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Louisiana-Pacific Corporation (NYSE:LPX)

Q2 2008 Earnings Call

July 29, 2008 11:00 am ET

Executives

Curtis M. Stevens - Executive Vice President of Administration and Chief Financial Officer

Rick Frost - Chief Executive Office

Mike Kinney - Investor Relations

Becky Barckley - Investor Relations

Analysts

George Staphos - Bank of America Securities

Chip Dillion - Citigroup

Peter Ruschmeier - Lehman Brothers

Richard Skidmore - Goldman Sachs

Christopher Chun - Deutsche Bank Securities

Angie Salom - Deutsche Bank Securities

Operator

Good day ladies and gentlemen, and welcome to the second quarter 2008 Louisiana-Pacific Corp. earnings conference call. (Operator instructions). I would now like to turn the presentation over to your host for today's conference, Mr. Curt Stevens, Executive Vice President of Administration and Chief Financial Officer. Please proceed.

Curtis Stevens

Thank you. Good morning, we appreciate all of you joining us for the Louisiana-Pacific conference call and discuss our financial results for the second quarter ended June 30, 2008. With me today are Rick Frost, LP CEO, and Mike Kinney and Becky Barckley, our regular investor relations contacts. As usual, I will start the call with a review of the financial results for the second quarter, provide a discussion about our performance of our individual segments, and give you some comments on the balance sheet. I will then turn over the call to Rick, who will discuss the current market environment, the challenges and accomplishments during the second quarter of 2008, and a summary of his thoughts and plans for the rest of the year.

As we have done in the past, we have opened up this call to the public and are doing a webcast. This can be accessed through www.lpcorp.com. Additionally, to help with our earnings call we have provided a presentation with supplemental information. As I go through the discussion today I will reference these slides. As a caution, this presentation should be reviewed in conjunction with the publicly available earnings release that we sent out this morning.

I want to remind all the participants about the forward-looking statement comment that is included in our earnings release and shown on Slide 2 of the presentation. In these uncertain times in the housing market and the turmoil in the credit markets, forward-looking statements are even more difficult in today's environment.

Please also be aware of the discussion on the use of non-GAAP financial information, it is included on Slide 3. There is also an Appendix to the presentation that contains the necessary reconciliations. I am not going to re-read these statements, but I am incorporating them with this reference.

The first slide I am going to talk about is the earnings summary, which is Slide 4 of the presentation. We are reporting today a net loss for the second quarter of $81 million, or $0.79 per diluted share. Continuing operations, we had a loss of 79 million, or $0.77 and discontinued operations at a loss of about 1 million. Net sales from continuing operations were 387 million. For the same period last year, we reported a net loss of 23 million, or $0.22 per diluted share. On continuing operations, we had a loss of 16 million, or $0.15 a share, discontinued operations had a loss of 8 million. Net sales were 461 million.

For the first six months of 2008, we are reporting a net loss of 127 million, or $1.24 per diluted share, on sales from continuing operations of 736 million. This compares to a loss of 61 million or $0.58 per share in the first six months of 2007. Each of these reported periods did have special items that are generally not attributable to ongoing operations.

If you look at Slide 5, there is a summary of those items. During the second quarter of 2008 we did record settlement costs associated with the OSB anti-trust action. The total amount recorded was 48 million, which includes settlements with the direct purchaser class, the indirect purchaser class, and an estimate for the opt-outs. Although a very difficult decision, with a miniscule risk of an adverse jury verdict, posed too great a threat and we need to focus on the future.

During the quarter we did experience a fire at our Clarke County OSB facility that shut it down. For Q2 we recorded the estimated cost of repairs at a little over $4 million and $1 million for Workers Compensation deductibles. We do anticipate an insurance recovery for a significant portion of these costs will come, but under accounting rules we do not record any gain until amounts are confirmed in writing by the insurance companies. For reference, our deductible under this property insurance program which includes damage as well as business interruption, is $2.5 million.

We continue to feel the turbulence of credit markets through our holdings and auction-rate securities. Compared to the end of March of 2008, we recorded an additional, other than temporary impairment of 1.6 million to the income statement, an increase to temporary impairment reported on the balance sheet by just short of 13 million. This means that the 151 million face value of the ARS only 72 million, or less than 50%, is currently recorded in long-term investments on the balance sheet. I believe this is very conservative.

We continue to pay claims under the 2000 ABTCO class action settlement. The claim period is 25 years. During the last several quarters we have had an unusual increase in claims activity. Based on this, we did work with our consulting economists and we increased the reserve by about $15 million. And we will continue to watch this closely. To comment this is the non-discounted estimate of payments during this 25-year class period.

