Canfor Reports Results for Third Quarter of 2018

VANCOUVER, Oct. 24, 2018 /CNW/ - Canfor Corporation (TSX: CFP) today reported third quarter 2018 results:

Highlights

• Solid third quarter with adjusted operating income of $244 million and sales of $1.32 billion
• Adjusted net income of $157 million, or $1.23 per share
• Net cash of $198 million, or 8.8% net cash to total capitalization, at September 30, 2018

Financial Results

The following table summarizes selected financial information for the Company for the comparative periods:

The Company reported operating income of $201.8 million for the third quarter of 2018, down $80.3 million from reported operating income of $282.1 million for the second quarter of 2018, with the decline reflecting lower operating earnings in both the lumber and pulp and paper segments.  Reported results for the third quarter of 2018 included a net duty expense of $42.6 million, at a current effective countervailing duty ("CVD") and anti-dumping duty ("ADD") rate of 14.94%, compared to $51.7 million reported in the second quarter of 2018.  After adjusting for duties, operating income was $244.4 million for the third quarter of 2018, down $89.4 million from similarly adjusted operating income in the second quarter of 2018.

Adjusted lumber segment earnings primarily reflected steep declines in Western Spruce/Pine/Fir ("Western SPF") and Southern Yellow Pine ("SYP") benchmark lumber prices, and to a lesser extent, the disruptive impacts of severe forest fires in Western Canada, and Hurricane Florence in the US South, which contributed to significant cost pressures and temporary operational downtime as a result of limited log deliveries and evacuation alerts.  Pulp and paper segment earnings largely reflected a 20% decrease in pulp shipments that was mostly timing-related, and to a lesser extent, higher market-driven fibre costs.

Notwithstanding the downward pressure on pricing through the third quarter of 2018, lumber demand in the North American market remained relatively stable, with US housing starts averaging 1,218,000 units on a seasonally adjusted basis, down 3% from the previous quarter and up 4% from the third quarter of 2017.  Offshore lumber consumption remained solid through the third quarter, with demand particularly strong in Japan.

While the average benchmark North American Random Lengths Western SPF 2x4 #2&Btr price at US$482 per Mfbm was down US$116 per Mfbm, or 19%, compared to the second quarter of 2018, Western SPF lumber unit sales realizations benefitted from a strong order file to start the quarter, a higher-value sales mix, and improved offshore pricing.  The average benchmark North American Random Lengths SYP East 2x4 #2 price was US$488 per Mfbm, down US$101 per Mfbm, or 17%, with this decline offset, in part, by a modest increase in 2x10 pricing.  The sharp drop in lumber prices from the historical highs seen in the second quarter of 2018, was primarily attributable to higher inventory levels throughout the supply chain, in part from a continued gradual improvement in transportation networks.

Total lumber production, at 1.28 billion board feet, was 3% lower than the prior quarter as the benefit of improved productivity was more than offset by increased statutory holidays in the current quarter and the aforementioned disruptions.  Total lumber shipments, at 1.29 billion board feet, were down 4% from the previous quarter reflecting reduced production, a drawdown of inventory in the previous quarter following the severe winter weather experienced in the first quarter of 2018, and the impact of flooding and road closures following Hurricane Florence.  Unit manufacturing and product costs in the third quarter of 2018 were moderately higher than the previous quarter reflecting higher market-based stumpage and the significant impacts of Hurricane Florence in the US South and severe forest fires in Western Canada, which contributed to lower harvested volumes and increased competition for purchased wood.  Log costs in the US South remained stable through the quarter.

Global softwood pulp market conditions remained balanced through the third quarter of 2018, with US-dollar Northern Bleached Softwood Kraft ("NBSK") pulp list prices, for the most part, reflecting steady global demand.  Average NBSK pulp unit sales realizations were in line with the previous quarter as a weaker Canadian dollar and record high US-dollar NBSK pulp list pricing in North America offset a slight decrease in the China US-dollar NBSK pulp list price.  Average Bleached Chemi-Thermo Mechanical Pulp ("BCTMP") unit sales realizations showed a modest decrease quarter-over-quarter as a result of lower US-dollar BCTMP prices. 

Pulp shipments were down 66,200 tonnes, or 20%, from the previous quarter, reflecting the combination of a drawdown of inventory in the previous quarter as weather related transportation constraints eased, a 10,000 tonne vessel slippage into October, the impact of early fall maintenance and softer market demand from China in the first part of the quarter. 

