| This report contains “forward looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 |
| These statements include the discussion of our business strategies and expectations concerning future operations, margins, profitability, liquidity and capital resources |
| In addition, in certain portions of this report, the words “anticipate,” “believe,” “estimate,” “may,” “will,” “expect,” “plan” and “intend” and similar expressions, as they relate to us or our management, are intended to identify forward looking statements |
| These forward looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these forward looking statements |
| These statements are based upon the current expectations and assumptions of, and on information available to, our management |
| Further, investors are cautioned that, unless required by law, we do not assume any obligation to update forward-looking statements based on unanticipated events or changed expectations |
| In addition to specific factors that may be described in connection with any particular forward-looking statement, factors that could cause actual results to differ materially from those expressed or implied by the forward looking statements include (but are not limited to) the following: We have required waivers to maintain compliance with financial covenants and must refinance our Halsey pulp mill leases, and could face defaults if we are unable to do so |
| Certain of our debt agreements contain customary conditions to borrowing, including compliance with financial covenants relating to maximum leverage ratios, net worth tests, minimum interest coverage ratios and minimum liquidity amounts |
| As of December 31, 2005, we would have been in violation of two financial covenants under our Halsey pulp mill leases, except that on December 28, 2005, we entered into amendments pursuant to which the other parties to the Halsey leases waived compliance with the covenants |
| The Halsey leases include early repurchase options pursuant to which we may repurchase the Halsey mill on January 2, 2007 for an aggregate repurchase price of dlra59dtta1 million |
| Under the lease amendments signed on December 28, 2005, the covenant waivers expire as of September 30, 2006 if we haven’t given irrevocable notice of exercise of the early repurchase options by that date |
| Accordingly, we face likely defaults if we do not refinance the dlra59dtta1 million repurchase price by January 2, 2007 |
| As of March 31, 2006, we expect to be out of compliance with a covenant under our Canadian revolving credit facility and, accordingly, on March 29, 2006, we obtained a waiver from the lenders |
| This facility expires in July 2006 and, unless renewed or replaced, will convert into two term loans at that time and be unavailable for further revolving borrowings |
| We also expect to be out of compliance with covenants under our US revolving credit facility at March 31, 2006, and therefore have obtained a waiver from that lender as well |
| Compliance with covenants under our revolving credit facilities, or waivers, is necessary for 12 ______________________________________________________________________ [35]Table of Contents us to comply with the new quarterly dlra15 million minimum liquidity covenant under the Halsey leases |
| While we do not expect to be out of compliance with financial covenants at June 30, 2006, if our second quarter financial results are worse than expected, we could be out of compliance |
| Any failure by us to comply with applicable covenants and early purchase obligations, or to obtain waivers therefrom, would result in an event of default with respect to, and could result in the acceleration of, a portion of our debt, which, in turn, could lead to our inability to pay our debts |
| Our independent auditors have expressed substantial doubt about our ability to continue as a going concern |
| In connection with our 2005 financial statements our independent registered public accounting firm issued an unqualified opinion containing an explanatory paragraph that states that we have significant borrowings which require compliance with financial covenants subject to quarterly measurement and have suffered recurring losses, which raise substantial doubt about our ability to continue as a going concern |
| Our financial statements have been prepared assuming we will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities and commitments in the normal course of business |
| The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts and the amount and classification of liabilities that might be necessary should we be unable to continue as a going concern |
| The fact that this opinion has been issued could have material adverse effects on our business, results of operations and cash flows, by causing parties we deal with to question our financial ability to perform our obligations |
| For example, one or more of our suppliers could decide not to sell to us or impose restrictive sales terms |
| Financial uncertainty also could affect our relationships with customers, employees and others |
| Our indebtedness could reduce our ability to use cash flow for purposes other than debt service or otherwise restrict our activities |
| Our total debt as a percentage of total capitalization at December 31, 2005 was 75 percent |
| This leverage, or higher leverage if we were to incur additional indebtedness, could have important consequences |
| For example, it could make it difficult to obtain any necessary future financing for working capital, capital expenditures, debt service requirements or other purposes |
| Our high level of leverage requires a substantial portion of our cash flow from operations to satisfy debt service requirements, thereby reducing our ability to use cash flow to fund working capital, capital expenditures, development projects, acquisitions, dividends and other general corporate purposes |
| High leverage also limits flexibility in planning for, or reacting to, changes in business and increases vulnerability to a downturn in the business and general adverse economic and industry conditions |
