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Executives

Don Kayne - President and Chief Executive Officer

Alan Nicholl - Chief Financial Officer

Alistair Cook - Senior Vice President, Wood Products Operations

Wayne Guthrie - Senior Vice President of Sales and Marketing

Analysts

Daryl Swetlishoff - Raymond James & Associates

Mark Kennedy - CIBC World Markets

Chris Damas - BCMI Research

Paul Quinn - RBC Capital Markets

Canfor Corporation (OTCPK:CFPZF) Q1 2012 Earnings Call April 27, 2012 11:00 AM ET

Operator

Good morning, ladies and gentlemen. Welcome to the Canfor Corporation First Quarter Results 2012 Conference Call. A recording of the call and a transcript will be available on Canfor’s website. During this call, Canfor’s 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 and such statements.

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

Don Kayne

Thank you, operator and good morning everyone and welcome to Canfor’s conference call to discuss the company's first quarter results for 2012. Before I get started today I wanted to take few moments to reflect on the tragic explosion at Sinclar Group’s Lakeland Mill in Prince George on Monday night. Canfor holds a one-third ownership stake in Sinclar Group, so this incident is very very close to home.

24 employees from the mill were taken to hospital and 2 men have lost their lives to this tragedy. Of course are our concerns are with the entire Lakeland team and their families, most particularly those that were injured. We are also conscious of the fact that this is second serious fire in six months in the BC Interior sawmill. While it is much too early to speculate on the possible cause of the Lakeland fire, this combined with the recent explosion at Babine Forest Products in Burns Lake has caused to redouble our focus on safety.

Now returning to the quarter, I will speak briefly about our quarter one highlights before turning the call over to our Chief Financial Officer, Alan Nicholl. Alistair Cook, our Senior Vice President of Wood Products Operations and Wayne Guthrie, our Senior Vice President of Sales and Marketing are also available today as well to answer any questions you may have specific to their responsibility area.

Canfor reported a net loss of $16.2 million over the first quarter of 2012, on sales of $607.6 million. Improving lumber market conditions in the U.S. are encouraging and we did see some positive pressure on North American lumber prices over the quarter. These gains were unfortunately offset by continued weakness in offshore low-grade prices with inventories in China returning to more normal levels. We expect to see market improvement in low-grade prices over quarter one.

Also encouraging is that we continue to see a steady improvement in productivity and unit conversion cost at our lumber operations. These gains reflect our targeted capital expenditures and a strong focus on continuous improvement across our operations. In quarter one we successful completed our acquisition of Tembec Southern BC solid wood assets, adding approximately 1.1 million cubic meters of annual timber harvesting rights and 420 million board feet of lumber production to our capacity.

This acquisition is a significant element in continuing to strengthen our overall fibre quality across the company. We were pleased to complete that deal and welcome the new divisions to Canfor in March. We also completed further capital projects in the quarter as part of our $300 million three-year strategic capital investment program. Investment in quarter one included a planer upgrade at the Grande Prairie sawmill, which was completed on time and on budget and is currently exceeding expected targets.

Overall quarter one shows slow but steadily improving operating performance and market conditions, and as we look ahead we are reasonably optimistic that continued steady gains in the U.S. housing market and the rebound of low grade prices in China will lead to improved results in quarter two.

I will now turn things over to Canfor’s Chief Financial Officer, Alan Nicholl, to provide more details concerning our Q1 financials.

Alan Nicholl

Thank you, Don, and good morning everyone. My comments will be principally focused on our financial performance for the first quarter of 2012 by reference to the previous quarter. In my comments I will be referring to our first quarter over a few slide presentation, which you will find on our website in the Investor Relations section on the webcast. Full details on the (inaudible) are contained in our news release issued on Wednesday evening.

For the first quarter of 2012, we reported an equity shareholder net loss of $16 million of $0.11 per share. This compares to shareholder net loss of $44 million or $0.31 per share for the fourth quarter of 2011, and a shareholder net income of $7 million or $0.05 a share for the first quarter of 2011.

On slide three of our presentation we highlight various non-operating items net of tax and non-controlling interest, which effect comparability of our results between the fourth and first quarters. The net impact of these items in the first quarter was to improve net earnings by $6 million or $0.05 a share. The more significant items in the first quarter included foreign exchange gains on long-term debt and gains on various financial derivatives as well as the transaction costs related to the acquisition of Tembec Southern BC Wood Product assets. And more on this transaction in a few moments.

