Canfor Corporation

Don Kayne - President, Chief Executive Officer Alan Nicholl – Senior Vice President-Finance, Chief Financial Officer Sean Curran - Vice President, Sales & Marketing, Canfor Pulp Brett Robinson - President, Canfor Pulp Wayne Guthrie – Senior Vice President, Sales & Marketing

Mark Kennedy - CIBC Sean Steuart - TD Securities

Good morning, everyone and thanks joining the Canfor and Canfor Pulp third quarter results conference call. I will speak briefly to the result of both companies before I turn things over to Alan Nicholl, who is the Chief Financial Officer for both Canfor Corporation as well as Canfor Pulp Products Inc.

Alan will provide a more detailed overview of our performance in quarter three after which we will take some questions. With me today to address your questions are Brett Robinson, President of Canfor Pulp; Wayne Guthrie, our Senior Vice President of Sales and Marketing for Canfor; and Sean Curran, Vice President of Sales and Marketing for Canfor Pulp.

Canfor's net income for Q3 was $46 million, down from $54 million in quarter two. This largely reflects the higher than normal shipment levels we experienced in Q2 following the transportation challenges earlier this year.

While lumber shipments were 9% lower in Q3 compared to Q2, lumber realizations were generally in line with the previous quarter. Canfor Pulp posted a net income of $24 million in Q3 which was up from $19 million in Q2.

Improvements reflect increased production versus Q2 due to scheduled maintenance shuts in that quarter. Pulp shipments were down 3% as compared with Q2, again reflecting abnormally high shipments in that quarter following the Vancouver Port Strike.

Pulp markets were solid and global softwood pulp producer inventory levels returned to balance over the quarter. We recently announced the acquisition of three mills in the southern United States.

The operating assets of Beadles and Balfour Lumber located in Thomasville and Moultrie, Georgia and Southern Lumber Company’s mill in Hermanville, Mississippi, These announcements reflect our continued confidence in the Southern Yellow Pine market and a strong fibre basket and operating conditions there. We also announced the construction of two new pellet facilities that will be lined with our sawmills in Chetwynd and Fort St.

John. We see pellets as a growth part of our business and increasing related energy production is a continuing area of focus for us.

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.

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

Full details of our results are contained in the Canfor and Canfor Pulp news releases which were issued on Wednesday and yesterday respectively. As always, you will find an overview slide presentation on both the Canfor and Canfor Pulp Web sites in the Investor Relations section under webcast.

The presentation highlights consolidated and segmented results and I will be referring to this presentation during my comments. For the third quarter of 2014, Canfor reported shareholder net income of $46 million or $0.34 a share, down from $54 million or $0.39 a share for the second quarter of 2014 and up from $28 million or $0.20 a share reported for the third quarter of 2013.

On Slide 3 of our presentation we highlight various non-operating items net of tax non-controlling interest, which affect the comparability of our results between the quarters. In the third quarter these items had a net negative impact of approximately $5 million or $0.04 a share.

After taking account of these items which related mostly to a mark-to-market adjustment on contingent consideration from the sale of our 50% ownership of Peace Valley OSB in 2013, the third quarter adjusted shareholder net income was $51 million or $0.38 a share compared to similarly adjusted net income of $57 million or $0.41 a share for the second quarter of 2014. You will see on Slide 4 of our presentation that Canfor's third quarter operating income was $86 million, a decrease of $12 million from the previous quarter.

The decrease primarily reflected higher than normal lumber shipments in the second quarter following resolution of the transport related challenges seen earlier in the year and higher log cost offset somewhat by an increase in Canfor Pulp's operating income in the current quarter mostly stemming from higher operating rates. Results for the lumber segment are highlighted on Slide 5 of our presentation.

The current quarter's operating income was $60 million that was down $15 million from the previous quarter. Most of this variance, as I mentioned, was attributable to lower shipments which were down 9% of $113 million board feet from Q2 after the release of the previous quarter of the higher than normal inventory build from earlier in the year.

Further impacting the third quarter lumber sales were higher log costs reflecting increased logging and hauling costs as well as higher stumpage rates on logs processed by our mills in the period. Lumber sales realizations were relatively stable with stronger North American lumber prices offset by lower offshore sales realizations.

Unit manufacturing costs reflect the higher log cost and to a lesser extent a modest increase in cash conversion cost due to lower lumber production. The lower production related really to a combination of one additional day of statutory downtime in Canada, continued capital ramp ups at several mills following several major capital upgrades and semi-annual maintenance shuts at southern pine operations in July.

