Canfor Corporation

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

Sean Steuart - TD Securities Paul Quinn - RBC Capital markets Daryl Swetlishoff - Raymond James

Thank you, operator and good morning everyone. And thank you for joining the Canfor and Canfor Pulp Q3 2015 results conference call.

I will speak briefly to the results 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 Incorporated. Alan will provide a more detailed overview of our performance in Q3 after which we will take some questions.

On the line 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; Stephen Mackie, our Senior Vice President of Good Products Operations Canada and Peter Hart our VP of Paper Sales and Marketing. Canfor reported shareholder net income after onetime items of $6 million or $0.05 a share.

On a similar basis, Canfor Pulp reported net income of $35 million or $0.50 a share again after onetime items. Over the quarter, we announced the permanent closure of our Canal Flats sawmill due to a lack of long-term economic fiber supply.

The mill's last day of operation will be early next month and we're focused on placing employees at other Canfor divisions and safely winding down the operations. In regards to Canfor Pulp, there was a modest increase in NBSK pulp shipments compared to the last quarter, owing to fewer maintenance outages and improved mill productivity including a craft mill setting a new monthly production record in August.

Global list prices were down in the quarter but these were outweighed by the weaker Canadian dollar. Lumber markets continue to face challenges in Q3, with our lumber segment reporting a small operating loss of $1 million after onetime items.

Prices are starting to recover as expected and we've seen positive appreciation particularly in both Yellow Pine and SPF price levels. China volume experienced a slowdown in September and October particularly low grade however high grades were more solid.

During the third quarter, Canfor announced the acquisition of Anthony Forest Products which operates six facilities producing lumber, engineered wood products, wood chips with a combined capacity of approximately 250 million board feet. This reflects a continuation of our strategy to grow our operations in strong, sustainable, high quality fiber regions.

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 third quarter of 2015 by reference to the previous quarter.

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

The presentation highlights consolidated and segmented results and I will be referring to this presentation during my comments. For the third quarter of 2015, Canfor reported a shareholder net loss of $17 million or $0.13 a share, down from net income of $11 million or $0.08 a share reported for the second quarter and down from $46 million or $0.34 a share reported for the third 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 quarters. In the third quarter of 2015 negative mark-to-market adjustments on derivatives instruments had an impact of approximately $9 million or $0.07 a share.

And onetime costs related to the 9th’s permanent closure of Canal Flats sawmill had an impact of $14 million or $0.11 a share. After taking an account of these adjustments the third quarter adjusted shareholder net income was $6 million or $0.05 a share compared to similarly adjusted net loss of $2 million or $0.02 a share for the second quarter of 2015.

You’ll note on Slide 4 of our presentation that Canfor's third quarter operating income was $9 million which represented a decrease of 9 million from the previous quarter. Operating income in the third quarter included onetime cost of $19 million for the aforementioned Canal Flats closure.

Excluding this provision operating income was up $10 million versus the second quarter largely reflecting improved pulp and paper segment results which more than offset a decline in the Company's lumber segment earnings. Results for the lumber segment are highlighted on Slide 5 of our presentation.

After adjusting for the Canal Flats closure provision as well as an inventory valuation adjustment of $6 million the lumber segment recorded a small operating loss of $1 million, down from operating income of $5 million reported for the previous quarter. The decrease primarily reflected lower U.S.

dollar at Southern Yellow Pine lumber sales realizations. Western SPF benchmark prices were generally in line with the second quarter reflecting a 6% weaker Canadian dollar which offset weaker low grade prices and to a lesser extent higher average export taxes over the quarter.

Total lumber production was down by 3% from the previous quarter with productivity gains partly offsetting the impact of additional staff holidays in Canada and shift configuration changes of certain Western SPF operations. Overall, unit manufacturing costs were lower than previous quarter with the productivity improvements and seasonally lower energy costs, positively impacting operating costs in the third quarter.

Lumber shipments were down 2% quarter-over-quarter. Canfor’s pulp and paper segment comprises the results of Canfor Pulp Products Inc.

As you will see on Slide 6 of our presentation, Canfor Pulp reported net income of $31 million or $0.45 a share compared to net income of $80 million or $0.25 a share for the second quarter a net income of $24 million or $0.34 a share for the third quarter of 2014. Canfor Pulp's third quarter net income after taking account of losses on financial derivates was $35 million or $0.50 a share.