During the second quarter of 2007 we did record a gain of 17.7 million. Associated proceeds received on a favorable verdict from a legal suit associated with the insurance on our hardboard siding. And an additional $1 million gain on a settlement with the Canadian government.

Adjusting for these unusual items, adjusted loss from operations in Q2 2008 would have been 35 million, or $0.34 per diluted share, compared to $28 million loss or $0.26 per diluted share in Q2 of 2007.

Slide 6, we updated this slide for the quarter. This is actual housing starts in the U.S. for single and multi-family. This graphical representation certainly shows the depth of the downturn. While Q2 of 2008 was higher than the immediately prior quarter, we believe this was attributable to seasonality rather than an increase in underlying demand. Compared to Q2 of '07, actual starts were 30% lower in the same quarter last year.

Slide 7 is a summary of our OSB performance. The loss in the OSB segment for Q2 was $35 million, which was lower than the same quarter last year where we had a $45 million loss, and last quarter with a $62 million loss. OSB pricing compared to the same quarter last year was up 6% while at the same time volumes were down 30% due to market curtailments taken during the quarter, as well as the indefinite curtailments associated. This reduced volume reduced sales by about $60 million.

Compared to Q1 of this year, pricing was up 17% while volumes were lower by 7%. On a quarterly comparison, pricing accounted for about $8 million increased sales and profitability. We did have a cost increase in the quarter, about $3.00 per thousand, attributable to raw materials with resin and wax primarily, about $10 due to the 30% lower production volume, and about $5 related to the change in the Canadian dollar as it strengthened about 9% from Q2 of '07.

Siding is Slide 8 of the presentation. This includes our SmartSides of both OSB and hardboard products, our Canexel siding and commodity OSB produced at one line at our Hayward mill.

For the quarter, sales lines were down by 6% of SmartSide, compared to the same quarter last year, and 35% higher than last quarter, although this would be related to seasonality. Sales prices were basically flat compared to both the same quarter last year and sequentially.

Housing starts are down 30%. We were off only 6%. So this is another solid quarter at retail for these products. Our CanExel volumes, they were lower by 18% in the same quarter last year and lower sequentially by 32%. The sequential change of 32% is a little misleading. In the first quarter of 2008 we did life volume restrictions on our winter buy program as we changed our primary distribution for this product that we had in place for previous years. The result was we had a significant increase in volume in Q1, which reduced the volume in Q2. A 4% increase in price compared to the same quarter last year is attributable to the stronger Canadian dollar, as most of these sales are made in Canada.

Slide 9 is our engineered wood products summary. The segment expanded this quarter to add laminated strand lumber produced at our Houlton, Maine facility. That adds to our LVL and I-Joist. The segment also includes the sale of I-Joist and LVL products produced by Abitibi or under an exclusive sales arrangement with an LVL producer. For Q2 we recorded a loss in EWP of 9 million, down from a profit of 4 million, and a loss of 8 million in the prior quarter. Volumes in both I-Joists and LVL were down significantly as this is a direct reflection of the reduced housing activity. Pricing drifted down a little bit compared to the same quarter last year and last quarter.

Also in the quarter, this segment, we mentioned we added the Houlton, Maine LSL sawmill. During the quarter we incurred all the expenses associated with the start-up, while we produced minimal saleable product. We did ship about $1 million of LSL to two customers in the quarter.

While there is no slide on other building products, let me make a few comments. Overall, we had a break-even quarter, compared to a loss of 3 million in the same quarter in 2007. Sales were at 36 million, a 50% increase from the same quarter last year. About half this increase is related to our operations in Chile, and half in export sales.

Our moulding results were basically flat with the previous year, which is very good in this market. As a reminder, that is exclusively a repair of the model product. In our (inaudible 00:14:33) operations, we broke even, compared to a small profit in the prior year. The offset there was due to higher administrative costs associated with the new mill start-up. And we did see some price pressure on OSB from imported product coming in from the U.S.

Our U.S. GreenFiber Joint Venture did better this quarter than the same period last year. Good strength in retail sales, but that was offset by continued weakness and a contractor business that is tied to new home construction. Higher paper costs, primarily raw materials continued to hurt the results.

On the selling, general administrative costs, both unallocated and overall, we had a slight increase from the prior year. The increase was driven primarily by higher sales and marketing costs to drive our war-for-share programs. Additionally, in the second quarter of 2007 we did reverse accruals associated with LP's 2007 management bonus program. In 2008 we continued to improve. Looking at the actual numbers, total SG&A was about 39 million in the quarter, compared to about 38.5 for the prior quarter, so relatively flat.