Canfor's pulp and paper segment principally comprises the results of Canfor Pulp Products Inc. And as you can see on Slide 6 of our presentation, Canfor Pulp reported net income of $24 million or $0.34 a share compared to net income of $19 million or $0.27 a share for the second quarter of 2014 and net income of $9 million or $0.13 for the third quarter of 2013.

Staying on Slide 6, Canfor Pulp's third quarter net income after taking kind of onetime items, was $25 million or $0.34 a share. This represented a $7 million or $0.08 per share increase from adjusted net income of $18 million or $0.26 a share for the second quarter.

The improvement in Canfor Pulp's results highlighted on Slide 7 mostly related to scheduled maintenance outages in both the pulp and paper businesses in the previous quarter, which more than offset modest decreases in pulp and paper shipments pulp sales realizations in the current period. Pulp shipments were down 3%, principally as a result of the higher shipment volume in the second quarter relating to the aforementioned transportation challenges.

Canfor Pulp's paper segment earnings showed a $3 million increase in operating income from the prior quarter, reflecting both the scheduled maintenance outage in the previous quarter and to a lesser modestly higher unit sales realizations in the current quarter. Capital spending in the third quarter totaled $64 million of which $46 million was in the lumber business and $16 million for Canfor Pulp.

We are currently projecting 2014 total capital spending of approximately $160 million for Canfor and close to $60 million for Canfor Pulp. During the third quarter Canfor Pulp repurchased 178,000 common shares under its normal course issuer bid, taking advantage of lower share prices that we saw during the quarter.

And yesterday the Canfor Pulp Products Inc. board announced the dividend payment of $0.0625 per share for the quarter consistent with that of the previous quarter.

At the end of the Q3 Canfor, excluding Canfor Pulp, had net debt of $142 million with available liquidity of $191 million. Canfor Pulp had net debt of $10 million with available liquidity of $118 million.

Net debt-to-total capitalization excluding Canfor Pulp was 9%, for Canfor Pulp was 2% and on a consolidated basis it was 9%. And with that, Don, I will turn the call back to you.

Thanks, Alan. And now, operator, we can turn the lines over to questions.

I have a couple of questions. I will start off, I guess on your lumber side, on your log costs.

Like I know in BC, it's a little different by regions, but I guess two questions, Don. Is there sort of an average log cost you can give us in terms of a delivered log costs for the interior.

And secondly, how much further cost pressure you see on that number in 2015?

Yes, hi, Mark. Yes, for sure, what I will give you is just basically what we have seen in Q3, is an increase of about 5%-6%, something in that order of magnitude.

And we are expecting Q4 to be up slightly overall, not anywhere near what I just mentioned in Q3 but we will see it go up slightly. In terms of 2015, we see in terms of total log cost inflation next year to be somewhat moderated from 2014.

Okay. So (indiscernible) if not, just a little bit down to me.

Yes, correct.

Okay. And then I wanted to ask a question, and maybe you can decide you would answer, but it's more on sort of the NBSK pulp prices look going forward here.

Like on a net transaction price basis in U.S. dollars, NBSK looks to be trading at or close to $200 premium right now over eucalyptus.

So going forward, do you think that it's wise just to keep that the same. So if eucalyptus prices go up, maybe you get an increase but if eucalyptus prices are flat, do you think you are going to keep trying to push for further NBSK increases.

Maybe on that one Mark, I will get Sean. Maybe you can comment on that.

Sure. When you talk about spreads between NBSK and eucalyptus, if you look at [BC] (ph) which they publish their numbers for October and they have published or they day before, it's about $140 spread in China and about $200 spread in the U.S.

market. And Europe might be right around the $180-$170 level depending where that settles for this month.

As to your question, I believe what you are asking is that if eucalyptus stays at the levels that’s it, will NBSK pricing move up? Is that what you are asking?

Right. Correct.

I would suggest with eucalyptus starting to move up that spread, where we have said I think publicly is somewhere in the area on a global average right around $150. I would suggest that your comment is corrected.

As eucalyptus moves up in price, than probably NBSK will move up in price. This price at where we are right now globally are basically sustainable.

Okay. And then my last question and I know you have listed on your introductory comments, Don, but I know you just returned from a trade mission over to China and Japan and Korea and just sort of your significant takeaways there for lumbar outlook in 2015 in those markets.

Yes. For sure, I will just make a couple of comments and Wayne, you jump in there too because you were with me.

But overall, again it was a very very good mission. We think that these things are very worthwhile in terms of helping us from a market development standpoint.

It was the most well attended, highest level mission that I have ever been on. I have been on several of them like a lot of us have in the industry.