Pulp production was down 11,200 tonnes, or 4%, from the previous quarter for the most part reflecting scheduled maintenance downtime at CPPI's Northwood NBSK pulp mill in late September (spanning quarter-end), which more than offset increased BCTMP production, following the commissioning of CPPI's energy reduction project at its Taylor Pulp mill at the end of June.  As previously announced, towards the end of the third quarter, Northwood extended its scheduled maintenance outage on one production line.  The outage is to enable necessary tube replacements to its No. 5 recovery boiler to rectify damage discovered during routine preventative maintenance inspections. This unscheduled outage is anticipated to result in an additional reduction in NBSK pulp production in the fourth quarter of 60,000-70,000 tonnes.  Pulp unit manufacturing costs were modestly higher than the previous quarter, principally reflecting market-related increases in sawmill and whole log residual chip costs, and an increased proportion of higher-cost whole log chips.

Canfor's collective agreement with the United Steelworkers ("USW") expired on June 30, 2018.  Canfor is a member of both the Council on Northern Interior Forest Employment Relations ("CONIFER") and the Interior Forest Labour Relations Association ("IFLRA"), which represent a total of seven of Canfor's operations in the USW negotiations.  USW Local 1-2017, who is participating in the CONIFER negotiations, issued a 72-hour strike notice on October 3, 2018 and moved into a legal strike position on October 6, 2018.  USW Local 1-2017 represents employees at four of Canfor's mills.  USW Locals 1-405 and 1-417, which are participating in the IFLRA negotiations, recently conducted strike votes at three of Canfor's mills.

Commenting on the Company's third quarter results, Canfor's President and Chief Executive Officer, Don Kayne, said, "Despite the significant operational disruptions presented by forest fires and extreme weather, our lumber business generated solid financial results, aided by the dedication and commitment of our employees and contractors who helped to mitigate the impact of the challenging operating conditions."  Kayne added, "Canfor Pulp recorded another financially solid quarter despite significant scheduled maintenance downtime at Northwood, ramp-up efforts at Taylor and several operational challenges.  We are very focused on completing our repairs to our No.5 recovery boiler at Northwood and returning to full operating capacity later this quarter".

Looking ahead, the US housing market and repair and remodeling sector is forecast to gradually pick up through the balance of 2018.  While North American lumber prices have continued to decline in October, lumber markets are anticipated to modestly improve through the quarter, in part reflecting solid offshore lumber demand and more balanced supply.  Results in the fourth quarter are anticipated to reflect lower unit sales realizations due to the current lumber market weakness, as well as continued log cost pressure in Western Canada as a result of increasing market-based stumpage and higher purchased wood costs.

Global softwood kraft pulp markets are projected to be balanced through the fourth quarter of 2018. Results in the fourth quarter of 2018 will include the continuation of the scheduled maintenance outage at CPPI's Northwood NBSK pulp mill, the aforementioned extended downtime at Northwood, as well as unscheduled downtime taken in early October at all of CPPI's NBSK pulp facilities as a result of a third party natural gas pipeline explosion near Prince George. Combined, these scheduled and unscheduled outages are anticipated to result in a total of 85,000-90,000 tonnes of reduced NBSK pulp production, as well as higher associated maintenance costs and lower shipment volumes in the fourth quarter of 2018. Bleached kraft paper demand is anticipated to remain positive through the fourth quarter of 2018.

Additional Information and Conference Call 
A conference call to discuss the third quarter's financial and operating results will be held on Thursday, October 25, 2018 at 8:00 AM Pacific time.  To participate in the call, please dial Toll-Free 1-888-390-0546.  For instant replay access until November 8, 2018, please dial Toll-Free 1-888-390-0541 and enter participant pass code 632748#.  The conference call will be webcast live and will be available at www.canfor.com.  This news release, the attached financial statements and a presentation used during the conference call can be accessed via the Company's website at http://www.canfor.com/investor-relations/webcasts.

Forward Looking Statements
Certain statements in this press release constitute "forward-looking statements" which involve known and unknown risks, uncertainties and other factors that may cause actual results to be materially different from any future results, performance or achievements expressed or implied by such statements.  Words such as "expects", "anticipates", "projects", "intends", "plans", "will", "believes", "seeks", "estimates", "should", "may", "could", and variations of such words and similar expressions are intended to identify such forward-looking statements.  These statements are based on management's current expectations and beliefs and actual events or results may differ materially.  There are many factors that could cause such actual events or results expressed or implied by such forward-looking statements to differ materially from any future results expressed or implied by such statements.  Forward-looking statements are based on current expectations and the Company assumes no obligation to update such information to reflect later events or developments, except as required by law.

Canfor is a leading integrated forest products company based in Vancouver, British Columbia ("BC") with interests in BC, Alberta, North and South Carolina, Alabama, Georgia, Mississippi and Arkansas.  Canfor produces primarily softwood lumber and also owns a 54.8% interest in Canfor Pulp Products Inc., which is one of the largest global producers of Premium Reinforcing Northern Bleached Softwood Kraft Pulp and a leading producer of high performance kraft paper.  Canfor shares are traded on The Toronto Stock Exchange under the symbol CFP.