| Exchange rate fluctuations have harmed and could continue to harm our operating results and cash flows |
| Although our sales are made primarily in US dollars, the majority of our operating costs and expenses are incurred in Canadian dollars |
| Significant variations in relative currency values, particularly a significant increase in the value of the Canadian dollar relative to the US dollar, adversely affect our results of operations and cash flows |
| A substantial portion of our pulp customer base is in Europe, Asia and other non-US markets |
| As such, the value of the US dollar as compared to foreign currencies directly affects our customers’ ability to pay and our relative competitive cost position with other regions’ pulps |
| Any significant exchange rate fluctuation could have a material adverse effect on our business, financial condition and results of operation |
| For example, a change in the Canadian to US dollar translation rate from 0dtta86 to 0dtta87 would decrease pre-tax income as measured in US dollars by an estimated dlra6dtta3 million on an annual basis |
| Fluctuations in our product prices and demand could harm our operating results and cash flows |
| Our financial performance depends primarily on the prices we receive for our products |
| Prices for both pulp and lumber products are highly cyclical and have fluctuated significantly in the past and may fluctuate significantly in the future |
| Increases or decreases in production capacity, increases or decreases in operating rates and changes in customer consumption patterns will cause changes in product prices |
| The economic climate of each region where our products are sold has a significant impact on the demand, and therefore the prices, for pulp 13 ______________________________________________________________________ [36]Table of Contents and lumber |
| Changes in regional economies can cause fluctuation in prices and sales volumes and, as a result, directly affect our profitability and cash flows |
| The continued uncertainties in the economic conditions of the United States and other international markets could adversely affect our results of operations and cash flows |
| The amount of downtime that our mills take fluctuates based on changes in pricing and demand for our products |
| Any future downward fluctuation in prices could have a material adverse effect on our business, financial condition and results of operations |
| Our markets are highly competitive |
| Our products are sold primarily in the United States, Europe, Canada and Asia |
| The markets for our products are highly competitive on a global basis, with a number of major companies competing in each market with no company holding a dominant position |
| For both lumber and pulp, a large number of companies produce products that are reasonably standardized; therefore, the traditional basis for competition has been price |
| Other competitive factors are quality of product, reliability of supply and customer service |
| In recent years, we have experienced increased competition and pricing pressure from new low-cost hardwood pulp producers in South America |
| Because of greater resources, many of our competitors may be able to make greater investments in technology or other cost cutting improvements, adapt more quickly to industrial changes or devote greater resources to the sale of their products |
| We cannot assure that we will be able to compete successfully against such competitors |
| We face significant fees on lumber imports into the United States |
| In May 2002, the US International Trade Commission, or ITC, imposed duties on certain types of softwood lumber imported into the United States from Canada after determining that imports of certain types of softwood lumber from Canada threatened US softwood lumber mill operators |
| Based on findings of the US Department of Commerce, or DOC, regarding subsidies and dumping margins, the ITC’s decision has subjected our imports of certain types of softwood lumber from Canada, on or after May 22, 2002, to these duties which have had a material adverse effect on our Wood Products business results of operations and cash flows |
| Various NAFTA and WTO rulings have been issued to date in Canada’s appeals of these duties, and these rulings are subject to further appeals |
| In the event that final rates differ from the depository rates, ultimate costs may be higher or lower than those recorded to date |
| The ultimate outcome or effect of NAFTA and WTO reviews, or whether a settlement between the Canadian and US governments may be reached, cannot be predicted |
| Our operations require substantial capital, and we may not have adequate capital resources to meet all of our capital requirements |
| Our businesses are capital intensive, and we regularly incur capital expenditures to expand our operations, maintain our equipment, increase our operating efficiency and comply with environmental laws |
| Our total capital expenditures were approximately dlra43dtta7 million in 2005, and we expect to spend approximately dlra28dtta5 million on capital expenditures during 2006 |
| If we require additional financing to fund capital expenditures, we may not be able to obtain it on favorable terms, or at all |
| In addition, our debt service obligations reduce our available cash flows |
| If we cannot maintain or upgrade our equipment or ensure environmental compliance, we could be required to cease or curtail some of our manufacturing operations, or we may become unable to manufacture our products at costs or quality that can compete effectively in one or more of our markets |
| We are subject to extensive environmental regulation |
| Our pulp and lumber operations are subject to a variety of national and local laws and regulations, many of which deal with the environment |
| These laws and regulations impose stringent standards on our operations regarding, among other things, air emissions, water discharges, use and handling of hazardous materials, use, handling and disposal of waste and remediation of environmental contamination |
