have expected to around the road and that has just gotten more solid over the last three, four years, so we are not concerned about that having any impact on our capital plans.

I guess, the other thing I would add to that is the focus that we are having and do have now are much more on getting maximum value out each log and giving us the diversity from a product mix standpoint as well, so between those two areas the plans that we have in place, we think are solid and sustainable for the future.

Paul Quinn - RBC Capital Markets

Great. That's all I had. Best of luck.

Don Kayne

Thanks a lot.

Operator

Thank you. There are no further questions registered at this time. This concludes today's conference call. Please disconnect your lines at this time and we thank you for your participation.

Don Kayne

Thank you, operator, and thanks everyone for joining the call. Talk to you next quarter.

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