Canfor Corporation
Third Quarter 2018
Management's Discussion and Analysis

This interim Management's Discussion and Analysis ("MD&A") provides a review of Canfor Corporation's ("Canfor" or "the Company") financial performance for the quarter ended September 30, 2018 relative to the quarters ended June 30, 2018 and September 30, 2017, and the financial position of the Company at September 30, 2018.  It should be read in conjunction with Canfor's unaudited interim consolidated financial statements and accompanying notes for the quarters ended September 30, 2018 and 2017, as well as the 2017 annual MD&A and the 2017 audited consolidated financial statements and notes thereto, which are included in Canfor's Annual Report for the year ended December 31, 2017 (available at www.canfor.com).  The financial information in this interim MD&A has been prepared in accordance with International Financial Reporting Standards ("IFRS"), which is the required reporting framework for Canadian publicly accountable enterprises.

Throughout this discussion, reference is made to Adjusted Operating Income and Operating Income before Amortization which Canfor considers to be a relevant indicator for measuring trends in the performance of each of its operating segments and the Company's ability to generate funds to meet its debt repayment and capital expenditure requirements.  Reference is also made to Adjusted Shareholder Net Income (calculated as Shareholder Net Income less specific items affecting comparability with prior periods – for the full calculation, see the reconciliation included in the section "Analysis of Specific Material Items Affecting Comparability of Net Income") and Adjusted Shareholder Net Income per Share (calculated as Adjusted Shareholder Net Income divided by the weighted average number of shares outstanding during the period).  Adjusted Operating Income, Operating Income before Amortization, Adjusted Shareholder Net Income and Adjusted Shareholder Net Income per Share are not generally accepted earnings measures and should not be considered as an alternative to net income or cash flows as determined in accordance with IFRS.  As there is no standardized method of calculating these measures, Canfor's Operating Income before Amortization, Adjusted Shareholder Net Income and Adjusted Shareholder Net Income per Share may not be directly comparable with similarly titled measures used by other companies.  Reconciliations of Operating Income before Amortization to Operating Income and Adjusted Shareholder Net Income to Net Income reported in accordance with IFRS are included in this MD&A.  Throughout this discussion, reference is made to the current quarter, which refers to the results for the third quarter of 2018.  

Factors that could impact future operations are also discussed.  These factors may be influenced by both known and unknown risks and uncertainties that could cause the actual results to be materially different from those stated in this discussion.  Factors that could have a material impact on any future oriented statements made herein include, but are not limited to: general economic, market and business conditions; product selling prices; raw material and operating costs; currency exchange rates; interest rates; changes in law and public policy; the outcome of labour and trade disputes; and opportunities available to or pursued by Canfor.

Certain comparative amounts for the prior period have been reclassified to conform to the current year's presentation.

All financial references are in millions of Canadian dollars unless otherwise noted. The information in this report is as at October 24, 2018. 

Forward Looking Statements

Certain statements in this MD&A constitute "forward-looking statements" which involve known and unknown risks, uncertainties and other factors that may cause actual results to be materially different from any future results, performance or achievements expressed or implied by such statements.  Words such as "expects", "anticipates", "projects", "intends", "plans", "will", "believes", "seeks", "estimates", "should", "may", "could", and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are based on management's current expectations and beliefs and actual events or results may differ materially.  There are many factors that could cause such actual events or results expressed or implied by such forward-looking statements to differ materially from any future results expressed or implied by such statements.  Forward-looking statements are based on current expectations and the Company assumes no obligation to update such information to reflect later events or developments, except as required by law.

THIRD QUARTER 2018 OVERVIEW

Selected Financial Information and Statistics

Analysis of Specific Material Items Affecting Comparability of Shareholder Net Income

The Company reported operating income of $201.8 million for the third quarter of 2018, down $80.3 million from reported operating income of $282.1 million for the second quarter of 2018, with the decline reflecting lower operating earnings in both the lumber and pulp and paper segments.  Reported results for the third quarter of 2018 included a net duty expense of $42.6 million, at a current effective countervailing duty ("CVD") and anti-dumping duty ("ADD") rate of 14.94%, compared to $51.7 million reported in the second quarter of 2018.  After adjusting for duties, operating income was $244.4 million for the third quarter of 2018, down $89.4 million from similarly adjusted operating income in the second quarter of 2018.

Adjusted lumber segment earnings primarily reflected steep declines in Western Spruce/Pine/Fir ("Western SPF") and Southern Yellow Pine ("SYP") benchmark lumber prices, and to a lesser extent, the disruptive impacts of severe forest fires in Western Canada, and Hurricane Florence in the US South, which contributed to significant cost pressures and temporary operational downtime as a result of limited log deliveries and evacuation alerts.  Pulp and paper segment earnings largely reflected a 20% decrease in pulp shipments that was mostly timing-related, and to a lesser extent, higher market-driven fibre costs.