In other earnings releases there has been much discussion on the effect of increases in costs of raw materials and energy that have had on global manufacturing, and really in all industries. Our cost of sales was similarly affected. Here are some numbers. We used Q2 of 2008 volumes across our product lines, raw materials costs and energy were higher by $11 million compared to Q2 of 2007 and $6 million higher than they would have been using Q1 of 2008 pricing. Year to date, this increase was $23 million, with little ability to pass it through to customers in this weakened housing environment.

We had a $5 million foreign exchange loss in the quarter, compared to about $13 million in the same quarter last year, and that is related to our operations in Canada, Chile and recently Brazil.

For Q2, our effective income tax rate was 42%. The major reconciling items, compared to statutory rate, are related to our foreign debt structure and state income taxes. As we continue a loss position, the impact of the foreign debt structure will continue to drive our benefit rate above the statutory rate.

As of today, we anticipate a significant portion of the tax benefit we accrued to date in 2008 will be refunded in 2009 based on our ability to carry-back the losses.

Investment in expense in the quarter was about $2 million, compared to income of 13 million in the same quarter last year. This is a result of lower earnings on investments, lower cash and investment balances and higher interest payments due to borrowing in Canada. We also significantly reduced capitalized interest now that a majority of the projects have been completed.

Slide 10 of the presentation talks about the balance sheet. Key balance sheet statistics. Cash, cash equivalents, investments, and restricted cash, all were at 511 million at the end of the quarter. We did receive 53 million anticipated $150 million tax refund in Q2. We expect the balance of that in Q3.

We mentioned earlier we did have a further impairment of around $14 million on the auction rate securities, which reduced that cash balance.

Working capital was over $400 million. Net cash in investments was about $110 million. Year to date capital expenditures stood at $125 million. About $45 million of this was the carry-over from the 2007 projects that were accrued at the end of the year. $45 million for the initial closing of the Brazilian acquisition and about a $4 million investment in our joint ventures. Book value per earnings share was just short of $16.00.

Over the past few months there have been several questions from analysts and investors about liquidity and our financing options. We continue to review multiple financing options that are available to us to manage our upcoming debt maturity and our operating needs. We had had discussions with our lead banks regarding a possible extension of our credit facility, but we also continue to review other financing options as well. Our current liquidity position of over 500 million of cash and investments provides us with significant flexibility in addressing these upcoming debt maturities.

I know that many of you would like us to be more specific. The turmoil and the bank and financing markets, coupled with SEC regulations, makes this difficult. Rest assured that we are looking at a variety of alternatives and will communicate our plans at the appropriate time.

Slide 12, the last slide in the presentation, provides the necessary calculations of non-GAAP financial measures discussed in this review.

With that, let me turn over to Rick, who will discuss the challenges, accomplishments, and actions during Q2, any thoughts about the market, and comments on the remainder of 2008.

Rick Frost

Thanks, Curt, and good morning everyone, and I also thank you for being interested in the LP building products Q2 earnings call. It is a beautiful day here in Nashville. It is going to be about 95 degrees today. I was out part of the month of June getting a total knee replacement, and I will tell you that that is just about as bad as the housing environment right now. But I am on the mend and I wish the market would be the same. I would like to be sharing better economic news with you than I did last quarter on the call, but there has not been much improvement.

We are still in a tough housing environment and concerns with the mortgage debt and the other financial markets continue to plague the housing industry, as you well know. One small bright spot, it does look like the president may sign the Housing Bill which I don't think is going to be the solution, but may provide some stability in this market.

I want to begin with a few comments on Q2. I will speak first on safety. Last quarter was the best quarter that we have had as a company with a safety experience rate of .62. In Q2 we had a set-back with the Clarke County thermal oil room explosion and fire that Curt mentioned briefly. We had four employees hurt in that incident and thank goodness not more seriously. But as a result, at mid-year we have a TIR now of .99, which is still under 1.0 and something to be proud of. It creates great challenges for our people in staying safe during these times of great distraction by intermittent running, by changing shift schedules, and the financial concerns that people are feeling at home.

Now, in regards to our new mills, I have a couple of perspectives to offer. I think as I have said a couple of times at conferences, the timing of our North American mill start-ups could certainly have been better. Bringing new mills on line during the worst housing downturn in the last 20 years has been a chore, and it is certainly not one that I would care to repeat. As I mentioned earlier in the safety section, we did have the unfortunate incident at our Clarke County OSB mill in early May, which caused damage to the mill and injuries to four employees. Fortunately those employees have all been released to come back to work. The damage was due to the thermal oil system that powered the press, and basically what we had to do was rebuild the thermal oil room at the plant. We anticipate that this mill will restart in early October and begin again moving up the start-up curve.

