Canfor Corporation

Don Kayne - CEO Alan Nicholl - SVP of Finance and CFO Brett Robinson - President, Canfor Pulp Wayne Guthrie - SVP, Lumber Sales and Marketing Peter Hart - VP, Pulp and Paper Sales and Marketing

Ketan Mamtora - BMO Sean Steuart - TD Securities Paul Quinn - RBC Capital Markets Hamir Patel - CIBC

Thank you, officer and good morning and thank you for joining the Canfor and Canfor Pulp Q4 2016 results conference call. I'll make a few comments about the quarter and our outlook before I turn things over to Alan Nicholl, Chief Financial Officer for both Canfor Corporation and Canfor Pulp.

Alan will provide a more detailed overview of our performance in Q4 after which we will take questions. In addition to Alan on the line with me today are Brett Robinson, President of Canfor Pulp; Peter Hart, Vice President of Pulp Sales; and Wayne Guthrie our Senior Vice President of Lumber Sales and Marketing.

Starting with Canfor Pulp, the mills ran well in the quarter but challenging weather in December impacted production in shipments as some vessel slipped into January. Demand from China continues to be strong and pricing has been moving higher in all markets.

Global softwood demand is positive for both NBSK and BCTMP and we expect this to continue through the second quarter as we begin the spring maintenance season. For our lumber operations, weather throughout our operating areas impacted our fourth quarter results.

That being said, through the considerable efforts of our teams we saw strong improvement in our financial performance over the course of 2016. Our key offshore markets remains steady and inventory levels are low particularly in China.

We expect solid demand throughout 2017. North American housing market continues as gradual but steady recovery and we expect the repair and remodeling sector to continue the significant growth witnessed over the last number of years.

Overall, we forecast U.S. consumption of softwood lumber to increase by approximately 2 billion feet in 2017 on top of the over 2 billion foot increase in 2016.

Early in January 2017 we completed the final phase of our purchase of beetles in Balfour lumber company acquiring the remaining 45% of that business. This completes the last of our phase purchased commitments.

Finally, I will end with comments on softwood lumber agreement. As you know, the U.S.

Department of Commerce is proceeding with its investigation in response to the petition filed by the U.S. coalition.

This was expected as was the fact that Canfor is one of the largest exporters in the country was selected as a respondent for both CBD and ADD investigations. Negotiations for a new managed trade agreement will continue alongside these investigations as will the Canadian government's defense of our industry against these unfounded allegations of subsidy.

In the meantime, our significant investments in our Canadian facilities our focused on geographic market diversification along with our strong mill network in the U.S. South of 1.4 billion board feet put us in a much stronger position than we were in previous rounds of softwood lumber disputes.

We will continue to focus on serving our customers in the U.S. market and working with industry and government towards a resolution.

With that I'll turn the call over to Alan to provide an overview of financial results.

Thanks Don, and good morning everyone. As usual my comment this morning will focus principally on our financial performance for the fourth quarter of 2016 by reference to the previous quarter.

All details of our results are contained in the Canfor Pulp and Canfor News Releases which were issued yesterday afternoon. As always you'll find an overview slide presentation on both the Canfor and Canfor Pulp websites in the Investor Relations section under webcasts.

The presentation highlights consolidated and segmented results and I'll be referring to this presentation during my comments. For the fourth quarter of 2016, Canfor reported shareholder net income of $38 million to $0.29 a share, down from net income of $51 million or $0.38 a share reported for the third quarter and well up from net income of $2 million or $0.01 a share reported for the fourth quarter of 2015.

On Slide 3 of the presentation we highlighted various non-operating items net of tax and non-controlling interest which affect the comparability of our results between the respective quarters. In the fourth quarter of 2016, these items had a negligible impact on the reported earnings numbers.

Results for the lumber segment are highlighted on Slide 5 of our presentation. Operating income for the fourth quarter was $57 million, an $18 million decrease from operating income reported in the prior quarter.

As highlighted in the press release, the lower operating income in large part reflected weather-related challenges in Western Canada that impacted both log deliveries and productivity. Likewise, lower shipment and production volumes in the fourth quarter reflected the weather-related challenges, as well as additional stat holidays.

Western SPF lumber sale civilization showed a modest quarter-over-quarter increase reflecting a 2% weaker Canadian dollar and a higher value sales mix. While lower Southern Yellow Pine sales realizations in U.S.

dollars reflected seasonal price declines for most wider grants which more than offset an increase in the price [indiscernible] lumber. Unit manufacturing costs were modestly higher than the previous quarter again primarily due to the aforementioned weather-related challenges and to a lesser extent seasonally higher energy costs.