After a taking account of these non-operating items, the first quarter adjusted net loss was $22 million or $0.16 a share. This compares to similarly adjusted net loss of $32 million or $0.22 a share for the fourth quarter, an improvement of $10 million or $0.06 a share. With respect to our first quarter operating performance, you will see on slide four of our presentation that reported EBITDA was $24 million. And this was an increase of $39 million from the prior quarter.

After excluding fourth quarter mill closure and asset impairment provisions as well as quarter-over-quarter inventory valuation adjustments and the aforementioned Tembec transaction comp, adjusted EBITDA for the first quarter of 2012 was $19 million compared to $27 million in the fourth quarter of 2008 and (inaudible). For the most part this decrease reflected weaker results in the pulp and paper segment. More on our operating performance in a few minutes when I speak to the individual segment performances.

Slide five show the Western SPF benchmark lumber prices for 2x4 #2&Btr and #3 utility lumber. This graph indicates the flow that #2&Btr price still increases from the prior quarter. Lower grade products slide early in the period. This reflects a slowing construction activity in China, in part related to the Lunar New Year as well as an increasing use of #2&Btr products by Chinese customers.

Weaker low-grade prices at the end of 2011 and into early 2012 had a negative impact on our sales realization in the first quarter, as much of our offshore pricing is negotiated quarterly in advance. As a side note and as Don referred to earlier, we are see a good improvement in our offshore low-grade prices to get this quarter.

Turning to slide six. You will see that the lumbar segments reported EBITDA of $3 million in the first quarter of 2012. And this represented an increase of $70 million for the prior quarter. After adjusting for inventory valuation movements and unusual items, EBITDA was negative $5 million in the first quarter of 2012. A slight improvement from the prior quarter.

Shipment of Canfor produced lumber were up slightly compared to the fourth quarter, principally from additional production made available for sale. The higher production reflected both Christmas shops in the prior quarter as well improved productivity that would sell in the current period. Sales realization were largely unchanged in the first quarter, as improved North America pricing was offset to a large degree by market realizations from offshore markets, principally China.

The first quarter also saw a reduction in residual fibre that’s been used as a result of lower market pulp prices. This impact was partially offset by lower cash conversion cost resulting from our increased production and lower log cost in the current period after some of the challenges presented last quarter by the unseasonably milder weather.

Turning to the pulp and paper segment on slide seven. You see that we reported first quarter EBITDA of $29 million and this was down $11 million compared to the fourth quarter. North American NBSK list pulp prices fell of a $50 U.S. per ton, reflecting a continuation of the softening global demand that we saw in the last half of 2011. Pulp production was up 7% from the fourth quarter following the completion in October of the extended Northwood pulp mill recovery boiler upgrade.

Unit cash manufacturing costs were down from the previous quarter, reflecting those higher production levels as well as lower saw mill residual chip cost paid to lumbar paid to lumber producers. More details have of Canfor Pulp’s results were discussed in their news release and conference call, earlier this week. Capital spending for the first quarter totaled $54 million. Of this $27 million was for the lumber business and there was an equal amount at Canfor Pulp. We received $8 million related to the reimbursable green transformation program in the quarter.

At the end of the first quarter of 2012, we have completed about 2/3rd of our $300 million strategic capital investment program for our lumbar business. In late March, we completed the acquisition of Tembec Southern BC Wood Products assets for a cash consideration of approximately $65 million. This included a preliminary networking capital payment. And this working capital payment is subject to final closing adjustments which will occur in the second quarter. During the first quarter the company also issued new term debt totaling $100 million, which was used to fund the above noted acquisition, as well as the repayment of $50 million of privately placed senior notes. This new debt is non-amortizing, floating rate debt with a maturity of February 2017.

By the beginning of the second quarter of 2012, $100 million of floating to fixed interest rate swaps will have been completed to take advantage of the current low interest rate environment. At the end of the first quarter, Canfor excluding Canfor Pulp had net debt of $280 million with available liquidity of $238 million. The higher net debt position at the end of the first quarter reflects that the company’ normal first quarter log inventory build. Net debt to total capitalization excluding Canfor Pulp was around 20% including Canfor Pulp it was aligned 22%.

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

Don Kayne

Thanks, Alan. Operator, I would now like to open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from Daryl Swetlishoff of Raymond James. Please go ahead.

Daryl Swetlishoff - Raymond James & Associates

Okay. Good morning, everybody. Don, my first question relates to -- how does the two tragic mill explosions we have seen in the region, affect how Canfor is going to be processing mountain pine build logs in the short term here?

