Canfor Corporation generated strong financial results in 2018 with reported operating income of $608.6 million, the highest operating earnings in over 10 years, and up $51.2 million, or 9%, from 2017.

Reported annual results include record-high pulp and paper segment earnings and solid lumber segment operating income. The latter was achieved despite major challenges presented by significant log supply constraints and log cost increases in British Columbia (“BC”), severe transportation issues in the first half of the year, extreme weather across North America and one of the worst forest fire seasons in BC, as well as significant market volatility during the year. For the fourth quarter of 2018, the Company reported an operating loss of $79.1 million, down $280.9 million from reported operating income of $201.8 million for the third quarter of 2018, with the decline in earnings reflecting lower operating income for both the lumber and pulp and paper segments.

Reported results for the fourth quarter of 2018 include a net duty expense of $39.9 million, at a current cumulative effective countervailing duty (“CVD”) and antidumping duty (“ADD”) rate of 16.14%, compared to $42.6 million reported in the third quarter of 2018. Reported results in the fourth quarter of 2018 also include a $36.7 million inventory valuation adjustment, representing the excess of the carrying cost of year-end lumber and log inventory over net realizable value. After adjusting for the aforementioned items, the Company’s operating loss was $2.5 million for the fourth quarter of 2018, down $246.9 million from similarly adjusted operating income in the third quarter of 2018. News Release 2 Adjusted lumber segment results reflected substantially lower Western Spruce/Pine/Fir (“Western SPF”) and Southern Yellow Pine (“SYP”) benchmark lumber prices, lower production and shipments, particularly in BC, and significantly higher unit log costs in Western Canada.

A combination of log supply constraints, log costs and market conditions resulted in Canfor curtailing production at the Company’s BC lumber operations by approximately 100 million board feet in the fourth quarter, with a further estimated reduction of approximately 95 million board feet in the first quarter of 2019. Results in the pulp and paper segment reflected repairs to one of the Canfor Pulp Product Inc.’s (“CPPI”) Northwood pulp mill (“Northwood”) recovery boilers, and operational disruptions resulting from a third-party natural gas explosion in Prince George early in the quarter, combined with their respective effects on production volumes, shipments and manufacturing costs. North American lumber consumption was down slightly in the fourth quarter of 2018, in part reflecting waning demand as the quarter progressed. US housing starts, on a seasonally adjusted basis, averaged 1,237,000 units (as at November 2018), in line with the previous quarter but down slightly from the fourth quarter of 2017.

Single-family starts were down 4%, while multi-family starts were up 8% compared to the third quarter of 2018. Demand in the repair and remodeling sector continued to be very strong through the fourth quarter of 2018. In Canada, housing starts remained near historical highs, averaging 217,000 units on a seasonally adjusted basis, up 10% from the previous quarter and down 5% from the same period in 2017. Offshore lumber consumption remained solid, with shipments to China increasing in the quarter.

The slowing North American demand coupled with an excess of supply placed significant downward pressure on prices through the fourth quarter; the average benchmark North American Random Lengths Western SPF 2×4 #2 & Btr price was down US$155 per Mfbm, or 32%, from the previous quarter, at US$327 per Mfbm, with similar decreases also seen across most Western SPF wider-width dimensions. As a result, Western SPF lumber unit sales realizations were also significantly down quarter-over-quarter, as the sharp declines in benchmark Western SPF lumber prices more than offset the 1 cent, or 1%, weaker Canadian dollar and a higher-value sales mix. SYP lumber unit sales realizations were also materially lower than the prior quarter reflecting increased available supply in the US South region, a 6% decrease in the SYP East 2×4 #2 price, and more pronounced seasonal price declines in wider SYP dimensions.

Total lumber shipments, at 1.11 billion board feet, were 14% lower than the previous quarter, largely due to announced curtailments resulting in lower volumes available for sale, with a higher proportion of volumes sold offshore. Total lumber production, at 1.13 billion board feet, was down 12% from the previous quarter reflecting the impacts of the aforementioned temporary production curtailments at the Company’s Western Canada operations, reduced shifts and, to a lesser extent, additional statutory holidays in the current quarter.

In addition, inclement weather in the US South impacted log deliveries and log profile, both of which contributed to lower productivity in the current quarter. Lumber unit manufacturing costs in the fourth quarter of 2018 were moderately higher than the previous quarter, largely reflecting the effects of timing on market-based stumpage increases, log supply and profile shortages, combined with reduced sawmill productivity and production, and to a lesser extent, seasonally higher energy costs.

Log costs in the US South remained in line with the previous quarter. Reflecting weaker demand from China, global softwood pulp market demand was down in the fourth quarter of 2018, with global softwood pulp producer inventory levels remaining above normal through the quarter. US-dollar Northern Bleached Softwood Kraft (“NBSK”) pulp list prices to China averaged US$805 per tonne, down 9% from the prior quarter, with prices ending the year at US$725 per tonne. CPPI’s average NBSK unit sales realizations, however, were broadly in line with the prior quarter as the lower US-dollar pricing to China was largely offset by higher US-dollar pricing to North America, proportionately higher shipments to North America and the weaker Canadian dollar.