Canfor's Pulp and Paper Segment comprises the results of Canfor Pulp products Inc. The company reported net income of $10 million or $0.15 a share compared to net income of $22 million or $0.34 a share for the third quarter and net income of $30 million or $0.43 a share for the fourth quarter of 2015.

The net earnings for the current quarter included a $5 million or $0.08 a share write-down of advances maybe in connection with the biofuels technology initiative with Licella. Notwithstanding the future potential benefits that may result from this innovative venture, this prudent accounting treatment reflected the research and development nature of these advances.

As you will see on the summary of Canfor Pulp's operating results on Slide 7, similar to the lumber segment the decrease in operating results in Q4 was primarily attributable to disruption to operations and logistics costs by the challenging weather. On the plus cost, global softwood pulp markets were relatively stable through most of the quarter with average NBSK pulp prices to China in line with those of the previous quarter.

NBSK pulp sales realizations were largely unchanged. BCTMP sales utilization showed healthy gains reflecting stronger U.S.

dollar pricing, as well as the weaker Canadian dollar. Shipments were down 14% from the prior quarter by primarily due to the lower NBSK production and the vessel shipment that slipped into early 2017.

Higher unit manufacturing costs reflected the lower productivity, as well as seasonally higher energy costs. Operating income for the paper segment in Q4 was $8 million up $1 million from the previous quarter reflecting both the weaker Canadian dollar as well as increased production.

Capital spending in the fourth quarter totaled $63 million of which $42 million was in the lumber business and $18 million in Canfor Pulp. 2017 capital spend is currently projected to be approximately $165 million for Canfor and just over $75 million for Canfor Pulp that latter number including major maintenance.

Consistent with other quarters, Canfor Pulp's, Board of Directors yesterday approved the continuance of a quarterly dividend of $0.0625 per share. And as Don mentioned earlier, immediately after year ended in January 2 Canfor completed the purchase of the remaining 45% of Balfour and Beadles at a cost of US$31 million.

This payment includes all of the company's previous purchase agreements. At the end of the year, Canfor excluding Canfor Pulp had net debt of $321 million with available liquidity of $330 million.

Canfor Pulp had net cash of $2 million with available liquidity of just over $100 million. Net debt to total capital excluding Canfor Pulp was 79% for Canfor Pulp it was zero and on a consolidated basis it was just over 15%.

And with that Don, I'll turn the call back over to you.

All right, thanks Alan. Operator, we would now be ready to take questions.

Good morning. First question and again - to the extent that you can, but can you provide any kind of additional color around - kind of the ongoing negotiations?

And is it still, with respect to the quarter, is it kind of figuring out the middle ground or any update that you can provide will be helpful.

Thank you for the question. I think there's not a lot more really than what I mentioned here in initial comments around the whole agreement.

I think – I guess the one positive is that there is certainly is some negotiations and conversations going on. I think the federal government has been leading this as they have been for some time now and we're - from what we understand we're pleased with the progress and a support that we're getting.

Maybe one comment I would make is because it will probably come up later is around critical circumstances that's the one thing that everyone is paying attention to and ourselves around that that subject we believe that we - through the discipline that we – I think ourselves and others have exercised in terms of overseas shipments and other markets that from our standpoint we are - we are not concerned around the threshold levels that would need to be in place.

Got it. That's helpful.

And Don is the level of quota still the main sticking point?

Well I think that the level of potentially level of market share is for sure at this point and likely at the end of the day here we will continue to be an - the key sticking point or the key negotiation point.

I see. That's helpful.

And then just switching to your Q4 lumber shipments, I was a little surprised they were down year-over-year and I know you referenced some bit of weather issue but anything going on there and why they were down year-over-year?

No, I think it really - it's 100% associated with that and we just had - it's hard to describe it but haven't seen several pictures of what our operations on both the pulp side frankly and the lumber side had to deal with through the quarter from severe weather, severe rain initially in October and November and then severe cold and all the fluctuations for the better part of two months which is continuing on actually but regardless of that just had a significant impact overall in terms of our ability to ship certainly in some cases.

I see. That's helpful.

And then Alan on the capital expenditure guidance that you gave, can you highlight maybe a couple of key projects that you have both in lumber and pulp, and how much of what you guided to is maintenance in that, both in lumber and pulp?

Sure, maybe Alan you could comment on that.

Well absolutely, good morning Ketan. So in terms of question the numbers that we given you are - they got typically close to 50% would be for lumber anyway with the cost of maintenance or certainly sustaining projects.

The key focus for us next year in Western Canada will be drying and so we got a number of CD case that we were building into budget. In the USA it's clearly we are very keen with a lot of discretionary spend to support the significant margins over getting there but optimization some upgrades but just all of which are really in the driving further improvements and productivity while as preserving our strong margins.