Don Kayne

Thanks, Daryl. I think well, first of all, probably more so what we are really focused right now on in the absence of any definitive reasons for both of those explosions actually that occurred up there, we’re really just focused now on making sure that while up to now we feel we have exceptionally good systems in place to manage the dust issues that have been talked about a lot, even though that’s not being confirmed that’s exactly what the cause is. But regardless, we are taking a very proactive approach here across all our operations to even advance further and have even a harder look at the processes and make sure that the ones that we have in place are solid. And more importantly, make sure that every single operation that we have within the company is safe for our employees going forward.

So we have got a lot of initiatives underway now including several things that we are working on. I won't get into details obviously but this weekend we have talked to some of our key competitors as well to make sure we are capitalizing on the overall benefits between all the companies to capitalize on all the knowledge together. So we are doing a lot of proactive things. We are not taking anything for granted here. We are not making assumptions. We are just focused harder on making sure that we have the right processes in place to prevent anything from happening in the future.

Daryl Swetlishoff - Raymond James & Associates

Thanks for that. I understand China’s shipments have been steady. What's your best guess today? I know you have a good view on China. What's your best guess today and what sort of year-over-year improvement we might see in offshore shipments?

Don Kayne

Yeah, Daryl, I mean from our standpoint, despite the fact we had a little bit of a, probably a decrease in Q4, but Q1 for the most part it’s bounced back in a positive way. And with what's going on in China and kind of the segments that we operate within as you know more on the residential side as well as the remanufacturing side and the concrete forming side, we haven't seen any reductions now. As a matter of fact it was looking good on into quarter two. And in terms of overall, we would say we at least hold our own and we are actually hoping to see an increase somewhere in the neighborhood of 10% or more in China this year, with some increase too in the higher grades.

Daryl Swetlishoff - Raymond James & Associates

That’s great. Now we are seeing some signs of life in the U.S., how would Canfor’s Chinese shipments policy change in the event we did see a material increase in U.S. prices. How would that change things for you?

Don Kayne

Well, actually, there’s going to -- we’ve added production this year with the capital we spend. We have Babine now at full production. We completed here some modernizations at Prince George sawmill, like Grande Prairie. With the Tembec acquisition, we feel we have got more -- we are going to have more product available anyway. I guess our strategy overall or our view overall going forward is to clearly support the Chinese market and all the key customers that have been supporting us through this last five years of difficult period. And that goes for everywhere in Asia for that matter and in Canada too.

However, at the same time, we also have a significantly strong base in the U.S. and we will make sure that we get product available for them as well going forward, wherever they are.

Operator

Thank you. Our next question is from Mark Kennedy of CIBC World Markets. Please go ahead.

Mark Kennedy - CIBC World Markets

Good morning. Don, first of all, is it too early yet or can you give us any guidance on sort of volumes and timing of product out of that East Kootenay region now?

Don Kayne

I mean it will be subject to a few things but the production capacity at the two mills is 420 million feet. So for now I think you could just take basically nine months of that or -- take 9 months volume of that equivalent and we should agree we would expect to ship that this year. We are not anticipating any curtailments there, if that’s what you are getting at at all. We should we operating at normal production levels.

Mark Kennedy - CIBC World Markets

Okay. And then in 2013, because that CapEx plan you have announced for your Radium sawmill?

Don Kayne

Yeah, that should add -- for 2013 that will add a couple of hundred million feet to that number.

Mark Kennedy - CIBC World Markets

Okay. If you can just remind us again as we look forward here. Have you hedged forward very much of your lumber volume at all and are you intending just to sort of ride out this market in case we do get some positive pricing moving down the road.

Don Kayne

Yeah, in terms of hedging, I am assuming you are talking about the futures market there, yes, for sure. You know we do participate in that market where when it makes sense over and above what we do on a day-to-day cash basis with our customer base. But that there is some variability in that, we just make those decisions as it may make sense on a weekly, monthly basis. But we don’t have any, at this stage there is no concrete strategy. That’s been of a -- that’s something that we do is pretty dynamic and it just kind happens when we think is the opportunity present.

Mark Kennedy - CIBC World Markets

And then just finally. If you can just comment, just generally in terms of your net realizations. I mean your average in Q1 probably lagged a little bit sort of what the reference SPF price was in Q1. And how do you see that changing moving into Q2.