Overall though, I thought that, certainly where we started out in China, and I thought that it continues to be lots of opportunities. Very positive.

We had some meetings with (indiscernible) that went really well. So believe that China despite some of the comments you here in terms of the press and what not, in terms of the conditions of the economy there and so forth, we felt it's just as strong going into 2015 as it has been and will be in 2014.

So we are bullish on China overall for wood products and the consumption of them going forward. In terms of Japan, same thing.

Some concern I guess over the VAT tax that was added back in 9 April and what they are going to do in terms of going forward and adding another x percent going forward. Lots of different views on that.

But aside from all of that, in terms of the overall business we think it's going to continue fairly strong going forward and just pay attention a lot to that. But we see a lot of new opportunities in Japan.

Wayne, talk a little bit about that maybe for Mark, some of the opportunities you are seeing.

Yes. So in Japan (indiscernible) housing is actually maintaining itself better some of the overall housing numbers.

So we have got opportunities there. And I think a big focus for the mission and a big focus of most of us in BC here, is how do we diversify a little bit into trying to get into the more traditional housing.

And that’s all brand new opportunity. So it will be hard work but we still opportunities there to maintain and maybe even increase our market share.

Thanks, good morning everyone. I got a one a bit late so I apologize in advance if you have covered this.

The most recent acquisition, Southern Lumber, it's more focus on I guess wider dimension lumber. I am wondering, Don, if you can just speak to that acquisition's strategic fit with your existing platform in the region and I guess just more broadly, I am trying to gauge if this is more representative of the types of acquisition opportunities in the region going forward.

Maybe just a bit more context on that acquisition.

Yes, sure, Sean. I think like we have been pretty consistently on all our acquisitions down there is certainly focus on the fibre for sure, and the ability to have some high value flexibility in terms of the product mix, in terms of higher prime percentages than maybe what we have got accustomed to.

And so Southern Lumber was probably, of all of them, they have all been for those reasons, but Southern Lumber was probably the most -- probably has the largest opportunity there from a high value standpoint. So we like the location and the logs there.

Pretty much larger than any other operations than we have, which gives us a lot more flexibility than we had anywhere else and which we like. We also like the location and the ability to reach some of the strong markets in the U.S.

south, particular Texas. So it gives us that opportunity as well.

But overall, probably of all the acquisitions that we have made it's probably the most opportunity upside in our view in terms of capturing the higher value product mix that we think we can get out of those logs there.

Okay. And I guess further to that, a lot of your recent marketing materials you are referencing your U.S.

platform and the growth you have there. There is some discussion at being able to access offshore demands with those mills.

Can you give us a context as to how much of your southern production of any rate now is being shipped offshore and how you see that trending over the next several years.

I guess, first of all, not a lot yet but it's more than it has been but it's of a low base. So across all the operations, definitely there is more going offshore.

But on a long term basis, certainly we believe the more options you could have and more access you can have to tidewater and give you that flexibility of better than we are going to be. Because I do see the yellow pine, just in general with the species itself and all the other species, it's going to provide us some actual opportunities down the road here.

And so if you look at all those acquisitions, as you accurately pointed out, they are pretty darn close to tidewater.

Okay. And then lastly from me.

As we look ahead to next year, and Don or Alan, maybe just a bit of context in how you are thinking about capital allocation pockets for next year. I am not sure if you have set your CapEx budget yet.

But how will you balance that with further share buybacks, M&A opportunities. Maybe just give us a bit of context on what you are thinking on that front.

Yes. So just on the capital itself.

Including the pellet plants that we announced that we are going to build, Sean, we anticipate next year we will spend about $200 million overall on CFP. And about $60 million on CFX or Canfor Pulp.

Okay. And then your thoughts on, further -- you've got a lot (indiscernible) in the balance sheet, lots of further buybacks, dividend growth at Canfor Pulp.

Anything helpful along on those lines?

Yes. I think maybe what I could say is, like we have talked about in the past, our number one priority per share is making sure that we capitalize on mills that we have correctly and keep them competitive and top quartile going forward, which we have been doing and we will continue to do.

In addition to that, both for CFX and for CFP, really is to -- the other areas there of course is the share repurchases that we have been focused on throughout the year, both companies. In terms of Canfor Pulp, separately, obviously the other consideration is the dividend side.

And also with the strong quarter and a positive situation that we are getting to in terms of cash and we expect that to continue into 2015. For sure, it does broaden some of the options that we will look at going forward for next year.

Whether that be on energy projects or even potentially some M&A. I think all I will say is, it's just broadens some of the opportunities that we will look at.