Canfor Corporation

Don Kayne - CEO Alan Nicholl - CFO Brett Robinson - President of Canfor Pulp Wayne Guthrie - SVP of Sales and Marketing for Canfor Stephen Mackie - VP of Good Products Operation Canada Peter Hart - VP of Pulp and Paper Sales and Marketing

Sean Steuart - TD Securities Mark Wilde - BMO Paul Quinn - RBC Capital Markets

Thank you, operator and good morning, everyone. Thank you for joining the Canfor and Canfor Pulp Q2 2015 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 and Canfor Pulp Products Inc. Alan will provide a more detailed overview of our performance in Q2 after which we will take questions.

On the line with me today to address your questions are Brett Robinson, President of Canfor Pulp; Wayne Guthrie, Senior Vice President of Sales and Marketing for Canfor; Stephen Mackie, our Vice President of Good Products Operation Canada and Peter Hart, who has recently have been appointed as the Vice President of Pulp and Paper Sales and Marketing. For the second quarter of 2015 Canfor reported shareholder net income $11 million, and Canfor Pulp reported shareholder net income of $18 million.

In regard to Canfor Pulp NBSK Pulp shipments were lower in Q2 versus Q1 primarily due to scheduled maintenance outages at several facilities in the second quarter. Global list prices were down in the quarter and overall sales realizations reflected lower pricing in all regions.

The Canfor Pulp board declared a special dividend of $1.125 payable in August. While we continue to invest heavily in our business through internal CapEx and the share buybacks we do not foresee a near term accretive acquisition opportunity.

As a result we believe it is appropriate to return a significant amount of capital to our shareholders. Softwood inventories are at the high end of the balanced range heading into the seasonally slower summer period so there is some risk of downward pressure on global softwood prices in the third quarter.

Lumber markets continue to face challenges in Q2, particularly SPF pricing in the U.S. which felt to its lowest level since 2012.

Prices have started to recover and are expected to appreciate modestly through the year end. The decrease in Lumber price resulted in a 7% average export tax on Canadian shipments to the U.S.

Our off shore shipments rose by 17% demonstrating continued demand and confidence in our SPF and SYP products in offshore markets. The U.S.

housing market shows continuing signs of recovery in the second quarter and we are cautiously optimistic that we’ll see improvement in the U.S. market for the remainder of the year.

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.

Thank you, Don and good morning to everyone. My comments this morning will focus principally on our financial performance for the second quarter of 2015 by reference to the previous quarter.

Full details of our results are contained in the Canfor Pulp and Canfor news releases which were issued yesterday. As always, you will find an overview slide presentation on 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 second quarter of 2015, Canfor reported shareholder net income of $11 million or $0.08 a share, that was down from $29 million or $0.22 a share reported for the first quarter of 2015 and down from $54 million or $0.39 a share reported for the second quarter of 2014.

On Slide 3 of our presentation we highlight various non-operating items net of tax and non-controlling interest, which affect the comparability of our results between the respective quarters. In the second quarter of 2015 positive mark-to-market adjustments on derivative instruments had a net impact of approximately $8 million or $0.06 a share.

And a mark-to-market gain on Canfor's investments in Liquid Mills [ph] and Vincent Global Lumber reflecting the seal of the investment subsequent to quarter end had a net impact of approximately $6 million of $0.5 a share. After taking account of these adjustments the second quarter adjusted shareholder net loss was $2 million or $0.02 a share compared to similarly adjusted net income of $47 million or $0.35 a share for the first quarter of 2015.

You’ll see on Slide four of our presentation the Canfor second quarter operating income was $18 million a decrease of $66 million from the previous quarter. The decrease reflected lower operating earnings in both the lumber and pulp and paper segments.

Results for the lumber segment are highlighted on Slide five of our presentation. The current quarter’s operating income for the lumber segment was $5 million down $43 million from the previous quarter.

The decrease principally reflected lower lumber prices, a 7% average export tax on Canadian shipments to the U.S. and a slightly stronger Canadian dollar.

Our total lumber production was up 5% from the previous quarter reflecting a continued growth in the U.S. side and to a less extent productivity improvements across all regions.

In pre-production and lower cash conversion cost reflecting the productivity gains as well as relatively stable log costs resulted in lower unit manufacturing costs in the quarter. Lumber shipments were up 17% reflecting strong offshore shipments in the current quarter as well as the contribution from our recent U.S.

south acquisitions and the aforementioned productivity improvements. Canfor’s pulp and paper segment comprises the results of Canfor Pulp Products Inc.

As you can see on Slide six of our presentation Canfor Pulp reported net income of $18 million or $0.25 a share compared to net income of $28 million or $0.40 a share for the previous quarter and net income of $19 million or $0.27 a share for the second quarter of 2014. Staying on Slide six, Canfor Pulp second quarter net income after taking the kind of one-time non-operating items net of tax was $13 million or $0.18 a share.