The current quarter's reported operating income was up $96.4 million from operating income of $105.4 million reported for the third quarter of 2017, reflecting a $56.0 million increase in lumber segment earnings and a $39.4 million increase in earnings for the pulp and paper segment.  The higher lumber segment earnings primarily reflected increased Western SPF and SYP benchmark lumber prices combined with a 3 cent, or 4%, weaker Canadian dollar, offset in part by market-driven increases in net log costs in Western Canada and higher duties in the current quarter, largely reflecting improved unit sales realizations.  Pulp and paper segment results reflected substantially higher average Northern Bleached Softwood Kraft ("NBSK") pulp and Bleached Chemi-Thermo Mechanical Pulp ("BCTMP") US-dollar pricing and the weaker Canadian Dollar, offset by higher unit manufacturing costs, largely attributable to higher market-based fibre costs, and to a lesser extent, lower production and shipments quarter-over-quarter.

OPERATING RESULTS BY BUSINESS SEGMENT
Lumber
Selected Financial Information and Statistics – Lumber

Markets

Notwithstanding downward pressure on pricing through the third quarter of 2018, lumber demand in the North American market remained relatively stable, with US housing starts averaging 1,218,000 units on a seasonally adjusted basis, down 3% from the previous quarter and up 4% from the third quarter of 2017.  Single-family starts, which consume a higher proportion of lumber, were down 3% from the previous quarter, while multi-family starts were down 4% from the second quarter of 2018.  Canadian housing construction activity was moderately lower than the previous quarter, at an average of 196,000 units on a seasonally adjusted basis.  Offshore lumber consumption remained solid through the third quarter, with particularly strong demand in Japan.

Sales

Sales revenues for the lumber segment for the third quarter of 2018 were $994.9 million, compared to $1.06 billion in the previous quarter and $857.7 million for the third quarter of 2017.  The 6% decrease in sales revenue compared to the prior quarter largely reflected lower Western SPF and SYP lumber unit sales realizations and lower shipments.  Sales revenues increased 16% compared to the third quarter of 2017 as significantly higher Western SPF and SYP benchmark lumber prices and the weaker Canadian dollar more than offset the impact of lower shipments in the current quarter.

Total lumber shipments, at 1.29 billion board feet, were down 4% from the previous quarter reflecting lower production as a result of operational related challenges in the current quarter, a drawdown of inventory in the previous quarter following the severe winter weather experienced in the first quarter of 2018, and severe flooding.  Total lumber shipments were modestly lower compared to the third quarter of 2017, largely reflecting the disruptions on production and transportation networks in the current quarter. 

While the average benchmark North American Random Lengths Western SPF 2x4 #2&Btr price at US$482 per Mfbm was down US$116 per Mfbm, or 19%, compared to the historically high pricing in the previous quarter, Western SPF lumber unit sales realizations benefitted from a strong order file to start the quarter, lower duty deposits and a 1% weaker Canadian dollar.  Western SPF lumber unit sales realizations also benefitted from a higher-value sales mix and moderately higher offshore sales realizations, due in part to the timing of shipments versus orders, as well as solid demand for the Company's higher-value products and increased shipments to Japan early in the quarter.  The average benchmark North American Random Lengths SYP East 2x4 #2 price was US$488 per Mfbm, down US$101 per Mfbm, or 17%, with this decline offset, in part, by a modest increase in 2x10 pricing.  The sharp drop in lumber prices from the historical highs seen in the second quarter of 2018 was primarily attributable to higher inventory levels throughout the supply chain, in part from a continued gradual improvement in transportation networks. 

Compared to the third quarter of 2017, lumber unit sales realizations were up significantly as higher US-dollar Western SPF and SYP benchmark lumber prices, the weaker Canadian dollar and favourable offshore unit sales realizations outweighed the impact of increased duties in the current quarter.  The average North American Random Lengths Western SPF 2x4 #2&Btr price was up US$76 per Mfbm, or 19%, while the SYP East 2x4 #2 price was up US$80 per Mfbm, or 20%.

Total residual fibre revenue in the current quarter was slightly higher than the prior quarter and significantly higher than the third quarter of 2017, largely reflecting increased market-based pricing.  Current quarter results also reflected seasonally higher log sales compared to the previous quarter due to increased timber harvesting following the spring break-up period in Western Canada.  Log sales were slightly lower than the third quarter of 2017, largely reflecting the impact of wildfires in Western Canada on log supply in the current quarter. 