Don Kayne

Yeah, I think that, I would say that Q1 was probably the, one of the lowest levels of spread that we have seen for a while. And the two main areas of course were the low grade pricing into China which were a significant discount compared to historical, doing better particularly on the narrow width. And also the other area that effected us that was on the short lengths. We have two mills that produce primarily short lengths and the discounts for short lengths were higher than normal.

Going forward we have already seen those in both cases collapse significantly. And we expect that going forward for the balance of this year that that will be back to more typical spread levels.

Operator

Thank you. Our next question is from Chris Damas of BCMI Research. Please go ahead.

Chris Damas - BCMI Research

Yes, good morning. You didn’t take your share of the partnerships cash flow for the first two months of the quarter. Is that because you are going to get the dividend for all three months? Is that a watch for you?

Don Kayne

I am not sure, can you repeat that question, I am not sure.

Chris Damas - BCMI Research

I say on Canfor Pulp, I am sorry. You didn’t take your share of the partnership’s cash flow, prior to March 2 when you did the exchange of partnership units for stock. I just wondered if that was because you are going to get the three months dividend that’s payable shortly. It was (accessed) I think on Wednesday. So I believe it’s cash flow neutral.

Don Kayne

Yeah, I would say on this we might have to get back to you on that exactly, because I am not sure if we understand we were just talking, since you were talking there. And maybe we will have to get back to you on that later. Follow up with more detail on that. I am not really sure we are 100% in sync there with the question. So rather than dwell on that on the call, if that’s okay with you we will get back to you.

Chris Damas - BCMI Research

And secondly it seems like Groundhog Day where every April we get a rally in the SPF futures and things look a little better and then the thing dies. So today we are up again close to the high of 297. There is a fair bit of volume so I am not sure if it’s all speculative. We have seen some housing starts increasing but most of it’s multiunit. And we had a big revision in February new home sales to 353. Ironically it was down this month, for March. So I am just wondering, do you think it’s going to die again? I mean we don’t really have a lot of new single-family dwellings built and they are probably a lot smaller than in the past.

Don Kayne

All right. Yeah, just I mean we don’t think it’s going to die. I mean we are obviously very cautious and conservative. We are not basing anything on some significant price increases either. But we certainly where we are at today is sustainable. And we could see further increases. And the reasons primarily are the aside from some of the positive permanent numbers we just saw indicating some pretty good future housing starts going forward. We do believe still there is very low inventory levels in the United States overall and everywhere too for that matter. That’s having a definite positive impact.

We see the home center business, the retail and remodeling markets to be somewhat rebounding and looking promising going into Q2 which they typically do. But this year we are seeing even more of that. And also the Asian businesses. It’s not only we talk a lot about China and Japan which has been solid and continues to be, but we are also seeing some business in some of the other Asia countries more than in the past. And we are seeing a bit of a rebound as well in the Middle East. So if you take a look at all of that in view of production levels which we don’t think have really increased all that much, we are not totally surprised that there has been a bit of an improvement here in prices. And we won't see huge increases from here but we also don’t see any measureable decreases either.

Operator

(Operator Instructions) Our next question is from [Dave Willis of SMC Canada] -- I am sorry, our next question is from Paul Quinn of RBC Capital Markets. Please go ahead.

Paul Quinn - RBC Capital Markets

Yes. Thanks very much. And sorry, I got on the line right just on a different conference call, so you might have addressed this. But you guys have got a pretty good read on China, I just want to see what your outlook is going forward here. It seems like that has been a substantial decrease in the last couple of quarters, primarily on logs but also on lumber. But what do you see for the balance of the year?

Don Kayne

For sure, we did talk about that briefly but I can definitely speak again about it. It’ basically Paul that China as you accurately indicated, Q4 was a bit tougher for several reasons, primarily inventory builds and the lunar New Year as we all spoke about. Going forward, we have seen a rebound in Q1 across the board both on low-grade volumes but also on high-grade volume. So we had some real good quarter overall in our view anyway.

Going forward, we haven’t really seen any real stress there in terms of any decreases or what not. Overall, this year we are in the -- to give you an order of magnitude, we believe that that we will see probably close to 10% in terms of volume increases into China this year. The other encouraging thing we are seeing in China is a real increase in the prices in China relative to North America and we expect that to continue for the balance of the year along with continued improvement in volumes of the higher grade.

Paul Quinn - RBC Capital Markets

Okay. And in terms of that mix shift for the volume of the higher grades, what have we seen or what does that data look like year-to-date in 2012 here versus 2011, 2010. Are we growing that percentage?