This represents a $22 million or $0.32 per share decrease from adjusted net income of $35 million or $0.50 a share for the first quarter of 2015. As you’ll note from Slide seven of our presentation Canfor Pulp’s lower earnings mostly reflected the impact of scheduled maintenance outages under Intercontinental Prince George and Taylor Pulp Mills during the quarter as well as lower unit sales realizations which reflected both lower prices in all regions and to a less extent the slightly stronger Canadian dollar and increased shipments to lower margin regions.

Pulp shipments increased 7% from the previous quarter due to a full quarter of shipment from the Taylor Pulp Mill as well as the smaller increase in shipments to China. Pulp production levels were up 2% from the previous quarter also reflecting the contribution from the Taylor Pulp Mill.

Lower operating earnings for our paper operation in the quarter reflected the impact of a scheduled maintenance outage coupled with a small decrease in prices and to a lesser extent the impact of the slightly stronger Canadian dollar. On April 1st we completed the acquisition of the Southern Lumber Mill in Mississippi.

The cash cost with this acquisition was $51 million and was financed by U.S. dollar cash on hand.

And just after quarter end as I mentioned earlier on July 1st Canfor sold its 33.3% investment in Lakeland Mills Ltd. and Winton Global Lumber Ltd.

for total cash consideration of $30 million. During the second quarter we purchased approximately 410,000 common shares of Canfor at an average price of $24.15 per share and the 138,000 common shares of Canfor Pulp at an average price of $14.51 per share.

Capital spending in second quarter totaled $49 million of which $34 million was in the lumber business and $13 million in Canfor Pulp. 2015 total capital spend is currently projected to be approximately $170 million for Canfor and $70 million for Canfor Pulp.

Yesterday the Canfor Pulp Board announced the dividend payment of $0.0625 per share for the quarter consistent with the first quarter. In addition as Don mentioned a special dividend of $1.125 per share was also declared reflecting the strong free cash flow of the company over the last 18 months.

At the end of Q2 Canfor excluding Canfor Pulp had net debt of $267 million with available liquidity of $207 million. Canfor Pulp had net cash of $40 million with available liquidity of $118 million.

Net debt to total capitalization excluding Canfor Pulp was 16% for Canfor Pulp it was negative 8% and on a consolidated basis it was 12%. And with that Don I’ll turn the call back over to you.

Thanks, Alan. Operator we’ll now go ahead and take questions.

Thanks. Good morning everyone.

Few questions on let’s start with the pulp business I guess, the thinking on the special dividend as opposed to just increasing the regular dividend can you go into a bit of detail on the rational for that decision?

Sure Sean, its Don. I mean clearly we looked at several options as we've spoken about over numerous quarters, number one concerned course has always been to maintain a strong balance sheet.

We recognized we've had some good cash flow over several quarters and so we looked at what we can do in addition to some of the share buybacks that we've been having and we felt that this would be the best way to give some of that money back to some of the shareholders so we looked at that, we looked at -- off course as you also know we've commented on possibly some M&A and as Alan I think mentioned in his comments we haven’t seen anything yet that we thought would be accretive enough to justify. So, this is what we thought was the best vehicle to use.

Okay, thanks Don. And then on the downtime you had in the second quarter on the Pulp side, is it possible for the dollar figure on the EBITDA impact from that downtime?

And typically yes. Good morning, Sean.

Typically it wasn’t guide to that, what accounts says that it was a fairly significant factor as I mentioned in my comments, hit along with the lower unit sales realizations were the two biggest factors as you would expect. I think what I could say is the increase in cost that we did see resulting from those maintenance outages is that it pertains to Q2 and we would expect the second half results to have lead more normal cost profile.

Right. Okay, thanks Alan and then last one from me and I'll get back in the queue.

On the lumber side we've seen a convergence in Western Canadian and Southern Pine Lumber prices in recent weeks. Do you guys have a perspective on, are we getting close to an equilibrium spread between the two regions, is this close to normalizing at this point?

And Wayne why don’t you give the answer.

It's Wayne. We think the big spread that was there earlier in the years as you say has come back in the normal, by the end of the year we think it will be back to where it's been historically.

So if you look at the two before benchmark prices we’re thinking there’ll be about a $50 spread by the end of the year.

Good morning. The first I wondered is just a request and that as we've got the two biggest Lumber producers in North America and you guys have your calls almost right on top of each other, so just going forward I wondered if we could see you guys separate the timing a little bit that would be helpful.

And moving from that I wondered Don, if you or some of the other guys could just talk a little bit about the continued strength in exports that you are seeing to China? Quite impressive and a little bit counter intuitive given what we hear about China these days.

Yes. Sure Mark and that's a good question, one we get often.