The Houlton, Maine mill laminated strand lumber is now shipping to customers and has been certified for both the 1.35e and the 1.55e strength products. This is good news, and we are shipping. However, this start-up has taken longer and it has been more costly than we planned. And about half of the loss incurred by engineered wood products business was related to this start-up and getting the 1.55e product available for sale. Our next objective at the plant is to now create the 1.75e product, and we hope to do that by the end of the year.

The LVL mill in Oregon, where we have an exclusive sales arrangement, has been producing volume since the first of the year and in Q2, with the broader portfolio of certified products, the volumes have come up quickly. The downside of that is that it is forcing more down time at our Golden, British Columbia facility.

Lautaro, Chile started up in Q1 as we reported. We did receive APA certification on that product and it has been shipping to customers for several months. Demand in Chile is still very good and our aim is to get this mill up to full production as quickly as possible and to restore pricing in Chile.

We did have the initial closing of our purchase of a 75% interest in an OSB mill in Brazil during Q2. We have a detailed transition plan underway, the current plan being for LP to assume operational control of this mill in early September.

On capital, we expect our capital expenditures for 2008 for completing the Houlton mill in Clarke County and other various projects in our operations, to be about 110 million. As we mentioned, we did additionally spend about 45 million in the quarter on the initial close of the Brazilian mill and we anticipate contributing another 25 million for our remaining equity and working capital contributions.

The other piece of our capital spending that we expect in 2008 is to exercise a call option to create a joint venture with the LVL manufacturer of the new mill in Oregon that we have the sales and marketing agreement with. In that, we would obtain a 50% ownership interest. And I would expect that cost to be approximately $35 million and completed either in the third or the fourth quarter of this year.

As Curt reviewed, our financial results for Q2 were poor and they were influenced by several factors. In the quarter we took 238 mill days of down time in OSB and this does not include the St. Michel mill which has been permanently shut down and the Silsbee mill that has been indefinitely shut down, neither of which ran during the quarter. As mentioned above, Clarke County was down for most of Q2, I think about 54 days. And we do not anticipate any production out of Clarke County until the next quarter, so in Q3 it will not be up.

In siding, both in our hardboard mills and SmartSide, and in engineered wood, we had the challenge to take significant down time and reduce our shifting patterns to keep our inventories at levels just to satisfy our customer needs.

Now due to an unusual increase of ABTCO class action hardboard siding claims, we did increase our reserves significantly and we are investigating the causes of this and monitoring that situation closely.

On another product-related issue, we have been seeing some deterioration problems on a small percentage of the decking products that we manufactured and sold several years ago. While we are no longer in the decking business, we do have warranty responsibility for the products that we made and sold. So we did increase this reserve by about $2 million. And I currently have a team in place out in the field to determine the cause of that deterioration, and what appropriate actions that we need to take as we learn more about that.

As most of you know, we did take the charge for the expected settlements of the OSB anti-trust action. As Curt mentioned, this was a very difficult decision. It is absolutely clear to me that no LP employees did anything wrong. But to fight this in court with the remote responsibility that a jury decision could go against the company that would have the potential of driving us into bankruptcy while we would be pursuing vindication through the appeals process. Simply put, it was a case where the probability was very low, but the stakes were very high and it was not a risk that I chose to take.

I will wrap up my comments with a look forward. I do not see any help from the housing market for the rest of this year. I think that is relatively consistent with what most of the forecasters are saying. Consensus from the forecasters is that new residential starts will be under $1 million for 2008 and with only a slight projected uptake in 2009. The published results that we have seen for starts and permits in the first six months of this year certainly give credibility to that forecast.

2008 is going to be a really tough year for anyone in building products in the new residential construction business. 2009 might be slightly better, but we are not counting on that at this point. I am hopeful that current interventions by government, the housing bill and support for the mortgage industry will prevent further deterioration. And I am predicting overall improvement in 2010, but I do not have a sense on the slope of that line yet.

So, what are we going to continue to do to manage through this downturn? As Curt always says, cash is king. We do have a strong balance sheet and we are mindful of managing our resources very carefully. Curt mentioned some of the discussions we were having around refinancing options. Now, during the last six quarters of the current fall in housing, our board has left the dividend at $0.15 per quarter. Because of our cash reserves and the expectation that the markets would rebound sooner than they have, I did discuss this with you on our last call that the Board is seriously considering either cutting or eliminating the dividend. Our board meeting is this weekend and we will make some decision. We will issue a press release next week after that board meeting to inform the market and investors what decision that we made.