| Changes in these laws or regulations have in the past, and could in the future, require us to make substantial expenditures in order to comply, which could have a material adverse effect on our business, results of operations and cash flows |
| 14 ______________________________________________________________________ [37]Table of Contents We may be subject to environmental liabilities that could require substantial expenditures |
| We are currently participating in the investigation and remediation of environmental contamination at two sites on which we previously conducted business |
| In addition, we are working with the Ministry of Environment in British Columbia regarding environmental contamination at the Mackenzie mill |
| We may also be required to investigate and remediate environmental conditions at other sites if contamination, presently unknown to us, is discovered |
| The ultimate cost to us for site remediation and monitoring of these sites cannot be predicted with certainty due to the difficulties in estimating the ultimate cost of remediation and determining the extent to which contributions will be available from other parties |
| Expenditures that may be required in connection with these sites could have a material adverse effect on our business |
| The availability and pricing of the raw materials we use are subject to fluctuations, which could increase our expenses |
| Logs, wood chips and sawdust, the principal raw materials used in the manufacture of our products, are purchased in highly competitive, price-sensitive markets |
| These raw materials have historically exhibited price and demand cyclicality |
| Supply and price of these raw materials are dependent upon a variety of factors, many of which are beyond our control |
| Changes in the pricing of logs under British Columbia’s current stumpage system as the result of negotiations to resolve the US – Canada lumber import duty issue could affect the cost of logs for our Canadian sawmills |
| Other factors include changing environmental and conservation regulations and natural disasters, such as forest fires, infestations, wind storms or other extreme weather conditions |
| A decrease in the supply of logs, wood chips and sawdust can cause higher raw material costs and, as a result, material fluctuations in our results of operations and cash flows |
| Our Nanaimo pulp mill’s long-term fiber supply agreement with Weyerhaeuser was assumed by Cascadia Forest Products LTD (Cascadia), a wholly-owned subsidiary of Brascan Corporation, in May 2005, concurrent with the sale of Weyerhaeuser’s coastal sawmill and timberlands |
| The contract allows us to acquire 1dtta7 million cubic meters of fiber per year through 2019 |
| Our Mackenzie pulp mill purchases approximately 72 percent of its fiber requirements from sawmills primarily located in Mackenzie, British Columbia and operated by Canfor |
| Fiber is purchased at market or at prices determined under a formula intended to reflect market value of the fiber |
| The failure by Cascadia or Canfor to produce the required fiber pursuant to these contracts could have a material adverse effect on us |
| There can be no assurance that we will be able to obtain an adequate supply of softwood fiber for our pulp operations from these or alternate suppliers |
| We are subject to Canadian forest management policies and regulations that could harm our supply and cost of logs |
| In March 2003, the Government of British Columbia, or Crown, introduced the Forestry Revitalization Plan, or Plan, that provides for significant changes to Crown forest policy and to the existing allocation of Crown timber tenures to licensees |
| The changes prescribed in the Plan include: the elimination of minimum cut control regulations, the elimination of existing timber processing regulations, and the elimination of restrictions limiting the transfer and subdivision of existing licenses |
| In addition, the Crown has legislated that licensees, including us, are required to return to the Crown 20 percent of their annual allowable cut or AAC, in excess of 200cmam000 cubic meters |
| As a result, we anticipate that our historical mix of approximately 70 percent tenure acquired logs and 30 percent open market log purchases will shift to a mix of approximately 55 percent tenure acquired logs and 45 percent open market log purchases |
| Our AAC has been reduced by 177cmam000 cubic meters as of the beginning of 2006 and we expect a further reduction of 22cmam000 cubic meters at the beginning of 2007 |
| The timber tenure acquired in 2005 with the Fort St |
| James sawmill had already been reduced under the Plan and is not subject to further reduction |
| Although we expect the reductions in our AAC to be made up through market purchases of logs at costs generally consistent with the cost of logs acquired under tenures, and our average purchased log costs have been slightly lower than our tenure acquired log costs for the last three years, there is uncertainty as to the impact our AAC reduction will have on the supply and cost of purchased logs available to us |
| Accordingly, 15 ______________________________________________________________________ [38]Table of Contents we cannot assure you that our increased dependence on purchased logs will not have an adverse affect on our results of operations and cash flows |
| In addition, as part of the Plan, the Crown has proposed to introduce a market-based timber pricing system for stumpage fees in the British Columbia interior |
| The market-based timber pricing system was originally targeted to be implemented in 2004; however, it now appears that the provincial government is re-evaluating this system with no specific implementation date |
| While we generally believe that a new market-based system would result in some increase in stumpage fees compared to the existing system, we cannot estimate the amount of the potential impact |
| We depend on third parties for transportation services |
| We rely primarily on third parties for transportation of the products we manufacture and distribute, as well as for delivery of our raw materials |