Don Kayne

Yeah, it is. It’s grown quite a bit the last couple of years. We are probably running in the neighborhood, I don’t really have it right in front of me here, but probably around 40%, something like that. And, but we think that can go much higher. I mean clearly the Chinese are recognizing that the higher grades given them a lot better recovery in some of the remanufacturing plants across the country. So we are seeing more and more of the #2&Btr being used and even higher grades in that for that matter.

Paul Quinn - RBC Capital Markets

In terms of the efforts government and company efforts getting wood frame construction going in China, how is that progressing? What have we got going forward?

Don Kayne

Yeah, I mean we are still progressing. It’s definitely the goal that I think we all have in industry. We see the uptake potential there. It’s significant going forward. It’s going to continue to take a real aggressive promotional efforts and coordinated industry and government efforts like we have been doing the last five years. But I guess the thing we need to keep focusing hard on is going forward even continuing that. I think there has been, you know from all my conversations with, certainly with government there is that -- there is no, we haven’t seen any back off there at all. And so that is what we are focused on going forward. And it’s not all just single family housing as we have said before, it’s applications within some of the multifamily applications and multistory too, for that matter. There is a lot more use in some of those applications but frankly as long as it is being used in the wood frame construction , we are not so concerned whether it’s single or multifamily.

Paul Quinn - RBC Capital Markets

Okay. And then just looking over to the U.S. market. What do you see is the biggest issue of the U.S. housing recovery?

Don Kayne

Probably, just the recovery around employment and that impact on foreclosures. But both of those -- you know there is still, despite the fact they have come down from the peak, that’s still a concern. And so -- but I do believe they are making solid progress there. I guess the other concern could be, depending on Europe right, and that whole Europe issue around the sovereign debt issue. If that were to become significantly negative again it could have some negative impacts in the U.S. In terms of the U.S., to guess the other one, would just be the credit availability. I mean we have heard, there continues to be stress there. You know just on available credit to finance new homes and in existing homes too, for that matter. Right from the consumer standpoint. So that probably is another one that we watch. But overall I think you can -- we are seeing better numbers and it has given us a little more confidence on the recovery there. It is at least underway.

Operator

Thank you. Our next question is from Mark Kennedy of CIBC World Markets. Please go ahead.

Mark Kennedy - CIBC World Markets

Just a follow up question, Don. I mean you are obviously focused on completing your internal improvements program still. But I am just interested in your thoughts as you look at growth opportunity in the solid wood business. I mean there is sort of two schools, right. You could be more cautious and wait till markets have definitely got to a different point but then price points of doing things might increase as well. So I am just wondering your thought process on that.

Don Kayne

Yeah, I guess you are right on the fact being of being cautious for sure. And we will continue to be absolutely and make sure number one that we preserve our balance sheet whatever we do. But I think that, and I have spoken about this before but I think for us the key factor is fibre. And in making sure whatever we do it’s based on strengthening our fibre position which we have been focused on for the last few years and particularly lately. And we think that’s absolutely critical to our long-term sustainability and success. And so anything we do to will be -- and we will have a large component of that will be, based on that. So going forward we just continue to look as things arise both for SPF but also for southern yellow pine, because we are really pleased with that business as well now and we see some optimism there as well going forward.

Operator

Our next question is from [David Rosel] of Desjardins Capital Markets. Please go ahead.

Unidentified Analyst

I was just wondering if you could comment a little bit on the Tembec acquisition that you made this quarter. Actually the last quarter and closed this quarter. Does this effect in any way the system in terms of taking higher cost capacity off line or does it change the asset mix whatsoever?

Don Kayne

Well, in terms of -- that Tembec acquisition was based on a couple of things. Number one, we felt that whilst the timing was right, Tembec was in a position where it wasn’t part of their core business and were looking to do something with that asset. And at the same time we were looking for an opportunity to essentially significantly improve our fibre base in the southern part of the province. And in addition to improving our fibre base in the southern part of the province, we also -- which is a key part of our thinking going forward, is making sure that that fibre base is aligned with our customer base and the products that that customer base requires. And what you get down on that southern part of the province is exceptionally good fibre, it’s big fibre, it’s high quality fibre. And it makes a lot of high value products which we are very focused on to try to differentiate ourselves away from relying on the #2&Btr market.

So that’s really that whole. So in terms of what that adds to our overall asset mix is, it just really strengthens or fibre mix and significantly increases our percentage of non-beetle fibre that we have across the company particularly in British Columbia.

Operator

Thank you. We have 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 we look forward to talking to you during the next quarter.

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