Operations

Total lumber production, at 1.28 billion board feet, was 3% lower than the prior quarter as the benefit of improved productivity was more than offset by increased statutory holidays in the current quarter and operational disruptions related to the severe wildfires in Western Canada and Hurricane Florence in the US South. Production also reflected reduced drying capacity at the Company's Urbana sawmill following a kiln fire in August.  Total lumber production was slightly lower than the third quarter in 2017, in part reflecting the fire-related disruptions in Western Canada, which resulted in low log inventories. 

Unit manufacturing and product costs in the third quarter of 2018 were moderately higher than the previous quarter reflecting higher market-based stumpage and the significant weather-related impacts, which contributed to lower harvested volumes and increased competition for purchased wood.  Log costs in the US South remained stable through the quarter.  Compared to the third quarter of 2017, unit manufacturing and product costs were significantly higher, largely reflecting market-driven increases in purchased wood costs and stumpage, and, to a lesser extent, increased logging and hauling costs in Western Canada.

Pulp and Paper
Selected Financial Information and Statistics – Pulp and Paper¹⁴

Markets

Global softwood pulp market conditions remained balanced through the third quarter of 2018, with US-dollar NBSK pulp list prices, for the most part, reflecting steady global demand.  Softwood pulp producer inventories at the end of August 2018 were moderately above the balanced range at 33 days of supply, an increase of five days from June 2018¹⁷, in part reflecting timing of order placement, particularly from China.  Market conditions are generally considered balanced when inventories are in the 27-30 days of supply range. Global shipments of bleached softwood pulp for the first eight months of 2018 were down 1.1% compared to the first eight months of 2017¹⁸.

Sales

Total pulp shipments for the third quarter of 2018 were 262,400 tonnes, down 66,200 tonnes, or 20%, from the previous quarter and down 40,900 tonnes, or 13%, from the third quarter of 2017.  The decline in pulp shipments when compared to the previous quarter reflects the combination of a drawdown of inventory in the previous quarter as weather-related transportation constraints eased, a 10,000 tonne vessel slippage into October, the impact of early fall maintenance and softer market demand from China in the first part of the quarter. Compared to the third quarter of 2017, the 13% decrease in pulp shipments reflected a 6% decrease in pulp production quarter-over-quarter coupled with the aforementioned timing-related shipment impacts during the current quarter.

The average China US-dollar NBSK pulp list price of US$887 per tonne, as published by RISI, was slightly lower than the previous quarter.  Average NBSK pulp unit sales realizations were in line with the previous quarter reflecting the 1 cent, or 1%, weaker Canadian dollar and rising US-dollar NBSK pulp list pricing in North America offset by the slight decrease in the China US-dollar NBSK pulp list price.  Average BCTMP unit sales realizations showed a decrease quarter-over-quarter, as US-dollar BCTMP list price decreases more than offset the weaker Canadian dollar.  

Compared to the third quarter of 2017, the average China US-dollar NBSK pulp list price was up US$217 per tonne, or 32%, while US-dollar list prices on shipments to North America were up US$287 per tonne, or 24%, over the same period.  These higher global US-dollar prices resulted in substantially higher average NBSK pulp unit sales realizations, combined with a 3 cent, or 4%, weaker Canadian dollar.  Average BCTMP unit sales realizations saw more moderate increases compared to the third quarter of 2017, primarily reflecting the improvement in BCTMP market demand combined with the weaker Canadian dollar.

Energy revenues were in line with the second quarter of 2018, principally due to seasonally higher power prices offset by the higher scheduled maintenance outages in the current period.  Energy revenues were moderately lower than the third quarter of 2017, driven by quarter-over-quarter production impacts on energy generation.

Paper shipments in the third quarter of 2018 were 33,600 tonnes, a slight increase over the second quarter of 2018, largely reflecting higher production following a scheduled maintenance outage in the prior quarter. Paper shipments were broadly in line with the third quarter of 2017.

Paper unit sales realizations in the third quarter of 2018 saw a moderate increase compared to the previous quarter, reflecting higher market-driven US-dollar pricing and the weaker Canadian dollar.  Compared to the third quarter of 2017, paper unit sales realizations increased significantly primarily due to higher market-driven US-dollar pricing and, to a lesser extent, the weaker Canadian dollar.

Operations

Pulp production was down 11,200 tonnes, or 4%, from the previous quarter for the most part reflecting scheduled maintenance downtime at CPPI's Northwood NBSK pulp mill in late September (spanning quarter-end), which more than offset increased BCTMP production, following the commissioning of CPPI's energy reduction project at its Taylor Pulp mill at the end of June.  As previously announced, towards the end of the third quarter, Northwood extended its scheduled maintenance outage on one production line.  The outage is to enable necessary tube replacements to its No. 5 recovery boiler to rectify damage discovered during routine preventative maintenance inspections.  This unscheduled outage is anticipated to result in an additional reduction in NBSK pulp production in the fourth quarter of 60,000-70,000 tonnes. 