Bleached Chemi-Thermo Mechanical Pulp (“BCTMP”) US-dollar pricing came under modest downward pressure during the current quarter; however, CPPI’s sales realizations remained steady quarter-over-quarter reflecting the timing of shipments (versus orders) and the weaker Canadian dollar. Pulp production was down 61,400 tonnes, or 22%, from the previous quarter. This lower production primarily reflected the continuation of the scheduled maintenance outage at Northwood from the previous quarter, the aforementioned recovery boiler extended downtime at Northwood, as well as unscheduled downtime taken as a result of a third-party natural gas pipeline explosion which impacted CPPI’s three NBSK pulp mills and, to a lesser extent, several other operational challenges during the current quarter. Combined, these scheduled and unscheduled outages impacted NBSK pulp production by approximately 90,000 tonnes.

In addition, in late December, CPPI curtailed production at its Taylor BCTMP mill for seven days in the face of reduced residual fibre availability resulting from various sawmill curtailments in the region, which impacted BCTMP production by approximately 5,000 tonnes. In the third quarter of 3 2018, a scheduled maintenance outage at Northwood and ramp up at Taylor following the commissioning of the energy reduction project, reduced pulp production by approximately 30,000 tonnes. Pulp shipments were down 31,700 tonnes, or 12%, from the previous quarter reflecting the impact of the aforementioned downtime partly offset by a drawdown of pulp inventories through the period.

The anticipated benefit of a slipped vessel shipment from the previous quarter into the fourth quarter was offset by a delayed vessel shipment over the year end. NBSK pulp unit manufacturing costs were up significantly from the previous quarter, in large measure due to reduced productivity in the current quarter as well as higher related maintenance, energy and chemical costs, associated with the unscheduled outages. Fibre costs were broadly in line with the third quarter of 2018. At the end of December, CPPI experienced kiln-related operational disruptions at two of its NBSK pulp mills.

While these challenges have now been resolved, the related production loss was approximately 20,000 tonnes early in the first quarter of 2019. The Company maintained its strong balance sheet position in 2018, as it continued to apply a disciplined approach to cash allocation, while retaining a focus on internal investment and growth. Solid progress continued to be made on its previously announced US$125 million organic growth initiative in the US South and included the completion of various capital projects at the Company’s Moultrie, Fulton and Urbana sawmills.

Recognizing challenging market conditions and inflationary construction cost pressures the Company has decided to defer its decision on the construction of a greenfield sawmill until at least the end of 2019. On the acquisition front, the Company entered into agreements to purchase Elliott and VIDA. Following the anticipated completion of these acquisitions in the first half of 2019, Canfor’s lumber production capacity will increase to approximately 7.2 billion board feet, which includes the Company’s SYP lumber capacity growing to approximately 2.0 billion board feet as a result of the Elliott acquisition and organic growth in the US South. Canfor’s collective agreement with the United Steelworkers (“USW”) expired on June 30, 2018. The Company is encouraged that a Memorandum of Agreement (“MOA”) for a new five-year term has been reached with the USW. The MOA includes seven of Canfor’s certified mills in BC. The USW will be conducting ratification votes on the MOA over the coming weeks.

In addition, Canfor has three mills represented in the negotiation process being led by the Interior Forest Labour Relations Association (“IFLRA”). Canfor remains optimistic that a settlement will be reached between the IFLRA and the USW. Commenting on the Company’s fourth quarter results, Canfor’s President and Chief Executive Officer, Don Kayne, said, “In our lumber business, the fourth quarter was challenging in Western Canada in terms of market conditions, log costs, and log supply constraints, which led to the difficult decision to temporarily curtail BC operations. We are encouraged by the recent overall market activity.” Kayne added, “Our pulp operations also had a challenging fourth quarter. We are very focused on getting our pulp production performance back on track in the coming months.” Looking further ahead, the US housing market is currently forecast to show a modest recovery through 2019, while the repair and remodeling sector in the US is projected to record solid growth.

North American lumber prices are anticipated to improve through the first quarter of 2019 primarily reflecting low inventories in the supply chain as a result of production curtailments and seasonally stronger demand during the traditionally busy spring building season.

For the Company’s key offshore lumber markets, demand is anticipated to remain solid through the first quarter of 2019. Prices in Europe are projected to be more stable reflecting solid demand in that region. Results through 2019 are anticipated to be impacted by continued log cost pressure in Western Canada as a result of ongoing log supply constraints. Notwithstanding high inventory levels, global softwood kraft pulp markets are projected to be steady through the first half of 2019, reflecting an anticipated pick-up in demand from China and reduced supply during the traditional spring maintenance period. The BCTMP market is projected to be steady in the first half of 2019. Bleached kraft paper demand is expected to remain solid through the first quarter of 2019.