And this represented a $22 million or $0.32 a share increases from adjusted net income of $30 million or $0.18 a share for the second quarter. As you’ll see on Slide 7, Canfor Pulp’s results reflect the fewer maintenance outages under pre-productivity as well as a modest increase in NBSK pulp sales realizations that reflected the 6% weaker Canadian dollar which had weighed a smaller decrease in U.S.

dollar list prices. And as Don noted the craft pulp mill set a new monthly production record in August.

The weaker Canadian dollar also had a positive impact on the paper operation results which also benefitted from a 12% increase in production as the paper mill returned to more normalized production levels following its own scheduled maintenance outage in the second quarter. Capital spending in the third quarter totaled $61 million of which $43 million was for the lumber business and $15 million for Canfor Pulp.

2015 total capital spend is currently projected to be around $170 million for Canfor and $60 million for Canfor Pulp. During the third quarter Canfor announced the acquisition of Anthony Forest Products for a purchase price of US$93.5 million including approximately $15 million of working capital.

The transaction is scheduled to close in the next week. Around quarter end Canfor also completed several financings and refinancings including the issuance of a new US$100 million nine-year term loan with Prudential Capital and a new US$100 million eight-year term loan commitment.

These financings both strengthen our liquidity and support our growth in the U.S. side.

During the third quarter Canfor Pulp paid a special dividend of $1.125 per share as well as a quarterly dividend of $0.625 per share resulting in total distributions to Canfor Pulp shareholders of $83 million. Also during the third quarter Canfor Pulp repurchased approximately 557,000 of its common shares at an average price of $12.38 per share for a total of $7 million.

And yesterday the Canfor Pulp Board announced the continuation of its $0.625 dividend payment per share for the quarter. At the end of Q3, Canfor excluding Canfor Pulp had net debt of $260 million with available liquidity of $149 million before taking account of the aforementioned U.S.

dollar financing. Canfor Pulp had net debt of $33 million with available liquidity of 117 million.

Net debt to total capitalization excluding Canfor Pulp was 16%, for Canfor Pulp it was 7% and on a consolidated basis its 15%. And with that Don I’ll turn the call back over to you.

All right, thanks very much Alan. So, operator we’ll now go ahead and take questions.

A couple of questions on capital allocation with respect to both companies, I guess starting with Canfor Corp, on a pro-forma basis for the Anthony Forest Products acquisition and backing out Canfor Pulp, I would get your pro-forma net debt to cap up around 30% maybe a little bit higher. I guess just general thoughts on Canfor with leverage at the Canfor Corp level and your thoughts on additional room for incremental sawmill acquisitions from here?

So, to your point on our pro-forma debt, we come out actually with a slightly lower amount I think than you mentioned on a pro-forma basis but I think the point you highlight is around our Canfor on slightly higher debt to cap, what I would say to you is that we remain very disciplined and very keen to stay with a very conservative balance sheet and are very keen to make sure that the we preserve that. So we're looking at that pretty closely and we're not concerned at all with this purchase and where it takes us and as we look out actually we see lots of room for further strengthening of our balance sheet without jeopardizing our strategy and our key priorities.

Okay. And then on the Canfor Pulp level, notwithstanding I guess you are not more of downtime near-term and the good pressure cost structure but we would see a transition back to net cash, at some point next year maybe just a bias to returning capital to shareholders your thoughts on that, you've been busy on the buyback but beyond that maybe talk about I guess your thinking behind special dividends which you took in Q3 and how you’d weighed out against something like a Dutch auction in terms of returning capital to shareholders?

For sure Sean so, just trying and answer the various questions you put forward. So I think, just as a refresh we did say a total of $83 million I think in terms of total dividends and putting out special dividend and it is important to emphasize that that was a onetime special dividend and it was potentially communicated as such and also reflected the options of attractive acquisition opportunities as well.

And so it was made after careful thought by the Board and so we believe it was well received, we've had very good feedback from our shareholder base so with that in mind to your point around our cash generally the share we’re benefiting from strong operating performance and a strong balance sheet. We are mindful that it does appear to get a little bit of weakness in pulp markets but notwithstanding.

We still expect to have a fairly solid performance over the next couple of quarters. We've worked very keen to pursue to keep that top quartile margin focused Sean, we do like the share buyback and the baseline dividend hybrid if you like and as you will have noted we spent a $7 million on share buybacks in the quarter, we're keen to keep that going as well.

So, right now we're feeling pretty comfortable with that we got the balance right but for sure we need to revisit this periodically and we do so with the Board.

Just a couple of quick questions one on Anthony Forest Products, maybe you could just go through the mills they've got, it looks like there are two sawmills, two engineered wood plants, two chip plants, did I get that right?