Compared to the third quarter of 2017, pulp production was down 19,800 tonnes, or 6%, primarily due to the previously noted scheduled maintenance outage at Northwood in the current quarter and the ramp up at the Taylor mill, which more than offset a scheduled maintenance outage at the Intercontinental NBSK pulp mill in the third quarter of 2017, which reduced pulp production by approximately 10,000 tonnes.

Pulp unit manufacturing costs were modestly higher than the second quarter, principally reflecting market-related increases in sawmill and whole log residual chip costs, and an increased proportion of whole log chips.  Compared to the third quarter of 2017, higher pulp unit manufacturing costs were mostly attributable to market-related increases to fibre costs and, to a lesser extent, lower productivity.

Paper production for the third quarter of 2018 was 34,100 tonnes, up 11% compared to the previous quarter and broadly in line with the third quarter of 2017. The increase, when compared to the second quarter of 2018, principally reflected the scheduled maintenance outage completed in the prior quarter which reduced paper production by approximately 4,000 tonnes.  The previous quarter outage contributed to higher paper unit manufacturing costs compared to the current quarter.  Compared to the third quarter of 2017, paper unit manufacturing costs showed a significant increase largely due to higher slush pulp costs associated with increased NBSK pulp sales realizations in the current quarter.

Unallocated and Other Items

Selected Financial Information

Corporate costs were $7.2 million for the third quarter of 2018, up $0.8 million from the previous quarter, and down $1.0 million from the third quarter of 2017 largely reflecting lower costs associated with the softwood lumber dispute. 

Net finance expense of $5.5 million for the third quarter of 2018 was down $0.7 million from the previous quarter and down $2.6 million from the third quarter of 2017 primarily reflecting increased interest income from the Company's improved cash balance.  In the third quarter of 2018, the Company recognized a foreign exchange gain on its US-dollar term debt held by Canadian entities, offset in part by a loss on US-denominated duties receivable due to the stronger Canadian dollar at the end of the quarter (see further discussion on the term debt financing in the "Liquidity and Financial Requirements" section).

At times, the Company uses a variety of derivative financial instruments as partial economic hedges against unfavourable changes in foreign exchange rates, energy costs, lumber prices, and interest rates.  In the third quarter of 2018, the Company recorded a net loss of $1.6 million related to its derivatives instruments, principally reflecting realized losses on lumber futures contracts as a result of the sharp decline in lumber prices.

Other expense, net, of $4.1 million in the third quarter of 2018 principally related to unfavourable foreign exchange movements on US-dollar denominated working capital balances.

Other Comprehensive Income (Loss)

The following table summarizes Canfor's Other Comprehensive Income (Loss) for the comparable periods:

The Company recorded an after-tax gain of $3.0 million in the third quarter of 2018 and an after-tax gain of $1.5 million in the second quarter of 2018 in relation to changes in the valuation of the Company's employee future benefit plans, primarily reflecting a return on plan assets greater than the discount rate. This compared to an after-tax gain of $13.0 million recorded in the third quarter of 2017, largely reflecting a change in the discount rate used to value the employee future benefit plans and the return generated on plan assets.

In addition, the Company recorded a loss of $10.8 million in the third quarter of 2018 related to foreign exchange differences for foreign operations as a result of the strengthening of the Canadian dollar relative to the US dollar at the end of the quarter.  This compared to a gain of $12.5 million in the previous quarter and a loss of $19.9 million in the third quarter of 2017.

Subsequent to quarter-end, on October 3, 2018, the Company purchased $58.9 million of buy-in annuities through its defined benefit pension plans, increasing the total purchase price of annuities to $481.8 million.

SUMMARY OF FINANCIAL POSITION

The following table summarizes Canfor's cash flow and selected ratios for and as at the end of the following periods:

The changes in the components of these cash flows are discussed in the following sections:

Operating Activities

Cash generated from operating activities was $201.1 million in the third quarter of 2018, compared to $369.9 million in the previous quarter and $127.1 million in the third quarter of 2017.  The decrease in operating cash flows from the previous quarter primarily reflected lower cash earnings and increased income tax installments in the current quarter.  Compared to the third quarter of 2017, the increase in operating cash flows was primarily attributable to higher cash earnings and favourable non-cash working capital balances, which more than offset higher income taxes paid in the current quarter.

Financing Activities

Cash used in financing activities was $66.3 million in the current quarter, compared to cash used of $9.4 million in the previous quarter and cash used of $89.6 million in the third quarter of 2017.  During the current quarter, the Company made cash distributions of $2.1 million to non-controlling shareholders, broadly in line with both comparative quarters.  The Company had no balance outstanding on its operating loan facility at the end of the third quarter of 2018, similar to the prior quarter and the third quarter of 2017.