We will continue to manage our mill outputs to match the take-aways that we have. We have to be mindful of not tying up any more cash in inventory than we need to. Right now, I am anticipating that our OSB business will sustain approximately 280 days of mill downtime in Q3. The 30% of that will be at Clark County. We have completed several very large capital projects, but we have also dialed back our capital expenditures and plans to maintenance levels. Exceptions to this have been our investment in Brazil and the probable purchase of interests in the JVLVL mill later this year.

Looking forward, along with the market demand, Curt mentioned this as well. I am concerned about inflation in raw material costs. Energy costs are surging into most of the tributaries of the supply chain. Now, our challenge will be to offset these as best we can with operating decisions, but we must also figure out how to pass these costs on, which is very difficult in a down market. Our sales and marketing force continues to aggressively sell our products with the purpose of creating a preference for doing business with LP and our measurement vehicles continue to be very positive in showing us that our LP products consumed per housing start are improving year-over-year. The problem is we need more starts.

We also continue to be please with our lean sigma efforts and that is contributing the largest part of our cost and process improvement work and we are exceeding our goal for the year of three to one returns, meaning the savings that we get as compared to the amount of money we spend to achieve those savings.

With that said, I will turn it back over to Curt.

Curt Stevens

Thanks, Rick. That was not very upbeat. So now, why do we not open up for questions?

Question-and-Answer Session

Operator

(Operator instructions). Your first question comes from the line of George Staphos of Bank of America Securities. Please proceed.

George Staphos - Bank of America Securities

Thanks, everyone, good morning. Rick, maybe first question, I know it is a little early, but just hypothetically, do you have further opportunities if you need to rebalance within the fleet of mills and do you think have opportunities on the cost curve by which to improve performance if, in fact, you chose to take some downtime as we look out to 2009?

Rick Frost

I think the way I will try to answer that is when you take temporary downtime, it is the most expensive

downtime you can take because you do not get it fixed cost. Now, we have shut down two mills to get at the fixed cost structure and if we are hopeful at continuing to get at the fixed cost structure. Then what we would have to do is to look at some of our temporary decisions and to declare them as more permanent. And then actually get the rest of the costs out of the system. I am not prepared to say anything more about that at this time.

George Staphos - Bank of America Securities

Okay, I understand and could you remind us or give us a bit more in the way of detail in terms of what is attractive to you about the joint venture in Oregon and the decision on the timing to invest a bit more now in light of some of the obvious other challenges from a cash flow standpoint.

Rick Frost

Well, the timing was pretty well predicated on the deal that we made when this mill was built and we have a call option and we think that it makes sense for us to execute that. So, it is a very low cost source of product and what we want to do--at this point in time, what you have to do is you have to make LVL at the lowest possible cost. That is the only way that you can sell it. So, it makes sense for us. It is a good mill. It will reduce our cost structure in that part of the world and we had planned to do it and we have the ability to do it.

George Staphos - Bank of America Securities

Okay. Thanks. I will turn it over.

Operator

And your next question comes from the line of Chip Dillion of Citigroup. Please proceed.

Chip Dillion - Citigroup

Hi, good morning. My question first is to make sure I got this right. On the CapEx, did you say, I am sorry, 110 million for the second half?

Curt Stevens

Chip, I think what Rick’s comment was 110 million, not including the acquisition.

Chip Dillion - Citigroup

And that is for the whole year?

Curt Stevens

That is for the whole year.

Chip Dillion - Citigroup

Okay and that includes, obviously, the remaining spending for Houlton and I guess Clark County is pretty much paid for.

Curt Stevens

Right.

Chip Dillion - Citigroup

Okay.

Curt Stevens

What you have to add to that, though, is you have to add the Matusa (ph 00:35:49) and this proposed LVL.

Chip Dillion - Citigroup

And MAC-ISA, I think already, has been like about 45 million?

Curt Stevens

Correct.

Chip Dillion - Citigroup

And so, that will be 70 all in so there is another 25 and then the 35 for the Oregon JV.

Curt Stevens

Correct.

Chip Dillion - Citigroup

And could you describe the plant in Oregon, is it similar to Houlton?

Curt Stevens

No, no, this laminated veneer limber it is not LSL.

Chip Dillion - Citigroup

Okay.

Curt Stevens

It would be similar to what we produce in our Golden facility and in our Wilmington, North Carolina plant.

Chip Dillion - Citigroup

Okay and would 35 million represent a discount to replacement costs or what?

Curt Stevens

Well, that is our estimate at this time. There is a quite a mechanism to go through to get to the actual number.

Chip Dillion - Citigroup

Okay and then, Curt, if you could just review the--we see you need the CapEx, I guess, for the second half is going to be another 35 or 4 million. And then you have this 60 million from MAC-ISA in Oregon and then I think you have term loan of what 127 million and when is that due?