In terms of pulp you know there's some maintenance project in there. There is a couple of energy projects we're looking out as well, and so will be refreshing analysis regularly to go through the year but clearly that gives you a flavor of some of the thinking that's embedded in our numbers.

Sure it does. That's helpful.

Just one follow-up on that. How much of these kind of projects help you to increase capacity in the U.S.?

Are these more productivity cost reduction kind of projects?

This is probably a bit of both and I think the - we talked last time around that we thought it would be in the neighborhood of between 100 and 200 million more feet positive impact through the capital that we're spending in and on both the revenue opportunity but as well as the cost reduction opportunities.

I see. That's helpful.

And then last question. Just kind of talk us through how you're thinking about kind of, you know, capital allocation, M&A, obviously balance sheet is in pretty good shape both at Canfor Corp and on the pulp side, and especially concerning this whole uncertainty around the lumber period how you are thinking about your drive to increase capacity in U.S.

south?

I think Ketan, I’ll let Alan talk about the pulp site particularly around the buybacks but as we've indicated it several these analysts calls over the last - probably several years, our capital allocation continues to be focusing on the balance sheet and reducing debt. We would - certainly though we felt particularly in the last year 18 months we made significant progress around that in terms of our debt reduction.

Certainly after that capitalizing the facilities, we continue to do that as you spoke about continue to do that going forward in both the North and the South, the opportunities there. And then of course the buybacks what Al will talk about and then of course M&A and as a result of the debt buyback – or the debt reductions that we made in the last 12 to 18 months, will continue what we have is looking at some of the opportunities that no doubt will present themselves.

Notwithstanding valuations will continue to be an increase an issue here perhaps but that where it stands. Alan, why don't you talk to Ketan about our pulp side around buybacks and there stands on there.

So, we guided in recent quarters around the fact that we’ve been taken what we call the products from share buyback behavior. I think it is largely predicated on some of the precious that we saw coming in on the supply side.

We are certainly encouraged by what we are seeing on the pricing front and our outlook for this year is much better than it was even six months ago. So with a stronger balance sheet and a stronger outlook for this year, I think we’re keen clearly to support a not just significant capital effort but keen with the Board's strong support to review our share buyback activity here as we go to 2017.

Okay. That's very helpful.

Appreciate all the color. Good luck in 2017.

Thanks. Good morning, everyone.

A question on the current surge we're seeing in western SPF pricing. How much of that would you attribute to shipment management around the potential for critical circumstance assessment?

Don, I gather by your comments before, you guys haven't curtailed any volume based on that potential assessment. Is that correct?

I’ll let Wayne talk about some of the detail there, but yes absolutely, I mean we've said all along and I know you know this Sean probably. We've been supportive of our diversification from the start and the importance of overseas shipments and so really ourselves we continued on that path and we think it's the right one clearly and as a result of that we're confident that we will be a little under the threshold for critical circumstance but Wayne you’ve been doing a lot of work and that's why don’t you fill Sean in a few of those things.

From our perspective Sean a few things happening here. First of all, the market in U.S.

is very good. Customers are needing more lumber, the demand - the orders coming - their orders are coming in a little bit faster than anticipated and I think there are a little bit shorter of inventory then they thought they were going in 2017.

So good underlying demand even before we get into all of the noise around the trade. Secondly, we're seeing some of the end of last year is up five consecutive months of increased shipments to Chain, you heard all about that low inventories over there which we can validate are still the case.

And so you got more draw from China and quite frankly anybody anticipated and we expect that going right to 2017, so that’s the second thing. And then you add the emotion and the confusion and the reality that some of the player have reduced shipments.

So get all that up and it's created this bit of storm here that we’re seeing on pricing right now and as Don talked about in his opening comments, you got to be – there is a lot of emotion right now on the topic but we’re going to stick with the plan, we got markets all around the world. We’ll just continue to stay disciplined and focused on our customers but I think this volatile price environment is likely here to stay for a while as we get through the next few quarters.

Wayne, just one follow-up on China. You mentioned better volumes through the latter part of 2016.

But it looked to me like the December volumes pulled back quite a bit. You mentioned for your business on pulp, there were vessel delays tied to weather.

Did the weather affect any of the volumes to China in December? And I gather you're seeing better volumes to start the year.

Yes, so good catch, December was down a little bit late but like what happened in our coal business we had several vessels delayed. There is actually congestion here at the Port of Vancouver and so we've got some late shipment into that market, you also got the complication of Chinese New Year which kind of messes up shipments.

I think the absolute number in January when we get to report out, it will be down as well but our order book has been consistently increasing not dramatically but consistently increasing and once we get through the noise of the congestion, once we get through the Chinese New Year, I think we’ll see that trend continue. I think you’ll see some shippers have to go back to [indiscernible] to alleviate some of this congestion down here and we’re working on some of those things to – because the demand looks pretty solid.