| In particular, a significant portion of the goods we manufacture and raw materials we use are transported by railroad, trucks, and ships |
| If any of our third-party transportation providers were to fail to deliver the goods we manufacture or distribute in a timely manner, we may be unable to sell those products at full value, or at all |
| Similarly, if any of these providers were to fail to deliver raw materials to us in a timely manner, we may be unable to manufacture our products in response to customer demand |
| In addition, if any of these third parties were to cease operations or cease doing business with us, we may be unable to replace them at reasonable cost |
| Any failure of a third-party transportation provider to deliver raw materials or finished products in a timely manner could harm our reputation, negatively impact our customer relationships and have a material adverse effect on our financial condition and operating results |
| A material disruption at one of our facilities could prevent us from meeting customer demand, reduce our sales and negatively impact our net income |
| One or more of our major pulp mills or sawmills, or one of its larger machines within an otherwise operational facility, could cease operations unexpectedly due to a number of events, including prolonged power failures; an equipment failure; a chemical spill or release; explosion of a boiler; the effect of a drought or reduced rainfall on water supply; disruptions in the transportation infrastructure, including roads, bridges, railroad tracks and tunnels; fires, floods, earthquakes, or other catastrophes; terrorism or threats of terrorism; labor difficulties; or other operational problems |
| Any such downtime or facility damage could prevent us from meeting customer demand for our products and/or require us to make unplanned capital expenditures |
| If our relationships with our union employees were to deteriorate, we could be faced with labor shortages, disruptions or stoppages, which could adversely affect our business and reduce operating margins and income |
| Approximately 80 percent of our employees are paid on an hourly basis and most of these employees are covered under collective bargaining agreements |
| If we were unable to reach agreement on the terms of any collective bargaining agreement with any group of our employees, we could be subject to work slowdowns or stoppages |
| An increase in the cost of our purchased energy would lead to higher manufacturing costs, which could adversely affect our operating results |
| Energy is vital to our operations and is one of our significant raw materials |
| We estimate that energy comprised approximately ten percent of the cost of sales of the Pulp segment and approximately three percent of the cost of sales of the Wood Products segment during 2005 and 2004 |
| Energy prices, particularly for electricity and natural gas, have been volatile in recent years and currently exceed historical averages |
| These fluctuations impact our manufacturing costs and contribute to earnings volatility |
| Increases in the cost of purchased energy have adversely affected, and further increases in such costs could further adversely affect, our operating results and cash flows |
| 16 ______________________________________________________________________ [39]Table of Contents Our forest operations may be adversely affected by First Nations People’s claims to Canadian land |
| Our Canadian forest operations are primarily carried out on public forestlands under forest licenses |
| Many of these lands are subject to the constitutionally protected treaty or common law rights of the First Nations people of Canada |
| First Nations groups in British Columbia have made claims of ownership or interests in substantial portions of land in the Province and are seeking compensation from the government with respect to these claims |
| The Supreme Court of Canada has held that the First Nations groups have a spectrum of aboriginal rights in lands that have been traditionally used or occupied by their ancestors |
| The Court’s decision did not apply to any particular lands and was stated in general terms |
| The Court held that aboriginal rights and title are not absolute and may be infringed upon by government in furtherance of a legislative objective, including forestry, subject to meeting a justification test and being consistent with the fiduciary relationship between government and First Nations groups |
| To address the claims of the First Nations groups, the governments of Canada and British Columbia instituted a negotiation process under the administration of a treaty commission |
| In July 2002, the voting public approved a referendum of principles for treaty making |
| This gave Provincial negotiators the authority to negotiate and make commitments on topics that are consistent with the referendum principles and for which current policies exist |
| Any settlements that may result from the negotiation process may involve a combination of cash and resources and grants of conditional rights to gather food on public lands and some rights of self-government |
| The issues surrounding aboriginal rights and title are not likely to be resolved by the Canadian governments in the near future |
| In November 2004, the Supreme Court of Canada confirmed that the Crown has a duty to consult with First Nations when the Crown has knowledge, real or constructive, of the potential existence of an aboriginal right or title and contemplates conduct that might adversely impact it |
| The consultation process required by the Court is currently not clearly defined, creating some uncertainty regarding Crown processes for grants and renewals of timber tenures |
| If significant areas of Canada are found by the courts to be subject to aboriginal title, the Company’s forest tenures and its ability to harvest timber from those tenures could be materially adversely affected |
| A reduction in the timber supply could have a material adverse effect on the Company’s financial condition, cash flows and results of operations |