Curt Stevens

The term loan is due at the end of December it is 125 million Canadian and that was the remaining balance in the 235 that we put in place as part of our attack strategy and we can do the repatriation of earnings from Canada.

Chip Dillion - Citigroup

Got you. And who is the bank there?

Curt Stevens

It is our standard banking group. It is actually a little bit expanded because they have to have a Canadian presence, so there is a probably a predominance of Canadian banks in that facility.

Chip Dillion - Citigroup

Oh, okay and then, beyond that, I think you have some maturities next year. Could you just review those?

Curt Stevens

We have $200 million senior debt piece that is due in August of 2010. Next year, the only thing we have got is the renewal of our revolving credit facility.

Chip Dillion - Citigroup

And that has nothing outstanding, right?

Curt Stevens

It is only--it has outstanding layers of credit.

Chip Dillion - Citigroup

Got you, got you.

Curt Stevens

There is no outstanding balance on that.

Chip Dillion - Citigroup

Okay, so as we think about the 511 million of cash and investments, obviously the ARSs are in the 106, but you can pretty much get at the other 400 of that right?

Curt Stevens

That is correct.

Chip Dillion - Citigroup

Okay and if Rick or you want to sort of give us your thoughts. If you sort of add up the joint venture in Oregon and the Brazilian investment, that is over 100 million. I just remember back in the early 2000s you all had sort of a plan to keep your net cash at between two and 300 million. And you are still in tough times and you are below that and I am just kind of wondering why you are doing these other investments when you are below that level and you have to renew with the banks. If you could just give us your thoughts on that.

Curt Stevens

Well, let me make a couple of other comments. One, we are anticipating close to a $100 million tax refund this quarter, which will offset some of that. And I think the comment we said is we wanted to keep 200, 250 to 300 of cash on the balance sheet. I do not think we ever said net cash.

Chip Dillion - Citigroup

Okay.

Rick Frost

That is correct. I always said, I called it my rainy day fund, and I always said between 250 and three.

Curt Stevens

And if you look at our debt to total cap, we are still one of the best ratings in the industry.

Chip Dillion - Citigroup

And after you get this refund and let us say when you do turn profitable, what is your sort of--not predicting what you do in the third quarter and beyond, but just up to now, do you have a? I guess you are carrying back to get this 100 million, would you then? Let us just say, hypothetically, you started to make money tomorrow, would you be taxpayer right away or do you have actual carry forths you can use?

Curt Stevens

I would have to research that before I gave you an answer on that. I think we would become a taxpayer because I think we can carry back the current real offsets.

Chip Dillion - Citigroup

So, if you lose money in the second half, you might even have more refunds you can go back and grab is that right?

Curt Stevens

Well, yes. In fact, today we have got as of--and this will be in the queue, so you will see it there, but if you break out our receivables, we show an increase in receivables up to 280. But if you look at the trade receivables, they are only about 75 of that. There is 170 million income tax receivable in there, 100 that I talked about getting in Q3 would come out of that. The remaining balance, we would expect to be able to carry back from the 2008 filing.

Chip Dillion - Citigroup

And so you would get that, obviously, the first half of ’09.

Curt Stevens

Correct, or the summer of ’09, depending on--

Chip Dillion - Citigroup

And given as much money as you made in the up cycle, if you do keep losing, you basically can continue to crawl back I would think.

Curt Stevens

Well, at some point, it is going to run out and hopefully, the market is going to turn so I do not have to worry about that.

Chip Dillion - Citigroup

(Laughter). Got you. Alright, thank you.

Curt Stevens

Yep.

Operator

Your next question comes from the line of Peter Ruschmeier of Lehman Brothers.

Peter Ruschmeier - Lehman Brothers

Thanks, good morning.

Curt Stevens

Morning.

Peter Ruschmeier - Lehman Brothers

Hey, Curt, I was hoping you could help us with, remind us what the capitalized interest was in ’07 and what you think it is for ’08 and I guess it really drops off in ’09.

Curt Stevens

Well, it should drop down dramatically in ’09. I have Becky scurrying to get you that number ’07, Pete.

Peter Ruschmeier - Lehman Brothers

Okay.

Curt Stevens

If you have another question, I will answer that, she will get it for you.

Peter Ruschmeier - Lehman Brothers

Alright, maybe shifting gears to the LVL in Oregon, can you remind us who the partner is there? And the 35 million call option estimate, what does that do for you in terms of your increase in your equity of the LVL capacity? What kind of capacity does that buy you?