Cash used for financing activities also included share purchases under Canfor's Normal Course Issuer Bid.  In the third quarter of 2018, the Company purchased 2,282,590 common shares for $63.7 million (an average price of $27.91 per common share), of which $60.0 million was paid in the quarter.  During the third quarter of 2017, Canfor purchased 3,526,387 common shares under its Normal Course Issuer Bid for $75.0 million.  See further discussion of the shares purchased under the Normal Course Issuer Bid in the following "Liquidity and Financial Requirements" section.

Investing Activities

Cash used for investing activities was $114.5 million for the current quarter, compared to $85.7 million for the previous quarter and $59.1 million for the same quarter of 2017.  Capital additions were $117.2 million, up $29.6 million from the previous quarter and up $59.7 million from the third quarter of 2017.  Current quarter capital expenditures included costs related to significant upgrades at the Company's sawmills in the US South, as well as various smaller, high-returning capital projects aimed at increasing drying capacity and productivity in Western Canada.  In the pulp and paper segment, capital expenditures primarily related to the previously announced energy projects at CPPI's Northwood and Taylor pulp mills as well as CPPI's new ERP software system project, combined with maintenance-of-business capital associated with the aforementioned maintenance outages during the quarter.

Liquidity and Financial Requirements

At September 30, 2018, the Company on a consolidated basis had cash of $591.3 million, no amounts drawn on its operating loans, and $65.1 million reserved for several standby letters of credit.  At period end, the Company had total available undrawn operating loans of $454.9 million, including undrawn facilities for letters of credit.

At September 30, 2018, excluding CPPI, the Company had undrawn $350.0 million bank operating loan facilities, and $54.3 million reserved for several standby letters of credit, the majority of which related to unregistered pension plans.  Interest is payable on the operating loans at floating rates based on the lenders' Canadian prime rate, bankers acceptances, US-dollar base rate or US-dollar LIBOR rate, plus a margin that varies with the Company's debt to total capitalization ratio.

At September 30, 2018, CPPI had an undrawn $110.0 million bank operating loan facility and $10.8 million in letters of credit outstanding under the operating loan facility. During the second quarter of 2018, the maturity date of CPPI's principal operating loan facility was extended from January 31, 2020 to April 6, 2022.

The Company and CPPI remained in compliance with the covenants relating to their operating loans and long-term debt during the quarter and expect to remain so for the foreseeable future.

The Company's consolidated net debt (cash) to total capitalization at the end the third quarter of 2018 was (8.8)%.  For Canfor, excluding CPPI, net debt to capitalization at the end of the third quarter of 2018 was 0.4%.

On March 5, 2018, the Company renewed its normal course issuer bid whereby it can purchase for cancellation up to 6,439,764 common shares or approximately 5% of its issued and outstanding common shares as of March 1, 2018.  The renewed normal course issuer bid is set to expire on March 6, 2019.  During the third quarter of 2018 the Company purchased 2,282,590 common shares for $63.7 million (an average price of $27.91 per common share), of which $60.0 million was paid in the quarter.  Since inception of the normal course issuer bid in 2013, the Company has purchased 16,409,541 shares for $383.0 million (an average of $23.34 per common share).  Canfor and CPPI may purchase more shares through the balance of 2018 subject to the terms of their normal course issuer bids. 

As at September 30, 2018, Canfor's ownership interest in CPPI remained unchanged from the end of the prior quarter at 54.8%.

OUTLOOK

Lumber

Looking ahead, the US housing market and repair and remodeling sector is forecast to gradually pick up through the balance of 2018.  While North American lumber prices have continued to decline in October, lumber markets are anticipated to modestly improve through the quarter, in part reflecting solid offshore lumber demand and more balanced supply.  Results in the fourth quarter are anticipated to reflect lower unit sales realizations due to the current lumber market weakness, as well as continued log cost pressure in Western Canada as a result of increasing market-based stumpage and higher purchased wood costs.

Pulp and Paper

Global softwood kraft pulp markets are projected to be balanced through the fourth quarter of 2018.  Results in the fourth quarter of 2018 will include the continuation of the scheduled maintenance outage at CPPI's Northwood NBSK pulp mill, the aforementioned extended downtime at Northwood, as well as unscheduled downtime taken in early October at all of CPPI's NBSK pulp facilities as a result of a third party natural gas pipeline explosion near Prince George.  Combined, these scheduled and unscheduled outages are anticipated to result in a total of 85,000-90,000 tonnes of reduced NBSK pulp production, as well as higher associated maintenance costs and lower shipment volumes in the fourth quarter of 2018.  Bleached kraft paper demand is anticipated to remain positive through the fourth quarter of 2018.