Great, thanks for the context guys. That's all I had.

Thanks. Good morning, Don and Al.

Just a clarification on software lumber negotiations. Are you referring to company-to-company negotiations because my understanding was Trump Administration wasn’t in place yet for government stuff and when do you expect that to happen?

More just a preliminary discussions, I think more with the new route down there which some of them still not formed 100%. So I guess it all is really trying to indicate is that, there is some proactive stuff it’s going on, just trying to get a handle on it.

Clearly Paul there will be a huge education process necessary here because we got the new administration like you said. So we are not expecting any immediate answer to this deal at all but clearly there - there's a lot of work that is being done and has been done and we will try to, I'm certain that the Canadian government at least will be working hard on trying to get some of the key points across right so.

Yes, so we'll see how it goes here but that's what I was referring to.

All right. And then just staying with the file, one of your Canadian peers suggested that they'd be okay with a quota.

Are you of the same opinion, or open mind on the subject of resolution?

I guess from our standpoint we know clearly as you as we've talked before Paul and we would still be of the same opinion is that – it's likely for us anyway going to come down to have market share number and so that's going to be critical. And so it’s been market share number but there's a whole host of other factors as well as the market share on its own and people tend to just talk about market share but there's a some other key points maybe equally important that have to be considerations as well that - I would want to speak about the phone but certainly we're looking at it as likely to be down the road here as related probably more to market share.

Okay. Then just flipping over to I guess the pulp side.

We're seeing some strength in short-term pricing here. You know, how sustainable do you think that is in light of the capacity additions coming to the market later this year in 2018?

And then secondly, I'm hearing rumors of an investigation on the pulp side, potential collusion, which I suspect happens all the time in the marketplace, when buyers are seeing higher prices. But have you got any knowledge of that?

Maybe – thanks Paul, I’ll let Peter answer that – take that question if that’s okay.

Okay. Thanks Paul.

Certainly as we look from now to the end of the second quarter we expect to see continued positive momentum on the pulp side particularly because of the upcoming spring maintenance season. For the second half of the year there will potentially be some challenges as new capacity ramps up.

As to your second comment about potential investigation, not something I have heard off at all.

All right then. Thank you very much.

Best of luck, guys.

Hi, good morning. Just clarify for us, first of all, is it only the countervailing duties that are currently in that sort of potential retroactive period?

It just seems to me like the lumber market is behaving like the anti-dumping duties are also retroactive right now, potentially.

Yes, what we are referring to right now is just countervail which is a preliminary date for that as you probably know was late April so, assume and anybody they got caught up with that it would be three months prior to that so, early February essentially like right now, you would in a right now if you potentially if you, you were over shipped into the United States.

Right. And the retroactive and dumping would be April 1?

The preliminary determination I believe is April 29 to be exact, and so it will be three months prior to that. So you are looking whatever that is January 29, February 1 really.

Yes. In countervailing, I guess I meant when we get the dumping preliminary.

Yes, so the anti-dumping is the end of June is when the preliminary determination is so, three months prior to that so, whatever that is, I guess that’s March.

Right, okay. That's helpful.

So and were as I mentioned were one of the respond as we’re both right so.

Right, okay. Then I had a question about log cost inflation.

You know, what's your expectations for this year in both the U.S. south and PC?

Alan, go ahead.

So, in terms of the USA we continue to see very muted log cost prices. So, we’re forecasting log cost to be fairly flat again this year with respect to Western SPF we're forecasting just a couple of percent increase this year Hamir.

Thanks for that Alan. A just a final question for Wayne.

You referenced - appreciate your comments on the China market, and realize that things might change depending on how the trade case unfolds, but what's your expectation this year for volume growth on the export front?

Well, it’s - to your point its really depends on how this great thing unfolds, and I think a lot of guys will react to that, yes, leave that aside for a second, I think you are going to see continued increase demand in China, like could be significant. I think there is two things happening in China that we quite frankly didn’t expect to get as much fraction is happening, there is a lot of wood frame housing going on especially in higher end resort type developments and that is drawn now for specifically for Canadian lumber and North American lumber.

And the European made huge advances in the last couple of years in the furniture sector and that’s kind of a roadmap for some of the higher value products that we're producing. So, I think you will see continued growth in China may be not in the commodity side but just an absolute volume and that will be definitely there, depend really pleased that the resiliency of that market.

I mean our sales were up a little bit last year very minus low single digit percentages which is still up and this year we expect at least five - may be up a little bit so, Asia looks pretty stable.

Okay, great. Thanks very much.

That’s all I had.

Thanks operator, and thanks everyone who participated. We'll talk you at the end of the next quarter.