Curt Stevens

Well, the partner in that would prefer we not disclose them and will when we do the transaction, but right now, it is a little bit sensitive. That facility currently is about 4 and a half million cubes and we would a 50% interest in that. We also believe we have the ability to increase that when the market demand comes up.

Peter Ruschmeier - Lehman Brothers

Okay, so the 35 million would take you to 50%?

Curt Stevens

Correct, correct.

Peter Ruschmeier - Lehman Brothers

Okay

Curt Stevens

Just the capitalized interest for the second quarter 2007, it was $4 million and it was under a million for the second quarter of this year. And for the six month it was seven versus three and a half.

Rick Frost

One more comment to refresh your memory on engineered wood products. Last year, we shut down our Hines-Oregon mill, which had a capacity of about 5 million cubes and we did that with an eye for this volume being available to us at a lower cost structure. And so this is the continuation and substitution in our engineered wood products business for the shutdown of the Hines-Oregon mill.

Peter Ruschmeier - Lehman Brothers

Okay, that is helpful. Rick, could you maybe comment on what you learned so far about the Brazilian OSB opportunity. You know both in terms of how you see the domestic and export opportunity developing over time?

Rick Frost

Yes, actually, I am headed down there in September when we actually take over operational control. The mill is in pretty good shape. We are going to have to put a little bit of money into it. Our primary responsibility down there right now is to improve the quality of that product. That is one of the advantages of them partnering with us. We are having their recipe sent up here to our lab and hopefully we will get that product stamped. And currently it is not being used for structural product. So the first thing that we have to do is improve the quality of that product so it can get a structural product stamp.

What seems to be very exciting about Brazil is that as you look at the demographics of Brazil and all the forecasts around Brazil, Brazilian families will be expanding at an average annual rate of two percent per year for the next 20 years. Current unmet housing needs in Brazil are at over 2.1 million involving both new homes and repair and remodel. And Brazil is viewed as a very excellent real estate opportunity around the world.

Housing investment is projected to grow from a current state in ’07 of about 165 billion Real, up to over 400 billion Real in the next 20 plus years. So, if you look at the improvement in the financing ability, the financing system of the Brazilian housing market. By the deregulation that has occurred there, there is going to be a surge of funds available to meet the housing needs. So we are looking at the number of new families, in Brazil, will move from today around 60 million to 95 million over the next 25 years. So there is going to be a need for 37 million new homes in Brazil.

And I believe that an awful lot of that is going to fit into the way that we develop the market in Chile. A lot of that will be low income housing where we can go in and actually give prototypes to the government models, which is the way we got into Chile to get the new housing construction themes accepted.

So if you look today in the population in Brazil it is about 189 million people. Over the next 20 years there is going to be 230 million people. And homes today in Brazil there are 56 million and projected to be 93 million in 2030. So we think we are in at the right time in having structural components in Brazil. And it may actually give us an opportunity to export some of our other products down there as well.

I really am hopeful that very little of the Brazilian product is exported. I think it can all be consumed within the country.

Peter Ruschmeier - Lehman Brothers

Okay that is very helpful. And Rick, good luck with the recovery on the knee.

Rick Frost

Hey, man, I am coming along.

Curtis Stevens

Pete, I am glad you asked that question. He has been prepping for a week on that one.

Peter Ruschmeier - Lehman Brothers

Thanks guys. I appreciate it.

Operator

Your next question comes on the line of Richard Skidmore of Goldman Sachs. Please proceed.

Richard Skidmore - Goldman Sachs

Good morning guys. Curt, could you talk about what you would expect inflation to be up in the third quarter versus the second quarter given what you have seen thus far in the month of July.

Curtis Stevens

I think your question has to do with raw materials. I am not going to say what the economy is going to do.

Well, you know, we have seen natural gas slide back down. So we do expect to have some improvement in natural gas pricing in the third quarter. We have seen oil down below $130 a barrel. The derivatives that go into our P-UP and our NDI resins have not come off much. But I do not anticipate a big increase in the third quarter over the second quarter.

I am guessing if I sit here in October for the third quarter call I would probably tell you that raw materials and energy are going to be up slightly from Q2 but not significantly.

Richard Skidmore - Goldman Sachs

Okay. And then just shifting to a balance sheet question. The current portion of contingency reserves, 68 million dollars. Is that something that is going to be paid out in 2008? Or can you clarify what that is?

Curtis Stevens

48 million is the OSB settlement.

Richard Skidmore - Goldman Sachs

Okay.

Curtis Stevens

And we paid ten of that already. And then we will pay the balance before October 1st.

The other piece of that is, if you recall, the fourth quarter of last year we reserved about $9 million for an environmental settlement in Lockhart and we have not paid that yet. So we are anticipating that that will get finalized here in the next six months.