OUTSTANDING SHARES

At October 24, 2018, there were 126,342,890 common shares of the Company outstanding. 

CRITICAL ACCOUNTING ESTIMATES

The preparation of financial statements in conformity with International Financial Reporting Standards requires management to make estimates and assumptions that affect the amounts recorded in the financial statements.  On an ongoing basis, management reviews its estimates, including those related to useful lives for amortization, impairment of long-lived assets, certain accounts receivable, pension and other employee future benefit plans, asset retirement and deferred reforestation obligations, and the determination of ADD expensed and recorded as recoverable based upon currently available information.  While it is reasonably possible that circumstances may arise which cause actual results to differ from these estimates, management does not believe it is likely that any such differences will materially affect the Company's financial condition, other than the possibility of material effects to the income statement from the Company's estimated ADD duty receivable as discussed in Note 14 in the interim financial statements. 

ADOPTION OF NEW ACCOUNTING STANDARDS

Effective January 1, 2018, the Company has adopted IFRS 15 Revenue from Contracts with Customers. IFRS 15 supersedes IAS 18 Revenue, IAS 11 Construction Contracts and related interpretations.  The standard establishes a framework based on transfer of control for determining how much and when revenue is recognized, and includes expanded disclosure requirements.  The adoption of IFRS 15 has had no significant impact on the Company's interim financial statements.

Effective January 1, 2018, the Company has adopted IFRS 9 Financial Instruments. IFRS 9 supersedes IAS 39 Financial Instruments: Recognition and Measurement.  The standard includes requirements for recognition, measurement, impairment and derecognition of financial assets and liabilities, as well as general hedge accounting.  The adoption of IFRS 9 has had no significant impact on the Company's interim financial statements.

ACCOUNTING STANDARDS ISSUED AND NOT APPLIED

In January 2016, the International Accounting Standards Board issued IFRS 16 Leases, which will supersede IAS 17 Leases and related interpretations. The required adoption date for IFRS 16 is January 1, 2019. IFRS 16 introduces a single, on-balance sheet lease accounting model for lessees.

A lessee recognizes a right-of-use asset representing its right to use the underlying asset and a lease liability representing its obligation to make lease payments.  In addition, the nature of expenses related to those leases will change as IFRS 16 replaces straight-line operating lease expense with an amortization expense for right-of-use assets and interest expense on lease liabilities.

IFRS 16 may be applied retrospectively to each prior period presented (full retrospective approach), or with the cumulative effect of adoption recognized at initial application (modified retrospective approach).  The Company has elected to apply the modified retrospective approach upon adoption at January 1, 2019, measuring the right-of-use asset at its carrying amount had the standard been applied at commencement of the lease.  The short-term and low-value recognition exemptions available under the standard will be utilized, along with certain practical expedients.

The Company continues to evaluate the impact of adopting the new standard, which will be completed and disclosed in the financial statements for the first quarter of 2019.  Based on lease information available to date, the financial statement impact at transition is estimated to result in a 1%-2% increase in total assets and total liabilities respectively, with no material change to net income.

INTERNAL CONTROLS OVER FINANCIAL REPORTING

During the quarter ended September 30, 2018, there were no changes in the Company's internal controls over financial reporting that materially affected, or would be reasonably likely to materially affect, such controls.

RISKS AND UNCERTAINTIES

A comprehensive discussion of risks and uncertainties is included in the Company's 2017 annual statutory reports which are available on www.canfor.com or www.sedar.com.

In addition to exposure to changes in product prices and foreign exchange, the Company's financial results are impacted by seasonal factors such as weather and building activity.  Adverse weather conditions, as well as forest fires, can cause logging curtailments, which can affect the supply of raw materials to sawmills and pulp mills.  Market demand also varies seasonally to some degree.  For example, building activity and repair and renovation work, which affects demand for lumber products, is generally stronger in the spring and fall months.  Shipment volumes are affected by these factors as well as by global supply and demand conditions.  Net income is also impacted by fluctuations in Canadian dollar exchange rates, the revaluation to the period end rate of US-dollar denominated working capital balances, US-dollar denominated debt and revaluation of outstanding derivative financial instruments.

SELECTED QUARTERLY FINANCIAL INFORMATION

Other material factors that impact the comparability of the quarters are noted below: 

Canfor Corporation
Condensed Consolidated Balance Sheets

Subsequent Events (Note 6 and Note 15)

The accompanying notes are an integral part of these condensed consolidated interim financial statements. 

APPROVED BY THE BOARD

Canfor Corporation
Condensed Consolidated Statements of Income

Canfor Corporation
Condensed Consolidated Statements of Other Comprehensive Income (Loss)