I'll just make one quick comment and I'll give to Wayne to provide maybe a little more color and a little more detail there. But overall as you accurately stated we've seen continued progress in China on a number of fronts, not only on volume but also on some other products that we’re selling their overall and so we really haven’t experienced any of that; some of the negative that you certainly hear out there.

And so we remain positive through the first half of this year and going forward we’re very positive on the future there not just this year but also moving forward over the next three, four, five years. It's a good story and we think it's going to continue and there is terms of opportunity.

So Wayne talk about some of the specifics though, I think Mark will probably find it interesting.

Sure. Thanks Don.

Yes just to add to what Don said there and I understand that it did, it does conflict with some of the headlines that are out there. If we decided to do the same thing we did over the last few years which is just try to sell low grade in the big major cities, we’d be struggling in China too.

But reality is that in the interior cities and in new products and that’s particularly in some of the higher value product, there are opportunities that we’re uncovering their every quarter. So our business is changing, we're having to reinvent ourselves there but we continue to find new opportunities, we’re very excited about continuing along that.

We also think just on the side that worst maybe behind us in terms of some of the slowdown. We may start to see some infrastructure even by the end of the year, start to come back again.

So you can't be complacent in China, you have be looking for new opportunities every quarter, but they are there if you get out there.

Okay. And then Don just also on kind of the on Lumber pricing, there has been kind of a disparity between what's happen in the futures market the last week or two and what the -- some of the trade reporting services are coming up with.

Can you help us understand that?

Yes. Wayne why don’t you speak to that.

Well, I don’t think we want to comment too much on the highly-highly speculative future’s market here particularly at one spot in time, but our position is right or wrong you looking at an open interest of less than 4,000. So it’s very-very thinly created, it could be influence one way or the other quite easily.

We do not draw a direct co-relation between what we’re selling wood for today and what that is indicating. Reality is, if you are trying to comment earlier commodity hedge funds have decided that their commodities are negative and so they are shorting a lot of commodities and we had kind of caught up in that flow, but what you are seeing on that board is not reflective of what we're seeing in the cash markets today.

Okay, right. I had just two other question one is can you address the fire situation out there?

And what effect it may have on your business as we move through the third quarter?

Yes, absolutely Mark. I’ll get Steven that is very current on that whole situation.

Sure. Thanks, Don.

Good morning Mark. Yes, I guess what I’d say about the fire situation today, there is no significant fires affecting our operating area to date or at this time, however there is significant risk out there, conditions are extremely dry and with lots of fires burning across Western U.S.

and Canada and surrounding region there are limited resources to action fires in response when they do occur. So our folks with our contract or general operation personal are remaining very busy through the fire season, we’ve got a long summer still ahead of us.

So there is risk to our operation but we’re not being materially impacted today.

And Steve and how long does the fire season usually run for you guys out in BC?

That’s a good question as well. It started much earlier in this year than typical and I can’t really predict the weather patterns, but it will go through September.

Okay. All right.

The last question I had is it possible to get some sense for the difference in margins between the Southern U.S. operations right now and Canadian operations?

Mark, so what the sense we’ll give you is, it’s better in the south.

Not surprising given southern log prices I guess.

Yes, that mean with all fairness we don’t provide that guidance, that directly, but it is definitely safe to say the returns that we’re getting in the southern part of the United States south-eastern where we primarily operate are definitely strong than what they would be in BC.

Okay, all right. That’s helpful.

Thanks Don.

Thanks. Good morning guys.

Just following up on Sean’s question just for some additional help, I mean it looks like we missed widely on the quarter on Canfor Pulp and it looks to be not so much on the pulp realizations, but on the maintenance downtime. Can you give us any additional help on the maintenance downtime, was it bigger in the quarter than it usually is because those costs were significantly higher than I expected.

Yes, for sure Paul and let me get Brett, you can comment that to Paul.

Yes. So the steps were not abnormal, the costs maybe were a little bit higher as we took on some major work, but we would expect that to come back to normal.

We do have the big north wood shut at the end of Q3 moving into Q4 and we would suggest the realizations were the biggest impact on the quarter.

Okay. And then just on the -- getting back for the CapEx guidance of 70 million on Canfor Pulp, what are those projects that you’re spending 70 million on?

We would be focused on energy projects first. We do have some log displacement ideas.

We are really working hard on figuring out Taylor today, that one’s still to be determined and then beyond that it would be cost reduction focused and [indiscernible] or opportunities to create production where we can.

Okay. And then do we expect the CapEx level, the 70 million going in the ‘16 or is it fall back after that?

No, we will expect to retain that going forward.

Okay. And just switching over the lumber side, just trying to figure out where the lumber prices are going for the balance of the year.

What you guys anticipating or Wayne what do you expecting with the expiry of this after the lumber agreement?