Richard Skidmore - Goldman Sachs

Okay and the OSB settlement is this year being paid out?

Curtis Stevens

Yes. Ten of it has already been paid. And then the additional, whatever it is, 34 million will be paid before October 1st.

Richard Skidmore - Goldman Sachs

Okay and then on slide 12 or whatever that goes through your net cash position. Is that contingency reserve in that number or not. It does not look like it but I just want to make sure?

Curtis Stevens

It would be in the current liabilities in the working capital?

Richard Skidmore - Goldman Sachs

Okay. Thank you.

Operator

Your next question comes from the line of Angie Salom of Deutsche Bank.

Angie Salom - Deutsche Bank

Hello. Can you hear me now? I was just wondering if you could tell us what was available under your credit facilities at the quarter end? How much LOCs were against it?

Curtis Stevens

Under the credit facility right now we have an unsecured line that is cullable in Canada. It is 100 million. We have got about 35 outstanding on that. So it is about 65 available there. And then in the U.S. we have 115 million in our credit line. The only thing that is outstanding against that is letters of credit.

But as we talked about in last quarter’s 10-Q if we were to access that we would need to cash collateralize it.

Angie Salom - Deutsche Bank

Okay so, the cash collateralization is still in place?

Curtis Stevens

Correct.

Angie Salom - Deutsche Bank

Okay. And I know it is difficult to discuss any sorts of refinancing. But is there any sorts of details you can give us on options you are looking at? Are you, you know, refinancing the credit facilities or the term loan that is coming up in December?

Curtis Stevens

I think what I said is we are exploring a variety of options and those would be some of the options we are exploring.

Angie Salom - Deutsche Bank

Okay and is there a time frame when you would be able to tell us what those options were?

Curtis Stevens

Well if you can tell me when the credit markets are going to be open and when the banks are going to be open with their checkbooks I could probably give you a better timing. But we will be prepared this quarter to take advantage of windows of opportunity.

Angie Salom - Deutsche Bank

Okay. So as far as you being comfortable with the amount of cash that you have currently, if for example the credit markets did not open up by December when the term loan is due, you would just pay it off?

Curtis Stevens

That would be our intention, yes.

Angie Salom - Deutsche Bank

And then just what exactly is under the debt balance currently? Could you break that down for us, if there is nothing drawn on the credit facility? It looks like the recourse notes were paid down. Is that just an accounting adjustment?

Curtis Stevens

The recourse notes are related to an installment sale on several timber transactions. And that is a slightly higher receivable than there is a payable on that. So the receivable to payable self liquidates. So there is no cash consideration for LP other than the small amount that will get in the receivable above the payable.

Angie Salom - Deutsche Bank

Okay thank you very much.

Operator

Your next question comes from the line of Christopher Chun of Deutsche Bank.

Christopher Chun - Deutsche Bank

Yes, thanks. Can you just tell us what CapEx is going to be for ’09?

Curtis Stevens

The guidance that we have given there, Christopher, is that we try to hold that to 25 million. We do not really have any further commitments or large projects that we anticipate would flow into 2009. So it would be basically at those maintenance levels.

The only changes that might be what we find when we go into the Brazilian mill as Rick talked about. But it should be a pretty low level.

Rick Frost

I think what I actually said on the last call is that it would be under 50 million. And I was arm wrestling the guys that want the money and I am winning.

Christopher Chun - Deutsche Bank

Okay. In the OSB business I saw that you ran at an EBITDA loss again. I was wondering if you might be able to break out for us in terms of the cost structure at the segment level, how much of that is fixed and how much is variable?

Curtis Stevens

You are asking about the OSB cost?

Christopher Chun - Deutsche Bank

Right.

Curtis Stevens

The comments I have made talked about the from compared to Q2 of last year. I did talk about the increase in raw materials being about three bucks a thousand. That the effect of the 30% reduced production which would be fixed costs were up about $10.00 a thousand. And there was about $5.00 in the Canadian currency.

Christopher Chun - Deutsche Bank

Right. I guess we could extrapolate to some extent based on those comments. I was wondering if you cared to make any?

Rick Frost

We do not really publicly comment on our cost breakdown for obvious reasons.

Christopher Chun - Deutsche Bank

Fair enough thanks.

Operator

(Operator instructions).

Curtis Stevens

Well, Chanel, if there is no more questions then we thank you all for you participation. As usual, Becky and Mike are available for follow up questions. We appreciate your attendance. Thank you.

Operator

Ladies and gentlemen that concludes the presentation. Thank you for your participation. You may now disconnect. Have an excellent week.

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