Yes one sawmill, two engineered wood plants all and two chip plants.

Okay, so you have got the 150 million at Urbana, where's the extra 100 million of lumber capacity coming from?

That has been coming from Urbana and Arkansas and then I also didn’t add there, we have got a joint venture in terms of the Hydrous two up in Ontario with EACOM.

Okay. So I'm talking to you because you've got combined capacity of 250 million equivalent but then you're talking about Urbana at 150, so the delta is 100, where's that?

That's combined with the two engineered wood products plants and the OSB plant adjusted into FDM because those products are key distributors, I said Hydrous. The two engineered wood plants and the I-joist plant combined are 100 million.

Okay. I got it, I got it, okay and no OSB okay.

And then just looking on the lumber operations given the net loss in the quarter and it looks like that would be given most of that would be in the USF what haven’t you taken the associated downtime in the quarter?

In the south, Paul?

Yes.

Primarily, I guess I mean everybody does things for different reasons I mean we've had in terms of the -- no doubt the prices have come down there but from our standpoint the mills that we've offering down there are making a sufficient margin and we didn't feel it is was justified whatsoever.

Okay. And then just turning to the expiry of Softwood Lumber, it seems like the market prices have come up i.e.

this wall of wood hasn't really materialized and not that many expected it except for a few traders but what's happening in terms of current negotiations and what's your outlook on that file?

In terms of Softwood lumber quality and clearly we were working towards an extension as you're aware but I think part of the issue there was of course with the Canadian election coming up and that caused problems and probably was the main reason for not being able to get that done. I think going forward we're fairly positive I think we know that we over the next probably three to six months, there'll be some negotiations definitely underway after the election and the new canvas introduced on November 4th, we would expect that, that would start to begin fairly soon, I think there's some motivation and some feelings from both sides I think that we would like to see a deal certainly during the standstill period.

So, we remain somewhat optimistic there, but time will tell.

I know it's early days in terms of the Liberal government but do you see any change in philosophy with respect to the -- I feel like it’s -- on that change?

I don't think so, I think that whether it’s Conservatives or the Liberals I think they both have a fairly good recognition of these from what I've heard and we've heard that they're keen to recognize that we need to get some deal done. And get some certainty in markets and what not going forward.

So, we don't see having any negative implication whatsoever.

And then just lastly, we were expected actually really strong pulp results last quarter, that didn't happen but they sure came through this quarter. Can you talk to the productivity improvements at your mill system and do you expect that to be ongoing at this level?

Sure, Paul may be I will let Brett talk about that, if…

Yes, we have done a good job, we wouldn't place an initiative for remediate over the last couple of years, focused on liability, the guys are doing a tremendous amount of effort into training, documentation and building a strong approach to our maintenance outages as well as our area shutdowns, it's starting to show in reliability across the board as well as execution of our outages so yes we feel pretty good about our results there, productivity and I think going forward we should be able to continue to deliver that.

A question for Wayne on just the low grade lumber market, how long do you think that this discount to the benchmark persists and what will be the mechanisms that lead to low grade pricing getting higher?

Well, who knows right? It went a lot lower than the any of us anticipated, it is going back as you can see, it's trending back towards normal, I think we're seeing a little bit of an uptick in our volume for the November and December bookings into China so that will help, still not back to normal but trending back towards normal.

The U.S. absorption of the low grade and you can see what's happened to the prices in the last four weeks, it has been a lot better than we anticipated.

So, I think business there might have been better than we anticipated, so that's helped. So, I guess we got Chinese New Year we got winter so, it's not going to happen overnight, but I would think in the next quarter or two, we'll see it trend back towards normal.

And Don, just as you look out over the next couple years, you've been concentrating it appears more in the U.S. South for growth opportunities, ultimately I mean assuming that you can find the right assets, what sort of proportion of U.S.

South production would Canfor like to have in the four months of time?

I think over the next probably over the next five year period, I mean clearly, we like being down the South, we see the opportunity there to probably increase from where we are in terms of how much that will be in terms of order of magnitude, I think that's a bit dynamic now, but we wouldn't be unhappy to see another 5% to 10% growth down there overtime, but clearly it just depends on what we're more interested in the quality of the growth than we're just growing of course and we've also got some cooling opportunities we think down the road in terms of DC as well. So, just overall I think that probably in order of 5% to 10% wouldn't be out of the question longer term, but it's more around the quality of the growth and the growth so.

Thanks operator and I appreciate everybody participating on our call for Q3 and look forward to talking to you next quarter. Thank you.