Paul, it’s going to be -- I don’t know if we can draw a direct correlation between that event and what we think prices are going to do. I think what we’re going to try to focus on here is, we bottomed out six or eight weeks ago, we’ve been grinding a little bit higher.

We might have to give a little bit back here just because it’s gotten slow in the summer again. But we just think if you draw a line between today and the end of the year we’re going to have just a slow steady and kind of back where we were in ‘13 and ‘14 prices.

So we think ‘16 will be better. So, we’ll kind of go back towards that end of that 300 and at a level 300 somewhere by the end of the year.

During those events, so when the tax changes and expiry of that, that will create some short term volatility for sure and it always does and there is always lots of emotion around those, but taking the short volatility out and just looking at between now and the end of the year I think as Alan said in his comments it’s just going to be slow grind to higher back to where we’ve been historically.

Okay. Thanks for that.

And then just last question, I guess log inventory volumes in front of your lumber mills I guess there has been a number of curtailments or just work around with the fire season, are those significantly lower or are they but normal for this year?

We’ve normal situation on logs, Paul.

Great. That’s all I had.

Best luck guys. Thanks.

Okay. Thanks, Paul.

Hi guys. Follow up on Taylor, I think we have decent senses that mills contribution or a lack thereof this quarter, be able to back end of the results, I’m wondering if you can give -- I guess your take on BCTMP markets which are under I guess relatively sever pressure right now.

And just long-term thoughts on what you can do to position that mill to be a long term survival in the industry?

Maybe Brett, you can take that.

Sure. Thanks, Sean.

BCTMP markets absolutely are off considerably and we see that continuing in Q3, we would see some moderates rebound into the end of the Q3-Q4 but that would be dependent on China market and not in different to the Lumber side we are seeing better indications there. The Tailor mill, we’re still building our strategic plans for that mills but we’re very excited about the potential to reduce its cost structure.

It hasn’t had a lot of capital investment over the last many years so we’ll work through towards a good strategic plan, but were pretty excited about where we’ll get that mill long term.

Any context on what some of the capital -- discussionary capital projects there could be?

Yes for sure. Our priority right now is the BC hydro funding and really what we're looking at is the efficiency related projects that will recapture steam, repurpose that into the process push gas out to reduce our electricity cost, it's still early days to give you much more detail than that.

Okay. Thanks for the details Brett.

You're welcome.

Hi guys. I'm sitting here watching the Canadian dollar a fall below $0.77 and with the high sensitivity that especially Canfor Pulp's earnings has.

With this move specifically, I know that historically in the past you haven’t hedged but would it makes sense to lock in some of these potential gains over the next year?

Yes. Good morning.

I appreciate where you are coming from there. I think we continually revisit our hedging strategy and should probably make you aware that we can vary the amount of hedging we do, quite a lot just depending on various factors.

I think there is still much volatility in the markets and in [indiscernible] it’s a tough one to call, but something that will continue to look at closely. Today we got hedges going out -- existing hedges going out to Q3 and will look at fitting more in place and due course, we don’t have any plans right now to lever on any more at this point, but it is something we are all watching closely.

Okay. Thanks for that Alan.

Good morning. Just a question Don what you are seeing for log cost here for the balance of the year.

Do you expect them to stay stable or are we looking at any treat [ph]?

Never too many treats, but overall mark probably SPF and Yellow Pine combined we are looking probably in the neighborhood of to 1% to 2%.

Okay.

At least till kind of overall for the balance of this year.

And any visibility yet on your SPF log cost? Like in the BC interior there as you are looking to 2016, do you think there is more cost push coming or not?

Probably a little and that's little bit early to tell yet in terms of where that's going to end up, but we expected some just moderate inflation next year at this stage and the same would be -- same table would be applied to Yellow Pine as well.

Okay. And then on the Lumber side just I guess recent thoughts on where you think inventory levels are at in the distribution system in the U.S.

like the sense I get is things are more hand-to-mouth would you sort of agree with that and if that -- is that potentially setting the stage for some upside price surprises here at some point?

I think you’re pretty accurate on the inventory side for sure but what we're seeing, but Wayne why don’t you maybe comment on that and I’ll answer the second part of that question.

So, we think our inventory is in great shape, our transportation supply has been excellent, our customer takeaway has been very good. So our inventories is at or below plan.

We think our customers are expecting to have a very-very good third quarter in the U.S. commensurate it with the number that you are seeing projected out there and so we don’t think there is any inventory buildup in the distribution system on the North American side or for that matter even on the offshore side.

I think there is a lot of speculation of some short term volatility because of [indiscernible] and those types of issues but it does look like a pretty good third quarter. So, we don’t want to predict prices here but there is nothing from an inventory standpoint that would lead us to be overly negative.

Great. Thanks very much.

No, that's it from me.

Alright. Thank you very much operator and thanks everyone that joined the call and we look forward to talking to you at the end of Q3.

Thank you.